Classical theory:
Classical economist emphasized the transaction demand for money because according to classical economist money acts as a medium for exchange of goods and services in Fisher’s equation of Exchange.
MV=PT where
M= The total quantity or supply of money
V= Velocity of money
P= The price level
T= Total amount of goods and services
The right hand side of the equation PT represents the demand for money, which in turn depends upon the value of transactions to be undertaken in the economy. And MV represents the supply of money which is given and is in equilibrium equals the demand for money. Thus the equation becomes.
Md=PT,
Ms=MV
In the end the classical theory of demand for money may be summarized as under:
- Money acts as a medium of exchange
- Velocity of money is constant
- The people hold a constant fraction of their nominal income for transaction and precaution motives.
- Quantity of money demanded is directly related to the price levels.