In this blog post we are going to be looking at The value of money: definition, measurement of value of money, factors determining the value of money and theory.
Table Of Contents
- Definition of the value of money.
- Factors that determine the value of money.
- Measurement of value of money
- And the quantity theory of money.
THE VALUE OF MONEY
Definition: The value money is defined as the quantity of goods and services which a given amount of money can buy. In other words, the value of money refers to the purchasing power of money.
When a certain amount of money can buy fewer goods and services, this will mean that the value of money has fallen and this can only happen when there is rise in prices. But if a given amount has risen, and this can only happen when there is a fall in prices such as when a N50 note can purchase 20 cups of beans instead of 10, this means there is an increase in the value of money.
FACTORS THAT DETERMINE THE VALUE OF MONEY
Here are the various factors which determines the value of money, they include:
- The price level: The value of money varies with the price level. If the price level increases, this would mean that a given sum of money would buy a fewer goods and services. The value of money therefore falls with an increase in the price level. Note that a fall in price leads to an increase in the value of money.
- The supply of money and its speed or velocity in circulation: When a given quantity of money in circulation increases while there is little or no corresponding increase in the availability of quantity of goods and services, this would mean that a larger quantity of money would purchase fewer commodities. The value of money will therefore be low. The velocity of circulation of money refers to the speed at which money circulates within the economy by changing from one hand to another. When there is an increase in the velocity of circulation of money, prices increases, leading to a lowering in the value of money.
- Inflation and deflation: It is generally known that the value of money reduces during the period of inflation while its value increases during deflation.
- Volume of goods and services: The level of production determines the volume of goods and services in an economy. When more goods and services are available while the supply of money remains constant, the value of money will increase. This is due to the fact that more commodities can be purchased with a given sum of money.
MEASUREMENT OF VALUE OF MONEY
Next, we are going to be looking at the measurement of value of money
- The value of money as well as the nations cost of living is measured by the use of price index, which is also called index of retail prices. A price index is a weighed average of prices and is expressed as a percentage of prizes existing in a base year. As discuss earlier, the value of money inversely related to price level. An index number is defined as a single number which measures changes in prices of goods and services over a given period of time. The price index number can be determined by illustrating with different items, namely bournvita and sugar. The prices of the two items in 2023 are taking as a base year and the prices of 2024 as a current year.
THE QUANTITY THEORY OF MONEY
Next we take a look at the quantity theory of Money, definition and examples.
Definition: The quantity theory of Money is defined as the relationship between the quantity of money in circulation in an economy and the price level.
The quantity theory of Money is one of the theories that try to explain what happens when there is an imbalance between the demand for money (by household and firms) and supply of money to those economic units. The theory explained that if people hold more money than they require ( i.e, if there is an excess supply of money over the demand), they will spend the surplus on currently produced goods and services. This will increase the price level.
The quantity theory of Money also state that an increase in the quantity of money in circulation would bring about services.
Professor Irving Fisher remodified the quantity theory of money into what is known as velocity of circulation of money. Velocity of circulation of money according to professor Fisher, refers to the speed at which money circulate within the economy by changing from one hand to another. When there is an increase in the velocity of circulation of money, prices will increase, leading to lower value of money.
The quantity theory of Money modified by Fisher is expressed in what is known as the quantity equation of exchange and is represented by this equation MV = PT
M = supply of money
V = velocity of circulation of money
P = price level
T = quantity of goods
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