Cash-in-advance constraint
Encyclopedia
The cash-in-advance constraint (sometimes known as the Clower constraint after American economist Robert Clower) is an idea used in economic theory
to capture monetary phenomena. In the most basic economic models (such as the Walras
model or the Arrow-Debreu model
) there is no role for money, as these models are not sufficiently detailed to consider how people pay for goods, other than to say everyone has a budget constraint. To be able to say anything about the money supply
, inflation
monetary policy
and so on, economists must therefore introduce additional assumptions into their models. One possibility, and the more popular one, is to introduce a cash-in-advance constraint i.e. a requirement that each consumer or firm must have sufficient cash available before they can buy goods. An alternative assumption would be a 'Money-in-the-Utility-Function' assumption, which states that people have a tendency to hold a certain amount of cash because they derive utility from holding it. Without these (or similar) assumptions economic theory would find it difficult to explain why people carry around a good (money) which takes up space in their wallet, can't be consumed and does not earn any interest.
, which require the buyer to take possession of the merchandise as soon as it is loaded onto transportation, meaning the buyer assumes the financial risk if the shipment is lost or damaged en route. In actual daily business these sort of terms are extremely rare unless the goods or services are of phenomenal value and high fragility.
A constraint is any operating condition that puts a limit on the ability of a business to conduct its operations.
or financing.
In these modeling 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.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
to capture monetary phenomena. In the most basic economic models (such as the Walras
Léon Walras
Marie-Esprit-Léon Walras was a French mathematical economist associated with the creation of the general equilibrium theory.-Life and career:...
model or the Arrow-Debreu model
Arrow-Debreu model
In mathematical economics, the Arrow–Debreu model suggests that under certain economic assumptions there must be a set of prices such that aggregate supplies will equal aggregate demands for every commodity in the economy.The model is central to the theory of...
) there is no role for money, as these models are not sufficiently detailed to consider how people pay for goods, other than to say everyone has a budget constraint. To be able to say anything about the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
, inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
and so on, economists must therefore introduce additional assumptions into their models. One possibility, and the more popular one, is to introduce a cash-in-advance constraint i.e. a requirement that each consumer or firm must have sufficient cash available before they can buy goods. An alternative assumption would be a 'Money-in-the-Utility-Function' assumption, which states that people have a tendency to hold a certain amount of cash because they derive utility from holding it. Without these (or similar) assumptions economic theory would find it difficult to explain why people carry around a good (money) which takes up space in their wallet, can't be consumed and does not earn any interest.
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 such as Free On BoardFree On Board
FOB is an initialism which pertains to the shipping of goods. Depending on specific usage, it may stand for Free On Board or Freight On Board. FOB specifies which party pays for which shipment and loading costs, and/or where responsibility for the goods is transferred...
, which require the buyer to take possession of the merchandise as soon as it is loaded onto transportation, meaning the buyer assumes the financial risk if the shipment is lost or damaged en route. In actual daily business these sort of terms are extremely rare unless the goods or services are of phenomenal value and high fragility.
A constraint is any operating condition that puts a limit on the ability of a business to conduct its operations.
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.Uses
It is mostly used in a theoretical sense, to provide proofs of economic efficiencies, since it does not (by definition) involve terms of creditCredit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...
or financing.
In these modeling 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
Wealth
Wealth is the abundance of valuable resources or material possessions. The word wealth is derived from the old English wela, which is from an Indo-European word stem...
in terms of cash on hand while elevating the likelihood of using junk bonds as instruments of solvency, a dangerous premise.