Cash-in-advance constraint

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The cash-in-advance constraint is an idea used in economic modelling to demonstrate how equilibrium affects purchases. This is sometimes used to demonstrate Pareto efficiencies. In the simplest possible terms, it is a description of how "cash-in-advance" limits the absolute spending power of a business.[1]

Contents

[edit] Terms

Cash in advance is a term describing terms of purchase, when full payment for a good or service is due before the merchandise is shipped. This presents the least risk to a seller while having the most risk to the buyer. It is often combined with other terms requiring the buyer to take possession of the merchandise as soon as it is loaded onto transportation, meaning the buyer is out of luck if something happens to the shipment en route. In actual daily business these sort of terms are extremely rare unless the goods or services are of phenominal value and high fragility.[2]

A constraint is any operating condition that puts a limit on the ability of a business to conduct it's operations.

[edit] Examples

A company with $5000 on hand and incomes of $3000 a month has a constraint of $8000. That means, if the terms of an economic exchange (buying equipment, etc) require terms that are cash-in-advance, then the limit that the company can actually obtain is $8000.

[edit] Uses

It is mostly used in a theoretical sense, to provide proofs of economic effieciencies, since it does not (by definition) involve terms of credit or financing.

In these modelling theories, CIAC tends to show that up-front restrictions artificially limit the ability of companies to maintain positive inventory levels while reducing capital investment. They also inhibit real wealth in terms of cash on hand while elevating the likelihood of using junk bonds as instruments of solvency, a dangerous premise. [3]

[edit] References

  1. ^ S. R. Aiyagari and N. Wallace, ”Existence of Steady-States with Positive Consumption in theKiyotaki-Wright Model”, Review of Economic Studies 58 (1991), 901-916
  2. ^ C. Hellwig, ”Money, Intermediaries, and Cash-in-Advance constraints”, FMG discussion paper349, London School of Economics, 2000
  3. ^ Kam, Eric and Paul Missios, (2003) "Wealth effects in a cash−in−advance economy." Economics Bulletin, Vol. 5, No.2 pp. 1−7
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