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Quantity theory of money

The foundation stone of MONETARISM. The theory says that the quantity of MONEY available in an economy determines the value of money. Increases in the MONEY SUPPLY are the main cause of INFLATION. This is why Milton FRIEDMAN claimed that 'inflation is always and everywhere a monetary phenomenon'.

The theory is built on the Fisher equation, MV = PT, named after Irving Fisher (1867-1947). M is the stock of money, V is the VELOCITY OF CIRCULATION, P is the average PRICE level and T is the number of transactions in the economy. The equation says, simply and obviously, that the quantity of money spent equals the quantity of money used. The quantity theory, in its purest form, assumes that V and T are both constant, at least in the short-run. Thus any change in M leads directly to a change in P. In other words, increase the money supply and you simply cause inflation.

In the 1930s, KEYNES challenged this theory, which was orthodoxy until then. Increases in the money supply seemed to lead to a fall in the velocity of circulation and to increases in real INCOME, contradicting the classical dichotomy (see MONETARY NEUTRALITY). Later, monetarists such as Friedman conceded that V could changein response to variations in M, but did so only in stable, predictable ways that did not challenge the thrust of the theory. Even so, monetarist policies did not perform well when they were applied in many countries during the 1980s, as even Friedman has since conceded.


Part of the “ile” family that signposts positions on a scale of numbers (see also PERCENTILE). The top quartile on, say, the distribution of INCOME, is the richest 25% of the POPULATION.


Market failure? Not necessarily. Usually a queue reflects a PRICE that is set too low, so that DEMAND exceeds SUPPLY, so some customers have to wait to buy the product. But a queue may also be the result of deliberate rationing by a producer, perhaps to attract attention - by a restaurant that wants to appear popular, say. Customers may regard a queue, such as a waiting list for health treatment, as a fairer way to distribute the product than using the PRICE MECHANISM.


A form of PROTECTIONISM. A country imposes limits on the number of goods that can be imported from another country. For instance, France may limit the number of cars imported from Japan to, say, 20,000 a year. As a result of limiting SUPPLY, the PRICE of the imported good is higher than it would be under FREE TRADE, thus making life easier for domestic producers.