Do People Accept Money Because Government Endorses It?
Demand for goods arises because of perceived benefits. For instance, individuals demand food because it nourishes them. This is not so, however, about pieces of paper we call money, so why do we accept them?
According to Plato and Aristotle, the acceptance of money is a historical fact endorsed by government decree. It is government decree, so it is argued, that makes a particular thing accepted as the general medium of the exchange. Carl Menger, however, doubted the soundness of that view, writing:
An event of such high and universal significance and of notoriety so inevitable, as the establishment by law or convention of a universal medium of exchange, would certainly have been retained in the memory of man, the more certainly inasmuch as it would have had to be performed in a great number of places. Yet no historical monument gives us trustworthy tidings of any transactions either conferring distinct recognition on media of exchange already in use, or referring to their adoption by peoples of comparatively recent culture, much less testifying to an initiation of the earliest ages of economic civilization in the use of money.
Why Conventional Demand—Supply Analysis Fails to Explain the Price of Money
How does something the government proclaims become the medium of the exchange, acquiring value? We know that the price of a good is the result of the interaction between demand and supply. From this, we could reach a conclusion that the price of money is also set by the laws of demand and supply.
While demand for goods emerges because of perceived benefits, people demand money because of its purchasing power with respect to various goods. The demand for money depends upon the purchasing power of money while the purchasing power of money depends on the demand for money.
We are caught in a circular trap. (The demand for money is dependent on its purchasing power while the purchasing power is dependent for a given supply on the demand for money). The circularity seems to vindicate the view that the acceptance of money is the result of the government decree.
Mises Supports Menger’s Insight
Ludwig von Mises’s regression theorem supports Menger’s insights. Mises not only solved the money circularity problem, b
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