Why Is There Money? Endogenous Derivation of 'money' as the Most Liquid Asset: a Class of Examples by Ross

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. I. Formalizing Menger's 'Origin of Money' The title of this article, Why is there money?, is one of the classic issues in the foundations of economic theory, with contributions extending from Smith's Wealth of Nations, to the present. Money, like written language and the wheel, is one of the fundamental discoveries of civilization. Nevertheless, despite the evident superiority of monetary trade over the inconveniences of barter, there is a counterintuitive --superficially irrational --quality to monetary exchange. Monetary trade involves one party to a transaction giving up something desirable (labor, his production, a 1 This paper has benefited from seminars and colleagues' helpful comments at the University of California Santa Barbara, University of California San Diego, NSF-NBER Conference on General Equilibrium Theory at Purdue University, Society for the Advancement of Behavioral Economics at San Diego State University, Econometric Society at the University of Wisconsin Madison, SITE at Stanford University, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Minneapolis, Midwest Economic Theory Conference at the University of Illinois Urbana Champaign, University of Iowa, Southern California Economic Theory Conference at UC Santa Barbara, Midwest Macroeconomics Conference at University of Iowa, University of California Berkeley, European Workshop on General Equilibrium Theory at University of Paris I, Society for Economic Dynamics at San Jose Costa Rica, World Congress of the Econometric Society at University of Washington, and from comments of Meenakshi Rajeev. Remaining errors are the author's.