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26.b. The Quantity Equation
Developed by economist Irving Fisher, who reasoned that velocity is determined by the institutions in an economy that affect the way individuals conduct transactions. Thus, the quantity of money in the economy is related to the number of dollars exchanged in transactions. The quantity equation is expressed as the link between transactions and money, and is expressed as:
Money x Velocity = Price x Transactions
M x V = P x T
The left-hand side of the quantity equation tells us about the money used to make transactions in the economy. M represents the quantity of money. V represents the transactions velocity of money; in other words, it represents the number of times a dollar bill changes hands in a given time period.
The right-hand side of the quantity equation tells us about transactions. T is the total number of transactions during some time period, or in other words, the number of times in that time period that goods or services are exchanged for money. P represents the price of a typical transaction in the economy. PT, which is the product of Price and Transactions, is the number of dollars exchanged in the economy in the time period.
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