Title: Airbnb as an economic space. An economic space is either physical or non-physical system that creates a model through which people can design and interact with financial values. There are numerous platforms that can be classified as economic spaces including social websites such as Airbnb and Facebook. These platforms create spaces for people to gather and interact. Basically, the interaction of individuals within an economic space is determined by its structure and design. Each economic space has specific behaviors and traits associated with the social systems it forms. Airbnb has numerous benefits as an economic space because of its scale, allowing people to list and book accommodation from any part of the world.
Airbnb as an Economic Space
Airbnb is platform
that allows peers to list and reserve housing around the world. Individuals
with vacant rooms are allowed to register on Airbnb as hosts in order to list
their properties. Similarly, guests enroll on the platform as hosts and are
permitted to verify their identity using their online profiles or government-issued
documents before they are allocated an accommodation. The platform is
accessible through mobile application and websites. Recently, I interacted with
Airbnb as a guest and experienced the numerous benefits associated with the
space. It is easier, cheaper, and accessible from every part of the world. The
listed properties are of diverse sizes and prices and are in locations that
allow tourists to stay with the local people during their travel period. Airbnb
is global in terms of scale because like many internet-based platforms, it is
utilized by a global audience (Coe, Kelly, &
Yeung, n.d.). Guests have the option of choosing the listing based on
diverse criteria such as region, city, price, date, and features of property.
Nonetheless, the platform can be categorized into several scales that include a global, regional, national, urban, and local scale. One aspect of the platform that should be noted is that it is operated from a particular region although it is global. The listing of the products occurs from any place in the globe and hosts can easily update if their space is already booked.
Airbnb is fascinating because complementary economic activities are occurring concurrently at multiple scales (Coe, Kelly, & Yeung, n.d.). The accommodation services enabled by Airbnb are part of the sharing economy where users share assets and services using digital intermediaries. The difference between Airbnb and the traditional accommodation services is in the way of delivering these services. Because of the unique model utilized by Airbnb, there are numerous advantages for the hosts, the guests, and the populations at local levels. While searching for a suitable accommodation based on the available budget, I interacted with numerous hosts and the diverse properties available to clients across the globe. Basically, the actions of both the guests and hosts are shaped by the design of the platform, with each having a personalized interface to mediate the interactions.
Regarding interventions aided by Airbnb, it is not easier to isolate one scale of the system because the processes at a particular scale depend on the activities at another scale. The decisions that lead to the success of the business model are made at different levels of the systems. In this context, the human effort is augmented by digital structures. Each of the consumers is beneficiaries of the knowledge invested in the web platform. In the contemporary economic spaces, technology is the main tool to enhance the efficiency of the everyday activities. However, it is apparent that Airbnb platform does not overshadow the essence of ordinary work in the physical sense.
The design of the platform reveals what is an economic space and what it can do. Airbnb is a hallmark of economic globalization that braved the traditional methods of looking for accommodation. Consumers across the globe can choose from a variety of available spaces. Airbnb is a unique form of economic geography that has rationalized the tourism and travel industry (Walker, n.d.). Essentially, the analysis of Airbnb as an economic space is not confined in a singular scale but rather understanding that different scales are performing and active at the same time. When the platform is considered in one scale, we create a restricted and ambiguous understanding of the digital model used (Coe, Kelly, & Yeung, n.d.).
Airbnb is popular
because it allows efficient and easier listing of properties that serve a
global clientele. It is a digital system that allows people to undertake
economic activities in a worldwide scale. There are numerous economic benefits
associated with Airbnb because of the several scales that allow economic
activities at the individual, local, national, and international level. The
platform can be accessed through the website or mobile application and lists
properties of diverse features, prices, and location. At all scale levels, the
activities occur simultaneously. Listing and booking of accommodation occurs
from any part of the world and the activities of one scale depend on the
performance of the other. Airbnb is different from the traditional accommodation
services because it offers benefits to people at different scales of the
economic hierarchy simultaneously.
Coe, N. M., Kelly, P. F., & Yeung, H. W.-C.
(n.d.). Thinking geographically. In Conceptual Foundations.
Walker, R. A. (n.d.). The geography of production.
Title: Economic Circular Flow. Everyday expenditure is determined by the current treads on the economic status of a country. The prices of commodities has been influenced greatly by the prices treads of the energy generating fuels such the prices of the petroleum products. In addition the economic stability of a country is another key factors that determine the prices. For example in a country that is experiencing inflation, the prices of most commodities are relatively high, a fact that is contributed by poor performances in exchange rate earnings.
In most cases, the interest rates are mostly determined by the central bank. They are used as the main monetary tool that is used by policy makers and the economist to control the supply of money in the economy thus regulating the inflation rate in the economy. The central bank is there to issue loans to the commercial banks so that they can circulate the money to the citizens. In addition the commercial bank gives the commercial banks the directives on the minimum rate at which they are going to lend their customers. Therefore the federal system is the main determinant of the interest rate irrespective of the market forces on demand and supply of money.
Basically interest rate are use as incentive as well as disincentives to the people willing to take loans from any commercial banks. As an incentive, the commercial banks well give out loans at an affordable interest rate that will attract many business and other people willing to take a loan. This will increase the aggregate money supply in the economy. This is commonly used in case an economic stimulus is necessary. On the other had high interest rates discourages business taking loans.
The action leads to reduced business transactions and hence less amount of money circulation in the economy. The action is used during the period of inflation. When the interest rates are high, the prices of commodities are also relatively high, the consequence is high cost of financing the loans. For this reason people tend to purchase commodities that are of lower prices, this is always subject to quality. During my purchased the interest rate were lower therefore the price of my vehicle was relatively low. At the period the interest rate was about 14% compounded on reducing balance.
The price of gasoline was relatively lower compared to the previous prices. In every economy the prices of the petroleum products greatly influence the prices of other commodities. This is due to the transportation of commodities from the area of manufacturing to the market. Lower prices of gasoline in during the time of the purchase therefore ensured that the prices were lower and affordable. The prices for the crude oil and other related products were also low. Therefore even the maintenance of the vehicle was cheaper. When I made my purchase the prices of gasoline were dropping which was an implication that the future prices are going to be lower. This was just a prediction that is always necessary thing to do before buying any consumable good.
Securing a loan requires collateral and other securities. Most banks will. Always give loans to individual who after a careful appraisal shows the ability to pay the loan. In addition to this banks prefer giving loans to the people who are employed or business people who show to have a sustainable businesses that can be able to finance the acquired loan. I went for a loan after I was employed having considered all the above factors. These are the once that led to a successful loan application.
During the recession period the economy is characterized by high inflation rate meaning that the prices of most commodities are considerably high. During the purchase the interest rates were lower a probable recession times. The lower interest rates in the commercial banks were to encourage more people to take loans. This is a move that facilitates the increment in the supply of money circulation in the economy. In addition to this reduced interest rate facilitates more investors to borrow loans to set up more investments. This action is there to improve the production business cycle that improve the production of an economy.
During recession period there are chance of unemployment and therefore it’s risky to take a loan during the period. However when taking a loan it is important to reconsider other sources of income that can fund the loan once the source of income is suddenly withdrawn. Before making my decision on whether to take the loan or not I had considered other factors that will finance my loan in case of such uncertainty.
Due to the great recession of 2008 that the country realized its impact the government is still operating on with the fiscal expansionary policy measures despite of the deficit that the country was experiencing. Fiscal policies involved reduction on taxes and adjustments on government expenditures. The tax relieve lowered the prices of the vehicles greatly which gave me a good opportunity to purchase a good Car of my choice.
In addition the international monetary fund study had realized a possibility of positive multiplier effect on the expansionary fiscal policies that had been set. The effect was subjected unemployment and future output. More output and employment implied better future of the economy. These were encouragement to the foreign and local investors, consequently there were prospects of high future productivity. This gave me a prediction that there is a larger probability of retaining my source of income as well as creation of more sources that will cater for the maintenance and financing my loan.
The united state environmental protection agency has been trying over the years to fight the environmental pollution has been a problem in our cities and towns. One of their effort is to encourage the vehicles and other fuel users to purchase machines that are fuel saving and those that operate with complete combustion of fuel to minimize the release of carbon monoxide to the environment.
These efforts should not be ignored as the implication on pollution is both health and economic problems, a fact that a well productive economy is composed of healthy people. For this reason I had to choose a simple vehicle that has low fuel consumption capacity.
The emissions such as carbon dioxide causes acid rain that has adverse effects on metallic structures which most of our houses and other structures are made of. In addition there is adverse effect on agriculture which is one of the source of raw materials for our industries. The emissions also may cause diseases after inhaling these poisonous diseases. This consequently minimizes the production level of the nationals and hence lower GDP.
Basically the circular flow model is made up of two sectors which determine income output and expenditure. Equilibrium state is arrived at when the tendency of income levels, expenditure and output does not exist. This is an implication that income, output and expenditure are equal. The buyer expenditure in this case becomes the sellers’ income. The income gained from sale of their product is also spent to pay for other factors of production. During the processes, there is transfer of income to the owners of these factors. These expenditures consequently leads to the circular flow of payments.
The Circular Flow Model
For many years the position of the circular flow economy has greatly influenced the prices. This is due to the monetary and fiscal policies that an economy takes either to control inflation or to correct a recession. Introduction of injections and stimulus of the economy also influence the expenditure. When the interest rate are high the money in circulation is reduced thus most consumers will have little money to consume. In addition due to uncertainty people will tend to hold money due to fears of the deflation and recession. Uncertainty about future tend to influence people to either hold money or use money in making future investment.
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Economics models are false and so government should ignore their predictions. Explain, discuss and evaluate the accuracy of this statement.
Price Elasticity – Economics models are the tools which economists use to predict future economic developments by measuring past relationships among variables such as household income, consumer spending, employment, interest rates, tax rates etc. and forecasting how changes in some of these variables will affect other variables. An economic model is said to be complete if it can accurately forecast many of the variables future course, however, no economic model can be complete in true sense. There are several forces outside the model that affect the calculation and forecasting of variables. There are two ways by which these outside factors affect the forecasting and economic predictions. The input errors are concerned with inaccurate assumption of outside variables and model errors which explains the deviation of the equation of economic model from the assumption to the actual. Hence, it can be said that economic models are subjective approximations of reality and are designed to explain the observation. Therefore, the model’s predictions should be moderated so that it can accommodate the effect of random data variables (Deming, 2000).
Many researchers believe that economic theories and models simply provide ways to look at systems and determine how changes in variables affect the overall outcome. It also explains advantages and disadvantages of various economic models and systems. However, predictions and subsequent policy decisions are made after following value judgement of policymakers or the government. Therefore, the government should view at economic model only as a framework which provide insight of a contextual theory. More empirical evidence and real life economic parameters should be considered while making policy decisions based on economic predictions (Godley & Lavoie, 2006).
No economic model can perfectly predict the real future. A good example of the economic model’s failure is to predict the reasons for the global financial crisis of 2008. The prevailing economic model was deficient to provide sufficient attention towards the relationship between demands, wealth, and excessive financial risk taking. There were considerable research which had been conducted to uncover the same and also a new behavioural equation was added to the existing economic models. The true test of the new model will happen when it will effectively flag financial risk levels that would need a precautionary policy change. This is an ongoing process which consist of constructing, testing, and revising models and outside forces so that economists and policymakers can predict the future course of economy (Taylor, 2009).
Government neither can overlook economic models’ forecasts nor make predictions completely based on them. It has also been seen that economists seem to put aside political factors outside their equation. Politics among other outside factors is the most important factor that helps to determine the outcome of economic policy. In view of these analysis, it is suggested to use structural models which makes several “what if” economic analysis on several input combinations. In this way, the policymakers would have substantial information on various numerical variables and the forecast can be recalculated whenever required (Diermeier, Eraslan & Merlo, 2003).
Identify estimates of the price elasticity of demand for at least three different products
The “law of demand” suggests that the higher the price of a good, the lesser demand from consumers. This is the fundamental law of all economic models to predict the economic forecasts. In order to predict consumer behaviour in more details, economists use several techniques which evaluate the sensitivity of consumers’ demands with respect to changes in price. The most commonly used technique is known as “price elasticity of demand”. In simple terms, it is the proportionate change in demand given a change in price. For example, if a one unit decline in the price of a product produces a one unit increase in demand for that product, the price elasticity of demand is said to be one (Green, Malpezzi & Mayo, 2005).
Numerous studies suggest that the majority of consumer goods and services falls in the price elasticity of between .5 and 1.5. Essential products to everyday living, which have fewer substitutes, typically have lower elasticity for example, staple foods. Since, staples such as cereals are necessities in the diet, and are usually cheaper so that people safeguard their income for spending on such essentials when prices increase. Furthermore, lower income households tend to have higher price elasticity for food items than high income households. As food products occupies a large share of total income in these households, price changes have a substantial impact on the allocation of budget. On the other hand, magnitude of the elasticity for animal source foods such as fish, meat and dairy are higher than staple cereals as these are considered as luxury food items and there are always many substitutes available for consumption of these food choices (Andreyeva, Long & Brownell, 2010).
Goods with many substitutes, or are considered luxuries as are not essential, or whose purchase can be easily postponed, have higher elasticity. For example, the demand of automobile is considered as elastic as there are three kind of substitution takes place. In response of a unit price change, consumer of a new car can delay the purchase, or can choose to purchase another category of car or chose not to buy a new car and use another mode of transport. Furthermore, in case of buying a particular model of car, it would be highly elastic demand as there will be a lot of substitutes. On the other hand, demand for cars in rural areas would be inelastic over the longer run. Because there are very few alternative mode of transports available (Parry, Walls & Harrington, 2007).
Another example can be taken from health care services, where the demand for health care expenditure is found to be price inelastic. A range of price elasticity estimates it to be -0.17, which means that a one unit increase in the price of health care will lead to a 0.17 unit reduction in health care expenditures. Moreover, the demand for health care is also found to be income inelastic as it is in the range of 0 to 0.2. The positive sign of the elasticity suggests that there will be increase for health care demand as income increases, however the low magnitude of the elasticity indicates that the demand response would be relatively very small (Duarte, 2012).
Andreyeva, T., Long, M. W., & Brownell, K. D. (2010). The impact of food prices on consumption: a systematic review of research on the price elasticity of demand for food. American journal of public health, 100(2), 216-222.
Deming, W. E. (2000). The new economics: for industry, government, education. MIT press.
Diermeier, D., Eraslan, H., & Merlo, A. (2003). A structural model of government formation. Econometrica, 71(1), 27-70.
Duarte, F. (2012). Price elasticity of expenditure across health care services. Journal of health economics, 31(6), 824-841.
Godley, W., & Lavoie, M. (2006). Monetary economics: an integrated approach to credit, money, income, production and wealth. Springer.
Green, R. K., Malpezzi, S., & Mayo, S. K. (2005). Metropolitan-specific estimates of the price elasticity of supply of housing, and their sources. The American Economic Review, 95(2), 334-339.
Parry, I. W., Walls, M., & Harrington, W. (2007). Automobile externalities and policies. Journal of economic literature, 45(2), 373-399.
Taylor, J. B. (2009). The financial crisis and the policy responses: An empirical analysis of what went wrong (No. w14631). National Bureau of Economic Research.
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The Contribution Of Art And Fashion Industry To The National (UK) Economy
According to a report released by the British Research Council (2014), the fashion industry in Britain contributes £26 billion to the country’s economy. This is a 22 % increase from the contribution made in 2009 which added up to £21 billion. The report was released by the council during the London Fashion Week. These statistics intrigue various questions relating to the contribution of art and fashion to the economy of the country. Although art and fashion have been part of the UK’s culture for many years, their impact on a country’s economy has not been greatly considered over the years. However, in the recent years, the expansion of the global market has greatly impacted the art arena, which has further impacted the economy either positively or negatively.
Research Question: Is the art and fashion industry influential enough in the economy to attract both local and foreign investments in the long-term?
Purpose and objectives
The aim of the research is to assess the impact of the arts and the fashion industry on the economy in the UK in accordance to information revealed by the Arts Council and the British Fashion Council. The main objectives of the research will be to review and collate existing research relating to the economic impact of the arts and the fashion industry in the country. The other objective is to understand the measures and methodologies put in place for assessing the effect of creative industries, programmes, facilities and projects. Assessing the quality and comprehensiveness of the existing evidence is another objective of the research. The research also aims at informing the future agenda for effective research within the sector. It will also include evidence-founded making of policies by the Arts Council and Fashion Council. Identifying fundamental research needs that will assist in improving the research’s robustness is another scope of the research. The proposal will also include a practical resource to help the parties working in the sector.
The Keynesian theory states that the production of goods and services by the businesses is influenced by consumers’ ability to spend. The twenty first century has experienced changes in issues relating to increase in consumer spending, hence the increase in production of various goods and services. The arts and fashion industry has not been alienated from this impact. The rapid expansion of economies that started taking place in the late twentieth century through to the twenty first century has been of great impact globally. It is believed that one of the most impacted is the arts and fashion industry.
The consumption, investment, government and net exports characterize the Keynesian theory. This research will analyse these concepts in relation to the oil and arts industry, and how they have affected the economy in the UK. The research is also sensitive to the impact of the local fashion industry on its economy. It is relevant to assess whether the most impact is evident from exports or products bought by the local consumers. The household disposable income and the general GDP are of relevance to this research. It is relevant to understand the past scenarios relating to the industry and steps that have been taken to heighten the industry to the current position. As evidently put by Keynes, the increase in consumer spending will increase the production of goods. Consequently, a decrease in consumer spending will also decrease production in the industry. It is relevant to understand the individual contribution of the various sectors in an economy. This will allow the relevant parties to make decisions relating to the present and the future of the industry in question. In this case, it will be identified whether the impact on the economy, if any, is long-term. It is relevant to understand whether it can attract investors.
Empirical / Contextual Literature Review
The Art Council England and British Fashion Council provide various reports that reveal the financial/economic impact of the arts and the fashion industry in the economy. Other economic related sources will be assessed in order to realize the share of the industry on the overall economic figure. Research will be carried out in some areas such as the Research Department of the Arts Council. The research may also include email, telephone or postal inquiries from the Culture, Media and sports Department. Other sources include the Arts Council of Northern Ireland, Arts Council of Wales, the Scottish Arts Council, among others.
After the research process, a small number of studies will be gotten, read and evaluated with the use of Draft Standards for Reporting on Statistics (Hutton, 2001). Sharp and Benefield (2001) insist that the NFER (National Foundation for educational Research) guidelines to be incorporated in order to present quality research. The researcher will also scrutinize the references in order to assess whether there are other potential materials that are relevant. The review will mainly cover research that is done in the United Kingdom. This will include England, Wales and Scotland. In order to make the research more comprehensive, statistics relating to other countries such as the USA and Australia will be included.
The research will include literature which has information concentrating on the economic contribution of the fashion and arts sectors. The inclusion of the arts sector will also lead to the inclusion of some aspects of the creative industry and culture in the UK. The research will briefly give the social-economic aspect of the industry, due to issues relating to the employment arena and the general impact of the people’s livelihoods. The materials considered are gauged on various levels. They include a widened geographical spread, diversified study foci, diversified methodologies and approaches, research quality and studies target groups. Other issues relate to issues addressed or policy area, research date in question, impact on the sector and best evidence presentation. Blake (2000) reminds researchers that a review does not have to reproduce in detail the articulated claims relating to the economic impact of the fashion or arts industry. This is because they have been covered adequately in these resources. The researchers only need to find the information relevant to their topic and then integrate it accordingly in order to answer their research question (Jermyn, 2001).
The study design that will be used is the historical approach. Babin et al (2012) states that the historical approach is one in which information is collected by reviewing the historical data presented by older reports or valid sources of information. This empirical report should not be altered. In order to place more emphasis on historical study, Gillham (2008 state that historical method is something that exceeds simple data-gathering. It involves analyzing, and confirming the information retrieved from these sources by engaging other research methods. For example, interviews will be included in this research method. The true meaning of data collected should be reported from the point of view of the objectives and the basic assumption of the project under way. The facts obtained may be accurate expressions of central tendency, deviation or correlation; but the report is not research unless discussion of these data is carried up to the level of adequate interpretation. Data must be subjected to the thinking process in terms of ordering reasoning. The design also saves on time. The researchers are also able to present factual information from the target resources using cheaper means.
The main method will include reviewing the past and current statistical information available on the materials. However, interviews will be integrated in the research method. The interviews will be done in order to verify some of the unclear data, or place emphasis on the available information. Such technique will be used for target people who may provide more information other than the information available in the report. Since interviews are one-on-one, the researcher is able to read other forms of communication such as body language, hesitations, amongst others (Creswell, 2003). Interviews also limit the time that the information will reach the researcher.
Additionally, questionnaires will be handed to people who will not find time for interviews. It can be passed through emails or other communication channels agreed upon by the researcher and the target person. As indicated earlier, it is used to verify information that is unclear or that which has not been updated. VanderStoep & Johnston (2009) indicate that the measurement quality is highly dependent on the reliability of the instrument used to collect data. In order to follow this statement, the researcher will pre-test the questionnaires being used. Validity entails, whether the spirit of the questionnaires is in accordance with the purpose of the research. In order to confirm validity, selected questionnaires will be given to respondents in order to pre-test data collection. Once the questionnaires are returned, they will enable the accurate assessment of the validity of research instruments. The questions in the questionnaires will also be used to conduct the oral interviews. The questionnaires will not be included in the final analysis.
Babin, B. J., Carr, J. C., Griffin, M., & Zikmund, W. G. 2012,. Business research methods (9th ed.). Stamford, CT: Cengage Learning.
Blake Stevenson Limited, 2000, “The Role of the Arts in Regeneration”, Scottish Executive Central Research Unit, Edinburgh.
Creswell, J. W. 2003, Research design: Qualitative, quantitative, and mixed method approaches. Thousand Oaks, CA: Sage Publications
Gillham, B. 2008, Small-scale social survey methods: Real world research. London: Continuum International Pub. Group.
Hutton, L, 2001, Draft Standards for Reporting on Statistics, The Arts Council of England. 110
Jermyn, H, 2001, The Arts and Social Exclusion: A review prepared for the Arts Council of England, The Arts Council of England, Londo.
Sharp, C and Benefield, P, 2001, Literature Reviews Course Notes, NFER, unpublished.
VanderStoep, S. W., & Johnston, D. D. 2009, Research methods for everyday life: Blending qualitative and quantitative approaches. San Francisco, CA: Jossey-Bass.
Balance of Advantages of the UK Joining the EMU and/or Using the Euro as a Functional Currency
The Economic and Monetary Union is an agreement between participating European nations to share a single currency, the Euro and a single economic policy with set conditions of fiscal responsibility. There are currently 27 member-states of varying degrees of integration with the EMU.
Currently there are 16 member states who adopted the Euro: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Slovenia, Spain, Cyprus, Malta and Slovakia. Further 3 countries including United Kingdom, Denmark and Sweden did not join the EMU even though they had an option to do so. Main reason for the UK not to join the Euro was the strength of the Pound and the British economy against the countries in the Euro zone. Joining EMU was predicted to cause economic problems in the country as European Central Bank would seize full power over the monetary policy in the UK including for instance setting benchmark interest rates. Economists are therefore divided into two groups: pro and cons the EMU. Aim of this report is to show on the example of invented for the purpose of the report Multinational Corporation (Insomnia plc) the influence of UK joining the EMU and/or using Euro as a functional currency.
History of Insomnia PLC
Insomnia plc is a UK based Multinational Corporation with their headquarters in Aberdeen, Scotland. The company was founded in 1987 by Mira Stavika. Insomnia designs, produces and sells luxurious clothing, shoes and accessories for adults and kids. The company has internationalized through subsidiary undertakings in Italy, Spain, Germany and France as well as international trade with India, where the clothing is manufactured and exported to UK. The special packaging for cloths is produced in Slovakia. Since 2001, the company is listed on the London Stock Exchange and the largest German stock exchange in Frankfurt (FWB Frankfurter Wertpapierborse). The corporation owns approximately 60% of each subsidiary.
Scope of Business
After importing clothing to the UK, Insomnia stores it and resells majority part of it to their subsidiaries at the 20% mark-up. The remaining part is being sold in the UK. Subsidiaries and parent trade the clothing in the Insomnia branded shops. Apart from the payments for the import of clothing, foreign entity has to pay to its UK parent the management fee for the administrative and managerial services it provides. Out of the profit the foreign entities obtain, 70% is re-invested in their business; the remainder is paid to shareholders in form of dividends. Almost 40% of Company’s debt is denominated in Pound Sterling where the remaining part (60%) is in Euro. Revenue of the company comes in 70% from Euro and 30% from UK braches in Pound Sterling.
Parent company uses Pound Sterling as a functional and reporting currency, whereas all of the subsidiaries occupying in the Euro zone, use Euro as a functional and reporting currency.
Current Exposures in a Monetary Union
Insomnia plc trades mainly in the foreign markets. This exposes the company into a series of uncertainties mainly regarding the exchange rate of the currencies. Exchange rates cannot be predicted with the ideal accuracy, but companies can at least forecast their exposure to exchange rates fluctuations which comes in three types.
Transaction exposure is the degree to which the short–to–medium term cash flows denominated in foreign currencies are affected by the exchange rate fluctuations. This type of exposure has direct and large effect on the value of the company’s earnings.
Insomnia is highly affected by this type of exposure due to majority of its operations denominated in foreign currency. Buying clothing from the manufacturers in India and selling these to their foreign subsidiaries highly exposes company. Depending on the economic conditions, value of Indian Rupee and Euro can change rapidly within short period of time (Even as much as 10% within a year; Madura, 2007). Invoicing of clothing imported from India is denominated in Rupee, so if the value of this currency appreciates against the Pound, payables of UK company will increase and adverse. Similarly sales of the clothing to subsidiaries are invoiced in foreign currency, the Euro, which can affect cash flow in the adverse way to Rupees. Transaction exposure affects debt as well. Due to the Euro/Sterling exchange rate increase by 16.3% in 2009, debt of the company increased significantly last year as 60% of debt is denominated in Euro.
Extent to which present value of company’s future cash flows are affected by the exchange rate fluctuations is referred as economic exposure. ‘All types of anticipated future transactions that cause transaction exposure also cause economic exposure because these transactions represent cash flows that can be influenced by exchange rate fluctuations. Economic exposure includes transaction exposure and indirect effects on revenue and cost. ’ (Madura, 2007)
Insomnia is exposed as well to the economic exposure. If the Indian Rupee appreciates against the Pound as in previous example, the company may need to increase the price of clothing sold in the UK and price of goods sold to subsidiaries as will have to pay more for the supplies. In this case, customers might shift their purchases to the cheaper clothes’ retailers both in the UK and Euro zone which will decrease export of cloths to subsidiaries and result in the reduction of the future revenues of the corporation. If Pound appreciates, home sales are expected to decrease due to the foreign competition as well. Basically, increase in value of Pound will result in a decrease in both cash inflows and outflows, and adverse. (Madura, 2007)
How does this affect a wider monetary union? Subsidiaries have their own accounting records, but in reality parent fully controls the entities. Parent company has to show its own and subsidiaries’ accounts in a consolidated manner through consolidated financial statement. To do so, there is a need to translate financial statements of all subsidiaries of different currencies into reporting currency of the parent, which is Pound Sterling.
As exchange rates vary over time, the translation of the foreign entity’s accounts is exposed to exchange rate movements called translation exposure.
Insomnia plc has to translate the Euro denominated financial statements of its subsidiaries to the Pound Sterling, which is governed by the Financial Reporting Standards (FRS 23) and the International Accounting Standards (IAS 21). Assets and liabilities should be translated at the closing date; whereas income and expenses at the exchange rates at the transaction dates (average rate for the period is allowed, if reasonable).
Translation exposure does not affect the cash flow directly, but investors base their decisions on the consolidated financial statements. When in 2005 Insomnia announced that its consolidated earnings will be negatively affected by the translation exposure to Euro, investors responded very fast by selling their shares of the company, which led to decline in value of the stock by 5%.
What is the impact of hedging on a wider monetary union? Exchange rate fluctuation exposures affect the cash flows of the entity in a direct or indirect way. The main aim of hedging is to minimize the effects and the uncertainty of the exchange rates fluctuations. Hedging may as well reduce agency costs, expected tax liability, and the cost of financial distress. Insomnia uses forward contracts to secure the exchange rate of their transactions and thus minimize the transaction exposure. For payables it negotiates the forward contract to buy foreign currency, for receivables – contract to sell foreign currency. The company, being risk averse, uses forward contracts to minimize the economic and translation exposure as well. To minimize the cost of hedging, company first calculates the net transactions exposure in each currency for each of the subsidiaries, then hedge against this balance. Additionally, company invoices the exports to its subsidiaries in the same currency in which they will pay management fees and dividends to a UK parent. It cannot be done for the transactions with the suppliers in India and Slovakia.
Effects of the UK Joining EMU on Insomnia Plc
Creating single market forming free flow of goods, capital, services and people within the European Union was the main objective of creating the EMU. To adopt Euro, countries need to fulfill “Convergence Criteria” set out by the Maastricht Treaty, but benefits outweigh the hard to accomplish objectives of price, exchange rate and fiscal stability as well as interest rate convergence and an impact on a wider monetary union.
Cost Savings on Cross-Border Transactions
Increase in trade within the European Union is one of the main objectives of the EMU. It is supposed to increase the consumption possibilities. According to Rose (2000) trade within domestic economy is far higher than international. Joining EMU and having single market with other EU countries will significantly increase the trade by making it domestic. It could be a great advantage for the Insomnia. It is thought to be achieved through cost savings on the cross-border transactions. Trading across Euro zone is much cheaper due to no need for exchanging money to foreign currency, hedging or keeping high reserves of foreign exchange. This will speed up the transactions and decrease its cost. Insomnia will benefit from this as company already trades with the subsidiaries from the Euro zone. Joining EMU will decrease costs of trading with them, whereas leaving problem of high costs of trade with India unsolved. Staying outside the EMU could be a big disadvantage in case of Pound appreciation. Shall this happen, export and sales in foreign countries will decrease as price of company’s goods will be higher. If joining EMU, Euro fluctuations would not have an effect on the exports to subsidiaries.
So far, strength of Sterling against Euro has already resulted in the reduced UK exports, which in turn forced foreign investors to pull out of the UK (Gillette, Siemens) and many more threat to pull out if UK will not adopt Euro. For the economy it is a disadvantage, but it is in favour of Insomnia plc, as it will reduce the competition. However, today’s situation is not positive for the company as “investors come here [to UK] because we have lower taxes and less regulation than the Euro-zone.” (Dominic Cummings, F/T; 12/06/01)
Stability of Prices
Stability influences monetary union, one of the advantages of joining EMU according to the European Commission is having more stable prices due to anti-inflationary regulations by European Central Bank. It is to be done by setting benchmark interest rates (according to the Fisher Effect) and exchange rate. It will affect Insomnia indirectly. In the event of the crisis in one of the EMU countries it is very possible that ECB will adjust interest rates in all other countries regardless the domestic conditions of single states. UK economy then may become unstable and collapse unfavourably affecting cash flows of the company. The risk of this happening is large due to high Euro volatility comparing to Dollar and Pound since it was introduced.
However, price stability can bring more advantages than the disadvantages to the Insomnia. Creditors being sure that prices will remain stable in the future are more willing to lend at lower interest rate which encourages domestic investments. Historically, UK interest rates have been higher than in the Euro-zone. In case of higher interest rates in the country, it may attract foreign investors in putting funds into Insomnia, but customers are more willing to save money rather than spend on clothing. Controlled inflation, stabilized prices and elimination of exchange rate fluctuations result in the ease of making long term investment decisions, planning and borrowing for Insomnia. (“Stability: Why is it important for you?”; ECB, 2009)
Price Transparency in a Monetary Union
Price transparency of a monetary union is driven by the price stability. When joining EMU, costs of the same goods across the whole Euro-zone will be much easier to compare. Prices of the Insomnia plc are relatively more expensive than the competitors, revealing it will lead customers to shift their purchases to different retailers. This might effect in the downwards pressure on prices and make it harder to keep different pricing policies on similar quality and use products. It is a big advantage for customers, but not for the Insomnia businesses. On the other hand, price transparency might help the company to find and work with the new, cheaper suppliers of clothing’s packaging. In addition, if Insomnia wants to set up a new subsidiary in the Euro-zone country, can easily compare costs of doing so among various locations. Stock prices of EMU countries are more comparable and prices are more stable as well, so it is easier and safer for the foreign investors to chose and invest in stock of Insomnia. Although, highly correlated markets decrease the diversification of the European investor.
Joining Euro will effect in long-term savings on the book-keeping. The Company has to hire people and keep tracks of costs, expenditures, margins etc. in various currencies. These costs will be reduced due to single currency used by the parent and subsidiaries. On the other hand, the disadvantage of one currency would be the cost of change over. This will require staff training, new tills software as well as labelling. Using Euro by UK might make company’s products more attractive to Euro zone customers due to easier purchases of goods online with no exchange rate uncertainty.
However, contrasting to the UK, in the Euro zone there is a VAT fee on children clothing, which will increase the price of such company’s items. It is a disadvantage for the clothing company. (Stephen Castle, the Independent, 15/07/03)
The level of hedging in Insomnia will be significantly decreased. Due to having Euro as a functional currency, company’s transaction exposure will be minimized drastically, due to having majority of transactions denominated in Euro. Insomnia will have to hedge only against the Indian Rupee. Economic exposure to exchange rate fluctuations will be decreased as well due to majority of the company’s operations based in the single, highly integrated market. Appreciation or depreciation of the Euro will not have an effect on the price of goods relatively to the competitors, trade or competition itself within the EMU. It will influence only trade with India and only Rupee will have to be hedged against. Translation exposure will be eliminated. As company needs to translate only the financial statements of its subsidiaries within the EMU, there is no need for this, therefore any need for hedging.
Using Euro as a Functional Currency of Insomnia Plc
“Functional currency is the currency of the primary economic environment in which the entity operates. The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash.”(IAS 21) Insomnia considers the choice of the functional currency based on the factors stated by the IAS 21:
The currency: That mainly influences sales prices for goods and services (this will often be the currency in which sales prices for its goods and services are denominated and settled); and of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.
The currency: That mainly influences labour, material and other costs of providing goods or services (this will often be the currency in which such costs are denominated and settled).
According to the factors stated above, Insomnia should change its functional currency into Euro. The effect of this action will be similar to joining the EMU. Insomnia having Euro as a functional currency will benefit from the fixed exchange rate and reductions in cost of managing currency risk, speed of Euro transactions as well as price transparency. UK market will not be highly integrated with the Euro zone, as it would be in case of joining EMU. Insomnia would not be able to gain from the lower interest rates and stable prices. Obtaining cross-border funds will be easier when having Euro as functional currency, but due to prices being less stable, the cost of financing will be slightly higher than in the EMU. VAT on children clothing will not be introduced giving an advantage to Insomnia. Hedging will be decreased as well. Transaction exposure will be minimized, but by less than when joining EMU. There will be a need to hedge small amounts against receivables in Pounds and payables in Rupees as the majority of transactions are denominated in Euro. The company could easily reduce the exposure even more by invoicing in Euro, shifting this way the exposure down the supply chain. Economic exposure will be slightly decreased. In opinion of the report’s author, appreciation or depreciation of Euro throughout the EMU will not have an effect on the company or its competition. Although, UK will not be consistent with the single market, interest rates and inflation of the EMU zone, which may cause the differentiation in prices of the same goods (no price stability). Translation exposure will be shifted from translating from Euro to Pounds, to translation of Pounds to Euro. Exposure will be however decreased due to only 30% of revenue coming in Pounds.
On the other hand, it is argued (E. Christie; A. Marshall) that there is no connection in reduction in hedging with the decrease in risk. According to the article, the majority of UK MNCs using Euro as functional currency stated that there is no reduction in hedging. Author of the report argues with this opinion. It is probable that questioned companies had different levels of trade with the Euro zone states. Insomnia plc has its majority of operations focused within the EMU zone, therefore the advantages of reduced risk will benefit in lower incentives for hedging. Moreover, hedging policies could stay unchanged due to the different types of risk (non currency) faced by the companies. According to the article, using Euro did not encourage companies to expand internationally, which illustrates currency exchange risk as only one of the factors influencing investment decisions.
UK joining the EMU will bring Insomnia Plc lots of advantages. Stable prices, elimination of the exchange rate uncertainty leading to cost savings on the cross-border transactions, price transparency, possible growth, easier accessible borrowing, higher stock liquidity and decrease in hedging are just the major benefits to the company. However, there are factors which can influence the corporation in a negative way including not always favorable price transparency or additional costs of change over. Similarly, using the Euro as a functional currency involves its advantages and disadvantages, but the last have greater power than in the case of joining the EMU. It is decided that main exposures of the company involve the exchange risk; therefore reducing this uncertainty will be significantly beneficial to the Insomnia plc in the short and long term.
Anon, An Analysis on Whether UK Should Join the Euro
Artis, M., The call of a common currency, Europe without Currency Barriers, paper no. 3