Quantity theory of money

Fisher’s equation of exchange

Ram (Rs 50)

Radheshyam (Rice seller)

Rs 50 Shyam (Barber)
(Rs 50)

Ghanshyam( Vegetable vendor)

Rs 50

Quantity of money or Money Supply (M) = Rs 50

Velocity of circulation of money (V) = 4
Output or transaction (Y or T) = Rs 200
Price Level (P) = ?

Equation of exchange, MV = PT (or PY)

P = MV
Y
P = MV = Rs 50 x 4 = Rs 200 = 1
Y Rs 200 Rs 200
Condition 1, If the central bank increases the money supply by 50%.
M1 = M + 50% of M = Rs 50 + 50% of Rs 50 = Rs 50 + Rs 25 = Rs 75
P1 = M1V = Rs 75 x 4 = Rs 300 = 1.5
Y Rs 200 Rs 200
Price level (P) α M(Money Supply) ; M↑→ ↑P

Condition 2, If the output in the economy increases by 75%.

Y1 =Y + 75% of Y = Rs 200 + 75% of Rs 200 = Rs 200 + Rs 150 = Rs 350
P1 = M1V = Rs 75 x 4 = Rs 300 = 0.8
Y Rs 200 Rs 200
Price level (P) α 1 ; Y ↑ → ↓P
Y(Output)