Hey guys my name is Vidhi Galra and welcome back to my channel 5 minute economics where I teach economic concepts in a span of just five minutes the topic for today is the quantity theory of money Fisher's approach and in this particular video I'll be covering the Fisher's equation assumptions, diagrams, the background as well as the criticisms. In short, all you need to know about this oh so simple theory. So yeah, let's get started.
Also guys, please don't forget to subscribe to my channel in case you haven't already. It will mean a lot to me. Thanks! you so guys before we begin let me give you a little background of this theory so this theory dates back to 16th century where it was observed in that when money was flowing from America to Europe the prices in Europe started to increase because the money supply in Europe increased so it dates back to that time whereas this theory was brought up by Ivan Fisher in the year 1911 when he spoke about it in his book but chasing power of money what did Ivan Fisher observed he said this As the quantity of money in an economy increases, the price aka the inflation tends to rise.
Case member, Irene Fisher is a monetarist economist and he has brought out this concept very strongly where he said that one important factor which is responsible for inflation is the rise in the money supply in the economy. He also said that at that time the value of money starts to fall when the money supply increases. Through these two statements we can say that there is a is a direct relationship between money supply and price as money supply increases price also increases whereas there is an indirect relationship between non e supply and value of money the value of money keeps falling so initially a good maybe we can see a bunch of bananas which were available for ten rupees is now costing us twenty rupees so when the price rises you know the value has fallen the value of money is fallen so this these two things were said and he also said this is uh observed in ceptris paribus that is other things remaining constant so guys this is the equation mv is equal to pt which we will be studying further in detail but before that let me just quickly run through the assumptions of the fury so number one velocity which is v over here remains constant number two volume of transactions remain constant which is t over here economy is at full employment it means everyone is fully employed next price is a passive factor it means that price cannot change automatically automatically it can change due to changes in some other factors like change in money supply next this is a long-run theory and lastly which is the most important assumption is that money is used only as a medium of exchange that is we you know know the functions of money store of value and all of that have been overlooked money is only looked as a medium of exchange that is we've seen only the transaction demand of money so now guys please pay attention because now we'll be doing the crux of this theory so whenever guys we study the quantity theory of money Fischer's approach this particular equation MV is equal to P is some PD is something what you need to remember always so what does each variable over here stand for so M stands for money supply Chitna money you know money in circulation is our money supply whereas V is our velocity of money so what is basically velocity of money velocity of money is basically the number of times money exchanges hands in an economy for example a hundred rupee note so hundred rupee note we give it to someone then they go and buy something they give it to someone and then they further go and you know buy that from that 100 rupee note.
So number of times that 100 rupee note goes in circulation that frequency is known as velocity of money. P stands for the average price level pertaining in the economy whereas T stands for the volume of transactions which occur in an economy. So what does Fisher say from his equation?
He says now let us just consider the left hand side first which is the supply side. So he says when we multiply M into V that is the total money supply that is money supplied into our velocity of money okay number of times that money supply has moved so we get the total money supply in an economy for example here we've considered MS hundred and V velocity as poor we get 400 as our MV whereas coming to the right hand side of the equation which is PD what over here we say is that P stands for price level like right and T stands for volume of transactions so when the price is multiplied by the world volume of transactions we get PT so we get basically what the total money demanded for transaction purposes for example we buy a phone cover we've kept the price as 200 and it's bought twice so you know the T is 2 over here again if we multiply P into T we get 400 so in this case what we notice is that MV is equal to PT what did Fisher say Fisher said that when V and T We presume these to be constants. Remember in the assumptions we study.
When V and T are constant in our economy, then it is true that when money supply increases, price tends to increase. In fact, he called this as a that is a truth or a fact. He called it as an identity.
He said this is definitely true. You can just think logically. When money will rise in the economy, price is bound to rise and of course then value of money will bound to fall. is the relation which you have to remember it is a fact and it is a true word fisher had told us so now guys i've just drawn two very simple graphs for your explanation and you might need to draw it if required in an exam so basically here we've shown the relationship between price and money supply graphically we studied that both hold a direct relationship so when we notice initially we are at om and op okay our x axis we have money supply and y axis we have price so we notice when money supply increases from OM to OM dash our price also rises from OP to OP dash and similarly vice versa when money supply falls our price also falls thus our relationship is a direct relationship giving us a you know straight line curve whereas on the other hand we have price and value of money which obviously have an inverse relationship with each other we notice over here initially we are at OVM which is the value of money I have taken it as VM and OP price but we notice when the price rises from OP to OP dash or OP double dash I can say our value of money falls from OVM to OVM double dash you know value of money is falling and similarly when the price falls our value of money rises thus giving us a negatively inclined curve so this is just a simple you know graphical explanation of the theory so lastly guys I would like to conclude the video with some criticisms so in economics I've always taught you that criticisms are very much derived from massage So over here V&T which were considered to be constant, it was heavily criticized by the Keynesian economists that V&T cannot be constant. You know when population increases, V is tending to increase.
Obviously, zyada log hoge, zyada paisa circulation me rahega. When natural resources or technological developments happen then T cannot be constant. Next full employment is a very rare phenomena and it is not possible. They've also neglected interest rate over here. So whenever you know we are talking about money supply and price, interest rate is bound to come but here they've totally detected that role of interest rate then only applicable in the long run too much emphasis on money supply has been given and lastly and most importantly as I said money is only looked as a medium of exchange if you know ignore the other functions of money like store of value and you know it's speculative demand of money all that has been ignored so this is what that this theory is all about guys I hope this video was useful for you please do like my video and subscribe to my channel and I hope to see in the next