Money and Markets: Essays in Honor of Leland B. Yeager

144 Robert L. GreenfieldA one-classroom economyMy story begins. Here in our one-classroom economy, we five people work hard.We produce chairs – one chair each, let’s say, per month, or 12 chairs per year.Each of the five of us, then, has a 12-chair real income flow per year. If we cared todo so, we could devote our entire 60 chair per year real income to current consumption;we could use the chairs in our dining rooms, on our patios, or wherever.If used now, each chair will last a year and then disappear.It’s always somebody else’s chair, of course, that appeals to us, and getting itrequires trade. Conducting trade on the basis of barter, of course, would beinconvenient for everyone. Luckily, however, each one of us has a checking accountwith the one-room economy’s only bank. I can sell a chair to one person, have thebank add the proceeds to my account, and then, by writing a check myself, buy a chairfrom someone else. We use no money other than the checking accounts issued by this– our one and only – bank. (The bank would issue folding money, too, but becausenobody prefers it to checking account money, has no call to do so.)Now, who knows when I’ll come across the chair of my dreams? It may happenwhen I have no chair to sell or when I just can’t find anyone who wants to buy mychair. To make sure that I don’t find myself in such a circumstance, to make sure thatI can buy a chair on even a moment’s notice, I find it convenient to hold a checkingaccount balance that is roughly the equivalent of two months’ income (i.e., twochairs), as does everyone else. All of my receipts and expenditures flow through mychecking account balance, receipts enlarging that balance and expenditures reducingit. When I deposit someone else’s check, my balance grows and that other person’sbalance falls; and when someone else deposits a check of mine, my balance falls andthat other person’s balance rises. In neither case does the sum of the two balanceschange.Say, then, that there exist 1,000 of these checking account dollars, total. Makingthe 1,000-unit stock of money the equivalent of two months’ flow of income requiresthat the annual flow of income be $6,000. Each of the 60 chairs that we produceannually must therefore have a $100 price tag.The demand for money and the supply of capitalNow our population doubles, from five people to ten. Like each of us old timers,each of the five newcomers can produce one chair per month, 12 per year, and,again like each of us old timers, each newcomer wants to hold a $200 checkingaccountbalance, the equivalent of two months’ income. With the newcomers’arrival, then, potential total real income jumps from 60 chairs per year to 120chairs per year, and the aggregate demand for money balances grows from $1,000to $2,000.To accumulate a $200 checking account balance, each of the five newcomers iswilling to make a one-time sacrifice of two months’ income. The newcomers as agroup, in other words, are willing just to hold the money that selling ten of their firstyear’s 60 chairs brings in, instead of using that money to buy chairs for themselves.