What is a barter system? What are its drawbacks?
What is barter (barter exchange)? State inconveniences (problems) of barter exchange. Explain any one problem of barter system.
Meaning of barter. ‘Direct exchange of goods against goods without use of money is called barter exchange’. Alternatively economic exchanges without the medium of money are referred to as barter exchanges. An economy based on barter exchange (i.e., exchange of goods for goods) is called C.C. economy, i.e., commodity for commodity exchange economy. In such an economy, a person gives his surplus goods and gets in return the goods he needs. For example, when a weaver gives cloth to the farmer in return for getting wheat from the farmer, this is called barter exchange. Similarly, the farmer can get other goods of his requirements like shoes, cow, plough, spade, etc. by giving his surplus wheat (or rice or maize). Thus system of barter exchange fulfils to some extent the requirement of both the parties involved in exchange. However as the transactions increased, inconveniences and difficulties of barter exchange also increased involving rising trading costs. Trading costs are nothing but costs of engaging in trade. Its two components are – search cost and disutility of waiting. Remember, search cost is the high cost of searching suitable persons to exchange goods and disutility of waiting refers to time period spent on searching the required person. This ultimately led to evolution of money as medium of exchange.
Following are some of the drawbacks or inconveniences of barter.
Inconveniences (problems) of barter exchange.
(i) Lack of double coincidence of wants. Double coincidence of wants means what one person wants to sell and buy must coincide with what some other person wants to buy and sell. ‘Simultaneous fulfillment of mutual wants by buyers and seller's is known as double coincidence of wants. There is lack of double coincidence in the wants of buyers and sellers in barter exchange. The producer of jute may want shoes in exchange for his jute. But he may find it difficult to get a shoemaker who is also willing to exchange his shoes for jute. Thus a seller has to find out a person who wants to buy seller's goods and at the same time who must have what the seller wants. This is called double coincidence of wants which is the main drawback of barter exchange.
(ii) Lack of common measure of value. In barter, there is no common measure (unit) of value. Even if buyer and seller of each other commodity happen to meet, the problem arises in what proportion the two goods are to be exchanged. Each article must have as many different values as there are other articles for which it is to be exchanged. When thousands of articles are produced and exchanged, there will be unlimited number of exchange ratios. Absence of a common denominator in order to express exchange ratios create many difficulties. Money obviates these difficulties and acts as a convenient unit of value and account.
(iii) Lack of standard of deferred payment. There is problem of future (or deferred) payments. It is difficult to engage in contracts which involve future payments due to lack of any satisfactory unit. As a result future payments are to be stated in term of specific goods or services. But there could be disagreement about quality of the goods, specific type of the goods and change in the value of the goods.
(iv) Difficulty in storing wealth (or generalised purchasing power). It is difficult for the people to store wealth or generalise purchasing power for future use in the form of goods like cattle, wheat, potatoes, etc. Holding of stocks of such goods involve costly storage and deterioration.
(v) Lack of divisibility. How to exchange goods of equal value? The shoemaker wants a loaf in exchange of his shoes but exchange value of a piece of loaf is but a fraction of a pair of shoes. Shoes cannot be sub-divided without destroying their values. Similarly, if a person wants to purchase cloth equal to the value of the half his cow, he cannot do so Without killing his cow. Thus lack of divisibility makes barter exchange impossible.
In order to overcome the above disadvantages of the barter system, money was invented by the society.
(a) Meaning of money. Money is any thing serving as a medium of exchange. Most definitions of money are based on different ‘functions of money’ as their starting point. ‘Money is that which money does’. According to Prof. Walker, ‘Money is as money does.’ This means that the term money should be used to include anything which performs the functions of money, viz., medium of exchange, measure of value, unit of account etc. Since general acceptability is the fundamental characteristic of money, therefore, money may be defined as ‘anything which is generally accepted by the people in exchange of goods and services or in repayment of debts.’
(b) Functions of money. In general terms, main function of money in an economic system is “to facilitate the exchange of goods and services and help in carrying out trade smoothly.” Its basic characteristic is general acceptability. Functions of money are reflected in the well known following couplet:
Thus conventionally money performs the following four functions (primary and secondary) each of which overcomes one or the other difficulty of barter. Medium of exchange and measure of value are primary functions because they are of prime importance whereas Standard of deferred payment and Store of value are called secondary functions as they are derived from primary functions.
1. Money as the Medium of Exchange. Money came into use to remove the inconveniences of barter as money has separated the act of purchase from sale. Medium of exchange is the basic or primary function of money. People exchange goods and services through the medium of money. Money acts as a medium of exchange or as a medium of payments. Money by itself has no utility (except perhaps to the miser). It is only an intermediary. The use of money facilitates exchange, exchange promotes specialisation, specialisation increases productivity and efficiency. A good monetary system is, therefore, of immense utility to human society. Money is also called a bearer of options or generalised purchasing power because it provides freedom of choice to buy things he wants most from those who offer best bargain.
2. Money as a Unit of Account or Measure of Value. Money serves as unit of account or a measure of value. Money is the measuring rod, i.e., it is the unit in which the values of other goods and services are measured in terms of money and expressed accordingly. Different goods produced in the country are measured in different units, e.g., cloth in metres, milk in litres, sugar in kilograms. Without a common unit of measure, exchange of goods and services becomes very difficult. Values of all goods and services can be expressed in a single common unit called money. Again without a measure of value, there can be no pricing process. Without a pricing process, organised marketing and production is not possible. Thus, the use of money as a measure of value is the basis of specialised production. The measuring rod of money is also indispensable to all forms of economic planning. Consumers compare the values of alternative purchases in terms of money. Producers compare the relative costliness of the factors of production in terms of money and also plan their output on the basis of the money yield. It is, therefore, highly important that the value of money should be stable.
3. Money as the Standard of Deferred Payments. Deferred payments are payments which are made sometime in future. Debts are usually expressed in terms of the money of account. Loans are taken and repaid in terms of money. The use of money as the standard of deferred or delayed payments immensely simplifies borrowing and lending operations because money maintains a constant value through time. Thus money facilitates the formation of capital markets and the work of financial intermediaries like Stock Exchange, Investment Trust and Banks. Money is the link which connects the values of today with those of the future. It has become possible because value of money is stable and it has general acceptability and durability.
4. Money as a Store of Value. Wealth can be stored in terms of money for future. It serves as a store value of goods in liquid form. By spending it we can get any commodity in future. Keynes places great emphasis on this function of money. Holding money is equivalent to keeping a reserve of liquid assets because it can be easily converted into other things. People, therefore, normally wish to keep a part of their wealth in the form of money because savings (storing of value) in terms of goods is very difficult. Wheat or any other product which will command a value cannot be stored for a long period. The desire for money (cash) is known as liquidity preference. Clearly money is the best form of store of value.
Another Function ‘Liquidity of Money’ is added these days. Liquidity means ''convertibility in cash''. Thus the ability to convert an asset into money/cash quickly and without loss of value is called liquidity of asset. An asset is highly liquid if it can be exchanged promptly and without loss. Modern economists are laying stress on liquidity of money. Since by definition, money is the most generally accepted commodity, it is also the most liquid of all resources. Possession of money enables one to get hold of almost any commodity in any place and money never locks a buyer. It is this peculiarity which distinguishes money from all other commodities. A preference for liquidity is preference for money.
Money, thus, acts as common medium of exchange, a common measure of value, as stamlard of deferred payments and a store of value.
Importance (significance) of money. Money occupies a unique position in a modern capitalist economy In its absence, the whole prosperous economic life would collapse like a pack of cards. The advantages or uses of money can be best understood by considering the system in which money is absent. Although uses of money are manifold but a few of its important advantages are given below :
1. It helps in removing drawbacks of barter. How? Let us discuss it in the context of drawbacks of barter and functions of money.
(i) Money as medium of exchange solves the barter's problem of lack of double coincidence of wants as money has facilitated separation of purchase from sale. You can sell goods for money to whoever wants it and with this money you can buy goods from whoever wants to sell them. Money is accepted as medium of exchange. People exchange goods and services through medium of money when they buy goods or sell products. Thus money acts as intermediary which solves barter's problem of lack of double coincidence of wants.
(ii) Money as measure (unit) of value or a unit of account solves the barter problem of lack of common measure (unit) of value. Money measures exchange value of commodities and makes keeping of business accounts possible.
(iii) Money as standard of deferred payments helps to solve the barter problem of lack of standard of deferred payment. Again it helps to make contracts which involve future payments.
(iv) Money as store of value solves the barter problem of lack of storing wealth (or generalised purchasing power). Moreover money in convenient denominations (like Indian coins of 5, 10, 20, 50, 100 paise and currency notes of र 2, 5, 10, 100, 500, 1000) solves the barter problem of absence or lack of divisibility.
Doubtlessly money helps in removing the difficulties of barter system as explained above.
2. It facilitates exchange of goods and services and helps in carrying on trade smoothly. The present highly complicated economic system will not exist without money.
3. Money helps in maximising consumers' satisfaction and producers' profits. It helps and promotes saving.
4. Money promotes specialisation which increases productivity and efficiency.
5. It facilitates planning of both production and consumption.
6. Money can be utilised in reviving the economy from depression.
7. Money enables production to take place in advance of consumption.
8. It is the institution of money which has proved a valuable social instruments of promoting economic welfare. The whole economic science is based on money; economic motives and activities are measured by money. In fact, money makes its appearance in every phase of economics. In the words of Marshall:
“Money is the centre around which economic science clusters.”
What is a ‘legal tender’? What is ‘fiat money’?