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Low opportunity cost money drives out high opportunity cost money

July 25, 2012

Goods can be used for many different things. It’s one of the phenomena that makes economics interesting. Land can be used for housing, stores, parks, farms, grazing, whatever. It’s because resources have a variety of uses that makes choice interesting and difficult. If a good only has one function, it’s easy to allocate: do that one function. Money is a good which is used to facilitate indirect exchange. Taken in a totally abstract way, would you want to use something as money if it had a lot of high value alternate uses, or only low value alternate uses? If you use a high valued item as money, you must give up that high valued use. If you use a low valued item as money, you only lose a low valued use, and thus much less. For example, a society which used bars of titanium for money would have to give up golf clubs, airplanes, surgical tools, and other things which would have otherwise been made with the titanium. If a society instead uses something totally useless as money, it loses no productive capacity at all. It is clear that if you could simply designate one thing as money, which everyone had to then use, you should pick the most useless of all resources.

However, in the real world, there are a couple of problems with this. Money, in order to function properly, must be widely desired and have a stable quantity, among other traits. Any low value item being deemed money needs to have an institutional framework which people trust to stabilize its quantity and ensure that it will be accepted as payment in the future. Using iron or rice as money would require no trust at all. If the monetary system broke down, people could use just the iron or rice for it’s high value alternate uses. If the money is green paper and the system breaks down, holders of money lose everything. Likewise, real resources are inherently limited in quantity – no trust required. Green paper, on the other hand, could be easily produced and thus effort needs to be expended to ensure that it’s not, at least, not at a high rate. Instead of viewing high inherent value of money as good or bad, we should view it as a continuum, where trusted institutions can allow people to gain the use of high value resources by using low valued resources for money instead.

Further reading on Money:
A brief history of money
Monies used in the past

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