There are three methods of calculating the discount rate used to assess the value of a business:
- Capital Asset Pricing Model (CAPM).
- The method of cumulative construction.
- Weighted average cost of capital (WACC) method.
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The discount rate is used to bring the value of future cash flows to the present value (at the current point in time). This operation is called , it is the inverse of the calculation operation compound interest. Such an operation is necessary due to the fact that the amount of money available on this moment, It has great value than the same amount that will be received in the future.
Cash flow discounting is used for business valuation purposes in the following cases:
- Within the forecast period.
- As part of the present value of individual assets and liabilities. For example, to calculate the cost of a loan debt, if it is assumed that repayment will occur over a long period of time.
The discount rate is calculated from capital asset pricing models (CAPM) or cumulative construction method if the full cash flow. Both of these methods of calculation include as initial stage calculation of the risk-free interest rate.
Risk free interest rate
The risk-free rate (also called the risk-free rate of return) is the percentage of return that can be earned by investing in zero-risk assets.
A zero-risk asset must meet the following conditions:
- The rate of return is known before the investment is made.
- The risk of capital loss is minimal even if force majeure occurs.
- The lifetime of the asset (circulation period) is commensurate with the residual life of the business being valued.
Usually such conditions are met by government bonds or deposits for an appropriate period in reliable banks. In this case, the value of the risk-free rate is about 4-5%. This so-called nominal risk-free rate, the value of which does not take into account the rate of inflation.
Real risk-free rate taking into account the inflation rate is calculated by the formula:
Rf = Rn + I + Rn*I, where
Rn - nominal risk-free rate
I - inflation rate
An example of calculating the real risk-free rate
Nominal risk-free rate Rn = 4%
Inflation rate I = 7%
Real risk-free rate:
Rf = 0.04 + 0.07 + 0.07*0.04 = 0.1128 = 11.28%
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Capital Asset Pricing Model (CAPM)
The discount rate calculated by this model takes into account the systematic risk, i.e. risk inherent in the entire market or market segment.
Calculation formula for the CAMP model:
R = Rf + β*(Rm-Rf), where
Rm- Average rate market returns
Rf - Real risk-free rate
β is a measure of the risk of the valued business in relation to the market (beta coefficient).
Sometimes the basic formula for calculating the CAPM model is supplemented with three additional terms (three standard risk premiums):
R \u003d Rf + β * (Rm-Rf) + Rmb + Rzk + Rst
Rmb - risk premium for investing in small business
Rзк - premium for the risk of investing in a closed company
Rst - country risk premium
Cumulative construction method
Takes into account the non-systematic risks inherent in the specific business being assessed.
The formula for calculating the discount rate using the cumulative construction method:
Rk = Rf + (R1 + R2 + ... + Rn) + (Rmb + Rbk + Rst), where
Rf - Real risk-free rate
R1, ..., Rn - one or more of the following risk factors:
- Key figure factor
- Leadership Quality Factor
- Funding source factor
- Factor of production diversification
- Customer diversification factor
- The resource constraint factor
- Other risk factors specific to the business or industry being assessed.
Rmb, Rzk, Rst - three standard bonuses.
Weighted average cost of capital (WACC) method
The discount rate is calculated using the WACC method - the weighted average cost of capital, if debt-free cash flow is discounted during business valuation. That is, the cash flow in which the receipt of a loan, the payment of a loan and the payment of interest on a loan are not taken into account.
Irving Fisher is an American neoclassical economist. Born February 27, 1867 in Saugerties, pc. NY. He made a great contribution to the creation of the theory of money, and also derived the “Fischer equation” and the “exchange equation”.
His work was taken as a basis modern techniques to calculate the rate of inflation. In addition, they helped in many ways to understand the patterns of inflation and pricing.
Full and simplified Fisher's formula
In a simplified form, the formula will look like this:
i = r + p
- i - nominal interest rate;
- r is the real interest rate;
- π is the rate of inflation.
This entry is approximate. How less value r and π, the more precisely this equation is fulfilled.
The following would be more accurate:
r = (1 + i)/(1 + π) - 1 = (i - π)/(1 + π)
Quantity Theory of Money
The quantity theory of money is an economic theory that studies the impact of money on the economic system.
In accordance with the model put forward by Irving Fisher, the state must regulate the amount of money in the economy in order to avoid their lack or excess.
According to this theory, the phenomenon of inflation arises due to non-compliance with these principles.
Insufficient or excessive amount of money supply in circulation entails an increase in the rate of inflation.
In turn, the growth of inflation implies an increase in the nominal interest rate.
- Rated the interest rate reflects only the current income from deposits, excluding inflation.
- Real The interest rate is the nominal rate of interest minus the expected rate of inflation.
Fisher's equation describes the relationship between these two indicators and the rate of inflation.
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How to use to calculate the return on investment
Suppose you make a deposit of 10,000, the nominal interest rate is 10%, and the inflation rate is 5% per year. In this case, the real interest rate will be 10% - 5% = 5%. Thus, the real interest rate is the lower, the higher the inflation rate.
It is this rate that should be taken into account in order to calculate the amount of money that this deposit will bring you in the future.
Interest calculation types
As a rule, the accrual of interest on profits occurs in accordance with the compound interest formula.
Compound interest is a method of accruing interest on profits, in which they are added to the principal amount and subsequently participate in the creation of new profits.
A short summary of the compound interest formula looks like this:
K = X * (1 + %)n
- K is the total amount;
- X is the initial amount;
- % - percentage value of payments;
- n is the number of periods.
At the same time, the real interest that you receive by making a deposit at compound interest will be the lower, the higher the inflation rate.
At the same time, for any type of investment, it makes sense to calculate the effective (real) interest rate: in essence, this is the percentage of the initial deposit that the investor will receive at the end of the investment period. Simply put, it is the ratio of the amount received to the amount originally invested.
r(ef) = (P n - P)/P
- r ef is the effective percentage;
- Pn is the total amount;
- P is the initial contribution.
Using the compound interest formula, we get:
r ef = (1 + r/m) m - 1
Where m is the number of accruals for the period.
International Fisher effect
The international Fisher effect is an exchange rate theory put forth by Irving Fisher. The essence of this model is the calculation of present and future nominal interest rates in order to determine the dynamics of changes in the exchange rate. This theory works in its purest form if capital moves freely between states whose currencies can be correlated with each other in value.
Analyzing precedents of rising inflation in different countries, Fisher noticed a pattern in the fact that real interest rates, despite the increase in the amount of money does not increase. This phenomenon is explained by the fact that both parameters are balanced over time through market arbitrage. This balance is maintained for the reason that the interest rate is set taking into account the risk of inflation and market forecasts for the currency pair. This phenomenon has been named Fisher effect .
Extrapolating this theory to international economic relations, Irving Fisher concluded that a change in nominal interest rates has a direct impact on the appreciation or depreciation of the currency.
This model has not been tested in real conditions. Its main disadvantage It is generally accepted that it is necessary to fulfill purchasing power parity (the same cost of similar goods in different countries) for accurate forecasting. And, besides, it is not known whether the international Fisher effect can be used in modern conditions, taking into account fluctuating exchange rates.
Inflation forecasting
The phenomenon of inflation is an excessive amount of money circulating in the country, which leads to their depreciation.
The classification of inflation occurs on the basis of:
uniformity - the dependence of the inflation rate on time.
Uniformity — distribution of influence on all goods and resources.
Inflation forecasting is calculated using inflation index and hidden inflation.
The main factors in forecasting inflation are:
- change in the exchange rate;
- increase in the amount of money;
- change in interest rates;
Another common method is to calculate the inflation rate based on the GDP deflator. For forecasting in this technique, the following changes in the economy are recorded:
- profit change;
- change in payments to consumers;
- changes in import and export prices;
- change in rates.
Calculation of return on investment, taking into account the level of inflation and without it
The formula for return without taking into account inflation will look like this:
X \u003d ((P n - P) / P) * 100%
- X - profitability;
- P n - total amount;
- P - initial payment;
In this form, the final profitability is calculated without taking into account the time spent.
X t \u003d ((P n - P) / P) * (365 / T) * 100%
Where T is the number of days the asset is held.
Both methods do not take into account the impact of inflation on profitability.
Yield adjusted for inflation (real yield) should be calculated using the formula:
R = (1 + X) / (1 + i) - 1
- R - real profitability;
- X is the nominal rate of return;
- i is inflation.
Based on the Fisher model, one main conclusion can be drawn: inflation does not generate income.
Raise nominal rate due to inflation will never be more than the amount of money invested, which has depreciated. In addition, a high inflation rate implies significant risks for banks, and the compensation of these risks lies on the shoulders of depositors.
Application of the Fisher Formula in International Investments
As you can see, in the above formulas and examples, high inflation always reduces the return on investment, at a constant nominal rate.
Thus, the main criterion for the reliability of an investment is not the amount of payments in percentage terms, but inflation target.
Description of the Russian investment market using the Fisher formula
The above model is clearly seen on the example of the investment market of the Russian Federation.
The fall in inflation in 2011-2013 from 8.78% to 6.5% led to an increase in foreign investment: in 2008-2009 they did not exceed 43 billion rubles. dollars a year, and by 2013 reached the mark of 70 billion. dollars.
The sharp increase in inflation in 2014-2015 led to a decrease in foreign investment to a historic low. Over these two years, the amount of investments in the Russian economy amounted to only 29 billion rubles. dollars.
At the moment, inflation in Russia has fallen to 2.09%, which has already led to an influx of new investments from investors.
In this example, you can see that in matters of international investment, the main parameter is the real interest rate, which is calculated according to the Fisher formula.
How is the inflation index for goods and services calculated?
The inflation index or consumer price index is an indicator that reflects changes in the prices of goods and services purchased by the population.
Numerically, the inflation index is the ratio of prices for goods in the reporting period to prices for similar goods in the base period.
i p = p 1 / p
- i p - inflation index;
- p 1 - prices for goods in the reporting period;
- p 2 - prices for goods in the base period.
Simply put, the inflation index indicates how many times prices have changed over a certain period of time.
Knowing the inflation index, we can draw a conclusion about the dynamics of inflation. If the inflation index takes on values greater than one, then prices are rising, which means that inflation is also growing. The inflation index is less than one — inflation takes negative values.
To predict changes in the inflation index, the following methods are used:
Laspeyres formula:
I L = (∑p 1 * q) / (∑p 0 * q 0)
- I L is the Laspeyres index;
- The numerator is the total cost of goods sold in the previous period at the prices of the reporting period;
- The denominator is the real value of goods in the previous period.
Inflation, when prices rise, is given a high estimate, and when prices fall, it is underestimated.
Paasche index:
Ip = (∑p 1 * q) / (∑p 0 * q 1)
The numerator is the actual cost of products of the reporting period;
The denominator is the actual cost of the products of the reporting period.
Ideal Fisher Price Index:
I p = √ (∑p 1 * q) / (∑p 0 * q 1) * (∑p 1 * q) / (∑p 0 * q 0)
Accounting for inflation when calculating an investment project
Accounting for inflation in such investments plays a key role. Inflation can affect project implementation in two ways:
- in kind- that is, entail a change in the project implementation plan.
- In terms of money- that is, affect the final profitability of the project.
Ways to influence the investment project in the event of an increase in inflation:
- Change in currency flows depending on inflation;
- Accounting for the inflation premium in the discount rate.
An analysis of the level of inflation and its possible impact on an investment project requires the following measures:
- consumer index accounting;
- forecasting changes in the inflation index;
- forecasting changes in the income of the population;
- forecasting the amount of cash collections.
Fisher's formula for calculating the dependence of the cost of goods on the amount of money
In general, Fisher's formula for calculating the dependence of the cost of goods on the amount of money has the following entry:
- M - the volume of money supply in circulation;
- V is the frequency with which money is used;
- P - the level of cost of goods;
- Q - quantities of goods in circulation.
By transforming this record, we can express the price level: P=MV/Q.
The main conclusion from this formula is inverse proportionality between the value of money and its quantity. Thus, for the normal circulation of goods within the state, it is required to control the amount of money in circulation. An increase in the quantity of goods and prices for them requires an increase in the amount of money, and, in the case of a decrease in these indicators, the money supply should be reduced. This kind of regulation of the amount of money in circulation is assigned to the state apparatus.
Fisher's formula as applied to monopoly and competitive pricing
Pure monopoly presupposes, first of all, that one producer completely controls the market and is perfectly aware of its state. The main goal of a monopoly is to maximize profit at minimum cost. The monopoly always sets the price above the marginal cost and the output is lower than under perfect competition.
The presence of a monopoly producer on the market usually has serious economic consequences: the consumer spends more money than in conditions of fierce competition, while the rise in prices occurs along with the growth of the inflation index.
If the change in these parameters is taken into account in the Fisher formula, then we will get an increase in the money supply and a constant decrease in the number of circulating goods. This situation leads the economy into a vicious cycle in which an increase in the rate of inflation leads to an increase only to an increase in prices, which in the end stimulates the rate of inflation even more.
The competitive market, in turn, reacts to an increase in the inflation index in a completely different way. Market arbitrage leads to the conformity of prices to the conjuncture. Thus, competition prevents an excessive increase in the money supply in circulation.
An example of the relationship between changes in interest rates and inflation for Russia
On the example of Russia, you can see the direct dependence of interest rates on deposits on inflation
Thus, it can be seen that the instability of external conditions and the increase in volatility in the financial markets makes the Central Bank lower rates when inflation rises.
The interest rate characterizes the cost of using borrowed funds in the financial market. Rising interest rates mean that loans in the financial market will become more expensive and less accessible to potential borrowers. One of the reasons for the increase in interest rates is the increase in inflation. To describe the relationship between the interest rate and inflation, it is necessary to introduce the concepts of real and nominal interest rates.
The nominal interest rate (R) is the interest rate not adjusted for inflation.
The real interest rate (r) is the interest rate adjusted for the inflation rate.
With data on the inflation rate (π) and the nominal interest rate (R), the real interest rate (r) can be calculated using the Fisher formula:
If 0% ≤ π ≤ 10%, then the approximate formula can be used to calculate the real interest rate: r ≈ R – π
If we express the nominal rate from the approximate formula, that is, R ≈ r + π, then we get an effect called the Fisher effect. In accordance with this effect, two main components and, accordingly, two main reasons for the change in the nominal interest rate can be distinguished: real interest and the inflation rate. However, when a financial institution (bank) determines the nominal interest rate, it usually comes with some expectations about the future rate of inflation. Therefore, the formula can be formalized to the following form: R ≈ r+, where is the expected inflation rate.
Then, in accordance with the Fisher effect, the dynamics of the nominal interest rate is largely determined by the dynamics of the expected inflation rate.
nominal and real exchange rates.
Exchange rate national currency is the most important macroeconomic indicator.
The nominal exchange rate is the ratio of the values of two currencies (in the exchange office we see exactly the nominal figures).
The real exchange rate is the ratio of the values of goods produced in different countries, or the ratio at which the goods of one country can be exchanged for similar goods in another country.
= × , where is the real exchange rate, P* is the price of foreign goods (in dollars), P is the price of domestic goods (in rubles), is the nominal exchange rate of the dollar against the ruble.
The change in the real exchange rate, based on the formula, is influenced by two factors: the nominal exchange rate and the ratio of prices abroad and in our country. In other words, an increase in the nominal exchange rate of the dollar (and, accordingly, a fall in the nominal exchange rate of the ruble) has a positive effect on the competitiveness of the domestic economy, while growth has a negative effect.
Approximate formula (for small changes): ∆% ≈ ∆% + - π
Purchasing power parity.
Purchasing power parity is the amount of one currency, expressed in units of another currency, required to purchase the same product or service in the markets of both countries.
= , - absolute PPP (prices for goods suitable for international exchange, when converted into one currency, should be the same)
∆% ≈ π - , ∆% = 0 - relative PPP (the nominal exchange rate is adjusted to compensate for the difference in inflation rates)
Question #10
Economic growth and cycle. Long- and short-term processes in the economy. What is a "recession" according to the NBER definition? Signs of an economic recession / recovery. Pro- and countercyclical indicators. Leading and lagging indicators. Recession and "overheating" - what is their danger? Economic growth and its possible sources. Decomposition of economic growth.
The economic growth is the long-term trend of increasing real GDP. To measure growth use:
1. Absolute growth or growth rate of real GDP;
2. Similar indicators per capita for a certain period of time.
IMPORTANT:
1) a trend, this means that real GDP should not necessarily increase every year, it only means the direction of the economy, the so-called "trend";
2) long-term, because the economic growth is an indicator characterizing the long-term period, and, therefore, we are talking about an increase in potential GDP (i.e., GDP at full employment of resources), about an increase in the production capabilities of the economy;
3) real GDP (rather than nominal, the growth of which can occur due to an increase in the price level, even with a reduction in real output). That's why important indicator economic growth is an indicator of the value of real GDP.
the main objective economic growth- the growth of well-being and the increase in national wealth.
A generally accepted quantitative measure of economic growth are indicators of absolute growth or growth rates of real output in general or per capita:
Business cycle- these are several periods of different activity to the economy (according to the US National Bureau of Economic Analysis).
Recession according to NBER (National Bureau of Economic Analysis)– a significant decline in economic activity that has spread throughout the economy, lasting more than several months and noticeable in the dynamics of production, employment, real income and other indicators.
Mathematically, Fisher's Equation The equation looks like this:
real interest rate + inflation = nominal interest rate;
Here R is the real interest rate;
N is the nominal interest rate;
Pi - ;
The Greek letter Pi is commonly used to represent . It should not be confused with the pi constant used in geometry.
For example, if you put a certain amount of money in a bank at 10% per annum, with an inflation rate of 7%, then the nominal interest rate under such conditions will be 10%. Real rate will be only 3%.
Application of the Fisher Equation in Economics
If inflation is taken into account, then this is not a real interest rate, but a nominal rate that is adjusted or changes with inflation. The inflation rate used in evaluating the equation is the expected rate of inflation over the life of the loan. In Fisher's theory, the hypothesis was put forward that the count should be constant. The rate of inflation is taken into account differently when determining the interest rate of a loan within areas affected by current activities, technology and other world events that affect the real economy.
This equation can be applied both before the conclusion of the contract, and after the fact, that is, as a loan analysis. If the equation is used to evaluate credit ex post. For example, it can help determine purchasing power and calculate the cost of a loan. It is also used to help lenders determine what the interest rate should be. By using this formula, lenders can take into account the planned loss of purchasing power and therefore charge favorable interest rates.
The Fisher equation is commonly used in estimating investment amounts, bond yields, and ex post investment calculations.
Fisher also owns, which determines the dependence of the price and the amount of money in circulation. Many economic indicators depend on the amount of money. First of all, these are prices and rates on loans. Moreover, under conditions of stability economic development the amount of money supply regulates prices. In the case of structural imbalances, the primary change in prices is possible, and only then there is a change in the cash supply. It turns out that depending on changes in various conditions in the economy, political life countries, ecology prices can change, but vice versa can change due to an increase or decrease in prices. The formula looks like this:
Here M is the amount of money in circulation;
V is the rate of their turnover;
P - the price of the goods;
Q - volume, or quantity of goods
This formula is purely theoretical, since it does not contain a unique solution. However, we can conclude that the dependence of prices and money supply is mutual. In developed economies (a single country or group of countries) with one currency, the amount of money in circulation must correspond to the level of the economy (production volume), the level of trade and income. Otherwise, it will be impossible to ensure price stability, which is the main condition for determining the amount of cash in circulation.
Fisher's equation
Prices and the amount of money are directly related.
Depending on various conditions, prices may change due to changes in the money supply, but the money supply can also change depending on changes in prices.
The exchange equation looks like this:
Fisher formula
Undoubtedly, this formula is purely theoretical and unsuitable for practical calculations. Fisher's equation does not contain any single solution; within the framework of this model, multivariance is possible. However, under certain tolerances, one thing is certain: The price level depends on the amount of money in circulation. Usually two assumptions are made:
the speed of money turnover is a constant value;
All production capacities on the farm are fully utilized.
The meaning of these assumptions is to eliminate the influence of these quantities on the equality of the right and left sides of the Fisher equation. But even if these two assumptions are met, it cannot be unconditionally asserted that the growth of the money supply is primary, and the rise in prices is secondary. The dependence here is mutual.
In the conditions of stable economic development the money supply acts as a regulator of the price level. But with structural disproportions in the economy, a primary change in prices is also possible, and only then a change in the money supply (Fig. 17).
Normal economic development:
Disproportion of economic development:
Rice. 17. Dependence of prices on the money supply in conditions of stability or economic growth
Fisher formula (exchange equation) determines the amount of money used only as a medium of exchange, and since money also performs other functions, the determination of the total need for money involves a significant improvement in the original equation.
The amount of money in circulation
The amount of money in circulation and the total amount of commodity prices are related as follows:
The above formula was proposed by representatives quantitative theory money. The main conclusion of this theory is that in each country or group of countries (Europe, for example) there must be a certain amount of money corresponding to the volume of its production, trade and income. Only in this case will the price stability. In the case of an inequality in the quantity of money and the volume of prices, changes in the price level occur:
Thus, price stability- the main condition for determining the optimal amount of money in circulation.
QUANTITY THEORY OF MONEY
On the question of the value of money, bourgeois political economy has long been dominated by the quantity theory of money, which asserts that the value of money is inversely related to its quantity.
The founders of the quantitative theory of money were Charles Montesquieu (1689-1755) in France, D. Locke (1671-1729) and D. Hume (1711-1776) in England. Adhering to nominalistic views on the question of the essence of money, the founders of the quantitative theory also saw in metallic money only a sign that did not have intrinsic value; they determined the value of gold and silver money by their number and argued that the more money there is in the country, the higher the commodity prices.
Unlike Montesquieu, who defined the value of money as the quotient of dividing the total amount of money by the total amount of goods, Hume determined the value of money by the ratio between the amount of money in circulation and the mass of goods on the market, believing that goods and money that do not enter into circulation do not affect for prices. The main flaw in the quantity theory of money is the denial of the function of money as a measure of value, in recognizing money as a mere medium of circulation, in its fetishization of the latter. The quantifiers believe that all money acquires "purchasing power" as a result of its circulation, and that money allegedly has no value before the process of circulation. K. Marx, criticizing Hume's quantitative theory, wrote:
"In his opinion, commodities enter the circulation process without price, and gold and silver without value."
Representatives of the quantity theory of money mistakenly believe that commodity prices are established in the sphere of circulation as a result of the ratio between the amount of money and goods. In reality, however, commodities are first measured in terms of money as a measure of value and acquire prices, and this happens before they go on sale and come into contact with money as a medium of circulation. The second flaw in the quantity theory of money is the identification of gold and paper money and the extension of the laws of circulation of paper money to gold and silver money.
The third flaw in the quantity theory is the misunderstanding of the relation between the value of money, the prices of commodities, and the quantity of money in circulation. Proponents of this theory argue that the amount of valuable money in circulation does not depend on the conditions of production, prices and value of goods, that any amount of money, even gold, can be in circulation, and that the amount of money determines their value and the price level of goods. K. Marx, showing that the prices of goods do not depend on the amount of money in circulation, but, on the contrary, the amount of full-fledged money necessary for circulation is determined by the level of commodity prices, wrote:
“Thus, prices are not high or low because more or less money is in circulation, but on the contrary, more or less money is in circulation because prices are high or low.”
A special group of supporters of the quantity theory represented by prominent English economists D. Ricardo (1772-1823), James Mill (1773-1836), John Stuart Mill (1806-1873) can be called representatives of the classical quantitative theory of money. They treated money as a commodity without depriving it of intrinsic value.
"...that commodities rise or fall in the chain in proportion to the increase or decrease in the quantity of money, I consider a fact beyond dispute."
D. Ricardo made an attempt to combine the quantity theory of money with the theory of labor value, for which he created the doctrine of the automatic regulation of the amount of gold in circulation by importing and exporting it abroad. According to this theory, net imports of gold or an increase in domestic production of gold increase the amount of money in circulation, resulting in a surplus of money in circulation, leading to higher prices and a decrease in the relative value of money. This should lead to an outward flow of gold, causing the money supply to shrink, prices to fall to normal levels, and the relative value of gold to rise.
The failure of this theory lies in the erroneous assumption that all the gold in the country is a medium of exchange. In real life, even under conditions of gold circulation, a part of gold always serves as a treasure or world money and is not in the sphere of internal circulation. Ricardo did not understand the economic law governing the amount of money in circulation. According to this law, the amount of valuable money in circulation is always maintained at a level corresponding to the needs of circulation in money, and money that is not needed for circulation is hoarded and goes into treasures. During the period of the general crisis of capitalism, the quantity theory of money, combined with nominalism, is used to justify paper money circulation and the policy of inflation.
A prominent American representative of the so-called new quantitative theory of money I. Fisher (1867-1947) created a mathematical formula for the dependence of the price level on the money supply:
PQ=MV ,
where M is the money supply; V is the velocity of money circulation; Q - the number of circulating goods; P is the level of commodity prices.
Transforming this equation, we get that Fisher determines the level of commodity prices by the formula
P \u003d MV / Q,
those. the product of the mass of banknotes and the speed of their circulation, divided by the number of goods.
Based on this formula, Fisher concludes that the value of money is inversely proportional to its quantity:
“Thus,” writes the author, “from the simple fact that the money spent on goods must be equal to the quantity of these goods times their prices, it follows that the price level must rise or fall according to the change in the quantity of money, if in at the same time there will be no change in the speed of their circulation or in the amount of goods exchanged.
Fisher's "Equation of Exchange" PQ = MV expresses the quantitative relationships between the sum of commodity prices and the circulating money supply; but this equation does not give the right to conclude that the prices of commodities are determined by the amount of money in circulation. On the contrary, the quantity of money in circulation is determined by commodity prices, since commodities acquire prices before they enter circulation, and not by virtue of the functioning of money as a medium of circulation, but by virtue of the functioning of money as a measure of value.
The invisible hand of the market in balancing supply and demand
Each person, Adam Smith believed, regardless of the will and consciousness, is directed towards achieving economic benefits for the whole society. Thus, the invisible hand of the market is aimed at obtaining benefits for people. Each manufacturer, for example, strives for its own benefit, but the way to it lies through the satisfaction of the needs of a number of people. This is the whole essence of the principle of the invisible hand of the market: a set of different producers, as if driven by an invisible force, effectively, voluntarily, actively implements the interests of the whole society.
Profit performs a signal function in the mechanism of the invisible hand of the market and ensures the competent and harmonious distribution of all resources, that is, it balances supply and demand. So, if production is unprofitable, then the amount of resources involved will be reduced. Soon such production will disappear, because the environment of competitors will put pressure on it. The main principle of the invisible hand of the market is that resources are spent on profitable production.
Real Society and the Invisible Hand of the Market: The Problem of Embodiment
And although Adam Smith formulated the principle of the invisible hand of the market correctly, it is difficult to apply it to real economic life. Specific conditions must be taken into account. For example, in the second half of the nineteenth century, tremendous changes took place in the Western European economy. There were enterprises turning into monopolies. This is clearly not included in the model of the invisible hand of the market by all definitions. As a result of the development of technology, enterprises have become dependent on each other. Their ups and downs were simultaneous. Because of this, the market system collapsed, foreseen by Karl Marx. When the process of monopolization of Western markets began to gradually subside, in many industries, companies turned out to be uncompetitive. And today, monopolies in the economy do not interfere with the development of the economy at all, although such a model does not fit the description of the invisible hand mechanism at all.
How does the second hand work?
It turned out that the market also has a "second hand", and it exists much longer than even the "first". Economic relations can also be influenced by status differences between people. At the heart of this principle is the observation not of prices, but of what goods, services and with what effect are sold. Such a “hand” has ruled society since ancient times, it’s just that economists didn’t think about it. This is a new manifesto for the development of the market, which implies the provision of product diversity and a high rate of its renewal. By purchasing goods, people try to demonstrate their taste, position in society, that is, they mark their own status. Having understood such mechanisms, it is possible to create a completely new effective market management system in the future.
As Adam Smith pointed out, the amazing thing about an economy based on private property and free bargaining is that market prices subordinate the actions of self-interested people to the prosperity of society or the nation as a whole. The entrepreneur, “guided only by his own benefit,” is nonetheless guided by the “invisible hand” of market prices “towards a goal (namely, the economic prosperity of the country), which was not at all his intention.
Many people find it difficult to understand the law of the "invisible hand" because there is a natural tendency to associate order with central planning. If the task is a reasonable distribution of resources, it seems natural that some branch of the central government should be responsible for this. The law of the "invisible hand" states that this is not necessary at all. With private property and freedom of exchange, prices, forcing millions of consumers, producers and resource providers to make their personal choices, are also a means of harmonizing their interests. Prices contain information about consumer preferences, costs and factors related to time, location and other circumstances that neither an individual nor an entire planning body can take into account. Just one single summarizing figure - the market price - provides manufacturers with the full amount of information necessary to bring their personal actions into line with the actions and preferences of others. The market price guides and incentivizes both producers and resource providers to produce the things that are most valued relative to their cost of production.
Business decision makers don't need a central authority to tell them what to produce and how. This function is performed by prices. For example, no one has to force a farmer to grow wheat, to persuade a builder to build houses, or a furniture maker to make chairs. If the prices of these and other commodities indicate that consumers value their value at least at the same level as their cost of production, entrepreneurs, in pursuit of personal gain, will produce them.
There is also no need for a central authority to control the production methods of enterprises. Farmers, builders, furniture makers and many other manufacturers will seek the best combination of resources and the most efficient organization of production, since lower costs mean higher profits. It is in the interests of every manufacturer to reduce costs and improve quality. Competition practically forces them to do so. It will be difficult for producers with high costs to survive in the market. Consumers looking to make the most of their money will see to it.
The "invisible hand" of the market process works so automatically that most people don't even think about it. They simply take it for granted that goods are produced in roughly the quantities that consumers want to purchase them. The long queues that characterize centrally planned economies are virtually unfamiliar to people living in a market economy. The availability of a huge variety of products that strikes the imagination of even modern consumers is also largely taken for granted. The "invisible hand" creates order, harmony and diversity. This process, however, goes so latently that few people understand its essence, and only a few do it justice. However, it is decisive for the economic well-being of society.
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The theory of unemployment by the English economist J. M. Keynes, which can be called the theory of insufficient demand, has the greatest distribution in modern bourgeois political economy. According to Keynes, "the volume of employment is in a very definite way related to the volume of effective demand", and the presence of "underemployment", i.e. unemployment, is due to the limited demand for goods.
Keynes derives the insufficiency of consumer demand from the properties of human psychology, stating that the propensity to consume decreases with increasing income. According to him, as their income grows, people spend less and less of it on consumption and save more and more, and the decrease in the propensity to consume is supposedly an eternal psychological law.
“The psychology of society,” says Keynes, “is such that with the growth of total real income, aggregate consumption also increases, but not to the extent that income grows.”
Keynes explains the lack of demand for the means of production by the weakness of the "stimulus to investment." This “incentive to invest” depends, in his opinion, on many factors: on what kind of income the capitalist expects to receive as a result of investments, on whether he believes in the reliability of investments or considers them risky, whether he evaluates economic, optimistic or pessimistic, social and political perspectives, etc. Here Keynes also assigns the main role to psychological aspects.
Keynes attaches particular importance to the level of lending interest. He argues that the level of interest is the regulator of the amount of investment and that the higher the rate of interest, the less incentive for entrepreneurs to invest. The rate of interest, according to Keynes, under modern capitalism is too high, which slows down investment and thus leads to high unemployment.
Acting, in the witty expression of William Foster, as an emergency doctor in a sick capitalism, Keynes argues that unemployment is such a disease of modern capitalism that it is completely curable if only the right medicines are applied.
“It is clear,” wrote Keynes, “that the world will no longer tolerate the unemployment which, except for short periods of excitement, accompanies and, in my opinion, inevitably accompanies modern capitalist individualism. However, with the help of a correct analysis of the problem, it is possible to cure the disease and at the same time preserve efficiency and freedom, that is, to destroy unemployment while maintaining capitalism, which Keynes considers synonymous with "efficiency and freedom."
To eliminate unemployment under capitalism, according to Keynes, it is necessary to increase government spending, which supposedly can compensate for the insufficient propensity to consume individuals and bring the total amount of effective demand to a level that ensures "full employment". He further considers it necessary to stimulate investment by lowering the rate of interest, for which the state and central banks should increase the issuance of paper money or fiat banknotes. Keynes's doctrine found numerous followers: in England - V. Beveridge, J. Robinson and others, in the USA - E. Hansen,
S. Harris and others, as well as in other capitalist countries. Keynesians also proceed from the position of the determining role of market demand. For example, according to E. Hansen, "the only thing missing before the war, the only thing the American economy needs, is sufficient aggregate demand"
Calling the problem of supplying such demand "the most important problem," Hansen writes:
"You cannot rely on the private economy to generate sufficient energy on its own to provide full employment."
Therefore, he advocates an increase in government spending as a way to ensure full employment. Noting the "tremendous increase in the government's financial operations," Hansen states that "this is the Xinxian cure for stagnation," a means of securing sufficient aggregate demand and full employment.