What Is a Medium Of Exchange?

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

Key Takeaways

  • A medium of exchange is an intermediary instrument or system used to facilitate the sale, purchase, or trade of goods between parties.
  • In modern economies, the medium of exchange is currency.
  • If money–as represented by a currency–is no longer viable as a medium of exchange, or if its monetary units can no longer be accurately valued, consumers lose their ability to plan budgets, and there is no longer a way to gauge supply and demand accurately.

How a Medium Of Exchange Works

Using a medium of exchange allows for greater efficiency in an economy and stimulates an increase in overall trading activity. In a traditional barter system, trade between two parties can only happen if one party has a commodity that another party desires, and vice versa. The chance of this happening simultaneously as a cross occurrence–where each party desires something that the other party has–is improbable. Thankfully, with a medium of exchange, such as gold, if one party had a cow and happened to be in the market for a lawnmower, the cow owner could sell his animal for gold coins, which he may, in turn, use to purchase the lawnmower.

Using a medium of exchange allows for greater efficiency in an economy and stimulates an increase in overall trading activity.

Money As a Medium of Exchange

Money enables anyone who possesses it to participate as an equal market player. When consumers use money to purchase an item or service, they are effectively making a bid in response to an asking price. This interaction creates order and predictability in the marketplace. Producers know what to produce and how much to charge, while consumers can reliably plan their budgets around predictable and stable pricing models.

If money–as represented by a currency–is no longer viable as a medium of exchange, or if its monetary units can no longer be accurately valued, consumers lose their ability to plan budgets. Additionally, there is no longer a way to gauge supply and demand accurately. In short, market volatility will cause the markets to become chaotic.

Prices are bid up or raised, in response to worries about scarcity and fears of the unknown. Meanwhile, supply diminishes because of hoarding behaviors, coupled with an inability of producers to quickly replenish inventory.

Alternative Currencies As a Medium of Exchange

Alternative currencies have appeared throughout time during periods of economic duress to spur commerce or buttress a national currency. In the early 20th century, companies had to issue company scrip and other forms of emergency currency in order to pay their workers. At the time, massive bank failures had caused widespread cash shortages. Workers could redeem the scrip for food and services, or they could hold onto it for future redemption once U.S. dollars became available.

Example of an Alternative Medium of Exchange

Across the U.S., local currencies have sprung up with the primary purpose of fostering economic growth and sustainability in a given region. The best-known case of thriving local money occurred in 2006, in the Berkshires region of Massachusetts, with the first issuing of BerkShares on September 29, 2006. Subsequently, approximately 400 locally-owned participating businesses now accept them. The value of BerkShares is pegged to the value of the dollar but is issued at a discount. BerkShares can be obtained at participating bank branches (nine branch offices of three local banks) in exchange for U.S. dollars at a rate of 95 cents.