Foundation
The foundation of the equation of exchange is the more complex relation
where
- and are the respective price and quantity of the i-th transaction.
- is a row vector of the .
- is a column vector of the .
The equation
is based upon the presumption of the classical dichotomy — that there is a relatively clean distinction between overall increases or decreases in prices and underlying, “real” economic variables — and that this distinction may be captured in terms of price indices, so that inflationary or deflationary components of p may be extracted as the multiplier P, which is the aggregate price level:
where is a row vector of relative prices; and likewise for
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