Question

In November 2016 , the Indian government decided to withdraw paper currency that made up more than 86 percent of the value of all rupee bills in circulation. An article in the Wall Street Journal published shortly after that decision described a small merchant in India as having "traded one customer a kilogram of potatoes, cauliflower and tomatoes for half a liter of honey. That was a good deal, he says. In normal times, the honey would be 120 rupees in the market (around \(\$ 1.80\) ) and the vegetables 70 rupees." Is this merchant's ability to arrange a barter deal with a customer an indication that the Indian economy doesn't actually require money to function efficiently? Briefly explain.

Short answer

While the ability to barter can facilitate individual transactions, it doesn't indicate that an economy can function efficiently without money. Money simplifies and standardizes transactions, thus significantly increasing economic efficiency.

Step-by-step solution

Understanding the Barter System

Recognize the barter system as an ancient method of exchange where goods or services were directly exchanged for other goods or services without any intermediary such as money. In this given scenario, a merchant traded vegetables for honey.

Analyzing Efficiency of Barter System

Analyze the efficiency of a barter system. It is important to note that a barter system lacks divisibility, has problems with storing value, and significantly lacks a universal medium of exchange which can hinder efficiency.

Understanding the Role of Money

Understand that money serves as a common medium of exchange, a unit of measurement for value and a store of value, enhancing the overall efficiency of transactions in an economy.

Conclude the Exercise

While the barter transaction was successful in this scenario, it does not necessarily mean that the entire economy can function efficiently in this manner. The absence of money would make transactions more difficult on a large scale.

Key concepts

Medium of Exchange

In economic transactions, the concept of a medium of exchange plays a vital role. A medium of exchange is anything widely accepted as a method of payment. It simplifies trade by eliminating the need for a double coincidence of wants, which is required in a barter system. Imagine if you had to find someone willing to trade exactly what you wanted for exactly what you could offer every time you needed something.
This would be cumbersome and inefficient. Money fulfills this role seamlessly. With money, you can sell your goods or services to anyone and use the proceeds to buy what you need from others. Money's universal acceptability makes buying and selling easier and faster. It serves as a bridge between parties in a transaction, enabling smooth and efficient trading.
Without a common medium, an economy leans towards bartering, which can be limiting and time-consuming.

Role of Money

The role of money in an economy extends beyond merely being a medium of exchange. It serves three primary functions: a unit of account, a store of value, and a standard of deferred payment. First, it provides a common measure for valuing goods and services, making it easier to compare prices and costs. This uniformity helps businesses and consumers make informed decisions about what to buy or sell.
Secondly, money acts as a store of value, allowing individuals to save purchasing power for the future. In contrast, perishable goods like vegetables or honey in a barter system degrade over time, reducing their value. Money, especially when invested wisely, retains value over prolonged periods, enabling people to plan long-term.
Lastly, money's ability to function as a standard of deferred payment allows for credit transactions and installment plans. People can borrow money to buy items immediately and pay off the debt over time. This flexibility increases economic activity by enabling more significant purchases and investments.

Economic Efficiency

Economic efficiency refers to the optimal use of resources to achieve the desired outcomes. When an economy operates efficiently, resources are allocated in a way that maximizes total satisfaction or output. Compared to a barter system, a monetary economy enhances economic efficiency by reducing transaction costs and facilitating easier price comparisons. The presence of money eliminates the complexities of barter trade, such as searching for compatible trading partners and negotiating multitudinous deals. With money, the cost of transactions decreases since individuals and businesses spend less time and resources on finding exchange partners. Moreover, money allows for economies of scale, as businesses can grow and enhance productivity by specializing in the production of certain goods or services. Markets become more fluid, opportunities increase, and innovation thrives, leading to an overall gain in economic output. Thus, despite a merchant's ability to make a barter deal in a specific instance, a monetary economy is indispensable for wider, efficient economic function.