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Monetizing Trade: A Tatonnement Example

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  • Starr, Ross M.

Abstract

This paper presents a class of examples where a barter economy develops through agents' optimizing decisions into a monetary economy. A barter economy with m commodities is characterized by m(m-1)/2 commodity pair trading posts for active trade of each good for every other. Monetary equilibrium is characterized by active trade concentrated on m-1 posts, those trading in 'money' versus the m-1 other nonmonetary commodities. Specialization, the concentration of the trading function in a few trading posts in the monetary trade arrangement, reflects the workings of scale economies in transaction costs. As households discover that some pairwise markets (those with high trading volumes) have lower transaction costs, they restructure their trades to take advantage of the low cost. When a trading post's transaction cost is sufficiently low, households find it advantageous to use the low transaction cost goods as intermediary goods in their transactions, rather than trade directly (at high transaction cost trading posts) for the goods they want. The process converges to an equilibrium where only the high volume trade through a single intermediary good ('money') takes place. Monetization of trade results from dynamic adjustment to scale economies in the transaction technology.

Suggested Citation

  • Starr, Ross M., 1998. "Monetizing Trade: A Tatonnement Example," University of California at San Diego, Economics Working Paper Series qt4mz6w2j1, Department of Economics, UC San Diego.
    • Handle: RePEc:cdl:ucsdec:qt4mz6w2j1
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    References listed on IDEAS

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    1. Ostroy, Joseph M & Starr, Ross M, 1974. "Money and the Decentralization of Exchange," Econometrica, Econometric Society, vol. 42(6), pages 1093-1113, November.
    2. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-954, August.
    3. Hahn, F H, 1971. "Equilibrium with Transaction Costs," Econometrica, Econometric Society, vol. 39(3), pages 417-439, May.
    4. Abhijit V. Banerjee & Eric S. Maskin, 1996. "A Walrasian Theory of Money and Barter," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 111(4), pages 955-1005.
    5. Ostroy, Joseph M. & Starr, Ross M., 1990. "The transactions role of money," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 1, pages 3-62, Elsevier.
    6. Foley, Duncan K., 1970. "Economic equilibrium with costly marketing," Journal of Economic Theory, Elsevier, vol. 2(3), pages 276-291, September.
    7. David Starrett, 1973. "Inefficiency and the Demand for "Money" in a Sequence Economy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 40(4), pages 437-448.
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    Cited by:

    1. Howitt, Peter & Clower, Robert, 2000. "The emergence of economic organization," Journal of Economic Behavior & Organization, Elsevier, vol. 41(1), pages 55-84, January.

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