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The following equation that is the fundamental equation behind the Quantity Theory of Money: MV = PY, (1) where M is the nominal money supply,
The following equation that is the fundamental equation behind the Quantity Theory of Money: MV = PY, (1) where M is the nominal money supply, Vi is the velocity of money, P4 is the price level of goods and services and Y, is the level of output. All the variables are measured in period t as indicated by the subscript. This equation describes a theory relating the nominal value of period output to the stock of money being used to purchase this output. The ratio between the nominal expenditure on period output and the stock of money is the number of times the stock of money is turned over in order to equate expenditures to the money supply. Consider our textbook OLG model of a monetary economy. Assume that young individuals are born and receive an endowment of ej units of the consumption good while old individuals receive no endowments. A stock of fiat money of size M is divided equally across the initial N old individuals and there is no money growth. Each period, a cohort of young individuals of size N is born and the previous period's old leaves the economy. The size of the youth population is constant over time. Individuals live for two periods. Their objective is to maximize lifetime utility u(C1,t) + Bu(C2,t+1) where the utility function u(c) has the properties that the marginal utility of consumption is strictly positive, u' (c) > 0, there is diminishing marginal utility of consumption u" (c) 0, there is diminishing marginal utility of consumption u" (c)
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