THREE ESSAYS ON THE THEORY OF MONEY AND FINANCIAL INSTITUTIONS ESSAY 2: THE EXCHANGE ECONOMY, MONEY AND MARKETS By

This essay is the second of three. The first is nontechnical and in part autobiograhpical describing the evolution of my approach to developing a micro economic theory of money and financial insttutions. This essay is devoted to a mathematical sketch of a closed economic exchange system with general equilibrium GE and rational expectations RE viewed game theoretically. It squeezes the last drop out of statics and an illusory dynamics in the form of the RE extension of GE with no other externalities beyond money and markets. The third essay builds on process models adding uncertainty,innovation, an active government, nonsymmetric information and other externaties that all lead away from a static equilibrium model to an evolving entity where competition involving finance and innovation is part of a dynamic non-equilbium process. 1 A Process Approach to Prices In this and a subsequent essay a step by step approach is adopted to laying on successive unavoidable complications to the basically accepted pure abstraction of the static, non-process, optimal price system in order to handle process in general and innovation in particular. 1.1 A Contextual Link In the first part of the three essays I presented a more or less informal and partially autobiographical sketch of my search for a satisfactory theory of money and financial institutions. I argue that the very nature of an adequate theory of money involves an intimate intermix of abstract description of function with vast manifestation of institutional forms that perform the functions. As many models are being covered here, only brief descriptions of the formal structures and solutions are noted along with some comments on some still open problems. 1.2 The equilibrium model of the effi cient price system Our point of take off is the Arrow, Debreu, McKenzie (ADM) demonstrations of the existence of an effi cient price system in an economy with private ownership of the means of production and allocation of product by means of prices that are shown to lead to an effi cient allocation of resources. As all control and timing aspects of firms and the timing of their production processes were dispensed with