Money vs. Barter | Why is barter ineffective?

In a very simple economy, with very few goods, people can barter. But when the economy grows, barter trade becomes ineffective. Let me explain this with the simple example.

There was a small village by the river. At first, there where only two families. One of them bred rabbits, and the other grew wheat. To diversify their diet, they traded with each other. They agreed that one bag of wheat will be exchangeable for one rabbit. After some time, other families began to settle on the village. Every family produced something else. Some of them produced clothes, others fished and still others bred cattle. Over time, there were many goods and services.

A shoemaker, send his daughter Catherine to get a bag od wheat. The girl took the shoes and went to the farmer to propose a trade. The farmer agreed because he needed shoes and so they exchanged. Next day, shoemaker, sent Catherine again to get another bag of wheat. But this time the farmer replied: “I’m sorry, I don’t need a second pair of shoes, but I will give you wheat for a box of apples”. So Catherine went to the gardener and proposed to exchange the shoes for some apples. The gardener replied: “I never wear shoes in the summer, I won’t be needing them for at least six months, I can give you apples in exchange for new horseshoes for my horse though”. So the girl went to the forge, but the blacksmith said, that he will give her horseshoes only for a new pair of trousers. Finally the local seamstress agreed to exchange shoes for trousers. Unfortunately, this wasn’t the end. It took Catherine half a day to find someone who needed shoes, but it took another half a day to finally get the wheat that she wanted.

Barter trade is ineffective and time-consuming. People needed something that can be used as a medium of exchange, something everyone can accept. They needed money.

Money has specific properties. It is a medium of exchange, which allows us to avoid the problems that Catherine had. It’s also a unit of account and can be used as a measure of costs and revenues through market prices.

Here are some characteristics of money that allow it to be used this way. It’s durable, which means it should last a long time without breaking; it’s homogeneous, which means that each unit should be identical; portable so that it’s small enough that you can carry it with you; divisible, so that you can make change; and importantly – it should maintain it’s value over a long period of time – so your saving would be worth the same even after many years.

Throughout human history there’ve been many media of exchange like cattle, salt or seashells. None of them lasted very long as money. Cattle, for example wasn’t divisible, interchangeable or easily portable. It also didn’t maintain it’s value over the long period of time. Salt becomes stale over time so it looses value over time and it wasn’t homogeneous because one bag of salt could be better quality than another. However one thing did emerge that had these qualities – gold and precious metals, which can be minted into coins or bars. Gold can be a medium of exchange and a unit of account. We can count up the number of gold coins something cost. It’s durable because it doesn’t corrode and it can last a thousand years. It’s homogeneous because all 1 ounce coins are identical and can be marked for purity. Coins are portable too, so a lot of purchasing power can fit in ones pocket. It’s divisible because the coins can be different weights. And what’s most important, gold has been a very stable store of value, because it’s quantity is limited by nature. Only a small amount of gold is mined each year in comparison to the quantity already in circulation. Because of these properties of gold, it has served as money for most of human history. In modern times however, the whole world has abandoned the gold standard. We’ll see the consequences of this in the next videos. Please subscribe.