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Class 12 Tuition > Learn Economics > How is money used as a medium of exchange? Explain.
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How is money used as a medium of exchange? Explain.

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A medium of exchange is an intermediary instrument used to facilitate the sale, purchase or trade of goods between parties. For an instrument to function as a medium of exchange, it must represent a standard of value accepted by all parties. In modern economies, the medium of exchange is currency. The...
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A medium of exchange is an intermediary instrument used to facilitate the sale, purchase or trade of goods between parties. For an instrument to function as a medium of exchange, it must represent a standard of value accepted by all parties. In modern economies, the medium of exchange is currency.

The use of a medium of exchange allows for greater efficiency in an economy and creates more trade. In a traditional barter system, trade between two parties could only occur if one party had and wanted what the other party had and wanted, and vice versa. But the chances of this occurring at the same time are minimal. Let's say one party had a cow and the other had a lawn mower: with a medium of exchange such as gold coins, all the cow owner would have to do is find a buyer for the cow and she would receive gold coins. Then all she would have to do is find someone selling a lawn mower, which she could purchase with gold coins.

Money enables anyone who has it to participate equally in market. When consumers use it to purchase something, they are essentially making a bid in response to an asking price. That is what brings order and predictability to the marketplace. Producers know what to produce and how much to charge and consumers can plan their budgets around predictable pricing.

When money, as represented by a currency, is no longer viable as a medium of exchange, or its monetary units can no longer be accurately valued, there is no predictability, no ability to plan, no ability to gauge supply and demand. In short, the markets become chaotic. Prices are bid up for fear of scarcity and the unknown, and supply is diminished from hoarding and the inability of producers to replace it quickly enough.

Alternative currencies have been used throughout time as a means to spur commerce or augment a national currency in times of economic duress. In the early 20th century, companies were forced to issue company scrip and other forms of emergency currency in order to pay their workers massive bank failures caused wide-spread cash shortages. The scrip could be redeemed for food and services or held for future redemption in U.S. Dollars when they became available.

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IITian, XLRI; CAT - 99.37 || XAT - 99.88

In order to understand this, let's go back to the barter system that originated in pre-historic times. The system can most simply be described as a system of give and take. For example, if you need goats and the other person needs horses, you simply exchange them. But what if you now want a cow but the...
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In order to understand this, let's go back to the barter system that originated in pre-historic times. The system can most simply be described as a system of give and take. For example, if you need goats and the other person needs horses, you simply exchange them. But what if you now want a cow but the person having a cow doesn't want the horse that you have? This is where money comes into the picture. Money is nothing but a universally agreed tender which can be exchanged for goods and services.

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