Equation of exchange

Equation of exchange is an equation, first made popular by Irving Fisherin his 1911 book Purchasing Power of Money, which states: The average amount of money outstanding (M) multiplied by velocity (V), i.e., total expenditures divided by the average amount of money outstanding, equals the sum of the average price paid for each good and service (p) multiplied by the quantity of each sold (q), or MV = Σ (pq + p'q' . . . + p(n) q(n)), or more often MV = PT, in which P represents average prices and T the total physical volume of trade.

In short, the equation merely equates the sums spent to the total of prices paid, assuming an equality between the values of the prices paid and the goods bought. This is contrary to the subjective or marginal theory of value, wherein all voluntary exchanges are exchanges of unequal values. In using totals and averages, the equation of exchange also implies the fallacies inherent in the concepts of "price level" and the "neutrality of money" (q.v.).

Although designed as an explanation of the purchasing power of money, the equation of exchange is an holistic concept which fails to explain either how the purchasing power of money arises or how changes in it occur. The purchasing power of money is actually determined by the reactions of individuals to their ever changing individual situations and not by any mathematical formula.