What is the Role of Finance in the Economy?
The U.S. financial system is critical to the functioning of the economy as a whole and banks are central to the financial system. In addition to providing substantial employment, finance serves three main purposes:
Credit provision :- Credit fuels economic activity by allowing businesses to invest beyond their cash on hand, households to purchase homes without saving the entire cost in advance, and governments to smooth out their spending by mitigating the cyclical pattern of tax revenues and to invest in infrastructure projects. Banks directly provide a substantial amount of credit in the U.S., but, unlike in almost any other economy, financial markets are the ultimate providers of most credit.
Liquidity provision:- Businesses and households need to have protection against unexpected needs for cash. Banks are the main direct providers of liquidity, both through offering demand deposits that can be withdrawn any time and by offering lines of credit. Further, banks and their affiliates are at the core of the financial markets, offering to buy and sell securities and related products at need, in large volumes, with relatively modest transaction costs. This latter role is particularly important in the U.S., given the dominance of markets, but is often under-appreciated.
Risk management services:- Finance allows businesses and households to pool their risks from exposures to financial market and commodity price risks. Much of this is provided by banks through derivatives transactions. These have gotten a bad name due to excesses in the run-up to the financial crisis but the core derivatives activities provide valuable risk management services. Many argue that the U.S. financial system grew overly large in the bubble period and is still too large today. We agree that some of the activities that took place in the bubble period involved taking on excess amounts of risk, but it is extremely hard to determine the right size of the financial system based on well-grounded economic theories. In truth, it is very difficult to judge the right size of almost any industry and attempts at the use of central planning and other mechanisms to correct assumed problems of this nature have usually failed.
What do you understand about the concept of Public Finance ?
Classical and neo-classical economists discussed public finance in the context of money raising and money spending activities of the government. In Public finance we study the finances of the government . Thus public finance deals with the questions of how the government raises its resources to meet its ever- rising expenditure.
Definition of Public Finance
- Huge Dalton :
According to Dalton , “Public finance is concerned with the income and expenditure of public authorities and the adjustment of one with the other ”.
- Otto Eckstein :
According to Otto Eckstein, “Public finance is the study of the effects of the budget on the economy , particularly the effects on growth , stability, equity and efficiency”.
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Richard Musgrave :
According to Richard Musgrave, “Public finance is concerned with the complex of problems that center around the revenue - expenditure process of government”.
It also deals with fiscal policies which ought to be adopted to achieve certain objectives such as price stability , economic growth, and a more equal distribution of income. As per the thinkers view the role of public finances changes from time to time.
Explain the concept of market failure.?
Market failure
- Market :
Market is a place where buyers and sellers come in close contact with each other. Either directly or indirectly. Perfectly competitive market is a form of perfect market and other market such as monopoly, oligopoly , monopolistic competitive market , oligopsony and monopsony are also special form of imperfectly competitive market sellers that have an objective of maximizing profit whereas buyers opine to maximize utility. An ideal market is the market where both are equally satisfied which generally we find in a perfectly competitive market.
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Market failure :
Generally market failure occurs when quantity demanded by the consumer does not get equated or supplied by the producer. On the other hand when resources are misallocated or allocated inefficiently.
According to Michael Todoro market failure is a “phenomenon that results from the existence of market imperfections that weaken the functioning of a free market economy i.e it fails to realise its theoretical beneficial results. ”
Profit Maximization Vs Wealth maximization
In any company, the management is the decision taking authority. As a normal tendency the management may pursue its own personal goals ( Profit maximization) but in an organization, where there is a significant outside participation (shareholders, lenders etc.) the management may not be able to exclusively pursue its personal goals due to the constant supervision of the various stakeholders of the company-employees, creditors, customers, Government etc.
Every entity associated with the company will evaluate the performance of the management from the fulfillment of its own objective. The survival of the management will be threatened if the objective of any of the entities remains unfulfilled. The wealth maximization objective is generally in accord with the interests of the various groups such as owners, employees, creditors, and society, and thus, it may be consistent with the management objective of survival. Due to limitation (timing and social consideration etc.) in profit maximization, in today’s real world situations which is uncertain and multi-period in nature, wealth maximization is a better objective. Where the time period is short and degree of uncertainty is not great, wealth maximization and profit maximization amount to essentially the same.
Profit Maximization as its name signifies refers that the profit of the firm should be increased while Wealth Maximization aims at accelerating the worth of the entity. Profit maximization is the primary objective of the concern because of profit act as the measure of efficiency. On the other hand, wealth maximization aims at increasing the value of the stakeholders.
Definition of Profit Maximization
Profit Maximization is the capability of the firm in producing maximum output with the limited input, or it uses minimum input for producing stated output. It is termed as the foremost objective of the company. It has been traditionally recommended that the apparent motive of any business organization is to earn a profit, it is essential for the success, survival, and growth of the company. Profit is a long term objective, but it has a short-term perspective i.e. one financial year. Profit can be calculated by deducting total cost from total revenue. Through profit maximization, a firm can be able to ascertain the input-output levels, which gives the highest amount of profit. Therefore, the finance officer of an organization should take his decision in the direction of maximizing profit although it is not the only objective of the company.
Definition of Wealth Maximization
Wealth maximization is the ability of a company to increase the market value of its common stock over time. The market value of the firm is based on many factors like their goodwill, sales, services, quality of products, etc. It is the versatile goal of the company and highly recommended criterion for evaluating the performance of a business organisation. This will help the firm to increase their share in the market, attain leadership, and maintain consumer satisfaction and many other benefits are also there. It has been universally accepted that the fundamental goal of the business enterprise is to increase the wealth of its shareholders, as they are the owners of the undertaking, and they buy the shares of the company with the expectation that it will give some return after a period. This states that the financial decisions of the firm should be taken in such a manner that will increase the Net Present Worth of the company’s profit.
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