Before the advent of money, the activity of exchange was carried out through barter system. In barter system people exchanged goods and services in their possession with goods and services available with others. For example, a farmer exchanged his surplus food grain (over and above his own needs) with the weaver for his surplus cloth.
This activity helped both the farmer and weaver to satisfy their wants. The barter system of exchange worked well so long as human wants were simple and limited in number. However, in course of time human wants multiplied, which led to specialisation of occupations. This resulted in a lot of difficulties for exchange through the barter system. Consequently, need for a single and commonly acceptable medium of exchange was fell, this ultimately led to invention and, evolution of money.
In the barter system people faced the following major problems:
I) Lack of double coincidence or wants: Barter requires double coincidence of wants. For instance, if 'A' has, a goat rind wants to exchange it for cloth. Then he must find some person who has surplus cloth to offer while, at the same time, needs the goat which is offered by ‘A'. Such coincidences were easy when human wants were simple and number of goods produced were limited. But, as number of goods multiplied, such coincidences of, wants became both difficult and time-consuming. With the advent of money, this difficulty disappeared, as one can now sell product for money and then with the help of that money, he/she can buy a goods and services of his/her choice.
II) Problem of a common measurement of value: In the absence of money, value of every commodity was to be ascertained in terms of all other goods. For example, how much wheat or milk or salt or rice needs to be offered in exchange for one meter of cloth? If there were, say, 10 goods in a society, people were required to determine and remember 45 values, while if there were 100 goods there would be 4950, such values. The number of exchange values required for transactions may be found by the expression, n (n - 1)/2 where 'n' is number of goods.
However, with money in circulation, value of each commodity has to be expressed only in terms of money. Hence, in case of 100 goods, in a monetary economy people will have to know only 100 values.
III) Loss due to sub-division of goods: Many goods, if sub-divided, will lose them value partially or sometimes wholly. For example, a table or a refrigerator or a TV set cannot be sub-divided into parts as in doing so they will lose their value. In this situation, a person who wants to exchange his TV for five or six commodities, will find it difficult to get all these five or six desired goods from one person. Hence, he would need to sub-divide the TV into five or six parts, but by doing so TV will lose its value. On the other hand, if money is used as a medium of exchange, there would not be any such problem as money is perfectly divisible.
IV) Difficulty in storage s f wealth: It is very difficult to save and create wealth in the absence of money as many of the goods lack durability, and all kinds of services are perishable and hence cannot be stored for future use. People could not think of storing something to provide against future contingencies as wealth stored in the form of goods like wheat, animal skin, etc., would not last long. However, money being durable has become a convenient form to save and store wealth.
