By Dr.

Charu Banga

Information Economics

Information

Economics

Collection of data

A Study of how people choose to use resources

Information is made up of a collection of data and knowledge is made up of different strands of information. Information has gone from scarce to superabundant. That brings huge new benefits but also big headaches - Kenneth Cukier Data are becoming the new raw material of business: an economic input almost on a par with capital and labour. Knowledge is power & information is a valuable resource

Think…..

Is Information an Asset???

information is being treated as a commodity that can be owned. controlled and traded in the market Today the availability of abundant data enables companies to cater to small niche markets anywhere in the world.Nowadays. . Now statisticians mine the information output of the business for new ideas.

  Information Economics is a branch of economic theory that studies how information affects an economy and economic decisions “Information activity" is defined to include those specific industries and occupations whose primary function is to produce. or transmit economically valuable information “Information Economics treats information explicitly as a resource” . process.

So. the division of information gathered may be the most fundamental form of division of labour. Value of information is not quantifiable.   The cost of producing information is independent of the scale on which it is used. . it depends on its “use and context” There is a great deal of difference between personal & group information or you may call it as organizational use of information.

so there is a limit to the rate at which decision makers can absorb information. There are usually significant information differentials in terms of possession of information.    Learning takes time. The complexities of information activities makes information as a resource difficult to contain within the traditional production function mode of analysis. access to information & capacity to use information. . The greater part of cost of information is often the cost incurred by the recipient.

◦ Better workforce. better trained and more capable of dealing with problems. based on availability and use of scientific and technical information. based on more knowledge about consumer needs. leading to improved investment decisions and allocation of resources. ◦ Better product planning and marketing. ◦ Better economic data. ◦ Better management from improved communication and decision-making. . ◦ Better engineering.

 Costs are incurred in acquiring information. information as an „overhead‟ expense. Accounting practice treats.  .    Rarely are results clearly attributable to the information on which they were based. It is likely that the return is over the long term. Except for the information industries information is not directly productive. while the expenditure is made immediately. themselves. subject to cost-cutting.

Information is important for support of product research and development. for management of personnel.   As far as importance of information to business is concerned. for knowledge of government regulations. for use of industry standards. for marketing. so that any potential investor can assess the extent to which it has been recognized. business plan should identify the role of information in support of the business objectives. The returns to profitability from investment in information are real and large. for access to finance. .

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Its major tasks: ◦ ◦ ◦ ◦ ◦ ◦ Exchange rate stability Control of inflation High employment High rate of capital formation Increase in savings Achievement of BOP Equilibrium  . It is an economic policy of the government applied for regulating the volume of currency and credit in the economy.

 Open Market Operations – Buying and selling of government bonds. banks have less cash. AD falls and prices falls. ◦ In inflation – RBI sells government bonds. ◦ In deflation – RBI buyback government bonds. people get their money that they deposit in banks. AD rises and prices rise. thus banks give less loans/ credit creation falls. credit creation rises. . people withdraw money from banks.

prices falls. credit creation falls. ◦ In deflation . credit creation falls. AD rises and thus. . prices rise. AD falls and thus. people borrow less. Also if banks borrow at higher rate from RBI. banks borrow less from RBI. banks borrow more from RBI. ◦ In inflation – bank rate is increased. credit creation rises. Bank Rate/Discount Rate Policy – rate at which commercial banks borrow from central banks. credit creation rises. people borrow more. bank lending rates falls. AD falls and prices falls. Also if banks borrow at lower rate from RBI. bank lending rates rises. AD rises and prices rise.bank rate is reduced.

prices rise. Changes in CRR – CRR is the percentage of total deposits of bank that must be kept with RBI as cash. less money with banks. AD falls. prices fall. more money with banks. ◦ In inflation – CRR is increased. . AD rises.CRR is reduced. credit creation falls. credit creation rises. ◦ In deflation .

borrower has to give security worth Rs. ◦ In inflation – MR rises. 1. ◦ In deflation – MR falls.g. prices falls. – if MR is 30% & loan requirement is Rs. borrower has to pay more security. borrower takes less loans. Change in margin requirement – it is that % of loan that a borrower has to give as security over & above the value of loan. E. borrower pays less security & borrows more. credit creation rises. credit creation falls. AD rises and prices rise.3 lac or collateral money worth Rs. 1 lac. AD falls. . 30000.

 Current rates as on October 31. 2012: ◦ ◦ ◦ ◦ ◦ ◦ Inflation 7.5% Bank rate 9% CRR 4.25% SLR 23% Repo rate 8% Reverse repo rate 7% .

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It influences trade & capital flows across national boundaries. relative profitability of various industries. It is one of the important macroeconomic variable like interest rate & money supply. real wages of workers and finally. allocation of resources within and across countries. Exchange Rate is the relative price of one currency in terms of another.   .

Forward Exchange Rate Bilateral Vs. Fixed/Pegged Vs. Effective Exchange Rate Real Effective Exchange Rate (REER) Vs. Floating/Flexible Exchange Rate Spot Vs. Nominal Effective Exchange Rate (NEER)    .

    During the Bretton Woods era. Then came the basket peg where the margins of +/.25% to current rate & further. Indian rupee was pegged to pound sterling.5% were introduced. .2. After the collapse of fixed rate system. 1993. +/. there was a gap when it was pegged to US Dollar and then restored back to sterling in 1972 & maintained till September 1975. Finally came the Liberalized Exchange Rate Management System (LERMS) in March 1992 and market-determined exchange rate system in February.

Risk is the measure of variability of the value of the item attributable to the risk factor. The magnitude of risk is determined by the magnitude of exposure and the degree of variability in the relevant risk factor.   . Exposure is a measure of sensitivity of the value of a financial item (asset or liability) to changes in the relevant risk factor.

Currency Exposure Short-term Long-term Accounting/ Translation Cash Flows Operating Strategic Contractual Anticipated .

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Interest rate volatility is the major source of uncertainty particularly for financial institutions.  . Interest is the price paid for borrowed funds that is the cost to the borrower & return to the lender.

Compounded/Effective Fixed Vs. real interest rate and inflation rate (Fisher effect)  . Simple Vs. Floating   Nominal Vs. Real Relationship between nominal interest rate.

 Fluctuations in interest rate affect a firm‟s cash flows by affecting interest rate income on financial assets & interest expenses on liabilities. Interest rate exposure through „Gap Analysis‟ can be assessed  .  Effective assessment & management of interest rate exposure requires a clear statement of firm‟s risk objective.

the following period would be set in line with the market rate. A rise in rates shall affect cash flows. Suppose it requires foreign currency financing & is forced to borrow on floating rate basis. The firm‟s future interest payments are therefore uncertain. an additional element of risk is introduced in project appraisal. ◦ Consider a firm that wants to undertake a fixed investment project. several developing countries have suffered from the increase in real interest rates as interest payments on their floating rate borrowings have eaten away a progressively increasing part of their real export earnings. For instance: ◦ If the Co. . at every reset date. Since its cost of capital is uncertain.  At the macro level. has borrowed on the floating rate basis.

The cash flows of a project may decline as a result of fall in the rate of inflation but the firm is locked into a high cost borrowing. Subsequently.◦ Consider a firm that has borrowed on a fixed rate basis to finance a fixed investment project. . ◦ A fund manager is holding a portfolio of fixedincome securities such as government & corporate bonds. Returns on these reinvestments is uncertain. Fluctuations in interest rates causes 2 kinds of risk:  The market value of his portfolio varies inversely with interest rates (capital gain/loss risk)  He receives periodic interest payments on his holdings that have to be reinvested. inflation rate in the economy slows down & market rate of interest declines.

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◦ Quantity channels/credit channels such as bank lending channel.  . that affects the aggregate demand by altering quantity or availability of credit. Monetary transmission channels are classified into two: ◦ Price channels such as interest rate channel. exchange rate channel & other asset price rate channels. that affect aggregate demand by affecting price/cost of credit. Process through which changes in monetary policy instruments affects inflation. output & other economic variables is known economic mechanism.

the interest & exchange rates are emerging to be crucial monetary transmission channels. With the reforms in place & changes in the structure of the Indian economy. .

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though. After some time. and on the assumption that the volume of imports and exports change little immediately. . this causes a depreciation of the current account. and domestic consumers may buy fewer of the costlier imports. the trade balance may improve on what it was before the devaluation. A devalued currency means imports are more expensive. the volume of exports may start to rise because of their lower more competitive prices to foreign buyers. Eventually.    It is the trend of a country‟s trade balance following a devaluation or depreciation under a certain set of assumptions. if this happens.

 Equally. cheaper alternatives (which might not exist). in the short run. which are cheaper to foreign buyers using foreign currencies) remain price inelastic. which are now cheaper in the foreign currency. Moreover. This is due to time lags in the consumer's search for acceptable. demand for the more expensive imports (and demand for exports. instead of their own domestically produced goods and services. . many foreign consumers may switch to purchasing the products being exported into their country.

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How the short-run effects of monetary and fiscal policy depend crucially upon the exchange–rate regime. . This implies that the nominal exchange rate is proportional to the real exchange rate. Whether exchange rates should be fixed or floating. Assumption 4: Our LM* curve will be vertical because the exchange rate does not enter into our LM* equation. Assumption 3: The money supply is also set exogenously by the central bank (M). Assumption 2: The price level is exogenously fixed since the model is used to analyze the short run (P).The   distinction between fixed and floating exchange rates. Assumption 1: The domestic interest rate is equal to the world interest rate (r = r*).

there is only one value of Y that equates money demand with supply. Goods market equilibrium – the IS* curve: e where e = nominal exchange rate = foreign currency per unit domestic currency The IS* curve is drawn for a given value of r*. is vertical because: given r*. regardless of e. LM* Y . Intuition for the slope: IS* Y Money market equilibrium – the LM* curve: The LM* curve:   e is drawn for a given value of r*.

BoP i<i* above BoP line: capital inflow below BoP line: capital outflow y .Balance of payment (BOP) curve: i i>i* When there is perfect capital mobility. the BoP line is horizontal.

R LM BP IS Y .

the central bank trades domestic for foreign currency at a predetermined price. Next. under fixed exchange rates. e is allowed to fluctuate in response to changing economic conditions. in a floating exchange rate system ◦ then. In contrast. policy analysis – ◦ first. in a fixed exchange rate system .   In a system of floating exchange rates.

Mundell-Fleming Model Flexible Exchange Rate i LM BoP IS1 IS2 1 2 perfect capital mobility fiscal policy ineffective y G↑ → IS shifts right → i>i* → FA↑ → e↓ → NX↓ → IS shifts left .

i LM1 1 perfect capital mobility monetary policy effective LM2 BoP IS1 IS3 2 MS↑ → LM shifts right → i<i* → FA↓ → e↑ → NX↑ → IS shifts right y .

Mundell-Fleming Model Fixed Exchange Rate i perfect capital mobility fiscal policy effective LM1 2 LM3 BoP IS1 1 IS2 G↑ → IS shifts right → i>i* → FA↑ → e↓ → LM shifts right → e↑ y .

Mundell-Fleming Model Fixed Exchange Rate i LM1 2 1 LM2 BoP IS y perfect capital mobility monetary policy ineffective MS↑ → LM shifts right → i<i* → FA↓ → e↑ → LM shifts left → e↓ .

Monetary policy hurts the other country. ◦ With secondary IS curve movements. If two countries trade a lot. shift IS right causes a secondary effect of shift IS back left: G↑ here → NX↓ here →NX↑ abroad → shift IS right abroad → y↑ abroad  This is why the government strongly encourages other countries to use a fiscal stimulus and strongly discourages other countries from using a monetary stimulus. . one country’s policies can effect the other country. there is an opposite effect on the other country. shift LM right causes a secondary effect of shift IS right: NX↑ here → NX↓ abroad →shift IS left abroad → y↓ abroad  Fiscal policy helps the other country.

but not all three: As κ rises. Krugman modified the Mundell-Fleming Model “Impossible Trinity” by arguing that we can attain any two of the three desirable attributes. the choice between monetary independence & exchange rate stability sharpens .

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