Question

Consider a fiat money/barter system like that portrayed in this chapter. Suppose the number of goods is 100, i.e., J = 100. Each search for a trading partner costs a person 2 units of utility, i.e., α = 2. (a) (2.5 points) What is the probability that a given random encounter between people of separate islands will result in a successful barter? (b) (2.5 points) What are the average lifetime search costs for a person who relies strictly on barter? (c) (2.5 points) What are the average lifetime search costs for a person who uses money to make exchanges? Now consider exchange costs. Suppose it costs 4 units of utility to verify the quality of goods accepted in exchange and 1 unit of utility to verify that money accepted in exchange is not counterfeit. (d) (2.5 points) What are the total exchange costs of someone utilizing barter? (e) (2.5 points) Whate are the total exchange costs of someone utilizing money?

Answer 1

a) The probability of successful barter is

b) The search costs for barter economy will be equal to

  

   2 (100² - 100)

   2 X (9,900)

   19,800

c) The search for a money economy will be equal to

2 X 2 X 100

400

d) Exchange Cost = $4

Thus, total exchange cost = 19,800 + 4

= 19,804

e) Exchange Cost = $4 + $1 = $5

=$5

Thus total exchange cost = $400 + $5

= $405