Question

During the early part of the last century, a prominent English lord spent a month each winter vacationing on a small island in the Indian Ocean. He paid for his expenses by writing checks on his London bank account. So great was the impression of his lordship on the local inhabitants, that instead of cashing his checks, they held on to them dearly, and transferred them among themselves in settlement of transactions and for the payment of debts – that is, the checks circulated as a "medium of exchange."

(a)          What characteristics or qualities would make his lordship's checks a good money to the islanders? How might the islanders benefit by substituting the lord's checks in place of the commodity money that had been used prior to his lordship's annual visits?

(b)         Who actually paid for his lordship’s vacation? Carefully explain your reasoning.

Answer 1

a. The characteristics that would make the lordship's checks a good money for the islanders are :

i) Acceptability : The acceptability quality of money states that money/check are accepted by everyone without hesitation. As the islanders regarded the checks so high in value that they accepted the checks as commodity money.

ii) Limited Supply : As the checks were limited in supply, the value of these checks were high for the islanders.

If the islanders substituted the lord's checks with commodity money, they would have the following benefits :

i) Divisibility : The commodity money can be further divided into smaller denominations while the checks have a singular value. This would make it difficult for the islanders to make payments with value smaller than the value of checks.

ii) Uniformity : The commodity money provides uniformity in value while the checks made by lordship's might differ in values. This makes it convenient for islanders to use commodity money.

b. The lordship made all of the payments by drawing check on his bank which would've made the Bank pay all of his expenses when the checks were drawn on it. This would've made the lordship bear the expenses at the end of the day. But, the islanders did not draw these checks, so neither the bank had to pay nor the lordship. Rather, by not drawing these checks, the islanders used these to transfer the checks between themselves, which made the islanders pay the expenses indirectly.