Fail in trading term means if the buyer does not pay owed value or the seller does not deliver securities by settlement date.
What is Keynesian economics? Keynesian economics is the economic theory that states demand is the driver of economic growth. This economic theory also states that fiscal aid helps recover an economy from a recession. Certain Keynesian economic principles stand in stark contrast to the Classical theory of economics. The theory was given by John Maynard Keynes in the 1930s and published in Keynes’ “General Theory of Employment, Interest and Money” in 1936. The Keynesian theory stated that government spending was an essential factor in increasing demand and maintaining full employment. What are the theories under Keynesian economics? Aggregate demand is affected by a host of factors: Aggregate demand is affected by various factors public and private factors. Monetary and fiscal policy both affect the level of aggregate demand in the economy. Any decision taken by the monetary authority or the government greatly affects the economy’s level of demand. Say’s Law proposes that supply generates its own demand. However, Keynesian economics suggests that demand is the driver of supply and overall growth in the economy. Sticky Wages: According to the theory of sticky wages, employers would prefer laying off workers over decreasing the existing workers’ wages. This happens because even in the absence of labour unions, workers would still resist wages cuts. Even if the employers were to reduce wages, it would lead to economic depression as demand would fall and people would become more cautious about their spending. Keynes advocated that the labour markers do not function independently from the savings market. Therefore, prices and wages respond slowly to changes in supply and demand. Liquidity Trap: Liquidity trap refers to an economic scenario where there is a contraction in the economy despite very low interest rates. This contrasts with the relationship between interest rates and investment given in Classical economics. How is Keynesian economics different from Classical economics? Classical economics states that the economy self-regulates in case of a disequilibrium. Any deviations from the market equilibrium would be adjusted on its own without any government regulation. However, Keynesian economics propagates that government intervention must maintain equilibrium or come out of an economic downturn. Keynesian economics highlights the importance of monetary and fiscal policy, while Classical economics does not mention any government intervention. Another crucial difference is that Classical economics suggests that governments should always incur less debt, while Keynesian economics advises that governments should practice deficit financing during a recession. Classical economics states that government spending can be harmful as it leads to crowding out of the private investment. However, it has been later established that this happens when the economy is not in a recession. Government borrowing competes with private investment leading to higher interest rates. Thus, Keynesian economics is of the view that deficit spending during a recession does not crowd out private investment. What are the policy measures advocated by Keynesian economics? According to Keynes, adopting a countercyclical approach can help economies stabilise. This means that governments must move in a direction opposite to the business cycles. The theory also states that governments should recover from economic downturns in the short run itself, instead of waiting for the economy to recover over time. Keynes wrote the famous line, “In the long run, we are all dead”. The short run knowledge of the economy would be far better than the long run prediction made by any government. Thus, it makes sense for governments to focus on short run policies and maintain short run equilibrium. Keynes’ multiplier effect states that government spending would increase the GDP by a greater amount than the increase in government spending. This multiplier effect established a reason for governments to go for fiscal support when the economy requires it. What have been the criticisms of Keynesian economics? The initial stages of Keynesian economics propagated that monetary policy was ineffective and did not play any role in boosting economic growth. However, the positive effects of monetary policy are well established and have been integrated into the new Keynesian framework. Another criticism is that the advantage of the fiscal benefits to the GDP cannot be measured. Thus, it becomes difficult to fine-tune the fiscal policy to suit the economic scenario better. Also, the Keynesian belief of increased spending leading to economic growth may lead to the government investing in projects with a vested interest. It could also lead to increased corruption in the economy. The theory of rational expectations suggests that people understand that tax cuts are only temporary. Thus, they prefer to save up the income left behind to pay for future increases in taxes. This is the Ricardian Equivalence theory. Thus, fiscal policy may be rendered ineffective due to this. Supply-side economics has also shown contrast to Keynesian beliefs. During the stagflation in the 1970s, the Phillips curve failed, bringing out the importance of supply-side economics.
Defining Macroeconomics Macroeconomics is a branch of Economics that evaluates the functioning of an economy as a whole. It studies the performance and behaviour of key economic indicators such as economy’s output of goods and service, exchange rates, the growth of output, the rate of unemployment and inflation, and balance of payments. Macroeconomics emphasises on the policies and economic behaviour that influence consumption and investment, exchange rates, trade balance, money flow, fiscal and monetary policy, interest rates, national debt, and factors influencing wages and prices. The scope of the subject goes beyond microeconomic topics like the behaviour of individuals, firms, markets, and households. History of Macroeconomics Macroeconomics originated with John Maynard Keynes post the great depression when the classical economist failed to explain the great economic fallout. Classical economics mostly comprised theories that studied pricing, distribution, and supply & demand. In 1936, John Maynard Keynes published – The General Theory of Employment, Interest and Money – effectively changing the perception of how macroeconomic problems should be addressed. The theories of Keynes shifted to focus on aggregate demand from the aggregate supply. Keynes said: ‘In the long run, we are all dead’. This statement was made to dismiss the notion that the economy would be in full employment in the long run. Later the theories developed by Keynes formed the basis for Keynesian economics, which gained popularity over other schools of thoughts including Neoclassical economics. Neoclassical economics emerged in the 1900s. It introduced imperfect competition models, which included marginal revenue curves, indifference curves. The theories in neoclassical economics argued about the efficient allocation of limited productive resource. Neoclassical economists explain consumption, production, pricing of goods and services through supply and demand. Some assumptions of this thought were an individual’s motive is to maximise utility as companies seek to maximise profits. Individuals make rational choices and act independently on perfect information. Over the years, many new schools of thought in Macroeconomics have found footing in the economics world. These include monetarist theories, new classical economics, new Keynesian economics, and supply-side macroeconomics. Difference between Macroeconomics and Microeconomics Major topics in Macroeconomics National income and output The estimation of national income includes the value of goods and services produced by a country in a financial year domestically and internationally. National income essentially means the value of total output generated by an economy in a year. National income can also be referred as national expenditure, national output or national dividend. Financial systems Understanding financial systems is an important concept in macroeconomics. A financial market is a market for financial securities and commodities, including bonds, shares, precious metal, agriculture goods. It is important for an economy to have markets where buyers and sellers can exchange goods. A financial market helps in the allocation of resources. Financial markets facilitate savings mobilisation, i.e. financial intermediaries channelise funds from savers to borrowers. Investment remains on the agenda for policymakers to promote growth, and financial markets facilitate funds by allowing individuals to invest in bonds and stocks, which are issued by institutions seeking funds for investments. Business cycles A Business cycle or an economic cycle refers to fluctuations in production, trade or economic activities. The upward and downward movement generally indicates the fluctuations in gross domestic product. A business cycle has four different phases: expansion, peak, contraction, and trough. An expansion in an economy is when economic growth, employment, prices are rising. The peak is achieved when the economy is producing maximum output, inflation is visible, and employment levels are running high. After a peak, the economy enters into contraction, which leads to a fall in employment, depleting economic activity, and stabilisation in prices. At trough, the economy is at the bottom of the cycle, and the next phase of expansion starts after the trough. Interest rates Macroeconomics also deals with interest rates in the economy. Interest rate policy of an economy is formulated and maintained by the central bank. A central bank manages the money supply in the economy. The intervention by the central bank to propel economic growth is called monetary policy. The monetary policy of an economy seeks to maintain employment and inflation in the economy. The motive of the monetary policy is to achieve full employment and maintain stable prices.
If a person has the history of not paying bills on time, it is termed as bad credit. The failure in timely payment is often shown in a low credit score of the individual. A company may also have a negative credit score if its payment history is uneven and may reflect in its current financial position.
What is capital? Capital refers to the financial assets held by a firm and/or funds outsourced from other forms of financing. Capital can have multiple meanings; however, this is the definition used in finance. In a more general sense, capital is understood as anything that generates more value. Capital can be defined differently based on the usage of the term. In finance, capital refers to the equity, debt, investments and working capital held by firms. In economics, capital refers to human capital which is the capacity of individuals in an economy to contribute towards economic production. Natural resources may sometimes also be referred to as capital; however, this usage of the term is excluded from both economics and finance. Is money a form of capital? Money cannot be strictly defined as capital because money itself is an instrument to purchase goods and services which end up becoming the capital. For instance, the investments made in financial instruments by firms are a form of financial capital. Thus, any money held by a firm may not precisely be termed as capital; however, once it is invested in financing activities, it becomes a form of capital. What are the components of financial capital? Financial capital includes the following: Debt: The most common form of capital used in business is debt. Firms may take borrowings from banks or from family members to finance their operations in the beginning. In case of borrowings from the banks or any monetary institutions, firms must repay the principle with interest. Debt is an easy method of financing business activities; however, the interest associated with it might make it expensive for some. If the business fails, the borrower must repay the debt. The advantage of taking a loan is that the profits need not be shared. Equity Capital: The type of capital comes from investors who put their money in the initial stages of the company. This is done in exchange for a part of the profits that must be shared with the investors in the future. Businesses may initially fund their processes themselves; thus, they own 100% equity and would earn all the profits. However, angel investors or venture capitalists may sometimes invest too. In those cases, a proportion of the profits goes to these investors. This may be disadvantageous in some cases, where investors end up taking a large stake in the company in exchange for initial capital provided by them. Businesses that are at an early stage might benefit from the initial investment; however, their profits in future are decreased by a large percentage. Working capital: This includes the most liquid assets that a company possesses. These are the assets that can be easily converted to cash. Working capital is maintained to fulfil daily transactions and is calculated on a regular basis. It can be obtained by subtracting current liabilities from current assets, or by adding accounts receivables and inventory, and subtracting accounts payable from both. To summarise, working capital is derived as: How is financial capital different from economic capital? Financial and economic capital are both utilised in a business. However, financial capital is a much broader term. Economic capital, on the other hand, refers to the estimated amount of money required to bring a firm out of losses. It can be interpreted as the amount of money required to repay the outstanding liabilities. The concept of economic capital was introduced to manage risk. This is used to analyse the amount of funds that would be required to compensate any losses in the future. There are various models used to determine the capital needed to manage risks. Economic capital may sometimes also include human capital, or the tools used to produce goods. In economics, capital may also refer to one of the factors of production used in producing goods and services in an economy. Out of the two, financial capital is the most prime version utilised by firms and is commonly seen across businesses. Therefore, if used alone, the word capital most commonly refers to financial capital only. What is the cost of capital? There is a cost associated with acquiring capital. Since capital includes loans and borrowings to finance the business, the cost of capital depends upon the coupon, interest rates, and yield to maturity of the debt. The Capital Asset Pricing Model or CAPM is used to calculate the cost of equity. CAPM uses the volatility of the returns as a measure of calculating how much the investment should cost in a year. On the other hand, cost of debt is equal to the interest paid on loans. Cost of equity would always be higher than the cost of debt. This is so because the cost of equity is riskier and more vulnerable to fluctuations. Why is capital important for businesses? Capital allows businesses to expand and grow in wealth. It boosts productivity in the economy and provides valuable goods and services necessary to sustain. Businesses realise the importance of maintaining capital and they use various methods to analyse on how to maintain it.