Money, Financial Intermediation and Governance

Money, Financial Intermediation and Governance

Dino Falaschetti and Michael J. Orlando

Dino Falaschetti and Michael Orlando unify the treatment of the many deeply related topics in money and banking in this wide-ranging book. By continually building on the assumption that economic actors are maximizers, they explain how monetary and financial services, as well as related governance mechanisms, influence economic performance. In this manner, Money, Financial Intermediation and Governance not only lets readers make sense of today’s monetary authorities and financial markets, it lets them see through superficial complexities to the fundamental influences that will shape those organizations for years to come.

Chapter 3: A Model Economy

Dino Falaschetti and Michael J. Orlando

Subjects: business and management, corporate governance, economics and finance, corporate governance, financial economics and regulation, money and banking


INTRODUCTION In addition to understanding the necessity of modeling and what constitutes a good model, we now understand why the axiom of maximizing behavior can yield firmly grounded insights to human sociality. We conclude Part I by employing this axiomatic approach to build a very simple model economy. Building this model will not only strengthen our ability to think like a social scientist, it will also let us precisely define the fundamental issues in ‘money and banking’ – that is, how societies economize on transacting in spot and future markets, and how this organization relates to economic performance. MAXIMIZING-HOUSEHOLDS AND THE DEMAND CURVE Equipped with the axiom of maximizing-behavior, we can now build (from the ground up!) a model economy. We’ll start by considering how households’ egoistic behavior yields the familiar principles-level insight that demand curves slope downward. Suppose that households enter our model economy with preferences represented by the indifference curves shown in Figure 3.1.1 Also assume that, subject to a budget constraint, our households choose consumption bundles ‘as if’ they maximize utility. Characterized as such, our household’s problem is formally identical to that of our moose in Chapter 2 – that is, maximizing-households choose bundles like (x1, x2) from feasible opportunity sets. Why does our axiom yield this implication? In short, any other choice would forgo superior, and feasible, levels of utility. If our household consumed less of good 1 than is represented by x1, for example, then it would not be maximizing. Indeed, for all such inferior...

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