Management Notes

# Management Notes

Reference Notes for Management

# Equation of exchange is converted into the quantity theory of money by assuming the following variables as constants

## Equation of exchange is converted into the quantity theory of money by assuming the following variables as constants

1. V and T
2. M and V
3. M and P
4. V and P

Correct Answer: a. V and T

It represents the relationship between the money supply, the velocity of money, the price level, and real economic output. It is expressed as follows:

MV=PT

Where: M = Money supply V = Velocity of money (average number of times a unit of currency is spent in a given time period) P = Price level (average price of goods and services) T = Transaction volume (real economic output or total amount of goods and services produced and exchanged)

The quantity theory of money is derived from the equation of exchange by making certain assumptions. In the quantity theory of money, the velocity of money (V) and the volume of transactions (T) remain constant in the short run. The price level (P) is therefore directly influenced by changes in the money supply (M).

Why the other options are not correct

### b. M and V

It would imply that the money supply and velocity of money remain constant. Irrespective of changes in other variables if M and V were assumed to be constants. Due to changes in monetary policy, economic conditions, and people’s spending behavior, both M and V can vary in real-world observations.

### c. M and P

If M and P are considered constants, the money supply and the price level remain the same. In reality, M and P can change due to a number of factors, including inflation, deflation, changes in the money supply by central banks, and shifts in aggregate demand and supply.

### d. V and p

If V and P are constants, the velocity of money and the price level should remain constant. Nevertheless, in practice, both V and P can fluctuate based on economic conditions, consumer behavior, technological advances, and monetary policy measures.

## Conclusion

The correct answer is (a) V and T. The quantity theory of money is derived from the equation of exchange. By assuming the velocity of money (V) and the volume of transactions (T) are constant in the short run. By making this assumption, economists can determine whether changes in the money supply (M) are directly related to changes in the price level (P).

There are three other options: (b) M and V, (c) M and P, and (d) V and P, which are incorrect because they assume constant values for variables that fluctuate in reality. It is useful to understand how the money supply is related to inflation, economic activity, and overall economic activity using the quantity theory of money.

However, It is necessary to recognize, however, that real-world economies are more complex, and assumptions made in the quantity theory of money may not always hold true.

Equation of exchange is associated with