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Capital Rationing

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Capital rationing is a situation in which a firm is unable to obtain all of the capital it needs to finance its investment projects. This can occur when there is a shortage of available capital, or when the cost of capital is high.

Causes of Capital Rationing:

  • Shortage of available capital: When there is a shortage of available capital in the market, firms may be unable to obtain all of the capital they need.
  • High cost of capital: When the cost of capital is high, firms may be unwilling to borrow as much money.
  • High interest rates: When interest rates are high, firms may be more likely to invest in projects that have a lower return on investment.

Effects of Capital Rationing:

  • Limited investment: Capital rationing can limit the amount of investment that firms can make.
  • Higher cost of production: Capital rationing can lead to a higher cost of production for firms, as they may be forced to use less efficient equipment or technologies.
  • Lower returns on investment: Capital rationing can lead to lower returns on investment, as firms may be forced to invest in projects that have a lower return on investment.

Examples of Capital Rationing:

  • A firm is unable to obtain all of the capital it needs to build a new factory.
  • A firm is unwilling to borrow money at a high interest rate because the cost of borrowing is too high.
  • A firm invests in a project that has a low return on investment because the firm is unable to find other investment options.

Policy Responses to Capital Rationing:

  • Government intervention: Governments can intervene in capital rationing by providing subsidies for investment or by regulating interest rates.
  • Private sector initiatives: Firms can take steps to reduce their need for capital, such as by increasing their use of technology or by outsourcing production.

Conclusion:

Capital rationing is a situation in which a firm is unable to obtain all of the capital it needs to finance its investment projects. It can be caused by a shortage of available capital, a high cost of capital, or high interest rates. Capital rationing can have a number of negative effects on firm performance, including limited investment, a higher cost of production, and lower returns on investment.

FAQs

  1. What is capital rationing with an example?

    Capital rationing limits investments due to scarce funds. For example, a company with $1 million may choose only the most profitable projects if it needs $2 million for all options.

  2. What does capital rationed mean?

    It means a company has limited funds and must prioritize which projects to invest in.

  3. Which technique is used for capital rationing?

    Techniques include Profitability Index (PI), Net Present Value (NPV), and Internal Rate of Return (IRR).

  4. What is rationing of credit with an example?

    Itโ€™s when banks limit lending despite demand. For example, a bank might restrict loans to risky sectors.

  5. What are the advantages of capital rationing?

    It helps control spending, reduce risks, and ensures only high-return projects are funded.

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