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A Course Material on

Engineering Economics and Cost analysis

By
Mr.V.Venugopal
ASSISTANT PROFESSOR
DEPARTMENT OF CIVIL ENGINEERING
SASURIE COLLEGE OF ENGINEERING
VIJAYAMANGALAM 638 056

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QUALITY CERTIFICATE

This is to certify that the e-course material


Subject Code : CE 2451
Subject

: Engineering Economics and Cost Analysis

Class

: IV Year CIVIL

Being prepared by me and it meets the knowledge requirement of the university curriculum.

Signature of the Author


Name: V.Venugopal
Designation: AP/Civil

This is to certify that the course material being prepared by Mr.V.Venugopal is of adequate
quality. She has referred more than five books among the minimum one is from abroad author.

Signature of HD
Name: N.SATHISH KUMAR
SEAL

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Table of Contents
CHAPTER

CONTENTS

BASIC ECONOMICS
1.1 Definition of economics

1.2 Nature and scope of economic science

1.3 Nature and scope of managerial economics

1.4 Basic terms and concepts

1.5 Goods - utility - value - wealth

1.6 Factors of production

10

1.7 Land - its peculiarities

11

1.8 Economies of large and small scale

12

1.9 Consumption - wants - its characteristics and classification

13

1.10 Law of diminishing marginal utility

13

1.11 Relation between economic decision and technical decision.


2

PAGE NO

14

DEMAND AND SCHEDULE


2.1 Demand

23

2.2 Demand schedule

23

2.3 Demand curve

25

2.4 Law of demand

26

2.5 Elasticity of demand

27

2.6 Types of elasticity

28

2.7 Factors determining elasticity

29

2.8 Measurement - its significance

32

2.9 Supply - supply schedule

35

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2.10 Supply curve - law of supply

40

2.11 Elasticity of supply

42

2.12 time element in the determination of value

43

2.13 Market price and normal price

44

2.14 Perfect competition

45

2.15 Monopoly - monopolistic competition.


3

50

ORGANISATION
3.1 Forms of business

54

3.2 Proprietorship - partnership

54

3.3 Joint stock company

54

3.4 Cooperative organisation - state enterprise

55

3.5 Mixed economy

55

3.6 Money and banking

56

3.7 Commercial banks

56

3.8 Central banking functions

57

3.8 Control of credit

57

3.9 Monetary policy

59

3.10 Credit instrument.

62

FINANCING
4.1 Types of Loans

66

4.2 External Commercial Borrowings (Ecb)

67

4.3 International Finance Corporations.

68

4.4 Objectives of Funds Flow:

69

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4.5 Financial Statement Analysis
4.6 Long-Term Borrowing
4.7 Short-Term Borrowing:
4.8 Balance sheet:
4.9 Profit or Loss Account:
5

70
71
72
72
73

COST AND BREAK EVEN ANALYSES


5.1 Methods of Costing and Types of Costing

74

5.2 Cost out put relation

78

5.3 Short run Cost Output Relations

78

5.4 Long run Cost Output Relations

78

5.5 Full cost pricing

79

5.6 Marginal-cost pricing

79

5.7 Definition Of 'Bid Priceing'

80

5.8 Rate of return pricing.

80

5.9 Basics for Assessing Rate of Return.

81

5.10 Internal Rate Of Return - Irr

82

5.11 Net Present Value

83

5.12 Payback Method

84

5.13 Profitability Index

84

5.14 Net Present Value

84

5.15 Costbenefit analysis

85

5.16 Feasibility report:

87

5.17 Technical feasibility.

88

5.18 Permanent settlement.

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88

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5.19 Economic feasibility study.
5.20 Economic Feasibility Analysis.
5.21 Break-even Analysis

89
90
90

5.22 Financial Feasibility Study

92

5.23 Break-Even Analysis Assumptions:

93

5.24 Managerial Uses of Break-Even Analysis:

93

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CE 2451
PC

ENGINEERING ECONOMICS AND COST ANALYSIS

LT
3 003

OBJECTIVE
The main objective of this course is to make the Civil Engineering student know about the
basic law of economics, how to organise a business, the financial aspects related to
business, different methods of appraisal of projects and pricing techniques. At the end of this
course the student shall have the knowledge of how to start a construction business, how to
get finances, how to account, how to price and bid and how to assess the health of a project.
UNIT I
BASIC ECONOMICS
7
Definition of economics - nature and scope of economic science - nature and scope of
managerial economics - basic terms and concepts - goods - utility - value - wealth - factors of
production - land - its peculiarities - labour - economies of large and small scale consumption - wants - its characteristics and classification - law of diminishing marginal
utility - relation between economic decision and technical decision.
UNIT II
DEMAND AND SCHEDULE
8
Demand - demand schedule - demand curve - law of demand - elasticity of demand - types of
elasticity - factors determining elasticity - measurement - its significance - supply - supply
schedule - supply curve - law of supply - elasticity of supply - time element in the
determination of value - market price and normal price - perfect competition monopoly - monopolistic competition.
UNIT III
ORGANISATION
8
Forms of business - proprietorship - partnership - joint stock company - cooperative
organisation
- state enterprise - mixed economy - money and banking - banking - kinds - commercial banks
- central banking functions - control of credit - monetary policy - credit instrument.
UNIT IV
FINANCING
9
Types of financing - Short term borrowing - Long term borrowing - Internal generation of
funds - External commercial borrowings - Assistance from government budgeting support and
international finance corporations - analysis of financial statement Balance Sheet - Profit and
Loss account - Funds flow statement.
UNIT V
COST AND BREAK EVEN ANALYSES
13
Types of costing traditional costing approach - activity base costing - Fixed Cost
variable cost marginal cost cost output relationship in the short run and in long run
pricing practice full cost pricing marginal cost pricing going rate pricing bid pricing
pricing for a rate of return appraising project profitability internal rate of return pay back
period net present value cost benefit analysis feasibility reports appraisal process
technical feasibility-economic feasibility financial feasibility. Break even analysis -basic
assumptions breakeven chart managerial uses of break even analysis.
TOTAL: 45 PERIODS
TEXT BOOKS
1.
Dewett K.K. & Varma J.D., Elementary Economic Theory, S Chand & Co., 2006
2.
Sharma JC Construction Management and Accounts Satya Prakashan, New Delhi.
REFERENCES
1.
Barthwal R.R., Industrial Economics - An Introductory Text Book, New Age
2.
Jhingan M.L., Micro Economic Theory, Konark
3.
Samuelson P.A., Economics - An Introductory Analysis, McGraw-Hill
4.
Adhikary M., Managerial Economics
5.
Khan MY and Jain PK Financial Management McGraw-Hill Publishing Co., Ltd
6.
Varshney RL and Maheshwary KL Managerial Economics S Chand and Co

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CE 2451

Engineering economics and cost analysis


Chapter-1
Basic Economics

1.1 DEFINITION - ECONOMICS


Economics is the science that deals with production, exchange and consumption of various
commodities in economic systems. It shows how scarce resources can be used to increase wealth
and human welfare. The central focus of economics is on scarcity of resources and choices
among their alternative uses.The resources or inputs available to produce goods are limited or
scarce. This scarcity induces people to make choices among alternatives, and the knowledge
of economics is used to compare the alternatives for choosing the best among them. For
example, a farmer can grow paddy, sugarcane, banana, cotton etc. In his garden land. But he has
to choose a crop depending upon the availability of irrigation water.Two major factors are
responsible for the emergence of economic problems.
They are:
i)
the existence of unlimited human wants and
ii)
the scarcity of available resources.
The numerous human wants are to be satisfied through the scarce resources available in
nature. Economics deals with how the numerous human wants are to be satisfied with limited
resources. Thus, the science of economics centres on want - effort - satisfaction.
Economics not only covers the decision making behaviour of individuals but also the macro
variables of economies like national income, public finance, international trade and so on.
A. DEFINITIONS OF ECONOMICS
Several economists have defined economics taking different aspects into account. The word
Economics was derived from two Greek words, oikos (a house) and nemein (to manage) which
would mean managing an householdusing the limited funds available, in the most satisfactory
manner possible.i) Wealth DefinitionAdam smith (1723 - 1790), in his book An Inquiry into
Nature and Causes of Wealth of Nations (1776) defined economics as the science of wealth. He
explained how a nations wealth is created. He considered that the individual in the society wants
to promote only his own gain and in this, he is led by an invisible hand to promote the interests
of the society though he has no real intention to promote the societys interests.
Criticism: Smith defined economics only in terms of wealth and not in terms of human welfare.
Ruskin and Carlyle condemned economics as a dismal science, as it taught selfishness which
was against ethics. However, now, wealth is considered only to be a mean to end, the end being
the human welfare. Hence, wealth definition was rejected and the emphasis was shifted from
wealth towelfare.
ii) Welfare Definition
Alfred Marshall (1842 - 1924) wrote a book Principles of Economics(1890) in which he
defined Political Economy or Economics is a study of mankind in the ordinary business of life;
it examines that part of individual and social action which is most closely connected with the
attainment and with the use of the material requisites of well being. The important features of
Marshalls definition are as follows:
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a) According to Marshall, economics is a study of mankind in the ordinary business of life, i.e.,
economic aspect of human life.
b) Economics studies both individual and social actions aimed at promoting economic welfare of
people.
c) Marshall makes a distinction between two types of things, viz. Material things and immaterial
things. Material things are those that can be seen, felt and touched, (E.g.) book, rice etc.
Immaterial things are those that cannot be seen, felt and touched. (E.g.) skill in the operation of a
thrasher, a tractor etc., cultivation of hybrid cotton variety and so on. In his definition, Marshall
considered only the material things that are capable of promoting welfare of people.
Criticism: a) Marshall considered only material things. But immaterial things, such as the
services of a doctor, a teacher and so on, also promote welfare of the people.
b) Marshall makes a distinction between
(i) those things that are capable of promoting welfare of people and
(ii) those things that are not capable of promoting welfare of people. But
anything, (E.g.) liquor, that is not capable of promoting welfare but commands a price,
comes under the purview of economics.
c) Marshalls definition is based on the concept of welfare. But there is no clear-cut definition of
welfare. The meaning of welfare varies from person to person, country to country and one period
to another. However, generally, welfare means happiness or comfortable living conditions of an
individual or group of people. The welfare of an individual or nation is dependent not only on
the stock of wealth possessed but also on political, social and cultural activities of the nation.
iii) Welfare Definition
Lionel Robbins published a book An Essay on the Nature and Significance of Economic
Science in 1932. According to him, economics is a science which studies human behaviour as
a relationship between ends and scarce means which have alternative uses. The major features
of Robbins definition are as follows:
a) Ends refer to human wants. Human beings have unlimited number of wants.
b) Resources or means, on the other hand, are limited or scarce in supply. There is scarcity of a
commodity, if its demand is greater than its supply. In other words, the scarcity of a commodity
is to be considered only in relation to its demand.
c) The scarce means are capable of having alternative uses. Hence, anyone will choose the
resource that will satisfy his particular want. Thus, economics, according to Robbins, is a science
of choice.
Criticism: a) Robbins does not make any distinction between goods conducive to human welfare
and goods that are not conducive to human welfare. In the production of rice and alcoholic drink,
scarce resources are used. But the production of rice promotes human welfare while production
of alcoholic drinks is not conducive to human welfare. However, Robbins concludes that
economics is neutral between ends.
b) In economics, we not only study the micro economic aspects like how resources are
allocated and how price is determined, but we also study the macro economic aspect like how
national income is generated. But, Robbins has reduced economics merely to theory of resource
allocation.
c) Robbins definition does not cover the theory of economic growth and development.
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iv) Growth Definition Prof. Paul Samuelson defined economics as the study of how men and
society choose, with or without the use of money, to employ scarce productive resources which
could have alternative uses, to produce various commodities over time, and distribute them for
consumption, now and in the future among various people and groups of society.
The major implications of this definition are as follows:
a) Samuelson has made his definition dynamic by including the element of time in it.
Therefore, it covers the theory of economic growth.
b) Samuelson stressed the problem of scarcity of means in relation to unlimited ends. Not
only the means are scarce, but they could also be put to
alternative uses.
c) The definition covers various aspects like production, distribution and consumption.
Of all the definitions discussed above, the growth definition stated by Samuelson appears to be
the most satisfactory. However, in modern economics, the subject matter of economics is divided
into main parts, viz., i) Micro Economics and ii) Macro Economics.
Economics is, therefore, rightly considered as the study of allocation of scarce resources (in
relation to unlimited ends) and of determinants of income, output, employment and economic
growth.
1.2 SCOPE OF ECONOMICS
Scope means province or field of study. In discussing the scope of
economics, we have to indicate whether it is a science or an art and a positive
science or a normative science. It also covers the subject matter of economics.i) Economics - A
Science and an Art
a) Economics is a science: Science is a systematized body of knowledge that
traces the relationship between cause and effect. Another attribute of science is
that its phenomena should be amenable to measurement. Applying these
characteristics, we find that economics is a branch of knowledge where the
various facts relevant to it have been systematically collected, classified and
analyzed. Economics investigates the possibility of deducing generalizations as
regards the economic motives of human beings. The motives of individuals and
business firms can be very easily measured in terms of money. Thus, economics
is a science.
Economics - A Social Science: In order to understand the social aspect of
economics, we should bear in mind that labourers are working on materials
drawn from all over the world and producing commodities to be sold all over the
world in order to exchange goods from all parts of the world to satisfy their
wants. There is, thus, a close inter-dependence of millions of people living in
distant lands unknown to one another. In this way, the process of satisfying
wants is not only an individual process, but also a social process. In economics,
one has, thus, to study social behaviour i.e., behaviour of men in-groups.
b) Economics is also an art. An art is a system of rules for the attainment of a
given end. A science teaches us to know; an art teaches us to do. Applying this
definition, we find that economics offers us practical guidance in the solution of
economic problems. Science and art are complementary to each other and
economics is both a science and an art.
ii) Positive and Normative Economics
Economics is both positive and normative science.
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a) Positive science: It only describes what it is and normative science prescribes


what it ought to be. Positive science does not indicate what is good or what is
bad to the society. It will simply provide results of economic analysis of a
problem.
b) Normative science: It makes distinction between good and bad. It prescribes
what should be done to promote human welfare. A positive statement is based on
facts. A normative statement involves ethical values. For example, 12 per cent
of the labour force in India was unemployed last year is a positive statement,
which could is verified by scientific measurement. Twelve per centunemployment is too high
is normative statement comparing the fact of 12 per
cent unemployment with a standard of what is unreasonable. It also suggests how
it can be rectified. Therefore, economics is a positive as well as normative
science.
iii) Methodology of Economics
Economics as a science adopts two methods for the discovery of its laws and
principles, viz., (a) deductive method and (b) inductive method.
a) Deductive method: Here, we descend from the general to particular, i.e., we
start from certain principles that are self-evident or based on strict observations.
Then, we carry them down as a process of pure reasoning to the consequences
that they implicitly contain. For instance, traders earn profit in their businesses
is a general statement which is accepted even without verifying it with the
traders. The deductive method is useful in analyzing complex economic
phenomenon where cause and effect are inextricably mixed up. However, the
deductive method is useful only if certain assumptions are valid. (Traders earn
profit, if the demand for the commodity is more).
b) Inductive method: This method mounts up from particular to general, i.e., we
begin with the observation of particular facts and then proceed with the help of
reasoning founded on experience so as to formulate laws and theorems on the
basis of observed facts. E.g. Data on consumption of poor, middle and rich
income groups of people are collected, classified, analyzed and important
conclusions are drawn out from the results.
In deductive method, we start from certain principles that are either
indisputable or based on strict observations and draw inferences about individual
cases. In inductive method, a particular case is examined to establish a general
or universal fact. Both deductive and inductive methods are useful in economic
analysis.
iv) Subject Matter of Economics
Economics can be studied through a) traditional approach and (b) modern
approach.
a)Traditional Approach:
Economics is studied under five major divisions
namely consumption, production, exchange, distribution and public finance.1.Consumption: The
satisfaction of human wants through the use of goods and
services is called consumption.
2.Production: Goods that satisfy human wants are viewed as bundles of
utility. Hence production would mean creation of utility or producing (or

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creating) things for satisfying human wants. For production, the resources like
land, labour, capital and organization are needed.
3. Exchange: Goods are produced not only for self-consumption, but also for
sales. They are sold to buyers in markets. The process of buying and selling
constitutes exchange.
4. Distribution: The production of any agricultural commodity requires four
factors, viz., land, labour, capital and organization. These four factors of
production are to be rewarded for their services rendered in the process of
production. The land owner gets rent, the labourer earns wage, the capitalist is
given with interest and the entrepreneur is rewarded with profit. The process of
determining rent, wage, interest and profit is called distribution.
5. Public finance: It studies how the government gets money and how it spends
it. Thus, in public finance, we study about public revenue and public
expenditure.
b) Modern Approach
The study of economics is divided into: i) Microeconomics and ii)
Macroeconomics.
1. Microeconomics analyses the economic behaviour of any particular decision
making unit such as a household or a firm. Microeconomics studies the flow of
economic resources or factors of production from the households or resource
owners to business firms and flow of goods and services from business firms to
households. It studies the behaviour of individual decision making unit with
regard to fixation of price and output and its reactions to the changes in demand
and supply conditions. Hence, microeconomics is also called price theory.
2. Macroeconomics studies the behaviour of the economic system as a whole or
all the decision-making units put together. Macroeconomics deals with the
behaviour of aggregates like total employment, gross national product (GNP),
national income, general price level, etc. So, macroeconomics is also known as
income theory.
Microeconomics cannot give an idea of the functioning of the economy as a
whole. Similarly, macroeconomics ignores the individuals preference andwelfare. What is true
of a part or individual may not be true of the whole and
what is true of the whole may not apply to the parts or individual decisionmaking
units. By studying about a single small-farmer, generalization cannot be
made about all small farmers, say in Tamil Nadu state. Similarly, the general
nature of all small farmers in the state need not be true in case of a particular
small farmer. Hence, the study of both micro and macroeconomics is essential to
understand the whole system of economic activities.
1.3 Factors of production
In economics, factors of production, resources, or inputs are what is utilized in the production
process in order to produce outputthat is, finished goods. The amounts of the various inputs
used determine the quantity of output according to a relationship called the production function.
There are three basic resources or factors of production: land, labour, and capital .Some modern
economists also consider entrepreneurship or time a factor of production. These factors are also

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frequently labeled "producer goods" in order to distinguish them from the goods or services
purchased by consumers, which are frequently labeled "consumer goods." All three of these are
required in combination at a time to produce a commodity.
Factors of production may also refer specifically to the primary factors, which are land, labor
(the ability to work), and capital goods applied to production. Materials and energy are
considered as secondary factors in classical economics because they are obtained from land,
labour and capital. The primary factors facilitate production but neither become part of the
product (as with raw materials) nor become significantly transformed by the production process
(as with fuel used to power machinery). Land includes not only the site of production but natural
resources above or below the soil. Recent usage has distinguished human capital (the stock of
knowledge in the labor force) from labor.Entrepreneurship is also sometimes considered a factor
of production. Sometimes the overall state of technology is described as a factor of production.
The number and definition of factors varies, depending on theoretical purpose, empirical
emphasis, or school of economics.
Managerial Economics : Definition, Nature, Scope
Managerial economics is a discipline which deals with the application of economic theory to
business management. It deals with the use of economic concepts and principles of business
decision making. Formerly it was known as Business Economics but the term has now been
discarded in favour of Managerial Economics.
Managerial Economics may be defined as the study of economic theories, logic and methodology
which are generally applied to seek solution to the practical problems of business. Managerial
Economics is thus constituted of that part of economic knowledge or economic theories which is
used as a tool of analysing business problems for rational business decisions. Managerial
Economics is often called as Business Economics or Economic for Firms.

Definition of Managerial Economics:


Managerial Economics is economics applied in decision making. It is a special branch of
economics bridging the gap between abstract theory and managerial practice. Haynes, Mote
and Paul.
Business Economics consists of the use of economic modes of thought to analyse business
situations. - McNair and Meriam
Business Economics (Managerial Economics) is the integration of economic theory with
business practice for the purpose of facilitating decision making and forward planning by
management. - Spencerand Seegelman.

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Managerial economics is concerned with application of economic concepts and economic


analysis to the problems of formulating rational managerial decision. Mansfield
1.4 Nature of Managerial Economics:
The primary function of management executive in a business organisation is decision making
and forward planning.
Decision making and forward planning go hand in hand with each other. Decision making means
the process of selecting one action from two or more alternative courses of action. Forward
planning means establishing plans for the future to carry out the decision so taken.
The problem of choice arises because resources at the disposal of a business unit (land, labour,
capital, and managerial capacity) are limited and the firm has to make the most profitable use of
these resources.
The decision making function is that of the business executive, he takes the decision which will
ensure the most efficient means of attaining a desired objective, say profit maximisation. After
taking the decision about the particular output, pricing, capital, raw-materials and power etc., are
prepared. Forward planning and decision-making thus go on at the same time.
A business managers task is made difficult by the uncertainty which surrounds business
decision-making. Nobody can predict the future course of business conditions. He prepares the
best possible plans for the future depending on past experience and future outlook and yet he has
to go on revising his plans in the light of new experience to minimise the failure. Managers are
thus engaged in a continuous process of decision-making through an uncertain future and the
overall problem confronting them is one of adjusting to uncertainty.
In fulfilling the function of decision-making in an uncertainty framework, economic theory can
be, pressed into service with considerable advantage as it deals with a number of concepts and
principles which can be used to solve or at least throw some light upon the problems of business
management. E.g are profit, demand, cost, pricing, production, competition, business cycles,
national income etc. The way economic analysis can be used towards solving business problems,
constitutes the subject-matter of Managerial Economics.
Thus in brief we can say that Managerial Economics is both a science and an art.
1.5 Scope of Managerial Economics:
The scope of managerial economics is not yet clearly laid out because it is a developing
science. Even then the following fields may be said to generally fall under Managerial
Economics:
1. Demand Analysis and Forecasting

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2. Cost and Production Analysis


3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
These divisions of business economics constitute its subject matter.
Recently, managerial economists have started making increased use of Operation Research
methods like Linear programming, inventory models, Games theory, queuing up theory etc.,
have also come to be regarded as part of Managerial Economics.
1.Demand Analysis and Forecasting: A business firm is an economic organisation which is
engaged in transforming productive resources into goods that are to be sold in the market. A
major part of managerial decision making depends on accurate estimates of demand. A forecast
of future sales serves as a guide to management for preparing production schedules and
employing resources. It will help management to maintain or strengthen its market position and
profit base. Demand analysis also identifies a number of other factors influencing the demand for
a product. Demand analysis and forecasting occupies a strategic place in Managerial Economics.
2.Cost and production analysis: A firms profitability depends much on its cost of production.
A wise manager would prepare cost estimates of a range of output, identify the factors causing
are cause variations in cost estimates and choose the cost-minimising output level, taking also
into consideration the degree of uncertainty in production and cost calculations. Production
processes are under the charge of engineers but the business manager is supposed to carry out the
production function analysis in order to avoid wastages of materials and time. Sound pricing
practices depend much on cost control. The main topics discussed under cost and production
analysis are: Cost concepts, cost-output relationships, Economics and Diseconomies of scale and
cost control.
3.Pricing decisions, policies and practices: Pricing is a very important area of Managerial
Economics. In fact, price is the genesis of the revenue of a firm ad as such the success of a
business firm largely depends on the correctness of the price decisions taken by it. The important
aspects dealt with this area are: Price determination in various market forms, pricing methods,
differential pricing, product-line pricing and price forecasting.
4.Profit management: Business firms are generally organized for earning profit and in the long
period, it is profit which provides the chief measure of success of a firm. Economics tells us that
profits are the reward for uncertainty bearing and risk taking. A successful business manager is
one who can form more or less correct estimates of costs and revenues likely to accrue to the
firm at different levels of output. The more successful a manager is in reducing uncertainty, the

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higher are the profits earned by him. In fact, profit-planning and profit measurement constitute
the most challenging area of Managerial Economics.
5.Capital management: The problems relating to firms capital investments are perhaps the
most complex and troublesome. Capital management implies planning and control of capital
expenditure because it involves a large sum and moreover the problems in disposing the capital
assets off are so complex that they require considerable time and labour. The main topics dealt
with under capital management are cost of capital, rate of return and selection of projects.
Conclusion: The various aspects outlined above represent the major uncertainties which a
business firm has to reckon with, viz., demand uncertainty, cost uncertainty, price uncertainty,
profit uncertainty, and capital uncertainty. We can, therefore, conclude that the subject-matter of
Managerial Economics consists of applying economic principles and concepts towards adjusting
with various uncertainties faced by a business firm.
1.6 Basic terms and Concepts
Value
Value refers to a worth that can be expressed in dollars and cents. The paradox of value is the
situation where some necessities have little monetary value, whereas some non-necessities have
a much higher value. Scarcity is required for value, but scarcity alone isn't enough to create
value.
Utility
Utility is the capacity to e useful and provide satisfaction; it is required for something to have
value. The utility of a good or service may vary form one person to the next. A good or service
does not have to have utility for everyone, only utility for some.
Wealth
Wealth is the accumulation of those products that are tangible, scare, useful, and transferable
from one person to another. A nation's wealth is comprised of all items. Goods are counted as
wealth but services are not because they are intangible.
The moat commonly accepted definition of wealth is that it consists of all useful and agreeable
things which possess exchange value, and this again is generally regarded as coextensive with all
desirable things except those which do not involve labour or sacrifice for their acquisition in the
quantity desired. On analysis it will be evident that this definition implies, directly, preliminary
conceptions of utility and value, and, indirectly, of sacrifice and labour, and these terms, familiar
though they may appear, are by no means simple and obvious in their meaning. Utility, for the
purposes of economic reasoning, is usually held to mean the capacity to satisfy a desire or serve
a purpose (.J. S. Mill), and in this sense is clearly a much wider term than wealth. Sunshine and

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fresh air, good temper and pleasant manners, and all the infinite to the general definition, is
exchange value, but a little refiexion will show that in some cases it is necessary rather to
contrast value with wealth. " Value," says Ricardo, expanding a thought of Adam Smith,
"essentially differs from riches, for value depends not on abundance but on the difficulty or
facility of production." According to the well-known tables ascribed to Gregory King, a
deficiency of a small amount in the annual supply of corn will raise its value far more than in
proportion, but it would be paradoxical to argue that this rise in value indicated an increase in an
important item of national wealth. Again, as the mines of a country are exhausted and its natural
resources otherwise impaired, a rise in the value of the remainder may take place, and as the free
gifts of nature are appropriated they become valuable for exchange, but the country can hardly be
said to be so much the wealthier in consequence. And these difficulties are rather increased then
diminished if we substitute for value the more familiar concrete term " money-price," - for the
contrast between the quantity of wealth and its nominal value becomes more sharply marked.
Suppose, for example, that in the total money value of the national inventory a decline were
observed to be in progress, whilst at the same time, as is quite possible, an increase was noticed
in the quantity of all the important items and an improvement in their quality, it would be in
accordance with commonsense to say that the wealth of the country was increasing and not
decreasing.
So great are these difficulties that some economists (e.g., Ricardo) have proposed to take utility
as the direct measure of wealth, and, as Mr Sidgwick has pointed out, if double the quantity
meant double the utility this would be an easy and natural procedure. But even to the same
individual the increase in utility is by no means simply proportioned to the increase in quantity,
and the utility of different commodities to different individuals, and a fortiori of different
amounts, is proverbial. The very same things may to the same individual be productive of more
utility simply owing to a change in his tastes or habits, and a different distribution of the very
same things, which make up the wealth of a nation, might indefinitely change the quantity of
utility, but it would be paradoxical to say that the wealth had increased because it was put to
better uses.
1.7 basic characteristics of land in economics
In economics, land is one of three types of resources. There are land, labor, and capital.
Resources are those things that are used to make other goods and services.
Land
Land is defined as anything that is not made by humans but is exploited to produce a good or
service. Some examples of land would be
The surface area on which a building is built
Crude oil that can be taken from the ground

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Any mineral that occurs naturally and can be mined for use.
Land does not include something like the wheat that goes into bread. That is a natural product,
but it was produced by people's efforts.
Labour economics
Labour economics seeks to understand the functioning and dynamics of the markets for wage
labour. Labour markets function through the interaction of workers and employers. Labour
economics looks at the suppliers of labour services (workers), the demands of labour services
(employers), and attempts to understand the resulting pattern of wages, employment, and
income.
In economics, labour is a measure of the work done by human beings. It is conventionally
contrasted with such other factors of production as land and capital. There are theories which
have developed a concept called human capital (referring to the skills that workers possess, not
necessarily their actual work), although there are also counter posing macro-economic system
theories that think human capital is a contradiction in terms.
Large Scale and Small Scale Production Compared
Modern times have witnessed a wonderfully rapid growth in the average size of the individual
business. Indeed, the change in the size of the business unit during the past half-century is almost
as striking as the change from house industry to factory industry in the second half of the
eighteenth century. The movement has gone so far and is still proceeding so rapidly as to excite
very general fear as to its social consequences. Certain dangers resulting from the consolidation
of large competing corporations will be discussed elsewhere.; but it is pertinent at this point, in
connection with the subject of the organization of production, to advert briefly to the advantages
claimed for large scale production and to the compensating advantages enjoyed by small scale
producers.
Advantages of Large Scale Production. The advantages claimed for production on a large scale
resolve themselves into two general classes: (1) economies in making the goods, and (2)
economies in marketing the goods. As to the first, it is claimed that in production on a large scale
there is a saving in (a) capital cost, per unit of product, both in fixed and in circulating capital; in
(5) labor cost, owing to the possibility of more efficient organization ; in (c) the possibility of
making improvements, both through the employment of special investigators and inventors, and
through the comparison of methods in different departments of the same factory or in the same
departments of different factories under the same ownership; in (d) the cost of superintendence;
in (e) the utilization of waste, as is instanced by the Standard Oil Company and the large beef
and pork packing companies; in (f) providing their own aids to making and marketingmaking
their own cans, boxes, etc., and owning railways and steamship lines, etc. In businesses enjoying

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this last advantage, we have examples of integration of industry as well as of concentration of


industry.
Among the second class of advantages claimed for large scale production, economies in
marketing the goods, are the following: (a) economy in securing trade, through advertising and
commercial travellers; (6) economy in "carrying " stocks of goods, a relatively smaller stock
being sufficient to meet the fluctuations in demand; (c) economy in getting goods to consumers,
through the power to secure better freight rates for large shipments, and through the power
possessed by some concerns to avoid "cross freights"; (d) economy in securing a foreign market,
through the greater power of the large concern to withstand the cutthroat competition common in
"hard times."
The Strong Points of Small Scale Productio. Against these alleged advantages of large scale
production may be set the following considerations which seem to promise a continuation of a
considerable measure of small scale production, at least in certain lines of industry: (a) First of
all, it is claimed by experts that in many lines of business a plant of moderate size is the plant of
really maximum efficiency in regard to capital and labor costs. (6) In many cases the advantage
of the large scale business in the matter of concentration of power is neutralized by the fact that
modern invention, especially in connection with electricity, is revolutionizing the methods of
distribution of power, putting the small manufacturer on a level with his greater rival, (c) It is,
furthermore, very doubtful whether large scale producers can secure that minute and economical
supervision which characterizes small scale industry ; whether, in other words, hired managers
can compete in this regard with individual entrepreneurs who will reap all gains as they bear all
risks. (d) The small producer has a distinct advantage in his greater power to know the personal
wants of his market. In many industries the personal element plays so large a part that the small
producer will for a long time be able to hold his own, even if he cannot oust the large producer
from the field. Finally, by cooperation of neighboring small producers, it is possible to secure
much the same opportunities as to (e) invention and improvement of processes and (f) utilization
of " waste " that we have spoken of as regularly inhering in large scale industry.
It must be borne in mind that our comparison has been between small scale and large scale
production, not between small scale production and monopolized production. Monopolized
production is usually, though by no means always, production on a large scale. But production
on a large scale is not at all the same thing as monopolized production. Had we been speaking of
the production of monopolized goods, it would have been possible to add many to the list of
alleged advantages or economies in production, and some of the advantages of which we have
spoken would in the case of a monopoly have been much more marked and undisputed. Thus in
the matter of "cross freights" and again in the case of advertising, many would admit advantages
in the case of a monopoly who would deny that they accrue simply to large scale production.
This whole matter of the relative advantages of small scale and large scale production has been
of late days the subject of rather acrimonious debate, and can by no means be regarded as settled.

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We have chosen, therefore, to write rather suggestively than positively. For this very reason,
however, the topic should furnish the better material for discussions and debate by the class.
Production (economics)
Production is a process of combining various material inputs and immaterial inputs (plans, knowhow) in order to make something for consumption (the output). It is the act of creating output, a
good or service which has value and contributes to the utility of individuals.
Economic well-being is created in a production process, meaning all economic activities that aim
directly or indirectly to satisfy human needs. The degree to which the needs are satisfied is often
accepted as a measure of economic well-being. In production there are two features which
explain increasing economic well-being. They are improving quality-price-ratio of commodities
and increasing incomes from growing and more efficient market production.
The most important forms of production are
market production
public production
household production
In order to understand the origin of the economic well-being we must understand these three
production processes. All of them produce commodities which have value and contribute to wellbeing of individuals.
The satisfaction of needs originates from the use of the commodities which are produced. The
need satisfaction increases when the quality-price-ratio of the commodities improves and more
satisfaction is achieved at less cost. Improving the quality-price-ratio of commodities is to a
producer an essential way to enhance the production performance but this kind of gains
distributed to customers cannot be measured with production data.
Economic well-being also increases due to the growth of incomes that are gained from the
growing and more efficient market production. Market production is the only one production
form which creates and distributes incomes to stakeholders. Public production and household
production are financed by the incomes generated in market production. Thus market production
has a double role in creating well-being, i.e. the role of producing developing commodities and
the role to creating income. Because of this double role market production is the primus motor
of economic well-being and therefore here under review.
1.8 Law Of Diminishing Marginal Utility
DEFINITION OF 'LAW OF DIMINISHING MARGINAL UTILITY'

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A law of economics stating that as a person increases consumption of a product - while keeping
consumption of other products constant - there is a decline in the marginal utility that person
derives from consuming each additional unit of that product.
INVESTOPEDIA EXPLAINS 'LAW OF DIMINISHING MARGINAL UTILITY'
This is the premise on which buffet-style restaurants operate. They entice you with "all you can
eat," all the while knowing each additional plate of food provides less utility than the one before.
And despite their enticement, most people will eat only until the utility they derive from
additional food is slightly lower than the original.
For example, say you go to a buffet and the first plate of food you eat is very good. On a scale of
ten you would give it a ten. Now your hunger has been somewhat tamed, but you get another full
plate of food. Since you're not as hungry, your enjoyment rates at a seven at best. Most people
would stop before their utility drops even more, but say you go back to eat a third full plate of
food and your utility drops even more to a three. If you kept eating, you would eventually reach a
point at which your eating makes you sick, providing dissatisfaction, or 'dis-utility'.
1.9 Economic Concepts And Techniques Used In Managerial Economics
Managerial economics uses a wide variety of economic concepts, tools, and techniques in
the decision-making process. These concepts can be placed in three broad categories: (1) the
theory of the firm, which describes how businesses make a variety of decisions; (2) the theory of
consumer behavior, which describes decision making by consumers; and (3) the theory of market
structure and pricing, which describes the structure and characteristics of different market forms
under which business firms operate. 1.THE THEORY OF THE FIRM Discussing the theory of
the firm is an useful way to begin the study of managerial economics, since the theory provides a
broad framework within which issues relevant to managerial decisions are analyzed. A firm can
be considered a combination of people, physical and financial resources, and a variety of
information. Firms exist because they perform useful functions in society by producing and
distributing goods and services. In the process of accomplishing this, they use society's scarce
resources, provide employment, and pay taxes. If economic activities of society can be simply
put into two categoriesroduction and consumptionirms are considered the most basic economic
entities on the production side, while consumers form the basic economic entities on the
consumption side. The behavior of firms is usually analyzed in the context of an economic
model, an idealized version of a real-world firm. The basic economic model of a business
enterprise is called the theory of the firm. 2.PROFIT MAXIMIZATION AND THE FIRM.
Under the simplest version of the theory of the firm it is assumed that profit maximization is its
primary goal. In this version of the theory, the firm's owner is the manager of the firm, and thus,
the firm's owner-manager is assumed to maximize the firm's short-term profits (current profits
and profits in the near future). Today, even when the profit maximizing assumption is
maintained, the notion of profits has been broadened to take into account uncertainty faced by

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the firm (in realizing profits) and the time value of money (where the value of a dollar further
and further in the future is increasingly smaller than a dollar today). It should be noted that
expected profit in any one period can itself be considered as the difference between the total
revenue and the total cost in that period. Thus, one can, alternatively, find the present value of
expected future profits by subtracting the present value of expected future costs from the present
value of expected future revenues. THE CONSTRAINED PROFIT MAXIMIZATION. Profit
maximization is subject to various constraints faced by the firm. These constraints relate to
resource scarcity, technology, contractual obligations, and laws and government regulations. In
their attempt to maximize the present value of profits, business managers must consider not only
the short-term and long-term implications of decisions made within the firm, but also various
external constraints that may limit the firm's ability to achieve its organizational goals. The first
external constraint of resource scarcity refers to the limited availability of essential inputs
(including skilled labor), key raw materials, energy, specialized machinery and equipment,
warehouse space, and other resources. Moreover, managers often face constraints on plant
capacity that are exacerbated by limited investment funds available for expansion or
modernization. Contractual obligations also constrain managerial decisions. Labor contracts, for
example, may constrain managers' flexibility in worker scheduling and work assignment. Labor
contracts may also determine the number of workers employed at any time, thereby establishing
a floor for minimum labor costs. Finally, laws and regulations have to be observed. The legal
restrictions can constrain decisions regarding both production and marketing activities. Examples
of laws and regulations that limit managerial flexibility are: the minimum wage, health and
safety standards, fuel efficiency requirements, antipollution regulations, and fair pricing and
marketing practices. PROFIT MAXIMIZATION VERSUS OTHER MOTIVATIONS BEHIND
MANAGERIAL DECISIONS. The present value maximization criterion as a basis for the study
of the firm's behavior has come under severe criticism from some economists. The critics argue
that business managers are interested, at least partly, in factors other than the firm's profits. In
particular, they may be interested in power, prestige, leisure, employee welfare, community wellbeing, and the welfare of the larger society. The act of maximization itself has been criticized;
there is a feeling that managers often aim merely to "satisfice" (seek solutions that are considered
satisfactory), rather than really try to optimize or maximize (seek to find the best possible
solution, given the constraints). Under the structure of a modern firm, it is hard to determine the
true motives of managers. A modem firm is frequently organized as a corporation in which
shareholders are the legal owners of the firm, and the manager acts on their behalf. Under such a
structure, it is difficult to determine whether a manager merely tries to satisfy the stockholders of
the firm while pursuing other goals, rather than truly attempting to maximize the value (the
discounted present value) of the firm. BUSINESS VERSUS ECONOMIC PROFITS. As
discussed above, profits are central to the goals of a firm and managerial decision making. Thus,
to understand the theory of firm behavior properly, one must have a clear understanding of
profits. While the term profit is very widely used, an economist's definition of profit differs from
the one used by accountants (which is also usually used by the general public and the business

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community). Profit in accounting is defined as the excess of sales revenue over the explicit
accounting costs of doing business. This surplus is available to the firm for various purposes. An
economist also defines profit as the difference between sales revenue and costs of doing
business, but includes more items in figuring costs, rather than considering only explicit
accounting costs. For example, inputs supplied by owners (including labor, capital, and space)
are accounted for in determining costs in the definition used by an economist. These costs are
sometimes referred to as implicit cost their value is imputed based on a notion of opportunity
costs widely used by economists. In other words, costs of inputs supplied by an owner are based
on the values these inputs would have received in the next best alternative activity. For
illustration, assume that the owner of the firm works for ten hours a day at his business. If the
owner does not receive any salary, an accountant would not consider the owner's effort as a cost
item. An economist would, however, value the owner's service to his firm at what his labor
would have earned had he worked elsewhere. Thus, to compute the true profit, an economist will
subtract the implicit costs from business profit; the resulting profit is often referred to as
economic profit. It is this concept of profit that is used by economists to explain the behavior of a
firm. The concept of economic profit essentially recognizes that owner-supplied inputs must also
be paid for. Thus, the owner of a firm will not be in business in the long run until he recovers the
implicit costs (also known as normal profit), in addition to recovering the explicit costs, of doing
business. As pointed out earlier, a given firm attempts to maximize profits. Other firms do the
same. Ultimately, profits decline for all firms. If all firms are operating under a competitive
market structure, in equilibrium, economic profits (the excess of accounting profits over implicit
costs) would be equal to zero; accounting profits (equal to explicit costs), however would be
positive. When a firm makes profits above the normal profits level, it is said to be reaping abovenormal profits.

HOW A FIRM ARRIVES AT A PROFIT-MAXIMIZING POINT. Let us assume


throughout the discussion that a firm uses an economist's definition of profits. Assume that profit
is the excess of sales revenue over cost (now assumed to be composed of both explicit and
implicit costs). It can also be assumed, as discussed above, that the profit maximization is the
firm's primary goal. Given this objective, important questions remain: How does the firm decide
on the output level that maximizes its profits? Should the firm continue to produce at all if it is
not profitable? A manufacturing firm, motivated by profit maximization, calculates the total cost
of producing any given output level. The total cost is made up of total fixed cost (due to the
expenditure on fixed inputs) and total variable cost (due to the expenditure on variable inputs).
Of course, the total fixed cost does not vary over the short runnly the total variable cost does. It
is important for the firm to also calculate the cost per unit of output, called the average cost. In
addition to the average cost, the firm calculates the marginal cost. The marginal cost at any level
of output is the increase in the total cost due to an increase in production by one unitssentially,
the marginal cost is the additional cost of producing the last unit of output. The average cost is

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made up of two components: the average fixed cost (the total fixed cost divided by the number of
units of the output produced) and the average variable cost (the total variable cost divided by the
number of units of the output produced). As the fixed costs remain fixed over the short run, the
average fixed cost declines as the level of production increases. The average variable cost, on the
other hand, first decreases and then increases; economists refer to this as the U-shaped nature of
the average variable cost. The U-shape of the average variable cost curve is explained as follows.
Given the fixed inputs, output of the relevant product increases more than proportionately as the
levels of variable inputs used increase. This is caused by increased efficiency due to
specialization and other reasons. As more and more variable inputs are used in conjunction with
the given fixed inputs, however, efficiency gains reach a maximumhe decline in the average
variable cost eventually comes to a halt. After this point, the average variable cost starts
increasing as the level of production continues to increase, given the fixed inputs. First
decreasing and then increasing average variable cost lead to the U-shape for the average variable
cost. The combination of the declining average fixed cost (true for the entire range of production)
and the U-shaped average variable cost results into an U-shaped behavior of the average total
cost, often simply called the average cost. The marginal cost also displays a U-shaped patternt
first decreases and then increases. The logic for the shape of the marginal cost curve is similar to
that for the average variable costoth relate to variable costs. But while the marginal cost refers to
the increase in total variable cost due to an increase in the production by one unit, the average
variable cost refers to the average variable cost per unit of output produced. It is important to
notice, without going into finer details, that the marginal cost curve intersects the average and the
average variable cost curves at their minimum cost points. In a graphic rendering of this concept
there would be a horizontal line, in addition to the three cost curves. It is assumed that the firm
can sell as many units as it wants at the given market price indicated by this horizontal line.
Essentially, the horizontal line is the demand curve a perfectly competitive firm faces in the
markett can sell as many units of output as it deems profitable at price "p" per unit (p, for
example, can be $10 per unit of the product under consideration). In other words, p is the firm's
average revenue per unit of output. Since the firm receives p dollars for every successive unit it
sells, p is also the marginal revenue for the firm. A firm maximizes profits, in general, when its
marginal revenue equals marginal cost. If the firm produces beyond this point of equality
between the marginal revenue and marginal cost, the marginal cost will be higher than the
marginal revenue. In other words, the addition to total production beyond the point where
marginal revenue equals marginal cost, leads to lower, not higher, profits. While every firm's
primary motive is to maximize profits, its output decision (consistent with the profit maximizing
objective), depends on the structure of the market it is operating under. Before we discuss
important market structures, we briefly examine another key economic concept, the theory of
consumer behavior. 3.THE THEORY OF CONSUMER BEHAVIOR Consumers play an
important role in the economy since they spend most of their incomes on goods and services
produced by firms. In other words, they consume what firms produce. Thus, studying the theory
of consumer behavior is quite important. What is the ultimate objective of a consumer?

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Economists have an optimization model for consumers, similar to that applied to firms or
producers. While firms are assumed to be maximizing profits, consumers are assumed to be
maximizing their utility or satisfaction. Of course, more goods and services will, in general,
provide greater utility to a consumer. Nevertheless, consumers, like firms, are subject to
constraintsheir consumption and choices are limited by a number of factors, including the
amount of disposable income (the residual income after income taxes are paid for). The decision
to consume by consumers is described by economists within a theoretical framework usually
termed the theory of demand. The demand for a particular product by an individual consumer is
based on four important factors. First, the price of the product determines how much of the
product the consumer buys, given that all other factors remain unchanged. In general, the lower
the product's price the more a consumer buys. Second, the consumer's income also determines
how much of the product the consumer is able to buy, given that all other factors remain
constant. In general, a consumer buys more of a commodity the greater is his or her income.
Third, prices of related products are also important in determining the consumer's demand for the
product. Finally, consumer tastes and preferences also affect consumer demand. The total of all
consumer demands yields the market demand for a particular commodity; the market demand
curve shows quantities of the commodity demanded at different prices, given all other factors. As
price increases, quantity demanded falls. Individual consumer demands thus provide the basis for
the market demand for a product. The market demand plays a crucial role in shaping decisions
made by firms. Most important of all, it helps in determining the market price of the product
under consideration which, in turn, forms the basis for profits for the firm producing that
product. The amount supplied by an individual firm depends on profit and cost considerations.
As mentioned earlier, in general, a producer produces the profit maximizing output. Again, the
total of individual supplies yields the market supply for a particular commodity; the market
supply curve shows quantities of the commodity supplied at different prices, given all other
factors. As price increases, the quantity supplied increases. The interaction between market
demand and supply determines the equilibrium or market price (where demand equals supply).
Shifts in demand curve and/or supply curve lead to changes in the equilibrium price. The market
price and the price mechanism play a crucial role in the capitalist systemhey send signals both to
producers and consumers. 4.THEORIES ASSOCIATED WITH DIFFERENT MARKET
STRUCTURES As mentioned earlier, firms' profit maximizing output decisions take into
account the market structure under which they are operating. There are four kinds of market
organizations: perfect competition, monopolistic competition, oligopoly, and monopoly.
PERFECT COMPETITION. Perfect competition is the idealized version of the market structure
that provides a foundation for understanding how markets work in a capitalist economy. Three
conditions need to be satisfied before a market structure is considered perfectly competitive:
homogeneity of the product sold in the industry, existence of many buyers and sellers, and
perfect mobility of resources or factors of production. The first condition, the homogeneity of
product, requires that the product sold by any one seller is identical with the product sold by any
other supplierf products of different sellers are identical, buyers do not care from whom they buy

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so long as the price charged is also the same. The second condition, existence of many buyers
and sellers, also leads to an important outcome: each individual buyer or seller is so small
relative to the entire market that he or she does not have any power to influence the price of the
product under consideration. Each individual simply decides how much to buy or sell at the
given market price. The implication of the third condition is that resources move to the most
profitable industry. There is no industry in the world that can be considered perfectly competitive
in the strictest sense of the term. However, there are token examples of industries that come quite
close to having perfectly competitive markets. Some markets for agricultural commodities, while
not meeting all three conditions, come reasonably close to being characterized as perfectly
competitive markets. The market for wheat, for example, can be considered a reasonable
approximation. As pointed out earlier, in order to maximize profits, a supplier has to look at the
cost and revenue sides; a perfectly competitive firm will stop production where marginal revenue
equals marginal cost. In the case of a perfectly competitive firm, the market price for the product
is also the marginal revenue, as the firm can sell additional units at the going market price. This
is not so for a monopolist. A monopolist must reduce price to increase sales. As a result, a
monopolist's price is always above the marginal revenue. Thus, even though a monopolist firm
also produces the profit maximizing output, where marginal revenue equals marginal cost, it
does not produce to the point where price equals marginal cost (as does a perfectly competitive
firm). Regarding entry and exit decisions; one can now state that additional firms would enter an
industryhenever existing firms are making above normal profits (that is, when the horizontal line
is above the average cost at the profit maximizing output). A firm would exit the market if at the
profit maximizing point the horizontal line is below the average cost curve; it will actually shut
down the production right away if the price is less than the average variable cost.
MONOPOLISTIC COMPETITION. Many industries that we often deal with have market
structures that are characterized by monopolistic competition or oligopoly. Apparel retail stores
(with many stores and differentiated products) provide an example of monopolistic competition.
As in the case of perfect competition, monopolistic competition is characterized by the existence
of many sellers. Usually if an industry has 50 or more firms (producing products that are close
substitutes of each other), it is said to have a large number of firms. The sellers under
monopolistic competition differentiate their product; unlike under perfect competition, the
products are not considered identical. This characteristic is often called product differentiation.
In addition, relative ease of entry into the industry is considered another important requirement
of a monopolistically competitive market organization. As in the case of perfect competition, a
firm under monopolistic competition determines the quantity of the product to produce based on
the profit maximization principlet stops production where marginal revenue equals marginal cost
of production. There is, however, one very important difference between perfect competition and
monopolistic competition. A firm under monopolistic competition has a bit of control over the
price it charges, since the firm differentiates its products from those of others. The price
associated with the product (at the equilibrium or profit maximizing output) is higher than
marginal cost (which equals marginal revenue). Thus, production under monopolistic

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competition does not take place to the point where price equals marginal cost of production. The
net result of the profit maximizing decisions of monopolistically competitive firms is that price
charged under monopolistic competition is higher than under perfect competition, and the
quantity produced is simultaneously lower. OLIGOPOLY. Oligopoly is a fairly common market
organization. In the United States, both the steel and automobile industries (with three or so large
firms) provide good examples of oligopolistic market structures. Probably the most important
characteristic of an oligopolistic market structure is the interdependence of firms in the industry.
The interdependence, actual or perceived, arises from the small number of firms in the industry.
Unlike under monopolistic competition, however, if an oligopolistic firm changes its price or
output, it has perceptible effects on the sales and profits of its competitors in the industry. Thus,
an oligopolist always considers the reactions of its rivals in formulating its pricing or output
decisions. There are huge, though not insurmountable, barriers to entry to an oligopolistic
market. These barriers can exist because of large financial requirements, availability of raw
materials, access to the relevant technology, or simply existence of patent rights with the firms
currently in the industry. Several industries in the United States provide good examples of
oligopolistic market structures with obvious barriers to entry, such as the automobile industry,
where significant financial barriers to entry exist. An oligopolistic industry is also typically
characterized by economies of scale. Economies of scale in production implies that as the level
of production rises, the cost per unit of product falls from the use of any plant (generally, up to a
point). Thus, economies of scale lead to an obvious advantage for a large producer. There is no
single theoretical framework that provides answers to output and pricing decisions under an
oligopolistic market structure. Analyses exist only for special sets of circumstances. One of these
circumstances refers to an oligopoly in which there are asymmetric reactions of its rivals when a
particular oligopolist formulates policies. If an oligopolistic firm cuts its price, it is met with
price reductions by competing firms; if it raises the price of its product, however, rivals do not
match the price increase. For this reason, prices may remain stable in an oligopolistic industry
for a prolonged period. MONOPOLY. Monopoly can be considered as the polar opposite of
perfect competition. It is a market form in which there is only one seller. While, at first glance, a
monopolistic form may appear to be rarely found market structure, several industries in the
United States have monopolies. Local electricity companies provide an example of a monopolist.
There are many factors that give rise to a monopoly. Patents can give rise to a monopoly
situation, as can ownership of critical raw materials (to produce a good) by a single firm. A
monopoly, however, can also be legally created by a government agency when it sells a market
franchise to sell a particular product or to provide a particular service. Often a monopoly so
established is also regulated by the appropriate government agency. Provision of local telephone
services in the United States provides an example of such a monopoly. Finally, a monopoly may
arise due to declining cost of production for a particular product. In such a case the average cost
of production keeps falling and reaches a minimum at an output level that is sufficient to satisfy
the entire market. In such an industry, rival firms will be eliminated until only the strongest firm
(now the monopolist) is left in the market. Such an industry is popularly dubbed as the case of a

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natural monopoly. A good example of a natural monopoly is the electricity industry, which reaps
the benefits of economies of scale and yields decreasing average cost. Natural monopolies are
usually regulated by the government. Generally speaking, price and output decisions of a
monopolist are similar to a monopolistically competitive firm, with the major distinction that
there are a large number of firms under monopolistic competition and only one firm under
monopoly. Nevertheless, at any output level, the price charged by a monopolist is higher than the
marginal revenue. As a result, a monopolist also does not produce to the point where price equals
marginal cost (a condition met under a perfectly competitive market structure). MARKET
STRUCTURES AND MANAGERIAL DECISIONS. Managerial decisions both in the short run
and in the long run are partly shaped by the market structure relevant to the firm. While the
preceding discussion of market structures does not cover the full range of managerial decisions,
it nevertheless suggests that managerial decisions are necessarily constrained by the market
structure under which a firm operates. TOOLS OF DECISION SCIENCES AND
MANAGERIAL ECONOMICS Managerial decision making uses both economic concepts and
tools, and techniques of analysis provided by decision sciences. The major categories of these
tools and techniques are: optimization, statistical estimation, forecasting, numerical analysis, and
game theory. While most of these methodologies are fairly technical, the first three are briefly
explained below to illustrate how tools of decision sciences are used in managerial decision
making. 5.OPTIMIZATION. Optimization techniques are probably the most crucial to
managerial decision making. Given that alternative courses of action are available, the manager
attempts to produce the most optimal decision, consistent with stated managerial objectives.
Thus, an optimization problem can be stated as maximizing an objective (called the objective
function by mathematicians) subject to specified constraints. In determining the output level
consistent with the maximum profit, the firm maximizes profits, constrained by cost and capacity
considerations. While a manager does not solve the optimization problem, he or she may use the
results of mathematical analysis. In the profit maximization example, the profit maximizing
condition requires that the firm choose the production level at which marginal revenue equals
marginal cost. This condition is obtained from an optimization exercise. Depending on the
problem a manager is trying to solve, the conditions for the optimal decision may be different.
6.STATISTICAL ESTIMATION. A number of statistical techniques are used to estimate
economic variables of interest to a manager. In some cases, statistical estimation techniques
employed are simple. In other cases, they are much more advanced. Thus, a manager may want
to know the average price received by his competitors in the industry, as well as the standard
deviation (a measure of variation across units) of the product price under consideration. In this
case, the simple statistical concepts of mean (average) and standard deviation are used.
Estimating a relationship among variables requires a more advanced statistical technique. For
example, a firm may want to estimate its cost function, the relationship between a cost concept
and the level of output. A firm may also want to know the demand function of its product, that is,
the relationship between the demand for its product and different factors that influence it. The
estimates of costs and demand are usually based on data supplied by the firm. The statistical

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estimation technique employed is called regression analysis, and is used to develop a


mathematical model showing how a set of variables are related. This mathematical relationship
can also be used to generate forecasts. An automobile industry example can be used for the
purpose of illustrating the forecasting method that employs simple regression analysis. Suppose a
statistician has data on sales of American-made automobiles in the United States for the last 25
years. He or she has also determined that the sale of automobiles is related to the real disposable
income of individuals. The statistician also has available the time series (for the last 25 years) on
real disposable income. Assume that the relationship between the time series on sales of
American-made automobiles and the real disposable income of consumers is actually linear and
it can thus be represented by a straight line. A fairly rigorous mathematical technique is used to
find the straight line that most accurately represents the relationship between the time series on
auto sales and disposable income. 7.FORECASTING. Forecasting is a method or a technique
used to predict many future aspects of a business or any other operation. While the term
"forecasting" may appear to be rather technical, planning for the future is a critical aspect of
managing any organizationusiness, nonprofit, or otherwise. In fact, the long-term success of any
organization is closely tied to how well the management of the organization is able to foresee its
future and develop appropriate strategies to deal with the likely future scenarios. There are many
forecasting techniques available to the person assisting the business in planning its sales. For
illustration, consider a forecasting method in which a statistician forecasting future values of a
variable of business interestales, for example examines the cause-and-effect relationships of this
variable with other relevant variables, such as the level of consumer confidence, changes in
consumers' disposable incomes, the interest rate at which consumers can finance their excess
spending through borrowing, and the state of the economy represented by the percentage of the
labor force unemployed. Thus, this category of forecasting techniques uses past time series on
many relevant variables to forecast the volume of sales in the future. Under this forecasting
technique, a regression equation is estimated to generate future forecasts (based on the past
relationship among variables).

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UNIT-II DEMAND and SCHEDULE

The demand for a commodity is its quantity which consumers are able and willing to buy at
various prices during a given period o f time. Demand is a function of Price (P), Income (Y),
Prices o f related goods(P R) and tastes (T) and expressed as D=f(P ,Y,PR,T). When income,
prices of related goods and tastes are given, the demand function is D=f (P ). It shows
quantities of a commodity purchased at given prices.
2.1THE VARIOUS TYPES OF DEMAND
i. Price demand: Price demand refers to various quantities of a commodity or service that a
consumer would purchase at a given time in a market at various hypothetical prices. It is
assumed that other things, such as consumers income, his tastes and prices of inter- related
goods, remain unchanged. The demand o f the individual consumer is called individual
demand and the total demand of the entire consumer combined for the commodity or service
is called industry d emand. The total demand for the product of an individual firm at various
prices is known as firms demand or individual sellers demand.
ii. Income demand: Income demand indicates the relationship between income and the quantity
of commodity demanded. It relates to the various quantities of a commod ity or service that
will be bought by the consumer at various level o f income in a given period of time, other
things equal. The inco me demand function for a commodity increases with the rises in
income and d ecreases with fall income. The inco me demand curve has a positive slope. But
this slope is in the case o f normal goods. In the case of inferior goods the demand curve id is
backward sloping
iii. Cross demand: In case o f related goods the change in the price of one affects the demand of
the other this known as cross demand and its written as d=f(pr). Related goods are of two
types, substitutes and complementary. In the case of the substitutes o r competitive goods, a
rise in the price o f one good a raises the demand, arise in the price of one good a raises the
demand for the other good b, the price o f remaining the same the opposite holds in the case of
a fall in the price of a when demand for b falls.
2.2 INDIVIDUAL DEMAND SCHEDULE AND CURVE AND MARKET DEMAND
SCHEDULE
Individuals demand schedule and curve: An individual consumers demand refers to the
quantities of a commodity demanded b y him at various prices. A demand schedule is a list of
prices and quantities and its graphic representation is a demand curve.

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X axis-quantity demanded
Y axis- price
DD- demand curve
Explanation:
i. The demand schedule reveals that when the price is Rs.P2, quantity demanded is Q2 units. As
the price decreases to P, the quantity demanded increases t o Q.
ii. The individual demand curve focuses on the effects of a fall or rise in the price of one
commodity on the consumers behavior. They are the substation and income effects.
Market demand schedule and curve: In a market, there is not one consumer but many
consumers of a commodity. The market demand of a commodity is depicted on a demand
schedule and demand curve. The y show the sum total of various quantities demanded by all
the individuals at various prices. S uppose there are three individuals A, B and C in a market
who purchase the commodity. The demand schedule for the commodity is depicted in table
below.

X axis-quantity demanded
Y axis- price
DD- demand curve
Explanation:

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i. Suppose there are three individuals A,B and C in a market who buy OA,OB and OC
quantities of the commodity at the price OP, as shown in panels (A),(B) and (C) respectively.
ii. In the market OQ quantity will be bought which is made up by adding together the quantities
OA,OB and OC.
iii. The market demand curve DM is obtained by the lateral summation of the individual demand
curves DA, DB and Dc
2.3 DIFFERENCE BETWEEN
QUANTITY DEMANDED

CHANGES

IN

DEMAND

AND

CHANGES

IN

Change in Quantity demanded: A demand curve is the graphic representation of the law of
demand. Movement alo ng a demand curve is caused b y a change in the own price of the
commodity. Such as change is called extension and contraction of demand. This means
movement on the demand curve resulting in extension of demand. Demand contracts as price
of good increases. This movement on a demand curve is known as change in quantity
demanded. This is be explained with the help of a diagram

X axis -------Quantity of X
Y axis---------price of X
DD ------------demand curve
Explanation:
The figure shows that as the price increases the demand decreases & as the price decreases
the demand for the commodity increases.

Change in demand: A shift of the demand curve is brought about by change in factors other
than the own price eg. It changes in factor like incomes of the consumer prices of substitute
products, percentage of women going out to work etc, this is known as change in demand.
This is explained with the help of a diagram.

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X axis -------Quantity of X
Y axis---------price of X
DD ------------demand curve
DD1 ------------Shift in Demand curve
Explanation:
The purchasing power of the consumer increases at each given price he starts buying more of
the co mmodity. This tendency of the consumer leads to shifts in this demand curve. S imilar
results will emerge if other determinants like price of related goods, tastes, etc, change. All
the other determinants are therefore, called shift factors, which lead to change in demand.
2.4 THE NATURE OF THE DEMAND OR THE VARIOUS DEMAND DISTINCTIONS
i. Derived de mand and autonomous: Those inputs or commodities which are demanded to
help in further production of commodities are said to have in further production of
commodities are said to have derived demand. For example, raw material, labour machines
etc are demanded not because the y serve only direct consumption need o f the purchaser but
because the y are needed for the production of goods having direct demand (say , food ,
scooter . building ,etc)
ii. Demand for producers goods and consume rs goods: The difference in these two types of
demand is that consumers goods are needed for producing other goods (consumers goods or
further producers goods)
iii. Demand for durable goods non durable goods: Durable goods whether producers durable
or consumers durable are the ones which can be stored and whose replacement can be
postponed. O n the other hand, the non durables are needed as a routine and their demand is
their fore made largely to meet day to- day needs.
iv. Industry demand a nd firm or co mpany de mand: The term company demand denotes
demand for a particular product of a particular firm Industry demand refers to the total
demand for the product of a particular industry.
v. Total demand and ma rket segment de ma nd: Demand for the market segments is to be
studied b y breaking the total demand into different segments like geo graphical areas , sub products, product use, distribution channels, size of customer groups, sensitivity to price etc.
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The market segments are so demarcated that each segment has its own ho mogenous demand
characteristics. F urther, each o f these market segments must differ significantly in terms of
delivered prices, net profit margins, and number of substitute s, co mpetition, seasonal,
patterns and cyclical sensitivity.
vi. Short run de mand and long run de mand: Short run demand refers to demand with its
immediate reactions to price changes, Income fluctuations etc. W hereas long run demand is
that which will ultimately exist as a result demand of the change in pricing promotion or
products improvement , after enough time is allowed to lat the market adjust itself to the new
situation.
2.5 THE CAUSES FOR THE DOWN WARD SLOPING OF THE DEMAND CURVE
i. Based on the law of diminishing ma rginal utility: The law of demand is based on the law
of diminishing marginal utility. According to this law, when a consumer b uys more units of a
commodity, the marginal utility of that commodity continues to decline therefore the
consumer will buy more units of that commodity only when its price falls. W hen less units
are available, utility and the consumer will be prepared to pay more for the commodity.
ii. Price effect: W ith the increase in the price as of the product many consumers will either
reduce or stop its consumption and the demand will be reduced. Thus to the price effect when
consumer consume more or less of the commodity, the demand curve slope downward.
iii. Income effect: When the p rice of a commodity falls the real income o f the consumer
increase because he quantity. On the contrary with the rise in the price of the commodity the
real income of the consumer falls. This is called the income effect.
iv. Substitution effect: The other effect o f change in the prices of the commodit y is the
substitution effect. W ith the falls in the price o f a commodity the prices of its substitutes
remaining the same consumer will buy more of this commodity rather that the substitutes. As
a result its demand will increase.
v. Persons in different inco me gro ups: There are person in different income groups in every
society but the majority is in low income gro up. The downward sloping demand curve
depends upon this group. Ordinary people buy more when price falls and less when prices
rise. The rich do not have any some quantity even at a higher price.
vi. Different uses of certain co mmodities: There are different uses of certain commodities and
service that are responsible for the negative slope of the demand curve with the increase in
the price of such products they will be used only for more important uses and their demand
will fall.

2.6 THE REASON FOR THE EXCEPTIONAL DEMAND CURVE


i. War: If a short age is feared in anticipation o f war people ma y start buying for building
stocks, for hoarding even when the price rises.
ii. Depression: During a depression, the prices o f commodities are very low and demand for
them is also less. This is because of the lack of purchasing power with consumer.
iii. Giffen paradox: If a commodity happens to be necessity of life like wheat a nd its price goes
up, consumer are forced to curtail the consumption of more expensive foods like meat and
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fish and wheat being still the cheapest the y will consume more for it. The marshallion
example is applicable to develop ed economies. In the case of underdevelopment economy,
with the fall in the p rice of an inferior commodity like maize. Co nsumers will start
consuming more o f the superior commodity like wheat. As a result, the demand for maize
will fall .this is what Marshall called giffen parado x whic h makes the d emand curve to have a
positive slope.
iv. Demonstration effect: It consumers are affected b y the principle of conspicuous
consumption or demonstration effect the y will like to buy more o f those commodities which
confer distinction on the possessor, when their prices rise. On the other hand, with the fall in
the prices of such articles, their demand falls, as is the case with diamonds.
v. Ignorance effect: Co nsumers buy more at a higher price under goods the influences of the
ignorance effect where a commodity ma y be mistaken for some other co mmodity, due to its
price, deceptive packing, label, etc.
vi. Speculation: Marshall mentions speculation as one of the important exception to the
downward sloping demand curve. According to him the law of the demand does not apply to
the demand in a campaign between groups of speculators. A group, which desire to upload a
great quantity of a thing on to the market, often begins b y buying so me of it openly; it
arranges to sell a great deal quietly and through unaccustomed channels.
2.7 THE VARIOUS DETERMINATS OF MARKET DEMAND
i. Price of the product: The law of demand states that the quantity demanded of a product
which its consumers users would like to buy per unit of time, increases when its price falls
and decreases when its price increases other factors remaining constant.
ii. Price of the related goods:
The demand for a commodity is also affected b y the changes
in the price of its related goods. Related goods may be substitutes or complementary goods
iii. Cons umer inco me: Income is the basic determinant of quantity of a product demanded since
it determines the purchasing power o f the consumer. That is why higher current disposable
incomes spend a larger amount on consumer goods and services than those with lower
income.
iv. Cons umer taste and preferences: Taste and preferences generally depend on the life style
social customs religious value attached to a commodity, habit of the people, the general levels
of living of the society a nd age and sex of the consumers taste and preferences. As a result,
consumers reduce or give up the consumption of the some goods and add new ones to their
consumption pattern
v. Adve rtisement expenditure: Advertisement costs are incurred with the objective of
promoting sale of the product. Advertisement helps in increasing demand for the product.
vi. Cons umers exceptions: Consumers exceptions regarding the future prices incomes and
supply position o f goods, etc pla y an important role in determining the demand for goods and
services in the short run.
vii. Demonstration effect: W hen new commodities or new models of existing one appear in the
market rich people buy them first.
viii. Cons umer credit facility: Availability of credit to the consumers from to the seller banks
relation and friends, or from other source encourages the consumer to buy more that what
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the y is why consumers who can borrow more can consume more than those who cannot
borrow. Credit facility mostly affects the demand for durable goods, particularly those which
requires bulk payment at the time of purchase.
ix. Population of the country: The total domestic demand for a product of mass consumption
depends also on the size of the population. Give n the price, per capita income taste and
preference etc, the larger the population the larger and demand for a product. With an
increase (or decrease) in the size of population and with the emplo yment percentage
remaining the same demand for the product tends to increase (or decrease).
x. Distribution of National Income: The level of national income is the basic determinant o f
the market demands for a productthe higher the national income, the higher the demand for
all normal goods and services. A past from its level the distribution pattern of national
income is also an important determinant of a product.
2.8 ELASTICITY OF DEMAND
Elasticity of demand may be defined as the ratio of the percentage change in demand to the
percentage change in price. Ep= Percentage change in amount demanded
Percentage change in price
2.9 TYPES OF ELASTICITY DEMAND
i. Price elasticity of de mand: Elasticity of demand ma y be defined as the ratio of the
percentage change in price.
Ep = percentage change in quantity demanded / percentage change in price
ii. Income elasticity of de mand: The income elasticity of demand (Ey) e xpress the
responsiveness of a consumer demand or expenditure or consumption) for any good to the
change in his income .it ma y be defined as the ratio of percentage change in the quantity
demanded of a commodity to the percentage in income. Thus
Ey = percentage change in quantity demanded / percentage change in income
iii. Cross elasticity of demand: The cross elasticity of demand is the relation between
percentage change in the quantity demand ed of a good to the percentage change in the price
of a related good. The cross elasticity good A and good B is
Eba= percentage change in the quantity demanded of B/ percentage change in price of A

2.10 TYPES OF PRICE ELASTICITY OF DEMAND


i. Perfectly elastic demand: W here no reductio n in price is needed to cause an increase in
quantity demanded. This is explained with the help of a diagram.

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X axis-quantity demanded
Y axis- price
DD1- demand curve
Explanation: Price elasticity of demand is infinity when a small change in price leads to an
infinitely large change in the amount demanded. It is perfectly elastic demand. [E=]
ii. Perfectly in elastic demand: Here a large change in price causes no change in quantity
demanded. It is zero elastic demand [E=0]. This is explained with the help of a diagram.

X axis-quantity demanded
Y axis- price
DD1- demand curve
Explanation: The figure shows that even if the price decrease from p to p1 there is no
change in the quantity demand. This happens in case of necessities like salt.
iii. Unitary elastic: Where a given proportionate change in price causes an equally proportionate
change in quantity demand. This is explained with the help of a diagram.

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X axis-quantity demanded
Y axis- price
DD1- demand curve
Explanation: Price elasticity of demand is unity when the change in demand is exactly
proportionate to the change in price. [E=1].
iv. Relatively elastic: W here a small change in price causes a more than proportionate change in
quantity demanded. The price elasticity o f demand is greater than unity [E >1]. This is
explained with the help of a diagram.

X axis quantity demanded


Y axis price
DD demand curve
Explanation: The figure shows that the re is a small decrease in price fro m P to P1, but it has
resulted in a large increase in quantity demanded from Q to Q1. It is also known as relatively
elastic demand.

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v. Relatively inelastic demand: W here a change in price causes a less than proportionate
change in quantity d emanded. The price elasticity of demand is lesser than unity [E <1]. This
is explained with the help of a diagram.

X axis quantity demanded


Y axis price
DD- demand curve
Explanation: The figure shows that there is a large decrease in price fro m P to P1, but it has
resulted in only a small increase in quantity demanded from Q to Q1. It is also known as
relatively elastic demand.
2.11 TYPES OF INCOME ELASTICITY OF DEMAND
i. Positive and elastic inco me demanded: The value of the coefficient E is greater than unity ,
which means that quantity demanded of good X increases b y a larger percentage than the
income of the consumer. This is explained with the help of a diagram.

X axis quantity demanded


Y axis Income
DD- demand curve
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Explanation: The curve Ey shows a positive and elastic income demanded. In the case of
necessities, the coefficient of income of income elasticity is positive but low, Ey=1. Income
elasticity of demanded is low when the demand for a commodity rises less than proportionate
to the rise in the income.
ii. Positive but inelastic income de mand: It is low if the relative change in quantity demanded
is less tha n the relative change in mone y income. Ey<1. This is explained with the help of a
diagram.

X axis quantity demanded


Y axis Income
DD- demand curve
Explanation: The curve Ey shows a positive but in elastic income demand. In the case o f
necessities, the coefficient of income elasticity is positive but low, Ey<1. Income elasticity of
demand is low when the demand for a commodity rises less than proportionate to the rises
less than proportionate to the rise income.
iii. Unitary inco me elasticity of demand: The p ercentage change in quantity demanded is equal
to the percentage change in money income. This is explained with the help of a diagram.

X axis quantity demanded


Y axis Income
DD- demand curve

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Explanation: The curve Ey shows unitary income elastic ity of demand. In the case of
comforts, the coefficient of income elasticity is unity (Ey=1) when the demand for a
commodity rises in the same proportions as the increases in income.
iv. Ze ro income elasticity: A change in income will have no effect on the quantity demanded.
The value of the coefficient Ey is equal to zero. This is explained with the help of a diagram.

X axis quantity demanded


Y axis Income
DD- demand curve

Explanation: The curve shows a vertical income, elasticity demand curve Ey with zero
elasticity
If with the increases in income, the quantity demanded remains unchanged the coefficient of
income elasticity, Ey=0.
v. Infe rior goods: Inferior goods have negative income elasticity of demand. It explains that
less is bought at higher inco mes and more is bought at lower incomes. The value of the
coefficient Ey is less than zero or negative in this case. This is explained with the help of a
diagram.

X axis quantity demanded


Y axis Income
DD- demand curve
Explanation: The coefficient of income elasticity of demand in the case of inferior goods is
negative. In the case o f an inferior good, the consumer will reduce his purchases of it, when
his income increases.

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2.12 DIFFERENT TYPES OF CROSS ELASTICITY OF DEMAND
A. CROSS ELASTICITY OF SUBS TITUTES : In case of substitutes, as the price of one
good increases the demand for the other good also increase at the same time.
i. Relatively elastic: Where a small change in price of good A causes a large change in quantity
demanded of good B. The elasticity o f substitutes is greater than unity [E >1].This is
explained with the help of a diagram.

X axis quantity demanded of B


Y axis price of A
DD demand curve
Explanation: The figure shows that there is a small increase in price of good A from a to a1,
but it has resulted in a large increase in quantity demanded of B from b to b1. It is also known
as relatively elastic demand.
ii. Relatively inelastic demand: W here a large change in price of good A causes a small change
in quantity demanded of good B. The elasticity of substitutes is lesser than unity [E <1]. This
is explained with the help of a diagram.

X axis quantity demanded of good B


Y axis price of good A
DD- demand curve
Explanation: The figure shows that there is a large increase in price o f good A from a to a1,
but it has resulted in only a small increase in quantity demanded of good B from b to b1. It is
also known as relatively in elastic demand.
iii. Unitary elastic: Here a given proportionate change in price causes an equally proportionate
change in quantity demand. This is explained with the help of a diagram.

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X axis-quantity demanded of good B


Y axis- price of good A
DD- demand curve
Explanation: Price elasticity of demand is unity when the change in demand is exactly
proportionate to the change in price. [E=1].
iv. Perfectly in elastic demand: Here a large change in price causes no change in quantity
demanded. It is zero elastic demand [E=0]. This is explained with the help of a diagram.

X axis-quantity demanded of good B.


Y axis- price of good A.
DD- demand curve
Explanation: The figure shows that even if the price increases from a to a1 there is no
change in the quantity demand. This happens in case of necessities like salt.
v. Unrelated goods: If two goods are not at all related then they have negative elasticity of
demand. This is explained with the help of a diagram.

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X axis quantity demanded of good B.


Y axis Price of good A.
DD- demand curve
Explanation: The figure shows that in case on unrelated goods if the price of good A
increase from a to a1, then the demand for good B will decrease from b to b1.

B. CROSS ELAS TICITY OF COMPLIMENTAR Y GOODS: In case of complimentary


goods, as the price of o ne good increases the demand for the other good decreases at the
same time.
i. Perfectly elas tic demand: W here no reductio n in price is needed to cause an increase in
quantity demanded. This is explained with the help of a diagram.

X axis-quantity demanded of good B


Y axis- price of good A
DD- demand curve
Explanation: Price elasticity o f demand is infinity when a small change or no change in
price of good A leads to an infinitely large change in the amount demanded of good B. It is
perfectly elastic demand. [E=]
ii. Perfectly in elastic demand: Here a large change in price of good B causes no c hange in
quantity demanded o f good B. It is zero elastic demand [E=0]. This is explained with the help
of a diagram.

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X axis-quantity demanded of good B


Y axis- price of good A
DD- demand curve
Explanation: The figure shows that even if the price of good B decreases from a to a1 there
is no change in the quantity demand of good A. This happens in case of necessities like salt.
iii. Unitary elastic: W here a given proportionate change in price causes an equally proportionate
change in quantity demand. This is explained with the help of a diagram.

X axis-quantity demanded of good B


Y axis- price of good A
DD- demand curve
Explanation: Price elasticity of demand is unity when the change in demand is exactly
proportionate to the change in price. [E=1].
iv. Relative ly elastic: Where a small change in price of good B causes a more than
proportionate change in quantity demanded of good A. The price elasticity of demand is
greater than unity [E >1].This is explained with the help of a diagram.

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X axis quantity demanded of good B


Y axis price of good A
DD demand curve
Explanation: The figure shows that there is a small decrease in price fro m a to a1, but it has
resulted in a large increase in quantity demanded from b to b1. It is also known as relatively
elastic demand.
v. Relatively inelastic demand: W here a change in price causes a less than proportionate
change in quantity d emanded. The price elasticity of demand is lesser than unity [E <1]. This
is explained with the help of a diagram.

X axis quantity demanded of good B


Y axis price of good A
DD- demand curve
Explanation: The figure shows that there is a large decrease in price fro m a to a1, but it has
resulted in only a small increase in quantity demanded from b to b1. It is also known as
relatively elastic demand.

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2.13 DIFFERENT METHODS OF MEASURING ELASTICITY OF DEMAND
1. Total outlay: According to this method, we compare the total outla y of the purchases or
total revenue, i.e, total value o f sales from the po int of view of the seller before and after the
variations in price. This is explained with the help of a diagram.

X axis -------Quantity of X
Y axis---------price of X
DD ------------demand curve
Explanation: If the elasticity of demand is equal to unity for all prices of the commodity
only fall in price will cause a proportionate increases in the amount bought, and therefore will
make no change in the total outla y which purchases make for the commodity thus one is the
dividing point. If the elasticity is greater than one it is said to be elast ic and it is less than it is
inelastic curve having same elasticity throughout:-

2. Point elasticity: The concept of price elasticity can be used in comparing the sensitivity of
the different types of goods e.g., luxuries and necessaries) to changes in their prices. The
elasticity of d emand is alwa ys negative because change in quantity demanded is in opposite
direction to the change in price that is a fall in p rice is followed b y rise in demanded and vice
versa hence elasticity less than zero.

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X axis -------Quantity of X
Y axis---------price of X
DD ------------demand curve
Explanation:
Elasticity is represented b y fraction distance fro m d to a point on the curve divided b y the
distance from the other end to that point. Thus elasticity of demand is seen on the points P3,
P2and P1 respectively. It is seen that elasticity at a lower point on the curve is less than at a
higher point.
3. Arc elasticity: Arc elasticity is a measure of the average responsiveness to price changes
exhibited by a demand curve over some finite stretch of the curve. This is explained with the
help of a diagram below.

X axis -------Quantity of X
Y axis---------price of X
DD ------------demand curve

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Explanation:i. Any two points on a demand curve make an arc the area between p and m on the DD curve is
an arc which measures elasticity over a certain range of prices and quantities.
ii. On any two points of a demand curve the price elasticitys of demand are likely to be
different depending upon how we calculate them.
iii. The closer the two points p and m are, the more accurate will be the measure of elasticity.
iv. The arc elasticity is in fact the elasticity of the midpoint between p and m on the demand
curve .
v. If there is no difference between the two points and the y merge into each o ther o r coincide,
arc elasticity becomes point elasticity.

2.14 THE FACTORS DETERMING PRICE ELASTICITY OF DEMAND


i. Necessaries and conventional necessaries: people buy fixed quantities of such commodity
whatever is the price. The change in the price o f wheat ma y be immaterial for upp er classes,
but its consumption will certainly increase among the poor when the price falls. It ma y be
noted that demand for a necessity life as a whole ma y be inelastic, b ut in a competitive
market, demand for the output of any particular firm is highly elastic. If it raises the price a
bit, it may lose the entire market.
ii. Demand for luxuries is elastic: It stands to reason that lowering of the price of things like
radio will lead to more bring bought i.e. the demand is elastic. Thus for the same article the
demand ma y be elastic for some people and inelastic for others elastic in one country and
inelastic in another and elastic at one time and inelastic at another.
iii. Proportion of total expenditure: It a consumption good absorbs only a small proportion of
total expenditure, eg, salt the demand will not be much affected b y a change in p rice hence, it
will be inelastic.
iv. Substitutes: The main cause of difference in the responsiveness of the demand for that there
are more completing substitutes for some goods than for others. When the price of tea rises,
we may curtail its purchase and take of coffee, and vice versa. In a case like this a change in
price will lead to expansion or contraction in demand.
v. Goods having several uses: Coal is such a commodity when it will be used for several
purposes e. g, cooking heating and industrial purposes; and its demand will increase. But ,
when the price goes up, it use will be restricted only to very urgent uses and consequently
less will be purchased when the prices rises the demand will thus contract when wheat
becomes very cheap it can be used even as cattle feed hence demand for a commodity having
several uses is elastic
vi. Joint demand: If for instance, carriages beco me cheap but the prices of horses continue to
rule high, demand for carriage will not extend much. In other words the demand for jointly
demanded goods is less elastic.
vii. Goods the use of which can be postponed: Most of us during the war postponed our
purchases where we co uld e.g. building a house, buying furniture or having a number of
warm suits. We go in for such things in a large measure when the y are cheap demand for
such goods is elastic.
viii. Level of prices: If a thing is either very e xperience or very cheap, the demand will be in
elastic. If the price is too high, a fall in it will not increase the demand much. If on the other

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hand , it is too low, people will have already purchased as much as they wanted: any further
fall will not increase the demand.
ix. Market imperfectio ns: Owing to ignorance about market trends the demand for a good may
not increase hen its price falls for the simple reasons that consumers ma y not be aware o f the
fall in price.
x. Technological factors: Low price elasticity ma y be due o some technical reasons. For
example lowering of elasticity ma y be electricity rates ma y not increase co nsumption because
the consumers are unable to buy the necessary electric appliances.
xi. Time period: The elasticity of demand is greater in the long run than in the short run for the
simple reasons that the consumer has more time to make adjustment in his scheme of
consumption. In other word he is able to increase or decrease his demand for a commodity
2.15 PRACTICAL APPLICATION (OR) IMPORTANCE (OR) SIGNIFICANCE OF
ELASTICITY OF DEMAND
i. Taxation: The tax will no doubt raises the prices but the demand being in elastic, people
must continue to buy the same quantity o f the commodity. Thus the demand will not
decrease.
ii. Monopoly prices: In the same manner, the b usinessman, especially if he is a monopolist,
will have to consider the nature of demand while fixing his price. In case I is in elastic, it will
pay him to him to change a higher price and sell a smaller quantity. If, on the other hand, the
demand is elastic he will lower the prices, stimulate demand and thus maximize his
monopoly net revenue
iii. Joint products: In such cases separate costs are not ascertainable the producers will be
guided mostly b y demand and its nature fixing his price. The transport authorities fix their
rates according to this principle when we say that they charge what the traffic will bear
iv. Increasing returns: W hen an industry is subject to increasing returns the manufacturer
lowers the price4 to develop the market so that he may be able to produce more and take full
advantage of the economies of large scale production.
v. Output: Elasticity o f demand affects industrial output reduction in price will certainly
increases the sale in the market as a whole.
vi. Wages: Easticity of demand also exerts its influence on wages. If demand for a particular
type of labour is relatively inelastic, it is easy to raise wages, but not otherwise.
vii. Poverty in plenty: The concept of elasticity explains the paradox of poverty in the midst of
plenty. This is
specially so if prod uce is perishable. A rich harvest ma y actually fetch less
money a poor one.
viii. Effect on the economy: The working of the economy in general is affected b y the nature of
consumer demand. It affects the total volume of goods and services prod uced in the country.
It also affects producers demand for different factors of production their allocation and
remuneration.
ix. Economies policies: Modern governments regulate output and prices. The government can
create public utilities where demand is inelastic and monopoly element is present.

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x. Inte rnational trade: The nature of d emand for the internationally traded goods is helpful in
determining the quantum of again of gain accruing to the respective countries. Thus is how it
determines the terms of trade.
xi. Price dete rminatio n: The concept of elasticity o f demand is used in explaining the
determination of price under various market conditions.
xii. Rate of foreign exchange: With fixing the rate o f exchange, the government has to consider
the elasticity or otherwise of its imports and exports.
xiii. Relation between price elasticity average revenue and marginal revenue: This
relationship enables us to understand and co mpare the conditions of equilibrium under
different market conditions.
xiv. Price determinatio n: Price determination is forced to be profitable if elasticity o f demand in
another. The monopolist can charge a higher price in the market where elasticity o f demand is
less and a lower price where elasticity of demand is greater
xv. Measuring degree of monopoly powe r: The less is the elasticity of demand higher will be
the price and wider the difference between the marginal cost and greater the monopoly
power, and vice versa.
xvi. Classification of goods as substitutes and complements: Goods are classified as substitutes
on the basis of cross elasticity. Two commodities may be considered as substitutes if cross
elasticity is positive and complements when elasticity is negative.
xvii. Boundary between industries: Cross elasticity of demand is also useful in indicating
boundaries between industries. Goods with high cross elasticitys constitute one industry,
where as goods with lower elasticity constitute different industries.
xviii. Market forms: The concept of cross elasticity help[s to understand different market forms
infinite cross elastic ity indicates perfect market forms infinite cross elasticity indicates
perfect competitions, where as zero or hear zero elasticity indicates pure monopoly and high
elasticity indicates imperfect competition
xix. Incidence of taxes: The concept of elasticity o f demand is used in explaining the incidence
of indirect taxes like sales tax and excise duty. less is the elasticity of demand higher the
incidence, and vice versa. In case of inelastic demand the consumer have to buy the
commodity and must bear the tax.
xx. Theory of distribution: Elasticity of demand is useful in the determination of relative shares
of the various factors determination of relative shares of the various factors of production is
loss elastic, its share in the national dividend is higher, and vice versa. If elasticity of
substitution is high the share will be low.

2.16 SUPPLY
The supply o f a commodity means the amount of that commodity which producers are able
and willing to offer for sale at a given price. The supply curve is explained with the help of a
diagram.

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X axis-----Quantity Supplied
Y axis------Price
Explanation: The figure shows that as the price of a commodity increases from P to P1, the
supply also increases from Q to Q1. It means that price & supply are directly related.
Reserve Price
If the p rice falls too much, supply ma y dry up altogether. The price below which the seller
will refuse to sell is called Reserve P rice. At this price, the seller is said to buy his own
stock.

Law of Supply
Other things remaining the same, as the price of a commodity rises, its supply increases; and
as the price falls, its supply declines.
Supply function
Supply function of a firm or an industry (a group of firms) is an algebrate expression relating
the quantity of a commodity which a seller is willing and able to supply. The supply function
can be written as: x=f (Px, FE, FP, PR, W, E, N)
Where certain important determinants of supply are: Product price (Px), Factor productivities
or State of Technology(FE), Factor prices(FP), rises of other products related in
production(PR), Weather, strikes and other short-run forces(W), Firms expectations about
future prospects for prices, costs, sales and the sate of economy in general(E), Number (N)

2.17 Limitations of Law of Supply


i. Future Prices: When the p rice rises and the seller expects the future price to rise further,
supply will decline as the seller will be induced to withhold supplies so as to sell later and
earn larger profits then.
ii. Agricultural Output: Law of supply ma y no t apply in case of agricultural commodities as
their production cannot be increased at once following price increase.
iii. Subsistence Farme rs: In underdeveloped countries where agriculture is characterised with
subsistence farmers, law of supply may not apply.
iv. Factors other than Price not Remaining Constant: The law of supply is stated on the
assumption that factors other than the price of the commodity remain constant.

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2.18 FACTORS INFLUENCING SUPPLY
i. Goals of firms: The supply of a commodity depends upon the goals of firms.
ii. Price of the commodity: The supply o f a commodity depends upon the price of that
commodity. Ceteris paribus the higher the p rice of the commodity the more pro fitable it will
be to make that commod ity. O ne expects, therefore, that the higher the price, the greater will
be the supply.
iii. Prices of all other commodities: The supply of a commodity depends upon the prices o f all
other commodities. Generally, an increase in the price of other co mmodities will make
production of the commodity whose price does not rise relatively less attractive than it was
previously. We thus expect that ceteris paribus, the supply of one commodity would fall as
the price of other commodities rises.
iv. Prices of factors of production: The supply of a commodity depends upon the prices of
factors of production. A rise in the price of one factor o f productio n will cause a large
increase in the costs of making those goods which use a great deal of that factor, and only a
small increase in the cost of producing those co mmodities which use a small amount of the
factor.
v. State of technology: The supply of a commodity depends upon the state of technology.
vi. Time factor: Time factor can also determine elasticity of supply. Time can be broadly
classified into three categories: Market period is the one where supply is fixed as no factor of
production can be altered.
vii. Short period is the time period when it is possible to adjust supply only b y changing the
variable factors like raw- material, labor, etc., and Long period where supply can be changed
at will because all the factors can be changed.
viii. Agreement among the producers: S upply ma y be consciously decreased b y agreement
among the producers.
ix. To raise price: Supply may also be destroyed to raise price.
x. Taxation on output or imports: Supply ma y also be affected b y taxation on output or
imports. Government ma y also restrict production of certain commodities on grounds of
health (e.g., opium in India).
xi. Political disturbances or war may also create scarcity of certain goods.
2.19 CHANGE IN SUPPLY AND SHIFT IN SUPPLY
Change in supply means increase or decrease in quantity supplied at the same price. This is
explained with the help of a diagram.

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X axis-----Quantity Supplied
Y axis------Price
SS- Supply Curve
Explanation: The figure shows that as the price of a commodity increases from P to P1, the
supply also increases fro m Q to Q1. It means that price & supply are directly related. The
movement of the supply is along the same curve. In other words increase in supply is known
as extension of supply & decrease in supply is known as contraction of supply.
2.20 SHIFT IN SUY
PPCLURVE
Shift in supply means shifting the entire supply curve due to various reasons other than price
like changes in technolo gy, government policies etc. This is explained with the help of a
diagram.

X axis-----Quantity Supplied
Y axis------Price
Explanation: The figure shows that as the price of a commodity does not change but still the
supply curve shifts from SS TO S1S1 OR S2S2. It means shifting the entire supply curve is
due to various reasons other than price like changes in technology, government policies etc.

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2.21 ELASTICITY OF SUPPLY
It can be defined as the degree of responsiveness of supply to a given change in price.
The formula to find out the elasticity of supply is:
Es = percentage change in quantity supplied / percentage change in price

2.22 TYPES OF ELASTICITY OF SUPPLY


i. Perfectly elastic supply: Where no change in price is needed to cause an increase in quantity
supplied. This is explained with the help of a diagram.

X axis-quantity supplied
Y axis- price
SS- supply curve
Explanation: The elasticity of supply is infinity when a small change in price leads to an
infinitely large change in the quantity supplied. It is perfectly elastic supply. [E=]
ii. Perfectly in elastic supply: Here a large change in price causes no change in quantity
supplied. It is zero elastic supply [E=0]. This is explained with the help of a diagram.

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X axis-quantity supplied
Y axis- price
SS- supply curve
Explanation: The figure shows that even if the price increases from p to p1 there is no
change in the quantity supplied.
iii. Unitary elastic: W here a given proportionate change in price causes an equally proportionate
change in quantity supplied. This is explained with the help of a diagram.

X axis-quantity supplied
Y axis- price
SS- supply curve
Explanation: Elasticity of supply is unity when the change in supply is exactly proportionate
to the change in price. [E=1].
iv. Relatively elastic: Where a small change in price causes a more than proportionate change in
quantity supplied. The price elasticity o f supply is greater than unity [E >1 ].This is explained
with the help of a diagram.

X axis-quantity supplied
Y axis- price
SS- supply curve

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Explanation: The figure shows that there is a small increase in price fro m P to P1, but it has
resulted in a large increase in quantity supplied from Q to Q1. It is also known as relatively
elastic supply.
v. Relatively inelastic Supply: W here a large change in price causes a less than proportionate
change in quantity supp lied. The elasticity o f supply is lesser than unity [E <1]. This is
explained with the help of a diagram.

X axis-quantity supplied
Y axis- price
SS- supply curve
Explanation: The figure shows that there is a large increase in price from P to P1, but it has
resulted in only a small increase in quantity supplied from Q to Q1. It is also known as
relatively inelastic supply.

2.23 THE LAW OF DIMINISHING MARGINAL UTILITY


The law of diminishing marginal utility states that as the quantity consumed of a commodity
increases, the utility derived from each successive unit decreases, consumption of all other
commodities remaining the same.

Assumptions of diminishing marginal utility


i. The utility analysis is based on the cardinal co ncept which assumes that utility is measurable
and additive like weights and lengths of goods.
ii. Utility is measurable in terms of money.
iii. The marginal utility of money is assumed to be constant.
iv. The consumer is rational who measures, calculates, chooses and compares the utilities of
different units of the various commodities and aims at the maximization of utility.
v. He has full knowledge of the availability of commodities and their technical qualities.
vi. He possesses perfect knowledge of the choices of commodities open to him and his choices
are certain.

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vii. He knows the exact prices of various commodities and their utilities are not influenced b y
variations in their price.
viii. There are no substitutes.
This is explained with the help of a diagram.

X axis Quantity demanded


Y axis Utility
TU-Total Utility
DMU-Diminishing Marginal Utility
Explanation:
i. With the increases in the number of units consumed per unit of time, TU increases but at a
diminishing rate.
ii. The downward sloping Mu curve shows that marginal utility goes on decreasing as
consumption increases.
iii. At 4 units consumed, the TU reaches its maximum level the point of saturation and mu
becomes zero.
beyond this MU become negative and TU begins to decline .
2.24 IMPORTANCE OF THE LAW OF DIMINISHING MARGINAL UTILITY
i. Taxation: Pro gressive system of taxation, imposing a heavier burd en o n the rich people, is a
practical application of this principle in the field of public finance. Richer a person the
higher is the rate of the tax he has to pay since to him the marginal utility of money is less.
ii. Price determination: The law expla ins why with increase in its supply, the value of a
commodity must fall. It thus forms a basis of the theory of value.
iii. Household expenditure: The law of diminishing marginal utility governs our daily
expenditure. Since one knows that a larger purchase w ill mean lower marginal utility, one
will restrict their purchase o f a particular commod ity, because the y cannot afford to waste our
limited resources.

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iv. Downward sloping demand curve: It is this law which tells us why demand curve slope
downwards. It is due to this law that smaller utility lines cut larger portions of the
commodity line, i.e., X-axis.
v. Value-in-use and value -in-exchange: It also explains the divergence between value-in- use
and value-in-exchange.
vi. Socialis m: The marginal utility to the rich o f the wealth, that the y might lose, is not so great
as the marginal utility of the wealth which is transferred to the poor.
vii. Basis if some economic laws: Some very important laws of econo mics are based on the law
of diminishing marginal utility, ex. Law of demand, the concept of consumers surplus, the
concept of elasticity of demand, the law of substitution, etc. These laws and concepts have
ultimately been derived from the law of diminishing marginal utility.

2.25 LIMITATIONS OF DIMINISHING MARGINALIL


UITTY
i. Utility cannot be measured ca rdinally: The basis of the utility analysis- that it is
measurable- is defective because utility is a subjective and psycholo gical concept which
cannot be measured cardinally. In really, it can be measured ordinally.
ii. Single commodity model is unrealistic: The utility analysis is a single commodity model in
which the utility of one commodity is regarded independent of the other. Marshall
considered substitutes and complementary as one commodity, but it makes the utility analysis
unrealistic.
iii. Money is an imperfect measure of utility : Marshall measures utility in terms of mone y, but
mone y is an incorrect and imperfect measure o f utility because the value of mone y often
changes.
iv. Marginal utility of money is not constant: The fact is that a consumer does not buy only
one commodity but a number o f commodities at a time. In this wa y when a major part of his
income is spent on buying commodities, the marginal utility of the remaining stock of mone y
increases.
v. Man is not rational: This assumption is also unrealistic because no co nsumer compares the
utility and disutility from each unit of a commodity while buying it. Rather, he buys them
under the influence of his desires, tastes or habits. Moreover, consumers income and p rices
of commodities also influence his purchases. Thus the consumer does not buy commodities
rationally. This makes the utility analysis unrealistic and impracticable.
vi. Utility analysis does not study income effect, substitution effect a nd price effect: The
utility analysis does not explain the effect o f a rise or fall in the income of the consumer on
the demand for the commodities. It thus neglects the income effect. Again when with the
change in the price o f one commodity there is a relative change in the price of the other
commodity, the consumer substitutes one for the other. This is the substitution effect which
the utility analysis fails to discuss.
vii. Utility analysis fails to clarify the study of inferior and giffen goods: Marshalls utility
analysis of demand does not clarify the fact as to why a fall in the price of inferior and giffen
goods leads to a decline in its demand.

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viii. The assumption that the consume r buys mo re units of a commo dity whe n its price falls
is unrealistic:
It ma y be true in the case of food products like oranges, bananas,
apples, etc. but not in the case of durable goods.
ix.

The utility analysis breaks down in the


case of durable consumer goods like scooters, transistors, radio, etc. because they are
indivisible. The consumer buys only one unit of such commodities at a time so the it is
neither possible to calculate the marginal utility o f one unit nor can the demand schedule and
the demand curve for that good be drawn. Hence the utility analysis is not applicable to
indivisible goods.
2.26 BTHE LAW OF -EQUIMARGINAL UTILITY
It is also called as the law of substitution, or the law of indifference, or the law of maximum
satisfaction. It is called the law of subs titution because when we substitute the more useful
one. It is known as the law of maximum satisfaction, because through its application we are
able to maximize our satisfaction. According to the law of equi- marginal utility, it is only
when marginal utilities have been equalized, through the process of substitution. That one
gets maximum satisfaction.
Assumptions of law of equi- marginal utility

i. The utility analysis is bases on the cardinal concept which assumes that utility is measurable
and additive like weights and length of goods.
ii. Utility is measurable in terms of money.
iii. The marginal utility of money is assumed to be constant.
iv. The consumer is rational who measures, calculates, chooses and compares the utilities of
different units of the various commodities and aims at the maximization of utility.
v. He has full knowledge of the availability of commodities and their technical qualities.
vi. He possesses perfect knowledge o f the choices of commodities open to him and his choices
are certain.
vii. He knows the exact prices of various commodities and their utilities are not influenced by
variations in their prices.
viii. There are no substitutes.
This is explained with the help of a diagram.

X axis Quantity demanded


Y axis Income
Ua-Total Utility of a
Ub-Total Utility of b

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3.13.33ChapterCC
C
3333jllolubgfthcxfcxh3.1 FORMS

Chapter 3
Organization

3.1 Forms of business


Have you ever thought who brings the required capital, takes the responsibility of arranging other
resources, puts them into action, and coordinates and controls the activities to earn the desired profits? If you
look around, you will find that a small grocery shop is owned and run by a single individual who performs all
these activities. But, in big businesses, it may not be possible for a single person to perform all these activities.
So in such cases two or more persons join hands to finance and manage the business properly and share its
profit as per their agreement. Thus, business organisations may be owned and managed by a single individual
or group of individuals who may form a partnership firm or a joint stock company. Such arrangement of
ownership and management is termed as a form of business organisation. A business organisation usually takes
the following forms in India:
(1) Sole proprietorship
(2) Partnership
(3) Joint Hindu Family (4) Cooperative Society
(5) Joint Stock Company
Let us now learn in detail the exact nature of these forms of business organisation, excluding
Joint Stock Company which will be taken up in the next lesson.
3.2Sole proprietorship
Gopal runs a grocery shop in the local market. He buys goods from the wholesale market and sells it to
the customers as per their requirement. By doing so he earns some profit. He had started his business two
years ago by investing Rs. 1 lakh, which he had borrowed from his friend. Today, he is running his business
successfully, earning a good profit, and has been able to pay back the borrowed money. He has also
employed two persons to help him in the shop. Gopal says, he is the owner of a sole proprietor concern
Definition of Sole Proprietorship
J.L. Hanson: A type of business unit where one person is solely responsible for providing the capital and
bearing the risk of the enterprise, and for the management of the business
3.3 Characteristics Of Sole Proprietorship Form Of Business Organisation
(a) Single Ownership: The sole proprietorship form of business organisation has a single owner who
himself/herself starts the business by bringing together all the resources.
(b) No Separation of Ownership and Management: The owner himself/herself manages the business as per
his/her own skill and intelligence. There is no separation of ownership and management as is the case with
company form of business organisation.

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(c) Less Legal Formalities: The formation and operation of a sole proprietorship form of business
organisation does not involve any legal formalities. Thus, its formation is quite easy and simple
3.4 Merits Of Sole Proprietorship Form Of Business Organisation
(a) Easy to Form and Wind Up: It is very easy and simple to form a sole proprietorship form of business
organisation. No legal formalities are required to be observed. Similarly, the business can be wind up any time
if the proprietor so decides.
b) Quick Decision and Prompt Action: As stated earlier, nobody interferes in the affairs of the sole
proprietary organisation. So he/she can take quick decisions on the various issues relating to business and
accordingly prompt action can be taken.
(c) Direct Motivation: In sole proprietorship form of business organisations. the entire profit of the
business goes to the owner. This motivates the proprietor to work hard and run the business efficiently.
(d) Flexibility in Operation: It is very easy to effect changes as per the requirements of the business. The
expansion or curtailment of business activities does not require many formalities as in the case of other forms of
business organisation
(e) Maintenance of Business Secrets: The business secrets are known only to the proprietor. He is not
required to disclose any information to others unless and until he himself so decides. He is also not bound to
publish his business accounts
(f) Personal Touch: Since the proprietor himself handles everything relating to business, it is easy to
maintain a good personal contact with the customers and employees. By knowing the likes, dislikes and
tastes of the customers, the proprietor can adjust his operations accordingly. Similarly, as the employees
are few and work directly under the proprietor, it helps in maintaining a harmonious relationship with them,
and run the business smoothly.
3.5 Limitations Of Sole Proprietorship Form Of Business Organisation
(a) Limited Resources: The resources of a sole proprietor are always limited. Being the single owner it is
not always possible to arrange sufficient funds from his own sources. Again borrowing funds from
friends and relatives or from banks has its own implications. So, the proprietor has a limited capacity to
raise funds for his business
(b) Lack of Continuity: The continuity of the business is linked with the life of the proprietor. Illness,
death or insolvency of the proprietor can lead to closure of the business. Thus, the continuity of business
is uncertain.
(c) Unlimited Liability: You have already learnt that there is no separate entity of the business from its
owner. In the eyes of law the proprietor and the business are one and the same. So personal properties of
the owner can also be used to meet the business obligations and debts.
(d) Not Suitable for Large Scale Operations : Since the resources and the managerial ability is limited, sole
proprietorship form of business organisation is not suitable for large-scale business
(e) Limited Managerial Expertise: A sole proprietorship from of business organisation always suffers from
lack of managerial expertise. A single person may not be an expert in all fields like, purchasing, selling,
financing etc. Again, because of limited financial resources, and the size of the business it is also not
possible to engage the professional managers in sole proprietorship form of business organisations.

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3.6 Partnership
Partnership is an association of two or more persons who pool their financial and managerial resources and agree
to carry on a business, and share its profit. The persons who form a partnership are individually known as
partners and collectively a firm or partnership firm.
Lets assume that Gopal joins hand with Rahim to start a big grocery shop. Here both Gopal and
Rahim are called partners who are running the partnership firm jointly. Both of them will pool their resources
and carry on business by applying their expertise. They will share the profits and losses in the agreed ratio. In
fact, for all terms and conditions of their working, they have to sit together to decide about all aspects. There
must be an agreement between them. The agreement may be in oral, written or implied. When the agreement is
in writing it is termed as partnership deed. However, in the absence of an agreement, the provisions of the
Indian Partnership Act 1932 shall apply.
Partnership form of business organisation in India is governed by the Indian Partnership Act, 1932
which defines partnership as the relation between persons who have agreed to share the profits of the business
carried on by all or any of them acting for all
3.7 Characteristics Of Partnership Form Of Business Organisation
Based on the definition of partnership as given above, the various characteristics of partnership form of
business organisation, can be summarised as follows
(a) Two or More Persons: To form a partnership firm atleast two persons are required.
The maximum limit on the number of persons is ten for banking business and 20 for other businesses. If the
number exceeds the above limit, the partnership becomes illegal and the relationship among them cannot be
called partnership
(b) Contractual Relationship: Partnership is created by an agreement among the persons who have agreed to
join hands. Such persons must be competent to contract. Thus, minors, lunatics and insolvent persons are
not eligible to become the partners. However, a minor can be admitted to the benefits of partnership firm i.e.,
he can have share in the profits without any obligation for losses.
(c) Sharing Profits and Business: There must be an agreement among the partners to share the profits and
losses of the business of the partnership firm. If two or more persons share the income of jointly owned
property, it is not regarded as partnership.
d) Existence of Lawful Business: The business of which the persons have agreed to share the profit must be
lawful.Any agreement to indulge in smuggling, black marketing etc. cannot be called partnership business in
the eyes of law.
(e) Principal Agent Relationship: There must be an agency relationship between the partners. Every
partner is the principal as well as the agent of the firm. When a partner deals with other parties he/she acts as
an agent of other partners, and at the same time the other partners become the principal.
(f) Unlimited Liability: The partners of the firm have unlimited liability. They are jointly as well as
individually liable for the debts and obligations of the firms. If the assets of the firm are insufficient to
meet the firms liabilities, the personal properties of the partners can also be utilised for this purpose.
However, the liability of a minor partner is limited to the extent of his share in the profits
(g) Voluntary Registration: The registration of partnership firm is not compulsory. But an unregistered firm
suffers from some limitations which makes it virtually compulsory to be registered. Following are the
limitations of an unregistered firm
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3.8 Merits Of Partnership Form Of Business Organisation


(a) Easy to Form: A partnership can be formed easily without many legal formalities.
Since it is not compulsory to get the firm registered, a simple agreement, either in oral, writing or implied is
sufficient to create a partnership firm.
(b) Availability of Larger Resources: Since two or more partners join hands to start partnership firm it
may be possible to pool more resources as compared to sole proprietorship form of business
organisation.
(c) Better Decisions: In partnership firm each partner has a right to take part in the management of the
business. All major decisions are taken in consultation with and with the consent of all partners. Thus,
collective wisdom prevails and there is less scope for reckless and hasty decisions.
(d) Flexibility: The partnership firm is a flexible organisation. At any time the partners can decide to change
the size or nature of business or area of its operation after taking the necessary consent of all the partners.
(e) Sharing of Risks: The losses of the firm are shared by all the partners equally or as per the agreed ratio.
(f) Keen Interest: Since partners share the profit and bear the losses, they take keen interest in the affairs
of the business.
(g) Benefits of Specialisation: All partners actively participate in the business as per their specialisation
and knowledge. In a partnership firm providing legal consultancy to people, one partner may deal with
civil cases, one in criminal cases, another in labour cases and so on as per their area of specialisation.
Similarly two or more doctors of different specialisation may start a clinic in partnership.
(h) Protection of Interest: In partnership form of business organisation, the rights of each partner and
his/her interests are fully protected. If a partner is dissatisfied with any decision, he can ask for dissolution
of the firm or can withdraw from the partnership.
(i) Secrecy: Business secrets of the firm are only known to the partners. It is not required to disclose any
information to the outsiders. It is also not mandatory to publish the annual accounts of the firm.
3.9 Limitations Of Partnership Form Of Business Organisation
A partnership firm also suffers from certain limitations. These are as follows:
(a) Unlimited Liability: The most important drawback of partnership firm is that the
liability of the partners is unlimited i.e., the partners are personally liable for the debt and obligations of
the firm. In other words, their personal property can also be utilised for payment of firms liabilities.
(b) Instability: Every partnership firm has uncertain life. The death, insolvency, incapacity or the retirement of
any partner brings the firm to an end. Not only that any dissenting partner can give notice at any time for
dissolution of partnership.
(c) Limited Capital: Since the total number of partners cannot exceed 20, the capacity to raise funds remains
limited as compared to a joint stock company where there is no limit on the number of share holders.
(d) Non-transferability of share: The share of interest of any partner cannot be transferred to other
partners or to the outsiders. So it creates inconvenience for the partner who wants to transfer his share to
others fully and partly. The only alternative is dissolution of the firm.
(e) Possibility of Conflicts: You know that in partnership firm every partner has an equal right to
participate in the management. Also every partner can place his or her opinion or viewpoint before the
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management regarding any matter at any time. Because of this, sometimes there is friction and quarrel among
the partners. Difference of opinion may give rise to quarrels and lead to dissolution of the firm.
3.10 Types Of Partners
You have learnt that normally every partner in a firm contributes to its capital, participates in the day-today management of firms activities, and shares its profits and losses in the agreed ratio. In other words all
partners are supposed to be active partners. However, in certain cases there are partners who play a limited
role. They may contribute capital and such partners cannot be termed as active partners. Similarly, some
persons may simply lend their name to the firm and make no contribution to capital of the firm. Such persons
are partners only in name. Thus, depending upon the extent of participation and the sharing of profits, liability
etc., partners can be classified into various categories. These are summarised here under
(a) Based on the extent of participation in the day-to-day management of the firm partners can
be classified as Active Partners and Sleeping Partners. The partners who actively participate in the day-today operations of the business are known as active partners or working partners. Those partners who do
not participate in the day-to-day activities of the business are known as sleeping or dormant partners. Such
partners simply contribute capital and share the profits and losses

(b) Based on Liability, the partners can be classified as Limited Partners and General Partners. The
liability of limited partners is limited to the extent of their capital contribution. This type of partners is
found in Limited Partnership firms in some European countries and USA. So far, it is not allowed in India.
However, the Limited liability Partnership Act is very much under consideration of the Parliament. The
partners having unlimited liability are called as general partners or Partners with unlimited liability. It may be
noted that every partner who is not a limited partner is treated as a general partner.

(c) Based on the behaviour and conduct exhibited, there are two more types of partners besides the
ones discussed above. These are (a) Partner by Estoppel; and (b) Partner by Holding out. A person who
behaves in the public in such a way as to give an impression that he/she is a partner of the firm, is called
partner by estoppel. Such partners are not entitled to share the profits of the firm, but are fully liable if some
body suffers because of his/her false representation. Similarly, if a partner or partnership firm declares that a
particular person is a partner of their firm, and such a person does not disclaim it, then he/she is known as
Partner by Holding out. Such partners are not entitled to profits but are fully liable as regards the firms
debts
.
3.11 Suitability Of Partnership Form Of Business Organisation
We have already learnt that persons having different ability, skill or expertise can join hands to form a
partnership firm to carry on the business. Business activities like construction, providing legal services, medical
services etc. can be successfully run under this form of business organisation. It is also considered suitable where
capital requirement is of a medium size. Thus, business like a wholesale trade, professional services, mercantile
houses and small manufacturing units can be successfully run by partnership firms

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3.12 Formation Of Partnership Form Of Business Organisation
The following steps are to be taken in order to form a partnership firm:
(a) Minimum two members are required to form a partnership. The maximum limit is ten in banking and 20 in
other businesses.
(b) Select the like-minded persons keeping in view the nature and objectives of the business.
(c) There must be an agreement among the partners to carry on the business and share the profits and losses.
This agreement must preferably be in writing and duly signed by the all the partners. The agreement, i.e., the
partnership deed must contain the following:
(i)

Name of the firm

(ii) Nature of the business


(iii) Names and addresses of partners
(iv) Location of business
(v) Duration of partnership, if decided
(vi)
Amount of capital to be
contributed by each partner
(vii) Profit and loss sharing ratio
(viii) Duties, powers and obligations of partners. (ix)

Salaries and

withdrawals of the partners


(x)

Preparation of accounts and their auditing. (xi) Procedure for

dissolution of the firm etc. (xii) Procedure for settlement of disputes


(d) The partners should get their firm registered with the Registrar of Firms of the concerned state. Although
registration is not compulsory, but to avoid the consequences of non- registration, it is advisable to get it
registered when it is setup or at any time during its existence. The procedure for registration of a firm is as
follows.
(i) The firm will have to apply to the Registrar of Firms of the concerned state in the prescribed form.
(ii) The duly filled in form must be signed by all the partners.
3.13 Joint Hindu Family Form Of Business Organisation
After knowing about sole proprietorship and partnership forms of business organisation let us now discuss
about a unique form of business organisation that prevails only in India and that too among the Hindus. The Joint
Hindu Family (JHF) business is a form of business organisation run by Hindu Undivided Family (HUF), where
the family members of three successive generations own the business jointly. The head of the family known as
Karta manages the business. The other members are called co-parceners and all of them have equal
ownership right over the properties of the business.
The membership of the JHF is acquired by virtue of birth in the same family. There is no restriction for minors
to become the members of the business. As per Dayabhaga system of Hindu Law, both male and female
members are the joint owners. But Mitakashara system of Hindu Law says only male members of the family
can become the coparceners. While the Dayabhaga system is applicable to the state of West Bengal, Mitakshara
system
of
Hindu
Law
is
applicable
to
the
rest
of
the
country
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3.14 Characteristics Of Jhf Form Of Business Organisation


From the above discussion, it must have been clear to you that the Joint Hindu family business has certain
special characteristics which are as follows:
(a) Formation: In JHF business there must be at least two members in the family, and family should have some
ancestral property. It is not created by an agreement but by operation of law.
(b) Legal Status: The JHF business is a jointly owned business. It is governed by the
Hindu Succession Act 1956.
(c) Membership: In JHF business outsiders are not allowed to become the coparcener.
Only the members of undivided family acquire co-parcenership rights by birth.. (d) Profit Sharing: All
coparceners have equal share in the profits of the business.
(e) Management: The business is managed by the senior most member of the family known as Karta. Other
members do not have the right to participate in the management. The Karta has the authority to manage the
business as per his own will and his ways of managing cannot be questioned. If the coparceners are not
satisfied, the only remedy is to get the HUF status of the family dissolved by mutual agreement.
(f) Liability: The liability of coparceners is limited to the extent of their share in the business. But the Karta
has an unlimited liability. His personal property can also be utilised to meet the business liability.
(g) Continuity: Death of any coparceners does not affect the continuity of business.
Even on the death of the Karta, it continues to exist as the eldest of the coparceners takes position of Karta.
However, JHF business can be dissolved either through mutual agreement or by partition suit in the court.

3.15 Merits Of Jhf Form Of Business Organisation


Since Joint Hindu Family business has certain peculiar features as discussed above, it has the following merits.
(a) Assured Shares in Profits: Every coparcener is assured of an equal share in the profits irrespective of his
participation in the running of the business. This safeguards the interest of minor, sick, physically and mentally
challenged coparceners.
(b) Quick Decision: The Karta enjoys full freedom in managing the business. It enables him to take quick
decisions without any interference.
(c) Sharing of Knowledge and Experience: A JHF business provides opportunity for the young members of
the family to get the benefits of knowledge and experience of the elder members. It also helps in inculcating
virtues like discipline, self-sacrifice, tolerance etc.
(d) Limited Liability of Members: The liability of the coparceners except the Karta is limited to the extent of
his share in the business. This enables the members to run the business freely just by following the instructions or
direction of the Karta

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(f) Continued Existence: The death or insolvency of any member does not affect the continuity of
the business. So it can continue for a long period of time.
(g) Tax Benefits: HUF is regarded as an independent assessee for tax purposes. The share of
coparceners is not to be included in their individual income for tax purposes.
3.16 Limitation Of Jhf Form Of Business Organisation
(a) Limited Resources: JHF business has generally limited financial and managerial resource.
Therefore, it is not considered suitable for large business.
(b) Lack of Motivation: The coparceners get equal share in the profits of the business irrespective of
their participation. So generally they are not motivated to put in their best.
(c) Scope for Misuse of Power: Since the Karta has absolute freedom to manage the business,
there is scope for him to misuse it for his personal gains. Moreover, he may have his own limitations.
(d) Instability: The continuity of JHF business is always under threat. A small rift within the family may
lead to seeking partition
3.17 Cooperative organisation
You have learnt about Sole Proprietorship, Partnership and Joint Hindu Family as different forms of
business organisation. You must have noticed that while there are many differences among them in respect
of their formation, operation, capital contribution and liabilities, there is one similarity that they all are
engaged in business to earn profit. However, there are certain organisations which undertake business
activities with the prime objective of providing service to the members. Although they also earn some
amount of profit, but their main intention is to look after some common interest of its members. They
pool available resources from the members, utilise the same in the best possible manner and share the
benefits. These organisations are known as Cooperative Societies. Let us learn in detail about this
form of business organisation.
The term cooperation is derived from the Latin word co-operari, where the word Co means with
and operari mean to work. Thus, the term cooperation means working together. So those who
want to work together with some common economic objectives can form a society, which is termed as
cooperative society.
3.18 Characteristics Of Cooperative Society
Based on the above definition we can identify the following characteristics of cooperative society form
of business organisation:
(a) Voluntary Association: Members join the cooperative society voluntarily i.e., by their own
choice. Persons having common economic objective can join the society as and when they like,
continue as long as they like and leave the society and when they want.
(b) Open Membership: The membership is open to all those having a common economic interest. Any
person can become a member irrespective of his/her caste, creed, religion, colour, sex etc.
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(c) Number of Members: A minimum of 10 members are required to form a cooperative


society. In case of multi-state cooperative societies the minimum number of members should be
50 from each state in case the members are individuals. The Cooperative Society Act does not
specify the maximum number of members for any cooperative society. However, after the
formation of the society, the member may specify the maximum member of members.
(d) Registration of the Society: In India, cooperative societies are registered under the Cooperative
Societies Act 1912 or under the State Cooperative Societies Act. The Multi-state Cooperative
Societies are registered under the Multi-state Cooperative Societies Act 2002. Once registered,
the society becomes a separate legal entity and attain certain characteristics. These are as follows.
(i) The society enjoys perpetual succession
(ii) It has its own common seal
(iii) It can enter into agreements with others
(iv) It can sue others in a court of law
(v) It can own properties in its name
3.19 Types Of Cooperative Societies
You know cooperative organisations are set up in different fields to promote the economic well-being of
different sections of the society. So, according to the needs of the people, we find different types of
cooperative societies in India. Some of the important types are given below.
(a) Consumers Cooperative Societies: These societies are formed to protect the interest of
consumers by making available consumer goods of high quality at reasonable price.
(b) Producers Cooperative Societies: These societies are formed to protect the interest of small
producers and artisans by making available items of their need for production, like raw materials,
tools and equipments etc.
(c)

Marketing Cooperative Societies: To solve the problem of marketing the products, small
producers join hand to form marketing cooperative societies.

(d) Housing Cooperative Societies: To provide residential houses to the members, housing
cooperative societies are formed generally in urban areas.
(e) Farming Cooperative Societies: These societies are formed by the small farmers to get the benefit
of large-scale farming.
(f) Credit Cooperative Societies: These societies are started by persons who are in need of
credit. They accept deposits from the members and grant them loans at reasonable rate of
interest

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3.20 Merits Of Cooperative Society


The cooperative society is the only form of business organisation which gives utmost importance
to its members rather than maximising its own profits. After studying its characteristics and
different types, we may now study the merits of this form of business organisation
(a) Easy to Form: Any ten adult members can voluntarily form an association get it registered
with the Registrar of Cooperative Societies. The registration is very simple and it does not require
much legal formalities.
(b) Limited Liability: The liability of the members of the cooperative societies is limited upto their
capital contribution. They are not personally liable for the debt of the society.
(c) Open Membership: Any competent like-minded person can join the cooperative society any
time he likes. There is no restriction on the grounds of caste, creed, gender, colour etc. The time of
entry and exit is also generally kept open.
(d) Stable Life: The cooperative society enjoys the benefit of perpetual succession. The death,
resignation, insolvency of any member does not affect the existence of the society because of its
separate legal entity.
(e) Tax Concession: To encourage people to form co-operative societies the government generally
provides tax concessions and exemptions, which keep on changing from time to time.
(f) Democratic Management: The cooperative societies are managed by the Managing Committee,
which is elected by the members. The members decide their own rules and regulations within the
limits set by the law.

3.21 Limitations Of Cooperative Society


Although the basic aim of forming a cooperative society is to develop a system of mutual help and
cooperation among its members, yet the feeling of cooperation does not remain for long. Cooperative
societies usually suffer from the following limitations.
(a) Limited Capital: Most of the cooperative societies suffer from lack of capital. Since the members
of the society come from a limited area or class and usually have limited means, it is not possible to
collect huge capital from them. Again, governments assistance is often inadequate for them.
(b) Lack of Managerial Expertise: The Managing Committee of a cooperative society is not always
able to manage the society in an effective and efficient way due to lack of managerial expertise.
Again due to lack of funds they are also not able to derive the benefits of professional management.
(c) Less Motivation: Since the rate of return on capital investment is less, the members do not always
feel involved in the affairs of the society.
(d) Lack of Interest: Once the first wave of enthusiasm to start and run the business is exhausted,
intrigue and factionalism arise among members. This makes the cooperative lifeless and inactive.
(e) Corruption: Inspite of governments regulation and periodical audit of the accounts of the
cooperative society, the corrupt practices in the management cannot be completely ignored.

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3.22 Formation Of Cooperative Society


A cooperative society can be formed as per the provisions of the Cooperative Societies Act, 1912, or
under the Cooperative Societies Acts of the respective states. The various common requirements
prescribed for registration of a cooperative society are as follows:
(a) There must be at least ten persons having common economic interest and must be capable of
entering into contract. For multi-state cooperative societies at least 50 individual members from
each state should be present.
(b) A suitable name should be proposed for the society. (c) The draft
bye-laws of the society should be prepared.
(d) After completing the above formalities, the society should go for its registration.
(e) For registration, application in prescribed form should be made to the Registrar of
Cooperative Societies of the state in which the society is to be formed.
(f) The application for registration shall be accompanied by four copies of the proposed bye-laws of
the society.
(g) The application must be signed by every member of the society.
(h) After scrutinising of the application and the bye-laws, the registrar issues the registration certificate.
(i) The society can start its operation after getting the certificate of registration.
Mixed economy
Mixed economy is an economic system in which both the private sector andstate direct
the economy, reflecting characteristics of both market economiesand planned economies.
Most mixed economies
can be
described
as market
economies with
strong regulatory oversight and governmental provision ofpublic goods. Some mixed economies
also feature a variety of state-run enterprises.
In general the mixed economy is characterised by the private ownership of themeans of
production, the dominance of markets for economic coordination, with profit-seeking enterprise
and the accumulation of capital remaining the fundamental driving force behind economic
activity. But unlike a free-market economy, the government would wield indirect
macroeconomic influence over the economy through fiscal and monetary policies designed to
counteract economic downturns and capitalism's tendency toward financial crises
andunemployment, along with playing a role in interventions that promote social welfare.
Subsequently, some mixed economies have expanded in scope to include a role
for indicative economic planning and/or large public enterprisesectors.
There is not one single definition for a mixed economy,

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with it defined variously as a mixture of free markets with state interventionism, or as a mixture
of public and private enterprise, or as a mixture between markets and economic planning. The
relative strength or weakness of each component in the national economy can vary greatly
between countries. Economies ranging from the United States to Cuba have been termed mixed
economies. The term is also used to describe the economies of countries which are referred to
as welfare states, such as the Nordic countries. Governments in mixed economies often
provide environmental
protection,
maintenance
of employment
standards,
a
standardized welfaresystem, and maintenance of competition.
As an economic ideal, mixed economies are supported by people of various political persuasions,
typically centre-left andcentre-right, such as social democrats or Christian democrats. Supporters
view mixed economies as a compromise between state socialism and free-market capitalism that
is superior in net effect to either of those.

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CHAPTER-4
FINANCING

4.1 Types of Loans


Loan types vary because each loan has a specific intended use. They can vary by length of time,
by how interest rates are calculated, by when payments are due and by a number of other
variables.
Student Loans
Student loans are offered to college students and their families to help cover the cost of higher
education. There are two main types of student loans: those offered by the federal government,
and those offered by private lenders. Federally funded loans are better, as they typically come
with lower interest rates and more borrower-friendly repayment terms.

Learn more about student loans.

Mortgages
Mortgages are loans distributed by banks to allow consumers to buy homes they cant pay for
upfront. A mortgage is tied to your home, meaning you risk foreclosure if you fall behind on
loan payments. Mortgages have among the lowest interest rates of any loans.

Learn more about mortgages.

Auto Loans
Like mortgages, auto loans are tied to your property. They can help you afford a vehicle, but you
risk losing the car if you miss payments. This type of loan may be distributed by a bank or by the
car dealership directly. While loans from the dealership may be more convenient, they often cost
more overall.

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Learn more about auto loans.


Personal Loans
Personal loans can be used for any personal expenses and dont have a designated purpose. This
makes them an attractive option for people with outstanding debts, such as credit card debt, who
want to reduce their interest rates by transferring balances. Like other loans, personal loan terms
depend on your credit history.

4.2 EXTERNAL COMMERCIAL BORROWINGS (ECB)


Indian companies are allowed to access funds from abroad in the following methods:
(i) External Commercial Borrowings (ECB): ECBs refer to commercial loans in the form of
bank loans, securitized instruments (e.g. floating rate notes and fixed rate bonds, nonconvertible, optionally convertible or partially convertible preference shares), buyers credit,
suppliers credit availed of from non-resident lenders with a minimum average maturity of 3
years.
(ii) Foreign Currency Convertible Bonds (FCCBs): FCCBs mean a bond issued by an Indian
company expressed in foreign currency, and the principal and interest in respect of which is
payable in foreign currency. The bonds are required to be issued in accordance with the scheme
viz., "Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary
Receipt Mechanism) Scheme, 1993, and subscribed by a non-resident in foreign currency and
convertible into ordinary shares of the issuing company in any manner, either in whole, or in
part, on the basis of any equity related warrants attached to debt instruments. The ECB policy is
applicable to FCCBs. The issue of FCCBs is also required to adhere to the provisions
ofNotification FEMA No. 120/RB-2004 dated July 7, 2004, as amended from time to time.
(iii) Preference shares: Preferences Shares (i.e. non-convertible, optionally convertible or
partially convertible) for issue of which, funds have been received on or after May 1, 2007 would
be considered as debt and should conform to the ECB policy. Accordingly, all the norms
applicable for ECB, viz. eligible borrowers, recognized lenders, amount and maturity, end use
stipulations, etc. shall apply. Since these instruments would be denominated in Rupees, the rupee
interest rate will be based on the swap equivalent of LIBOR plus the spread as permissible for
ECBs of corresponding maturity.
(iv) Foreign Currency Exchangeable Bonds (FCEBs): FCEBs means a bond expressed in
foreign currency, the principal and interest in respect of which is payable in foreign currency,
issued by an Issuing Company and subscribed to by a person who is a resident outside India, in
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foreign currency and exchangeable into equity share of another company, to be called the
Offered Company, in any manner, either wholly, or partly or on the basis of any equity related
warrants attached to debt instruments. The FCEBs must comply with the Issue of Foreign
Currency Exchangeable Bonds (FCEB) Scheme, 2008, notified by the Government of India,
Ministry of Finance, Department of Economic Affairs vide Notification G.S.R.89(E) dated
February 15, 2008. The guidelines, rules, etc. governing ECBs are also applicable to FCEBs.
ECB can be accessed under two routes, viz., (i) Automatic Route outlined in paragraph I (A) and
(ii) Approval Route outlined in paragraph I (B).
ECB for investment in real sector-industrial sector, infrastructure sector and specified service
sectors in India as indicated under para I (A) (i) (a) are under the Automatic Route, i.e. do not
require Reserve Bank / Government of India approval. In case of doubt as regards eligibility to
access the Automatic Route, applicants may take recourse to the Approval Route. It is clarified
that eligibility for an ECB in respect of eligible borrowers, recognised lenders, end-uses, etc.
have to be read in conjunction and not in isolation.

4.3 International Finance Corporations.


The International Finance Corporation (IFC) is an international financial institution that offers
investment, advisory, and asset management services to encourage private sector development in
developing countries. The IFC is a member of the World Bank Group and is headquartered in
Washington, D.C., United States. It was established in 1956 as the private sector arm of the
World Bank Group to advance economic development by investing in strictly for-profit and
commercial projects that purport to reduce poverty and promote development.[1][2][3] The IFC's
stated aim is to create opportunities for people to escape poverty and achieve better living
standards by mobilizing financial resources for private enterprise, promoting accessible and
competitive markets, supporting businesses and other private sector entities, and creating jobs
and delivering necessary services to those who are poverty-stricken or otherwise vulnerable.[4]
Since 2009, the IFC has focused on a set of development goals that its projects are expected to
target. Its goals are to increase sustainable agriculture opportunities, improve health and
education, increase access to financing for microfinance and business clients, advance
infrastructure, help small businesses grow revenues, and invest in climate health.[5]

The IFC is owned and governed by its member countries, but has its own executive leadership
and staff that conduct its normal business operations. It is a corporation whose shareholders are
member governments that provide paid-in capital and which have the right to vote on its matters.
Originally more financially integrated with the World Bank Group, the IFC was established
separately and eventually became authorized to operate as a financially autonomous entity and
make independent investment decisions. It offers an array of debt and equity financing services

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and helps companies face their risk exposures, while refraining from participating in a
management capacity. The corporation also offers advice to companies on making decisions,
evaluating their impact on the environment and society, and being responsible. It advises
governments on building infrastructure and partnerships to further support private sector
development.

The corporation is assessed by an independent evaluator each year. In 2011, its evaluation report
recognized that its investments performed well and reduced poverty, but recommended that the
corporation define poverty and expected outcomes more explicitly to better-understand its
effectiveness and approach poverty reduction more strategically. The corporation's total
investments in 2011 amounted to $18.66 billion. It committed $820 million to advisory services
for 642 projects in 2011, and held $24.5 billion worth of liquid assets. The IFC is in good
financial standing and received the highest ratings from two independent credit rating agencies in
2010 and 2011.
4.4 Objectives of Funds Flow:
Profit & Loss Account and Balance Sheet are not able to give answer to some basic questions.
For this purpose Funds Flow Statement is prepared. According to Perry Mason who points out in
AICPA Research Study No. 2 that without such a statement, the following questions will remain
unanswered:
Meaning of the term Fund: - The term Fund has been assigned different meanings by
different people. In narrow sense Funds means cash and Bank balance. To many people funds
is nothing but having the net effect of various business events on the basis of cash. This explains
the trend towards the preparation and presentation of "Cash Flow Statement" in published report
of accounts.

But in wider sense the term Fund is the sum of cash and assets, which are easily convertible
into cash minus current liabilities. In other words Fund means excess of current assets over
current liabilities. Where current assets include cash in hand, cash at bank, bills receivable,
sundry debtors, stock, marketable securities and prepaid expenses etc. The current liabilities
include sundry creditors, bills payable, outstanding expenses, short-term loans and bank
overdraft etc.

Funds = Current Assets Current Liabilities = Working Capital

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Meaning of the term Flow: - The term Flow means change. Therefore flow of funds means
change in working capital. The change in funds may be either positive or negative. It may be
inflow of funds or outflow of funds.
4.5 Financial Statement Analysis
The process of reviewing and evaluating a company's financial statements (such as the balance
sheet or profit and loss statement), thereby gaining an understanding of the financial health of the
company and enabling more effective decision making. Financial statements record financial
data; however, this information must be evaluated through financial statement analysis to
become more useful to investors, shareholders, managers and other interested parties.
Financial ratio analysis
Financial ratios are very powerful tools to perform some quick analysis of financial statements.
There are four main categories of ratios: liquidity ratios, profitability ratios, activity ratios and
leverage ratios. These are typically analyzed over time and across competitors in an industry.

Liquidity ratios are used to determine how quickly a company can turn its assets into cash if it
experiences financial difficulties or bankruptcy. It essentially is a measure of a company's ability
to remain in business. A few common liquidity ratios are the current ratio and the liquidity index.
The current ratio is current assets/current liabilities and measures how much liquidity is available
to pay for liabilities.
Profitability ratios are ratios that demonstrate how profitable a company is. A few popular
profitability ratios are the breakeven point and gross profit ratio. The breakeven point calculates
how much cash a company must generate to break even with their start up costs. The gross profit
ratio is equal to (revenue - the cost of goods sold)/revenue. This ratio shows a quick snapshot of
expected revenue.
Activity ratios are meant to show how well management is managing the company's resources.
Two common activity ratios are accounts payable turnover and accounts receivable turnover.
These ratios demonstrate how long it takes for a company to pay off its accounts payable and
how long it takes for a company to receive payments, respectively.
Internal financing
In the theory of capital structure, internal financing is the name for a firm using its profits as a
source of capital for new investment, rather than a) distributing them to firm's owners or other
investors and b) obtaining capital elsewhere. It is to be contrasted with external financing which
consists of new money from outside of the firm brought in for investment. Internal financing is
generally thought to be less expensive for the firm than external financing because the firm does

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not have to incur transaction costs to obtain it, nor does it have to pay the taxes associated with
paying dividends. Many economists debate whether the availability of internal financing is an
important determinant of firm investment or not. A related controversy is whether the fact that
internal financing is empirically correlated with investment implies firms are credit constrained
and therefore depend on internal financing for investment
Long-term liabilities
Long-term liabilities are liabilities with a future benefit over one year, such as notes payable that
mature longer than one year.
In accounting, the long-term liabilities are shown on the right wing of the balance-sheet
representing the sources of funds, which are generally bounded in form of capital assets.
Examples of long-term liabilities are debentures, mortgage loans and other bank loans. (Note:
Not all bank loans are long term as not all are paid over a period greater than a year, an example
of this is a bridging loan.)
By convention, the portion of long-term liabilities that must be paid in the coming 12-month
period are classified as current liabilities. For example, a loan for which two payments of $1000
are due, one in the next twelve months and the other after that date, would be 'split' into two: the
first $1000 would be classified as a current liability, and the second $1000 as a long-term
liability (note this example is simplified, and does not take into account any interest or
discounting effects, which may be required depending on the accounting rules).
4.6 LONG-TERM BORROWING
Twice a year (generally in the Spring & Fall following the Annual General Meeting and SemiAnnual respectively) the MFA will fund the loan requests of clients which have been vetted
through all appropriate approval processes. Dates for regional district submission of loans
requests are typically one month prior to the Annual General Meeting and Semi-Annual meeting.
Once a loan has been approved, clients can generally expect funding to occur in April for the
Spring Issue or October for the Fall Issue. On occasion, the funding date may vary so please
monitor the website for updates. If funds are required prior to issuance, please access our Short
Term Borrowing page. The MFA will determine the exact date of funding as it monitors the
capital market for the best interest rates available.
Proceeds on a loan request will be 98.40% of the gross amount of the loan. 1.00% is deducted by
the MFA for security against loan default (this is held in trust by the MFA in its Debt Reserve
Fund* and will be refunded to clients, with interest, at loan expiry). The other 0.60% is deducted
as issue expenses to cover the costs of raising money - Bank Syndicate costs.

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Each new issue will generally be for a 10 year term, which means the lending rate will be set
from the date of funding for a period of 10 years. Members have the option to borrow for periods
ranging from of 5 to 30 years, therefore, any terms that exceed the 10 year period will have the
lending rate reset starting in year 11. Typically, the rate will be reset for the next 5 years
covering the start of year 11 to the end of year 15, and this 5 year reset process will continue as
required (i.e. until loan obligations mature). Interest payments will be required semi-annually;
with the first interest payment being 6 months after proceeds are received. Interest costs over the
life of the loan are based on the original amount borrowed.
4.7 Short-Term Borrowing:
An account shown in the current liabilities portion of a company's balance sheet. This account is
comprised of any debt incurred by a company that is due within one year. The debt in this
account is usually made up of short-term bank loans taken out by a company.
Definition of Short-Term Borrowings
Under the proposed rule, short-term borrowings would be defined by reference to
the various categories of arrangements that comprise the short-term obligations reflected in a
registrants financial statements, and all registrants would be required to present information
for each category of short-term borrowings. Specifically, as proposed, short-term
borrowings would mean amounts payable for short-term obligations that are:
1. Federal funds purchased and securities sold under agreements to repurchase;
2. Commercial paper;
3. Borrowings from banks;
4. Borrowings from factors or other financial institutions; and
5. Any other short-term borrowings reflected on the registrants balance sheet.

4.8 Balance sheet:


A Balance Sheet may well be described as a ststement of assets and liabilities including
capital amount.It reveals the assets and liabilities and capital amount as on a periodic of time.It
highlighys the asseys possessed by a business and sources of funds used in periodic change
rather than continuous one.In this sense it is statics where as business is dynamic.

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4.9 Profit or Loss Account:


The income statement and profit or loss account are not different but are interchaneably
used.Where as in U.S.A.income statement is a popular usage in U.K.it is more commonly
referred to as profit and loss account.According to AICPA terminology,income statement is
defined as a statement which shows the principal elements the positive and negative in the
derivations of income or loss the claims against income and the resulting net income or loss of
accounting unit.It simple words an income statement shows revenue and expences of an
accounting period.It matches revenue with cost.If the revenue exceeds the cost it implies the
profitability of business and of cost exceed revenue it implies the loss suffered by the
business.The same view hass been expressed by HARAY &GUTHMAN when he wrote that
"the statement of profit or loss is condensed and classified record of gains and losses causing
changes in the owners interest in the business for a period of time.

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CHAPTER-5
COST AND BREAK EVEN ANALYSES

5.1 Methods of Costing and Types of Costing


Methods of Costing
Different industries follow different methods to establish the cost of their product. This varies by
the nature and specifics of each business. There are different principles and procedures for
performing the costing. However, the basic principles and procedures of costing remain the
same. Some of the methods are mentioned below:
1. Unit costing
2. Job costing
3. Contract costing
4. Batch costing
5. Operating costing
6. Process costing
7. Multiple costing
8. Uniform costing

Unit costing: This method is also known as "single output costing." This method of costing is
used for products that can be expressed in identical quantitative units. Unit costing is suitable for
products that are manufactured by continuous manufacturing activity: for example, brick
making, mining, cement manufacturing, dairy operations, or flour mills. Costs are ascertained for
convenient units of output.
Job costing: Under this method, costs are ascertained for each work order separately as each job
has its own specifications and scope. Job costing is used, for example, in painting, car repair,
decoration, and building repair.
Contract costing: Contract costing is performed for big jobs involving heavy expenditure, long
periods of time, and often different work sites. Each contract is treated as a separate unit for
costing. This is also known as terminal costing. Projects requiring contract costing include
construction of bridges, roads, and buildings.
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Batch costing: This method of costing is used where units produced in a batch are uniform in
nature and design. For the purpose of costing, each batch is treated as an individual job or
separate unit. Industries like bakeries and pharmaceuticals usually use the batch costing method.
Operating costing or service costing: Operating or service costing is used to ascertain the cost
of particular service-oriented units, such as nursing homes, busses, or railways. Each particular
service is treated as a separate unit in operating costing. In the case of a nursing home, a unit is
treated as the cost of a bed per day, while, for busses, operating cost for a kilometer is treated as
a unit.
Process costing: This kind of costing is used for products that go through different processes.
For example, the manufacturing of clothes involves several processes. The first process is
spinning. The output of that spinning process, yarn, is a finished product which can either be sold
on the market to weavers, or used as a raw material for a weaving process in the same
manufacturing unit. To find out the cost of the yarn, one needs to determine the cost of the
spinning process. In the second step, the output of the weaving process, cloth, can also can be
sold as a finished product in the market. In this case, the cost of cloth needs to be evaluated. The
third process is converting the cloth to a finished product, for example a shirt or pair of trousers.
Each process that can result in either a finished good or a raw material for the next process must
be evaluated separately. In such multi-process industries, process costing is used to ascertain the
cost at each stage of production.
Multiple costing or composite costing: When the output is comprised of many assembled parts
or components, as with television, motor cars, or electronics gadgets, costs have to be ascertained
for each component, as well as with the finished product. Such costing may involve different
methods of costing for different components. Therefore, this type of costing is known as
composite costing or multiple costing.
Uniform costing: This is not a separate method of costing, but rather a system in which a
number of firms in the same industry use the same method of costing, using agreed-on principles
and standard accounting practices. This helps in setting the price of the product and in inter-firm
comparisons..

Types of costing :
Different cost accounting techniques are used in different industries to analyze and present costs
for the purposes of control and managerial decisions. The generally-used types of costing are as
follows:
Marginal costing: Marginal costing entails the allocation of only variable costs, i.e. direct
materials, direct labour and other direct expenses, and variable overheads to the production. It

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does not take into account the fixed cost of production. This type of costing emphasizes the
distinction between fixed and variable costs.
Absorption costing: In absorption costing, the full costs (that is, both fixed and variable costs)
are absorbed into production.
Standard costing: In standard costing, a cost is predicted in advance of production, based on
predetermined standards under a given set of operating conditions. Standard costs are compared
with actual costs periodically, and revised to avoid losses due to outdated costing.
Historical costing: Historical costing, unlike standard costing, uses actual costs, determined
after they have been incurred. Almost all organizations use the historical costing system of
accounting for costs.
Traditional costing
Basically, the traditional costing is used commonly by manufacturing companies to assign
manufacturing overheads to the units they produce. Using this, only the products are assigned an
overhead cost by the accountant. The downside of this method of costing is that it neglects to
consider the non-manufacturing costs like administration expenses which are associated with
production. Today, such method is considered outdated because a lot of the manufacturing
companies already use computers and machines for their production. Also business accounting
software is already being used widely. On the brighter side, the traditional costing is easy to use
especially for those companies that have one product.
Activity-based costing
On the other hand, the activity-based costing (ABC) is a more logical method of assigning
manufacturing overhead costs to products. Unlike traditional costing that simply assigns costs
based on the machine work hours, the ABC assigns costs first to the activities and processes that
cause the overhead. Then, these costs are assigned only to the products that require the activities.
Simply saying, the ABC is typically used as a supplemental costing system for businesses.
Difference between Activity-based costing and Traditional Costing

The difference between ABC or Activity Based Costing and TCA or Traditional Cost
Accounting is that ABC is complex whereas TCA is simple.

The ABC system began in 1981 whereas TCA methods were designed and developed between
1870 to 1920. In the TCA system, the cost objects and used up resources are required to evaluate

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the cost whereas in the ABC system the cost is dependent upon the activities used up by the cost
objects.

Activity Based Costing is accurate and preferred over the TCA cost management system. The
ABC method of cost management system is adopted when the overheads of the company are
high and there are large numbers of miscellaneous products. Inaccuracy or errors are most
unwanted and undesirable because of the competitive rates set by the competitors in the market.
Due to this heavy and stiff competition, a highly reliable and accurate method is required for the
cost management.

TCA or Traditional Cost Accounting uses a single overhead pool and is not able to calculate the
true cost. The costs of the objects are allocated randomly based upon the labor or machine hours
etc. ABC costing includes identifiable products parts or labor whereas TCA arbitrarily
accumulates expenses, salaries, depreciations etc.

Smaller targeted costs that are built upon activities are calculated with the help of the ABC
system. The ABC system is advantageous since it helps in simplifying the decision making
process and it makes management concepts become clear and target -oriented. It also helps in
evaluating performances and sets standards which can help the manager to use this information
for comparison purposes.

In the Traditional Cost Accounting System, the company determines the cost of production after
the products have been produced whereas in the target or Activity Based Accounting System, the
value or cost of the product is determined on the basis of customer feedback and pocket range.
The ABC system helps the company to determine whether to lower or raise the activities cost to
grab the consumers. The ABC system also helps in keeping up with the competitors without
sacrificing the quality and the quantity of the products.
Summary:
1. Traditional cost accounting is obsolete whereas Activity Based Accounting is used more by
various target-oriented companies.
2. ABC methods help the company to identify the needs of keeping or eliminating certain
activities to add value to the products.

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3. TCA methods focus on the structure rather than on processes whereas ABC methods focus on
the activities or processes rather than on the structure.
4. ABC provides accurate costs whereas TCA accumulates values arbitrarily.
5. TCA is almost obsolete whereas ABC methods are largely in use since 1981.

5.2 COST -OUTPUT RELATIONS


Cost output relations play an important role in business decisions pertaining to cost minimisation
or profit-maximisation and optimisation of output.Cost output relations are expressed through a
cost function.
5.3 Short run Cost Output Relations
The basic analytical cost concepts used in the analysis of cost behaviour are total,average and
marginal costs.The total costs is defined ass the actual cost that must be incurred to produce a
given quantity of output. The short run total cost is composed of two major elemnts:total fixed
cost(TFC) and total variable cost(TVC). That is in the short run,
TC = TFC + TVC
5.4 Long run Cost Output Relations
By definition,in the long run,all the inputs become variable.The variability of inputs is based
on the assumption that in the long-run ,supply of all the inputs including those held constant in
the shortrun becomes elastic. The firms are therefore in a position to expand the scale of their
production run by hiring a larger quantity of all the inputs.The long run output relations therefore
imply the relationship between the total costs and the total outputs ,whereas in the short run this
relationship is essentially one between the total output and the variable costs because fixed costs
remain constant.

Defining Budget Support


Different donor organisations use different definitions of budget support. In the most
commonsense, budget support typically refers to predictable, annual, medium-term resource
flowsthat are channeled to the recipient country using its own financial management system and
budget procedures. Budget support is typically based on an agreed set of performance
indicators in the form of institutional or policy reform measures or outcome indicators.

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While there is not yet an agreed definition of budget support, the following terms are those
used most frequently in discussion about it. It is useful to list them here and make some
comparisons for better understanding the budget support concept. The definitions below take
into account the different positions of donor organisations engaged in the use of these
instruments.

5.5 Full cost pricing


The Full Cost Pricing (FCP) Policy applies to SBAs2 that are not government-owned
corporations(GOCs) and fully commercialised business units (CBUs) in accordance with the
Commercialisationof Government Business Activities in Queensland Policy Framework.
The FCP Policy is incorporated by reference into the Queensland Governments Financial
Performance and Management Standard 2009 (FPMS). The FPMS requires that relevant SBAs
andCBUs must apply the Policy.
The FPMS is subordinate legislation under the Financial Accountability Act 2009.
Accordingly,while the FCP Policy itself does not have any legislative status, the FPMS imposes
a statutoryobligation upon SBAs and CBUs to comply with the Policy.

Components of a full cost pricing policy and how they are valued.
In the private sector, prices are usually set so that as a whole across the enterprise, they
recoverthe full cost of the provision of all goods and services, taxes and similar charges plus a
suitablereturn on the owners investment.This concept is incorporated in this Policy through the
establishment of a cost benchmark foreach SBA or CBU. The benchmark must take into account
all costs incurred in producing anddelivering the goods and services, as well as taxes and other
Government charges faced by theprivate sector competitor or equivalent business. Prices must
incorporate this benchmark plus areturn on investment similar to that required by the owners of
the private sector competitors orequivalent businesses.Each SBA or CBU to which this Policy
applies is to be examined separately to set the benchmark,and each SBA or CBU must price
commercially. The rate of return must be achieved over themedium term. This will allow the
relevant SBAs or CBUs to establish the required commercialstructures.

5.6 Marginal-cost pricing


Marginal-cost pricing, in economics, the practice of setting the price of a product to equal the
extra cost of producing an extra unit of output. By this policy, a producer charges, for each
product unit sold, only the addition to total cost resulting from materials and direct labour.
Businesses often set prices close to marginal cost during periods of poor sales. If, for example,
an item has a marginal cost of $1.00 and a normal selling price is $2.00, the firm selling the item
might wish to lower the price to $1.10 if demand has waned. The business would choose this

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approach because the incremental profit of 10 cents from the transaction is better than no sale at
all.
In the mid-20th century, proponents of the ideal of perfect competitiona scenario in which
firms produce nearly identical products and charge the same pricefavoured the efficiency
inherent in the concept of marginal-cost pricing. Economists such as Ronald Coase, however,
upheld the markets ability to determine prices. They supported the way in which market pricing
signals information about the goods being sold to buyers and sellers, and they observed that
sellers who were required to price at marginal cost would risk failing to cover their fixed costs.
5.7 DEFINITION OF 'BID PRICEING'
The price a buyer is willing to pay for a security. This is one part of the bid with the other being
the bid size, which details the amount of shares the investor is willing to purchase at the bid
price. The opposite of the bid is the ask price, which is the price a seller is looking to get for his
or her shares.
A bid price is the highest price that a buyer (i.e., bidder) is willing to pay for a good. It is usually
referred to simply as the "bid."
In bid and ask, the bid price stands in contrast to the ask price or "offer", and the difference
between the two is called the bid/ask spread.
An unsolicited bid or purchase offer is when a person or company receives a bid even though
they are not looking to sell. A bidding war is said to occur when a large number of bids are
placed in rapid succession by two or more entities, especially when the price paid is much
greater than the ask price, or greater than the first bid in the case of unsolicited bidding.
In the context of stock trading on a stock exchange, the bid price is the highest price a buyer of a
stock is willing to pay for a share of that given stock. The bid price displayed in most quote
services is the highest bid price in the market. The ask or offer price on the other hand is the
lowest price a seller of a particular stock is willing to sell a share of that given stock. The ask or
offer price displayed is the lowest ask/offer price in the market (Stock market).
The bid price is the highest price that a prospective buyer is willing to pay for a specific security.
The "ask price," is the lowest price acceptable to a prospective seller of the same security. The
highest bid and lowest offer are quoted on most major exchanges, and the difference between the
two prices is called the "bid-ask spread."
5.8 Rate of return pricing.
Target rate of return pricing is a pricing method used almost exclusively by market leaders or
monopolists. You start with a rate of return objective, like 5% of invested capital, or 10% of
sales revenue. Then you arrange your price structure so as to achieve these target rates of return.

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For example, assume a firm invests $100 million in order to produce and market designer
snowflakes, and they estimate that with demand for designer snowflakes being what it is, they
can sell 2 million flakes per year. Further, from preliminary production data they know that at
that level of output their average total cost (ATC) is $50 per flake. Total annual costs would be
$100 million (2 million units at $50 each). Next, management decides they want a 20% return on
investment (ROI). That works out to be $20 million (20% of a $100 million investment). Profit
margin will need to be $10 per flake ($20 million return over 2 million units). So the price must
be set at $60 per designer flake ($50 costs plus $10 profit margin). Similar calculations will
determine price based on rate of return to sales revenue.
An unusual consequence of this pricing model is that to keep the target rate of return constant,
the firm will have to continuously be changing its price as the level of demand changes. This can
be seen in the diagram below. Based on market demand expectations, the firm estimates it will
be operating at 70% capacity. Given its production function and cost structure, it knows its
average total costs at that output level will be represented as point A . If its predetermined rate of
return requirement is amount A, B, then it will set its price at P*. Because profit is equal to (PATC)*Q, then their total profit will be defined by area P*, B, A, P70%.
5.9 Basics for Assessing Rate of Return.
The goal of rate-of-return regulation is for the regulator to evaluate the effects of different price
levels on potential earnings for a firm in order for consumers to be protected while ensuring
investors receive a "fair" rate of return on their investment. There are five criteria utilized by
regulators to assess the suitable rate of return for a firm.
The first criterion is whether the rate of return is at a level substantial enough to attract capital
from investors. Government regulation of this fashion is meant to ensure that firms don't abuse
their monopoly powers to take advantage of consumers; however, they must also ensure that
regulation does not prevent customers from acquiring their essential goods and services. If the
rate of return is too low, investors will not be compelled to invest in the firm, preventing it from
having the financial capital to operate and invest in physical capital and labor, which in turn
would result in consumers being unable to receive their sufficient level of service, such as
electricity for their homes.
The second criterion that regulators must consider is the efficient consumer-rationing of services
provided by regulated firms. To promote consumer efficiency, prices should reflect marginal
costs; however, this must also be balanced with the first criterion.
Thirdly, regulators must ensure that the regulated monopolistic firm utilizes efficient
management practices. Here a regulator can examine whether or not the firm's leadership is
taking advantage of loopholes in regulation by overstating costs in order to be permitted to
operate at a higher price level.

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A fourth criterion a regulator must investigate is the firm's long-term stability. As above
mentioned, one of government's chief concerns is to ensure consumers are able to receive their
required level of service. Therefore, regulators must take into account the future prospects of the
firm, similarly to the way in which a stock-trader would evaluate a company's future potential.
The fifth and final criterion the regulator must take into account is fairness to the investors. This
is a separate concern from the first criterion since the regulator must both ensure that the
company receives the capital it needs to continue operating and that private investors are
receiving fair profits on their investment, otherwise such regulation would likely correspond to a
decrease in investment.
Appraising project:
The main task of the financial appraisal ofinnovation projects is to refine the
information that implies the projectsviability. The financial appraisal of
innovation projects is a resource investmentto reduce the uncertainty degree of the
information referring to the projectsfeasibility.The detailed financial appraisal of an
innovation project is elaborated for finalizethe project form and to select the most
successful variant of the project. Also, thefinancial appraisal of an innovation project isworked
out every time it is necessary tosubstantiate the decision of continuing or
stopping the evolution of an innovationproject.

5.10 INTERNAL RATE OF RETURN - IRR


The discount rate often used in capital budgeting that makes the net present value of all cash
flows from a particular project equal to zero. Generally speaking, the higher a project's internal
rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank
several prospective projects a firm is considering. Assuming all other factors are equal among
the various projects, the project with the highest IRR would probably be considered the best and
undertaken first.
The internal rate of return (IRR) is a rate of return used in capital budgeting to measure and
compare the profitability of investments. It is also called the discounted cash flow rate of return
(DCFROR) or simply the rate of return (ROR).[1] In the context of savings and loans the IRR is
also called the effective interest rate. The term internal refers to the fact that its calculation does
not incorporate environmental factors (e.g., the interest rate or inflation).
Internal Rate of Return
This method equates the net present value of the project to zero. The project is evaluated by
comparing the calculated Internal rate of return to the predetermined required rate of return.
Projects with Internal rate of return that exceed the predetermined rate are accepted. The major

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weakness is that when evaluating mutually exclusive projects, use of Internal rate of return may
lead to selecting a project that does not maximize the shareholders' wealth.
Definition
The internal rate of return on an investment or project is the "annualized effective compounded
return rate" or discount rate that makes the net present value of all cash flows (both positive and
negative) from a particular investment equal to zero.
In more specific terms, the IRR of an investment is the interest rate at which the net present
value of costs (negative cash flows) of the investment equals the net present value of the benefits
(positive cash flows) of the investment.
Internal rates of return are commonly used to evaluate the desirability of investments or projects.
The higher a project's internal rate of return, the more desirable it is to undertake the project.
Assuming all other factors are equal among the various projects, the project with the highest IRR
would probably be considered the best and undertaken first.
A firm (or individual) should, in theory, undertake all projects or investments available with
IRRs that exceed the cost of capital. Investment may be limited by availability of funds to the
firm and/or by the firm's capacity or ability to manage numerous projects.
Uses
Important: Because the internal rate of return is a rate quantity, it is an indicator of the efficiency,
quality, or yield of an investment. This is in contrast with the net present value, which is an
indicator of the value or magnitude of an investment.
An investment is considered acceptable if its internal rate of return is greater than an established
minimum acceptable rate of return or cost of capital. In a scenario where an investment is
considered by a firm that has equity holders, this minimum rate is the cost of capital of the
investment (which may be determined by the risk-adjusted cost of capital of alternative
investments). This ensures that the investment is supported by equity holders since, in general,
an investment whose IRR exceeds its cost of capital adds value for the company (i.e., it is
economically profitable).
5.11 Net Present Value
A project's net present value is determined by summing the net annual cash flow, discounted at
the project's cost of capital and deducting the initial outlay. Decision criteria is to accept a project
with a positive net present value. Advantages of this method are that it reflects the time value of
money and maximizes shareholder's wealth. Its weakness is that its rankings depend on the cost
of capital; present value will decline as the discount rate increases.

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5.12 Payback Method


A company chooses the expected number of years required to recover an original investment.
Projects will only be selected if initial outlay can be recovered within a predetermined period.
This method is relatively easy since the cash flow doesn't need to be discounted. Its major
weakness is that it ignores the cash inflows after the payback period, and does not consider the
timing of cash flows.
5.13 Profitability Index
This is the ratio of the present value of project cash inflow to the present value of initial cost.
Projects with a Profitability Index of greater than 1.0 are acceptable. The major disadvantage in
this method is that it requires cost of capital to calculate and it cannot be used when there are
unequal cash flows. The advantage of this method is that it considers all cash flows of the
project.
5.14 Net Present Value
The sum of discounted costs are subtracted from the sum of discounted benefits. Projects with
positive net present value should be considered; the greater the net present value, the more
justifiable the project. However, a large project could have a higher net present value than a
smaller project, even if it has a lower benefit-cost ratio.
In finance, the net present value (NPV) or net present worth (NPW) of a time series of cash
flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the
individual cash flows of the same entity.
In the case when all future cash flows are incoming (such as coupons and principal of a bond)
and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows
minus the purchase price (which is its own PV). NPV is a central tool in discounted cash flow
(DCF) analysis and is a standard method for using the time value of money to appraise long-term
projects. Used for capital budgeting and widely used throughout economics, finance, and
accounting, it measures the excess or shortfall of cash flows, in present value terms, above the
cost of funds.
NPV can be described as the difference amount between the sums of discounted: cash inflows
and cash outflows. It compares the present value of money today to the present value of money
in the future, taking inflation and returns into account.
The NPV of a sequence of cash flows takes as input the cash flows and a discount rate or
discount curve and outputs a price; the converse process in DCF analysis taking a sequence of
cash flows and a price as input and inferring as output a discount rate (the discount rate which
would yield the given price as NPV) is called the yield and is more widely used in bond
trading.
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5.15 Costbenefit analysis


Costbenefit analysis (CBA), sometimes called benefitcost analysis (BCA), is a systematic
approach to estimating the strengths and weaknesses of alternatives that satisfy transactions,
activities or functional requirements for a business. It is a technique that is used to determine
options that provide the best approach for the adoption and practice in terms of benefits in labor,
time and cost savings etc. (David, Ngulube and Dube, 2013). The CBA is also defined as a
systematic process for calculating and comparing benefits and costs of a project, decision or
government policy .
To provide a basis for comparing projects. It involves comparing the total expected cost of each
option against the total expected benefits, to see whether the benefits outweigh the costs, and by
how much.
CBA is related to, but distinct from cost-effectiveness analysis. In CBA, benefits and costs are
expressed in monetary terms, and are adjusted for the time value of money, so that all flows of
benefits and flows of project costs over time (which tend to occur at different points in time) are
expressed on a common basis in terms of their "net present value.
Closely related, but slightly different, formal techniques include cost-effectiveness analysis,
costutility analysis, riskbenefit analysis, economic impact analysis, fiscal impact analysis, and
Social return on investment (SROI) analysis.
Performance appraisal process:

A performance appraisal is a systematic and periodic process that assesses an individual


employees job performance and productivity in relation to certain pre-established criteria and

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organizational objectives. Other aspects of individual employees are considered as well, such as
organizational citizenship behavior, accomplishments, potential for future improvement,
strengths and weaknesses, etc.
To collect PA data, there are three main methods: objective production, personnel, and
judgmental evaluation. Judgmental evaluations are the most commonly used with a large variety
of evaluation methods. Historically, PA has been conducted annually (long-cycle appraisals);
however, many companies are moving towards shorter cycles (every six months, every quarter),
and some have been moving into short-cycle (weekly, bi-weekly) PA . The interview could
function as providing feedback to employees, counseling and developing employees, and
conveying and discussing compensation, job status, or disciplinary decisions PA is often
included in performance management systems. PA helps the subordinate answer two key
questions: first, "What are your expectations of me?" second, "How am I doing to meet your
expectations
Performance management systems are employed to manage and align" all of an organization's
resources in order to achieve highest possible performance. How performance is managed in an
organization determines to a large extent the success or failure of the organization. Therefore,
improving PA for everyone should be among the highest priorities of contemporary
organizations.
Some applications of PA are compensation, performance improvement, promotions, termination,
test validation, and more. While there are many potential benefits of PA, there are also some
potential drawbacks. For example, PA can help facilitate management-employee
communication; however, PA may result in legal issues if not executed appropriately, as many
employees tend to be unsatisfied with the PA process. PAs created in and determined as useful in
the United States are not necessarily able to be transferable cross-culturally.
Applications of results
A central reason for the utilization of performance appraisals (PAs) is performance improvement
(initially at the level of the individual employee, and ultimately at the level of the
organization). Other fundamental reasons include as a basis for employment decisions (e.g.
promotions, terminations, transfers), as criteria in research (e.g. test validation), to aid with
communication (e.g. allowing employees to know how they are doing and organizational
expectations), to establish personal objectives for training programs, for transmission of
objective feedback for personal development, as a means of documentation to aid in keeping
track of decisions and legal requirements and in wage and salary administ ration. Additionally,
PAs can aid in the formulation of job criteria and selection of individuals who are best suited to
perform the required organizational tasks. A PA can be part of guiding and monitoring
employee career development. PAs can also be used to aid in work motivation through the use of
reward systems.

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Potential benefits
There are a number of potential benefits of organizational performance management conducting
formal performance appraisals (PAs). There has been a general consensus in the belief that PAs
lead to positive implications of organizations. Furthermore, PAs can benefit an organizations
effectiveness. One way is PAs can often lead to giving individual workers feedback about their
job performance. From this may spawn several potential benefits such as the individual workers
becoming more productive.
5.16 Feasibility report:

Feasibility studies aim to objectively and rationally uncover the strengths and weaknesses of an
existing business or proposed venture, opportunities and threats present in the environment, the
resources required to carry through, and ultimately the prospects for success. In its simplest
terms, the two criteria to judge feasibility are cost required and value to be attained.
A well-designed feasibility study should provide a historical background of the business or
project, a description of the product or service, accounting statements, details of the operations
and management, marketing research and policies, financial data, legal requirements and tax
obligations. Generally, feasibility studies precede technical development and project
implementation.
A feasibility study evaluates the project's potential for success; therefore, perceived objectivity is
an important factor in the credibility of the study for potential investors and lending

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institutions.[citation needed] It must therefore be conducted with an objective, unbiased


approach to provide information upon which decisions can be based
5.17 Technical feasibility.
While complex, the Mars One Mission is feasible. The science and technology required to place
humans on Mars exists today. Much of what was learned from Skylab, Mir and the International
Space Station has resulted in vital data, experiences with systems and related know-how -- all of
which are applicable to living on Mars.
Mars One is not the first organization to ponder upon the idea of a manned mission to Mars.
Blueprints of a Mars human settlement are flung across much of history-- from science fiction
books to dossiers of national space agencies. And yet, no human has landed on Mars to this day.
Why should Mars One succeed?
The Mars One mission plan is based on five pillars that ensure its practicality and success.
5.18 Permanent settlement.
The Mars One crews are people that want to settle on Mars. Absence of a return mission reduces
the mission infrastructure radically. Earth return vehicles that can take off from Mars are
currently unavailable and untested technologies and such mission designs incur far greater costs.
For the astronauts, Mars will be a new home, where they will live and work. While this may
seem unreasonable to some, others have no greater ambition in their life. Such dedicated settlers
will be chosen by Mars One as their crews.
Use of In-Situ Resources.
Basic elements required for a viable living system are already present on Mars. Thus we need to
send more tools and equipment rather than raw elements. For example, the location for the first
Mars One settlement is selected for the water ice content of the soil there. Water can be made
available to the settlement for hygiene, drinking and farming. It is also the source of oxygen
generated through electrolysis. Mars also has ample natural sources of nitrogen, the primary
element (80%) in the air we breathe. Martian soil will cover the outpost to block cosmic
radiation.
The astronauts will soon be able to create habitation for themselves and new crews using local
materials soon after they arrive. For a long time, the supply requests from the outpost will be for
computers, clothing and complex spare parts, which cannot be readily reproduced with the
limited technology on Mars.

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5.19 Economic feasibility study.


Feasibility studies are crucial during the early development of any project and form a vital
component in the business development process. Accounting and Advisory feasibility studies
enable organizations to assess the viability, cost and benefits of projects before financial
resources are allocated. They also provide independent project assessment and enhance project
credibility.
Built on the information provided in the feasibility study, a business case is used to convince the
audience that a particular project should be implemented. It is often a prerequisite for any
funding approval. The business case will detail the reasons why a particular project should be
prioritized higher than others. It will also sum up the strengths, weaknesses and validity of
assumptions as well as assessing the financial and non-financial costs and benefits underlying
preferred options.
A Deloitte feasibility study can help your organization to:
Define the business requirements that must be met by the selected project and include the critical
success factors for the project
Detail alternative approaches that will meet business requirements, including comparative
cost/benefit and risk analyses
Recommend the best approach for preparing a business case or moving through the
implementation process
Our feasibility studies and business cases can help you answer crucial questions such as:
Have the alternatives been carefully, thoroughly and objectively examined?
What are the consequences of each choice on all relevant areas?
What are the results of any cost/benefit studies?
What are the costs and consequences of no action?
What are the impacts on the various interest groups?
What are the timelines for decisions?
Are the consequences displayed to make comparisons easier?

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5.20 Economic Feasibility Analysis.


Businesses, governmental entities, and other organizations face great uncertainty and risks when
making decisions about major investments in new manufacturing facilities, new products, new
markets, new technologies, new programs, and when acquiring other companies. Economic
feasibility studies provide the facts and analytical rigor to improve these types of strategic
decisions.
The linchpin of any economic feasibility study is the accuracy of the demand forecast. What are
the relevant economic patterns and trends? What are the fundamental economic drivers of
demand? Will consumers buy the new product, visit the new amusement, rent the new apartment,
or enroll in the new university? What prices will consumers pay? Whats the slope of the price demand curve? Will consumers be loyal or fickle? Decision Analyst, as one of the leading
marketing research firms in the world, understands how to answer these demand questions and
develop accurate sales revenue forecasts. Decision Analyst uses its own econometric models and
algorithms, and proprietary research methods, to forecast demand for new products, new
services, and new initiatives.
Once the demand side of the equation is understood, the supply variables must be analyzed.
What are the essential ingredients, components, human resources and skills, and materials on the
supply side? What will be the long-term cost trends for these supply components? As these
supply variables are identified and projected into the future, Decision Analyst builds a simulation
model of the business venture, or the new attraction or amusement, or the new product, or the
new real estate development. The demand forecast and the supply analyses come together in the
form of a DecisionSimulator that permits what if games to be played. What happens if the
price of a critical ingredient soars? What happens if demand is 10% below forecast? What
happens if a major competitor reduces prices by 5%?
The economic feasibility analysis often includes a comprehensive analysis of competitive firms
and competitive threats. Who and what constitutes the competition? What are the capabilities and
tendencies of these competitors? How are they likely to respond to a competitive threat? Can the
subject firm defend itself against competitive counterattack?
5.21 Break-even Analysis
An enterprise, whether or not a profit maximizer, often finds it useful to know what price (or
output level) must be for total revenue just equal total cost. This can be done with a breakeven
analysis. Strictly speaking, this analysis is to determine the minimum level of output
that allows the firm to break even, but it could be used for some other tasks.
In this Appendix, we introduce:
- The algebra of break-even analysis
- Break-even diagram
- Operating leverage

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One of the important indicators of success of the start-up company is the time from starting
the business till the moment when revenues of product sales equals the total costs associated
with the sale of product it is also called break-even point. In other words profit = 0. Breakeven
analysis is accounting tool to help plan and control the business operations.
Break-even point represents the volume of business, where companys total revenues (money
coming into a business) are equal to its total expenses (total costs). In its simplest form,
breakeven
analysis provides insight into whether or not revenue from a product or service has the
ability to cover the relevant costs of production of that product or service.
THE ALGEBRA OF BREAK-EVEN ANALYSIS
Let QBE denote the break-even output level. By definition
TR (at QBE) = TC (at QBE)
or TR (at QBE) = TFC + TVC (at QBE) (1)
The break-even condition (1) holds true for any cost and demand functions. Hence,
in general, when costs and demand are complex, the analysis of this condition might
not be any simpler than the analysis of profit maximization. Yet, what is widely
known in business as break-even analysis is indeed much easier than
profit analysis, although it also starts with the above identity, because it makes a very
important assumption: that price and average variable cost do not change with output level.
Break-even analysis is based on categorizing production costs between those which are:
VARIABLE cost that do vary with the number of units produced and sold (raw
materials, fuel, direct labor, revenue-related costs), and those that are
FIXED costs that dont vary with the number of units produced and sold (salaries,
rent and rates, depreciation, marketing costs, administration costs, R&R, insurance)
Calculating Break-even Point
To calculate break-even point we need to know following information:
The price that the company is charging,
variable costs (direct costs) of each unit and
fixed costs (or indirect costs/overheads).
1. TR = Total revenue
2. P = Selling price
3. Q = Number of units sold
4. TC = Total costs
5. F = Fixed costs
6. V = Variable costs
7. FC = Total fixed costs
8. VC = Total variable costs

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5.22 Financial Feasibility Study


A financial feasibility study is an assessment of the financial aspects of something. If this case,
for starting and running a business. It considers many things including start-up capital, expenses,
revenues, and investor income and disbursements. Other portions of a complete feasibility study
will also contribute data to your basic financial study.
A financial feasibility study can focus on one particular project or area, or on a group of projects
(such as advertising campaigns). However, for the purpose of establishing a business or
attracting investors, you should include at least three key things in your comprehensive financial
feasibility study:
Start-Up Capital Requirements,
Start-Up Capital Sources, and
Potential Returns for Investors.

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5.23 BREAK-EVEN ANALYSIS ASSUMPTIONS:

All costs are classified as either fixed or variable. If not impossible or impractical,
dividing costs into the variable and fixed cost elements as an extremely difficult job. This
is attributable to the inherent nature or characteristics of the cost per se.

Fixed costs remain constant within the relevant range. Fixed costs remain unchanged at
any level of activity within the relevant range, even at the zero level.

The behavior of total revenues and total costs will be linear over the relevant range, i.e.
will appear as a straight line on the BE chart. This is based on the idea that variable costs
vary in direct proportion to volume; the fixed costs remain unchanged, hence drawn as a
straight horizontal line on the graph within the relevant range; and that selling price is
constant.

In case of multiple product companies, the selling prices, costs and proportion of units
(sales mix) sold will not change. This cannot always be correct. Sales mix ratio may be
due to the change in the consuming habits of customers. Selling prices of the individual
products may likewise change due to competition, popularity and salability of the
products, etc.

There is no significant change in the inventory levels during the period under review.
Stated in another way, production volume is assumed to be almost (if not exactly) equal
to the sales volume, which causes an immaterial (or none at all) difference between the
beginning and ending inventories.

5.24 Managerial Uses of Break-Even Analysis:


To the management, the utility of break-even analysis lies in the fact that it presents a
microscopic picture of the profit structure of a business enterprise. The break-even analysis not
only highlights the area of economic strength and weakness in the firm but also sharpens the
focus on certain leverages which can be operated upon to enhance its profitability.
It guides the management to take effective decision in the context of changes in government
policies of taxation and subsidies.
The break-even analysis can be used for the following purposes:
(i) Safety Margin:
The break-even chart helps the management to know at a glance the profits generated at the
various levels of sales. The safety margin refers to the extent to which the firm can afford a
decline before it starts incurring losses.
The formula to determine the sales safety margin is:
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Safety Margin= (Sales BEP)/


Sales x 100
From the numerical example at the level of 250 units of output and sales, the firm is
earning profit, the safety margin can be found out by applying the formula
Safety Margin = 250- 150 / 250 x
100 =40%
This means that the firm which is now selling 250 units of the product can afford to
decline sales upto 40 per cent. The margin of safety may be negative as well, if the firm
is incurring any loss. In that case, the percentage tells the extent of sales that should be
increased in order to reach the point where there will be no loss.
(ii) Target
Profit:
The break-even analysis can be utilised for the purpose of calculating the volume of
sales necessary to achieve a target profit.
When a firm has some target profit, this analysis will help in finding out the extent of
increase in sales by using the following formula:
Target Sales Volume = Fixed Cost + Target Profit / Contribution Margin
per unit
By way of illustration, we can take Table 1 given above. Suppose the firm fixes the
profit as Rs.
100, then the volume of output and sales should be 250 units. Only at this level, it gets a
profit of
Rs. 100. By using the formula, the same result will be
obtained.
(iii) Change
in Price:
The management is often faced with a problem of whether to reduce prices or not.
Before taking a decision on this question, the management will have to consider a profit.
A reduction in price leads to a reduction in the contribution margin.
This means that the volume of sales will have to be increased even to maintain the
previous level of profit. The higher the reduction in the contribution margin, the higher is
the increase in sales needed to ensure the previous profit.

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UNIT: 1
BASIC ECONOMICS
2 MARKS

1. What is meant by economics?


Economics is a study of economic problems of the people concerning production, consumption,
exchange and distribution of wealth.

2. What is micro economics?


Micro economics is the study of a particular household, individual price, a firm or an industry.

3. What is macro economics?


Macro economics analyses the behaviour of broad economic aggregate like national income, general
income, and general price level. etc.

4. What sort of relationship exists between the demand for goods and the price of complementary goods?
The relationship between the demand for goods and the price of complementary goods is inverse. when the
price of complementary goods falls its demand would increase. it would increase the demand for goods as
they are going to be used along with the complementary goods.

5. State the law of diminishing marginal utility.


It states that with successive increase in the units of consumption of a commodity, every additional unit of
that commodity gives lesser satisfaction to the consumer. consumption beyond point of safety.
6. What are the assumptions of law of demand?
a) Price of related goods remains constant.
b) Income of the consumer does not change
c) Taste and preferences of the people remain unchanged.

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7. What are the factors which affect the price elasticity of demand for a commodity?
a) Nature of the commodity
b)Availability of substitutes
c) Share in the total expenditure d) Different
uses of a commodity

8. State the assumption of the law of supply.


a) Price of related goods remains unchanged. b)Technology
of production should not changed

c) Cost of factors of production should remain the same


d) Goals of the firm should not change

9. Give any three factors affecting elasticity of supply


a) Nature of commodity
b) Cost of production
c) Time element

10. Define market demand.


Market demand is the total quantity demanded by all the purchasers together.

11. State the law of supply


The law of supply states that the quantity of a commodity supplied varies directly with the price,
other determinants of supply remaining constant.

12. What is fixed cost?


Fixed costs are the cost which does not change with change in the level of output.

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13. Define marginal cost.


Marginal cost is the change in the total cost by producing an additional unit of output

14. State & explain the law of demand


The law of demand states that other things being equal demand when price falls and contracts
when price rises.

15. Why does the demand curve slope downwards to the right?
A normal demand curve slopes downwards from left to right and it means that more units of a good are
brought when price falls and less number of units are brought when rises. That is, when price falls, demand
expands. So the demand curve as a rule, slope downwards from left to right.

16. Define cross elasticity of demand.


Cross elasticity of demand is the responsiveness of demand for a commodity say X to a given change
in the price of a related say Y.

17. Classify

wants.

a)

Necessaries
b)

Comforts

c)

Luxuries

18. Name the factors influencing demand.


a) Changes in the price of other goods.
b) State of trade
c) Changes in the taste and fashion d)
Advertisement expenditure

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19. What is demand forecasting?


Demand forecasting is the estimate of level of demand to be expected for goods or services for some
period of time in the future.

20. What is meant by supply in economics?


Supply is the amount of commodity which will be offered for sale at a given price per unit of time.
UNIT: 2

DEMAND AND SCHEDULE


2 MARKS

1. What are the elements of financial management?


a )Fixed and working capital management.
b) Determining sources of funds
c) Financial analysis
d) Capital budgeting

2. Explain working capital


Working capital is that part of the capital which is required for the financing of working or
current needs of the firm.

3. What is meant by fixed capital?


Fixed capital is associated with the amount of capital acquired by an enterprise for acquiring fixed assets
such as land, building, plant, machinery and equipment, which are intended for long term continued use in
business.

4. Classify working capital a)Permanent


working capital b) Variable working
capital

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5. List the internal sources of finance.


a) Retained profit
b) Depreciation provisions
c) Deferred taxation
d) Personal funds

6. List

the

external

sources

of

finance. a) Venture capital funds


b) Loans from financial institutions
c) Loans from banks
d) Trade credit

7. What

are

the

responsibilities

of

good

financial

management? a)Profit planning


b) Worth maximization c)
Procurement of finance
d) Capital financing

8. Enumerate executive function of financial management.


a) Assessment of financial needs in terms of fixed and working capital
b) Choosing the sources of funds

9. What is the role of financial manager in an organization?


The specific role of a financial manager includes anticipation of financial needs, acquiring
financial resources and allocating funds in business.

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10. What is debenture?


A debenture is an instrument issued by a company which denotes an obligation resulting from the
borrowing of money through the instrument.

11. Name the state level financing institution for advancing loans to industries.
Tamilnadu industrial development corporation

12. What are retained earnings?


Retained earnings are profits not distributed by way of divided payments but retained within the
organization as revenue reserves. These retained earnings are utilized by the company to finance its
expansion plans or meet its requirements of working capital.

13. Explain what is meant by obsolescence of machine.


Obsolescence is the loss in value of an asset due to new inventions, modifications, and change in
legislation, styles, technology or other causes. It is different from wear & tear due to normal usage.

14. What is investment?


The purchase of capital goods, such as plant and machinery in a factory in order produce goods for
future consumption.

15. Define cost of capital.


Cost of capital is concerned with the amount that should be expended in order to acquire capital for
investment project.

16. What is financial accounting?


The art of recording, classifying and summarizing in a significant manner and in terms of money
transactions and events which are impart at least of a financial character and interpreting the resulting
thereof.

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17. State the nature of financial accounting.


a) The transaction is mostly financial in nature
b) It deals with the overall performance of the business.
c) It is more rigid in its approach

18. Write the types of business accounts. a) Personal account b) Real account
c) Nominal account

19. What are the systems of book keeping? a)Double entry system b) Single entry
system

20. What are the functions of financial management? a)determining financial needs b) Determining
sources of funds c) Financial analysis
d) Profit planning and control

UNIT: 3

ORGANISATION
2 MARKS

1. What are the components of cost? a)Prime cost


b) Factory cost
c) Office cost
d) Total cost
2. State the factors influencing pricing decisions.
a) Cost of manufacturing
b) Objectives and polices of management
c) Demand of the product
d) Distribution strength of the firm

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3. Explain short run period in economics.


Short run period is defined as a period during which at least one element of factor input is in fixed
supply, the fixed factor input is plant and equipment.

4. What is meant by incremental cost?


Incremental cost is the additional cost due to a change in the level or nature of business activity.

5. List out the various pricing policies in India. a) Skim


pricing
b) Penetration pricing c) Market
pricing d)Mixed pricing

6. What is meant by opportunity cost?


Opportunity cost of a factor refers to its value in its next best alternative use. Opportunity cost is also
known as transfer earnings on the foregone alternatives.
7. What are the pricing methods?
a)Cost plus pricing method

b) Break even analysis method


c) Target rate of return method
d)leadership pricing method

e) Going rate pricing method


f) Marginal cost pricing method
8. What is price index?
The ratio of one price to the price of the same item at a different time.

9. List

three

semi variables

costs.

a)electricity charges

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b) Telephone charges c)
Depreciation

d)maintenance expenses.
10. Explain the relationship between cost and output.
The cost of production in an industry depends on the rate of output which is important in economic
analysis of cost .the relationship between cost and output determines the cost function. Once the cost
function is determined estimates of future cost of production at various output levels can usually be
obtained.

11. List the main difference between short term cost & long term cost.
The short term cost are cost which are recurring but the long term costs are used over a period of
time.

12. Define safety margin.


Safety margin is the difference between the actual sales quantity and the break even sales quantity
expressed in monetary terms or as a percentage.

13. What are producer goods?


Producer goods are economic goods made for the purpose of producing consumer goods and other
capital goods.
14. State four pricing methods employed by businessmen.
15. a)Full cost pricing
b) Target rate of return pricing
c) Going rate pricing
d) Sealed bid pricing

16. Mention the methods of measuring national income. a)production


method
b)Income method
c) Expenditure method

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17. Explain equilibrium price.


It is a price at which the supply of, & demand for, a commodity are equal.

17. Define price.


Price is defined as the exchange value of a product or a service quantified in monetary terms.

18. Define cost.


Cost is the amount of expenditure notional or actual, attributes to a thing .cost refers to sacrifice or
receive some benefits.
19. Write a short note on skimming price policy.
Skimming pricing policy uses high prices to obtain a high profit and quick recovery of the
development costs in the early stages of a products life before competition intensifies.
20. What is price discrimination?
Price discrimination is the charging of different prices of different groups of individual for the same
goods or services for reasons not associated with differences in costs. This may occur when there is
a geographic separation of markets ,the structure of demand in each market being different.
UNIT-4
BREAK EVEN ANALYSIS
2 MARKS
1. What are the uncertainties a firm faces?
1) Dynamic nature of consumer needs
2) Diverse nature of competition
3) Uncontrollable nature of most elements of cost
4) Continuous technological developments
2. How is cost-volume-profit relationship determined?
The most important method of determining cost-volume-profit relationship is Break even
Analysis.
3. What is Break even Analysis?
The method of determining the cost-volume-profit relationship is known as Break even
Analysis.

4. Who are benefitted through Break even Analysis?

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Break even Analysis is useful for business executives, but also for an entrepreneur who is on
the threshold of setting up his own unit.
5. What is the usefulness Break even Analysis?
Break even Analysis is valuable for project appraisal executives, business students,
accountants etc.
6. How is the knowledge of Break even Analysis is helpful to business consultant?
The knowledge of Break even Analysis is helpful to business consultant is useful in order to
provide right recommendations to their clients.
7. What does break even Analysis involves?
Break even Analysis the study of revenue and costs of a firm in relation to its volume of
sales and specifically the determination of that volume at which the firms costs and revenue will be
equal.
8. What is breakeven point?
Breakeven point is defined as that level of sales at which total revenue is equal to total
costs and the net income is equal to zero.
9. Write the relationship between breakeven point and variable cost?
Write the formula for breakeven point and contribution per unit?

10. How is BEP determined?


BEPs are determined as
In terms of physical units In terms
of money
12. What is break even chart?
Break even chart is defined as a graphical presentation of fixed costs, variable costs and
sales revenue for various volumes of operations. It illustrates the profits or losses incurred at
different volumes of operations, the breakeven point and margin of safety.
13. Give the formula for Selected operating point.

14. Define (P/V) Ratio.


It is the ratio of contribution to sales, which is expressed in terms of percentages. It is
also called as Contribution Ratio.
15. What are the uses of BEA?
It predicts the effects of change in price on sales.
It predicts the effects of change on profitability of changes in costs and
efficiency.

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16. Write down the limitations of break even Analysis?


BEP Analysis assumes costs and revenue to be linear in function. This practice is not true.
Break Even Chart is useful only for single product companies.
17. How is BEP determined In terms of physical units?

18. How is BEP determined In terms of money?

19. How is Contribution Ratio Determined?


C
20. How is Contribution Margin per unit Determined? Contribution
Margin=Sales-Variable costs
21. Define Marginal Ratio.

It is the ratio of contribution to sales, which is expressed in terms of percentages. It is


also called as Contribution Ratio.

Unit 5
COST AND BREAK EVEN ANALYSIS
2MARKS
3. What are the uncertainties a firm faces?
1) Dynamic nature of consumer needs
2) Diverse nature of competition
3) Uncontrollable nature of most elements of cost
4) Continuous technological developments
4. How is cost-volume-profit relationship determined?
The most important method of determining cost-volume-profit relationship is Break
even Analysis.
3. What is Break even Analysis?
The method of determining the cost-volume-profit relationship is known as Break even
Analysis.
4. Who are benefitted through Break even Analysis?
Break even Analysis is useful for business executives, but also for an entrepreneur who is
on the threshold of setting up his own unit.
5. What is the usefulness Break even Analysis?
Break even Analysis is valuable for project appraisal executives, business
students, accountants etc.
6. How is the knowledge of Break even Analysis is helpful to business consultant?
The knowledge of Break even Analysis is helpful to business consultant is useful in order
to provide right recommendations to their clients.
7. What does break even Analysis involves?
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Break even Analysis the study of revenue and costs of a firm in relation to its volume of
sales and specifically the determination of that volume at which the firms costs and revenue will be
equal.
8. What is breakeven point?
Breakeven point is defined as that level of sales at which total revenue is equal to
total costs and the net income is equal to zero.
9. Write the relationship between breakeven point and variable cost?

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12. Write the formula for breakeven point and contribution per unit?

13. How is BEP determined?


BEPs are determined as
In terms of physical units In terms of
money
13. What is break even chart?
Break even chart is defined as a graphical presentation of fixed costs, variable costs and sales
revenue for various volumes of operations. It illustrates the profits or losses incurred at different
volumes of operations, the breakeven point and margin of safety.
15. Give the formula for Selected operating point.

16. Define (P/V) Ratio.


It is the ratio of contribution to sales, which is expressed in terms of percentages. It is also called
as Contribution Ratio.
20. What are the uses of BEA?
It predicts the effects of change in price on sales.
It predicts the effects of change on profitability of changes in costs and efficiency.
21. Write down the limitations of break even Analysis?
BEP Analysis assumes costs and revenue to be linear in function. This practice is not true.
Break Even Chart is useful only for single product companies.
22. How is BEP determined In terms of physical units?

23. How is BEP determined In terms of money?

24. How is Contribution Ratio Determined?


C
20. How is Contribution Margin per unit Determined? Contribution
Margin=Sales-Variable costs
21. Define Marginal Ratio.

It is the ratio of contribution to sales, which is expressed in terms of percentages. It is also called
as Contribution Ratio.

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