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'

The use of 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 and wanted what the other party had and wanted, and vice versa. But the chances of this occurring at the same time are minimal. Let's say one party had a cow and the other had a lawn mower: with a medium of exchange such as gold coins, all the cow owner would have to do is find a buyer for the cow and she would receive gold coins. Then all she would have to do is find someone selling a lawn mower, which she could purchase with gold coins.

Money as a Medium of Exchange

Money enables anyone who has it to participate equally in market. When consumers use it to purchase something, they are essentially making a bid in response to an asking price. That is what brings order and predictability to 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, no ability to gauge supply and demand. In short, the markets become chaotic. Prices are bid up for fear of scarcity and the unknown, and supply is diminished from hoarding and the inability of producers to replace it quickly enough.

Alternative Currencies as a Medium of Exchange

Alternative currencies have been used throughout time as a means to spur commerce or augment a national currency in times of economic duress. In the early 20th century, companies were forced to issue company scrip and other forms of emergency currency in order to pay their workers massive bank failures caused wide-spread cash shortages. The scrip could be redeemed 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 is the Berkshires region of Massachusetts. BerkShares were first issued in 2006 and are now accepted in all of communities by hundreds of businesses. The value of BerkShares are pegged to the value of the dollar but issued at a discount.

RELATED TERMS
  1. Medium Term

    Medium term is an asset holding period or investment horizon ...
  2. International Currency Exchange ...

    An international currency exchange rate is the rate at which ...
  3. Currency ETF

    Currency ETFs (exchange-traded funds) aim to replicate movements ...
  4. Currency Board

    A currency board is a monetary authority that makes decisions ...
  5. Linked Exchange Rate System

    A system of managing a nation's currency and exchange rate by ...
  6. Fourth Corner Exchange

    An alternative monetary exchange system based in the Pacific ...
Related Articles
  1. Insights

    What is Money?

    Money: It's a part of everyone's life, and we all want it, but do you know how it gains value and how it was created?
  2. Tech

    The History Of Money: From Barter To Banknotes

    Money has been a part of human history for at least 3,000 years. Learn how it evolved.
  3. Investing

    Why Gold Has Always Had Value

    Gold has an allure and a price tag, but with no real intrinsic value, why do we consider it so precious and valuable? Explore the answer.
  4. Investing

    How Gold Affects Currencies

    There is a strong correlation between gold's value and the strength of currencies trading on foreign exchanges.
  5. Personal Finance

    Currency Principle vs. Banking Principle: How Different?

    Understanding the difference between the currency principle and the banking principle helps to illustrate the most basic functions of money.
  6. Trading

    An Introduction To Complementary Currencies

    There are alternatives to national currencies. Discover complementary currencies and how they work.
  7. Trading

    Drastic Currency Changes: What's The Cause?

    Currency fluctuations often defy logic. Learn the trends and factors that result in these movements.
  8. Personal Finance

    The Worst Place to Exchange Currency

    Exchanging currency is a necessary part of traveling, but not all currency exchanges are created equal.
  9. Trading

    The Effects Of Currency Fluctuations On The Economy

    Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies.
RELATED FAQS
  1. What is foreign exchange?

    Foreign exchange is the conversion of a country's currency into another. In a free economy, a country's currency is valued ... Read Answer >>
  2. What is the gold standard?

    Learn more about the gold standard, including its complicated global history and its connection to the fiat system and the ... Read Answer >>
  3. How do changes in national interest rates affect a currency's value and exchange ...

    Generally, higher interest rates increase the value of a given country's currency, but Interest rates alone do not determine ... Read Answer >>
  4. Why do Bitcoins have value?

    Performing with transactional anonymity, Bitcoin has value as a private digital currency, investment tool and social networking ... Read Answer >>
Hot Definitions
  1. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  2. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  3. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  4. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  5. Monte Carlo Simulation

    Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted ...
  6. Price Elasticity of Demand

    Price elasticity of demand is a measure of the change in the quantity demanded or purchased of a product in relation to its ...
Trading Center