Why is there Money?
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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.
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Chapter 3: The Trading Post Model

Ross M. Starr


1 The trading post model consists of N commodities traded pairwise at 1 2 N (N 2 1) trading posts with distinct bid and ask prices reflecting transaction costs. Households create trading plans to optimize utility subject to prevailing prices and subject to a budget constraint at each post. A barter equilibrium will occur if most trading posts are active in equilibrium 2 most goods trading directly for most other goods. A monetary equilibrium occurs if active trade is concentrated on a few trading posts, those trading the common medium of exchange against most other goods. In Chapter 2 we examined the moneyless Arrow2Debreu model. It did not use money since all transactions were with a central market in a single instance, with a single budget constraint. There could be no role for a carrier of value between transactions when each agent or firm made only one transaction, however large. It is well known that a frictionless Arrow2Debreu model cannot accommodate a role for money. The single budget constraint facing transactors in the model precludes a carrier of value between transactions. The key to bringing money into the model is to let there be many transactions, each of which requires a payment for purchases or receives payment for sales. This can be achieved by reopening trade over time (Hahn, 1971, 1973; Starrett, 1973; Wallace, 1980), by randomly bringing households into contact for limited trading opportunities (Kiyotaki and Wright, 1989), or by segmenting the trading opportunities. The last approach will be...

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