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 7: Monetization of General Equilibrium

Ross M. Starr

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


1 In an economy with scale economies in the transaction cost function the economy converges to a monetary equilibrium with a locally unique ‘money’ through price-guided tâtonnement adjustment. Liquidity follows from high trading volume 2 so a high-volume good becomes ‘money’, leading to monetization of the economy’s equilibrium pattern of trade. 1 CONVERGENCE TO A UNIQUE ‘MONEY’ We learned in the previous chapter that there may be many monetary equilibria 2 in an economy with scale economies in the transaction cost function 2 each with a locally unique choice of the ‘money’, the locally unique common medium of exchange. How does the economy discover this equilibrium? And how does it make a choice among multiple equilibria? This chapter proposes a price-guided tâtonnement process leading to a monetary equilibrium allocation. The underlying principle is that liquidity follows from high trading volume 2 so if there is variation among commodities in trading volume, the high-volume goods are likely to become ‘money’, leading to monetization of the economy. Einzig (1966, p.  345) suggests ‘Money tends to develop automatically out of barter, through the fact that favourite means of barter are apt to arise . . . object[s] widely accepted for direct consumption’. That is, Einzig suggests that those goods with high trading volumes are the most liquid (presumably reflecting scale economy in transaction cost), and evolve into common media of exchange. That medium is unique because scale economies lead to ‘money’ as a natural monopoly. The following example demonstrates this process. As monetization...

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