Transactions School Theory

Transactions School Theory – To the transaction theorist who postulated the Transactions theory, the value of money like the value of any other economic good is determined by the forces of demand and supply. Although they recognized that the value of an economic good is determined by the conditions of supply and demand in a given moment of time, the transaction theorist preferred to think of the determination of the value of money as a process taking place in a period.

With respect to supply they considered not only the average quantity of money available throughout the period of time but also the average velocity of turnover of that quantity. Therefore, supply is average velocity. On the other hand, the demand for money is described by them as the volume of trade or as the total sales of commodities, services and property rights in exchange for money in a given period of time.

In the view of the theorist of the Transactions school theory therefore, there are three immediate determinants of the value of money, they are as follows,

  1. The average quantity of money available
  2. Its average velocity and
  3. The volume if the trade

The concern of the theorist is with the changes that take place in the magnitude of the three determinant because they hold that such changes, to the extent that they do not offset one another, produce variations in the value of the money, while in turn produced mal-adjustments through the government economic system.

As a general supply and demand analysis, they hold that in increase in the supply of money unaccompanied by a change in demand for money with its supply unchanged will cause it value to rise. Lastly they contend that changes in the supply of and demand for money will produce proportional variations in it value either direct or indirect depending upon which of the immediate determinants reproduce. In summary the fundamental proportion of the Transactions school theory is that other things being equal , the general price level varies in direct proportion to the supply of money and in inverse proportion to the demand for money ; Demand for money/M = Demand P/P…….. where M = Money Supply, P = price level and D = demand.

To demonstrate this position without necessarily proving it, the transactions theorist made use of the equation of Exchange – MV = PT. Irving Fisher modified this equation somewhat in the modern transaction by postulating the;

MV + M’V’ = PT where

MV = Money proper

M’V’ = Bank demand deposits

V = Velocity

But that aside, the original equation of exchange, P = general price level. It represents the average prices paid for all kinds of goods and services that entered into the transactions during a period of time. Because P is the interest as the transactions theorist attempts to explain why changes in P takes place;

M = Average quantity of money available throughout the years.

V = Average velocity of money in the same period is the average number of times a unit of money is spent during a unit time period.

Thus MV represents the total amount of spending in the economy for the money supply in the volume of trade or the demand for money in a given period is represented by T, that means that T iis an index number of quantities traded according to the Transactions school theory.

  1. Resources of the economy (i) Population, size, skill, philosophy (ii) Land, qty, fertility, natural resources (iii) Capital (iv) State of technology
  2. Extent to which resources are utilized
  3. Business structure and practice (i) Extent of specialization (i) degree of vertical integration (iii) Extent of barter .
  4. Volume of the goods already in existence.

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