Tag: Market Trends

Management Notes

Consumer Behaviour, Meaning and Nature, Challenges

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Consumer behavior refers to the study of how individuals, groups, and organizations select, purchase, use, and dispose of goods, services, ideas, or experiences to satisfy their needs and desires. It encompasses the psychological, social, and emotional factors that influence buying decisions. Understanding consumer behavior helps businesses develop effective marketing strategies, improve customer engagement, and enhance product offerings. It involves analyzing factors like personal preferences, cultural influences, social norms, and purchasing patterns. By comprehending what motivates consumers, companies can anticipate market trends, meet customer expectations, and create value-driven solutions that foster loyalty and long-term success.

Nature of Consumer Behaviour:

  • Complex Process

Consumer behavior is a complex process involving multiple psychological and social factors that influence decision-making. Consumers do not simply purchase products; they go through several stages, including need recognition, information search, evaluation of alternatives, purchase decision, and post-purchase behavior. The complexity arises due to varying individual preferences, motivations, cultural influences, and situational factors, making it challenging for businesses to predict consumer actions accurately.

  • Influenced by Various Factors

Consumer behavior is influenced by personal, psychological, social, and cultural factors. Personal factors include age, gender, and lifestyle, while psychological factors involve perception, learning, and attitudes. Social influences like family, reference groups, and social class also play a role. Additionally, cultural factors such as values, traditions, and societal norms shape consumer preferences and buying decisions.

  • Dynamic in Nature

Consumer behavior is dynamic and constantly evolving due to changes in personal preferences, technology, lifestyle, and market trends. New products, innovations, and marketing strategies influence consumer preferences over time. Additionally, external factors like economic conditions and societal shifts can alter consumer priorities, making it essential for businesses to stay updated and adapt to changing consumer needs.

  • Goal-Oriented

Consumers exhibit goal-oriented behavior, meaning their purchasing decisions are driven by the desire to fulfill specific needs or achieve certain outcomes. These needs may be functional, emotional, or symbolic. For instance, a consumer may buy a product for its practical utility, to gain emotional satisfaction, or to express social status. Understanding these goals helps marketers design better value propositions.

  • Varies Across Individuals

Consumer behavior varies greatly from person to person due to differences in personality, preferences, and socio-economic background. While some consumers may prioritize price, others might focus on quality, brand reputation, or convenience. This variability necessitates market segmentation and personalized marketing approaches to cater to different consumer groups effectively.

  • Involves Decision-Making

Consumer behavior involves a decision-making process where consumers evaluate various alternatives before making a final purchase. This process includes identifying needs, gathering information, comparing options, and making choices. Post-purchase evaluation, where consumers assess whether their expectations were met, is also a critical aspect. Businesses need to understand this process to influence decision-making positively.

  • Reflects Social Influence

Consumer behavior often reflects the influence of social factors such as family, friends, peer groups, and society at large. People tend to seek social acceptance and approval in their purchasing decisions. Word-of-mouth recommendations, social media, and online reviews have a significant impact on consumer behavior, making social influence a critical element in marketing strategies.

  • Varies by Product Type

Consumer behavior differs depending on the type of product or service being purchased. For high-involvement products like cars or electronics, consumers spend more time researching and comparing options. In contrast, low-involvement products like daily essentials involve quick decision-making. Understanding this distinction helps businesses tailor their marketing efforts to suit different product categories.

  • Influenced by Perception

Perception plays a significant role in consumer behavior, as individuals form subjective opinions about products and brands based on how they interpret information. Factors such as advertising, packaging, branding, and word-of-mouth shape consumer perceptions. Even if two products offer similar value, consumers may choose the one they perceive as superior due to effective marketing.

  • Leads to Customer Satisfaction

The ultimate goal of consumer behavior is to achieve customer satisfaction. When consumers feel that a product or service meets or exceeds their expectations, they experience satisfaction, leading to brand loyalty and repeat purchases. Conversely, dissatisfaction can result in negative reviews and lost customers. Understanding consumer behavior allows businesses to create offerings that maximize satisfaction and long-term relationships.

Challenges of Consumer Behaviour:

  • Complexity of Consumer Needs

Consumers have diverse and complex needs that vary across individuals and situations. A single product may cater to different needs for different people. For instance, one consumer may buy a car for luxury, while another buys it for utility. Understanding and predicting these multifaceted needs is a significant challenge for marketers aiming to create products that satisfy varying consumer expectations.

  • Rapidly Changing Preferences

Consumer preferences evolve rapidly due to factors like technological advancements, societal trends, and exposure to global cultures. What is popular today may become obsolete tomorrow. Keeping up with these changing preferences requires businesses to be highly adaptable and continuously innovate to meet new demands. Failing to do so can result in losing relevance in the market.

  • Influence of Social and Cultural Factors

Social and cultural factors greatly influence consumer behavior. These factors differ significantly across regions, making it challenging for global businesses to design universally appealing marketing strategies. For example, a product that is successful in one country may not resonate in another due to cultural differences. Understanding and respecting these nuances is critical for market success.

  • Impact of Psychological Factors

Consumer behavior is heavily influenced by psychological elements such as perception, motivation, attitudes, and beliefs. These factors are subjective and vary widely among individuals, making it difficult for marketers to generalize behaviors. Additionally, psychological factors are often subconscious, further complicating efforts to predict or influence consumer actions.

  • Information Overload

In today’s digital age, consumers are bombarded with information from multiple sources, including advertisements, social media, and peer reviews. This information overload makes it harder for businesses to capture and retain consumer attention. Moreover, consumers may struggle to process all the information, leading to unpredictable buying behavior.

  • Increasing Consumer Expectations

With the availability of numerous alternatives and personalized offerings, consumer expectations have risen significantly. Modern consumers demand high-quality products, exceptional service, and unique experiences. Meeting these elevated expectations requires businesses to continuously improve their offerings, which can be resource-intensive and difficult to sustain.

  • Influence of Technology

Technology has transformed how consumers interact with businesses. From online shopping to social media engagement, digital platforms have created new avenues for consumer behavior. However, this has also increased the complexity of tracking and understanding consumer preferences across multiple channels. Businesses must invest in advanced analytics to gain insights into online consumer behavior.

  • Brand Loyalty vs. Switching Behavior

Building brand loyalty is a key objective for businesses, but it has become more challenging due to increased competition and abundant choices. Consumers can easily switch to competitors if they find better value elsewhere. Marketers must constantly engage consumers and deliver superior value to retain loyalty while addressing switching behavior effectively.

  • Ethical and Sustainable Consumption

Modern consumers are increasingly concerned about ethical and sustainable practices. They prefer brands that prioritize environmental and social responsibility. Businesses face the challenge of aligning their operations with these values while maintaining profitability. Additionally, they must communicate their efforts effectively to gain consumer trust.

  • Difficulty in Segmenting Markets

Effective market segmentation is essential for targeted marketing, but it is not always easy to implement. Consumer behavior can vary within segments due to individual differences, making it hard to identify homogeneous groups. Moreover, segments may overlap, requiring businesses to adopt complex, multi-segment strategies for better targeting.

Management Notes

Factors affecting Consumer Behaviour

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Consumer behaviour refers to the study of how individuals, groups, or organizations select, buy, use, and dispose of goods, services, ideas, or experiences to satisfy their needs and wants. It involves understanding the decision-making process of consumers, including psychological, social, and economic influences. Businesses analyze consumer behaviour to identify patterns and preferences, enabling them to develop effective marketing strategies. Factors such as cultural background, personal preferences, lifestyle, and economic conditions shape consumer behaviour. By gaining insights into consumer actions and motivations, marketers can better meet customer expectations and enhance customer satisfaction.

  1. Cultural Factors

Consumer behavior is deeply influenced by cultural factors such as: buyer culture, subculture, and social class.

(a) Culture

Basically, culture is the part of every society and is the important cause of person wants and behavior. The influence of culture on buying behavior varies from country to country therefore marketers have to be very careful in analyzing the culture of different groups, regions or even countries.

(b) Subculture

Each culture contains different subcultures such as religions, nationalities, geographic regions, racial groups etc. Marketers can use these groups by segmenting the market into various small portions. For example marketers can design products according to the needs of a particular geographic group.

(c) Social Class

Every society possesses some form of social class which is important to the marketers because the buying behavior of people in a given social class is similar. In this way marketing activities could be tailored according to different social classes. Here we should note that social class is not only determined by income but there are various other factors as well such as: wealth, education, occupation etc.

  1. Social Factors

Social factors also impact the buying behavior of consumers. The important social factors are: reference groups, family, role and status.

(a) Reference Groups

Reference groups have potential in forming a person attitude or behavior. The impact of reference groups varies across products and brands. For example if the product is visible such as dress, shoes, car etc then the influence of reference groups will be high. Reference groups also include opinion leader (a person who influences other because of his special skill, knowledge or other characteristics).

(b) Family

Buyer behavior is strongly influenced by the member of a family. Therefore marketers are trying to find the roles and influence of the husband, wife and children. If the buying decision of a particular product is influenced by wife then the marketers will try to target the women in their advertisement. Here we should note that buying roles change with change in consumer lifestyles.

(c) Roles and Status

Each person possesses different roles and status in the society depending upon the groups, clubs, family, organization etc. to which he belongs. For example a woman is working in an organization as finance manager. Now she is playing two roles, one of finance manager and other of mother. Therefore her buying decisions will be influenced by her role and status.

  1. Personal Factors

Personal factors can also affect the consumer behavior. Some of the important personal factors that influence the buying behavior are: lifestyle, economic situation, occupation, age, personality and self concept.

(a) Age

Age and life-cycle have potential impact on the consumer buying behavior. It is obvious that the consumers change the purchase of goods and services with the passage of time. Family life-cycle consists of different stages such young singles, married couples, unmarried couples etc which help marketers to develop appropriate products for each stage.

(b) Occupation

The occupation of a person has significant impact on his buying behavior. For example a marketing manager of an organization will try to purchase business suits, whereas a low level worker in the same organization will purchase rugged work clothes.

(c) Economic Situation

Consumer economic situation has great influence on his buying behavior. If the income and savings of a customer is high then he will purchase more expensive products. On the other hand, a person with low income and savings will purchase inexpensive products.

(d) Lifestyle

Lifestyle of customers is another import factor affecting the consumer buying behavior. Lifestyle refers to the way a person lives in a society and is expressed by the things in his/her surroundings. It is determined by customer interests, opinions, activities etc and shapes his whole pattern of acting and interacting in the world.

(e) Personality

Personality changes from person to person, time to time and place to place. Therefore it can greatly influence the buying behavior of customers. Actually, Personality is not what one wears; rather it is the totality of behavior of a man in different circumstances. It has different characteristics such as: dominance, aggressiveness, self-confidence etc which can be useful to determine the consumer behavior for particular product or service.

  1. Psychological Factors

There are four important psychological factors affecting the consumer buying behavior. These are: perception, motivation, learning, beliefs and attitudes.

(a) Motivation

The level of motivation also affects the buying behavior of customers. Every person has different needs such as physiological needs, biological needs, social needs etc. The nature of the needs is that, some of them are most pressing while others are least pressing. Therefore a need becomes a motive when it is more pressing to direct the person to seek satisfaction.

(b) Perception

Selecting, organizing and interpreting information in a way to produce a meaningful experience of the world is called perception. There are three different perceptual processes which are selective attention, selective distortion and selective retention. In case of selective attention, marketers try to attract the customer attention. Whereas, in case of selective distortion, customers try to interpret the information in a way that will support what the customers already believe. Similarly, in case of selective retention, marketers try to retain information that supports their beliefs.

(c) Beliefs and Attitudes

Customer possesses specific belief and attitude towards various products. Since such beliefs and attitudes make up brand image and affect consumer buying behavior therefore marketers are interested in them. Marketers can change the beliefs and attitudes of customers by launching special campaigns in this regard.

Lucknow University BBA Notes

Theories of International Trade

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International trade allows countries to expand their markets for both goods and services that otherwise may not have been available domestically. As a result of international trade, the market contains greater competition, and therefore more competitive prices, which brings a cheaper product home to the consumer.

International trade gives rise to a world economy, in which supply and demand, and therefore prices, both affect and are affected by global events. Political change in Asia, for example, could result in an increase in the cost of labor, thereby increasing the manufacturing costs for an American sneaker company based in Malaysia, which would then result in an increase in the price charged at your local mall. A decrease in the cost of labor, on the other hand, would likely result in you having to pay less for your new shoes.

A product that is sold to the global market is called an export, and a product that is bought from the global market is an import. Imports and exports are accounted for in a country’s current account in the balance of payments.

Theories of International Trade

Classical Country- Based Theories

Modern Firm-Based Theories
Mercantilism Country Similarity
Absolute Advantages Product lifecycles
Comparative Advantage Global Strategic Rivalry
Heckscher-Ohlin Porter’s National Competitive Advantages

Mercantilism

According to Wild, 2000, the trade theory that state that nations ought to accumulate money wealth, typically within the style of gold, by encouraging exports and discouraging imports is termed mercantilism. In line with this theory different measures of countries’ well being, like living standards or human development, area unit tangential mainly Great britain, France, Holland, Portuguese Republic and Spain used mercantilism throughout the 1500s to the late 1700s.

Mercantilistic countries experienced the alleged game, that meant that world wealth was restricted which countries solely may increase their share at expense of their neighbours. The economic development was prevented once the mercantilistic countries paid the colonies very little for export and charged them high value for import. The most downside with mercantilism is that every one country engaged in export however was restricted from import, another hindrance from growth of international trade.

Absolute Advantage

The Scottish social scientist Smith developed the trade theory of absolute advantage in 1776. A rustic that has associate absolute advantage produces larger output of a decent or service than different countries mistreatment an equivalent quantity of resources. Smith declared that tariffs and quotas mustn’t limit international trade it ought to be allowed to flow in step with economic process. Contrary to mercantilism Smith argued that a rustic ought to focus on production of products within which it holds associate absolute advantage. No country then ought to turn out all the products it consumed. The speculation of absolute advantage destroys the mercantilistic concept that international trade could be a game. In step with absolutely the advantage theory, international trade could be a positive-sum game, as a result of there are gains for each countries to associate exchange. In contrast to mercantilism this theory measures the nation’s wealth by the living standards of its folks and not by gold and silver.

There’s a possible drawback with absolute advantage. If there’s one country that doesn’t have associate absolute advantage within the production of any product, can there still be profit to trade, and can trade even occur. The solution is also found within the extension of absolute advantage, the speculation of comparative advantage.

Comparative Advantage

The most basic idea within the whole of international trade theory is that the principle of comparative advantage, first introduced by economist David Ricardo in 1817. It remains a serious influence on a lot of international foreign policy and is thus necessary in understanding the fashionable international economy. The principle of comparative advantage states that a rustic ought to specialize in manufacturing and exportation those merchandise during which is includes a comparative, or relative price, advantage compared with different countries and will import those merchandise during which it’s a comparative disadvantage. Out of such specialization, it’s argued, can accrue larger profit for all.

During this theory there square measure many assumptions that limit the real-world application. The idea that countries square measure driven solely by the maximization of production and consumption and not by problems out of concern for employees or customers may be a mistake.

Heckscher-Ohlin theory

In the early decade a world trade theory referred to as issue proportions theory emerged by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is additionally referred to as the Heckscher-Ohlin theory. The Heckscher-Ohlin theory stress that countries ought to turn out and export merchandise that need resources that area unit well endowed and import merchandise that need resources in brief provide. This theory differs from the theories of comparative advantage and absolute advantage since these theory focuses on the production of the assembly method for a selected smart. On the contrary, the Heckscher-Ohlin theory states that a rustic ought to specialize production and export victimization the factors that area unit most well endowed, and so the most cost effective. Not turn out, as earlier theories declared, the products it produces most expeditiously.

The Heckscher-Ohlin theory is most well-liked to the Ricardo theory by several economists, as a result of it makes fewer simplifying assumptions. In 1953, economic expert revealed a study, wherever he tested the validity of the Heckscher-Ohlin theory. The study showed that the U.S was additional well endowed in capital compared to alternative countries, thus the U.S would export capital- intensive merchandise and import labor-intensive merchandise. Wassily Leontief observed that the U.S’s export was less capital intensive than import.

Modern or Firm-Based Trade Theories

In contrast to classical, country-based trade theories, the category of modern, firm-based theories emerged after World War II and was developed in large part by business school professors, not economists. The firm-based theories evolved with the growth of the multinational company (MNC). The country-based theories couldn’t adequately address the expansion of either MNCs or intraindustry trade, which refers to trade between two countries of goods produced in the same industry. For example, Japan exports Toyota vehicles to Germany and imports Mercedes-Benz automobiles from Germany.

Unlike the country-based theories, firm-based theories incorporate other product and service factors, including brand and customer loyalty, technology, and quality, into the understanding of trade flows.

(i) Country Similarity Theory

Swedish economist Steffan Linder developed the country similarity theory in 1961, as he tried to explain the concept of intraindustry trade. Linder’s theory proposed that consumers in countries that are in the same or similar stage of development would have similar preferences. In this firm-based theory, Linder suggested that companies first produce for domestic consumption. When they explore exporting, the companies often find that markets that look similar to their domestic one, in terms of customer preferences, offer the most potential for success. Linder’s country similarity theory then states that most trade in manufactured goods will be between countries with similar per capita incomes, and intraindustry trade will be common. This theory is often most useful in understanding trade in goods where brand names and product reputations are important factors in the buyers’ decision-making and purchasing processes.

(ii) Product Life Cycle Theory

Raymond Vernon, a Harvard Business School professor, developed the product life cycle theory in the 1960s. The theory, originating in the field of marketing, stated that a product life cycle has three distinct stages: (1) new product, (2) maturing product, and (3) standardized product. The theory assumed that production of the new product will occur completely in the home country of its innovation. In the 1960s this was a useful theory to explain the manufacturing success of the United States. US manufacturing was the globally dominant producer in many industries after World War II.

It has also been used to describe how the personal computer (PC) went through its product cycle. The PC was a new product in the 1970s and developed into a mature product during the 1980s and 1990s. Today, the PC is in the standardized product stage, and the majority of manufacturing and production process is done in low-cost countries in Asia and Mexico.

The product life cycle theory has been less able to explain current trade patterns where innovation and manufacturing occur around the world. For example, global companies even conduct research and development in developing markets where highly skilled labor and facilities are usually cheaper. Even though research and development is typically associated with the first or new product stage and therefore completed in the home country, these developing or emerging-market countries, such as India and China, offer both highly skilled labor and new research facilities at a substantial cost advantage for global firms.

(iii) Global Strategic Rivalry Theory

Global strategic rivalry theory emerged in the 1980s and was based on the work of economists Paul Krugman and Kelvin Lancaster. Their theory focused on MNCs and their efforts to gain a competitive advantage against other global firms in their industry. Firms will encounter global competition in their industries and in order to prosper, they must develop competitive advantages. The critical ways that firms can obtain a sustainable competitive advantage are called the barriers to entry for that industry. The barriers to entry refer to the obstacles a new firm may face when trying to enter into an industry or new market. The barriers to entry that corporations may seek to optimize include:

  • Research and development,
  • The ownership of intellectual property rights,
  • Economies of scale,
  • Unique business processes or methods as well as extensive experience in the industry, and
  • The control of resources or favorable access to raw materials.

(iv) Porter’s National Competitive Advantage Theory

In the continuing evolution of international trade theories, Michael Porter of Harvard Business School developed a new model to explain national competitive advantage in 1990. Porter’s theory stated that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. His theory focused on explaining why some nations are more competitive in certain industries. To explain his theory, Porter identified four determinants that he linked together. The four determinants are, local market resources and capabilities, local market demand conditions, local suppliers and complementary industries, and local firm characteristics.

  • Local market resources and capabilities (factor conditions). Porter recognized the value of the factor proportions theory, which considers a nation’s resources (e.g., natural resources and available labor) as key factors in determining what products a country will import or export. Porter added to these basic factors a new list of advanced factors, which he defined as skilled labor, investments in education, technology, and infrastructure. He perceived these advanced factors as providing a country with a sustainable competitive advantage.
  • Local market demand conditions. Porter believed that a sophisticated home market is critical to ensuring ongoing innovation, thereby creating a sustainable competitive advantage. Companies whose domestic markets are sophisticated, trendsetting, and demanding forces continuous innovation and the development of new products and technologies. Many sources credit the demanding US consumer with forcing US software companies to continuously innovate, thus creating a sustainable competitive advantage in software products and services.
  • Local suppliers and complementary industries. To remain competitive, large global firms benefit from having strong, efficient supporting and related industries to provide the inputs required by the industry. Certain industries cluster geographically, which provides efficiencies and productivity.
  • Local firm characteristics. Local firm characteristics include firm strategy, industry structure, and industry rivalry. Local strategy affects a firm’s competitiveness. A healthy level of rivalry between local firms will spur innovation and competitiveness.

In addition to the four determinants of the diamond, Porter also noted that government and chance play a part in the national competitiveness of industries. Governments can, by their actions and policies, increase the competitiveness of firms and occasionally entire industries.

Porter’s theory, along with the other modern, firm-based theories, offers an interesting interpretation of international trade trends. Nevertheless, they remain relatively new and minimally tested theories.

Management Notes

EXIM Bank, ECGC and other Institutions in Financing of Foreign Trade

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Once our economy opened up post liberalization and globalization, the import and export industry became a huge sector in our economy. Even today India is one of the largest exporters of agricultural goods. So to provide financial support to importers and exporters the government set up the EXIM Bank.

EXPORT AND IMPORT BANK OF INDIA (EXIM)

The Export and Import Bank of India, popularly known as the EXIM Bank was set up in 1982. It is the principal financial institution in India for foreign and international trade. It was previously a branch of the IDBI, but as the foreign trade sector grew, it was made into an independent body.

The main function of the Export and Import Bank of India is to provide financial and other assistance to importers and exporters of the country. And it oversees and coordinates the working of other institutions that work in the import-export sector. The ultimate aim is to promote foreign trade activities in the country.

The management of the EXIM bank is done by a board, headed by the Managing Director. There are 17 other Directors on the board. The whole paid-up capital of the bank (100 crores currently) is subscribed by the Central Government exclusively.

Functions of the EXIM Bank

Let us take a look at some of the main functions of Export and Import Bank of India bank:

  1. Finances import and export of goods and services from India.
  2. It also finances the import and export of goods and services from countries other than India.
  3. It finances the import or export of machines and machinery on lease or hires purchase basis as well.
  4. Provides refinancing services to banks and other financial institutes for their financing of foreign trade.
  5. EXIM bank will also provide financial assistance to businesses joining a joint venture in a foreign country.
  6. The bank also provides technical and other assistance to importers and exporters. Depending n the country of origin there are a lot of processes and procedures involved in the import-export of goods. The EXIM bank will provide guidance and assistance in administrative matters as well.
  7. Undertakes functions of a merchant bank for the importer or exporter in transactions of foreign trade.
  8. Will also underwrite shares/debentures/stocks/bonds of companies engaged in foreign trade.
  9. Will offer short-term loans or lines of credit to foreign banks and governments.
  10. EXIM bank can also provide business advisory services and expert knowledge to Indian exporters in respect of multi-funded projects in foreign countries

Importance of the EXIM Bank

Other than providing financial assistance, the Export and Import Bank of India bank is always looking for ways to promote the foreign trade sector in India. In the early 1990s, EXIM introduced a program in India known as the Clusters of Excellence.

The aim was to improve the quality standards of our imports and exports. It also has a tie-up with the European Bank for Reconstruction and Development. It has agreed to co-finance programs with them in eastern Europe.

In order to promote exports EXIM bank also has schemes such as production equipment finance program, export marketing finance, vendor development finance, etc.

ECGC (Export Credit Guarantee Corporation of India)

The ECGC Limited (Formerly Export Credit Guarantee Corporation of India Ltd) is a company wholly owned by the Government of India based in Mumbai, Maharashtra. It provides export credit insurance support to Indian exporters and is controlled by the Ministry of Commerce. Government of India had initially set up Export Risks Insurance Corporation (ERIC) in July 1957. It was transformed into Export Credit and Guarantee Corporation Limited (ECGC) in 1964 and to Export Credit Guarantee Corporation of India in 1983.

Functions of ECGC

  • Provides a range of credit risk insurance covers to exporters against loss in export of goods and services as well.
  • Offers guarantees to banks and financial institutions to enable exporters to obtain better facilities from them.
  • Provides Overseas Investment Insurance to Indian companies investing in joint ventures abroad in the form of equity or loan and advances.

Facilities by ECGC

  • Offers insurance protection to exporters against payment risks
  • Provides guidance in export-related activities
  • Makes available information on different countries with its own credit ratings
  • Makes it easy to obtain export finance from banks/financial institutions
  • Assists exporters in recovering bad debt
  • Provides information on credit-worthiness of overseas buyers

Institutions in Financing of Foreign Trade

Business activities are conducted on a global level and even between nations. There is an emergence of global markets. To keep the trade fair and manage trade-related issues on a global level, various International Institutions and Trade Agreements were established.

International Trade Associations

The nations were influenced financially because of World War 1 and World War 2. The reconstruction couldn’t happen as there was an interruption in the financial system furthermore there was a shortage of resources. At this crossroads, the prominent economist J. M. Keynes with Bretton Woods establish an association with 44 countries to meet this and to reestablish commonship on the planet.

This gathering brought forth the International Monetary Fund (IMF) International bank Of Reconstruction and Development (IBRD) and the International Trade Organization (ITO). These three associations were considered as three columns for the improvement of the global economy.

World Bank

The International Bank of Reconstruction and Development (IBRD) is usually known as the World Bank. The fundamental point of IBRD is to remake the war influenced the economies of Europe and help the improvement of underdeveloped economies of the world. The World Bank after 1950 focused more on financially unstable nations and invested heavily into social segments like health and education of such immature nations.

Currently, the World Bank includes five universal bodies responsible for offering fund to various countries. These bodies and its partners are headquartered in Washington DC taking into account diverse financial requirements and necessities.

As specified before, the World Bank has been allocated the undertaking of financial development and expanding the extent of the international business. Amid its underlying years of foundation, it gave more significance on creating facilitates like transportation, health, energy and others.

This has profited the underdeveloped nations too, without doubt, however, because of poor regulatory structure, the absence of institutional system and absence of accessibility of skilled labour in these nations has prompted disappointment. World Bank and its Affiliates Institutions:

  • International Bank for Reconstruction and Development (IBRD) 1945
  • International Financial Corporation (IFC) 1956
  • Multilateral Investment Guarantee Agency (MIGA) 1988
  • International Development Association (IDA) 1960
  • International Centre for Settlement of Investment Disputes (ICSID) 1966

The World Bank is no longer limited to simply offering money related help for infrastructure development, agriculture, industry, health and sanitation. It is somewhat significantly engaged with regions like reducing rural poverty, increasing income of the rural poor, offering specialized help, and beginning research schemes.

International Development Association (IDA)

International Development Association (IDA) was set up in 1960 as a partner of the World Bank. IDA was set up essentially to offer fund to the less developed countries on a soft loan basis. It is because of its intention of providing soft loans that it is called the Soft Loan Window of the IBRD. The objectives of IDA are as follows,

  • To help the underdeveloped countries by giving loans in simple terms.
  • Help at the end of poverty in the poorest nations
  • Give macroeconomics services such as, for example, those relating to health, nutrition, education, human resource advancement and control of the population.
  • To offer loans at marked down interests in order to energize economic development, the increment in manufacturing limit and good expectations for standard of living in the underdeveloped nations.

International Finance Corporation (IFC)

Established in July 1956, IFC was aimed to assist in terms of finance to the private sector of developing nations. IFC is also an associate of the World Bank, but it has its own separate legal entity, functions and funds. All the members of the World Bank are entitled to become members of IFC.

Multinational Investment Guarantee Agency (MIGA)

Established in April 1988, The Multinational Investment Guarantee Agency’s aim was to support the task of the World Bank and IFC. Some objectives of the MIGA are:-

  • Advance the stream of direct foreign investment into less developed member countries.
  • Give protection cover to fund supplier against political risks.
  • Guarantee extension of current investment, privatization and economic reconstruction.
  • Provide assurance against noncommercial perils, for example, dangers engaged in currency transfer, war and domestic clashes, and infringement of agreement.
Lucknow University BBA Notes

Recent World Trade Scenario of Trading

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The global economy has been on a subdued growth path since the advent of ‘Financial Crisis’ of 2008, and has now started to show signs of global recovery. In October 2017, the IMF projected world GDP growth to pick up from 3.2% in 2016 to 3.6% in 2017, and further to 3.7% in 2018. Economic activity has also picked up in developed market economies such as the US, UK, and Europe. There is a rise in global demand, which is expected to remain buoyant. The developing and emerging market economies have seen mixed economic performance. The pickup in momentum of global demand has been led by investment demand. More specifically, production of both consumer durables and capital goods have rebounded since the second half of 2016. Some factors that have contributed to these developments include global recovery in investments, led by infrastructure and real estate investment in China; firming global commodity prices; and end of an inventory cycle in US.

On the back of this global recovery, the world is witnessing a pickup in global trade. The Asian Development Bank, in its recent update1, noted that most of the emerging economies (excluding China) are witnessing a rebound in manufacturing exports, “particularly in electronics, where foreign direct investment has been strengthening”. The economies of south-east Asia are also gaining from increased activity along cross-border manufacturing supply chains. The World Trade Organization (WTO), has recently in its September 2017 press release upgraded the growth forecast for global trade in the year 2017, from 2.4% to 3.6%. Particularly, in the first half of 2017, world trade rose by a robust 4.2% (year on year), driven by exports of developing economies which grew by 5.9 percent as compared to a growth of 3.1 percent witnessed in exports of developed economies. Imports by developed and developing economies also increased by 2.1% and 6.9%, respectively. Moreover, the ratio of trade growth to world GDP growth is also set to recover and reach around 1.3, which will be at a highest level in last 5 years.

This pickup in global growth which has boosted demand for imports, spurred intra-Asia-trade as demand was transmitted through global value chains. In this current scenario, even though India is witnessing a mild rebound in its exports, there are concerns that merchandise exports in Asia’s second largest economy are lagging behind other major Asian economies. Today global attention is riveted on emerging and developing economies and especially Asia, driven by the continent’s growing appetite for industrial investment, burgeoning infrastructural requirements and its quest for expanding trade.

Indian economy and its trade scenario

India’s growth story, especially since the start of the 21st century has been remarkable. The Indian economy has come a long way since its economic liberalisation, and is amongst the fastest growing major economies of the world today. While India witnessed a relatively moderate growth during the period 2011-12 to 2013-14, on account of the global economic slowdown, the economy recorded a robust growth averaging 7.5 percent during the period 2014-15 to 2016-17, much above the growth rate of other emerging and developing economies. In the last one year, it has seen major economic policy developments with the introduction of Goods and Services Tax (GST) and demonetization of higher currency notes.

Even though the GDP growth in the first quarter of current fiscal has fallen down to a low of 5.7%, its lowest since March 2014, it is widely believed that the economy has bottomed out and it can only rise from here. According to the IMF, India is expected to grow at 7.2% in this fiscal year, aided by higher government spending and a pickup in the service sector performance.

Fueling India’s growth through international trade

In recent years, India’s robust growth has been driven by the dynamic private sector. An encouraging phenomenon that has been witnessed has been the emergence of a large number of investment driven small and medium enterprises with immense potential for growth. A large number of such enterprises have also endeavoured to expand their business operations overseas. The Indian economy is more globalized than we could imagine. As a result, India’s foreign trade has seen a multi-fold increase, since liberalization of the economy.

Accordingly, there have been significant structural shifts not only in the product basket, but also in the geographical composition of India’s foreign trade. The opening up of Indian economy led to a massive increase in the foreign trade, which aided in sustained GDP growth over last two decades. During the last 25 years Indian exports have increased by 17 times and imports by 19 times. India’s share in global merchandise exports has risen from 0.6 percent in early 1990s to 1.7 percent in 2016, and similarly the share of imports has risen from 0.6 percent to 2.4 percent during the same period. India’s trade to GDP ratio, a measure of an economy’s openness and integration into the global economy, has witnessed a phenomenal increase over the last few decades. Foreign trade which constituted around 13-15 percent of India’s GDP in the early nineties, peaked at 55 percent in 2012- 13 and today accounts for around 40 percent in 2016-17. India also, ranked as the 20th largest exporter and 14th largest importer in the world in 2016.

Concomitantly, India’s engagement with Global Value Chains (GVCs), which have become dominant feature of world trade, has increased significantly since 1990s. In manufacturing sector, especially for electrical and optical equipment, India is more integrated with the south east Asian region, while for services the integration in GVCs is with western countries like the US and UK. According to an OECD estimate, developing economies with fastest growing GVC participation have experienced a GDP per capita growth rate percent above average.

India has set an ambitious target of achieving exports worth US $ 900 billion by 2020, while accounting for a share of 3.5 percent of global exports4. In the current global macroeconomic scenario, while it seems like a challenging task, concerted efforts would need to be made for India to be able to achieve its trade target and realign its foreign trade policy with the new global trading system.

While the global economic scenario is crucial, the domestic factors are no less important, when it comes to trade. India’s overall trade policy faces certain challenges viz. inadequate export diversification in terms of products and geographical distribution; insignificant involvement of a majority of states in exports; rationalisation of the tariff regime and export promotion schemes; and factor market reforms which are critically linked with export performance. These challenges not only affect the productivity and competitiveness of domestic firms but also restrict them from participating in global production networks.

(i) Integrating into and moving up the value chain

Most manufactured products, often high technology manufactured products, that are part of GVCs are infrastructure critical products whose parts are manufactured in several countries. A robust transport and connectivity network supported by fast entry/exit through port/customs is a precondition to making such products as delay may disrupt the entire value chain. There is a need for India to focus on expanding production capacity along with value addition, and moving up the value chain,while creating an enabling environment to account for a sizeable share in major leading global exports. This gain seven more significance given that India’s labour force is projected to swell by about 110 mn by 2020. The biggest challenge is to employ the surplus labour coming out of agriculture into industry and services.

(ii) Upscaling Manufacturing

The Make in India initiative is an important initiative of the Government of India, which envisages to promote India as a manufacturing hub and investment destination. There is need for highlighting the potential and stimulating the manufacturing sector through supporting mechanisms and conducive policy measures, including support for R&D, technology orientation and investment incentives. A Higher expenditure on R&D generally correlates with increase in high-technology exports, and increased local value addition. R&D expenditure as a percentage share of GDP in India has remained extremely low at less than1 percent, much lower even in comparison to other developing economies. Also, while we lay emphasis on the manufacturing sector and thereby on manufactured exports, it is also important to ensure an enabling environment and improving our competitiveness by investing in infrastructure such as better connectivity through roads and ports, coal availability, labour reforms and flexibility in factor markets.

(iii) Aligning India’s Export Capability in-Line with Global Import Demand

With regard to India’s exports, while merchandise exports have more than doubled over the period 2006-07 to 2016-17 from US$ 126 billion to more than US$276 billion, there remains huge potential for exports of select products to select countries in line with India’s export capability and import demand. There is need for identifying and aligning India’s export capability vis-à-vis global import demand. Such in-depth analysis has been the focus of research studies in Exim Bank. Comparative analyses of global trends in trade, undertaken in such studies have yielded interesting results.

To Conclude

All in all, a pick-up in global growth is expected to contribute to the revival of international trade, but the downside risks such as the possible adoption of protectionist trade policies by especially developed market economies, around the world weigh on the recovery of trade. As a result, there is an increasing need for India and other emerging market economies, relying on export led economic growth, to take a proactive stand for globalization and international trade.

There is a need to shift our focus from exporting what we can (or supply based), to items that are globally demanded. A demand-based export basket diversification approach could give a big push to exports. While India has made remarkable progress in the recent past, it facesan even more challenging global environment today. Itis certainly a daunting, yet possible, task to ensure that India repositions itself as an important driver of global economic growth.

Management Notes

Various Phases of Trade Cycle

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Trade Cycle, also known as the business cycle, refers to the recurring fluctuations in economic activity characterized by periods of expansion, peak, contraction, and trough. These cycles reflect the natural rhythm of economic growth and contraction within a market economy. During expansion phases, economic output, employment, and consumer spending increase, leading to prosperity. Peaks mark the highest point of economic activity. Contractions, or recessions, follow, characterized by decreased production, rising unemployment, and reduced consumer spending. Finally, troughs represent the lowest point of the cycle, before the economy begins to recover. Understanding trade cycles is crucial for policymakers, businesses, and investors to anticipate and manage the impacts of economic fluctuations on various sectors and stakeholders.

Four Phases of a Trade cycle are:

  1. Prosperity phase: Expansion or the upswing.
  2. Recessionary phase: A turn from prosperity to depression (or upper turning point).
  3. Depressionary phase: Contraction or downswing.
  4. Revival or recovery phase: The turn from depression to prosperity (or lower turning point).

The above four phases of a trade cycle are shown in Fig. 1. These phases are recurrent and follow a regular sequence.

Phases of a Trade Cycle

1. Expansion Phase:

The expansion phase marks the beginning of the trade cycle. It is characterized by increasing economic activity across various sectors of the economy. During this phase, several key indicators typically show positive trends:

  • Gross Domestic Product (GDP) Growth:

GDP, which measures the total value of goods and services produced within a country’s borders, tends to rise during the expansion phase. Increased production, consumer spending, and investment contribute to this growth.

  • Employment:

As economic activity expands, businesses experience rising demand for goods and services. This often leads to increased hiring to meet the growing demand, resulting in lower unemployment rates.

  • Consumer Spending:

Consumers tend to have more disposable income during periods of economic expansion, leading to increased spending on goods and services. This increased consumer demand further fuels economic growth.

  • Business Investment:

Businesses are more likely to invest in capital goods, such as machinery and equipment, during the expansion phase. Higher confidence in future economic prospects encourages firms to expand their productive capacity to meet growing demand.

  • Stock Market Performance:

Stock prices typically rise during the expansion phase as investors anticipate higher corporate profits and economic growth. Bull markets, characterized by rising stock prices, are common during this phase.

2. Peak Phase:

The peak phase represents the highest point of economic activity within the trade cycle. It is characterized by several key features:

  • Full Capacity Utilization:

During the peak phase, resources such as labor and capital are fully utilized as demand for goods and services reaches its highest levels. Production may be operating at or near maximum capacity.

  • Inflationary Pressures:

As demand outstrips supply during the peak phase, prices tend to rise, leading to inflationary pressures. This can be reflected in higher consumer prices, wage growth, and increased production costs.

  • Tight Labor Market:

With low unemployment rates and high demand for labor, competition for workers intensifies during the peak phase. This can lead to wage increases and labor shortages in certain industries.

  • Business Confidence:

Businesses may become increasingly optimistic about future economic prospects during the peak phase, leading to higher levels of investment and expansion plans.

  • Stock Market Volatility:

While stock prices may continue to rise during the peak phase, volatility often increases as investors become more cautious about the sustainability of economic growth.

3. Contraction Phase:

Following the peak phase, the economy enters the contraction phase, also known as a recession or downturn. This phase is characterized by declining economic activity and several negative trends:

  • GDP Contraction:

Economic output, as measured by GDP, begins to decline during the contraction phase as demand for goods and services weakens. This can be driven by factors such as reduced consumer spending, declining investment, and falling exports.

  • Rising Unemployment:

As businesses cut back on production and investment in response to weakening demand, unemployment rates tend to rise. Layoffs and hiring freezes become more common as companies adjust to the downturn.

  • Decreased Consumer Spending:

Consumer confidence often declines during the contraction phase, leading to reduced spending on discretionary goods and services. Consumers may prioritize essential purchases and cut back on non-essential items.

  • Declining Business Investment:

Businesses become more cautious about investing in new capital projects and expansion plans during the contraction phase. Uncertainty about future economic conditions and weak demand can lead to a decrease in business investment.

  • Stock Market Decline:

Stock prices typically fall during the contraction phase as investors react to negative economic news and uncertainty about future earnings prospects. Bear markets, characterized by falling stock prices, are common during recessions.

4. Trough Phase:

The trough phase represents the lowest point of the trade cycle and marks the end of the contraction phase. While economic conditions remain challenging, there are signs of stabilization and the beginning of recovery:

  • Stabilization of Economic Indicators:

Economic indicators such as GDP, employment, and consumer spending may stabilize or show signs of improvement during the trough phase. The rate of decline in economic activity begins to slow down.

  • Policy Responses:

Governments and central banks often implement monetary and fiscal policies to stimulate economic growth during the trough phase. These may include interest rate cuts, fiscal stimulus measures, and efforts to restore confidence in the financial system.

  • Inventory Rebuilding:

Businesses may start to rebuild inventories during the trough phase in anticipation of future demand. This can contribute to a gradual increase in production and economic activity.

  • Bottoming Out of Stock Market:

While stock prices may still be volatile during the trough phase, there may be signs that the market is bottoming out as investors anticipate a recovery in corporate earnings and economic growth.

  • Early Signs of Recovery:

Some sectors of the economy may begin to show signs of improvement during the trough phase, signaling the start of the recovery process. These early indicators can include increased consumer confidence, rising business investment, and stabilization in housing markets.

Management Notes

Trade Cycle: Introduction and Theories of Trade Cycle

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Trade Cycle refers to fluctuations in economic activities specially in employment, output and income, prices, profits etc. It has been defined differently by different economists. According to Mitchell, “Business cycles are of fluctuations in the economic activities of organized communities. The adjective ‘business’ restricts the concept of fluctuations in activities which are systematically conducted on commercial basis.

Features of a Trade Cycle

  • A business cycle is synchronic. When cyclical fluctuations start in one sector it spreads to other sectors.
  • In a trade cycle, a period of prosperity is followed by a period of depression. Hence trade cycle is a wave like movement.
  • Business cycle is recurrent and rhythmic; prosperity is followed by depression and vice versa.
  • Trade cycle is cumulative and self-reinforcing. Each phase feeds on itself and creates further movement in the same direction.
  • Trade cycle is asymmetrical. The prosperity phase is slow and gradual and the phase of depression is rapid.
  • The business cycle is not periodical. Some trade cycles last for three or four years, while others last for six or eight or even more years.
  • The impact of a trade cycle is differential. It affects different industries in different ways.
  • Trade cycle is international in character. Through international trade, booms and depressions in one country are passed to other countries.

Theories of Trade Cycle

Many theories have been put forward from time to time to explain the phenomenon of trade cycles. These theories can be classified into non-monetary and monetary theories.

Non-Monetary Theories of Trade Cycle

(a) Sunspot Theory or Climatic Theory

It is the oldest theory of trade cycle. It is associated with W.S.Jevons and later on developed by H.C.Moore. According to this theory, the spot that appears on the sun influences the climatic conditions. When the spot appears, it will affect rainfall and hence agricultural crops.

When there is crop failure, that will result in depression. On the other hand, if the spot did not appear on the sun, rainfall is good leading to prosperity. Thus, the variations in climate are so regular that depression is followed by prosperity.

However, this theory is not accepted today. Trade cycle is a complex phenomenon and it cannot be associated with climatic conditions. If this theory is correct, then industrialised countries should be free from cyclical fluctuations. But it is the advanced, industrialised countries which are affected by trade cycles.

(b) Psychological Theory

This theory was developed by A.C. Pigou. He emphasized the role of psychological factor in the generation of trade cycles. According to Pigou, the main cause for trade cycle is optimism and pessimism among business people and bankers. During the period of good trade, entrepreneurs become optimistic which would lead to increase in production.

The feeling of optimism is spread to other. Hence investments are increased beyond limits and there is over production, which results in losses. Entrepreneurs become pessimistic and reduce their investment and production. Thus, fluctuations are due to optimism leading to prosperity and pessimism resulting depression.

Though there is an element of truth in this theory, this theory is unable to explain the occurrence of boom and starting of revival. Further this theory fails to explain the periodicity of trade cycle.

(c) Overinvestment Theory

Arthur Spiethoff and D.H. Robertson have developed the over investment theory. It is based on Say’s law of markets. It believes that over production in one sector leads to over production in other sectors. Suppose, there is over production and excess supply in one sector, that will result in fall in price and income of the people employed in that sector. Fall in income will lead to a decline in demand for goods and services produced by other sectors. This will create over production in other sectors.

Spiethoff has pointed out that over investment is the cause for trade cycle. Over investment is due to indivisibility of investment and excess supply of bank credit. He gives the example of a railway company which lays down one more track to avoid traffic congestion. But this may result in excess capacity because the additional traffic may not be sufficient to utilise the second track fully.

Over investment and overproduction are encouraged by monetary factors. If the banking system places more money in the hands of entrepreneurs, prices will increase. The rise in prices may induce the entrepreneurs to increase their investments leading to over-investment. Thus Prof. Robertson has successfully combined real and monetary factors to explain business cycle.

This theory is realistic in the sense that it considers over investment as the cause of trade cycle. But it has failed to explain revival.

(d) Over-Saving or Under Consumption Theory

This theory is the oldest explanation of the cyclical fluctuations. This theory has been formulated by Malthus, Marx and Hobson. According to this theory, depression is due to over-saving. In the modern society, there is great inequalities of income. Rich people have large income but their marginal propensity to consume is less.

Hence they save and invest which results in an increase in the volume of goods. This causes a general glut in the market. At the same time, as majority of the people are poor, they have low propensity to consume. Therefore, consumption will not increase. Increase in the supply of goods and decline in the demand create under consumption and hence over production.

This theory is not free from criticism. This theory explains only the turning point from prosperity to depression. It does not say anything about recovery. This theory assumes that the amount saved would be automatically invested. But this is not true. It pays too much attention on saving and too little on others.

(e) Keynes’ Theory of Trade Cycles

Keynes doesn’t develop a complete and pure theory of trade cycles. According to Keynes, effective demand is composed of consumption and investment expenditure. It is effective demand which determines the level of income and employment.

Therefore, changes in total expenditure i.e., consumption and investment expenditures, affect effective demand and this will bring about fluctuation in economic activity. Keynes believes that consumption expenditure is stable and it is the fluctuation in investment expenditure which is responsible for changes in output, income and employment.

Investment depends on rate of interest and marginal efficiency of capital. Since rate of interest is more or less stable, marginal efficiency of capital determines investment. Marginal efficiency of capital depends on two factors – prospective yield and supply price of the capital asset. An increase in MEC will create more employment, output and income leading to prosperity. On the other hand, a decline in MEC leads to unemployment and fall in income and output. It results in depression.

During the period of expansion businessmen are optimistic. MEC is rapidly increasing and rate of interest is sticky. So entrepreneurs undertake new investment. The process of expansion goes on till the boom is reached. As the process of expansion continues, cost of production increases, due to scarcity of factors of production. This will lead to a fall in MEC. Further, price of the product falls due to abundant supply leading to a decline in profits.

This leads to depression. As time passes, existing machinery becomes worn out and has to be replaced. Surplus stocks of goods are exhausted. As there is a fall in price of raw-materials and equipment, costs fall. Wages also go down. MEC increases leading to recovery. Keynes states that, “Trade cycle can be described and analyzed in terms of the fluctuations of the marginal efficiency of capital relatively to the rate of interest”.

The merit of Keynes’ theory lies in explaining the turning points-the lower and upper turning points of a trade cycle. The earlier economists considered the changes in the amount of credit given by banking system to be responsible for cyclical fluctuations. But for Keynes, the change in consumption function with its effect on MEC is responsible for trade cycle. Keynes, thus, has given a satisfactory explanation of the turning points of the trade cycle, “Keynes consumption function filled a serious gap and corrected a serious error in the previous theory of the business cycle”.

Critics have pointed out the weakness of Keynes’ theory. Firstly, according to Keynes the main cause for trade cycle is the fluctuations in MEC. But the term marginal efficiency of capital is vague. MEC depends on the expectations of the entrepreneur about future. In this sense, it is similar to that of Pigou’s psychological theory. He has ignored real factors.

Secondly, Keynes assumes that rate of interest is stable. But rate of interest does play an important role in decision making process of entrepreneurs.

Thirdly, Keynes does not explain periodicity of trade cycle. In a period of recession and depression, according to Keynes, rate of interest should be high due to strong liquidity preference. But, during this period, rate of interest is very low. Similarly during boom, rate of interest should be low because of weak liquidity preference; but actually the rate of interest is high.

(f) Schumpeter’s Innovation Theory

Joseph A. Schumpeter has developed innovation theory of trade cycles. An innovation includes the discovery of a new product, opening of a new market, reorganization of an industry and development of a new method of production. These innovations may reduce the cost of production and may shift the demand curve. Thus innovations may bring about changes in economic conditions.

Suppose, at the full employment level, an innovation in the form of a new product has been introduced. Innovation is financed by bank loans. As there is full employment already, factors of production have to be withdrawn from others to manufacture the new product. Hence, due to competition for factors of production costs may go up, leading to an increase in price.

When the new product becomes successful, other entrepreneurs will also produce similar products. This will result in cumulative expansion and prosperity. When the innovation is adopted by many, supernormal profits will be competed away. Firms incurring losses will go out of business. Employment, output and income fall resulting in depression.

Schumpeter’s theory has been criticised on the following grounds.

Firstly, Schumpter’s theory is based on two assumptions viz., full employment and that innovation is being financed by banks. But full employment is an unrealistic assumption, as no country in the world has achieved full employment. Further innovation is usually financed by the promoters and not by banks. Secondly, innovation is not the only cause of business cycle. There are many other causes which have not been analysed by Schumpter.

Monetary Theories of Trade Cycles

(a) Over-Investment Theory

Prof. Von Hayek in his books on “Monetary Theory and Trade Cycle” and “Prices and Production” has developed a theory of trade cycle. He has distinguished between equilibrium or natural rate of interest and market rate of interest. Market rate of interest is one at which demand for and supply of money are equal.

Equilibrium rate of interest is one at which savings are equal to investment. If both equilibrium rate of interest and market rate of interest are equal, there will be stability in the economy. If equilibrium rate of interest is higher than market rate of interest there will be prosperity and vice versa.

For instance, if the market rate of interest is lower than equilibrium rate of interest due to increase in money supply, investment will go up. The demand for capital goods will increase leading to a rise in price of these goods. As a result, there will be a diversion of resources from consumption goods industries to capital goods industries. Employment and income of the factors of production in capital goods industries will increase.

This will increase the demand for consumption goods. There will be competition for factors of production between capital goods and consumption good industries. Factor prices go up. Cost of production increases. At this time, banks will decide to reduce credit expansion. This will lead to rise in market rate of interest above the equilibrium rate of interest. Investment will fall; production declines leading to depression.

Hayek’s theory has certain weaknesses:-

  • It is not easy to transfer resources from capital goods industries to consumer goods industries and vice versa.
  • This theory does not explain all the phases of trade cycle.
  • It gives too much importance to rate of interest in determining investment. It has neglected other factors determining investment.
  • Hayek has suggested that the volume of money supply should be kept neutral to solve the problem of cyclical fluctuations. But this concept of neutrality of money is based on old quantity theory of money which has lost its validity.

(b) Hawtrey’s Monetary Theory

Prof. Hawtrey considers trade cycle to be a purely monetary phenomenon. According to him non-monetary factors like wars, strike, floods, drought may cause only temporary depression. Hawtrey believes that expansion and contraction of money are the basic causes of trade cycle. Money supply changes due to changes in rates of interest.

When rate of interest is reduced by banks, entrepreneurs will borrow more and invest. This causes an increase in money supply and rise in price leading to expansion. On the other hand, an increase in the rate of interest will lead to reduction in borrowing, investment, prices and business activity and hence depression.

Hawtrey believes that trade cycle is nothing but small scale replica of inflation and deflation. An increase in money supply will lead to boom and vice versa, a decrease in money supply will result in depression.

Banks will give more loans to traders and merchants by lowering the rate of interest. Merchants place more orders which induce the entrepreneurs to increase production by employing more labourers. This results in increase in employment and income leading to an increase in demand for goods. Thus the phase of expansion starts.

Business expands; factors of production are fully employed; price increases further, resulting in boom conditions. At this time, the banks call off loans from the borrowers. In order to repay the loans, the borrowers sell their stocks. This sudden disposal of goods leads to fall in prices and liquidation of marginal firms. Banks will further contract credit.

Thus the period of contraction starts making the producers reduce their output. The process of contraction becomes cumulative leading to depression. When the economy is at the level of depression, banks have excess reserves. Therefore, banks will lend at a low rate of interest which makes the entrepreneurs to borrow more. Thus revival starts, becomes cumulative and leads to boom.

Hawtrey’s theory has been criticised on many grounds

  • Hawtrey’s theory is considered to be an incomplete theory as it does not take into account the non-monetary factors which cause trade cycles.
  • It is wrong to say that banks alone cause business cycle. Credit expansion and contraction do not lead to boom and depression. But they are accentuated by bank credit.
  • The theory exaggerates the importance of bank credit as a means of financing development. In recent years, all firms resort to plough back of profits for expansion.
  • Mere contraction of bank credit will not lead to depression if marginal efficiency of capital is high. Businessmen will undertake investment in-spite of high rate of interest if they feel that the future prospects are bright.
  • Rate of interest does not determine the level of borrowing and investment. A high rate of interest will not prevent the people to borrow. Therefore, it may be stated that banking system cannot originate a trade cycle. Expansion and contraction of credit may be a supplementary cause but not the main and sole cause of trade cycle.
Management Notes

Production: Meaning, Factors of Production, Production Function, Features, Types

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Production is the process of creating goods and services by utilizing various resources. It involves combining inputs such as labor, capital, raw materials, and entrepreneurship to produce output that satisfies human wants and needs. The goal of production is to maximize efficiency, minimize costs, and generate value, contributing to economic growth and development. It is a key concept in economics as it drives the creation of wealth and the distribution of goods in a society.

Factors of Production:

  • Land:

Refers to all natural resources used in the production process, including raw materials like water, minerals, forests, and agricultural land. It is the base for extracting resources that are essential for creating goods and services.

  • Labour:

The human effort, both physical and mental, applied in the production process. Labor includes workers at all skill levels, from manual laborers to highly skilled professionals, and their efforts are rewarded in the form of wages or salaries.

  • Capital:

The tools, machinery, buildings, and technology used in the production of goods and services. Capital enhances the efficiency of labor and helps increase productivity, which in turn contributes to economic growth.

  • Entrepreneurship:

The ability to organize the other factors of production and take on the risks associated with starting and running a business. Entrepreneurs innovate, create new products, and take the initiative to bring together resources for production.

  • Knowledge:

Refers to technical know-how, expertise, and skills that influence the efficiency of production. This includes education, training, and research that enhance the ability to optimize the use of other factors of production.

  • Technology:

The tools, systems, and methods used to improve production efficiency and the quality of output. Technological advancements often lead to cost reductions, higher productivity, and the creation of new products or services.

Production Function

Production Function is an economic concept that describes the relationship between the inputs used in production and the resulting output. It shows how different combinations of labor, capital, and other factors of production contribute to the production of goods or services. The production function helps in understanding the efficiency of resource utilization, and how changes in the quantity of inputs affect the level of output. It is often expressed as an equation or graph, representing the technological relationship in production.

Mathematically, such a basic relationship between inputs and outputs may be expressed as:

Q = f( L, C, N )

Where

Q = Quantity of output

L = Labour

C = Capital

N = Land.

Hence, the level of output (Q), depends on the quantities of different inputs (L, C, N) available to the firm. In the simplest case, where there are only two inputs, labour (L) and capital (C) and one output (Q), the production function becomes.

Q = f(L, C)

“The production function is a technical or engineering relation between input and output. As long as the natural laws of technology remain unchanged, the production function remains unchanged.” Prof. L.R. Klein

“Production function is the relationship between inputs of productive services per unit of time and outputs of product per unit of time.” Prof. George J. Stigler

“The relationship between inputs and outputs is summarized in what is called the production function. This is a technological relation showing for a given state of technological knowledge how much can be produced with given amounts of inputs.” Prof. Richard J. Lipsey

Thus, from the above definitions, we can conclude that production function shows for a given state of technological knowledge, the relation between physical quantities of inputs and outputs achieved per period of time.

Features of Production Function

Following are the main features of production function:

  1. Substitutability

The factors of production or inputs are substitutes of one another which make it possible to vary the total output by changing the quantity of one or a few inputs, while the quantities of all other inputs are held constant. It is the substitutability of the factors of production that gives rise to the laws of variable proportions.

  1. Complementarity

The factors of production are also complementary to one another, that is, the two or more inputs are to be used together as nothing will be produced if the quantity of either of the inputs used in the production process is zero.

The principles of returns to scale is another manifestation of complementarity of inputs as it reveals that the quantity of all inputs are to be increased simultaneously in order to attain a higher scale of total output.

  1. Specificity

It reveals that the inputs are specific to the production of a particular product. Machines and equipment’s, specialized workers and raw materials are a few examples of the specificity of factors of production. The specificity may not be complete as factors may be used for production of other commodities too. This reveals that in the production process none of the factors can be ignored and in some cases ignorance to even slightest extent is not possible if the factors are perfectly specific.

Production involves time; hence, the way the inputs are combined is determined to a large extent by the time period under consideration. The greater the time period, the greater the freedom the producer has to vary the quantities of various inputs used in the production process.

In the production function, variation in total output by varying the quantities of all inputs is possible only in the long run whereas the variation in total output by varying the quantity of single input may be possible even in the short run.

Time Period and Production Functions

The production function is differently defined in the short run and in the long run. This distinction is extremely relevant in microeconomics. The distinction is based on the nature of factor inputs.

Those inputs that vary directly with the output are called variable factors. These are the factors that can be changed. Variable factors exist in both, the short run and the long run. Examples of variable factors include daily-wage labour, raw materials, etc.

On the other hand, those factors that cannot be varied or changed as the output changes are called fixed factors. These factors are normally characteristic of the short run or short period of time only. Fixed factors do not exist in the long run.

Consequently, we can define two production functions: short-run and long-run. The short-run production function defines the relationship between one variable factor (keeping all other factors fixed) and the output. The law of returns to a factor explains such a production function.

For example, consider that a firm has 20 units of labour and 6 acres of land and it initially uses one unit of labour only (variable factor) on its land (fixed factor). So, the land-labour ratio is 6:1. Now, if the firm chooses to employ 2 units of labour, then the land-labour ratio becomes 3:1 (6:2).

The long-run production function is different in concept from the short run production function. Here, all factors are varied in the same proportion. The law that is used to explain this is called the law of returns to scale. It measures by how much proportion the output changes when inputs are changed proportionately.

Types of Production Function:

1. Short-Run Production Function

In the short run, at least one input is fixed (usually capital), while other inputs (like labor) are variable. The short-run production function examines how changes in variable inputs affect output, keeping the fixed input constant.

Key Features:

  • Focuses on the law of variable proportions (diminishing marginal returns).
  • Output increases initially at an increasing rate, then at a decreasing rate, and eventually may decline.

Example:

A factory with fixed machinery (capital) adds more workers (labor). Initially, productivity increases, but as workers crowd the factory, additional output diminishes.

2. Long-Run Production Function

In the long run, all inputs are variable, allowing firms to adjust labor, capital, and other resources fully. The long-run production function focuses on the optimal combination of inputs to achieve maximum efficiency and output.

Key Features:

  • Examines returns to scale:
    • Increasing Returns to Scale: Doubling inputs results in more than double the output.
    • Constant Returns to Scale: Doubling inputs results in a proportional doubling of output.
    • Decreasing Returns to Scale: Doubling inputs results in less than double the output.
  • Useful for long-term planning and investment decisions.

3. Cobb-Douglas Production Function

A mathematical representation of the relationship between two or more inputs (e.g., labor and capital) and output. It is commonly expressed as:

Q = A*L^α*K^β*

Where:

  • Q: Total output
  • L: Labor input
  • K: Capital input
  • α,β: Elasticities of output with respect to labor and capital
  • A: Total factor productivity

Key Features:

  • Demonstrates the contribution of labor and capital to output.
  • Widely used in economics for empirical studies and forecasting.

4. Fixed Proportions Production Function (Leontief Production Function)

In this type, inputs are used in fixed proportions to produce output. Increasing one input without proportionately increasing the other does not lead to higher output.

Example:

A car requires one engine and four tires. Adding more engines without increasing the number of tires will not produce more cars.

5. Variable Proportions Production Function

Inputs can be substituted for one another in varying proportions while producing the same level of output.

Example:

A firm can use either more machines and less labor or more labor and fewer machines to produce the same output.

6. Isoquant Production Function

An isoquant represents all possible combinations of two inputs (e.g., labor and capital) that produce the same level of output. The isoquant approach analyzes how inputs can be substituted while maintaining output levels.

Key Features:

  • Focuses on input substitution.
  • Helps determine the least-cost combination of inputs for a given output.
Management Notes

Elasticity of Demand: Meaning, Types and Significance

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Elasticity of Demand refers to the responsiveness of the quantity demanded of a good or service to changes in its price. It measures how much the demand for a product changes when there is a change in its price. If demand changes significantly with a small price change, the demand is considered elastic. If the demand changes little or not at all, it is inelastic. The elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. This concept helps businesses and economists understand consumer behavior and pricing strategies.

Types of Elasticity:

Distinction may be made between Price Elasticity, Income Elasticity and Cross Elasticity. Price Elasticity is the responsiveness of demand to change in price; income elasticity means a change in demand in response to a change in the consumer’s income; and cross elasticity means a change in the demand for a commodity owing to change in the price of another commodity.

(a) Infinite or Perfect Elasticity of Demand

Let as first take one extreme case of elasticity of demand, viz., when it is infinite or perfect. Elasticity of demand is infinity when even a negligible fall in the price of the commodity leads to an infinite extension in the demand for it. In Fig. 1 the horizontal straight line DD’ shows infinite elasticity of demand. Even when the price remains the same, the demand goes on changing.

(b) Perfectly Inelastic Demand

The other extreme limit is when demand is perfectly inelastic. It means that howsoever great the rise or fall in the price of the commodity in question, its demand remains absolutely unchanged. In Fig. 2, the vertical line DD’ shows a perfectly inelastic demand. In other words, in this case elasticity of demand is zero. No amount of change in price induces a change in demand.

In the real world, there is no commodity the demand for which may be absolutely inelastic, i.e., changes in its price will fail to bring about any change at all in the demand for it. Some extension/contraction is bound to occur that is why economists say that elasticity of demand is a matter of degree only. In the same manner, there are few commodities in whose case the demand is perfectly elastic. Thus, in real life, the elasticity of demand of most goods and services lies between the two limits given above, viz., infinity and zero. Some have highly elastic demand while others have less elastic demand.

(c) Very Elastic Demand

Demand is said to be very elastic when even a small change in the price of a commodity leads to a considerable extension/con­traction of the amount demanded of it. In Fig. 3, DD’ curve illustrates such a demand. As a result of change of T in the price, the quantity demanded extends/contracts by MM’, which clearly is comparatively a large change in demand.

(d) Less Elastic Demand

When even a substantial change in price brings only a small extension/contraction in demand, it is said to be less elastic. In Fig. 4, DD’ shows less elastic demand. A fall of NN’ in price extends demand by MM’ only, which is very small.

Significance of Elasticity of Demand

  1. Determination of Output Level

For making production profitable, it is essential that the quantity of goods and services should be produced corresponding to the demand for that product. Since the changes in demand are due to the change in price, the knowledge of elasticity of demand is necessary for determining the output level.

  1. Determination of Price

The elasticity of demand for a product is the basis of its price determination. The ratio in which the demand for a product will fall with the rise in its price and vice versa can be known with the knowledge of elasticity of demand.

If the demand for a product is inelastic, the producer can charge high price for it, whereas for an elastic demand product he will charge low price. Thus, the knowledge of elasticity of demand is essential for management in order to earn maximum profit.

  1. Price Discrimination by Monopolist

Under monopoly discrimination the problem of pricing the same commodity in two different markets also depends on the elasticity of demand in each market. In the market with elastic demand for his commodity, the discriminating monopolist fixes a low price and in the market with less elastic demand, he charges a high price.

  1. Price Determination of Factors of Production

The concept of elasticity for demand is of great importance for determining prices of various factors of production. Factors of production are paid according to their elasticity of demand. In other words, if the demand of a factor is inelastic, its price will be high and if it is elastic, its price will be low.

  1. Demand Forecasting

The elasticity of demand is the basis of demand forecasting. The knowledge of income elasticity is essential for demand forecasting of producible goods in future. Long- term production planning and management depend more on the income elasticity because management can know the effect of changing income levels on the demand for his product.

  1. Dumping

A firm enters foreign markets for dumping his product on the basis of elasticity of demand to face foreign competition.

  1. Determination of Prices of Joint Products

The concept of the elasticity of demand is of much use in the pricing of joint products, like wool and mutton, wheat and straw, cotton and cotton seeds, etc. In such cases, separate cost of production of each product is not known.

Therefore, the price of each is fixed on the basis of its elasticity of demand. That is why products like wool, wheat and cotton having an inelastic demand are priced very high as compared to their byproducts like mutton, straw and cotton seeds which have an elastic demand.

  1. Determination of Government Policies

The knowledge of elasticity of demand is also helpful for the government in determining its policies. Before imposing statutory price control on a product, the government must consider the elasticity of demand for that product.

The government decision to declare public utilities those industries whose products have inelastic demand and are in danger of being controlled by monopolist interests depends upon the elasticity of demand for their products.

  1. Helpful in Adopting the Policy of Protection

The government considers the elasticity of demand of the products of those industries which apply for the grant of a subsidy or protection. Subsidy or protection is given to only those industries whose products have an elastic demand. As a consequence, they are unable to face foreign competition unless their prices are lowered through sub­sidy or by raising the prices of imported goods by imposing heavy duties on them.

  1. Determination of Gains from International Trade

The gains from international trade depend, among others, on the elasticity of demand. A country will gain from international trade if it exports goods with less elasticity of demand and import those goods for which its demand is elastic.

In the first case, it will be in a position to charge a high price for its products and in the latter case it will be paying less for the goods obtained from the other country. Thus, it gains both ways and shall be able to increase the volume of its exports and imports.

Management Notes

Distribution Channels, Role, Factors, Types

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Distribution Channels refer to the path or route through which goods and services travel from the producer or manufacturer to the final consumer. These channels include intermediaries such as wholesalers, retailers, agents, or distributors, who play an essential role in making the product available to the target market. The goal of distribution channels is to ensure that products reach the right place, at the right time, and in the right condition. Effective distribution channel management helps companies expand market reach, enhance product availability, and optimize costs, contributing to overall business success.

Role of Distribution Channels:

(i) Distribution channels provide time, place, and ownership utility

They make the product available when, where, and in which quantities the customer wants. But other than these transactional functions, marketing channels are also responsible to carry out the following functions:

(ii) Logistics and Physical Distribution

Marketing channels are responsible for assembly, storage, sorting, and transportation of goods from manufacturers to customers.

(iii) Facilitation

Channels of distribution even provide pre-sale and post-purchase services like financing, maintenance, information dissemination and channel coordination.

(iv) Creating Efficiencies

This is done in two ways: bulk breaking and creating assortments. Wholesalers and retailers purchase large quantities of goods from manufacturers but break the bulk by selling few at a time to many other channels or customers. They also offer different types of products at a single place which is a huge benefit to customers as they don’t have to visit different retailers for different products.

(v) Sharing Risks

Since most of the channels buy the products beforehand, they also share the risk with the manufacturers and do everything possible to sell it.

(vi) Marketing

Distribution channels are also called marketing channels because they are among the core touch points where many marketing strategies are executed. They are in direct contact with the end customers and help the manufacturers in propagating the brand message and product benefits and other benefits to the customers.

Role Determining the Choice of Distribution Channels:

Selection of the perfect marketing channel is tough. It is among those few strategic decisions which either make or break your company.

Even though direct selling eliminates the intermediary expenses and gives more control in the hands of the manufacturer, it adds up to the internal workload and raises the fulfilment costs. Hence these four factors should be considered before deciding whether to opt for the direct or indirect distribution channel.

Types of Distribution Channels:

Distribution channels refer to the pathways through which products move from the producer to the final consumer. The choice of distribution channel impacts the product’s availability, cost, and customer experience. There are several types of distribution channels, each suited to different business models and customer needs.

  • Direct Distribution Channel

In a direct distribution channel, the producer sells the product directly to the consumer without involving intermediaries. This can be done through physical stores, company-owned retail outlets, or online platforms. Direct channels allow businesses to have full control over the pricing, branding, and customer experience. They are commonly used for high-value, customized products, or when a business wants to establish direct relationships with customers, as seen in industries like luxury goods, technology, and exclusive services.

  • Indirect Distribution Channel

Indirect distribution channels involve intermediaries between the producer and the consumer. These intermediaries can be wholesalers, distributors, or retailers who help move the product through the market. Indirect channels are common for mass-market products where reaching a larger audience efficiently is crucial. For example, a manufacturer of consumer electronics may sell its products to wholesalers, who then distribute them to various retailers, making the product available in multiple locations.

  • Dual Distribution Channel

A dual distribution channel, also known as a hybrid channel, combines both direct and indirect methods. A company uses direct sales to reach some customers while also using intermediaries to sell through other channels. This type of distribution is useful for companies that want to diversify their sales efforts or reach different market segments. For example, a company might sell directly to large corporate clients but rely on retailers to reach individual consumers. This approach increases market coverage and flexibility.

  • Intensive Distribution

Intensive distribution aims to make the product available in as many locations as possible. This type of channel is used for products with high demand, low unit cost, and frequent purchases, such as consumer packaged goods, snacks, or toiletries. The goal is to saturate the market and make the product widely accessible. The product is sold through multiple retailers, wholesalers, and other outlets to ensure it is readily available for customers.

  • Selective Distribution

Selective distribution involves using a limited number of outlets or intermediaries to distribute products. The company selectively chooses the intermediaries based on their ability to provide quality service, reach specific customer segments, or meet certain brand standards. This approach is often used for moderately priced products such as electronics or appliances. It allows the producer to maintain some control over the product’s distribution while still reaching a broad audience.

  • Exclusive Distribution

Exclusive distribution channels are characterized by a highly selective approach where the producer only sells the product through a few specific intermediaries. This type of channel is often used for luxury or high-end products, where exclusivity and prestige are critical. By limiting the number of distributors or retailers, the brand can control its image and ensure that the product is positioned correctly in the market. For example, a high-end automobile manufacturer may only sell its cars through a select network of authorized dealerships.

Choosing the Right Distribution Channel:

Choosing the right distribution channel is a crucial decision that can significantly impact a company’s success in reaching its target market. The process involves evaluating various options based on the product type, target customer preferences, cost considerations, and competitive environment.

  • Product Type

The nature of the product plays a vital role in determining the best distribution channel. For example, perishable goods like fresh food products may require direct distribution to maintain freshness, while durable goods can be sold through wholesalers or retailers. Similarly, high-end, luxury products may be best suited for exclusive distribution channels, while mass-market items benefit from extensive channel networks.

  • Market Coverage

The level of market coverage needed for the product influences the choice of distribution channel. If the goal is to achieve intensive distribution (wide availability in as many outlets as possible), using intermediaries like wholesalers or retailers is essential. On the other hand, exclusive distribution may require fewer intermediaries to maintain control and exclusivity, which works well for high-end products.

  • Customer Preferences

Understanding how customers prefer to buy products is critical when selecting a distribution channel. In the digital age, many customers prefer purchasing products online, while others prefer a traditional in-store experience. Businesses need to assess the purchasing behavior and preferences of their target market to choose a channel that aligns with their customers’ expectations.

  • Cost Considerations

The cost of using a particular distribution channel is an important factor. Direct distribution, such as selling through a company-owned retail outlet or an e-commerce platform, may involve higher operational costs but provides more control. Indirect channels like wholesalers and retailers may reduce operational costs but may result in lower profit margins due to commissions and markups. Companies need to balance cost considerations with revenue goals to make the most cost-effective choice.

  • Control and Flexibility

When a company chooses a distribution channel, it also determines the level of control it will have over its products and brand. Direct distribution allows a company to maintain more control over product presentation, pricing, and customer experience. However, indirect channels offer less control, as they rely on intermediaries to sell the product. If maintaining control over branding and customer experience is a priority, a company may opt for a direct distribution channel.

  • Competition

The distribution strategy should also consider competitors’ actions. If competitors are using particular distribution channels, entering the same channels could help a company maintain its competitive edge. Alternatively, choosing unique or innovative channels can provide differentiation in the marketplace.

  • Market Reach

The geographical scope of the target market also affects the choice of distribution channels. If a company plans to reach international or distant markets, using a distribution network that includes international agents or global e-commerce platforms might be necessary. Alternatively, for a local or regional target market, a more localized approach with regional wholesalers or retailers may be sufficient.

  • Speed and Efficiency

The time it takes for products to reach customers is another consideration. If the market demands fast delivery, a direct distribution channel, such as e-commerce with quick fulfillment services or direct sales through retail stores, may be ideal. In contrast, some customers may be willing to wait for their products, in which case a slower, but more cost-effective, channel may suffice.

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