INTRODUCTION
The
quantity theory of money states that the quantity of money is the main
determinant of the value. The theory attempt to explain that due to the changes
in the quantity of money the value of money (purchasing power of money)
changes.
Any change in the quantity of money yield on exactly proportional
change in value of money (or the price level) According to Alfred Marshall, the
Chief merit of the cash-balances equation of the quantity theory of money is
that it removes the serious complications which creep in when we establish a
relationship between the velocity of money in circulation and the value of
money as has been done in the cash-transactions equation. The cash-balance
equation explains that the value of money is a function of its supply and its
demand as measured by “the average stock of command over commodities which
persons care to keep in a ready form”. The emphasis placed on K in the
cash-balances equation is more significant for understanding the phenomenon of
cyclical fluctuations than is v in the cash-transactions equation. The
cash-balances equation focuses attention on how changes in the value of real
cash balances cause cyclical changes in the level of prices. A distrust of the
people in the money unit in the country by diminishing their willingness to
hold it increases the prices and vice versa.
TRYING
FISHER PROVIDED THE TRANSACTIONS APPROACH OF THE QUANTITY THEORY OF MONEY
According to fisher, other things remaining unchanged,
as the quantity of money in circulation increases, the price level also in
direct proportion and the value o f money decreases and vice versa. Fisher
explained his quantity theory of money with the help of his famous equation of
exchange:
Mv=PT;.
Mv+Mi vi = Pt.
Cash balance approach was formulated by Marshall,
Pigou, Roberton, . According to this approach, the demand for money and supply
money. Cash-balance approach, consider the demand for money and supply of money
at a particular moment of time. The approach considers the demand for money not
as a medium of exchange but as a store value. Marshal has given his own
equation as M=KTP
RELATIONSHIP
BETWEEN (K) AND (V):
From the above relationship (K) = is the fraction of
real income which the people desire to hold money (proportion of the year’s
volume of trade over which the people hence the demand for money is given by
KT).
While
(V) is the transaction velocity of money circulation of bank deposit.
According to some economist, the two quantity equation
are fundamentally the same. While the cash transaction version of the quantity
theory of money emphasizes the value of money over a period of time by
incorporating the velocity of money (V) the cash balances equation explains the
value of money at a point of time by including the concept of the demand for
cash balances K. mathematically, the two equation can be reconcile by
substituting transactions equation and i/v for k in the cash balance. Marshall
thought that the essential cash or, in modern times have preference for
quantity is to bridge the time gap between the discrete receipts of money
income and its continuous, or at any rates less discrete spending. If the
transactions for money is such that the total money stock turns over, say, at
the rate of six times a year, then an equivalent of one-sixth of the annual
money value of cash balances at any given point of time. Thus, the demand for
the cash balances represented by kis the reciprocal of v, the velocity of money
in circulation, i.e; K=i/v. By substituting i/k = for V in the
cash-transactions equation MV= PT, we get M=KPT which is simply the cash
balance equation similarly, by substituting i/v for k in the cash-balance
equation M= KPT, we get MV=PT which is simply the cash-transaction equation.
According
to (John.N.O. 1 BE) the two equation are different observation of the same
phenomenon. The cash balance equation emphasizes on the “Money transactions
equation looks at the money on the wing”. The cash transactions equation is
concerned with money as a flow while the cash balances equation is with as a
stock while the cash transaction equation is stresses the transaction velocity
of money (V) the cash balance approach emphasizes the demand for cash balances
K. Both the equation, however, regard money serving only as a medium of
exchange in the economy.
WHY DO PEOPLE MAKE DECISION TO RETAIN MORE OR LESS
PURCHASES POWER THAN THEY HAVE RETAINED BEFORE
Transaction
demand for money:
Money’s most important function is to act as medium of exchange in the economy
consumerous consumer goods and services. Producer require money to buy play for
writing the factor services if the total income and expenditure flows were
perfectly synchronized income there would be no need to hold cash balances for
transactions purposes. The income and spending flows matched an time. While we
spend daily, income is received in a lump on the form of salary disbursed by
the employers or once in a year in the form of divided income paid by the
corporation to their share debenture holder or in form of interest paid
half-year by the government to the bond holder.
Precaution demand for money
Apart from
demanding money for transactions purposes, individuals and business require
money to meet the unforeseen contingencies. One finds it convenient to hold
some cash on which he can lean readily when some unforeseen arises. We going
out for shopping one normally takes more money with him than is sufficient for
his planned purchases because his plans might change or he might find some
excellent opportunity in the market t shop at the advantageous terms. To the
business the need for having immediate cash arises to meet contingent
liabilities or unforeseen opportunities to enter into advantageous purchases.
The total quantity of money needed to satisfy the precautionary motive varies
with individuals and firms depending upon their degree of conservatism, nature
of business, access to the money market and the stage of development of the
organized bill market providing facilities of quick conversion of interest-bearing
assets, like bonds, into cash.
SPECULATIVE
DEMAND FOR MONEY
The statement
that money is held by people for the transaction and precautionary purposes is
in conformity with the classical approach to the demand for money because
transactions demand for money is dependent on money’s function as the medium of
exchange in the economy while the precautionary demand for money can be added
to the classical approach without materially altering its conclusions. The
speculative demand for money, however, marks a complete break with the
classical theory of the demand for money. The speculative demand for money
recognizes money’s role as the permanent store of value or as Milton Friedman
has termed it the permanent abode of purchase power.
According to the
classicists, people would not hold assets in the unproductive or barren form of
money because by doing so they would have t forgo interest income which could
be earned by purchased interest-bearing riskless government securities instead
of holding money which was barren. Even if the rate of interest was low, it was
better to earn some income than none at all.
REFERENCE
John N.O. Ibe (2000) Fundamentals of
Monetary Theory, Policy
Glahoh and
Company
M.C Vaish (2005) Monetary Theory
Sixteenth Edition,
Vikas Publishing House PVT Ltd
Melzer, Allan H. “The Demand for Money:
The Evidence from the
Time Series,”
Journal of Political Economy (June 1963), PP. 219-46.