Quantity Theory of Money

The Quantity Theory of Money is an economic theory that describes the relationship between the quantity of money in an economy and the level of prices of goods and services sold. According to this theory, there is a direct proportionality between the amount of money in circulation (M) and the nominal value of economic output (PQ).

M represents the total money supply in the economy, V is the velocity of money, which represents the average frequency with which a unit of money is spent. P stands for the general price level, and Q signifies the quantity of goods and services produced (output). The theory assumes that V and Q are constant in the short term. When represented as an equation, it postulates that:

M × V = P × Q.

This relationship suggests that any change in the money supply will directly affect the price level if the velocity of money and the quantity of output remain unchanged.