On the Efficiency of Monetary Exchange: How Divisibility of Money Matters

Abstract

We use alternative assumptions about the divisibility of goods and money and the ability of agents to use lotteries on money to investigate to what extent the indivisibility of money is the cause for the typically inefficient production and consumption decisions in search-theoretic models of money. Our framework potentially generates three types of inefficiencies: the no-trade inefficiency, where no trade takes place even though it would be socially efficient to trade; and the too-much-trade and too-little-trade inefficiencies, where the quantities produced and exchanged are either larger or smaller than what the solution to a social planner's problem would mandate. It is shown that while the no-trade and the too-much-trade inefficiencies are caused by the indivisibility of money, the too-little-trade inefficiency remains even when money is divisible unless it is sufficiently valued.

Keywords: Money, Indivisibility, Search

JEL Classification: E00, D83, E52