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

Abstract

This essay derives the monetary character of trade, the existence of a common medium of exchange, as an outcome of the economic general equilibrium in a class of examples. The setting is a (non-monetary) Arrow-Debreu Walrasian model with the addition of two constructs: 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. There may be several instruments with identical lowest transaction cost creating multiple money's. Scale economies in transaction cost account for uniqueness of the monetary instrument in equilibrium. The monetary structure of trade and the uniqueness of money in equilibrium can thus be derived from elementary price theory.