What is Commodity Money? – All the Things You Need to Know

What is Commodity Money? - All the Things You Need to Know

Commodity money definition

Commodity money has both intrinsic value and market value. It is a kind of money that can be used as a good or service and can be used as a medium of exchange.

In other words, they can be identified as a physical good which can be used as a component for production or can be used as a consumption good. So, commodity money has a intrinsic value. Further commodity money is accepted as a payment method during or after the goods and services exchange process. So, commodity money has a market value.

As an example, we can use gold to create jewelry. Not only that, in early days, people have used gold coins as a medium of exchange when they buy goods and services.

A physical thing that we can see, touch, and feel is commodity money. Its inherent value ensures the public’s faith in it. People freely exchanging it in the knowledge that it will be accepted is evidence that it has value on its own.

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What is Commodity Money? – All the Things You Need to Know

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Characteristics of Commodity Money

The following are the main characteristics of commodity money.

Acceptability

Acceptability of money means everyone accepts that money for the transactions. It supports the role of the exchange medium. In the past, commodity money such as gold was acceptable to everyone and used without refusing to exchange for goods and services.

Durability

Durability also refers to the ability of money to retain its value from one transaction to the next and cannot be quickly broken down, deteriorated, degraded, or change its form.

When we select a commodity as money, it should be remained for a long period of time without losing its value.

Gold, silver, copper, and nickel are a few examples of metals that have historically been used as commodity money. because they are materials that are extremely durable. This is because an ounce of gold or silver today will remain as an ounce of gold or silver tomorrow and even a thousand years later.

Rarity

Supply of the command money is limited when compared with the demand for money. If there is no rarity for the commodity money, the economy can be fallen into inflation.

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Commodity money examples

commodity money examples

Gold

Silver

Copper

Salt

Tea

Sea Shells

Tobacco

Alcohol

Wheat

Rice

Cocoa nuts

What are commodity money advantages and disadvantages?

Advantages

  1. Commodity money has an additional or supplemental function. As an example, we can create fashion jewelry from gold other than using gold as commodity money.
  2. Since commodity money has an intrinsic value, it can be used during recession periods by without losing its value.
  3. The commodities that were used to make commodity money are still valuable. We could argue that the supply of commodity money is limited on purpose. 

Disadvantages

  1. Sometimes it is difficult to divide the commodity money to small values according to the requirements. For examples, it is not possible to break down commodity money such as gold bars, sea shells, cigarettes into small pieces. 
  2. There is a risk of losing or decreasing the value of the commodity money over time. As a result, commodities money always carries a risk of volatility. For examples, value of commodity money such as, salt and rice can be decreased over the time.
  3. People cannot correctly measure the value of the goods and services using commodity money. As examples, some people measure the value of wheat bushel as a silver coin while some people measure the value of wheat bushel as two silver coins.

Advantages Vs Disadvantages of Commodity Money

What are commodity money advantages and disadvantages

Commodity money vs fiat money

  • A fiat currency is a legal claim since the law grants it all of its attributes. Similar to a purchase voucher, it has a variable purchasing power and can be exchanged for goods and services. Contrarily, commodity money is money that gets its worth from the commodity from which it is made. On demand, it can be traded for a certain good.
  • Fiat money cannot be replaced for any other kind of wealth since it is inherently worthless. Governments basically announced that it has value for that purpose, which is why it is recognized as money. If a gold coin is produced, its worth would be determined by the price of gold rather than by its face value. Commodity money was created as a practical means of trading because it outperformed the barter trade system.
  • Fiat money is paper money that only serves to bind people to promises or obligations. Final payment is never made under a fiat monetary system because every transaction involves a promise, a representation, or an obligation that something else is owed. A commodity-based monetary system requires that the final payment always be given in the form of the commodity that was used as payment for the transaction. Since there is no obligation and receiving the commodity in payment terminates all other commitments, the commodity is used as a final payment.
  • Governmental monetary policy is necessary to control the amount of fiat money in the case of the fiat monetary system. This policy must be developed with expert input in order to achieve the desired outcomes. The amount of gold that is issued under a commodity monetary system, such as the gold standard, is decided by market forces. The amount of gold sent to the mint for coinage and the number of gold coins that were melted for other purposes are used by the general public to determine the number of gold coins they require.

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Commodity money and barter system

The barter economy was inherent with some limitations such as,

  • Barter economy only provides a standard measurement for some    items, which results in trade inefficiencies.
  • It is yet unknown whether the parties involved in the negotiation have a history of ethical behaviour.
  • Force can be used by a strong trader to seize items from a weak trader.
  • Only items that may be divided equally are used in bartering.
  • The powerful party may use bartering to force the impoverished party to obtain the required commodities.

The command money could solve these types of issues. Because commodity money is a type of good that is considered as money. People used these commodities to buy and sell other products because they had commonly recognized worth.The things that were traded had a few distinctive characteristics: they were strong, lightweight, and easy to store, making them valuable because of their high demand.

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