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palgrave-wright - Search-and-Matching Models of Monetary...

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Search-and-Matching Models of Monetary Exchange Prepared for The New Palgrave by Randall Wright University of Pennsylvania 1I n t r o d u c t i o n In this article we review a class of equilibrium search (matching) models that can be used to study the trading process, and in particular to develop a formal theory of money as a medium of exchange . Developing such a theory is one of the longest-standing issues in economics, but it met with at best limited success prior to the development of search-based models, which provide a natural frame- work in which to formalize venerable stories about money helping to facilitate exchange. 1 2 Background Diamond (1982) introduced a framework that, although it cannot used directly, can be extended naturally to build microfoundations for monetary economics. In his model, a [0 , 1] continuum of in f nitely-lived agents interact in an economy where activity takes place in two distinct sectors: one for production and one 1 These stories, going back to Smith, Jevons, Menger, Wicksell, and others (many of which are reprinted in Starr 1990) concern a double coincidence of wants problem in bilateral ex- change, as discussed below. Overlapping generations models (e.g. Wallace 1980) provide an alternative approach. Ostroy and Starr (1990) survey earlier attempts to develop microfoun- dations for monetary theory, including Jones (1976), which is similar in spirit if not detail to modern search models. There is not space here to discuss pros and cons of the various approaches, but it seems fair to say search and matching models now dominate the area. 1
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for exchange. In the f rst sector, agents encounter potential production oppor- tunities randomly over time according to a Poisson process with arrival rate α . Each opportunity yields a unit of output at cost c 0 ,where c is random with CDF F ( c ) .S in c e c is observed before a production decision is made, given an opportunity, there is a reservation cost k such that agents produce i f c k .F o r now, these goods are indivisible, and agents can store at most one at a time. All goods yield utility of consumption u> 0 , except by assumption agents cannot consume their own output; hence they must trade. Traders with goods meet bilaterally in the exchange sector according to a Poisson process with arrival rate γ . Upon meeting they trade, consume, and return to production. Since all goods are the same, and indivisible, every meeting yields trade, and every trade is a one-for-one swap. Generally, γ = γ ( N ) depends on the measure of agents in the exchange sector N . This is based on a matching technology that gives the number of agents who meet a partner per unit time as m ( N ) , with m 0 ( N ) > 0 , implying γ ( N )= m ( N ) /N
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This essay was uploaded on 04/20/2008 for the course ECON 800 taught by Professor Krueger during the Spring '02 term at Stanford.

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palgrave-wright - Search-and-Matching Models of Monetary...

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