M for Money is one of the most powerful forces shaping our world, and no one truly hates it. While it may not buy all the happiness in life, its absence often guarantees the lack of it. Money may not be everything, but life becomes much more challenging without it.
We need to earn and spend money to live a comfortable life, making money go around and return.
Introduction: Why Financial Laws Matter
Money doesn’t move randomly—it follows patterns, principles, and time-tested laws. Whether you’re investing, saving, or running a business, understanding the core financial laws can help you make smarter decisions and avoid costly mistakes.
These laws, rooted in economics and behavioural finance, explain how markets function, why people react to money the way they do, and what drives value. From Gresham’s Law to the Time Value of Money, these theories aren’t just academic but practical tools that shape everyday financial outcomes.
Let’s uncover the top 10 theoretical laws that every investor, entrepreneur, and financially savvy individual should know — but few ever talk about.
Every theory comes with its own set of merits, demerits, and limitations. In this article, we’ll focus solely on the positive aspects and key insights that make these theories valuable.
1. Gresham’s Law
“Bad money drives out good.”
When two forms of money are in circulation, the one perceived as less valuable tends to stay in circulation, while the more valuable one is hoarded or disappears.
Explanation: One of the earliest financial theories was proposed by Sir Thomas Gresham, a financial agent of Queen Elizabeth I in the 16th century. This theory explains people’s behaviour when it comes to spending and hoarding physical money.
At the time, coins were made from both precious metals (like gold and silver) and cheaper alloys. People would typically spend the coins made from cheaper materials while hoarding the more valuable ones — a phenomenon known as Gresham’s Law.
In modern times, Gresham’s Law can be observed in situations like inflation, currency debasement, and even in the debate between crypto and fiat currencies.
For example, in countries with weak or unstable local currencies, people often hoard U.S. dollars or other strong foreign currencies, while continuing to spend the weaker local money.
This behaviour reflects the same principle: individuals tend to hold onto what they perceive as more valuable and get rid of what they view as less stable or “bad” money.
2. Say’s Law
“Supply creates its own demand.”
A principle in economics that suggests the production of goods creates its own demand for those goods.
Explanation: This theory was suggested by French economist Jean-Baptiste Say in the early 19th century and is a fundamental principle in classical economics. Producing goods and services generates enough income to create demand for them.
When manufacturers produce goods, they spend money by paying wages to workers, rent to landowners, and profits to entrepreneurs. The income generated from these expenditures is then used to purchase the very goods that were produced, indirectly creating demand
3. The Law of One Price
“Identical goods should sell for the same price in efficient markets.”
Explanation: The price of the same product sold at different locations should be the same, assuming no transportation costs, taxes, or other market frictions exist. Imagine a specific smartphone model is selling for $500 in New York but $600 in London. According to the Law of One Price, the price discrepancy will prompt some buyers to purchase the phone in New York, ship it to London, and sell it at a profit. Over time, this will bring the price of the smartphone in both markets closer to $500.
E-commerce platforms are a clear example of the Law of One Price in action, as they often sell products at the same price regardless of location. They typically sell products at the same Maximum Retail Price (MRP), regardless of the buyer’s location, ensuring price consistency across markets.
4. Efficient Market Hypothesis (EMH) — Fama’s Theory
“All known information is already reflected in asset prices.”
There’s no way to consistently “beat the market” using known information.
Explanation: This theory, proposed by Eugene Fama in the 1960s, has become a foundational concept in modern finance. It asserts that financial markets are “efficient,” meaning that stock prices accurately incorporate all available information. As a result, it is impossible to consistently outperform the market using any data that is already publicly known.
EMH has three forms: weak, semi-strong, and strong.
5. Modigliani-Miller Theorem (M&M Theorem)
“Under ideal conditions, the value of a firm is independent of its capital structure.”
Explanation: This foundational theory, jointly proposed by economists Franco Modigliani and Merton Miller in 1958, is a cornerstone of corporate finance. The Modigliani-Miller Theorem explores the relationship between a company’s capital structure and its overall value, challenging traditional views on financing decisions.
A company’s financial strength can be analyzed through the lens of the Modigliani-Miller Theorem. However, in real-world scenarios, factors such as taxes, bankruptcy costs, and market imperfections play a significant role in shaping a firm’s financing decisions.
6. The Law of Diminishing Marginal Utility
“As a person consumes more of a good, the additional satisfaction from each extra unit decreases.”
Explanation: As a person consumes more of a good or service, the satisfaction derived from each additional unit tends to decrease, assuming all other factors stay the same. Read more about the Law of Diminishing Marginal Utility.
This principle helps explain consumer behaviour, pricing strategies, and why people don’t continue buying in excess, even when they have the means to do so.
Imagine you’re eating your favourite ice cream
1st scoop: It’s refreshing and highly satisfying — pure enjoyment at its peak.
2nd scoop: Still good, but the thrill has slightly faded.
3rd scoop: You’re starting to feel full; the excitement drops.
4th scoop: It’s becoming too much — you’re not really enjoying it anymore.
5th scoop: You feel uncomfortable and may even regret continuing.
7. The Time Value of Money (TVM)
“Money available today is worth more than the same amount in the future due to its potential to earn interest or investment returns.”
Explanation: The value of money decreases over time because of its potential to generate earnings. Simply put, £1,000 in hand today holds greater worth than receiving the same amount a year later, since having it now allows you to invest, earn interest, or put it to productive use, increasing its overall value. Read more here.
Key Formulas:
Future Value (FV):
FV = PV × (1 + r)ⁿ
Where PV = Present Value, r = interest rate, n = time period
2. Present Value (PV):
PV = FV / (1 + r)ⁿ
(Used to find today’s value of future money)
The TVM is used in
- Loan repayments and EMI planning
- Investment comparisons
- Business project evaluation (NPV, IRR)
- Retirement and savings planning
8. The Fisher Equation
“Nominal interest rate = Real interest rate + Expected inflation”
Explanation: The Fisher Equation, developed by American economist Irving Fisher, explains the relationship between inflation, the nominal interest rate, and the real interest rate. It serves as a vital tool for investors, borrowers, and savers to understand the true value of money over time—especially during periods of inflation.
The Fisher Equation highlights how the value of money erodes during inflation. Subtract the inflation rate from the nominal interest rate to find your real return or cost.
9. Metcalfe’s Law
“The value of a network is proportional to the square of its number of users.”
Explanation: Introduced in the 1980s by Robert Metcalfe, the co-inventor of Ethernet, Metcalfe’s Law suggests that the value of a communication network increases proportionally to the square of its user base, meaning the network becomes significantly more valuable as more users join. This principle applies not only to networks like the internet, social media platforms, and telephone systems, but also extends to ecommerce platforms, where the value increases as more users and participants join.
Therefore, with each new user, the overall value of the network increases at an accelerating rate.
10. Keynes’ Liquidity Preference Theory
“People prefer to hold cash unless rewarded with interest.”
Explanation: This theory, proposed by renowned British economist John Maynard Keynes in his seminal work The General Theory of Employment, Interest, and Money (1936), outlines how the demand for money is influenced by various factors, including interest rates, income levels, and economic uncertainty. It emphasises the role of liquidity preference in shaping individuals’ financial decisions and overall economic activity.
Keynes’ Liquidity Preference Theory explains “Why People Hold Cash”
According to Keynes, people prefer to hold their wealth in the form of liquid assets (like cash) rather than investing it or holding it in illiquid assets (like bonds, stocks, or real estate) due to three main motives:
- Transaction Motive:
People hold a certain amount of cash based on their income levels to cover daily expenses and routine financial transactions, ensuring smooth day-to-day operations without needing to liquidate assets.
2. Precautionary Motive:
As part of their financial safety net, individuals prefer to keep cash on hand to guard against unforeseen circumstances or emergencies. This could include situations like sudden medical expenses or job loss, where immediate access to funds is crucial.
3. Speculative Motive:
Individuals may choose to hold cash to capitalise on future investment opportunities, especially when they anticipate favourable conditions. By holding liquidity, they remain flexible to invest in assets when market prices are attractive or interest rates offer high returns.
Conclusion: Applying These Laws to Everyday Finance
Understanding and applying these fundamental financial laws can significantly improve your approach to managing money. For example, Gresham’s Law reminds us of the impact inflation and currency devaluation can have on our spending and savings habits. Say’s Law emphasizes the importance of creating value in the economy and how it influences our financial decisions.
The Law of One Price helps us recognize the impact of market efficiency, especially in today’s digital economy. Similarly, Metcalfe’s Law illustrates the exponential value that networks, such as social media or e-commerce platforms, create as they grow. By grasping the Time Value of Money and Fisher’s Equation, we can make smarter investment choices, calculate real returns, and better understand the costs of delaying decisions.
By integrating these theories into everyday financial planning, we gain deeper insights and make more informed decisions about saving, investing, and spending and become smarter in money management.
