There is much debate between the complete history of money andits origins. For the relevance of this essay we will disregard the debateand discuss the history of money and barter only in regards to moneys economicvalue and use. This in turn allows us to later analyse bitcoins merit as moneyand value. Prior to a monetary system humans are believed to have existed in a bartereconomy and slowly advanced towards a monetary system. which has existed inmany 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, GlynDavis P27). As money, hasexisted in numerous different formats it becomes evident, it’snear impossibleto define by its physical characteristics. Instead we defined money by itsfunction. In economic theory as highlighted in the BoE Summit Paper (Ali etal), something is considered money on its functionality as a medium ofexchange, unit of account and lastly store of value. *Although Glyn highlights manymore functions of money it is important to note that many other functions areabstract and not necessarily required. We look atthe barter economy, its problems and how these 3 functions of money alleviatethe inefficiencies and problems of bartering thus giving money value. The bartereconomy is described as an economy whereby a good one wishes to consume isobtained by directly trading it for the good one has and as such there is no goodused as a medium of exchange (ModellingMonetary Economics, Page 34-35).
Early onin civilisation when the economy was small and there were fewer goods a bartereconomy is not a large problem but as the economy grows, and there are morepeople and more goods to trade, a barter economy can be very inefficient for itrequires a double coincidence of wants an exchange to take place. A doublecoincidence of wants is when for person A and person B to trade both mustpossess what the other desires, in a large economy with many goods this canprove to be a costly endeavour. Further costs in a barter economy relate to theperishability of a good: e.g.
Assume Person A has some corn they wish toexchange for cotton. As a trade, can only occur in the instance of a doublecoincidence of wants, there may be an instance where by Person B is acquiringcotton in time = t, so that they can exchange it for corn. It is not unfair tosay that this would take some time and so if we assume that Person B acquirescotton in t+1 which they hope to exchange for corn. However, in t+1 thecorn(crop) has perished.
Person A has lost out on a trade and Person B who wentto acquire cloth only to exchange for corn has lost out, as they are stuck witha good they do not want and must again embark on a search for a doublecoincidence of wants.Paul Samuelssonfurther delves into the problem of a barter economy and its inefficiencies withthe use of the OLG model. Noting that without money, there would be noincentive to trade between generations and so the economy would be in autarkyMoneysolves these issues by acting as a decentralised record keeping system.The OLGmodel shows how the use of money in an economy not only facilitates tradebetween generations but also raises the welfare of the economy, such that bothparties are now better off. The mediumexchange function of money is very valuable in removing the costs of searching fora double coincidence of wants.
The Unitof Account function of money allows for real value to be placed not only upongoods but also other services. And allows for goods to be priced moreaccurately. 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 topurchase a pair of shoes. A pair of shoes aren’t worth 1 whole cow, but both partiesagree it is worth half a cow.
In this scenario, no trade can occur, you simplycannot give half a cow without killing the cow and thus destroying the value ofthe cow. Simply put because the cow is not divisible it cannot act as a properunit of account and so makes trade difficult. And lastlymoneys function as a store of value is of importance too, if money does nothave a stable store of value then nobody would be willing to accept it as amedium of exchange, out of fear that it would lose its value and they would beunable to use it.
The above example of corn highlights the reason why thisfunction of money is important. However, moneyis not without flaws, as Bruce Chap highlight. The use of money induces twotransactions, from goods to money and money back to goods, whereas a bartereconomy only requires one, a direct exchange of goods.
This can induce what issometimes referred to as an exchange cost. To assess the extent of an exchange cost we useBruce Chap’s model: Where ?= exchange cost of goods per person, ?m = exchange cost associated with usingmoney & J = number of goods in the economy. If weassume exchange costs to be zero in this model, then in the case where thenumber of goods is greater than 3 (J>3). Monetary exchange is cheaper thanbarter and thus a superior mechanism of payment. However in reality it is appropriate to consider there wouldbe exchange costs, especially if commodity money was to be used (i.e.
goldcoins). An exchange cost in such an example could include the cost of verifyingthe weight and quality of gold. Thus, in this scenario the advantage of money (reducessearch costs) could be offset by potential exchange costs. To deal with this issue, governments got involved andstamped the value of a coin on it.