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Assumption of Fisher’s Equation

Fisher’s equation of change is based upon the following assumptions:-

(1)    The price level or P is a passive factor in the equation of exchange. Price is affected by other factor in the equation but does not affect or cause change in those factors. The relation between P and other factors in the equation is one-sided in as much as P is determined by other elements in the equation but it does not determine them.

(2)    The theory assumes that T and V remain constant during the short period. Since T depends open the value of production, and the technique of production remaining unchanged during the short period, it also remains unchanged. Similarly, V depends upon the size of populations, state of economic development , money habits of the people, which remain unaltered during the short period.

(3)    The theory assumes that the ratio of bank money to legal lender money remains constant. In Fisher’s words, “under any given condition of industry and civilization deposits tend to hold a fixed normal ratio to money in circulation. Thus,. the inclusion of ‘M’ does not normally disturb the quantitative relation between money price.” If the ratio of bank money to legal money does not remain constant, than the quantitative relation between money and prices will not hold true.

Thus, four variables, i.e., M’, V, V’ and T remain constant in Fisher’s equation of exchange during the short period. Since general price level, P, is also a passive element in the equation, therefore, the changes in the quantity of money directly the price level.

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