A Basic Analysis Of The Balkan Economy In Relation To The E.U.
A Basic Analysis Of The Balkan Economy In Relation To The E.U.
I think that it is right to begin with
the Theory of consumer choice. The above consumer has expressed his
preference of choice. He has a taste for seafood which he prefers
above all other types of food. This does not mean that he only eats
seafood, but in line with the last two elements of the theory of consumer
choice, he has shown his preference for taste and on that assumption, will
do the best that he can for himself to consume as much seafood as he can.
The elements of the theory which govern exactly how much seafood he will
consume are the first two, namely the consumer’s income and the price of
seafood.
We can assume therefore, that the consumer
will devote as much of his budgeted income for food, to as much seafood
as he can afford in preference to other foods such as hamburgers.
A budget line can be drawn up to show
a trade off between say, fish suppers and hamburgers to indicate the combinations
of fish suppers and hamburgers the consumer can afford given his income
and the prices of each meal. Points on the buget line will all be within
the consumers budget for food. All points below the line will show the
possible combinations of dinners avaiable for his choice. All points
above the line wil be unaffordable. It will be possible to see how
far the consumer could indulge his passion for seafood in one week.
(Slope of budget line = -Pu/Pv)
The next considerations that might be
taken are the marginal rate of substitution of one meal for another without
changing the total utility, the diminishing marginal rate of substitution
which will hold utility constant and representation of taste as indifference
curves. I will not elaborate on these at this point as I believe that the
marginal utility and diminishing marginal utility are more relevany and
pertinent to the question.
I shall now contunue by defining
utility. In economic jargon, utility is a numerical method of appreciating
a consumer’s satisfaction. The word itself, as far as meaning is concerned,
has nothing to do with its meaning in everyday language. It has nothing
to do with usefulness, it is a satisfaction based unit of measurement.
Marginal utility on the other hand is,
in a sense, an extra utility. What is meant in economic jargon by marginal
is the additional pleasure a specific good gives to a consumer.
Diminishing marginal utility is the marginal
utility lessening due to the growth of consumption. For example, a consumer
consumes a pound of fish, and his utility is 10 units, and his marginal
utility is 10 units. If the same consumer consumed two pounds of fish,
his utility would be 15, but his marginal utility would be 7. The same
effect on marginal utility would take place if the amount consumed further
increase. Since marginal utility diminishes as the quantity of fish consumed
increases, we are faced with diminishing marginal utility.
The point is that no matter how good the
the consumer’s fish dinners are , the more that is consumed, the less satisfaction
will the consumer have compared to the initial portion. This of course
is down to personal taste, for consumer A may have a diminishing marginal
utility that decreases a lot more slowly than consumer B. The fact
remains, that at some point, both comsumers will become saturated by their
love for seafood and the law of diminishing marginal utility will make
itself apparent.
Our consumer, as this point, will seek
to substitute some of his fish dinners with hamburgers or another alternative.
To conclude, the title question based
on the argument above, the statement: “I love seafood so much I can’t get
enough of it” may be passionate, but economically speaking is implausible.
Even if theoretically speaking the consumer had access to an infinite amount
of seafood and an unlimited budget, in the end the good would not satisfy
the consumer enough to remain a preferred good, thus this change in preference
would result in the consumer literally having had enough.
First we must consider suppy and demand.
Supply is the quantity of a good that sellers want to sell at every price.
Demand is the quantity of a good that buyers want to buy at every price.
Equilibrium is the point where the supply is equal to the demand. At a
particular price these behaviours become quantity supply, quantity demand
and equilibrium price.
We must now look at the elasticity
of supply and elasticity of demand. The elacticity of supply measures the
responsiveness of the quantity suppled, to a change in the price of that
good.
Supply elasticity = (% change in
quantity supplied)
(% change in price)
The elasticity of supply informs
us how the equilibrium price and the quantity will change if there is a
change in the demand. The elasticity of demand shows us the shift in the
equilibrium point if there is a change in supply.
The elasticity of supply and the elasticity
of demand directly affect each other in the following ways.
As seen on the graphs below, the cross
section changes. This results in a change of position for the equilibrium
point.
In the particular case of a 5-pence
per gallon tax imposition on petrol, considering that the current price
of petrol is roughly 69.6-pence per gallon, there is no drastic shift in
the supply curve. Nevertheless, a slight shift in the supply curve triggers
a slight shift in the demand curve as shown below.
This scenario is better portrayed
in the lower left graph of the image below (fig.15.4). Since petrol in
England has no substitute or alternative good, (unlike the U.S.), the consumer
has no other mean of mobilizing his or her essential equipment of transportation.
This automatically makes the demand elasticity low.
It is needless to say that as a
result of these minor shifts the deadweight loss is minimal.
The producer unlike the consumer,
in this case will not be affected in terms of tax incidence, the reason
being that as a producer of this specific good, there is no immediate “obligation”
to bear the tax incidence himself, thus the burden of tax is loaded onto
the consumer.
The legislator, or better known
as “the government”, will suffer no incidence of any sort. The only way
the legislator will be affected is through the update of this particular
tax, which is an annual bureaucratic budgeting process.
Over the last century many countries throughout
the world have experienced inflation as their major economic problem. Expensive
wars have traditionally been recognized as the sources of inflation. Governments,
in effort to squeeze more production out of an economy, have often resorted
to printing or releasing more money to finance the purchase of arms and
soldiers1. In an economy already producing at full capacity, the issuing
of additional money serves to bid up the prices of the output of the economy,
resulting in inflation. It was generally assumed from past experience,
that once the economy returned to its normal state, the persistent tendency
for overall prices to rise would disappear, bringing inflation rates back
to normal. World War II brought the persistent inflation that economists
came to expect. In the 50’s and early 60’s inflation resumed to very low
rates concomitant with large growth increases and low unemployment. But,
from 1967 to 1974 the rates of inflation reached alarming proportions in
many countries, such as Japan and Britain, for no apparent reason. This
acceleration in inflation has forced many economists to reevaluate their
views, and often align themselves with a specific school of thought regarding
the causes and cures for inflation.
There are two opposite theories
regarding inflation. Monetarism indicates that inflation is due to increases
in the supply of money. The classic example of this relationship is the
inflation that followed an inflow of gold and silver into Europe, resulting
from the Spanish conquest of the Americas. According to monetarists, the
only way to cure inflation is by government action to reduce growth of
the money supply.
At the other end is the cost-push
theory. Cost-pushers believe that the source of inflation is the rate of
wage increases. They believe that wage increases are independent of all
economic factors, and generally are determined by workers and trade unions.
More specifically, inflation occurs when the wages demanded by trade unions
and workers add up to more than the economy is capable of producing. Cost-
pushers advocate limiting the power of trade unions and using income policies
to help fight off inflation.
In between the cost-push and monetarism
theory is Keynesianism. Keynesians recognize the importance of both the
money supply and wage rates in determining inflation. They sometimes advise
using monetary and incomes policies as complimentary measures to reduce
inflation, but most often rely on fiscal policy as the cure.
Before we can understand the policies
suggested by these different schools of thought, we must look at the historical
development of our understanding of inflation.
For approximately 200 years before
John Maynard Keynes wrote the General Theory of Employment, Interest ,
and Money, there was a broad agreement among economists as to the sources
of inflationary pressure, known as the quantity theory of money2. The Quantity
theory of money is easily understood through fisher’s equation MV=PY (
money supply times velocity of circulation of money equals price times
real income)
Quantity theorists believe that
over an extended period of time the size of M, the money supply, cannot
affect the overall economic output, Y. They also assume that for all practical
purposes V was constant because short term variations in the circulations
of money are short lived, and long term changes in the velocity of
circulation are so small as to be inconsequential . Lastly, this theory
rests on the belief that the supply of money is in no way determined by
the economic output or the demand for money itself.
The central prediction that can
now be made is that changes in the money supply will lead to equiproportionate
changes in prices. If the money supply goes up then individuals initially
find themselves with more money. Normally individuals will tend to spend
most of their excess money. The attempt of people to buy more than they
normally do must result in the bidding up of prices because of the competitive
nature of the market, inflation.
Also essential to the quantity theory
is the belief that in a competitive market, where wages and prices are
free to fluctuate, there would be an automatic tendency for the market
to correct itself and full employment to be established.
In figure 1, w stands for the real
wage rate (the amount of goods and services that an individuals money income
can buy), L d for the demand for labor and L s for the supply for labor.
Suppose now that the economic system inherited a real wage rate w 1, The
supply of labor is L s1 while the demand for labor is only L d1. At this
point there is substantial unemployment because labor is costly for employers
to buy. According to Classicalists, The existence of an excess supply of
labor will lead to a competitive struggle between the unemployed and employed
for the available jobs. This struggle will lead to a reduction of real
wages, thus employers will begin hiring more workers. Eventually competition
will drive down wages to an equilibrium called labor- arket clearance,
where the demand and supply for labor is equal; this is We Le. Classicalists
define Labor market clearance as the point of full employment. Thus, persistent
unemployment can only be explained by a mechanism which interferes with
a competitive market. They specifically blame monopolistic trade unions
for preventing the wage rate from falling to We. Unions may use many
threatening tactics to fight wage cuts. Those most effective mentioned
in the textbooks are collective bargaining and strikes.
The Great depression, as experienced
by the US and the countries of western Europe, cast a shadow over the Classical
approach to economics3. The self-righting properties of classical economics
were clearly not working when wages and unemployment failed to decrease.
Blaming trade unions for these massive increases in unemployment seemed
far fetched.
John Maynard Keynes was the first
writer to produce a non-classical, coherent, and convincing explanation
of the inter-war depression. He traced the sources of unemployment to a
deficiency of effective demand. Put simply, unemployment occurred when
total spending on output was not enough to fully employ the available workforce.
Effective demand, called expenditures, was split into two groups by Keynes,
consumption and investment. Consumption, the purchase of goods and services,
far outweighed investment as the major component of effective demand.
At the theories” core lay Keynes’
belief that an economies” total production, Y, will eventually adapt itself
to changes expenditures. Moreover Keynes argued that the equilibrium of
wages exist when the output of producers is equal to the amount that consumers
and investors are willing to spend on their output.
Consider figure 2 Total expenditure,
that is the sum of consumption and investment , is measured on the vertical
and real income on the horizontal. For practical purposes investment will
remain a constant in the graph and be represented by line I. If we add
the consumption function and the investment line, we get the the sum total
expenditures, line E (E = C+I).
For any given amount of expenditures,
Y can be located anywhere for a short time. If Y is above E, then producers
are simply accumulating unsold stocks of goods. Eventually they will be
forced to cut back on production until they can sell their existing stocks,
earning capital enough capital to restart production. Conversely, If Y
is below E, producers will be selling out of goods. Normally they will
increase production as soon as possible to catch up to the demand and make
the most profit. This is where, the 45 line comes into use. Y, according
to Keynes, will shift to the point where E intersects the 45 line.
When Y intersects E at the 45 line, there is an equilibrium between expenditures
and total output, and wages are stable.
In order to illustrate how Keynes’
principle of effective demand accounts for unemployment, let us assume
that the economy starts off at full employment where Ld (demand for labor)
equals Ls (supply). The label of the output necessary to sustain full employment
is Yf, f denoting full employment. If expenditures were smaller than Yf,
than Yf would adjust itself to the left on the graph to accommodate for
this. Because the level of total output has shrunk, the demand for labor
also has, and unemployment has risen correspondingly.
If one accepts the Keynesian model,
there are generally two things that can be done to raise the level of aggregate
demand to a point where Y adjusts to full employment. Raising government
expenditures, G, stimulating private investment, or lowering taxes, raising
consumption because people will have more money to spend, will both raise
the level of aggregate demand. Both these policies come under the heading
of fiscal policy, which is deliberate manipulation of the government budget
deficit in order to achieve an economic objective.
During the great depression, many
people rejected Keynes’ ideas on unemployment because they were scared
to be different. The contemporary orthodox view was that cuts in the money
wages would automatically be accompanied by cuts in the real wages, thus
raising employment. Classicalists prescribed the government a remedy for
unemployment based on implementing money wage reductions. Keynes rejected
this idea on both theoretical and empirical grounds.
After the first World War, collective
bargaining rendered the downward flexibility of wages highly improbable.
Any attempts at cutting money wages would be fiercely
resisted, as seen as the 1926 General
Strike in Britain painfully demonstrated. Keynes regarded the trade unions’
resistance to wage cuts as a product of the rigid structure of wage differentials.
This is actually just the relative position of the wages of a particular
type of labor to all others, F.E. mechanics get paid 1$,Electricians
get 2$, plumbers get 3$. If any one group received generally higher wages,
other groups would surely demand higher wages to preserve the structure.
On the other hand, if a single group wantonly decided to accept a wage
cut, other groups would likely not follow. Therefore labor groups vehemently
resisted wage cuts.
Theoretically, Keynes believed that
drops in the money wages would eventually be accompanied by a drops in
prices. This balanced deflation would bring real wages, the amount of goods
that could be bought, to their original amount. Employers would not take
on more workers because their real revenue, amount of goods they sell,
would remain unchanged.
In order to fully consider this statement,
we must first look at the terms used and consider their definitions with
respect to the larger content of the question.
We will first consider Positive Economics.
A positive economic statement is one which relies on real data, given true
statistics and related directly to a true situation. Following this, we
can say that a normative economic statement is one which is not purely
objective although it is related to a positive economic situation. What
the normantive statement does is to follow on with an opinion which is
subjective, biased and based purely on the personal feelings of the speaker.
“Positive economics is about what
is; normative economics is about what should be.”
Economics, John B. Taylor, Houghton
Mifflin Company, 1995, p.25
Now we must consider the definition of
“Fair”.
“Fair: satisfactory,
just, unbiased, according to the rules.”
The Concise Oxford Dictionary, Fifth
Edition, Edited by H. W. Fowler and F. G. Fowler, Oxford University Press,
1964
I propose to return to this deffinition
having discussed the first part of the question.
When we are dealing with positive economics,
we are strictly involved with a “clinical” procedure of thought and analysis
where the thought pattern lacks the usual influence of personal bias and
emotional charge. Positive economics relate explicitly to the existing
situation based on true data and real facts. It can be expressed as a bird’s
eye view of a real given situation. Since logic is the dominant factor
in this thought/perception process, it is natural for positive economics
to be described as “what is”, because very seldom does a situation occur
where “what is” achieves the goal of “what should be”.
The normative side of economics,
unlike the bird’s eye view of positive economics, is a viewpoint from within
a given situation. This of course directly involves “the personal bias,
the subjective opinion ralated to real or given data”. Only when perceiving
a situation from within, from a specific internal standpoint can you express
the “what should be”. The positive unbiased process of factual data
lacks the reality of the emotionally charged normative thought process
where comparisons and conclusions are drawn from a basis of personal criteria.
The normative statement need not necessarily be “what should be”,
it can just as easily relate to “what should not be”, either positive or
negative but it will always be based on a subjective opinion brought about
by a personal attitude to a positive economic situation.
We can therefore look at the given
statement and immediately see that, although there is undoubtably a distribution
of wealth in the United Kingdom, and this is indisputably a positive economic
statement, the hypothesis that it is not fair is purely based on supposition
of the speaker and therefore a normative statement.
Dealing with the word “fair” in
general provocates an emotional connotation. There is a direct link of
meaning with equilibrium, but equilibrium can vary depending on what
angle fair is expressed from. “Fair” can vary greatly in accordance with
its definition. If we consider the distribution of wealth in the United
Kingdom “according to the rules” we must ask whose rules. If they are the
rules of the political party in power, then the distribution is fair.
If they are the rules of a Marxist minority party, then the distribution
is not fair. In both cases “fair” is unsed non-normatively.
The opinion of the unemployed or the lower
social orders does not count in this case, as there are no recognised rules
for these groups of people. Any opinion offerred from them regarding “fair”
is automatically normative.
The same will apply if taking into account
the other officially accepted definitions of the meaning of “fair”. There
can be ambivalence about the objective or subjective interpretation of
the word “satisfactory”. The word “just” can also be interpreted
both objectively in a legal connotation and subjectively in a personal
connotation.
In a specific case though, for example,
“The distribution of income in the United Kingdom is not fair.”, when examined
from a positive point of view through the accepted definitions , one can
arrive at a conclusion which may very well be “Yes, the distribution is
fair.”, but this conclusion can opnly have been derived from an omni
perceptive and non-biased angle, if the word “fair” has been given a formally
accepted definition. It must also relate in the particular circumstance
to the real statistical data taken into consideration, regarding the real
distribution of wealth in the United Kingdom.
If this distribution of income were to
be looked at from a normative angle, there would of course not have been
a conclusion such as the one above, the reason being that normative thought
is “personalized” thought, and in the real world, which is what normative
economics deals with, one’s view dramatically differs from another’s, therefore,
a statement such as “The distribution of income in the United Kingdom is
not fair.” would sound more like an opinion rather than a scientific conclusion
and would belong to the definitioin “Biased” and “satisfactory”.
In conclusion to the essay question
regarding “fair” being used non-normatively, my view is that it is possible.
Personal view or preference does not prevent one from appreciating a situation
as a whole if looked at from a “temporarily” neutral and dispassionate
standpoint. For example, one may not particularly like the work of a certain
acclaimed writer, but one can appreciate his/her work’s worth and quality
as an axample of literary expressionism.
The given statement for the essay
is undoubtably normative. It could, however, have been been made
positive, as could any other statement containing the word “fair” by defining
the concept of fairness within the terms relating to the reality.
Financing a small firm can be achieved
in three ways. The most preferable but at the same time the least likely
is self financing from retained earnings, otherwise, the firm will have
to resort to either one of the two following financial markets. Debt capital
and equity capital ( which strictly speaking is the same as retained earnings,
both having their advantages and disadvantages.
Only after 1979 did clearing banks start
making loans with a maturity term in excess of ten years. In
the case of a loan to smaller companies, the fixed interest rates are usually
set at a premium over base rate ( 3% – 6%). Larger companies who have a
good credit rating will probably be offerred the premium on the inter-bank
rate which is lower than the base rate. Loans are usually secured
on the personal guarantee of the Directors or the owner of small companies
and in the case of larger ones, a charge is made against the assets of
the company. If the charges are “fixed”, that means that they are
linked with a specific asset of the company. “Floating” charges are
made on the general assets.
All bank loans are based on three elements
which the company has to be able to satisfy. The interest rate demanded
by the bank, the security demanded by the bank and the terms of repayment
which are open to individual arrangements between bank and borrower although
they usually consist of systematic amortization payments made over the
full time of the loan.
A small company will have to ensure
its capability of all three in spite of the fact that in comparison
to a larger company, it will be paying a higher interest rate, will be
risking security based on the owner’s personal assets rather than company
assets and repayment terms will probably be more rigid rather than
flexible as banks rightly see the small company borrower as a higher risk.
(This is explained later on when discussing the problems faced by the small
company in raising finance.)
There are sources of loans other than
from banks. Companies usually resort to these financial institutions
as a last resort because their interest payments are fixed and if inflation
falls, this will make the borrowing very expensive. These financial sources
can include pension funds, insurance companies, merchant banks, the European
Investment Bank and the ICFC. (Investment and Commercial Finance Corp[oration)
There is also the “medium term note” open
as an alternative which is a promisory note issued by the company promising
to pay a specified amount on a specified date. The procedure is for
the company to write the note and then to sell it in the market place.
The interest rate can be fixed or may fluctuate and the maturity date of
the note can be anything from under one year to as long as fifteen years.
The small company may issue a debenture,
which is a document issued in return for money lent. There are various
types of debentures but they all have some features in common. They are
usually in the form of a bond, undertaking the repayment of a loan on a
specified date and with regular stated payments of interest between the
date of issue and the date of maturity. These dividends have priority
to be paid before any other dividend is paid to any other class of shareholder.
The Companies Acts define the word “debenture” as including debenture stock
and bonds. Often the terms debenture and bond or loan stock are interchangeable
although I shall mention Bond and Loan Stock a little later on.
There are a number of reasons why an investor
would chose debentures in preference to other forms of company financing.
The major factor has to do with risk. Debt financing usually has
a fixed maturity. The investor enjoys priority both in interest and
in the possibility of the company going into liquidation. In addition,debenture
holders receive a fixed return on the investment and if the company does
not make large profits, will continue to receive the fixed interest rate
while the ordinary shareholders may have to wait the Board’s decision on
what and how much to pay out.
Now we must look at why a company would
issue debentures. The primary advantage is that the cost of the debt
is known and is limited. If the company makes greater profits, these
are not shared out with the debenture holders. The cost of the debt
is also limited because the risk of the debenture holders is lower than
that of the shareholder. Also, and importantly, the interest payment
that is made to the debenture holder is deductable against tax.
Debenture issues are not an unqualified
benefit for the company. There are some disadvantages in that assumptions
that were made ten years ago about the future trading position of the company
might prove to be wrong and the decision for long term debt unwise. The
company still has to repay the debt on the date of maturity.
A warrant, is in principle, a call option
issued by the company on its own stock.The warrant holder is able to buy
a specified number of shares at a specified price on a specified date.
Problems that face the young company will be discussed later but for a
company without a proven track record, raising finance can be difficult.
The warrant can be used as an enticer. Debenture holders have no
option to benefit from the company which performs well but companies can
tempt investors to their debenture stock by issuing convertibles or warrents
in return for lower interest rates in the immediate term. (a convertible
is a bond which can be converted to ordinary shares) The most common issuers
of warrants and convertibles are risky companies, young companies and those
whose risk profile is difficult to estimate. In other words, those
who may not fare so well in the credibility stakes at the bank.
The company can issue preference shares
and holders are part owners of the company, but preference shares are closer
to loan capital than to ordinary shares.In the heirarchy they come higher
than ordinary shares and lower than debentures. The clear company advantage
is that preference shares are a source of long term , though not permanent,
finance and that the dividend does not have to be paid if company profits
do not justify it. Preference shares are not really popular with companies
or investors. In 1993 they were only 7.7% of the total.
There are a number of characteristics
shared by small companies which make it difficult for them to obtain funds.
Their shorter trading records means that less is known about them and their
size often precludes fewer accounting skills in the company which are necessary
to put over a strong case for financing. Small companies have limited
access to markets for securities, and in particular, the Stock exchange,
which is both difficult and expensive.It is a view widely held, that smaller
companies are more likely to have to face liquidation and so potential
lenders will be much harder to pursuade.
The Financial institutions which
dominate the market for finance, usually seek to invest in such a way so
as to ensure that their particular investment is unlikely to affect share
prices. This is the strategy to invest small amounts in large companies.
These finance Institutions obviously prefer stable long term growth and
the most unlikely place to find this is in a young or small company.
These characteristics, combined with those
already mentioned in earlier paragraphs, for instance, fixed transaction
costs for raising finance putting the small company at a disadvantage,
make the small companies more or less dependent on banks for finance.
Institutions that invest in smaller companies will see a higher level of
risk; as a consequence, the expected returns are higher and so the cost
of the capital is raised.
Companies which find themselves in need
of additional finance and look to the public for this via the Stock Exchange
have access to variable income and capital investments and fixed income
investments. The capital market offers three types of securities,
Company securities such as loan stock, shares, and options; public
sector securities, such as guilt-edged securities issued by governments
and well established companies; and Eurobonds.
There are two facets to the capital
markets and each has its distinct function. The primary market issues
and deals in new securities. So, companies wishing to raise new equity
on the Stock Market “New Issues Market” is dealt with by the primary market.
The secondary market deals with existing financial claims. Dealing
on the secondary market does not raise new finance for the quoted company,
but it enables the lender to transfer the repayment rights to another,
while the borrower remains unaffected.
The secondary market is important to the
investor because it allows the initial investor to sell the investment
as and when he chooses. Without the secondary market, companies would find
investors less willing to tie up their money for any length of time so
making the raising of finance by share issue more difficult.
The primary function of these markets
is to match the lenders to the borrowers and effect the directing of funds
between them.
Not all companies are in a position to
use the Stock Exchange to raise finance. All companies wishing to
enter the Stock Market must be quoted and this is a costly procedure. Many
companies are either too small or too new to gain a listing full listing
but they need not be excluded from this method of raising finance because
there is then the Unlisted Securities Market where the requirements for
trading are lower. Companies have to show a three year trading record
and offer 10% of shares at the primary issue.
There are four major benefits to a company
which can issue ordinary or equity shares. There are no fixed charges associated
with ordinary shares. The company may pay a dividend if sufficient profit
is generated but it does not have to do so. There is no fixed maturity
date. If the company loses, the shares can be sold to increase the creditworthiness
of the company and they can be sold more easily than debentures or preference
shares because they carry a higher expectation of better returns and so
represent a better hedge against inflation.
The downside for the company comes in
the shape of costs and control aspects.
There is also the question of “what
does the firm want the financing for?”. The reason can either be for the
purpose of expansion or settling previously acquired debt. The truth is
that even in the healthiest of cases, a small firm faces certain standard
small firm problems such as the difficulty to diversify and transaction
costs. For example, if a firm is small, this means that whatever it produces
or trades is dealt with in much smaller quantities than a larger firm.
Thus, the small firm’s accounts read a higher cost in purchasing raw materials
(per unit), than the costs a large firm has when purchasing the same raw
materials at a much greater quantity.
Another problem on the top of the
problem list of a small firm is its total worth. In order for the firm
to enter into either a debt market or an equity market, it must be of a
substantial value. For the case of the debt market, the small firm will
not be able to acquire a substantial amount of capital through a loan due
to its lack in required collateral. In the case of the equity market, it
is difficult for a small firm to enter this market for the same reason,
but not implausible.
The main concern for the small firm
is the interest rate the debentures or loans it has issued carry. It is
for this reason that these sources of finance are preferred to be used
as short term solutions. In the case of a small firm though, these debentures
or loans may be the only way to kick-start the firm into growth. There
must be a source of finance for the firm to use in order for it to invest
long term through short term financial sources.
Long term investments are an integral
part of a small firm’s growth. Investments in technology mainly, give a
firm the potential to expand, provided that the new investment(s) are managed
and utilized appropriately, and integrated accordingly into the previous
assets of the small firm.
For the manager looking to raise
finance for the company the Stock Exchange offers a number of possibilities,
if the company is in a position to meet with the process of listing and
the costs. If not, debt capital and its distinguishing features of being
less expensive than equity capital, being of lower risk and therefore having
a lower rate of return together with tax deductable interest payments,
are commonly experienced by managers of small companies.
As an epilogue, an alternative to borrowing,
the economic value of leasing is calculated by discounting the incremental
cashflows of the lease over the borrowing alternative. In addition to the
taxation benefits, leasing helps to preserve cash, varies the borrowing
portfolio and provides a less restrictive form of finance. Its certainty
and flexibility reduces risk and allows the small companies a greater freedom
in their investment decision process because rentals are operating expenses.
I think that it is right to begin with
the Theory of consumer choice. The above consumer has expressed his
preference of choice. He has a taste for seafood which he prefers
above all other types of food. This does not mean that he only eats
seafood, but in line with the last two elements of the theory of consumer
choice, he has shown his preference for taste and on that assumption, will
do the best that he can for himself to consume as much seafood as he can.
The elements of the theory which govern exactly how much seafood he will
consume are the first two, namely the consumer’s income and the price of
seafood.
We can assume therefore, that the consumer
will devote as much of his budgeted income for food, to as much seafood
as he can afford in preference to other foods such as hamburgers.
A budget line can be drawn up to show
a trade off between say, fish suppers and hamburgers to indicate the combinations
of fish suppers and hamburgers the consumer can afford given his income
and the prices of each meal. Points on the buget line will all be within
the consumers budget for food. All points below the line will show the
possible combinations of dinners avaiable for his choice. All points
above the line wil be unaffordable. It will be possible to see how
far the consumer could indulge his passion for seafood in one week.
(Slope of budget line = -Pu/Pv)
The next considerations that might be
taken are the marginal rate of substitution of one meal for another without
changing the total utility, the diminishing marginal rate of substitution
which will hold utility constant and representation of taste as indifference
curves. I will not elaborate on these at this point as I believe that the
marginal utility and diminishing marginal utility are more relevany and
pertinent to the question.
I shall now contunue by defining
utility. In economic jargon, utility is a numerical method of appreciating
a consumer’s satisfaction. The word itself, as far as meaning is concerned,
has nothing to do with its meaning in everyday language. It has nothing
to do with usefulness, it is a satisfaction based unit of measurement.
Marginal utility on the other hand is,
in a sense, an extra utility. What is meant in economic jargon by marginal
is the additional pleasure a specific good gives to a consumer.
Diminishing marginal utility is the marginal
utility lessening due to the growth of consumption. For example, a consumer
consumes a pound of fish, and his utility is 10 units, and his marginal
utility is 10 units. If the same consumer consumed two pounds of fish,
his utility would be 15, but his marginal utility would be 7. The same
effect on marginal utility would take place if the amount consumed further
increase. Since marginal utility diminishes as the quantity of fish consumed
increases, we are faced with diminishing marginal utility.
The point is that no matter how good the
the consumer’s fish dinners are , the more that is consumed, the less satisfaction
will the consumer have compared to the initial portion. This of course
is down to personal taste, for consumer A may have a diminishing marginal
utility that decreases a lot more slowly than consumer B. The fact
remains, that at some point, both comsumers will become saturated by their
love for seafood and the law of diminishing marginal utility will make
itself apparent.
Our consumer, as this point, will seek
to substitute some of his fish dinners with hamburgers or another alternative.
To conclude, the title question based
on the argument above, the statement: “I love seafood so much I can’t get
enough of it” may be passionate, but economically speaking is implausible.
Even if theoretically speaking the consumer had access to an infinite amount
of seafood and an unlimited budget, in the end the good would not satisfy
the consumer enough to remain a preferred good, thus this change in preference
would result in the consumer literally having had enough.
First we must consider suppy and demand.
Supply is the quantity of a good that sellers want to sell at every price.
Demand is the quantity of a good that buyers want to buy at every price.
Equilibrium is the point where the supply is equal to the demand. At a
particular price these behaviours become quantity supply, quantity demand
and equilibrium price.
We must now look at the elasticity
of supply and elasticity of demand. The elacticity of supply measures the
responsiveness of the quantity suppled, to a change in the price of that
good.
Supply elasticity = (% change in
quantity supplied)
(% change in price)
The elasticity of supply informs
us how the equilibrium price and the quantity will change if there is a
change in the demand. The elasticity of demand shows us the shift in the
equilibrium point if there is a change in supply.
The elasticity of supply and the elasticity
of demand directly affect each other in the following ways.
As seen on the graphs below, the cross
section changes. This results in a change of position for the equilibrium
point.
In the particular case of a 5-pence
per gallon tax imposition on petrol, considering that the current price
of petrol is roughly 69.6-pence per gallon, there is no drastic shift in
the supply curve. Nevertheless, a slight shift in the supply curve triggers
a slight shift in the demand curve as shown below.
This scenario is better portrayed
in the lower left graph of the image below (fig.15.4). Since petrol in
England has no substitute or alternative good, (unlike the U.S.), the consumer
has no other mean of mobilizing his or her essential equipment of transportation.
This automatically makes the demand elasticity low.
It is needless to say that as a
result of these minor shifts the deadweight loss is minimal.
The producer unlike the consumer,
in this case will not be affected in terms of tax incidence, the reason
being that as a producer of this specific good, there is no immediate “obligation”
to bear the tax incidence himself, thus the burden of tax is loaded onto
the consumer.
The legislator, or better known
as “the government”, will suffer no incidence of any sort. The only way
the legislator will be affected is through the update of this particular
tax, which is an annual bureaucratic budgeting process.
Over the last century many countries throughout
the world have experienced inflation as their major economic problem. Expensive
wars have traditionally been recognized as the sources of inflation. Governments,
in effort to squeeze more production out of an economy, have often resorted
to printing or releasing more money to finance the purchase of arms and
soldiers1. In an economy already producing at full capacity, the issuing
of additional money serves to bid up the prices of the output of the economy,
resulting in inflation. It was generally assumed from past experience,
that once the economy returned to its normal state, the persistent tendency
for overall prices to rise would disappear, bringing inflation rates back
to normal. World War II brought the persistent inflation that economists
came to expect. In the 50’s and early 60’s inflation resumed to very low
rates concomitant with large growth increases and low unemployment. But,
from 1967 to 1974 the rates of inflation reached alarming proportions in
many countries, such as Japan and Britain, for no apparent reason. This
acceleration in inflation has forced many economists to reevaluate their
views, and often align themselves with a specific school of thought regarding
the causes and cures for inflation.
There are two opposite theories
regarding inflation. Monetarism indicates that inflation is due to increases
in the supply of money. The classic example of this relationship is the
inflation that followed an inflow of gold and silver into Europe, resulting
from the Spanish conquest of the Americas. According to monetarists, the
only way to cure inflation is by government action to reduce growth of
the money supply.
At the other end is the cost-push
theory. Cost-pushers believe that the source of inflation is the rate of
wage increases. They believe that wage increases are independent of all
economic factors, and generally are determined by workers and trade unions.
More specifically, inflation occurs when the wages demanded by trade unions
and workers add up to more than the economy is capable of producing. Cost-
pushers advocate limiting the power of trade unions and using income policies
to help fight off inflation.
In between the cost-push and monetarism
theory is Keynesianism. Keynesians recognize the importance of both the
money supply and wage rates in determining inflation. They sometimes advise
using monetary and incomes policies as complimentary measures to reduce
inflation, but most often rely on fiscal policy as the cure.
Before we can understand the policies
suggested by these different schools of thought, we must look at the historical
development of our understanding of inflation.
For approximately 200 years before
John Maynard Keynes wrote the General Theory of Employment, Interest ,
and Money, there was a broad agreement among economists as to the sources
of inflationary pressure, known as the quantity theory of money2. The Quantity
theory of money is easily understood through fisher’s equation MV=PY (
money supply times velocity of circulation of money equals price times
real income)
Quantity theorists believe that
over an extended period of time the size of M, the money supply, cannot
affect the overall economic output, Y. They also assume that for all practical
purposes V was constant because short term variations in the circulations
of money are short lived, and long term changes in the velocity of
circulation are so small as to be inconsequential . Lastly, this theory
rests on the belief that the supply of money is in no way determined by
the economic output or the demand for money itself.
The central prediction that can
now be made is that changes in the money supply will lead to equiproportionate
changes in prices. If the money supply goes up then individuals initially
find themselves with more money. Normally individuals will tend to spend
most of their excess money. The attempt of people to buy more than they
normally do must result in the bidding up of prices because of the competitive
nature of the market, inflation.
Also essential to the quantity theory
is the belief that in a competitive market, where wages and prices are
free to fluctuate, there would be an automatic tendency for the market
to correct itself and full employment to be established.
In figure 1, w stands for the real
wage rate (the amount of goods and services that an individuals money income
can buy), L d for the demand for labor and L s for the supply for labor.
Suppose now that the economic system inherited a real wage rate w 1, The
supply of labor is L s1 while the demand for labor is only L d1. At this
point there is substantial unemployment because labor is costly for employers
to buy. According to Classicalists, The existence of an excess supply of
labor will lead to a competitive struggle between the unemployed and employed
for the available jobs. This struggle will lead to a reduction of real
wages, thus employers will begin hiring more workers. Eventually competition
will drive down wages to an equilibrium called labor- arket clearance,
where the demand and supply for labor is equal; this is We Le. Classicalists
define Labor market clearance as the point of full employment. Thus, persistent
unemployment can only be explained by a mechanism which interferes with
a competitive market. They specifically blame monopolistic trade unions
for preventing the wage rate from falling to We. Unions may use many
threatening tactics to fight wage cuts. Those most effective mentioned
in the textbooks are collective bargaining and strikes.
The Great depression, as experienced
by the US and the countries of western Europe, cast a shadow over the Classical
approach to economics3. The self-righting properties of classical economics
were clearly not working when wages and unemployment failed to decrease.
Blaming trade unions for these massive increases in unemployment seemed
far fetched.
John Maynard Keynes was the first
writer to produce a non-classical, coherent, and convincing explanation
of the inter-war depression. He traced the sources of unemployment to a
deficiency of effective demand. Put simply, unemployment occurred when
total spending on output was not enough to fully employ the available workforce.
Effective demand, called expenditures, was split into two groups by Keynes,
consumption and investment. Consumption, the purchase of goods and services,
far outweighed investment as the major component of effective demand.
At the theories” core lay Keynes’
belief that an economies” total production, Y, will eventually adapt itself
to changes expenditures. Moreover Keynes argued that the equilibrium of
wages exist when the output of producers is equal to the amount that consumers
and investors are willing to spend on their output.
Consider figure 2 Total expenditure,
that is the sum of consumption and investment , is measured on the vertical
and real income on the horizontal. For practical purposes investment will
remain a constant in the graph and be represented by line I. If we add
the consumption function and the investment line, we get the the sum total
expenditures, line E (E = C+I).
For any given amount of expenditures,
Y can be located anywhere for a short time. If Y is above E, then producers
are simply accumulating unsold stocks of goods. Eventually they will be
forced to cut back on production until they can sell their existing stocks,
earning capital enough capital to restart production. Conversely, If Y
is below E, producers will be selling out of goods. Normally they will
increase production as soon as possible to catch up to the demand and make
the most profit. This is where, the 45 line comes into use. Y, according
to Keynes, will shift to the point where E intersects the 45 line.
When Y intersects E at the 45 line, there is an equilibrium between expenditures
and total output, and wages are stable.
In order to illustrate how Keynes’
principle of effective demand accounts for unemployment, let us assume
that the economy starts off at full employment where Ld (demand for labor)
equals Ls (supply). The label of the output necessary to sustain full employment
is Yf, f denoting full employment. If expenditures were smaller than Yf,
than Yf would adjust itself to the left on the graph to accommodate for
this. Because the level of total output has shrunk, the demand for labor
also has, and unemployment has risen correspondingly.
If one accepts the Keynesian model,
there are generally two things that can be done to raise the level of aggregate
demand to a point where Y adjusts to full employment. Raising government
expenditures, G, stimulating private investment, or lowering taxes, raising
consumption because people will have more money to spend, will both raise
the level of aggregate demand. Both these policies come under the heading
of fiscal policy, which is deliberate manipulation of the government budget
deficit in order to achieve an economic objective.
During the great depression, many
people rejected Keynes’ ideas on unemployment because they were scared
to be different. The contemporary orthodox view was that cuts in the money
wages would automatically be accompanied by cuts in the real wages, thus
raising employment. Classicalists prescribed the government a remedy for
unemployment based on implementing money wage reductions. Keynes rejected
this idea on both theoretical and empirical grounds.
After the first World War, collective
bargaining rendered the downward flexibility of wages highly improbable.
Any attempts at cutting money wages would be fiercely
resisted, as seen as the 1926 General
Strike in Britain painfully demonstrated. Keynes regarded the trade unions’
resistance to wage cuts as a product of the rigid structure of wage differentials.
This is actually just the relative position of the wages of a particular
type of labor to all others, F.E. mechanics get paid 1$,Electricians
get 2$, plumbers get 3$. If any one group received generally higher wages,
other groups would surely demand higher wages to preserve the structure.
On the other hand, if a single group wantonly decided to accept a wage
cut, other groups would likely not follow. Therefore labor groups vehemently
resisted wage cuts.
Theoretically, Keynes believed that
drops in the money wages would eventually be accompanied by a drops in
prices. This balanced deflation would bring real wages, the amount of goods
that could be bought, to their original amount. Employers would not take
on more workers because their real revenue, amount of goods they sell,
would remain unchanged.
In order to fully consider this statement,
we must first look at the terms used and consider their definitions with
respect to the larger content of the question.
We will first consider Positive Economics.
A positive economic statement is one which relies on real data, given true
statistics and related directly to a true situation. Following this, we
can say that a normative economic statement is one which is not purely
objective although it is related to a positive economic situation. What
the normantive statement does is to follow on with an opinion which is
subjective, biased and based purely on the personal feelings of the speaker.
“Positive economics is about what
is; normative economics is about what should be.”
Economics, John B. Taylor, Houghton
Mifflin Company, 1995, p.25
Now we must consider the definition of
“Fair”.
“Fair: satisfactory,
just, unbiased, according to the rules.”
The Concise Oxford Dictionary, Fifth
Edition, Edited by H. W. Fowler and F. G. Fowler, Oxford University Press,
1964
I propose to return to this deffinition
having discussed the first part of the question.
When we are dealing with positive economics,
we are strictly involved with a “clinical” procedure of thought and analysis
where the thought pattern lacks the usual influence of personal bias and
emotional charge. Positive economics relate explicitly to the existing
situation based on true data and real facts. It can be expressed as a bird’s
eye view of a real given situation. Since logic is the dominant factor
in this thought/perception process, it is natural for positive economics
to be described as “what is”, because very seldom does a situation occur
where “what is” achieves the goal of “what should be”.
The normative side of economics,
unlike the bird’s eye view of positive economics, is a viewpoint from within
a given situation. This of course directly involves “the personal bias,
the subjective opinion ralated to real or given data”. Only when perceiving
a situation from within, from a specific internal standpoint can you express
the “what should be”. The positive unbiased process of factual data
lacks the reality of the emotionally charged normative thought process
where comparisons and conclusions are drawn from a basis of personal criteria.
The normative statement need not necessarily be “what should be”,
it can just as easily relate to “what should not be”, either positive or
negative but it will always be based on a subjective opinion brought about
by a personal attitude to a positive economic situation.
We can therefore look at the given
statement and immediately see that, although there is undoubtably a distribution
of wealth in the United Kingdom, and this is indisputably a positive economic
statement, the hypothesis that it is not fair is purely based on supposition
of the speaker and therefore a normative statement.
Dealing with the word “fair” in
general provocates an emotional connotation. There is a direct link of
meaning with equilibrium, but equilibrium can vary depending on what
angle fair is expressed from. “Fair” can vary greatly in accordance with
its definition. If we consider the distribution of wealth in the United
Kingdom “according to the rules” we must ask whose rules. If they are the
rules of the political party in power, then the distribution is fair.
If they are the rules of a Marxist minority party, then the distribution
is not fair. In both cases “fair” is unsed non-normatively.
The opinion of the unemployed or the lower
social orders does not count in this case, as there are no recognised rules
for these groups of people. Any opinion offerred from them regarding “fair”
is automatically normative.
The same will apply if taking into account
the other officially accepted definitions of the meaning of “fair”. There
can be ambivalence about the objective or subjective interpretation of
the word “satisfactory”. The word “just” can also be interpreted
both objectively in a legal connotation and subjectively in a personal
connotation.
In a specific case though, for example,
“The distribution of income in the United Kingdom is not fair.”, when examined
from a positive point of view through the accepted definitions , one can
arrive at a conclusion which may very well be “Yes, the distribution is
fair.”, but this conclusion can opnly have been derived from an omni
perceptive and non-biased angle, if the word “fair” has been given a formally
accepted definition. It must also relate in the particular circumstance
to the real statistical data taken into consideration, regarding the real
distribution of wealth in the United Kingdom.
If this distribution of income were to
be looked at from a normative angle, there would of course not have been
a conclusion such as the one above, the reason being that normative thought
is “personalized” thought, and in the real world, which is what normative
economics deals with, one’s view dramatically differs from another’s, therefore,
a statement such as “The distribution of income in the United Kingdom is
not fair.” would sound more like an opinion rather than a scientific conclusion
and would belong to the definitioin “Biased” and “satisfactory”.
In conclusion to the essay question
regarding “fair” being used non-normatively, my view is that it is possible.
Personal view or preference does not prevent one from appreciating a situation
as a whole if looked at from a “temporarily” neutral and dispassionate
standpoint. For example, one may not particularly like the work of a certain
acclaimed writer, but one can appreciate his/her work’s worth and quality
as an axample of literary expressionism.
The given statement for the essay
is undoubtably normative. It could, however, have been been made
positive, as could any other statement containing the word “fair” by defining
the concept of fairness within the terms relating to the reality.
Financing a small firm can be achieved
in three ways. The most preferable but at the same time the least likely
is self financing from retained earnings, otherwise, the firm will have
to resort to either one of the two following financial markets. Debt capital
and equity capital ( which strictly speaking is the same as retained earnings,
both having their advantages and disadvantages.
Only after 1979 did clearing banks start
making loans with a maturity term in excess of ten years. In
the case of a loan to smaller companies, the fixed interest rates are usually
set at a premium over base rate ( 3% – 6%). Larger companies who have a
good credit rating will probably be offerred the premium on the inter-bank
rate which is lower than the base rate. Loans are usually secured
on the personal guarantee of the Directors or the owner of small companies
and in the case of larger ones, a charge is made against the assets of
the company. If the charges are “fixed”, that means that they are
linked with a specific asset of the company. “Floating” charges are
made on the general assets.
All bank loans are based on three elements
which the company has to be able to satisfy. The interest rate demanded
by the bank, the security demanded by the bank and the terms of repayment
which are open to individual arrangements between bank and borrower although
they usually consist of systematic amortization payments made over the
full time of the loan.
A small company will have to ensure
its capability of all three in spite of the fact that in comparison
to a larger company, it will be paying a higher interest rate, will be
risking security based on the owner’s personal assets rather than company
assets and repayment terms will probably be more rigid rather than
flexible as banks rightly see the small company borrower as a higher risk.
(This is explained later on when discussing the problems faced by the small
company in raising finance.)
There are sources of loans other than
from banks. Companies usually resort to these financial institutions
as a last resort because their interest payments are fixed and if inflation
falls, this will make the borrowing very expensive. These financial sources
can include pension funds, insurance companies, merchant banks, the European
Investment Bank and the ICFC. (Investment and Commercial Finance Corp[oration)
There is also the “medium term note” open
as an alternative which is a promisory note issued by the company promising
to pay a specified amount on a specified date. The procedure is for
the company to write the note and then to sell it in the market place.
The interest rate can be fixed or may fluctuate and the maturity date of
the note can be anything from under one year to as long as fifteen years.
The small company may issue a debenture,
which is a document issued in return for money lent. There are various
types of debentures but they all have some features in common. They are
usually in the form of a bond, undertaking the repayment of a loan on a
specified date and with regular stated payments of interest between the
date of issue and the date of maturity. These dividends have priority
to be paid before any other dividend is paid to any other class of shareholder.
The Companies Acts define the word “debenture” as including debenture stock
and bonds. Often the terms debenture and bond or loan stock are interchangeable
although I shall mention Bond and Loan Stock a little later on.
There are a number of reasons why an investor
would chose debentures in preference to other forms of company financing.
The major factor has to do with risk. Debt financing usually has
a fixed maturity. The investor enjoys priority both in interest and
in the possibility of the company going into liquidation. In addition,debenture
holders receive a fixed return on the investment and if the company does
not make large profits, will continue to receive the fixed interest rate
while the ordinary shareholders may have to wait the Board’s decision on
what and how much to pay out.
Now we must look at why a company would
issue debentures. The primary advantage is that the cost of the debt
is known and is limited. If the company makes greater profits, these
are not shared out with the debenture holders. The cost of the debt
is also limited because the risk of the debenture holders is lower than
that of the shareholder. Also, and importantly, the interest payment
that is made to the debenture holder is deductable against tax.
Debenture issues are not an unqualified
benefit for the company. There are some disadvantages in that assumptions
that were made ten years ago about the future trading position of the company
might prove to be wrong and the decision for long term debt unwise. The
company still has to repay the debt on the date of maturity.
A warrant, is in principle, a call option
issued by the company on its own stock.The warrant holder is able to buy
a specified number of shares at a specified price on a specified date.
Problems that face the young company will be discussed later but for a
company without a proven track record, raising finance can be difficult.
The warrant can be used as an enticer. Debenture holders have no
option to benefit from the company which performs well but companies can
tempt investors to their debenture stock by issuing convertibles or warrents
in return for lower interest rates in the immediate term. (a convertible
is a bond which can be converted to ordinary shares) The most common issuers
of warrants and convertibles are risky companies, young companies and those
whose risk profile is difficult to estimate. In other words, those
who may not fare so well in the credibility stakes at the bank.
The company can issue preference shares
and holders are part owners of the company, but preference shares are closer
to loan capital than to ordinary shares.In the heirarchy they come higher
than ordinary shares and lower than debentures. The clear company advantage
is that preference shares are a source of long term , though not permanent,
finance and that the dividend does not have to be paid if company profits
do not justify it. Preference shares are not really popular with companies
or investors. In 1993 they were only 7.7% of the total.
There are a number of characteristics
shared by small companies which make it difficult for them to obtain funds.
Their shorter trading records means that less is kno
