Why is there Money?

Why is there Money?

Walrasian General Equilibrium Foundations of Monetary Theory

Ross M. Starr

The microeconomic foundation of the theory of money has long represented a puzzle to economic theory. Why is there Money? derives the foundations of monetary theory from advanced price theory in a mathematically precise family of trading post models.

Chapter 2: An Economy Without Money

Ross M. Starr

Subjects: economics and finance, history of economic thought, money and banking


This chapter introduces the Arrow2Debreu general equilibrium model including futures markets and contingent commodity markets. The result is a model of a successfully functioning economy over time and uncertainty, without money. This model is not a practical proposal, rather it fully represents the classroom exercise of considering how an economy might work without money and monetary institutions. The point of the exercise is to formalize the essential functions of money by demonstrating how the economy would have to adapt in their absence. 1 1.1 THE ARROW2DEBREU MODEL OF GENERAL EQUILIBRIUM An Economy without Money To better understand what money does for us in an economy, a common classroom exercise is to conceive of how an economy would work without money. Economic analysis has actually done quite a thorough job of modeling this idea, known as the Arrow2Debreu model of general equilibrium. Once we understand the complexity of running an economy without money, the comparative ease of a monetary economy becomes evident. The late James Tobin once explained that the ‘inconveniences of barter’ consist in how difficult it would be to pay for lodging in a remote town, in a barter economy. Paraphrasing the elaboration in Ostroy and Starr (1974), the explanation goes as follows. Consider Professor Tobin traveling far from home. He stops at a hotel and asks for lodging for the night. The clerk replies, ‘That will be one hundred dollars (unit of account).’ Tobin agrees and extracts from the trunk of his car a copy of his...

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