Perfect Velocity

The income velocity of money is defined as the number of times an individual unit of currency turns over (i.e., is spent) in a specific period of time. According to Investopedia:

"Velocity is important for measuring the rate at which money in circulation is used for purchasing goods and services. This helps investors gauge how robust the economy is. It is usually measured as a ratio of GNP to a country's total supply of money."

To common sense, money velocity would be correlated with prices. If prices go down, desire for the item increases and more of it is purchased—so velocity increases. If prices rise, the opposite happens, and money velocity slows. Inventory shrinks as money velocity increases, and inventory grows as money velocity slows.

So velocity works to reconcile discrepancies of price and inventory. High velocity occurs when goods are priced low. This might be a good strategy when, say, one it starting a business, to become well known. Low velocity occurs when goods are overpriced.

So what is that “perfect velocity,” then, right in the middle of low and high? How is that determined?

Perfect velocity is no velocity, or no monetary exchange—an exact equilibrium at the given moment between money supply and inventory, where all goods are priced right at, or maybe slightly above, the total money supply, and nothing is bought. Perfect velocity is zero; viewing the economy at a freeze-frame moment. Now, say someone becomes hungry and wants a taco, there is a disruption in equilibrium. The onset of desire as driven by hunger drives the impulse for the taco over the price barrier, and the taco is bought and consumed.

Say instead of a couple dollars for a taco, the tacqueria owner charges $50 a piece. It is rare that desire for a taco ever goes that high, but surely there must be a few rich people who enjoy eating tacos in peace and quiet, so maybe a taco is sold every couple of weeks at that rate. Tacos are readily available and introduced into the economy as they are demanded, but if a manufactured item is regularly produced, and it is overpriced, then inventory starts to build. Prices must drop so the velocity is such that consumption equals production; if viewed over time, this is perfect velocity.

Perfect velocity is where the inventory remains constant and is consumed as fast as it is produced. If an item were hotly desired and flying off the shelves, it is under-priced. One might have to get on a waiting list to buy it. If inventory builds, an item is overpriced, which reflects an error of pricing. This concept of "perfect velocity" will be used to argue the equivalence of money supply and inventory.