What is a medium of exchange? (With purpose and benefits)
By Indeed Editorial Team
Updated 11 January 2023
Published 6 May 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Money serves as a medium of exchange for goods and services. For a barter system to work, there has to be a coincidence of desires between the individuals participating in a transaction. A medium of exchange eliminates the need for complex trading systems to exchange various commodities and services in a bartered way. In this article, we explore the definition of a medium of exchange, its purpose and its benefits.
What is a medium of exchange?
A medium of exchange refers to a device or system that acts as an intermediary between two parties to enable the sale, acquisition or transfer of goods or services. The system requires a standard of value to serve as a medium of exchange. It requires acceptance by all parties. Currencies remain the best representation of a medium of exchange and their function includes facilitating commercial operations.
The medium of exchange becomes a widely acknowledged mechanism to resolve economic transactions by providing an element with a collectively agreed-upon value of exchange. The existence of the monetary system as a mode of exchange allows for modern economic dynamics. If the means of exchange were not as conventional as currency, it's hard to settle many commercial processes swiftly and satisfactorily.
What's the function of money?
Money functions as a mode of exchange, because it operates as a middleman between the buyers and sellers. Instead of swapping shoes for accounting services, the accountant now swaps cash for accounting services. Society recognises money as the most acceptable payment in product marketplaces to act as a mode of exchange. Money represents stored value. If you use money to make purchases today, it remains possible to use that currency to make purchases in the future. This builds trust as a stable mode of exchange.
What's the purpose of a medium of exchange?
A valid medium of exchange has several elements. Although certain trade products remain more liquid than others, the value of all products can be turned into liquid assets if the proprietor deems it necessary. When considering a transaction involving a medium other than money, it's important to assess if the commodity you gain in exchange serves the business in the way you require. Here are some of the primary purposes of a medium of exchange:
The primary goal of a mode of exchange is to make it easier for people to buy and sell things. Since all parties concerned appreciate the value of the medium, most people in the economic system use it regularly. When a stable medium is lacking in alternative exchange techniques, such as barter, certain parties remain unable to establish the worth of the item being traded. This means the price may be more volatile, but value preferences are easier to see through purchasing patterns.
The goal of a mode of exchange with stored value includes the medium retaining value for the proprietor over time. Most people consider money the primary global mode of exchange. To become a medium of trade, a non-monetary product's worth increases or remains constant over time. Property, land and precious metals are some examples of these mediums.
Creates a standard unit of account
The purpose of a unit of account for means of exchange refers to giving a mechanism to compute the worth of a medium when it's provided in terms that aren't universal. For instance, the unit of account fluctuates compared to foreign currencies. All parties taking part in the trade correctly account for the units of exchange since a way of converting foreign exchange of one value to some other exists.
What's the function of a mode of exchange?
Money performs several important tasks in the economy. It's a unit of account, a store of value and a medium of exchange. Money facilitates business because it's typically seen as valuable by those in the economy. As most individuals value money, they're eager to exchange it for products and services in the hopes of one day utilising the money they got as a seller to purchase goods or services from elsewhere. If people stop seeing money as valuable, it loses its use as a means of exchange, since no one's eager to exchange products or services for it.
Benefits of money as a mode of exchange
A reliable mode of exchange like money catalyses the offering and acceptance procedure. The appraisal of goods and services becomes challenging without it. Making trade offers without money is still possible, but money ensures that if barter options are impossible, there's an alternative. Both businesses and consumers in the market are also better able to determine supply and demand.
Alternative modes of exchange
Cryptocurrency is one example of an alternative medium of exchange. Furthermore, each coin is different. Not all cryptocurrencies are exactly like Bitcoin. Each type of coin follows its own set of laws and uses its own blockchain. It's used in certain places exactly like regular money, but costs remain substantially lower and transaction times are much faster.
There are a variety of community-based currencies, used for either credit or exchange. The Brixton pound and Stroud pound are examples. These currencies are intended to boost local trade while also addressing social marginalisation. Although certain local currencies have taxes, no one's obliged to take them. It's just a method to put local resources to good use while also fostering a feeling of community.
Fiat money vs. commodity money
The monetary system is a collection of processes used by governments to distribute money to consumers. It's also used to manage the exchange and supply of money, particularly through altering market interest rates. Differences between fiat money and commodity money include:
Fiat money derives all of its attributes from the law. It's like purchasing a voucher that's redeemed for products and services. Commodity money refers to money that derives value from the commodity it represents. Copper, gold, silver, precious stones, tobacco, cocoa beans and barley make up some examples of goods used as modes of trade. The gold standard is a good demonstration of commodity money since it allows individuals to trade things without having to carry gold.
Commodity money refers to a type of money that's based on the exchange of a tangible good. Fiat money remains a future obligation since it's nothing more than an agreement to pay later. When it relates to fiat money, payment's never made. Instead, it's simply discharged. Commodity money brings the deal to a close. Fiat money refers to paper money that reflects nothing more than a promise or a commitment. Since a transaction's conducted with a promise or an obligation that something more is due, final payment never happens under a fiat financial system.
Under commodity financial markets, like the sterling silver standard, the supply of money isn't vulnerable to state manipulation. This is because it holds a value outside of its monetary use. In a fiat monetary system, governments keep control over money and adjust the money supply to suit political reasons.
Market forces determine the quantity of gold produced under a commodity currency system, like the gold standard. The amount of gold sent to the factory for coinage and the number of gold coins melted for other purposes specify the number of gold coins required by the general population. So, the understanding of all those who regulate the supply of money determines the value of commodity money.
Related: How do investment banks make money?
Could alternative currencies replace money?
Countries consider alternative currencies because of economic, political and environmental concerns. According to recent trends, there's a shift from a centralised government to distributed systems, which has a significant impact on international power distribution. Many organised alternative currency systems remain effective on a local level, but they're unlikely to catch on globally.
Alternative currencies, notably Bitcoin, have seen a surge in popularity. The entire number of Bitcoins in circulation is public and transactions remain independently validated, making them difficult to forge. Since these currencies remain digital, they don't degrade over time. Bitcoins are generated through a mining process in which participants get coins as a reward for solving a certain type of computer challenge. Bitcoin is supposed to have a finite total supply, which remains important for Bitcoin supporters concerned about inflation degrading the value of the pound.
Please note that none of the companies, institutions or organisations mentioned in this article are affiliated with Indeed.
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