Prior to the innovation of money, goods and services were exchanged directly for goods and services. The economy based upon this system of exchange is known as the barter economy. For example, A had surplus wheat and he wanted skin, B had surplus king and he wanted wheat. If both of them exchange their surplus commodities, this would be an act of barter. The barter system, thus, refers tot eh direct exchange of one good or services for another without the mediation of money.

The barter system has a number of disadvantages. The main disadvantages of the barter system are:

The functioning of the barter system necessitates a double coincidence of wants on the part of those involved in the barter exchange of goods and services. It is necessary for one party to want exactly what the other party offers in exchange and vice versa. If this double coincidence of wants is not matched exactly, no exchange will take place.

There is no common measure of value in th barter system. All commodities do not possess equal values. As there is no common measure of value, the ratio will be arbitrarily fixed according to the intensity of reciprocal demand.

Furthermore, in barter economy, one needs to be aware not only of the direct exchange ratio between the item offered and the item needed, but a host of other exchange ratios in addition. The number of exchange rates (values) between different goods would change rapidly and become quite   cumbersome even with a relatively limited number of commodities. This illustrated int eh following expression:

R_B N(N-1) / 2

R_Bis the number of rates of exchange or values in a barter economy and N represents the number of goods and services existing in the economy.

This adds to the complexities of the barter system.

There are certain goods which are not dividsible. Suppose A has a horse and B has a pair of shoes. Both agree to an exchange transaction. But according to the ratio of exchange arbitrarily fixed between them a portion of horse is equal in value to a pair of shoes. This transaction cannot take place because it is unthinkable to slice out a portion of a living horse for exchange.

Another difficulty under the barter system is related to the storing of wealth for future use. Most of the goods like wheat, skins, etc., lacked sufficient durability and deteriorated with the passage of time and, therefore, they could not be conveniently stored for future use.

The barter system was compatible only in a primitive economy, where everyone wore much the same kind of clothes, ate the same kind of food and engaged in similar activities. But, when people grew in the scale of vocalizations, wants multiplied and a certain degree of divinizing of labour was achieved, the difficulties of barter system became highly pronounced. The need for some other medium of exchange which could eliminate those difficulties and would facilitate transactions became apparent. This led to the invention of money.

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