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Jul 17 2006 at 11:39pm

In answer to the riddle you left at the end of your podcast, i submit this answer. will full acknowledge my answer may be disagree upon, or even wrong

The tourist pays for the hoilday. He just recieves a very large consumer surplus. As he did give the landlord something of value, and the landlord if rational said this was greater than the marginal cost of services rendered and accpeted the payement.

The fact that the paper is worth nothing to us, is subjective. as we may be able to mass produced. The value of any good is only the utility dervied from it, so value in money terms is only meant the good that can be purchased with.

to illustrate my point, let use this example. the tourist instead of a cheque, paid with a reimbrant (or other very valuable artwork), now if the tourist new the oppuroinity cost, he would be making a bad trade, but if he thought i had no value he is still paying for it. for the value of the reinbrant as a picture is very same to the cheque in this example. so the lanlord is no different from the cheque.

Given the barter economy can’t realise the value of the cheque in other terms than available in the barter economy. The tourist did pay for it, just the cost was neglible in our utility terms, but value to the people of the barter society, who are rather fond of the artsitry of cheques. The issue here is perhaps a flaw in exchange efficency. (if the cheque are blank, then probaly not)

Like people in a plane crash burning money to keep warm. The money no good if you can’t trade it for something useful.

i hope my answer was adequate, if i am incorrect please correct me.

Jul 18 2006 at 10:43am

The tourist paid for the trip. However, the fact the island economy persisted even long enough to be described for the puzzle rests on the definition of “isolated island”.

The tourist served as central bank for the island. What the islanders don’t know is that anyone in the ROW could equally well serve as central banker and destroy their economy. So let’s hope they stay “isolated” (perhaps the tourist can return yearly to make any required adjustments to their now fixed money supply). The tourist got to keep all the seignorage of the new currency, which was very large in this case.

Gabriel M.
Jul 18 2006 at 6:39pm

The tourist paid.
The value of an object is either its “consumption” value (using the checks to decorate your walls) or their expected discounted future returns (what you’ll be able to get for it).
So the islanders either traded in barter the lodging for a shiny object they “cosumed” or they expected to be able to exchange it later on, which I understand they did.

Jul 20 2006 at 1:04pm

The people who paid are the islanders who currently hold checks and see them only as a means for exchange, not consumption.

I think the answer is a little different than what others said and is some what confusing because of what our notion of “paying” is. Thinking economically, the person who “pays” for something is the person who gives up consumption. If I work a job and I “get paid” I have decreased the consumption of my time for money. My employer got work and I got some pieces of paper. Who paid for that? It was me, sort of. Unless I can trade the money for something else to consume, I have paid for it. But if the money has some value to me as a piece of art then I got something I wanted for my time. In a sense no one “pays” in that situation. We both got something we wanted in the second case, but in the first scenario I got money for some future consumptive purpose.

I don’t think this violates the idea of value in exchange. Your time is worth some dollars per hour but could be worth food per hour or something that has a consumptive value. A person who exchanges for something he see no value in itself has “paid” for the exchange because he did not get something he values more than what he gave up.

If the checks have become money for the island, then they only have a value because they can be used to trade for something else. If the checks become wall paper or artwork then in some sense no one has paid because everyone got something to consume. The person who pays is the person who accepts a check a sees no consumption value in it.

If the tourist returns in 10 years and finds his checks are still being traded and decides to pay for his trip again in checks, then who paid for that trip? The people who held the checks and did not see them as valuable paid for it. The checks have undergone inflation and are now worth less in exchange.

Jul 21 2006 at 12:27pm

The vacationer paid — if not, the transaction would not have taken place.

I’ve heard stories that Pablo Picasso lived this way for much of his life — his checks were never cashed because usually the signature was valued more than the amount of the purchase.

Jul 21 2006 at 1:50pm

The islanders paid for the vacation. The checks will increase the island’s money supply, increasing the demand for goods and services which will lead to higher prices. Thus the islanders pay for the vacation in the form of higher prices.

The Unbeliever
Jul 21 2006 at 1:59pm

My initial response was the same as Rob’s–the tourist exchanged a good for a service; the relative utility derived from that good (negligible to the tourist, but apparently worth more than 1 night’s lodging to the innkeeper) is irrelevant so long as both parties realized a net utility surplus. However, I nearly forgot two important facets of the story. First, the checks eventually replaced the barter system and became a form of currency. Second, the person who introduced the checks into the isolated society was a tourist, who presumably left the island after his vacation was over.

I say that ultimately, the entire island paid for his trip because of the eventual decision to treat checks as currency.

To begin with, before the tourist’s arrival, the local economy consisted entirely of consumable goods and “hard” assets, which were consumed and swapped; goods only exited the economy via consumption (eating food or staying in a hotel room), and were replenished by primary means (growing more food or waiting until the next night to rent the room out again). “Hard” assets such as artwork, tools, property, etc never left the economy as ownership changed hands because of the island’s isolation.

Enter the tourist. You now have an entity whose sole activity is to consume; he stayed in hotel rooms, he ate food… but from the island’s perspective, he also consumed “hard” goods because any “hard” goods like artwork he acquired via trading were removed from the economy after he left. He managed this by introducing new hard assets into the economy in the form of checks, which were initially treated as artwork; we can therefore express the value of the hotel room and food he bought in terms of artwork, i.e. 1 day’s worth of food is worth 1 artwork. So if there were X pieces of native artwork in the entire economy, and the tourist wrote n checks, then after he left there was essentially X-n pieces of native artwork on that economy plus n pieces of new artwork. A net wash in the short term, you might say; the tourist acted like any native artist in that economy by producing artwork and trading for other goods.

The final point of info, however, is that these pieces of artwork become a medium of exchange. Assuming the islanders have no consumable use for such scraps of paper, they essentially reduced the inherent value of the check to 0 since it is no longer treated as an artwork. So the total inherent value of the economy’s artwork, pre-tourist, was X; after the tourist, X-n + n; after the switch to currency, X-n.

The tourist has effectively removed value from the island’s economy, and the entire economy has paid an amount equal to the value of his vacation. (Note, however, that this choice was entirely up to the islanders who first chose to treat previously worthless artifacts as hard assets, then to subsequently devalue them back to inherently worthless artifacts which represented value.)

Jul 21 2006 at 2:00pm

With the exception of the tiny cost of the checks to the vacationer (a few pennies each), the vacation is paid for by the current (last) owners of the checks.

For example, when the lodging owner accepts the check, value is created equal to the value the vacationer places on his enjoyment of the vacation minus the cost of the check to him. Normally, the cost of the check to the vacationer includes the dollar amount of the check, but if it is never cashed, the cost is negligible.

The lodging owner ‘pays’ for the value of the check through his labor, investment in the lodging, etc., and the vacationer walks away with the consumer surplus. Next, the lodging owner trades the check for something else of more value to him. The next check holder pays for the value of the check through her labor, etc., and the lodging owner pockets any surplus. As long as each check owner makes a ‘good’ deal, where the value of the check is stable or increases, the original cost of the vacation to the providers (lodging owner, etc.) is ultimately paid for by the last check owners.

Note that if any person in the ownership chain makes a ‘bad’ deal, and trades the check for something of less value than they originally paid, that person will also end up paying some of the cost of the vacation.

Also, the island ends up being more wealthy by the difference in the cost of the products/services the original check owners gave the vacationer, and the value the final check owners place on them. The value is distributed among all the past and present check owners. And the world is richer by that value plus the surplus the vacationer walked away with.

Jul 21 2006 at 2:59pm

A transition from a barter to a monetary economy would reduce transaction costs enormously and (eventually) increase the division of labor, which would decrease prices, so I don’t buy that the villagers payed for it through inflation.

My guess is that the villager payed for his own vacation, but not in the way we normally think. Because those checks, before he left, had no widely accepted monetary value on the island, it seems that he got an enormous discount from the island’s businessmen. However, he provided more than just money (or discounted money) for the payment of those services and goods. He supplied a service of his own. That service–establishing a monetary system in a barter economy that would, in time, experience enormous gains from the decreased transaction costs, etc.–payed for his vacation.

Clinton Harris
Jul 21 2006 at 3:02pm

The tourist pays for his vacation. He pays with pieces of colored paper. It appears he is getting a free ride by virtue of the checks never being cashed. However, since they are circulating as currency, the tourist has the lost opportunity costs which amount to what else he could have purchased on the island for those pieces of colored paper.

Don Lloyd
Jul 21 2006 at 3:25pm

The tourist paid, just less than if his checks had been cashed.

Everyone, including all of the islanders, likely ended up better off. Certainly, all of the islanders who accepted checks at least expected that they would benefit from their exchange.

However, the largest benefit is likely to be the eventual increase in the supply and variety of consumption goods and services on the island that will be enabled by the transformation from a barter economy to a money economy, allowing a large increase in specialization and the division of labor. The problem text seems to suggest that that not only did the checks become a hard money, but that somehow the idea of money itself leaked in along with them.

Regards, Don

Jones Morco
Jul 21 2006 at 3:34pm

It’s like issuing money. They vacationer got the seigniorage; the islanders are paying for his vacation. It’s like the US issuing the currency that’s used all over the world.

Jul 21 2006 at 4:00pm

The statement at the end that the checks “begin to circulate on the island as money, replacing the barter system” is false. The checks are only accepted as payment becuase of their intrinsic worth. They might as well be cows or pieces of gold.

The cost of the room is shared by the tourist and the hotelier, becuase both forego opportunities in accepting the check as payment. The tourist foregoes the opportunity to redeem his limited supply of checks elsewhere on the island. The hotelier foregoes opportunity for payment in some other way, and by accepting the check also bears the risk of devaluation if the supply of checks increases (as seems likely).

The checks are a form of arbitrage. The tourist has moved them from a place where they are abundant to a place where they are scarce. This is actually an example of the value created by technology transfer.

Anshu Sharma
Jul 21 2006 at 5:03pm

The Island is China holding our US denominated currency never ‘cashing’ it for real goods or services. By delivering goods and services in exchange of IOUs to the (US) visitor, the island (China) is extending an indefinite interest-free loan to the visitor. The vacation is therefore fully paid for by the islanders.

So let’s go shop till we drop at Wal-Mart. China is paying!

Jul 21 2006 at 5:43pm

Back in the 1960’s, the Kennedy’s used to enjoy such “free” vacations on Cape Cod, as merchants would rather hold on to the check with a Kennedy’s signature (possibly to display it to other customers) than the cash that the check could be redeemed for.

Jul 21 2006 at 5:58pm

Nobody “pays for” the vacation of the tourist. The tourist just gives up slips of paper; the islanders exchange goods for a more efficient monetary unit. Both are better off.

Of course, this is slightly different from the trade deficit in that it assumes the checks are *never* cashed. At any rate, though, the tourist gets an interest-free loan. And the islanders get a more efficient way of trading.

It’s just like any trade. Both parties agree to it because they both benefit.

Jul 21 2006 at 11:58pm

Pardon me. In my comment I accidentally typed, “My guess is that the villager payed for his own vacation.” Of course I meant to say the tourist.

Jul 23 2006 at 1:13am

The fact that the villagers eventually started trading his checks as currency has no relevance as to who paid for his vacation. Did gold lose consumer value when it became money? They valued his checks as artwork, and thus by definition got something they valued enough to trade for it.

If this happened under the gold standard, and the tourist traded gold for his stay, but the islanders had never seen gold before, but accepted the gold because it was pretty and they knew the local metalsmith could mold it into something they could use, then everyone would say he paid for his vacation. The same goes for his artwork, aka his checks.

With either the checks and the gold he traded something the islanders valued, so they didn’t get ripped off. Therefore the tourist paid for his vacation in two ways. 1) The replacement cost of the checks. It might not even cost him the few cents of the replacement value of the checks if he closes out his checking account and switches to a new bank, or if he writes checks so infrequently as I do that he never would have replaced them at all anyway. 2) Via the effort (work) of enterprisingly creating new value for his paper checks.

With payment method of #2 in mind, one could say he ultimately paid for his vacation by transforming what was going to be pure leisure into a working vacation instead.

gene berman
Jul 23 2006 at 8:36am

I have a friend who graduated from Millersville STC in 1959 and went into teaching in the Lancaster, PA area. Almost immediately, he opened checking accounts in banks in the nearby towns of INTERCOURSE and BLUE BALL.

When travelling any distance from his immediate area (and especially when on vacation), he’d write as many checks as he could get accepted, usually for small amounts. He’d had a stamp made with which he’d stamp the face of each check:

Through the years, he successfully cashed many, many of these checks, few of which were ever submitted–receivers opting to save as curiosities or conversation pieces. He once told me he’d never gotten back a single one written for $5 or less.

The profit in the business of travellers’ checks is in interest earned on the “float,”–the purchase-money deposited but not-thus-far-redeemed or “used.” Thus, significant profit potential lies in marketing strategies persuading potential users to buy such checks well in advance of their intended trip or to continue holding them beyond their primary intended purpose. In 1980, I advanced a plan to a very large issuer of such checks–intended to increase dramatically the average “float” time of their product. The scheme was to join with a large, legal foreign lottery conducted on a regular basis, whereby the serialized identification of the existing sold checks themselves would be in the “pool” from which winning numbers were drawn–in the jurisdiction conducting the lottery. The intention was to avoid the US illegality of the check itself being considered as a lottery ticket by linking it to a “bonus” payable to both the actual lottery winner and the check-holder, said bonus being conditional upon the two “linking up” to present the winning ticket and the “bonus” check-claim. Of course, the intention was that both the lottery winner and every check-holder would have incentive to drastically extend their 1.) claiming of the winning; and 2.) holding of the check (keyed to a lottery event at least a month distant from check-purchase plus the after-time involved in their finding each other and coordinating their claims). “Float” would increase substantially, not only for the check-issuer but also for the entity conducting the lottery. For one reason or another, my idea was ultimately dropped but not before a fair amount of consideration.

Jul 23 2006 at 5:41pm

The islanders pay for the vacation.

Taking as given the checks become currency, the cost of the room is shared among whoever accepts the checks as payment for goods or services. As the supply of checks on the island increases, their value declines to zero. Each islander is “taxed” in proportion to what they give up in exchange for each unit of currency, and what they can obtain in using them as payment.

Jul 24 2006 at 10:07am

I wonder how any of the participants in this chain would relate this puzzle to recent stories about North Korea engaging in widespread (and apparently quite high-quality) counterfeiting of U.S. currency. The practice seems to be designed to either generate “hard” currency for North Korea’s regime, or just to enrich a few high-ranking insiders. Either way, who (in the global economy) ends up paying for that? And in a world of global electronic money, would N.Korea be better off counterfeiting ATM cards or hedge-fund derivatives? Just wondering …

Russ Roberts
Jul 24 2006 at 6:41pm

The islanders paid for the vacation, but in return, they received something of greater value, the artwork on the checks and ultimately, a better way of exchanging value on the island.

Particularly interesting or accurate insights came from SteveSC, Jones Morco, Maxim and Anshu Sharma, in no particular order.

Thanks to everyone who took a crack at it.

Jul 24 2006 at 7:17pm

“The islanders paid for the vacation, but in return, they received …”

If you get to define pay, why can’t I define value?


Jul 24 2006 at 10:40pm

Great question! I say the tourist pays. I posted my thoughts at my site.

Jul 25 2006 at 9:29am

My business is looking for opportunities in hard goods, manufacturing, and established businesses based upon a change in use. This is where I find opportunity — in new applications for existing goods and structures. In your analysis, all of my profits are borne by the seller. I disagree.

Lauren Landsburg
Jul 26 2006 at 6:45am

Some additional comments, links, and trackbacks not highlighted above can be found on these pages:

Econlib Editor

Christian Aldao
Jul 28 2006 at 12:08pm

The tourist doesn´t pay. All the members of the island are paying. This is simple, The tourist is acting as a central bank and you must know that a central bank has a gain called “seniorage” due to his monopoly of creating money. All this provided the rising amount of “money” printed (the checks) is equal to the increasing demand of money.

Jul 30 2006 at 1:52pm

Your position assumes you can define what people should value. I couldn’t care less what people should value — I care what they do value. I find it amusing that you believe an item becomes “currency” simply by virtue of the fact I put little or no effort into creating it.


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