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Velocity of Money

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The velocity of money is the rate at which money is exchanged from one transaction to another and how much a unit of currency is used in a given period of time. Velocity of money is usually measured as a ratio of GNP to a country's total supply of money.

The term "velocity of money" refers to how fast money passes from one holder to the next. It is important in any economy to take all measures to increase the velocity of money. Let's outline a very simple example of velocity of money and what it means to the economy, in general. Let's say that we have three companies/individuals, but only one has any money (money can be viewed as cash, but does not necessarily 'only cash'). If Company #1 sits on their money and simply holds on, for whatever reason, the velocity is understood to equal zero and thus all buying and/or spending is non-existent, and the general economy will most certainly suffer. But if Company #1 wants to expand their business and has certain "needs" (supplies, equipment, personnel, whatever) in order to expand, then they go to Company #2 to buy the necessary equipment or supplies or services or whatever the requirement was for Company #1 to expand. Now Company #2 has money that they can use to add employees or add products/supplies/services from Company #3. Now Company #3 can go to Company #1 and issue an order for Company #1 services/products/supplies/whatever.

This is a very simple example of increasing the "velocity" of money, and the frequency of those orders discribed in this "closed loop" dictates "the velocity of money". This, indeed, is referred to as the income velocity of money, which is the frequency at which the average same unit of currency is used to purchase newly domestically-produced goods and services within a given period of time period. In other words, it is the number of times one unit of money is spent to buy goods and services per unit of time.

Transactions as have been described can not only apply to newly produced goods and services, but also the purchase of financial assets and other service items. If the velocity of money is increasing, then transactions are occurring between individuals more frequently. It should be understood that the velocity of money changes over time and can be influenced by a variety of complex factors. Logically, the fast the velocity of money, the more robust the economy.
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