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Money pp 151–156Cite as

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Equation of Exchange

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Abstract

The equation of exchange (often referred to as the quantity equation) is one of the oldest formal relationships in economics, early versions of both verbal and algebraic forms appearing at least in the 17th century. Perhaps the best known variant of the equation of exchange is that expressed by Irving Fisher (1922):

$$ MV = PT $$

Equation (1) represents a simple accounting identity for a money economy. It relates the circular flow of money in a given economy over a specified period of time to the circular flow of goods. The left-hand side of equation (1) stands for money exchanged, the right-hand side represents the goods, services and securities exchanged for money during a specified period of time. M is defined as the total quantity of money in the economy, T as the total physical volume of transactions, where a transaction is defined as any exchange of goods, including physical capital, services and securities for money, P is an appropriate price index representing a weighted average of the prices of all transactions in the economy. Finally, to make the stock of money comparable with the flow of the value of transactions (PT), and to make the two sides of the equation balance, it is multiplied by V, the transactions velocity of circulation, defined as the average number of times a unit of currency turns over (or changes hands) in the course of effecting a given year’s transactions.

Keywords

  • Money Supply
  • Money Demand
  • Quantity Theory
  • Legal Tender
  • Nominal Income

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© 1989 Palgrave Macmillan, a division of Macmillan Publishers Limited

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Bordo, M.D. (1989). Equation of Exchange. In: Eatwell, J., Milgate, M., Newman, P. (eds) Money. The New Palgrave. Palgrave Macmillan, London. https://doi.org/10.1007/978-1-349-19804-7_17

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