What is a 'Medium Of Exchange'?

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

BREAKING DOWN 'Medium Of Exchange'

Using a medium of exchange allows for greater efficiency in an economy and creates more trade. In a traditional barter system, trade between two parties could only occur if one party had a commodity that another party valued and vice versa. However, the chances of this occurring at the same time are minimal. But with a medium of exchange such as gold, if one party had a cow and needed a lawn mower, the cow owner could sell the cow for gold coins and use the coins to buy a lawn mower.

Money as a Medium of Exchange

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

When money, as represented by a currency, is no longer viable as a medium of exchange, or its monetary units can no longer be accurately valued, there is no predictability, no ability to plan and no way to gauge supply and demand. In short, the markets become chaotic. Prices are bid up for fear of scarcity and the unknown, and supply diminishes because of hoarding behavior and the inability of producers to replace supply quickly enough.

Alternative Currencies as a Medium of Exchange

Alternative currencies have been used throughout time to spur commerce or buttress a national currency in times of economic duress. In the early 20th century, companies had to issue company scrip and other forms of emergency currency to pay their workers because massive bank failures caused widespread cash shortages. Workers could redeem the scrip for food and services or held for future redemption in U.S. dollars when they became available.

Local currencies have sprung up across the United States with the primary purpose of fostering economic growth and sustainability within a region. The best-known case of a successful local currency occurred in the Berkshires region of Massachusetts. BerkShares were first issued in 2006 and hundreds of businesses​​​​​​​ across all communities now accept them. The value of BerkShares is pegged to the value of the dollar but issued at a discount.

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