Barter or ‘commodity for commodity’ exchange suffered from the following disadvantages:
1. Lack of Double Coincidence of Wants:
Quite often, two individuals do not need each other’s product. For instance, a farmer, willing to exchange food grains for a cow, can’t do so unless the owner of the cow is willing to accept food grains in exchange for it.
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What if the cow-owner wants goats in exchange? If he does, the farmer with food grains would have to look for someone who owns either goats or a cow and is also willing to exchange whatever he has for food grains.
In case the latter owns a cow, the farmer’s problem is solved. He can exchange his food grains for the cow and the matter is over. But if the latter owns goats, the farmer has to exchange his food grains for the latter’s goats and then he has to lead them to the cow-owner to exchange them for the cow.
What if the cow-owner already concluded the deal with someone else? If he did, the farmer with goats would have to look for someone who is willing to exchange his cow for the farmer’s goats. The exchange of food grains for cow, if direct, implies existence of double coincidence of wants; and if indirect, it implies lack of double coincidence of wants. In the latter case, the process of exchange is a long one involving wastage of time and effort.
2. Lack of Divisibility of Certain Commodities:
Most often, commodities involved in exchange need not have identical values. What if the exchange involved splitting of the larger and the more valuable unit into smaller parts so that one or more parts of it may be exchanged for the smaller and the less valuable commodity? For example, the large commodity may be an elephant and the smaller one, a bunch of bananas.
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The owner of the elephant can’t chop off the animal’s earlobe to buy the fruit. Such commodities have to be given away as a whole unit even if it amounts to accepting an entire farm of bananas for which the elephant-owner may have no desire.
3. Lack of Common Denominator:
It is difficult to find a standard commodity as a unit of account to express the values of all the other commodities in. For instance, some measure of wheat may serve the purpose provided it implies same value for all the individuals at all the times and has the attribute of general acceptability.
Value of wheat depends on its demand, supply and quality. The attribute of its general acceptability is questionable because it is not required by all the people at all the times with the same intensity.
A small piece of gold of a standard quality and a fixed quantity may, instead, serve the purpose better as a unit of account. It possesses all the attributes needed for the purpose. The only drawback it suffers is its limited stocks.
4. Lack of Store Value:
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It is risky to store savings and surpluses in terms of commodities that deteriorate in value with the passage of time. All perishable commodities lack the attribute of store value. The same is the case with animals and animal skins that age with time and require maintenance and care. Gold pieces of fixed purity and weight possess a very high store value instead.
5. Lack of Standard of Deferred Payments:
Contracts are often drawn in business requiring payments to be made in future (deferred payments) by one party to another. Commodity money fails to qualify as a standard mode of payment which the agreeing parties may accept without questioning its quality and quantity to be transferred.
In particular it is the recipient who would like to make sure that the value of the agreed payment does not suffer due to deterioation. There is no standard commodity in terms of which a future payment can be agreed upon without involving an element of uncertainty of its value.
Clearly, the system of barter did initiate the exchange but failed to facilitate it with desired smoothness, acceptability and equitability. With the passage of time, as human activities grew in complexity and as trade evolved as an economic activity, the need for some medium of exchange possessing the attributes of universal acceptability and measure and store of value was increasingly felt by the societies.
Money of today fulfils these requirements but its evolution to its modern form has passed through a number of stages and forms all of which suffered from one drawback or another.