This theory was postulated by Irving Fisher an American Economist in his book ‘The Purchasing Power of Money’ in the year 1911.

This theory of money demand is classified under the classical theory of money demand

In this theory of money demand, Fisher and other classical economists lay stress on the medium of exchange function of money i.e. money as a means of buying goods and services. All transactions involving the purchase of goods and services and raw materials need money to indicate the value of transactions made.

If the accounting identity (i.e. the value paid must equal to the value received) is to occur then the value of goods, services and assets sold must be equal to the value of money paid for them. Thus, in any given period the value of all goods and services or assets sold must equal the no of transactions (T) multiplied by the average price of the transactions made (P). Hence the total value of transactions made is equal to PT. Similarly, because the value paid is identical to the value of money flow (that is money used for buying goods services and assets), the value of money flow is equal to the nominal money supply (M) multiplied by the average no of times the quantity of money in circulation is exchanged for transactions purposes i.e. transactions velocity of circulation (V)

Thus

MV=PT

Where M stands for Quantity of money in circulation

V; Transactions velocity of circulation

P; Average price

T; the total number of transactions

The above identity was transformed into a theory of demand by taking the following assumptions;

- According to Fisher the Nominal quantity of money is fixed by the Central Bank of a country and is assumed to be a given quantity in a particular period of time.

Further, the number of transactions in a period is a function of the National income (Y). The greater the Y, the greater the number of transactions. Fisher assumed that full employment of resources prevailed in the economy and hence the level of fully employed resources determined the volume of transactions (T).

T was therefore assumed to be fixed in the short run just like the full employment level.

- The most important assumption that makes Fisher’s identity a theory of money demand is that V remains constant and is independent of M, P and T.

Fisher thought that V is determined by; institutional and technological factors that do not vary in the short run, methods and practices of factor payments such as the frequency of wage payment, the habits of workers regarding the spending of their money after they receive them and development of banking and credit systems i.e. the ways and speed with which cheques are cleared, loans paid etc.

- In the equilibrium analysis, the nominal quantity of money (Ms) must be equal to the nominal Money demand i.e. Ms=Md

With the above assumptions, Fisher’s equation of exchange can be written as

Md = PT/V

According to the fisher’s transactions approach, demand for money depends on the following three factors.

T; total no of transactions in the economy

P; Average price level

V; transactions velocity of circulation of money

**Illustration**

Suppose the quantity of money is Ksh 5000 in an economy, the velocity of circulation of money (V) is 5 and the total output to be transacted (T) is 250 units. what is the average price in the economy?

Money demand is given by

Md= PT/V

The average price level (P) will be:

p=Md*V/T

Assuming an equilibrium position;

Md=Ms.

Thus, P will be given by;

P=Ms*V/T

P=(5000 *5)/250

P=Ksh.100 per unit

If now other things remain the same the quantity of money is doubled i.e. increased to Ksh 10000 then;

P=Ms*V/T

P= (10000*5)/250

P=Ksh 200 per unit

Thus, we see that according to the quantity theory of money, price level varies in direct proportion to the quantity of money.

A doubling of the quantity of money (M) will lead to a doubling of the price level. further, since changes in the quantity of money are assumed to be independent or autonomous of the price level, the changes in the quantity of money become the cause of the changes in the price level

**Limitations of Fishers transactions approach**

The Fishers transactions approach to money has several limitations;

- In Fisher’s transactions approach, not only are the transactions involving the current period of goods and services included but also those which arise in the sale and purchase of capital assets such as securities, shares, land etc. Due to the frequent changes in value for these assets, it is not appropriate to assume that T will remain constant even if Y is taken to be constant due to the full employment assumption.

- There is difficult to determine and define a general price level that covers not only the goods and services currently produced but also the assets mentioned above.