Existence and uniqueness of ‘money’ in general equilibrium: natural monopoly in the most liquid asset
Ross M. Starr
Economics Department, University of California, San Diego, La Jolla, CA 92093-0508, USA (e-mail: [email protected])
Received: February 15, 2002; revised version: December 27, 2002
Summary. The monetary character of trade, use of a common medium of ex- change, is shown to be an outcome of economic general equilibrium in the pres- ence of transaction costs and market segmentation (in trading posts with a separate budget constraint at each transaction). Commodity money arises endogenously as the most liquid (lowest transaction cost) asset. Scale economies in transaction cost account for uniqueness of the (fiat or commodity) money in equilibrium, creating a natural monopoly. Trading posts using a medium of exchange create a network externality inducing others’ adoption of the same medium. Bertrand monetary equi- libria (among competing trading posts) and uniqueness of ’money’ are robust to threats of entry. Government-issued fiat money has a positive equilibrium value from its acceptability for tax payments and sustains its natural monopoly through the scale of government economic activity.
Keywords and Phrases: Commodity money, Fiat money, Transaction cost, Scale economy, Double coincidence of wants.
JEL Classification Numbers: E40, D50.