Compensation for Quality Difference in a Search Model of Money∗

In this paper, we demonstrate a new and intuitive welfare-improving role for fiat money: compensating for quality differences between traded commodities. We con-struct a model with the following features; (i) there is no double-coincidence-of-wants problem, (ii) agents have perfect information about the qualities of goods, and (iii) there are no transaction costs nor any form of imperfect utility transfer. We identify situations where a market without money fails to motivate agents to produce goods of high quality. The introduction of money, however, allows agents with high quality goods to benefit from trade with agents who hold low quality goods and money. This can provide sufficient incentive for almost all agents to produce a high quality good.