Convergence to monetary equilibrium: computational simulation of a trading post economy with transaction costs

In the classic Arrow-Debreu model, the existence of money is not accommodated. However, using trading post market segmentation and requiring budget balance in each pair-wise transaction the model can converge to monetary equilibrium. Uniqueness of the common medium of exchange (commodity money) follows from scale economy in transaction costs. Also, this paper shows that existence and convergence to monetary equilibrium are totally different concept. In Full Double Coincidence of Wants situation, where previous market information helps households judging which good has highest saleableness, convergence takes place more easily than in Absence of Double Coincidence of Wants situation. This paper investigates the emergence of commodity money as the result of a tatonnement adjustment in a trading post economy. The convergence process models Menger‟s concept of saleableness – the most liquid good becomes the common medium of exchange. A computational approach is adopted to illustrate the monetary convergence as a result of decentralized adjustment process by utility maximizing households in the economy. Starting from an arbitrary initial economy, the analysis constructs a mapping from a compact economy space to monetary equilibrium or non-monetary equilibrium. By varying the transaction costs parameters and the household endowments, the paper successfully identifies the regions of parameter space where convergence to monetary equilibrium occurs as a result of decentralized adjustment process. The reasons for non-convergence are also investigated.