Question

What is the difference between commodity money and fiat money? Why do people accept fiat currency in trade for goods and services?

Answer 1

Solution:

A. Commodity Money: Commodity money is money which has intrinsic value. The intrinsic value comes from a commodity of which it is made. Intrinsic value means that the commodity has value even if it is not used as money. A commodity is a physical item that is readily interchangeable/ exchangeable with another item of the same type. The some examples of the commodity money are gold, silver, copper etc.

B. Fiat Money: Fiat money is money which hasn’t intrinsic value. It’s an alternative form of commodity money. Generally it is issued by the government by the law for the time being in force. It can be exchanged for the goods and services. Fiat money originated in 11th century China.

The difference are as follows:

1) Type

Fiat money is a paper money and it represents nothing but a promise or an obligation. On the other hand commodity money has an intrinsic value i.e made by metals tec.

2) Payment Implications
Commodity money is a sort of money that is considered as a present good which completes the transaction promptly. Whereas, fiat money is a future obligation as it is simply a promise to pay in the future.

Payment is never made when it comes to fiat money, instead it is only discharged.

3) Government Intervention
The quantity of money is not subject to governmental manipulation under commodity monetary systems like the silver or gold standard because it has a value of itself which is independent of its monetary use. On the other hand, the governments maintain control of the money under a fiat monetary system and can change the supply of money whenever they want to suit political considerations.

4) Determining the Quantity
Commodity money, like the gold standard, market forces determine the quantity of gold coined. Therefore, it can be said that the value of commodity money is determined by the wisdom and knowledge of all the people who are regulating the supply of money.

In case of the fiat monetary system, governmental monetary policy is required to regulate the quantity of fiat money.

5) Nature of Currency
Fiat money is a political currency, It is directly associated with the government debt even if it is directly issued by the government and is interest free. Whereas, commodity money is an economic currency and its quantity is determined by the needs of the economy as it is associated with the production of real goods and services.

Generally people accept fiat currency in trade for goods and services because it’s very easy to carry, whereas commodity money is made by metals or some other materials. It is issued by the government under the law for the time being in force. Hence it is acceptable by all the citizens.