Understanding the Quantity Theory of Money: Fisher's Approach Explained

[Music] hey guys my name is vidhi gavra and welcome back to my channel five minute

economics where i teach economic concepts in a span of just five minutes the topic for today is the

quantity theory of money fishers approach and in this particular video i'll be

covering the fish's equation the 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 thank 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 then that when money was

flowing from america to europe the prices in europe started to increase because the money supply and lot of

increase so it dates back to that time whereas this theory was brought up by ivan fisher in the year 1911

where he spoke about it in his book but chasing power of money what did iron fishes observed he said

this as the quantity of money in an economy increases

the price aka the inflation tends to rise case member iring 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 uh you know statements we can say that

there is a direct relationship between money supply and price as money supply increases

price also increases whereas there is an indirect relationship between money supply and value of money

the value of money keeps falling so initially a good maybe we can say a bunch of bananas which were available

for 10 rupees is now costing us 20 rupees so when the price rises you know the

value has fallen the value of money has fallen so this these two things were said

and he also said this is uh observed in citrus 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 theory 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 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 fishers approach this particular equation mv is equal to

p is sub pt is something what you need to remember always so what does each variable over

here stand for so m stands for money supply chain money you know money in circulation

is our money supply whereas v is a 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 100 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 we 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 m as 100 and v velocity as 4 we get 400 as our mv whereas coming to the right

hand side of the equation which is pt what over here we say is that p stands for price revenue

right and t stands for volume of transactions so when the price is multiplied by the 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 fischer say

fisher said that when we and t we've assumed these to be constants remember in the assumptions we

study when v and t are constant in an economy then it is true that when money supply

increases price tends to increase in fact he called this as a truism that is a truth

or a fact it's he called it this as an identity he said this is definitely true you can just

think logically chap money pesa is bound to rise and of course then

value of money will bound to fall so this is the relation which you have to remember it is a fact and it is a true

what 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 where we have money supply y

axis we have price so we notice when money supply increases from om to om dash a 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've taken it as vm and op price but we noticed when the price rises from

op to op dash or ob 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 uh you know

graphical explanation of the uh 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 assumptions so over here vnt which

were considered to be constant it was heavily criticized by the cancer economist that we

and t cannot be constants you know when population increases we is tending to increase obviously

circulation when natural resources or technology 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're talking about money supply and price interest rate is bound to come but here

they've totally depicted 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 you know ignored the other functions of

money like store of value and you know speculative demand of money all that has been ignored

so this is what 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 you in the next video

pretty soon