The Value of money: Cash Transaction Theory
In the light of the definitions, the amount of goods and services purchased by a certain amount of money at a given time is called the value of money. The value of money largely depends on the price level. The inverse relationship of the value of money with the price level. That is, when the price level increases, the value of money decreases and when the price level decreases, the value of money increases.
This inverse relation of the value of money to the price level can be expressed through specific equations.
Vm = f (P) =1/P
Where, Vm = value of money and p = price level
Internal and external value of money: Value of money refers to the purchasing power of money. The amount of goods and services that are available for a certain amount of money is called the value of money. Economist Robertson says, "The amount of goods and services available for a certain unit of money is called the value of money."
Cash Transaction Theory : Fisher’s Approach
The famous classical economist Irving Fisher wrote a book “ The Purchasing Power of Money” in 1911. In this book he discusses the Cash Transaction Theory. In this book he uses an equation to determine the relationship between the amount of money, the price level and the value of money. This equation is named after him, Fisher's equation. In this equation Fisher uses money only as a medium of transaction. Hence this equation is also known as Transaction Equation. Fischer's equations can be expressed explicitly.
There are two parts to that equation. Namely: demand for money and supply of money. Multiplying M by V gives the supply of money (MV). Multiplying P by T gives the demand for money (PT).
Fischer's Transaction Equation tells of determining the value of money by equating the demand for money with the supply of money. However, the above equation does not mention the various bonds and savings certificates created by the modern commercial banking system such as checks, bank drafts and the central bank. But these play a role as a medium of transaction.
Key points of Fischer's Transaction Equation: Like other commodities, the value of money depends on its demand and supply. If other conditions remain unchanged, the rate at which money supply increases, the value of money decreases at the same rate and the rate at which money supply decreases, the value of money increases at the same rate. In other words, if the money supply is doubled, the value of money will be halved. On the other hand, the relationship between money supply and price level is proportional. So if the money supply is doubled, the price level doubles.
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