Reflections On My First Blog Post

This post won't be of much use if you do not already understand the concept of marginal utility.

My first post Some Thoughts On Money was in retrospect a pretty good post, but it didn't deal with why the ideas expressed were important. I dealt with how money originally emerged in the marketplace. So what's the big deal here?

The Marginal(ist) Revolution

Classical economists had some pretty good ideas about economics, but their cost-theory of value was seriously flawed. It wasn't until the 1870s that the concept of subjective marginal utility came and gave us a comprehensive and logically coherent theory of value.

A small problem remained, however. What about the value of money? Let me quote Robert Murphy to illustrate the problem:

But many felt that a marginal utility explanation of money demand would simply be a circular argument: We need to explain why money has a certain exchange value on the market. It won't do (so these economists thought) to merely explain this by saying people have a marginal utility for money because of its purchasing power. After all, that's what we're trying to explain in the first place—why can people buy things with money?[1]

1) Why is the value of money what it is? Because of marginal utility of course.

2) And how do people estimate the marginal utility of money(i.e. how do they decide their current demand for money)? By looking at expected prices of course(i.e. the expected value of money).

3) How do people form expectations about the value of money? By looking at the past value of money of course. People have memories. So people value money(i.e. they give money its purchasing power) because money has purchasing power(i.e. it is valued by people).

4) So the value of money in time t(now) is determined by the expected value of money in time t+1(future). The value of money in time t-1(the past) was determined by people's expectations of the value of money in time t(now). And the value of money in time t-2(even further into the past) was determined by people's expectations of the value of money in time t-1(the past). And so on...

But isn't this an infinite regress? Can't we just go back in time in perpetuity and never solve the problem of how money has value? No, this isn't the case. At this point it's important to remember how money was initially created in the marketplace. This means that if we go back in time long enough, we will eventually hit a point at which the monetary unit ceases to be money. It's just another good.

And there's no problem with explaining the value of "just another good" with marginal utility analysis.

[1] Robert Murphy The Origin of Money and Its Value