Essays on Network Effects and Money

University dissertation from Department of Economics, P.O. Box 7082, S-220 07 LUND, Sweden

Abstract: This thesis contains four separate papers in the field of monetary economics. The common basis for all the papers is that they deal with money and network effects in one way or another. Although the common basis is the same in all the articles, different approaches are used: theory, econometrics and history of economic thought. This first essay focuses on the network effect in the use of money and the problems associated with this. A two-currency model is constructed to derive conditions about Nash equilibria inducing monetary unions and parallel currencies. Individual differences among the population are allowed, in contrast to a representative agent model. Equilibria are derived both when rational individuals make currency choices individually and when choices are made by vote maximizing politicians. The results are compared and evaluated according to the Pareto criterion. It is shown that neither political decision, nor the market process will guarantee an efficient outcome. The political solution will, however, more often give preferable solutions. Carl Menger has been cited as a forerunner to the network theory of money. The second essay analyzes Carl Menger's monetary theory and evaluates whether he was aware of the network characteristic of money. The analysis is focused on the German word Absatzfähigkeit, which is defined and analyzed by Menger and is central in his monetary theory. An English translation of this word can be marketability or saleability. Parts of this concept cover an essential idea behind the network property of a potential medium of exchange. The result is, nevertheless, mixed. It cannot be said that his analysis is complete enough to call him a forerunner in all respects. In the third essay the changeover process from the local national currency to the Euro in the countries participating in the third stage of EMU is described and analyzed. The article tries to find factors that can help to explain the different pace of transition between the countries introducing Euro bank notes. It is found that the initial supply of Euros, the country size, the duration of dual circulation and the number of bank branches (per capita) in the economy explain a large part of the variation in the pace of adoption. The first two factors can have its origin in the network property of currency. Psychological factors, such as nationalism, have not been found to significantly influence the outcome. The final essay analyzes the adoption pattern of a new currency. The purpose of the essay is to construct two different types of models, network models and mechanical velocity models, which may help to explain the adoption path and to enrich the theories explaining the adoption process of a new currency. It is shown that network models can generate both concave, convex and S-shaped adoption functions. The velocity models can only generate concave adoption functions. Both types of models can be used to derive the observed concave adoption pattern during the currency exchange period experienced in all Euro area countries.

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