Brief Notes on Graphical Exposition in the Fisher’s Quantity Theory of Money

In brief, the Fisherian version emphasises that the quantity of money and changes in it are the only significant causal factor that affects the value of money. It, thus, proves the hypothesis that the value of money is the function of its quantity.

Further, the equation MV = PT can also be interpreted in another sense, where M may be regarded as the economy’s demand for money. That is:

M = PT/V

Would imply that the demand for money (M), varies directly and proportionally to the price level (P) when annual transactions (T) and the spending rate of the community (V) are unchanged.

Fisher, thus, considers that the price level is not independent of the money supply. According to him, the process of price change starts with the change in money supply.

Initially, let there be equilibrium in the money economy, so that the amount of money supply (MV) is equal to the amount of money demanded in the economy (PT).

Now, if the central bank, the monetary authority, decides to increase the money supply, the flow of money in the economy will rise, leading to a larger money outlay on the given supply of real goods and services. Consequently, the price level will respond to the increased quantity of money.

In order to restore the equilibrium in the money market, the rise in price level, in fact, must be in proportion to the increase in the money supply. Money in terms of PT/V curve, MM denotes the initial quantity of money supply (OM).

Curve M ₁ M denotes change in money supply (from OM to OM ₁ = MM ₁ ). Originally, the equilibrium price level is OP, when E is the equilibrium or intersection point between money supply and money demand curves.

But when MM ₁ amount of money supply increases at P, there is excess of money supply over demand, so there is no equilibrium in the money economy.

To restore equilibrium at point E ₁ then, P must change (since T and V are assumed to be constant), so that demand would equate the increased supply of money.

Thus, the price level must change by PP ₁ Evidently, PP ₁ = MM ₁ . That is to say, the price level has increased directly and proportionately to the money supply.