DETERMINATION OF VALUE OF Chapter 2

MONEY
DETERMINATION OF VALUE OF MONEY
It has a value
Purchasing power/ purchasing capacity
Inverse relationship with general price level
It’s an ever changing
Different school of thoughts explain the change in
the value of money
DEFINITION OF VALUE OF MONEY
D.H. Robertson says:
“ By the value of money we mean that amount of things in general
which will be given in exchange for a unit of money.”
A.C. Pigou says:
“ Value of money means the exchange value of a unit of it.”
J.M. Keynes says:
“ Value of money means its purchasing power, and purchasing
power of the money is the quality of goods and services which a
unit of money will purchase.”
TYPES OF VALUE OF MONEY
Internal value of money
Purchasing power of money over domestic
goods and services.
External value of money
Purchasing power of money over foreign goods
QUANTITY THEORY OF MONEY
J.S. Mill says:
“ The value of money, other things being the same, varies inversely
as its quantity, every increase of quantity lowering the value and
every diminution raising it, in a ratio exactly of money double.”
F.W. Taussing says:
“ Double the quantity of money, and other things being equal,
price will be twice as high as before and the value of money one-
half, halve the quantity of money, and other things being equal,
prices will be one-half of what they were before and the value of
money double.”
QUANTITY THEORY OF MONEY
Irving Fisher says:
“ Other things remaining unchanged, as the quantity
of money in circulation increases, the price level also
increase in direct proportion and the value of
money decreases and vice versa.”
FISHER’S QUANTITY THEORY OF MONEY
Direct and proportionate relationship between the quantity of money and the
price level.
Equation of Exchange
PT = MV+M’V’
Here
P= Price Level
M= metallic Money and Currency Notes
V= Velocity of Money
M’= Credit Money
V’= Velocity of Credit Money
T= Transactions to be done by money
ASSUMPTIONS OF THEORY
Price level is motionless
Constant relationship between money and credit
money
Size of barter transaction is same
No change in volume of trade
Full employment
Velocity of money remains unchanged
LIMITATION OF THE THEORY
1. Rate of interest
2. No proportionate changes
3. Other things change
4. Medium of exchange
5. Velocity of circulation
6. Dependent variable
7. Commodity transactions
LIMITATION OF THE THEORY
8. Inconsistent elements
9. Full employment
10. Theory of value
11. Static theory
APPRAISAL OF THEORY
Issuance of currency (during inflation or deflation), bank
rate policy, open market operation of central bank
based on this theory.
Under and over issuance of currency.
Every change in money supply may not create change
the price level.
CASH BALANCE THEORY
D.H. Robertson says:
“ Money is only one of many economic things. Exactly the
same two factors as determined the value of any other
things, namely, the conditions for it and the quantity of it
available therefore, primarily determine its value.”
Alfred Marshall says:
“In every state of society there is some fraction of income,
which the people find it, worthwhile to keep in the form of
money.”
CASH BALANCE THEORY
A.C. Pigou says:
“ An increase in the supply of legal tender ought always,
since the elasticity of demand for legal tender is equal to
unity, to raise the price in the proportion in which the
supply has increased.”
CASH BALANCE THEORY
1. Increase in money supply increases the price level and decreases
the value of money with a given demand for money.
2. If there is no change in demand for money a decrease in money
supply decreases the price level and raises the value of money.
3. Similarly, when the supply of money remains the same increase
in demand for money decreases the price level and increases
the value of money.
4. When there is decrease in demand for money the price level
increases and value of money decreases if money supply is
constant.
EQUATION OF EXCHANGE

D.H. Robertson
P= M/KT or M= KTP
Here
P= Price level
M= Money supply
K= Real income help by people in form of cash
T= Amount of goods and services to be purchased
during the year.
APPRAISAL OF THE THEORY
1. Demand and supply
2. Measures cash held
3. Income level
4. General theory
CRITICISM
1. Constant variables
2. Failed to explain non-economic factors
3. Ignore interest rates
4. Ignore near money
5. Fails to consider investment goods