What is a Medium of Exchange?
A medium of exchange is a transitional instrument used to settle the trade of products and services among market participants. It is a system used to enable the exchange of items. Currency is the most common medium of exchange accepted as a standard by all parties for settling economic transactions.
In modern economies, currency as a medium of exchange has made economic dynamics possible. The standardization of currency as the medium of exchange has enabled quick trade settlements.
- A medium of exchange eases the trade of goods and services.
- The most common and generally accepted medium of exchange in the modern economy is money – represented as currency.
- A medium of exchange should have a consistent intrinsic value, be interchangeable, transportable, and reliable.
Characteristics of a Medium of Exchange
The following are the characteristics required of a medium of exchange:
- Common and obtainable
- Low preservation cost
- Resistance to falsification
- Large market value with respect to weight and volume
- Value common holdings
In an economy, a medium of exchange increases efficiency and acts as a stimulus for increasing trading-related activities. The most essential and important function of a medium of exchange is that it should have real value – i.e., it should possess steady purchasing power. Also, it should be widely accepted.
For any instrument to be widely accepted as a medium of exchange, it should be reliable, interchangeable, and have an intrinsic value.
Purposes of a Medium of Exchange
1. To facilitate exchange
The primary purpose of a medium of exchange is to assist a sale or purchase. The process of exchange is carried through a medium of exchange as participating parties acknowledge the worth of the medium.
2. Stored value
A medium of exchange should continue to have a stored value over time. The stored value can be used in successive exchanges and does not depend on the length of the time the medium was held.
Items other than money can also be used as mediums of exchange. A non-monetary instrument can be considered one if its value either appreciates or stays constant over time. Land and precious metals are some examples of non-monetary mediums of exchange.
3. Common language
The medium of exchange converts worldwide exchanges into common terms to enable smooth trade transactions. Regardless of the location, the dynamics of money is easily understood by the participating parties. When exchange methods other than money are used, the parties may find it difficult to determine the value of the exchanged item.
4. Measurement unit
The medium of exchange can also serve as a unit of account for calculating the medium’s worth when it is presented in uncommon terms. For example, since foreign currencies can be converted from one unit to another, the exchange units can be accounted for accurately.
Currency as a Medium of Exchange
Money, represented by currency, enables participation in the market as an equal player. The purchase of a product or service implies that consumers have made a bid following a price ask. Such an interaction allows the producers to determine the item category and the quantity to be produced.
Consumers can also predict the price models and plan their budgets accordingly. In case money loses its characteristics as a medium of exchange or the items exchanged cannot be valued accurately, it becomes difficult for the consumers to plan their budgets.
Furthermore, market unpredictability will result in a chaotic economy, as it becomes difficult to estimate demand and supply.
Alternative currencies, such as scrip, are available and have surfaced during times of economic pressure to stimulate trade. Local currencies have emerged in the U.S. to promote economic growth in a particular region.
BerkShares is an example of such currency. It was first issued in 2006 as the local currency of the Berkshires region in Massachusetts and is accepted by approximately 400 local businesses. The BerkShares value is pegged to the dollar value and is issued at 95 cents.
CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: