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Open Access Publications from the University of California

Why Is There Money? Endogenous Derivation of "Money" as the Most Liquid Asset: A Class of Examples

  • Author(s): Starr, Ross M.
  • et al.

The monetary character of trade, the existence of a common medium of exchange, is derived as an outcome of the economic general equilibrium in a class of examples. Two constructs are added to an Arrow-Debreu general equilibrium model: market segmentation with multiple budget constraints (one at each transaction) and transaction costs. The multiplicity of budget constraints creates a demand for a carrier of value between transactions. A common medium of exchange, money, arises endogenously as the most liquid (lowest transaction cost) asset. Government-issued fiat money has a positive equilibrium value due to its acceptability in payment of taxes. Scale economies in transaction cost account for uniqueness of the (fiat or commodity) money in equilibrium. The monetary structure of trade and the uniqueness of money in equilibrium can thus be derived from elementary price theory.

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