Question

In country X there are two one-dollar (face value) silver coins (A and B) of different silver content. In coin A the silver content is 1/5" the silver content in coin B. In country X both coins circulate and prices )of goods and services) are denominated in both coin A and B, although the price of a good in coin A may be different than the price of the same good in coin B. (a) Does it follow that Gresham's law much not hold (be true) since both coins circulate and prices are denominated in both coins? (In answering this part of the question, be sure to expalin what it is that Greham's law "says"). (b) If there are 22 goods in a barter economy, how many different prices will there be? Explain your answer.

Answer 1

Gresham's law can be colloquially explained as "bad money drives out good". In a more proper form, it means that, when there are two forms money in circulation, accepted by law and having similar face value, the more valuable form of money will gradually disappear from circulation.

In this case, as there are two one-dollar (face value) silver coins (A and B) with different silver content, this is not in line with the Gresham's law because even with different silver content, the face value is the same and the price of the goods is expressed in terms of both the coins. Eventually according to the Gresham's law, the coin with lower content will drive out the coin with the higher content.

In a barter economy, the prices of every good is mentioned in terms of every other good, so if there are 3 goods, A, B, C, There will be 3 prices AB, AC, BC, this is arrived by the formula n*(n-1)/2=3*2/2 =>3; if there are 4 goods, A, B, C, D There will be 6 prices AB, AC, AD, BC, BD, CD this is arrived by the formula n*(n-1)/2=4*3/2 =>6 similarly, if there are 22 goods, there will be 22*21/2 = 231 prices