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Definition of 'Equation Of Exchange'
An economic equation that showcases the relationship between money supply, velocity of money, the price level and an index of expenditures. The equation was derived by John Stuart Mill, and based of the early ideas of David Hume. The equation of exchange is as follows:
Where:
M = money supply
V = velocity of money
P = average price level of goods
T = index of expenditures (such as the total number of economic transactions)
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Investopedia explains 'Equation Of Exchange'
The equation of exchange has two primary uses. It represents a founding principle used by the quantity theory of money, which relates increases in the money supply to increases in the overall level of prices. Additionally, solving the equation for 'M' can serve as an indicator of the demand for money.
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