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The following shortcomings had to be reckoned with to allow for TRADE BY EXCHANGE/BARTERING:

It was necessary to find someone with a congruent need before exchange could take place;

sufficient products had to be available for exchange;

the products needed to be able to be divided;

products needed to be transportable; and

a standard unit for expressing the value of products was needed.

These problems associated with such barter (exchange trade) made people search for a medium that would be acceptable to all in exchange for their products. Anything that was in common usage and accepted by all would be acceptable as a MEDIUM OF EXCHANGE.

The search for a MEDIUM OF EXCHANGE makes it possible to identify the stages of development.

The first phase:

One product was exchanged for another, without the use of “currency”, or a “third product”, e.g. one bag of wheat was exchanged for one set of clothes. This therefore was the exchange rate that became the norm:

  • 1 set of clothing = 1 bag of wheat

The second phase:

During this phase, a “third thing” in which the value of goods could be expressed was introduced. Such a “third thing/article” normally comprised a product that was regarded as valuable in particular communities, e.g. a sheep, which was significant of a person’s wealth. Barter (exchange transactions) could therefore be entered into in relation to the value of a sheep or a number of sheep, e.g.:

  • 2 sets of clothing = 1 sheep = 2 bags of wheat

The third phase:

During this phase, an exchange medium that remained generally acceptable but overcame the shortcomings mentioned above became necessary. Metals like copper, silver and gold, which were regarded as “precious”, proved to be particularly suitable for use in this regard and for acceptance as medium of exchange. In terms of our example, we would present this as follows:

  • 1 set of clothing = 1 oz of silver = 1 bag of wheat

The fourth phase:

Because of the danger linked to carrying large amounts of “precious metals” on long journeys undertaken to trade in distant parts, it became customary to deposit the metals with approved goldsmiths and obtain a receipt acknowledging the deposit (the gold certificate). It then became acceptable to merely submit the certificates as proof in exchange transactions. The next step had goldsmiths issuing certificates in different denominations, which also became an acceptable medium of exchange.

The fifth phase:

When goldsmiths realised that the gold and silver for the certificates were not claimed that frequently, they began issuing more gold certificates (paper money) than could be substantiated with gold from their coffers. This was the origin of modern paper money.

The sixth phase:

The most recent developments, besides printing of notes and minting of coins, involve the use of cheques and credit facilities. An amount is paid into a current account at a bank and the account holder can then write out a cheque to present as payment. The recipient of the cheque can deposit the money (cheque amount) into his or her own account or withdraw it as cash. In this way a cheque performs all the functions of currency.

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Source:  OpenStax, Economic and management sciences grade 8. OpenStax CNX. Sep 11, 2009 Download for free at http://cnx.org/content/col11040/1.1
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