The role of money in exchange

Money occupies a central role in market economies because it acts as a medium of exchange. The advent of money replaced the need for exchange through barter and enabled producers and factor owners to specialise. For example, without money, a hairdresser would have to accept another good or service as direct payment for a haircut. However, if the hairdresser is paid in potatoes, it means that he must pay for his assistant in potatoes, as well as pay himself in potatoes, and his suppliers. However, what if another client wants to pay in rice, and yet another in wheat? What is a haircut worth in terms of rice or wheat? Exchange through barter is very complex, and barter economies tend to remain highly undeveloped because direct trade is extremely difficult.

Money allows complex trade and exchange

Money is any asset that is acceptable in the settlement of a debt incurred in an exchange. For an asset to be widely used as money, it must have certain properties, including that the asset is portable, divisible, durable and stable in value. Some assets fulfill the role of money much better than other ones. Potatoes, for example, would not make a good medium of exchange because they are not durable, nor do they have a stable value. Throughout history, gold and silver have frequently been used as money, given their divisibility into bars and coins. The introduction of paper money by the Chinese in the 9th Century AD marked a significant development in the evolution of money, especially given the ease with which different denominations could be created, and the portability of paper money in comparison with gold or coinage.  It is said that the Chinese invented paper money because there was a shortage of metal to make coins.

It is clear that the evolution of money as a medium of exchange, and as a store of wealth, had a considerable impact on the development of modern commerce, international trade, and global prosperity.

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