Importance of Money and the Fisher Equation of Exchange

Importance of money in a modern economy. Money is far more than a convenience for everyday shopping — it is the institution that makes a modern, specialised economy possible at all.

• For the individual — money lets a person sell their labour or produce for a common medium and then buy exactly the mix of goods and services they actually need, instead of being stuck with whatever a barter partner happened to offer.
• For the producer/business — money allows the value of output, cost, and profit to be measured precisely, which is what makes rational business decisions — what to produce, how much, and at what price — possible in the first place.
• For specialisation and division of labour — because money lets anyone exchange their specific output for anything else they need, workers and firms can specialise in a single trade or product rather than producing everything for themselves, raising overall productivity across the economy.
• For capital formation and banking — money that is saved rather than spent can be deposited with banks and lent onward to those who wish to invest, so money is the very medium through which an economy's savings are channelled into capital formation.
• For trade, domestic and international — money (and, across borders, foreign exchange) makes it possible to trade at any scale and over any distance, without either party needing to want the other's specific goods in return.
• For government and public finance — taxes are collected, public expenditure is budgeted, and public debt is raised and repaid entirely in money terms, making money central to how a government runs the economy and plans its development.

Fisher's equation of exchange. The American economist Irving Fisher expressed the link between the quantity of money in an economy and the general price level through a simple identity, known as the equation of exchange:

where $M$ is the total quantity of money in circulation, $V$ is the velocity of circulation of money (the average number of times a unit of money changes hands in a given period), $P$ is the general price level, and $T$ is the total volume (physical quantity) of transactions carried out in that period. The left-hand side, $MV$, is the total value of money spent in the economy; the right-hand side, $PT$, is the total value of goods and services sold — and since every rupee spent by a buyer is a rupee received by a seller, the two sides of the equation must always be equal.

Rearranging the equation gives the general price level directly:

$P = \dfrac{MV}{T}$ …