Formula to Calculate the Velocity of Money

The velocity of money refers to the frequency with which a currency unit can be exchanged for purchasing the goods and the services manufactured domestically during the specified period, i.e., it is the number of times money moves from one entity to another entity.

The formula for the Velocity of Money can be calculated:

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Where,

  • NGDP = Nominal Gross Domestic Product –  The Nominal Gross Domestic ProductNominal Gross Domestic ProductNominal GDP (Gross Domestic Product) is the calculation of annual economic production of the entire country’s population at current market prices of goods and services generated by four main sources: land appreciation, labour wages, capital investment interest, and entrepreneur profits calculated only on finished goods and services.read more will be calculated first either using the expenditure method or income method or factor of productionFactor Of ProductionFactors of production define resources used to produce or create finished goods and services, the sale and purchase of which keeps the market economy afloat.read more method.AM = Average amount of money that circulates in the country. This figure can be obtained from the central bank of the country.

Examples

Example #1

Consider the nominal GDP of country Y is $2,525, and the average amount of money circulation in the economy is $1345. Then, based on the above information, you must calculate the velocity of money.

Solution

We are given both the nominal gross domestic product and average money circulation. We can use the below formula to calculate the velocity of money. Use the below-given data for the calculation of the velocity of money.

Therefore, the calculation of the velocity of money is as follows,

=2525.00/1345.00

The velocity of money will be –

  • The velocity of money = 1.8773

Therefore, the velocity of money is 1.8773.

Example #2

St. Maarten is a very small island near the Caribbean island. The average population on the island is 41,109, as per the latest census data available. Assuming that the average amount of money kept per individual per month is $1,000. The country’s nominal GDP per the latest publicly available data is $1.394 billion. The finance minister was asked to calculate the money velocity of the country as the average growth has not crossed 2% for some of the last periods. The minister was advised to increase the money supply in the economy if the money velocity is below 50.

Based on the above details, you are required to calculate the Velocity of Money and comment on whether more printing of the money would be necessary?

We are given the Nominal Gross Domestic Product as $1.394 billion and average money circulation will be calculated per below:

Average Circulation of Money can be calculated using the below formula as,

The average amount of money per person in the economy x population of the country

=41109.00*1000.00

  • Average Circulation of Money =41109000.00

=1394000000.00/41109000.00

  • Velocity of Money = 33.91

Therefore, the velocity of money is 33.91 and since it is below 50, the country will be required to print more money.

Example #3

Economic Z is a special economy. Due to the recent war, two individuals have decided to start the business. One person named X has started a business of food, and another person named Y has started the business of clothing. Following transactions had taken place during 1st month of that year when initially they had $300:

  • X purchases food for $150 from Y.X purchases food again for $150.Y then purchases cloth from X for $200.Y then purchases cloth for his family from X for $100.

They continue these transactions for the next 11 months as well.

Based on the above information, you are required to calculate the velocity of money for this economy where currently only two traders are there.

The Nominal GDP would be $300 x 12 which is $3,600 as a nominal GDP. The average money that the economy had was $300.

=3600.00/300.00

  • The Velocity of Money = 12

Therefore, the velocity of money is 12.

Calculator

You can use this velocity of money formula calculator

Relevance and Uses

To be more specific, the economists are of differing opinions on whether the velocity of money concept can indeed be used to measure the country’s health or the inflationary pressures. Some monetarists argue that the money velocity can remain stable during changing expectations. Still, when there is a change in the supply of money, that shall alter the market expectations, and subsequently, inflation and money velocity would also be impacted. Take an example, when there is an increase in the supply of the money that should theoretically also lead to a price increase commensurately as there is more supply of the money which shall be chasing a similar level of services and goods in the country.

Then there will be vice versa with a decrease in the money supply. But, on the other hand, some critics argue that the velocity of money is not very stable, that it keeps on changing, and prices shall be resistant to change, which shall result in an indirect link and weaker link between the inflation and supply of money in the short period.

If the supply of money increases, but there is a decrease in velocity, then GDP might even decline or stay the same. Conversely, the GDP could rise if the money supply has not increased, but the money velocity has increased.

This has been a guide to the velocity of the money formula. Here we discuss the formula to calculate the velocity of money and practical examples and a downloadable excel template. You can learn more about economics from the following articles –

  • Forward PremiumForward PremiumForward premium is when the future exchange rate is predicted to be more than spot exchange rate. Notation of D/F indicates that the F currency is the base currency and D currency will depreciate against it.read moreFiat MoneyMoney Measurement ConceptMoney Measurement ConceptAccording to the money measurement concept of accounting, a company should only record in its financial statement only those events or transactions that are measured in terms of money. If assigning the monetary value to the transactions is not possible, it will not be recorded in the financial statement.read moreRecessionary GapQuantity Theory of Money Definition