The Quantity Theory of Money is an economic concept that links the amount of money in an economy to its overall price levels. It suggests that increasing the money supply, assuming other factors remain constant, leads to a proportional rise in prices, resulting in inflation. This relationship is often expressed through the equation of exchange: MV = PT, where M represents the money supply, V is the velocity of money (the rate at which money circulates), P stands for the price level, and T denotes the volume of transactions or real output.
The theory operates under several key assumptions:
Constant Velocity of Money (V): It assumes that the speed at which money changes hands remains stable over time.
Stable Volume of Transactions (T): It presumes that the real output or number of transactions in the economy doesn't fluctuate significantly.
Causality from Money Supply to Price Level: It posits that changes in the money supply directly influence price levels, not the other way around.
