The quantity theory of money stated by Fisher that P = MV/T is complete explanation of why prices change. Discuss.

The theory is based on the following assumptions

• The demand and supply for money are equal and therefore proportional
• The supply of money is exogenously determined i.e. minted by the Central Bank
• Barter engagement do not alter the quantity of money
• Price is the only affected by changes in money supply
• There is full employment
• The number of transactions (T) and velocity of money (V) do not change
• No money is withheld that is all of it is spent
• It is operational in the long run

However the theory is not complete as to why prices change. These are the reasons

• It assumes that velocity and number of transactions are kept constant, but this is not true because money supply increases also the volume of transactions increase and this affects velocity of money
• It assumes that the quantity of money (M) is directly proportional to the general price (P). But prices of different commodities do not change in the same proportions even if money (M) doubles. Therefore assumed general price level does not exist.
• The theory ignores existence of barter trade in which transactions take place without use of any money supplied. Therefore in some cases, price is determined by other factors other than the amount of money in the circulation. The theory fails to consider other factors that lead to change in price other than the quantity of money in the circulation
• In case of high liquidity preference, an increase in the quantity of money does not lead to an increase in price since much of the money is kept and not spent
• The theory only considers the transactions motive of holding money but again ignores motives of holding money such as precautionary and speculative motives. This is unrealistic because people do not only hold money for transaction purposes.
• The theory attempts to explain changes in the value of money but does not explain how the value of money is determined. Therefore the theory is weak in explanations and assumptions.
• The theory emphasizes the supply of money and does not talk about money demand yet practically the level of money demand determines how the money is to be spent and consequently affects economic activities in economy.
• The theory only gives relationship between money and the general price level but fails to give relationship between money and real factors in the development process
• The theory ignores the effect of government price control through minimum and maximum price legislations where an increase in money where an increase in money supply in economy will not lead to change in general prices level.
• It is assumed that increase in money supply lead to increase in the general price level assuming that whenever money is supplied is used for consumptions. However in case where there is marginal propensity to save (MPs) is high, it does not lead to an increase in general prices, since the additional quantity of money is the circulation is saved.
• This is not a theory at all, if it is a truism shows that M, V, P and T are related if it does not show us how these variable change,
• According to the theory, M, V, P and T are independent of each other, which is not true. A change in M can affect V and T so a rise in M can increase P but T can increase as well due to an increase in aggregate demand.
• When output increases and employment expands, money supply may increase without affecting the price level
• It ignores other causes of inflation than an increase in money supply