BARTER SYSTEM AND ITS INCONVENIENCE Definition of Barter System: The economic system which functions without the

use of money is given the name of barter system. In other words the economy which lacks any monetary media and the goods are exchanged with goods directly is a representative of barter system. Accordingly, we find that barter system is furnished with the followings: (i) There is a direct exchange of goods and money is not employed for transaction of goods and services. (ii) All the activities pertaining to consumption, distribution and allocation are performed on the basis of values of goods, not on the basis of money. Barter system remained in operation for a long time. As long as world's population was limited, the desires were not diversified, and the goods were produced on small scale the economic activities were carried under barter system . But with the passage of time the world's population expanded, the narrower and self sufficient life of villages broke; education spread; the era of invention and innovations started; and above all people experienced diversification in their desires. In such phenomenon Barter system failed to respond efficiently, and it had to be abandoned. Demerits of Barter System: (i) Lack of Double Coincidence of Wants: Under barter system, the goods were exchanged directly with the goods. But such situation may be attached with the lack of double coincidence of wants in between buyers and sellers. It is explained as: Suppose a person has cloth while the other has wheat. The wheat man wants to get cloth in exchange for cloth, but the cloth man does not wish to get wheat in exchange for its cloth. In such state of affairs trade will not take place leading to reduction in the welfare of trading parties. (ii) Difficult to Store the Goods: In barter system the goods served as money or the goods possessed the quality of "reserve purchasing power". Accordingly, people had to store them for future transactions. But so many goods, particularly which were perishable like milk, eggs, meat, fish, ice cream, and vegetables could not be stored for a long time. Even if the goods are stored or preserved in ware-houses or under the ground their value may deteriorate during the storing period. Moreover during such period, the tastes and likings of the people may also change. All such will affect the economic behavior of people. Page 1 of 10

(iii) Lack of Common Measure of Values: Under barter system the values of commodities were expressed in terms of some other commodities. For example if in an economic system 1000 goods are produced and this system operates without the use of money, then the value of each one good will have to be represented in the remaining 999 goods. Such situation will be extremely cumbersome. (iv) Credit Transactions were Difficult: Under barter system perhaps it was not possible to transact the goods on credit, i.e. the goods in exchange will be provided after some time period - a situation contradicting the philosophy of barter system. Moreover in barter system one could hardly represent the future activities and future transactions in some "Measure". Again if the trading parties are agreed upon some common measure then there may rise the issue of their value at the time of payment. (v) Lack of Counting System: Barter system lacked counting system. Accordingly in this system a firm will have to enter a variety of goods and services in its balance sheet. The costs, revenues and profits will be expressed in goods - such all will be tedious and complicated job. This will restrict the growth of firms and goods could not be produced on large scale. Again the economies of scale could not be reaped because of lack of specialization and division of labor. (vi) Difficult to Represent Factor Payments: Under barter system it was not possible to represent the factor payments like wages, rent interest and profit. In such situation the factors of production would be getting their payments in the form of goods. But along with changes in the values of goods the factors will not be satisfied with their goods remunerations. Moreover in this system the govt. will have to collect its revenues in the form of goods like vegetables, cattle, meat, eggs, beef, etc. How govt. would store such all goods. Again how govt. will make its expenditures in such state of affairs. Thus because of such problems barter system could not persist and function smoothly and the need for some monetary media was realized. Evolution of Money and Different Standards of Payments: With the passage of time the barter system lost its efficacy. Hence it was thought for some commodity which could be used to represent the values of goods and services. Moreover such commodity could be acceptable to the trading parties with out any hesitation. With such realization, the evolution of money started, which is presented below: (1) Commodity Money Standards:
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In the very initial stage the commodities like arrow, sword, knife, salt hides, cows, wine, wings of the birds, elephant teeth and slaves were used to make transactions. As in ancient Rome the salt and cattle were used as money. Tobacco was used as a medium of exchange in American colonies. While in certain other areas of the world the "pegs" were used to exchange the goods. But such commodities lacked the essential properties of money, as: (i) In that period there did not exist any commodity which had general acceptability as a medium of exchange. (ii) The good serving as money, should have the quality of divisibility. But the cattle lacked it. The cow would fail to maintain its value once it is slaughtered. (iii) The good which is to serve as money should easily be transported from one place to the other. But the pegs were not good money because of inconvenience attached with their transportation. (iv) The essential quality of money also requires for durability. But the commodities like salt, sugar, tobacco, vegetables and milk were not durables, their value may deteriorate. (2) Metallic Money Standards: Because of shortcomings attached with commodity standard the new development in history of money is given the name of metallic money standards. In this respect the iron and copper coins were used as money. Such metals were used as money because of their scarcity But with the passage of time the mining technology became popular and the scarcity of metals came to an end. The abundance of iron and copper led to decrease their value. Therefore, the period of iron and copper coins came to an end, and the period of bimetallism stoned. (i) Bimetallism: In the very beginning gold was expensive and there was a dearth of gold. Moreover, the people had such a low incomes that it was difficult to use gold for day to day transactions. While on the other side the silver was in abundance, it was cheap and its coins could be used even for minor transactions. Afterwards in 19th century the gold deposits were discovered in Australia and California. As a result the supply of gold increased. With this the period of bimetallism stoned where the Gold and Silver coins were used as money. Under this metallic standard, the official price of silver in terms of gold was determined. As during 1772 to 1834 in US the price of one ounce of gold was 15 ounces of silver. But the major shortcoming of bimetallism was
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identified by Sir Thomas Gresham. In this respect, he presented his law known as "Law of Gresham". Law of Gresham: Sir Thomas Gresham was financial advisor to Queen Elizabeth I. His life span was from 1519 to 1579. Gresham Law is as: "Bad Money Drives Out Good Money". Thomas Gresham told the Queen that those coins which were highly valued in terms of silver coins people had dropped them using as a medium of exchange. In this way, the more valued coins (gold coins) have gone out of circulation while those coins which were less valued in terms of silver coins remained in operation to be used for transactions. The reason behind this was: Henry VIII, who was father of Queen Elizabeth I decreased the proportion of pure silver in the silver coin from 92.5% to 33%, but he did not lower the face value of such coin by the same percentage. In this way, the silver coins emerged as "Bad Money", and gold coins were considered as "Good Money". Consequently, the coins whose real value did not decrease (gold coins) were collected by the people. The silver coins remained in circulation and gold coins went on getting out of circulation. There is another explanation of 'Law of Gresham': As there was an official price of gold in terms of silver, i.e. one ounce of gold was equal to 15 ounces of silver. But in addition to such official price, there also prevailed an unofficial rate of exchange between gold and silver. This rate of exchange was determined on the basis of supply of silver in the open market. If at any time there is excess supply of silver the price of silver will fall. It may happen that the price of silver in terms of gold goes up to 16 ounces. In order to earn profit people will take away the gold coins from circulation. By melting a gold coin the holder will be able to get 16 ounces of silver. When the profit motive of earning an extra ounce of silver will be existing the gold coins will be getting out of circulation which represent good money. Accordingly, the Bad Money (silver) will remain in circulation, and the Good Money will be out of circulation. Practically, law of Gresham was observed when official and unofficial prices of silver in terms of gold were witnessed. This paved the way for monometallic standard, rather bimetallism. Accordingly, Gold standard came into operation. (ii) Gold Standard:
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Under gold standard not only gold coins were used for transactions at domestic level, but international trade was also carried on the basis of gold. As in 1900 in US the gold standard, was in operation where the official price of gold was: $ = 25.8 grains of gold. It means that by giving 25.8 grains of gold one dollar can be obtained; while with one dollar 25.8 grains of gold can be had. It shows that gold as a commodity and gold as a money were convertible with each other at official rate of exchange. This convertibility provided confidence in dollars; i.e. people could be able to get 25.8 grains of gold if they sold the dollar coin of gold after melting it. As in different countries of world there prevailed the gold standard, the international transactions were also carried out under gold basis. The exchange rate between dollar and gold was fixed, again the rate of exchange between pound and gold was fixed. As a result the international exchange rate between pound and dollar was also fixed. The biggest advantage of gold standard was concerned with the stability in the value of currencies both at domestic and at world level. Because of such stability the people, businessmen and financial institutions were not worried of fall in the value of money. But gold standard was objected on the ground that it encouraged the outflow of gold when a country faced deficit in its balance of payments. In this way, the gold reserves of a country would be depleted creating a lot of problems for the country concerned. The outflow of gold will also have the effect of decreasing the supply of money at country level. This will create deflation making the domestic goods cheaper and foreign goods expensive. In this way, the BOP of a country may improve. But the deflationary tendencies may lead to create unemployment, fall in investment, bankruptcy of banks and unrest amongst laboring class. Moreover, when the outflow of gold continues, a shortage of gold will develop in the country leading to decrease the proportion of gold in the currency. In this way the confidence in the currency will shatter. Thus because of these demerits the gold standard could not maintain itself. After 1930's when State Intervention got popularity Gold Standard collapsed both at domestic level and at world level. (3) Representative Money: Earlier we discussed commodity money, and we told that till 1930's the gold remained in use as a money. But the gold as a money had to face a lot of problems, as: (i) The gold coins were bulky and it was difficult to carry them. (ii) The gold coins were easily identified, hence there prevailed a fear of being stolen away.
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(iii) Because of increase in population, trade, large scale production and diversification in desires the demand for money went on increasing, but the supply of gold could not be increased to the desired extent With these problems the era of 'Commodity Moneys' came to an end and the representative money period was set in. Definition and Concept of Money: According to definitions: "Money is a commodity which is generally acceptable as a medium of exchange and at the same time it acts as a measure and a store of value". This is the reason that Prof. Sigwick says: "Money is what, what money does". Thus the economists agree that anything which is to serve as money should be: (i) Generally acceptable. (ii) Could be used to measure the values of goods and services. (iii) Could be used to store the values. Thus keeping in view the above mentioned role and functions of money the experts follow the following methods to define money: (1) Transaction Approach which accords money as a medium of exchange. (2) Liquidity Approach which accords money as a temporary store of value. (3) Scientific Construct Approach which accords money as a measure of value. All are discussed below in turn. (1) Transaction Approach of Money: According to transaction approach only those commodities will be included in money which are just "Medium of Exchange". Thus all those goods which facilitate the sale or purchase of goods, or which facilitate the transaction of goods and services can be given the name of money. Hence, in the light of such approach to be money a commodity must have the quality of medium of exchange. As a result, the coins and currency notes which are issued by central bank and govt. and cheques of demand deposits Page 6 of 10

which are issued by commercial banks will be called money. They are considered as money because they can be used to purchase goods and services. Thus according to this approach money consists of (i) legal money and (ii) demand deposits. It is written as: Formula: M = CU + DD Where: M represents quantity of money, CU = currency and DD = demand deposits. It must be remembered that this approach to define money corresponds to classical theories. As classical economists accord money just as a medium of exchange. Money according to classical is just a token which is employed to purchase goods and services. Money can not influence the economic activity. To define money through transaction approach is beneficial from following point of view: (i) The money which is used to carry out the transactions can easily be controlled by central bank. Accordingly, the value of such money is stable. (ii) On the basis of transactive approach, the relationships between money and economic objectives can easily be predicted. The money which people possess to meet the daily needs is also given the name "Spending Money". But with the passage of time people got the realization that whatsoever they keep in the form of coins, currency and demand deposits does not yield any return, i.e., they have to lose interest what they could have earned against them. In this way, the possibilities in the development of definition of money took place and a new definition of money came forward. (2) Liquidity Approach of Money: Money is not just a medium of exchange, it is also a store of value. As Prof. Gurly and Shaw says: "Money as a store of value is an important property of money". Thus money should not include only currency and demand deposits, the assets should also be added in money. Thus according to this definition, "Money is like an asset", or money is like 'Reserve Purchasing Power' which
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people keep with them during the interim period of earning and spending. Thus according to this definition of money: "All those goods which have the quality of reserve purchasing power be also included in money". In the light of this theory we will add all those goods in money which are liquid. The liquidity represents how soon an asset with low costs can be used to purchase goods and services. In this way, not only currency but all other monetary and non-monetary assets like shares, bonds, houses, vehicles and shops will also be included in money. Because all these assets have the quality of money as a store of value. However, the degree of liquidity varies from assets to assets. It is the money which is the most liquid asset and it has not to converted in any other asset. As one rupee note remains one rupee note can be spent whenever one likes. On the other hand, house is also an asset, but it is not as liquid as one rupee. The sale of house will require time when as an asset it is converted into money. Thus according to liquidity approach money is not just a medium of exchange, it is something more than that. Normally all those goods which are medium of exchange also possess the quality of store of value. As the currency notes and demand deposits are not only medium of exchange, but they also serve as store of value. However, there are certain goods which have the quality of store of value, but they cannot be used as a medium of exchange, as the case of saving and time deposits of commercial banks. The such like deposits can not be withdrawn from banks readily and they can not be used for transactions. Therefore, these deposits represent just store of value. Thus it is- said that all those goods which are medium of exchange also have the property of store of value. While those goods which have the quality of store of value can not perform the function medium of exchange. It is shown as: Diagram:

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This figure shows that currency, demand deposits and traveler's cheques have the quality of medium of exchange (shown in the smaller circle). In addition to them if we include time deposits, mutual saving bank accounts and treasury bills we get all those goods which have the quality of money as a store of value. Thus if money is shown in a set, the money as a store of value will represent universal set while money as a medium of exchange will be a sub-set of this universal set. Thus according to liquidity approach all those assets whose nominal value neither increases nor decreases and they can easily be spent are called money. While those assets which experience slight rise in their value are known as Near Money, as the case of gold, silver and prize bonds etc. Finally we conclude by saying that according to liquidity approach money will be consisting of coins currency, demand deposits, saving bank deposits, fixed deposits and treasury bills etc. This must be kept in view that the philosophy of money as a medium of exchange is concerned with Keynesian thinking. As Keynes was of the view that money is not just a medium of exchange, but people have also the desire to save so that they could face unexpected circumstances. Moreover, people also save to earn interest or take advantage in the prices of goods and services. According to Keynes money can influence the economy through its role as a reserve purchasing power.
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(3) Scientific Construct Approach of Money Or Modern Approach of Money: This approach to define money is concerned with Milton Friedman and his followers. As Friedman says: "Money is not just a summation of medium of exchange and store of value, rather it is a scientific construct which has been invented for so many useful purposes". Friedman further says, money is anything which is helpful to us in many ways. It is not any thing which was exiting earlier, and now it has been discovered like USA, rather it is a scientific measure which has been invented like the measures in physics to measure length, temperature and power etc. Thus according to modem economists: "Money is anything which can be employed to measure the value of goods and services". As length of anything can be represented with the help of yardstick. In the same way, the values of goods can be represented with the help of money; national income can be shown with money; exports and imports can be shown with, the help of money; the domestic and foreign loans can be expressed with money; and the factor prices can be represented into monetary values with money.

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