Medium Of Exchange

Updated on January 30, 2024
Article byKhalid Ahmed
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Medium Of Exchange?

Medium of exchange in economics refers to a reliable, widely, and legally accepted intermediary, transitional or financial instrument having inherent worth. This worth is utilized to assign value to commodities and services for trade and exchange between their owners. It aims to promote the sale & purchase of goods and services as per their value for the proper functioning of the economy.

Medium of Exchange

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Currency and money are mediums of exchange. They are necessary for an economy for efficient trading and boosting the activities related to trade and exchange. Significantly, they have purchasing power, stored value, and common terminology and act as a standard unit measurement. It acts as a stabilizing factor in an economy.

Key Takeaways

  • The medium of Exchange definition describes the ability of a transitional financial instrument to enable the power of purchasing or selling to its holder. 
  • It is known as a circulating medium. It facilitates trade & exchange and stabilizes the economy.
  • Money is a general term for a circulating medium. It can have a variety of physical forms as per the prevalent market and nation. Examples include currency or gold, which people widely accept and understand. 
  • Currency is the physical form of money that is a reliable, valuable circulating medium. It possesses the power to give value to goods and services. 

Medium Of Exchange Explained

The medium of exchange in economics is a transitional or financial instrument that helps sell or buy, i.e., exchange goods and services. The entities involved in trading know its worth. The stored value of this median remains constant across the length of time. Most significantly, it translates into a common language of trade globally, without which global trade may never happen or flourish. It is also called a circulating medium.

Medium of Exchange tree

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Another aspect of a circulating medium is its ability to act as a unit of measuring the worth of the goods or services that traders trade or exchange. The capability of circulating mediums as a measuring unit aids in converting one currency to another without difficulty. Moreover, it enables money and currency to function as a standard parameter for trade and exchange of goods.

The circulating medium uses the general lexicon of money to facilitate trade and commerce. The widely accepted currency prevalent in the place of trading represents money. Currency is the face of money, without which exchange of goods and services is impossible. In short, the common term for the circulating medium is money physically represented by a currency.

Both currency and money have the inherent property of facilitating the exchange & trade of goods & services as per their valuation in the market. Circulating medium has helped in a market of trade that uses currencies. Even securities get their monetary value due to the value assigned to them by the currency and indirectly by circulating mediums. So, the function of circulating currency is to act as a standard value to exchange multiple goods or services. It may include any economic tools, objects, or financial instruments.

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Characteristics

To become a medium of exchange, an object must exhibit certain traits, which one must know of to better explain a medium of exchange. Let us check out the features below:

  • A medium of exchange is durable, which means it is meant to last longer and not go anywhere any time soon.
  • Portability is another trait. This indicates that these objects of exchange can be easily carried wherever one wants.
  • The third trait is to be acceptable. The parties involved in the transaction using a particular medium of exchange must mutually agree to accept it for the dealing.
  • It must be divisible if required.
  • The supply must be regulated and should be equal in shape, size, and also unit of measurement.

Examples

Let us consider the following examples to understand the medium of exchange definition better:

 Example 1

One of the examples of the medium of exchange is cryptocurrency, which is the latest advancement in the finance industry. It is a currency available in digital format, the give and take of which is handled virtually under strict coded guidelines. It works based on certain algorithms, which prevent double-spending and counterfeiting.

Example 2

Here is a medium of exchange example to understand the concept better. 

First, let’s assume a cocoa grower in Africa has to sell her product to buyers. But cocoa is quite rare and precious, so she searches for a buyer in her local area to exchange with other equally valuable goods like rice. However, the producer will face a loss if she does not find a buyer to sell her cocoa. 

Hence, she goes to the market to search for a buyer. An American willing to buy the cocoa in return for his tea surprises her. But the cocoa grower has never traded cocoa for tea, so she is now in a fix. Here, the traditional barter system will not work out as the cocoa buyer does not want to exchange her product for tea. In this situation, the circulating medium comes handy. 

The American buyer and African seller might agree to buy each other’s products using common and widely accepted commodities or financial instruments that will be reliable and have buying power worldwide. As a result, they settle down for gold coins as a circulating medium to exchange for their cocoa-tea trade, making it beneficial to both. Hence, one can observe from this example that the trade of goods was impossible without a common circulating medium. 

Currency As A Medium Of Exchange

Currency is a legal tender that the government issues of a place bearing the assurance of paying the value as printed on the note. It is a standardized financial instrument that the government issues to facilitate trade and exchange within a country. Traders and exchangers use it for international trade, albeit currency exchanges. They use the physical form of the circulating medium to trade & exchange and to understand a country’s economy.

It has the same property as contained in the circulating medium. For example, it enables trade or exchange between the seller and buyer of goods or services in exchange for their assigned monetary values. Without currency, no trade is possible anywhere globally. Currency determines a person’s or institution’s wealth; more currency means a higher monetary value for the person or the institution. Likewise, suppose a country’s currency can buy the maximum goods and services using the lowest denomination like the dollar. In that case, the value of a currency is highly valuable. And if large numbers of currency cannot buy small things, then the value of a currency is quite low and weak. 

Currently, the most powerful circulating medium is the currency of the United States, i.e., the dollar. The dollar is a standard of valuation of all other currencies of the world as it is the most stable and powerful currency in the world.

Money As A Medium Of Exchange

A circulating medium is any tool or instrument used to determine goods and services’ value during their exchange between people. Hence the function of money contains the same property as the circulating medium. Consequently, anyone can possess it to participate equally in the market. As a result, traders and exchangers use money widely worldwide to buy, sell or barter goods or services. 

Money allows its possessor to trade goods and services instead of the bid they place to buy these goods and services. It helps in building up a successful market. People cannot plan their budgets or produce goods or services without money. In such a case, it will disrupt the demand and supply. Moreover, the whole economy based on demand and supply would never exist in the first place. Hence, the primary function of the medium of exchange of money is to play an active and important role in the economy of the whole world. It is the pillar of all the economic theories currently in vogue.

Frequently Asked Questions (FAQs)

What are the purposes of a medium of exchange?

The objectives of these objects of exchanges include the following:
·      It facilitates buying and selling of goods in exchange for it.
·      A medium of exchange stores value over a time period.
·      There is a common language, which makes the mediums of exchanges can be converted into the same unit measure.

What is a good medium of exchange?

A good medium of exchange is one that is widely accepted, recognized, stable, divisible, and portable. When it fulfills these criteria, the two parties involved in the transaction can have a reliable deal.

Why is the currency accepted as a medium of exchange?

Since currency is a financial instrument that the government authorizes to exchange goods and services by assigning a specific value to them, the traders and exchangers accept it as the circulating medium.

What was the first medium of exchange by and for humans called?

The barter system was the first exchange medium for humans, the use of which could be traced back to ancient times when hunters exchanged one thing or item to obtain another. His exchange was done with respect to what the two parties involved in the transaction desired to obtain from each other.

This has been a guide to what is a Medium of Exchange. Here, we explain its examples, its characteristics, and current and money as Mediums of Exchange. You can learn more from the following articles – 

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