Endogenous Market Formation and Monetary Trade: An Experiment
Economic Science Institute Working Paper # 16-19, Chapman University
37 Pages Posted: 27 Sep 2016
Date Written: August 30, 2016
The theory of money assumes decentralized bilateral exchange and excludes centralized multilateral exchange. However, endogenizing the exchange process is critical for understanding the conditions that support the use of money. We develop a “travelling game” to study the spontaneous emergence of decentralized and centralized exchange, theoretically and experimentally. Players located on separate “islands” can either trade locally, or pay a cost to trade elsewhere, so decentralized and centralized markets can both emerge in equilibrium. The latter maximize trade meetings and are socially efficient; the former minimize trade costs through the use of money. In the laboratory, centralized exchange more frequently emerges when subjects perform diversified economic tasks, but also when they interact in large groups. This shows that to understand the emergence of money it is important to amend the theory of money such that the market structure is endogenized.
Keywords: endogenous institutions, macroeconomic experiments, matching, coordination, markets, money
JEL Classification: E4, E5, C9, C92
Suggested Citation: Suggested Citation