SMN Differential Encoding

National economic efficiency is an aggregate indicator which is usually used to express the quality of economic activity in general, it provide answer to the question of how a society or a nation make use or should make use of its resources at his disposal for meeting his needs. National economic efficiency has dual characters; first and foremost, point of view is appraised from both the short as well as long-term aspect and point of view. This naturally involves the questions:-

(a) What are the needs that must be met now or in the nearest future?

(b) What are the heeds that must be met in the long run e.g. in the next five or ten years.

If a nation has taking a decision to increase considerable the standard of living of his population in the next decades as an example, that nation knows that he has to make considerable savings now in other words, it must consume less today in other to consume more in the years ahead. This means that he has to

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make a choice amongst needs to be met at presents and needs to be met in the future. if the needs of a society to be met at present and in the long run are established, a closely connected issues has to be addressed namely:-

(a) What and how much should be produced currently as well as in the long-run? (Issues of consistency).

(b) How do we secure this production economically? (Once we asked this type of question, we are dealing with national economic profitability).

Both component of national economic efficiency namely:-

(i) Consistency (ii) and profitability are theoretical in separable, each of them being valued only in conjunction with the other. This interdependence of the two (2) items can be demonstrated as follows:- “There can be no high national economic activity if such activity does not comply the consistency of an economic – development” and vice-versa. This is quite obvious because gains attained on the basis of profitability can be offset by loss incurred due to shortages and bottlenecks resulting from inconsistency. On the other hand, huge investment and operational losses will create condition for future inconsistency.

Theoretically, the magnitude of national economic efficiency can find its expression in the rate of growth of national income for a sufficiently long period of time to proof whether the growth is a sustained one or not. Obviously, a high rate in certain period could have been achieved at the expense of low rate in another period, but the possibility of applying one aggregate criterion and indicator for measuring the national economic efficiency is real only if the national economy is treated as a whole, only in this case does the rate of growth of national income for a period covers both profitability and consistency.

National economic efficiency in the case of a single-economic activity or of a single project cannot be expressed by means of one aggregate indicator since very good result of one activity or project could have been achieved at the expense of other activities either currently or in the long-run. Thus, in the case of single project or activity, it is evitable to find separate criteria for consistency and profitability (national economic). Consistency is usually expressed by fixing in a development plan items to be produced in quantity and quality terms.

This is done on the basis of system of balance and input-output analysis. The national economic profitability considerations supply information on the most economical ways of their production of this activity. From all we have said so far follows that the degree of profitability can be expressed only in the form of indices or coefficients showing the ratio between benefit and cost.

6.3.2 National Economic Profitability of Investment Projects and Pricing Problems.

Profitability in general means comparison of benefits and costs, from the view point of commercial enterprise, profitability can be easily ascertained by comparing returns with capital outlay. However, it is extremely difficult to calculate profitability from the social point of view, since there is problem of finding out what actually are social benefits and social costs. The severity of

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this problem becomes more evident if we recall the indirect effects and external economies and dis-economies involve in any projects. The basic criterion of national economic efficiency is the increment of national income achieved under the condition that a sustained and rapid economic growth is secured. The second part of this criterion i.e. to secure a sustained and rapid economic growth refers to the consistency while the first part namely the increment of national income refers to national economic profitability. Since this increment can be considered as the basic social benefits which should be compared with social costs. The increase of national income should be understood to comprise all the direct as well as indirect results affecting national income achieved throughout the economy as a whole. In the case of an individual projects, this means that the evaluator should try to estimate and measures the total contributions to the national economy to be brought about by the facility. Therefore, we used the term „benefits‟ rather than increase of national income. Benefits done cannot say anything about social profitability; you must know how much has being sacrificed in other to achieve benefits. So, benefits must be compared with costs and the benefit – cost ratio calculated. The indices of national economic profitability are usually hampered by the problems of (i) determination and (ii) quantification of social benefits and costs in each case.

In practice social benefits and costs are usually derived from social objectives fixed by the government in general or for the project in question. In doing this, the following concept of social benefits and costs are applied:-

“Costs and benefits are simply two (2) sides of the same point at benefit measure the contribution of projects to an objectives, costs represent payment for resources that could have been used elsewhere if not for the projects”.

Benefits represent contribution to national income which will be produce by the projected union for example if the national income is presently 1,000 monetary unit and if diverting to the project resources now earning 10 monetary unit, the national can produce benefits of 30 monetary units the national income has increased to 1020 monetary units. The benefits of 30 monetary units compare with the cost in national income figure of 10 monetary units represent a benefit-cost ratio of 3:1. The second problem namely that of quantification of social benefits and cost is usually solved by (i) computing and applying the accounting-prices, wages and rates and by (ii) estimating indirect effects (external effects), we estimate such indirect effect in money-terms in other to facilitate comparisons and (iii) by establishing financial equivalent taking into account time factor.

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(a) Accounting Prices at Approximation of Shadowed Prices

In the literature on project evaluation, there are several concepts of prices namely:- shadowed, equilibrium, opportunity, official, market and accounting prices. This is frequently used in a confusing and inconsistent ways. The following definitions and explanations will bring about some clarifications in the pricing problems.

i. Market Prices: - Is any price which is actually paid.

ii. Official Prices: - Official price is market price which was fixed by an official body and government and consequently does not follow demand-supply mechanisms e.g. NEPA prices, fertilizer prices.

iii. Shadowed Price:- shadowed price is any price other than an observed market prices.

iv. Equilibrium Price: - Equilibrium price is price corresponding to equilibrium of demand and supply.

v. Opportunity Cost/Price: - These are prices which buyers are willing to pay for resources to be employed in the best possible alternative use.

If a balance and or equilibrium is assumed, opportunity costs are equal to equilibrium prices.

vi. Accounting Prices: - Accounting price is an approximation of shadowed, equilibrium and opportunity prices. They are the prices used in project evaluations.

vii. Social price: Social price is price employed in quantifying a value from the social point of view.

The interrelations between these prices, the following can be said:- shadowed, equilibrium and opportunity prices are in a sense synonymous. Their common quality being their abstract nature for example if market prices are distorted it is assumed that there must exist other set of prices which are different from the market price and which in the case of perfect competition will equilibrate demand and supply. To imagine the existence of prices which are different from the actual market price is the abstract way of conceiving equilibrium prices. At the same time, we can consider the same equilibrium as shadowed prices, if we just generally want to admit that besides actual price there exists others, the same thing applied opportunity cost. Shadowed (equilibrium and opportunity) price can be quantified with more or less accuracy depending on data used and method employed. The concrete price thus obtained is called Accounting prices.

The basic difference as well as the relationship between shadowed (equilibrium and opportunity) prices on the one hand and accounting price on the other is that the latter are approximations to the former. The term social price is usually used in the two following ways:-

(a) In the sense of prices that are equal to social prices. If t he social function of the former is stressed.

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(b) In the sense of social price that are equal to accounting price. This is in the case that the calculation of the latter was done from the national economy point of view.

As a rule, equilibrium-prices as well as opportunity cost considerably differed from the actual market-prices including rates and wages. The deviation of market prices from the equilibrium prices can arise from a variety of reasons e.g. imperfect functioning of the market due to the presence of monopolistic elements, administrative measures design to keep market prices at an artificial level; the necessity to quantify external effects and to fixed future-prices. If for example the official rate of foreign exchange is kept at an artificial level, it will considerably deviate from its opportunity cost. Export and import control usually tend to keep the official rate under the opportunity cost. If there is an excess supply of unskilled labour, which has resulted in unemployment, the opportunity cost of unskilled labour is well below in the market-wage. The collective preference of the population for present over future consumption find its expression in social rate of discount (accounting rate of interest) which may considerably deviate from the official as well as private rate. Equally the marginal rate of return on investment. Market prices of raw materials and machineries are usually distorted by different magnitude of taxation components if for example the price of raw-material A includes tax and custom-duties amounting to 40% and the prices of raw material B includes a subsidy of 10%

and this components do not reflect the scarcity of factors, it is obvious that both prices deviate considerably from their equilibrium prices or opportunity cost.

(b) Methods Employed in Calculations of Accounting Prices (i) Linear Programming Method

Theoretically, accounting prices as the most precise proxy of shadowed prices can be found by means of linear programming techniques where shadowed prices represent a set of value parameters of the dual solutions to a given overall development programmes. In practice however, because of the lack of adequate data, this procedure is in applicable, even if data were to be available, there are certain problem inherent in linear-programming which may require the application of non-linear techniques.

(2) Trial and Error Method

A second approach represent a trial and error method, in this method we assume the existence of universe of candidates projects namely a sufficiently wide range of suggested project with regard to available resources. This method has to do with successive approximation and it could be described as follows:-

(i) A random set of accounting prices is assumed.

(ii) The profitability of all candidates project of universe is calculated on the basis of these prices and the projects are now ranked in other of declining profitability.

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(iii) A set of project is then selected in this order until one of the resources is exhausted.

(iv) The aggregate yield of this project is determined

(v) The same process is repeated with different assumption regarding the set of accounting prices.

(vi) The procedure is continued until the maximum aggregate yield is reached.

(vii) The respective set of project will then represent the optimum set and the corresponding prices the accurate accounting-price.

This method though practically applicable, is very tedious and the results attained by it may not justify the extent of labour involved.

(4) Correction of Market Prices

In practice accounting price (rates) can roughly be estimated through correction of market prices that deviate from corresponding social equilibrium prices or opportunity cost to such an extent that the necessity of their correction is beyond any doubt. The market wages of unskilled labour usually needs downward corrections because the social opportunity cost of labour in developing countries with large unemployment is very low.

(c) Financial Equivalents

In pricing benefits and costs, the time factor plays very important role nominally the same amount of money have different value if paid or received at different dates, the difference being the interest representing the preference between present and future use of the money involved. In other words, financial equivalents between different amount of money paid or received at different or various dates could be achieved by employing the respective interest-rates. Financial equivalent can be established by using specific factor, the value of which can be achieved by employing the respective interest-rates. Financial equivalent can be established by using specific factor, the value of which can b found in special financial tables.