Sam Brittan writes:
FT.com / Columnists / Samuel Brittan - Money is making a comeback: Any IoU that is accepted in payment for services rendered can be regarded as money. There is a legendary exam question about a traveller who paid for a meal on a remote island by cheque. The natives were so impressed by this strange piece of paper that they passed it from hand to hand without anyone attempting to cash it. Who then paid for the traveller’s meal? (Please don’t tell me)...
Ha! I'm going to tell you whether you want me to tell you or not!
There are three possibilities. The check could serve as an expansion of the real money supply, if it is sufficiently easier to carry around and keep track of then previous moneys--previous markers of claims to purchasing power. If so, then nobody pays for the traveller's meal: the traveller's writing the check increased social wealth by more than the resources consumed, and everybody is better off. It is a free lunch.
A second possibility is that the check--being easier to carry around and keep track of--could crowd out and displace some other asset used as money. Say that the nominal (and real) money supplies remain fixed, and that the circulation of the check means that somebody loses their job stringing cowrie shells together, and has to get another lower-paying lower-value job doing something else. In this case, part of the lunch is paid for by the dismissed worker who loses his or her best opportunity. The rest of the lunch, however, is still free.
A third possibility, however, is that the check increases the nominal but not the real money supply. People are happy to hold the check, but the check is no easier to use than other forms of money, which are in fixed supply. In this case the price level rises, and everybody else with money in their pockets finds that their money buys less. In this case their is no free lunch: the lunch is paid for by an inflation tax implicitly levied on other money holders.
Those are the three possible answers. There will be a test.