Here is a compilation of term papers on the ‘Quantity Theory of Money’ for class 9, 10, 11 and 12. Find paragraphs, long and short term papers on the ‘Quantity Theory of Money’ especially written for school and college students.
Quantity Theory on Money
Term Paper Contents:
- Term Paper on the Quantity Theory of Money
- Term Paper on the Different Meanings of Value of Money
- Term Paper on the Determination of Value of Money
- Term Paper on the Theories of Determination of Value of Money
- Term Paper on the Equation of Quantity Theory of Money
- Term Paper on the Criticism of Quantity Theory of Money
- Term Paper on the Conclusion to Quantity Theory of Money
Term Paper # 1. Quantity Theory of Money:
We know that there is an inverse relationship between the price of money and price of commodities. It means when price of money decreases, the price of commodities increases and when the price of money increases, the prices of commodities decreases. So, it gets clarifies that the price of money changes constantly.
Why is there a change in the price of money? The study of the ‘Quantity Theory of Money’ is important to give the answer of this question. In other words, the ‘Quantity Theory of Money’ defines the causes of changes in the value of money.
Term Paper # 2. Different Meanings of Value of Money:
It is true that the price of money refers to its purchasing power.
(1) Purchasing Power:
Purchasing power refers to the ability of purchasing goods and services with a unit of money. This purchasing power is often measured in comparative terms. It means what amount of goods and services could be purchased with a unit of money in a base year and what amount of these goods and services can be purchased with that very unit in the current year. Index is also prepared on these bases only.
(2) Rate of Interest:
A meaning of the value of money is also often associated with the rate of interest. In this sense, it is predicted how much interest can be obtained from a certain amount of money in a year.
(3) Foreign Exchange Rate:
In this sense of money, it is predicted how many units of foreign money can be purchased with a certain unit of money of a particular country. In all the above three senses, the value of the money can be predicted. But the most common and accurate sense is that which is associated to the purchasing power of money.
Term Paper # 3. Determination of Value of Money:
To understand the ‘Quantity Theory of Money’ it is essential to know on which factors the value determination of money depends. According to economists, money is also a material. Now if we consider money as a material then its value should be determined just in the way the value of any material is determined.
We know that according to common rule of economics, price of any material is determined by the forces of demand and supply. So the value of money is also determined at that point on which a balance is established between the demand and supply of money. To understand the value determination of money, it is essential to understand the meaning of demand and supply of money.
Demand of Money:
Money is also demanded like commodities by the people of any country. But there are some differences between demand of any commodity and demand of money. Commodities carry the quality of utility. So, people demand commodities to satisfy their utility. But money doesn’t satisfy any utility. Goods are purchased for fulfillment of various requirements with the help of money.
In other words people get direct satisfaction through the demand of commodities while they get indirect satisfaction through money. Demand of money in and country is based on the supply of goods in that country. There is no uniform supply of goods all the time and so there is also not uniform demand of money ail the time. Thus the demand of money in any country depends on the amount of goods and services available there.
Supply of Money:
By supply of money, we refer to that amount of money which is available for exchange in the economy. As a source of exchange both legal tender money and non-legal tender money are together in the economy. Metallic money and paper money are included in legal tender money while credit instruments fall under the category of non-legal tender money.
So, all the three metallic money, paper money and credit instruments used in a country are included in the supply of money. But the form of money which people keep permanently locked in their safe or keep buried under the ground can’t be included in the supply of money because such money is not used for the purpose of exchange.
Supply of money depends on many factors. For example—the system of issuing note by the government of the country, the monetary policy of the government, amount of metals like gold and silver in the country and the confidence of people in credit money. Besides these, the supply of money is also affected by the velocity of circulation of money.
Velocity of Circulation of Money:
It refers to the number of circulation practices of a certain unit of money at a certain time. Suppose a person pays Rs. 100 wages to a labourer. The labourer purchases food materials with that money on the same day. Again that trader purchases a new commodity with that Rs. 100 on that very day. It means Rs. 100 had the velocity of circulation 3 in 1 day.
The velocity of circulation of money depends on the tendency of people. If people have more tendency of saving, there will be less velocity of circulation of money. On the other hand, if people will have a higher tendency of Expenses, the velocity of circulation will be more.
Term Paper # 4. Theories of the Determination of Value of Money:
Different scholars have described various theories of determination of value of money. Every theory has its own characteristics.
The descriptions of some important theories are given below:
I. Commodity Theory of Money:
It is the oldest theory of determination of value of money. According to this theory the value of money is also determined by demand and supply as it happens in the case of other commodities. This theory came in the use at the time when there was the use of metal currency in almost all countries of the world and it was made of gold or silver.
This theory was considered proper those days because the market price of gold and silver and the face price of money were approximately the same. These days the paper money has come in use in all the countries of the world. Paper money is made of paper and its internal value is zero. So there is no rationality of this theory at present.
If we consider that like other commodities value of money is determined by demand and supply, it becomes essential to clarify that by the demand and supply of money, we refer to the demand and supply of that material of which money is made. It simply means that the value of money will be governed by the market value of that metal of which the money is made. It is possible only when there is some internal value of money material. In the use of paper money there is no internal value of money material. Metallic money is also like symbolic money in those countries which have both paper money and metallic money in use.
Some economists hold that paper money is issued with the support of gold. It can be argued here that every country have their own system of issuing paper money. So it can be claimed perfectly that there is cent per cent security of gold behind paper money. Later amendments were made in this theory. Even after these, today ‘Commodity Theory of Money’ is impractical.
II. State Theory of Money:
Prof. Fredrick Knapp is the father of this theory of value of money. According to him, “The soul of currency is not in the material of the pieces, but in the legal ordinances which regulate their use.”
It became clear from this definition that the value of money does not depend on this factor that which money material has been used in making money, but it is determined by the government. The internal statement of this theory in the present day is that money is issued and regulated by the government of India or central bank. So, its value is also determined by the government.
According to Prof. Knapp, the government determines the value of money in the following ways:
(1) Legal Recognition:
The material which is given a legal acceptance by the government, it wins the confidence of people. People start accepting it as money. If this legal acceptance is removed, it won’t be in use as money. Due to this legal acceptance, money becomes a medium of exchange and the base of deferred payment.
(2) Issue of Money:
The amount of money issued by the government also determines the value of money. If the government wants to increase the value of money, it can do so by reducing the amount of money. Similarly, if the government wants to reduce the value of money, it can do so by issuing additional money.
(3) Determination of Commodity Prices:
Government in some countries determines the prices of commodities under some special circumstances. In India also, the government determined the prices of essential goods during the emergency. At present also, the prices of commodities for the ration shops (PDS Shop) are determined by the government. The government determines the value of money indirectly through this policy.
III. Drawbacks of Theory:
Following are the drawbacks on the basis of which this policy is criticized:
(1) The critics have the opinion that just by giving legal acceptance to anything; the government can’t give it the form of money. For this, it is essential that people should accept that substance as money. The incident of Germany is an example of this. After the World War I, the German government gave ‘Mark’ legal acceptance as currency, but people did not accept it. As a result, Mark could not continue its use as money.
(2) The critics also opine that it is true that the government supplies money. But it does not mean that the government only should determine the value of money. The real value of money is determined by its demand and supply.
(3) About the price determination of goods by the government, the critics hold that the government does it for selected commodities only. Thus, it can’t be the basis of price determination.
Despite the above criticism, the importance of this theory can’t be r ejected. The legality of money material can be an important element in determination of the value of money.
IV. Quantity Theory of Money:
This is an old theory related to the value determination of money. The conclusion of this theory is that the value of money is determined by changes taking place in the quantity of money.
There is lacking of solid proof regarding the founder of this popular theory related to determination of value of money. Different economists discuss the names used as the possible founders. The names used as possible founders are— Dauan Zatti, Jean Bodlin etc. Later it was amended by John Locke, David Hume, Adam Smith, Ricardo, J.S. Mill etc. But the credit of making this theory popular goes to the famous American economist Irving Fisher. So, this theory is popular by the name “Fisher’s Quantity Theory of Money.”
Before knowing Fisher’s point of view on this theory the study of the determinations of various scholars on this theory is essential.
Some important definitions are as follows:
(1) According to J.S. Mill, “The value of money, other things being the same, varies inversely as its quantity; every increase of quantity lowers the value and every diminution raising it in a ratio exactly equivalent.”
(2) According to Prof. Thomas, “According to the quantity theory of money, the value of money is determined by the relationship between the demand for money and its supply. It asserts that given the conditions of demand for money a given increase or decrease in its supply will lead to a proportionate increase or decrease in the general level of prices and as the value of money varies inversely with the price level, an increase in the volume of money will lead to a fall in its value and decrease to rise in that value.”
(3) According to Wicksell, “The value or purchasing power of money varies in inverse proportion to its quantity, so that an increase or decrease in the quantity of money, other thing being equal will cause a proportionate decrease or increase in its purchasing power in terms of other goods and thus a corresponding increase or decrease in all commodity prices.”
After the study of the above definitions it becomes clear that the scholars have laid much emphasis on the quantity of money in determining the value of money. That is why it is called the quantity theory of money.
Assumptions of Theory:
The Quantity Theory of Money is based on certain assumptions. In the above definitions of the theory the economists have used the term ‘other factors remain constant.’ Its simple meaning is this theory works only when there is no change in any other thing.
The main assumptions of this theory are as follows:
(1) There should be no Change in the Demand of Money:
It is essential for the functioning of this theory that the demand of money should stay still. It means there should be no change in the demand of money due to trade, industries, employment etc. So, when the demand will be stable, the value of money will be determined by its supply only.
(2) There should be no Change in the Transactions Completed through Barter System:
Although the barter system has largely come to an end, it is used for some transactions in a few countries. The quantity theory of money holds the opinion that the barter system is not in use. So, this theory can work only when there is no change in the amount of barter system as there is no role of money in the transactions of these goods.
(3) There should be no Change in the Amount of Credit Money:
Even when there is no legal recognition for the credit money, it is very popular. It is the assumption of this theory that there should be no change in the amount of the use of credit money.
(4) The Ratio between the Credit Money and Money in Circulation should be Stable:
The quantity theory of money is based on the assumption that there should be no change in the ratio between the credit money and money in circulation in the country. We know that the commercial banks keep a certain part of their customer’s deposits with them and distribute the remaining in the form of credit. So, there is formation of credit on the bases of this deposit, so this theory won’t work in this ratio.
(5) There should be no Change in the Velocity of Circulation of Money:
By the velocity of circulation of money we refer to the frequency of purchasing goods and services with a definite unit of money within a limited period. The quantity theory of money works by considering that the velocity of circulation of money will be stable. So, this theory will work only when there is no change in the velocity of circulation of money.
Term Paper # 5. Equation of the Quantity Theory of Money:
The economists had presented the quantity theory of money in the form of an equation in the olden days. It established relationship among the amount of money, the transactions made through it and the price level.
The equation presented by the ancient economists was as follows:
Where, P = the price level of goods and services
M = the amount of money in circulation in the country
T = quantity of trade
T (The quantity of Trade) is considered stable in this equation and it is assumed that all changes in the price levels of goods and services take place due to the change in M (The amount of money) in the country. Thus there is a direct relationship between P and M. As a result P increases naturally with the increase of M.
After sometime the economists found that the velocity of circulation of money has not been included in it.
Thus by removing this fault, the equation was amended to be in the following form:
In this equation V refers to the velocity of circulation of money. According to this equation P (The price level) is determined by the transactions done through MV. Thus there is a direct and proportional relationship between P and MV. But the major fault with this equation is that the credit money has not been included in it. So, Prof. Irving Fisher presented a new equation to remove this fault.
Prof. Fisher has presented his equation as the quantity theory of money in the following ways:
In this equation,
M = Total amount of money (legal tender money)
V = Velocity of circulation of legal tender money
M’ = Credit Money
V’ = the velocity of circulation of credit money
P = the price level of goods and services
T = quantity of Trade
If we explain fisher’s equations,
PT = MV + M’V’, we will find that PT is the demand of money and it tells about the supply of money in the form of MV + M’V’. It is clear from Fisher’s equation that there is a direct relationship of price level with MV + M’V’. Thus, according this equation if an increase in the supply of money is done and other factors stay constant, there will be a fall in the price level.
Here ‘Other Factors stays constant’ refers to no change in the amount of trade. Thus, this theory tells about the mutual relationship between the amount of money and the prices of goods and services. SO, it is called the ‘Quantity Theory of Money”.
Assumptions of Fisher’s Theory:
In the presentation of the above equation Fisher has assumed that V (The velocity of circulation of money), V’ (The velocity of circulation of credit money) and T (Trade, transactions) stay stable and there is a direct relationship of M (legal tender money) and M'(Credit money) with P. In other words, if there is an increase in M there is also an increase in P (General Price level).
On the contrary, if there is a decrease in M, there is also a decrease in P. But Fishers has also considered that all these factors stay stable for a short period only. He stated the reason for if that the quantity of trade and the use of money stay stable for a limited period only because there is no change in population, production, demand and the amount of consumption in a short period.
Besides these, there is also no change in the habits and interest of people in a short period. Thus, on this basis in a short period if the demand of money is stable then there is a direct impact of an increase or decrease in M on P.
Clarification through Diagram:
In the given picture line OX represents the amount of money (M) and line OY shows the price level. It is clear from the picture that when the quantity of money in circulation in the economy is OM, the price level is equal to OP1. But when the amount of money is made OM2, the price level increases to be OP2.
On the contrary, when the amount of money reduces to be OM3, the price level reduces to be OP3. In this presentation OT curve passes through points C, A and B which tells about the mutual relationship between changes in the amount of money and price level.
Term Paper # 6. Criticism of the Quantity Theory of Money:
Following are the criticism of the amended form of the ‘Quantity Theory of Money’ presented by Prof. Fisher:
(1) Unrealistic Assumptions:
The critics have the opinion that the assumptions taken as the basis in the analysis of the ‘Quantity Theory of Money’ are unrealistic. The critics have presented following arguments in support of this statement.
(a) Assumption of Full Employment is Unrealistic:
The critics have said that this theory of Prof. Fisher is based on this assumption that there is the condition of full employment in the economy. But if seen in reality, there is no condition of full employment in the economy.
(b) V and T do not remain Constant in the Short Run:
Prof. Fisher has supposed that there is no change in V and T in the short run. But it is not so in reality. There are the phases of recession and boom in the sector of trade. Rise in V in the time of boom and reduction in V at the time depression take place in the short run only.
It also has its effects on M because the effect of change in the amount of money is on the production of goods also. The economic history of many countries accepts this facts that there has been increase in the volume of trade due to increase in the supply of money. So, it is illusionary to imagine that T will stay stable always in the short term.
(c) M and V are not Independent Variables:
Fisher has assumed in his theory that M and V are independent units. It means they do not have effect on one another. But it is not true in reality. An increase in M increase in P (Price level) which in turn leads to an increase in V because, in this situation there is a greater possibility of future price rise. Thus, it can’t be supposed that there will not be a chance in V even if there is an increase in M. Thus M and V are not independent.
(d) Relation between M an M’:
Prof. Fisher has the opinion that there is a proportional relationship between legal tender money (M) and credit money (M’). But the critics don’t hold it true. According to them when there is a boom in the economy, the amount of credit money increases. So, the assumption made by Fisher is wrong.
(2) Too much Emphasis on Supply of Money:
The critics say that it is the general rule of economics that the price of any commodity is determined by its demand and supply. In the same way, value of money is also determined by its demand and supply. But in the ‘Quantity Theory of Money’ the supply side has been emphasised in the value determination of money and demand aspect has been neglected. Due to this fault of the ‘Quantity Theory of Money’ Prof. Keynes has propounded another theory of value determination of money.
(3) The Concept of Price Level is not Clear:
Prof. Fisher has considered in his theory that only the amount of money has influence on the prices of goods and commodities. But it is not true in the opinion of critics. They say that there are so many non-monetary factors like an exceptional change in demand on a particular time, the financial policy of the government, political unrest, and changes in the amount and cost of production which influence the price level.
De Cock has said criticising this theory, “The amount of money has been unnecessarily stressed in the ‘Quantity Theory of Money’ while there is no close and direct relationship between the amount of money and price level of commodities.”
(4) Negligence of Trade Cycle:
The supply of money has been taken as the basis for the determination of value of money in the ‘Quantity Theory of Money’. But the supply of money generally becomes ineffective in the condition of trade cycles. The price level decreases without a decrease in the amount of money during recession and price level rise without an increase in the amount of money during boom in the economy. In this way this theory does not clarify those changes in price level which arise due to trade cycles.
(5) This Theory Shows Long Run Tendency Only:
It is a major fault of this theory that it analyses the long-term aspect of value of money but do not has short-term analysis. However there are some important changes in the value of money in short period. Thus, negligence the short-term aspect is improper. Prof. Keynes has said, “There is not much gain by the study of long- term aspect because everybody dies in the long-term.”
(6) Static Theory:
The critics say that this theory is a permanent one. There is a lack of mobility in it. This theory is based on the imagination that there is a condition of full employment in the society. But it is not so in practice. There is a condition of mobility in the economy due to the fluctuation in practice. Thus, this theory is unable to measure the value of money in a mobile economy.
(7) Non Acceptance of the Importance of Time Lag:
Fisher’s Quantity Theory, emphasis the fact that, with the change in the supply of money, there is also a change in the prices of commodities. But the critics say that the change in the supply of money does not have an instant impact on the price level in the country, but the impact is slow and gradual. However, in the area of monopoly it has instant effect, but in complete and incomplete competition it has gradual effect.
(8) Negligence of Velocity of Circulation of Money:
It is a fault of this theory according to the critics that it does not analyse the velocity of circulation of money, nor does it throws light on the elements influencing it. Prof. Marshall has said, “A theory determining the value of money should throw light on all the causes influencing the velocity of circulation of money.”
(9) Money is not only a Medium of Exchange but also the Means for Store of Money:
As we know, money is not only a medium of exchange but also a means for store. But in this theory its effects are connected only to price level and thus money is presented as the mode of transaction. Thus, this theory is not perfect with the view.
(10) Value of Money is the Result of Total Income:
According to Prof. Crowther, “Value of money is determined by the total income of the country, not by the quantity of money.” They opine that the cause of fluctuation in the total income should be found out.
(11) International Effects:
These days, the market of commodities has become international. Every country wants to sell its products in other countries. As a result there is a competition in the prices of commodities. If we consider the point of Fisher’s Theory that the price level of commodities depends on the amount of money, there would be so much difference in prices of goods that it would not be able to make its place in the international market. Thus, Fisher’s logic is not correct.
Term Paper # 7. Conclusion to the Quantity Theory of Money:
On the bases of above criticism it can be said that, the ‘Quantity Theory of Money’ is unrealistic, faulty and meaningless. According to Prof. Keynes, “This theory is not only faulty but also incomplete and imaginary.” In reality, the mathematical form of this theory is insufficient. But, in spite of these criticisms it is not to say this theory unimportant. It is true that it is not complete with mathematical point of view, but it gives the information of a tendency.
It must be accepted that the changes in the prices in a country is certainly influenced by the changes in the amount of money. Robertson has said, “The Quantity Theory of Money is a strange truth to understand the value of money which is essential to understand to know the relationship between the amount of money in the real life and the prices of commodities.”
Prof. Fisher has presented many examples to prove the truth of his theory.
Some of these are given below:
(1) When the Spanish discoverers found out new mines of silver, they started exporting more and more silver to European countries, as a result the price – level went up in these countries.
(2) There was overproduction of goods in the period between 1820 and 1844 but the amount of money could not be increased in that ratio because there was not sufficient gold with Britain; as a result, the price level fell very much in Britain.
(3) There was a large scale export of gold from Australia and California to the countries having gold standard. As a result there was price rise in these countries. Again when the import of gold in these countries reduced, the price began to fall.
(4) There was inflation in Germany during World War I due to large scale issue of paper money.
(5) During the worldwide depression in 1929 that was a great fall of price in almost all countries due to deflation.
The above examples clarifies that the ‘Quality Theory of Money’ is not unimportant.