Archive for January, 2011

Tax Systems

            Professor John Palmer states that when we developed the Law of Diminishing marginal returns, we simplified our analysis by concentrating on just two inputs in the production process: labor and capital. There are tow ways of viewing the firm’s input use decision if we want to use some simple graphs. In the first approach, we consider the firm as hiring increasing amounts of labor while holding its amount of capital fixed. The graph below shows the diminishing marginal productivity of labor. As the labor force gets bigger and the stock of machines does not, each individual worker has a smaller quantity of machines to work with and less productivity.


            Another way of viewing the diminishing marginal return is to consider the firm as hiring more and more capital while holding the size of its labor force fixed.  According to Prof. Palmer, the second way of viewing this phenomenon of diminishing marginal returns is to consider the firm as hiring more and more capital while holding the size of its labor force fixed. The graph below shows the diminishing marginal productivity of capital. As the quantity of capital gets bigger, with the size of labor force fixed, each additional machine has a smaller quantity of labor to work with; so it ads less to the firm’s total output. 

            According to Prof. Palmer, the area under a firm’s marginal productivity curve measures the total amount that the firm has produced. Suppose this firm has hired six units of labor and four units of capital. Then the total output of this firm is shown in the area under the curve in the graph above. If the firm keeps its machine stock constant but hired one more worker, its total output would increase. The marginal product curve is the firm’s demand curve for that factory. Thus, to find out whether a certain factor, say, labor, receives a high wage or a low wage, we must simply add together the marginal product curves for all the firms to get the overall demand curve for labor. Then, see where that demand curve intersects the overall supply curve for labor. 
Roseman sates that some people like the so-called second earners in families, work more when wages are high. Others, like self-employed professionals, work less when wages are high. These positive and negative responses to higher wages appear to cancel out, since the overall supply of labor in completely inelastic.  According to Prof. Palmer, the graph below shows the overall demand curve for labor, and an inelastic supply curve for labor. Because these curves are for the whole economy, the total income available to all the citizens is the nation’s total product. Measured in physical units of output, then, society’s total income that is generated by the production process is the gray area in the graph. In output units, each laborer is receiving this equilibrium wage rate. The owners of scarce factors of production receive very high incomes, while the owners of abundant factors of production get very low incomes.
According to Prof. Palmer, we want scarce factors to carry very high prices, because if it costs firms a lot to use them, they will use such scarce items only where they are especially valuable. The efficiency we get from this system is what we want if the economy is to generate the most material welfare that is possible given our scarce resources. The way factors get paid in a market economy is efficient, but the outcome can be pretty discouraging on income distribution grounds for many individuals, especially if they own only a little bit of an abundant factor of production such as unskilled labor.
Roseman also states that we confront the trade-off between efficiency and equity. There are three possible ways to redistribute income among individuals. One option is to redefine the ownership of factors, for example, by taking land from the rich and giving it to the poor. A second option is to impose regulations on markets, such as a minimum wage law. Broadly speaking, economists prefer to focus on the third alternative: this involves leaving the ownership of factors as it is, and letting markets work so that flexible factor prices can ensure that resources are used efficiently.

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Four Steps to Forecast Total Demand – by F. William Barnett

·         In recent history, many companies have made serious strategic errors because of inaccurate industry wide demand forecasts.  During the 70’s and 80’s, U.S. electric utilities, the petroleum industry, and PC manufactures suffered serious financial harm because of investments in markets where growth and demand was over-projected.
·         The big mistake these companies made was they relied on the mistaken fundamental assumption that relationships driving demand in the past would continue unaltered.  The companies failed to foresee changes in end-user behavior or to understand their market’s saturation point.  History can be an unreliable guide for forecasting market demand given the emerging global economy, rapid technological innovation, and the evolution of industries.
·         By gauging total market demand explicitly, you have a better chance of controlling your company’s destiny.
·         There are four steps to total market forecast:
o    Define the market.
o    Divide total industry demand into its main components.
o    Forecast the drivers of demand in each segment and project how they are likely to change.
o    Conduct sensitivity analyses to understand the most critical assumptions and to gauge risks to the baseline forecast.
·         Defining the Market:
o    At first, it’s best to be overly inclusive, so define the market broadly enough to include all potential end users so that you can both identify the appropriate drivers of demand and reduce the risk of surprise product substitutions.
o    It is critical to understand product substitution in the market.  Be aware of how customer behavior may change if the price or performance of potential substitute products changes.  Be aware that a completely new product could displace a product (i.e. the calculator eliminated the slide rule).
o    How do you make sure you have included all important substitute products?:
§  Interviews with industrial customers
§  Market research about consumer products
§  Talk with experts in the relevant technologies
§  Review technological literature
§  Quantify the economic value of alternative products to different customers in order to gain insight into potential switching behavior
o    These analyses can lead to the construction of industry demand curves which represent the relationship between price and volume.
·         Dividing Demand into Component Parts:
o    Make each category small and homogenous enough so that the drivers of demand will apply consistently across its various elements, but also make each large enough so that the analysis will be worth the effort.
o    Outline alternative segmentations based, for example, on end-use customer groups or type of purchase.
o    In thinking about market divisions, managers need to decide whether use existing data on segment sized or to commission research to get an independent estimate.
o    Be wary that while this type of segmentation may be sufficient for forecasting total demand, it may not create categories useful for developing a marketing strategy.
·         Forecasting the Drivers of Demand:
o    Obvious tools for this step are regression and other statistical techniques to find some causes for changes in historical demand.
o    However, you must also look at factors where data are harder to find.
o    Demand is almost always affected by both macroeconomic variables and by industry-specific developments, i.e. shifts in the demand or supply curves, economic growth.
o    Knowing the drivers of demand is crucial to the success of any total market demand forecast.
·         Conducting Sensitivity Analysis:
o    Once the baseline forecast is complete, the challenge is to determine how far it could be off target.  It is important to always ask, “What things could cause this forecast to change dramatically?”  This allows marketers to identify potential risks and discontinuities such as developments in competing technologies, in customer industry competitiveness, in supplier cost structures, etc.
o    Think through and quantify the areas of greatest strategic risk.
o    Gauge the likelihood of such a development.
·         Determining an Appropriate Effort:
o    A big challenge in demand forecasting is to gauge the appropriate effort for the project’s purpose.  Ask, “How much do I need to know to make the decision at hand?”
o    Expensive forecasting is appropriate where the demand projection can significantly influence corporate strategy of where there is great uncertainty.
o    Issues which are not complicated, time is limited, or the total demand forecast is not that important don’t merit expensive analysis.

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Barriers for Small E-Businesses

  1. Technological
  2. Financial
  3. Organizational
  4. Operational

Technological Barriers

  • Some small e-businesses will lack internal IT expertise
  • Need to ensure adequate support available either internally or externally
  • Valuable for internal expertise to be gained through training where possible

Financial Barriers

  • Large web strategies and other IT initiatives can be very costly
  • Need to determine true “needs” not just the “wants”
  • Develop systems that can be scaled up and expanded easily

Organizational Barriers

  • Small businesses will also face change management issues
  • Owner/manager needs to be promoter of e-business
  • Provide adequate training and support

Operational Barriers

  • Volume of data can be small and yield limited results from analysis – need to determine case by case
  • Ability to integrate can be limited if back office not integrated
  • Support for growth must be available

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Developing a Small E-Strategy

  • Develop a strategy for e-commerce
  • Implement strategy effectively
  • Evaluate and revise

Potential Benefits
Benefits can include :

  • access to new markets
  • improved customer responsiveness
  • increased flexibility
  • improved profits 
  • increased innovation 
  • better managed resources 

Key Areas

  1. Marketing
    • Depending on business can be critical
  2. Customer support
    • Technology approaches can be remote
  3. Market intelligence
    • As market expands need additional details
  4. Operations
    • Simplify processes electronically
  5. Sales transactions
    • Expanding the market
  6. Public relations
    • Reach your audience at reasonable cost

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Preparing a Business Plan

Why Prepare a Plan?
The Business Plan is a written summary of what you hope to accomplish by being in business and how you intend to organize your resources to meet your goals. It is the road map for operating your business and measuring progress along the way.
1. The Business Plan identifies the amount of financing or outside investment required and when it is needed.
2. First impressions are important. A well-organized plan is essential for a lender or investor to assess your financing proposal and to assess you as a business manager.
3. By committing your plans to paper, your overall ability to manage the business will improve. You will be able to concentrate your efforts on the deviations from plan before conditions become critical. You will also have time to look ahead and avoid problems before they arise.
4 It encourages realism.
 5 It helps you to identify your customers, your market area, your pricing strategy and the competitive conditions under which you must operate to succeed. This process often leads to the discovery of a competitive advantage or new opportunity as well as deficiencies in your plan.
6.Three or four hours spent each month updating your plan will save you time and money in the long run and may even save your business. Resolve now to make planning a part of your management style.
Executive Summary
The format should start with an executive summary describing the highlights of the business plan. Even though your entire business is well described later on, a crisp, one or two page introduction helps to capture the immediate attention of the potential investor or lender.
·         Company name (include address and phone number)
·         Contact person (presenter’s name and phone number)
·         Paragraph about company (nature of business and market area)
·         Securities offered to investors (preferred shares, common shares, debentures, etc.)
·         Business loans sought (term loan, operating line of credit)  Highlights of Business Plan (your project, competitive advantage and “bottom line” in a nutshell–preferably one page maximum)
This summary page is extremely important in capturing the reader’s attention. Make sure it sells your idea so the reader will retain interest and continue reading
Table of Contents
A standard table of contents
  • Section titles and page numbers (for easy reference)
  • Business Concept
  • The business concept identifies your market potential within your industry and outlines your action plan for the coming year. Make sure your stated business goals are compatible with your personal goals, your own management ability and family considerations.
  • The heart of the Business Concept is your monthly sales forecast for the coming year. It is your statement of confidence in your marketing strategy and forms the basis for your cash flow forecast and projected income statement.
  • The business concept contains an assessment of business risks and a contingency plan. I urge you to take the offensive and be your own devil’s advocate. Being honest about your business risks and how you plan to deal with them is evidence of sound management.
Description of the Industry
·               Industry outlook and growth potential (industry trends, new products and developments. State your sources of information)
·               Markets and customers (size of total market, new requirements and market trends)
·               Competitive companies (market share, strengths and weaknesses, profitability)
·               National and economic trends (population shifts, consumer trends, relevant economic indicators)
Description of Business Venture
  • Product(s) or service (pictures, drawings, characteristics, quality)
  • Product protection/exclusive rights (patents, copyrights, trade marks, franchise rights)
  • Target market (typical customers identified by groups, present buying patterns and average purchase in dollars, wants and needs)
  • Competitive advantage of your business concept (your market niche, uniqueness, estimated market share) Business location and size (location(s) relative to market, size of premises)
  • Staff and equipment needed (overall requirement, capacity)
  • Brief history (principals involved, development work done)
 Business Goals
One year (specific goals, such as gross sales, profit margins, share of market, opening new store, plant or office, introducing new product, etc.)  Over the longer term (return on investment, business net worth, and sale of business)
 Marketing Plan
 Sales strategy (commissioned sales staff, agents, sales objectives, target customers, sales tools, sales support)
  • Distribution (direct to public, wholesale, retail, multiple outlets)
  • Pricing (costing, mark-ups, margins, break-even)
  • Promotion (media advertising, promotions, publicity-appropriate to reach target market)
  • Guarantees (product guarantees, service warranties)
  • Tracking methods (method for confirming who your customers are and how they heard about you)
 Sales Forecast
 Assumptions (one never has all the necessary information, so state all the assumptions made in developing the forecast)
  • Monthly forecast for coming year (sales volume in units and dollars)
  • Annual forecast for following 2-4 years (sales volume in dollars)
 Note: The sales forecast is the starting point for your projected income statement and cash flow forecast
 Production Plan (Manufacturing)
  • Brief description of production process (don’t be too technical)
  • Physical plant requirements (building, utility requirements, expansion capability, layout)
  • Machinery and equipment (new or used, lease or purchase, capacity)
  • Raw materials (readily available, quality, sources)
  • Inventory requirements (seasonal levels, turnover  rates, method of control)
  • Suppliers (volume discounts, multiple sources)
  • Personnel required (full-time, part-time, skill level, availability, training required)
  • Cost of facilities, equipment and materials (estimates and quotations)
  • Capital estimates (one time start-up or expansion capital required)
  • Purchasing plans (volume discounts, multiple sources, quality, price)
  • Inventory system (seasonal variation, turnover rates, method of control)
  • Space requirements (floor and office space, improvement required, expansion capability)
  • Staff and equipment required (personnel by skill level, fixtures, office equipment)
 Corporate Structure
 Legal form (proprietorship, partnership, corporation)
  • Share distribution (list of principal shareholders)
  • List of contracts and agreements in force (management contract, shareholder or partnership agreement, franchiser service agreement, service contract)
  • Directors and officers (names and addresses and role in company)
  • Background of key management personnel (brief resumes of active owners and key employees)
  • Contract professionals/consultants (possible outside assistance in specialized or deficient areas)
  • Organization chart (identify reporting relationships)
  • Duties and responsibilities of key personnel (brief job descriptions who are responsible for what?)
 Risk Assessment
 Competitors’ reaction (will competitors try to squeeze you out?)
  • What if . . . list of critical external factors (identify effects of strikes, recession, new technology, weather, new competition, supplier problems, shifts in consumer demand)
  • What if . . . list of critical internal factors (sales off by 30%, sales double, key manager quits, workers unionize)
  • Dealing with risks (contingency plan to handle the most significant risks)
 Action Plan
  • Steps to accomplish this year’s goals (flow chart by month or by quarter of specific action to be taken and by whom)
  • Checkpoints for measuring results (identify significant dates, sales levels, production levels as decision points)
 Financial Plan
The financial plan outlines the level of present financing and identifies the financing sought. This section should be kept concise with supporting material supplied only when requested.
The Financial Plan contains pro-forma financial forecasts. In carrying out your action plan for the coming year, these operating forecasts are your guide to business survival and profitability
Resolve now to refer to them often and, if circumstances dictate, re-work them as necessary. Before presenting your Business
Plan to a lender or investor; review your financial statements with your accountant. This familiarity will increase your credibility and at the same time provide you with a good understanding of what the financial statements reveal about the viability of your business.
 Financial Statements  
  • Previous years’ balance sheets and income statements (include past 2-3 years if applicable)
 Financial Forecasts
 This section will contain:
  • Opening balance sheet (for a new business only)
  • Projected income statements (detailed operating forecast for next year of operation and less detailed forecast for following two years. Use sales forecast as starting point)
  • Cash flow forecast (budget of cash inflow and outflow on a monthly basis for next year of operation)
 Financing and Capitalization
 Term loan applied for (amount, term, when required)
  • Purpose of term loan (attach detailed description of assets to be financed with cost quotations)
  • Owners’ equity (your level of commitment to the program)
  • Summary of term loan requirements (for a particular project or for business as a whole)
Preparing a business plan will generate a lot of thought and a lot of paper! Keep in mind, however, that the final document is a summary of your planning process. You can always refer to your working papers later on to substantiate a particular point.
Have your key employees and two or three impartial outsiders review the finished plan in detail. There may be something you overlooked or underemphasized. Also a critical review will be good preparation for your presentation to potential investors and lenders.

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6 Key Elements of a Marketing strategy

Outsmart the MBA Clones: The Alternative Guide to Competitive Strategy, Marketing and BrandingCompetitive marketing strategy occurs within departments, across organizations, and within people’s heads as a way of doing business. Competitive marketing strategy is defined as

a market-oriented strategy that establishes a profitable and sustainable market position for the firm against all forces that determine industry competition by continuously creating and developing a competitive advantage from the potential sources that exist in a firm’s value chain. 

The key elements are:

  1. Market-oriented: the strategy is based upon the needs and wants of the marketplace.
  2. Establishes a profitable market position: the end goal of the strategy is tomake a profit in the for-profit sector or to meet alternative metrics such as in the not-for-profit sector. In the latter case for example, a road safety campaign based on a particular marketing strategy might ‘make a profit’ if there is a decline in road injuries and deaths attributed to it.
  3. Establishes a sustainable market position: marketing strategy is not about one-off transactions. The aim is to reach a point where an organization finds a place in the market that fits its available marketing resources.
  4. Forces that determine industry competition: these are all the complex mix of ingredients that create the marketing ‘whirlwind’, such as government regulation, global competition, or the extent of buyers’ knowledge and understanding of a particular market.
  5. Continuously creating and developing a competitive advantage: few (if any) organizations can just rest on their laurels, so the idea is to find a spot where, if need be, the primary challenges can be tackled. Not all organizations have to do this on a continuous basis of course, but if it had to, an organization with a sound competitive marketing strategy would be able to. A simple example: you might make the best tomato ketchup in the best-recognized glass bottles, but if the market moves towards plastic ‘squeezy’ bottles you need to be able to adapt.
  6. Potential sources that exist in a firm’s value chain: competitive marketing strategy relates to what value any organization wants to create using its available marketing resources.

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Opportunity Cost and Comparative Advantage

The concept of opportunity cost and Comparative Advantage

  • The opportunity cost of producing something measures the cost of not being able to produce something else.
  • A country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the country than it is in other countries.
  • A country with a comparative advantage in producing a good uses its resources most efficiently when it produces that good compared to producing other goods.

A country has a comparative advantage in producing a good if the opportunity cost of producing that good in terms of other goods is lower in that country than it is in another country

Opportunity cost of producing

  • 1 unit of wine is 4 units of cheese
  • 1 unit of cheese is 1/4 units of wine.

Opportunity cost of producing

  • 1 unit of wine is 1/2 units of cheese
  • 1 unit of cheese is 2 units of wine.

The opportunity cost of producing wine in terms of cheese is lower in Portugal than in England (1/2<4), therefore Portugal has a COMPARATIVE ADVANTAGE in the production of wine.

Likewise, the opportunity cost of producing cheese in terms of wine is lower in England than in Portugal (1/4<2) so England has a COMPARATIVE ADVANTAGE in the production of cheese.

Let England and Portugal expand production in the direction of their comparative advantage.


England reduces production of wine by 1 unit freeing 8 hours of labour which go on to produce an additional 4 units of cheese.

Portugal reduces the production of cheese by 1 unit freeing 4 hours of labour which go on to produce an additional 2 units of wine.

                                   Additional CHEESE                Additional WINE
ENGLAND                      +4                                        -1
PORTUGAL                     -1                                       +2
World                               +3                                       +1

Without using any additional resources the world output rises just following the simple rule of Comparative Advantage.

Question: If each country specialises in the good in which it has a comparative advantage and exports it in exchange for the other good would both countries be better off? Why?

Answer: Yes if the relative world price is right!!!

Assume that the Relative World Price: One unit of wine sells for one unit of cheese.

With Trade: Gets 1 unit of cheese from England for 1 unit of wine.
Autarky: For 1 unit of wine Portugal could only get ½ unit of cheese.
Result: Better off!!!

With Trade: Gets 1 unit of wine from Portugal for 1 unit of cheese.
Autarky: For 1 unit of cheese England could only get 1/4 unit of wine.
Result: Better off!!!

1. The principle of comparative advantage predicts the pattern of trade and the gains from trade on the basis of relative prices in autarky (opportunity cost).
2. If a country trades at relative prices that differ from its relative autarky prices, then the country will be better off as a result of trading.

Assume that consumers trade at a new relative price that differs from the autarky price → New Equilibrium
A country will export the good which relative price under autarky is smaller than under trade.

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The Ricardian Model in International trade

The Ricardian Model is based on

*Technological differences (differences in labour productivities) between countries
*Concepts of opportunity cost and comparative advantage.

  • A simple example

Unit labour requirement (number of hours) to produce ONE unit of each good:
                                CHEESE               WINE
ENGLAND             2 (hours)               8 (hours)
PORTUGAL           4 (hours)               2 (hours)

England has an ABSOLUTE ADVANTAGE in producing cheese.
Portugal has an ABSOLUTE ADVANTAGE in producing wine.

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Why do countries trade?

Countries are different to each other: preferences, culture and institutions, weather, factor endowment (land, capital and labour), technology, distance and transportation costs.

Differences in labor, physical capital, natural resources and technology create productive advantages for countries.

Also economies of scale (larger is more efficient) create productive advantages for countries.

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Why study International Economics?

  • Countries are linked via trade (goods and services) and capital (international lending and borrowing, foreign direct investment). In the last decade we have observed the emergence of a ‘Global Economy’

  • It is a discipline that deals with economic interactions between sovereign (independent) countries. Governments regulate: trade, investment, the movement of capital (and other factors of production) and the supply of currency (exchange rate).

Main areas:

  • International Monetary (open economy macroeconomics and policy): balance of payments, exchange rate determination, international capital markets, international policy coordination)

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