Some Fundamentals of Exchange Theory.

Explains some everyday economic observations--the gap between buying and selling prices, the unavailability of many commodities, appearance and disappearance of markets, the use of money--in terms of the transaction cost of exchanges. Standard price theory avoids an economic theory of exchange by assuming that markets function perfectly and costlessly. This paper also ignores market imperfection, but works out the results of transaction costs in two models of two-commodity exchange. In one, the difference between buying price and selling price is the proportional cost of exchange; in the other, the cost per transaction is fixed and the price unique. No market will exist unless transactors pay enough to reward the middleman's services. Use of a universally acceptable commodity--money--lowers the cost of holding inventory to cover the time between production and consumption. Even without considering market imperfections, timing irregularities, together with the high costs of multiparty clearing, suffice to justify the choice of a money. 20 pp. (See also P-4666.) (MW)