Medium of Exchange
View FREE Lessons!
Definition of Medium of Exchange:
A medium of exchange is a function of money that expedites trade between a buyer and seller because it is widely accepted as payment for a good or service. Most societies use their currency, but stones, salt, gold, and tobacco have been used as a medium of exchange.
Most economies use their currency as their medium of exchange because people recognize its value. A business or person accepts money knowing it can be exchanged for other goods and services. A medium of exchange should have a standard value so it is easy to compare values between goods and services. Currency in and of itself has no value. You cannot eat currency, nor can you wear currency, but it can be used to purchase food and clothing because it is accepted as a medium of exchange.
The efficiency gained by an economy with a medium of exchange is easily understood when comparing it to an economy relying on barter, or the exchange of goods or services without the use of money. An individual would need to identify something they offer that the other party needs in order to negotiate a trade. For example, if I am a dairy farmer and need a coat it is much easier for me to purchase a coat paying money than it is to search for someone else who has a coat my size who is willing to trade for my milk.
Normally some unit of exchange evolves in an economy. Initially, it may be a commodity that everyone finds value in. For example, tobacco was used as currency in Virginia and North Carolina during the 1600s because English currency was in short supply and everyone knew they could easily trade their tobacco.
The medium of exchange should be easily carried, durable, divisible, and not subject to wild fluctuations of value.
Dig Deeper With These Free Lessons:
What is Money
Fractional Reserve Banking and the Creation of Money
Monetary Policy – The Power of an Interest Rate