Prior to money,goods were exchanged for goods to satisfy the needs of individuals.
This-exchange of goods for goods is known as the barter system of exchange.
According to Chandler,
“The direct exchange of economic goods for one another is called barter.”
However, the barter system was not sufficient to serve the ever-increasing needs and wants of individuals.
Following are some of the drawbacks of the barter system:
(a) Double Coincidence of Wants:
Refers to one of the assumption of barter system that led to its failure. The double coincidence of wants implies that the exchange of goods and services between two individuals would take place only when both the individuals require each other’s goods. For instance, the exchange of goods can only lake place between Mr. M and Mr. N in case Mr. N requires the good that Mr. M is selling. On the other hand, Mr. M is also willing to purchase the good that Mr. N is selling.
Therefore, the acts of sale and purchase of both, Mr. N and Mr. M should correspond to each other. Such type of exchange of goods and services is possible only in case of a simple economy w here people are aware of needs and wants of each other. However, it is not possible to know the requirements of each other in a complex economy where the wants of individuals are unlimited. In such a case, barter system involves wastage of time and efforts.
(b) Common Measure of Value:
Constitutes one of the important reasons for the failure of the barter system. In barter system, there is no common measure of value; therefore, it is difficult to find out any fixed ratio for exchanging goods and services.
For example, an individual is willing to buy wheat in exchange of cloth. In such a case, the condition of double coincidence of wants is satisfied. However, another problem that arises in this exchange is the exchange value of cloth and wheat.
In simpler words, it is difficult to decide what quantity of wheat should be exchanged with the particular quantity of cloth. In such a case, the exchange rate is determined on the basis of intensity of wants of an individual.
If the intensity of want of the individual requiring wheat is very high, then his/her bargaining power would decrease. As a result, he might give more quantity of cloth in exchange of small quantity of wheat. In such a case, it is difficult to determine the exchange rate of two goods without any common measure of value.
(c) Indivisibility of Goods:
Refers to another crucial drawback of the barter system. The barter system of exchange was not applicable in case of goods that lose their utility if divided into parts. For example, the value of one camel is equal to two horses. This implies that if an individual wants one horse in exchange of camel, then he/she has to sacrifice half of his/her camel.
In such a case, the utility from camel would be negligible and goods without utility lose its value. On the other hand, if the individual exchanges the full camel in exchange of one horse, then he/she would incur losses. The loss incurred by the individual would be equal to the utility value of one horse. Therefore, in the barter system, it was difficult to exchange indivisible goods.
(d) Store of Value:
Refers to one of the reason for the failure of the barter system. According to the barter system, value is stored in the form of commodities, such as cereal grains and cattle.
However, storing wealth in the form of commodities is difficult because of the following reasons:
(i) Perishability of Goods:
Refers to one of the main difficulties in storing wealth in the form of commodities. Perishable goods include vegetables, cattle, and fruits, which cannot be stored for a longer time as they get spoiled. This causes loss of wealth of individuals.
(ii) Quality of Goods:
Implies that the quality of goods declines if they are stored for a longer period of time. As a result, goods lose their value.
(iii) Space for Goods:
Refers to the fact that storing value in the form of commodities, such as cattle and grains, require lot of space. The huge space for storing goods may not be always available.
(iv) Expenses on Goods:
Constitutes the main difficulty in storing value in the form of commodities. Generally, storing commodities, such as cattle, involves high cost. This is because of the reason that one has to spend a lot for procuring feed for the cattle and maintaining hygienic conditions.
Jevons has explained the drawback of storing value in the form of commodities with the help of an example. In his example, he has cited a singer who belonged to Paris. The singer visited an island of Africa to give a singing performance.
At that time, barter system was prevalent in Africa. Therefore, the singer received grains and cattle as a reward. The cattle ate up the grains received by him, thus, the singer left with cattle only.
Besides this, during his return to Paris, his cattle also died due to some disease. In this way, he was not able to store value in the form of commodities. Thus, it can be said that storing value in the barter system was very difficult.
(e) Deferred Payments:
Refer to one of the most important drawback of the barter system. Deferred payments involve those payments that are made sometime in future. For example, interests, rents, loans, and insurance premium. In the barter system, commodities are used as a medium of exchange; therefore, it is very difficult to make deferred payments.
Chandler, the economist, has mentioned certain reasons that made deferred payments difficult in the barter system, which are as follows:
i. Leads to disputes with respect to the quality of goods. For example, if deferred payment is made in terms of wheat, then the quality purchased today may differ from the quality of wheat returned to the creditor of wheat after a period of time.
ii. Leads to disputes with respect to the nature of goods.
iii. Leads to disputes with respect to changes in the value of commodities used for deferred payments over a passage of time.
Owing to various difficulties, the barter system was insufficient to cater to the ever growing needs of individuals. Therefore, the concept of money was introduced by economists.