What are the basic theories of money?
One widely accepted theory of money is known as the Quantity Theory of Money. This simply states that the price level of money is a function of the quantity of money as it relates to the demand for money necessary to meet the needs of current transactions. This is referred to as the transactions demand for money. Here’s a brief explanation: For the purpose of analysis, let us assume that full employment is the natural state of the economy. Further, we shall assume that the total output (GNP) is at its maximum in this natural state. That is, technological advances are ignored. In such an economy, an increase in the supply of money will cause people to spend the added quantity. That is, aggregate demand for goods will increase. This in turn, with output fixed, will push up prices until a new equilibrium is established. Thus, the increase in money supply can only increase price levels. Conversely, given the same conditions, if the supply of money is decreased, aggregate demand will fall,
