Barter and Commodity Money

Abstract

THE NEED FOR exchange is derived from the problem that the goods a person produces may not be the goods that person wants to consume. In Chapter 1 we modeled this problem by assuming that people had goods when young but also wanted to consume when old. Because of the model's simplicity we use it as the foundation on which we build more complicated models. The simple model, however, allows no alternatives to fiat money – fiat money is used in exchange because there is no other way to trade what one has for what one wants. The model has only a single type of good in every period, so trading goods for goods is ruled out. In this chapter we consider models of two historically important alternative trading possibilities – direct barter and commodity money. In a fiat monetary system, goods trade for fiat money, but goods trade directly for goods in an economy with barter or commodity money. We distinguish between the two in the following way. In a direct barter economy, the goods one owns are exchanged for the goods one desires. In a commodity money economy, the goods one owns may be traded for a good that is not consumed but is traded, in turn, for the good one desires. In each case, we compare the performance of the model economy using fiat money with the alternative trading device. The first model illustrates how direct barter may be more costly than monetary exchange, the trading of goods for money and, subsequently, money for goods.