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 a commodity that another party valued and vice versa. However, the chances of this occurring at the same time are minimal. Therefore, using a medium of exchange such as gold, if one party had a cow and needed a lawn mower, the cow owner could find a buyer for the cow and receive gold coins. Then, that individual could find someone selling a lawn mower, which could be purchased with the gold coins.

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 essentially making a bid in response to an asking price. This creates 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 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 is diminished 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 as a means to spur commerce or buttress 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 to pay their workers because 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 occurred in the Berkshires region of Massachusetts. BerkShares were first issued in 2006 and are now accepted in all communities by hundreds of businesses. The value of BerkShares is pegged to the value of the dollar but issued at a discount.

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