The Equation of Exchange: A Derivation

This paper provides a theoretically plausible model to explain the equation of exchange, deriving it from an agent's utility maximization problem and the profit maximization behavior of a competitive firm. It shows that the marginal propensity to consume is constant, while the average propensity to consume is decreasing as income increases. Supporting the notion that consumption growth is positively related to income growth, it confirms that the marginal propensity to consume has a theoretical basis for modifying velocity, money demand and consumption,given that money demand is inversely related to the interest rate and positively related to income