INTRODUCTION We now understand that money is anything that acts as an exchange medium, and informally developed the idea that money ﬁnds value from its capacity to facilitate trade. Our objective for the present chapter is to further develop this idea. We’ll do so by examining how money aﬀects an economy’s consumption possibilities (that is, consumers’ budget sets from Part I), and the level of real economic activity more generally (that is, the level of Q or ‘quantity’ from equilibrating Part I’s demand and supply sides). Leaving this chapter, we should better appreciate how money, despite having no direct eﬀect on consumption possibilities, strongly inﬂuences the level of welfare that societies enjoy.1 THE INFERIOR BARTER EQUILIBRIUM An Illustration Suppose, for a moment, that we ﬁnd ourselves in a money-less world. Suppose also that, while we enjoy a substantial resource endowment (that is, we are ‘rich’), there also exist consumption bundles that would make us happier than would consuming our endowment. How might we trade for these more attractive bundles? For example, if our endowment does not include a car, and we maintain a strong preference for a car, how would we act on this preference? Notice that we cannot simply go to an auto dealer and exchange ‘money’ for a car. Rather, we must happen upon an individual who owns a car we want and maintains a suﬃciently strong preference for elements of our endowment. In other words, to enjoy consumption bundles that are superior to...
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