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 withthe Theory of consumer choice. The above consumer has expressed hispreference of choice. He has a taste for seafood which he prefersabove all other types of food. This does not mean that he only eatsseafood, but in line with the last two elements of the theory of consumerchoice, he has shown his preference for taste and on that assumption, willdo 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 willconsume are the first two, namely the consumers income and the price ofseafood.
We can assume therefore, that the consumerwill devote as much of his budgeted income for food, to as much seafoodas he can afford in preference to other foods such as hamburgers. A budget line can be drawn up to showa trade off between say, fish suppers and hamburgers to indicate the combinationsof fish suppers and hamburgers the consumer can afford given his incomeand the prices of each meal. Points on the buget line will all be withinthe consumers budget for food. All points below the line will show thepossible combinations of dinners avaiable for his choice. All pointsabove the line wil be unaffordable. It will be possible to see howfar the consumer could indulge his passion for seafood in one week.
(Slope of budget line = -Pu/Pv)The next considerations that might betaken are the marginal rate of substitution of one meal for another withoutchanging the total utility, the diminishing marginal rate of substitutionwhich will hold utility constant and representation of taste as indifferencecurves. I will not elaborate on these at this point as I believe that themarginal utility and diminishing marginal utility are more relevany andpertinent to the question. I shall now contunue by definingutility. In economic jargon, utility is a numerical method of appreciatinga consumers satisfaction. The word itself, as far as meaning is concerned,has nothing to do with its meaning in everyday language.
It has nothingto 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 marginalis the additional pleasure a specific good gives to a consumer. Diminishing marginal utility is the marginalutility lessening due to the growth of consumption.
For example, a consumerconsumes a pound of fish, and his utility is 10 units, and his marginalutility 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 sameeffect on marginal utility would take place if the amount consumed furtherincrease. Since marginal utility diminishes as the quantity of fish consumedincreases, we are faced with diminishing marginal utility. The point is that no matter how good thethe consumers fish dinners are , the more that is consumed, the less satisfactionwill the consumer have compared to the initial portion.
This of courseis down to personal taste, for consumer A may have a diminishing marginalutility that decreases a lot more slowly than consumer B. The factremains, that at some point, both comsumers will become saturated by theirlove for seafood and the law of diminishing marginal utility will makeitself apparent. Our consumer, as this point, will seekto substitute some of his fish dinners with hamburgers or another alternative. To conclude, the title question basedon the argument above, the statement: “I love seafood so much I cant getenough of it” may be passionate, but economically speaking is implausible. Even if theoretically speaking the consumer had access to an infinite amountof seafood and an unlimited budget, in the end the good would not satisfythe consumer enough to remain a preferred good, thus this change in preferencewould 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 aparticular price these behaviours become quantity supply, quantity demandand equilibrium price. We must now look at the elasticityof supply and elasticity of demand. The elacticity of supply measures theresponsiveness of the quantity suppled, to a change in the price of thatgood. Supply elasticity = (% change inquantity supplied)(% change in price)The elasticity of supply informsus how the equilibrium price and the quantity will change if there is achange in the demand. The elasticity of demand shows us the shift in theequilibrium point if there is a change in supply. The elasticity of supply and the elasticityof demand directly affect each other in the following ways.
As seen on the graphs below, the crosssection changes. This results in a change of position for the equilibriumpoint. In the particular case of a 5-penceper gallon tax imposition on petrol, considering that the current priceof petrol is roughly 69. 6-pence per gallon, there is no drastic shift inthe supply curve.
Nevertheless, a slight shift in the supply curve triggersa slight shift in the demand curve as shown below. This scenario is better portrayedin the lower left graph of the image below (fig. 15. 4).
Since petrol inEngland has no substitute or alternative good, (unlike the U. S. ), the consumerhas 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 aresult 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 reasonbeing 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 ontothe consumer. The legislator, or better knownas “the government”, will suffer no incidence of any sort. The only waythe legislator will be affected is through the update of this particulartax, which is an annual bureaucratic budgeting process. Over the last century many countries throughoutthe world have experienced inflation as their major economic problem. Expensivewars have traditionally been recognized as the sources of inflation. Governments,in effort to squeeze more production out of an economy, have often resortedto printing or releasing more money to finance the purchase of arms andsoldiers1.
In an economy already producing at full capacity, the issuingof 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 tendencyfor overall prices to rise would disappear, bringing inflation rates backto normal. World War II brought the persistent inflation that economistscame to expect. In the 50’s and early 60’s inflation resumed to very lowrates concomitant with large growth increases and low unemployment. But,from 1967 to 1974 the rates of inflation reached alarming proportions inmany countries, such as Japan and Britain, for no apparent reason. Thisacceleration in inflation has forced many economists to reevaluate theirviews, and often align themselves with a specific school of thought regardingthe causes and cures for inflation.
There are two opposite theoriesregarding inflation. Monetarism indicates that inflation is due to increasesin the supply of money. The classic example of this relationship is theinflation that followed an inflow of gold and silver into Europe, resultingfrom the Spanish conquest of the Americas. According to monetarists, theonly way to cure inflation is by government action to reduce growth ofthe money supply. At the other end is the cost-pushtheory. Cost-pushers believe that the source of inflation is the rate ofwage increases.
They believe that wage increases are independent of alleconomic factors, and generally are determined by workers and trade unions. More specifically, inflation occurs when the wages demanded by trade unionsand workers add up to more than the economy is capable of producing. Cost-pushers advocate limiting the power of trade unions and using income policiesto help fight off inflation. In between the cost-push and monetarismtheory is Keynesianism. Keynesians recognize the importance of both themoney supply and wage rates in determining inflation. They sometimes adviseusing monetary and incomes policies as complimentary measures to reduceinflation, but most often rely on fiscal policy as the cure.
Before we can understand the policiessuggested by these different schools of thought, we must look at the historicaldevelopment of our understanding of inflation. For approximately 200 years beforeJohn Maynard Keynes wrote the General Theory of Employment, Interest ,and Money, there was a broad agreement among economists as to the sourcesof inflationary pressure, known as the quantity theory of money2. The Quantitytheory of money is easily understood through fisher’s equation MV=PY (money supply times velocity of circulation of money equals price timesreal income)Quantity theorists believe thatover an extended period of time the size of M, the money supply, cannotaffect the overall economic output, Y. They also assume that for all practicalpurposes V was constant because short term variations in the circulationsof money are short lived, and long term changes in the velocity ofcirculation are so small as to be inconsequential . Lastly, this theoryrests on the belief that the supply of money is in no way determined bythe economic output or the demand for money itself. The central prediction that cannow be made is that changes in the money supply will lead to equiproportionatechanges in prices.
If the money supply goes up then individuals initiallyfind themselves with more money. Normally individuals will tend to spendmost of their excess money. The attempt of people to buy more than theynormally do must result in the bidding up of prices because of the competitivenature of the market, inflation. Also essential to the quantity theoryis the belief that in a competitive market, where wages and prices arefree to fluctuate, there would be an automatic tendency for the marketto correct itself and full employment to be established. In figure 1, w stands for the realwage rate (the amount of goods and services that an individuals money incomecan 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, Thesupply of labor is L s1 while the demand for labor is only L d1. At thispoint there is substantial unemployment because labor is costly for employersto buy. According to Classicalists, The existence of an excess supply oflabor will lead to a competitive struggle between the unemployed and employedfor the available jobs. This struggle will lead to a reduction of realwages, thus employers will begin hiring more workers. Eventually competitionwill drive down wages to an equilibrium called labor- arket clearance,where the demand and supply for labor is equal; this is We Le.
Classicalistsdefine Labor market clearance as the point of full employment. Thus, persistentunemployment can only be explained by a mechanism which interferes witha competitive market. They specifically blame monopolistic trade unionsfor preventing the wage rate from falling to We. Unions may use manythreatening tactics to fight wage cuts. Those most effective mentionedin the textbooks are collective bargaining and strikes.
The Great depression, as experiencedby the US and the countries of western Europe, cast a shadow over the Classicalapproach to economics3. The self-righting properties of classical economicswere clearly not working when wages and unemployment failed to decrease. Blaming trade unions for these massive increases in unemployment seemedfar fetched. John Maynard Keynes was the firstwriter to produce a non-classical, coherent, and convincing explanationof the inter-war depression. He traced the sources of unemployment to adeficiency of effective demand.
Put simply, unemployment occurred whentotal 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 itselfto changes expenditures. Moreover Keynes argued that the equilibrium ofwages exist when the output of producers is equal to the amount that consumersand 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 verticaland real income on the horizontal. For practical purposes investment willremain a constant in the graph and be represented by line I. If we addthe consumption function and the investment line, we get the the sum totalexpenditures, 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 producersare simply accumulating unsold stocks of goods. Eventually they will beforced to cut back on production until they can sell their existing stocks,earning capital enough capital to restart production.
Conversely, If Yis below E, producers will be selling out of goods. Normally they willincrease production as soon as possible to catch up to the demand and makethe most profit. This is where, the 45 line comes into use. Y, accordingto 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 expendituresand total output, and wages are stable.
In order to illustrate how Keynes’principle of effective demand accounts for unemployment, let us assumethat the economy starts off at full employment where Ld (demand for labor)equals Ls (supply). The label of the output necessary to sustain full employmentis Yf, f denoting full employment. If expenditures were smaller than Yf,than Yf would adjust itself to the left on the graph to accommodate forthis. Because the level of total output has shrunk, the demand for laboralso 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 aggregatedemand to a point where Y adjusts to full employment. Raising governmentexpenditures, G, stimulating private investment, or lowering taxes, raisingconsumption because people will have more money to spend, will both raisethe level of aggregate demand.
Both these policies come under the headingof fiscal policy, which is deliberate manipulation of the government budgetdeficit in order to achieve an economic objective. During the great depression, manypeople rejected Keynes’ ideas on unemployment because they were scaredto be different. The contemporary orthodox view was that cuts in the moneywages would automatically be accompanied by cuts in the real wages, thusraising employment. Classicalists prescribed the government a remedy forunemployment based on implementing money wage reductions. Keynes rejectedthis idea on both theoretical and empirical grounds. After the first World War, collectivebargaining rendered the downward flexibility of wages highly improbable.
Any attempts at cutting money wages would be fiercelyresisted, as seen as the 1926 GeneralStrike 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 particulartype of labor to all others, F. E.
mechanics get paid 1$,Electriciansget 2$, 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 wagecut, other groups would likely not follow. Therefore labor groups vehementlyresisted wage cuts. Theoretically, Keynes believed thatdrops in the money wages would eventually be accompanied by a drops inprices.
This balanced deflation would bring real wages, the amount of goodsthat could be bought, to their original amount. Employers would not takeon 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 withrespect 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 truestatistics and related directly to a true situation.
Following this, wecan say that a normative economic statement is one which is not purelyobjective although it is related to a positive economic situation. Whatthe normantive statement does is to follow on with an opinion which issubjective, biased and based purely on the personal feelings of the speaker. “Positive economics is about whatis; normative economics is about what should be. “Economics, John B. Taylor, HoughtonMifflin Company, 1995, p. 25Now we must consider the definition of”Fair”.
“Fair: satisfactory,just, unbiased, according to the rules. “The Concise Oxford Dictionary, FifthEdition, Edited by H. W. Fowler and F.
G. Fowler, Oxford University Press,1964I propose to return to this deffinitionhaving 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 analysiswhere the thought pattern lacks the usual influence of personal bias andemotional charge. Positive economics relate explicitly to the existingsituation based on true data and real facts.
It can be expressed as a birdseye view of a real given situation. Since logic is the dominant factorin this thought/perception process, it is natural for positive economicsto be described as “what is”, because very seldom does a situation occurwhere “what is” achieves the goal of “what should be”. The normative side of economics,unlike the birds eye view of positive economics, is a viewpoint from withina given situation. This of course directly involves “the personal bias,the subjective opinion ralated to real or given data”. Only when perceivinga situation from within, from a specific internal standpoint can you expressthe “what should be”.
The positive unbiased process of factual datalacks the reality of the emotionally charged normative thought processwhere 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 ornegative but it will always be based on a subjective opinion brought aboutby a personal attitude to a positive economic situation. We can therefore look at the givenstatement and immediately see that, although there is undoubtably a distributionof wealth in the United Kingdom, and this is indisputably a positive economicstatement, the hypothesis that it is not fair is purely based on suppositionof the speaker and therefore a normative statement. Dealing with the word “fair” ingeneral provocates an emotional connotation. There is a direct link ofmeaning with equilibrium, but equilibrium can vary depending on whatangle fair is expressed from. “Fair” can vary greatly in accordance withits definition.
If we consider the distribution of wealth in the UnitedKingdom “according to the rules” we must ask whose rules. If they are therules of the political party in power, then the distribution is fair. If they are the rules of a Marxist minority party, then the distributionis not fair. In both cases “fair” is unsed non-normatively. The opinion of the unemployed or the lowersocial orders does not count in this case, as there are no recognised rulesfor these groups of people. Any opinion offerred from them regarding “fair”is automatically normative.
The same will apply if taking into accountthe other officially accepted definitions of the meaning of “fair”. Therecan be ambivalence about the objective or subjective interpretation ofthe word “satisfactory”. The word “just” can also be interpretedboth objectively in a legal connotation and subjectively in a personalconnotation. In a specific case though, for example,”The distribution of income in the United Kingdom is not fair. “, when examinedfrom a positive point of view through the accepted definitions , one canarrive at a conclusion which may very well be “Yes, the distribution isfair. “, but this conclusion can opnly have been derived from an omniperceptive and non-biased angle, if the word “fair” has been given a formallyaccepted definition.
It must also relate in the particular circumstanceto the real statistical data taken into consideration, regarding the realdistribution of wealth in the United Kingdom. If this distribution of income were tobe looked at from a normative angle, there would of course not have beena conclusion such as the one above, the reason being that normative thoughtis “personalized” thought, and in the real world, which is what normativeeconomics deals with, ones view dramatically differs from anothers, therefore,a statement such as “The distribution of income in the United Kingdom isnot fair. ” would sound more like an opinion rather than a scientific conclusionand would belong to the definitioin “Biased” and “satisfactory”. In conclusion to the essay questionregarding “fair” being used non-normatively, my view is that it is possible.
Personal view or preference does not prevent one from appreciating a situationas a whole if looked at from a “temporarily” neutral and dispassionatestandpoint. For example, one may not particularly like the work of a certainacclaimed writer, but one can appreciate his/her works worth and qualityas an axample of literary expressionism. The given statement for the essayis undoubtably normative. It could, however, have been been madepositive, as could any other statement containing the word “fair” by definingthe concept of fairness within the terms relating to the reality.
Financing a small firm can be achievedin three ways. The most preferable but at the same time the least likelyis self financing from retained earnings, otherwise, the firm will haveto resort to either one of the two following financial markets. Debt capitaland equity capital ( which strictly speaking is the same as retained earnings,both having their advantages and disadvantages. Only after 1979 did clearing banks startmaking loans with a maturity term in excess of ten years.
Inthe case of a loan to smaller companies, the fixed interest rates are usuallyset at a premium over base rate ( 3% – 6%). Larger companies who have agood credit rating will probably be offerred the premium on the inter-bankrate which is lower than the base rate. Loans are usually securedon the personal guarantee of the Directors or the owner of small companiesand in the case of larger ones, a charge is made against the assets ofthe company. If the charges are “fixed”, that means that they arelinked with a specific asset of the company.
“Floating” charges aremade on the general assets. All bank loans are based on three elementswhich the company has to be able to satisfy. The interest rate demandedby the bank, the security demanded by the bank and the terms of repaymentwhich are open to individual arrangements between bank and borrower althoughthey usually consist of systematic amortization payments made over thefull time of the loan. A small company will have to ensureits capability of all three in spite of the fact that in comparisonto a larger company, it will be paying a higher interest rate, will berisking security based on the owners personal assets rather than companyassets and repayment terms will probably be more rigid rather thanflexible as banks rightly see the small company borrower as a higher risk. (This is explained later on when discussing the problems faced by the smallcompany in raising finance.
)There are sources of loans other thanfrom banks. Companies usually resort to these financial institutionsas a last resort because their interest payments are fixed and if inflationfalls, this will make the borrowing very expensive. These financial sourcescan include pension funds, insurance companies, merchant banks, the EuropeanInvestment Bank and the ICFC. (Investment and Commercial Finance Corporation)There is also the “medium term note” openas an alternative which is a promisory note issued by the company promisingto pay a specified amount on a specified date. The procedure is forthe 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 ofthe 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 varioustypes of debentures but they all have some features in common. They areusually in the form of a bond, undertaking the repayment of a loan on aspecified date and with regular stated payments of interest between thedate of issue and the date of maturity. These dividends have priorityto be paid before any other dividend is paid to any other class of shareholder. The Companies Acts define the word “debenture” as including debenture stockand bonds.
Often the terms debenture and bond or loan stock are interchangeablealthough I shall mention Bond and Loan Stock a little later on. There are a number of reasons why an investorwould chose debentures in preference to other forms of company financing. The major factor has to do with risk. Debt financing usually hasa fixed maturity. The investor enjoys priority both in interest andin the possibility of the company going into liquidation. In addition,debentureholders receive a fixed return on the investment and if the company doesnot make large profits, will continue to receive the fixed interest ratewhile the ordinary shareholders may have to wait the Boards decision onwhat and how much to pay out.
Now we must look at why a company wouldissue debentures. The primary advantage is that the cost of the debtis known and is limited. If the company makes greater profits, theseare not shared out with the debenture holders. The cost of the debtis also limited because the risk of the debenture holders is lower thanthat of the shareholder.
Also, and importantly, the interest paymentthat is made to the debenture holder is deductable against tax. Debenture issues are not an unqualifiedbenefit for the company. There are some disadvantages in that assumptionsthat were made ten years ago about the future trading position of the companymight prove to be wrong and the decision for long term debt unwise. Thecompany still has to repay the debt on the date of maturity. A warrant, is in principle, a call optionissued by the company on its own stock. The warrant holder is able to buya specified number of shares at a specified price on a specified date.
Problems that face the young company will be discussed later but for acompany without a proven track record, raising finance can be difficult. The warrant can be used as an enticer. Debenture holders have nooption to benefit from the company which performs well but companies cantempt investors to their debenture stock by issuing convertibles or warrentsin return for lower interest rates in the immediate term. (a convertibleis a bond which can be converted to ordinary shares) The most common issuersof warrants and convertibles are risky companies, young companies and thosewhose risk profile is difficult to estimate. In other words, thosewho may not fare so well in the credibility stakes at the bank. The company can issue preference sharesand holders are part owners of the company, but preference shares are closerto loan capital than to ordinary shares.
In the heirarchy they come higherthan ordinary shares and lower than debentures. The clear company advantageis 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 profitsdo not justify it. Preference shares are not really popular with companiesor investors. In 1993 they were only 7. 7% of the total. There are a number of characteristicsshared by small companies which make it difficult for them to obtain funds.
Their shorter trading records means that less is known about them and theirsize often precludes fewer accounting skills in the company which are necessaryto put over a strong case for financing. Small companies have limitedaccess to markets for securities, and in particular, the Stock exchange,which is both difficult and expensive. It is a view widely held, that smallercompanies are more likely to have to face liquidation and so potentiallenders will be much harder to pursuade. The Financial institutions whichdominate the market for finance, usually seek to invest in such a way soas to ensure that their particular investment is unlikely to affect shareprices.
This is the strategy to invest small amounts in large companies. These finance Institutions obviously prefer stable long term growth andthe most unlikely place to find this is in a young or small company. These characteristics, combined with thosealready mentioned in earlier paragraphs, for instance, fixed transactioncosts 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 ofrisk; as a consequence, the expected returns are higher and so the costof the capital is raised. Companies which find themselves in needof additional finance and look to the public for this via the Stock Exchangehave access to variable income and capital investments and fixed incomeinvestments. The capital market offers three types of securities,Company securities such as loan stock, shares, and options; publicsector securities, such as guilt-edged securities issued by governmentsand well established companies; and Eurobonds.
There are two facets to the capitalmarkets and each has its distinct function. The primary market issuesand deals in new securities. So, companies wishing to raise new equityon the Stock Market “New Issues Market” is dealt with by the primary market. The secondary market deals with existing financial claims. Dealingon 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 theinvestor because it allows the initial investor to sell the investmentas and when he chooses.
Without the secondary market, companies would findinvestors less willing to tie up their money for any length of time somaking the raising of finance by share issue more difficult. The primary function of these marketsis to match the lenders to the borrowers and effect the directing of fundsbetween them. Not all companies are in a position touse the Stock Exchange to raise finance. All companies wishing toenter the Stock Market must be quoted and this is a costly procedure.
Manycompanies are either too small or too new to gain a listing full listingbut they need not be excluded from this method of raising finance becausethere is then the Unlisted Securities Market where the requirements fortrading are lower. Companies have to show a three year trading recordand offer 10% of shares at the primary issue. There are four major benefits to a companywhich can issue ordinary or equity shares. There are no fixed charges associatedwith ordinary shares. The company may pay a dividend if sufficient profitis generated but it does not have to do so. There is no fixed maturitydate.
If the company loses, the shares can be sold to increase the creditworthinessof the company and they can be sold more easily than debentures or preferenceshares because they carry a higher expectation of better returns and sorepresent a better hedge against inflation. The downside for the company comes inthe shape of costs and control aspects. There is also the question of “whatdoes the firm want the financing for?”. The reason can either be for thepurpose of expansion or settling previously acquired debt.
The truth isthat even in the healthiest of cases, a small firm faces certain standardsmall firm problems such as the difficulty to diversify and transactioncosts. For example, if a firm is small, this means that whatever it producesor trades is dealt with in much smaller quantities than a larger firm. Thus, the small firms accounts read a higher cost in purchasing raw materials(per unit), than the costs a large firm has when purchasing the same rawmaterials at a much greater quantity. Another problem on the top of theproblem list of a small firm is its total worth. In order for the firmto enter into either a debt market or an equity market, it must be of asubstantial value. For the case of the debt market, the small firm willnot be able to acquire a substantial amount of capital through a loan dueto its lack in required collateral.
In the case of the equity market, itis difficult for a small firm to enter this market for the same reason,but not implausible. The main concern for the small firmis the interest rate the debentures or loans it has issued carry. It isfor this reason that these sources of finance are preferred to be usedas short term solutions. In the case of a small firm though, these debenturesor loans may be the only way to kick-start the firm into growth. Theremust be a source of finance for the firm to use in order for it to investlong term through short term financial sources. Long term investments are an integralpart of a small firms growth.
Investments in technology mainly, give afirm the potential to expand, provided that the new investment(s) are managedand utilized appropriately, and integrated accordingly into the previousassets of the small firm. For the manager looking to raisefinance 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 andthe costs. If not, debt capital and its distinguishing features of beingless expensive than equity capital, being of lower risk and therefore havinga 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 incrementalcashflows of the lease over the borrowing alternative.
In addition to thetaxation benefits, leasing helps to preserve cash, varies the borrowingportfolio and provides a less restrictive form of finance. Its certaintyand flexibility reduces risk and allows the small companies a greater freedomin their investment decision process because rentals are operating expenses. I think that it is right to begin withthe Theory of consumer choice. The above consumer has expressed hispreference of choice. He has a taste for seafood which he prefersabove all other types of food. This does not mean that he only eatsseafood, but in line with the last two elements of the theory of consumerchoice, he has shown his preference for taste and on that assumption, willdo 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 willconsume are the first two, namely the consumers income and the price ofseafood. We can assume therefore, that the consumerwill devote as much of his budgeted income for food, to as much seafoodas he can afford in preference to other foods such as hamburgers. A budget line can be drawn up to showa trade off between say, fish suppers and hamburgers to indicate the combinationsof fish suppers and hamburgers the consumer can afford given his incomeand the prices of each meal. Points on the buget line will all be withinthe consumers budget for food. All points below the line will show thepossible combinations of dinners avaiable for his choice.
All pointsabove the line wil be unaffordable. It will be possible to see howfar the consumer could indulge his passion for seafood in one week. (Slope of budget line = -Pu/Pv)The next considerations that might betaken are the marginal rate of substitution of one meal for another withoutchanging the total utility, the diminishing marginal rate of substitutionwhich will hold utility constant and representation of taste as indifferencecurves. I will not elaborate on these at this point as I believe that themarginal utility and diminishing marginal utility are more relevany andpertinent to the question. I shall now contunue by definingutility. In economic jargon, utility is a numerical method of appreciatinga consumers satisfaction.
The word itself, as far as meaning is concerned,has nothing to do with its meaning in everyday language. It has nothingto 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 marginalis the additional pleasure a specific good gives to a consumer. Diminishing marginal utility is the marginalutility lessening due to the growth of consumption. For example, a consumerconsumes a pound of fish, and his utility is 10 units, and his marginalutility 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 sameeffect on marginal utility would take place if the amount consumed furtherincrease. Since marginal utility diminishes as the quantity of fish consumedincreases, we are faced with diminishing marginal utility. The point is that no matter how good thethe consumers fish dinners are , the more that is consumed, the less satisfactionwill the consumer have compared to the initial portion.
This of courseis down to personal taste, for consumer A may have a diminishing marginalutility that decreases a lot more slowly than consumer B. The factremains, that at some point, both comsumers will become saturated by theirlove for seafood and the law of diminishing marginal utility will makeitself apparent. Our consumer, as this point, will seekto substitute some of his fish dinners with hamburgers or another alternative. To conclude, the title question basedon the argument above, the statement: “I love seafood so much I cant getenough of it” may be passionate, but economically speaking is implausible. Even if theoretically speaking the consumer had access to an infinite amountof seafood and an unlimited budget, in the end the good would not satisfythe consumer enough to remain a preferred good, thus this change in preferencewould 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 aparticular price these behaviours become quantity supply, quantity demandand equilibrium price.
We must now look at the elasticityof supply and elasticity of demand. The elacticity of supply measures theresponsiveness of the quantity suppled, to a change in the price of thatgood. Supply elasticity = (% change inquantity supplied)(% change in price)The elasticity of supply informsus how the equilibrium price and the quantity will change if there is achange in the demand. The elasticity of demand shows us the shift in theequilibrium point if there is a change in supply.
The elasticity of supply and the elasticityof demand directly affect each other in the following ways. As seen on the graphs below, the crosssection changes. This results in a change of position for the equilibriumpoint. In the particular case of a 5-penceper gallon tax imposition on petrol, considering that the current priceof petrol is roughly 69. 6-pence per gallon, there is no drastic shift inthe supply curve.
Nevertheless, a slight shift in the supply curve triggersa slight shift in the demand curve as shown below. This scenario is better portrayedin the lower left graph of the image below (fig. 15. 4).
Since petrol inEngland has no substitute or alternative good, (unlike the U. S. ), the consumerhas 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 aresult 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 reasonbeing 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 ontothe consumer.
The legislator, or better knownas “the government”, will suffer no incidence of any sort. The only waythe legislator will be affected is through the update of this particulartax, which is an annual bureaucratic budgeting process. Over the last century many countries throughoutthe world have experienced inflation as their major economic problem. Expensivewars have traditionally been recognized as the sources of inflation. Governments,in effort to squeeze more production out of an economy, have often resortedto printing or releasing more money to finance the purchase of arms andsoldiers1.
In an economy already producing at full capacity, the issuingof 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 tendencyfor overall prices to rise would disappear, bringing inflation rates backto normal. World War II brought the persistent inflation that economistscame to expect. In the 50’s and early 60’s inflation resumed to very lowrates concomitant with large growth increases and low unemployment.
But,from 1967 to 1974 the rates of inflation reached alarming proportions inmany countries, such as Japan and Britain, for no apparent reason. Thisacceleration in inflation has forced many economists to reevaluate theirviews, and often align themselves with a specific school of thought regardingthe causes and cures for inflation. There are two opposite theoriesregarding inflation. Monetarism indicates that inflation is due to increasesin the supply of money. The classic example of this relationship is theinflation that followed an inflow of gold and silver into Europe, resultingfrom the Spanish conquest of the Americas. According to monetarists, theonly way to cure inflation is by government action to reduce growth ofthe money supply.
At the other end is the cost-pushtheory. Cost-pushers believe that the source of inflation is the rate ofwage increases. They believe that wage increases are independent of alleconomic factors, and generally are determined by workers and trade unions. More specifically, inflation occurs when the wages demanded by trade unionsand workers add up to more than the economy is capable of producing. Cost-pushers advocate limiting the power of trade unions and using income policiesto help fight off inflation. In between the cost-push and monetarismtheory is Keynesianism.
Keynesians recognize the importance of both themoney supply and wage rates in determining inflation. They sometimes adviseusing monetary and incomes policies as complimentary measures to reduceinflation, but most often rely on fiscal policy as the cure. Before we can understand the policiessuggested by these different schools of thought, we must look at the historicaldevelopment of our understanding of inflation. For approximately 200 years beforeJohn Maynard Keynes wrote the General Theory of Employment, Interest ,and Money, there was a broad agreement among economists as to the sourcesof inflationary pressure, known as the quantity theory of money2.
The Quantitytheory of money is easily understood through fisher’s equation MV=PY (money supply times velocity of circulation of money equals price timesreal income)Quantity theorists believe thatover an extended period of time the size of M, the money supply, cannotaffect the overall economic output, Y. They also assume that for all practicalpurposes V was constant because short term variations in the circulationsof money are short lived, and long term changes in the velocity ofcirculation are so small as to be inconsequential . Lastly, this theoryrests on the belief that the supply of money is in no way determined bythe economic output or the demand for money itself. The central prediction that cannow be made is that changes in the money supply will lead to equiproportionatechanges in prices. If the money supply goes up then individuals initiallyfind themselves with more money.
Normally individuals will tend to spendmost of their excess money. The attempt of people to buy more than theynormally do must result in the bidding up of prices because of the competitivenature of the market, inflation. Also essential to the quantity theoryis the belief that in a competitive market, where wages and prices arefree to fluctuate, there would be an automatic tendency for the marketto correct itself and full employment to be established. In figure 1, w stands for the realwage rate (the amount of goods and services that an individuals money incomecan 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, Thesupply of labor is L s1 while the demand for labor is only L d1. At thispoint there is substantial unemployment because labor is costly for employersto buy.
According to Classicalists, The existence of an excess supply oflabor will lead to a competitive struggle between the unemployed and employedfor the available jobs. This struggle will lead to a reduction of realwages, thus employers will begin hiring more workers. Eventually competitionwill drive down wages to an equilibrium called labor- arket clearance,where the demand and supply for labor is equal; this is We Le. Classicalistsdefine Labor market clearance as the point of full employment. Thus, persistentunemployment can only be explained by a mechanism which interferes witha competitive market. They specifically blame monopolistic trade unionsfor preventing the wage rate from falling to We.
Unions may use manythreatening tactics to fight wage cuts. Those most effective mentionedin the textbooks are collective bargaining and strikes. The Great depression, as experiencedby the US and the countries of western Europe, cast a shadow over the Classicalapproach to economics3. The self-righting properties of classical economicswere clearly not working when wages and unemployment failed to decrease.
Blaming trade unions for these massive increases in unemployment seemedfar fetched. John Maynard Keynes was the firstwriter to produce a non-classical, coherent, and convincing explanationof the inter-war depression. He traced the sources of unemployment to adeficiency of effective demand. Put simply, unemployment occurred whentotal 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 itselfto changes expenditures. Moreover Keynes argued that the equilibrium ofwages exist when the output of producers is equal to the amount that consumersand 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 verticaland real income on the horizontal. For practical purposes investment willremain a constant in the graph and be represented by line I. If we addthe consumption function and the investment line, we get the the sum totalexpenditures, 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 producersare simply accumulating unsold stocks of goods. Eventually they will beforced to cut back on production until they can sell their existing stocks,earning capital enough capital to restart production. Conversely, If Yis below E, producers will be selling out of goods. Normally they willincrease production as soon as possible to catch up to the demand and makethe most profit. This is where, the 45 line comes into use.
Y, accordingto 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 expendituresand total output, and wages are stable. In order to illustrate how Keynes’principle of effective demand accounts for unemployment, let us assumethat the economy starts off at full employment where Ld (demand for labor)equals Ls (supply). The label of the output necessary to sustain full employmentis Yf, f denoting full employment. If expenditures were smaller than Yf,than Yf would adjust itself to the left on the graph to accommodate forthis.
Because the level of total output has shrunk, the demand for laboralso 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 aggregatedemand to a point where Y adjusts to full employment. Raising governmentexpenditures, G, stimulating private investment, or lowering taxes, raisingconsumption because people will have more money to spend, will both raisethe level of aggregate demand. Both these policies come under the headingof fiscal policy, which is deliberate manipulation of the government budgetdeficit in order to achieve an economic objective. During the great depression, manypeople rejected Keynes’ ideas on unemployment because they were scaredto be different.
The contemporary orthodox view was that cuts in the moneywages would automatically be accompanied by cuts in the real wages, thusraising employment. Classicalists prescribed the government a remedy forunemployment based on implementing money wage reductions. Keynes rejectedthis idea on both theoretical and empirical grounds. After the first World War, collectivebargaining rendered the downward flexibility of wages highly improbable. Any attempts at cutting money wages would be fiercelyresisted, as seen as the 1926 GeneralStrike 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 particulartype of labor to all others, F. E. mechanics get paid 1$,Electriciansget 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 wagecut, other groups would likely not follow. Therefore labor groups vehementlyresisted wage cuts. Theoretically, Keynes believed thatdrops in the money wages would eventually be accompanied by a drops inprices. This balanced deflation would bring real wages, the amount of goodsthat could be bought, to their original amount. Employers would not takeon 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 withrespect 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 truestatistics and related directly to a true situation. Following this, wecan say that a normative economic statement is one which is not purelyobjective although it is related to a positive economic situation. Whatthe normantive statement does is to follow on with an opinion which issubjective, biased and based purely on the personal feelings of the speaker. “Positive economics is about whatis; normative economics is about what should be. “Economics, John B.
Taylor, HoughtonMifflin Company, 1995, p. 25Now we must consider the definition of”Fair”. “Fair: satisfactory,just, unbiased, according to the rules. “The Concise Oxford Dictionary, FifthEdition, Edited by H.
W. Fowler and F. G. Fowler, Oxford University Press,1964I propose to return to this deffinitionhaving 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 analysiswhere the thought pattern lacks the usual influence of personal bias andemotional charge. Positive economics relate explicitly to the existingsituation based on true data and real facts. It can be expressed as a birdseye view of a real given situation. Since logic is the dominant factorin this thought/perception process, it is natural for positive economicsto be described as “what is”, because very seldom does a situation occurwhere “what is” achieves the goal of “what should be”. The normative side of economics,unlike the birds eye view of positive economics, is a viewpoint from withina given situation.
This of course directly involves “the personal bias,the subjective opinion ralated to real or given data”. Only when perceivinga situation from within, from a specific internal standpoint can you expressthe “what should be”. The positive unbiased process of factual datalacks the reality of the emotionally charged normative thought processwhere 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 ornegative but it will always be based on a subjective opinion brought aboutby a personal attitude to a positive economic situation. We can therefore look at the givenstatement and immediately see that, although there is undoubtably a distributionof wealth in the United Kingdom, and this is indisputably a positive economicstatement, the hypothesis that it is not fair is purely based on suppositionof the speaker and therefore a normative statement.
Dealing with the word “fair” ingeneral provocates an emotional connotation. There is a direct link ofmeaning with equilibrium, but equilibrium can vary depending on whatangle fair is expressed from. “Fair” can vary greatly in accordance withits definition. If we consider the distribution of wealth in the UnitedKingdom “according to the rules” we must ask whose rules. If they are therules of the political party in power, then the distribution is fair.
If they are the rules of a Marxist minority party, then the distributionis not fair. In both cases “fair” is unsed non-normatively. The opinion of the unemployed or the lowersocial orders does not count in this case, as there are no recognised rulesfor these groups of people. Any opinion offerred from them regarding “fair”is automatically normative. The same will apply if taking into accountthe other officially accepted definitions of the meaning of “fair”. Therecan be ambivalence about the objective or subjective interpretation ofthe word “satisfactory”.
The word “just” can also be interpretedboth objectively in a legal connotation and subjectively in a personalconnotation. In a specific case though, for example,”The distribution of income in the United Kingdom is not fair. “, when examinedfrom a positive point of view through the accepted definitions , one canarrive at a conclusion which may very well be “Yes, the distribution isfair. “, but this conclusion can opnly have been derived from an omniperceptive and non-biased angle, if the word “fair” has been given a formallyaccepted definition. It must also relate in the particular circumstanceto the real statistical data taken into consideration, regarding the realdistribution of wealth in the United Kingdom.
If this distribution of income were tobe looked at from a normative angle, there would of course not have beena conclusion such as the one above, the reason being that normative thoughtis “personalized” thought, and in the real world, which is what normativeeconomics deals with, ones view dramatically differs from anothers, therefore,a statement such as “The distribution of income in the United Kingdom isnot fair. ” would sound more like an opinion rather than a scientific conclusionand would belong to the definitioin “Biased” and “satisfactory”. In conclusion to the essay questionregarding “fair” being used non-normatively, my view is that it is possible. Personal view or preference does not prevent one from appreciating a situationas a whole if looked at from a “temporarily” neutral and dispassionatestandpoint.
For example, one may not particularly like the work of a certainacclaimed writer, but one can appreciate his/her works worth and qualityas an axample of literary expressionism. The given statement for the essayis undoubtably normative. It could, however, have been been madepositive, as could any other statement containing the word “fair” by definingthe concept of fairness within the terms relating to the reality. Financing a small firm can be achievedin three ways. The most preferable but at the same time the least likelyis self financing from retained earnings, otherwise, the firm will haveto resort to either one of the two following financial markets.
Debt capitaland equity capital ( which strictly speaking is the same as retained earnings,both having their advantages and disadvantages. Only after 1979 did clearing banks startmaking loans with a maturity term in excess of ten years. Inthe case of a loan to smaller companies, the fixed interest rates are usuallyset at a premium over base rate ( 3% – 6%). Larger companies who have agood credit rating will probably be offerred the premium on the inter-bankrate which is lower than the base rate.
Loans are usually securedon the personal guarantee of the Directors or the owner of small companiesand in the case of larger ones, a charge is made against the assets ofthe company. If the charges are “fixed”, that means that they arelinked with a specific asset of the company. “Floating” charges aremade on the general assets. All bank loans are based on three elementswhich the company has to be able to satisfy. The interest rate demandedby the bank, the security demanded by the bank and the terms of repaymentwhich are open to individual arrangements between bank and borrower althoughthey usually consist of systematic amortization payments made over thefull time of the loan.
A small company will have to ensureits capability of all three in spite of the fact that in comparisonto a larger company, it will be paying a higher interest rate, will berisking security based on the owners personal assets rather than companyassets and repayment terms will probably be more rigid rather thanflexible as banks rightly see the small company borrower as a higher risk. (This is explained later on when discussing the problems faced by the smallcompany in raising finance. )There are sources of loans other thanfrom banks. Companies usually resort to these financial institutionsas a last resort because their interest payments are fixed and if inflationfalls, this will make the borrowing very expensive. These financial sourcescan include pension funds, insurance companies, merchant banks, the EuropeanInvestment Bank and the ICFC.
(Investment and Commercial Finance Corporation)There is also the “medium term note” openas an alternative which is a promisory note issued by the company promisingto pay a specified amount on a specified date. The procedure is forthe 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 ofthe 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 varioustypes of debentures but they all have some features in common. They areusually in the form of a bond, undertaking the repayment of a loan on aspecified date and with regular stated payments of interest between thedate of issue and the date of maturity.
These dividends have priorityto be paid before any other dividend is paid to any other class of shareholder. The Companies Acts define the word “debenture” as including debenture stockand bonds. Often the terms debenture and bond or loan stock are interchangeablealthough I shall mention Bond and Loan Stock a little later on. There are a number of reasons why an investorwould chose debentures in preference to other forms of company financing.
The major factor has to do with risk. Debt financing usually hasa fixed maturity. The investor enjoys priority both in interest andin the possibility of the company going into liquidation. In addition,debentureholders receive a fixed return on the investment and if the company doesnot make large profits, will continue to receive the fixed interest ratewhile the ordinary shareholders may have to wait the Boards decision onwhat and how much to pay out.
Now we must look at why a company wouldissue debentures. The primary advantage is that the cost of the debtis known and is limited. If the company makes greater profits, theseare not shared out with the debenture holders. The cost of the debtis also limited because the risk of the debenture holders is lower thanthat of the shareholder. Also, and importantly, the interest paymentthat is made to the debenture holder is deductable against tax. Debenture issues are not an unqualifiedbenefit for the company.
There are some disadvantages in that assumptionsthat were made ten years ago about the future trading position of the companymight prove to be wrong and the decision for long term debt unwise. Thecompany still has to repay the debt on the date of maturity. A warrant, is in principle, a call optionissued by the company on its own stock. The warrant holder is able to buya specified number of shares at a specified price on a specified date. Problems that face the young company will be discussed later but for acompany without a proven track record, raising finance can be difficult.
The warrant can be used as an enticer. Debenture holders have nooption to benefit from the company which performs well but companies cantempt investors to their debenture stock by issuing convertibles or warrentsin return for lower interest rates in the immediate term. (a convertibleis a bond which can be converted to ordinary shares) The most common issuersof warrants and convertibles are risky companies, young companies and thosewhose risk profile is difficult to estimate. In other words, thosewho may not fare so well in the credibility stakes at the bank. The company can issue preference sharesand holders are part owners of the company, but preference shares are closerto loan capital than to ordinary shares. In the heirarchy they come higherthan ordinary shares and lower than debentures.
The clear company advantageis 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 profitsdo not justify it. Preference shares are not really popular with companiesor investors. In 1993 they were only 7.7% of the total.There are a number of characteristicsshared by small companies which make it difficult for them to obtain funds.Their shorter trading records means that less is kno
