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CÁC CÔNG TRÌNH NGHIÊN CỨU KHÁC
POLICY ON TWO
A new solution group for macroeconomic stability
and economic crisis prevention
NỀN KINH TẾ THỊ TRƯỜNG
CHÍNH SÁCH HAI ĐỒNG NỘI TỆ
Một nhóm giải pháp mới nhằm ổn định kinh tế vĩ mô và phòng ngừa khủng hoảng kinh tế
Hanoi, January 2009
The entire world has just said good-bye to the year of 2008 with a heavy mood. Everyone welcomes the new spring with decisions of tightening expenditure to deal with the economic crisis evaluated as the biggest crisis since the industrial big slump in 1930s of last century. In 2008 securities index in our country reduced over 60% and average reduction in the world was 40%. Low economic yield and unemployment increase are popular situation in all countries, so the governments must issue the huge demand stimulating packages to save the economy. This economic crisis can last until 2010 and cause serious damage to many countries in the world.
The surprised thing for everyone is that the crisis happened quickly and strongly, but at the beginning of the year 2008 nobody received any official warning on the economic crisis, only a credit crisis rising from substandard lending in America. In the middle of the year 2008 we were known about a global financial crisis happening and in the last months of the year 2008 everyone was witness of a global economic crisis at serious level. Was the theoretical models in economics backward than the reality? Or at least they had many big gaps and macroeconomic analysis became indefinite. Therefore, economists must spend much time and effort to make the subject of economics become the scientific subject which grasps every movement of the economy. So, any new creation of professional researches or amateur researches in the field of economics has high referent value and event character.
In this book, besides the contents with general features on economics, each chapter mentions to remarkable new matters at micro level and macro level of market economy. In chapter 1, we can find a method of defining the commodity value according to a new logic; in chapter 2, you have reason to worry about a economic model without progress; in chapter 3, we make acquaintance of general macroeconomic index and two solutions of regulating the economy; in chapter 4 – the final chapter – this chapter can make a strong impression on readers by a proposal on the currency policy without antecedent in the reality. Moreover, through this book, some important concepts in the economics described briefly and concisely help readers easy to approach.
Writer: Do Duc Luong
Đỗ Đức Lương
Chapter 1: MARKET ECONOMY
1.3 Market economy
1.4 Equation of exchange equilibrium
1.5 Business operation expenses, revenue and profit
1.6 Selection of consumers.
1.7 Currency interest rate and average rate of return in business operation
1.8 Price and commodity value.
1.9 Supply, demand and price change
1.10 Operation law of market economy
Chapter 2: KNOTS IN THE ECONOMY
2.1 Growth model 0%
2.2 Contradiction between production and consumption
2.3 Cohabitation with inflation
2.5 Debt burden
Chapter 3: MACROECONOMIC REGULATION
3.1 Except of macroeconomic regulation
3.2 Market economy setups
3.3 Fiscal year policy
3.4 Currency policy
3.5 Target of macroeconomic regulation
3.6 Macroeconomic regulation under the first resolution group
3.7 Macroeconomic regulation under the second solution
Chapter 4: POLICY ON TWO DOMESTIC CURRENCIES
4.1 Currency circulation flow in economy
4.2 Policy on two currencies
|4.3 Kết luận|
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In the old days, under the primitive commune regime, people lived in small communities called Clan or Tribe. They lived and worked together under gregarious form. With the rudimental production tools, the yield from cultivation, breeding and hunting are only enough for use in the community and have no redundant products. The situation of enough food, enough money was popular in all communes. That was the typical self-sufficiency economic model in the human society. In the later, in the advanced economic-social forms, we still find the features of self-sufficiency model existing in backward economic area.
With the time, creative labor changed production tools, labor productivity was improved with requirement of raising the professional skills. Since that division of labor and production specialization appeared, marking a big change of production force. Groups of people in the society made different products to satisfy their demand and exchange to maximize the utility level. Commodity economy appeared naturally as the indispensable request of the life.
The simple commodity economy according to the type of exchanging goods operates fluently only when number of kinds of commodity can count by figures. In reality, the production is not monotonous like this, the increasingly commodity quantity bothers the process of exchange. Clothes producer who has redundant products and wants to exchange the food must find the breeder who has demand of using clothes, it is not easy. Using the intermediate goods – a beginning currency form – as parity exchange product is very useful in the commodity economy in the transition stage from simply to complex. Suppose the society agrees to consider rice as intermediate commodity in the exchange process and used everywhere, whenever in the community, then the exchange problem of producers becomes easier. Clothes producer who has redundant products and wants to exchange the food is not necessary to find the breeder who needs clothes, they can exchange clothes for rice of somebody and then exchange rice for food of any breeder. This new exchange method, executing two steps but two simple steps, is like as changing a complicated problem into two simple problems.
Currency is an intermediate commodity (sheep, cloth…) or a special designed product (paper money, polymer money …) which is established as a convention by the society as a value measurer for every other commodity and service during the process of transaction between buyers and sellers.
At the beginning stage of the commodity economy, currency is often an intermediate familiar commodity as sheep, cloth or even salt. In the later, mining industry develops, people use the metal money with more preeminent features than kinds of currency as commodity. Nowadays, paper money, polymer money and metal money are popular forms of currency used by countries. These currency kinds are not commodity, but a special product form based on the sophisticated print technology and unique production skills.
Commodities and services will be used by the people or be the input for the production process, however, currency is only intermediate exchange item and it doesn’t lose during the circulation process. The currency is used as payment mean and it is accounting unit in the whole economy. Because of strict management by the Government, currency has stable value and people use it as the mean of hoarding, saving according to the time.
The commodity economy takes place the mutual exchange between buyers and sellers on the same commodity. In the first stage of commodity exchange, seller and seller are individuals, have no relation. The exchange process takes place spontaneously or dictated by feeling. In many cases, the price of a kind of commodity is different between this group and other group although they live nearly. The commodity circulation develops increasingly, makes sellers and buyers close to each other. Sellers discuss together on the situation of commodity supply, product quality and the price. Buyers exploit their information and from commodity suppliers. Since that, the commodity price is formed according to general platform with the popular features and commodity volume for exchange. The appearance of commodity market creates good conditions for exchange activity based on the clear information and sound competition between buyers and sellers.
The market is a form of “shapeless economic organization” created by the interlacing relations between seller and buyer, since that determine the price of commodity (services), commodity quantity for supply and payment method among parties.
We know that, enterprise, cooperative, supermarket or market are “shaped economic organizations”. There, there is the management system, fixed address and even juridical personality. The market is not clear. The market is only “slack alliance” between seller and buyer of the same kinds of goods. When we mentions to Cafe market, we want to mention to the set of suppliers and customers who have the demand on buying and selling cafe. Among them, there are lots of relations of exchanging information to establish the temporary equilibrium on the price, yield for exchange. There are many kinds of markets such as: rice market, fruits and vegetables market, real estate market, securities market… The market scale is diversified such as: local market, regional market, domestic market, international market.
1.3 Market economy
The market economy is the high-grade commodity economy. The development process from the simple economy to the market economy must spend another intermediate stage hereof called temporarily as concentrated commodity economy. In the concentrated commodity economy, commodity exchange doesn’t bring spontaneous character, but concentrate into commodity market in local areas and have no connection among resident areas, so it can’t consider as markets.
The market economy is the economic model which commodity (service) markets operate freely, through that enterprises decide by them the plan of business operation, households select the suitable spending methods.
Commodity markets make “the front” of the economy, and behind are many enterprises with fierce competitive strategies to exist and develop. Behind that “front” millions of households with limited income must calculate the expenditure plan so that it is economical and effective.
The enterprises supply output goods products to the market but purchase the materials and input production tools from the market. They select the manpower from labor market and borrow capital from the monetary market. Households buy commodities and services for consumption in the markets; concurrently supply the labor service and idle capital resource to the market.
The commodity market operating freely means it is operated according to natural rules without imposition by the Government. Forbidding commerce is not suitable for free market. However, competent authorities inspect the market to prevent the counterfeit, imitation… this is necessary and benefit for the market. With some special commodity markets such as medicine, veterinary drug… the business condition is not easy as other common commodity markets. Tax policy of the Government deforms the market bigger or smaller but doesn’t change the common rules of the market. Intervention of the Government into the market with method of both managing and creating good condition so that the market develop healthily takes place popularly in the world, different only from intervention level.
In opposition to the market economy model is centrally planned economy. The economic model in which the state controls every activity from production, distribution to consumption has ever existed in the system of socialist states before. This imperative economy overloads for state authorities and doesn’t create the competitive motive force in enterprises as well as laborers. The result is low labor productivity, resources waste, non-high product quality and finally the economy based on administrative subsidies collapses.
1.4 Equation of exchange equilibrium
In this section, we establish an equation on binding relation between commodity and currency in the circulation process. This is not a new proposal, in reality the equation of commodity exchange equilibrium was discovered for a long time by economists, however, in majority of documents on economics circulating, this matter is not explained in details so readers are hard to imagine. Here we need to study more detailed. Simply, we have an example on a brief economic model in which only three groups of people produce closely and exchange goods to each other. Three items for buying and selling are food, foodstuff and clothes with quantity and unit price as below:
The process of buying, selling, exchanging commodity among three groups of people is divided into many times; each trading order has small volume but taking place continuously in a year. The first group sells the food and uses money earned to buy foodstuff and clothes; the second group sells the foodstuff and buys food and clothes; the third group sells clothes and buys food and foodstuff. We call M cash mount issued to serve the process of circulating goods, so M is total cash held by three groups for trading. In this model, suppose that M = 1,000,000 dong (One million dong).
From above data table, we are easy to calculate total commodity transaction turnover in the year as 14,500,000 dong. We find that three groups of people use only cash amount 1,000,000 dong but re-circulating many times and in a year having total trading turnover as 14,500,000 dong. If call V currency circulating speed, MV = 14,500,000, infer V = 14.5. It means within 1 year, they re-circulate the current money amount average 14.5 times to execute successfully transaction value 14,500,000 dong.
Now, from above simple example, we generalize for a real economy with tens thousand kinds of commodity, service put into circulation and trading activities take place continuously. Commodity from production place to consumers must spend many intermediate stages such as distributor, general agent, and retail store. In each intermediate stage, commodity are changed the owner, the price is defined and money is handed. Because commodity must circulate through many intermediate stages, total transaction commodity volume in the economy is greater than total commodity volume produced. A transaction having commodity and currency exchange is called a successful transaction. Selling commodity on credit or consigning products aren’t considered as a successful transaction, when currency is paid by buyer, we have a successful transaction.
If call Qi and Pi in turn volume and unit price of i-th successful transaction, call n total number of times of successful transaction during the examined period. We have:
Turnover of i-th successful transaction: Qi Pi
Total transaction turnover during the examined period:
∑ Qi Pi (i= 1…n)
Call M total issued currency value, V average circulation times of currency during the examined period, we have following equation:
∑ QiPi = MV (1)
This is the equation of commodity - currency exchange equilibrium in the market economy.
Total transaction turnover of commodity and service in a defined duration is equal to product of currency volume and average circulation speed of currency.
Next we change equation (1) to shorter form.
Call Q total volume of transaction commodity and service: Q = ∑ Qi
Set P = ∑QiPi/Q, P is called general average price of all commodities and services. So, PQ = ∑QiPi (2)
Finally from (1) and (2) we have the shorten equation as following:
PQ = MV (3)
Q is total unit of commodity and service for executing the transaction
P is general average price of all commodities and services
M is total circulating currency value
V is average circulating times of currency
Now try applying equation (3) in the example on simple economic model mentioned above to calculate all its values.
PQ = MV = 14,500,000 , with M = 1,000,000 → V = 14.5
Q = ∑ Qi , so, Q = 900 + 90 + 10 = 1000 →
P = 14,500,000/1000 = 14,500
From the equation PQ = MV we have following formulas: P = MV/Q and M = PQ/V. These formulas have important meaning in analyzing the inflation and currency policy which we will mention in next chapters.
From theory to reality
In the reality, volume of commodities and services is very big, concurrently each kind of commodity circulates through many different intermediate stages, so synthesizing all transactions of whole economy is unfeasible and overlaps. To simplify, people often total up the final yield of commodities and services of the economy to put in application and analysis in equation of exchange equilibrium.
If call Q value of final yield of commodities and services converted according to the price level of time as original point; call P index of current average price compared with the original time; call M total average circulation currency value; call V basic currency circulation speed, we have the equation: PQ = MV.
1.5 Business operation expenses, revenue and profit
Commodity production is an important stage of the economy, executed by business households, cooperatives or companies; hereafter we call enterprises in general. Enterprises use combining the input factors to change into commodity products at output.
On ownership, the enterprise can belong to private ownership, collective ownership or state owned. A typical enterprise includes board of directors, management apparatus and investment capital. Enterprise board of directors includes representatives of enterprise owner; they plan the business strategy; establish the management apparatus and take part in controlling the activities of the enterprise. Management apparatus includes people who are dynamic, have ability of management and professional knowledge; they decide the production plan, method of product consumption, manpower recruitment and salary regulation in the enterprise. Investment capital (owning or borrowing) is divided into two parts: fixed capital and circulating capital. Fixed capital includes land, factory, machines, equipment and transport vehicle. Circulating capital includes cash, production raw materials, semi-finished product and inventory.
Input factors can divided into three sections. The first section includes raw materials or semi-finished products put into the production, and then they are combined together and changed into commodity products at output. The second section includes resource of fuel, electrical energy for operating machines, equipment and transport vehicle. The third section, very important, includes manpower, technicians; they are people who operate equipment, pack products and transport commodity to consume.
The output of production process includes commodity products with plentiful designs and models. That is the crystallization between the creative labor of human and the diversity of raw material resource in the nature. Each commodity product has private use to satisfy some demand of people.
1.5.1 Business operation expenses
Business operation expenses are all expenses during the business operation process from stage of importing the input raw materials to stage of packing the finished products and delivering. It includes expenses of raw materials, energy, worker salary, fixed assets depreciation;… management expense, capital borrowing expense and tax expense. In brief, there are many kinds of expense. However, to simplify the problem and give advantage to research, we divide the business operation expenses into three kinds of expense: manpower expense, material resources expense and derived expense.
Manpower expenses are expenses related to human factor in the process of production and distribution of products; including salary, bonus for staff and enterprise management apparatus, shift meal expense, health insurance expense, labor safety expense. Another important component in manpower expense is expense for training, improving professional knowledge for staff and investment expense for researching and developing new products.
Material resources expenses are expenses related to physical factors during the process of production; including expenses of raw materials, energy, design and packing of products, fixed assets depreciation, expense of repairing machines, equipment, extinguish system, environmental protection.
Derived expenses are expenses related indirectly to the process of business operation; including financial expense (if any), tax and fee, trademark protection, intellectual property registration, commercial copyright, and especially marketing advertisement expense.
If call business operation expense Psx-kd, manpower expense Pn , material resources expense Pv and derived expense Pp, we have following formula:
Psx-kd = Pn + Pv + Pp (1)
Beside the way of dividing total business operation expenses into three groups of expense as above, we can divide in other way, for example, into four groups including: production expense, sales expense, enterprise management expense and financial expense.
Production expenses include expenses related to the stage of production of the enterprise such as: expense of raw material, energy, product packing; assets depreciation; manpower expense...
Sales expenses include the marketing advertisement expense, delivery expense, tax and fee...
Enterprise management expenses include the expense of operating the management apparatus and administrative units, insurance expense, labor safety expense, expense for training, improving professional knowledge for staff and investment expense for researching and developing new products...
Financial expenses include expenses related to borrowing capital, renting financial assets ...
If designate production expense as Psx, sales expense as Pbh, enterprise management expense as Pql, financial expense as Ptc, we have:
Psx-kd = Psx + Pbh + Pql + Ptc
In reality, many enterprises operate in many fields, besides the main business activity, they take part in the financial investment and other investment operations. Here we calculate only business operation expense related to main business activity of the enterprise.
Enterprises produce not only one kind of commodity or service but also diversifications of product. Then if we want to calculate the business operation expense of each item, we calculate three kinds of particular expense for each item and then add together according to the formula (1).
Revenue is total sales turnover of the enterprise in a defined duration. If designate D as revenue, P as average commodity price, Q as consumption commodity yield, we have:
D = PQ (2)
After selling, manufacturer bears responsibility for product warranty in a certain period and can spend an expense amount for warranty and maintenance. So, real revenue is the difference between net revenue and revenue deduction.
If the enterprise sells many commodity items, the revenue of each kind of commodity can be calculated according to the formula (2), in which the price and quantity is correlative to each kind.
Similar to the section of calculating the production expense, here we calculate only revenue related to main business activity of the enterprise without paying attention to kinds of revenue collected from other investment activities.
The profit of the enterprise is the difference between the revenue and the business operation expense in a period. Because the business operation expense as above includes taxes as well as the enterprise reward funds, the profit in this section is net profit – the final profit of investor or shareholders. If designate M as profit, from above result we have:
M = D - Psx-kd
There are three cases happening to value of M correlative to three levels of effective operation of the enterprise. If M = 0, it means the revenue is equal to the business operation expense, the enterprise breaks even. If M > 0, the revenue is bigger than the expense, we say the enterprise is profitable. If M < 0, the revenue is smaller than the expense, the enterprise is unprofitable.
After calculating the profit of the enterprise, we have not evaluated the effect of the investment. Suppose that two enterprises have the same absolute profit M, however the first enterprise has scale of capital, worker quantity doubling to the second enterprise, we find that the first enterprise has the business effect lower than the second enterprise. So, to evaluate the effect of the investment capital, we must calculate the rate of return of the enterprise. This value is defined by the way: dividing the profit in a year of the enterprise by equity and then converting according to percent rate. The equity of the enterprise is not always equal to total investment capital of the enterprise because total investment capital can include borrowing capital.
The inflation reduces the purchasing power of the currency, so the price of assets invested before of the enterprise is changed now. Therefore, the equity of the enterprise must be calculated according to current price, then evaluating the rate of return has the real meaning. Like this, compare of business effect among enterprises will ensure the accuracy. From now, when mention to the investment capital of the enterprise, it means we mention to the equity of the enterprise adjusted according to current price.
If call R the rate of return of the enterprise, I the equity of the enterprise, M the profit in a year; we have:
R = M/I * 100%
R is positive when M > 0; R = 0 when M = 0; R is negative when M < 0.
If define the profit and the particular investment capital for business operation of each kind of commodity, we can calculate the rate of return for each item.
We note that, here we calculate only the profit related to main business activity.
1.6 Selection of consumers
Each individual or household has an expenditure budget according to the plan, subject to rich level and private hobbies; they have the expenditure selections according to private style. In general, first priority is for the expenditure serving the essential demand such as food, house service, clothes, study, travel and healthcare. Next is buying or replacing household appliances such as television, fridge, computer,… and demand of entertainment to improve the spirit life. People who have high income often go to restaurant, hotel, beauty salon, buy car, use high-grade tourist service… or live in expensive villa.
Beside expenditure budget, a typical household has a list of assets including one or many kinds such as real estate, bond, bank deposit…, precious metals, stock.
The expenditure budget of families is supplemented from monthly personal income of members in the family. Income items through the investment or assets liquidation can be added to family expenditure budget. Many families, not all, at some time use the borrowing money to add to expenditure budget.
With a budget limited and expenditure plan defined before, individuals and households select in the market to find the items having the suitable price and quality to get the max utility. For example, poor households with tight expenditure budget, when they select the commodity, they can’t pay attention to the quality, they must be interested in the price. With rich households, the commodity quality is the first priority, after that it is the price.
Consumption belief in people increases, or in other words, families are ready to loosen the purse-strings when the social economic condition is stable, the job is enough. With each household, when the income increases - the expenditure increases, when the income decreases - the expenditure decreases. With households owning the list of assets, the change of assets value in the market affects to the consumption psychology. Suppose that price of stock increases stably and at high level, the value of stock assets booms, stock investors earn big money and they will be more open-handed in expenditure and shopping. When the periodical statistics show that the economy is in the recession, unemployment, households will response by contraction, retrenchment to prevent the risks whenever.
1.7 Currency interest rate and average rate of return in business operation
We find that, the poverty still exists around the world. However, the global population increases continuously. In almost countries, the situation is similar. Meanwhile the natural resources are more and more scarce. A basic contradiction in the economy is the demand of human is higher and higher, but supply ability is limited. That contradiction pushes the material price to increase and it is the cause of price inflation.
1.7.1 Currency interest rate
The reality shows that, forming a credit market is because of objective reasons. The families understand that, the currency is also a mean for hoarding the value. So, with total monthly income, they add only a part into regular expenditure budget, and a part is hoarded for important intentions later or preventing the risks. Some enterprises trade profitably, but they don’t divided all the profit into shareholders, they gather money to execute the investment project in the future. In another aspect, many households have demand of buying house or car and they hoarded nearly all amount of money for shopping, because the necessary demand they want to buy but not enough money. Many enterprises trading profitably are short of capital to expand the scale, increase the competitive ability and earn more profit. Demand and supply will create the market. Nowadays, the commercial bank system is the center of the credit market in each country. The banks mobilize the idle balances in the society according to different schedules and then lend the potential customers.
If the money is stored in the cabinet or strong-box of the family, in the later the amount is the same, no change. However, the money is to lend, it makes the interest, the longer the time for lending is, the bigger the interest is. This is because of at least two reasons. Firstly, although lending friends or depositing at a bank, lending still contains a certain implicit risk because the partner is loss-marking or goes bankrupt leading to incapacity for payment, so the interest rate is the reward for acceptance of risk. Secondly, the inflation decreases the purchasing power of currency according to the time, so the interest rate is the compensation for depositor to balance the purchasing power at two times. The depositor is enjoyed the saving interest from borrower through the intermediate role of the bank.
If you have the temporary idle balances and don’t have demand of investing hazardously, apart from depositing, some other investment products in the financial market make you pay attention such as: Treasury bill, public bond, corporate bond. This is the financial instruments issued by the Government or companies with different dead-line and the interest rate level defined before.
1.7.2 Average rate of return in business operation
Depositing or buying the bond is the simple and safe investment form, contributing capital into business operation or investing in stock contains many risks. Business operation enterprises have many relations in the operation process.
Firstly, the enterprises must produce, trade according to the regulation of the law, execute the current tax policy. With the time, the law system is continuously completed and has the changes affecting strongly the business operation of the enterprise. The financial market has a strong attachment to the enterprise through services of mobilizing capital, investment trust and multilateral payments operations. Currency interest rate, exchange rates, and the liquidity in the interbank market are the matters cared by the enterprises. The market of the input factors is the place where the enterprise imports the materials, sells the finished products, energy and recruits manpower serving to business operations. The sale market of output commodity of the enterprises can be in the country or abroad, the relationship between the manufacturer and sale market is very important and has permanence in each enterprise. In the background of globalization, the investment capital flows circulate quickly and the commercial relation develops, the commodity markets change strongly, create many risks and squeeze on competition for the enterprises.
Consider the relation between the enterprise and the rest of economy to show the complicated level of business operation. The reasons which create the instability in the market of finance – currency, the shocks in the market of commodities, services, technology changing too fast or the unstable legal environment can create the irresistible risks for the enterprises. In the first months of the year 2008, the inflation in our country increased quickly, the state bank executed the solution of tightening the currency, pushed the lending interest rate too high, the small and medium enterprises hardly approached to borrowing resources leading to the stagnant business operation, many enterprises produced half-heartedly or forced to bankrupt. In the middle of the year 2008, the price of many important input commodities such as petrol, metal ore, food… doubled than that at the beginning of the year, and then suddenly halved, even had one-third left at the end of the year, this shocked to many enterprises. The financial crisis in 2008 originated from United State and spread around the world, now as the world economic crisis is a big storm. In United State, the Government of this country spends fearlessly one thousand billion USD to rescue the insurance groups, complexes of lending money on mortgage or bank financial institutions before the risk of falling. Besides that many great names in US finance must incorporate or go bankrupt. In addition, “VIPs” in US automobile manufacture branch are appealing to the support from the Government to avoid the line collapse.
Know the risks enclosing to business operation, the enterprises want the suitable profit to balance the investment effect. The rate of return of the enterprise in general must be higher than the input interest rate at banks to attract the investment. We know that individuals or community who provides capital to trade is because of the basic target: profit. There are charitable organizations, they establish the business units to create the jobs for street children or somebody establishes company to create the reputation. Cases like this are insignificant. Some people don’t like to be in somebody’s employ, they establish the small business to work by themselves, their goal is also profit, but if failing they accept considering their effort as interest. An important question is: How much profit do the enterprises want and how is average profit in reality? For the enterprises, the profit is as much as possible; they always use every chance to increase the income. However, the business world is very fierce, there are winner and loser, there are success and failure. With entire economy in general, most of enterprises get the suitable rate of return.
General model on market economy
We consider the general economic model in figure 1.5 including fully components in pure competitive background to establish the short-term balance of the economy. This model supposes that the economy is close, pure competitive and the policies of financial year - currency is stable.
The enterprises provide commodity to the market and receive the input commodity in the market including raw materials, semi-products, energy and labor service. The banks provide the credit to the enterprises but receive the investment trust and interbank payment operation. Households and individuals buy consumer goods in the markets concurrently provide the labor service to the market. Households have demand of depositing, borrowing capital and paying by the bank. Households also supply manpower, direct investment capital to the enterprises and enjoy the income and revenue.
Average rate of return of enterprises block
The enterprises desire the high profit; they must find the way of increasing the revenue and decreasing the input expenses. However, households with limited budget want to buy goods with cheap price and the salary of members of the family is as high as possible. At first sight, we think that is the severe contradiction, but in the fact, it is easy to harmonize because the benefit of two parties is close for the goal of existing and developing together. Markets of commodity – service and manpower salary balance automatically and operate fluently as arranged.
If designate RDN as average rate of return of enterprise block in a certain period.
Z as total of companies, production units, business households… (Called the enterprises) in every fields of business operation of the economy.
Ii as equity of the i-th enterprise, (i = 1…Z ). As foregoing, to ensure the uniformity and reasonableness when comparing the operation effect of the enterprises, this value must be calculated again according to the current price.
Mi as net profit of the i-th enterprise in a year. So, if we know the profit of the enterprise in any period of time, need to convert to the profit calculated in a year.
Ri as rate of return of the i-th enterprise in a certain period of time; Ri = Mi / Ii * 100%.
We have: RDN = (R1I1 + R2I2 + ....+ RzIz ) / (I1 + I2 + .....+ Iz) = = ∑Mi / ∑Ii * 100%
The average rate of return of all the enterprises is equal to the rate of return calculated commonly for entire of business block.
Because the currency interest rate changes according to short-term time with the situation of price inflation, subject to each period of economic development, the absolute value of RDN don’t reflect exactly the operation effect of business block.
If we call Rtb arithmetic average of the interest rate of input and output of the bank system in a certain stage; RDN as average rate of return of business block in same stage; and put ∆R = RDN - Rtb; then ∆R is the value showing better on the level of effective operation of business block when comparing with savings interest rate level in same stage. When average rate of return RDN is more than average interest rate Rtb, we have ∆R > 0; when RDN = Rtb, we have ∆R = 0; when RDN < Rtb we have ∆R < 0.
Now we start to go into the core and interesting matter of this item that is to find the answer of the question on average rate of return of the enterprises. To have the relative exact answer, we have to survey a business cycle with hot and cold states of the economy. Through each development stage in the economic cycle, basic factors such as: price of commodity, currency interest rate, psychographics and investment change; this affects definitely to production scale and operation effect of the enterprises. Notice that the economic model considered in this section is the close economy, perfect competition and having little intervention of the Government.
We start the prosperous development stage of the economy. Then the inflation is at average level, suitable interest rate, moderate unemployment and high economic yield. This temporary equilibrium state is called hot equilibrium state of the economy, consumption belief and investment is at high level. Commodity price trends increasingly meanwhile the salary and interest rate increase more slowly, so average rate of return of the enterprises is greater than the lending interest rate of banks. At that time, the enterprises want to borrow more money to expand the business operation to get more profit. The investment capital in entire economy increases uniformly, enough job, the income of households is improved, expenditure in the society increases. In the stage of prosperous economy, the inflation and the interest rate increase, the unemployment decreases, the economic yield is always at high level. This stage is shown by section 0-1 in figure 1.6.
Figure 1.6: The relative change of average rate of return of business block comparing with banking interest rate (∆R) through different development stages of economic cycle
The commodity price increases continuously with the time and at some time, the inflation rate is higher than saving interest rate. Many people want to keep money to look up the working chance and not want to deposit money into the bank because the current interest rate is not attractive. To ensure liquidity and keep the customers, banks concurrently increase saving interest rate and lending interest rate. High inflation leads to decrease real income of employees and pressure for increasing salary in the enterprises. High capital expense and pressure of increasing salary make the enterprises limit the investment. At this time, average rate of return of the enterprises starts to trend going down. This stage is shown by section 1-2 in figure 1.6.
Investment capital in business operation increases strongly in the previous stage, now produces the products and make increasing the output commodity yield, in which quantity of consumption commodity for supply also increases. Because of high interest rate, households economize more and decrease expenditure, so demand of consumption commodity decreases, leading to that consumption commodity price trends to decrease. The enterprises which produce consumption commodity will decrease the profit and limit the expanse of production. The dull situation in the enterprises which produce consumption commodity will spread quickly to area of the enterprises which produce raw materials and tools. Therefore, the common investment tendency in whole economy is temporarily slack. At that time, average rate of return of the enterprises is lower than lending interest rate, but better than the input interest rate of the bank. Average rate of return of the enterprises is like this, however when consider each particular enterprise, it is different. Some enterprises get the rate of return higher than the lending interest rate level of the bank, and they want to borrow more capital to expand the business. The enterprises which get the rate of return lower than the lending interest rate level of the bank, but higher than the interest rate of saving deposit trend to stabilize the production, not expanding the scale but not want to narrow the production. The enterprises which have the rate of return lower than saving deposit interest rate or do at a loss find the way of narrow the production or dissolve. So, three groups of enterprise which have the different business effect, select the private direction and general production scale of the economy change at small level. At this equilibrium state, the situation of business operation and commodity price in the markets starts to stabilize, the bank interest rate is suitable, and expenditure activities of families equilibrate to supply commodity resource. We call this is stable equilibrium state of the economy. This stage is shown by section 2-3 in figure 1.6.
Now we continue to suppose that while the economy is at stable equilibrium state, there is a shock on the market of real estate. The script can follow: Because in previous years, people who have demand of buying the house increase, the real estate companies mobilize the big capital resource to invest in this lucrative field. The speculators also enter in the market to find the short-term profit, so appear imaginary demand everywhere. Because want to earn more profit, the real estate companies concentrate in building the high-grade apartments and villas to sell. When the projects complete, the investors understand that, the real demand on villas and high-grade apartments is very low, mainly the speculation activity of creating the imaginary demand. The real estate market freezes temporarily, the price reduces strongly, projects under construction stop temporarily, the workers in construction field are massively out of work. The stagnant real estate market will affect to the other relative production fields such as construction materials, interior goods, … The unemployment rate in the society increases, the people limit the expenditure. The price of goods in the markets has the sign of reducing strongly and of course, the profit level of the enterprises reduces continuously. The average rate of return of the enterprises also reduces thereof, and if the commodity price reduces continuously, the average rate of return of the enterprises can reduce lower than the input interest rate of the bank. This stage is shown by section 3-4 in figure 1.6.
Figure 1.6 (2nd re-draw for follow advantageously): The relative change of average rate of return of business block comparing with banking interest rate (∆R) through different development stages of economic cycle
The low investment effect makes the production scale of the economy narrow gradually. After a period of adjusting, the commodity price and production scale establish the bottom level and not reducing. The economy gets the new temporary equilibrium state, called cold equilibrium state, at that time, the average rate of return of the enterprises can be lower than the level of saving deposit interest rate. Normally, when the commodity price level reduces, the bank interest rate will reduce, but when the economy is taken ill, the belief reduces, the overdue debt increases in the banks, so reducing the interest rate will be hard to attract the idle balances in the people. The interest rate only reduces if having the intervention by the Government through the policy of the loose currency. However, here we temporarily don’t count the role of the Government, we want consider the method of self-adjusting of the economy. The economy continues to operate normally at new temporary equilibrium state, in which the price stabilizes at low level and saving interest rate is rather attractive. This stage is shown by section 4-5 in figure 1.6.
In next period, the enterprises re-arrange the business operation; the banks recover the belief of the customers. Households and economic organizations which have the idle balances, are afraid of risks before, but now they bring money to deposit in the bank to enjoy the interest. The area of business operation doesn’t have new changes; lending debit balance can’t increase, the input interest rate trends to reduce gradually, bringing about the similar reduction at lending interest rate. Such interest rate development is very convenient for business operation. On the other hand, when the interest rate reduces and the belief in the economy increases, people are fiery with consumption and this pushes up the price of commodity. The price of commodity increases, this improves the profit of the enterprises. The enterprises continue to mobilize the capital, expand the business scale to increase the profit. The unemployment in the society reduces, the commodity yield increases and can get the equal level with the period of before happening the economic shock. This stage is shown by section 5-6 in figure 1.6.
Commodity price increases at suitable level, after that enters into stability and equilibrium with commodity yield. Bank interest rate can increase little and establish new platform. The average rate of return of the enterprises is in the middle of the input and output interest rate of the banks. At this time, the economy returns to stable equilibrium state. This stage is shown by section 6-7 in figure 1.6.
Summarize above analyses we find that, the economy trends to change continuously in long-term, but it can equilibrate temporarily in short-term. At short-term equilibrium states, the price of commodity, interest rate and yield level is relative stable. Figure 1.6 shows the process of relative change of the average rate of return of the enterprises according to the time correlative with changes of the economy through some short-term equilibrium states analyzed above.
Figure 1.6 (3rd re-draw for follow advantageously): The relative change of average rate of return of business block comparing with banking interest rate (∆R) through different development stages of economic cycle
(0-1) is the temporary equilibrium state, in which the price, yield, interest rate and average rate of return of the enterprises are at high level, we call this hot equilibrium state. (1-2) is the adjusting stage of the economy. (2-3) is stable equilibrium state, there the yield, price, interest rate reduce comparing with hot equilibrium state. At this equilibrium state, the average rate of return of the enterprises is equal to arithmetic average of the input and output interest rate of the bank. (3-4) shows the depression stage of the economy. (4-5) is cold equilibrium state, the yield, price and interest rate here are low. (5-6) is the stage of rehabilitating the economy. (6-7) is new stable equilibrium state, the yield, price and interest rate here rehabilitate strongly comparing with the bottom (4-5).
Finally, we return the main content of this section that is to try to answer the question: where is the average profit of the enterprises? As we know, at hot equilibrium state of the economy, the average rate of return of the enterprises is higher than the output interest rate of the bank. At the cold equilibrium state, the average rate of return of the enterprises is lower than the input interest rate at the bank. And at the stable equilibrium states, the average rate of return of the enterprises is between the input and output interest rate of the bank. So, if consider in the long-term, the average rate of return of the enterprises is equal to arithmetic average of input interest rate and output interest rate of the bank.
If call R1 long-term average input interest rate of the bank, call R2 long-term average lending interest rate of the bank, call RDN long-term average rate of return of the enterprises, we have:
RDN = (R1 + R2) / 2
In a close and perfect competitive market economy, long-term average rate of return of all enterprises is equal to arithmetic average of long-term average interest rate at input and output of system of commercial banks.
For example: in a long-term period, if R1 = 8%, R2 = 12% then RDN = 10%. Or R1 = 3%, R2 = 6%, then RDN = 4.5%.
We try calculating RDN in 5 years with the data as following:
We have: R1 = (5% + 4% + 6% + 7% + 3% ) / 5 = 5%
R2 = (8% + 7% + 9% + 10% + 6%) / 5 = 8%
RDN = (R1 + R2) / 2 = (5% + 8%) / 2 = 6.5%
At the beginning of this section, we suppose about the model of the market economy which is close, perfect competitive and bears little influence by the Government. In fact, the regulation of the Government in the market economy changes only the adjusting time of each hot or cold stage of the economic cycle, it can’t level the cycles or keep the economy at fixed equilibrium state. Therefore, macroeconomic regulating role of the Government doesn’t affect much long-term average rate of return of business block. In an economy which doesn’t have perfect competition in some fields, the average rate of return in those fields is bigger than that in other fields and this can affect the common average rate of return of all the enterprises. In an open economy, investors can select the suitable place in different countries to execute the business project with the highest effect. Besides that, open trade relation makes wrong our analyses on economic cycle mentioned above. Therefore, in an open economy, the average rate of return of the enterprises depends on the competitive ability of domestic business block in the world market.
1.8 Price and commodity value
We start by brief and clear concepts.
1. In common meaning, commodity is any product transacted, bought and sold in the market. Commodity is divided in at least 4 kinds: physical commodity, service commodity, super-commodity and secondary commodity.
2. Physical commodity is a physical product with particular use and traded in the market, they have the origin from the nature constituted by labor of human. For example: rice, coal, domestic water, television, antibiotic,…
3. Service commodity is a spirit product or right of using temporarily a particular product, right of being guided, cared from someone, all trade in the market. For example, watch the music program, travel, rent the house, rent the car, tutor, …
4. Super-commodity is the complexes of commodity – service which is big, multifunction, traded in the market. For example, enterprises, hospitals, ports, …
5. Secondary commodity is instruments of finance, vouchers of confirming assets ownership by money, ordinary commodity or a part of ordinary commodity, traded in the market. For example, enterprise share, public bond, futures contract, …
6. In the market economy, commodity value shows at economic value, calculating by money amount and decided by manufacturers – distributors.
7. Commodity price is the exchange value through transaction, calculating by money amount and decided by the market.
The topic on price and commodity value is paid attention because it brings the practicability in the life and has special economic meaning. Perhaps you leant about different concepts related to this content, but here we analyze according to another method and infer the important results.
As mentioned above the commodity is divided into many different kinds, each kind has specific characteristics, so determining the value of commodity can’t observe a common formula. In this section, we mention only determining the value of general kinds of physical commodity and service commodity.
1.8.1 Proper value of commodity
In the market economy, there are many different fields of business operation to meet the diversified demand of people. Each field of business operation has many competitive enterprises to affirm the post in the business world. Each enterprise has specific production technology, certain management ability and particular sales method. The commodity of an enterprise has the common features and different features with enterprises in same field. We start this topic by determining the proper value of commodity.
In previous sections, we determined the expense of business operation of the enterprise (Psx-kd) by accumulating three kinds of expense: manpower expense, material resources expense and derived expense. That is total expense to produce and distribute the commodity quantity Q of the enterprise. So we are easy to calculate the expense of business operation for a commodity unit by dividing total expense by commodity yield Q.
If call pksx-kd expense of business operation for a commodity unit of a typical enterprise K, we have:
pksx-kd = Pk sx-kd / Qk
In which: Pksx-kd is total expense of business operation of enterprise K in a certain period, Qk is commodity quantity produced and sold in that period.
In reality, there are many enterprises which produce and trade in same commodity type, each enterprise applies particular production technology and secret, different method of marketing and sales, so the expense of business operation for a commodity unit will be different.
In before section, we know that the long-term average rate of return of the enterprises (RDN) in entire economy is equal to arithmetic average of the input and output interest rate of the bank. However, because of severe competition among the enterprises in same production field and among fields, the rate of return of each field of production and each enterprise is different; it can be bigger, equal or smaller than RDN.
Call Vk necessary commodity price so that enterprise K which we are considering, gets the rate of return equal to the average rate of return of the enterprises RDN. Here Vk is only supposed price, it is not necessary equal to real price of commodity in the market. We have following formula:
Supposed profit of the enterprise Mk = Vk Qk - pksx-kd Qk = ( Vk - pksx-kd)Qk
Supposed the rate of return of the enterprise Rk = Mk / Ik * 100% = ( Vk - pksx-kd)Qk / Ik * 100% = RDN
In which, Ik is equity of the enterprise, Qk is commodity yield consumed in a year, pksx-kd is expense of business operation for a commodity unit.
From above formula, we have: (Vk - pksx-kd) Qk = Ik RDN → Vk - pksx-kd =
→ Vk = pksx-kd + IkRDN / Qk
Value Vk reflects the expense of business operation with specific characteristic in each enterprise and contains a profit level enough for the enterprise to get the rate of return equal to the average rate of return RDN. Vk is called proper value of commodity produced by enterprise K. In reality, if product sale price of enterprise K is bigger than proper value of commodity Vk the rate of return of the enterprise is bigger than average rate of return RDN. If product sale price is equal or lower than Vk the rate of return of enterprise K is equal or lower than RDN.
Commodity value in circulation
In the market economy, there is division of labor at high level. Manufacturers concentrate in raising the productivity, quality of products and marketing, spreading in the market. Normally, they find only big distribution clues to deliver without executing all process of distributing commodity. Professional distribution system executes the duty of transporting commodity from production enterprise to the final users everywhere. Commodity distribution system can include many intermediate stages, so retail price of commodity can be higher much than factory cost of the manufacturer.
Commodity distributors are specific enterprises with similar input and output factors, if they are different, the difference is only time and delivery place. Commodity distribution clues don’t change the shape, structure or quality of products, but they must provide capital for business, transport expense, yard expense to collect commodity, expense of market research and manpower for sales. So, commodity although produced only in a fixed place, is presented and appeared around the world.
Commodity distributors are also business units, distribution activity is free, so the idle capital resource in the society can be put in production or investment of expanding the distribution system. In the stable conditions of the market, the average rate of return of distribution field is correlative to other fields of business operation.
We consider a distribution enterprise A, this distributor imports many different kinds of commodity and resell in the market. Suppose that, in the commodities imported by distributor A there is commodity B produced by enterprise K. Import price of commodity B is Pk. To distribute a commodity B, enterprise A must bear the expense pka. Call mka necessary profit of enterprise A collected on a commodity unit B so that the rate of return of enterprise A is equal to RDN. Call Vka proper value of commodity B at output of enterprise A. We have:
Vka = Pk + pka + mka
Suppose in long-term, average commodity B price of enterprise K for distributor A is equal proper value Vk determined by enterprise K, it means Pk = Vk .
So: Vka = Vk + pka + mka.
From above formula, we find that through the intermediate distribution stage, the proper value of commodity rises. The more intermediate stages there are, the higher the proper value of commodity is pushed. In reality, distribution field also has severe competition to exist and control the market share, so intermediate stages of the distribution system will reduce according to the time and finally form an irreducible distribution system.
1.8.2 Average value of a variety of commodity
In the competitive market, many manufacturers bring together out market a kind of commodity which is similar about size, shape, use, etc, we call it a variety of commodity. A commodity item is divided into many groups of commodity; each group of commodity includes many varieties of commodity. For example, rice has 2 groups: ordinary rice and sticky rice, each group of ordinary rice or sticky rice has not less 10 different varieties of rice. Television item includes many groups of commodity such as television using image tube, LCD television, Plasma television,… Each group of television also includes many varieties such as television 14”, 21”, 25”,… New drug item can include hundreds groups of commodity, vitamin is a group of commodity, acid ascorbic is a variety of commodity under group of vitamin, there are tens of different acid ascorbic supplied by many manufacturers.
We consider a variety of commodity B. There are N enterprises in same field producing variety of commodity B, each enterprise has specific technology, so production expense is different.
Call Vk proper value of commodity produced by k-th enterprise ( k = 1….N). Call Qk commodity quantity consumed by k-th enterprise in a year. Call Vo average value of variety of commodity B. We have:
Suppose that N enterprises sell commodity B in the market with different price subject to particular property on the product produced by each enterprise, but average price is equal to Vo. We try calculating the rate of return of entire field including N enterprises to consider the result.
R = ∑Mk / ∑Ik In which R is the rate of return of entire field; Mk , Ik is in turn profit and investment capital of k-th enterprise.
Mk = PkQk - pksx-kd Qk = (Pk - pksx-kd ) Qk in which, Pk is product sale price of k-th enterprise, pksx-kd is expense of business operation for a commodity product of k-th enterprise.
→ ∑Mk = ∑(Pk - pksx-kd )Qk = ∑ PkQk - ∑ pksx-kd Qk
Because of supposing Vo as average sale price of N enterprises so: ∑ PkQk = Vo ∑ Qk
Vo is also average value of variety of commodity B, so: Vo ∑ Qk = ∑ VkQk
→ ∑ Mk = ∑ PkQk - ∑ pksx-kd Qk = ∑ VkQk - ∑ pksx-kd Qk = ∑ (Vk - pksx-kd )Qk
We find that (Vk - pksx-kd )Qk is the profit of k-th enterprise when Pk = Vk that is also the profit enough to k-th enterprise having rate of return equal to RDN .
If put (Vk - pksx-kd )Qk = Mko we have:
R = ∑Mk / ∑Ik = ∑Mko / ∑Ik , because Mko / Ik is equal with every k from 1….N and equal to RDN so:
R = ∑Mko / ∑Ik = RDN
Finally we find that, if average sale price of enterprises is equal to average commodity value Vo, the rate of return of entire field is equal to RDN .
1.8.3 Average price of a variety of commodity
We continue the variety of commodity B mentioned above.
Call Po average price of the variety of commodity B, call Pk and Qk is in turn product sale price and sold commodity volume of k-th enterprise, with k = 1…N. We have:
Po = ∑ PkQk ∑ Qk
If Po = Vo , it means average commodity price is equal to average commodity value, the rate of return of entire field of producing variety of commodity B is equal to RDN. Then investment effect in field of producing commodity B is equal to average level of the economy. Among N enterprises producing commodity B, the enterprise which has high rate of return will continue to expand investment to increase the profit and market share, the enterprises which have low rate of return will narrow the production to raise the effect. Perhaps some weak enterprises will leave out this field to change to other field of production, and some enterprises in other fields change to invest, produce commodity B. In general, in this case, production field of commodity B is in equilibrium state, investment capital flow and commodity yield supplying to the market are always stable, supply and demand is equilibrium and the price changes little. We call it is equilibrium state of a production field.
Put: Po = coVo in which, co is coefficient of reflecting the supply and demand in the market of commodity B.
When co = 1 we have Po = Vo , then the commodity market is equilibrium, we have supply is equal to demand.
When co > 1 we have Po > Vo , it means average commodity price of entire field is bigger than average commodity value of entire field, the rate of return of entire field is bigger than average rate of return of the economy. At that time, with market of commodity B, supply is smaller than demand.
When co < 1 we have Po < Vo , it means average commodity price of entire field is smaller than average commodity value of entire field, the rate of return of entire field is smaller than average rate of return of the economy. At that time, with market of commodity B, supply is bigger than demand.
1.8.4 Proper price of commodity
Each enterprise has different production technology, the commodity in the same variety has particular features, although in general they are similar. For example, consider a kind of commodity, namely television LCD 32”. There are many firms producing together this variety of commodity such as: Samsung, LG, Sony, Panasonic, Sanyo, Toshiba,…. Look at the appearance, the products of firms are similar, but consider carefully there are differences about sharp level, control software, warranty, … And of course, the price is different. The specific unique features on the product can create the special consumption effect, make the price increase higher than commodity of the same variety. Although produce the product in same variety, each firm tries to create the particular impression for customers. That is about product quality, marketing method or way of taking care of the customers.
Call Pk price of commodity B produced by enterprise k in the field.
Put Pk = ckPo in which: Po is average price of commodity B in the entire field, ck is the coefficient of reflecting particular supply and demand of k-th enterprise in the market of commodity B.
If ck = 1 then Pk = Po , price of commodity B produced by enterprise k is equal to average price of entire field.
If ck > 1 then Pk > Po , price of commodity B produced by enterprise k is bigger than average price of entire field.
If ck < 1 then Pk < Po , price of commodity B produced by enterprise k is smaller than average price of entire field.
From Pk = ckPo and Po = coVo → Pk = ckcoVo in which: Vo is average value of variety of commodity B, co is coefficient of reflecting the supply and demand in the market of commodity B.
From previous parts, we have: Vk = pksx-kd + IkRDN / Qk
When Pk = Vk , it means price of commodity is equal to its value, the enterprise gets the rate of return equal to RDN.
From Vk = pksx-kd + IkRDN / Qk → Vk - pksx-kd = IkRDN / Qk
Put mo = Vk - pksx-kd = IkRDN / Qk , mo is the profit on a commodity unit when the enterprise has the rate of return equal to RDN.
Put m = Pk - pksx-kd , this is real profit on a commodity unit.
Put ∆m = m - mo = (Pk - pksx-kd) - (Vk - pksx-kd ) = Pk - Vk = ckcoVo - Vk = ckcoVo - pksx-kd - IkRDN / Qk
∆m is called competitive profit on a commodity unit (competitive profit of enterprise for short). If ∆m > 0 it proves the enterprise has good competitive capacity and at that time the enterprise gets superprofit. Value ∆m < 0 warns about bad competitive capacity of the enterprise comparing with other competitors in the market. ∆m = 0 shows that the enterprise has average competitive capacity in entire field.
From formula ∆m = ckcoVo - pksx-kd - IkRDN / Qk , we find that IkRDN is known before and invariable, co and Vo are specific values for entire production field and if there is change, it will affect whole the field. Therefore, each enterprise wants to increase the profit in general and value ∆m in particular, the enterprise must increase consumption yield Qk, decrease production expense pksx-kd and increase proper coefficient of supply and demand ck .
1.9 Supply, demand and price change
According to common principle, when we mention the supply and demand of a kind of commodity, it means we want to mention the real supply ability of the enterprise and effective demand of buyer, to eliminate the phenomenon of imaginary supply or imaginary demand. Supply and demand are not specific figures but are functions of describing the behavior tendency of seller and buyer in the market. However, volume of supply and volume of demand are the clear figures.
Volume of supply is the commodity quantity which supplier wants to sell at a specific price and in a determined period.
Volume of demand is the commodity quantity which buyer wants to buy at a specific price and in a determined period.
With a price level and period set before, manufacturers will bring out the market a specific commodity volume of supply suitable for the capacity and production effect. Similarly, with a price level and fixed period, buyer will consider and select the suitable commodity quantity to buy.
The period of surveying the volume of supply or volume of demand is subject to the desire of researcher and property of commodity. With items such as food, foodstuff, the surveying period can be daily or according to long or short time. With most of ordinary items, we can survey according to week, month, quarter or year. With the market of automobile or real estate, the surveying period at least is a month, even years, the collected data really has meaning.
Supply is general function to denote a set of volume of supply when the commodity price changes and surveying period is constant.
Demand is general function to denote a set of volume of demand when the commodity price changes and surveying period is constant.
Constant period plays the important role for surveying volume of supply and volume of demand when the price changes. When the period changes, the changes about investment capital flow, production technology will affect the supply and the changes about taste and income affect the demand.
1.9.1 Supply line and demand line
The simplest method to understand about supply and demand is to show them by graphs. We don’t hope to have the exact graphs because we don’t have enough specific figures but only expected figures on volume of supply or volume of demand. The supply line or demand line will be the imitating lines with sketch. However, they still show the nature of seller and buyer in the market.
With the low price, few enterprises want to supply the product, so the volume of supply is small; at low price level P1 we have small volume of supply Q1. When the price increases, the volume of supply also increases, at price level P2 > P1 we have the correlative volume of supply Q2 > Q1. The supply line SS in figure 1.7 shows the changes of volume of supply when the price changes.
Contrary to the supply, the cheaper commodity price is, the more buyers are and the bigger the volume of supply is, at low price level P1 we have rather high volume of supply Q1. When the price level increases, buyers decrease and volume of supply decreases, at price level P2 > P1 we have volume of demand Q2 < Q1. Demand line DD in figure 1.8 describes the change of commodity volume of demand when the price level changes.
1.9.2 Short-term equilibrium state
Now we remember the variety of commodity B mentioned in previous parts and continue analyzing the relation of supply and demand in the market by the graphs. Firstly, imitate the supply line and demand line on commodity B in next 1 month. We had the data related to the situation of supply and demand of commodity B in last 1 month. The average price level and consumption yield of variety of commodity B in last 1 month is in turn Po and Qo. Suppose that, at present, we find that no reason can change the market of commodity B comparing with last month. So, the supply line and demand line on commodity B imitating for next month preserve comparing with last month. Two lines of supply and demand (SS and DD) of commodity B show together on a coordinate system intersecting at point G(Po,Qo) as in figure 1.9.
At point G volume of supply is equal to volume of demand, besides no point satisfies such condition. With price levels more than Po volume of supply is bigger than volume of demand and at price levels less than Po volume of demand is bigger than volume of supply. Po is short-term equilibrium price of market of commodity B.
1.9.3 The shift of supply line
Suppose that variety of commodity B is a kind of ordinary rice. In last several months, the rice market in the world and in Vietnam is relative stable, The supply line and the demand line on rice in Vietnamese market with period of 1 month is always stable. Monthly average price is Po(VND/kg) and consumption yield in the month is Qo(kg). At this moment, we also survey the supply line and demand line on rice within next 30 days and find that they don’t change comparing with last month.
But after a week, a strong storm happens suddenly in the southern of South China Sea. This storm affects provinces in Southern Vietnam and Thailand, many main rice zones have a bad harvest. The news on the storm is spread and it affects the rice market at once. Rice suppliers understand what will happen in next period and start to limit sell rice to the market. From this moment, short-term supply line (1 month) on the rice changes. At each price level, volume of supply will decrease and supply line SS shifts to the right of the graph to position S1S1 as in figure 1.10. In general, demand line on rice in next month is stable; it means the line DD is constant. Two lines of supply and demand in next month intersect at point G1 correlative to new price level P1 and consumption yield Q1. At new equilibrium point of rice market, the price increases and consumption commodity quantity reduces.
Suppose that the storm doesn’t appear, but there is the information on a main crop more abundant than usual in Southeast Asia, the short-term supply line SS, in stead of shifting to the right, will shift to the left of the graph and establish new equilibrium point with demand line at point G2 correlative to price level P2 < Po and yield Q2 > Qo.
Besides the reasons on weather affecting main crops shifts the supply line, there are many other reasons affecting similarly. For example, applying new rice variety increases the productivity leading to increasing supply resource or using the progressive cultivating technology reduces the input expense and increases the supply resource. But the industrialization wave overflows into rural area, this will lead to narrow the agricultural land and reduce the ability of supplying rice.
1.9.4 The shift of demand line
We continue on the rice market. In previous months, suppose that the rice market is equilibrium at point G(Po,Qo), and at present the market is stable and two lines of supply and demand for next month is preserved.
We suppose that new event happening in the week is the fact Organization of Petroleum Exporting Countries OPEC suddenly cuts strongly the exploiting yield, make the price of crude oil increase. When the crude oil price increases, some developed countries use cereals as raw material for refining the biological oil to replace the ordinary oil. The oil price is high; more maize is put into factories of preparing biological petrol. The maize price in the market increases gradually and it becomes expensive comparing with other kinds of cereals, many people intend to use other kinds of cereals in stead of maize such as rice or wheat, make demand on rice increase. Therefore, now with each price level set before, the correlative volume of demand on rice will increase. The demand line DD in next month will shift to the right to the position D1D1 as in figure 1.11. The unusual price increase of maize affect only demand on rice, not affect the rice supply resource, so the supply line SS for next month is preserved. Two lines of supply and demand for next month intersect at point G1 correlative to price level P1>Po and Q1>Qo. At new equilibrium point of rice market, both of price level and consumption yield increase.
Another script can happen to the rice market. Suppose that in previous months the rice market is still equilibrium at point G (Po,Qo) and the next month is expected to not change. However, a problem happens suddenly. Scientists discover the pesticide in rice exceeding the permitted level. Therefore, the careful customers change from using rice to using wheat, the demand on rice reduces. Demand line DD will shift to the left of the graph and supply line SS preserves. These lines will intersect at point G2 correlative to P2<Po and Q2<Qo.
In reality, there are many reasons affecting the rice demand and shifting the demand line to the left or the right of the graph.
1.9.5 Long-term equilibrium state
We have just surveyed the rice market in short-term, in particular in a month. With such short period, when happen a shock on the supply, the supply line shifts strongly, the demand line preserves, or a shock on the demand, the demand line shifts strongly, the supply line preserves. However, in stead of surveying in a month, we survey the rice market in a next year; the situation will have many changes. The problem is, in short-term the market doesn’t have enough time to react with big shock happening suddenly, in long-term both supply and demand change to adapt to the market development. Return to the example on the rice market and the shift of supply line to the right when the storm causes bad crops. Therefore, in short-term the supply resource is scarce and rice price increases. After the rice price increases, farmers in areas which doesn’t happen the natural calamity find that the rice price is rather expensive and profitable for the crops, they try to take care of rice better than before to hope to get high productivity, both of having a good crop and having high price. Other farmers, who left rice to grow vegetables and crops before, now find the change they return to work before. Therefore, both of productivity and area of rice for next crop can increase strongly enough compensate for deficiency on rice damaged by severe storm in last crop of rice. So, in medium-term, volume of supply on rice will increase and can restore the yield as high as the yield before the storm happens. Supply line SS after shifting to the right because of the shock on supply, now shifts to the left, back to position before.
Clearly, short-term equilibrium state and long-term equilibrium state is different, we need to take account of them when survey the commodity markets. In short-term, the contingent factors often affect the development of supply and demand but in long-term the real demand of buyer and business effect of seller will decide the supply and demand in the market.
Now, we survey together the rice market in long-term, particularly in a year. Suppose that the lines of supply and demand in last year is SS and DD as in the figure 1.12, concurrently G0 is long-term equilibrium point of the market in last year, correlative to average price Po and rice yield consumed in the year is Q0.
Call Vo average value of rice kind in next year. Suppose that in next time, price of input items for rice production doesn’t change such as price of fertilizer, rice variety, wages, … Need to suppose additionally the stable natural conditions as previous years. Like this, in next year, average value of rice preserves and equal to average value of rice in previous year. Compare two values Po and Vo to infer the important results. If Po is lower than Vo, it means average price of rice in last year is lower than average value of rice. Then average rate of return of rice production field is lower than average rate of return of entire economy. Because rice manufacturers such as farmers, cooperatives, farms, plantations apply the different production technology, different input expense, therefore the rate of return is different. In reality, there is a section of rice manufacturers incurring losses or have low business effect. Therefore, the area of growing rice runs the risk of reducing in next rice crops because some farmers who grew rice but no effect, change to grow other agricultural products. Supply resource of rice in long-term will reduce and supply line SS shifts to the right of the graph. Consider the demand on rice in long-term, suppose that there is no unusual thing and demand line on rice preserves. When the line SS shifts to the right, the rice price increases gradually and consumption yield reduces.
Notice that when a group of farmers who work with bad effect must change from growing rice to growing other farm produce, the rice yield reduces and average value of rice reduces. Two values Po and Vo change in reverse order, when Po increases, Vo reduces. Supply line SS doesn’t shift unlimited to the right, it will stop when Po = Vo.
We continue to survey the rice market within 1 year, but this time, there are changes from demand. We continue to suppose that the rice market in last year is equilibrium at point G0 with the supply line SS and demand line DD as in figure 1.13. Average price of rice in last year is P0 lower than average value V0. Suppose that conditions related to rice production is constant, the average value of rice in next year is equal to V0. As above, we find the supply line SS will shift to the right so that average price moves towards equal to its value.
Now we continue to consider the rice demand. Because the price of petrol escalates, a big quantity of cereals is used into the goal of preparing the biological petrol, so the price of maize, soybeans increases. Many people change from using other kinds of cereals with high price to using rice, so the demand on rice increases. If this situation is not temporary but long-term, the demand line on rice in next year will shift much to the right of the graph. Suppose the line DD to shift to the new position DvDv as in figure. The line SS will shift gradually to the right according to the time until average price is equal to value V0 and then it stops. Suppose that the line SS shifts to new position SvSv. Two lines of supply and demand for next year as SvSv and DvDv intersect at point Gv correlative to new price P = V0, and yield Q = Qv. Notice that, because the supply yield in next year changes from Q0 to Qv , average value of rice in next year has the change with average value of rice in previous year.
In brief, in short-term the market changes strongly because of the shocks, in long-term, the market changes with more basic characteristics. The income ability and the taste of customers will be the motive power to shift the demand line, average value of commodity is the centre attracting the shift direction of supply line. In long-term, the market is equilibrium at the position which average price of the commodity is equal to its average value.
1.10 Operation law of market economy
In daily life, economic activities hold the most of time fund of each of us. Select goods when shop, work in an enterprise, calculate the daily expenditure or research the investment plans, all they are related to money, rice – economic values. The market economy is severe competition, all parts in the market economy must observe its operation laws to exist and develop. The operation law of the market economy uses the value of currency as the motive power and the market is the arbitrator to fix the final result of the competition. Competition for the economic target is the basic factor which helps the market economy regulate by itself and get the equilibrium state in short-term as well as long-term.
1.10.1 Benefit equilibrium in each individual
Each individual has the particular ability on health, intelligence, personality, aptitude and assets. The market economy has high freedom, the scopes of business are diversified with many types of enterprises. Individuals, subject to the ability, select their job as employee or employer. The enterprises must compete severely to exist, they appreciate the manpower. Through the labor market, each person can select a favorite job with suitable salary; the enterprises recruit the personnel team with suitable ability and competitive salary.
1.10.2 Benefit equilibrium in family
Each family has own budget, it is formed from the income of members in the family. Those items can include salary, bonus, interest + saving principal and interest + investment capital. Families must plan to allocate the budget for usual expenditure, buying durable goods and a part for savings or contributing capital for business. With limited budget, families are careful in selecting the necessary consumption goods – services to get the optimal satisfaction. The price of commodity in the market is formed naturally through the rub between buyer and seller. The equilibrium price of commodity shows their social value. There are some factors affecting plan of allocating the budget of families. First is the inflation which reduces the purchasing power of currency and each family must spend more money to receive the commodity volume as before. The rate of allocating expenditure also changes because price level changes unequally among items. If saving interest increases, households will consider more carefully between buying durable commodity for using today and depositing for saving to buy more in another moment.
1.10.3 Benefit equilibrium in each enterprise
Each enterprise must plan an effective business strategy to compete with competitors in the same scope. They need to promote the own strength to impress on the product from quality, price to serving style. To collect high profit, enterprises must reduce production expense suitably, raise the commodity quality and strengthen advertisement marketing to improve the specific coefficient of supply and demand in the market. In the process, subject to the profit, each enterprise has the reasonable behavior to optimize the profit or limit the loss. The enterprises which have the rate of return lower than interest rate of saving deposit must raise the competitive ability, if not they must narrow the production and dismiss employees. The enterprises which have the rate of return in the middle of average interest rate of input and output of the banks are ranked in average grade. These enterprises, although don’t want to expand the scale of enterprise, not to go as far as to narrow the production or cut the manpower. Group of leading enterprises of entire field has the rate of return higher than average output interest rate of the bank. They want to expand the business scale to increase the profit by own fund or borrowing. When the enterprise still has the ability to increase the profit, the enterprise has the motive power to increase the supply yield. The enterprise stops temporarily swelling out when the marginal profit is equal to expense of borrowing capital, in other words, when marginal revenue is equal to total marginal expense, the enterprise stops temporarily expanding the production scale.
1.10.4 Benefit equilibrium in business operation sector
In the same field of production, enterprises compete to affirm the position and trademark. Different fields of production have no direct reason to confront in the market, social capital flow allocated into each field is not fix but adapt oneself to the circumstances. The economy has many different scopes, because the changes on supply and demand happen continuously, the situation of business operation in each field has certain advantages and difficulties. The rate of return among fields distributes unequally according to the time, therefore, the investment capital flow is always asked with insistence from this field to other field. The fields of business operation which the average rate of return of entire field is bigger than RDN and have growing prospect will be taken special interest by the society. The quick-witted investors find the way of narrowing production at fields which are not effective in order to concentrate the resources into places having good profit. The social capital flow shifts to the direction of increasing the profit and reducing the risk for itself. The scale of promising fields will be expanded until the rate of return of entire field reduces and equal to average rate of return RDN. The bad fields of business operation will narrow the scale, reduce the yield until the rate of return of the field increases gradually and get the value equal to RDN.
We divide the economy into two sectors: sector of production and sector of consumption. The macro-equilibrium shows at the equilibrium of total supply and total demand in gross domestic product (GDP). In normal economic conditions, the situation of market price is stable, the equilibrium yield of supply and demand and people’s income are stable. When happen the change on supply or demand, because of any reason, also affect macro-equilibrium of the economy. Hereafter we will survey the model of total supply and total demand of the economy in different periods: short-term, medium-term and long-term; when the economic background changes. Time for short-term or long-term is subject to the real condition and determined by surveyor. With the proper supposition on time convention for this section as following: short-term is 6 months, medium-term is 12 months and long-term is 24 months.
Suppose that the economy is at short-term equilibrium state expected with line of total supply SS and line of total demand DD intersecting at G0, correlative to yield Q0 and average price P0 as in figure 1.14. The important matter is, when appear the shocks changing from supply or demand, how does the economy behave to re-establish the new equilibrium state? We consider the event of a country just joining in WTO for example. Besides the event of joining in WTO, suppose that in survey time, other conditions of the economy have few changes.
Suppose that all people and enterprises think that the economy will develop strongly in the future because the country has just joined in WTO. Although current income is like as before, everyone is joyful and happy when they think the economy of the country develops, it means the income in the future will increase and their purse is fuller. Everyone awards by themselves by increasing the expenditure from that time. Short-term line of total demand DD moves strongly to the right of the graph to the position D1D1 and short-term line of total supply SS is constant. Two new lines of total supply and total demand intersect at point G1, correlative to average price P1 > P0 and yield Q1 > Q0. New short-term equilibrium state of the market is established at the level which the price and yield increase comparing with old equilibrium state, reflecting the excitement of all society before deciding to join in WTO of a nation.
Suppose that the economy is at medium-term equilibrium state supposed with line of total demand DD and line of total supply SS intersecting at point G0, correlative to average price P0 and equilibrium yield Q0 as in figure 1.15. As above we find the reaction of the market in short-term before the decision of joining in WTO of a country. However, in medium-term and long-term, the matter will be different when initial excited psychology is replaced by economic selections in the production and consumption. When joining in WTO, customs barrier must reduce and competitive pressure for domestic enterprises increases. Import duty of commodity and service reduces strongly, create the advantage for domestic sector of production because the input expense reduces. Therefore, medium-term line of total supply SS will shift to the left to the new position S2S2 as in figure. When join in WTO both of export and import increase, if internal economy has weak competition ability, the import increases more quickly than the export and vice versa. Therefore, after join in WTO, total demand and domestic commodity depend on competitive ability of the country in the world market. Suppose that domestic commodity proves weaker than in international competition, then total demand for domestic commodity reduces, medium-term total demand line DD shifts to the left to the position D2D2 on the graph.
Two new medium-term lines of total supply and total demand (S2S2 & D2D2) intersect at point G2 correlative to average price P2 < P0 and Q2 < Q0. We find that in new equilibrium state, both of price and yield reduce, reflecting the weak competition of the economy of a country after joining WTO.
In section 1.7 we know that, the average rate of return of business block in long-term RDN is equal to arithmetic average of long-term input and output interest rate of the bank system. In section 1.8 we judge that, the value of commodity is determined through expense of business operation and the average rate of return RDN. Therefore, when considering entire economy in long-term, general average price P0 of every commodity and service will be equivalent to general average value V0 of every commodity and service.
Suppose that the economy is in long-term equilibrium state expected total demand line DD and total supply line SS intersecting at point G0, correlative to average price P0 = V0 and equilibrium yield Q0 as in figure 1.16.
We have just surveyed the medium-term equilibrium state of the economy with suppositions including the event of joining WTO and weak competitive ability of domestic economy comparing with the rest of the world. With such initial suppositions, long-term lines of total supply and total demand of the economy will shift to the direction similar to medium-term lines of total supply and total demand. Total supply line SS moves to the position SvSv and total demand line DD moves to the position DvDv. These two new lines of total supply and total demand intersect at equilibrium point Gv correlative to general average price Pv = V and the yield Qv. V is long-term general average value of every commodity and service considered in new background of the economy. In this case, V < V0, reflects that the expense of business operation of business block reduces when the country joins in WTO. And Qv < Q0 shows the weak competition of domestic economy when integrating in international economy.
The market economy has ability of adjusting by itself not only for an “WTO event” as supposed above but also for any shock according to other direction such as reducing the demand or increasing, reducing the supply. However, necessary adjustment time for markets, including markets of commodity and currency, back to equilibrium state depends on “intensity” of shocks. In reality, the financial crises or real estate market crises often produce a strong stir on entire economy and if let the market be self-adjusting, it takes much time and opportunity cost, Governments often intervene through policies of fiscal year – currency to limit the maximum damages caused by the economic crisis.
KNOTS IN THE ECONOMY
POLICY ON TWO DOMESTIC CURRENCIES