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Small Business and Liquidity Constraint

Author

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  • McCain, Roger

    (School of Economics)

Abstract

This essay will adapt the life-cycle theory of saving to the case of a small business proprietor who can invest his saving either in his own business or in financial securities, and may face a constraint on borrowing because of the limited liquidity of the business assets. This exercise does not seem to have been done before. For simplicity, certainty is assumed throughout. Thus risk and risk aversion play no explicit part, though it is assumed that there may be a margin between the rate at which the businessperson can borrow and the rate of return that she can obtain on financial capital and that there may be capital rationing by lenders. These elements may be consequences of risk in a more complex model that does allow uncertainty, but those considerations are beyond the scope of this essay, which aims only to extend the life cycle hypothesis to allow for investment in business capital and for a lending margin and capital rationing. The first section introduces liquidity constraint, with some very selective examples from the longstanding literature on the topic; the second presents a formal model, and the third gives a diagrammatic exposition of the model. These sections focus on the application to a small business. A following section discusses application to consumers in general. A brief summary and conclusions follow.

Suggested Citation

  • McCain, Roger, 2016. "Small Business and Liquidity Constraint," School of Economics Working Paper Series 2016-3, LeBow College of Business, Drexel University.
  • Handle: RePEc:ris:drxlwp:2016_003
    as

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    References listed on IDEAS

    as
    1. Roger A. McCain, 2014. "Reframing Economics," Books, Edward Elgar Publishing, number 15390.
    2. Deaton, Angus, 1991. "Saving and Liquidity Constraints," Econometrica, Econometric Society, vol. 59(5), pages 1221-1248, September.
    3. Simon Parker, 2000. "Saving to Overcome Borrowing Constraints: Implications for Small Business Entry and Exit," Small Business Economics, Springer, vol. 15(3), pages 223-232, November.
    4. Erik G. Hurst & Benjamin W. Pugsley, 2016. "Wealth, Tastes, and Entrepreneurial Choice," NBER Chapters, in: Measuring Entrepreneurial Businesses: Current Knowledge and Challenges, pages 111-151, National Bureau of Economic Research, Inc.
    5. Luís M B Cabral & José Mata, 2003. "On the Evolution of the Firm Size Distribution: Facts and Theory," American Economic Review, American Economic Association, vol. 93(4), pages 1075-1090, September.
    6. R. Glenn Hubbard & Kenneth L. Judd, 1986. "Liquidity Constraints, Fiscal Policy, and Consumption," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 17(1), pages 1-60.
    7. Bjuggren, Per-Olof & Sund, Lars-Goran, 2002. "A Transaction Cost Rationale for Transition of the Firm within the Family," Small Business Economics, Springer, vol. 19(2), pages 123-133, September.
    8. Marjorie Flavin, 1985. "Excess Sensitivity of Consumption to Current Income: Liquidity Constraints or Myopia?," Canadian Journal of Economics, Canadian Economics Association, vol. 18(1), pages 117-136, February.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Liquidity constraint; Small business;

    JEL classification:

    • M13 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - New Firms; Startups
    • M20 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - General

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