A Basic Analysis Of The Balkan Economy In Relation Essay Example
The concept of consumer choice should be the starting point when discussing the European Union.
The consumer mentioned earlier has a liking for seafood, although it does not imply that they exclusively consume seafood. As per the theory of consumer choice, their primary concern is taste and they strive to eat a maximum amount of seafood possible. The quantity of seafood consumed fluctuates based on their income and the price of seafood. Rather than opting for substitutes such as hamburgers, the consumer dedicates a part of their food budget towards buying seafood. A budget line can be employed to depict various combinations of fish suppers and hamburgers that the consumer can purchase depending on their income and meal prices.
Within the consumers budget for food, points on the buget line indicate affordable options. Combinations of dinners below the line represent po
...ssible choices. Points above the line, on the other hand, are unaffordable. One can determine how much the consumer can indulge in seafood per week by examining the slope of the budget line (-Pu/Pv). Other considerations include the marginal rate of substitution for meals without changing overall utility, the effect of diminishing marginal rate of substitution on utility, and taste representation through indifference curves. However, I will not delve into these topics at this time as I believe that marginal utility and diminishing marginal utility are more pertinent to the question.
In economics, utility is a quantitative measure of consumer satisfaction. It differs from its everyday meaning as it does not refer to usefulness but rather serves as a measurement unit based on satisfaction. Additionally, marginal utility can be viewed as an additional form of utility. In economic
terms, "marginal" indicates the extra pleasure that a particular good provides to a consumer.
Diminishing marginal utility refers to the decrease in marginal utility as consumption increases. For instance, if a consumer consumes one pound of fish, their utility is 10 units and their marginal utility is also 10 units. However, if they consume two pounds of fish, their utility increases to 15 units but their marginal utility decreases to 7 units. This decrease in marginal utility continues as the amount consumed further increases. Therefore, the concept of diminishing marginal utility applies when the quantity of fish consumed increases.
The main idea is that no matter how delicious the fish dinners that a consumer enjoys are, the more they eat, the less satisfaction they will experience with each subsequent portion. This ultimately depends on individual preference, as one consumer may have a slower decrease in satisfaction than another. Nevertheless, both consumers will eventually reach a point where they are no longer satisfied with seafood due to the law of diminishing marginal utility. At this point, they will seek to replace some of their fish dinners with an alternative like hamburgers. In conclusion, while someone may passionately declare "I love seafood so much I can't get enough of it," economically speaking, this statement is unrealistic. Even if the consumer hypothetically had access to an unlimited amount of seafood and an unlimited budget, the food would still not provide enough satisfaction to remain a preferred choice. As a result, their preference would shift and they would truly have had enough.
When examining market dynamics, it is essential to consider both supply and demand. Supply pertains to the quantity of a
product sellers aim to sell at different prices, while demand represents the amount of a product buyers wish to purchase at varying prices. Equilibrium occurs when the quantity supplied matches the quantity demanded. This equilibrium is influenced by a specific price that aligns with the behaviors of both supply and demand.
The following section discusses the elasticity of supply and demand. Supply elasticity measures the response of the quantity supplied to a change in price for a good. It is calculated using this formula: Supply elasticity = (% change in quantity supplied) / (% change in price). Understanding supply elasticity helps determine how changes in demand will affect the equilibrium price and quantity. Similarly, demand elasticity illustrates how changes in supply will shift the equilibrium point.
The graph's cross section displays the connection between the elasticity of supply and demand, resulting in a shift in the equilibrium point. Nonetheless, when a 5-pence per gallon tax is included to the existing price of roughly 69.6-pence per gallon, it does not have a notable effect on the supply curve.
The lower left graph in figure 15.4 visually demonstrates how a slight modification in the supply curve leads to a corresponding adjustment in the demand curve. In contrast to the United States, where consumers have alternative goods for transportation, petrol is irreplaceable in England, leaving individuals with no substitutes. As a result, changes in price have little effect on the demand for petrol (low elasticity), resulting in minimal deadweight loss from these small shifts in supply and demand. Instead of bearing the tax burden themselves, petrol producers pass it onto consumers.
The government, also referred to as the legislator, will not face
any negative impact. The only possible influence on the legislator is the adjustment of this specific tax, which occurs annually as part of the bureaucratic budgeting process. Inflation has been a significant economic issue for numerous countries worldwide in the last century. Expensive wars have historically been identified as the root cause of inflation. Governments, in their attempt to bolster economic output, have frequently resorted to printing or circulating additional money to finance military expenditures1.
Introduction of additional funds into a functioning economy leads to an increase in prices, causing inflation. Previously, it was thought that once the economy stabilized, the continuous rise in prices and inflation rates would cease. However, World War II resulted in an extended period of predicted inflation. During the 1950s and early 1960s, there was a recovery with minimal unemployment and significant economic growth alongside minimal levels of inflation.
Between 1967 and 1974, inflation rates in Japan and Britain experienced a significant rise without any clear explanation. This unexpected increase in inflation caused economists to reevaluate their views and align themselves with different schools of thought regarding the causes and solutions for inflation. There are two opposing theories concerning inflation. Monetarism suggests that an increase in the money supply results in inflation. An example illustrating this connection is the inflation that occurred after Europe obtained large amounts of gold and silver due to the Spanish conquest of the Americas.
Monetarists argue that government intervention is necessary to control inflation by reducing the growth of the money supply. On the other hand, cost-push theory posits that inflation comes from wage hikes. According to this theory, economic factors do not affect wage increases; instead, they
are mainly influenced by workers and trade unions. Inflation occurs when trade unions and workers demand wages that surpass the economy's production capacity. Supporters of the cost-push theory suggest limiting trade unions' power and implementing income policies as methods to tackle inflation.
In between the cost-push and monetarism theory lies Keynesianism. Keynesians recognize the significance of both the money supply and wage rates in determining inflation. They suggest using monetary and incomes policies as complementary measures to reduce inflation, but mostly rely on fiscal policy as the solution. To comprehend the proposed policies by these different schools of thought, we must examine the historical development of our understanding of inflation. For approximately 200 years prior to John Maynard Keynes writing the General Theory of Employment, Interest , and Money, economists generally agreed on the sources of inflationary pressure, referred to as the quantity theory of money2.
The Quantity theory of money can be easily understood through Fisher's equation MV=PY. This equation states that the money supply (M) multiplied by the velocity of circulation of money (V) equals the price level (P) multiplied by real income (Y). According to quantity theorists, the size of the money supply (M) does not significantly impact overall economic output ((Y)) in the long term. They also argue that the velocity of circulation of money (V) remains relatively constant, as short-term variations in money circulation are temporary and long-term changes are negligible. Furthermore, this theory assumes that the supply of money is not influenced by economic output or demand for money itself. Therefore, a central prediction can be made - changes in the money supply will result in proportional changes in prices.
If the
money supply increases, individuals will initially have more money. They usually spend most of their additional money, leading to a competitive market where prices are bid up and resulting in inflation. The quantity theory assumes that in a competitive market with flexible wages and prices, the market will naturally correct itself and achieve full employment. Figure 1 depicts w as the real wage rate (the purchasing power of income), Ld as labor demand, and Ls as labor supply. Let's assume that the economic system starts with a real wage rate of w1, with Ls1 representing the supply of labor and Ld1 representing the demand for labor.
Classicalists argue that the main reason for the current high unemployment rate is the expensive labor costs for employers. This creates a surplus of available workers, leading to competition between unemployed and employed individuals for job opportunities. To address this competition and decrease labor expenses, employers will increase their hiring, ultimately resulting in lower wages. This cycle continues until a state of equilibrium is achieved in the labor market, known as labor market clearance. According to Classicalists, reaching labor market clearance signifies full employment.
Unemployment that persists can only be ascribed to a mechanism that disrupts a competitive market. Monopolistic trade unions are specifically accused of inhibiting the wage rate from declining to We. Unions employ various intimidating tactics to resist reductions in wages. The most effective tactics mentioned in textbooks are collective bargaining and strikes. The Classical approach to economics was overshadowed by the Great Depression, which affected both the US and western European countries3.
The self-correcting characteristics of traditional economics did not function as expected when wages and unemployment did
not decrease. It seemed unlikely that trade unions were solely responsible for the significant rise in unemployment. John Maynard Keynes provided the first comprehensive and persuasive explanation for the inter-war depression, deviating from classical economic theories. He attributed the unemployment problem to a lack of effective demand.
In simple terms, unemployment happens when the total spending on output is insufficient to employ the available workforce. Keynes divided effective demand, also known as expenditures, into two categories: consumption and investment. Consumption, which refers to the purchase of goods and services, outweighed investment as the primary component of effective demand. At the heart of Keynes' theories was the belief that an economy's total production (Y) will eventually adjust itself to changes in expenditures. Additionally, Keynes argued that wage equilibrium exists when producers' output is equal to the amount that consumers and investors are willing to spend on it.
Figure 2 depicts the measurement of total expenditure, including both consumption and investment. The vertical axis signifies total expenditure, while the horizontal axis denotes real income. In the graph, investment is assumed to be consistent and is displayed as line I. When we combine the consumption function with the investment line, we obtain line E, representing the summation of total expenditures (E = C+I). In the short term, Y can be positioned anywhere given a specific amount of expenditures. If Y surpasses E, it indicates that producers are amassing unsold goods.
In the future, producers will have to reduce production until they can sell their current inventory and earn enough capital to resume production. On the other hand, if Y is below E, producers will sell goods instead. Usually, they will increase
production promptly to meet the demand and maximize profit. This is when the 45 line becomes relevant.
According to Keynes, Y will move to the point where E intersects the 45 line, establishing equilibrium between expenditures and total output and stabilizing wages. To demonstrate how Keynes' principle of effective demand explains unemployment, let's assume that the economy starts at full employment where Ld equals Ls. The output needed to sustain full employment is labeled as Yf, f indicating full employment. If expenditures were less than Yf, Yf would adjust leftward on the graph. This reduction in total output would decrease the demand for labor and result in a corresponding increase in unemployment.
If one accepts the Keynesian model, there are typically two options to increase aggregate demand and achieve full employment. These options include increasing government expenditures (G), stimulating private investment, or lowering taxes to raise consumption. By implementing these policies, the level of aggregate demand can be raised. Both of these strategies fall under the umbrella of fiscal policy, which involves deliberately manipulating the government budget deficit to attain economic objectives. During the great depression, many individuals rejected Keynes' ideas on unemployment due to fear of being unconventional.
According to contemporary Orthodox beliefs, reducing money wages would lead to a decrease in real wages and ultimately increase employment. Classicalists suggested that the government could address unemployment by implementing wage reductions. However, Keynes opposed this notion based on both theoretical and empirical reasoning. Additionally, collective bargaining after the First World War made it highly unlikely for wages to be flexible downwards.
Keynes believed that attempting to reduce money wages would be met with strong opposition, as shown by the
example of the 1926 General Strike in Britain. He attributed trade unions' resistance to wage cuts to the inflexible wage differentials. Wage differentials refer to the relative position of wages for a specific type of labor compared to others. For instance, if mechanics earn $1, electricians earn $2, and plumbers earn $3, any group with higher wages would prompt other groups to demand higher wages to maintain the existing structure. Conversely, if one group voluntarily accepted a wage cut, other groups would likely not follow suit.
Accordingly, labor organizations strongly opposed reductions in wages. In terms of theory, Keynes maintained that decreases in money wages would eventually lead to decreases in prices. This balanced deflation would result in maintaining the purchasing power of real wages, which represents the quantity of goods that can be purchased, at its original level. As a consequence, employers would not hire more employees as their actual revenue, which is the quantity of goods they sell, would stay the same. To thoroughly evaluate this assertion, it is necessary to examine the terminology employed and contemplate their definitions in relation to the broader context of the question.
We will first discuss Positive Economics, which involves making statements based on real data and true statistics that are directly related to real situations. In contrast, Normative Economics involves statements that are not purely objective, but still related to positive economic situations. These statements offer subjective opinions that are biased and based solely on the speaker's personal feelings.
- "Positive economics is about what is; normative economics is about what should be."
- Economics, John B. Taylor, Houghton
Mifflin Company, 1995, p.25
When we engage in positive economics, our thoughts are strictly focused on analyzing the existing situation without personal bias or emotional influence. Positive economics deals with true data and real facts and provides an overview of a given situation. It can be understood as a "what is" perspective because it relates to the actual conditions rather than what should ideally be. In contrast, normative economics offers a viewpoint from within a specific situation and includes personal bias and subjective opinions based on real or given data.
The expression of "what should be" only occurs when perceiving a situation internally, from a specific standpoint. The objective process of factual data lacks the reality of the emotionally charged normative thought process. This thought process involves drawing comparisons and reaching conclusions based on personal criteria. The normative statement can pertain to either positive or negative aspects, and is always rooted in subjective opinion shaped by a personal attitude towards a positive economic situation. The given statement reveals that there is undoubtedly a distribution of wealth in the United Kingdom, which is indisputably a positive economic statement. However, the hypothesis that it is unfair is purely based on the
speaker's supposition, making it a normative statement. The word "fair" generally carries an emotional connotation.
There is a direct connection between equilibrium and meaning, but the interpretation of "fair" can differ depending on perspective. "Fair" can vary significantly based on how it is defined. When examining the distribution of wealth in the United Kingdom "according to the rules," it is important to question whose rules these are. If they align with those of the ruling political party, then the distribution is considered fair. However, if they align with the rules of a minority Marxist party, then the distribution is deemed unfair. In both scenarios, the term "fair" is used without making a normative judgment.
The viewpoint of the unemployed or lower social classes is irrelevant because there are no established guidelines for these groups. Any opinion they express about "fairness" is automatically subjective. The same applies if we consider other officially accepted definitions of "fairness". There may be uncertainty about whether the word "satisfactory" should be understood objectively or subjectively. Similarly, the word "just" can be interpreted both in a legal sense and a personal sense.
In a specific case, such as the distribution of income in the United Kingdom being deemed unfair, an examination with accepted definitions could potentially lead to the conclusion that it is fair. However, this conclusion would only be valid if it is derived from an unbiased perspective, relying on formally accepted definitions. Furthermore, it must be based on real statistical data regarding the actual wealth distribution in the United Kingdom. If we were to approach this income distribution from a normative standpoint, the aforementioned conclusion would not hold true. This is because
normative thought is subjective, varying from person to person in the real world, which is the domain of normative economics. Therefore, labeling the statement "The distribution of income in the United Kingdom is not fair." as an opinion rather than a scientific conclusion would be more appropriate, categorizing it as biased and subjective. In conclusion, my perspective on using "fair" non-normatively is that it is indeed possible. Personal views or preferences do not hinder one's ability to objectively evaluate a situation when adopting a temporarily neutral and dispassionate standpoint.One may not have a personal preference for the creations of a renowned writer, yet it is possible to acknowledge and respect the value and caliber of his/her literary expressionism.
The provided essay prompt is unquestionably normative. It has the potential, however, to be made positive, as could any other statement that includes the word "fair," by defining fairness within the context of reality. There are three possible ways to finance a small firm. The most desirable but also the least likely option is self-financing through retained earnings. Alternatively, the firm will need to rely on one of two financial markets: debt capital and equity capital (which, strictly speaking, is the same as retained earnings). Both options have their advantages and disadvantages. Clearing banks did not start granting loans with a maturity term exceeding ten years until 1979.
When lending to smaller companies, fixed interest rates are typically set at a premium above the base rate (3% - 6%). However, larger companies with a good credit rating may be offered the premium on the inter-bank rate, which is lower than the base rate. Loans are typically secured by the
personal guarantee of directors or owners of small companies. In the case of larger companies, a charge is placed against the company's assets. If the charges are "fixed," they are associated with a specific asset. "Floating" charges, on the other hand, are placed on general assets. All bank loans are based on three elements that the company must meet.
The bank requires the interest rate, security, and repayment terms for a loan. These terms can vary between banks and borrowers but typically involve regular payments over the loan period. Small companies face challenges in meeting these requirements compared to larger companies. They must pay higher interest rates, provide personal assets as security, and face more inflexible repayment terms. This is because banks consider small companies to have a higher risk profile. However, small companies may explore alternative sources of loans besides banks. These sources include pension funds, insurance companies, merchant banks, the European Investment Bank, and the ICFC. Companies often turn to these options as a last resort due to fixed interest payments that can become expensive if inflation decreases.
(Investment and Commercial Finance Corporation) The company has an alternative option called "medium term note" which is a promissory note. This note is issued by the company with a promise to pay a specific amount on a specific date. To sell this note, the company writes it and puts it on the market. The interest rate can be fixed or variable, and the maturity date can range from under one year to up to fifteen years. Additionally, a small company may issue a debenture, which serves as a document in exchange for borrowed money.
Different types of debentures
share certain characteristics. Typically, they manifest as bonds, guaranteeing the repayment of a loan on an agreed-upon date with regular interest payments from the issuance date until maturity. These interest payments take priority over dividends for other classes of shareholders. According to the Companies Acts, the term "debenture" encompasses debenture stock and bonds.
The terms debenture, bond, and loan stock are often used interchangeably, although I will address Bond and Loan Stock separately later on. There are several reasons why an investor might prefer debentures over other types of company financing. The main reason is related to risk. Debt financing typically has a predetermined maturity date. The investor has priority in both interest payments and in the event of the company being liquidated.
Debenture holders receive a fixed return on their investment. If the company does not generate significant profits, debenture holders will still receive the fixed interest rate. In contrast, ordinary shareholders may have to wait for the Board's decision on dividend payouts. The issuance of debentures by a company is motivated by several reasons. A key advantage is that the company knows and limits the cost of the debt. If the company earns higher profits, these are not distributed among debenture holders. Additionally, the cost of debt is limited because debenture holders face lower risk compared to shareholders. Furthermore, the interest payment made to debenture holders is tax-deductible.
Debenture issues may not always be advantageous for companies as there are potential drawbacks. The assumptions made about the company's future trading position a decade ago could turn out to be incorrect, making the decision to take on long-term debt unwise. Additionally, the company is still obligated to
repay the debt when it matures. On the other hand, a warrant is essentially a call option issued by the company for its own stock. Warrant holders have the right to purchase a specified number of shares at a predetermined price on a specific date. Later on, we will discuss the challenges faced by young companies, as raising finances can pose difficulties for businesses with no established track record.
The warrant can serve as an enticer, enticing investors to purchase debenture stock by offering convertibles or warrants with lower interest rates. Risky companies, young companies, and those with difficult-to-estimate risk profiles are the most common issuers of convertibles and warrants. Essentially, these issuers may not have a strong credibility standing at the bank.
The company has the ability to issue preference shares, which grant holders partial ownership of the company. However, preference shares more closely resemble loan capital rather than ordinary shares. In terms of hierarchy, preference shares rank higher than ordinary shares but lower than debentures. One clear advantage for the company is that preference shares provide a source of long-term financing that is not necessarily permanent. Additionally, if company profits do not justify it, the dividend payment for preference shares does not have to be made. Despite these advantages, preference shares are not widely favored by companies or investors. In 1993, they accounted for only 7.7% of the total. Small companies face challenges in obtaining funding due to shared characteristics such as limited trading history and a lack of accounting expertise within the company, which hinders their ability to make a strong case for financing.
Small companies often struggle to access securities markets, especially the Stock
Exchange, due to the difficulty and expense involved. It is widely believed that smaller companies are more likely to face liquidation, making it harder for them to persuade potential lenders. Financial institutions that dominate the finance market typically prefer to invest in large companies in order to minimize the impact on share prices. This strategy involves investing small amounts over time. Young or small companies are less likely to offer the stable long-term growth that these institutions desire. Moreover, the previously mentioned disadvantages faced by small companies, such as fixed transaction costs for raising finance, further exacerbate their dependence on banks for funding. Investing in smaller companies carries higher risk, leading to higher expected returns and increased capital costs.
Companies seeking additional finance and turning to the Stock Exchange can tap into various types of investments. The capital market provides access to variable income and capital investments, as well as fixed income investments. Securities offered include company securities like loan stock, shares, and options, public sector securities such as guilt-edged securities issued by reputable companies and governments, and Eurobonds. The capital market consists of two facets, each serving a different purpose. The primary market focuses on issuing and trading new securities.
The primary market handles companies' raising of new equity on the Stock Market through the "New Issues Market". On the other hand, the secondary market deals with existing financial claims. Although dealing on the secondary market does not generate new finance for the quoted company, it allows lenders to transfer repayment rights to another party without affecting the borrower. The secondary market is crucial to investors as it permits them to sell their investment whenever they
desire. Without the secondary market, companies would struggle to find investors who are willing to commit their funds for a prolonged period, thus making it more challenging to raise finance through share issuance. Consequently, both markets serve the main purpose of connecting lenders and borrowers and facilitating the movement of funds between them.
Not all companies are able to use the Stock Exchange as a means of raising finance. In order to be listed on the Stock Market, a company must go through a costly process of being quoted. However, smaller or newer companies that do not meet the requirements for a full listing can still participate in raising finance through the Unlisted Securities Market, which has lower trading requirements. In order to qualify for this market, companies must demonstrate a three year trading record and offer 10% of shares at the initial offering. Participating in this market provides four major benefits to companies.
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