Demand for a good arises because of its perceived benefit. For instance, people demand food because of the nourishment it offers them. This is however not so, with regard to the pieces of paper we call money – why do we accept them?
Following the view of Plato and Aristotle, economists regard the acceptance of money as an historical fact introduced by the government decree[1]. It is government decree, so it is argued, that makes a particular thing accepted as the general medium of the exchange i.e. money.
In his writings, Carl Menger raised doubts about the soundness of the view that the origin of money is a government proclamation. According to Menger,
An event of such high and universal significance and of notoriety so inevitable, as the establishment by law or convention of a universal medium of exchange, would certainly have been retained in the memory of man, the more certainly inasmuch as it would have had to be performed in a great number of places. Yet no historical monument gives us trustworthy tidings of any transactions either conferring distinct recognition on media of exchange already in use, or referring to their adoption by peoples of comparatively recent culture, much less testifying to an initiation of the earliest ages of economic civilization in the use of money[2].
Why conventional demand – supply analysis fails explaining the price of money
So how does a thing that the government proclaims will become the medium of the exchange, acquire purchasing power or a price? We know that the price of a good is the result of the inter-action between demand and supply. From this, we could reach a conclusion that the price of money is also set by the law of demand-supply.
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