Why is there Money? Convergence to a Monetary Equilibrium in a General Equilibrium Model with Transaction Costs
This paper presents a class of examples where a nonmonetary economy converges in a tatonnement process to a monetary equilibrium. Exchange takes place in organized markets characterized by an array of trading posts where each pair of goods may be traded for one another. A barter equilibrium with m commodities is characterized by m(m-1)/2 commodity pair trading posts, most of which host active trade. A monetary equilibrium with unique money is characterized by active trade concentrated on m-1 posts, those trading in 'money' versus the m-1 nonmonetary commodities. There are two distinct sources of monetization: absence of double coincidence of wants and scale economies in transaction costs. As households discover that some pairwise markets (those dealing in the 'natural' money or those with high trading volumes) have lower transaction costs, they restructure their trades to take advantage of the low cost. Use of media of exchange arises endogenously from their low transaction cost. Uniqueness of the medium of exchange in equilibrium results from scale economies in the transaction technology.
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