Fisher's Equation of Exchange
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Fisher's Equation of Exchange

Fisher's Equation of Exchange Fisher, who developed the theory, tried to put it in the form of the following algebraic equation of exchange:

Fisher's Equation of Exchange

Fisher, who developed the theory, tried to put it in the form of the following algebraic equation of exchange:

P= M/ T or, (Price level is equal to money divided by trade or goods exchanged)

Where P stands for price level, M is money, and T stands for trade or goods exchanged.

This simple equation can be true only of a small isolated community,

(a) where the number of transactions is small,

(b) where there are no barter transactions,

(c) where, except coins, there are no other types of money like notes and cheques in use, and

(d) Where every piece of money changes hands but once. Such isolated communities are not found now-a-days, however.

We observe that in modern communities a coin changes hands a number of times. The butcher takes it to the baker and the grocer and he again to some other person. The work done by a coin which is circulated five times is equal to that done by five coins which change hands only once each. As slated earlier, this speed is called the velocity of circulation.

Hence, to find out the effective amount of money in a country, we have to multiply the total number of coins by their velocity. Out equation would then be:

P= MV/ T or, (Price level is equal to money multiplied by velocity of money divided by trade or goods exchanged)

Where V is the velocity of circulation of money

But in addition to metallic money, in every modern country, there is a large amount of paper money which helps in the exchange of goods. Instruments of credit like cheques, drafts and bills also serve the same purpose. There velocity of circulation has also to be taken into consideration. So our equation finally develops into: —

P= MV+M'V’/ T 0r (or, (Price level is equal to money multiplied by velocity of money plus credit money multiplied by velocity of circulation divided by trade or goods exchanged)

Where M' stands for credit money, and V for its rapidity or velocity of circulation. The equation signifies that the price level (P) changes when the quantity of money (M) or quantity of credit money (M') changes or when their velocities (V and V’) change. Of course, P will also change if the quantity of goods (T) required to be exchanged changes.

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