Money Quantity Theory: Definition and Examples
YOGYAKARTA - Did you know that the price of goods and services is not only closely related to the amount of demand, but also related to the amount of money circulation in one economic ecosystem. This statement is called the quantity theory of money. To understand this theory further, read the following article.
The Quantity Theory of MoneyQuoted from Investopedia, the quantity theory of money is a theory whose seeds of thought were formulated by the Polish mathematician Nicolaus Copernicus in 1517.
From the basis of Nicolaus's work, other economists were then developed until today's most well-known version is the development of the American economist Irving Fisher in 1911. From this development, the theory became more popular thanks to Milton Friedman and Anna Schwartz through his book entitled A Monetary History of the United States (1963).
In monetary economics, the quantity theory of money or QTM is a thought that states that the general price level of goods and services is directly proportional to the amount of money in circulation.
This means that if the amount of money in circulation is twice the amount it should be, then the price of goods or services will also follow.
Thus it can also be concluded that the amount of money in circulation will have an impact on the decline in the value of money. This impact will trigger inflation and if this happens, purchasing power will fall and have other domino effects.
How to Calculate the Quantity of MoneyThe quantity of money in the economic system, its exchange rate is determined as with other goods, namely by considering supply and demand. The formula that can be used is as follows.
MVT≡PTT
Where,
M is the amount of money
VT is the velocity of money turnover from all transactions (money turnover)
PT is the price level of all transactions
T is the total transactions in the economy.
According to QTM, in a given period of time the total number of money issuers is equal to the total assessment of traded goods.
The transaction volume (T) itself depends on the supply of goods or services being traded. If in the economy the supply of goods is getting bigger, then the number of transactions and trade is also getting bigger. The same applies in reverse.
For example, in a small Indonesian city, the amount of money in circulation is IDR 1,000,000, and the money is transferred 5 times a month. So, the total spending in the city is IDR 5,000,000.
If there are 100 goods traded in the city, then the average price per item is Rp5,000,000:100 = Rp50,000.
Then, if the amount of money in circulation increases to Rp. 2,000,000 with the assumption that the money is still changing hands 5 times, then the total expenditure becomes Rp. 10,000,000. If the number of goods traded remains 100, then the average price per item will rise to Rp. 10,000,000:100 = Rp. 100,000.
So, with the increase in the amount of money in circulation, the price of goods in the city increased to Rp. 100,000.
That's the information related to the quantity theory of money. Visit VOI.id for other interesting information.