This paper determines conditions under which the introduction of money, modeled as a commonly accepted good with a non-negative marginal utility, allows a barter economy to replicate the features of a market economy with a well functioning monetary system.
Money is used for side payments in an exchange economy in which the consumption vectors of self-interested agents are required to satisfy individual rationality. Exchange is not required to be bilateral, as coalitions of three or more agents may be formed. Nonemptiness of the core of this economy is shown to depend on the initial distribution of goods and money, agents' valuation of money, and their tolerance to accept it, both at the individual and at the coalitional (aggregate) level.
Money is shown to have two effects. First, it allows resources to flow to their best possible use, a result which markets alone may not necessarily be able to accomplish. Second, it may allow markets to form, when goods alone lead to segmented markets.
Principal implications of the model include the following: (1) In the absence of money markets may form but the allocation of goods is not necessarily group rational. (2) Introducing money into the economy may allow the market to achieve a group rational allocation of resources. (3) Introducing money into the economy allows markets to form when goods alone lead to segmented markets. (4) Money is useful in its market formation role if it satisfies two properties. First, it must be sufficiently valuable to each agent. Second, its use must be sufficiently widespread. (5) Money can have perverse effects. It may breakdown markets if it is improperly distributed, or if the benefit it confers is too asymetric.
Finally, the model is used to explain the breakdown of the inter war (1928-1933) gold-exchange standard and the ensuing collapse of world trade. It is also used to analyze the effect that the collapse of the paper mark had on distribution and market structure during and after the hyperinflation that afflicted Germany during the period 1921-1925.
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