Even Robinson Crusoe Understood The Price And Value Of Money

Nothing is as crucial to the functionality of a free market as its money. Money constitutes half of every transaction, representing one side of all value expressed in the exchange of goods and services. But what, exactly, is the price of money?

The commodity with the highest marketability tends to become a society’s preferred medium of exchange — that is, its money. Prices denominated in this common medium enable economic calculation, which in turn allows entrepreneurs to spot opportunities, make profits and push civilization forward.

We’ve seen how supply and demand determine the price of goods, but determining the price of money is a bit trickier. Our predicament is that we have no unit of account to measure the price of money because we already express prices in… you guessed it, money. And because we cannot use monetary terms to explain it, we must find another way to express money’s purchasing power.

People buy and sell money (exchange goods and services for it) based on what they expect that money will buy them in the future. As we’ve learned, acting individuals always make choices on the margin. Hence, the law of diminishing marginal utility. In other words, all actions are preceded by a value judgment in which actors choose between their most valued end and their next strongest desire. The law of diminishing marginal utility applies here as it does elsewhere: the more units of a good a person possesses, the less urgent the satisfaction each additional unit provides.

Money behaves no differently. Its value lies in the additional satisfaction it can provide. Whether that’s buying food, security or future options doesn’t matter. When people trade their labor for money, they do so only because they value the purchasing power of that money more than the immediate use of their time. The cost of money in an exchange is thus the highest utility a person could have derived from the amount of cash they gave up. If a person chooses to work for an hour to afford a rib-eye steak, they must value the meal more than one hour of forgone leisure.

Recall that the law of diminishing marginal returns tells us that each successive unit of a homogenous good satisfies a less urgent desire a person has. Therefore, the value a person attaches to an additional unit diminishes for each unit added. However, what constitutes a homogenous good is entirely up to the individual. Since value is subjective, the utility of each additional monetary token depends on what the individual wants to achieve. To the individual, each extra token is not homogenous in terms of what serviceability it brings to them. To a person who wishes to buy nothing but hot dogs with his money, a “unit of money” is the same as whatever the price of a hot dog is. That person has not added a unit of the homogenous good “money for hot dogs” until he has acquired enough cash to buy one more hot dog.

This is why Robinson Crusoe could look upon a pile of gold and deem it…