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Thomas Henderson Econ. 2010 Microeconomic Paper Prof.

Wilson Fall 2013

Credit Management and Budgeting

Credit Management and budgeting are issues that have to be dealt with at various different levels across almost every organization and individually. People often underestimate the far-reaching effects of credit management and budgeting decisions. It can often be a relatively small decision that ultimately destroys an organization or individual. Carefully weighing the marginal costs and benefits of each credit management and budgeting decision is extremely important for individuals and for society as a whole. One could argue that credit management and budgeting decisions start with the government. Governments must budget for everything. A government typically funds its budgets with either tax revenues or borrowed money. Therefore, credit management and budgeting decisions are a staple in any government. And each of those decisions has a marginal cost and a marginal benefit. For example, if our government decides that is important to defend its people, it must budget for those costs as defense is not

free. Defense requires people, weapons, technology, etc. and those all cost money. And every dollar the government decides to spend on defense must come from either borrowed money or tax revenues. In theory, these funds are limited by the ability to tax the people or to raise the funds from investors. Defending the people naturally benefits the people being defended with safety. Defense spending benefits people with jobs for those that work in the industry which allows them to spend on other things which benefits others with jobs in industries where that spending takes place and so on. It benefits the companies that operate in the defense industry. Each of these benefits has a marginal effect. In other words, for every weapon purchased as a result of defense spending, there will be a certain amount of marginal benefit, and presumably, at some point, that marginal benefit will drop below the marginal cost and, therefore, be wasteful. Naturally, it would not seem to be a significant benefit to have 50 of the same gun for each operator of the gun. And every dollar spent on those guns would come at the expense of some other spending, such as education, healthcare, etc. or at the expense of saving and not needing to borrow as much. An example of this in our own government is how much it is spending on tanks. The government earmarked $255,000,000 for continued upgrade of the M1 Abrams tank to the M1A2SEP variant, despite DODs proposal to suspend tank production until 2017 in order to achieve savings. (1) Spending too much on one industry can result in a redistribution of wealth which basically means that one industry is enriched at the expense of another. If a government spends too much money it may have to raise taxes, which costs those who pay the taxes. Or the government may have to borrow more and more money which will cost more and more to service the debt, and should decrease its ability to borrow in

the future, all things being equal. If the government borrows too much and cannot borrow anymore and cannot tax the people anymore, it would have to default on its debt which could lead to wars or loss of resources or even collapse. Obviously, this would be quite a cost to those that were intended to benefit. Corporations and other organizations are something of a microcosm to the government. They too have to decide what to spend money on and whether or not it makes sense to borrow more money. They have to weigh the marginal costs and benefits of those decisions in hopes of accomplishing their goals and staying afloat. Their decisions also affect the wellbeing of society. As we saw during the Great Recession (2) many corporations had decided to borrow too much money and eventually went out of business. This cost many people there jobs and resulted in large losses to investors and creditors. One interesting example of a company that apparently did not weigh the marginal costs and benefits of managements credit and budgeting decisions was Merrill Lynch. The former CEO, John Thain, couldn t have possibly concluded that a $35,000 toilet was going to provide sufficient marginal benefit relative to the cost. Thain also remodeled his office for about $1.2 million while his company was failing. Can you imagine the nerve this guy has, to spend all that money on his office - even if the company was a raging success? Thain spent $35,000 on a toilet. I sincerely hope that for that amount of money, Thain's crap turned to gold. (3) Ultimately, Merrill Lynch only narrowly avoided complete collapse thanks to the Federal Reserve and Bank of America (which is another case of where the government and corporations had to weigh the marginal costs and benefits in the context of credit management and budgeting).

Individuals face these same decisions on a daily basis. Consider the purchase of a new home. Most individuals would need to get a loan for a home. The bigger the loan, the more they pay, and the more they pay for housing, the less they have for the rest of their budget. If they borrow too much, they are likely to default and lose their home. They would need to do the same type of careful weighing of marginal costs and benefits as corporations or governments. Does that extra bathroom create marginal benefits equal to or greater than the marginal costs? And from a budgeting standpoint, is that extra bathroom more important than a family vacation? Or worse, is that extra bathroom worth foreclosure or bankruptcy? Even small purchases can create a slippery slope. Your Netflix subscription probably isnt going to be the demise of your credit management and budgeting, but if you disregard all small purchases, they will add up and can bring you down. People so often incorrectly weigh these marginal costs and benefits and elect those things that provide little or no marginal benefit at great marginal costs in place of things that might have a very small marginal cost, but enormous marginal benefit. For instance, that extra bathroom might add $10,000 to the cost of your home and you may never use it and never derive any benefit from it. And you may have to give up several family vacations and lifetime subscriptions that might have been worth more than any amount of money. Credit management and budgeting decisions can permeate throughout our lives and through many organizations. We often dont consider how big of an impact they can have on the future and on other people. Even seemingly small decisions can have a major impact. It is increasingly important to pay attention to and weigh the marginal

costs and benefits of our credit management and budgeting decisions, no matter the stage on which they are made.

Bibliography

1.) http://cagw.org/reporting/pig-book Congressional Pig Book 2012 cagw.org 2012 2.) http://en.wikipedia.org/wiki/Great_Recession Great Recession wikipedia.org 2008 3.) http://www.huffingtonpost.com/matt-littman/john-thains-35000-toilet_b_162350.html John
Thains $35,000 Toilet Matt Littman huffingtonpost.com 2009