Tuesday, May 13, 2008

Managerial Economics(For Batch 2003 and Earlier) - 3

Q5. Write notes on.
E. Fiscal Policy
The ‘fiscal policy’ refers to the variations in taxation and public expenditure programmes by the government to achieve the predetermined objectives. Taxation is a measure of transferring funds from the private purses to the public coffers: it amounts to withdrawal of funds from the private use. Public expenditure, on the other hand, increases the flow of funds into the private economy. Thus, taxation reduces private disposable income and thereby the private expenditure, end public expenditure increases private incomes and thereby the private expenditure. Since tax-revenue and public expenditure form the two sides of the government budget, the taxation and public expenditure policies are also jointly called as ‘budgetary policy.’

Fiscal or budgetary policy is regarded as a powerful instrument of economic stabilization. The importance of fiscal policy as an instrument of economic stabilization. The importance of fiscal policy as an instrument of economic stabilization rests on the fact tat government activities in modern economies are greatly enlarged, and government tax-revenue and expenditure account for a considerable proportion of GNP, ranging from 10-25 per cent. Therefore, the government may affect the private economic activities to the same extent through variations in taxation and public expenditure. Besides, fiscal policy is considered to be more effective than monetary policy because the former directly affects the private decisions while the Latter does so indirectly. If fiscal policy of the government is so formulated that it during the period of expansion, it is known as ‘counter - cyclical fiscal policy’.

F. Monetary Policy
Monetary policy refers to the programme of The Central Bank’s variations, in the total supply of money and cost of money to achieve certain predetermined objectives. One of the primary objectives of monetary policy is to achieve economic stability. The traditional instruments through which Central Bank carries out the monetary policies are: -

Quantitative Credit Control Measures such as open market operations, changes in bank rate and changes in statutory reserve ratios. Briefly speaking, open market operation by the Central Bank is the sale and purchase of government bonds, treasure bills, securities, etc, to and form the public. Bank rate is the rate at which Central Bank discounts the commercial banks’ bills of exchange or first class bill. The statutory reserve ratio is the proportion of commercial banks’ time and demand deposits, which they are required to deposit with the Central Bank or keep cash in- vault. All these instruments when operated by the Central Bank reduce (or enhance) directly and indirectly the credit creation capacity of the commercial banks and thereby reduce (or increase) the flow of funds from the banks to the public.

In addition these instruments, Central Banks use also various selective credit control measures and morel suasion. The selective credit controls are indented to control the credit flows to particular sectors without affecting the total credit, and also to change the composition of credit from undesirable to desirable pattern. Moral suasion is a persuasive method to convince the commercial banks to behave in accordance with the demand of the time and in the interest of the nation.

N. Distinction between Shares and Debentures
Following are the points of differences between shares and debentures
Shares are part of the capital of the company. Debentures constitute loan to the company.
Shareholders are owners of the company, whereas debenture-holders are creditors of the company. Shareholders enjoy the rights like right to vote, right to attend general meetings etc. Usually these rights are not available to a debenture-holder.
As regards return of principal amount, the debenture-holders will have prior claim over shareholders, in the event of liquidation of a company.
Shareholders get dividend depending on the profitability of the company as a reward for their investment. In the event of no loss, the company may not declare dividend. In respect of debentures a fixed rate of interest is paid, irrespective of the profitability of the company. Payment of interest is mandatory.
Debentures are generally secured by creating a change on the assets of the company. Share capital being the risk capital, no security is offered to the shareholders.
Normally, debentures are issued for a limited period. That means debentures are redeemed during the life of the company. The share capital is the permanent source, is generally not returned to the shareholders during the lifetime of the company. This is subject to exception of redeemable preference shares or buy back of shares, which has been allowed by the companies act recently.

Limitation of cost-benefit analysis
Cost - benefit analysis suffers from following limitations. : -

Critics have pointed out that this analysis is applicable in a partial equilibrium framework. However economists like AC. Harberger have shown that it can be applied to the general equilibrium analysis as well
The exactness and usefulness of this analysis is limited by the fact that it is based on the assumption that maximization of net wealth can ensure maximization of social welfare.
The cost benefit analysis is applied on another assumption that the existing pattern of distribution of income, distribution is given and has to be kept as it is. In fact, a change in income distribution does lead to a change in net wealth and further in social welfare.
Another limitation of the analysis is that it ignores the effect of diminishing marginal utility of additional wealth or income with every incremental dose of income or wealth being added to the existing total.
By assuming the positive correlation between wealth and welfare, the analysis assumes away all difficulties involved in the calculation of present and future cost as well as private and social cost.
Whatever applies to costs also applies to benefits i.e., calculation of present and future benefits as well as private and social benefits involves similar difficulties.

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