+ M V T - - Monetary Economics Diagrammatic Illustration Figure (A) shows the effect of changes in the quantity of money on the price level. When the quantity of money is OM, the price level is OP. When the quantity of money is doubled to OM , the price level is also doubled to OP . Further, when the quantity of money is increased four-fold to OM , the price level also increases by four times to OP .
This relationship is expressed by the curve OP = f (M) from the origin at . Figure (B), shows the inverse relation between the quantity of money and the value of money, where the value of money is taken on the vertical axis. When the quantity of money is OM, the value of (A) P P P M M M y P=f (M) Price Level x (B) OI/P OI/P OI/P M M M I/P=f (M) Quantity of Money Value of Money x y Figure . money is OI / P.
But with the doubling of the quantity of money to OM , the value of money becomes one-half of what it was before, (OI / P ). But, with the quantity of money increasing by four-fold to OM , the value of money is reduced by OI / P . This inverse relationship between the quantity of money and the value of money is shown by downward sloping curve IO / P = f(M). b) Cambridge Approach (Cash Balances Approach) i) Marshall’s Equation The Marshall’s equation is expressed as: M = KPY Where M is the quantity of money Y is the aggregate real income of the community P is Purchasing Power of money K represents the fraction of the real income which the public desires to hold in the form of money.
Thus, the price level P = M/KY or the value of money (The reciprocal of price level) is /P = KY/M The