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 4: An Elementary Linear Example: Liquidity Creates Money

Ross M. Starr

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


1 This chapter considers a pure exchange trading post economy with linear transaction costs. One commodity has, by assumption, distinctively low transaction cost. Bid and ask prices for all goods in exchange for the low transaction cost good reflect its low transaction cost, creating a narrow bid2ask spread. In general equilibrium and assuming the absence of double coincidence of wants, the low transaction cost commodity becomes the common medium of exchange. Its specialization as the common medium of exchange is the result of decentralized exchange and competitive pricing. There is no role for government, legal tender, or consensus. Monetization is fully decentralized. 1 THE MOST SALEABLE GOOD The most elementary function of money 2 the medium of exchange 2 is as a carrier of value held between successive transactions. Carl Menger (1892 p. 243) reminds us that the distinguishing feature of the medium of exchange should be liquidity: [W]hy . . . is . . . economic man . . . ready to accept a certain kind of commodity, even if he does not need it . . . in exchange for all the goods he has brought to market[?] .  .  . The theory of money necessarily presupposes a theory of the saleableness [Absätzfahigkeit] of goods [Call] goods . . . more or less saleable, according to the . . . facility with which they can be disposed of . . . at current purchasing prices or with less or more diminution . . . Men . . . exchange goods .  .  . for other goods .  .  . more saleable [which] become generally acceptable media of exchange. (Emphasis in original) 2 ‘Saleableness’ is liquidity. Though Menger notes many dimensions to liquidity...

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