The Quantity Theory of Money is the oldest and has been the most influential theory purporting to explain the determination of the value of money at any one time and the variations of this value over periods of time.
The Quantity Theory of Money is the crux of the classical monetary thoughts which proclaim the idea of a unique functional relationship between money and prices.
The Italian writer, Davanzatti, was the originator of the idea of the Quantity Theory of Money. But the theme of the quantity theory as an explanation for the changes in the value of money, however, received wider acceptance in the classical thinking through David Hume’s book on Political Discourses, published in 1752. Hume mentioned that: “prices are proportional to the plenty of money supply.”
In its crudest form, the theory states that the price level or the value of money is dependent upon the quantity of money the price level varies in direct proportion to the quantity of money; hence the value of money varies in an inverse proportion.
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Thus, if the quantity of money is doubled so will the price level and therefore the value of money is halved; and alternatively, if the quantity of money is halved, so will the price level, so that the value of money is doubled.
J. S. Mill, a noted classical economist, for instance, writes: “The value of money, other things being the same, varies inversely as its quantity; every increase in quantity lowers the value and every diminution raising it in a ratio exactly equivalent.”
In short, the quantity theory implies that the quantity of money brings about a directly proportionate change in the price level and hence an inversely proportionate change in the value of money.
Thus, it emphasises a functional relationship between the quantity of money and the value of money.