Tuesday, May 26, 2009

Concept VIII: Profit & The Quantity Theory of Money

Consider a shop with a quantity of goods q* that he has produced at a cost of M*.

If there is nobody around, the shop has no business.

Suppose there are people who love the goods but they have no money.

The shop can extend credit to the people and let them have the goods they want.

The shop can fix a price or negotiate with the people.

Suppose the goods q1 are sold at price p1.

The people owe the shop a sum equivalent to p1q1 - which may or may not be greater than M*.

The shop can extend credit until there are no more goods in the shop.

If the total credit given out is p1q1+p2q2=p*q*, then the accrued profit of the shop is equivalent to (p*q*-M*).

The quantity is unchanged at q* (being fully sold out), the price fetched varies (p1 and p2) while there is no quantity of money.

Of course, the transaction is not completed until the people pay the shop or the shop recoups by taking some of the possessions of the people such as motorbike or land.


In the macroeconomy, the national output y can be produced with a quantity of the money supply M.

Businesses can sell what they produce at whatever price the demand is.

If the stock of money supply is unchanged, it is likely that the market price they can fetch is insufficient for them to make a profit.

However, they can fix the price that will give them the expected profit.

They can sell in batches of smaller quantities or they can extend credit to their customers.

This process of retailing and credit extension can go on even when the banks are reluctant to lend, so long as the people have confidence in each other.

In this way, therefore, MV=py where M=the money stock, p=market price, y=national output and V=velocity of money or the number of times M goes round the system.

In reality, V is variable for it depends very much on the system of buying and selling that the society has come to accept and the confidence society has of itself.

In the modern impersonal world, V is likely to be very low because shops do not trust their customers and they require banks to provide the credit.

If banks are not prudent in their lending, the banking system can go bankrupt and the economic system can falter.

Profitability is nothing but a product of credit expansion.

Sustainable economic growth is nothing but credit expansion in the right direction.

1 comment:

walla said...