CHAPTER 1 THE EMERGENCE AND CHALLENGE : OF THE CREDIT ECONOMY : LEARNING OUTCOMES 1. Know the transition from barter economy to credit economy; 2. Explain the importance of the need for money; 3. Understand the birth of credit; 4. Explain the importance of the use of credit; 5. List down the advantages and disadvantages of credit; 6. Understand the cost of using credit; 7. Understand how credit affect prices; 8. Explain the impact of credit upon the creditor and debtor; and 9. Identify the foundations of credit. Introduction As we move back from the times of the distant past to the present — from the time man first set foot on the face of the earth to the time when he landed on the moon, we also recall the many periods in man’s history by the various names given by historians and scholars based upon the kind of implements used, the developments achieved by nations and its peoples, as well as the inventions that have contributed to the progress of mankind As human history moves toward the year 2000, with its awe-inspiring challenges and opportunities on the one hand and a host of problems, on the other, business and industry are attracting and increasing attention from companies and institutions almost on a global scale that could affect the life and standard of living of peoples all over the world. Variety of organizations are showing an unprecedented interest in the field of marketing as a tool of importance to economies of nations. While marketing is considered as man’s newest action discipline, nevertheless, there is no denying the fact that it is also one the oldest professions of man. Then, there is continuing, emphasis on finance in national development. From the time of simple barter through ie stage of a money economy to today’s credit economy remarkable developments. paves pane piace far and wide. With the tremendous growth in the use of credit, we ig the latter part of the twentieth century, as the dynamic force which propels conomies of the many highly industrialized countries of the world. Hence, the terms”The M eet Bunce cour s ed Society”, “The Credit Society”, and many others to describeTransition from Barter Economy to Money Economy y f human history was marked by economic self-suffici family dis Able-bedied members of family units were charged with the tack sibility of providing the basic needs of life, such as: food, clothing and shel purest man became equipped with better tools as well as learning in the product; of goods, surplus goods beyond the immediate needs of the family became comme. Hence, the need for a system of exchange termed as barter. . Barter may be defined as “the direct exchange of “one commodity another,” of goods for goods, services for services, goods for services or vice weg ™ ange of goods for goods was understood as the “barter economy.” This exe The complicated money and credit exchange system of today is the Product of along process of evolution. It had its crude beginning in a barter economy, In the days before the dawn of civilization, the earliest method of acquiring goods that were owned by someone else was probably by a simple act ofa plundss or robbery where brute force and strength had the force of authority. In fact the stronger party almost always took possession of the property of the weaker one through force and, at times, through stealth. However, when primitive society gave way to a recognition of private property in any article, a remarkable advancement had taken place. Thus, in time. only those things that are already owned by one individual can be conveyed unto another, either as a gift or in exchange for other articles Although simple barter represented an advance over economic self sufficiency in permitting high levels of productivity through economicspecialization, nevertheless, it remained a highly inefficient method of exchanging goods. A maior problem generally arises when the economic goods being offered in exchange were of quite different values. More so, when they were invisible. As such, barter with its time-consuming aspect as a method of exchange militated against increasing production thereby retarding the rate of wealth accumulation and economic growth. The solution to this pernicious problem, characteristic of exchange through the use of barter, brought about the development of a common medium of exchange that took various forms, History records the fact that there was hardly anything that has not been employed as money by some people at one time or another: fish- hooks, sea-shells, beads, cows, slaves, cotton, tobacco and many others. Cattle was @ convenient standard of value in ancient Persia (now known as Iran). Hoes ha knives are said to have been used as money by the Chinese, and later, through # slow process of evolution, miniature copies of said articles, although lacking utility as commodities, nevertheless circulated as money. ‘The precious metals seem to have acquired monetary functions among Peoples who knew them almost as early as did other commodities. \ rpecaeite AgeeThe Need for Money. In his book entitled “Wealth of Nations” Adam Smith entertained the belief that money originated in man’s rational effort to meet the necessity of finding some medium of exchange. Thus, it was introduced into man’s economic life designed purposely to overcome the shortcomings of barter. Money in whatever form has not only eliminated the shortcomings of barter and facilitated exchange transactions but, moreover, continues to plan an important role in economic society. For instance, it is responsible for increasing production and thus adds to the creation of wealth and also in accelerating consumption with the concomitant rise in the standard of living of the people. The use of money for production insures and spreads benefits to every member of economic society. Raw materials are turned into finished products which provide not only gainful employment among the country’s labor force but also contribute to the increase in, what economists call, the multiplier effect. However, in the beginning, the use of money was not intended for production. Rather, it was intended for sumptuary purposes, that is , for consumption. This explains the reason why the taking of interest on money lent was not only looked upon with disfavor but actually forbidden. According to Aristotle, a fourth-century B.C. philosopher said in this connection: “Money is barren. It does not breed.” As such, he concluded that it is intended to be used only in exchange but not to increase at interest. - Barrenness was to him an essential nature of money; usury (interest) which made money bear fruit, was unnatural. Saint Thomas Aquinas took up this view and combined it with the doctrine of Roman Law which distinguished between goods which were consumptibles and fungibles. Roman Law had not made use of this distinction in reference to the problems of loans on interest at all. It had merely classified goods according to whether they were consumed in use or not. In due time, important modifications appeared in the history of thought governing interest. Of these exceptions, the most important was the doctrine of “damnum emergens” that is, the suffering of a loss by the lender. Where a delay (mora) occurred in the repayment of a loan, the lender was entitled to exact a conventional penalty. Still more important in helping to break down the original prohibition was the doctrine relating to “lucrum cessans”. To have lost the chance of gain through lending money also became a justification for the receiving of interest. The Growing Need and Demand for Money. Many events have contributed to the growing need and demand for money. However, four stood out prominently because of their importance and far reaching significance. The decline in the spiritual power of the church and the eventual recognition of the institution of private property have opened the gates that saw the need anddemand for money. For it cannot be stated too strongly that with the demise g barter as a method of exchange in progressive countries of the world, the use money became important and compelling. Commodities as well as articles of vai in which the labor of workers has made their existence possible are offered in he exchange market for a price. That price is money. No longer is man haunted by the thought that acquiring more and more goods would mean the loss of heaven and his consequent eternal damnation. The need for exchange, which meant the concomitant use of money, was felt, and in face eventually, led to the sanction of exchange provided there was a fair exchange. Thig brought about the birth of that dictum—"justwm pretium” which in economics means e”, the doctrine of the “just pr Where the economy was one of feudalism, as observed in early England, there was little need for money. The reason is not far to seek. Under feudalism, the people, many of them slaves or serfs, were bound to the land and to the lord of the manor who, in turn, owed fealty to a king who was frequently stronger than some of his powerful knights. Each manor or village unit was largely self-sufficient, each with its own fields, livestock, homespun clothing gristmill, smith, and carpenter. Methods of production were crude, and little or no surplus above current needs was created. Production was almost entirely for consumption on the manor rather than for sale. Services were rendered free by the vassals to the lord. With the fall of feudalism and the rise of mercantilism came the increasing importance of money. In fact, it is silver were equated with the wealth of the nations, so much so that national commercial policy was aimed and directed towards the acquisition of gold and silver which then were held synonymous with money. With emphasis on foreign trade, manufacturing came to be considered important, not to produce for home consumption as in the days of feudalism, but for exporting abroad. Merely to export was not sufficient either. It was necessary, according to mercantilist policy, that the amount exported from a country should exceed as much as possible the amount imported by the country so that the balance of trade would be favorable and the difference would come into the country in the form of money or treasure. For commerce to thrive and flourish, increasing production is necessary just as there is a need for a lubricating media that will help facilitate exchange. The use of medium of exchange has not only freed trade from the inconvenience of barter but doubtless made possible a tremendous increase in the productive capacity of labor, through specialization or “division of labor”. The rise of specialization, local markets and money opened up the possibility of persons producing not only for survival but for gain. Those who were successful at accumulation, by dint of either talent or force, began to exchange goods and services that they held as surplus for the labor of other men. Thus, the birth of early capitalism. The oscillating forces of capitalism whi i i pie ‘ pitalism which has given meaning and substan to the exercise of economic freedom and the rise of a market system among othersSS en Pe have, by and large, accounted for rapid exchange transactions, and helped the development of financial institutions. The fact however that the supply of money in many instances could not adequately meet the increasing volume of goods entering the exchange transactions accounted for money being supplemented by the use of credit. The Birth of Credit One of the unique features of our business system is that it operates to a large extent on promises, called credit. Business firms sell to consumers on credit and buy from other businessmen on credit. The word credit comes from the Latin credere which means “to trust”. The widespread use of credit is a strong evidence to support the belief that the people have trust in one another. The emergence of credit, it might be helpful to point out, is not one of design. Rather, it is a product of necessity. Thus, it may be logical to expect, it passed through along process of evolution and development. Nature. Credit is akin to a two-way street. The sale of a good or service on the basis of deferred payment gives rise to the existence of a credit transaction involving two parties, the creditor and the debtor. For every debtor, there is a creditor and vice versa Insofar as the debtor is concerned, credit to him represents power - the ability to obtain goods without an actual tender of payment. Since the grant of credit by the creditor to the debtor is accompanied by a promise on the part of the latter to pay at a certain later date, an obligation arises which must be discharged as promised. The creditor, as seller of goods or services on credit, has both the moral and legal right to demand of his debtor to pay the obligations when due. If the amount is not paid when due, the creditor has a right of action against the debtor which he can at once put in force. For thjs reason, not a few writers have held credit as a “right of action against a person for a sum of money. Thus, credit is essentially a transfer of goods, services or funds giving the rise to obligations that must be discharged in the future. __ Other Meanings of Credit. At this point, it is perhaps important to indicate the different meanings which the term credit conveys. - In banking, credit is held to refer to “an entry in the books of a bank showing its obligation to a customer,” that is, for the deposits made by latter.Im bookkeeping, credit is “an entry showing that the person nam right to demand something but not necessarily money. ed has g In commerce, credit pertains to “an exchange i 2 e, c Is transaction” indicated in a foregoing discussion. 5 On #8 already Other meanings of credit are those held in connection with bys transactions consummated on the basis of deferred payment, the standin debtor in the eyes of the creditor and documentary evidence, 8 of the During recent times, one hears the use of such popular express “buying on credit” or “extension of credit”. Such terms are merely interary ® describe business transactions which involve the purchase and sale of mena services with money payments to be made at some future time. This is the con eh meaning of credit as used in everyday transactions. eae In another sense, credit may be held synonymously with specific referen, to the buyer's credit standing, that is, the ability to obtain goods or services or eres money against a promise to pay for them at a later date. Likewise, the term credit may refer to a credit instrument, that is, a document which serves to evidence the existence of a business transaction anchored on trust. The Use of Credit. The use of credit especially in the business world is so common that, by way of compliment, it is generally called as “the life-blood of business”. For this reason, it may appear trite or unnecessary to focus attention on its importance. However, for the sake of emphasis, business entities and individuals find credit a distinct convenience. The business firm which sells goods on credit confers benefit to its customers just as it helps the continued operation of its business. The customers are able to obtain the desired goods even at a time when they suffer from lack of cash or purchasing power. These customers, like the middlemen (wholesalers and retailers), through the credit assistance extended to them, are able to stock their warehouses and stores with sufficient number of goods that they later sell to their customers. On the part of the former, by granting credits to others, there is an nace the volume of sales which would not have been possible if such goods were offere strictly on cash basis. Credit, properly used, is of outstanding benefit to society. Savings Ye might otherwise remain idle help turn the wheels of industry. As sud nie increase total production, employment, and consumption, just as it helps 1 national income and improve people's standard of living, Briefly noted, idle NTT donot mean much, Unless employed in production, they do not benefit oure society.Credit connects our business and financial enterprises in an invisible but mighty chain. Unfortunately, failure in one sector of the economy generally spreads rapidly to the others until they engulf the whole economy. Someone has aptly stated that “credit is a delicate plant which flourishes extravagantly under favorable conditions and is exceedingly quick to wither in adversity. “It bears the seed of its own destruction With the birth of the credit economy, it is difficult and inconceivable to think of an economic society that shuns the use of credit. No economic society can grow and achieve a considerable degree of progress without the continued tse of credit. It must be emphasized that credit represents the very force that sustains and aids business in the attainment of its objectives. This is apparent, if not very obvious, to say the least. Itis only through the use of credit that business transactions in large volume become possible. Credit not only finances trade and commerce in almost every conceivable way, but it also provides the needs of seasonal business. Advantages of Credit 1. Credit facilitates and contributes to the increase in wealth by making funds available for productive purposes. 2. Credit saves time and expense by providing a safer and more convenient means of completing transactions. 3. Credit helps expand the purchasing power of every member of the business community ~ from producer to the ultimate consumer. 4. Credit enables immediate consumption of goods thereby providing for an increase in material well-being. 5. Credit helps expand economic opportunities through education, job training and job creation. 6. Credit spreads progress to various sectors of the economy. 7. Credit makes possible the birth of new industries. Credit helps buying become more convenient for customers.Disadvantages of Crear While there are numerous advantages that are derived from the use of en nevertheless, on the other side of the coin may be noted certain shortcomin a Neigh against its use, especially when devoid of care and caution. They cae snention the important ones, the following: to 1. Credit at times, encourages speculation. This happens when those in char the savings of other people throw cautions to the winds and thereby Gee careless and unscrupulous in their eagerness and desire to expand adit on nd make huge profits. 2. Credit also tends to contribute to extravagance and carelessness on the part people, who obtains credit is not using his own money but is using the roe bf other people, he is therefore charged with an obligation of the highest cider Many do not understand such social responsibility. As such, many fail e appreciate that trust. 3, Because of credit, many entrepreneurs resort to over-expansion. Failure to generate expected income can only cause a collapse which affects the nation’s economy. ation that business can be expanded or contracted rapidly through the use of credit, businessmen are not only susceptible but eventually succumb to an air of confidence or pessimism. Credit causes one businessman to be dependent upon others. In order to extend credit, he must have faith in other businessmen and also in the future. Thus, it follows that if credit relations become strained, may businesses may fail and a business recession may set in 4. Owing to the observ The Cost of Using Credit It goes without saying that almost everyone who uses credit understandably has to pay for it. However, hardly is there anyone who seems to know exactly how much he pays. Even those who think they know usually estimates the cost to be ‘one-half or one-third of what actually it is. This is not really odd as it might sound. Credit, as may be observed, does not carry a price tag on it, like shoes, handbags, clothes, and similar items. To use credit wisely, it is necessary to know how much it costs. But it may be asked: What then determines the cost of credit? The price of credit, like the price of almost any other good or servic’, depends upon the cost of providing it. Thus, if one buys a pair of shoes, the price he has 0 pay must cover the seller's costs of doing business plus a fair profit. When Yo" is credit, the price you pay has to cover the lender's costs plus a fair profit: The re0s0! why credit charges vary is simple. Some lenders charge higher rates than others. general, however, all sellers of goods produced by means of borrowed funds hetthe same kinds of costs: interest, operating expenses and risk. Interest Money has many uses. Anyone who extends credit cannot use the money Joaned in some other way until the debt is paid. He, therefore, has a right to charge for its use. This charge is called interest. Interest is usually expressed as a per cent, such as 12 per cent. This is the interest rate. An interest rate of 12 per cent means that for every peso owed, the borrower must pay 12 centavos. Unless stated otherwise, interest is usually quoted as an annual charge: Interest is a price, and like other prices, it may vary from time to time. One factor that affects interest rates is competition. Sometimes: the demand for credit is greater than the amount of money available for lending. Then borrowers compete with one another to obtain credit. This tends to push up the interest rate. At other times, however, the amount wanted or needed. As such , lenders, are forced to compete with one another for business thereby tending to force down the interest rate. Operating Expenses It is hardly necessary to point out the observation that business enterprises that extend credit shoulder the same operating expenses as other businesses. They must pay rent. They also pay for light, telephone service, water and others just as they must pay their workers for their services in production. In addition, lenders incur, the expense of investigating applicants for credit purposely to find out if they are good risks and therefore worthy of credit Collection Pranother item which includes sending notices when payments are due and keeping a record of payments made. The more payments there are to be collected, the greater is the cost that will be incurred in their collection. When one pays a debt in lump Sum, the cost of collecting occurs only once. However, when one pays a debt in installments, the cost of collecting occurs as many times as there are payments. Fora debt paid in 12 installments, the cost of collecting occurs 12 times. This explains why installment credits always cost much more than single-payment loans and charge accounts, When borrowers fail to pay their debts on time, of course, collection costs increase. It should be pointed out, in this connection, that the cost of investigating a borrower's credit and the cost of collection do not vary much regardless of the amount of credits involved. In other words, it costs no more to investigate a borrower wanting to borrow P25,000 worth of credit than to investigate one wanting to borrow P2,000 worth, Similarly, the cost of collection is no different whether payments are P50 or P200. Only the number of payments makes the difference.Risk Extending credit always involves a risk for the lender since he ca certain that the debt willbe paid. When a lenders unable to collecta dees oss. Losses from unpaid debts represent an added cost of doing business. Needles, to say, such losses are highest among lenders who assume the greatest risk. Lender. who deal only with people who are known to pay their debts promptly have fey losses, if any, The more risk a lender is willing to assume, doubtlessly, the more he must charge. ‘ In stores that are not careful in the granting of credit, the losses from failure to collect debts are likely to be high. One may well expect to find inflated prices in stores that recklessly advertise generous credit terms to everyone. Stores that extend credit wisely, however, have practically minimal losses from bad debts. We need not assume, however, that a merchant who sells on credit must necessarily sell at higher prices than a merchant who sells for cash. If selling on credit increases sales, the total ‘overhead cost of each sale may actually be decreased. On the other hand, stores that regularly grant credit often also supply delivery services and other conveniences ‘All of these services combined may cause the store to sell at higher prices than a cash-and-carry store. Cost of Credit to the Individual ‘As an observation, any cost of credit is passed on either to the individual consumer on the basis of each sale, or to all buyers through higher prices. Sometimes, discounts are allowed to individuals in ordinary credit transactions. Common terms in such a case are “2% in ten days, net thirty days”. These terms mean that, if the purchaser pays the amount within ten days, he may deduct a discount of 2% from the amount of the bill; but if he does not desire to take advantage of the 2% discount, he may pay the net amount at the end of 30 days. The company which sells on this basis is willing to forego a 2% for the use of the money for 20 days. In other words, if he buys on these terms goods amounting to P1,000.00, he may take a discount of P20.00 at the end of ten days and therefore pay only P980.00. However, let us suppose that the buyer has enough money to pay the bill but believes that he can use the money better in some other way. He therefore prefers to wait until the end of 30 days before paying the bill. By doing so, he pays P20 for using P980 for 20 days. If interest is figured on the basis of 360 days, he is paying interest at the rate of 36.72% a year to use this money. How Credit Affects Prices Increases and decreases in credit affect prices in very much the same way as increases and decreases in the supply of money. Since credit expands the use ‘of money, it serves to increase rapidity with which money is used. If a person has woP100.00 to spend and borrows P100.00, he has a total purchasing power of P200.00. If everyone in the Philippines borrows in this way, the purchasing power in terms. of pesos is doubled. If, at the same time, the supply of goods and services remain unchanged, prices will increase because there is an increased amount of money and credit with which to buy products and services. When money and credit are increased, however, the supply of goods and services may also increase. If the purchasing power continues to increase faster than the supply of goods and services, prices will continue to rise. When credit decteases, prices tend to decrease. The prices of goods and their relation to the amount of money, the rapidity of use of money, and the amount of credit may be likened to weights on the ends of a pair of scales. me that the scales are in balance, with the goods on one end and money and credit on the other end, If the amount of money decreases, the goods will drop in price. If the amount of money increases, the goods will rise in price. Clearly then, the same results will be observed from a decrease or an increase in credit. Suppose, however, that as the prices of goods rise, the supply begin to rise This increase in supply will tend to keep the prices down. If there is, however, a sufficiently large expansion of (a) the amount of money (b) the velocity in the turnover of money, or (c) the use of credit, the prices will continue to rise. These three factors usually go hand in hand. Impact of Credit upon the Creditor and Debtor A rise in the value of money (fall in prices) generally speaking harms the debtor. However, it cannot be assumed that such a circumstance will tend to benefit the creditor for indeed it could happen that the debtor may become insolvent and the creditor will thus lose all or a part of his loan. In the same manner, a fall in the value of money (rise in prices) may injure the creditor without in any way helping the debtor. This is because the rate of wages may rise more slowly than the cost of living during a period of rising prices Foundations of Credit For the credit system to continue in its existence and attain a healthy growth and development, it is necessary that it should solidly anchored on strong pillars or foundations for support. As observed, the foundations of credit are: 1. Creditors must have absolute confidence in the personal character and in the ability as well as willingness of their debtors to accept, honor and settle their obligations. In passing, it may be mentioned that credit, from the Latin term “creditum’ is founded on trust. Unless creditors have trust on their would be debtors, then credit accommodations will not be favorably considered.‘CREDIT & COLLECTION 2. Proper facilities must exist for performing credit operations. Sources of credit information must be available to those granting credit if a correct and proper evaluation of credit rating is to be made which is the first criterion in the grant of credit. The grant of credit likewise entails the use of documents to evidence the existence of credit transactions between the creditor and debtor which seeks to establish their obligations to one another. 3. The money standard must be stable. If money is subject to frequent and wide fluctuations as to cause its purchasing power to become uncertain at any time after a contract is entered into by the contracting parties, the holders of surplus funds will necessarily feel reluctant to part with their funds or goods knowing that the purchasing power of the money that will be paid , to them may not be equal to the value of what has been advanced whether in money, goods or services. Under such a circumstance, many individuals may not even save a part of their incomes. The net effect is that banks and banking institutions which obtain their loanable funds out of the savings deposits entrusted into their custody will not have much to extend as loans. 4. The government must stand ready to assist the creditor in enforcing payment of loan extended to the debtor. Our laws recognize and protect the enforcement of valid obligations arising from contracts freely and lawfully entered into by the contracting parties. While it is true that, as provided in our Constitutions, no individual shall be imprisoned for non-payment of a debt, nevertheless, our courts can order properties of debtors attached for their refusal to honor and pay their indebtedness and have them sold at public auction to cover their obligations.1. Define barter and discuss the transition from barter economy to money economy. 2. Discuss the birth of credit and its significance in our economy.3. Enumerate the advantages and uses of credit. 4. Explain the cost of credit to the individual. 5. How does credit affects prices?(CREDIT & COLLECTION ‘CHAPTER 1 CEARNENG EXERCLEE 1 Date: “Year / Section: Score | Test I. TRUE OR FALSE. Write T on the blank space provided if the statement is correct and F if the statement is incorrect. The complicated money and credit exchange system of today is a product of a long process of evolution. The use of money eliminated the shortcomings of barter The emergence of credit is a product of necessity. vr ye An economic society can grow and achieve a considerable degree of progress by not using credit. 5. The price of credit does not depend upon the cost of providing it Extending credit always involves a risk for the lender, A rise in the value of money harm the debtor. . A fall in the value of money may injure the creditor. . Credit system to continue its existence and attain a healthy growth and development, it is not necessary that it should anchored in strong pillars. 10. The grant of credit does not entail the use of documents. Test IL. Fill in the blank with the correct answer. The direct exchange of one commodity for another. Transfer of goods, services or funds giving the rise to obligations that must be discharged in the future . It is the life-blood of business. x The charge for the use of money loan. Creditor’s absolute confidence in the existence of credit transactions between creditor and debtor. Evidence in the existence of credit transactions between the Creditor and Debtor. ’. It means “to trust” . Suffering of a loss by the lender. To have lost the chance of gain through lending money. . Itmeans “just price”.