Quantity Equation

Published Jan 14, 2023

Definition of Quantity Equation

The quantity equation is an economic equation that describes the relationship between the money supply, the price level, and the real output of an economy. It states that the money supply (M) multiplied by the velocity of money circulation (V) is equal to the price level (P) multiplied by the real GDP (Y).

This results in the following formula: MV = PY.

Example

To illustrate this, let’s assume the money supply in an economy is USD 500 billion, the velocity of circulation is 5, and the real GDP is USD 1 trillion. That means the quantity equation can be written as follows:
M x V = P x Y
400 billion x 5 = P x 1 trillion
P = 2000 trillion / 1 trillion
P = 2

Why the Quantity Equation Matters

The quantity equation is an important tool for economists and policymakers. It helps them to understand the relationship between the money supply, the price level, and the real output of an economy. This, in turn, allows them to make better decisions when it comes to monetary policy.

If the money supply increases, all else equal, the equation tells us that the price level will also increase. Thus, policymakers can use this information to adjust the money supply in order to keep inflation in check.