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WU

Introduction to tax Law

Why are taxes necessary?

  1. for¬†government¬†‚Äď a¬†source of¬†revenue
  2. for¬†business¬†‚Äď the¬†cost of¬†(food, income are taxed) business/living
  3. for¬†society¬†‚Äď a¬†price for¬†civilization (Oliver Wendell Holmes)

How to measure the importance of taxes?

  1. tax to GDP ratio
  2. ‚ÄúHigh‚ÄĚ and¬†‚Äúlow‚ÄĚ tax countries
  3. Is there a¬†‚Äúright‚ÄĚ / ‚Äúfair‚ÄĚ level of¬†tax?

Austria has Tax/GDP = 40%. The government wants to lower it, but it is not possible for now. The re are low and high tax countries: AT and Germany are high-tax, Hungary and Switzerland have low-tax.

There is a suitable level of tax: high tax countries provide better services: Free universities, free insurance, and high pensions.
In low-tax countries, services are mostly paid: In Switzerland, citizens should pay for insurance.

VAT is 20% for every consumption is significant.
There are income taxes of 40%-50% in AT. Taxes have a significant impact on the taxpayers’ budget.

Government should adequately justify the amount of tax paid.
Public deficit: Gov spends more money than it gains.

Taxes can help to attract businesses: Ireland was one of the poorest nations in The EU. At the end of 20 century, Ireland decreased the tax to 12.5% from 25%. The population increased by 25%, and before, it was the immigration country. The Republic of Ireland has become so successful that the UK fears that Northern Ireland will become a part of Ireland.

What is a tax?

  1. compulsory
  2. Imposed by legislation / levied by the government
  3. Under the rule of law
  4. For a public purpose
  5. Not paid in exchange for a specific service to the taxpayer

In the UK, there was a discussion that Social networks do not pay enough taxes. People say that they have to pay more. The law did not require that, but there was a public opinion. Some companies voluntarily pay more taxes to the budget to satisfy the public.

There should be a law where it stays that a taxpayer has to pay the taxes. It goes deep into history.

The rule of law means that the payment should be within the limits of the law. High-income people pay more taxes than others, and this is due to democracy: The majority wants wealthy people to pay more.

After the last financial crisis in 2008, many countries asked banks to pay additional taxes to a fund. The government spends money to rescue packages. So they were forced to pay more without any return, even though that banks pay the highest taxes.

Government imposes (–ĺ–Ī–Ľ–į–≥–į—ā—Ć—Ā—Ź) / levies (–≤–∑—č–ľ–į—ā—Ć—Ā—Ź) taxes on¬†different levels of¬†States:

  1. federal
  2. subnational
  3. municipal

States are free to choose the amount of state income taxes.
Florida is an example of a no-state tax, but it still has the federal tax.

There are such municipal taxes (fees) in Vienna as property-related taxes.

What types of taxes may exist?

  1. Income tax¬†‚Äď has become less critical over time.
  2. Corporate income tax¬†‚Äď Corporate income tax is relatively low
  3. Value-added tax (VAT)/ goods and services taxes (GST)/ sales taxes. Most important, biggest tax in the EU
  4. Wealth taxes
  5. Inheritance and gift taxes
  6. Real estate transfer taxes
  7. Consumption taxes
  8. Energy taxes¬†‚Äď e.¬†g., help to¬†decrease the¬†carbon footprint.

Is there a perfect tax mix?

The US does not have the VAT, but it has the sales tax much lower than VAT in the EU. However, the corporate income is much higher than in the EU.

There are not enough consumption and income taxes in developing countries, so the corporate tax is high.

Inflation is essential now. In some decades, money will lose half of its cost due to inflation. That means that people have to spend their money, consume. The government will get its VAT.

What is a purpose of a tax?

  1. to generate revenue for public budgets
  2. to influence behavior
  3. To¬†price-in external cost (Pigouvian Taxes)¬†‚Äď A¬†carbon tax.
  4. To purpose non-tax goals. e. g., many tax-exemptions, non-deductions.

Tobacco taxes are paid for centuries even though the harm from them was discovered only in the 20th century. The tax was not about behavior before, but the way how to get extra cash. If gov wants to get rid of tobacco behavior, then gov has to raise tobacco taxes in New Zealand significantly.

In¬†AT¬†salaries as¬†5k‚ā¨ and¬†more cannot be tax-deductable because the¬†income was too high.

People in retail, supermarket workers, have a low payment. The government wants to increase the income of these workers by deducting some taxes.

Is a specific purpose/justification legally needed at all?
For the tax as such?/ For the design of a specific tax?

Germany has a problem with introducing carbon taxes. The constitution stays that people and companies pay taxes on consumption, but carbon emission is not consumption; it is production.
Austria can do that, but then everyone will have to pay taxes on the breath.

Who decides on a tax system?

Taxes are at the core of State sovereignty.
‚ÄúThe¬†power to¬†tax is the¬†power to¬†govern‚Ä̬†‚Äď ‚ÄúTaxes are politics converted into money.‚ÄĚ
Tax sovereignty may result in¬†tax competition between states¬†‚Äď pros and¬†cons.

European union

  1. VAT¬†‚Äď fully harmonized (but¬†not¬†on¬†the¬†tax rate: standard rate from 15% to¬†27%. E.g., Hungary has 27%)
  2. Income tax¬†‚Äď not¬†harmonized
  3. Corporate income tax¬†‚Äď Common (Consolidated) Corporate Tax Base (CC(C)TB) proposed
  4. Anti Tax Avoidance Directive (ATAD)
  5. EU fundamental Freedoms¬†‚Äď to¬†ensure non-discrimination in¬†the¬†Single Market
  6. Prohibition of¬†State Aid¬†‚Äď to¬†ensure fair competition

International Agreements (Tax treaties)¬†‚Äď to¬†avoid international double taxation.

Microeconomics: Glossary

A

Absolute advantage. when country a can produce a good cheaper than another.
Accounting cost. actual expenses + depreciation for capital equipment.
Actual return. return that an asset earns.
Actuarially fair. situation where an insurance payment = the expected payout.
Adverse selection. market failure, where companies sell products of different qualities at a single price due to asymmetric information.
Advertising elasticity of demand. % change in quantity demanded resulting from 1% increase of advertising expenditures.
Advertising-to-sale ratio. advertising expenditures/ sales
Agent. the Individual employed by a principal (director) to achieve the principal’s objective.
Amortization. Policy of treating a one-time expenditure as an annual cost spread out over some years.
Anchoring (—Ź–ļ–ĺ—Ä–Ĺ–ĺ—Ā—ā—Ć). Tendency to¬†rely heavily on¬†one prior piece of¬†information when making a¬†decision.
Antitrust laws. Rules and regulations prohibit actions that can restrain competition.
Arbitrage. the practice of buying at a low price in one place and selling higher in another.
Arc elasticity demand. price elasticity that is calculated over a range of prices.
Asset. Something that provides a flow of money or services to the owner.
? Asset beta. constant that measures the sensitivity of an asset’s return to market movements and, therefore, the asset’s non-diversifiable risk.
Asymmetric information. a situation in which a buyer and a seller possess different information about a transaction.
Auction market. a market in which products are bought and sold through formal bidding processes.
Average expenditure curve. supply curve representing the price per unit that a firm pays for a good.
Average expenditure. the price paid per unit of a good.
Average fixed cost. Fixed cost / the level of output(?).
Average product. Output per unit of a particular input. 
Average total cost. Firm’s total cost / the level of output. 
Average variable cost. variable cost / the level of input.

B

Bad. the good that is less preferred than more.
Bandwagon (–ľ–į—Ā—Ā–ĺ–≤–ĺ–Ķ –ī–≤–ł–∂–Ķ–Ĺ–ł–Ķ)effect. when a¬†person buys something because others do it either. Positive network externality in¬†which a¬†consumer wishes to¬†possess good in¬†part because others do.¬†
Barrier to entry. Conditions impede (block) entry by new competitors. E.g., when the prices to start are too high or if the monopolists prohibit you from being a partner with anyone.
? Bertrand model. Oligopoly model in which firms produce a homogeneous good, each firm treats the price of its competitors as fixed, and all firms decide simultaneously what price to change.
Bilateral monopoly. Market with one seller and one buyer.
Block pricing. charging different prices for¬†different quantities (‚Äúblocks‚ÄĚ) of¬†a¬†good.
Bond. contract in which a borrower agrees to pay the bondholder (the lender) a stream of money
Bubble. An increase of price not based on fundamentals of demand or value, but instead on a belief that the price will keep going up.
Budget constraints. Constraints that consumers face as a result of limited incomes.
Budget line. All combinations of goods for which the total amount of money spent = income.
Bundling. Practice selling two or more products as a package.

C

Capital Asset Pricing Model (CAPM). Model in which the risk premium for a capital investment depends on the correlation of the investments return with the return on the entire stock market. (If your return less the market return, then you’ll be paid on this amount?)
? Cardinal utility function. Utility function describing by how much one market basket is preferred to another.
Cartel. Market in which some of all firms explicitly collude (cooperate in a secret by the unlawful way), coordinating prices and output levels to maximize joint profits.
Chain-weighted price index. Cost-of-living index that accounts for changes in quantities of goods and services.
?Coase theorem. Principle that when parties can bargain without cost and to their mutual advantage, the resulting outcome will efficient regardless of how property rights are specified
Cobb-Douglas production function. q = AK^åL^ß, where q is the rate of output, K is the quantity of capital, and L is the quantity of labor, and where A, å, and ß are constants.
Cobb-Douglas utility function. U(X, Y) = A^å*Y^(1-å), where X and Y are two goods and a is a constant. 
Common property resource. a resource to which anyone has free access.
Common-value auction. Auction in which the item has the same value to all bidders, but bidders don’t know. That value precisely and their estimates of it vary.
Company cost of capital. Weighted avatar of the expected return on a company’s stock and the interest Tate that it pays for debt.
Comparative advantage. situation, in which country 1 has an advantage over country 2 in producing a good because the cost of producing the good in 1, relative to the cost of producing other goods in 1, is lower than the cost of producing the good in 2, relative to the cost of producing other goods in 2. 
Complements. two goods for which an increase in the price of one leads to a decrease in the quantity demanded of the ofter.
Completely inelastic demand. Principle that consumers will buy a fixed quantity of a good regardless of its price.
Condominium. A housing unit that is individually owned but provides access to common facilities that are paid for and controlled jointly by an association of owners. 
Constant returns to scale. Situation in which output doubles when all inputs are doubled. 
Constant-cost Industry. Industry whose long-run supply curve is horizontal. 
Consumer Price Index. Measure of¬†the¬†aggregate (—Ā–ĺ–≤–ĺ–ļ—É–Ņ–Ĺ—č–Ļ) price level.¬†
Consumer surplus. Difference between what a consumer is willing to pay for a good and the amount actually paid. 
Constant curve. curve showing all efficient allocations of goods between who consumers, or of two inputs between two production functions.
Cooperative. Association of businesses, or people jointly owned and operated by members for mutual benefit. 
Cooperative game. game in which participants can negotiate binding contracts that allow them to plan joint strategies.
Corner solution. a situation in which the marginal rate of substitution of one good for another in a chosen market basket is not equal to the slope of the budget line.
Cost function. Function relating the cost of production to the level of output and other variables that the firm can control.
Cost-of-living index. Ration of the present cost of a typical bundle of consumer goods and services compared with the cost during a base period. 
Cournot equilibrium. Equilibrium in the Cournot model
Cournot model. Oligopoly model in which firms produce a homogeneous (same) good, each firm treats the output of its competitors as fixed, and all firms decide simultaneously (at the same time) how much to produce.
Cross-price elasticity of demand. Percentage change in the quantity demanded of one good resulting from a 1-percent increase in the price of another.
Cyclical industries. Industries in which sales tend to magnify cyclical changes in GDP and national income

D

Deadweight loss. Net loss of total (consumer and producer) surplus.
Decreasing returns to scale. Situation in which output less than doubles when all inputs are doubled. (Less productive if more products)
Decreasing-cost industry. industry, whose long-run supply curve is downward sloping.
Degree of economies of scope (SC). Percentage of cost-saving resulting when two or more products are produced jointly (together) rather than individually. (Mb means by one or two companies)
Demand curve. Relationship between the quantity of a good that consumers are willing to buy and the price of the good.
Derived demand. Demand for an input that depends on, and is derived from, both the firms’ level of output and the cost of inputs.
Deviation. Difference between expected payoff and¬†actual payoff (–≤—č–Ņ–Ľ–į—ā–į).
Diminishing marginal utility. principle that as¬†more of¬†a¬†good is consumed, the¬†consumption of¬†additional amounts will yield smaller additions to¬†utility (–≤—č–≥–ĺ–ī–į, –Ņ—Ä–į–ļ—ā–ł—á–Ĺ–ĺ—Ā—ā—Ć, –Ņ–ĺ–Ľ—Ć–∑–į). The¬†more you consume, the¬†less you need to¬†get the¬†benefit.
Discount rate. The rate used to determine the value today of a dollar received in the future.
Diseconomies of scale. A situation in which a doubling of output requires more than a doubling of cost.
Diseconomies of scope. A situation in which the joint output of a single firm is less than could be achieved by separate firms when each produces a single product. 
Diversifiable risk. Risk that can be eliminated either by investing in many projects or by holding the stocks of many companies.
Diversification. Practice of reducing risk by allocating resources to a variety of activities whose outcomes are not closely related.
Dominant Firm. Firm with a large share of total sales that sets the price to maximize profits, taking into account the supply response of smaller firms.
Dominant strategy. Strategy that is optimal no matter what an opponent does.
Double marginalization. when each firm in a vertical chain marks up its price above its marginal cost, thereby increasing the price of the final product.
Duality. Alternative way of looking at the consumer’s utility maximization decision: Rather than choosing the highest indifference curve, given a budget constraint, the consumer chooses the lowest budget line that touches a given indifference curve.
Duopoly. Market in which two firms compete with each other (Airbus and Boeing).
Dutch auction. Auction in which a seller begins by offering a relatively high price, then reduces it by fixed amounts until the item is sold.

E

Economic cost. cost to a firm utilizing economic resources in production.
Economic efficiency. Maximisation of aggregate consumer and producer surplus.
Economic rent. Amount that firms are willing to pay for input less the minimum amount necessary to obtain it.
Economics of scale. a situation in which output can be doubled for less than a doubling of cost (So then more, then more effective production).
Economics of¬†scope. Situation in¬†which joint (—Ā–ĺ–≤–ĺ–ļ—É–Ņ–Ĺ—č–Ļ) output of¬†a¬†single firm is greater than output that could be achieved by¬†2 different firms when each produces a¬†single product.
Edgeworth box. a diagram showing all possible allocation of either 2 goods between 2 people or of 2 inputs between 2 production processes.
Effective yield (rate of return). percentage return that one receives by investing in a bond.
Efficiency wage. Wage that a¬†firm will pay to¬†an¬†employee as¬†an¬†incentive not¬†to¬†shirk (—Ā—ā–ł–ľ—É–Ľ —á—ā–ĺ–Ī—č –Ĺ–Ķ —É–ļ–Ľ–ĺ–Ĺ—Ź—ā—Ć—Ā—Ź –ĺ—ā —Ä–į–Ī–ĺ—ā—č, —ā–Ķ–ľ —Ā–į–ľ—č–ľ —É–ľ–Ķ–Ĺ—Ć—ą–į—Ź –Ī–Ķ–∑—Ä–į–Ī–ĺ—ā–ł—Ü—É).
Efficiency wage theory. Explanation for the presence of unemployment and wage discrimination which recognizes that labor productivity may be affected by the wage rate.
Elasticity. Percentage change in one variable resulting from a 1-percent increase in another variable.
Emissions fee. Charge levied on each unit of a firm’s emissions.
Emissions standard. Legal limit in the number of pollutants that a firm can emit.
? Endowment (–Ņ–ĺ–∂–Ķ—Ä—ā–≤–ĺ–≤–į–Ĺ–ł–Ķ) effect. Tendency of¬†individuals to¬†value an¬†item more when they own it than when they don‚Äôt.
Engel curve. Curve relating the quantity of a good consumed to income. 
English auction. Auction in which a seller actively solicits progressively higher bids from a group of potential buyers.
? Equal marginal principle. Principle that utility is maximised when the consumer has equalised the marginal utility per dollar of expenditure across all goods.
Equilibrium (market clearing) price. Price that equates the quantity supplied to the quantity demanded. 
? Equilibrium in dominant strategies. Outcome of a game in which each firm is doing the best it can regardless of what its competitors are doing.
Excess demand. When the quantity demanded of a good exceeds the quantity supplied.
Excess supply. When the quantity supplied of a good exceeds the quantity demanded.
Exchange economy. Market in which 2 or more consumers trade 2 goods among themselves.
? Expansion path. Curve passing through points of tangency between a firm’s isocost lines and its isoquants.
Expected return. Return that an asset should earn on average.  
Expected utility. Sum of the utilities associated with all possible outcomes, weighted by the probability that each outcome will occur.
Expected value. Probability-weighted average of the payoffs associated with all possible outcomes.
? Extensive form or a game. Representation of possible moves in a game in the form of a decision tree.
Extent of a market. Boundaries of a market, both geographical and in terms of range of products produced and sold within it.
? Externality. Action by either a producer or a consumer which affects other producers or consumers, but is not accounted for in the market price.

F

Factors of production. Inputs into the production process (e. g. Labor, capital, materials).
First-degree price discrimination. Practice of charging each customer her reservation price.
First-price auction. Auction in which the sales price is equal to the highest bid.
Fixed cost (FC). Cost that does not vary with the level of output and that can be eliminated only by shutting down.
Fixed input. Production factor that cannot be varied.
? Fixed-proportions production function. Production function with L-shaped isoquants, so that only one combination of labor and capital can be used to produce each level of output.
Fixed-weight index. Cost-of-living index in which the quantities of goods and services remain unchanged.
Framing. Tendency to rely on the context in which a choice is described when making a decision.
Free entry (or exit). Condition under which there are no special costs that make it difficult for a firm to enter (or exit) an industry.
Free rider. Consumer or producer who does not pay for a nonexclusive good in the expectation that others will.

G

Game. Situation in which players (participants) make strategic decisions that take into account each other’s actions and responses.
General equilibrium analysis. Simultaneous (–ĺ–ī–Ĺ–ĺ–≤—Ä–Ķ–ľ–Ķ–Ĺ–Ĺ–ĺ–Ķ, —Ā–ł–Ĺ—Ö—Ä–ĺ–Ĺ–Ĺ–ĺ–Ķ) determination of¬†the¬†prices and¬†quantities in¬†all relevant markets, taking feedback effects into account.
? Giffen good. Good whose demand curve slopes upward because the¬†(negative) income effect is larger than the¬†substitution (–∑–į–ľ–Ķ—Č–Ķ–Ĺ–ł–Ķ) effect. (e.¬†g. with luxury good when price is low, then demand falls, or¬†cheap fast food or¬†cheap fruits**. if it‚Äôs to¬†cheap, then people will be afraid to¬†buy it).

H

Hicksian substitution effect. alternative to the Slutsky equation for decomposing price changes without resource to indifference curves.
Horizontal integration. Organisational form in which several plants produce the same or related products for a firm.
Human capital. Knowledge, skills, and experience that make an individual more productive and thereby able to earn a higher income over a lifetime 

I

Ideal cost-of-living index. cost of attaining a given level of utility at current prices relative to the cost of attaining the same utility at base-year prices.
Import quota. Limit on the quantity of a good that can be imported
Income effect. Change in consumption of a good resulting from an increase in purchasing power, with relative prices held constant.
Income elasticity of demand. Percentage change in the quantity demanded resulting from a 1-percent increase in income
Income-consumption curve. Curve tracing the utility-maximizing combinations of 2 goods as a consumer’s income changes.
Increasing returns to scale. Situation in which output more than doubles when all inputs are doubled.
Increasing-cost industry. Industry whose long-run supply curve is upward sloping.
Indifference curve. Curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction. (2 indifference curves can’t intersect).
Indifference map. Graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent.
Individual demand curve. Curve relating the quantity of a good that a single consumer will buy to its price.
Inferior (–Ņ–ĺ–ī—á–ł–Ĺ—Ď–Ĺ–Ĺ—č–Ļ) good. A¬†good that has a¬†negative income effect.

Infinitely elastic demand. Principle that consumers will buy as much of a good as they can get at a single price, but for any higher price, the quantity demanded drops to zero, while for any lower price, the quantity demanded increases without limit.
Informational cascade. An assessment (e. g., of investment opportunity) based in part on the actions of others, which in turn were based on the actions of others.
Interest rate. the rate at which one can borrow or lend money.
? Intertemporal price discrimination. Practice of separating consumers with different demand functions into different groups by charging different prices at different points in time. (Hardcover and paperback books difference at a price is high)
Isocost line. Graph, showing all possible combinations of labor and capital that can be purchased for a given total cost.
Isoelastic demand curve. Demand curve with constant price elasticity.
Isoquant. curve showing all possible combinations of inputs that yield the same output. 
Isoquant map. graph combining a number of isoquants used to describe a production function.

K

Kinked demand curve model. oligopoly model in which each firm faces a demand curve kinked at the currently prevailing price: at higher prices, demand is very elastic, whereas at lower prices, it is inelastic.

L

Labor productivity. Average product of labor for an entire industry or for the economy as a whole.
Lagrangian. function to be maximized or minimised, plus a variable (the Long-range multiplier) multiplied by the constraint.
Laspeyres price index. Amount of money at current-year prices that an individual requires to purchase a bundle of goods and services chosen in a base year / cost of purchasing the same bundle at base-year prices.
Law of diminishing marginal returns. Principle that as the use of an input increases with other inputs fixed, the resulting additions to output will eventually decrease.
Law of small numbers. Tendency to overstate the probability that a certain event will occur when faced with relatively little information. 
Learning curve. Graph relating amount of inputs needed by a firm to produce each unit of output to its cumulative output.
Least-squares criterion. Criterion of¬†‚Äúbest fit‚ÄĚ used to¬†choose values for¬†regression parameters, usually by¬†minimising the¬†sum of¬†squared residuals between the¬†actual values of¬†the¬†dependent variable and¬†the¬†fitted values.
Lerner Index of Monopoly Power. Measure of monopoly power = excess of price / marginal cost as a fraction of price.
Linear demand curve. Demand curve that is a straight line.
? Linear regression. Model specifying a linear relationship between a dependent variable and several independent (or explanatory) variables and an error term
Long run. Amount of time needed to make all production inputs variable.
Long-run average cost curve (LAC). Curve relating average cost of production to output when all inputs, including capital, are variable.
Long-run competitive equilibrium. All firms in¬†an¬†industry are maximizing profit, no¬†firm has an¬†incentive (—Ā—ā–ł–ľ—É–Ľ) to¬†enter or¬†exit, and¬†price is such that quantity supplied equals quantity demanded.
Long-run marginal cost curve (LMC). Curve showing the change in long-run total cost as output is increased incrementally by 1 unit.
Loss aversion. Tendency for individuals to prefer avoiding losses over acquiring gains.

M

Macroeconomics. branch of economics that deals with aggregate economic variables, such as the level and growth rate of national output, interest rates, unemployment, and inflation.
Marginal benefit. Benefit from the consumption of one additional unit of a good.
Marginal cost. Cost of one additional unit of a good.
Marginal expenditure. Additional cost of buying one more unit of a good
Marginal expenditure curve. curve describing the additional cost of purchasing one additional unit of a good.
Marginal external benefit. Increased benefit that accrues (–Ĺ–į—Ä–į—Č–ł–≤–į–Ķ—ā –Ņ—Ä–ĺ—Ü–Ķ–Ĺ—ā) to¬†other parties as¬†a¬†firm increases output by¬†one unit.
Marginal external cost. Increase in cost imposed external as one or more firms increase output by one unit.
Marginal product. Additional output produced as an input is increased by one unit.
Marginal rate of substitution (MRS). Maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good.
Marginal rate of technical substitution (MRTS). Amount by which the quantity of one input can be reduced when one extra unit of another input is used, so that output remains constant. 
? Marginal rate of transformation. Amount of one good that must be given up to produce one additional unit of a second good.
Marginal revenue. Change in revenue resulting from an increase in output by one unit.
Marginal revenue product. Additional revenue resulting from the sale of output created by the use of one additional unit of an input.
Marginal social benefit. Sum of the marginal private benefit + marginal external benefit.
Marginal social cost. Sum of the marginal cost of production and the marginal external cost.
Marginal utility (MU). Additional satisfaction obtained from consuming one additional unit of a good.
Marginal value. Additional benefit derived from purchasing one more unit of a good.
Market. Collection of buyers and sellers that, through their actual or potential interactions, determine the price of product or set of products.
Market basket (or bundle). List with specific quantities of one or more goods. 
Market definition. Determination of the buyers, sellers, and range of products that should be included in a particular market.
Market demand curve. curve relating the quantity of a good that all consumers in a market will buy to its price. 
? Market failure. Situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers.
Market mechanism. Tendency In a free market for price to change until the market clears.
Market power. Ability of a seller or buyer to affect the price of a good.
Market price. Price prevailing (–Ņ—Ä–Ķ–ĺ–Ī–Ľ–į–ī–į—é—Č–į—Ź) in¬†a¬†competitive market.
Market signalling. Process by which sellers send signals to buyers conveying information about product quality.
Maximin strategy. strategy that maximises the minimum gain that can be earned.
Method of Lagrange multipliers. Technique to max or min a function subject to one or more constraints.
Microeconomics. a¬†branch of¬†economics that deals with the¬†behavior of¬†individual economic units¬†‚Äď consumers, firms, workers, and¬†investors¬†‚Äď as¬†well as¬†the¬†markets that these units comprise.
Mixed bundling. Selling two or more goods both as a package and individually (MB like gel and shampoo for gifts and normally separately)
Mixed strategy. Strategy in which a player makes a random choice among two or more possible actions based on a set of chosen probabilities.
Monopolistic competition. Market in which firms can enter freely, each producing its own brand or version of a differentiated product. 
Monopoly. Market with only one seller.
Monopsony. Market with only one buyer.
Monopsony power. buyer’s ability to affect the price of a good.
Moral hazard. when a party whose actions are unobserved can affect the probability or magnitude of a payment associated with an event.
Multiple regression analysis. Statistical procedure for quantifying economic relationships and testing hypotheses about them.
Mutual fund. Organisation that pools funds of individual investors to buy a large number of different stocks or other financial assets.

N

Nash equilibrium. set of strategies or actions in which each firm does the best it can given its competitors’ actions. 
Natural monopoly. Firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms.
Negatively correlated variables. Variables having a tendency to move in opposite directions.
Net present value (NPV) criterion. Rule holding that one should invest in the present value of the expected future cash flow from on investment is larger than the cost of the investment.
Network externality. Situation in which each Individual’s demand depends on the purchases of other individuals. (If everyone buys Tesla, I buy too)
Nominal price. Absolute price of a good, unadjusted for inflation.
Noncooperative game. Game in¬†which negation (–ĺ–Ņ—Ä–ĺ–≤–Ķ—Ä–≥–į—é—Č–ł–Ķ) and¬†enforcement of¬†binding (–ĺ–Ī—Ź–∑—č–≤–į—é—Č–ł–Ķ) contracts are not¬†possible.
Nondiversifiable risk. Risk that cannot be eliminated by investing in many projects or by holding the stocks of many companies.
? Nonexclusive good. Good that is difficult or impossible to charge for its use, and this good can’t be excluded from consumption.
Nontrivial good. Good for which the marginal cost of its provision to an additional consumer is zero (e. g., a game license for the second friend)
Normative analysis. Analysis examining questions of what ought to be.

O

Oligopoly. Market in which only a few firms compete with one another, and entry by new firms is impeded (barrier)
Oligopsony. market with only a few buyers.
Opportunity cost. Cost associated with opportunities forgone the firm’s resources are not put to their best alternative use.
Opportunity cost of capital. Rate of return that one could earn by investing in an alternate project with similar risk.
**Optimal strategy. -Strategy that maximizes a player’s expected payoff.
Ordinal utility function. Utility function that generates a ranking of market baskets in order of most to least preferred.
Overconfidence. Overestimating an Individual’s prospects or abilities.
Over-optimism. An unrealistic belief that things will work out well.
Over-precision. An unrealistic belief that one can accurately predict outcomes.

P

Paasche index. Amount of money at current-year prices that an individual requires to purchase a current bundle of goods and services / the cost of purchasing the same bundle in a base year.
Pareto efficient allocation. Allocation of goods in which no one can be made better off unless someone else is made worse off.
Parallel conduct. Form of¬†implicit (—Ā–ļ—Ä—č—ā—č–Ļ) collusion (—Ā–≥–ĺ–≤–ĺ—Ä) in¬†which one firm consistently follows actions of¬†another.
Partial equilibrium analysis. Determination of equilibrium prices and quantities in a market independent of effects from other markets.
Payoff. (–≤—č–Ņ–Ľ–į—ā–į) value associated with a¬†possible outcome.
Payoff matrix. Table showing profit (or payoff) to each firm given its decision and the decision of its competitor.
Peak-load pricing. Practice of¬†charging higher prices during peak periods when capacity constraints (–ĺ–≥—Ä–į–Ĺ–ł—á–Ķ–Ĺ–ł—Ź) cause marginal costs to¬†be high (e.¬†g., in¬†winter people need ski, but¬†the¬†production is restricted).
Perfect complements. Two goods for which the Marginal Rate of Substitution (MRS is how much of one good you’re ready to give up for another) is zero or infinite; The indifference curves are shaped as right angles.
Perfect substitutes. Two goods for which the Marginal Rate of Substitution of one for the other is constant.  
Perfectly competitive market. Market with many many buyers and sellers, so that no single buyer or seller has a significant impact on price.
Perpetuity. Bond paying out a fixed amount of money each year forever.
Point of elasticity of demand. Price elasticity at a particular point on the demand curve.
Positive analysis. Analysis describing relationships of cause and effect
Positively correlated variables. Variables having a tendency to move in the same direction.
Predatory pricing. Practice of pricing to drive current competitors out of business and to discourage new entrants in a market so that a firm can enjoy higher future profits.
Present discounted value (PDV). The current value of an expected future cash flow.
Price discrimination. Practice of charging different prices to different consumers for similar goods.
Price elasticity of demand. Percentage change in quantity demanded of a good resulting from a 1-percent increase in price.
Price elasticity of supply. Percentage change in quantity supplied of a good resulting from a 1-percent increase in price.
Price leadership. Pattern of pricing in which one firm regularly announces price changes that other firms should match.
Price of risk. Extra risk that an investor must incur to enjoy a higher expected return.
? Price rigidity. characteristic of oligopolistic markets by which firms are reluctant (unwilling) to change prices even if costs of demands change.
Price signaling. form of¬†implicit collusion (—Ā–ļ—Ä—č—ā—č–Ļ —Ā–≥–ĺ–≤–ĺ—Ä) in¬†which a¬†firm announces a¬†price increase in¬†the¬†hope that other firms will follow suit.
Price support. Price set by government above free-market level and maintained by governmental purchases of excess supply.
Price taker. Firm that has no influence over market price and thus takes the price as given.
Price-consumption curve. Curve tracing the utility-maximizing combinations of two goods as the price of one changes.
Principal. (Director) Individual who employs one or more agents to achieve an objective.
Principal-agent problem. Problem arising when agents (e. g., firm’s managers) pursue their own goals rather than the goals of principals (e. g., the firm’s owners).
Prisoners’ dilemma. Game theory example in which two prisoners must separately decide whether to sell the other prisoner out or not**. if he does, he will not get a sentence, when another gets ten years; if they both don’t confess, then they get one year, and if both confess, then they will get 15 years (Time can differ).
Private-value auction. Auction in which each bidder knows his or her individual valuation of the object up for bid, with valuations differing from bidder to bidder.
Profitability. Likelihood that a given outcome will occur. 
Producer Price Index. Measure of the aggregate price level for intermediate products and wholesale goods.
Producer surplus. Sum over all units produced by a firm of differences between the market price of a good and the marginal cost of production. 
? Product transformation curve. Curve showing the various combination of two different outputs (products) that can be produced with a given set of inputs.
Production function. Function showing the highest output that a firm can produce for every specified combination of inputs.
Production possibilities frontier. Curve showing the combinations of two goods that can be produced with fixed quantities of inputs.
Profit. Difference between revenue and total cost.
Property rights. Legal rules stating what people or firms may do with their property.
Public good. Nonexclusive and¬†non-rival (–Ĺ–Ķ–ļ–ĺ–Ĺ–ļ—É—Ä–Ķ–Ĺ—ā–ĺ—Ā–Ņ–ĺ—Ā–ĺ–Ī–Ĺ—č–Ļ) good: the¬†marginal cost of¬†provision to¬†an¬†additional consumer is zero, and¬†people cannot be excluded from consuming it.
Pure bundling. Selling products only as a package.
Pure strategy. Strategy in which a player makes a specific choice or takes a specific action.

Q

Quantity forcing. Use of a sales quota or other incentives to make downstream firms sell as much as possible.

R

Rate-of-return regulation. Maximum price allowed by a regulatory agency is based on the (expected) rate of return that a firm will earn.
Reaction curve. Relationship between a firm’s profit-maximizing output and the amount that the firm thinks its competitor will produce.
Real price. Price of a good relative to an aggregate measure of prices; price adjusted for inflation.
Real return. Simple (or nominal) return on an asset**. the rate of inflation.
Reference point. The point from which an individual makes a consumption decision.
Rent-seeking. Spending money in socially unproductive efforts to acquire, maintain, or exercise monopoly.
Rental rate. Cost per year of renting one unit of capital.
Repeated game. Game in which actions are taken, and payoffs received over and over again.
Reservation price. Maximum price that a customer is willing to pay for a good.
Return. Total monetary flow of an asset as a fraction of its price.
Returns to scale. Rate at which output increases as inputs are increased proportionately. 
Rist averse (opposition). Condition of preferring a certain income to a risky income with the same expected value.
Risk loving. Condition of preferring a risky income to a certain income with the same expected value.
Risk neutral. Condition of being indifferent between a certain income and an uncertain income with the same expected value. 
Risk premium. Maximum amount of money that a risk-averse individual will pay to avoid taking a risk.
Riskless (risk-free) asset. Asset that provides a flow of money or services that is known with certainty.
Risky asset. Asset that provides an uncertain flow of money or services to its owner.
? R-squared (R^2). the percentage of the variation in the independent variable that is accounted for by all the explanatory variables.

S

Salience. (–∑–Ĺ–į—á–ł–ľ–ĺ—Ā—ā—Ć) The¬†perceived importance of¬†a¬†good or¬†service.
Sample. Set of observations for study, drawn from a larger universe.
Sealed-bid auction. Auction in¬†which all bids are made simultaneously in¬†sealed (–Ņ–Ķ—á–į—ā–Ĺ—č–Ļ) envelopes (–ļ–ĺ–Ĺ–≤–Ķ—Ä—ā), the¬†winning bidder being the¬†Individual who has submitted the¬†highest bid.
Second-degree price discrimination. Practice of charging different prices per unit for different quantities of the same good or service.
Second-price auction. Auction in which the sales price is equal to the second-highest bid. (Hmm, what if I say an infinity on the bet of 1$?)
Sequential game. Game in which players move in turn, responding to each other’s actions and reactions.
? Shirking (avoiding) model. Principle that workers still have an incentive to shirk (=avoid) if a firm pays them a market-clearing wage because fired workers can be hired somewhere else for the same wage.
Short-run. Period of time in which quantities of one or more production factors cannot be changed.
Short-run average cost curve (SAC). Curve relating average cost of production to output when level of capital is fixed.
Shortage. Situation in which the quantity demanded exceeds the quantity supplied.
? Slutsky equation. Formula for¬†decomposing the¬†effects of¬†a¬†price change into effects of¬†substitution (–∑–į–ľ–Ķ–Ĺ—č) and¬†income.
? Snob effect. Negative network externality in which a consumer wishes to own an exclusive or unique good.
Social rate of discount. Opportunity cost to society as a whole of receiving an economic benefit In the future rather than in the present.
Social welfare function. Measure describing the well-being of society as a whole in terms of the utilities of individual members.
Specific tax. Tax of a certain amount of money per unit sold.
Speculative demand. Demand-driven not by the direct benefits one obtains from owning or consuming a good but instead by an expectation that the price of the goodwill increase. 
? Stackelberg model. Oligopoly model in which one firm sets its output before other firms do.
Standard deviation. Square root of¬†weighted average of¬†the¬†squares of¬†the¬†deviations (–ĺ—ā–ļ–Ľ–ĺ–Ĺ–Ķ–Ĺ–ł–Ļ) of¬†the¬†payoffs associated with each outcome from their expected values.
Standard error of the regression. estimate of the standard deviation of the regression error.
Stock of capital. Total amount of capital available for use in production.
? Stock externality. Accumulated result of action by a producer of the consumer which, though not accounted for in the market’s price, affects other producers or consumers.
Strategy. Rule or plan of action for playing a game
Subsidy. (negative tax) Payment reducing the buyer’s price below the seller’s price. 
Substitutes. two goods for which an increase in the price of one leads to an increase in the quantity of the other.
Substitution effect. Change in consumption of a good associated with a change in its price, with the level of utility held constant.
Sunk cost. Expenditure that has been made and cannot be recovered.
Supply curve. Relationship between the quantity of a good that producers are willing to sell and the price of a good.
Surplus. Situation in which the quantity supplied exceeds the quantity demanded.

T

Tariff. Tax on an imported good.
?Technical efficiency. Condition under which (different?) firms combine inputs to produce a given output as inexpensively as possible.
Technological change. Development of new technologies allowing factors of production to be used more effectively.
Theory of consumer behavior. Description of how consumers allocate incomes among different goods and services to maximize their well-being.
Theory of the firm. Explanation of how a firm makes cost-minimizing production decisions and how a firm makes cost-minimizing production decisions, and how its cost varies with its output.
Third-degree price discrimination. Practice of dividing consumers into two or more groups with separate demand curves and charging different prices to each group.
Tit-for-tat strategy. Repeated-game strategy in which a player responds in kind to an opponent’s previous play, cooperating with cooperative opponents and retaliating (make an attack in return) against uncooperative ones. 
Total cost (TC or C). Total economic cost of production, consisting of fixed and variable costs (TC = FC + VC).
Transfer prices. Internal prices at¬†which parts and¬†components from upstream divisions are ‚Äúsold‚ÄĚ to¬†downstream divisions within a¬†firm.
Tradeable emissions permit. System of marketable permits, allocated among firms, specifying the maximum level of emissions that can be generated.
Two-part tariff. Form of pricing in which consumers are charged both an entry and a usage fee.
Tying. Practice of requiring a customer to purchase one good in order to purchase another.

U

User cost of capital. The annual cost of owning and using a capital asset = economic depreciation + forgone interest.
User cost of production. The opportunity cost of producing and selling a unit today and so making it unavailable for production and sale in the future.
? Utility. (–ü–ĺ–Ľ–Ķ–∑–Ĺ–ĺ—Ā—ā—Ć/–Ņ—Ä–į–ļ—ā–ł—á–Ĺ–ĺ—Ā—ā—Ć) Numerical score representing the¬†satisfaction that a¬†consumer gets from a¬†given market basket.
Utility function. Formula that assigns a level of utility to the individual market basket.
Utility possibilities frontier. Curve showing all efficient allocations of resources measured in terms of the utility levels of two individuals.

V

? Value of complete information. Difference between the expected value of a choice when there is complete information and the expected value when information is incomplete.
Variability. Extent to which possible outcomes of an uncertain event differ.
Variable cost (VC). Cost that varies as output varies. 
Variable profit. Sum of profits on each incremental unit produced by a firm that means profit ignoring fixed costs.
Vertical Integration. Organisational form in which a firm contains several divisions, with some producing parts and components that others use to produce finished products.

W

Welfare economics. Normative (through norms and standards) evaluation of markets and economic policy.
Welfare effects. Gains and losses to consumers and producers.
Winner‚Äôs curse. Situation in¬†which the¬†winner of¬†a¬†common-value auction is worse off as¬†a¬†consequence of¬†overestimating the¬†value of¬†the¬†item and¬†thereby overbidding (—Ā–ł—ā—É–į—Ü–ł—Ź, –≤ –ļ–ĺ—ā–ĺ—Ä–ĺ–Ļ –Ņ–ĺ–Ī–Ķ–ī–ł—ā–Ķ–Ľ—Ć –į—É–ļ—Ü–ł–ĺ–Ĺ–į —Ā –ĺ–Ī—Č–Ķ–Ļ —Ā—ā–ĺ–ł–ľ–ĺ—Ā—ā—Ć—é –Ĺ–į—Ö–ĺ–ī–ł—ā—Ā—Ź –≤ —Ö—É–ī—ą–Ķ–ľ –Ņ–ĺ–Ľ–ĺ–∂–Ķ–Ĺ–ł–ł –≤ —Ä–Ķ–∑—É–Ľ—Ć—ā–į—ā–Ķ –∑–į–≤—č—ą–Ķ–Ĺ–ł—Ź —Ā—ā–ĺ–ł–ľ–ĺ—Ā—ā–ł –Ņ—Ä–Ķ–ī–ľ–Ķ—ā–į –ł, —Ā–Ľ–Ķ–ī–ĺ–≤–į—ā–Ķ–Ľ—Ć–Ĺ–ĺ, –Ņ–Ķ—Ä–Ķ–ļ—É–Ņ–ļ–ł).

Z

Zero economic profit. A firm is earning a normal return on its investment, which means that it is doing as well as it could by investing its money elsewhere.

Business and society course 101

We develop management skills and learn theories to solve problems, that we will have in future. This article contains the main information, that was in the book.

Entrepreneurial perspective

Entrepreneurship is an Essence of business. It comprises 3 things: innovativeness, risk taking and management skills. These qualities can be learnt, or be the talent.
The¬†innovative process is a¬†process of¬†‚Äúcreative destruction‚ÄĚ.

Henry Ford¬†‚ÄĒ not¬†engineer, but¬†innovator.

He made a¬†car ‚ÄúTin Lizzy‚ÄĚ for¬†ordinary people for¬†$295*25 in¬†our currency. He established franchising system of¬†car shops, petrol stations and¬†promoted highway infrastructures.
The average worker worked 8 hours a day and gained $5 for that ($135 now). The work was safe.
Till 1927 he sold 15m cars, but GMC was more innovative and Ford lost in future.

Ray Kroc¬†‚ÄĒ milkshake seller made a¬†franchise out of¬†a¬†small restaurant.

Dick and Mac McDonald offered cheap and tasty burgers.
Kroc just implemented a conveyer system and optimized the kitchen area.
In 2000’s subway outperformed McDonald’s, because they made healthy food.

Dietrich Mateschitz¬†‚ÄĒ brought Red Bull from Thailand to¬†Austria.

He had 49% of company, while Thai partner had 51%.
Red Bull is a¬†sport sponsor and¬†has¬†‚ā¨6b in¬†revenues.
Has hundreds of competitors.

Jobs¬†‚ÄĒ Apple, Pixar, NeXT.

Best advertiser ever.
He was kicked out after successful projects, but¬†became an¬†intrapreneur¬†‚ÄĒ entrepreneur in¬†a¬†company. He made Macintosh, but¬†was fired and¬†opened company NeXT, and¬†also sponsored Pixar¬†‚ÄĒ P.S. he did not¬†invent Pixar, he just was the¬†main investor.
‚ÄúA¬†lot of¬†times, people don‚Äôt know what they want until you show it to¬†them‚ÄĚ

What is in common?

  1. Idea or vision. How to do better?
  2. They weren’t engineers, they just implemented marketing, design...
  3. Work hard for the goal
  4. Content-related goals (e. g. produce cheap and good cars)
  5. Profit is on the second place
  6. Plenty customers who is ready to pay
  7. Risk of failure

Motives

  1. Create something and make an impact
  2. Independence or autonomy
  3. Wealth and fame

Theory of entrepreneurship explains:

  1. How company grows from startup to enterprise
  2. How business helps the national economy
  3. Why businesses fail
  4. How to create a suitable environment for business (VC, Angels etc)
  5. Why after a growth, companies loose their positions

Joseph Schumpeter¬†‚ÄĒ Austrian pioneer of¬†the¬†theory of¬†entrepreneurship

Joseph defines dynamic entrepreneur or pioneer as the engine that is driving a progress. Pioneer develops new processes or products. by doing that, he takes an advantage over competitors or creates a new market (blue ocean). But other companies try to imitate or copy the idea of a pioneer. This is called Dynamic competitive process.
When another pioneer will bring a¬†new idea, the¬†old pioneer‚Äôs idea will be destroyed. It is a¬†Process of¬†creative destruction. The¬†last type is a¬†Recombinant Innovation¬†‚ÄĒ when a¬†new idea is a¬†combination of¬†existing ideas.

Entrepreneurial behavior is often ¬ęirrational¬Ľ, rather intuitive. Pioneer‚Äôs idea is innovative, because it breaks old patterns. To¬†increase chances to¬†be successful, we need a¬†business plan.
Business plan shows us an overall concept of a business idea for investors, shows chances and risks, helps to think about further development of business, identifies threats and protects you from overconfidence and wonders.

Disruptive innovation displaces an existing technology.
Business model innovation does not change a product, but a logic of a business plan.
For example: Netfilx displaced video stores, Uber changed a business model of taxi companies.

Financial perspective

How much money do you earn or¬†loose?¬†‚ÄĒ How to¬†measure financial business performance? What is a¬†value of¬†a¬†company? How to¬†ensure liquidity and¬†solvency? How to¬†decide on¬†investments?

Taxi OPC example

Lena has¬†‚ā¨50k and¬†wants to¬†open a¬†taxi company. She will buy a¬†car for¬†‚ā¨40k and¬†offer newspapers and¬†coffee to¬†customers for¬†free. To¬†be successful, she need data. Lena asks her friend about taxi business. They forecast¬†‚ā¨3000 in¬†receipts from customers¬†‚ÄĒ revenues. Plus, she will spend¬†‚ā¨500 per¬†month for¬†expected ongoing expenditures such as¬†gas, insurance and¬†coffee.
Her operating (net) cash flow is¬†‚ā¨3000¬†‚ÄĒ¬†‚ā¨500 =¬†‚ā¨2500. Inflow¬†‚ÄĒ outflow = flow.

Lena will buy a¬†car, coffee machine and¬†washing machine. These are capital expenditures or¬†CAPEX. CAPEX is a¬†cash flow from investment activities. The¬†difference is that Lena can sell these things, but¬†used gas or¬†eaten chocolate¬†‚ÄĒ not.
She will sell car (and¬†all other CAPEX) for¬†‚ā¨15k and¬†buy a¬†new one for¬†‚ā¨45k in¬†5 years.

let’s count cash inflow and outflow

CAPEX (-40000) + Revenues (3000*12) + expenditures (-500*12) = Overall cash flow (-10000) in the year 1.

Revenues (3000*12) + expenditures (-500*12) = Overall cash flow (30000) in the year 2,3,4.

Sell and buy car (15000-45000) + Revenues (3000*12) + expenditures (-500*12) = Overall cash flow (0) in the year 5.

Looks like she lost money in¬†the¬†1st year. but¬†she did not. These are cash flows, not¬†profits. She will definitely loose money if her operating cash flow was negative. Her cash flow is¬†‚ā¨2500. If her cash flow will be higher, she will afford to¬†hire a¬†driver or¬†buy the¬†second taxi. Don‚Äôt forget about capital expenditures. Cash flow is often negative in¬†the¬†1st year, so Lena has to¬†make a¬†Financing decision, where to¬†get money. If she had not¬†‚ā¨50k, she had to¬†borrow money to¬†buy a¬†car. The¬†cash flow from loans or¬†your savings is called Cash flow from financing activities. We don‚Äôt count them in¬†overall cash flow.

Measure profit: Income Statement (P&L)

The problem of CAPEX in cash flow is that we write CAPEX only in the year, when we bought a car, but we used car equally for 5 years.
Let’s count capital expenditure as resale value of car divided for the time you used a car.
‚ā¨40000¬†‚ÄĒ¬†‚ā¨15000 =¬†‚ā¨25000. This is a¬†resale value of¬†a¬†car. Then we payed¬†‚ā¨5000 per¬†year for¬†a¬†car. This is a¬†Straight line Depreciation.
If we are not¬†sure about selling this car, we can count¬†‚ā¨40000/5years = 8000. This is a¬†normal Depreciation, the¬†5th element of¬†EBITDA.

Expenses are the monetary value of resource consumption during a time period (coffee, newspapers)
Revenues are the monetary value of goods/services that were sold during a time period
Difference between Expenses and Expenditures.

Profit in¬†cost of¬†sales method = revenues¬†‚ÄĒ expenses.
Profit in¬†cost of¬†production method = monetary value of¬†goods/services produced during a¬†time period¬†‚ÄĒ expenses. Here we count all the¬†produced and¬†semi-produced goods, that have been sold and¬†have not¬†been sold yet.

Revenues (36000)¬†‚ÄĒ Ongoing expenses (6000)¬†‚ÄĒ Depreciation (5000) = Profit (25000)
This profit is the same for all the years, because the costs are equally allocated.

But can the cost be really equally allocated? What if i the 2nd year there were in 2 times more rides than in the first? Does not matter, the cost of a car stays the same

Measure profit: Balance Sheet

Corporate net worth (equity) in¬†the¬†beginning of¬†1st year is Taxi (40000) + Bank deposit (10000)¬†‚ÄĒ Liabilities (0) =¬†‚ā¨50000.

Corporate net worth in¬†the¬†end of¬†1st year is Taxi cost (40000)¬†‚ÄĒ Depreciation (5000) + bank deposit(10000 + revenues(36000)¬†‚ÄĒ ongoing expenditures(6000) ) = 35000 + 40000 =¬†‚ā¨75000

Profit = money in¬†the¬†beginning of¬†1st year (75000)¬†‚ÄĒ money in¬†the¬†end of¬†1st year (50000) =¬†‚ā¨25000

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difference between income statement and balance sheet

Income statement helps you to optimize your profits. It shows your transactions, that create resources (products, services) and  transactions, that consume resources (wages, buying materials, selling goods)

balance sheet shows you, which part of the company is yours and which part does the bank or investor have. Creditors use balance sheet to count risks of your failure.

Both of them are important for shareholders and stakeholders (workers, banks, tax authorities)
There are some legal rules, that say how the structure and valuations have to be made.
It helps e. g. investors to compare different firms. Accounting systems and procedures, that help (external) stakeholders are called Financial Accounting.

Accounting systems (Income statement or balance sheet) provide the basis for company-internal analyses such as forecasting profits and making profound business decisions. Accounting systems and procedures, that help managers are called Management Accounting.
The planning and steering of a company by means of (accounting) data and analytics is also referred to as Management Control or Management/Managerial Accounting.

The three main pillars of accounting

Cash Flow
Income Statement P&L
Balance Sheet

Financial ratios

Return On Investments
ROI = Profit / invested capital (with government bonds and other securities).
Capital in denominator should always correspond to the definition of profit in numerator.

**Return On Capital Employed* I*
ROCE = EBIT (Earnings Before Interest and Taxes) / Capital employed
Capital does not contain securities. Profit contains interest

Return On Capital Employed II
Roce = Operating Profit (before or after taxes) / Operating Assets
Operating assets are on the left side of the balance sheet

Return On Equity
ROE = Profit/Equity
Equity is on the right side of the balance sheet

ROI is the most popular, because it can be easily translated into a value driver system

  1. You can use the income statement to see the drivers of profit.
  2. You can use the balance sheet to see the types of capital that comprise overall
    capital (types of assets as well as types of claims).

Profit Margin = Profit / Revenues

Liquidity Ratio = Current Assets / Short-term Liabilities

Gearing (leverage ratio) = Dept (liabilities) / Equity

Corporate Finance and investment Decisions

Investment decisions are decisions about business transactions with an initial cash outflow, in the expectation of future cash inflows that exceed the cash outflow in value.
Lena invests in a taxi (cash outflow) to generate revenues in the future (cash inflow). Investment Theory explores the investment decisions and develops criteria for reasonable decision making.

Financing decisions help us to find money for the investments. Financing starts with a cash inflow followed by cash outflows (interest and repayment). Financing Theories deal with the analyses of financing opportunities and financing structures. Lena’s investments are solely financed with equity. But most entrepreneurial activities cannot be pursued without any use of debt financing.

Financing decisions help corporations got raise equity by issuing shares on the capital market. They can also raise debt capital by issuing bonds (it’s cheaper than lending money in a bank).
Capital Market Theory is based on Microeconomic Theory, and tries to explain market mechanisms and price determination on capital markets.

The¬†value of¬†a¬†company is given by¬†its equity = Assets¬†‚ÄĒ Liabilities.

Eugen Schmalenbach noted that the (economic) value of an asset for the owner does not follow from the price the owner paid when purchasing the asset, but from the future value (utility) the asset generates for the asset owner. A buyer purchases an object, if the price is lower than the value of future usage from the buyer’s subjective perspective. Since the price can be observed objectively, but the future value (utility) depends on the buyer and is hard to determine, the purchase price of an asset is often used as an approximation for its value. E.g., the balance sheet uses purchase prices (minus depreciation) as an approximation of asset value.

The purchase price of an asset is an adequate approximation of its value, if the asset is traded on a well-functioning market (many suppliers and consumers, high information transparency, low transaction cost).
Very few assets (and¬†hardly any companies) are traded (as¬†a¬†whole) on¬†well functioning markets. Therefore, there is no¬†‚Äúobjective‚ÄĚ value of¬†most goods (and¬†companies). It all depends on¬†the¬†subjective judgments of¬†potential buyers on¬†their use of¬†these assets (or¬†companies).

When we counted the value of the company by measuring cash flows, we did not count the Inflation.

-40,000 + 30,000 / (1 + r) + 30,000 / (1 + r^2) + 30,000/ (1 + r^3) + 30,000 / (1 + r^4) + 45,000 / (1 + r^5)

= 101,637 for r=0.05

We also did not¬†count a¬†salary. If Lena will have the¬†salary of¬†‚ā¨24k per¬†year, then
+6,000 / (1 + r) + 6,000 / (1 + r^2) + 6,000/ (1 + r^3) + 6,000 / (1 + r^4) +21,000 / (1 + r^5)
= -2,270 for r=0.05
The¬†Net Present Value (NPV) is negative¬†‚ÄĒ so, this is bad investment. Let‚Äôs find the¬†average rate of¬†return. This is r in¬†the¬†previous equation:
+6,000 / (1 + r) + 6,000 / (1 + r^2) + 6,000/ (1 + r^3) + 6,000 / (1 + r^4) +21,000 / (1 + r^5)
= 0
the average rate of return r = ~ 3.3%. That means, if there is no inflation, then this business will generate 3.3% of profit a year. Lena will return investments in 33 years.

What about investments

Investors are not so much interested in historical purchase prices of assets (balance sheet), but they are more interested in the future cash flows (or earnings) generated by a company’s activities. While historical purchase prices, however are verifiable, future cash flows are not.
Stock prices are depending on the expectations and future cash flows (earnings) generated by a firm.
Possible purposes for evaluating company value are:

  1. determination of income taxes
  2. information of¬†investors, providers of¬†debt (banks) or¬†other stakeholders¬†‚ÄĒ measuring and¬†managing the¬†financial performance of¬†the¬†company

Strategic perspective

strategy is about competitive advantage and about finding appropriate ways to reach predefined goals.
In a strategic analysis, the resource-based view and the market-based view complement each other.

Ford model T example

There was not such an affordable car on market.
Standardized manufacturing process. lower manufacturing costs than competitors (‚Äúcost leadership‚ÄĚ)
Reason for¬†success¬†‚ÄĒ high value creation for¬†the¬†customer due to¬†low price
Why was a leader just for 10 years? imitators copied the manufacturing process and they met the customer preferences. You don’t have an advantage forever, you should regain it.

Red Bull example

first provider of an energy drink. There are a lot of imitators, who make the same products, unique selling proposition was vanished.
Competitive advantage is a popular and well-perceived brand.
Red Bull is more expensive than competitors, but customers are ready to pay for superior, special product.

Cost leadership, quality leadership and market barriers

Competitive advantage is based on the fact that companies manage to establish potential market barriers against potential competitors
Barriers can be based on:

  1. low manufacturing cost¬†‚ÄĒ cost leadership
  2. High product quality, brand¬†‚ÄĒ quality leadership
  3. Niche product¬†‚ÄĒ combination of¬†both

SWOT

Strengths and Weaknesses are the Resource-Based View.
Opportunities and Threats are the Market-Based View.
Find your unique and powerful abilities. Think how to improve weak abilities.
What does the market want. How to develop my strengths.

BCG Portfolio

Relative market share = The company’s own market share / market share of the company’s strongest competitor
Market growth = increase in market volume compared to the previous year / market volume in the previous year.

Customer perspective

Customer perspective focuses on needs and wants, benefits and value created for a customer. Customer oriented view is a core of modern marketing.
‚ÄúThe¬†basic function of¬†marketing is to¬†attract and¬†retain customers at¬†a¬†profit‚ÄĚ.
Customer attraction and retention has to be profitable.

Red Bull example

Customer need¬†‚ÄĒ ¬ęlifestyle drink¬Ľ for¬†sport and¬†adventures.
Advertising and¬†marketing¬†‚ÄĒ associates Redbull with success, sport, fun.
This created an added value for customer. And established a valuable brand.
Ads and marketing are the unique customer advantages of Redbull.

Ford Model T

Customer need¬†‚ÄĒ ¬ęcheap basic car¬Ľ.
By Franchising Ford created a customer-oriented distribution network.
Price and distribution are the unique customer advantage of Ford.

Maslow hierarchy

  1. Physiological needs (food, sleep, shelter)
  2. Safety Needs (financial security)
  3. Social Belonging (family, love)
  4. Esteem (recognition, prestige)
  5. Self-actualization

Relevance of marketing

Basic needs are mostly satisfied nowadays.
Marketing stimulates needs from higher layers
Marketing is dishonored as¬†¬ędubious¬Ľ or¬†¬ęshallow¬Ľ.
In the long run, marketing cannot be successful by deceiving customers, but only by creating a sustainable customer benefit

The 4Ps

  1. Product: which products and services should be offered to a particular group of customers? New products, designs and variations. Brand names, guarantees, packaging, product serving.
  2. Price: At which price should a product be offered? Price policy, discrimination, willingness to pay of a particular group of customers. Discounts and negotiations.
  3. Promotion: How can potential new customers be informed about a particular new product and be convinced about its benefit? Ads, promotions, online marketing, social media. Gifts, discount cards for loyal customers.
  4. Place: How should the product or service be provided to a customer? sale channels (indirect/direct), transport, storage. Number and location of shops

A¬†company can differentiate its products from its competitors and¬†gain a¬†competitive advantage by¬†using the¬†¬ę4Ps¬Ľ
The¬†realized revenue is the¬†central source of¬†¬ęgenerating money¬Ľ. The¬†pricing is crucial with regard to¬†the¬†financial success; a¬†higher price can be justified by¬†more advertising, better service or¬†a¬†customer-oriented distribution.
The precise knowledge about customer wants and needs is essential for the optimal choice of the marketing mix.
Creating sustainable customer benefit is the top priority
Processes and activities within the company should be aligned to wants and needs of the customers

Production and process perspective

The Production perspective deals with the transformation of production
inputs into products and services.
The Process perspective has a goal to optimize the supply chain with regard to customer benefit and the cost of creating goods and services

Ford Model T example

Revolutionary Production process made Ford model T the most affordable car.
The¬†total manufacturing process was divided into small specialized tasks, which were then optimized. For¬†each task it was analyzed which sequence of¬†motions was most suitable to¬†perform the¬†predefined task in¬†a¬†minimum amount of¬†time. This form of¬†optimization using scientific analysis of¬†motion sequences is referred to¬†as¬†‚ÄúScientific Management‚ÄĚ or¬†‚ÄúTaylorism‚ÄĚ (Frederick Taylor).
Ford combined Taylorism with assembly line production.

McDonald’s example

McDonald’s made a burger for 30 seconds instead of 30 minutes. To do that, they made the Business process reengineering. they decomposed a hamburger production in a sequence of  activities Taylorism/“assembly line production
They focused on 2 types of burgers (cheeseburger and hamburger) and few softdrinks to reduce complexity of production process and to make fast preparation possible.

Employee perspective

In a knowledge based society human resources are key for economic success
The consideration of the production process as an interaction of people is at the core of the employee perspective.

Hawthorne studies¬†‚ÄĒ lights experiments in¬†factory

Engineers conducted a¬†series of¬†scientific management (Taylorism) studies to¬†optimize job performance. There were 2 groups. In¬†the¬†control group received a¬†constant level of¬†light density, while in¬†a¬†¬ętreatment group¬Ľ the¬†light density was changing. Interesting, but¬†the¬†productivity was increasing in¬†both groups, when they increased the¬†level in¬†both and¬†increased in¬†treatment, when decreased the¬†intensity of¬†illumination.
Harvard professor told that emotional factor were responsible for this effect. He added, that informal structures and social factors (group dynamics, informal hierarchies, group coherence, etc.) influenced the job performance.

These studies had a¬†strong impact on¬†the¬†theory of¬†labor relations and¬†the¬†relevance of¬†incentives and¬†motivation for¬†workers within an¬†organization, development of¬†behavioral (and¬†humanistic) management theories as¬†a¬† ‚Äúcountermovement‚ÄĚ of¬†Taylorism (scientific methods)

Traditional view

  1. Traditional view of Taylorism and Fordism is that production process is divided into individual tasks to economize the benefits of specialization and to optimize the fulfillment of subtasks.
  2. Hierarchical organization structure clearly defines responsibilities and authorities
  3. Motivation and performance is based on centralized authority (threat of layoff), bureaucracy (rules and procedures) and explicit incentives (precised motivation)

Humanistic Management Theory

Business management does not¬†only have an¬†objective/rational component (optimization of¬†processes), but¬†also has ¬ępersonal, human, psychological, social¬Ľ component. Managers can also influence employees by¬†being charismatic, being a¬†role model or¬†just a¬†good leader with vision of¬†the¬†full picture.
In¬†industrial company machines are the¬†main strategic resources. In¬†today‚Äôs ‚Äúknowledge-based‚ÄĚ society ‚Äúhuman capital‚ÄĚ is the¬†most relevant strategic resource and¬†source of¬†competitive advantage.
Thus, questions on leadership and management of human capital have gained core relevance for the economic success of companies

Normative perspective

Corporate Governance as the set of rules and mechanisms that shape value generation and distribution of value (appropriation) among stakeholders.
The independence between the size of the pie and its distribution

three cases to show the importance of business ethics

  1. Was that harassment in the workplace?
  2. The Ford Pinto case
  3. Ethics vs. Career

Check yourself in a quizz

in this PDF you can find answers for the mock exam

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