In the past, when people were living in small societies and there was not much development as you see today. They were helping each other through barter system to mutually benefit one another. Barter system means exchange of one kind of goods and services for another kind of goods and services. There was no involvement of money in barter system.
This was happening in ancient civilisations. Some examples of Barter System are:
The barter system is not prevalent now. In today’s world nobody pays any good in exchange of another good. Everybody pays money to buy goods and services.
1. A common problem with the barter system is the lack of double coincidence of wants. Double coincidence of wants mean that if one wants to exchange some good with another person then the latter must also be willing to exchange his good with the first person. For example, a person wants cloth and he has rice with him to offer in return. Then he can exchange rice for cloth with another person who has cloth and who also wants rice. In practical life, such situation may or may not arise.
A related problem of barter system was that, one had to spend lot of time in searching for the person who was ready to exchange. However, in the early period of human civilisation this was a very difficult task as there was no proper facility with regard to transport and communication.
2. Lack of division of goods: Certain goods are not physically divisible into small pieces. Suppose, a person possesses a cow and he wants items, such as cloth, food grains, etc. Then how much of cow can be traded for cloth; how much of cow can be traded for food grains? It was very difficult to determine because, a cow cannot be divided into several pieces.
3. Lack of divisibility of goods: Under barter system, it was difficult to equate the values of different goods which were traded because of lack of common unit of measurement. For example, it will be very difficult to determine the amount of cow required to trade for some specific amount of food grains, or some yards of cloth.
4. Another problem of barter system is that a person must store a large volume of his own good in order to exchange for his or her desired goods with others on day to day basis. For example, a farmer who has produced wheat. Obviously he will use some amount of wheat for his own consumption and keep some amount to get other necessary items by trading with others. If he wants furniture, then he will go to a carpenter who is willing to trade furniture in return of his wheat. Similarly, if he wants cloth, then he has to trade with a weaver who is ready to give cloth by receiving wheat and so on.
5. A major problem of barter system is that, a good looses its original quality and value if it is stored for a long period. Many goods, such as salt, vegetables, etc, are perishable. Hence, goods were never accepted for trading in future because they could not be used as store of value. This also implies that no good could be used for the purpose of lending and borrowing.
Due to above problems, the barter system could not continue for long. As human civilisation progressed people realised that there has to be some common medium of exchange which can be easily carried, stored, and used to express value of a good. So money came into being. Hence, the need for money arose due to the failure of barter system.