There is much debate between the complete history of money and
its origins.

For the relevance of this essay we will disregard the debate
and discuss the history of money and barter only in regards to moneys economic
value and use. This in turn allows us to later analyse bitcoins merit as money
and value.

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

 

Prior to a monetary system humans are believed to have existed in a barter
economy and slowly advanced towards a monetary system. which has existed in
many diverse forms ranging from ‘Amber, eggs, feathers, gongs, hoes, ivory,
jade, kettles, leather, mats, nails, oxen, pigs, quartz, rice, salt, thimbles,
umiacs, vodka, and others. (History of Money, Glyn
Davis P27).

 

As money, has
existed in numerous different formats it becomes evident, it’s

near impossible
to define by its physical characteristics. Instead we defined money by its
function. In economic theory as highlighted in the BoE Summit Paper (Ali et
al), something is considered money on its functionality as a medium of
exchange, unit of account and lastly store of value. *Although Glyn highlights many
more functions of money it is important to note that many other functions are
abstract and not necessarily required.

 

We look at
the barter economy, its problems and how these 3 functions of money alleviate
the inefficiencies and problems of bartering thus giving money value.

 

The barter
economy is described as an economy whereby a good one wishes to consume is
obtained by directly trading it for the good one has and as such there is no good
used as a medium of exchange (Modelling
Monetary Economics, Page 34-35).

Early on
in civilisation when the economy was small and there were fewer goods a barter
economy is not a large problem but as the economy grows, and there are more
people and more goods to trade, a barter economy can be very inefficient for it
requires a double coincidence of wants an exchange to take place. A double
coincidence of wants is when for person A and person B to trade both must
possess what the other desires, in a large economy with many goods this can
prove to be a costly endeavour. Further costs in a barter economy relate to the
perishability of a good: e.g. Assume Person A has some corn they wish to
exchange for cotton. As a trade, can only occur in the instance of a double
coincidence of wants, there may be an instance where by Person B is acquiring
cotton in time = t, so that they can exchange it for corn. It is not unfair to
say that this would take some time and so if we assume that Person B acquires
cotton in t+1 which they hope to exchange for corn. However, in t+1 the
corn(crop) has perished. Person A has lost out on a trade and Person B who went
to acquire cloth only to exchange for corn has lost out, as they are stuck with
a good they do not want and must again embark on a search for a double
coincidence of wants.

Paul Samuelsson
further delves into the problem of a barter economy and its inefficiencies with
the use of the OLG model. Noting that without money, there would be no
incentive to trade between generations and so the economy would be in autarky

Money
solves these issues by acting as a decentralised record keeping system.

The OLG
model shows how the use of money in an economy not only facilitates trade
between generations but also raises the welfare of the economy, such that both
parties are now better off.

 

The medium
exchange function of money is very valuable in removing the costs of searching for
a double coincidence of wants.

The Unit
of Account function of money allows for real value to be placed not only upon
goods but also other services. And allows for goods to be priced more
accurately. The importance of this function can be highlighted in an example:
where if we assume cows are used as a medium of exchange and somebody wishes to
purchase a pair of shoes. A pair of shoes aren’t worth 1 whole cow, but both parties
agree it is worth half a cow. In this scenario, no trade can occur, you simply
cannot give half a cow without killing the cow and thus destroying the value of
the cow. Simply put because the cow is not divisible it cannot act as a proper
unit of account and so makes trade difficult.

 

And lastly
moneys function as a store of value is of importance too, if money does not
have a stable store of value then nobody would be willing to accept it as a
medium of exchange, out of fear that it would lose its value and they would be
unable to use it. The above example of corn highlights the reason why this
function of money is important.

 

However, money
is not without flaws, as Bruce Chap highlight. The use of money induces two
transactions, from goods to money and money back to goods, whereas a barter
economy only requires one, a direct exchange of goods. This can induce what is
sometimes referred to as an exchange cost.

To assess the extent of an exchange cost we use
Bruce Chap’s model: Where

 ?
= exchange cost of goods per person, ?m = exchange cost associated with using
money & J = number of goods in the economy.

 

 

 

 

 

 

 

 

 

 

            If we
assume exchange costs to be zero in this model, then in the case where the
number of goods is greater than 3 (J>3). Monetary exchange is cheaper than
barter and thus a superior mechanism of payment.

However in reality it is appropriate to consider there would
be exchange costs, especially if commodity money was to be used (i.e. gold
coins). An exchange cost in such an example could include the cost of verifying
the weight and quality of gold.

Thus, in this scenario the advantage of money (reduces
search costs) could be offset by potential exchange costs.

To deal with this issue, governments got involved and
stamped the value of a coin on it.