Money as a Medium of Exchange

What this means

Suppose you are a shoemaker and you want bread. You find the baker. You offer shoes. The baker says, "I already have shoes. I need a new roof."

Now you are stuck. To eat, you have to find a roofer who happens to want shoes, trade for roofing, then bring the roofing to the baker and hope she still wants it. Economists call this problem the double coincidence of wantsA situation where two traders each happen to have exactly what the other wants at exactly the same time., and it is the reason direct trading of goods for goods, called barterTrading goods or services directly for other goods or services without using money., breaks down quickly in any economy larger than a few families.

Money solves this. When something works as a medium of exchangeAnything widely accepted in a community as payment for goods and services., you sell shoes to anyone who wants shoes, take the money, and hand that money to the baker. The baker accepts it not because she wants the money itself, but because she knows the roofer will accept it from her.

That last sentence is the whole idea. Money works because of shared expectation. The paper in a wallet is not valuable as paper. It is valuable because everyone around you believes everyone else will take it. Break that belief and the paper is just paper.

This is also why money changes across time and place. Cowrie shells were widely used as money in parts of China and later across large trading regions. Salt has served as money in societies far from the sea, where getting it was hard and everyone needed it. Neither works today. Something becomes money when a community accepts it, and stops being money when the community stops.

Once money exists, something powerful follows. You no longer need to produce a little of everything you need. You can become excellent at one thing. That is specializationConcentrating on producing one good or service rather than trying to produce everything you need., and it is why a dentist can spend the whole day on teeth and still eat dinner.

Why it matters

Every job you have ever heard of depends on this. A software engineer does not write code that anyone can eat, wear, or live in. She writes code, receives money, and converts that money into groceries, rent, and a bus pass. Remove the medium of exchange and the entire job disappears, because nobody would trade food for code directly.

It also explains a frustration you have probably already experienced. Arcade tokens work in the arcade and nowhere else. A gift card to one store buys nothing at the store next door. These are money-like things with a very small circle of acceptance, and the size of that circle is exactly what separates them from real money.

Try it

1. Run a barter round first, so the problem is felt rather than described. On slips of paper, give each student one good they produce (bread, haircuts, shoes, phone repair, eggs, tutoring) and one different good they need. Do not let them look at anyone else's slip.
2. Give students four minutes to trade their way to the good they need. Only direct swaps are allowed, and both people must want what the other has. Count how many students succeeded.
3. Record the failures on the board. Ask the students who got stuck to explain exactly where the chain broke.
4. Now run the same round again, but hand every student ten paper tokens and announce that everyone must accept tokens as payment. Time it. Compare how long this round takes and how many students succeeded.
5. Break the system on purpose. Quietly tell three students that they will no longer accept tokens. Run a third short round and watch what happens to everyone else's willingness to take tokens.
6. Investigate two historical cases. Research cowrie shells as money in China and salt as money in a society located far from the ocean. For each, list the specific features that made it work there: was it hard to counterfeit, durable, portable, hard to get, wanted by everyone?
7. Then answer the harder half of the question in writing: why did each of those stop being money? Name at least one condition that changed.
8. Apply the test. Pick something in your own life that acts like money in a small circle (arcade tokens, school lunch credits, a game's in-game currency). Explain what would have to change for it to become money everywhere, and why that almost certainly will not happen.

Check yourself