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Explain using the concept of utility, why barter occurs. What underlying feature must be present for barter to take place?

The main factor governing most consumer behaviour is obtaining utility by purchasing goods and services. Utility basically expresses the satisfaction a person obtains from purchasing a particular good or service. In today’s economies barter has been substituted by exchange using mediums like money. However, there was a reason why economies initially used barter which links directly to the concept of utility.

In subsistence economies people tend to produce their own food depending on what they can produce more efficiently given their resources. So a person that had a large amount of fertile land would produce wheat, on the other hand a person that had the ability to breed chickens would use them for meat or eggs. Even though a person could in theory live just by eating what he produces given the concept of diminishing marginal utility this doesn’t happen in reality. Assuming utility is measured in utils the following table shows the total utility and marginal utility of every egg for the egg producer.

Because the egg producer’s utility decreases if he consumes excessive amounts of eggs and because the wheat producer will tire of consuming wheat products, in order to maximise their utility they will exchange the amount of goods that yield constantly reducing utility for another good, thus maximising their utility. This is because even though utility increases up until the 6th unit consumed as illustrated by the second column, marginal utility, as illustrated by the 3rd column starts decreasing after the 2nd unit consumed. What marginal utility illustrates is the utility obtained from every last unit consumed. Thus we see that barter will occur if the marginal utility of an egg to the egg producer will be smaller than the marginal utility of wheat. While at the same time, it must hold that the marginal utility of wheat to the wheat producer must be smaller than the marginal utility of an egg. Both conditions must hold in order for barter to take place because only then we have what is called “a double co incidence of wants.

This is an important constraint in a barter economy however, which led to the evolution of money. As division of labour became more complex, the “double co-incidence of wants” condition became increasingly difficult to fulfil. As a result even though a wheat producer may want to buy eggs the egg producer may want to buy another good such as sugar. Also it is possible that the greater division of labour led to payment issues forcing certain producers to have to pay employers who weren’t able to pay their employees in terms of the goods they wanted to have to seek alternative ways of paying them. Gradually, therefore, it became apparent that some commodities were in general demanded by a large number of people. This meant that a producer would be willing to accept such a commodity (e.g. gold) not because of its intrinsic utility to him but because he knows he can easily exchange it with someone else who produces the goods that he actually wants. Thus barter, as a system of direct exchange was superseded by a money economy which is a system of indirect exchange. So the chicken producer can sell his eggs to anyone who pays gold then look for someone who produces what he really wants and who will accept gold in exchange, because he too knows that other people will also accept it in exchange for the things that he wants. This is why barter was swamped for exchange using the medium of gold and eventually money.