Introduction:

The Theory of cash transaction is purely a quantitative theory of money which is based on the primary function of money that is medium of exchange. The framer of the theory was Adam Smith, David Ricardo, J.S. Mill Etc. Later on the theory was popularized by Irving Fisher.

Theory Explanation.

Cash transaction approach is a relationship between the supply of money and the general price level. The explanation was given by the classical economist like David Hume, wick sell, Adam Smith, Ricardo and J.S mill. It was refined and popularized by the professor Irving fisher in the 1920. According to this theory any change in the quantity of money produces direct and proportional change in the price level.

In the words of Irwin fisher “other things remaining constant as the quantity of money in circulation increases, the price level also increases in direct proportion and the value of money decreases and vice versa”

Fisher has explained his theory in terms of his equation of exchange, PT=MV+MV where

• P = general price level
• T =physical volume of output.
• M=total quantity of money
• V= velocity of circulation of money
• M= total quantity of credit money

According to him V and T are constant; P varies directly and proportionately with a change in M. Fisher explains If the quantity of money in circulation in double the price level will also be doubled and value of money is reduce the price level also decrease in the same proportion. This relationship is explained with the help of following diagram;

Fishers quantity theory of money is explained with the help of figure A and B. Figure A shows that the effect of changes in the quantity of money on the price level. when the quantity of money is M, the price level is P. than the quantity was M2 than the price level is also P2 and the quantity was M4, price level will also be P4 and so on.

In the case of figure B there will be opposite relationship between quantity of money and the value of money. When quantity of money is M1 the value of money is 1/p and when quantity of money is M2 than the value of money is 1/p2 and than when the quantity of money is M4 than the value will be 1/p4 and so on. this shows that the continuous rise in the quantity of money there will be continuous fall in the value of money.

Assumptions:

• Money is assume to perform the functions of medium of exchange that is money demanded only for the purpose of purchasing goods and services
• Price level P2 is a passive factor in the equation of exchange and it is affected by other factors
• The theory assumes that the physical volume of output remains constant
• The theory also assumes the velocity of circulation of currency and Bank deposit remain constant
• The supply of money is considered as an independent variable which does not vary with p, t or v

Criticisms:

• In real v and T are not constant they influence price level also
• The four variables M,V, P and T are not independent of one another
• Quantity of money is not principal cause of changes in the price level
• Keynes criticized this theory because it neglects the rate of interest
• The theory regards money has merely a medium of exchange and ignores store of value and maybe wanted for speculative purpose also.

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