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Money and credit - Ivanov V.M.

9.2. The demand for money in quantitative theory

The quantitative theory of money and prices is a theory of demand for money, since the proponents of this theory (for example, M. Friedman) in their conception proceed from the equation of exchange.

Proponents of quantitative theory focus on the role of money as a means of payment. Hence, the demand for money is determined by how much they need for citizens and firms to make their payments.

The equation of exchange, converted to the form


illustrates that the amount of money in circulation is equal to the ratio of nominal income to money velocity.

If we replace the amount of money M in circulation with the amount of demand for money MD, that is, the amount of money that economic agents want to keep as part of their asset portfolios under the existing conditions, we get

From the last equation it follows that the amount of demand for money depends on three factors:

• absolute price level; ceteris paribus, a higher price level requires more money to buy the necessary amount of manufactured products;

• level of real production volume; as the real volume of production increases, real incomes also increase, and the presence of higher real incomes implies a larger volume of transactions, therefore, more money is required to complete an increased number of transactions;

• the velocity of money in the movement of income (the number of revolutions per year, which, on average, makes every dollar of the total money supply for the purchase of goods and services that make up the real gross national product); all parameters that affect the speed of money circulation will also affect the demand for money. The economists of the classical school are inclined to believe that the velocity of money is constant and is determined by such institutional factors as the number of annual salary payments to workers.

Critics of this theory (primarily J. Keynes) emphasize that V is a behavioral variable that is influenced by many different factors. In particular, it depends on factors creating a "motive for savings."

Imagine a household that for a certain period receives an income equal to PQ. Assume that a household cannot invest in non-monetary assets and uses them evenly throughout the period. At the end of the period, the household is left without money. In the next period, it again receives income PQ and completely spends it. Obviously, on average, the household during the period has the amount of money equal to PQ. For example, in Ukraine, wages are paid once every two weeks. Therefore, on average, each hryvnia is used twice during the period, hence V = 2.

In fact, the velocity of money is approximately three. This discrepancy indicates that people are holding cash not only for daily payments, but also as a means of accumulation.