Cambridge International as and a level Economics Ebook

Fisher 
equation
, which is 
MV
=
PT
. Th
is is now more commonly 
written as 
MV
=
PY
. 
M
is the money supply, 
V
is the velocity 
of circulation (i.e., the number of times money changes 
hands), 
P
is the price level and 
T
or 
Y
is the transactions or 
output of the economy. Both sides of the equation have to 
equal each other since both sides represent total expenditure 
in the economy. To turn the equation into a theory, 
monetarists assume that 
V
and 
Y
are constant, not being 
aff ected by changes in the money supply, so that a change 
in the money supply causes an equal percentage change in 
the price level. For example, the money supply may initially 
be US$80 billion, the velocity of circulation 5, price level 
100 and output is 4 billion. If 
V
and 
Y
are unchanged, an 
increase in the money supply by 50% to 120 would cause the 
price level to also rise by 50% to 150. Th
e monetarist view 
is that infl ation is a monetary phenomenon. Keynesians, 
however, argue that the equation cannot be turned into 
a theory since 
V
and 
Y
can change with a change in the 
money supply and so no predictions can be made about 
what eff ect a change in 
M
will have on 
P
.
Quantity Theory of Money: 
the theory that links inflation 
in an economy to changes in the money supply.
Fisher equation: 
the statement that 
MV
=
PY
.
KEY TERMS
TOP TIP
In explaining the Quantity Theory of Money, it is always 
useful to give an example.