The Yale School of Management, also known as Yale SOM, is the graduate business school of the University of Yale in New Haven, Connecticut. Yale SOM operates education and research in leadership, entrepreneurship, operations management, organisational behavior, behavioral economics, marketing, and other areas.
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.
Behavioural Economics According to the school of classical economics, people are intrinsically rational, looking to maximise their utility, and make decisions that are best for oneself. A behaviourist is likely to challenge this school of thought, opining that people often times work irrationally, whether on purpose or not. How should the best parts of psychology and economics interrelate in an enlightened economist's mind? One of the greatest minds of the 20th century, Mr Charlie Munger stated that- “I don't think it's going to be that hard to bend economics a little to accommodate what's right in psychology.” Humans are emotional and easily distracted beings. Consequently, decision making may or may not be made in their self-interest always. Every day, humans make decisions as basic as what amount should one pay for lunch, whether one should pursue a course, invest in gym equipment or how much should be kept aside as monthly savings to making personal finance decisions. There is a dedicated branch of economics that seeks to explain why people decide, what they decide. This branch is called behavioral economics. Your brain effects your thinking- Making Wrong Investment Decision? Blame Your Amygdala! Let us deep dive- What Is Behavioural Economics? Behavioral economics combines understandings from psychology, judgment, decision making and economics with an intent to produce an accurate understanding of human behaviour. It relates to the economic decision-making processes of individuals and institutions. The concept explores reasons as to why people sometimes tend to make irrational decisions, why and how their behaviour does not follow predictions of economic models. It should be noted that behavioural economics focuses on the observable behaviour of humans and does not have strong theoretical or normative assumptions about how an economic system/ business sector or stock market works or should work. Read: Understanding Behavioural Finance & Investment Decisions Let us further break this down with an example: Unlike the field of classical economics, in which decision-making is entirely based on logic, behavioural economics gives room to irrational behaviour and further attempts to understand reasons behind the same. Brexit, for instance is a classic example of how behavioural economics can be useful because behavioural economics can help illuminate how the narrow vote to leave the European Union (EU referendum) was influenced majorly by gut choices, as some experts suggest, as opposed to rational decision-making. The Origin Of Behavioural Economics A keen observer of human behaviour, American economist Richard H. Thaler is broadly believed to be the founder of behavioural economics. He was awarded the 2017 Nobel Memorial Prize in Economic Sciences for his significant contributions to behavioural economics. Thaler’s opinions on the branch is believed to have been inspired by notable works of Israeli psychologist and economist Daniel Kahneman and cognitive and mathematical psychologist Amos Nathan Tversky. Daniel Kahneman also won a Nobel Memorial Prize in Economic Sciences in 2002 for his brilliant work on prospect theory, which he developed along with Tversky. Thaler is best known for incorporating psychological assumptions into analyses of economic decision-making. One of Thaler’s popular ideas – Nudge: Why Move the Earth When A Nudge Can Do! Simple Solutions to Complicated Problems What Are Various Themes Of Behavioural Economics? Three prevalent themes in behavioural economics comprise heuristics, framing and market efficiencies. Why Is Behavioural Economics Important? Behavioural economics provides new ways to think about barriers and drivers to a range of behaviours. This makes it significant, as traditional economic theory does not use insights from psychology, sociology and neuroscience to explain people’s decisions. So much so, behavioural economics seems to have the power to change the way economists and policymakers think about real world problems. Must read: How To Use Psychology To Aptly React To The Coronavirus Pandemic The field also builds a bridge between economic theory and reality- a bridge based on scientific evidence coming from disciplines in behavioural science. Some experts even regard behavioural economics as a counter-revolution, which takes economics closer to its roots, based on psychological intuition and introspection wherein psychology enacts a scientific discipline that can offer much more than merely intuitions and introspection. Besides, understanding basic concepts from behavioural economics can be very useful. It can help people be better negotiators. How Does Behavioural Economics Influence Market Participants? Clearly, people don’t behave as rational, as traditional economists have assumed. They are affected by cognitive biases, are extremely influenced by other people and often practice herd mentality, have different perceptions about attitudes and behaviours. In context to the stock market, erroneous, irrational financial decisions are the result of different unpredictable reactions by market participants subject to losses and high market risks. Therefore, for decision-making, it is essential to consider all the factors in the market-which creates a place for behavioural economics besides accounting fundamentals, macro and micro-economic factors, economic projections, etc. Consider this- a sudden drop in the value of a few stocks followed by an equally rapid recovery, demonstrates that market participants did not cause such movements by rational choices but rather emotional reactions. Read: What does Fear Do to your Portfolio? Stocks that Scared Investors in 2019 No wonder Benjamin Graham, the father of value investing, and mentor of Warren Buffett the world’s best investor coined the term ‘Mr. Market.” Clearly, he understood there is more to market than numbers. Read: Are you a Growth Investor? Then You Must Wear the Hat of a Psychologist! Why Has Behavioural Economics Concept Risen Over The Years? Let us take cues from dramatic global events over the years- for instance the Great Financial Crisis of 2008 or the novel coronavirus crisis of 2020 (Global Virus Crisis, as some call it). Read: Things to Learn from Past Crises: Role of Financial Planners During Times of Crisis These could not be explained by traditional neoclassic economic models though the impact of these events has been beyond massive. Therefore, other schools of economic thought gained traction and behavioural economics was one such concept. Businesspersons seemed to make decisions based on their emotional state of mind while investors demonstrated nervousness that caused a massive sell off to an extent that circuit breakers had to be launched while. Acts of spontaneity, irrationality, impatience, and herd mentality amid incidents of recent years have paved the way for economists to believe that the human mind is a crucial key to understand economic patterns, financial decisions and eventually- market and economic stances. Do You Know Few Top Behavioural Economists? Besides the foundation setters Kahneman, Tversky and Thaler, a number of economists, and psychologists have emerged as prominent figures within the field of behavioural economics over the years- Behavioural economics enhances the explanatory power of economics as it provides it with a firm and more rational psychological basis. It surely is a way to make economics more accurate by incorporating more realistic assumptions about how humans behave. Besides, good understanding of human decision-making, its rational and irrational aspects, offers opportunities of influencing choices that take better account of how people actually respond to the context within which their decisions are made. There are various to help one not fall prey to behavioural traps, mind you, knowledge alone does not help, but an ability to look at bigger picture and through the eyes of various mental models would help one reduce the errors. Eliminating behavioural errors would not be possible or rather would one be flawless and loose the human touch? Read: All I want to know is where I am going to die so that I’ll never go there- Inversion a Power Tool
What is a partnership? In business, a partnership is an arrangement where two or more persons share the profits according to agreements. Partners are collectively co-owners of the enterprise and also contribute to the capital of the business. Partners also share the management responsibilities of the firm. A partnership is essentially an agreement to advance the mutual interest of the partners. Partners in the agreement could involve businesses, Governments, individuals, schools, or a combination of any of these. Partnership laws in each jurisdiction govern the rules, regulations, and obligations of the partnership firms. Partners not only share profits but losses and liabilities as well. What are the advantages of a partnership? Easier and fewer obligations Partnership structure was designed to spur growth in small businesses. Unlike limited companies, a partnership structure tends to have lesser obligations like simpler accounting standards. In most jurisdictions, partnerships attract different tax structures, and the entity is not taxed, instead the income of partners is taxed. Companies are incorporated under company laws and have a plethora of obligations, but partnerships come with relatively lesser obligations. Sharing the booms and boons In a sole proprietorship, capital is employed by a single person, who has all the obligations for the liabilities and is the owner of all assets. Conversely, a partnership enables sharing capital deployment, asset, liabilities, losses, and profits. Partnership structure allows sharing roles and responsibilities in the business enterprise. Knowledge, experience, reach and skills With many partners in a firm, it allows broadening the capability of the management decision and outcomes. Partnership firms also onboard new partners based on their needs. For instance, a law partnership could invite a new partner, who specialises in a practice lacking at the firm. Collective financial commitment Partners in a firm are invested in the business through the capital. Losses and profits are also shared on a share in the firm, which is usually based on the proportion of capital invested in the business. It also motivates the partners to remain committed to the firm since losses and profits would be shared as well. What are the disadvantages of a partnership firm? No separate legal entity A partnership firm has no independent legal existence unless the agreement has a specific provision in place. When the partners of the firms leave or cease to be partners anymore, the firm is dissolved. In this way, the firms could be unstable and uncertain. Taxation Since partnership firms are not taxed separately and the profits are shared by the partners that are taxed at individual income tax level, partners cannot retain the earnings. Partnership firms do not provide tax planning opportunities compared to limited companies. Thus, making it tax inefficient for the partners. Profit-sharing Even if one partner has made significantly more efforts compared to other partners, the profits would be shared as per the partnership agreement. Profit and loss sharing could be good, but it may well turn out to be disastrous as well. Disagreement with partners More number of partners in a firm increases the chances of higher level of disagreements among them. Since decisions are also bound to be consulted with each partner, the decision-making ability of the firm could be hampered in the event of disagreements among partners. What are the types of partnerships? General Partnerships General Partnerships are the most common partnership firms that exist in many jurisdictions. Small businesses often incorporate a General Partnership since it is the simplest partnership, which requires minimal formalities. Share of profits could be enlisted in the partnership agreement and is usually based on a similar proportion of the capital invested by the partners. At least one partner in GP has unlimited liabilities since a partnership is not a separate legal entity. In this way, partners will be held accountable if the firm enters bankruptcy and dues are supposed to be cleared by the partners. Limited Partnerships Limited Partnerships allow one to have limited partners in the firm. LPs can have a mix of general partners and limited partners. It is incorporated to designate limited partners with specific responsibilities without bearing any significant liability. It can be the case that limited partners are not involved in the daily operations of the business and contribute on a consulting basis. Limited partners usually invest capital in the business and take a share of profit. They largely remain out of the decision-making roles. Limited Liability Partnerships Limited Liability Partnerships are a more complex type of partnerships. The structure allows partners to have limited liabilities along with limited scope on managerial decisions. These limits are often defined by the extent of a partner’s investment in the firm.
What is meant by Disequilibrium? Disequilibrium refers to a situation where the market forces of demand and supply are out of balance. Disequilibrium can be caused by various factors which can be external or internal. Economic forces may cause a disequilibrium that lasts for a short term. But, it can also be a long-term disequilibrium under certain circumstances. In the situation of disequilibrium, there may be excess demand or excess supply. This means that either the demand in the market is not able to meet the supply or vice versa. Thus, there can either be a shortage in the market, or a surplus. While, equilibrium is a state where market forces are balanced. Any changes to this state would lead to a distortion in the economy. How does an economy move towards disequilibrium? Equilibrium is achieved when an economy is in its natural state without any external intervention. Thus, the goods market equilibrium refers to a state where prices are stable due to the stability of demand and supply. When prices rise above the equilibrium price, then there can be surplus of goods. Similarly, when prices go below equilibrium price then there can be a shortage of goods. Both cases of a price increase or decrease are examples of disequilibrium. However, this is not a permanent state as markets eventually move towards equilibrium. Notably, market forces adjust to incorporate a shortage or a surplus. Therefore, disequilibrium is not a long-term state rather is a temporary disbalance in the market forces. Markets acclimate to a new state of equilibrium with relevant policies and regulation. What are the causes of disequilibrium? Markets may move out of equilibrium due to various external factors. However, it is also possible that markets do not always operate on full efficiency. Factors leading to disequilibrium include: Sticky Prices: Firms may be apprehensive to increase prices in case of increased demand. Thus, due to the rigidity in prices, demand in the economy might go unfulfilled. This can lead to a shortage even without any changes to prices. Thus, there is disequilibrium in the economy due to rigidity in prices. Government intervention: Tariffs and quotas imposed by governments can lead to distortion in the economy. Policies like price floors and price ceiling can also lead to disequilibrium in the economy. All these government policies move the economy towards a price level that is different from the natural equilibrium level. Deficit or surplus in the current account: A disbalance in a country’s level of imports and exports is a common instance. A deficit or surplus in current account can lead to a disequilibrium in the balance of payments. This happens when there is a difference in the level of domestic saving and domestic investment in an economy. An excess investment in the economy implies that foreign capital has been purchased to finance it. Thus, there must be a corresponding deficit in the current account. Other factors: Other additional factors like inflation or exchange rate imbalances may also lead to a disequilibrium in the economy. The political scenario in a country as well as international political disturbances may also lead to disequilibrium. How can the situation of disequilibrium be resolved? There are two schools of thought that can explain how economies recover from a disequilibrium. According to Keynes, a disequilibrium would not self-regulate. Keynes gave the argument that the natural rate of unemployment is always less than the full employment rate. This happens because there is always a certain degree of frictional unemployment. Keynesian economics postulates that government intervention is necessary to come out of disequilibrium. Thus, many governments make it a practice to adopt fiscal measures and monetary expansion measures in times of an economic recession or when there are distortions in the economy. The second approach involves classical school of thought. According to this, any distortion in the economy is self-correcting. Meaning any changes from the equilibrium level are bound to get adjusted on their own, without any external regulations. This is the theory of the invisible hand propagated by the economist Adam Smith. However, this may always be the case as certain instances of disequilibria require immediate action by the government. How can disequilibrium be practically understood? Consider the following diagram, where the price level P1 represents a price floor wherein the government fixes a price below which serves as the minimum selling price for the sellers. This means that the sellers need to be paid an amount that is at least equal to P1. This price floor has led to a market distortion. At price level P1, there is an excess supply of the good. However, at this price not all consumers can purchase the good. Thus, the demand is unable to meet the supply and there is a disequilibrium. Similarly, a price ceiling P3 ensures that buyers pay maximum amount equal to P3 and not any amount beyond that. However, fixing a price ceiling creates excess demand. Thus, a disequilibrium has set in the economy. A sudden demand shock can also lead to market disequilibrium. For instance, post a war, or during a global crisis, there might be a sudden contraction in demand. Thus, there would be an economic recession because of this. However, the supply may not adjust as immediately. Thus, there would be excess supply in the economy. To overcome this, producers would decrease prices so that demand increases. This would lead to adjustment in demand and a new equilibrium would set in as shown in the diagram below. Here, as the Demand curve falls from D1 to D2, there is an excess supply at point B. Thus, when prices are reduced from P1 to P2, the economy moves to point A, which is the new equilibrium point.