In theory, people are generally able to exchange goods and services without the need for a monetary transaction between the parties involved. For instance, a farmer can trade 10 kilograms of apples with another farmer for 10 liters of milk. There would be a number of limitations on a barter economy: Each party to a transaction would have to want what the other offers. The two farmers in the example above should agree that x kilograms of apples are worth y liters of milk and be willing to exchange them at such conditions.
The exchanged goods and services ought to be divisible. If the goods are indivisible (such as a car), the owner wouldn’t be able to use them to purchase other goods and services of lower value.
The goods a person can exchange may be perishable, which means their owner should exchange or use them before they lose their value. It means that services and many types of goods wouldn’t allow the value associated with them to be stored.
Governments may offer incentives to limit barter even when it’s feasible, as it generally reduces tax revenue.
Once we understand the limits of barter, we can easily understand the functions of money in our society.
Money as a Medium of Exchange
A medium of exchange is an asset used in transactions to exchange goods and services. Gold and other precious metals have been used as a medium of exchange before money itself, or alongside it.
Not every asset can serve as an exchange medium. An asset must possess the following characteristics in order to function properly as a medium of exchange: It must be readily acceptable. It is generally true if the medium of exchange has a known value. People know how much a $100 dollar bill is worth and have at least an idea of what it can buy at any given moment.
It must be simple to divide. A good medium of exchange ought to be able to handle both large and small transactions. Banknotes and coins are generally available in different denominations in order to allow large value transactions, as well as small value ones.
It must have a high value relative to its weight. It is because a good medium of exchange should be easy to transport. Banknotes and coins are light and easy to carry.
It must be difficult to counterfeit. It would not be accepted in transactions if its value could not be determined with reasonable certainty. Money as a Standard of Deferred Payment
The above function is somehow related to the first, as it creates credit and allows transactions to be settled in the future. Money must be an accepted way to value and settle a debt in the future in order to be a standard of deferred payment. Money as a Store of Wealth
As services can’t be stored and a lot of goods are perishable, society requires more effective ways of storing wealth. Money is able to keep most of its value, at least during times of low inflation, and it is simple to store, retrieve, and use at a later time. Money as a Valuation Instrument The value of all goods and services traded in an economy can be measured using money as a universal unit of account. A money-based economy makes it easier for people to understand the value of goods and services because prices can be shown using only one value measure. Conversely, in a barter economy, the prices for a good or service should be established based on all the other goods or services produced and exchanged.
Money made of precious metals Especially in the past, gold and other precious metals have been successfully used as money in many societies. It is due to the following:
Because their value was known, they could be easily divided, were difficult to counterfeit, and had a high value in relation to their weight, they were a good medium of exchange for transactions settled immediately or in the future. Due to the fact that they are non-perishable goods, precious metals are regarded as a good wealth store. However, others would argue that their success as stores of wealth also depended on people’s expectations. Due to expectations that the demand for items like jewelry and ornaments will continue to be strong, they are expected to maintain their value because others will continue to value them in the future. They were good and simple measures of value. Gold grams or ounces could be easily used to measure the cost of goods and services by anyone.