MONEY IS USED FOR BUYING OR SELLING GOODS, FOR MEASURING VALUE AND FOR STORING WEALTH. Almost every society now has a money economy based on coins and paper notes of one kind or another. However, this has not always been true. In primitive societies a system of barter was used. Barter was a system of direct exchange of goods. Somebody could exchange a sheep, for example, for anything in the market place that they considered to be equal value. Barter however was a very unsatisfactory system because people's precise needs seldom coincided. People needed a more practical system of exchange, and various money systems developed based on goods, which the members of a society recognized as having a value. Cattle, grain, teeth, shells, features, skulls, salt, elephant tusks and tobacco have all been used. Precious metals gradually took over because, when made into coins, they were portable, durable, recognizable, and divisible into larger and smaller units of value.
A coin is a piece of metal, usually disc-shaped, which bears lettering, designs or numbers showing its value. Until the 18th and 19th centuries coins were given monetary worth based on the exact amount of metal contained in them, but most modern coins are based on face value, the value the governments choose to give them, irrespective of the actual metal content. Coins have been made of gold (Au), silver (Ag), copper (Cu), aluminum (Al), nickel (Ni), lead (Pb), zinc (Zn), plastic and in China even from pressed tealeaves. Most governments now issue paper money in the form of notes, which are "promises to pay". Paper money is obviously easier to handle and much more convenient in the modern world. Checks, bankers, cards and credit cards are being used increasingly and it is possibly to imagine a world where "money" in the form of coins and paper currently will no longer be used. Even today, in the U.S many places-especially filling stations-will not accept cash at night for security reasons.
Barter and the Double Coincidence of Wants
As long as specialization was limited, desirable trades were relatively easy to uncover. As the economy developed, however, greater specialization in the division of labor increased the difficulty of finding goods that each trader wanted to exchange. Rather than just two possible types of producers, there were, say, a hundred types of producers, ranging from potters to shoemakers. The potter in need of new shoes might have trouble finding a shoemaker in need of pots. Barter depends on a double coincidence of wants, which occurs only when traders are willing to exchange their product for what the other is selling. The cobbler must be willing to exchange shoes for the pots offered by the potter, and the potter must be willing to exchange pots for the shoes offered by the cobbler. Not only might this double coincidence of wants be hard to find but after the two traders connect they would also need to agree upon a rate of exchange—that is, how many pots should be exchanged for a pair of shoes? Increased specialization made the barter system of exchange more time-consuming and cumbersome.
When only two goods are produced, only one exchange rate must be determined, but as the number of goods produced in the economy increases, the number of exchange rates grows sharply. Negotiating the exchange rates among commodities is complicated in a barter economy because there is no common measure of value. Sometimes the differences in the value of the products made barter difficult. For example, suppose the cobbler wanted to buy a home. If a home exchanged for 2000 pairs of shoes, the cobbler would be hard-pressed to find a home seller in need of that many shoes. These difficulties with barter have led even very simple and primitive economies to use money, as we will see next.
Earliest Money and Its Functions
We have already discussed the movement from self-sufficiency to more specialized production requiring barter. We saw that the greater the degree of specialization in the economy, the more difficult it became to discover a double coincidence of wants and then to negotiate mutually beneficial exchanges. We should note that nobody actually recorded the emergence of money. Thus, we can only speculate about how money first came into use.
Through repeated exchanges, traders may have found that there were certain goods for which there was always a ready market. If a trader could not find a desired match or did not need goods for immediate consumption, some good with a ready market could be accepted instead. So traders began to accept certain goods not for immediate consumption but because these goods would be acceptable to others and therefore could be retraded later. For example, corn might become accepted because traders knew corn was always in demand. As one good became generally acceptable in return for all other goods, that good began to function as money. As we will see, anything that is used as money serves three important functions: a medium of exchange, a standard of value, and a store of wealth.
Medium of Exchange If a community, by luck or by design, can find one commodity that everyone accepts in exchange for whatever is sold, traders can save much time, disappointment, and sheer aggravation. Separating the sale of one good from the purchase of another requires something acceptable to all parties involved in the transaction. Suppose corn plays this role, a role that clearly goes beyond its usual function as food. We call corn a medium of exchange because corn is accepted in exchange by all buyers and sellers, whether or not they want corn for its own uses. A medium of exchange is anything that is generally accepted in return for goods and services sold. Corn is no longer an end but a means to an end. The end may be shoes, meat, pots, whatever. The person who accepts corn in exchange for some product may already have more corn than the entire family could eat in a year, but the corn is not accepted with a view toward consumption. It is accepted because it can be readily exchanged for other goods. Corn can be used to purchase whatever is desired whenever it is desired. Because in this example corn both is a commodity and serves as money, we call corn a commodity money. The earliest money was commodity money.
Standard of Value As one commodity, such as corn, became widely accepted, the prices of all goods came to be quoted in terms of corn. The chosen commodity became a common standard of value. The price of shoes or pots could be expressed in bushels of corn. Thus, not only does corn serve as a medium of exchange but it also becomes a yardstick for measuring the value of all goods and services. Rather than having to quote the rate of exchange for each good in terms of every other good, as was the case in the barter economy, the price of everything could be measured in terms of corn. For example, if a pair of shoes sells for two bushels of corn and a five-gallon pot sells for one bushel of corn, then one pair of shoes exchanges for two five-gallon pots.
Store of Wealth Because people often do not want to make purchases at the same time they sell an item, the purchasing power acquired through sales must somehow be preserved. Money serves as a store of wealth by retaining purchasing power over time. The cobbler exchanges shoes for corn in the belief that other suppliers will accept corn in exchange for whatever the cobbler demands later. Corn represents a way of deferring purchasing power yet conserving that power until consumption is desired. The better money is at preserving purchasing power, the better it serves as a store of wealth.
When we think of someone selling one good in order to be able to buy a second good, then the exchange of the first good for corn is only half of the exchange. Goods are first exchanged for the commodity money, corn; corn is -later exchanged for other goods. Breaking the exchange in two is much more convenient than trying to work out a barter arrangement, with its frequent delays and disappointments. With money, the buyers and sellers need to have only one good in common instead of two.