Transcript soft budget constraint

Who am I?
• Name: KATYA
• 2nd year PhD student
at Department of
Economics
• Home country:
Belarus
• Instructor for
ECON4313 “Russian
Economy”
Economics of Shortages
Resource Allocation
Traditional
Economy
Centrally
planned
economy
Long-lived
tradition of the
past
Instruction
from higher
authority
Market
Economy
Market
mechanism
Focus
- NOT traditional economies
- NOT market economies
INSTEAD
- Centrally planned economies
Centrally planned economies of the recent past: the USSR,
Poland, Romania, Bulgaria, Czechokoslovakia, Hungary,
China; modern day examples: Cuba and North Korea
Workings of Centrally Planned
Economy
• The central authority comes up with general
plan (e.g. 5-year plan)
• How to implement: “Material balance”
tables
• In the USSR were computed for as many as
15 - 28 thousand categories of goods and
services
Material Balance: An example
Steel material balance for 2005 (mil. pounds)
Sources (available)
Production at home
Inventory/reserves
(from 2004)
Uses (needed)
89 For car-makers
8 For construction
For ship-building
Total
97 Total
39
37
24
100
Material Balance: An example
Steel material balance for 2005 (mil. pounds)
Sources (available)
Production at home
Inventory/reserves
(from 2004)
Imports
Total
Uses (needed)
89 For car-makers
39
8 For construction
37
3 For ship-building
24
100 Total
100
Question
- How often does it happen to you that you go
to a store with a clear idea of what you want
and you cannot find the item you are looking
for?
Follow-up Questions
- Why do you think the item wasn’t there?
- How quickly were you able to find it
elsewhere?
- How would you feel if the “search” for
goods became your daily routine?
Not just a product of imagination when
one talks about shortage economies
AND
according to the Hungarian economist
Janos Kornai, the centrally planned
economy is an economy of shortage.
What is a Shortage?
P
S
P*
P
D
QS
Shortage
QD
Determinant: price
Q
Are shortages good or bad?
- Can shortage of capital or labor in the
economy tell us anything positive?
- Why are shortages of inputs bad for
producers?
A Shortage Economy: Definition
An economy where shortages:
• Affect every market
• Cause agents’ behavior to change
• Permanent in nature
Consumer in a Shortage Economy
Option 1: consumer goes to a store, the
good he is looking for is there, and he
buys it right away
• does not happen too often
Consumer in a Shortage Economy
Option 2: the good is there but
consumer has to stand in line to buy it
Consumer in a Shortage Economy
Option 3: the good is not available
now and the buyer continues to look
for it elsewhere
Where are the Shoes?
Consumer in a Shortage Economy
Option 4: the good is not available now
and can only be purchased in the future as
it becomes available and the buyer has to
queue for it
Example:
Waiting lists
Consumer in a Shortage Economy: Waiting lists
Waiting time for housing in the 1980s in the
centrally planned economies of the Eastern
Europe (in years)
Czech and
Republics
Hungary
Slovak
6-8
4-6
Poland
15-30
USSR
10-15
Consumer in a Shortage Economy: Waiting lists
Telephone queues (international comparison)
Queue as a percentage of subscribers
1971-1975
1976-1980
1981-1985
Czechoslovakia
25.1
30.2
11.3
Hungary
36.6
47.2
55.5
Poland
33.6
45.7
57.1
Austria
14.1
8.5
2.9
Belgium
0.8
1.2
0.7
France
13.1
7.9
0.9
Consumer in a Shortage Economy: Waiting lists
Waiting for Cars: International Comparison, 1989
Country
Waiting Period in years
Model of a Car
Lada Skoda Wartburg Trabant Dacia
Bulgaria
10-12
5
2
1
1
Czechoslovakia
3-4
-
-
-
-
East Germany
17
16
14-16
14
15
Hungary
4-6
6
1
0
-
Poland
5-6
6-8
3-4
2-3
-
Trabant (Eastern Germany)
Lada (USSR)
Dacia (Romania)
Wartburg (Eastern Germany)
Consumer in a Shortage Economy
Option 5: the good is not available
and buyer abandons the purchase
Question
• So why do shortages have to arise in
the centrally planned economies and,
moreover, it can’t be otherwise?
Possible Explanations
• General: incompetence of the planner
• Supply side: poor contract performance
• Demand side
“road to take”
Budget Constraint
• Economic facts:
– Have to pay for goods and services
– Have limited funds to spend
Budget Constraint
Consumer’s Budget Constraint:
Illustration
bananas
unaffordable
Budget constraint
Qb
affordable
Qa
apples
Consumer’s Budget Constraints:
Hard or Soft
• Can only spend as much as one has (e.g. with
own current and future resources) 
hard budget constraint;
• Can spend more than one has 
soft budget constraint
Consumer’s Budget Constraint
• Would we think of consumer as having soft or
hard budget constraint?
• Does this apply to consumers in both market
economy and centrally planned economy?
Observation 1: In the centrally planned
economy consumer is faced with hard
budget constraint
Firm’s Budget Constraint
• Does budget constraint exist for firms?
• Hard BC: can spend only as much as it has
• Soft BC: has a slack somewhere
What would make firm’s budget constraint
soft? Is there a difference between firms in
market economies and those in the CPE?
Firms in Market and Centrally
Planned Economies: Comparison
Market Economy
Planned Economy
State resources
Firm
Firm
State
Firm’s
resources
Market
Firm’s
resources
Market
Firm’s Budget Constraint in
Centrally Planned Economy
• State is the source of slack for firms in
the centrally planned economy
Observation 2:
• Firms are faced with soft budget
constraint
Firm’s Budget Constraint:
Illustration
Input 2
Budget constraint
Input 1
Budget Constraint and Demand:
Relationship
• If we were to compare quantities
demanded by the consumer or a firm
under soft and hard budget constraint
which would be higher?
Soft budget constraint
resources
Greater
Relationship between Demand and
Budget Constraint: Illustration
With more resources shift
from D1 to the right, D2; in
fact can choose any quantity
between Q* and Q**, e.g. Q
Price
P
D2 (demand with slack)
D1 (demand without slack)
Q* Q
Q**
Quantity
Relationship between Demand and
Budget Constraint: Price Changes
Price
With slackness in your budget
constraint demand curve shifts
to the right and quantity
demanded Q2 is the same as
before, even with higher price
P2
P1
D2 (Demand with slack)
D1 (Demand without slack)
Q2
Q1=Q2
Quantity
Occurrence of Shortages
• When are shortages most likely to arise?
Volume of goods
in the market
Firms and Consumers
Firm with
soft budget
constraint
Consumer with
hard budget
constraint
Consumer-Firm: Consequences
• When supply is fixed, in the presence of a
firm with soft budget constraint:
• availability of goods in the market for
consumers
Decreases
• Likelihood of shortages
Increases
Firms and Firms
Firm with
soft budget
constraint
Firm with soft
budget
constraint
Firm-Firm: Consequences
• When supply is fixed, in the presence of a
firm with soft budget constraint:
• availability of goods in the market for firms
Decreases
• Likelihood of shortages
Increases
General Conclusion
Presence of firms with soft budget
constraint decreases availability
of the good in the market for other
firms and consumers
Chain of reaction
• Higher demand for good X by firm A
• Shortage for consumer + shortage for firm B
• Firm B cannot produce if uses good X as input
• Shortage of firm B’s product
• Shortage for consumer + shortage for firm C using
firm B’ good as input
…
Results
• Shortages spread through the economy
• Shortages change behavior
• Become permanent in nature
Shortage economy
Plausible???