B01MCXH20Z Ebok PDF

Economics & Management Science
for
Marine Engineers
By Prof. Pradeep Prabhu
(Maharashtra Academy of Naval Education and Training, Pune)
Prepared as per Indian Maritime University syllabus of

Economics & Management Science (UG/ME/MS/T/312)
Economics & Management Science for Marine Engineers - by Prof. Pradeep Prabhu 1
Rs. 500
Dedicated to my mother,
who had learnt all this,
without going to any school
Prof. Pradeep Prabhu
Preface
The information explosion has completely changed the way knowledge is acquired today. It
has now become meaningless to spend hours on topics, which students can acquire simply
by reading through the books or surfing on the internet. Secondly, if a teacher has to waste
his time on spoon feeding trivial concepts, then where shall he find the time to share his
invaluable practical experiences and insights with his students?
It is practically not possible to draft the practical experiences into a book and pass on to the
students like a sure shot capsule. I truly believe that teaching should be full of ideas. And if
teacher can correlate his practical experience with the topics at hand, I have observed,
students often listen to him with rapt attention.
But I have noticed in my teaching career, that many marine engineering cadets start falling
behind in their academics because of the rigor of their tough daily schedule and the peer
pressure of continuously banging the ‘thumbs up’ of the social websites. The situation gets
even worse for the first year cadets, because their bodies are yet to adapt to this rigorous
life of a cadet. Of course, this rigor is must to make them ready for a tougher and
challenging sea life. But for any teacher it is difficult to see the students coming to classes
without revising the concepts covered in previous classes, leave alone coming prepared for
the today’s class.
This book is an attempt to bridge the gap between students’ ever increasing academic
pressures and their ever shortening time for studies. The book has been synthesized with
my years of firsthand experience in the industry and in teaching. I expect the students to
come prepared for the classes and help their teachers convert their classroom into an
amazing place for lively debates on Science and Technology.
I hope this book will help them achieve this objective.
Prof. Pradeep Prabhu

January 1, 2016
Index
1. Introduction to Management Principles & Practices
1.1. Fundamental Principles of Sound Management

1.2. Need for sound management principles and practices
1.3. Growth of modern management thoughts
1.4. Management functions
1.5. Process planning & its applications
1.6. Long term corporate strategies
1.7. Policy distribution
1.8. SWOT Analysis
1.9. Communication
1.10. Developing organization structures
1.11. Centralization vs. Decentralization of decision making
1.12. Authority, Responsibility and Accountability
1.13. Basic principles of delegation - empowerment of employees,
1.14. Boundaries of authority.
2. Accounting & Financial Management
2.1. Methods of Capital formation

2.2. Control of Working Capital
2.3. How to read a balance sheet and a Profit & Loss statement
2.4. Budgetary Control
2.5. Standard Costing, Favorable & Adverse variances
2.6. Discounted cash flow method for project appraisals with continuous or discreet
cash flows
2.7. Breakeven Analysis
2.8. Cost Benefit Analysis
2.9. Methods of Depreciation
2.10. Factory Costing and Cost Estimation
2.11. Financial & Physical Ratios
3. Production & Operations Management
3.1. Factors of production

3.2. Distinction between products & services
3.3. Types of production system - Jobbing, Lot, Mass and Continuous
3.4. Functions of Production Planning and Control
3.5. Product Development Principles
3.6. Standardization, Simplification & Specialization
3.7. Plant Location and Plant Layouts
3.8. Logistics & Supply Chain Management
3.9. Integrated Material Management - functions of material planning, inventory
control, safety stock, cyclical stock, purchase and stores performance,
measurement parameters, codification, wastage control.
3.10. Introduction to Operations Research - Linear Programming, Distribution Methods
3.11. Network Techniques in Management — Critical Path Method (CPM) Program
Evaluation & Review Technique (PERT)
3.12. Resources Allocation & Loading smoothing
3.13. Operational Sales Forecasting
3.14. Works Study - Job Evaluation & Merit Rating
3.15. Total Quality Management - Quality Control, ISO 9000 series
3.16. Maintenance Management
3.17. Line-of-Balance, Just-In-Time and Decision Theory
4. Human Resource Development
4.1. The personnel Function,

4.2. Selection & Recruitment
4.3. Role of Psychological Tests in Recruitments
4.4. Training of employees,
4.5. Performance Appraisal & counseling
4.6. Employees’ Reward Practices
4.7. Legal Requirements and Regulation of Working Condition Employer's Liabilities
for Health and Safety
4.8. Management By Objectives
4.9. Leadership, Group Dynamics and Management of Discipline
4.10. Motivation theories and Incentives, Maslow's hierarchy of needs theory, X and Y
theory Hertzberg's Hygienic and motivational theory, Elton Mayo's contribution
4.11. Accident Prevention, and Fatigue
4.12. Relation with Trade Unions
4.13. Workers Participation in Management
4.14. Work load management and prioritization
4.15. The importance of effective communication
5. Importance of economics in Marine Engineering study
5.1. Basic economic concepts

5.2. Demand analysis
5.3. Supply analysis
5.4. Equilibrium of Supply And Demand
5.5. Elasticity of demand
5.6. Elasticity of supply
5.7. Impact of Tax on Price and Quantity
5.8. Importance of economics in Marine Engineering study
6. Production function, Law of return, Economics of scale
6.1. Isoquant and Isocost curves

6.2. Concept of Cost
6.3. Revenue
6.4. Cost-output relationship
6.5. Cost curves in a shorter period
6.6. Cost curves in a longer period
6.7. Determination of price under free market
6.8. Price control by governments
6.9. Types of markets
6.10. Factors governing extent of market
6.11. Pricing under perfect competition
6.12. Monopoly, Monopolistic competition and oligopoly
7. Money
7.1. Types of Money

7.2. Functions of Money
7.3. Types and Causes of Inflation
7.4. Functions of Commercial Banks
7.5. Functions of Central Banks
7.6. Features of Money
7.7. Capital market
7.8. National Income
7.9. Overview of Macroeconomics
8. Taxation
8.1. Direct and indirect taxes

8.2. Government budgets
8.3. Economic development and Growth
8.4. Features of underdevelopment with reference to India.
8.5. Globalization of Indian economy.
9. Domestic and foreign trade
9.1. Basis of International Trade

9.2. Trade theories
9.3. Free Trade vs Protection.
9.4. Balance of payments - components, causes of deficit, steps to correct deficit.
9.5. Exchange Rates - Types, determination, Devaluation of currency, Free
convertibility of currency with reference to Indian Rupee
9.6. Functions of I.M.F, World Bank, W.T.O.
10. Shipping Routes & Ports
10.1. Major Shipping Routes

10.2. Types of Ports
10.3. Ports of India
10.4. Fishing
10.5. Major Sea Fishing Zones
10.6. Offshore Oil Producing Zones
10.7. India's Overseas Trade
10.8. Special Economic Zones
1. Introduction to Management Principles & Practices
1.1. Fundamental Principles of Sound Management
Efficiency
Efficiency means that the organization is managed both effectively and economically.
Effective managers are capable of producing superior results and economical managers
achieve them while minimizing the resources they use. Therefore, efficiency involves
intended results at optimal costs.
Balance
Balance is a state of stability stemming from a desirable mix of opposing ideas and forces.
The resulting harmony between these forces contributes to the sound management of the
organization. Managers show balance in the exercise of their authority by making right
choices about the resources they use and the actions they take while achieving these
results or objectives expected of them.
Equity
Equity means that the organization is managed in such a way that it is fundamentally fair in
its dealings. Equity takes shape from the underlying principles that govern actions of
everyone in the organization. These principles induce other people and produce effects on
them. The guidelines on these principles are clearly demarcated in Indian Labor Law and
Protection of Human Rights Act. Every manager must adhere to these principles while
dealing with other people in his organization.
Transparency
Transparency means that the organization is managed in such a way that the complete
reality of its current status can be seen or accessed by any stake holder without any
distortion or tampering. Transparency is the ultimate goal for any manager who exercises
authority delegated to him by the stake holders and who is accountable to them for his
actions.
Selflessness
Selflessness means that while carrying out his duties, the manager should consciously and
deliberately keep aside his personal interests or personal advantages beyond what has
been granted to him by the contract or described in an explicit way. He should, therefore,
act in the best interests of the organization and for it benefit.
Continuity
Continuity means that the organization is managed in such a way that smooth,
uninterrupted operations are ensured. What this means is that, the manager will ensure that
his successor receives the inputs needed for performing in his position and enjoys
adequate authority required for that position.
1.2. Need for sound management principles and practices
The stake holders or the prospective stake holders are interested in knowing, whether their
organizations are being managed on sound management principles or not. Primary reasons
for this exercise are -
o As a part of the investment decision – whether to commit additional resources on this

specific business or a project, or scout for alternative investment options.
o As an accountability assessment exercise post delegation of authorities or restructuring
of the organization.
o To implement systems improvement programs for enhancing performance of certain
processes of the organization.
o To enhance value for every stake holder.
o To ensure congenial employee atmosphere.
o To assess compliance to various regulations of the country.
o To assess the long-term viability of the business.
o To assess whether the organization can continue to carry out its mission.
o To fulfill the duties of a corporate citizen.
A careful look at following statements gives us an idea of whether the organization has
adopted sound management principles in running its business or not.
o Profit and Loss Statements and the Balance Sheets of previous few years give us an
idea of financial health of the organization. Whether the organization has adequate cash
in-flows to take care of the cash out-flows. Whether the organization is earning higher
short-term profits by compromising its long-term interests?
o A customer satisfaction survey will give us an insight into whether its customers are
happy about its products and services.
o An employees’ satisfaction survey will give us an insight into the level of motivation
amongst the employees and what actions need to be taken to keep them motivated.
o Financial parameters like ROI (Return on Investment), Operating Profit Margin, Net
Profit Margin, Sales Growth, Profit Growth etc. gives us the momentum of the business
from the perspective of the shareholders.
o Certain financial market ratios like P/E (Price to Earnings) and P/B (Price to Book Value)
give us an idea of the market’s general confidence in the future earnings of the
company. Too high a ratio indicates speculative activity in the company’s shares, and to
low a ratio indicates market’s lack of confidence in company’s performance.
o Product or Services innovation, R & D (Research and Development) pipeline,
acquisition of intellectual property etc. gives us an idea of the future of the company and
its eagerness to remain ahead of the competition and how well does it succeed in
turning this property into marketable goods and services.
o A careful look at the complaints against a company or the legal issues running against a
company gives an idea of whether the company is involved in any major public scandal.
o A careful look at the labor unrests and strikes gives us an idea of the general human
relations atmosphere in the company, and its effects on the future operations of the
company.
1.3. Growth of modern management thoughts
The formation of big companies has resulted in separation of the ownership and the
management. This change in ownership pattern has brought-in ‘salaried and professional
managers’ in place of ‘owner managers’. The ceding of control to the hired management
resulted in the wider use of scientific methods of management. But at the same time the
professional management has become socially responsible to the needs of various sections
of society such as customers, shareholders, suppliers, employees, trade unions and other
government agencies.
Three distinct streams of modern management thought have been noticed since.
o Quantitative or Mathematical Approach

o Systems Approach.
o Contingency Approach.
Quantitative or Mathematical Approach or Management Science Approach:
Mathematics has been universally accepted as an important tool for management

decisions. Mathematical tools give us a quantitative basis for our decision-making and
consider management as a system of mathematical models and processes. This branch of
modern management is also called ‘Operations Research’. The techniques like linear
programming, simulation, queuing theory, games theory etc. are being used for tackling a
wide range of management decisions. These models do help us in systematic analysis of
business problems, but these models are no substitute for sound judgments which come
out of firsthand experiences of managers.
This approach has contributed impressively to the development of orderly thinking amongst
managers. It has given exactness to the management discipline.
Limitations:
(i) This approach does not give any weightage to human element which plays a dominant
role in any organization.
(ii) In real lives executives have to take decisions quickly without waiting for full information
to develop models.
(iii) Decision-making is just one part of the managerial activities. Management has many
other functions other than decision-making.
(iv) This approach assumes that all variables to decision-making are measurable and inter-
dependent. This may not be always possible.
(v) Sometimes, the information available to the business for developing mathematical
models is not up to date and may lead to wrong decision-making.
Systems Approach:
This approach views the organization as an organic and open system, which is composed
of interacting and interdependent parts, called subsystems. The system approach is to look
upon management as a system or as “an organized whole” made up of sub-systems
integrated into a unity. A system is simply an assembly of things, parts, and actions forming
a complex whole. One of its most important characteristic is that it consists of a hierarchy of
sub-systems. That is the parts forming the major systems and so on. A company can be
considered a system composed of sub-systems such as production, marketing, finance,
accounting and so on.
The basic features of systems approach are as under:
o A system consists of interacting elements. It is a set of inter related and inter-dependent

parts arranged in such a manner that it produces a unified whole.
o The various sub-systems should be studied in their inter-relationships rather, than in
isolation from each other.
o An organizational system has a boundary that determines which parts are internal and
which are external.
o A system does not exist in a vacuum. It receives information, material and energy from
other systems as inputs. These inputs undergo a transformation process within the
system and leave the system as output to other systems.
o An organization is a dynamic system as it is responsive to its environment. It is
vulnerable to changes in its environment.
In the systems approach, attention is paid towards the overall effectiveness of the system
rather than the effectiveness of sub-systems. The entire interdependence of the sub-
systems is taken into account while designing the system. The idea of systems can be
applied to the entire organization and not only the objectives and performances of individual
department (sub-systems).
Contingency or Situational Approach
Management problems are different under different situations and require to be tackled as
per the demand of the situation. One best way of doing things may be useful for repetitive
things but not for managerial problems. The contingency theory aims at integrating theory
with practice in systems framework. The behavior of an organization is said to be
contingent on forces of environment. “Hence, a contingency approach is an approach,
where behavior of one sub-unit is dependent on its environment and relationship to other
units or sub-units that have some control over the sequences desired by that sub-unit.”
Thus behavior within an organization is contingent on environment, and if a manager wants

to change the behavior of any part of the organization, he must try to change the situation
influencing it. Therefore, the organization’s system is not a matter of managerial choice, but
contingent upon its external environment.
Contingency approach is an improvement over the systems approach. The interactions

between the sub-systems of an organization have long been recognized by the systems
approach. Contingency approach also recognizes that organizational system is the product
of the interaction of the sub systems and the environment. Besides, it seeks to identify
exact nature of inter-actions and inter-relationships.
This approach calls for an identification of the internal and external variables that critically
influence managerial actions and organizational performance. According to this, internal
and external environment of the organization is made up of the organizational sub-systems.
Thus, the contingency approach provides a pragmatic method of analyzing organizational
sub-systems and tries to integrate these with the environment.
Contingency views are ultimately directed towards suggesting organizational designs

situations. Therefore, this approach is also called situational approach. This approach helps
us to evolve practical answers to the problems demanding solutions. The contingency view
seeks to understand the inter-relationships within and among sub-systems as well as
between the organization and its environment and seeks to define patterns of relationships
for organization’s designs and initiate managerial actions which are most appropriate for
specific situations.
Features of Contingency Approach:
o Firstly, the contingency approach does not accept the universality of management
theory. It stresses that there is no ‘one best way’ of doing things. Management is
situation oriented, and managers should explain their objectives, design their
organizations and prepare their strategies, their policies and their plans according to the
prevailing circumstances.
o Secondly, for managerial policies and practices to be effective, it must adapt to changes
in the environment.
o Thirdly, it should improve diagnostic skills so as to anticipate and be ready for the
environmental changes.
o Fourthly, managers should have sufficient human relation’s skill to accommodate and
stabilize change.
o Finally, it should apply the contingency model in designing the organization, developing
its information and communication system, following proper leadership styles and
preparing suitable objectives, policies, strategies, programs and practices. Thus,
contingency approach looks to hold a great deal of promise for the future development
of management theory and practice.
Principles of Management
Fayol’s Principles of Management

According to Henri Fayol there are fourteen 'Principles of Management'.
These are the guidelines for decision making and they form the rationale for the actions of
the company’s managers.
1. Division of Work - According to this principle the whole work is divided into small
tasks. The specialization of the workforce according to the skills of a person ,
creating specific personal and professional development within the labour force and
therefore increasing productivity; leads to specialization which increases the
efficiency of labour.
2. Authority and Responsibility - This is the issue of commands followed by
responsibility for their consequences. Authority means the right of a superior to give
enhance order to his subordinates; responsibility means obligation for performance.
3. Discipline - It is obedience, proper conduct in relation to others, respect of authority,
etc. It is essential for the smooth functioning of all organizations.
4. Unity of Command - This principle states that each subordinate should receive
orders and be accountable to one and only one superior. If an employee receives
orders from more than one superior, it is likely to create confusion and conflict.
5. Unity of Direction - All related activities should be put under one group, there
should be one plan of action for them, and they should be under the control of one
manager.
6. Subordination of Individual Interest to common (mutual) Interest - The
management must put aside personal considerations and put company objectives
firstly. Therefore the interests of goals of the organization must prevail over the
personal interests of individuals.
7. Remuneration - Workers must be paid sufficiently as this is a chief motivation of
employees and therefore greatly influences productivity. The quantum and methods
of remuneration payable should be fair, reasonable and rewarding of effort.
8. The Degree of Centralization - The amount of power wielded with the central
management depends on company size. Centralization implies the concentration of
decision making authority at the top management.
9. Line of Authority/Scalar Chain - This refers to the chain of superiors ranging from
top management to the lowest rank. The principle suggests that there should be a
clear line of authority from top to bottom linking all managers at all levels.
10. Order - Social order ensures the fluid operation of a company through authoritative
procedure. Material order ensures safety and efficiency in the workplace. Order
should be acceptable and under the rules of the company.
11. Equity - Employees must be treated kindly, and justice must be enacted to ensure a
just workplace. Managers should be fair and impartial when dealing with employees,
giving equal attention towards all employees.
12. Stability of Tenure of Personnel - Stability of tenure of personnel is a principle
stating that in order for an organization to run smoothly, personnel (especially
managerial personnel) must not frequently enter and exit the organization.
13. Initiative - Using the initiative of employees can add strength and new ideas to an
organization. Initiative on the part of employees is a source of strength for
organization because it provides new and better ideas. Employees are likely to take
greater interest in the functioning of the organization.
14. Esprit de Corps/Team Spirit - This refers to the need of managers to ensure and
develop morale in the workplace; individually and communally. Team spirit helps
develop an atmosphere of mutual trust and understanding. Team spirit helps to finish
the task on time.
Taylor’s Principles of Scientific Management
The scientific approach to management is known as the classical theory of management.

This principle was proposed by Fredrick Winslow Taylor (F.W Taylor) – the father of
management science. He noticed that a lot of disorder was prevailing at the factories and
many resources were being wasted at the workplaces. The managers and staffs had no
idea about the systematic and efficient options of performing tasks. They all were following
traditional ways of doing the work. Therefore he tried to eliminate these wastages through
his scientific management approach.
While working in Midvale Company as a manager he observed that employees were not
performing up to their capacity of productivity. He thought that this condition was occurring
because of no care towards the wastage. Taylor worked on experiments to increase the
worker’s efficiency so that maximum output could be achieved by optimum utilization of
efforts. His approach involved -
1. Scientific task setting: - Taylor observed that the managements did not know exactly
how much work – that is, pieces of work produced or volume of work produced - which
was supposed to be performed by the workers during a fixed period of time - called a
working day. In a working day, how much work is supposed be done by a worker, is
fixed by a manager and the task is set every day. The process of task setting requires
scientific techniques. To make a worker do a certain quantity of work in a working day is
called scientific task setting.
Replacing the rule of thumb with science:- it requires scientific study and analysis of
each element of the job in order to replace the rule of thumb. Only through scientific
investigation and standardization better ways of doing work can be developed. Scientific
selection of employees requires that decisions to make on facts rather than on opinions
and beliefs.
2. Differential payment system: - under this system, a worker received the piece rate
benefit which would encourage the workers to work more for higher amount of wages.
Incentives are given to raise the standard output levels to higher levels and motivate
workers to produce more & more, and utilize the otherwise waste time to earn higher
wages.
3. Reorganization of supervision: - concepts of separation of planning and doing and

functional foremanship were developed. Taylor opined that the workers should only
emphasize in planning or in doing. There should be 8 foreman in which four are for
planning and four for doing. For planning they were route clerk, instruction card clerk,
time and cost clerk and disciplinarian. And for doing they were speed boss, gang boss,
repair boss and inspector.
Division of responsibility: - introduction of functional foremanship made division of

responsibility. Many foremen should be appointed out of which 4 for planning and 4 for
doing. In planning they were route clerk, instruction cord clerk, time and cost clerk and
disciplinarian. And for doing they were speed boss, gang boss, repair boss and
inspector. This promoted division of work which promoted division of responsibility
4. Scientific recruiting and training: - staffs and workers should be selected and employed
on scientific basis. Management should develop and train every worker by providing
proper knowledge and training to increase their skills and make them effective.
Development of employees: - personnel management must be backed up by scientific
selection of employees along with proper training to them. Efforts should be made to
develop each employee to achieve efficiency and prosperity.
5. Economy: - efficient cost accounting system should be followed to control cost which
can minimize the wastages.
Maximum output: - Taylor was more concerned with continuous increase in production
and productivity. It maximum output is derived from optimum utilization of resources
than surely it will bring higher profits and better benefits to the employer and employees.
6. Mental revolution: - Taylor argued that both management and workers should try to
understand each other instead of quarreling for profits and benefits which would
increase production, profit and benefits.
Cooperation:- cooperation between management and labor is the major foundation of
scientific management. It creates a sense of mutuality through which maximum
prosperity can be guaranteed.
7. Harmony in group activities: - In the past there was only discord between the owners
and employees on various issues. Taylor emphasized harmony among employees and
employers to attain common goals which would eliminate wastage and maximize the
incomes of every stake holder.
1.4 Management functions
Management is social process involving

responsibility for economical and effective
execution of the operations of an enterprise
for attaining certain objectives. It is a
dynamic process consisting of interactions
between various elements and activities.
These activities are different from operative
functions like marketing, finance, purchase,
production etc. These activities are in fact
common to each and every manger
irrespective of his level or status in any
organization.
Henry Fayol describes management as -

To manage is to forecast and plan, to
organize, to command, & to control.
Whereas Luther Gullick identifies it with a keyword ’POSDCORB’, where P stands for
Planning, O for Organizing, S for Staffing, D for Directing, Co for Co-ordination, R for
Reporting & B for Budgeting. But the most widely accepted functions of management
described by Koontz and O’Donnell are Planning, Organizing, Staffing, Directing and
Controlling.
Even though theoretical purposes it may be convenient to separate the function of

management, but practically these functions are overlapping with each other. That is, each
function blends into the other & each one affects the performance of another.
Planning
It is the basic function of management. It deals with chalking out a future course of action &
deciding in advance the most appropriate course of actions for achievement of pre-
determined goals. According to Koontz, “Planning is deciding in advance - what to do, when
to do & how to do it. It bridges the gap from where we are at present & where we want to be
in future”. A plan is a future course of actions. It is acquiring the entire action plan even
before laying the first brick. It is an exercise in problem solving & decision making.
Planning is determination of the courses of action to achieve desired goals. Thus, planning
is a systematic thinking about ways & means for accomplishment of pre-determined goals
with minimal utilization of resources, with minimal impact on the ecosystem and attaining
them within the available time frame. Therefore, planning is necessary to ensure proper
utilization of resources. It is all a pervasive activity, it is an intellectual activity and it helps in
eliminating mis-coordination, uncertainties, risks, and wastages which happen in execution
process.
Organizing
It is the process of bringing together, physical, financial and human resources and
developing a productive relationship between them for achieving the organizational goals.
According to Henry Fayol, “To organize a business is to provide it with everything useful for
its functioning i.e. raw material, tools, capital and personnel”. To organize a business
involves determining & providing human and non-human resources to the organizational
structure. Organizing as a process involves:
o Identification of activities.
o Classification of grouping of activities.
o Identifying nodes of responsibilities, called positions, posts or designations.
o Delegation of authority and assignment of responsibilities to these nodes.
o Framing interrelationships between authorities and responsibilities of these nodes.
Staffing
It is the function of manning the organization structure and keeping it manned until the
operation is going and dissolving the same when the operation is wound up. Staffing
function has assumed greater importance in the recent years due to advancements in
technology, increase in size of businesses, and increasing complexity of human behavior.
The main purpose of staffing function is to put right men on right jobs i.e. putting square
pegs in square holes and round pegs in round holes. According to Kootz & O’Donell,
“Managerial function of staffing involves manning the organization structure through proper
and effective selection; appraisal & development of personnel to fill the roles designed in
the structure”.
Staffing involves:
o Manpower Planning (estimating the man power requirement)

o Recruitment, Selection & Placement (searching right people, choosing the right person
and giving him the right place in the organization)
o Training & Development.
o Compensation.
o Performance Appraisal.
o Promotions & Transfer.
Directing
It is akin to human nervous system. It is that part of managerial function which actuates the
organization structure to work efficiently for achieving the motive of the organization. It is
considered life-spark of the enterprise which sets in motion the actions of people. Direction
is that inert-personnel aspect of management which deals directly with influencing, guiding,
supervising, and motivating personnel for achieving organizational goals.
Direction has following elements:
o Supervision - implies overseeing the work of subordinates by their superiors. It is the act
of watching & directing the work & the workers.
o Motivation - means inspiring, stimulating or encouraging the sub-ordinates and imbibes
the zeal to work. Monetary or non-monetary incentives may be used for this purpose.
o Leadership - may be defined as a process by which manager guides and influences the
work of subordinates in the desired direction.
o Communications - is the process of exchanging the information, experiences, opinions
etc. with each other. It is a bridge for understanding each other’s actions for effective
course correction.
Controlling
It implies measuring accomplishments against set standards and taking corrective actions
on deviations to ensure achievement of organizational goals. The purpose of controlling is
to ensure that everything occurs in conformity to the standards. An efficient system of
control helps to predict deviations before they actually occur. According to Theo Haimann,
“Controlling is the process of checking whether or not proper progress is happening
towards the objectives and goals, and acting if necessary, to correct any deviation”.
According to Koontz & O’Donnell, “Controlling is, ‘the measurement of performance &
taking corrective actions on the process in to ensure that the enterprise’s objectives are
met. It plans corrective actions to accomplish those goals”.
Therefore controlling has following steps:
o Establishment of standard performance.

o Measurement of actual performance.
o Comparison of actual performance with the standards and finding out deviations, if any.
o Taking corrective action.
Planning
Planning is looking ahead and chalking out the future courses of action. It is a preparatory
step. It is a systematic activity which determines when, how and who is going to perform a
specific job. Planning is a detailed programme regarding future courses of action.
It is rightly said “Well planned is half done”. Therefore planning takes into consideration
available & prospective human and physical resources of the organization so as to get
effective co-ordination, contribution & perfect adjustment. It is the basic management
function which includes formulation of one or more detailed plans to achieve optimum
balance of needs or demands with the available resources.
According to Urwick, “Planning is a mental predisposition to do things in an orderly way, to

think before acting and to act in the light of facts rather than guesses”. Planning is deciding
best alternative among others to perform different managerial functions in order to achieve
predetermined goals.
According to Koontz & O’Donell, “Planning is deciding in advance what to do, how to do
and who is to do it. Planning bridges the gap between where we are to, where we want to
go. It makes possible things to occur which would not otherwise occur”.
Steps in Planning Function
Planning function of management involves following steps:-
1. Establishment of objectives
a. Planning requires a systematic approach.

b. Planning starts with the setting of goals and objectives to be achieved.
c. Objectives provide a rationale for undertaking various activities as well as indicate
direction of efforts.
d. Moreover objectives focus the attention of managers on the end results to be
achieved.
e. As a matter of fact, objectives provide nucleus to the planning process. Therefore,
objectives should be stated in a clear, precise and unambiguous language.
Otherwise the activities undertaken are bound to be ineffective.
f. As far as possible, objectives should be stated in quantitative terms. For example,
Number of men working, wages given, units produced, etc. But such an objective
cannot be stated in quantitative terms like performance of quality control manager,
effectiveness of personnel manager.
g. Such goals should be specified in qualitative terms.
h. Hence objectives should be practical, acceptable, workable and achievable.
2. Establishment of Planning Premises
a. Planning premises are the assumptions about the lively shape of events in future.
b. They serve as a basis of planning.
c. Establishment of planning premises is concerned with determining where one tends
to deviate from the actual plans and causes of such deviations.
d. It is to find out what obstacles are there in the way of business during the course of
operations.
e. Establishment of planning premises is concerned to take such steps that avoids
these obstacles to a great extent.
f. Planning premises may be internal or external. Internal includes capital investment
policy, management labour relations, philosophy of management, etc. Whereas
external includes socio- economic, political and economic changes.
g. Internal premises are controllable whereas external are non- controllable.
3. Choice of alternative course of action
a. When forecast are available and premises are established, a number of alternative
course of actions have to be considered.
b. For this purpose, each and every alternative will be evaluated by weighing its pros
and cons in the light of resources available and requirements of the organization.
c. The merits, demerits as well as the consequences of each alternative must be
examined before the choice is being made.
d. After objective and scientific evaluation, the best alternative is chosen.
e. The planners should take help of various quantitative techniques to judge the
stability of an alternative.
4. Formulation of derivative plans
a. Derivative plans are the sub plans or secondary plans which help in the achievement
of main plan.
b. Secondary plans will flow from the basic plan. These are meant to support and
expediate the achievement of basic plans.
c. These detail plans include policies, procedures, rules, programmes, budgets,
schedules, etc. For example, if profit maximization is the main aim of the enterprise,
derivative plans will include sales maximization, production maximization, and cost
minimization.
d. Derivative plans indicate time schedule and sequence of accomplishing various
tasks.
5. Securing Co-operation
a. After the plans have been determined, it is necessary rather advisable to take
subordinates or those who have to implement these plans into confidence.
b. The purposes behind taking them into confidence are :-
I. Subordinates may feel motivated since they are involved in decision making
process.
II. The organization may be able to get valuable suggestions and improvement
in formulation as well as implementation of plans.
III. Also the employees will be more interested in the execution of these plans.
6. Follow up/Appraisal of plans

a. After choosing a particular course of action, it is put into action.
b. After the selected plan is implemented, it is important to appraise its
effectiveness.
c. This is done on the basis of feedback or information received from departments
or persons concerned.
d. This enables the management to correct deviations or modify the plan.
e. This step establishes a link between planning and controlling function.
f. The follow up must go side by side the implementation of plans so that in the light
of observations made, future plans can be made more realisti
Organizing
Organizing is the function of management which follows planning. It is a function in which

the synchronization and combination of human, physical and financial resources takes
place. All the three resources are important to get results. Therefore, organizational function
helps in achievement of results which in fact is important for the functioning of a concern.
According to Chester Barnard, “Organizing is a function by which the concern is able to
define the role positions, the jobs related and the co-ordination between authority and
responsibility. Hence, a manager always has to organize in order to get results.
A manager performs organizing function with the help of following steps:-
1. Identification of activities - All the activities which have to be performed in a concern

have to be identified first. For example, preparation of accounts, making sales, record
keeping, quality control, inventory control, etc. All these activities have to be grouped
and classified into units.
2. Departmentally organizing the activities - In this step, the manager tries to combine
and group similar and related activities into units or departments. This organization of
dividing the whole concern into independent units and departments is called
departmentalization.
3. Classifying the authority - Once the departments are made, the manager likes to
classify the powers and its extent to the managers. This activity of giving a rank in order
to the managerial positions is called hierarchy. The top management is into formulation
of policies, the middle level management into departmental supervision and lower level
management into supervision of foremen. The clarification of authority helps in bringing
efficiency in the running of a concern. This helps in achieving efficiency in the running of
a concern. This helps in avoiding wastage of time, money, effort, in avoidance of
duplication or overlapping of efforts and this helps in bringing smoothness in a concern’s
working.
4. Co-ordination between authority and responsibility - Relationships are established
among various groups to enable smooth interaction toward the achievement of the
organizational goal. Each individual is made aware of his authority and he/she knows
whom they have to take orders from and to whom they are accountable and to whom
they have to report. A clear organizational structure is drawn and all the employees are
made aware of it.
Staffing
The managerial function of staffing involves manning the organization structure through
proper and effective selection, appraisal and development of the personnels to fill the roles
assigned to the employers/workforce.
According to Theo Haimann, “Staffing pertains to recruitment, selection, development and

compensation of subordinates.”
Nature of Staffing Function
1. Staffing is an important managerial function- Staffing function is the most

important mangerial act along with planning, organizing, directing and controlling.
The operations of these four functions depend upon the manpower which is available
through staffing function.
2. Staffing is a pervasive activity- As staffing function is carried out by all mangers
and in all types of concerns where business activities are carried out.
3. Staffing is a continuous activity- This is because staffing function continues
throughout the life of an organization due to the transfers and promotions that take
place.
4. The basis of staffing function is efficient management of personnels- Human
resources can be efficiently managed by a system or proper procedure, that is,
recruitment, selection, placement, training and development, providing remuneration,
etc.
5. Staffing helps in placing right men at the right job. It can be done effectively
through proper recruitment procedures and then finally selecting the most suitable
candidate as per the job requirements.
6. Staffing is performed by all managers depending upon the nature of business,
size of the company, qualifications and skills of managers,etc. In small companies,
the top management generally performs this function. In medium and small scale
enterprise, it is performed especially by the personnel department of that concern.
Directing
Directing is said to be a process in which the managers instruct, guide and oversee the
performance of the workers to achieve predetermined goals. Directing is said to be the
heart of management process. Planning, organizing, and staffing have got no importance if
direction function does not take place.
Directing initiates action and it is from here actual work starts. Direction is said to be
consisting of human factors. In simple words, it can be described as providing guidance to
workers is doing work. In field of management, direction is said to be all those activities
which are designed to encourage the subordinates to work effectively and efficiently.
According to Human, “Directing consists of process or technique by which instruction can
be issued and operations can be carried out as originally planned” Therefore, Directing is
the function of guiding, inspiring, overseeing and instructing people towards
accomplishment of organizational goals.
Direction has got following characteristics:
1. Pervasive Function - Directing is required at all levels of organization. Every manager

provides guidance and inspiration to his subordinates.
2. Continuous Activity - Direction is a continuous activity as it continuous throughout the
life of organization.
3. Human Factor - Directing function is related to subordinates and therefore it is related
to human factor. Since human factor is complex and behaviour is unpredictable,
direction function becomes important.
4. Creative Activity - Direction function helps in converting plans into performance.
Without this function, people become inactive and physical resources are meaningless.
5. Executive Function - Direction function is carried out by all managers and executives
at all levels throughout the working of an enterprise, a subordinate receives instructions
from his superior only.
6. Delegate Function - Direction is supposed to be a function dealing with human beings.
Human behaviour is unpredictable by nature and conditioning the people’s behaviour
towards the goals of the enterprise is what the executive does in this function.
Therefore, it is termed as having delicacy in it to tackle human behaviour.
Controlling
Controlling consists of verifying whether everything occurs in confirmities with the plans
adopted, instructions issued and principles established. Controlling ensures that there is
effective and efficient utilization of organizational resources so as to achieve the planned
goals. Controlling measures the deviation of actual performance from the standard
performance, discovers the causes of such deviations and helps in taking corrective actions
According to Brech, “Controlling is a systematic exercise which is called as a process of

checking actual performance against the standards or plans with a view to ensure adequate
progress and also recording such experience as is gained as a contribution to possible
future needs.”
According to Donnell, “Just as a navigator continually takes reading to ensure whether he is

relative to a planned action, so should a business manager continually take reading to
assure himself that his enterprise is on right course.”
Controlling has got two basic purposes
1. It facilitates co-ordination
2. It helps in planning
Features of Controlling Function
Following are the characteristics of controlling function of management-
1. Controlling is an end function- A function which comes once the performances are
made in conformities with plans.
2. Controlling is a pervasive function- which means it is performed by managers at
all levels and in all type of concerns.
3. Controlling is forward looking- because effective control is not possible without
past being controlled. Controlling always look to future so that follow-up can be made
whenever required.
4. Controlling is a dynamic process- since controlling requires taking review
methods, changes have to be made wherever possible.
5. Controlling is related with planning- Planning and Controlling are two inseparable
functions of management. Without planning, controlling is a meaningless exercise
and without controlling, planning is useless. Planning presupposes controlling and
controlling succeeds planning
1.5. Process planning & its applications
Process Planning is a process of establishing the shortest and most economical path that
each part is to follow from the point it is received as raw material until it leaves as a finished
part or a finished product. The document which incorporates this vital information is called a
process sheet or route sheet. The information contained in the process sheet can be put to
a following uses:
(a) Scheduling: The scheduling cell of PPC can obtain for each operation the set-up-
time and the processing time. This information helps them to prepare load and
schedule charts.
(ii) Material Movement: The shop supervisor and the dispatch clerk can know where the
jobs require to be sent for the next operation.
(iii) Cost Reduction & Cost Control: A process sheet gives an idea of the tooling
(standard tools, jigs and fixtures, templates, gauges and measuring instruments),
which could be arranged prior to the starting of the operation. This cuts down set-up
time and there by reduces labour cost and overheads.
(iv) Costing:
Costing group can use the information to determine pre and post production cost of
each component.
(v) Method of working :
Method study engineer without going on the shop floor can know as to how presently
the part is being manufactured.
(vi) Requirement of Man Power and Machine:
Set-up times and processing times given in different route sheets may be
consolidated machine wise into total man hours or machine hours required to enable
the management to take decisions concerning requirements of man power and
machines.
(vii) Shop Efficiency
Operation wise time data given in the process sheet is also helpful to the shop
personal to know whether the shop performance is in line with the expected
performance
1.6. Long term corporate strategies
The formation of a corporate strategy cannot afford a generic approach, which can be
copied and tailored to fit to any organization. Similarly, even a few definitions and concepts
may get interpreted in different ways, and sometimes individual circumstances might dictate
the development process or implementation of some strategies.
Corporate strategies are based on specific answers to the following questions:
o Where your organization is today?

o Where you want it to be?
o How you want to get there?
The risk of not changing with the circumstances or not innovating can be significant for the
survival of the business – you have to assume that your competition is certainly innovating
and moving ahead, and you may be left behind in terms of efficiency, reputation, brand
loyalty and financial gain, if lessons are not learnt and due recognition is not given to the
factors influencing your success in delivering your business goals.
These factors certainly will impact on your corporate strategies and business plan. If the
purpose of the plan is business development rather than (just) a means of raising finance, it
should be the basis for your management system - if the business plan is finalized on
Friday afternoon, the management system should ensure how it can be implemented it from
next Monday morning.
Defining corporate strategy is a process. The objective of the process is to combine the
activities of the various functional areas of a business in a way which will achieve its
organizational objectives.
Left unchecked, market forces will continually conspire to deplete our profits. Powerful
business strategies can counteract those tendencies, but good strategies are difficult to
formulate. A McKinsey research report “The strategic yardstick you can’t afford to ignore”
finds that a very small number of companies create most economic profit. The research
also shows that a significant number of good companies outperform even in so-called bad
industries, where the average economic profit is less than the market average.
How do they do it? In other words, where do powerful strategies come from? Sometimes it’s
luck, or good timing, or a stroke of inspiration. It’s quite possible to load the dice in favour of
developing good strategies by focusing on the core building blocks that often get
overlooked. One is the need to gain agreement - before creating strategy - on the essential
decisions and the criteria for making them. Another is to ensure that the company is
prepared and willing to act on a strategy once it is adopted. Too much of what passes for
strategy development, many times consists of hurried efforts that skip one or more of the
essentials, resulting strategies which are often flawed from the start.
It’s also easy, though, to go too far in the other direction and make the creation of strategy a
rigid, check list exercise. Appealing as a formula-driven approach might be, it ignores the
truth that strategy creation is a creative journey - and an inherently messy one at that.
Original insights into strategy formulation are hard to come by. Shaping keen insights into
good strategies requires deep interpersonal engagement and debate from senior
executives, as well as the ability to deal with ambiguities in charged and often stressful
circumstances. When would-be strategists overlook this dynamics, they cover the
essentials in name only. Consequently, they miss opportunities and threats, or create great
paper strategies that remain perpetually unfinished in practice.
By better understanding both the method and how to get the most out of it, companies can
boost the odds that the strategies they create will beat the market.
Do justice to strategy’s building blocks
Most companies demonstrate a variety of good habits when they create strategies, and
they get many things right. But what they miss can be critical. Consider these examples:
 a technology company that prided itself on analytical rigor but never accurately
diagnosed how difficult it would be for a targeted customer group to provide
reasonable returns
 a motorcycle company that rightly focused on industry structure in its core business
but made a losing bet on a related business – gearless scooters - after failing to
forecast declining returns stemming from structural shifts there
 a telecommunications company’s strategy team, which recognized the importance of
involving senior managers but ended up alienating them by holding a series of time-
consuming workshops that focused on alignment around strategic choices, though
the full set of choices hadn’t yet been identified
These problems don’t have to happen. Companies do better when they ground all their
strategy-development efforts and processes in an understanding of the building blocks of
strategy. These straightforward modes of activity (exhibit) track the progression of a
strategy from its roots as an idea through its emergence as an operational reality.
The building blocks of strategy help

companies make strategic choices and
carry them through to operational
reality.
One central building block is a deep

insight into the starting position of
the company: where and why it
creates - or destroys - value
(diagnose). Executives also need a
point of view on how the future may
unfold (forecast). By combining
insights into a company’s starting
position with a perspective on the
future, the company can develop and explore alternative ways to win (search) and
ultimately decide which alternative to pursue (choose). With the strategy selected, the
company needs to create an action plan and reallocate resources to deliver it (commit).
These five core building blocks are book-ended by two others. One is an initial block
(frame) to ensure that the team properly identifies and agrees to both the questions asked
and the decisions made as the strategy is developed – that is, it fixes a frame for the
strategy development activity. The final block (evolve) is dedicated to the constant
monitoring and refreshing of the strategy as conditions change and new information
becomes available.
To some extent, the building blocks simply represent a thorough list of activities that all
good strategists perform. And while all are important and should be included in the creation
of strategy, slavishly following this or any other framework won’t bring success. Depending
on the situation, some blocks will be more critical than others and therefore require more
attention.
Re-create, recommit, and refresh
Let’s see how ill-suited traditional strategic-planning processes are to the dynamism and
pace of 21st-century business life. It’s even less clear, what should happen to many
organizations’ well-oiled, but out dated approaches. Shut them down? Morph them into
budgeting and operational-planning processes? Use them to synthesize the valuable
insights emerging from more frequent strategic dialogues involving larger numbers of
executives?
The building blocks of strategy shed fresh light on what strategic planning should and
shouldn’t try to do. Periodically - perhaps as often as every three to five years, or if new
competitors arrive or markets unexpectedly shift - companies must re-create their
strategies. This cannot be accomplished through typical planning processes, as it requires
broader skills, wider engagement, and more flexibility to make big strategic choices than
they allow. Therefore forget about strategic planning when you need to revamp your
strategy; instead, take a more immersive strategy-development approach using all of the
seven building blocks described above.
At the other end of the spectrum is what we describe as the need to recommit organizations
to established strategies. Traditional strategic planning is tailor-made for this purpose, and
thinking about the task in these terms helps elevate it above the glorified budgeting
exercise into which some processes lapse. Two of the building blocks described here -
commit and evolve - are useful reminders of what any such strategic-planning process
should accomplish: the constant monitoring of strategy, the reallocation of resources, the
alignment of management on strategic priorities, and the creation of targets, budgets, and
operational plans.
Between these two extremes lies the strategic refresh, which is particularly relevant for
organizations where a lot of valuable, on-going strategy dialogue takes place among
members of the top team. Such engagement can highlight nagging issues that might one
day necessitate a strategic redo but certainly merit attention now. For example, if signs
suggesting that one or more key assumptions have become less valid emerge from
strategic dialogues at the business-unit level, it might be time to update the company’s
perspective on long-term trends. This exercise could be elevated in importance by making it
a core theme of the upcoming strategic-planning process. In such situations, it’s a good
idea to check all seven building blocks quickly, with an emphasis on understanding the
strategic implications of underlying changes. If they are big enough, that could be a red flag
signalling the need to re-create the strategy and thus to elevate the discussion beyond
strategic-planning parameters.
That’s why taking some time to frame issues at the outset, is so important. When strategists
do so, they are better able to identify the real choices and constraints facing their
organizations and to see which building blocks are likely to matter most given the situation
at hand. Unfortunately, many executives feel that taking the time to frame strategy choices
thoughtfully and to decide where to focus strategy-development efforts is a luxury they don’t
have.
Two-thirds of the 200 executives surveyed, rushed to provide outputs in their strategic-
planning processes. This pressure is understandable in today’s always-on, fast-changing
environment, but it can be hazardous to a company’s strategic health. That’s especially true
in the all-too-common situations when it’s not immediately obvious what factors will
determine the success or failure of a change to strategy.
A financial-services institution in the Asia–Pacific region, for example, was investigating a

growth opportunity involving the creation of an online business. Changing the company’s
focus in this way would be a big undertaking, but the upside potential was large. Moreover,
the members of the strategy team could already see that demonstrating the channel’s
significant potential to the top team would be straightforward. Before doing that, however,
they stepped back to spend some time thinking through the idea’s broader strategic context
- framing, in other words.
When they did, they saw a serious risk of cannibalization for one of the company’s existing
businesses. The new venture would also require substantial funding over the next three to
five years before it contributed financially. This had important implications, and the team’s
members needed to convince themselves that the risk was worth taking. Moreover, if the
company made the move, would it stick with the effort when the time came to provide
funding for people and technology?
Instead of steaming ahead with analytical work to prove the potential, the team recognized
that it would be critical to invest a disproportionate amount of time and effort to the commit
building block. The strategy team did this, in part, by developing a powerful multimedia
concept prototype to capture the imaginations of the top team and the executives
representing key support functions. The team’s focus on gaining commitment was
prescient; the prototype and the communication around it helped convince the leaders that
the concept was so compelling for consumers that if the company didn’t cannibalize its
existing business, a competitor would probably have come up with the idea. The effort also
helped motivate the leaders of the finance and IT functions to support the new offer. The
company launched it in record time, promising early results in both customer acquisition
and levels of customer engagement.
In retrospect, the team credits the conversations and debates held during this framing
period as necessary to identify and resolve the potential stumbling blocks related to the
organization’s strategic direction. Although messy at times, this activity helped build an
organizational commitment to the strategy and its importance to the company.
Myth-bust your story
A focus on strategic building blocks also can help companies develop penetrating insights.
While “insight” conjures up visions of research, data crunching, and “aha” moments, real
strategic insight also rests on a seemingly mundane and easy-to-overlook factor: a
thorough understanding of how and why a company, its competitors, and others in the
industry value-chain make money. Absent dumb luck, a strategy that doesn’t tap directly
into such an understanding will underperform.
The difficulty, as professor Phil Rosenzweig of the International Institute for Management
Development has explained so well, is that a company’s performance - good or bad -
creates strong impressions that powerfully shape the way people perceive strategies,
leaders, cultures, and organizational effectiveness. A commodity company, for instance,
might falsely attribute its strong performance to the efficiency of its operations. Yet despite
its efficiency, the economics of those operations could be swamped by market-structure
changes that have significant pricing implications or by unexpectedly volatile demand.
One way senior executives can address the challenge, is explicitly questioning received
corporate wisdom to prove or disprove them. In the creation of strategy, this approach
means dispassionately identifying the elements that contribute to performance, while
discounting any factor contaminated by perceptions of the company’s supposed greatness.
It also requires a curiosity that’s woefully lacking in some strategic-planning processes.
Nearly eight in ten executives, for example, say that the processes of their companies are
more geared to confirming existing hypotheses than to testing new ones.
To see how these dynamics play out in practice, consider the experience of a global retailer
that was revisiting its strategy after the previous one had delivered five years of strong
earnings. The positive results, most in the company believed, reflected good execution and
the success of a recent initiative to refresh the store format. Still, the leader of the business
felt there could be more to the story and worried that continuing along the same path might
not produce the same results in the future. To determine what was actually driving
performance, the leader met with the company’s strategy team, as well as other executives.
This was time well spent. The resulting discussions sparked important insights—revealing,
for example, that while overall performance was good, there were problems under the
surface. On the positive side, the company was steadily improving its margins and winning
customers from a higher-cost competitor. Nonetheless, the solid network growth at the top-
line level appeared to be masking a worrisome decline in the productivity of older stores.
The big drag on performance, the team discovered, was the loss of mainstream customers
to a cheaper competitor, which careful analysis showed to have an unassailable advantage
on cost. Increasing promotional activity had so far seemed to stem the march of this
aggressive rival, but the retailer was running out of steam and hitting practical limits.
Significant changes would have been necessary.
Let them grapple
This realization was the product of more than just number crunching. The thoughtful
argument and debate surrounding the analysis from day one played a vital part in
generating the insights. Many companies forget this truth when they create strategy.
Instead, they put too much emphasis on preparing documents and completing analyses
and not enough on stimulating the productive debates that lead to better decisions.
Getting executives to grapple with the issues can be a messy process, and the debates
may be quite personal. After all, formulating good strategies typically involves revisiting
fundamental and deeply held beliefs about a company’s past and future, and people tend
not to shift their views without a fight. But without the necessary fights, and without the use
of carefully designed decision-making techniques, companies may end up with rubber-
stamped strategies whose flaws are exposed during implementation - or afterward, by
competitors.
When companies find ways to get executives grappling - throughout the strategy -
development process - with the choices that matter, they make better, less biased
decisions. They also improve the likelihood that the relevant stakeholders will be on board
when the time comes to make and act on choices.
Let’s look again at the retailer’s strategy team as it engaged with the company’s broader
leadership group to share its observations. Most strategy teams interact with decision
makers by presenting management with a summary report and recommendations. But this
team understood that senior managers needed time to debate the issues themselves and
reach their own conclusions - and that such collective discussions would improve the
resulting strategy.
Because the senior managers had a very hands-on attitude, the strategy team designed a
series of weekly meetings called think tanks to let them work through a profit-deconstruction
exercise illuminating the company’s past. In each session, the analysis was tabled after a
certain point, and the management team’s members took turns drawing out conclusions or
identifying further questions that needed answering. The strategy team was prohibited from
bringing any conclusions of the analysis to these meetings, much to its discomfort. This
ensured that company leaders were invested in the decision-making process and could
challenge the strategy team with new ideas.
Through a series of small-group meetings, the leadership team (with analytical help from
the strategy team) debated the reasons for the company’s past success and how to
continue it. By unpacking these complex dynamics together, the leadership team arrived at
an accurate, sharp diagnosis: the company needed to restore mainstream shoppers’ trust in
its prices. The result was a simple, focused strategy for delivering “value” products and
reinforcing that market position with customers. Furthermore, because the management
team was deeply involved in the diagnosis, its members had a strong incentive to drive
implementation.
Don’t leave the strategy unfinished
We occasionally hear some version of this saying: “I’d rather have a good strategy and
great execution than vice versa.” This attitude reflects confusion about what great strategy
is. Such a strategy creates a path for action and is inherently incomplete without it. Yet
many companies fail to get the conditions for successful implementation right, and fully two-
thirds of the executives struggle with the issue.
It’s a crucial struggle. No strategy, however brilliant, can be implemented successfully

unless the people who have the most important jobs know what they need to do differently,
understand how and why they should do it, and have the necessary resources. An added
challenge, of course, is that strategic choices often involve big changes over long, three-to
five-year time frames.
Finishing a strategy, therefore, requires creating tangible, proximate goals that connect to
the longer-term strategy. It’s easy to create a high-level list of next steps and things to do
differently on Monday morning. It’s much harder to roll back the future and connect it to the
present so that people understand what they need to do differently and actually do it.
When companies fail to set proximate goals, the results can be disappointing. An Asian
telecommunications company, for example, had landed on an intriguing and counterintuitive
strategy involving two big shifts: it wanted to move its target customer base from big
business to the midmarket and to standardize its products rather than provide customized
service to large clients. Making the changes work, however, would require salespeople to
start saying no to new business from large and complex clients so that the company could
redirect its efforts to midmarket customers. The short-term pain (lower revenues and higher
costs) would ultimately lead the company to a market-beating position.
The management team understood and encouraged the shift and was ready to act. But the
strategy team did not do enough to prepare the organization for the moves, instead
spending its time on detailed initiative-planning exercises. Absent any effort to translate the
company’s strategic desires into proximate goals for its employees, those employees
balked at the changes.
Sales managers, for example, not only viewed saying no to larger customers as a short-
term loss for the business but also were simply not as excited about pursuing midmarket
customers with simpler needs. They understood the strategy intellectually and believed the
analysis, but their skills, incentives, and ways of working and even thinking had not
changed. Without such changes, they couldn’t connect the necessary steps to a longer-
term goal and naturally reverted to their old ways, creating a backlash that inevitably
undermined the strategy. Only afterward did the team recognize the kinds of activities that
might have helped—for example, changing the salespeople’s goals, resetting the overall
budget to acknowledge the transition from one customer segment to another, and using the
reallocated funding to generate a new product-development road map.
Creating strategy in today’s environment of complexity, ever-changing priorities, and
conflicting agendas is a daunting task. Yet when senior executives invest the time and effort
to develop a more thorough, thoughtful approach to strategy, they not only increase the
odds of building a winning business but also often enjoy a positive spin-off: the gifts of
simplicity and focus, as well as the conviction to get things done.
1.7. Policy Distribution
What are Policies?
Business activities should be based on some solid principles that serve as guidelines for
direction. These principles are nothing but policies which help a business firm in attaining its
goal. Policy does not tell a person exactly what to do, but it does point out the direction in
which to go. While objectives are a goal or an end to be sought, policies are a general rule
of action which helps in attaining a goal.
Policy Statements
Statements released by corporate firms generally highlight the major policies behind their
action. For instance, if a firm says that, its aim is to provide the customers with products
that are competitive in terms of quality, price, weight and contents, it tries to sum up the
recurring problems in the industry and assures the customers that it will serve the
customers in the true spirit of business.
What is the meaning of Policy Formulation?
Policies are generally formulated by the officials of the top management cadre, as policies
reflect the mode of thought and principles underlying the activities of an organization.
Policies guide a firm in the following aspects.
 Thinking
 Decision making
 Conduct of business
 Enterprise operations
 Problem solving
So, it is evident that each policy contains two components, a “principle” and a “rule of
action”. Corporate policies are statements of directions, guidance for corporate thinking,
corporate behavior and action, and therefore cover a very broad area. Such policy
formulations are made in the light of challenges posed from the external environment
exposing the strengths and weaknesses of the organization.
Policy Distribution
All organizations have guidelines and internal policies to protect them. However, your staff
is often less familiar with these policies than they should be. They don’t usually break rules
on purpose; they’re just not fully aware of some policies and how some of the things they
do can affect your organization.
These are some of the risks that organizations face if their staff fails to follow policies and
guidelines:
 Legal liability
 Negative PR
 Destroyed business relationships
 Lost data
 Injured staff
 Dissatisfied customers
In less overt cases, failing to follow policies and guidelines can result in sexual
harassment, bullying and subtle exclusion. All these situations can reduce productivity and
increase your organization’s legal liability.
So why aren’t staff members aware of internal policy?
Not top-of-mind - Legal and IT teams are usually very aware of the serious risks your
organization faces when staff members lose information or breach security. However, this is
not usually top-of-mind for staff members outside these areas. They are simply busy doing
their jobs with limited resources in the best way they can.
Out of sight, out of mind - Your IT or legal team may not be communicating policies and
guidelines in the best way. For example, they may be sending them out in mass emails or
putting them on your intranet. Unfortunately, when most staff members today face
‘information overload’, communicating in these ways is unlikely to ‘cut through’.
How to communicate internal policies:
o Develop an on-going program - Treat communicating policy as a program, not a one-off

event. This means rolling policies out and reinforcing them regularly over time.
o Use distribution lists and segmentation - Set up distribution lists that group staff by the
types of policies they need. For example, shop floor workers may need to understand
health and safety policies that affect their roles; sales teams may need to be more
aware of policy that covers how they use customer data. Think of all staff. Don’t forget
remote staff, shift workers, contractors and outsourced staff. Schedule and target policy
communications to these staff too.
o Develop a priority system - Send the policies staff needs to do their jobs to them directly.
An engaging desktop alert is a good option to consider. Load less relevant internal
policies and detailed information on your intranet for staff to read when they need it. But
make sure they know this information exists and I how to find it.
o Focus on behavior change - The change in behavior you are seeking could be as simple
as encouraging staff to ask themselves questions before they act. Use a series of
screensavers to prompt staff to ask themselves questions like “Is it illegal?”, “Does it
meet company policy?”, “Is this the right thing to do?”, and “How would this look to a
customer or my manager?”
o Appropriate tone and language: The language used for policy communication should be
convincing and friendly for wider acceptability.
o Use engaging ways to capture staff’s attention – Slogans and banners can be used for
catching employees’ attention.
o Interactive elements - Let staff have their say and give feedback about how policies
affect their day-to-day work. Some policies can backfire, making it hard for staff to do
their jobs effectively. For example, are your policies stopping your customer-facing staff
delivering the kind of service that will keep your customers happy?
o Use multiple channels of communication to reinforce the policies in employees’ minds.
o Request acknowledgement from the targeted employees.
o Measure acceptance and understanding regularly by suitable appraisal methodology.
1.8. SWOT Analysis
SWOT Analysis is a strategic planning technique used to evaluate the Strengths,

Weaknesses, Opportunities, and Threats perceived by an enterprise. It involves specifying
the objectives of the business venture or a project and identifying the internal and external
factors that are favorable and unfavorable for achieving those objectives. The technique is
credited to Albert Humphrey, who led a convention at Stanford University in the 1960s and
1970s using data from Fortune 500 companies.
SWOT analysis starts with defining the desired outcome or objective. It can be incorporated
into the strategic planning model.
Strengths: attributes of a person or company that are helpful to achieving the objectives.
Weaknesses: attributes of a person or company that are harmful to achieving the objective.
Opportunities: external conditions that are helpful to achieving the objectives.
Threats: external conditions which could do damage to the objective.
Identification of SWOTs is essential because subsequent steps in the planning for

achieving the prime objectives may be derived from the SWOTs.
First, the decision makers have to determine whether the objective is attainable, given the
SWOTs. If the objective is NOT attainable a different objective must be selected and the
process is repeated until a set of meaningful objectives emerges.
The SWOT analysis is often used in academia to highlight and identify strengths,
weaknesses, opportunities and threats. It is particularly helpful in identifying areas for
development.
Internal and external factors
The aim of any SWOT analysis is to identify the key internal and external factors that are
important to achieving the objectives. These come from within the company's unique value
chain. SWOT analysis groups key pieces of information into two main categories:
Internal factors – The strengths and weaknesses internal to the organization.

External factors – The opportunities and threats presented by the external environment to
the organization.
The internal factors may be viewed as strengths or weaknesses depending upon their
impact on the organization's objectives. What may represent strengths with respect to one
objective may be a weakness for another objective too. The factors may include all of the
4P's - Product, Price, Place & Promotion; as well as personnel, finance, manufacturing
capabilities, and so on. The external factors may include macroeconomic matters,
technological change, legislation, and socio-cultural changes, as well as changes in the
marketplace or competitive position. The results are often presented in the form of a matrix.
SWOT analysis is just one method of categorization and has its own weaknesses. For
example, it may tend to persuade companies to compile lists rather than think about what is
actually important in achieving the objectives. It also presents the resulting lists without any
prioritization.
It is prudent not to eliminate too quickly any candidate from SWOT entry. The importance of
individual SWOTs will be revealed by the value of the strategies it generates. SWOT items
that produce valuable strategies are important items and the items that do not generate any
valuable strategy may not be important items.
Case Study:
SWOT Analysis of Bharti Airtel

Strengths
 Bharti Airtel had over 325 million customers across its operations at the end of and it
operates in 20 countries across Asia and Africa. The company ranks amongst the top 4
mobile service providers globally in terms of subscribers. In India, the company's
product offerings include 2G, 3G and 4G wireless services, mobile commerce, fixed line
services, high speed DSL broadband, IPTV, DTH, enterprise services including national
& international long distance services to carriers. It is planning to roll out 5G service in
2020.
 Other stakeholders in Bharti Airtel include Sony-Ericsson, Nokia - and Sing Tel, with
whom they hold a strategic alliance. This means that the business has access to the
knowledge and technology from other parts of the telecommunications world.
 The company has covered the entire Indian nation with its network. This has
underpinned its large and rising customer base.
Weaknesses
 An often cited weakness of the company is that when the business was started by Sunil
Bharti Mittal over 20 years ago, the business had little knowledge and experience of
how a cellular telephone system actually worked. So the start-up business had to
outsource the knowhow to industry experts in the field.
 The company has hived off its tower infrastructure into Bharti Infratel. As Bharti Infratel
charts its own growth plans, it might host other telecom companies on its towers. This
might hamper company’s growth plans.
 The fact that the Airtel could not pull off a deal with South Africa's MTN, may signal the
lack of any real emerging market investment opportunity for the business once the
existing markets mature.
Opportunities
 If net-neutrality debate gets settled in favor of the service providers, then a new
revenue stream will open up for the service providers in the form of income from the
internet companies.
 Global telecommunications and new technology brands see Airtel as a key strategic
player in the Indian market.
 Despite being forced to outsource much of its technical operations in the early days, the
company has developed its own methodologies - for example shifting from the
Revenue-Per-Customer model to Revenue-Per-Minute model, which is better suited to
India, as the company moved into small and remote villages and towns.
 The company is investing in its operation in 120,000 to 160,000 small villages every
year. It sees that less well-off consumers may only be able to afford only a few rupees
per call, and it wants to use its 'Matchbox' strategy (small recharges) to make the
business scalable.
 Bharti Airtel has embarked on another joint venture with Vodafone Essar and Idea
Cellular to create a new independent tower company called Indus Towers. This new
business controls more than 60% of India's network towers. IPTV is another new
service that may underpin the company's long-term strategy.
Threats
 Airtel and Vodafone seem to be having an on/off relationship. Vodafone which owned a
5.6% stake in the Airtel business sold it back to Airtel, and instead invested in its rival
Hutchison Essar. Knowledge and technology previously available to Airtel now moves
into the hands of one of its competitors.
 The quickly changing pace of the global telecommunications industry could tempt Airtel
to go along the acquisition trail which may make it vulnerable if the world goes into
recession.
 Bharti Airtel could also be the target for the takeover vision of other global
telecommunications players that wish to move into the Indian market.
Airtel comes to you from Bharti Airtel Limited, India's largest integrated and the first
private telecom services provider with a footprint in all the 23 telecom circles. Bharti
Airtel since its inception has been at the forefront of technology and has steered the
course of the telecom sector in the country with its world class products and services.
The businesses at Bharti Airtel have been structured into three individual strategic
business units (SBU's) - Mobile Services, Airtel Telemedia Services & Enterprise
Services.
1.9. Communication
Corporate communication is a set of activities involved in managing and orchestrating all

internal and external communications aimed at creating favorable point of view among
stakeholders on which the company depends for it’s existence. It is the messages issued by
a corporate organization, body, or institute to its audiences, such as employees, media,
channel partners and the general public. Organizations aim to communicate the same
message to all its stakeholders, to transmit coherence, credibility and ethic. Corporate
Communications help organizations explain their mission; combine its visions and values
into a cohesive message to the stakeholders. The concept of corporate communication
could be seen as an integrative communication structure linking stakeholders to the
organization.
Three principal clusters of task-planning and communication form the backbone of business
and the activity of business organizations. These include management communication,
marketing communication, and organizational communication.
o Management communication takes place between management and its internal and
external audiences. To support management communication, organizations rely heavily
on specialists in marketing communication and organizational communication.
o Marketing communication gets the bulk of the budgets in most organizations, and
consists of product advertising, direct mail, personal selling, and sponsorship activities.
o Organizational communication consists of specialists in public relations, public affairs,
investor relations, environmental communications, corporate advertising, and employee
communication.
The purposes of corporate communication are:
o To promote the profile of the "company behind the brand" (corporate branding)
o To minimize discrepancies between the company's desired identity and brand features
o To delegate tasks in communication
o To formulate and execute effective procedures to make decisions on communication
matters
o To mobilize internal and external support for corporate objectives
o To coordinate with international business firms
Interpersonal Communication Skills
Interpersonal communication is the process by which people exchange information,

feelings, and meaning through verbal and non-verbal messages: it is face-to-face
communication. Interpersonal communication is not just about what is actually said - the
language used - but how it is said and the non-verbal messages sent through tone of voice,
facial expressions, gestures and body language.
Basic elements of communication
Much research has been done to try to break down interpersonal communication into a
number of elements in order that it can be more easily understood. Commonly these
elements include:
The Communicators
For any communication to occur there must be at least two people involved. It is easy to
think about communication involving a sender and a receiver of a message. However, the
problem with this way of seeing a relationship is that it presents communication as a one-
way process where one person sends the message and the other receives it. For example,
while one person is talking and another is listening.
In fact communications are almost always complex, two-way processes, with people
sending and receiving messages to and from each other simultaneously. In other words,
communication is an interactive process. While one person is talking the other is listening -
but while listening they are also sending feedback in the form of smiles, head nods etc.
The Message
Message not only means the speech used or information conveyed, but also the non-verbal
messages exchanged such as facial expressions, tone of voice, gestures and body
language. Non-verbal behavior can convey additional information about the spoken
message. In particular, it can reveal more about emotional attitudes which may underlie the
content of speech.
Noise
Noise has a special meaning in communication theory. It refers to anything that distorts the
message, so that what is received is different from what is intended by the speaker. Whilst
physical 'noise' (for example, background sounds or a low-flying jet plane) can interfere with
communication, other factors are considered to be ‘noise’. The use of complicated jargon,
inappropriate body language, inattention, disinterest, and cultural differences can be
considered 'noise' in the context of interpersonal communication. In other words, any
distortions or inconsistencies that occur during an attempt to communicate can be seen as
noise. See our page: Barriers to Effective Communication for more information.
Feedback
Feedback consists of messages the receiver returns, which allows the sender to know how
accurately the message has been received, as well as the receiver's reaction. The receiver
may also respond to the unintentional message as well as the intentional message. Types
of feedback range from direct verbal statements, for example "Say that again, I don't
understand", to subtle facial expressions or changes in posture that might indicate to the
sender that the receiver feels uncomfortable with the message. Feedback allows the sender
to regulate, adapt or repeat the message in order to improve communication.
Context
All communication is influenced by the context in which it takes place. However, apart from
looking at the situational context of where the interaction takes place, for example in a
room, office, or perhaps outdoors, the social context also needs to be considered, for
example the roles, responsibilities and relative status of the participants. The emotional
climate and participants' expectations of the interaction will also affect the communication.
Channel
The channel refers to the physical means by which the message is transferred from one
person to another. In face-to-face context the channels which are used are speech and
vision, however during a telephone conversation the channel is limited to speech alone.
Communication noise
It refers to influences on effective communication that influence the interpretation of

conversations. While often looked over, communication noise can have a profound impact
both on our perception of interactions with others and our analysis of our own
communication proficiency.
Forms of communication noise include psychological noise, physical noise, physiological

and semantic noise. All these forms of noise subtly, yet profoundly influence our
communication with others and are vitally important to anyone’s skills as a competent
communicator.
Psychological noise
Psychological noise results from preconceived notions we bring to conversations, such as

racial stereotypes, reputations, biases, and assumptions. When we come into a
conversation about these ideas, irrespective of what the other person says, we can easily
get blinded to their original message. Most of the time psychological noise is difficult to get
rid of, and we must simply reconcile to the reality that it exists and consider those
distractions when we converse with others.
Physiological noise
Physiological noise has to do with distractions from the natural effects of the body, such as
being tired or hungry. The pains a person received will also result in physiological noise.
For instance, great anger or sadness may cause someone to lose focus from the facts of
the matter.
Physical noise
Physical noise is any external or environmental stimulus that distracts us from receiving the
intended message sent by a communicator. Examples of physical noise include: others
talking in the background, background music, a startling noise and acknowledging someone
outside of the conversation.
Semantic noise
This is noise caused by the sender. i.e., the encoder. This type of noise occurs when
grammar or technical language is used that the receiver (the decoder) cannot understand,
or cannot understand it clearly. It occurs when the sender of the message uses a word or a
phrase that we don't know the meaning of, or which we use in a different way from the
speakers. This is usually due to the result that the encoder had failed to practice audience
analysis at first. The type of audience is the one that determine the jargon one will use.
The Context of Communication
All communications have a context and it always happens for a reason.
Communication can fail because one or more of the participants overlook the context. To
help avoid misunderstandings, and therefore communicate more effectively, it is important
that the context of the communication is understood by all. Why is the communication
happening? It is important that participants are on the same ‘wavelength’ so that they
understand why the communication is occurring. It may be useful to start a larger
conversation by explaining why it is happening.
Knowing why communication is occurring is an important first step - there are however
problems that affect the context of the communication:
Timing
Timing is fundamental to successful communication. While considering a suitable time to
hold a conversation you should make sure that there is enough time to cover all that is
needed, including time to clarify and negotiate. Talking to an employee about a strategic
decision five minutes before they have to leave the office for the day, for example, would
probably not be as successful as having the same conversation the following morning.
Location
It should be fairly obvious that communication is going to be less effective if it is conducted

in a noisy, uncomfortable or busy place. Such places have many distractions and often a
lack of privacy.
Misconceptions
The context of communication is also governed by our own feelings about it.
As already discussed, we stereotype people and therefore can develop inaccurate

misconceptions and false assumptions. When communicating we may assume that:
 All parties know what we are talking about;

 We know the other person’s views and opinions of the situation;
 We should not show any emotion;
 We are right, they are wrong etc.
1.10. Developing organization structures
An organizational structure defines how activities such as task allocation, coordination and
supervision are directed toward the achievement of organizational aims. It can also be
considered as the viewing glass or perspective through which individuals see their
organizations and its environment. Organizations are a type of clustered entities. An
organization can be structured in many different ways, depending on its objectives. The
structure of an organization will determine the mode in which it operates and performs.
Organizational structure allows the desired allocation of responsibilities for different

functions and processes to different entities such as the branch, department, workgroup
and individual. Organizational structure affects organizational action in two (big) ways:
o First, it provides the foundation on which standard operating procedures and routines
rest.
o Second, it determines which individuals get to participate in which decision-making
processes, and thus to what extent their views shape the organization’s actions.
Functional structure
A functional organizational structure is a structure that consists of activities which are

grouped as per the functions involved. Some of the common functions within an
organization include production, procurement, marketing, human resources, and
accounting.
Organizing of functions in such a way leads to operational efficiency, because employees

become specialists in their own fields of expertise. The most typical problem with a
functional organizational structure is however that communication within the company can
get rigid, making the organization slow and inflexible. Therefore, lateral communication
between functions becomes very important, so that information is disseminated, not only
vertically, but also horizontally within the organization. Communication in organizations with
functional organizational structures can be rigid because of the standardized ways of
operation and the high degree of formalization between functions.
As a whole, a functional organization is best suited as a producer of standardized goods

and services at large volumes and low costs, where uncertainties are few and everyone
knows his job well. Coordination and specialization of tasks are centralized in a functional
structure, which makes producing a limited amount of products or services efficient and
predictable. Moreover, efficiencies can further be realized as functional organizations
integrate their activities vertically so that products are sold and distributed quickly and at
lowest cost. For instance, a small business could make components used in production of
its products instead of buying them.
Even though functional units often perform with a high level of efficiency, their level of
cooperation with each other is sometimes compromised. Such groups may have difficulty
working well with each other because of territorial differences or unwillingness to cooperate.
The differences among units may cause delays and reduce their commitment due to
competing interests, and wasted time, making projects to fall behind schedules. This
ultimately can bring down production levels, and dent at the company-wide employee
commitment toward meeting organizational goals.
But every manager must bear in his mind that there are two distinct organizations coexist in
every organization - One formal and the other informal.
The formal organization is usually defined by an organizational chart and clear job
descriptions. The official reporting relationships are clearly known to every manager and
every employee. Alongside formal organizations, informal organizations evolve out of
relationships, like, dislikes, common interests, race, religion, cast, creed, common
neighborhood, common natives, common schools, colleges, clubs etc. and the patterns of
such human interactions within an organization cannot be officially defined or regulated.
Formal organizational structures are categorized as:
(i) Line organizational structure.
(ii) Staff or functional authority organizational structure.
(iii) Line and staff organizational structure.
(iv) Committee organizational structure.
(v) Divisional organizational structure.
(vi) Project organizational structure.
(vii) Matrix organizational structure and
(viii) Hybrid organizational structure.
(ix) Informal Organization Structures
1. Line Organizational Structures:
Line organization structures have only direct, vertical relationships between different levels
in the organization. There are almost no horizontal relationships or formal contacts between
people at the same levels. Therefore, there are only line departments, which are directly
involved in accomplishing certain primary goals of the organization. For example, in a
typical line organization, departments like Production, Purchase, Quality Assurance, Design
& Development and Marketing etc. function autonomously, and the interaction between
these departments happens only where the lines converge, that is, where the ultimate
superiors of the lines report to the same individual. Hence, in a line organization authority
follows a predetermined chain (line) of command clearly defined in the organization
structure.
Features:
It has only direct vertical

relationships between different
levels in the organization.
Advantages of a pure line

organization are:
(i) A line structure intends to simplify

and clearly define responsibilities,
authorities at various levels and
assign accountability to these
relationships. The scopes of
responsibility and authority are precisely and unambiguously defined.
(ii) This structure promotes faster decision making and flexibility in decisions.
(iii) Because line organizations are comparatively smaller, the managements and
employees enjoy greater closeness amongst themselves.
Disadvantages of a pure line organization are:
(i) As the firm grows bigger in size, the shortcomings in the technical and administrative
competence of the employees becomes quite noticeable, rendering line organizations
ineffective and inefficient.
(ii) Higher speed of decision making and flexibility available in line management may not
properly compensate for the lack of specialized knowledge necessary for managing
complex organizations of today.
(iii) This might entail managers to acquire specialization in diverse fields of operation,
rendering him ineffective because of lost focus and preoccupation with diverse and
unrelated activities.
(iv) In line organizations there is a tendency to become overly dependent on a select few
people who perform variety of jobs jobs, rendering the manager helpless at times without
these people.
2. Staff or Functional Authority Organizational Structure
The jobs or positions in an organization can be categorized as:
(i) Line position:
Line position will be in a direct chain of command. It is responsible for achievement of

organization’s certain goals and targets
(ii) Staff position:
A position is intended to provide expert advice and support to the line positions in executing
their responsibilities.
The line officers or managers have the direct authority and responsibility (called line
authority and responsibility) to achieve the organizational goals. The staff officers or
managers have staff authority (i.e. advisory authority) over the line. This is also known as
functional authority. Here the line personnel willingly adhere to the advices of staff
personnel, because they are convinced of the value added by their advices in achieving the
organizational goals, for which they are primarily responsible.
An organization where staff departments have advisory authority over line personnel in their
own areas of specialization is known as a functional authority organization.
In line organizations, the line

managers may not possess
expertise in every area of each
function they perform. But in
functional authority organizations,
staff personnel who are specialists
in certain fields are given functional
responsibility and authority. They
have the right to issue work orders
in their own names in their
designated areas of expertise only.
Here the principle of unity of

command gets compromised
because of the presence of duel
command above them - functional
authority and line authority. That is,
a worker or a group of workers might receive instructions or orders from their line
supervisors, as well as the staff specialists, which might lead to confusion and conflicting
directives, which might result in decreased effectiveness and reduced efficiency. A few staff
specialists, instead of advisory authority, might try to exert direct authority over line
personnel. For example, a quality control inspector might try to direct the machine operator
on production issues.
Of course, this type of organization structure overcomes certain disadvantages of pure line
organizational structures; but it still has certain major disadvantages like:
o Conflicts arising from duel command structure and

o Aggregation of authority at higher levels in the organization to avoid conflicts.
3. Line and Staff Organizational Structure:
Most large organizations have this type of organizational structures. These organizations
have direct, vertical relationships between different levels and also specialists responsible
for advising and assisting the line managers. Such organizations have both line and staff
departments. Staff departments provide line people with advice and assistance in their
areas of specialization. For example, quality control department advising production
department on reducing rejection rates.
Line functions include production

and marketing etc., and staff
functions include Personnel, Quality
Assurance, R & D, Finance, and
Accounting etc.
Here the staff role is not limited to

advising. They are also responsible
for the ultimate goal of the
organization, so that there is no
conflict of objectives between the
line personnel and that of the staff
personnel. The work priorities are
decided by the line managers, and
the functional responsibilities are
handled by the staff personnel
keeping the work priorities of the
line managers in mind. Hence, the
the principle of unity of command is
automatically adhered to.
Therefore Advising, Service and

Control are the primary staff
functions.
Some staff personnel perform only one of these functions, but some might perform all of
these functions. The primary advantage of this structure is the utilization of the expertise of
staff specialists by the line personnel, keeping organization’s ultimate goal in mind. The
span of control of the line managers can now be expanded, because they are relieved of
functions, which the staff people perform for them as per their need.
Advantages of line and staff organizational structure
(i) Availability of staff specialists
(ii) Increased span of control
(iii) Line authorities can be relieved of routine and specialized decisions.
(iv) No need for all-round executives.
4. Committee Organizational Structure:
a. These organization structures are formed for managing typical problems or situations
b. These are temporary organization structures, with experienced people drawn from
various departments or from the society in general.
c. These organizations are disbanded after accomplishing the set objectives.
d. Committee organization structure is more suitable while framing corporate policies. e.g.
Board of Directors or a Board of Trustees representing diverse stake holders.
Advantages:
1. Committee decisions may be better than individual decisions, because of diversity of

experiences and insights of committee members.
2. Better interaction between committee members leads to better co-ordination of activities
3. Committee members can be eager to participate in group decision making.
4. Group discussions may lead to creative decisions.
Disadvantages:
1. Committees may not take decisions in time, might take unreasonably longer to arrive at
decisions and hence become more expensive for the organization.
2. Group actions may lead to compromises, indecisiveness, and lack of ownership for sub-
optimal decisions.
3. ‘Buck passing’ may become common when decisions backfire.
5. Divisional Organizational Structure:
In these type of organization

structures, there can be different
bases on which departments are
formed. For example:
(i) Function wise,

(ii) Product wise,
(iii) Geographic territory wise,
(iv) Project wise and
(iv) A combination any of the above
approach.
Every division can have its own

line, staff, line-&-staff, and
committee type organization
structure.
Divisional organization structures

are very common where
companies operate in various
product segments, diverse
geographies or when it needs
resources on a very scale.
Many large corporations have

divisions for catering to
international procurement, mining,
power generation, personnel etc.
For example, Philips has divisions

catering to Domestic Appliances,
Consumer Electronics,
Professional Electronics, Medical
Systems, Lighting etc.
Similarly, Infosys has divisions like Financial Services & Insurance; Energy, Utilities,
Communications & Services; Manufacturing; and Retail, Consumer Packaged Goods
Logistics & Life Sciences for catering to the IT requirements of these business segments.
Larsen & Toubro has divisions like Construction, Hydrocarbon Engineering, Power,
Metallurgical & Material Handling, Heavy Engineering, Ship Building – Defense & Merchant,
Electrical & Automation, Construction & Mining Machinery, Valves, EVAC Alloys, Infotech,
Technology Services, Infrastructure Development Projects, Metro Rail, Finance, and
Realty.
Observing the scale of operation of these companies, we’ll realize that it would have been
impossible to operate for them at this scale without employing the divisional organization
structure.
5. Project Organizational Structure:
The line, line-&-staff and functional authority organizational structures facilitate

establishment and distribution of authority for vertical coordination and control rather than
horizontal relationships. In some projects (complex activities consisting of a number of
interdependent and independent activities) work processes might flow horizontally,
diagonally, upwards and downwards. The direction of work flow depends on the distribution
of talent and abilities of the people in the organization and the need to apply those
resources to the problem that exists. To cope up with such situations, project organizations
and matrix organizations have emerged.
A project organization is a temporary organization structure constituted to achieve specific

results by using various teams of specialists drawn from different functional areas of the
organization. The project team focuses its entire energy and resources on the assigned
project. Once the project’s goal is accomplished, the team members from these functional
departments might go back to their original positions or might be assigned a new project.
Some of the examples of projects are: Research and Development projects, Product
development, Construction of a new plant, Housing complex, Shopping complex, Bridge,
Ship Building etc.
Importance of Project
Organizational Structure:
(i) Work is defined by a specific

goal and target date for completion.
(ii) Work may be unique and not

routine to the organization.
(iii) Work is complex needing

specialized skills, diverse
experiences and talents.
(iv) Work is critical in terms of gains

or losses.
(v) Work may be one time in nature.
Characteristics of project organization:
a. Personnel are assigned to a project from the existing permanent organization and are
under the direction and control of the project manager.
b. The project manager specifies what efforts are needed and when work will be
performed, whereas the concerned specialist executes the work using his resources.
c. The project manager gets the needed support from production, quality control,
engineering etc. for completion of the project.
d. The authority over the project team members is shared by project manager and the
respective functional managers in the permanent organization.
e. The services of the specialists (project team members) are temporarily loaned to the
project manager till the completion of the project.
f. There may be conflict between the project manager and the departmental manager on
the issue of exercising authority over the team members.
g. Since authority relationships are overlapping with possibilities of conflicts, informal
relationships between project manager and departmental managers (functional
managers) become more important than formal authority.
h. Full and free communication is essential among those working on the project.
6. Matrix Organizational Structure:
A matrix organizational structure is

a company structure in which the
reporting relationships are set up as
a grid, or matrix, rather than in the
traditional hierarchy. In other words,
employees have dual reporting
relationships - generally to both a
functional manager and a product
manager.
In matrix structures, there are

functional managers and product
(or project or business group)
managers. Functional manager are
in charge of specialized resources such as production, quality control, inventories,
scheduling and marketing. Product or business group managers are in charge of one or
more products and are authorized to prepare product strategies or business group
strategies and call on the various functional managers for the necessary resources. This
type of organization is suitable when the firm has to be highly responsive to a rapidly
changing external environment.
In the 1970s, Philips, a Dutch multinational electronics company, set up matrix

management with its managers reporting to both a geographical manager and a product
division manager. Many other large corporations, including Caterpillar Tractor, Hughes
Aircraft, and Texas Instruments, also set up reporting along both functional and project lines
around that time.
Advantages
This organizational structure superimposes a horizontal set of divisions and reporting

relationships onto a hierarchical vertical functional structure, hence the name matrix.
In a matrix organization, instead of choosing between lining up staff along functional,

geographic or product lines, management has both. Staffers report to a functional manager
who can help with skills and help prioritize and review work, and to a product line manager
who sets direction on product offerings by the company. This structure has some
advantages:
o Resources can be used efficiently, since experts and equipment can be shared across
projects.
o Products and projects are formally coordinated across functional departments.
o Information flows both across and up through the organization.
o Employees are in contact with many people, who help with sharing of information and
can speed the decision process.
o Staffers have to work autonomously and do some self-management between their
competing bosses; this can enhance motivation and decision making in employees who
enjoy it.
Disadvantages
The matrix structure is generally considered the toughest organizational form to work in,
due to the conflicting pulls on resources. The overlaps can lead to turf battles, and difficulty
in determining accountability.
1. High administration cost.
2. Potential confusion over authority and responsibility.
3. High prospects of conflict.
4. Overemphasis on group decision making.
5. Excessive focus on internal relations.
The problem with this structure is the negative effects of dual authority similar to that of
project organization. The functional managers may lose some of their authority because
product managers are given the budgets to purchase internal resources. In a matrix
organization, the product or business group managers and functional managers have
somewhat equal powers. There is possibility of conflict and frustration but the opportunity
for prompt real time and efficient accomplishment is also quite high.
7. Hybrid Organizational Structures:
A hybrid organization is an
organization that mixes elements,
value systems and action logics of
various sectors of business.
In this type of structures there may

be a simultaneous division of work
on functional lines and also on
geographcal, product wise or on the
basis of any other factor.
The functional managers may be

situated at a higher level than the
geographical managers to avoid
conflict of interests.
A hybrid organization may be
operating in both the public sector and the private sector, simultaneously fulfilling public
duties and developing commercial market activities. As a result the hybrid organization
becomes a mixture of both a part of government and a private corporation.
Advantages
o Alignment of corporate and divisional goals

o Functional expertise and/or efficiency
o Adaptability and flexibility in divisions
Disadvantages
o Conflicts between corporate departments and divisions

o Excessive administration overhead
o Slow response to exceptional situations
8. A Combination Organization Structure
In a combination Organization
Structure, there is a simultaneous
functional division and geographical
or product wise division, with all of
them enjoying same level of
authority and control.
This structure is used by the

businesses which face considerable
uncertainty. It is used by
multinational companies operating
in the global environment, for
example, International Business Machines USA. This kind of structure depends on factors
such as degree of international orientation and commitment. Multinational corporations may
have their corporate offices in the country of origin and their international divisions
established in various countries reporting to the CEO or president at the headquarters. The
international divisions or foreign subsidiaries may be grouped into regions such as North
America, Asia, and Europe. and again each region may be subdivided into countries within
each region. While the focus is on international geographic structures, companies may also
choose functional or process or product departmentalization in addition to geographic
pattern while at the head quarter’s the departmentalization may be based on function.
Advantages:
1. Alignment of corporate and divisional goals.
2. Functional expertise and efficiency.
3. Adaptability and flexibility in divisions.
Disadvantages:
1. Conflicts between corporate departments and units.
2. Excessive administration overhead.
3. Slow response to exceptional situations.
9. The Informal Organization:
An informal organization is the set of relationships and patterns of human interaction within
an organization which are not officially defined, but evolve out of various social
engagements. Alongside the formal organization, an informal organization structure evolves
which consists of personal relationships created not by officially designated managers but
by organizational members themselves at every level. Since managers cannot avoid these
informal relationships, they must be trained to cope up with it.
The informal organization has the following characteristics
(i) Its members are joined together to satisfy their personal needs (need for affiliation,
friendship etc.)
(ii) It is a continuously changing organization - The informal organization is dynamic.
(iii) It involves members from various organizational levels.
(iv) It is also affected by relationship outside the firm.
(v) It has a pecking order: certain people are assigned greater importance than others by
the informal group for reasons known to them.
Even though an informal organizational structure does not have its own formal
organizational chart, it has its own subtle chain of command.
Benefits of Informal Organization:
(i) Assists in accomplishing the work faster.
(ii) Helps in removing weakness of the formal structure.
(iii) Expands the effective span of control.
(iv) It compensates for minor violations of formal organizational principles.
(v) Provides an additional channel of communication.
(vi) Provides emotional support for employees.
(vii) Encourages better management and control.
Disadvantages of informal organization:
(i) May work against the purpose of the formal organization.
(ii) Reduces the degree of predictability and control.
(iii) Reduces the number of practical alternatives.
(iv) Increases the time required to complete activities.
1.11. Centralization vs. Decentralization of decision making
Centralization of authority means the power of planning and decision making are
exclusively retained by the top management, while in the case of Decentralization, the
powers for the same are dispersed voluntarily by the top management to the middle or
lower levels of the management.
One of the basic principles of management is the span of command. As the number of
people reporting to any manager increases, his effectiveness and efficiency of doing the
work diminishes. Therefore it is necessary for any manager to priorities his activities based
on various parameters like vitality of the activity, technological consequences, financial
consequences, social consequences, labor relations, legal consequences, experience and
knowledge needed etc. He has to undertake a detailed cost benefit analysis of these
activities against the cost of his own time, and divest himself of those activities which are at
the lower end of the pecking order, hence expensive for a manager to do it himself.
Such activities, which are at the lower end of the pecking order, are outsourced to a
comparatively junior level manager, whose cost to the company is much lower than the
senior manager. This manager in tern does the similar analysis and pushes the lower end
activities to the next levels. In this manner lower end of the activities are pushed to the
lower levels, at which it makes the best economic sense.
It is necessary to exercise due caution while carrying out this exercise, because many
careless managers might push down vital activities and put the entire system at the risk.
That is why, careful study of authorities and responsibilities is necessary while carrying out
this exercise. The manager might delegate the authority of doing certain tasks and taking
certain decisions to the lower level, but he should still be held responsible for the decisions
taken by his subordinates. This check ensures proper diffusion of authorities and
responsibilities thorough out the organization.
The process of transferring authority and creation of responsibility between superior and
subordinates to accomplish a certain task is called delegation of authority. It can take place
without decentralization. It can be withdrawn by delegator at any time. It minimizes the work
burden of managers of the unit, departments or plants. Here the relationships between
superior and immediate subordinates are defined. It is a technique of management which is
used to get the things done through others. It is confined to the manager and his
subordinates. It has to be kept in mind that only authorities are delegated, not the
responsibilities. The process of control remains in hands of a superior who supervises the
activities of his subordinates. It is essentially an art of management science. When authority
is not delegated to subordinates there is really no motivation for performance from the
subordinates. Therefore delegation is the process of sharing power and work with the
subordinates.
But, many times it has been observed that many managers end up doing the work of their
subordinates, for the fear of losing their control over the operations, or for the lack of
confidence in their subordinates, or for the fear of a subordinate demonstrating his prowess
at managing the operations and eventually displacing his superior. This escalates the cost
of operation of the company and might eventually displace it from the markets.
Basis for Centralization Decentralization

Comparison
Meaning The retention of powers and The dispersal of authority,
authority with respect to planning responsibility and accountability to
and decisions, with the top the various management levels, is
Basis for Centralization Decentralization
Comparison
management, is known as known as Decentralization.
Centralization.
Communication Vertical Open and Free
Flow
Decision Making Slow Comparatively faster
Advantage Proper coordination and Leadership Sharing of burden and responsibility
Power of Lies with the top management. Multiple persons have the power of
decision making decision making.
Reasons Inadequate control over the Considerable control over the
organization organization
Best suited for Small sized organizations Large sized organizations
1.12. Authority, Responsibility and Accountability
Meaning of Authority
Authority is the kind of right and power through which it guides

and directs the actions of others so that the organizational goals
can be achieved. It is also related with decision making. It is
vested in a particular position, and not in any person, because
authority is given by an institution and therefore it is legal.
Therefore, Authority is:
o An institutionalized and legal power inherent in a

particular job, function, or position that is meant to enable its
holder to successfully carry out his or her responsibilities.
o Power that is delegated formally. It includes a right to command a situation, commit
resources, give orders and expect them to be obeyed; it is always accompanied by an
equal responsibility for one's actions or a failure to act.
Meaning of Responsibility
Responsibility is a duty or obligation to satisfactorily perform or complete a task (assigned

by someone, or created by one's own promise or circumstances) that one must fulfill, and
which has a consequent penalty for failure.
Meaning of Accountability
The obligation of an individual or organization to account for its activities, accept

responsibility for them, and to disclose the results in a transparent manner. It also includes
the responsibility for money or other entrusted property.
There is a definite relationship be-tween authority, responsibility and accountability.

Without a clear understanding of this relationship, effective functional management, with
clear lines of reporting and communication, becomes a remote possibility.
Authority demands the ability to give orders properly. Responsibility demands the ability to
follow through, assuring that the orders given by them are carried out properly. Authority
must always be equal to responsibility, and must be sufficient to fulfill the requirements of
the job.
But it should never be more than what is necessary to get the job done. Authority and
responsibility must never be dual, shared or overlapping. One person, and only one
person, should be responsible for the successful completion of every assignment.
As long as there is singular delegation of authority and responsibility, the individuals with
responsibility may be assigned accountability; however, when more than one person shares
the authority and responsibility for something, neither can be held accountable for what
might go wrong.
Authority
Authority must be clearly defined and follow clear paths. Without clear definition, there will
be confusion. An organizational chart should clearly define the paths, while job descriptions
clearly define the full scope of the authority for each position.
Every individual, from the president of the company down to the floor sweepers, must know
the limits and scope of the authority of his or her position.
These limitations - this scope - must never be circumvented. When an individual

circumvents the authority of any other, he effectively relieves that individual of all
responsibility and accountability for an unspecified length of time.
Additionally, such circumvention harms the morale of that individual. The side effects will
spread downwards to the individual’s subordinates.
Authority may be delegated along with equal and corresponding responsibility. The extent
of such delegation must be clearly spelled out in writing.
Authority does not imply autocracy, but it does require the use of orders and instructions.
Orders
The order is defined as the signal which allows coordinated action. Orders cannot be given
blindly; each must be tested to assure that it is necessary, clear, complete, and reasonable,
with compliance both possible and probable.
A complete order will supply a specific goal or objective, with permissible variations. It will
note a method or means of performance. It will state who, what, when, where, and how,
specifying the individual who will be held responsible and accountable for its proper
performance.
Ensuring responsibility
The prime task of every manager is the assumption of responsibility. Measure your own
performance in terms of what you were ordered to do and what you actually accomplished.
Stimulate interest and, whenever possible, provide incentive. The incentive of reward, after
the successful completion of a task, does work, when properly handled.
The use of fear as a driving force is obsolete in modern business practices. Punishment is
correct after willful wrongdoing, but only if it is willful.
Any other type of wrong-doing merely implies a lack of training and a need for coaching.
Inflexible rules:
You will see to it that every order which is issued is carried out.
You will not forget it, change it, or countermand it.
If it is your responsibility to do something, there are no excuses for not accomplishing that
objective. Regardless of what happens, your are answerable for attaining, or not attaining,
that objective.
You cannot shift the responsibility for not having it done. There might be mitigating
circumstances, but you are still responsible for accomplishing that goal.
Accountability
Every order which has been given, and given correctly, carries responsibility. Responsibility
implies accountability. Accountability is a two-way street for every manager. Each will be
held accountable by a supervisor, who will hold a subordinate accountable.
Accountability means liability for any variance from the anticipated norm, whether that
variance is a positive or a negative one.
It implies the need for explanation. If you are to avoid blame, you must exercise
accountability over your subordinates, and you must do it consistently, if your department is
to operate effectively.
Inconsistency breeds a loss of credibility, a loss of trust, and a loss of respect. Without trust,
there is no loyalty, when there is no loyalty, morale falls.
As morale falls, so does the motivation and both the quality and quantity of production.
Inconsistency creates inefficiencies.
Hold people accountable and do it consistently. Offer praise when it is due and training or
disciplinary action when indicated. If you fail to do either, or both, the chances are that your
department will not run efficiently, economically, or effectively.
One thing has to be kept in mind, that any manager who fails to shoulder the responsibility
and owns up accountability for the economic, efficient and effective operation of his
department, neither deserves the title of a manager, nor the salary of a manager.
1.13. Basic principles of delegation - empowerment of employees,
When leaders empower their employees, those employees are able to take on greater
responsibility and enjoy higher authority. In order to do so, employees must be given the
resources needed to make this happen. Unfortunately, some employees often feel as
though they do not have the support or resources to feel empowered. Employees may be
unclear as to what empowerment actually means in tangible terms.
From the time that we're born, we're on this path to self-sufficiency. We want to be able to
do things on our own with a little help along the way whenever we need it. Indeed, a key
ingredient in self-sufficiency is a solid support system. However, supporting is not the same
as doing; a good support system is there to provide the foundation for someone else to
achieve greatness, not to do it for them.
For example, a mother does not do her child's homework for them simply because they're
struggling with some of the concepts, but does provide guidance and encouragement as a
support to her child. She essentially empowers her child to do the homework on their own.
A key ingredient in self-sufficiency is a solid support system to empower employees. What

is important to grasp here is that empowerment is not something that a person can do for
another; rather it is something that someone has to give to someone else so that they can
in turn do whatever it is that they are now empowered to do. This is also true of
organizations, while most people think empowerment is something that a manager does for
their subordinates, what really happens is that the manager empowers the employee to do
things on their own. Empowerment comes from the individual, not the manager.
Empowerment occurs when an employee is given the freedom, power, trust, autonomy, and
encouragement to carry out job-related tasks. When used as a motivational strategy,
empowerment can provide an employee with a sense of pride and ownership over their
work. People want to feel in control of their destiny, especially in the workplace.
Essentially, empowerment provides a worker with intrinsic, or self-induced, rewards by

allowing them to make decisions on their own and see the success that follows. Employees
associate their success with their own abilities, motivating them to continue to strive for
higher levels of productivity in future tasks.
Managers can promote organizational success by inviting employees to be innovative in

their ideas, solutions, and decisions while at the same time giving them authority to see
them through to implementation. Empowerment enables subordinates to work
independently as they control their own jobs by using their own knowledge, skill sets,
abilities, and decision-making skills to achieve personal and organizational goals.
While employee empowerment comes in many forms, it can vary in degree and scope. The
result is often one of increased motivation and job satisfaction. Therefore, effective
managers continually look for ways to empower their staff to reach those personal and
organizational successes that is just mentioned.
To begin with, a manager should spend time showing their employees that they value them
as members of the organization. This should be a genuine demonstration by management,
which clearly communicates to the employee that the manager appreciates each employee
for their unique contributions that they make to the organization. Asking employees to share
the leader's vision for organizational success and inviting them to participate in the
decision-making processes that are needed to see that vision become a reality are two
ways that a manager can demonstrate their appreciation. A large part of that dynamics is a
sense of trust, meaning the manager has to be able to trust the employee to be capable of
making effective decisions on their own.
The act of empowering includes:
o Increasing employees’ accountabilities

o Supporting employees’ to make decisions
o Allowing employees’ to be self-directed and
o Making them feel worthwhile and
o Developing a sense of trust in their minds
o Identifying what tasks, activities or projects that can be entrusted at various levels
o Communicating thoroughly the expectations and parameters of measurement
o Ensuring that all resources are available at their discretion to do those tasks
o Building trust by being a facilitative manager
o Clearing obstacles for employees to ensure success and feel good about their jobs
Employee Empowerment is most effective when there is a win-win situation – employees

build new skills or achieve new results by taking on greater accountability and management
gets benefitted by better quality, better labor relations and higher profitability.
Through employee empowerment companies can make the employees feel as an important
stake holder, and get valuable insights into the general labor sentiment, general market
scenario, technological trends, product development ideas, and cost reduction ideas.
1.14. Boundaries of authority.
Boundary is the container for group work. We encounter boundaries constantly but may not
experience them as such. Time, task, and territory provide the basis for the study .of
boundaries in group relations work. While conversation may continue after the departure of
the consultant, the boundaries shift with the absence or presence of someone in a
designated authority role.
In everyday life we have deadlines, due dates, departure times, and the like to which we
must adhere to. Failure to attend to these time boundaries carries consequences,
depending on the rigidity of the boundary. Anyone who has ever been late to a train station
or an airport knows this fact very well. If you are not at the gate at the departure time, the
doors will be closed and your travel plans will be altered. A missed deadline may have no or
limited consequence in certain contexts while in others it may mean a lost opportunity or in
more severe situations, the end of a professional role.
In a similar light, territory boundaries are easy to spot. They are the space in which work
happens in a group. In most offices or organizations, we often speak of "turf battles,"
meaning the metaphoric territory where one person or group's responsibilities ends and
another's begin. The more common issue of territory as a boundary often comes in the form
of literal boundaries. Currently and historically there are contentious issues about
boundaries between nations. Wars and unrest in certain pockets of the world can be tied,
among other issues, to disputes over the demarcation of territory between one group and
the other. These spaces become markers of identity, carrying with them more than a
geographic line in the sand. We need only to turn to different expression of conflict such as
those in the Middle East between Israelis and Palestinians, or in Kashmir between India
and Pakistan, or in Rwanda between the Hutus and the Tutsis.
While territory and time boundaries are perhaps easiest to see, in group relations work, the
task boundary is the key. The way the work is understood and the manner in which. it is to
be conducted strongly influences nearly every aspect of group life. The challenge is when
there are different understandings of the task within groups or group members. In day-to-
day parlance, the task is akin to the mission of an organization, the terms of reference in a
business contract, the syllabus for a course, or a work order in a repair shop. Within loose
or tight parameters, the group is supposed to do its work. Yet most of us can think of the
examples from our own experience where the clearest delineation of the task has resulted
in varied and at times undesired outcomes, because of differences in understanding. From
the renovation of our home that is not yet really complete, to the work team that produced a
less than desirable good, to the board that emphasized funding over organization’s values
and focus, to the engineers that designed a bridge that collapsed, the task somewhere had
got lost, or the boundary as it relates to the task was undermined, subverted, or simply
violated.
Boundary considerations extend beyond time, task and territory. Included in this analysis
are boundaries of resources, roles and responsibilities. The most important of these
resources, often determines the capacity of the individuals and organizations to complete
even the most rudimentary tasks. We can think of resource boundaries expressed and
represented by basic survival elements such as air, food and water. Lack of attention to
these resource boundaries, there will be no life. Other resources, such as money in family
budgets, the number of team members available to work on a project, or the kind of relief
available to disaster ravaged areas, all are influenced by the kind of boundary involved.
Inadequacy of resources and the management of them determines the success or failure of
any project.
Some groups or organizations work better with relatively rigid time, task and territorial
boundaries; whereas others prefer to work with more with hazy boundaries. The key point is
that there should be clarity about boundaries within an organization. In addition to this it
helps to understand the boundary culture within an organization. For example, a
newspaper-publishing agency needs to have the newspaper print ready at a certain time,
yet it needs to be flexible until the last minute in order to report the latest news.
Although the concept of boundaries is rather simple and therefore conceivably easily
dismissed, the consequences of diminishing the importance of boundaries can be far
reaching. Attention to clearly defined boundaries is in the interest of the task. It is crucial
that boundaries are:
• Clearly defined
Clear specification of time, task and territory boundary should answer the questions:
"When?" "What?" and "Where?" During a specific time, in a specific location we will work on
this particular task. Examples of inadequate boundary management are: two meetings may
be scheduled at the same time in the same space, or two consultants are working
independently on a similar policy because the task boundary between the two was not
clarified.
• Agreed upon
Although a boundary may be clearly outlined, interested parties need to come to some
agreement about what the stated time, task or territory boundary is or how they interpret it.
If disagreement persists, there may be at least agreement on ‘who the authority is?’ that
calls the boundary. This is where the boundary and authority converge.
• Adhered to
If boundaries are taken as guidelines, rather than clear instructions in support of

accomplishing the task, an organizational culture can become rather chaotic — for example
meetings hardly ever start on time, tasks are forgotten or done twice; people are unclear on
where the next meeting will take place. Especially in situations like this it may be helpful for
an organization to ask what their use of boundaries represents.
The concept of boundary as a region is where the space, time or task boundary is seen as
a transition or bridge space. In terms of time boundary, the one event has not quite ended,
yet the next event is already in people's mind. Or an event has just started but people are
still somewhat preoccupied with whatever happened before. One way of acknowledging the
transitional nature of the beginning of a meeting is to do a check-in on state of mind - the
length of the check-in depending upon the length of the meeting - so that attendees are in a
position to acknowledge what they bring to the meeting, which generally speaking makes
them more available for the present task. The entrance space to a person's office or a
meeting room is an example of a territory boundary transition region. In terms of task
boundary, two departments with different tasks may have subtasks that are closely related
and will need to manage that transition space or region. Seeing the boundary as a region
allows for a transition function prior to and subsequent to the boundary and it may prevent
the boundary from either becoming rigid or chaotic. Understanding boundaries as a region
may highlight the delicate nature of boundaries and the attention that it requires. At times it
is helpful to reflect upon the representation of how individuals and groups in an organization
deal with boundaries.
Authority
Authority is defined as the right to do work. In his book Leadership without Easy Answers.
Ronald Heifetz defines authority as "conferred power to perform a service". When a person
takes up her authority we assume that she takes responsibility and that she is accountable
for her actions. We make a distinction between formal authority and personal authority.
Formal or Delegated Authority
Formal authority may be derived from a group or body — the Board of Directors of a
nonprofit agency or corporation - or from an individual such as one's immediate supervisor
or manager. Authorization involves one person or group giving over or delegating some of
their own formal authority so that another might do certain work on their behalf. For
example, formal authority may be given to someone through a job description outlining his
role in an organization; the role of manager comes with a particular job description.
Therefore, it is crucial that formal authority is:
• Clearly defined
Authority needs to be clearly defined by the body that is granting it and understood by the
person or body that is receiving it. Lack of clarity about the scope of authority a person has
been given may result in unattended tasks. Incomplete job descriptions or incomplete
instructions by a person's supervisor may result in incomplete tasks or may cause an
employee to do tasks that he is not officially assigned to do.
• Taken up accordingly
People are clear about the formal authority they have received but for some reason do not
take up some of the authority that they have or take up too much authority. For example the
Program committee not only has provided a program but also organized a fundraising
event. Or the president of a non-profit organization has been given authority by the bylaws
to name committee members but only with the consent of committee chairs. If she names
committee members without the chairs' consent, she has exceeded her formal authority.
• Accompanied by tools to exercise it
It is not uncommon that people are authorized to do a certain task, but they lack the tools to
complete the task successfully. In a non-profit context an example may be that a person is
authorized to organize a lecture by the Executive Committee, but the committee does not
make available any funds to support that lecture.
Personal Authority
The way an individual takes up formal authority is called personal authority. Personal
authority is how we execute our formal authority. Personal authority is influenced by many
different factors, i.e. our psychological make up, our social identity, our cultural background,
etc. For example, the well-known Myers-Briggs Type Indicator in terms of extroversion and
introversion, intuition and sensing, feeling and thinking, judging and perceiving influences
how we take up personal authority. An extraverted executive might consult many
employees in groups and meetings in a decision making process, whereas an introverted
executive may delegate some of the consultation with employees to her subordinates and
receive feedback through the subordinates prior to making the decision.
After formal authority has been established and clarified, a person has to take up her
personal authority to execute her formal authority. Important considerations are, what really
helps and what really hinders a person in taking up their personal authority? Group
relations work teaches us that many factors play a role in how we take up our authority, and
they span a continuum of things that are known to us, to things that are unknown to us. For
example a person may take up more or less authority depending upon how he thinks the
persons affected by his authority will value his behavior. In such a case a manager may
postpone an unpopular decision endlessly. People make decisions in part because of
desires and fears that have little to do with the task, but more with managing their anxiety,
particularly related to ambition, competition, political correctness, etc. The more individuals
know about the elements that influence their authority, the more likely they may exercise
personal authority in relation to the task.
Role
People occupy certain roles. His span of these roles is rather transitory yet robust, ranging
from mere moments to a lifetime. Roles can be achieved, acquired, assigned, and/or
ascribed to us. According to the goodness of it, roles can be reflections of or equated with
our identity. The link is made clearer through the distinction of formal and informal roles.
Formal Role
A formal role is much like a job description. It defines the duties to be performed, the
parameters for completing tasks, the people and processes with which interaction must
take place, and often the outcomes or deliverables that mark the tangible successful
performance of the role. Typically some external authority assigns these roles to us. Our
bosses, managers, teachers, supervisors, and the like also serve as the arbiters of how well
we take up these roles, and at times, determine whether we will continue in them. If the role
comes through merit or privilege, we may have more range in how we take up our role
compared to someone who is newly assigned a role. In other words, a history of
exceptional performance and/or personal attributes (such as race, gender, age, etc.) that
are allied to the organization or particular authority figure influence how the role is
perceived and filled. It requires that individuals understand their roles and can clearly
communicate what that role is. Clarity about one's role is not only important for the person
who takes up the role, but also for the people who work with the person in a particular role,
because, misperceptions about roles happen quite frequently.
In addition, it is essential for a person in any role to know how other people perceive her in
that role and how that influences their behavior. Given that role is intricately connected with
authority and boundaries, a misperception of the role may result in a misperception of
authority and boundaries. For example, the role description of a team leader may include
evaluation of team members and recommending them for promotion. It is likely that if team
members are not aware that this is part of the team leader's role, they may give him less
authority and their performance may get affected.
Finally, role shifts and on occupying multiple roles. With role shifts we mean moving from
one role to another more permanently, for example the promoted colleague becoming
manager, or the former professor being a friend. The former role influences how the current
role is viewed and vice versa. Awareness of these role shifts may assist both parties in
making the transition. Shifting between multiple roles requires that a person maintains
clarity both for oneself and for the people the person is interacting with about what role one
is in at any particular moment.
Informal Role
The informal roles people take on are not found in a job description or in any contract
between employer and employee. Nonetheless individuals take on roles that serve to fill the
gaps of authority and tasks abandoned, yielded, or implicitly ceded to them by the
organization or group. These roles range several continuums: from simple to complicated,
from more implicit to more explicit and from conscious to subconscious. Let us give some
examples. The care taking roles: who makes the coffee in the morning, or who changes the
light bulbs in the office. A coordinating role - there are five project managers in an
organization but no one has been designated to coordinate the projects, which person
steps forward to do so. The antagonist role is one example - the person who always
questions every decision, procedure and change.
Both informal as well as formal roles are in part dictated by what our valence is. Valence
refers to a person's tendency to take up particular roles in groups. For example a person
may have the valence to be "the quiet observer" or "the practical voice" or a person may be
"the emotional one." Given that a person's valence is a subconscious dynamic that gets
activated to regulate anxiety; an individual's valence does not change much from one group
or another, although it may be more or less activated in one or the other group. Generally
speaking a person's valence influences both their formal and informal role. For example, a
person with a leadership valence is likely to have formal leadership or likely to take informal
leadership role.
One of the authors, Rene Molenkamp has developed The Metaphor Method for Role
Analysis, a method of becoming clearer about one's informal role by making use of the
subconscious through images and metaphors. Although the method was developed within
group relations conferences, it has been applied to working groups.
A brief description of what the method involves: a group member is interested in what
informal role she plays in the group. All members of that group are silent for a moment and
think of an image or a metaphor for the person's role and write it down, including the person
herself. Then, one by one, people share their images and metaphors and give a brief
explanation of why they think that image or metaphor came to their mind.
Two things are particularly important here. One is to try to make links between the different
images and metaphors and to see what they have in common. (for example, movement,
height, distance, elements, detailed descriptions), The second is to pay attention to how the
person's own image or metaphor fits with the images and metaphors she received from
other people. There may be discrepancy between how the person perceives herself and
how other people perceive her, which can be painful initially, but a significant and insightful
learning experience.
To summarize, essentials related to role are:
• Complete description
An accurate and complete description and understanding of the formal role avoids role
confusion and potential conflict with colleagues.
• Understanding of both one’s formal and informal roles
Understanding how one's informal role gets activated and how it influences our formal role
is the foundation of the ability to make different choices about group participation in the
future.
Task
From a group relations perspective, the next task has never been done before. Yes, we
may have a technical "fix" for a variety of circumstances, but the task remains dynamic.
While a similar task may have been done previously the change in the time boundary alone
makes it different. Each person involved with the task also brings his or her perceptions to
the moment. Conflicts arise when perceptions of the task differ from person to person or
from group to group. In other words, we tend to import our histories and experiences to a
task. Group relations work calls on us to be conscious of what bring into a situation. In
reality, most of us are engaged in curious enactments of past triumphs and tragedies
related to similar tasks. What we have not resolved or what we have learned will work in
other settings we will replay. In the former case we await some new outcome. In the latter,
we seek to have our reality yet again confirmed. In short, if there is an absence of
consciousness about what is being imported, we can be assured that what will be exported
will be inconsistent with the true nature of the task.
We distinguish different kinds of task. There is the primary task (also referred to as
functional task or work task), which corresponds with the mission of an organization. Most
organizations face multiple tasks all vying to be expressed in the service of the primary
task. This is the point where authority, becomes central, i.e. the person who decides what
task has priority. It is the authority boundary in conjunction with the task boundary that
helps the task become clear and for the work of the group to be taken on successfully. Lack
of clarity at the authority boundary, destructive chaos is likely to result and the survival of
the group will be in peril. While in some instances such a collapse is desirable for the new
group to arise and for the task to be achieved. Yet from the perspective of the group that
dies, the loss continues to live well after the time boundary passes off.
When a group works on a task, members of the group always, albeit mostly
subconsciously, have the survival of the group in mind. We call this the survival task of the
group. Although this fundamental task is frequently disguised or masked, survival as a
group becomes the primary preoccupation and latent motivating force for all group
members. Therefore, primary task and the survival task co-exist, at times the survival task
is in service of the primary task and complimentary but many times it is in conflict with the
primary task.
This survival instinct of group members is the foundation for off task behavior. Off task
behavior can be distinguished in four categories: dependency, pairing, fight/flight or
oneness (in group relations terms, these categories are called basic assumptions).
Dependency is when the group waits for one person to take leadership, as if other
members don't have those skills. Pairing is when the group uses a pair to produce the
solution in the form of a prophetic idea or person, often this happens in the form of a fight
which may eventually result in some solution (thesis, antithesis, synthesis) or in the form of
some emotional connection that 'enlightens' Fight is when the group starts a conflict about
relatively inconsequential things and flight is when the group either literally or
metaphorically distances itself from the task, for example by members starting to take
personal phone calls during a meeting, or by entering into fantasy land and thinking about
the next dream vacation. Oneness is when the group acts totally undifferentiated, as if there
is no difference of opinion let alone conflict within the group.
The purpose of the process task is to give attention to the survival task without necessarily
acting it out. It provides an opportunity for members of a group to look at their own
dynamics, including dependency, pairing, fight/flight and oneness behavior, issues of
competition and authority, interpersonal relationships, trying to understand the meaning of
behavior of an individual for the group, or group behavior as such. When a certain time is
set to work on the process task it is likely to reduce the amount of off task behavior and it
may enhance the work of the primary task. Attention to the process task can take place at
the end of a regular meeting, or it can be a regularly returning meeting as part of a group's
ongoing work together, depending upon the size of the group and the intensity of its work
together.
It is crucial that
• All parties have great clarity about the task
• Someone in the group can distinguish the different kinds of tasks
• To realize that the task is always fluid because of factors that influence the way a person
perceives the task
Boundary – Authority – Roles - Tasks analysis of a workgroup or an organization may

assist in preventing loss of valuable resources. Off task behavior often results in
productivity loss, mental stress, frustration and interpersonal / intergroup conflicts. The
consequences of any of these problem areas may impede or slow down the primary task
and may ultimately be destructive for the organization.
2. Accounting & Finance Management
2.1 Methods of Capital Formation
Meaning of Capital Formation:
Capital formation means increasing the stock of real capital in a country.
In other words, capital formation involves making of more capital goods such as
machines, tools, factories, transport equipment, materials, electricity, etc., which are all
used for future production of goods.
For making additions to the stock of Capital, saving and investment are essential.
Process of Capital Formation:

In order to accumulate capital goods some current consumption has to be
sacrificed. The greater the extent to which the people are willing to abstain from
present consumption, the greater the extent that society will devote resources to new
capital formation. If society consumes all that it produces and saves nothing, future
productive capacity of the economy will fall as the present capital equipment wears out.
In other words, if whole of the current productive activity is used to produce consumer goods and
no new capital goods are made, production of consumer goods in the future will greatly
decline. To cut down some of the present consumption and wait for more consumption in the
future requires far-sightedness on the part of the people.
Three Stages in Capital Formation:
Although saving is essential for capital formation, but in a monetized economy, saving may not
directly and automatically result in the production of capital goods. Savings must be invested
in order to have capital goods. In a modern economy, where saving and investment are
done mainly by two different classes of people, there must be certain means or
mechanisms by which the savings of the people are mobilized and channelized to the
businessmen to invest in capital.
Therefore, in a modern free enterprise economy, the process of capital formation consists of
the following three stages:
( a ) Creation of Savings:
An increase in the volume of real savings so that resources, that would have been
devoted to the production of consumption goods, should be released for purposes of
capital formation.
( b ) Mobilization of Savings:
A finance and credit mechanism, so that the available resources are obtained by private
investors or government for capital formation.
( c ) Investment of Savings:
This is the act of investment itself, so that resources are actually utilized for the
production of capital goods.
Let’s discuss these three stages in detail:
Creation of Savings:
Savings are done by individuals or households. They save by not spending all their
incomes on consumer goods. When individuals or households save, they release
resources from the production of consumer goods. Viz. Workers, natural resources,
materials, etc., thus released are made available for the production of capital goods.
The level of savings in a country depends upon the power to save and the will to save.
The power to save or saving capacity of an economy mainly depends upon the average
level of income and the distribution of national income. The higher the level of income,
the greater will be the amount of savings.
The countries having higher levels of income are able to save more. That is why the
rate of savings in the U.S.A. and Western European countries is much higher than that
in the under-developed and poor countries like India. Further, the greater the
inequalities of income, the greater will be the amount of savings in the economy. Apart
from the power to save, the total amount of savings depends upon the will to save.
Various personal, family, and national considerations induce the people to save.
People save for their old age and unforeseen emergencies. Some people save to
start a new business or to expand the existing business. However, many people save
for their children’s education, marriage and to help their children to start a business.
Further, it may be noted that savings may be either voluntary or forced. Voluntary
savings are those savings which people do of their own free will. As explained above,
voluntary savings depend upon the power to save and the will to save of the people. On
the other hand, taxes by the Government represent forced savings.
Moreover, savings may be done not only by households but also by business
enterprises and governments. Business enterprises save when they do not distribute
the whole of their profits, but retain a part of them in the form of undistributed profits.
They then use these undistributed profits for investment in real capital.
The third source of savings is government. The government savings constitute the
money collected as taxes and the profits of public undertakings. The greater the
amount of taxes collected and profits made, the greater will be the government savings.
The savings so made can be used by the government for building up new capital goods
like factories, machines, roads, etc., or it can lend them to private enterprise to invest in
capital goods.
Mobilization of Savings:
The next step in the process of capital formation is that the savings of the households
must be mobilized and transferred to businesses for investment. In the capital market,
funds are supplied by the individual investors (who may buy securities or shares
issued by companies), banks, investment trusts, insurance companies, finance
corporations, governments, etc.
If the rate of capital formation is to be stepped up, the development of capital market is
very necessary. A well-developed capital market will ensure that the savings of the
society are mobilized and transferred to the businesses which requires them.
Investment of Savings in Real Capital:
For savings to result in capital formation, they must be productively invested. In order
that the investment of savings should take place, there must be a good number of
honest and dynamic entrepreneurs who are ready and able to take risks and handle
uncertainty of future production.
Businesses will invest only if there is a sufficient incentive for investment. The
incentive for investment depends on the marginal efficiency of capital, that is, the
difference between the expected rate of return on the capital employed and the cost of
that capital, that is, the current rate of interest. The businesses will be willing to
invest, if the marginal efficiency of the capital is enough to cover the uncertainties
involved in any business enterprise.
Additionally, the size of the market also provides scope for profitable investment by
imparting economies of scale. Thus, the primary factor which determines the level of
investment or capital formation, in any economy, is the size of the market for goods.
Foreign Capital:
Capital formation in a country can also take place with the help of foreign capital, i.e.,
foreign savings.
Foreign capital can take the form of:
(a) Direct private investment by foreigners,
(b) Loans or grants by foreign governments,
(c) Loans by international agencies like the World Bank.
There are very few countries which have successfully marched on the road to economic
development without making use of foreign capital in one form or the other. India is
receiving a good amount of foreign capital for investment and capital formation under the
Five-Year Plans.
Deficit Financing:
Deficit is the extra expenditure done by the government over and above it’s income. The money
for this excess expenditure is borrowed from the Reserve Bank of India by issuing it the
promissory notes, called the Government of India Securities. Thus, deficit financing creates new
money. This newly-created money is another source of capital formation in a developing
economy. Owing to very low standard of living of the people, the extent to which voluntary
savings can be mobilized is sometimes quite limited. Similarly, taxation beyond certain limit
becomes oppressive and, therefore, politically untenable. Deficit financing is, therefore, the
only method remaining for the governments to fall back upon for funds.
However, this source of development financing may lead to inflationary pressures in the
economy. Because this money is obtained in exchange of just a paper called a
promissory note. This excess money will start chasing limited goods, and start pushing
the prices of goods upwards. But deficit financing can be utilized to certain extent
without creating much pressure. India is struggling to maintain it’s fiscal deficit at 3.5%
of GDP.
As soon as the prices of goods start going up, the Reserve Bank of India sells the
Securities issued by the Government of India to the Commercial Banks to absorb the
excess money from the economic system.
Disguised Unemployment:
Another source of capital formation is to mobilize the saving potential that exists in the
form of disguised unemployment. Surplus agricultural workers can be transferred from
the agricultural sector to the non-agricultural sector without diminishing agricultural
output.
The objective is to mobilize these unproductive workers and employ them on various
capital creating projects, such as roads, canals, building of schools, health centers and
bunds for floods, in which they do not require much more capital to work with. In this
way', the hitherto unemployed, labour can be utilized productively and turned into
capital, as it were.
Capital Formation in the Public Sector:

In these days, the role of government has greatly increased. In an under -developed
country like India, government is very much concerned with the development of the
economy. Government is building dams, steel plants, roads, machine-making factories
and other forms of real capital in the country. Thus, capital formation takes place not
only in the private sector by individual entrepreneurs but also in the public sector by
government.
There are various ways in which a government can get resources for investment
purposes or for capital formation. The government can increase the level of direct and
indirect taxation and then can finance its various projects. Another way of obtaining
the necessary resources is the borrowing by the Government from the public.
The government can also finance its development plans by deficit financing. Deficit
financing means the creation of new money. By issuing more notes and exchanging
them with the productive resources the government can build real capital. But the
method of deficit financing, as a source of development finance, is dangerous because
it often leads to inflationary pressures in the economy. A certain measure of deficit
financing, however, can be had without creating such pressures.
Another source of capital formation in the public sector is the profits of public
undertakings which can be used by the government for further investment. As stated
above, government can also get loans from foreign countries and international agencies
like World Bank. India is getting a substantial amount of foreign assistance for
investment purposes under the Five-Year Plans.
2.2 Control of Working Capital (WC)
Successful business is about investing in the right ideas, the right equipment, and
the right people. And to invest, businesses need capital – either from the owners,
from retained profits or from others willing to advance credit or loans.
There are two types of capital need: for ‘fixed capital’ to invest in things such as
buildings, plant and equipment; and ‘working capital’ principally to pay for stock and
to cover the amount of credit extended to customers.
Long Term Capital doesn’t vary in the short term. It varies only when major
investment decisions are made.
Whereas Working Capital, fluctuates with the level of business. During the period of
brisk business the WC increases and during slack period it decreases.
The management of working capital involves managing inventories, accounts

receivable and payable, and cash. It involves a direct relationship between a firm's
short-term assets and its short-term liabilities. Working capital management ensures
that a company has sufficient cash flow to meet its short-term debt obligations and
operating expenses. The prime objective of Working capital management is to
minimizing the risk of insolvency and maximizing the return on assets.
Each company has different demands for how much Working Capital (WC) they
need, but all companies prefer to have positive WC. Having too little WC impairs a
company's ability to meet its financial obligations. It is hard to pay expenses or debts
that come due in the short-term. Having too much WC can also be bad because it
means that there are assets that are not being invested. Holding too many short term
assets slows future growth of the company. Thus, managing WC to an acceptable
level is one of the most important jobs of management.
Working capital is the difference between the Current Assets (CA) and the Current
Liabilities of the company. These are basically the assets & liabilities of the company,
which are going to disappear from its books within a very short period of time, say 12
months. Therefore, WC = CA – CL. WC can be adjusted by increasing or decreasing
its two components: current assets (CA) and current liabilities (CL). Increasing CA or
decreasing CL increases WC. Managements can employ certain policies to manage
company’s WC, some of which are listed below:
o Cash management: Identify the cash balance that allows the business to meet
day to day expenses, but reduces cash holding costs. Cash is a CA.
o Inventory management: Identify the level of inventory which allows for

uninterrupted production but reduces the investment in raw materials and
minimizes reordering costs and hence increases the cash flow. Inventory is a
CA.
o Debtors management: Sundry debtors are the customers who buy the
company’s products or services on deferred payment. Debtors management
involves identifying appropriate credit policies, such as credit terms, that will
attract customers, such that any impact on cash flows and the cash conversion
cycle will be offset by increased business and hence Return on Capital (or vice
versa). Credit extended to customers (accounts receivable) is a CA.
o Creditors management: Sundry creditors are the suppliers of raw materials or
services to the company on deferred payment. Creditors management involves
identifying appropriate payment policies towards company’s suppliers, such as
credit terms, to seek minimum prices and ensuring continuity of operations.
Credit extended to the company by the suppliers (accounts payable) is a CL.
o Financing management: Identify the appropriate source of financing. Short -

term financing (as well as long-term financing that comes due in the next year
or operating cycle) is a CL.
By adjusting these five primary influencers on CA and CL, management can change
the WC to a desirable level.
The primary objective of working capital management is to ensure that sufficient cash
is available to:
• meet day-to-day cash flow needs

• pay wages and salaries when they fall due
• pay creditors to ensure continued supplies of goods and services
• pay government taxation and providers of capital – dividends and
• ensure the long term survival of the business entity
Poor working capital management can lead to over-capitalization and overtrading,

that is, operating at unsustainably high level of sales.
The two main aspects of working capital management are ratio analysis and
management of individual components of working capital.
A few key performance ratios of a working capital management system are the
working capital ratio, Working Capital Turnover Ratio, Accounts Payable Turnover,
Accounts Receivable Turnover and Inventory turnover. Ratio analysis helps
managements to identify areas of focus such as inventory management, cash
management, accounts receivable and payable management.
Working Capital Ratio (Current Assets to Current Liabilities):
The working capital ratio is the same as the current ratio. It is the relative proportion
of an entity's current assets to its current liabilities, and is intended to show the
ability of the business to pay for its current liabilities with its current asse ts. A
working capital ratio of less than 1.0 is a strong indicator that there will be liquidity
problems in the future, while a ratio in the vicinity of 2.0 is considered to represent
good short-term liquidity.
Working Capital Turnover Ratio (Sales to Working Capital):
This ratio indicates, sales is how many times of the working capital. The working
capital turnover ratio measures how well a company is utilizing its working capital to
support a given level of sales. A high turnover ratio indicates that management is
being extremely efficient in using a firm's short-term assets and liabilities to support
sales. Conversely, a low ratio indicates that a business is investing in too many
accounts receivable and inventory assets to support its sales, which could eventually
lead to an excessive amount of bad debts and obsolete inventory.
Accounts Payable Turnover (Purchases to Accounts Payable):
This ratio indicates, how quickly payables are being paid or to what extent the
suppliers are financing the company’s purchases. Hence, a smaller ratio is desirable
for the company.
Accounts Receivable Turnover (Credit Sales to Accounts Receivable):
This ratio indicates how quickly customers are paying on their accounts. Accounts
receivable is a big source of cash flow for a company, therefore rapid turnover, that
is, bigger ratio is desirable in this case.
Inventory Turnover (Cost of Goods Sold to Inventory):
This ratio indicates how rapidly inventory is being sold. Usually, the faster the
inventory is sold, the more profitable the firm will be. Hence, this ratio should be as
high as possible.
2.3 How to read a Balance Sheet and a Profit & Loss statement
What is a Balance sheet?
It is nothing but a proof of, how the money, which was available for the business, was
utilized by the company.
e.g If your father gives you Rs. 1000 for buying a shirt.
The sources of funds here will be Rs. 1000
Out of these Rs 1000, you bought a shirt for Rs. 800 and Rs 200 is still lying with you.
Now your father asks you the account.
This account, that is the balance sheet, will look like this.
Sources of funds
Capital 1000
Total 1000
Application of funds
Shirt 800
Cash & bank balances 200
Total 1000
The company gets money from three main sources
1. Shareholder’s funds (that’s is owners money)

a. Capital (that is actual investment by the owners)
b. Reserves & Surplus (that is total profits re-invested over the period of time.)
2. Loan (loans taken from the banks)
a. Secured Loans (that is the loans for which something is assured as a security)
b. Unsecured Loans (that is the loans for which nothing is assured for security)
3. Deferred tax
a. Deferred tax liability (the money belonging to the income tax department, but
that is lying with the company at a given point of time)
b. Deferred tax assets (the money belonging to the company, and that is lying
with the tax department at a given point of time)
a – b = the net amount that belongs to the tax department, but lying with the
company. As if the tax department is financing the operations of the company
The total of 1 + 2 + 3 = Sources of funds
NOW THE COMPANY HAS TO GIVE A PROOF OF, WHERE THIS MONEY HAS GONE.
This proof is called ‘Application of funds’.
It is divided into six categories
1. Fixed Assets
a. Gross Block (The price at which the assets were actually purchased, many
years back)
b. Depreciation (Total reduction in value, because every year the worth of the
asset goes down by some percentage)
a – b = Net Block (today’s worth of the asset, that is, if the company plans to sell
the asset, it will get the amount exactly equal to the Net Block)
In some of the balance sheets, instead of showing the Gross Block and the
Accumulated Depreciation separately, directly the Net Block, that is, the present
worth of the asset is shown.
2. Capital Work in Progress (Amount spent on the projects, on which production has
not started) As per the tax laws, the depreciation can be deducted only when the
company actually starts using the asset. Until then it will be shown as the Capital
work in Progress.
3. Lease Adjustment Account (If the company takes a property on rent for a few
years, and if it pays the rental for the entire duration as advance, we can calculate
the rent remaining with the landlord at the end of any period)
4. Technical Know-how (If the company buys a technology for a few years, and if it
pays the fees for the entire duration as advance, we can calculate the Know-how fee
remaining with the technology supplier at the end of any period)
5. Investments (Surplus cash invested by the company in some other businesses,
either for profit or for assisting the supplier or in the competitors business)
6. Net Current Assets (Described below)
1+2+3+4+5+6 = Application of funds

Net Current Assets
It is a mini statement of small-term assets and liabilities. The life of these assets is
generally less than one year.
e.g. the inventories will not remain inventories forever. They will be assembled and sold
as products. Thus, converting it into money.
Net Current Assets has two parts
1. Current Assets
a. Inventories
b. Sundry debtors (Sale has happened, but the customer had not paid the bill
yet)
c. Cash & bank balances (as the cash may get converted into material at any
point in time)
d. Other current assets (small value items, not specifically clubbed into
inventories)
e. Loans & Advances (given to the suppliers & own employees)
2. Current Liabilities
a. Current Liabilities or Sundry Creditors (Purchase of the raw material has
happened, but the supplier has not been paid yet)
b. Provisions (the money has been kept aside for a tricky situations)
1 - 2 = Net Current Asset (Taken to the application of funds part of the main balance
sheet)
In some of the balance sheets, instead of showing the Net Current Assets, the
Current Liabilities are shown under the Sources of Funds and Current Assets are
shown under the Application of Funds, even though the ultimate effects remains
same.
Profit & Loss Statement
The important thing to remember about profit and loss (income statement) is that it
represents a period of time (generally, 3 or 6 or 12 months). This contrasts with the balance
sheet, which represents the ending moment of that period.
Income statement, also referred as the profit and loss statement (P&L) or earnings
statement or operating statement or statement of operations, is the company's financial
statement that indicates how the revenue, that is, money received from the sale of products
and services is transformed into net profit, that is, money remaining in company’s hand
after taking care of all the expenses.
The revenue or the sales income is also called as the "top line" and the Net Profit is also
called as the "bottom line". It mentions the revenues or the sales income identified for a
specific period, and the expenditure done for these revenues.
The expenditure includes direct expenditure done on raw materials and salaries, as well as
indirect expenditures like reduction in the worth of the machinery (e.g., depreciation and
amortization of various assets) and taxes. The purpose of the income statement is to show
the managers and investors whether the company has made or lost the money during the
period under review.
The income statement can be prepared in one of two methods. The Single Step income
statement takes a simpler approach, totaling revenues and subtracting expenses to find the
bottom line. The more complex Multi-Step income statement (as the name implies) takes
several steps to find the bottom line, starting with the gross profit. It then calculates
operating expenses and, when deducted from the gross profit, yields income from
operations. Adding to income from operations is the difference of other revenues and other
expenses. When combined with income from operations, this yields income before taxes.
The final step is to deduct taxes, which finally produces the net income for the period
measured.
Usefulness and limitations of income statement
Income statements should help investors and creditors determine the past financial
performance of the enterprise, predict future performance, and assess the capability of
generating future cash flows through report of the income and expenses.
However, information of an income statement has several limitations:
o Items that might be relevant but cannot be reliably measured are not reported (e.g.
brand recognition and loyalty).
o Some numbers depend on accounting methods used (e.g. using FIFO or LIFO
accounting to measure inventory level).
o Some numbers depend on judgments and estimates (e.g. depreciation expense
depends on estimated useful life and salvage value).
Uses of the Profit and Loss Account.
1) The main use is to monitor and measure profit, as discussed above. This assumes that
the information recording is accurate. Significant problems can arise if the information is
inaccurate, either through incompetence or deliberate fraud.
2) Once the profit (loss) has been accurately calculated, this can then be used for
comparison i.e. judging how well the business is doing compared to itself in the past,
compared to the managers’ plans and compared to other businesses.
3) There are ways to ‘fix’ accounts. Internal accounts are rarely ‘fixed’, because there is
little point in the managers fooling themselves (unless fraud is going on) but public accounts
are routinely ‘fixed’ to pass a good impression to the outside world. If you understand
accounts, you can usually (not always) spot these ‘fixes’ and take them out to get a true
picture.
Items on income statement
Operating section
Revenue - Cash inflows or money coming-in because of the company’s ongoing primary
operations. It is usually presented as sales minus sales discounts, returns, and allowances.
Expenses - Cash outflows or money spent on delivering products or services in ongoing

primary operations. This may include raw material cost, wages & salaries, electricity etc.
General and administrative expenses (G & A) - represent expenses to manage the

business (officers’ salaries, legal and professional fees, utilities, insurance, depreciation of
office building and equipment, office rents, office supplies etc.)
Selling expenses - represent expenses needed to sell products (e.g., sales salaries,
commissions and travel expenses, advertising, freight, shipping, depreciation of sales store
buildings and equipment). This is usually understood as a major portion of non-production
related costs.
R & D expenses - represent expenses included on research and development
Depreciation - is the reduction in worth of the machinery during a specific period, that is,
the accounting period, for the fixed assets which have been capitalized on the balance
sheet.
Non-operating section
Other revenues or gains - revenues and gains from other than primary business activities
of the company (e.g. rent, patents). It also includes gains and losses that are either unusual
or infrequent (e.g. sale of securities or fixed assets)
Other expenses or losses - expenses or losses not related to primary business operations
of the company.
Exceptional items - They are reported separately because this way users can better
predict future cash flows - irregular items most likely will not recur. These are reported net
to taxes.
Discontinued operations – This includes financial implications related to the operations,

which the company has permanently sold off or stopped. This is a most common type of
irregular item. Shifting business location, stopping production temporarily, or changes due
to technological improvement do not qualify as discontinued operations.
Extraordinary items - are both unusual and infrequent. e.g. natural disaster, expropriation,
prohibitions under new regulations.
Changes in accounting principle: is, for example, deciding to depreciate an investment
property that has previously not been depreciated. However, changes in estimates (e.g.
estimated useful life of a fixed asset) do not qualify.
Earnings per share
Because of its importance, earnings per share (EPS) are required to be disclosed on the
face of the income statement. A company which reports any of the irregular items must also
report EPS for these items either in the statement or in the notes.
There are two forms of EPS reported:
 Basic: in this case "weighted average of shares outstanding" includes only actual
stocks outstanding.
 Diluted: in this case "weighted average of shares outstanding" is calculated as if all
stock options, warrants, convertible bonds, and other securities that could be
transformed into shares are transformed. This increases the number of shares and
so EPS decreases. Diluted EPS is considered to be a more reliable way to
measure EPS.
Bottom line
"Bottom line" is the net income that is calculated after subtracting the expenses from
revenue. Since this forms the last line of the income statement, it is informally called
"bottom line." It is important to investors as it represents the profit for the year attributable to
the shareholders.
2.4 Budgetary control
There are two types of control over operations of a business, namely budgetary and
financial.
a) Budget:
A formal statement of the financial resources set aside for carrying out specific activities in
a given period of time. It helps in co-ordination of the activities of an organization. e.g.
advertising budget or salesforce budget.
b) Budgetary control:
A control technique whereby actual results are compared with the budgets and the
differences (called variances), if any are observed, then a few experiences people are given
the responsibility of identifying the reasons for the variances and taking suitable corrective
actions to minimize them. If it is impossible to control the variances, then original budgets
are revised accordingly.
Budgetary control and responsibility centers:
These enable managers to monitor organizational functions.
A responsibility center can be defined as any functional unit headed by a manager who is
responsible for the activities of that unit.
There are four types of responsibility centres:
a) Revenue centers: Organizational units in which outputs are measured in monetary terms
but are not directly compared to input costs. They are only concerned about the money
coming in e.g. Sales Department.
b) Expense centers: Units where inputs are measured in monetary terms but outputs are
not.
c) Profit centers: Where performance is measured by the difference between revenues

(outputs) and expenditure (inputs). Inter-departmental sales are often made using "transfer
prices".
d) Investment centers: Where outputs are compared with the assets employed in producing
them, i.e. Return On Investment.
Advantages of budgeting and budgetary control
o It compels management to think about the future, which is probably the most important
feature of a budgetary planning and control system.
o Forces management to look ahead, to set out detailed plans for achieving the targets for
each department, operation and (ideally) each manager, to anticipate and give the
organization a purpose and direction.
o Promotes coordination and communication because of mutual dependence.
o Clearly defines areas of responsibility. Requires managers of budget centers to be
made responsible for the achievement of budget targets for the operations under their
personal control.
o Provides a basis for performance appraisal of employees (variance analysis). A budget
is basically a yardstick against which actual performance is measured and assessed.
Control is provided by comparisons of actual results against budget plan. Departures
from budget can then be investigated and the reasons for the differences can be divided
into controllable and non-controllable factors.
o Enables remedial action to be taken as variances emerge.
o Motivates employees by participating in the setting of budgets.
o Improves the allocation of scarce resources.
o Economizes management time by using the management by exception principle. i.e.
management will focus its attention on problem areas only.
Problems in budgeting
Whilst budgets may be an essential part of any business, they do have a number of
disadvantages, because budgets are seen as pressure device imposed by management,
thus resulting in:
o Bad labor relations & inaccurate record-keeping.
o Departmental conflict over resource allocation and departments blaming each other if
targets are not attained.
o It is difficult to reconcile personal goals and corporate goals.
o Wastage may arise if managers adopt the view, that if the allocated sum is not spent,
the department will get less allocation in the next fiscal.
o Responsibility versus controlling, i.e. some costs are under the influence of more than
one person, e.g. power costs.
o Managers may overestimate costs so that they will not be blamed in the future should
they overspend.
Characteristics of a god budget
o Participation: involves as many people as possible in drawing up the budget.

o Comprehensiveness: encompasses the whole organization.
o Standards: bases it on established standards of performance.
o Flexibility: allows for changes under changing circumstances.
o Feedback: constantly monitors performance.
o Analyzes costs and revenues: this can be done on the basis of product lines,
departments or cost centers.
Budget organization and administration:
a) Budget centers: Units responsible for the preparation of budgets. A budget center may
encompass several cost centers.
b) Budget committee: This may consist of senior members of the organization, e.g.
departmental heads and executives (with the managing director as chairman). Every part of
the organization should be represented on the committee, so that there is a representative
from sales, production, marketing and so on.
c) Functions of the budget committee include:
o Coordination of the preparation of budgets, including the issue of a manual

o Issuing of timetables for preparation of budgets
o Provision of information to assist budget preparations
o Comparison of actual results with budget estimates and investigation of variances.
c) Budget Officer: He controls the budget administration. His job involves,
o Liaising between the budget committee and managers responsible for budget
preparation
o Dealing with budgetary control problems
o Ensuring that deadlines are met
o Educating people about budgetary control.
d) Budget manual: This document contains
o Charts the organization

o Details the budget procedures
o Contains account codes for items of expenditure and revenue
o Timetables the process and
o Clearly defines the responsibilities of persons involved in the budgeting system.
Budget preparation
a) Sales budget: this involves a realistic sales forecast. This is prepared in units of each
product and also in sales value.
Methods of sales forecasting include: sales force opinions, market research, statistical
methods (correlation analysis and examination of trends) and mathematical models.
While using these techniques consider, company's pricing policy, general economic and
political conditions, changes in the population, competition, consumers' income and tastes,
advertising and other sales promotion techniques, after sales service, credit terms offered
etc.
b) Production budget: expressed in quantitative terms only and is geared to the sales
budget.
The production manager's duties include, analysis of plant utilization and work-in-progress
budgets.
If requirements exceed capacity he may have to decide on, subcontracting, planning for
overtime, introducing another shifts work, hire or buy additional machinery
c) Raw materials and purchasing budget: The materials purchases budget will be both
quantitative and financial. The materials usage budget is in quantities, but the materials
purchases budget is both quantitative and financial.
Factors influencing this budget include production requirements, planned stock levels and
storage space and trends in material prices.
d) Labour budget: is both quantitative and financial. This is influenced by - production

requirements, man-hours available, grades of labor required, wage rates (union
agreements) and the need for incentives.
e) Cash budget: a cash plan for a defined period of time. It summarizes monthly receipts
and payments. Hence, it highlights monthly surpluses and deficits of actual cash. Its main
uses are:
o To maintain control over company’s cash requirements, e.g. stock and debtors
o To enable a firm to take precautionary measures and arrange in advance for investment
and loan facilities whenever cash surpluses or deficits arises
o To show the feasibility of management's plans in cash terms
o To illustrate the financial impact of changes in management policy, e.g. change of credit
terms offered to customers.
Receipts of cash may come from of cash sales, payments by debtors, sale of fixed assets,
issue of new shares, receipt of interest and dividends from investments.
Payments of cash may be for purchase of stocks, payments of wages or other expenses,
purchase of capital items, payment of interest, dividends or taxation.
2.5 Standard Costing, Favorable and Adverse Variances
You know that management accounting is, managing the business through accounting
information. In this process, management accounting facilitates managerial control. These
measures should be applied correctly so that performance takes place according to plans.
Planning is the first tool for making the control effective. The vital aspect of managerial
control is cost control. Hence, it is very important to plan and control costs. Standard
costing is a technique which helps you to the control costs and business operations. It aims
at eliminating the wastes and increasing the efficiency through setting up standards or
formulating cost plans.
Meaning of a Standard
When you want to measure something, you must take some parameter or yardstick for
measuring. We can call this yardstick as the standard. What are your daily expenses? An
average of Rs. 500. If you have been spending this much for so many days, then this
becomes your daily standard expense.
The word standard means a benchmark or yardstick. The standard cost is a predetermined
cost which determines in advance what each product or service should cost under given
circumstances.
Therefore, standard cost is the amount the company thinks, a product or the operation of
the process should cost for that period of time, based upon certain assumed conditions of
efficiency, economic conditions and other factors.
Definition
The Institute of Cost Accountants of India has defined standard cost as “a predetermined
cost which is calculated from management’s standards of efficient operations and relevant
necessary expenditure.” They are the predetermined costs on technical estimate of
material, labor and overhead for a selected period of time and for a prescribed set of
working conditions. In other words, a standard cost is a planned cost for a unit of product or
service rendered.
The technique of using standard costs for the purposes of cost control is known as standard
costing. It is a system of cost accounting which is designed to find out how much should be
the cost of a product under the existing conditions. The actual cost can be ascertained only
when production is undertaken. The predetermined cost is compared to the actual cost and
a variance, that is, the deviation between the two enables the management to take
necessary corrective measures.
Advantages
Standard costing is a management control technique for every activity. It is not only useful
for cost control purposes but is also helpful in production planning and policy formulation. It
allows management by exception (focusing only on problem areas).
In the light of various objectives of this system, some of the advantages of this tool are
given below:
Efficiency measurement - The comparison of actual costs with standard costs enables the
management to evaluate performance of various cost centers. In the absence of standard
costing system, actual costs of different periods may be compared to measure efficiency. It
is not proper to compare costs of different periods because circumstance of both the
periods may be different. Still, a decision about base period can be made, with which actual
performance can be compared.
Finding of variances - The performance variances are determined by comparing actual

costs with standard costs. Management is able to spot out the place of inefficiencies. It can
fix responsibility for deviation in performance. It is possible to take corrective measures at
the earliest. A regular check on various expenditures is also ensured by standard costing
system. These variances can be favorable (when the company benefits because of the
deviation), or unfavorable (when the company suffers because of the deviation). They can
be controllable (when the deviation is within company’s control), or uncontrollable (when the
deviation is beyond company’s control). The managers of the cost centers are expected to
justify the variances, unfavorable variances in particular. The managers of the cost centers
reporting favorable variances are encouraged by giving suitable recognition. This system
ensures elimination of inefficiencies and continual improvement.
Management by exception - If the performance of the departments or the individuals is

according to the predetermined standards, then there is nothing to worry about. The
attention of the management is often drawn by the departments or individuals, when their
actual performance is less than the budgeted performance. The Management by exception
means, once everyone is given a target for performance, then the management need not
supervise each and everything. The responsibilities are fixed and everyone tries to achieve
his/her targets. The management will step-in only when deviations are reported.
Cost control - Every costing system aims at cost control and cost reduction. The standards
are constantly monitored and effort are made to improve the efficiency. Whenever
variances occur, the reasons are studied and immediate corrective actions are taken. The
corrective actions taken on weaker areas enables the company to control the costs.
Eliminating inefficiencies - The setting of standards for different elements of cost requires
a detailed study of those elements. The standards are set differently for manufacturing,
administrative and selling expenses. Improved methods are used for setting these
standards. The determination of manufacturing expenses will require time and motion study
for labor and effective material control devices for materials. Similar studies will be needed
for finding other expenses. All these studies will make it possible to eliminate inefficiencies
at different levels.
The limitations of Standard Costing
It cannot be used in those organizations where non-standard products are produced. If the
production is undertaken according to the customer specifications, then each job might
involve different processes. But there is always a scope to break down these processes into
elements, which may be standard in nature.
The process of setting standards is a difficult task, as it requires technical skills and
cooperation of people at different levels. The time and motion study is required to be
undertaken for this purpose. These studies require a lot of time and money.
The conditions under which standards are set do not remain static. With the changes in
circumstances, if the standards are not revised, then the entire exercise become futile.
The fixing of responsibilities is not an easy task. The variances need to be classified into
controllable and uncontrollable variances. Standard costing is applicable only for
controllable variances. Uncontrollable variances occur because of the factors beyond
company’s control.
For example, if a company changes the technology, then it has to revise the standards.
Frequent revision of standards is also very expensive.
Setting of Standards
Normally, setting up standards is based on the past experiences. The total standard cost
includes direct materials, direct labor and overheads. Normally, all these are fixed to some
extent. The standards should be set up in a systematic way so that they are used as a tool
for cost control.
Setting Standards for Direct Materials
There are several basic principles which ought to be taken into consideration while setting
up the standards for direct materials. If material is used for a product, it is known as direct
material. On the other hand, if the material cost cannot be assigned to the manufacturing of
the product, it will be called indirect material. Therefore, it involves two things, quality of
material and price of the material.
When you want to purchase the raw material, the quality and size should be determined.
The standard quality to be maintained should be decided. The quantity is determined by the
production department. This department makes use of historical records, and an allowance
for changing conditions is taken into consideration while setting the standards. A number of
test runs may be undertaken on different days and under different situations, and an
average of these results is used for setting material quantity standards.
The second step in determining direct material cost will be a decision about the standard
price. Material’s cost will be decided in consultation with the purchase department. The cost
of purchasing and store keeping of materials should also be taken into consideration. The
procedure for purchase of materials, minimum and maximum levels for various materials,
discount policy and means of transport are the other factors which have bearing on the
materials cost price. It includes the following, Cost of materials, Ordering cost and Carrying
cost.
The objective is to increase the efficiency of procurement and store keeping.
Setting Direct Labor Cost
If you want to engage a labor force for manufacturing a product or a service for which you
need to pay some amount, this is called wages. If the labor is engaged directly to produce
the product, this is known as direct labor. The second largest amount of cost, after raw
material, is of labor cost. The benefit derived from the workers can be assigned to a
particular product or a process. If the wages paid to workers cannot be directly assigned to
a particular product, these will be known as indirect wages. The time required for producing
a product would be ascertained and labor cost should be properly graded. Different grades
of workers will be paid different rates of wages. The times spent by different grades of
workers for manufacturing a product should also be studied for deciding upon direct labor
cost. The setting of standard for direct labor will be done basically on the following
considerations - Labor rate per hour for skilled labor, semi-skilled labor, and unskilled labor.
For setting a standard time for labor force, we normally take into account previous
experiences, past performance records, test run result, work-study etc. The labor rate
standard refers to the expected wage rates to be paid for different categories of workers.
The anticipation of expected changes in labor rates will be an essential factor in this
approach. In case there is an agreement with workers for payment of wages in the coming
period, these rates should be used for calculating the standard labor cost. If a premium or
bonus scheme is in operation, then anticipated extra payments should also be included.
Where a piece rate system is used, standard cost will be fixed per piece. The object of fixed
standard labor time and labor rate is to seek maximum efficiency in the use of labor.
Setting Standards of Overheads
The next important element of cost comes under overheads. Overheads are costs which
cannot be directly assigned exclusively to particular product, but it is unavoidable and
incurred on running a company. The very purpose of setting standard for overheads is to
minimize the total cost of operation. Standard overhead rates are computed by dividing
overhead expenses by direct labor hours or units produced. The standard overhead cost is
obtained by multiplying standard overhead rate by the labor hours spent or number of units
produced. The determination of overhead rate involves three things:
The overheads are classified into fixed overheads, variable overheads and semi-variable
overheads. The fixed overheads remain the same irrespective of level of production, while
variable overheads change in the proportion of production. The expenses increase or
decrease with the increase or decrease in output. Semi-variable overheads are neither
fixed nor variable. These overheads increase with the increase in production but the rate of
increase will be less than the rate of increase in production. The division of overheads into
fixed, variable and semi-variable categories helps in determining overheads.
Determination of Standard Costs
1. Determination of Cost Center - A cost center is a department or part of a department or

an equipment or machinery or a person or a group of persons in respect of which costs are
accumulated, and one where control can be exercised. Cost centers are necessary for
determining the costs. If the whole factory is engaged in manufacturing a product, the
factory will be a cost center. In fact, a cost center describes the product while cost is
accumulated. Cost centers enable the determination of costs and fixation of responsibility.
A cost center relating to a person is called personnel cost center, and a cost center relating
to products and equipment is called impersonal cost center.
2. Current Standards - A current standard is a standard which is established for use over a
short period of time and is related to current condition. It reflects the performance that
should be attained during the current period. The period for current standard is normally
one year. It is presumed that conditions of production will remain unchanged. In case there
is any change in price or manufacturing condition, the standards are also revised. Current
standard may be ideal standard and expected standard.
3. Ideal Standard - This is the standard which represents a high level of efficiency. Ideal
standard is fixed on the assumption that favorable conditions will prevail and management
will be at its best. The price paid for materials will be lowest and wastes etc. will be
minimum possible. The labor time for making the production will be minimum and rates of
wages will also be low. The overheads expenses are also set with maximum efficiency in
mind. All the conditions, both internal and external, should be favorable and only then ideal
standard will be achieved. Ideal standard is fixed on the assumption of those conditions
which may rarely exist. This standard is not practicable and may not be achieved. Though
this standard may not be achieved, even then an effort is made to achieve it. The deviation
between targets and actual performance is measured, and suitable alterations are made in
the standards. In practice, ideal standards have adverse effects on the employees,
because, they do not try to reach the set standard, saying the standards are not realistic.
4. Basic Standards - A basic standard may be defined as a standard which is established
for use for an indefinite period which may a long period of time. Basic standard is
established for a long period of time and is not adjusted to the preset conditions. The same
standard remains in force for a long period. These standards are revised only on the
changes in specification of the material and the technology of production. It is indeed just
like a number against which subsequent process changes can be measured. Basic
standard enables the measurement of changes in costs over a period of time. The changes
in manufacturing costs can be measured by taking basic standard as a reference. But the
basic standard cannot serve as a tool for cost control purposes, because the standard is
not revised for a long period of time. The deviation between standard cost and actual cost
cannot be used as a yardstick for measuring efficiency, if we are using basic standards.
5. Normal Standards - As per terminology, normal standard has been defined as a standard
which, it is anticipated, can be attained over a future period of time, preferably long enough
to cover one trade cycle. This standard is based on the conditions which will cover a future
period of five years, concerning one trade cycle. If a normal cycle of ups and downs in sales
and production is 10 years, then standard will be set on average sales and production
which will cover all the years. The standard attempts to cover variance in the production
from one time to another time. An average is taken from the periods of recession and
depression. The normal standard concept is theoretical in nature and cannot be used for
cost control purposes, because there is a lot of variation in costs incurred during boom and
recession. Normal standard can be properly applied for absorption of overhead costs over a
long period of time.
6. Organization for Standard Costing - The success of standard costing system will depend
upon the setting up of proper standards. For the purpose of setting standards, a person or a
committee should be given this job. In a big concern, a standard costing committee is
formed for this purpose. The committee includes production manager, purchase manager,
sales manager, personnel manager, chief engineer and cost accountant. The cost
accountant acts as a co-coordinator of this committee.
7. Accounting System - Classification of accounts is necessary to meet the required

purpose, i.e. function, asset or revenue item. Codes can be used to have a speedy
collection of data.
Revision of Standards
For effective use of this technique, we need to revise the standards as the circumstances
change, for gaining better control over operations.
Standards may need to be changed to accommodate changes in the organization or its

environment. When there is a sudden change in economic circumstances, technology or
production methods, the standard cost will no longer reflect reality. They will not help us to
predict the inputs required nor will help us to evaluate the efficiency of a particular
department. If the standards are continually not being achieved and if large deviations or
variances from the standard are consistently reported from a cost center, then they need to
be carefully reviewed. In practice, changing standards frequently is an expensive task and
can cause confusion amongst employees. For this reason, standard cost revisions are
usually made only once a year. At times of rapid price inflation, price and wage rate
standards may have to be revised continually. This, however, leads to reduction in value of
the standard as a yardstick. At the other extreme is the adoption of basic standard which
remains unchanged for years together.
2.6 Discounted cash flow method for project appraisals with continuous
or discreet cash flows
Entrepreneurs or companies take their business decisions based on certain assumptions.
These assumptions, which are made for the foreseeable future, are related to
o The business outlook, that is, the level of business expected.

o The technology outlook, that is, the evolution of technology.
o The manpower outlook, that is, the availability of trained manpower.
o The political outlook. (Sun TV vs Jaya TV)
o Social outlook (Communal peace)
o Financial outlook (cost of borrowing)
o Energy outlook (availability of power)
Based on these outlooks, the companies take the business decisions. For any enterprise or
a project, during the gestation period a lot of money outflow happens in developing the
market (advertising & sales), training the employees and the infrastructure required for
manufacturing. The money inflow during this period may be happen to be lower than the
outflow, resulting in losses for the companies during the gestation periods.
But as the sale starts picking up and as better manufacturing practices are discovered, this
gap narrows down, and finally companies start making profits. This widening of profit
continues for a few more years, until machines become older or a new technology comes
on the horizon. If a competitor employs the new technology, his cost of production may turn
out to be lower than the company’s cost of production. This enables him to sell his wares
cheaper than the company’s. Hence, forcing the company to reduce its prices. Similarly, as
the trained manpower gets older, their efficiencies may drop. As existing employees retire,
additional cost has to be incurred on training of new employees. This all results in
diminishing returns from the investment. And if we decide to continue with the same
infrastructure, a time will come in future, beyond which it would become unviable to run the
company with that infrastructure.
In summary, the project will start with net negative returns (losses) in the initial few years.
Then it will start making nominal profits. The profits keep growing, until the costs due to
older machines or out dated technologies pull it down. Finally, the project will start incurring
losses. At this point, the company has decide, whether to scrap the existing infrastructure
and invest in a new setup or risk its own existence.
Therefore, managers, based on their understanding of the outlook, quantity the profits (or
losses) that the company will earn at various points of time in future. They also quantify the
amount the company will realize on scrapping of the existing equipment.
In some of the businesses, the cash flows may occur continuously over a period of time or
it may occur at discrete instances over a period of time, depending on the nature of
the business. For example, for a company involved in the business of fast-moving-
consumer-goods, there will be an income (money coming in) on every day of the business.
But for a company involved in a business of ship building, there will be income only after
certain milestones (which are specified in the contract) are met. The earlier is called the
continuous cash flow, and the latter is called the discreet cash flow.
For any business to become viable, the net inflow from the enterprise throughout its life,
has to be greater than the net outflow on the enterprise. The gap between these two cash
flows has to be large enough to take care of the cost of financing and the uncertainty of
doing a business.
To ascertain the viability of the project, we need to find out the present worth of all future
cash flows.
For example, if a friend borrows Rs 10,000 from you and he returns that money back to you
after one year. Whether you win or lose in this deal?
Your answer would be no-profit-no-loss, if you ignore the inflation. That is, with Rs 10,000
you would be able to buy 10 shirts last year. But this year, with Rs 10,000 you would be
able to buy only 9 shirts. This effectively means, that you have received only Rs. 9,000 from
your friend. This reduction in the purchasing power of money is called inflation.
In India the average rate of inflation is 8% per annum.

100
That means, getting Rs. 100 after one year is equivalent to getting = 𝑅𝑠 92.6 today.
1.08
If he gives the money back after two years, then that will be equivalent to
92.6 100⁄ 100

1.08
= = = 𝑅𝑠 85.7
1.08 1.08 1.082
Therefore, if A is the amount received after n number of years and i is the rate of inflation,
𝐴
then the present worth of that amount would be 𝑃 = (1+𝑖)𝑛
If I is the initial investment and S is the scrap value of the project after n number of years.
And, if A1, A2, A3,…… are the receipts after 1, 2, 3,….years respectively, and if i is the rate
of inflation
Then the net cash flow from the enterprise will be
𝐴1 𝐴2 𝐴3 𝐴𝑛 𝑆
= −𝐼 + { + + + ⋯ + } +
(1 + 𝑖) (1 + 𝑖)2 (1 + 𝑖)3 (1 + 𝑖)𝑛 (1 + 𝑖)𝑛
The venture will be profitable, only if the net cash flow is positive.
Illustration: If a company invests Rs 25 lakh in a project. It makes Rs 1,00,000 profit in the
first year of operation. The profit expands at the rate of 25% per annum for the first 8 years
of operation. Then it expands at 15% per annum for next 4 years and 10% per annum for 4
more years. Finally the company decides to scrap the project and realizes Rs 5 lakh after
16 years of operation. Ascertain, whether the investment was profitable? What would have
been your decision, if initial investment was Rs 40 lakh? If you want to sell your project after
commissioning it, how much money should you expect?
Year Initial Profit Today's Scrap Today's

Investment worth of the value of worth of the
profit at 8 % the scrap value at
inflation plant 8 % inflation
0 2500000
1 100000 92593
2 125000 107167
3 156250 124036
4 195313 143561
5 244141 166158
6 305176 192313
7 381470 222584
8 476837 257620
9 548363 274318
10 630617 292098
11 725210 311030
12 833991 331189
13 917390 337323
14 1009129 343569
15 1110042 349932
16 1221046 356412 500000 145945
-2500000 3901902 145945
Net
Cash 1547847
flow
2.7 Break-Even analysis
Break-even analysis is a technique widely used by production management and
management accountants to foresee the cash flow from a business operation. It is based
on categorizing production costs between those which are "variable" (costs that change
when the production output changes) and those that are "fixed" (costs not directly related to
the volume of production).
Total of variable and fixed costs are then compared with the sales revenue, to determine
the level of sales at which the business will neither a profit nor make a loss. That level of
sale is called the "break-even point" of the operation.
The Break-Even Chart
In its simplest form, the break-even chart is a graphical representation of costs of

production and revenues from that production shown on the same chart for various levels of
operation. The point at which neither profit nor loss is made is known as the "break-even
point" and is represented on the chart by the intersection of these two lines.
Fixed Costs
Fixed costs are those business costs that are not directly related to the level of production
or output. In other words, even if the business has a zero output or high output, the level of
fixed costs will remain more or less the same. In the long term fixed costs can alter -
perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or
through the growth in overheads required to support a larger, more complex business
(hiring managers from IITs & IIMs).
Examples of fixed costs – Rentals, Depreciation, Research and development, Marketing

costs (non- revenue related), Administration costs etc.
Variable Costs
Variable costs are those costs which vary directly with the level of output, such as raw
materials, direct labour, fuel and revenue-related costs such as commissions paid.
A distinction is often made between "Direct" variable costs and "Indirect" variable costs.
Direct variable costs are those which can be directly attributable to the production of a
particular product or service and allocated to a particular cost center. Raw materials and the
wages those working on the production line are good examples of direct variable costs.
Indirect variable costs cannot be directly attributable to production but they do vary with
output. These include depreciation (where it is calculated related to output - e.g. machine
hours), maintenance and certain labour costs.
Semi-Variable Costs
Whilst the distinction between fixed and variable costs is a convenient way of categorizing
business costs, in reality there are some costs which are fixed in nature but which increase
when output reaches certain levels. These are largely related to the overall "scale" and
complexity of the business. For example, when a business has relatively low levels of
output or sales, it may not require costs associated with functions such as human resource
management or a fully-resourced finance department. However, as the scale of the
business grows (e.g. output will grow, number of people employed will grow, and number of
transactions and complexity of transactions will grow) then more resources may be required
to run the operation. If production rises suddenly then some short-term increase in
warehousing and transport may also be required. In these circumstances, we say that part
of the cost is variable and part of it is fixed.
Illustration: Fixed cost for a smartphone manufacturer is Rs. 20 Crores. The Variable cost
is Rs. 35000. Its MRP is Rs. 42000. At what production level shall the company break-
even? At what production level shall the company make the profit of Rs. 10 Crores?
Solution:
Total Cost = Variable Cost + Fixed Cost
Total Cost = 35000 x Q + 20 x 100000 x 100
Sale = 42000 x Q
At Break-Even Point, Profit = 0
Profit = Sale – Total Cost = 0
0 = 42000 x Q – (35000 x Q + 20 x 100000 x 100)
Therefore, Q = 2857 Nos
When the company makes a Profit of 10 Cr,
Profit = Sale – Total Cost = 10 x 100000 x 100
10 x 100000 x 100 = 42000 x Q – (35000 x Q + 20 x 100000 x 100)
Therefore, Q = 42857 Nos. If the company sells 42857 units, it will earn Rs 10 Cr in profit.
2.8 Cost Benefit Analysis
This is a systematic approach to estimating the strengths and weaknesses of various

alternatives that satisfy a given need of a business. It is a technique that is used to quantify
the cost of exercising an option and the benefits accrued by doing so.
Factors Influencing Make-Or-Buy Decisions
(a) Cost Analysis: Cost analysis refers to the determination of cost to make an item as well
as cost to buy it. The cost to make an item should include the estimated cost of raw
materials, direct labour, depreciation, interest on investment, insurance and property taxes,
incremental administrative overheads, incremental fixed cost (procurement or setup cost)
and carrying cost of raw materials and work-in-progress, appropriate allowance for
machining and work spoilage, idle time and other risks of doing business. The cost to buy
an item should include purchase price of the part, transportation cost, octroy and sales tax,
incremental procurement cost and carrying cost, incremental receiving and inspection costs
etc.
(b) Availability of production capacity:
(c) Suppliers’ unsatisfactory performance: Situations may arise when the items currently
being purchased from outside needs make-or-buy investigation. Some of the suppliers do
not give quality items, some do not ship as per their first delivery promise and there are
others who do not supply unless buyer’s men donot drive them mad with their frequent
visits or telephone calls. No buyer can afford to bear such a nuisance for a long time.
(d) Quantity requirement: Quantity requirement is another factor which influences Make-
or-buy decisions. A company generally prefers to make an item if the quantity
required per year is fairly large and subcontract if its annual requirement is small.
(e) Quality requirements: A company’s product may comprise of certain parts which are
quite difficult to manufacture to buyer’s quality specifications. A buyer generally
understands the intricacies of his parts better than his vendors.
(f) More than one supplier policy: More-than-one supplier policy refers to a buyer’s
decision to manufacture part of its requirement at the home plant and sub-contract the rest.
The buyer can use supplier’s rates as yardstick to measure the profitability of his
operations.
(g) Physical location: Physical location can exert a considerable influence on make-or-buy
decisions. A firm which is situated in an area populated with a variety of ancillaries is more
prone to “buy from outside” than a firm which is isolated from such amenities.
The Cost Benefit Analysis involves following steps
a. List the alternative projects or programs.

b. List the stakeholders.
c. Select parameters of measurement.
d. Predict outcome of cost and benefits over a relevant time period.
e. Convert all costs and benefits into a common currency.
f. Apply the discounting rate.
g. Calculate the net present value of various options.
h. Perform sensitivity analysis.
i. Adopt recommended choice.
2.9 Methods of Depreciation
The economic worth of any equipment diminishes over the period of time because of the
following reasons.
1. As machines are utilized for production purposes, their life & accuracy diminishes
because of wear and tear.
2. As new technology emerges, it becomes difficult to employ machines with older
technology to make a profits. As the demand for such machines vanishes, their
economic worth too diminishes.
It is therefore necessary to quantify the actual reduction in economic worth of the machinery
in a given financial year and also since its purchase, to know the present worth of the
machinery.
This reduction in the economic worth of the machinery is called depreciation. This is very
much akin to consumption of raw material for production purposes. Whenever we produce
something, we are directly consuming the raw material. But the consumption of the
machinery happens gradually and indirectly.
For example, if we invest Rs 20 Crore in machinery for manufacturing smartphones, and if

that machinery loses its economic worth by Rs 5 Crores in the first year of operation, then
depreciation is said to be Rs 5 Crore and the net worth of the machinery at the end of the
first year is Rs 15 Crore.
This amount of Rs 5 Crore is shown in the expenditure part of the Profit & Loss Statement
and remaining Rs 15 Crore is shown in the assets part of the Balance Sheet.
Similarly, if a company manufactures 50,000 smartphones in the first year, then each phone
5,00,000,00
has effectively consumed 50000 = 𝑅𝑠 1000 worth of machinery in manufacturing it.
As it is practically impossible to estimate the economic worth of the machinery at the end of
each financial year, the depreciation is theoretically estimated by using simple
mathematical formulas.
a. Straight Line Depreciation – In this method, same depreciation is charged over the
entire useful life of the machinery. For example, if the machinery costs Rs 20 Crore, and
if it is utilized for 10 years, then yearly depreciation as per Straight Line Depreciation
method is Rs 2 Crore per year.
b. Reducing Balance Depreciation – In this method a certain percentage of the asset’s
value, say 25 %, is considered as depreciation. For example, if the initial cost of the
machinery is Rs 20 crore, then 25% of Rs 20 Crore, that is Rs 5 crore, will be
considered as depreciation in the first year. In the second year, 25% of remaining Rs 15
crore, that is Rs 3.75 Crore will be considered as depreciation. Therefore, in this method
the depreciation expense decreases at a constant rate as the life of the asset
progresses.
c. Sum of the Years Digits Depreciation – In this method, the depreciation charge declines
by a constant amount as the life of the asset progresses. For example, if the
depreciation in the first year is Rs 6 crore, in the second year it will be Rs 5 Crore, then
Rs 4 crore, Rs 3 Crore, until the entire investment is recovered.
d. Units of Activity Depreciation – In this method, the initial worth of the machinery is
divided by the number of units it will produce in its productive life time, to theoretically
calculate the per unit depreciation. Here the annual depreciation varies depending upon
the number of units produced each year.
2.10 Factory Costing and Cost Estimation
Most of businesses keep a range of products in their portfolios. This is necessary to

diversify the risk, satisfy diverse consumer tastes and also tap into various market
segments. These products may be produced at different locations or same locations; they
may be produced using the same machinery or different machinery; they might need the
manpower with same skill level or with a completely different skill level. This level of
complexity makes the task of deciding the production cost very difficult and prone to errors.
Cost estimation is very difficult to do accurately, but it is very important for us to understand
the relative impact of design and production decisions on overall cost and manufacturability.
Correct determination of production costs is essential for deciding –
o The breakeven point

o The production for certain profit level
o Discontinuance of unprofitable and non-strategic products.
o Introduction of products with decent profit margins.
o The investments for expansion.
In case of existing products, the production costing may be a little easier than the products
which are not in the current production range. In case of the later, the production process is
broken down into basic elements, which are common to the existing production range. Then
the costs are assigned to each element of production to finally arrive at the total cost by
summing up the elemental costs.
The costs that can be directly traced to the final product are called direct costs. For
example, the raw material required for producing a smartphone is a direct material cost.
The wages paid for assembling a smartphone are direct labor costs.
Similarly, a machine needs electrical power to run it, it needs certain expenditure on its
maintenance, certain expenditure on rent for the space utilized for its installation, certain
depreciation to reflect reduction in its worth, certain amount to pay back the interest on
capital borrowed for buying that machine, certain consumables like lubricants to keep it
running without any trouble.
Some of these costs may be direct in nature, that is, spent on a specific machine, for
example, electrical power or operator’s wages, and some of the costs can be indirect in
nature, for example, the production manager’s salary etc. The sum of all these expenditures
in a month or a year is divided by the number of hours the machine actually runs in that
period, gives us the machining cost per hour, called the machine hour rate.
Similarly, some of the expenditures, which are incurred on the company as a whole, for
example, the expenditure on security staff, telephones, office stationery, salaries of office
staff, running of company vehicles, purchase of insurance cover, the property taxes paid,
waste disposal, effluent treatment, sanitation etc. are covered under overheads. These
expenditures, which are indirectly done, are distributed over various cost centers, either
proportionate to its usage by the cost center or proportionate to the worth of the cost center
or number of people using that service.
Finally all costs are distributed under following headings.
Description Rs.
Direct Costs
o Material cost Costs of the material that can be traced
inside the product
o Processing cost Machine hour rate multiplied by number
of hours actually needed per unit of the
product.
o Advertisement, Selling & Distribution Amount spent for this purpose in a year,
cost of a specific product. divided by number of units sold
o Overheads (Telephone bills, STP Amount spent for this purpose in a year,
Plants, A/C Plants etc.) divided by number of units sold
Indirect Costs
o Material (Lubricants, stationery, fuel Amount assigned to this product, divided
etc.) by number of units sold.
o Labor (Security staff, Top Amount assigned to this product, divided
management salaries etc.) by number of units sold.
o Advertisement, Selling & Distribution Amount assigned to this product, divided
cost of entire company as a whole. by number of units sold.
o Overheads (Head office expenses) Amount assigned to this product, divided
by number of units sold.
The ultimate goal of this exercise is to know the exact cost of production of a certain
product, and decide its pricing strategy. This approach helps the companies in foreseeing
the consequences of their decisions. At times the companies may decide to sell the
products below its cost of production, to force the competition to shut down or to prevent
the competition from entering into to its area of operation.
In case of new products or processes, the estimation of manufacturing costs soon after
research and development (R&D) commences, can provide a good indication of the
project’s economic viability. Its early estimation helps the businesses in directing research
efforts to promising opportunities, and allows them to better assign resources to new
products.
Similarly, determination of the relative contribution of variable costs, fixed operating costs,
and capital depreciation to the total product costs allows cost-reduction efforts to be
focused on those cost components that are likely to be most significant.
2.11 Financial & Physical Ratios
Financial ratios are mathematical comparisons of various entries of the financial statement.
These relationships between various entries helps investors, creditors, and internal
company management to understand how well a business is performing and draws its
attention to the areas needing improvement.
Financial ratios are the most common and widespread tools used to analyze the status of
the business. Ratios are easy to understand and simple to compute. They can also be used
to compare different companies in different industries. Since a ratio is simply a
mathematical comparison based on proportions, big and small companies can be
compared using ratios from their financial statements. In a sense, financial ratios don't take
into consideration the size of the company or the industry, but are just ‘thumbs rule’
computations of financial position of the business.
Ratios allow us to compare companies across industries, big and small, and to identify their
strengths and weaknesses. Financial ratios are often divided up into seven main
categories: liquidity, solvency, efficiency, profitability, market prospect, investment leverage,
and coverage ratios.
Liquidity Ratios
Liquidity ratios analyze the ability of a company to pay off both its current liabilities as they
become due, as well as their long-term liabilities as they become current. In other words,
these ratios show the cash levels of a company and the ability to turn other assets into cash
to pay off liabilities and other current obligations.
Liquidity is not only a measure of how much cash a business has. It is also a measure of
how easy it will be for the company to raise enough cash or convert assets into cash.
Assets like accounts receivable, trading securities (bonds), and inventory are relatively easy
for many companies to convert into cash in the short term. Thus, all of these assets go into
the liquidity calculation of a company.
Here are the most common liquidity ratios.
Sr. Name of the ratio Description

1. Quick Ratio It shows the level of quick assets to current liabilities.
The quick ratio or acid test ratio is a liquidity ratio that measures
the ability of a company to pay its current liabilities when they
come due by liquidating (means by selling and converting into
cash) only the quick assets. Quick assets are current assets that
can be converted to cash within 90 days or in the very short-
term. Cash, cash equivalents, short-term investments or
marketable securities, and current accounts receivable are
considered quick assets. Marketable securities are traded on an
open market with a known price and readily available to buyers.
2. Current Ratio
The current ratio measures the company’s ability to pay off its
short-term liabilities (current liabilities) with its (short term
assets) current assets. The current ratio is an important
measure of liquidity because short-term liabilities are due within
the next year. This means that companies with larger amounts
of current assets will more easily be able to pay off the current
liabilities without having to sell off long-term assets.
3. Interest Coverage Interest Coverage Ratio = Profit before interest and taxes (EBIT)
Ratio Interest Expense
It measures the extent to which the profit is able to take care of
the interest payments due to the banks.
Solvency Ratios
Solvency ratios, also called leverage ratios, measure the company's ability to sustain
operations indefinitely, by comparing debt levels with equity, assets, and earnings. In other
words, solvency ratios identifies company’s ability to pay its bills in the long term. The
solvency ratios focus more on the long-term sustainability of the business.
Solvency ratios show the company's ability to make payments and pay off its long-term
obligations to creditors, bondholders, and banks. Better solvency ratios indicate a more
creditworthy and financially sound company in the long-term.

1. Debt to Equity
Ratio
The debt to equity ratio is a financial, liquidity ratio that
compares a company's total debt to total equity. The debt to
equity ratio shows the percentage of company financing that
comes from creditors and investors. A higher debt to equity ratio
indicates that more creditor financing (lender’s money) is used
than investor financing (owner’s money).
A lower debt to equity ratio usually implies a more financially

stable business. Companies with a higher debt to equity ratio
are considered more risky to creditors and investors than
companies with a lower ratio, because, the debt must be finally
repaid to the lender in the form of principal repayment and
regular interest payments, irrespective of whether the company
has the ability to keep the repayment obligation. Companies
having a very high debt to equity ratio large amounts of debt
may not be able to make the payments during recession.
2. Equity Ratio
The equity ratio is an investment leverage or solvency ratio that

measures the amount of assets that are financed by owners'
investments by comparing the total equity in the company to the
total assets.
It shows how much of the total company assets are owned

outright by the investors. In other words, it shows after all of the
liabilities are paid off, how much assets the investors will be
ending up with.
Companies with higher equity ratios demonstrate to the new

investors and creditors that the owners are committed to their
company and are willing to finance it with their own money.
3. Debt Ratio
This shows, how many assets the company must sell in order to
pay off all of its liabilities.
A lower debt ratio usually implies a more stable business with

the potential of longevity, because, a company with lower ratio
also has lower overall debt. Companies with higher levels of
liabilities compared with assets are considered highly leveraged
and more risky by the lenders.
Efficiency Ratios
Efficiency ratios also called activity ratios. They measure how well companies utilize their
assets to generate income. Efficiency ratios often look at the time it takes for the companies
to collect cash from customers or the time it takes companies to convert inventory into cash
(means, sales them as final product). These ratios are used by management to improve the
efficiency of the company, and also convince the outside investors and creditors about the
profitability of the company, because, most often, the companies that are efficient with their
resources, become profitable ultimately.

1. Accounts
Receivable
Turnover Ratio The accounts receivable turnover ratio measures how many
times a business can collect its average accounts receivable
during the year. A company with a higher ratio shows that credit
sales are more likely to be collected than a company with a
lower ratio. Since accounts receivable are often pledged as
collateral for loans, ensuring the quality of receivables is very
important.
This ratio basically indicates, on an average how much of your

capital is stuck with the customers as a percentage of credit
sales.
2. Asset Turnover
Ratio
The asset turnover ratio is an efficiency ratio that measures the
company's ability to generate sales from its assets by comparing
net sales with average total assets. In other words, this ratio
shows how efficiently a company can use its assets to generate
sales.
3. Inventory Turnover
Ratio
The inventory turnover ratio is an efficiency ratio that shows how
effectively inventory is managed by comparing cost of goods
sold with average inventory for a period. This measures how
many times average inventory is "turned" or sold during a
period.
This ratio basically indicates, on an average how much of your

capital is stuck in inventories as a percentage of the total cost of
the goods sold.
Profitability Ratios
Profitability ratios demonstrate company's ability to generate profits from its operations.
These ratios basically show how well companies can achieve profits from their operations.

1. Gross Margin Ratio
The gross margin of a business is calculated by subtracting cost

of goods sold from net sales.
2. Profit Margin Ratio
Net income equals total revenues minus all sorts of expenses

and is usually the last number reported on the income
statement.
3. Return on Assets
Ratio - ROA
The return on assets ratio or ROA measures how efficiently a
company can manage its assets to produce profits during a
period.
4. Return on Capital
Employed
Return on capital employed or ROCE is a profitability ratio that
measures how efficiently a company can generate profits from
its capital employed by comparing net operating profit to capital
employed.
5. Return on Equity
Ratio
The return on equity ratio shows how much profit each rupee of
common stockholders' equity (owner’s money) generates.
Market Prospect Ratios
Market prospect ratios show investors what they should expect to receive from their
investment. They might receive future dividends, or just an appreciated stock value. These
ratios are helpful for investors to predict how much stock prices will be in the future based
on current earnings and dividend levels.

1. Earnings Per Share
This is the amount of money each share of the company would

receive if all of the profits were to be distributed to the
shareholders at the end of the year.
2. Price Earnings P/E
Ratio
The price earnings ratio shows what the market is willing to pay
for a stock based on its current earnings.
Investors often use this ratio to evaluate what a stock's fair

market value should be by predicting future earnings per share.
The companies with higher future earnings are usually expected
to issue higher dividends or have appreciating stock in the
future.
3. Dividend Payout
Ratio
The dividend payout ratio measures the percentage of net
income that is distributed to shareholders in the form of
dividends during the year. In other words, this ratio shows the
portion of profits the company decides to keep to fund
operations and the portion of profits that is given to its
shareholders.
4. Dividend Yield
Ratio
The dividend yield is a financial ratio that measures the amount
of cash dividends distributed to common shareholders relative to
the market value per share. The dividend yield is used by
investors to show how their investment in stock is generating
either cash flows in the form of dividends or increases in asset
value by stock appreciation.
3. Production & Operations Management
3.1 Factors of production
Factors of production refer to an economic term to describe the inputs that are used in the
production of goods or services in an attempt to make economic profit. The resources
required for generation of goods or services, generally are classified into four major groups:
1. Land (including all natural resources),

2. Labor (including all human resources),
3. Capital (including all man-made resources), and
4. Enterprise (that is entrepreneurship, which brings all the above resources together for
production)
These factors are also classified as management, machines, materials, and money, they
are also called 4Ms of production. More recently, knowledge has also come to be
recognized as a distinct factor of production in its own right.
Economic resources are the goods or services available to individuals and businesses to be
used to produce valuable economic output. Entrepreneurship is also considered as an
economic resource because, it is just because of this, all other resources get connected.
Land
Land is an economic resource, which encompasses natural resources found within nation’s
boundaries, including timber, fisheries, farms and other similar natural resources. Land is
usually a limited resource for many countries (e.g. Singapore). Although some of the natural
resources, such as timber, food and animals, are renewable, the physical land is usually a
fixed resource. Nations must carefully use their land resources by creating a mix of natural
and industrial utilities. Using land for industrial purposes allows nations to improve the
production processes for turning natural resources into consumer goods, but it also
diminishes its land available for agricultural purposes or depletes its forest covers, denting
the ecosystem of the nation. The industrial activity also results in release of effluents in
rivers and water bodies and fumes and gases in the atmosphere. This also results in
depletion of the economic worth of the stock of land available with the nation.
Labor
Labor represents the human capital available to transform raw national resources into
consumer goods. Human capital includes all able-bodied individuals capable of working in
the nation’s economy (including migrant labor) and providing various services to other
individuals or businesses. This factor of production is a flexible resource as workers can be
allocated to different areas of the economy for producing consumer goods or services.
Human capital can also be improved through training or educating workers to complete
technical functions or business tasks when working with other economic resources. The
level of development of any nation human can be easily identified from the composition of
its manpower involved in Primary employment (those involved in basic pre-industrialization
jobs), Secondary employment (jobs involved in manufacturing activities), Tertiary
employment ( jobs providing service like banking, teaching and nursing etc.) and the
Quaternary employment ( jobs involving research and development activities). The nations
attempt to provide enough educational and training facilities to their citizens, to achieve a
balance between the supplies of manpower to various classes of employment. The higher
the percentage of population involved in higher level jobs, the higher human development
index the country will have.
Capital
Capital has two economic definitions as a factor of production. Capital can represent a
monetary resource, which companies can use to purchase natural resources, like land and
other capital goods. The monetary resources flow through a nation’s economy, as
individuals buy and sell goods. The capital also includes economic worth of major physical
assets companies use to produce goods or services. These assets include buildings,
production facilities, equipment, vehicles and other similar items. Individuals may create
their own capital production resources, purchase them from another individual or business
or lease them for a specific amount of time from individuals or other businesses.
Entrepreneurship
Entrepreneurship is considered a factor of production because economic resources may

exist in an economy, but may not get transformed into consumer goods in the absence of
enterprise. Entrepreneurs usually have an idea for creating a valuable good or service and
assume the risk involved in transforming economic resources into consumer products.
Entrepreneurship is also considered a factor of production, because someone has to take
the responsibility of coordinating, allocating and distributing other economic resources to
produce consumer products and services to satisfy the need of the economy.
Knowledge (or Knowhow)
Of late knowledge is being considered as a factor of production in itself, because there are
a few companies in the world, whose only business is to do research and development in
various arenas to develop advanced technologies in various fields. These technologies are
then leased out to other companies for a fee (e.g. Toshiba invests heavily in research and
development and often pioneers new technologies).
3.2 Distinction between Products & Services
Products and services are two closely aligned concepts, and, in fact, most products have
an element of service in them. For example, a car buyer when he decides to buy a new car,
he has in his back of the mind a comprehensive bundle of service benefits, in addition to
the tangible components of the car. However, there is a distinct difference between them
and it is important to establish some working definitions of the two.
One way to look at them is to look from the customers’ point of view. When a customer
asks "what can you make for me?", then they are asking about a product; but when a
customer asks "what can you do for me?", then they are asking about a service. While a
product is something that can be measured and counted, a service is less concrete and is
the result of the application of skills and expertise towards an identified need.
Products
A product is something you can point at, whereas a service is any activity which can only be
perceived. Products are tangible and discernible items that the organization produces,
including digital output, which can be stored for future sale or consumption. e.g. cars,
fridges, smartphones, movies and operating systems. Similarly, cement, machines, nuts &
bolts, tubes & tires are a few examples of products.
It is comparatively easier to notice the gaps in product quality in case of tangible products. If
a particular brand of car is giving a trouble-free performance for a reasonably long period of
time, while consuming as little fuel as possible, while giving as much comport to the
passengers as possible and owing which also adds to the status of the buyer, then it can be
called a good product. Similarly, a cement brand which shows stated results and also
maintains consistency in quality from bag to bag, can be called a good product.
Services
A service is the production of an essentially intangible benefit, either in its own right or as a
significant element of a tangible product, which through some form of exchange, satisfies
an identified need. Sometimes services are difficult to identify because they are closely
associated with a good; such as the aftersales service of a smartphone. e.g. car servicing,
spa, restaurant etc.
The quality of a service is a subjective phenomenon, because different people will consider
different parameters while deciding the quality of service. Therefore, surveys are done to
get the idea of the customers’ perception of the quality of service. While conducting these
surveys, first a list of parameters is drafted. Then weightages are assigned to these
parameters based on the importance of these parameters. Then the top 8 to 10 parameters
are picked up for surveys. Suitable corrective actions are taken to improve the parameters
based on the outcome of the surveys. That’s why listening to the customers’ grievances is
the key to the success in service industry.
Products & Services can be differentiated as follows.
Basis for Comparison Products Services

Meaning Goods are the material items Services are amenities,
that can be seen, touched or facilities, benefits or help
felt and are ready for sale to provided by other people.
the customers.
Nature Tangible Intangible
Transfer of ownership Yes No
Basis for Comparison Products Services
Evaluation Very simple and easy Complicated
Return Goods can be returned. Services cannot be returned
back once they are provided.
Separable Yes, goods can be separated No, services cannot be
from the seller. separated from the service
provider.
Variability Identical Diversified
Storage Goods can be stored for use Services cannot be stored.
in future or multiple use.
Production and There is a time lag between Production and Consumption
Consumption production and consumption of goods occurs
of goods. simultaneously.
3.3 Types of production systems – Jobbing, Lot, Mass & Continuous
Project and Jobbing Production
Jobbing production is characterized by the manufacture of one or few numbers of a single

product designed and manufactured strictly to customer’s specifications, within a given
period of time and within the price fixed prior to the contract. Some typical examples of
industries engaged in jobbing production are; component manufacturers for third parties,
general repair shops; fabricators; special purpose machine tool manufacturers; workshop to
manufacture jigs and fixtures for others; building contractors; tailoring shops stitching made-
to-measure suites; manufacturers of ships, cranes, furnaces, turbo-generators, pressure
vessels; and others manufacturing articles made to customers’ orders.
Characteristics of Jobbing Production:
(a) Small production runs - Jobbing production is characterized by the manufacture of one
few pieces of a product at a time under a separate contract. The production is made
strictly to customers’ specifications
(b) Flow of materials - The flow of materials and components between different stages of
manufacture is highly discontinuous due to imbalance operation wise work content.
(c) Manufacturing cycle time - A considerable amount of pre-planning and organization is
necessary in such a venture. Relatively long delays occur at the assembly as well as at
the materials processing stages due to lack of materials or components, imbalanced
work flow, design changes, design errors detected during manufacture, inaccurate work
measurements, etc. which tend to lengthen the manufacturing cycle time. At times, the
time needed to design the product exceeds its manufacturing time.
(d) Layout of Plant & Equipment - Plant and equipment is designed or procured and
arranged to obtain maximum flexibility. General purpose machines and handling
equipment capable of performing variety of operations with minimum set-up times are
installed in lieu of variety in products. The machines are arranged to give process layout
– that is, the layout by function. Similar machines capable of doing similar type of
operations are grouped together and kept at one place; milling machines are grouped at
another place; drilling machines are grouped at third place, gear cutting machines are
located at the fourth place; and so on and so forth. Each group of machines is usually
designated as a work center or a section or a shop. The grouping of machines in this
way gives a lot of flexibility in loading and scheduling of machines. Temporary machine
breakdowns and operator’s absenteeism can be taken care of by shifting jobs to another
machines or shifting operators from less important jobs to important jobs.
(e) Skill of Labor: The labor force is usually very skilled, highly qualified trade apprentices
who are expected to work with minimum instructions and use their talent to manage the
complexity and variety in the jobs performed. Instructions regarding “what to make” are
issued in the form of specifications while instructions as to “how to manufacture” are
usually verbal. The workmen being highly skilled are expected to work independently
and display a great deal of initiative and judgment on their jobs. They are required to set
up their own machines and prepare their own special tools or production aids in order to
further the manufacture of a part or an assembly.
(f) Quality of Supervision - Highly competent general engineers are engaged as foremen in
the base workshop and a group of site engineers, practical men, with thorough training,
capable of taking independent charge of each contract are employed to work at the site.
Therefore these engineers (supervisors) in a jobbing production are the reservoir of job
knowledge. The supervisor besides being able administrator is expected to improvise
and determine best work methods, determine tool requirements, select the best process
and provide management with reliable estimates of labour and materials for specific
orders. The span of control – the number of workmen to be supervised by a supervisor –
is kept low because of technical nature of the job.
(g) Work-In-Progress - The work-in-progress inventory in a jobbing production is generally
very large as detailed scheduling and progress control in this type of production is
economically infeasible. For various reasons, jobs get delayed causing temporary work
shortages. To overcome work shortages and keep men and machines busy, more work
is released to the shops which in turn increase work-in-progress.
(h) Functions of Production Planning and control - The success of jobbing production
mainly depends on the ability of the engineer in charge of the contract.
o Materials are indented and purchased on receipt of orders unlike in batch or mass
production where material requirements are planned well in advance.
o Tools control function is simple. Standard tools are stocked while special tools are
either made on the shop floor by the operators or purchased on request from
supervisor.
o Process planning activity is almost absent. Drawings and specifications are directly
given to the supervisor who is expected to decide work methods, select optimum
processes, fix up machine tools to be used and estimate time required to complete
an operation.
o The scheduling activity is more or less decentralized. A schedule is prepared to
show the start and completion date of each major component of the product. Job
tickets giving completion date of each component are raised and given to the shop.
The activity of day to day scheduling is left to the individual shop supervisor.
o Progressing function is relatively very simple. Day to day information on the progress
of work on the shop floor is difficult due to sluggish activity. Production meetings are
thus expected to account for job progress.
Batch Production
Batch production is characterized by the manufacture of a limited number of a specific

product (but large quantities of similar products put together) produced at regular intervals
and stocked in warehouses as finished goods (or finished parts) awaiting sales (or
withdrawal for assembly). Typical examples of batch production are - process industries
such as pharmaceuticals, paints, chemicals; medium and heavy engineering industry
engaged in the manufacture of electric motors, switch gears, heavy motor vehicles, internal
combustion engines; manufacturers of readymade garments; manufacturing and assembly
shops such as machine tools; sub-contractors which take on machining of batches of
components to the drawing of a large manufacturer; etc.
The working of batch production can be understood from the following example – A
company manufacturing tractors requires axle shafts. Two axle shafts are required for each
tractor. The axle shafts are made from steel forgings. 500 nos. of forgings – 500 being the
batch size – are faced and centered. The batch is moved from facing and centering
machine to the copying lathe were the shafts are copy turned. The copy turned jobs are
next moved to gear hobbling machine and then to spline hobbling machine respectively to
perform gear cutting and spline cutting operations. The batch similarly undergoes further
remaining operations in succession-gear shaving, heat treatment, center lapping,
straightening, cylindrical grinding, spline grinding until the final operation that is inspection.
This is a typical example of batch production. The jobs comprising the batch move from one
operation to the next. No subsequent operation is performed until all the jobs have
undergone the previous operation. At times, however, the subsequent operation may be
started to overlap the previous operation. The items comprising the batch on completion of
last operation are usually delivered to the stores. The quantity produced in a batch is
usually in excess of immediate demand. More progressive organizations work out economic
lot size - the quantity which strikes an optimum balance between the preparation cost and
the cost of carrying inventory – for each of their major components /products.
Characteristics of batch production
(a) Short runs :

Batch production is also characterized by short production runs and frequent changes of
set up. The equipment and the assembly set up is used for a limited number of parts or
assemblies and is then changed to make a different products. The production is
generally made to stock.
(b) Skill of labor:
The labor force is expected to possess skill in one specific manufacturing process:
turning, milling, drilling, welding, grinding, hobbling, fitting etc. Simpler machine set-ups
may be performed by the operator but those involving complex operations are set by the
separate machine setter.
(c) Quality of Supervision:
The supervisors have considerable knowledge of a specific process. Supervisor in the
grinding section for example, may not know about turning and drilling work but is
expected to possess a full of knowledge of different types of grinding operations.
Similarly, a supervisor in the hobbling section is expected to have sound knowledge in
working of different types of hobbling machines.
(d) Extent of Supervision :
The amount of supervision required in batch production is lower than that of jobbing
production and is dependent on the batch size. The ratio of direct workmen to
supervisors is more or less a function of batch size. The smaller the batches, the lower
is the ratio of direct workers to supervisors, and vice-versa. This is because smaller lots
require the supervisors to spend a great deal of their time in allocating new work, giving
instructions, follow up on the shop floor for proper movement of materials from and to
the machines, identifying delays and interruptions, and arranging, in consultation with
planning, work load in his section to keep his men busy.
(e) Layout of plant & Equipment:
Plant and equipment is designed or procured and arranged to obtain maximum
flexibility. General purpose machines and handling equipment capable of performing
variety of operations with minimum setup times are installed in lieu of variety of
products. The machines are arranged to give process layout – layout by function.
Similar machines capable of doing similar types of operations are grouped together and
kept at one place. Presses for example, are put together and kept at one place, milling
machines are placed together at another place, drilling machines are kept at the third
place, and gear cutting machines are located at the fourth place and so on. Each group
of machines is usually designated as a work center or a section or a shop.
(f) Materials Handling :
Materials handling in batch production as compared to jobbing production is small.
Individual components and parts are placed in trolleys or in bins and are transported as
unit loads. Materials handling may be mechanized by deploying power driven trucks.
(g) Manufacturing Cycle Time:
The manufacturing cycle time is comparatively smaller than jobbing production but is
much more than mass and flow production. The batches of work tend to queue up at
different machines due to differing cycle times, batch sizes and sequence of operations.
(h) Work-in-Progress
Work in progress is comparatively large due to varying work content of different
components, imbalances in manufacturing times, formation of queues between the
machines.
(i) Flexibility of Production Schedules :
Disruptions due to machine breakdowns or absenteeism do not seriously affect
production as another machine can be used or another operator from another machine
can be shifted.
(j) Functions of Production Planning and Control
Functions of production planning and control in a batch production are more complex
than those in jobbing production or mass and flow production:
o Materials control and tools control functions are important. Scientific stock-control
system needs to be used to ensure routine replenishment.
o Detailed operational layouts and route sheets are prepared for each part of the
product.
o Loading and scheduling needs to be more detailed and more sophisticated since
every machine requires to be individually scheduled.
o Progressing function is very important to collect information on progress of work. A
separate progress card need to be maintained to record progress of each
component.
o Expediting is generally necessary since jobs many a times due to imbalances in
work contents tend to lag behind.
Mass and Flow Production
Mass as well as flow production are characterized by the manufacture of a several number
of a standard product produced and stocked in the warehouses as finished goods awaiting
sales. The goods under mass production are manufactured either at a single operation or a
series of operations on one machine. Typical examples of mass production units are
continuous manufacturing industries such as plastic goods, sintered products, hardware;
manufacture and assembly shops of automobiles, refrigerators, radios, television sets,
electric fans, motors, domestic appliances etc.
Characteristics of Mass & Flow Production
(b) Flow of material:

The flow of materials is continuous and there is little or no queueing at any stage of
processing.
(c) Machines and Plat Layout :
Special purpose machines are used and the plant assembly stages are laid out on the
basis of product layout – the layout-by-sequence.
(d) Materials Handling :
Materials handling is comparatively less firstly because materials move through a short
distance between stages and secondly the materials handling activity is mostly
mechanized by conveyors and transfer machines
(e) Skill of labor :
Relatively low skilled labor is employed.
(f) Manufacturing cycle time:
The manufacturing cycle time is very short. The machine capacities are balanced by
duplicating machine wherever necessary.
(g) Quality of Supervision :
Supervision is relatively easier as only few instructions are necessary and that too at the
start of the job.
(h) Work in progress :
Work in progress is comparatively less since the manufacturing line is balanced.
(i) Flexibility in production schedules :
Interruptions due to breakdowns and absenteeism seriously affect production as
stoppage of one machine usually disturbs the working of other machines. “Systematic
maintenance” and “Provisioning of stand-by-operators” are, therefore two major
management functions.
Continuous or Process Production
It is characterized by the manufacture of a single product produced and stocked in the

warehouses awaiting sales. The flexibility of such plants is almost zero as only one type of
product can be produced in such plants. Typical examples of such plants are sugar, steel,
cement, paper, coke, refineries, etc.
Characteristics of continuous or process production
i. Layout of Plant & Equipment :

The layout of plant, shape and size of its buildings, location of services and storage
yards, position of cranes and conveyors is such that material flow is unidirectional and at
the steady rate. Special purpose machinery and equipment with built-in controls to
measure output and regulate input are employed to suit the need.
ii. Materials handling

Materials handling is highly mechanized. Conveyor system and automatic transfer
machines move materials from one stage to another.
iii. Manufacturing Cycle time:
The manufacturing cycle time is almost zero. The whole plant is like one large machine
wherein raw materials enter at one end and emerge as finished product at the other
end.
iv. Skill of Labor:
Production labor consists of semi-skilled-workmen and skilled technicians.
v. Quality of Supervision :
The supervisor in continuous production is highly qualified and is expected to possess
considerable knowledge of processes involved.
vi. Work in Progress :
The work-in-progress inventory is very small as material flow is continuous.
vii. Production planning & control functions in Continuous Production:
o Materials control function is of crucial importance. Material needs to be planned well
in advance. Scientific inventory control system is a must for such plants.
o Tools control function is almost absent because of the nature of the plant.
o Process planning activity is absolutely not required since it is the plant which
decides the route.
o Scheduling activity is very simple and is merely restricted to final targets.
o Progressing and expediting functions are extremely simplified and are merely limited
to recording of the final production at the end of the shift.
3.4 Functions of Production Planning and Control
1. The Sales Enquiry:
The production procedure starts with the receipt of a sales enquiry in the sales department.
2. Technical Feasibility:
The original sales enquiry or its copy together with the attachments is forwarded to
Engineering Department to check on its technical feasibility.
The enquiry is studied for materials, limiting dimensions, heat treatment details and
accuracies to establish whether or not the enquiry is for one of standard items of the
company or it is for the one which shall require to be manufactured. For the items to be
manufactured to customer’s design, the enquiry is further studied to establish whether or
not:
o The company’s facilities have spare capacity.
o The company’s available facilities are capable of doing the job within the desired
accuracies.
o The materials required for the items are available/can be procured within the
reasonable period/special materials which cannot be procured.
o The special tooling (if any) required to manufacture the job is available.
o The quantity required by the customer is of interest to us.
The enquiry which is found infeasible is returned with a relevant remark back to sales
department.
The enquiry that is found feasible is translated into the rough design by the Engineering or
Product Development Department. Only rough design is prepared at this stage since no
actual order has yet been received.
3. Routing and Tentative Delivery Period:
The Routing section of PPC translates the rough design into rough manufacturing plan. It
prepares the bills of materials, performs make-or- buy analysis, determines the operations
necessary for each part to be made at the company’s own plant; decides the machine tool
for each operation; and estimates time (set-up as well as processing time) for each
operation.
The scheduling section of PPC then decides on the tentative delivery period after checking
its load charts.
4. Cost Estimate:
The costing department works out the requirements of raw materials for each part.
Machining cost is determined based on estimates of operation wise timings and machine
hour rates. Tooling cost is estimated for both standard as well as special tools. Packaging
and packing charges are also computed and added separately.
5. Quotation:
The information from costing group is passed on to the sales department to prepare
quotation after adding necessary profit. This quotation is sent to the buyer either through
post or is handed over personally.
6. The Follow-Up on Quotation:
The follow up on quotation may or may not be done by the sales department depending on
company’s position of orders.
7. Receipt of Purchase Order:
If the company’s quotation is approved of, the potential buyer sends his purchase order.
The purchase order is received by the sales department. The sales department scrutinizes
the contents of the purchase order so as to ensure that the rate and other terms and
conditions are in accordance with those stated in the quotation. Once the purchase order is
in order, the sales department raises a document called SALES ORDER or ORDER
ACCEPTANCE. One copy of the order acceptance is forwarded to the Production,
Planning and Control Department and another copy to the Engineering Department.
8. Engineering Drawings:
The Engineering Department on receipt of the copy of the order acceptance transposes the
rough design into manufacturing drawings. The preparation of the manufacturing drawings
involves making drawings for every part. The engineering department also prepares part
lists.
9. Materials Control:
All the information developed by the engineering department is sent to PPC department.
The PPC department then works on the part-lists supplied by the Engineering Department
and establishes the requirements of stock items (standard items) and raw materials. The
stores is then informed of the requirement of raw materials and parts and on the dates on
which they are required. The dates are determined by the PPC after referring to the delivery
commitments (if already made). The stores in turns checks on the availability of the
required items, reserves their quantities against work-orders (wherever they are available),
and raises purchase indents for the items that are out of stock.
10. Routing:
The routing section of Production, Planning and Control next determines the proper routing-
the sequence of operations and the machines to be used.
11. Tools Control:
The tools control section of PPC then works out the requirement of cutting tools (standard
as well as nonstandard tools), gauges and measuring instruments, jigs and fixtures. It
indents non-stock items of tooling and follows up with tool room for timely manufacture of
jigs and fixtures.
12. Scheduling:
The scheduling section of PPC refers to its load and schedule chart and fixes up the start
and completion dates of each operation keeping promised delivery date in mind.
13. Dispatching:
The order and instructions prepared by the department are released to the concerned
supervisors as their authority to perform the work according to the method outlined in the
route sheet and to a predetermined schedule.
14. Progressing:
The progressing cell of PPC collects data from manufacturing shops, records progress of
work, and compares progress against the plan.
15. Expediting or follow-up:
Manufacturing activity is not a smooth activity. Unexpected delays and interruptions crop
up. Special efforts are required to eliminate these delays and keep the rate of production
unto the schedule. This is made possible by intensive progress chasing by the expediting or
follow up section of PPC.
3.5 Product Development Principles
Following principles provide us a sound basis for good engineering product development:
1. Quality is a must (TQM approach) - Total Quality describes the culture, attitude and
organization of a company or organization that aims to provide, and continue to provide,
its customers with products and services that satisfy their needs. The culture requires
quality in all aspects of operations, where right things are done right at the first time, and
defects and waste eliminated in the design stage itself.
2. Strive for reducing the product development cycle time – Product development cycle
time has become a key competitive parameter for any organization. Reduced product
development lead times often open up new market opportunities and improved profits
for the companies, which are available only to the pioneers (Apple). They reduce market
risks by reducing the time gap between product specification and product delivery,
because the chances of customers’ preferences changing increase as the time gap
between product specification and product delivery increases. The sooner customers
use a product, the sooner their feedback can be incorporated into a new-improved
version of the product.
3. Strive for innovation - Innovation is the prime corporate strategy for any company aiming
for a top slot in its class of business.
4. Strive for achieving synergy between vision, strategy, plan and metrics - The end result
of the business processes, right from the business vision, mission, objectives, strategy,
plan and implementation, is that the organization conducts itself so as to meet its
objectives. The metrics that quantify the objectives, help the company in achieving and
improving the performance.
5. Strive for making a family of products (products related to each other) - Business Units
with a family of products provide a means to simplify the operations. They avoid
confusion and offers the advantages of incremental learning.
6. Listening to the customer - This is a key ingredient of Total Quality Management. The
organization must be able to develop products and services that customers want.
7. Setting up a clearly defined and well-organized product development processes - The

product development cycle time of any organization depends closely on the
development process it follows. Any attempt to improve product development cycle
times will involve investigation and improvement of its development process. A particular
organization will be looking to find the optimum processes for its product family of
products for wastage and cost minimization.
8. Setting up cross-functional product development teams - The use of cross-functional

product development teams has a major effect on both product development cycle times
and quality of the product. With people from different functions working together, in
addition to getting diverse perspective, the development too gets done faster, because
the activities are done in parallel rather than in series. Quality improves because people
from different functions work together to understand and solve development problems.
The process is quicker and quality is better - so the net result is that it is also cheaper.
9. Getting the supplier involved early in the development process - Early involvement of
suppliers in the development process allows the organization to make the best use of
supplier skills and knowledge at the product development stage itself.
10. Developing a product development methodology - Without a well-defined product
development methodology, it's unlikely that the members of the development
organization are going to be working in harmony. The rules for working together during
the development of a product have to be defined and communicated to the team
members. A clearly-defined approach to development that is appropriate for the product
family, and is understood by all team members, will provide the best results.
11. Employing adequately trained people - at the heart of the organization are people, not
machines. The organization needs to have skilled people who can work together,
sharing their knowledge and experiences - saving time and money for the company, and
eliminating errors of communication and ignorance. They need to be trained to work with
the techniques, practices and systems that the organization has chosen to use in the
development process.
12. Utilizing Computer Aided Design systems - While CAD systems still lack human
intelligence in design and styling skills, they are much more accurate and much faster
than people when it comes to carrying out the majority of design tasks.
13. Utilizing digitized product models controlled by EDM (Electronic Document

Management) and PDM (Product Data Management) systems - With paper-based
information and manual information management systems, information easily gets lost
or takes a long time to retrieve, information gets corrupted during communication, older
versions may get used, and the wrong configuration may get assigned. PDM and EDM
systems can manage information much better than manual information management
systems. They can provide exactly the right information at the right time.
14. Utilizing simulation and rapid prototyping - Computer-based simulation and rapid
prototyping provides fast and low-cost proof of design concepts and reliability.
15. Using best practices and techniques for product development - The term 'Best practice
and techniques' refers to many relatively modern ways of working. Some of these have
been in existence for many years but still appear as modern compared to the very
traditional techniques used by many engineering organizations. They include techniques
such as Benchmarking, Design for Assembly (DFA), Failure Modes Effects and
Criticality Analysis (FMECA), Activity Based Costing (ABC) and Taguchi techniques.
3.6 Standardization, Simplification & Specialization
What is Standardization and Variety Reduction?
Standardization and Variety reduction is the voluntary elimination of unnecessary variety
and formulating and applying rules to regulate the variety. Only a limited number of grades,
types and sizes of the product are retained in the product range. In other words, the parts
may be common to a large number of products, and they may be available as standard
bought out items. That is why; interchangeability is said to be the basis of standardization.
What is Simplification?
Simplification is a process of product analysis through which unnecessary design features
are eliminated from the product to make the products simple and user friendly. The end
result of such simplification exercise was the Apple’s first clutter free iPhone, which had a
single switch. For this purpose, most of the modern companies have the value-engineering
teams. These teams are supposed to discuss the functionality and utility of each and every
product, process and a service, and also each and every subcomponent of these things.
The features of the product, which do not enhance the value of the product, are dropped
from the design. Similarly, the components which do not add value to the product, are
dropped from the design or substituted by cheaper alternatives, which are in line with the
values added by the substituted components.
What is Specialization?
Specialization is the act of confining activities to a limited field. In factory management,
specialization means focusing on a relatively small portion of the options, and to the
production of a limited line of products. Having decided to specialize in a particular field, the
manufacturer is next faced with the problem of deciding which types and sizes of this
specialized line of products are to be manufactured. For instance, if specialization is
desirable in electrical motors, the company might decide to focus its attention on motors
ranging from 5 to 20 horsepower, and strive to excel in this limited range of motors.
Benefits of Standardization, Simplification & Specialization:

1. Reduction in manufacturing cost: Diversity of products and components usually
entails small production runs associated with heavy setup costs.
2. Reduction in inventory investment: Investment in inventory, to a greater extent,

depends on the number of items and number in turn can be reduced through variety
reduction. The reduction in inventory investment results firstly due to reduction in re-order
quantity and secondly due to reduction in safety stock.
3. Savings in purchase cost: Standardization of raw materials, bought-out components

and supplies enables bulk purchases which is decidedly the easiest way of securing
competitive prices.
4. Effective advertising: Reduction in variety of products enables concentrated advertising

with the same cost.
5. Reduction in direct labor cost: Lesser variety implies greater expertise of workers
resulting from the need to work on limited machines for longer periods. The learning
curve concept developed at the Stanford Research Institute underlines the above
philosophy.
6. Lower process rejection and improvement in quality: specialized skill of workers

resulting from repetitive working on limited machines. Use of expensive measuring
instruments, gauges and testing devices since their purchase is justified when the
quantities processed are large.
7. Better machine utilization: Longer production runs, made possible due to reduced
variety, result in better machine utilization.
8. Effective production planning and control
Areas of Standardization, Simplification & Specialization :

a. In the end products.
b. In the components.
b. In equipment.
c. In supplies.
d. In bought out items.
e. In raw materials.
f. In maintenance supplies.
g. In procedures
h. In services
i. In documents
Techniques of Standardization, Simplification & Specialization:
Income Contribution Analysis:

Income contribution analysis is an effective tool to decide which of the company's
products - could be abandoned with an advantage. Income analysis refers to the
ranking of the products on the basis of their income and critical analysis of the low
income products. A general survey shows that 80% of the sales result from 20% of the
variety and balance 20% of the sales result from 80% of the sales result from 80% of the
varieties manufactured. Before the decision is made to eliminate any of the less popular
(low income) products it is necessary to find out:
a) Why some of the company's products are more popular than others?
b) Why some of the company's products are not popular than others?
Contribution analysis pre-supposes to a reasonable accuracy the determination of, the cost
and contribution of each product. The analysis may reveal that some of company’s
products are popular because their selling prices are uneconomically low. The analysis
may further reveal that products or models with the largest sales are subsidizing the
losses made by those with low demand.
Such products, those with low demand and negative contribution should be taken for
detailed analysis to see whether their sales can be increased, whether their costs can
be reduced or whether their prices can be revised. In the absence of any one of the above
possibilities, the products may be considered for elimination or discontinuation.
Illustration of Income Contribution Analysis:
A television set manufacturer wants to rationalize the models offered by the company. The
last year’s data is as follows. Using Pareto’s law, rationalize the models on offer.
Model Price Cost Quantity

Sold
SNY - 15 57200 48600 5800
SNY - 10 42900 36500 7700
SNY - 11 82600 70200 1200
SNY - 23 93100 79100 800
SNY - 24 80300 68200 3200
SNY - 65 8900 7500 11200
SNY - 56 80400 68300 1600
SNY - 47 55400 47100 7500
SNY - 35 23500 20000 10900
SNY - 37 36400 30900 8500
SNY - 49 62600 53200 4900
SNY - 73 68000 57800 3300
SNY - 3 24400 20700 9200
SNY - 88 6300 5400 12600
SNY - 81 12200 10300 10900
Solution:
Model Price Cost Quantity Profit Profit Profit Rank

Sold Margin per per
Model Model
in
Million Rs
A B C D E = B - F=DxE G = H
C F/1000000 Highest profit 1st Rank
Lowest Profit Last Rank
SNY - 15 57200 48600 5800 8600 49880000 49.88 2
SNY - 10 42900 36500 7700 6400 49280000 49.28 3
SNY - 11 82600 70200 1200 12400 14880000 14.88 13
SNY - 23 93100 79100 800 14000 11200000 11.2 15
SNY - 24 80300 68200 3200 12100 38720000 38.72 6
SNY - 65 8900 7500 11200 1400 15680000 15.68 12
SNY - 56 80400 68300 1600 12100 19360000 19.36 11
SNY - 47 55400 47100 7500 8300 62250000 62.25 1
SNY - 35 23500 20000 10900 3500 38150000 38.15 7
SNY - 37 36400 30900 8500 5500 46750000 46.75 4
SNY - 49 62600 53200 4900 9400 46060000 46.06 5
SNY - 73 68000 57800 3300 10200 33660000 33.66 9
SNY - 3 24400 20700 9200 3700 34040000 34.04 8
SNY - 88 6300 5400 12600 900 11340000 11.34 14
SNY - 81 12200 10300 10900 1900 20710000 20.71 10
Total 491.96
Arrange the table in the descending order of the rank
Model Price Cost Quantity Profit Profit Profit Rank Cumulative % Strategy
Sold Margin per per Profit Cumula
Model Model tive
in Profit
Million
Rs
A B C D E=B-C F=DxE G = H I = J =
F/10000 Highes D1 I1/Total
00 t profit D1+D2 I2/Total
1st D1+D2+D3
Rank
Lowest
Profit
Last
Rank
SNY -
55400 47100 7500 8300 62250000 62.25 1 62.25 12.7% Retain
47
SNY -
57200 48600 5800 8600 49880000 49.88 2 112.13 22.8% Retain
15
SNY -
42900 36500 7700 6400 49280000 49.28 3 161.41 32.8% Retain
10
SNY -
36400 30900 8500 5500 46750000 46.75 4 208.16 42.3% Retain
37
SNY -
62600 53200 4900 9400 46060000 46.06 5 254.22 51.7% Retain
49
SNY -
80300 68200 3200 12100 38720000 38.72 6 292.94 59.5% Retain
24
SNY -
23500 20000 10900 3500 38150000 38.15 7 331.09 67.3% Retain
35
SNY -
24400 20700 9200 3700 34040000 34.04 8 365.13 74.2% Retain
3
SNY -
68000 57800 3300 10200 33660000 33.66 9 398.79 81.1% Retain
73
SNY -
12200 10300 10900 1900 20710000 20.71 10 419.5 85.3% Discontinue
81
SNY -
80400 68300 1600 12100 19360000 19.36 11 438.86 89.2% Discontinue
56
SNY -
8900 7500 11200 1400 15680000 15.68 12 454.54 92.4% Discontinue
65
SNY -
82600 70200 1200 12400 14880000 14.88 13 469.42 95.4% Discontinue
11
SNY -
6300 5400 12600 900 11340000 11.34 14 480.76 97.7% Discontinue
88
SNY -
93100 79100 800 14000 11200000 11.2 15 491.96 100.0% Discontinue
23
Total 491.96
Frequency Analysis
Frequency analysis is an effective cure available to keep the range of items within limits.
Initial survey is made of items in store to analyze the consumption over a period say a year.
The relevant information to be collected for each type of item is:

(i) Type and size of the item.
(ii) Consumption per period.
The information so collected is analyzed to identify most frequently used types/sizes which
can be retained as standard. The analysis is followed by 'discussions with the designer to
explore the possibility of dropping the types /sizes with low consumption.
Illustration of Frequency Analysis

Table below gives the last year consumption of "2 BA socket head cap screws" in a
company manufacturing variety of scientific and medical equipment:
Length Consumption of 2BA (5/32” wrench) socket head cap screws

1/4” Nil
3/8” 28
1/2” 1720
5/8” 287
3/4” 2152
7/8” 203
1” 75
11/4” 2359
11/2” 158
13/4” 875
2” 43
Total 7900
Solution: Assign the ranks

Length Consumption of 2BA Rank
(5/32” wrench) socket
head cap screws
1/4” 0 12
3/8” 28 11
1/2” 1720 4
5/8” 287 6
3/4” 2152 3
7/8” 203 7
1” 75 9
11/4” 2359 2
11/2” 158 8
13/4” 875 5
2” 43 10
Total 7900 1
Arrange the table in the ascending order of rank

Length Consumption of 2BA Rank Cumulative % Strategy
(5/32” wrench) socket Cumulative
head cap screws
11/4” 2359 2 2359 29.9% Retain
3/4” 2152 3 4511 57.1% Retain
1/2” 1720 4 6231 78.9% Retain
13/4” 875 5 7106 89.9% Retain
5/8” 287 6 7393 93.6% Discontinue
7/8” 203 7 7596 96.2% Discontinue
11/2” 158 8 7754 98.2% Discontinue
1” 75 9 7829 99.1% Discontinue
2” 43 10 7872 99.6% Discontinue
3/8” 28 11 7900 100.0% Discontinue
1/4” 0 12 7900 100.0% Discontinue
Total 7900
Preferred Numbers
The products like bulbs, motors, shoes, packed foods or similar items can be made in a very
small or very large sizes and number of sizes in between. To make a product in such a large
number of sizes is both impracticable and un-economical for any company. The company,
therefore, must & decide upon limited sizes. A scientific basis for establishing sizes was
evolved by Renard. The Renard series is based on geometric progression wherein each
succeeding size bears a fixed ratio to the preceding size. A preferred number progression
generally generates several small sizes and comparatively a few larger sizes within a given
range and that is what a customer expects from a product.
If a = smallest size.
b = largest size
r = ratio of each size to the previous size
1
n 1
= (b/a)
If n = total number of sizes to be made, then standard sizes to manufactured
are a, ar, ar2, ar 3 , arn-1
Illustration 1 of preferred numbers

The manufacturer of Bright Paints wants to supply his product in five different sizes. One
liter is desired for the smallest size and 20 liters for the largest size. Would the idea of
preferred numbers be of any use to them? Using preferred numbers, in what five
different sizes should they supply?
Solution:
The ratio of each size to the previous size is given by the relation
1
 20 
Substituting the given data, we get r=   5 1
 1 
= (20) 1/4
= 2.114
The sizes now can be found by multiplying each previous size by a constant 2.114.
The following table (Table 20.3) is developed now. The first column gives the theoretical
sizes while the second column
n shows the size which might actually be used for the purpose of simplicity.
Fixation of preferred sizes

Size calculated (liters) Sizes as rounded off (liters)
a (1.00) 1 ltr.
a r (1.00 X 2.114 = 2.114) 2 ltrs.
a r2 (2.114 x 2.114 = 4.469) 4 or 5 ltrs.
ar 3(4.469 x 2.114 = 9.4475) 9 or 10 Itrs.
ar4 (9.4475 x 2.114 = 20.00) 20 Itrs.
Illustration 2 of preferred numbers

The Vidyut Products Limited, the manufacturer of electric appliances have decided to
include electric bulbs in their product range. The electric bulbs as per company's plan shall
be supplied only in six ratings. 10 watts have chosen as the lowest rating and 100 watts
has been chosen as the highest rating.
Using preferred numbers, what six different ratings should the company make?
Solution
The ratio of each size to the previous size is given by the relation:
Substituting the given data, we get-
1
 100 
r =  5
 10 
1
= (10) 5
= 1.585
The ratings can be found by multiplying each previous size by this constant 1.585.
The following table (Table 20.4) is developed now. The first column gives the calculated
sizes while second column shows the sizes which might actually be used for the purpose of
simplicity.
Fixation of preferred ratings.
Sizes as calculated (rating) Sizes as rounded off (rating)

10 10
10x1.585=15.85 15
15.85x1.585=25.12 25
25.12x1.585=39.82 40
39.82x1.585=63.11 60
63.11x1.585=100 100
The standardized ratings of bulbs to be manufactured, therefore, are 10, 15, 25, 40,
60 and 100 watts (six sizes).
3.7 Plant Location and Plant Layouts
Plant Location
Every business is faced with the task of deciding the best location and best sites for its
plants or factories. Innumerable factors influence these decisions. Most of the factors are
economical in nature, but a few of them may have social and political consequences. As
these decisions many times are irreversible in nature, they have to be taken with a lot of
considerations. Ultimately, the decisions have to be taken, so as to ensure the long-term
health of the business.
What is plant location?

Plant location refers to the choice of region and the selection of a particular site for setting
up a business unit or a factory. But the choices are made only after considering the costs
and benefits of different alternatives. It is a strategic decision that cannot be changed once
it is taken. If at all it is changed, it involves a considerable amount of cost. Each individual
plant is a case in itself and a complete analysis has to happen for every plant, keeping the
entire organization in a perspective. Business should try to make an attempt to optimize the
location.
What is an ideal location?

An ideal location is the one where the cost of the product is minimal, has a large market,
has ample raw material, has ample skilled manpower, has least transportation cost, has
least economic risk, has political stability and has a maximum social gain (cooperative
atmosphere and docile work culture). It is the place offering maximum net advantage or
which offers lowest unit cost of production and distribution. For achieving this objective,
business can make use of location analysis for this purpose.
Locational Analysis
Location analysis is a dynamic process wherein businesses analyze and compare the pros
and cons of alternative sites with the aim of selecting the best site for a given purpose.
It consists of the following parameters:
(a) Demographic Analysis: It involves study of population in the area in terms of total
population, its age composition, its per capita income, its educational level, its skill levels,
its occupational structure, its work culture and work ethics, its developmental status etc.
(b) Trade Area Analysis: It is an analysis of the geographic area that provides continued
clientele to the businesses. Companies would also see the feasibility of accessing the trade
area from alternative sites, so that the investment can outright be eliminated. Similarly,
availability of raw material, availability of ancillary units, availability of water and power are
some of the important factors of trade analysis.
(c) Competition Analysis: It helps to judge the nature, location, size and quality of
competition in a given trade area. It would also analyze unfulfilled needs of the population.
(d) Site economics: Alternative sites are evaluated in terms of establishment costs and
operational costs under this. Costs of establishment are basically the cost incurred for
permanent physical facilities. But operational costs are incurred for running a business on
day to day basis; they are also called as running costs.
(e) Taxation – Many state governments offer tax exemptions for promoting industries in
certain areas.
(f) E-Commerce has added another dimension to the location analysis. The cost of reaching
the customer through a local retail outlet has to be compared with cost of reaching the
customer through an online market place. In case of the prior, the cost of transportation
gets divided over large quantities bought by the retailer, but it adds the running cost of
expensive retail outlets and showrooms. But in case of the latter, individual units of the
merchandise are hauled over large distances, but the frontline retail outlets and showrooms
can be eliminated.
Selection Criteria
The important considerations for selecting a suitable location are:
1. Natural or climatic conditions of the place.

2. Availability and proximity of the sources of raw material.
3. Minimal transportation costs in obtaining raw material and also in distribution or
marketing of finished products to the ultimate consumers.
4. Ease of access to market. That is, how easily the goods can be reached to the market.
5. Availability of Infrastructural facilities such as developed industrial sites, linking roads,
proximity to the railway stations, airports or maritime ports, availability of electricity,
water, public utilities, civil amenities and means of communication & commutation.
6. Availability of skilled and un-skilled manpower and technically qualified and experienced
managers.
7. Availability of banks and financial institutions.
8. Links to developed industrial hubs or business centers for economizing on the
transportation costs and miscellaneous expenses.
9. Safety and security of the property and the manpower.
10. Government influences such as, subsidized electricity, subsidized interest, subsidized
transport, tax relief, subsidies on investment. Negative influences such as stringent
pollution control and environmental clearances, or forced servicing of certain classes of
customers.
11. Proximity to residential areas.
Significance
From this discussion we can conclude that, the location of a plant is an important business
decision because it influences the cost of production and its distribution to a great extent. In
some cases, we may observe that a wrong location might make the transportation cost
even 10% of the total cost. Therefore, an appropriate location is essential to the efficient
and economical working of a plant. A firm may fail due to its wrong location or its growth
might get restricted and capital efficiency may get dented.
Plant Layout
The efficiency of production depends on how well various machines; production facilities
and amenities are located in a plant to minimize the total cost of production. Only a properly
laid out plant can ensure smooth and rapid movement of the material from raw material
stage to the finished product stage. Plant layout encompasses new layout as well as
improvements in the existing layout.
It may be defined as a science of locating machines, processes and plant services within
the factory so as to achieve the right quantity and quality of the output at the lowest
possible cost of manufacturing. It involves a judicious arrangement of production facilities
so that workflow is as smooth as possible.
Definition of a Plant Layout
Plant layout refers to the arrangement of physical facilities such as machinery, equipment,
furniture etc. within the factory or a shop in such a manner, so as to have quickest flow of
material at the lowest possible cost and with the least amount of handling while processing
the product from the receipt of material to the shipment of the finished product.
The overall objective of plant layout is to design a physical arrangement that most
economically meets the required output – quantity and quality. Plant layout ideally involves
allocation of space and arrangement of the equipment in such a manner that overall
operating costs are minimized.
Importance of Plant Layout
Plant layout is an important decision as it represents long-term commitment. An ideal plant

layout should provide the optimum relationship among output, floor area and manufacturing
processes. It facilitates the production process, minimizes material handling, minimizes time
and cost, and allows maximum flexibility of operations, ensures easy production flow of
materials, makes economic use of the building, promotes effective utilization of manpower,
and offers maximum employees’ convenience, their safety and comfort at, maximizes
exposure to natural light and ventilation. It is also important because it affects the flow of
material and processes, labor efficiency, level of supervision and control, usage of space
and expansion possibilities etc.
Objectives of scientific Layouts
1. Proper and efficient utilization of available floor space

2. Ensure work progress from one point to another point without delays
3. Provide enough production capacity.
4. Reduce material handling costs
5. Reduce hazards to personnel
6. Utilize labor efficiently
7. Improve employees’ morale
8. Reduce accidents
9. Provide for volume and product flexibility
10. Provide for ease of supervision and control
11. Provide for employees’ safety and health
12. Allow ease of maintenance
13. Allow proper machine and equipment utilization
14. Improve productivity
Types of Layouts
As discussed so far, the plant layout facilitates the arrangement of machines, equipment
and other physical infrastructure in a planned manner within the factory premises. A
business entity must take due care while laying down proper layouts of their production or
service plants. The type of layout differs from plant to plant, from location to location and
from industry to industry. But the basic principles governing the plant layouts are more or
less similar.
Product Layouts
Product type layouts are more suitable, where repetitive production of same or similar
products takes place. The precondition for having such a layout for similar products is that
the process sequence for all these products should be more or less same.
In this type of layout, the special purpose machines and sophisticated material handling
equipment are arranged as per the sequence of the processing. The output of the
preceding machine becomes the input of the succeeding machine. The movement of the
material between these machines happens with some sort of mechanization like conveyer
belts or robotic arms. The inspection stations are at the appropriate locations, so as to
maintain the flow of the material. The rejected material is removed from the system and re-
workable material is re-introduced at the appropriate workstation, in such a way that the
flow of the material is not disturbed. The slower machines are multiplied in such a way that
the output from the faster machines is completely taken care of by many number of slower
machines and machines are maintained using PMS by trained employees.
If suppose, the speed of machine number 5 is one third of machine number 4, then three
machines of type 5 will be installed, so that the output from machine number 4 doesn’t have
to wait for its turn at machine number 5. The same logic is applied at each station until at
least 80% of the stations do not accumulate the material for processing.
Process layouts
In process type of layouts, the machines are arranged as per their types. For example, all
lathe machines will be in one place (called turning shop), all milling machines will be in one
place (called milling shop) etc. The positions of these shops are such that the material
flows, more or less in one direction, from the raw material stage to the finishing stages.
These machines may be having diverse configuration to take care of variety of jobs.
This type of arrangement facilitates production of a diverse range of products and designs.
Factors Influencing Plant Layout
1. Layout of the factory building - The nature and size of the building determines the floor
space available for the layout. While designing the special requirements, e.g. air
conditioning, dust control, humidity control etc. must be kept in mind.
2. Nature of the product – product type of layout is suitable for uniform products whereas
process type layout is more appropriate for custom-made products.
3. Production process: In assembly type industries, product layouts are better suited. In job
type manufacturing or where intermittent production runs are involved, process layouts
are more suitable.
4. Type of machinery - General purpose machines are often arranged as per process
layout, whereas special purpose machines are arranged according to product layout
5. Repairs and maintenance - machines should be so arranged that adequate space is
available between them for movement of equipment and people required for repairing
and cleaning of the machines.
6. Human needs: Adequate arrangement should be made for cloakrooms, washrooms,
lockers, drinking water, toilets and other employee facilities.
7. Proper provision should be made for disposal of effluents, if any.
8. Plant environment - Heat, light, noise, ventilation and other aspects should be duly
considered, e.g. paint shops and plating section should be located in another hall so that
dangerous fumes can be removed through proper ventilation arrangements.
9. Adequate safety arrangement should also be made, so that the layout is conducive to
health and safety of employees.
10. It should ensure free and efficient flow of men and materials.
11. It should take care of future expansion and diversification plans.
Dynamics of Plant Layout
Plant layout is a dynamic rather than a static concept. It means, if once done it is not going
to be permanent in nature. It will rather see improvements or revisions in the layout
depending upon procurement of new machines or equipment, improvement in
manufacturing processes, changes in materials handling devices etc. But, any revision in
layout must be made only when the savings resulting from the revision exceed the costs
involved in such revision.
Revisions in plant layout may become necessary because of the following reasons:
107
1. Increase in the output of the existing product
2. Introduction of a new product and diversification
3. Technological advancements in machinery, material, processes, product design, fuel
etc.
4. Deficiencies in the layout unnoticed by the layout engineer in the beginning or the ones
brought to his notice by the employees.
Applications of Plant Layout
Plant layout is applicable to all types of industries, hospitals, schools and offices. Certain
plants require special arrangements which might make the layout appear distinctly different.
For example, in case of a plant manufacturing of detergent powder, a multi-story building is

specially constructed to house the boiler. Materials are stored and poured into the boiler at
different stages at different floors. Other facilities are also provided around the boiler at
different stations.
In case of talcum powder, the machinery is arranged vertically i.e. from top to bottom. Thus,
material is poured into the first machine at the top and powder comes out at the bottom of
the machinery located at the ground floor.
Yet another example of plant layout is the newspaper press, where the time element is of
supreme importance. Here plant layout must be simple and direct so as to eliminate
distance, delay and confusion. There must be a perfect coordination of all departments and
machinery or equipment, because they can’t afford to fail in their delivery.
Plant layout is also applicable to five star hotels. Here lodging, bar, restaurant, kitchen,
stores, swimming pool, laundry, shaving saloons, shopping arcades, conference hall,
parking areas etc. should all find an appropriate place in the layout. Similarly, they should
also be not so monotonous, that all five star hotels appear same. Here importance must be
given to cleanliness, elegance, convenience and compaction, which attracts customers.
Plant layouts are also applicable to a cinema halls, where emphasis is on comfort and
convenience of the cinemagoers. The projector, screen, sound box, firefighting equipment,
ambience etc. should be kept in mind while making the layouts.
Plant layout also applies to the arrangement of other facilities, such as receiving and
dispatching points, inspection facilities, employee facilities, canteens, water dispensers,
storage etc. Generally, the receiving and the dispatching departments should be at either
end of the plant. The storeroom should be located close to the production, receiving and
dispatching centers to minimize handling costs. The final inspection should be right next to
dispatch department as inspections are done at the end just before the dispatch.
The maintenance department consisting of lighting, safety devices, fire protection, collection
and disposal of garbage, scrap etc. should be located in a place which is easily accessible
to all the other departments in the plant. The other employee facilities like toilet facilities,
drinking water facilities, first aid room, cafeteria etc. can be a little away from other
departments, to avoid employees unnecessarily visiting those places, but they should also
be within easy reach of the employees.
3.8 Logistics & Supply Chain Management
In a general business sense, logistics is the management of the flow of things between the
point of origin and the point of consumption in order to satisfy the needs of the consumers
or producers, whenever they need it, wherever they need it and doing it at the lowest
possible cost. The resources managed in logistics can include the flow of physical items
such as foods, materials, animals, equipment, and abstract items like information.
Logistics management is the part of supply chain management that plans, implements, and
controls the efficient, effective forward, and reverse flow and storage of goods, services,
and related information between the point of origin and the point of consumption in order to
meet customer's requirements. The complexity of logistics can be visualized and optimized
with simulation software. The minimization of the use of resources is a common motivation
in logistics. A professional working in the field of logistics management is called a
logistician.
The Supply Chain Management compliments logistics efforts by producing the goods and
services in a network of factories and storing them in a network of strategically located
warehouses, to feed into the logistic network, either owned by the company or outsourced
by the company, to satisfy the needs of the consumers at the lowest possible cost. Supply-
chain management basically connects company’s supply side with its demand side.
Therefore, Logistics and Supply Chain Management (SCM) is the production at strategically
located plants, storage in strategically located ware houses, and the management of the
flow of goods and services finally through strategically appointed whole sellers, retailers
and franchisees. It includes the movement and storage of raw materials, work-in-process
inventory, and finished goods from point of origin to point of consumption. Interconnected
networks, channels and nodal businesses are involved in the provision of products and
services to the end customers. Logistics and Supply Chain Management has been defined
as the "design, planning, execution, control, and monitoring of the supply chain activities
with the objective of creating net value, building a competitive infrastructure, leveraging
worldwide logistics, synchronizing supply with demand and measuring performance against
global standards"
SCM draws heavily from the areas of industrial engineering, systems engineering,
operations management, logistics, procurement, and information technology, and it strives
for an integrated approach to the distribution function.
Features of a Supply Chain Management system:
o The management of upstream and downstream flows of materials, finished goods, and
related information among suppliers, producers, resellers, and final consumers.
o Supply chain strategies require a total systems view of the links in the chain that work
together to maximize the end users’ satisfaction, while rewarding the participants of the
supply chain the true economic worth of their contribution on a continual basis. To
achieve this, the costs must be lowered throughout the chain by eliminating
unnecessary expenses, unnecessary handling and movements. The main objective is to
increase efficiency, eliminate bottlenecks and add real or perceived value to the end-
user. The supply chain system must be responsive to customer requirements.
o The integration of key business processes across the supply chain for the purpose of
creating value for customers and stakeholders.
o Supply chain management encompasses the planning and management of all activities
involved in sourcing, conversion, and logistics management. It also includes
coordination and collaboration with channel partners, which may be suppliers,
intermediaries, third-party service providers, or customers. Supply chain management
integrates supply and demand management within and across companies. More
recently, the loosely coupled, self-organizing network of businesses that cooperate to
provide product and service offerings has been called the Extended Enterprise.
Through the implementation of Logistics & Supply Chain Management system, companies
can implement cost-saving programs such as just-in-time (JIT).
The two phases of the movement of materials include:
o Materials management, or the timely inward movement of materials, parts, and supplies
to the company.
o Physical distribution, or the timely outward movement of company’s physical products to
its customers.
3.9 Integrated Materials Management
Fundamentals of Inventory Management
What Are Inventories?
1. Raw Materials are those basic un-fabricated materials which have undergone no
conversion whatsoever since their receipt from the suppliers.
2. Finish parts which may either be bought-out-parts or piece parts (also called works
made parts).
3. Work-in-process comprises of items in partially completed condition of manufacture.
4. Finish goods are the final products ready to be shipped.
5. Tools
a. Standard tools used on machines such as saws, drills, reamers, taps, chasers,
b. Milling cutters, hobs, broaches, form tools, inserts etc.
6. Hand tools such as hand-saws, drill guns, hammers, mallets, needles, pliers, punches,
spanners, wrenches etc.
7. Supplies include material used in running the plant or in making company’s products
but do not themselves go into the product. Supplies, therefore, include –
a. Miscellaneous consumable stores.
b. Welding, soldering and tinning materials.
c. Abrasive materials.
d. Brushes, mops and bobs.
e. Empties.
f. Oils and greases.
g. General office supplies.
h. Printed forms.
i. ledgers and journals
j. Electric supplies.
8. Machinery spares include –
a. Consumable spares.
b. Replacement spares.
c. insurance spares such as propeller of a ship
Why Do A Firms Carry Inventories?
1. To economize on buying / manufacturing cost.

2. To keep pace with changing market conditions.
3. To satisfy demand during period of replenishment.
4. To take care of contingencies (i.e. prevent stock-outs)
5. To stabilize production.
6. To prevent loss of sale.
7. To satisfy other business constraints.
8. Supplier’s condition of minimum quantity.
9. Government regulations.
10. Seasonal availability.
Objectives Of Scientific Inventory Control System.
1. Continuity of productive operations.

2. Effective use of capital.
3. Reduction of administrative workload.
4. Service to the customers.
5. Economy in purchasing.
6. Reduction of risk of loss.
7. Practical system
8. Zero discrepancy between physical stock and book balance.
9. Administrative simplicity.
Relevant Costs for Inventory Decisions
 Inventory carrying cost.

 Procurement cost.
 Set-up cost.
 Stock-out cost.
Inventory Carrying Cost
(a) Capital cost is either the cost of borrowing capital or the cost of diverting company’s
funds to invest in inventories. The former means the interest rate, the later implies the
forgone opportunity cost.
(b) Storage cost includes cost of storage space (i.e. annual rent or depreciation), cost of
Maintenance and repairs, cost of storage facilities (i.e racks, bins etc.) cost o
preservation (i.e. rust preventive oils and greases), cost of record keeping, and cost of
periodic / annual stock verification etc.
(c) Deterioration and Obsolescence : Deterioration is the loss from reduction value due to
one or more of the following reasons:
1) The part/item/material may have limited shelf life and may deteriorate if stored for a
long time.
2) The item also deteriorate when storage conditions are inadequate, unsatisfactory or
both.
3) Deterioration can also result from poor handling in the stores.
Obsolescence is the loss from reduction in inventory value of the items / components that
are rendered unusable by the company due to changes in design or due to the
developments in the field.
Procurement Cost
a. Paper work cost

b. Postage cost
c. Follow up cost: Telephones, trunk calls, telegrams, telexes and faxes are the aids
commonly used by buyers for pre-delivery follow up as well as for shortage chasing.
d. Cost of visits to the vendors’ plants.
e. Expediting cost
1. to make alternate arrangement.
2. to decide expedited routing of goods from supplier.
f. Operating cost of the vehicles.
g. Inspection and testing costs.
h. Administrative costs.
Set Up Cost
(a) Idle time cost is the loss due to inability of the company to produce during the period
the machine is under set up.
(b) Cost of idle wages paid to the direct worker(s) for the period the machine is under
preparation.
(c) Work order cost is the cost of raising a work order and other auxiliary orders namely
stores issue order, move order, inspection order, goods forwarding note etc.
(d) Foregone profit implies the loss in profit for the time the machine is under preparation.
Stock out Cost
1. Cost of men and machines rendered idle.

2. Cost due to loss of profit on the production which did not take place.
3. Cost of emergency actions such as air freighting charges.
4. Cost due to premium price paid. It equals the price difference when the item is procured
from alternate source of supply.
5. Cost due to penalty paid for the delayed shipments.
6. Cost due to overtime paid to workmen employed in inward inspection, production shops
etc. and to indirect staff to complete targets of production.
7. Cost due to customers’ dissatisfaction resulting from a delayed shipment.
8. Cost due to loss of business since the irate customer may not place repeat orders or he
may tell other customers how unpredictable in delivery commitments the suppliers’ firm
is.
Selective Control of Inventories
“One can’t control everything and even if one can, it is never worth it. Effectiveness results
when important aspects of a problem are pursued more rigorously than others. A major
portion of managerial time should be spent in performing more important jobs. Less
important tasks - those involving routine decisions and which involves less risk – should be
delegated to a lower level.
Types of classification
Classification Criteria employed

ABC analysis Usage value (i.e. consumption per period
price per unit)
HML analysis (High-Medium-Low) Unit price (i.e. it does not take consumption
into account)
VED analysis (Vital-essential-desirable) Criticality of the item (i.e. loss of
production)
SDE analysis (Scarce-Difficult-Easy) Procurement difficulties
GOLF analysis (Government-Ordinary- Source of procurement
Local-Foreign )
S-OS analysis (Seasonal – Off Seasonal) Seasonality
FSN analysis (Fast-Slow-Non-moving) Issues from stores
XYZ analysis Inventory investment
ABC Analysis
A-Items : It is usually found tat hardly 5-10% of the total items account for 70-75% of the
total money spent on the materials. These items require detailed and rigid control and need
to be stocked n smaller quantities. These items should be procured frequently, the quantity
per occasion being small. A healthy approach, however, would be to enter into contract wit
the manufacturers of these items and have their supply in staggered lots according to
production program of the buyer.
B-Items : These items are generally 10-15% of the total items and represent 10-15% of the
total expenditure on the materials. These are intermediate items. The control on these items
need not be as detailed and as rigid as applied to C items.
C-Items : These are numerous (as many as 70-80% of the total items), inexpensive
(represent hardly 5-10% of the total annual expenditure on materials) and hence insignificant
(do not require close control) items. The procurement policy of these items is exactly the
reverse of A items. C items should be procured infrequently and in sufficient quantities.
HML Analysis
H-M-L analysis is similar to ABC analysis except for the difference that instead of “usage
value”, “price” criterion is used. The items under this analysis are classified into three groups
which are called “High”, “Medium” and “Low”.
HML analysis helps to-

o Assess the storage and security requirements (e.g. high priced items like bearings, worm
shafts, worm wheels, etc. require to be kept in cupboards.)
o To keep control over consumption at the departmental head level.
o Determine the frequency of stock verification.
o To evolve buying policies to control purchases.
o To delegate authorities to different buyers to make petty cash purchase.
VED Analysis
VED analysis represents classification of items based on criticality. The analysis classifies
the items into three groups called Vital, Essential and Desirable.
“Vital” category encompasses those items for want of which production would come to halt.
“Essential” group includes items whose stock outs cost is very high. And “Desirable” group
comprises of items which do not cause any immediate loss of production or their stock out
entail nominal expenditure and cause minor disruptions for a short duration.
An item may be vital for number of reasons, namely
o If the non-availability of the item can cause serious production losses.

o Lead time for procurement is very large.
o It is non-standard item and is procured to buyer’s design.
o The source of supply is only one and is located far off from the buyer’s plant.
S-D-E Analysis
S-D-E analysis is based on problems of procurement namely:
o Non-availability
o Scarcity
o Long lead time
o Geographical location of suppliers, and
o Reliability of suppliers, etc.
S-D-E analysis classifies the items into three groups called “Scarce” “Difficult” and “Easy”.
“Scarce” classification comprises of items which are in short supply.
“Difficult” classification includes those items which are available indigenously but are not
easy to procure.
“Easy” classification covers those items which are readily available.
S-D-E analysis is employed by the purchase department:
I. To decide on the method of buying
II. To fix responsibility of buyers.
G-NG-LF Analysis/ Golf Analysis
G-NG-LF analysis (or GOLF analysis) like S-D-E analysis based on the nature of the
suppliers which determine quality, lead time, terms of payment, continuity or otherwise of
supply and administrative work involved.
“G” group covers items procured from “Government”.
“NG” (O in GOLF analysis) group comprises of items procured from “Non-Government” (or
Ordinary) suppliers.
“L” group contains items bought from “Local Suppliers”.
“F” group contains those items which are purchased from “Foreign Suppliers”
S-OS Analysis
S-OS analysis is based on seasonality of the items and it classifies the items into two
groups S (seasonal) and OS (i.e. Off Seasonal).
(i) Seasonal and are available only for a limited period.

(ii) Seasonal but are available throughout the year.
(iii) Non-seasonal items whose quantity is decided on different considerations.
F-S-N-Analysis
F-S-N analysis is based on the consumption figures of the items. The items under this
analysis are classified into three groups: F (fast moving), S (low moving) and N (non-
moving).
X-Y-Z Analysis
X-Y-Z analysis is based on value of the stocks on hand (i.e. inventory investment). Items
whose inventory values are high are called x Items while those whose inventory values are
low are called Z items. And Y items are those which have moderate inventory stocks.
Illustration of ABC Analysis
The annual consumption data of Marine Spares of Shipping Company is as follows.
Component Annual Consumption Price

Code (units)
MV - 65 4181 1162
MV - 24 591 2413.1
MV - 88 9435 3456
MV - 10 7586 4614.9
MV - 47 8444 5168.8
MV - 37 916 6374.2
MV - 81 8721 7482.6
MV - 56 4082 8133.4
MV - 23 9397 9777.3
MV - 35 3243 1424.1
MV - 49 7054 2350.7
MV - 3 5260 3280.9
MV - 73 1178 453.9
MV - 10 210 93.5
MV - 15 9367 209.3
Suitably classify these items for administrative focus.
Solution:
Component Annual Price Annual Rank

Code Consumption Consumption
(units) in Rs.
A B C BXC Highest gets first rank
Lowest gets last rank
MV - 65 4181 1162 4858322 10
MV - 24 591 2413.1 1426142.1 13
MV - 88 9435 3456 32607360 6
MV - 10 7586 4614.9 35008631.4 4
MV - 47 8444 5168.8 43645347.2 3
MV - 37 916 6374.2 5838767.2 9
MV - 81 8721 7482.6 65255754.6 2
MV - 56 4082 8133.4 33200538.8 5
MV - 23 9397 9777.3 91877288.1 1
MV - 35 3243 1424.1 4618356.3 11
MV - 49 7054 2350.7 16581837.8 8
MV - 3 5260 3280.9 17257534 7
MV - 73 1178 453.9 534694.2 14
MV - 10 210 93.5 19635 15
MV - 15 9367 209.3 1960513.1 12
Component Annual Price Annual Rank

Code Consumption Consumption
(units) in Rs.
A B C BXC Highest gets first rank
Lowest gets last rank
MV - 23 9397 9777.3 91877288.1 1
MV - 81 8721 7482.6 65255754.6 2
MV - 47 8444 5168.8 43645347.2 3
MV - 10 7586 4614.9 35008631.4 4
MV - 56 4082 8133.4 33200538.8 5
MV - 88 9435 3456 32607360 6
MV - 3 5260 3280.9 17257534 7
MV - 49 7054 2350.7 16581837.8 8
MV - 37 916 6374.2 5838767.2 9
MV - 65 4181 1162 4858322 10
MV - 35 3243 1424.1 4618356.3 11
MV - 15 9367 209.3 1960513.1 12
MV - 24 591 2413.1 1426142.1 13
MV - 73 1178 453.9 534694.2 14
MV - 10 210 93.5 19635 15
Classify as per the rule < 80% - A, > 80% & < 90% - B, > 90% - C
Component Annual Price Annual Rank Cumulative Percentage Class
Code Consumption Consumption in Consumption Cumulative
(units) Rs. Consumption
A B C D=BXC E F= F1/Total < 80% - A

Highest gets D1 F2/Total > 80% & < 90% - B
first rank D1+D2 F3/Total > 90% - C
Lowest gets D1+D2+D3
last rank .
MV - 23 9397 9777.3 91877288.1 1 91877288.1 25.9% A Class

MV - 81 8721 7482.6 65255754.6 2 157133042.7 44.3% A Class
MV - 47 8444 5168.8 43645347.2 3 200778389.9 56.6% A Class
MV - 10 7586 4614.9 35008631.4 4 235787021.3 66.5% A Class
MV - 56 4082 8133.4 33200538.8 5 268987560.1 75.8% A Class
MV - 88 9435 3456 32607360 6 301594920.1 85.0% B Class
MV - 3 5260 3280.9 17257534 7 318852454.1 89.9% B Class
MV - 49 7054 2350.7 16581837.8 8 335434291.9 94.6% C Class
MV - 37 916 6374.2 5838767.2 9 341273059.1 96.2% C Class
MV - 65 4181 1162 4858322 10 346131381.1 97.6% C Class
MV - 35 3243 1424.1 4618356.3 11 350749737.4 98.9% C Class
MV - 15 9367 209.3 1960513.1 12 352710250.5 99.4% C Class
MV - 24 591 2413.1 1426142.1 13 354136392.6 99.8% C Class
MV - 73 1178 453.9 534694.2 14 354671086.8 100.0% C Class
MV - 10 210 93.5 19635 15 354690721.8 100.0% C Class
Total 354690721.8
Application of HML Analysis
Solve the above problem using HML Analysis
Solution: Assign the rank

Component Price Rank
Code
Highest price first rank

Lowest price last rank
MV - 65 1162 12
MV - 24 2413.1 9
MV - 88 3456 7
MV - 10 4614.9 6
MV - 47 5168.8 5
MV - 37 6374.2 4
MV - 81 7482.6 3
MV - 56 8133.4 2
MV - 23 9777.3 1
MV - 35 1424.1 11
MV - 49 2350.7 10
MV - 3 3280.9 8
MV - 73 453.9 13
MV - 10 93.5 15
MV - 15 209.3 14
As in HML analysis the criteria of classification is based on price of the item, the
consumption column is not necessary.
Component Price Rank Cumulative Percentage Class
Code Value Cumulative
Value
A B C D= E= < 80% - H
B1 D1/Total > 80% & < 90% - M
B1+B2 D2/Total > 90% - L
B1+B2+B3 D3/Total
MV - 23 9777.3 1 9777.3 17.3% H Class
MV - 56 8133.4 2 17910.7 31.8% H Class
MV - 81 7482.6 3 25393.3 45.0% H Class
MV - 37 6374.2 4 31767.5 56.3% H Class
MV - 47 5168.8 5 36936.3 65.5% H Class
MV - 10 4614.9 6 41551.2 73.7% H Class
MV - 88 3456 7 45007.2 79.8% H Class
MV - 3 3280.9 8 48288.1 85.6% M Class
MV - 24 2413.1 9 50701.2 89.9% M Class
MV - 49 2350.7 10 53051.9 94.1% L Class
MV - 35 1424.1 11 54476 96.6% L Class
MV - 65 1162 12 55638 98.7% L Class
MV - 73 453.9 13 56091.9 99.5% L Class
MV - 15 209.3 14 56301.2 99.8% L Class
MV - 10 93.5 15 56394.7 100.0% L Class
Total 56394.7
Economic Lot Size (Purchased Items)
One of the basic decisions that must be made in any stock control system is that of
determining the quantity to order since investment in inventories largely depends upon the
quantities in which the items are ordered for replenishment.
Ordering large lots infrequently reduces administrative work but increases investment in
stocks. Ordering small lots frequently keeps the investment low but increases
administrative work.
Mathematical Treatment of Economic Lot Size:
Assumptions underlying the EOQ model:

a. The demand of the item occurs uniformly over the period at the known rate.
b. The replenishment of the stock is instantaneous.
c. The time that elapses between the placing a replenishment order and receiving the item
into stock, called lead time, is zero.
d. The price per unit is fixed and is independent of the order size.
e. The cost to place an order and process the delivery is fixed and does not vary with the
lot size.
f. The inventory carrying charges vary directly and linearly with the size of the
g. Inventory and is expressed as a percentage of average inventory investment.
h. The item can be procured in the quantities desired, there being no restriction of any
kind.
i. The item has fairly long shelf life, there being no fear of deterioration or spoilage.
The symbols used while deriving the equation for EOQ:
Annual consumption of the item (units) : S

Price per unit (Rs) : Cu
Procurement cost per order (Rs) : Cp
Inventory carrying cost as a percentage of average
Inventory investment (decimal) : i
Order quantity (units) : q
Economic order quantity : qo
Preparation of the model:
𝐀𝐧𝐧𝐮𝐚𝐥 𝐩𝐫𝐨𝐜𝐮𝐫𝐞𝐦𝐞𝐧𝐭 𝐜𝐨𝐬𝐭 𝐀𝐏𝐂 = No. of orders per year ∗ Procurement cost per order
Annual consumption
= ∗ Procurement cost per order
Order quantity
S
= ∗ Cp
q
𝐀𝐧𝐧𝐮𝐚𝐥 𝐢𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐜𝐚𝐫𝐫𝐲𝐢𝐧𝐠 𝐜𝐨𝐬𝐭 𝐀𝐈𝐂𝐂

= Average inventory investment ∗ Inventory carrying cost per unit of investment
q
= ∗ Cu ∗ i
2
S q
𝐀𝐧𝐧𝐮𝐚𝐥 𝐓𝐨𝐭𝐚𝐥 𝐂𝐨𝐬𝐭 𝐀𝐓𝐂 = ∗ Cp + ∗ Cu ∗ i
q 2
Optimization of the model:
To determine economic order quantity (qo), that is, to find out the order quantity that
minimizes the total cost, we must differentiate ATC, that is, the Annual Total Cost, with
respect to the decision variable q and equating the derivative to zero.
𝑑(𝐴𝑇𝐶) − 𝑆 𝐶𝑝 𝐶𝑢 𝑖
∴ = + =0
𝑑𝑞 𝑞2 2
When order quantity equals EOQ then q = q0

2 𝑆 𝐶𝑝
∴ 𝑞02 = 𝐶𝑢 𝑖
2 𝑆 𝐶𝑝
∴ 𝑞0 = √ 𝐶𝑢 𝑖
q0 is in whole numbers
An illustration of the formula:
A company uses 75 numbers of an item per month. Each unit costs the company Rs.25/-
The cost of putting through each order and inventory carrying charges per month are
computed at Rs.36 and 1.5% of the average inventory investment respectively.
In what economic lots should the item be purchased to minimize annual total cost?
Solution :
Economic order quantity is given by the formula.

2 𝑆 𝐶𝑝
𝑞0 = √ 𝐶𝑢 𝑖
Where S = Annual consumption (units)
= 75 x 12
= 900 numbers.
Cp = procurement cost per order (Rs.)
= Rs.36/-
Cu = Price or cost per unit (Rs.)
= Rs.25/-
i = (1.5 x 12 / 100) = 0.18 per year
Substituting the values in the EOQ formula, we get
2∗900∗36
𝑞0 = √ 25∗0.18
= 120 numbers.
An Alternate Formula for EOQ
Let A = Annual consumption in rupees

Qo = Economic order quantity in Rs.
𝑨𝐧𝐧𝐮𝐚𝐥 𝐂𝐨𝐧𝐬𝐮𝐦𝐩𝐭𝐢𝐨𝐧 𝐢𝐧 𝐑𝐬. = Annual Consumption in units ∗ Price per unit
= S ∗ Cu
Multiplying both sides of the EOQ equation by unit price, Cu we get,
2 S Cp
Cu ∗ q 0 = Q0 = Cu ∗ √ Cu i
2 A Cp
Q0 = √ i
Qo is in Rs.
An illustration of the alternate formula:
Rinki toys buy a special spring worth Rs.14,400 each year. It has now entered into a
contract with the manufacturer to supply springs in staggered lots against the purchase
order to be raised by M/s Rinki Toys covering annual requirement. The procurement cost
and inventory carrying cost of the buyer are as under:
Cost of replenishing the stock of an item once: Rs.24 per occasion
Inventory carrying cost as percentage of : 12% average inventory investment
How frequently should springs be received by Rinki Toys and what should be the value of
each consignment?
Solution :
Economic order quantity (Qo) when the consumption is specified in terms of monetary
figures is given by the formula :
2 A Cp
Q0 = √ i
Where A = Annual usage of the item (Rs.)
= Rs.14,400
Cp = Procurement cost per order (Rs.)
= Rs.24
i = Inventory carrying cost per annum (decimals)
= 0.12
Substituting the values of the parameters in the above formula, we get
2∗14400∗24
Q0 = √ 0.12
= Rs.2,400
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛
𝐴𝑛𝑑 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑟𝑒𝑐𝑒𝑖𝑝𝑡𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟 = 𝑄0
14400
= =6
2400
 The springs should be procured six times in a year and the value of each consignment
should be Rs.2,400.
Know Your Lead Time

Meaning Of Lead Time - There is a definite time lag between identification of the need for
an item till it is received in store ready for issuing after placing of order, manufacturing,
transport, receiving and inspection. The total time that elapses between the recognition of
the need for an item until fulfillment of the need is called lead time of the item and it plays
an important role in establishing the right time for procurement.
The right time for the procurement of an item is the time the stock on hand is just enough to
satisfy demand for the period required for its procurement. Since there may be increase in
demand between the time the order is placed and material is received in store, safety stock
may be added to the average requirement of the lead time. This implies that the right time
for procurement of an item is the tie when stock drops to a level which is enough to take
care of demand during the period necessary to replenish stock (lead time) and extension of
lead time.
Elements of Lead Time
1. Time required by the indenting department to convey requirements to purchase.

2. Time required by the purchase department to convert a purchase indent into a purchase
order.
3. Time required by the supplier to route buyer’s order through his administrative channels
and fill up the same.
4. Transit time for the goods to reach buyer’s works.
5. Time required by the receiving department to inward goods.
6. Time required by inward (primary) inspection to verify the quality of goods.
7. Time required by the stores department to take goods into stock and update stock
records.
Major Parts Of Lead Time
Internal lead time, also called buyer’s lead time, is the sum of servicing time and receiving
time. The servicing time includes time required by the buyer to call quotations, compare
quotations, visit vendors, negotiate terms, obtain sanctions, enter into contract etc. and
receiving time is made up of time required to uncrate and inspect goods, move them
between stores, deposit them into appropriate bins and make entries into stock cards.
External lead time, also called processing time or suppliers’ lead time, is made up of
administrative, manufacturing and delivery times required by the supplier.
Fixing Safety Stocks to Prevent Stock-outs

What Is the Safety Stock?
Safety stock, also called minimum stock or buffer stock or contingent stock or reserve
stock, is the lower limit below which the stock should not be allowed to fall under normal
circumstances.
It is obvious that in the absence of safety-stock, any delay in delivery or increase in

consumption will render men and machines idle with multiple cost implications.
Stock-outs generally give rise to following losses:
(i) Customers’ dissatisfaction.

(ii) Loss of customer or loss of order.
(iii) Loss of production.
(iv) Emergency purchases at higher cost.
(v) Higher freight cost due to expedited (speedier) routing.
(vi) Loss of face for sales personnel.
(vii) Interdepartmental conflicts and tensions.
(viii) Poor quality of goods (since defective goods may be salvaged under pressure).
Neither the lead time nor the demand is constant! Usually, they vary! Variations in them
make the ideal system a theoretical concept. Variations in demand and/or variations in lead
time cause following problems:
(i) Variations in demand (lead time constant):

Variation in demand affects both replenishment level and replenishment stock. If the
demand rate increases, replenishment level reaches earlier and replenishment stock gets
consumed prior to receipt of fresh supply causing a situation called stockout. And if the
demand rate reduces, the replenishment is delayed and some replenishment stock is still
on hand at the time of fresh supply.
(ii) Variations in lead time (demand constant):

Variations in lead time do not affect replenishment level but affect replenishment
stock. If the lead time gets extended, replenishment stock is consumed prior to receipt of
fresh supply thereby causing stockout (Fig 11.3). And if the lead time is shortened, some
replenishment stock is still on hand at the time of receipt of fresh supply.
(iii) Variations in demand as well as lead time:
Factors Influencing the Safety Stock:
(a) Category of the item: Safety stock needs to be kept less for A - Category items. The
possibility of stock out can be considerably cut down by careful forecasting, frequent
reviewing and more progressing. C - Category items, on the contrary, requires sufficient
safety stock to eliminate progressing and to reduce the possibility of stock outs. A moderate
policy is required for B - Category items, safety stock being neither too high nor too low.
(b) Lead time: The longer the lead time, the higher is the degree of uncertainty. Higher
safety stock, therefore, is needed in case of items of longer lead time.
(c) Number of suppliers: The more the number of suppliers, the lesser can be the safety
stock.
(d) Criticality of the item: Critical items need greater degree of insurance than non-critical
items. Standard items can be allowed low levels of safety stock. Items manufactured to
buyer’s design and those requiring procurement of special raw materials need higher safety
stocks.
(e) Availability of substitutes: Lesser safety stock may be kept for items to which
substitutes are available.
(f) Possibility to do the job at the home plant: Little or no safety stock is necessary if the
item in the event of contingencies can be manufactured at the home plant.
(g) Service level desired by the management: Service level refers to the extent of
guarantee against stockout and, therefore a service level of 98% puts such a guarantee at
98% (i.e. probability of stockout at 2%)
(h) Order Quantity: Large order quantity purchases reduce the number of danger zones
(i.e. frequency of stock dropping to danger level) and, therefore, lesser can be the safety
stock.
(i) Risk of obsolescence and deterioration: A little safety stock needs to be maintained
for items having limited shelf life and components liable for modifications.
(j) Space restrictions: Lesser safety stock may be kept for bulky items such as cotton
waste.
(k) Stock out cost: Certain items like basic raw materials are very important from
production point of view. Any stock out will render a machine or a group of machines idle. A
large safety stock is, therefore, necessary for such items.
Replenishment Systems
Fixed-Order-Quantity-System:
a. Re-order quantity is always the same which is usually the economic order quantity.
b. The time interval between deliveries varies.
c. Replenishment action is initiated when the stock on hand is just sufficient to meet
demand during lead time.
d. Safety stock is kept to take care of increase in demand during lead time as well as to
meet demand when lead time is extended.
e. Re-order level equals safety stock plus average consumption during lead time.
f. Average inventory (I) equals safety stock plus half of the re-order quantity.
Basic Parameters:
The basic parameters required to operate re-order level system are:
(a) Re-order level, as mentioned earlier, equals the sum of minimum stock and the lead
time consumption.
Symbolically, the same would be,
Re-order level = m+LxC

where m = minimum stock (units)
L = lead time (days/weeks/months)
C = daily/weekly/monthly consumption (units)
(b) Re-order quantity (q) under this system is fixed and normally it equals the economic
order quantity (EOQ) or modified economic order quantity (M.O.Q.)
Maximum stock (M) under re-order level system
Under the re-order level system, maximum level is the sum of minimum stock and the re-
order quantity.
If m = minimum stock and
qo = economic order quantity, then
Maximum stock (M) = m + qo
Average inventory under re-order level system
Average inventory in general is either the sum of half of the minimum stock and maximum
stock or merely the sum of minimum stock and half of the re-order quantity i.e.
Average inventory = m + qo
2
An illustration on the working of the system

Monthly consumption of a particular item belonging to ‘B’ category and having unit price of
Re.1 has been estimated to be 300 units. The inventory carrying cost and the procurement
cost for the company have been computed to be 18% and RS.36 per order respectively.
Stock records show that this item can normally be procured within a period of one month. If
the company adheres to the policy of one month safety stock for all ‘A’ and ‘B’. category of
items.
Calculate-
(a) re-order quantity
(b) re-order level
(c) minimum level
(d) maximum level, and
(e) average inventory
assuming re-order level system of replenishment.
Solution
(a) Re-order quantity under re-order level system is usually the economic order quantity
(which may be modified in the light of constraints) and is given by the relation.
2 𝑆 𝐶𝑝
𝑞0 = √ 𝐶𝑢 𝑖
where S = annual consumption (units)

= 300 x 12
= 3,600 units
Cp = procurement cost per order
= Rs.36 per order.
i = inventory carrying cost as percentage of average inventory investment
(decimals)
= 0.18
Substituting the values in the above relation, we get
2∗3600∗36
𝑞0 = √ 1∗0.18
= 1200 units
(b) Minimum level (m) also known as safety-stock is given equal to one month’s
consumption. Therefore, minimum level will be 300 units.
(c) Re-order level (P) which is the sum of safety-stock and lead time consumption. It will
be-
R.O.L. = safety-stock + lead time consumption
= 300 + 300
= 600 units
(d) Maximum level (M) which is the sum of minimum stock and the order quantity. Thus it
will be-
M = safety stock + order quantity
= 300 + 1200
= 1500 units
(e) Average inventory (I) which is the sum of minimum stock plus half the re-order quantity,
will be
I = m + qo
2
= 300 + 1200
2
= 300 + 600
= 900 units.
Two-Bin-System
Working of the system:
Two-bin-system which operates on the principle of re-order level physically segregates the
entire stock of an item two bins. The second bin contains stocks equivalent to re-order level
(minimum stock plus lead time consumption) and is deemed to be sufficient to satisfy
probable demand during the period necessary for replenishment.
The first bin contains enough stock (order quantity – lead time consumption) to satisfy
demand between the receipt of materials and the placing of next order.
To start with, the stock from the first bin is consumed. The emptying of the first bin indicates
that the stock has reached the re-order level and the same is to be replenished. The stock
in the second bin is then utilized until the receipt of fresh supply.
The fresh supply, when received, is once again physically distributed between the two bins
as per pre-fixed ratio.
Inventory Control of ‘Manufactured Items’
Economic Lot Size
Assumptions underlying the model

(a) The item is consumed at the known demand rate which is constant.
(b) The cost to set up a machine (or a group of machines) and order, writing is fixed and
does not vary with the lot size.
(c) The inventory carrying changes vary directly and linearly with the size of inventory and
are generally expressed as a percentage of average inventory investment.
(d) The Production rate is infinite (i.e. stock replacement is instantaneous).
(e) The quantity on shop order is manufactured and delivered in full, there being no
intermediary issues while the item is being manufactured.
(f) The item can be manufactured in the desired quantity free from restrictions of any kind
such as tool stand-up time, assembly requirements, space restrictions, risk of obsolescence
etc.
Mathematical treatment of the model The symbols used :
Annual requirement of the item (units) =S

Manufacturing cost per unit = Cu
6
Set-up cost per production run = Cp
Inventory carrying cost as a percentage of average =i
Inventory investment
Quantity per production run =q
Preparation of the model
Two costs are involved in the inventory decisions of manufactured items: set-up cost and
inventory carrying cost.
Annual set-up cost = (No. of production runs per year) x (Set-up cost per production run)
S
= ∗ Cp
q
𝐀𝐧𝐧𝐮𝐚𝐥 𝐢𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐜𝐚𝐫𝐫𝐲𝐢𝐧𝐠 𝐜𝐨𝐬𝐭 𝐀𝐈𝐂𝐂

= Average inventory investment ∗ Inventory carrying cost per unit of investment
q
= ∗ Cu ∗ i
2
S q
𝐀𝐧𝐧𝐮𝐚𝐥 𝐓𝐨𝐭𝐚𝐥 𝐂𝐨𝐬𝐭 𝐀𝐓𝐂 = ∗ Cp + ∗ Cu ∗ i
q 2
Optimization of the model:
To determine economic manufacturing quantity (qo), that is, to find out the manufacturing
quantity that minimizes the total cost, we must differentiate ATC, that is, the Annual Total
Cost, with respect to the decision variable q and equating the derivative to zero.
𝑑(𝐴𝑇𝐶) − 𝑆 𝐶𝑝 𝐶𝑢 𝑖
∴ = + =0
𝑑𝑞 𝑞2 2
When manufacturing quantity equals EMQ then q = q0

2 𝑆 𝐶𝑝
∴ 𝑞02 = 𝐶𝑢 𝑖
2 𝑆 𝐶𝑝
∴ 𝑞0 = √ 𝐶𝑢 𝑖
q0 is in whole numbers
An illustration on the model:

A ligh t en gin ee rin g compan y u se s a spe cia l t ype of stud a t an approximately
constant rate of 6,000 per year. The studs are manufactured at the company's
own plant. Each stud costs the company Rs. 2. The company's personnel
estimate that it cost Rs. 300 to put through each shop order. The inventory carrying
charges are estimated at 20% of the average inventory investment.
How frequently should production runs be made and what quantity should be
manufactured in each production run for minimum cost?
Solution :
Economic manufacturing quantity formula is
2 𝑆 𝐶𝑝
𝑞0 = √ 𝐶𝑢 𝑖
Where S = Annual consumption (units)

= 6000 studs
Cp = Set-up cost per production run (Rs)
= Rs. 300
Cu = Manufacturing cost per unit (Rs)
= Rs. 2
i = Inventory carrying cost as a percentage of average inventory
investment (decimals)
= 0.20
2∗6000∗300
𝑞0 = √ = 3000 studs
2∗0.20
Quantity to be manufactured for minimum cost = 3000 studs
Frequency of production runs = S / q0 = 6,000 / 3,000 = 2
Physical Inventories
Why Physical Stock Does Not Tally-With Stock Balance?
(a) Clerical errors:

o They receive material but forget to make entries (i.e. post receipt)
o They issue materials but not post requisitions.
o They issue incorrect quantities (i.e. over issue and under issue)
o They make errors in copying and posting receipt quantities.
o They post on wrong cards.
o They make errors in addition and subtraction while posting.
(b) Incorrect location of parts: A part may get lost due to incorrect location. Physically,
the part may be lying somewhere under different nomenclature but discrepancy will be
shown during stock taking.
(c) Materials handling: Carelessness in handling of materials often causes breakages,

damages, or leakages of materials which lead to-discrepancies.
(d) Shrinkage and usage of different issue units: Sometimes the material might shrink
or the discrepancies may arise when materials are purchased in one unit and are issued in
different unit. Wires, for example, may be bought by weight (kgs) but -issued by length;
sheets may be procured by weight but issued by numbers.
(e) Atmospheric conditions: Certain items always end up with surplus or shortages
account of their basic characteristics.
(f) Seasoning and preservation: Items like wood, leather etc. are seasoned in oil to
prevent cracking or eating into by ants. Such items usually show surplus due to absorption
of oil.
(g) Theft, pilferage and malpractices
(h) Incorrect stocktaking
(i) Un-accounted materials destroyed in destructive tests
(j) Misplacement of papers and vouchers
(k)Material issued to line because of urgency: Often materials on receipt from

suppliers are issued directly to line because of urgency. The failure to obtain issue
vouchers cause discrepancies.
(l)Poor storage conditions: Spoilage / wastage resulting from damages caused by worms,
moths, rodents etc. is yet another reason for discrepancies.
Methods of Taking Inventory:
The physical inventory can be conducted by one of the three ways:
a. Once a year count, called annual stocktaking.
b. Rotating counts, called continuous stocktaking.
c. Low point counts, called re-order point stocktaking.
3.10 Introduction to Operations Research
Operations Research (O.R.), or operational research, is a discipline that deals with the
application of advanced analytical methods to help make better decisions. The terms
management science and analytics are sometimes used as synonyms for operations
research.
Employing techniques from other mathematical sciences, such as mathematical modeling,

statistical analysis, and mathematical optimization, operations research arrives at optimal or
near-optimal solutions to complex decision-making problems.
Operations research overlaps with other disciplines, notably industrial engineering and
operations management. It is often concerned with determining a maximum (such as profit,
performance, or yield) or minimum (such as loss, risk, or cost.)
Operations research encompasses a wide range of problem-solving techniques and

methods applied in the pursuit of improved decision-making and efficiency, such as linear
programming, simulation, mathematical optimization, queuing theory, Markov decision
processes, economic methods, data analysis, statistics, neural networks, expert systems,
and decision analysis. Nearly all of these techniques involve the construction of
mathematical models that attempt to describe the system.
Because of the computational and statistical nature of most of these fields, O.R. also has
strong ties to computer science. Operations researchers faced with a new problem must
determine which of these techniques are most appropriate given the nature of the system,
the goals for improvement, and constraints on time and computing power.
Linear Programming
Linear programming (LP) is a mathematical method for determining a way to achieve the
best outcome (such as maximum profit or lowest cost) in a given mathematical model for
some list of requirements represented as linear equations.
More formally, linear programming is a technique for the optimization of a linear objective
function, subject to linear equality and linear inequality constraints.
Likewise, linear programming is heavily used in microeconomics and company

management, such as planning, production, transportation, technology and other issues.
Although the modern management issues are ever-changing, most companies would like to
maximize profits or minimize costs with limited resources. Therefore, many issues can boil
down to linear programming problems.
Simpler problems can be solved graphically, but for complex problems involving a large
number of parameters, sophisticated software are available in the market to solve
simultaneous equations with large number of variables.
Illustration of Linear Programming

A manufacturer of split air conditioners is stuck with bottleneck on two of its machines,
HMT- 1 & HMT-2. It wants to optimize the production mix for two of its models, CRR-35 &
CRR – 87. CRR-35 takes 2 hours on HMT- 1 & 1 hour on HMT-2, whereas CRR-87 takes 1
hour on HMT- 1 & 2 hours on HMT-2. Total time available for HMT- 1 & HMT-2 is 2500 &
3500 hours respectively. The profit per unit of CRR-35 & CRR – 87 is Rs. 800 and Rs. 1200
respectively. What is the optimum production mix?
Solution:
HMT – 1 HMT - 2 Profit Quantity
Produced
CRR - 35 2 1 800 X
CRR - 87 1 2 1200 Y
2500 3500
Let us form the constraints
2 X + 1 Y <= 2500 ………….Line 1

1 X + 2Y <= 3500…………..Line 2
The equation of profit will be
P = 800 X + 1200 Y………..Line 3
Let us plot the graph for the same
The X & Y intercepts of Line 1 are (0,2500), (1250,0)
And the X & Y intercepts of Line 2 are (0,1750), (3500,0)
Let us plot these lines
The coordinates of the intersection of

line 1 & 2 are, (500, 1500)
The profit at,
Point C = 0
Point D = 2100000
Point B = 1000000
Point A = 2200000
The highest profit is earned at a point,

which is farthest from the origin in the
feasible region.
Transportation Model (Vogel’s algorithm)
The Transportation and Assignment problems deal with assigning sources and jobs to
destinations and machines. We will discuss the transportation problem first.
Suppose a company has m factories where it manufactures its product and n outlets from
where the product is sold. Transporting the product from a factory to an outlet costs some
money which depends on several factors and varies for each choice of factory and outlet.
The total amount of the product a particular factory makes is fixed and so is the total
amount a particular outlet can store. The problem is to decide how much of the product
should be supplied from each factory to each outlet so that the total cost is minimum.
Transportation models are vital for multinational companies having plants and warehouses
located at many different in many countries. The genesis of a successful logistics business
lies in the cost optimization. Many e-commerce companies are adopting this model while
deciding the retailer to deliver the merchandize at your doorsteps.
Illustration of Transportation
Suppose an auto company has three plants in cities A, B and C and three major
warehouses in D, E and F. The capacities of the three plants during the next quarter are
1000, 1500 and 1200 cars. The quarterly demand of the three warehouses is 2000, 1000
and 700 cars respectively. The transportation costs (which depend on the mileage,
transport company etc.) between the plants and the warehouses is as follows:
Cost Table Warehouse D Warehouse E Warehouse F
Plant A 80 215 147

Plant B 100 108 104
Plant C 102 68 85
Solution:
Cost Table Warehouse D Warehouse E Warehouse F Plant Capacity
Plant A 80 215 147 1000

Plant B 100 108 104 1500
Plant C 102 68 85 1200
Warehouse
2000 1000 700
demand
Let’s calculate the difference between best and the second best options.
Cost Table Warehouse Warehouse Warehouse Plant Row

D E F Capacity Difference
Plant A 80 215 147 1000 67
Plant B 100 108 104 1500 4
Plant C 102 68 85 1200 17
Warehouse
2000 1000 700
demand
Column
20 40 19
Difference
As the cost of not choosing the best option is highest in case of Plant A, we’ll allocate the
production of Plant A to the lowest cost warehouse D.
Cost Table Warehouse Warehouse Warehouse Plant Second stage

D E F Capacity Row
Difference
80 215 147 Capacity Not
Plant A
(1000) (Nil) (Nil) Over Applicable
Plant B 100 108 104 1500 4
Plant C 102 68 85 1200 17
Warehouse
1000 1000 700
demand
Column Difference 20 40 19
As the capacity of Plant A is over, we’ll omit Plant A and repeat the steps.

D E F Capacity Row
Difference
Plant A
Plant B 100 108 104 1500 4
Plant C 102 68 85 1200 17
Remaining
Warehouse 1000 1000 700
demand
Second stage
2 40 19
Column Difference
As the cost of not choosing the best option is highest in case of warehouse E, we’ll allocate
the production to warehouse E from the lowest cost Plant C.

D E F Capacity Row
Difference
Plant A
Plant B 100 108 104 1500 4
68 17
Plant C 102 85 1200
(1000)
Remaining
Demand
Warehouse 1000 700
Over
demand
Second stage Not
2 19
Column Difference Applicable
As the capacity of demand of warehouse E is over, we’ll omit warehouse E and repeat the
steps.
Cost Table Warehouse Warehouse Warehouse Plant Third stage
D E F Capacity Row
Difference
Plant A
Plant B 100 108 104 1500 4
68 17
Plant C 102 85 1200
(1000)
Remaining
Demand
Warehouse 1000 700
Over
demand
Third stage Not
2 19
As the cost of not choosing the best option is highest in case of warehouse F, we’ll allocate
the production to warehouse F from the lowest cost Plant C.

D E F Capacity Row
Difference
Plant A
Plant B 100 108 104 1500 4
68 85 Capacity Not
Plant C 102
(1000) (200) Over Applicable
Remaining
Demand
Warehouse 1000 500
Over
demand
There is There is
Third stage Not
only one only one
option left option left
Allocating the remaining production to remaining demand.

D E F Capacity Row
Difference
Plant A
100 104 Capacity 4
Plant B 108
(1000) (500) Over
68 85 Capacity Not
Plant C 102
(1000) (200) Over Applicable
Remaining
Demand Demand Demand
Warehouse
Over Over Over
demand
There is There is
Third stage Not
only one only one
option left option left
Therefore, the total cost of distribution will be
= 80 x 1000 (from plant A to warehouse D)
+ 100 x 1000 (from plant B to warehouse D)
+ 104 x 500 (from plant B to warehouse F)
+ 68 x 1000 (from plant C to warehouse E)
+ 85 x 200 (from plant C to warehouse F)
= 3,17,000
3.11 Network Techniques in Management
Critical Path Method / Critical Path Analysis
What can CPA / CPM give?
Critical Path Analysis offers several advantages. It
(a) Forces a through pre-planning. Each and every activity comprising the project is
identified and recorded. Nothing is left to memory or chance which prevents crises in
scheduling.
(b) Increases co-ordination of tasks as technological relationships between the activities
suggest which activities can run simultaneously and which activities should succeed which
others.
(c) Helps computation of different project durations for different level of resources and
thereby select a plan that minimizes total project costs.
(d) Indicates optimal start and finish times for each activity of the project.
(e) Defines areas of responsibility for different departmental heads for timely execution of
the project.
(f) Facilitates progress reporting and limits unnecessary discussions at the progress
meetings to a minimum.
viii. Identifies trouble spots often in advance and apply remedial measures.
ix. Enables the plan to be revised in accordance with changed/changing circumstances.
x. Helps to exercise “control by exception” and prevent cost over runs.
Network Logic
(a) An activity
An activity represents a task and has a definite beginning and a definite end. An activity is
represented by an ‘Arrow’ ()
(b) An event represents the start or the completion of the task. An event is graphically
represented by a circle.
(c) Activity relationships
A project is made up of various activities which are interrelated.
To construct a network, the project is first torn into its activities and then technological
relationships between the activities are established.
(d) Dummy Activities
A fundamental convention used in drawing the network is that one activity must follow
another. A “dummy activity” in some situations is used to avoid ambiguities or illogicalities.
Step In The Use Of Critical Path Analysis

1. Breaking down a project into a set of identifiable activites.
2. Establishing technological relationship between activities.
3. Making of an arrow diagram called network :
4. Estimating time of the activites
PERT (The Program (or Project or Progress) Evaluation and Review Technique)
concept of multiple times
One major difference between PERT and CPM is the formers adoptability for the projects
where high degree of uncertainty prevails and hence activity duration during performance is
expected to very considerably for certain activities.
The concept of three time estimate was evolved to reduce the extent of uncertainty.
The above mentioned three time estimate suggests:

i. Optimistic time (a) - This indicates the minimum time an activity can take if everything
goes smoothly without any interruptions. The chances that such a time could even be
shorter. The optimistic time is represented by ‘a’.
ii. Pessimistic time (b) - This indicates the minimum time an activity can take if everything
goes wrong in a sort of catastrophe. The chances that this time could even be longer
should be one in hundred or less. Pessimistic time is denoted by ‘b’.
iii. Most likely time (m) - This indicates the time an activity can take most often if it is
repeated again and again under the same conditions. Most likely time is denoted by ‘m’.
Three time estimates are not directly entered into the network. They are transformed
into an expected time, te, using the statistical relation given below:
Identifying critical path, critical activities and slack of activities.
Earliest event time (Te)
Earliest event time represents the earliest possible occurrence time of the event. This gives
the earliest possible start time of the activities emanating from the event.
Latest event times TL

Latest event time TL represents the latest occurrence time of the event. The following
simple rules govern the computation of the latest event time:
Analysis of activity durations
Mere computation of event time is not sufficient. Equally important is the task of
establishing is the date at which each activity should start and end to maintain:
Earliest starting date (ES)

The network logic indicates than an activity cannot commence until its preceding event is
completed. This implies that the earliest start time of an activity equals earliest event time
(Te) of the tail event.
Determination of float or flexibility available for an activity
Total float
Total float of the activity implies the excess of available time over its duration.
F t = LF – EF.
Total float of an activity is calculated as follows:
Total float = Latest event time of the head event

Minus Earliest event time of the tall event
Minus Activity duration.
Free float
Free float refers to that portion of total float within which an activity can be manipulated
without affecting the float of succeeding activities.
Free float can be obtained as under:
Free float = Earliest event time of head event

Minus Earliest event time of tail event
Minus Activity duration
Illustration of PERT
Activity Optimistic Most likely Pessimistic Tail Head

Time Time Time Event Event
a m b
A 6 8 10 1 2
B 3 5 7 4 5
C 7 9 11 4 7
D 1 3 5 2 3
E 5 7 9 5 6
F 2 4 6 7 6
G 1 2 3 3 8
H 4 6 8 6 8
Draw the network diagram and show the critical path.

Calculate the free float & total float of each activity.
Solution:
Project duration: 19 Weeks
Activity Time Total Float Free Float

Estimate HTL – TTE - Te HTE – TTE - Te
A 8 14 – 0 – 8 = 6 8–0–8=0
B 5 6–0–5=1 5–0–5=0
C 9 9–0–9=0 9–0–9=0
D 3 17 – 8 – 3 = 6 11 – 8 – 3 = 0
E 7 13 – 5 – 7 = 1 13 – 5 – 7 = 1
F 4 13 – 9 – 4 = 0 13 – 9 – 4 = 0
G 2 19 – 11 – 2 = 6 19 – 11 – 2 = 6
H 6 19 – 13 – 6 = 0 19 – 13 – 6 = 0
3.12 Resources Allocation & Loading smoothening
The first step in resource management is to decide exactly what resources are
considered important enough to be managed. While the most resource used is
people or workers (such as welders or carpenters), it may also include other
resources such as machines (such as an excavator or loader), space on a project
where space is restricted and where this restriction limits the amount of other resources
which can be deployed at any one time, financial resources (money) that are
needed to perform the required work, or materials needed to accomplish different
activities. Generally, a resource can be defined as anything (labor, equipment, material,
money, etc.) that is needed to have the work done.
Often resources are specified in terms of the number of units of resource required, e.g., 5
welders or 3 computer programmers. Alternatively, resources may be specified in
terms of the hours or days that a specific resource is required, e.g., 40 welder-hours or
24 man-days.
Resources may be considered as consumable, such as materials that may be used once
and once only, or non-consumable, such as people, which may be used again and again.
The way in which consumable resources are used is not critical as long as they are
used efficiently. However, the way in which non-consumable resources are used can
have a significant impact on the project.
Resource management is therefore mainly concerned with non-consumable resources.
Also, resources may be classified according to their importance to key resources,

secondary resources and general resources. Key resources are the most important,
expensive and non-available resources in the project such as skilled labors, or equipment.
These types of resources will have a great attention in the resource scheduling process.
Secondary resources are those resources which have no constraints on their
availability, such as normal labor. General resources are defined as those resources
that are used by all or most of the activities on the project such as site
overheads. General resources will not be included in the resource
management plans.
The most important resources that project managers have to plan and manage on
day-to-day basis are people, machines, materials, and money.
Obviously, if these resources are available in abundance then the project could be
accelerated to achieve shorter project durations. On the other hand, if these resources
are severely limited, then the result more likely will be a delay in the project
completion time. In general, from a scheduling perspective, projects can be classified as
either time constrained or resource constrained.
Resource leveling (smoothing)
A project is classified as time constrained in situations where the project completion time
cannot be delayed even if additional resources are required. However, the additional
resource usage should be no more than what is absolutely necessary. Accordingly,
the primary focus, for the purposes of scheduling, in time constrained projects is to
improve resource utilization. This process is called resource leveling or smoothening. It is
applicable when it is desired to reduce the hiring and firing of the resources and to smooth
the fluctuation in the daily demand of a resource, as shown in the figure. In this case,
resources are not limited and project duration is not allowed to be delayed. The objective
in this case is to shift non-critical activities of the original schedule, within their float
times so that a better resource profile is achieved.
On the other hand, a project is resource constrained if the level of resource availability
cannot be exceeded. In those situations where resources are inadequate, project delay is
acceptable, but the delay should be minimal. The focus of scheduling in these situations is
to prioritize and allocate resources in such a manner that there is minimal project delay.
However, it is also important to ensure that the resource limit is not exceeded and the
technical relationships in the project network are respected.
Resource Allocation
Resource allocation, also called resource loading, is concerned with assigning the
required number of resources identified for each activity in the plan. More than one type of
resource may be assigned to a specific activity. For example, fixing steel plates on a bridge
deck may require different types of resources such as: welders, laborers and a
certain type of welding machine. From a practical view, resource allocation does not
have to follow a constant pattern; some activities may initially require fewer
resources but may require more of the same resources during the later stages of the
project.
After each activity has been assigned its resources, the next step is to aggregate
the resources used by all activities. Resource aggregation is simply the summation, on
a period-by-period basis, of the resources required to complete all activities based on the
resource allocation carried out previously.
The results are usually shown graphically as a histogram. Such aggregation may be done
on an hourly, daily, or weekly basis, depending on the time unit used to allocate
resources. When a bar chart is used, the resource aggregation is fairly
simple and straightforward. For a given bar chart, a resource aggregation chart can be
drawn underneath the bar chart. However, a separate graph will be required for each
resource type.
An example is shown in figure, where, for a particular resource, the required resource units
for each time period are written on the bar chart. The total number of resource units for
each time period can then be summed and a resource aggregation or load chart can
be produced as presented underneath the bar chart. Thus, having a project scheduling
is necessary to facilitate the bar chart drawing.
The non-critical activities, activities which are not on the critical path, do not have fixed
starting and finishing times but are constrained by the earliest and latest starting and
finishing times. This situation offers the planner chance for adjusting the demand for
resources. The figure illustrates a situation, which shows the resource aggregation when
the activities scheduled on their early times and late times. It can be seen that the
resource requirements that arise when both earliest and latest start times are
considered are different. The shaded area represents the resources required by the
critical activities, as these activities have a fixed position because their early times
equal their late time. The figure shows, also, the accumulation of resources at the
beginning of the project when the activities scheduled on their early times. On the other
hand, the resources accumulate at the end of the project when the activities scheduled on
their late times.
Resource Leveling (Smoothing)
As shown in the figure, the problem of resource fluctuation appears after the initial
scheduling of the project without considering the resources. The peaks and valleys in
the resource profile indicate high day-to-day variation in the resource demand.
Resource smoothing is the process that attempts to determine a resource requirement that
is "smooth" and where peaks and valleys are eliminated. For example, even if 7 units of
a given resource are available at any one time, utilizing 5 of these units each week is
preferable than using 4 units for the first week, 7 the next, 2 the next and so on. Even if
there is no limit to the amount of any one resource available, it is still desirable that
resource usage is as smooth as possible. Given that the resource requirements of those
activities on the critical path are fixed, some order or priority needs to be established for
selecting which activity and which particular resource associated with this activity
should be given priority in the smoothing process.
Resource leveling shifts non-critical activities within their float times so as to move
resources from the peak periods (high usage) to the valley periods (low usage), without
delaying the project (i.e., area underneath the resource profile remains constant).
Usually, project managers may prefer having a desired resource profile in which the
resource usage starts with low values and then the resources are built up until its
maximum values reached and then it starts to decrease as the project approaches its end
as shown in the figure.
Proper attention to resource allocation and load smoothening is necessary to avoid
disruption in the operations. This is necessary to retain the commitment of vital resources
like skilled workers and specialized ancillary units. To achieve this objective, many
seasonal businesses resort to diversification or production accumulation.
3.13 Operational Sales Forecasting
A large number of business activities depend upon projection of future, namely:

1. To forecast future call-off against finished goods inventory and to smoothen out
the imbalances between production and sales.
2. To schedule production activity so that the customer's orders and stock orders are filled
at the least cost and with the best utilization of plant and machinery.
3. To convert future manufacturing needs into materials schedules so that the materials
are ordered and received on time.
4. To assess requirement of shop capacity so that shortfall, if any, can be provided for.
5. To forecast the requirements of ancillary units to meet its future needs of materials,tools,
bought out items, parts, supplies etc.
6. To conduct its recruitment and training activity so that trained manpower can be made is
available in the quantities and at the time required.
To rationalize the decision making process in the above mentioned areas, some kind of
sales forecast is a must.
(b) Moving Average Method:

Moving average is a simple statistical method to establish and extrapolate trend of past
sales. The method makes use of old data and computes a rolling average for a constant
number of periods. It discards old figures as new ones come in. i. e. fresh average is
computed at the end of each period by adding the demand of the most recent period and
omitting the demand of the oldest period. Since the data used in this method changes from
period to period, hence the expression “moving average" is used.
Selection of the period of moving average requires a great amount of care. An inappropriate
period can distort the-data there by giving wrong picture of the trend.
This method can be used only for short term forecasting.
An illustration on moving average (when n is odd):

The data given below represents the sales figures of a company for the last 12 months of
the year 2015.
Month Sales (Rs.00)

Jan. 410
Feb. 560
Mar 480
Apr. 500
May 640
June 510
July 710
Aug. 800
Sept 820
Oct 909
Nov. 860
Dec. 950
(i) Calculate three months moving average ignoring decimal values.
(ii) Forecast the demand for the month of January 2016.
(iii) If the actual demand in the month of Jan 2016 is 857 nos, what shall be the forecast
for the month of Feb 2016?
Solution:
(i) Three months moving average:
Table shows the calculations of three months moving average. The table is self-
explanatory.
Table: Calculation of 3 months moving average
Month Sales (Nos) 3 months moving average
Moving total Moving average
Jan. 410
Feb 560
Mar. 480 1450 483
Apr 500 1540 513
May 640 1620 540
June 510 1650 550
July 710 1860 620
Aug. 800 2020 673
Sept. 820 2330 777
Oct. 909 2529 843
Nov. 860 2589 863
Dec. 950 2719 906
* Decimal values are ignored.
(ii) Forecast for the month of January 2016
As the secular trend for the month of Jan. 2016 is not known hence the forecast for
month shall equal the last moving average of 906 nos.
(iii) Forecast for the month of Feb. 2016 :

Forecast for the average of the three months of Feb. 2010 = immediate months
preceding the month of Feb.
Figure of the Demand Demand
last moving + figure of - figure of
= total Jan. 2010 Nov. 2009
3
=2719 + 857 - 906
3
= 890
 Forecast for the month of Feb 2010 = 890
Regression Analysis
Another well-known terminology for "Regression Analysis" is the method of least squares.
Regression analysis is the mathematical method of obtaining the "line of best fit
relationship" between a dependent variable and a single independent variable. It eliminates
the need to draw a graph to extrapolate a trend. The line of best fit is obtained by
computing parameters of the straight line from the use of statistical formulae.
In a simple linear regression, the relationship between the dependent variable (y) and some
independent variable (x) can be represented by a straight line,
y = a +bx.
The value of the constants, a and b, are obtained from the following two simultaneous
equations:
∑y = na + b∑x
∑xy = a∑x + b∑x2
Thereby giving the value of ‘a’ and ‘b’ as under
Illustration of Regression Analysis

Historical data on the sale of tractors of company for the year2009 to 2015 is given below.
Year Sales
2009 3286
2010 4751
2011 5867
2012 4580
2013 5020
2014 8444
2015 11072
Using regression analysis technique

(a) Establish the equation of the straight line satisfying the historical data.
(b) Find the trend values for these values.
(c) Project the forecast for the year 2016.
Solution:
As the years are serially appearing, it would be easier if we convert the actual year into year
count.
Actual Year Sale of Tractors Square of Product of x
Year Count deviation and y
x y x2 xy
2009 1 3286 1 3286
2010 2 4751 4 9502
2011 3 5867 9 17601
2012 4 4580 16 18320
2013 5 5020 25 25100
2014 6 8444 36 50664
2015 7 11072 9 77504
2
n=7 ∑x= ∑ y = 43,020 ∑ x = 140 ∑ xy = 201977
28
Substituting these values in the equations, we get:

b = 1067.8 and a = 1874.7
 The equation of the line of best fit is
y = 1874.7+ 1067.8 x
By putting x = 1,2,3,4,5,6,7 in this equation we obtain the trend values as under.

Year x Trend values = 1874.7 +
1067.8x
2003 1 2942
2004 2 4010
2005 3 5078
2006 4 6146
2007 5 7214
2008 6 8281
2009 7 9349
From the above equation, the projection of forecast for the year 2010 will be 10417
Illustration 2 of Regression Analysis

Many a times, the sale of a commodity does not depend on time factor but is effected by one
of the economic factors. Linear regression method may be used here too to extrapolate the
trend. We present an illustration to explain the concept:
A company manufacturing TV sets find that there exists a relationship between the
population and sale of TV sets in the city. The following data has been collected:
Population of the city (in
15 22 25 36 42
lakhs)
No.of TVs demanded (in
65 80 96 130 185
thousands)
Fit a linear regression equation and estimate the demand for TVs for a city with a
population of 60 lakhs.
Solution:
Population of No.of TVs demanded Square of the Product of the

the city (in (in hundreds) population population and number
lakhs) of TVs demanded
(x) (y) (x2) (xy)
15 65 225 975
22 80 484 1760
25 96 625 2400
36 130 1296 4680
42 185 1764 7770
∑ x = 140 ∑y = 556 ∑ x2 = 4394 ∑xy = 17585
Regression equation of demand (y) on the economic indicator (population x) = y = a + bx

The values of the constants can be calculated from the following two simultaneous
equations:
∑ y = na + b∑x … (i)
∑xy = a∑x + b∑x2 … (ii)
Substituting the values from the table,

b = 4.2553
By substituting the values of ‘b’ in equation (iii) we get
A = -7.9477
By substituting the values of ‘a’ and ‘b’ in the regression equation of y on x, we get
y = -7.9477 + 4.2553x
Now the demand for TVs in a city with a population of 60 lakhs will be 24,752 nos. obtained
by putting the value of x = 60 in the above regression equation:
y = -7.9477 + 4.2553 x 60
= 247.52 hundreds
 The expected demand of TVs in a city with a population of 60 lakhs is 24,752 sets.
In such forecasting, the forecasting of the population may be dependent upon the time
series.
3.14 Works Study - Job Evaluation & Merit Rating
To survive in the current competitive and global environment, it is important for any
organization to continuously look at ways to improve efficiency and enhance productivity. If
you don’t, someone else will, and your business will be wiped out from the market. The
businesses need to discover new, easy and cost-effective ways of manufacturing to remain
in the game.
Work study and industrial engineering play important roles in job design, job simplification,
job enrichment, value analysis/engineering, method analysis, and operational analysis.
Industrial engineering deals with design, enhancement and setting up of engineering
systems minimize employees’ efforts and maximize their productivity.
Work Study – Time Study and Method Study
Time study is a direct and continuous observation of a task, using timekeeping devices
(e.g., decimal minute stopwatch, computer-assisted electronic stopwatch, and videotape
camera) to record the time taken to accomplish a task. This technique is often used where:
o repetitive work cycles operation are involved,

o wide variety of dissimilar work is performed, or
Time study is defined as "a work measurement technique consisting of careful time
measurement of the tasks with a time measuring instrument, adjusted for any observed
variance from normal effort or pace and to allow adequate time for such items as foreign
elements (outside of operator’s control), unavoidable or machine delays (break downs), rest
to overcome fatigue, and personal needs."
The application of science to tackle business problems, and the use of time-study was
pioneered by Frederick Taylor. At its most basic level time studies involve breaking down
each job into component parts or measurable elements. Timing each element and then
rearranging the elements to synthesize efficient methods of working. By measuring and
modifying the elements, Taylor wanted to transform the way management was done in
those days.
Taylor placed his emphasis on the content of a fair day’s work, and sought to maximize
productivity irrespective of the physiological cost to the worker.
Work study uses the techniques like time study and method study to understand human
work potential in terms of the time spent on completing a task, looking at ways to make the
task simpler and easy to do, so as to increase the productivity and efficiency. Work study is
used to find the means of increasing on-job performance of the employees, make optimum
use of the plant and machinery, and standardize the operating procedures. Therefore, work
study involves:
 Scientific and controlled analysis of the existing methods of operation.

 Measuring performances of mentally and the physically sound operators, and setting
that performance as the standard for performance measurement of other operators.
For an organization, productivity can be increased over a period of time, if workers are
trained to be efficient and focused on the organization’s goals.
The advantages of work study are:
 Increase in efficiency.
 Optimum utilization of resources.
 Efficient flow of material and products.
 Efficient handling of material with optimum layout.
 Increased profitability.
 Increased morale of workers with an increase in safety and efficiency.
 Availability of benchmarks help the organization in setting performance targets for
the organization.
 Better job satisfaction and incentive planning.
Method Study is a scientific process for a better job design. It studies the existing job
processes through slow motion videography. It tries to eliminate unnecessary elements or
movements from the operation and propose job processes which are efficient and cost
effective.
Method study ensures that there is an increase in overall productivity and profitability of the
organization. Method study involves following procedures:
 Selection of work to be studied.

 Recording the present method.
 Critical examination of the facts.
 Development of most practical, economic and effective alternative method.
 Installation of new method.
 Maintenance of new method
Industrial Engineering
Industrial engineering is a branch of engineering which deals with the optimization of

complex processes, systems or organizations. Industrial engineers work to eliminate waste
of time, money, materials, man-hours, machine time, energy and other resources. Industrial
Engineers try to figure out how to do things better, to improve quality and productivity.
Industrial engineering is concerned with the development, improvement, and

implementation of integrated ecosystem of people, money, knowledge, information,
equipment, energy, materials, involving mathematics and social sciences together with the
principles of engineering design to specify, predict, and evaluate the systems or processes
for maximizing benefits to the organization and imparting maximum safety to the employees
and the property.
Industrial engineering is concerned with developing the most effective and efficient way to
use the plant, people, machinery and materials. The main objectives of industrial
engineering are as follows:
 To increase productivity without incurring the incremental costs.

 To encourage automation as to decrease human intervention.
 To develop efficient and effective operation work cycle.
Industrial engineering involves ergonomic studies for maximizing operator’s convenience

and comfort while using the machineries. It involves layout studies for eliminating material
handling and automation of repetitive and error prone operations.
Merit Rating
Merit Rating is also known as performance appraisal or performance evaluation. It is a

systematic process for measuring the performance of the employees in terms of job
requirements.
It utilizes various rating techniques for comparing individual employees in a work group in
terms of personal qualities or deficiencies and the requirements of their respective jobs. It is
an established fact that people differ in their abilities and aptitudes. These differences are
natural to a great extent and cannot be eliminated even by providing same training and
education facilities to them.
There will be some differences in the quality and quantity of work done by different workers
even on the same job. Therefore it is essential for the management to know these
differentials so that employees having better abilities may be rewarded and the wrong
selection and placement maybe restricted or avoided.
Concepts and Definitions of Merit Rating:
According to Scot and Spriegel, "Merit-rating of an employee is the process of evaluating

the employee's performance on the job in terms of the requirements of the job". It is a
technique of assessing the worth of an employee with reference to job requirements.
According to Dale Yodder, "Refers to all formal procedures used in working organizations to
evaluate personalities and contribution and potential of group members". In the words of
Yodder all types of methods used in evaluating the worth of employees for the organization
are termed as performance appraisal.
In views of Alford and Beaty,"Employees rating is the evaluation or appraisal or the relative
worth to the company of a man's services on his job". According to his definition the
contribution of employees on jobs and their usefulness to the company is assessed under
performance appraisal.
Thus according to the above mentioned definitions merit-rating or performance appraisal is

a systematic evaluation of employees’ contribution to the organization in performance of
their jobs. This evaluation is normally done by the immediate superior in the organization
which is reviewed in turn by his superior. Not only the qualities, but deficiencies are also
taken into consideration to improve the performance of employees.
Objectives of Merit Rating

People differ in abilities and aptitudes. Management should know these differences so that
employees are assigned jobs according to their capability.
Main objectives of merit rating are as follows:
1. To assess the work of employees in relation to their job requirements.

2. To consider employees/workers for promotions, transfer, layoffs etc.
3. To assess the good and bad points in working of employees and then making
suggestions for improvement.
4. To help in wage and salary administrations and taking decisions about incentives and
increments to be given to the workers.
5. To evaluate skill and training capabilities of employees and helping in planning suitable
training and development programs for workers.
6. To know the problems faced by workers while doing various jobs.
7. To provide a basis for comparison to segregate efficient and inefficient workers.
8. To help management in placement/transfer to workers according to their capacity,
interest, aptitude and qualifications.
9. To help supervisors to know their subordinates more closely for increasing their
efficiency and improving productivity
3.15 Total Quality Management
Total Quality Management, TQM, describes a management approach to long-term success
through customer satisfaction. In a TQM effort, all members of an organization participate in
improving processes, products, services, and the culture in which they work.
Total Quality Management Principles: The 8 Primary Elements of TQM
Total quality management can be summarized as a management system for a customer-

focused organization that involves all employees in continual improvement. It uses strategy,
data, and effective communications to integrate the quality discipline into the culture and
activities of the organization. Many of these concepts are present in modern Quality
Management Systems, the successor to TQM. Here are the 8 principles of total quality
management:
1. Customer-focused - The customer ultimately determines the level of quality. No matter

what an organization does to foster quality improvement—training employees, integrating
quality into the design process, upgrading computers or software, or buying new measuring
tools—the customer determines whether the efforts were worthwhile.
2. Total employee involvement - All employees participate in working toward common

goals. Total employee commitment can only be obtained after fear has been driven from
the workplace, when empowerment has occurred, and management has provided the
proper environment. High-performance work systems integrate continuous improvement
efforts with normal business operations. Self-managed work teams are one form of
empowerment.
3. Process-centered - A fundamental part of TQM is a focus on process thinking. A process

is a series of steps that take inputs from suppliers (internal or external) and transforms them
into outputs that are delivered to customers (again, either internal or external). The steps
required to carry out the process are defined, and performance measures are continuously
monitored in order to detect unexpected variation.
4. Integrated system - Although an organization may consist of many different functional

specialties often organized into vertically structured departments, it is the horizontal
processes interconnecting these functions that are the focus of TQM.
Micro-processes add up to larger processes, and all processes aggregate into the business
processes required for defining and implementing strategy. Everyone must understand the
vision, mission, and guiding principles as well as the quality policies, objectives, and critical
processes of the organization. Business performance must be monitored and
communicated continuously.
An integrated business system may be modeled as per ISO 9000 standards. Every
organization has a unique work culture, and it is virtually impossible to achieve excellence
in its products and services unless a good quality culture has been fostered. Thus, an
integrated system connects business improvement elements in an attempt to continually
improve and exceed the expectations of customers, employees, and other stakeholders.
5. Strategic and systematic approach - A critical part of the management of quality is the
strategic and systematic approach to achieving an organization’s vision, mission, and goals.
This process, called strategic planning or strategic management, includes the formulation of
a strategic plan that integrates quality as a core component.
6. Continual improvement - A major thrust of TQM is continual process improvement.
Continual improvement drives an organization to be both analytical and creative in finding
ways to become more competitive and more effective at meeting stakeholder expectations.
7. Fact-based decision making - In order to know how well an organization is performing,

data on performance measures are necessary. TQM requires that an organization
continually collect and analyze data in order to improve decision making accuracy, achieve
consensus, and allow prediction based on past history.
8. Communications - During times of organizational change, as well as part of day-to-day

operation, effective communications plays a large part in maintaining morale and in
motivating employees at all levels. Communications involve strategies, method, and
timeliness.
These elements are considered so essential to TQM that many organizations define them,
in some format, as a set of core values and principles on which the organization is to
operate. The methods for implementing this approach come from the teachings of such
quality leaders as Philip B. Crosby, W. Edwards Deming, Armand V. Feigenbaum, Kaoru
Ishikawa, and Joseph M. Juran.
ISO 9000
ISO 9000 is a family of standards for quality management systems. ISO 9000 is maintained
by ISO, the International Organization for Standardization and is administered by
accreditation and certification bodies. The rules are updated, the time and changes in the
requirements for quality, motivate change. In September 2015 changes were made to the
requirements of ISO 9001 and published as ISO 9001:2015.
Some of the requirements in ISO 9001 (which is one of the standards in the ISO 9000
family) include
A set of procedures that cover all key processes in the business
 monitoring processes to ensure they are effective;

 keeping adequate records;
 checking output for defects, with appropriate and corrective action where necessary;
 regularly reviewing individual processes and the quality system itself for effectiveness;
and
 facilitating continual improvement
A company or organization that has been independently audited and certified to be in

conformance with ISO 9001 may publicly state that it is "ISO 9001 certified" or "ISO 9001
registered". Certification to an ISO 9001 standard does not guarantee any quality of end
products and services; rather, it certifies that formalized business processes are being
applied.
Although the standards originated in manufacturing, they are now employed across several
types of organizations. A "product", in ISO vocabulary, can mean a physical object,
services, or software.
Summary of ISO 9001:2015
Risk management based on a “risk-based thinking” approach has become fundamental in

the ISO 9001:2015 standard. Quality results from proper management of these risks.
Quality cannot exist unless the organization can provide its client a conforming product or
service over the long term. Risk also has its counterpart, opportunity. The ISO9001:2015
standard also embraces the concept of positive uncertainty.
As such, the process approach and PDCA (plan-do-check-act) remain two essential pillars
of ISO 9001:2015 standard.
Managing risk also means working towards continuous improvement. Corrective action
corresponds to an unidentified, wrongly qualified or mismanaged risk and preventive action
addresses a risk of possible but un-occurred noncompliance.
The salient features of ISO 9001:2015 are as follows.
o The quality policy is a formal statement from management, closely linked to the
business and marketing plan and to customer needs. The quality policy is
understood and followed at all levels and by all employees. Each employee needs
measurable objectives to work towards.
o Decisions about the quality system are made based on recorded data and the
system is regularly audited and evaluated for conformance and effectiveness.
o Records should show how and where raw materials and products were processed,
to allow products and problems to be traced to the source.
o You need a documented procedure to control quality documents in your company.
Everyone must have access to up-to-date documents and be aware of how to use
them.
o To maintain the quality system and produce conforming product, you need to provide
suitable infrastructure, resources, information, equipment, measuring and monitoring
devices, and environmental conditions.
o You need to map out all key processes in your company; control them by monitoring,
measurement and analysis; and ensure that product quality objectives are met. If
you can’t monitor a process by measurement, then make sure the process is well
enough defined that you can make adjustments if the product does not meet user
needs.
o For each product your company makes, you need to establish quality objectives;
plan processes; and document and measure results to use as a tool for
improvement. For each process, determine what kind of procedural documentation is
required (note: a “product” is hardware, software, services, processed materials, or a
combination of these).
o You need to determine key points where each process requires monitoring and
measurement, and ensure that all monitoring and measuring devices are properly
maintained and calibrated.
o You need to have clear requirements for purchased product.
o You need to determine customer requirements and create systems for
communicating with customers about product information, inquiries, contracts,
orders, feedback and complaints.
o When developing new products, you need to plan the stages of development, with
appropriate testing at each stage. You need to test and document whether the
product meets design requirements, regulatory requirements and user needs.
o You need to regularly review performance through internal audits and meetings.
Determine whether the quality system is working and what improvements can be
made. Deal with past problems and potential problems. Keep records of these
activities and the resulting decisions, and monitor their effectiveness (note: you need
a documented procedure for internal audits).
o You need documented procedures for dealing with actual and potential non-
conformances (problems involving suppliers or customers, or internal problems).
Make sure no one uses bad product, determine what to do with bad product, deal
with the root cause of the problem and keep records to use as a tool to improve the
system.
Certification
ISO does not itself certify organizations. Many countries have formed accreditation
bodies to authorize certification bodies, which audit organizations applying for ISO 9001
compliance certification. Although commonly referred to as ISO 9000:2000 certifications,
the actual standard to which an organization's quality management can be certified is
ISO 9001:2000. Both the accreditation bodies and the certification bodies charge fees
for their services. The various accreditation bodies have mutual agreements with each
other to ensure that certificates issued by one of the Accredited Certification Bodies
(CB) are accepted worldwide.
The applying organization is assessed based on an extensive sample of its sites,

functions, products, services and processes; a list of problems ("action requests" or
"non-compliances") is made known to the management. If there are no major problems
on this list, or after it receives a satisfactory improvement plan from the management
showing how any problems will be resolved, the certification body will issue an ISO 9001
certificate for each geographical site it has visited.
An ISO certificate is not a once-and-for-all award, but must be renewed at regular
intervals, usually around three years and recommended by the certification body only
after it is convinced of the conformance to the provisions of the ISO standards.
ISO 9000 requires following six mandatory procedures
Appointment of a Management Representative - A senior person belonging to the

senior management is appointed as a Management Representative (MR). The MR is a
liaison officer between the top management and the rest of the organization. He
oversees the conformance to the six mandatory procedures mentioned below.
Control of documents – To avoid usage of unauthorized or outdated procedures, the

department heads are required to maintain the controlled copies of the latest
procedures.
Control of records – The records which are generated while conducting the operations
are maintained on controlled forms and preserved for the period specified in the
controlled procedures.
Internal audit – Internal audits of the departments are conducted by the trained internal
auditors at the intervals specified in the controlled procedures. Whenever non-
conformities are observed by the auditors, suitable corrections are made on the
deviations and suitable corrective actions are taken to avoid its recurrence after
conducting a detailed root cause analysis of the deviations.
Control of nonconforming product - You may find a non-conformance in a service, a

product, or a process itself. It occurs when something does not meet the specifications
in some way or the other. Such a product should be released to the customer only after
removing the nonconformities. If it is not possible to remove the non-conformities, the
product should either be scrapped or destroyed, or may be released to the customer
with explicit permission of the customer vis-s-vis the non-conformity.
Corrective action – Whenever non-conformities are observed in the products and

services, a detailed root cause analysis of the deviations is done, and corrective actions
are taken to avoid its recurrence. The procedures are suitably amended to reflect the
corrective actions taken.
Preventive action – Sometimes non-conformities do not occur, but there are good
chances of something going wrong because of the flaws inherent in the process. Under
this situation, the action is taken to avoid the occurrence of non-conformities in future.
Such an action is called preventive action.
Management Review – Periodic reviews of the quality system’s performance are

conducted by the top management. The decisions which are necessary for adhering to
the customers’ expectations are taken in these meetings and responsibilities are
assigned various employees.
Any more is up to you. You must determine what further documentation is required in
your company for your Quality Management System to function effectively.
3.16 Maintenance Management
Many businesses are surprised to learn that significant maintenance amounts can be
saved by using right maintenance management methods in the right places. The impact
of random or inappropriate maintenance can certainly be felt in terms of the
deteriorating quality of products and services, increasing operating costs and shrinking
the bottom-lines. Therefore it makes sense to select the appropriate maintenance
policies for each asset.
Preventive maintenance
Preventive maintenance (also called planned maintenance or planned preventive

maintenance) is driven by time or event based triggering. Maintenance tasks that are
undertaken during PM’s are pre-determined based on a number of factors including
experience, age, manufacturer’s recommendations etc. It is assumed that a machine
component will degrade within a time period that is common for its type. Under a
preventive management approach, the relevant parts will be removed, replaced or
rebuilt on or before the expected failure point. For example, your engine oil in your car is
proactively replaced at 10,000 miles. Mean-time-between-failure (MTBF) statistics can
determine help optimize preventive maintenance management schedule to include
inspections, repairs and rebuilds.
The main issue with a preventive maintenance approach is that the way a machine is
used, how often it is used, as well as a number of other variables, directly impact the
operating life of the machine and its components. In many cases, parts are replaced
when there is no need. Therefore, this approach can sometimes result in unnecessary
maintenance. Unnecessary maintenance can become even more costly if the technician
causes collateral damage during the replacement.
Predictive maintenance or condition-based maintenance
Predictive maintenance is determined by the condition of equipment rather average or

expected life statistics. Essentially, this methodology tries to predict the failure before it
actually happens by directly monitoring the machine during normal operating condition.
In the car example above, rather than replacing the oil every 10,000 miles, using
predictive maintenance methodology, oil samples are taken at regular intervals and the
oil is replaced when it degrades beyond a certain point. This is called condition-based
maintenance. In many cases, when predictive analysis spots an issue, the repair can be
scheduled at a time that minimizes the impact on production.
A range of cost-effective tools can be used within a predictive maintenance program to

analyze system performance and produce accurate factual data about pivotal systems,
so that maintenance activities can be undertaken the moment they are needed.
Improvements in quality, profitability and productivity can result when predictive
maintenance is used on capital-intensive assets.
Computerized maintenance management system (CMMS)
A CMMS software package maintains a computer database of information about an

organization’s maintenance operations, i.e. CMMIS – computerized maintenance
management information system. This information is intended to help maintenance
workers do their jobs more effectively (for example, determining which machines require
maintenance and which storerooms contain the spare parts they need) and to help
management make informed decisions (for example, calculating the cost of machine
breakdown repair versus preventive maintenance for each machine, possibly leading to
better allocation of resources). CMMS data may also be used to verify regulatory
compliance.
CMMS packages may be used by any organization that must perform maintenance on
equipment, assets and property. Some CMMS products focus on particular industry
sectors (e.g. the maintenance of vehicle fleets or health care facilities). Other products
aim to be more general.
CMMS packages can produce status reports and documents giving details or
summaries of maintenance activities. The more sophisticated the package, the more
analytical facilities are available.
Many CMMS packages can be either web-based, meaning they are hosted by the
company selling the product on an outside server, or LAN based, meaning that the
company buying the software hosts the product on their own server.
CMMS packages are closely related to computer-aided facility management packages

(also called facility management software).
SCADA
Supervisory control and data acquisition (SCADA) is a system for remote monitoring
and control that operates with coded signals over communication channels to acquire
information about the status of the remote equipment. It is a type of computer based
industrial control system (ICS) system that monitors and controls industrial processes.
SCADA systems can include multiple sites separated by large distances.
SCADA can be used in manufacturing, power generation, fabrication, refining, water

treatment and distribution, wastewater collection and treatment, oil and gas pipelines,
electrical power transmission and distribution, wind farms, civil defense siren systems,
and large communication systems, airports, ships, and air conditioning systems.
This system keeps on relaying the status of the machinery to the control room.
Depending on the reading of the parameters, for example – the temperature of the
bearing, the decisions on condition based maintenance is taken.
Management of Spares
Spare parts, are extra parts that are available in the proximity of a functional area, such as
an automobile, ship or an engine for carrying out their repairs.
Service parts management is an essential part of the maintenance management process to

ensure that right spare parts, consumables and other resources are available at the right
place at the right time.
Spare parts are sometimes considered as uneconomical because:
o the parts might never be used

o if stored for long, the parts might not be stored properly, leading to defects
o maintaining inventory of spare parts has associated costs
o parts may not be traceable when needed
In the absence of spares company's effective production capacity might drop. Therefore,
companies need to plan and maintain their service parts inventory and workforce to achieve
optimal machine availability.
Spare parts are the lifeblood of operational reliability and plant capacity. No plant can
operate at a high level of output without a reliable supply of functional spare parts. Spare
parts form the bedrock on which operational reliability is built and this requires appropriate
storage, treatment of, and timely access to the required parts. Yet, spare parts are also the
most overlooked contributor to reliability outcomes. Many companies routinely operate
without properly implementing even the most fundamental aspects of spare parts
management at their sites. Often these companies have storerooms with neat shelves and
clear labels but this is not enough for highly reliable spare parts management. To help
make a difference in company’s operational reliability there are certain guidelines to
improve its spare parts management.
1. Develop a Clear Cut Spare Parts Stocking Criteria
To stock or not to stock, that is the question. One of the major flaws in most spare parts
management systems is the absence of clear criteria on when to stock an item and when
not to stock an item. The absence of any guidelines forces your team into a process of ad
hoc and inconsistent decision making. The result of this is that you stock items that don’t
require stocking and don’t stock items (sometimes critical items) that you should stock. To
avoid this you need to develop and implement specific guidelines to aid decision making on
when to stock an item and when to not stock an item.
2. Provide Clear Guidelines on How Many Parts to Stock
Once you have established clear cut spare parts stocking criteria the next step is to
establish clear guidelines on how many of an item to stock. By developing and
implementing clear stocking guidelines you provide the logic for decision making on stock
levels and calculating reorder quantities. The advantage of this is that it provides guidance
to your team, continuity for decision making, and provides the basis for future audits of
inventory holdings.
3. Accept that Some Stock Outs are OK
One of the main fears of most reliability and maintenance engineers is that, at the time of
actual need, the required spare part will not be available. This is commonly referred to as a
stock outs. The stock outs can’t be eliminated without tying up massive amounts of money
in stocks, which would be better used elsewhere. Even that would not guarantee
elimination of all stock outs. This would possibly require holding multiple units of every part
in your plant. That’s why, accepting stock outs in areas where they have little or no impact
should be acceptable.
4. Review the Holdings of Critical Spare Parts
Classify the spares based on criticality and decide on their stocking policy.
5. Identify the Causes of Excess Spare Parts Inventory
The impact of not holding a required spare part can be massive. Downtime costs often far
outweigh the purchase and holding costs of spares and this can lead to holding far more of
some spares than is really required. Therefore, it is important to regularly review your
inventory and eliminate excess spare parts holdings.
6. Review the Storeroom Security
The importance of maintaining security around their spare parts inventories can’t be
ignored. There are good chances of high value maintenance spares of smaller sizes
vanishing without leaving any trace behind.
3.17 Line-of-Balance, Just-In-Time and Decision Theory
Line-of-Balance
One of the basic problem in a batch production is the control of' work-in-progress as it s
usual practice to let the work proceed in-discrete steps, from one operation to the next, after
the work is completed at each stage. The assembly normally does not start until all parts
are completed. The delivery schedules are often missed due to lack of information
regarding the desired progress to be made at different stages and inability to take action on
time. The line-of-balance technique was evolved to overcome this difficulty and provide an
effective instrument for co-ordination-among the key activities of a large number of
departments.
Application of Line-of-Balance
M/s. Rath Engineers engaged in the manufacture of water pumps has received a big
order from an automobile firm. The order is for 2800 pumps which is required to be
delivered according to the delivery schedule given in table below. The manufacturing
process comprises of nine distinct stages whose stage time relationships are given in next
table.
The order was received three months back and the delivery is to, commence from
Jan. this year. The management is keen to maintain the delivery schedule committed to the
customer.
(a) Prepare line-of-balance for each month to highlight the progress of work that
must take place in order to meet delivery schedule.
(b) What must be the progress of work at each stage at the end of Feb.?
(c) If the actual progress as on 1st March is as under, what corrective action do you
propose?
(A) Receipt of raw materials (castings) 1000 sets
(B) Receipt of raw materials (bar-stock) 1200 sets
(C) Receipt of raw materials (standard bought out parts) 1500 sets
(D) Receipt of made-to-order parts (springs etc.) 600 sets
(E) Manufacturing of water pump housings 800 sets
(F) Machining of water pump housings 1000 Nos.
(G) Assembly 500 Nos.
(H) Testing 500 Nos.
(I) Packing and Dispatch 400 Nos.
Delivery Schedule
Month Quantity to be delivered

January 200 Nos.
February 200 Nos
March 300 Nos
April 300 Nos
May 400 Nos
June 600 Nos
July 400 Nos
August 400 Nos
Stage time Relationships
Stage Description Time Depends on

(weeks) stage
1 Purchase of raw materials (castings) 4 --
2 Purchase of raw materials (Bar stocks) 2 --
3 Purchase of standard parts 1 --
4 Purchase of made-to-order parts 8 --
5 Machining of water pump housings 4 1
(Castings)
6 Machining of parts 2 2
7 Assembly 2 3,4,5 & 6
8 Testing 2 7
9 Packing and dispatch 1 8
Solution:
Stage Stage lead Equivalent weeks Period months Progress of the work
th
A time C D = C/4 through i stage at week 8
B
1 9 8+9=17 4.25 1100
2 7 8+7= 15 3.75 925
3 5 8 + 5 = 13 3.25 775
4 5 8 +5 = 13 3.25 775
5 5 8 +5 = 13 3.25 775
6 5 8 +5 = 13 3.25 775
7 3 8+3=11 2.75 625
8 1 8+ l = 9 2.25 475
9 0 8+0=8 2.00 400
Gantt chart, developed by an American Engineer, Henry L. Gantt, is a very useful aid in
loading and scheduling, dispatching and progressing.
The chart consists of a simple grid (chart) formed by a series of horizontal and vertical lines.
The vertical lines divide horizontal lines into small squares representing units of
measurement which may be days, weeks or months. The horizontal lines divide vertical
lines into sections which are used to represent either operations (job schedule) or to
represent work centers It is also called a load chart.
As mentioned in the preceding paragraph, the chart may be drawn to show at a glance the
scheduling of various operations involved in a job or it may be drawn to show work ahead of
each machine or work center with respect to time i.e. in days or weeks.
Just-In-Time (JIT)
What Is JIT?
Just-in-time (JIT) manufacturing, also known as just-in-time production or the Toyota

production system (TPS), is a methodology aimed primarily at reducing the flow times
within production as well as response times from suppliers and to customers. The idea of
Just-In-Time is, to produce and deliver finished goods just in time to be sold, make sub-
assemblies just in time to be assembled into finished goods, fabricate / purchase parts just
in time to go into sub-assemblies and procure raw materials just in time to be transformed
into fabricated parts.
JIT though cuts down drastically the inventory at different stages, yet it is not just a way to
reduce inventory; rather it is a means of solving problems that block the building of an
excellent manufacturing organization.
JIT thus aims at reduction (if not elimination) of the non-value-added activities (called
wasteful activities) such as moving work around, loading / unloading, carrying, storing,
stocking, counting, scheduling, inspecting, reworking and thereby enabling the firm to
concentrate on value added operations like machining, heat treatment, assembly and
packing.
Implementation of JIT can lead to the following benefits to the user:
o Reduction in manufacturing lead time.

o Defect free production.
o Lower inventory investment.
o Greater conformance to delivery commitments.
o Lesser cost of production (or increase in productivity)
o Faster response to market needs.
o Improved morale of the work force.
Methodology
o Housekeeping – physical organization of the facility and adherence to discipline

o Make it right the first time – elimination of defects.
o Setup reduction – flexible changeover of production from one product to another
o Lot sizes of one – the ultimate lot size and flexibility. (The system is so efficient, that it
can produce one item of a given product, and change over to another product, without
any loss of time or economic efficiency)
o Uniform plant load – load balancing as a control mechanism
o Balanced flow – organizing flow by scheduling the throughput
o Skill diversification – multi-functional workers to avoid disruptions
o Control by visibility – Online monitoring and communication
o Preventive maintenance – flawless running of machines, no defects
o Fitness for use – optimum design for process performance
o Compact plant layout – product-oriented design
o Streamlining movements – smoothened materials handling
o Supplier networks – akin to extensions of a factory
o Worker involvement – small size improvement groups
o Cellular manufacturing – Interconnected cells of production systems for flow.
o Pull system – production only when there is a demand pull from upstream
The Kanban System (The Pull System)
What is pull system?
An ideal JIT system is one-at-a-time production flow where in each operation pulls the
previous operation and makes it produce at the rate needed (that is in an ideal system,
parts flow from machine to machine one at a time at the rate and frequency required by its
customer – that is, final assembly operation).
JIT Purchasing
It is in fact the technique to eliminate waste in purchase function by developing long term,
mutually beneficial relationships with fewer but better suppliers. It aims at:
o Eliminating wastage in the purchase process (e.g. Order processing costs, follow up
costs, stock out costs, packaging and packing costs, freight costs, handling costs etc.)
o Eliminating waste at suppliers’ end (transport costs, rejection costs etc.)
o Eliminating purchased inventory.
Decision Theory
Decision theory is an interdisciplinary area of study that concerns mathematicians,

statisticians, economists, philosophers, managers, politicians, psychologists and anyone
else interested in analyses of decisions and their consequences. The basic formalism of
decision theory is the payoff table, which maps mutually exclusive decisions to mutually
exclusive states of nature. For example, "Decision X leads to Outcome Y", "Decision Y
leads to Outcome Z", and so on. When the set of outcomes corresponding to any given
decision is not known, we refer to this situation as decision under uncertainty, the field of
study which dominates decision theory.
Application of decision Theory

A company has recently discovered a new molecule for enhancing the yield of wheat. It
wants to commercialize the discovery. The market research suggests 50%, 30% and 20%
possibility of low, medium and high demand respectively.
The investments are Rs. 100, 70 and 40 Crores for big, average and tiny size plant
respectively. The cost of expanding the medium size plant to big size is Rs. 40 Crore. The
cost of expanding a small size plant to big and medium size costs Rs. 90 and Rs. 75 Crore
respectively.
The discounted operating returns from the operation are as follows.
Discounted operating returns

Starting plant size
Large Medium Small
High 250 200 160
Demand Medium 150 120 96
Low 100 80 64
Decide the optimum course of action.
Solution:
If we plot a decision tree as shown below, we realize that building a large plant would yield
highest risk weighted average income of Rs. 45 Cr.
However, the actual income would vary depending upon the exact demand situation.
If the demand turns out to be high – the company will make a profit of Rs. 150 Cr.
If the demand turns out to be medium – the company will make a profit of Rs. 50 Cr.
And If the demand turns out to be high – the company will neither make any profit nor any
loss.
We shall therefore, build a large plant which will take care of any demand in future.
4. Human Resource Development
“Take away my factories, take away my money, just leave me my people, and I am sure, I’ll
have it all again with me one day.” - Andrew Carnegie
The potential of HRD can be understood from the above function.
4.1 The Personnel Function

The role of human resource management is to plan, develop, and administer policies and
programmes designed to make judicious use of the organisation’s human resources. It is
that part of management which deals the people at work and their interrelationships for
optimizing the operations of the company.
Its objectives are:
1. Effective utilisation of human resources

2. Desirable working relationships among all members of the organisation, and
3. Maximum individual development.
The major functional areas in human resource management are:
1. Planning,
2. Staffing,
3. Employee development, and
4. Employee maintenance.
Human Resource Planning: In this function, the number and the type of employees of
particular category needed to accomplish the organisational goals are determined.
Research is an important part of this function because human resource planning requires
collection of data and analysis of this data to forecast demand and supply scenario of the
human resources. The basic human resource planning strategy is staffing and employee
development.
Job Analysis: This is the process of describing the characteristics of a particular job and
specifying the human requirements, such as skills and experiences needed to perform
those jobs. The prime objective of job analysis is the job description. A job description
defines work duties and expectations from specific jobs. Job descriptions are a vital inputs
to employees, managers, and personnel people because job content has a great influence
on personnel programmes and practices.
Staffing: This is the process of recruitment and selection of the human resources for an
organisation. Recruiting is the personnel function that advertises and attracts qualified
applicants to fill the job vacancies. In the selection function, the most qualified applicants
are selected for hiring from among those applying for the job.
Orientation: Orientation is one of the first steps towards helping a new employee adjust
himself to the new job and the culture of the new employer. It is a method to acquaint new
employees with particular aspects of their new job, including pay and benefit programmes,
working hours, and company’s rules and expectations.
Training and Development: The training and development function gives employees the
skills and knowledge to perform their jobs effectively. In addition to providing training for
new or inexperienced employees, organisations often provide training programmes for
experienced employees whose jobs are undergoing change. Large organisations often
have development programmes which prepare employees for higher level responsibilities
within the organisation. Training and development programmes provide useful means of
assuring that employees are capable of performing their jobs at acceptable levels.
Performance Appraisal: Performance appraisal function monitors employees’

performance to ensure that it is at acceptable levels. Human resource professionals are
usually responsible for developing and administering performance appraisal systems,
although the actual appraisal of employee performance is the responsibility of immediate
supervisors and managers. Besides providing a basis for pay, promotion, and disciplinary
action, performance appraisal information is essential for employees’ development, since
the knowledge of superior’s feedback helps in motivating the employees and guiding them
in their performance improvement.
Career Planning: Career planning function has been developed to help the employees to
grow in their jobs and provide them career advancement opportunities. Career planning
activities include assessing employees’ potential for growth and advancement in the
organisation to take new challenges and bigger responsibilities.
Compensation: Human resource personnel provide a systematic method for determining

the economic worth of the employees’ contribution while performing certain jobs. Arriving at
the true economic worth of the employees’ contribution is necessary for the maintenance of
human resources and optimizing the cost of human resources. Since employees’
compensation is a major cost to any organisation, it is one of the major considerations in
human resource planning. Compensation affects the staffing function, because people are
generally attracted to the organisations offering a higher level of pay. Employee
compensation is also related to employees’ development, because the compensation
provides an important incentive for motivating the employees to show higher levels of job
performance and rise up to higher paying jobs in the organisation.
Benefits: Benefits are indirect forms of compensation to the employees. As such, the
human resource function of administering employees’ benefits has many characteristics
common to the compensation function. Benefits may include both the legally mandated
items like bonus and those offered at employer’s discretion like gratuity. The cost of
employees’ benefits has risen to such a level that they have become a major consideration
in human resources planning. However, the discretionary benefits are primarily related to
encourage the performers to perform even better and cajole the non-performers to emulate
the performers for getting higher benefits.
Labour Relations: The term “labour relations” refers to interaction with employees who are
represented by a trade union. Unions are legally sanctioned grouping of employees, who
join together to place a collective voice, while taking the decisions which affect wages,
benefits, working conditions, and other aspects of employment. With regard to labour
relations, the personnel responsibility primarily involves negotiating with the unions
regarding wages, service conditions, and resolving disputes and grievances vis-à-vis
employees.
Record-keeping: The oldest and most basic personnel function is the employees’ record-
keeping. This function involves recording, maintaining, and retrieving employee related
information for a variety of purposes. Records which must be maintained include application
forms, health and medical records, employment history (jobs held, promotions, transfers,
lay-offs), seniority lists, earnings and hours of work, absences, turnover, tardiness, and
other employee data like confidential records regarding indiscipline and belligerence.
Complete and up-to-date employee records are essential for most personnel functions.
More than ever employees today have a bigger interest in their personnel records. They are
eager to know what is there in their employee records, and why certain statements have
been made, and why certain records may or may not have been updated by the company.
Personnel records generally provide the following information:
1. A store of up-to-date and accurate information about the company’s employees.

2. A guide to the action to be taken regarding an employee, particularly by comparing
him with other employees.
3. A guide when recruiting a new employee, e.g. by showing the rates of pay received by
comparable employees.
4. A historical record of previous action taken regarding employees.
5. The raw material for statistics which check and guide personnel policies.
6. The means to comply with certain statutory requirements.
7. History of indiscipline and belligerence.
Personnel Research: HRD people are generally engaged in some form of employee
research or the other. The objective of this research is to get facts and information about
the personnel so as to develop and maintain a programme that works. It is impossible to
run a personnel programme without some pre-planning and post-reviewing. For that matter,
any survey is, in a sense, research. There is a wide scope for research in the areas of
recruitment, employee turnover, terminations, training, and so on. Through a well-designed
attitude survey, employee opinions can be gathered on wages, promotions, welfare
services, working conditions, job security, leadership, industrial relations, and what
employees feel about the management. In spite of its importance, however, in most
companies, research is the most neglected area because many times personnel people are
busy tackling the urgent situations at the cost of important matters. Proper research often
eliminates urgent situations by picking up the symptoms of the problem much before the
problems become obvious to everyone. Employees’ Research is not the sole responsibility
of the HR department, even though the initial responsibility is that of the HR department,
they are often assisted by line supervisors and executives at all levels of management. The
assistance that can be rendered by trade unions and other organisations should also not be
ignored, but can be properly made use of.
Apart from the above, the HR function involves managing change, technology, innovation,
and diversity by offering cross-fertilisation of ideas of people from different departments or
even different organisations. For this purpose periodic social audit of HR functions is very
essential.
HR professionals have a pan organization role. They are required to have a thorough
knowledge of the organisation and its intricacies and complexities. The ultimate goal of
every HR person should be to develop a linkage between the employee and the
organisation because ensuring the employee’s commitment to the organisation is crucial for
its success. The first and foremost role of HR functionary is to impart continuous education
to employees about the changes and challenges faced by the company, country and the
world economy. The employees should also know about the company’s balance sheets,
profit and loss statements, sales growth, diversification plans, restructuring plans, and price
movements of the company’s products, turnover and all such details. The HR professionals
should impart education to all employees through small booklets, video films, and lectures
to ensure transparency and bridge the gap between the employees’ perception about the
management and the ground situation faced by the management.
The primary responsibilities of a human resource manager are:
1. To develop a thorough knowledge bank of corporate culture, plans and policies.

2. To act as an internal change agent and consultant.
3. To initiate changes and act as an expert and a facilitator.
4. To actively involve himself in company’s strategy formulation.
5. To keep communication lines open between the HRD function and individuals and
groups both within and outside the organisation.
6. To identify and evolve HRD strategies in consonance with overall business strategy.
7. To facilitate the development of various organisational teams and their working
relationship with other teams and individuals.
8. To try and relate people and work so that the organisation objectives are achieved
effectively and efficiently.
9. To diagnose problems and to determine appropriate solution particularly in the human
resources areas.
10. To provide co-ordination and support services for the delivery of HRD programmes and
services.
11. To evaluate the impact of an HRD intervention or to conduct research so as to identify,
develop or test how HRD in general has improved individual or organisational
performance.
12. To amicably settle employees’ grievances.
13. To enter into negotiations with the unions for collective bar gaining of their wages and
benefits.
4.2 Selection & Recruitment Process
In order to increase the efficiency of hiring, a scientific approach to recruitment and

selection of employees is necessary. In general, following steps have to be followed while
carrying out the selection & recruitment exercise.
Step 1: Identify Vacancy and Evaluate Need
Proper planning and evaluation of the need will lead to hiring of the right person for the
specified role.
While hiring for a new position, it is important to:
o Understand and take into consideration strategic goals and any upcoming changes
that may impact this role?
o Understand the core skills required now and those which may be needed in the
future.
While hiring for a Replacement, it is important to:
o Review the role and decide if there are any changes required as certain tasks and
responsibilities performed by the previous person may not or should not be
performed by the new person
Carefully evaluate any changes needed in the following:
o Is there still a requirement for this role at all?

o The organization level required for performing these tasks.
o The tasks carried out by the previous employee
o The tasks that are to be removed or added in the new job description.
o Supervisory or lead responsibility added or removed from the job description.
o Budget responsibility (if any)
o Working hours of the new job description.
Step 2: Develop Position Description
Prior to developing the job description the hiring manager should identify the following:
o General Information - Pay roll Title, Pay Grade, Working Title, Department Name,
Department Head, Supervisor Name, Specific requirements of the job seekers,
Occupational Qualifications etc.
o Position Purpose - Describes the department’s functions, the unit’s functions, and/or the
organizational unit’s functions. The statement should summarize the position’s essential
functions and its role in relation to supporting, administering, or managing the activities
of the department, unit, or organizational unit.
o Essential Functions - Essential job functions describe the duties and responsibilities of a
position. A job function is considered essential when the performance of the function is
the purpose for the position. Typically, an essential function occupies a significant
amount of time of the employee’s time and requires specialized skills to perform. By
accurately describing the essential functions of the job, job seekers will have a clear
understanding of the role and your expectations for performing them.
o Minimum Requirements - The minimum requirements or “basic qualifications” are those
qualifications or criteria which was established in advance and advertised to potential
applicants:
o Preferred Qualifications - Preferred qualifications are skills and experience preferred in
addition to basic qualifications and can be used to narrow down the pool of applicants.
These preferred skills, knowledge, abilities and competencies can describe a more
proficient level at which the essential functions can be performed.
A position description is the core of a successful recruitment process. It is used to develop

interview questionnaire, interview evaluations and references check questionnaire. A well-
written position description:
o Provides a first impression of the company to the candidate

o Clearly articulates responsibilities and qualifications to attract the best suited candidates
o Provides an opportunity to clearly articulate the value proposition for the role
o Serves as a document to defend against the complaints of discrimination from
unsuccessful candidates, by providing written evidence that the selections was based
on rational business needs.
o Improves retention as turnover is highest with newly hired employees. Employees tend
to be dissatisfied when they are required to perform duties, about which they were not
originally hired for.
o Optimizes search engine results by ensuring job postings rank high in candidate search
results when searching on-line
o Determines FLSA (Fair Labor Standards Act) classification and it can be used to map to
the appropriate Payroll Title
o Identifies tasks, work flow and accountability, enabling the department to plan how it will
operate and grow
o Assists in establishing performance objectives
o Is used for career planning and training by providing clear distinctions between levels of
responsibilities and competencies required
o Is used as a benchmark to assist in ensuring internal and external equity
Step 3: Develop Recruitment Plan
Each position requires a documented Recruitment Plan which is approved by the

organizational unit. A carefully structured recruitment plan maps out the strategy for
attracting and hiring the best qualified candidate and helps to ensure an applicant pool
which includes women and underrepresented groups including veterans and individuals
with disabilities.
In addition to the position’s placement goals the plan contains advertising channels to be
used to achieve those goals. The recruitment plan is typically developed by the hiring
manager in conjunction with the Departmental HR Coordinator. Placement goals identified
are displayed on the position requisition.
Recruitment plan elements:
o Posting Period – that is, the time available for recruitment

o Placement Goals - Placement Goals may include placement of graduates from IIMs and
IITs, women, veterans and individuals with disabilities etc.
o Additional Advertising Resources - A variety of recruiting sources (both internal and
external) should be utilized to attract candidates to ensure diversity. Every effort should
be made to conduct a thorough search by advertising widely before filling a position.
o Diversity Agencies - Agencies which assist women and under-represented groups are
another great source of talent.
o Resume Banks - Resume banks are another good source for identifying qualified
candidates. Job seekers post their resume to these which are then searched by
prospective employers.
Step 4: Select Search Committee
To ensure applicants selected for interview and final consideration are evaluated by more
than one individual to minimize the potential for personal bias, a selection committee is
formed. The hiring manager will identify members who will have direct and indirect
interaction with the applicant in the course of their job. Each hiring manager should make
an effort to appoint a search committee that represents a diverse cross section of the staff.
A member of the committee will be appointed as the Affirmative Action Facilitator (Job
reservations in India). Under-represented groups and women are supposed to have equal
opportunity to serve on search committees and special efforts should be made to
encourage their participation. Departments that lack diversity in their own staff should
consider appointing staff outside the department to such search committees or develop
other alternatives to broaden the perspective of the committee.
Step 5: Advertise the Position and Implement the Recruitment Plan
Once the position description has been completed, the position can then be posted to the
company website and other advertisement channels. Every effort should be made to ensure
the accuracy of the job description and the text of the advertisement. It may not be possible
to change elements of a position once posted, because it may impact the prospective
candidates’ response. This can be typically done using the social media and other
networking channels.
Step 6: Review Applicants and Develop Short List
Once the position has been posted, candidates will apply via company’s website or emails.
Candidates may complete an electronic application available on company’s website or send
in an email for the purpose. Filling the details in a form available on the company’s website
standardizes the data capture.
Applicants are those who apply during the initial application period. All applicants must be
reviewed and considered. Candidates who apply after the initial application period are
considered only for future recruitments.
It is recommended that all search committee members review all Applicants to ensure more
than one person assesses their qualifications and that individual opinion or biases are
avoided. It is permissible to have at least two committee members review all Applicants for
certain recruitments in which there are extensive applicant pools to best narrow down the
pool. Alternatively, Human Resources may perform this function. Each committee member
may provide comments to each Applicant’s qualifications as they relate to the minimum
requirements of the position.
A phone screen may be conducted to obtain information such as availability, salary

requirements, special position requirements (e.g. ability to perform shift work), ascertain
minimum requirements and other preliminary information to assist the search committee
with their review. It is possible to screen out an applicant due to information obtained during
this initial screening and therefore phone screens should be properly documented and
attended by at least two search committee members or Human Resources.
Step 7: Conduct the Interview
The interview is the single most important step in the selection process. It is the opportunity
for the employer and prospective employee to learn more about each other and validate
information provided by both. By following these interviewing guidelines, you will ensure
you have conducted a thorough interview process and have all necessary data to properly
evaluate skills and abilities. Choose one or two questions from each minimally required skill
and competency to develop your interview questions.
The Committee Chair should determine the following:
o Format of the interview and order of questions

o Questions to be asked to all applicants and the weight assigned
o Who is going to ask which questions
o Whether a work sample should be submitted
o The optimum start date for the position
o Any other details applicants may need about the role that were not noted in the position
description
A typical format of panel interviews might be:
o Introductions of each panel member

o A brief description of the role they are being interviewed for
o Description of how the interview panel will conduct the interview (e.g. each alternates
questions and all will take notes)
o The candidate gives an overview of their experience
o Each panel member provides their questions at the conclusion of the interview.
o The interviewee is given time at the end to ask questions
o The interviewee is informed of the next step (e.g. will be contacted either by phone or in
writing of the outcome)
o Thank the candidate for coming and ensure someone shows the candidate out
Virtual Interviews
To reduce travel costs and time associated with interviewing out of area applicants, virtual
interviews can provide an alternative method to in-person interview.
Interview Questions
Questions should be relevant to the position and seek information on specific skills and
abilities to perform the job such as “describe your experience working with power plants”.
Interview questions not pertaining to the current requirements of the position should not to
be used.
After the Interview
Upon completing the interview, committee members will complete their evaluation and
forward to the Committee Chair along with any interview notes. Candidate evaluations
should be sure to include only those comments which are relevant to the requirements of
the position.
Testing and other Selection Methods
Tests and other selection methods such as requesting work or writing samples and
presentations are additional tools used to assess candidates.
Step 8: Select and Shortlist
Once the interviews have been completed, the committee will meet to discuss the
interviewees. Committee members will need to assess the extent to which each one met
their selection criteria.
The search committee evaluation report will be helpful in justifying decisions and making
them as objective as possible.
Reference Checks
The purpose of a reference check is to obtain information about a candidate’s behavior and
work performance from prior employers that could be critical to your decision, regardless of
their skills, knowledge, and abilities. As past performance is the best predictor of future
success, it is recommended references be obtained from current and previous supervisors
who can speak to the candidate’s on the job performance. A hiring mistake is costly in time,
energy, and money. Failure to check references can have serious legal consequences. If
an employee engages in harmful behavior, which would have been revealed in a reference
check, the company can be held legally responsible for “negligent hiring”. Reference checks
should be conducted on the finalist(s) prior to making an offer to avoid problems to the
candidates.
Step 9: Finalize Recruitment
Upon completion of the recruitment process the offer to the selected finalist is made.
Prior to initiating the offer, it is recommended that one more check of the selection process
be completed as follows:
o Review the duties and responsibilities of the position and ensure they were accurately
described and reflected in the job description and interview process
o Review selection criteria used to ensure they were based on the qualifications listed for
the position
o Confirm interview questions clearly matched the selection criteria
o Confirm all applicants were treated uniformly in the recruitment, screening, interviewing
and final selection process
o Should there be any issues with the above, contact your Organizational Human
Resources Coordinator.
Initiating the Offer
Once a final check of the selection process has been completed and the final applicant has
been determined, the Committee Chair or designee will notify the Departmental HR
Coordinator of the finalist’s name, salary and start date. Once approved, the Departmental
HR Coordinator notifies the Committee Chair or designee of offer approval. Then the
Committee Chair or designee makes the offer to the finalist.
Negotiating the Offer
Whenever possible, it’s recommended your best offer be made the first time as this displays
proper market and internal equity practices and demonstrates good faith to the applicant.
When offering the finalist the position, be sure to discuss the total compensation package
(in addition to salary) such as paid time off and retirement benefits. Be excited and
enthusiastic about the offer and let them know you are excited about them joining your
team.
Finalizing the Offer
It is important that each recruitment process is properly closed, including the notification of
those interviewed and not selected, as well as all documentation associated with the
recruitment process.
To ensure proper closure of the selection process, the Staff Recruitment and Selection
Checklist should be completed and the following actions conducted:
o Once an offer has been accepted, the Committee Chair or designee notifies the
Departmental HR Coordinator and requests the offer letter be sent to the selected
candidate.
o The Departmental HR Coordinator prepares and sends the offer letter.
o The Departmental HR Coordinator ensures written acceptance of offer from the selected
candidate.
o The Departmental HR Coordinator enters the finalist information into the company’s
ERP system upon receipt of the offer acceptance from the selected candidate.
o The Departmental HR Coordinator contacts those individuals interviewed, but not
selected by phone or letter to express their regrets.
o The Departmental HR Coordinator ensures all recruitment related documents are
uploaded to the ERP system.
o Upon notification of the recruitment being closed, the Departmental HR Coordinator will
close out the recruitment requisition.
4.3 Role of Psychological Tests in Recruitments
Hiring new employees is a critical part of any business. Many companies have begun to
incorporate psychological testing into the hiring process to mitigate the risk of making hiring
mistakes. But what role should these tests play when hiring key executives?
There are a number of characteristics that contribute to a key executive’s success.

Certainly the executive must have the background and aptitude to perform the job. But
fitting in with the company culture can be just as crucial to their success.
Psychometric testing is a latest method of psychological measurement to assess the

orientation of the personality for certain professions. It attempts to do this in a scientific and
unbiased manner.
Psychological testing for recruitment brings objectivity and standardization to the

recruitment process. It tries to connect the complexities of human nature to assess his
temperament for doing certain jobs.
Psychological testing for recruitment attempts to measure different traits of a candidate.

The structured approach of psychological testing can offer insights into how well a
candidate fits into the company’s culture. Personality tests are used to determine the
personality type, values, interests, and skills of the potential employee.
The common types of psychometric tests used in recruitment include:
Tests of ability: Such tests judge the performance of a candidate based on the correct
answers. Tests measuring ability are grouped into achievement tests ( those assessing
existing capability of a candidate), and aptitude tests (those assessing potential of a
candidate). Both these tests probe the candidate’s general mental abilities and sometimes
specific job-related abilities through verbal reasoning, numerical reasoning, abstract
reasoning, mechanical aptitude, clerical aptitude, and spatial (3D) reasoning.
Personality tests: These tests assess the candidate’s way of behaving, thinking, feeling or
perceiving in particular situations, and aim to build the candidate’s personality profile to
interpret how the person behaves in different circumstances. Such tests have no right or
wrong answers. Common types of personality tests include tests of interests, motivation,
attitudes and the like. Myers Briggs Personality Tests ranks among the most popular
personality tests to identify personality type, and they are widely used by many
organizations.
Advantages of Psychometric Testing
The results of psychometric tests are likely to be more valid than subjective judgments
made based on how a candidate behaves during other conventional selection methods
such as assessment centers, written tests, group discussions, interviews, and the like. The
soundness of such subjective judgment depends on the presence or absence of distorters
such as prejudices and bias of the interviewer, the extent to which a candidate puts up a
true face, the range of situations or emotions covered in the interview, the general mood or
environment of both the candidate and the interviewer, the competence of the interviewer
and the like.
Psychometric tests adopt a standardized approach to obtain and judge the relevant
information for an objective assessment of the candidate. Since personality tests do not
have a possible correct answer, it forces the candidate to reveal his or her true nature.
Psychometric tests are complex and expensive to set up, and require trained and
experienced manpower. The information that they provide regarding the nature of the
candidate, as opposed to hiring a wrong candidate in its absence, training them, and then
firing them and repeating the entire recruitment process all over again makes psychometric
tests a comparatively hassle free and low cost effective recruitment option.
Challenges in front of Psychometric Testing
Most psychometric tests, particularly personality questionnaires, require considerable

experience to administer and interpret, and the possibility of misinterpretation or
inappropriate interpretation of results, may result in wrong recruitment or losing a promising
candidate.
The major challenge facing most organizations in using psychometric tests for recruitment
is selecting a valid instrument from various tests and questionnaires available in the market.
It is very difficult for untrained people to distinguish superior psychometric instruments from
those which are inferior.
Another problem associated with the usage of psychometric tests in recruitment process is
inexperienced users trying to use personality questionnaires to assess a person's ability or
skill in a particular area. For instance, a candidate scoring highly on the “leadership"
personality dimension only means that the candidate has basic personality characteristics
commonly found amongst effective leaders, and has the potential to become a good leader,
with the right exposure and experience. It does not indicate that the person actually
possesses a high level of leadership skill. People not conversant with how psychometric
tests work might straightaway place such a candidate in a leadership role based on these
findings. In the absence of proper leadership training, the person might fail, and everyone
might blame the psychometric tests for its inefficiencies.
Disadvantages of Psychometric Testing
The biggest criticism against psychometric tests in recruitment is that the questions are
behavioral in nature, and the answers do not reflect the motives or dynamics of the
candidate’s personality, making such tests no different from ordinary tests. For instance,
psychological tests might reveal that two candidates might each drink three glasses of
alcohol a night, and proceed to make a judgment based on this information. One candidate
might drink due to chronic alcoholism, while the other might drink due to depression or lack
of sleep. Psychological tests do not make such distinction.
Finally, although psychometric testing claims objectivity and freedom from bias, it is still
possible for a skilled candidate to fake the results. The advantage is that while just about
anyone can fake a behavior during a normal interview, it takes skill and a determined effort
to fake behavior in a psychological test.
Most Psychometric Test Reports Will Address Following Aspects Of The Personality
o General intellectual level and problem-solving style

o Emotional maturity and personality
o Interpersonal style
o Management style or selling ability
o Decision-making and organizational skills
o Leadership competencies
o Ambition and aspirations
Additional Inputs Needed For Framing The Psychometric Tests Are
o Characteristics of the position

o Core competencies for the position and the company
o Possible barriers that could confront the successful candidate
o History of past incumbents
o Culture of the team surrounding the position
o Culture of the organization
o Short- and long-term expectations from the position
o Possible career path for the successful candidate
4.4 Training of employees
Training of employees takes place after his orientation takes place. Training is the process
of enhancing the skills, capabilities and knowledge of the employees for doing a particular
job. Training process molds the thinking of employees and leads to quality performance
from them. It is continuous and never ending in process. The employee training is essential
for an organization’s success. In spite of the importance of training, a trainer can encounter
resistance from both employees as well as managers. Both groups may claim that training
is taking them away from their work. However, a trainer can combat this by demonstrating
that training is actually a crucial part of employees’ and managers’ work.
Why Employee Training Is Important
Training is crucial for organizational development and success. It is fruitful to both

employers and employees of an organization. An employee will become more efficient and
productive if he properly trained in his job.
Training is generally given for following basic purposes:
o New candidates who join an organization are given training. This training familiarizes
them with the organizational mission, vision, rules and regulations and the working
conditions.
o The existing employees are trained to refresh and enhance their knowledge.
o If any updates and amendments take place in technology, training is given to cope up
with those changes. For instance, purchasing a new equipment, changes in technique of
production, computerization. The employees are trained about the use of new
equipment and working methods.
o When promotion and career growth becomes important, training is given to the
employees, so that they are prepared to shoulder the responsibilities of the higher level
job.
The benefits of training can be summed up as:
o It improves morale of the employees - Training helps the employees to get job security
and job satisfaction. The more satisfied the employees are and the greater is their
morale, and the more they will contribute to organizational success and the lesser will
be their absenteeism and turnover.
o They will need lesser supervision - A well trained employee will be well acquainted with
the job and will need less of supervision. Thus, there will be less wastage of time,
material and efforts.
o There will be fewer accidents - Errors are likely to occur if the employees lack
knowledge and skills required for doing a particular job. The more trained an employee
is, the less are the chances of committing accidents on job and the more proficient the
employee becomes.
o There will higher chances of employee’s promotion - Employees acquire skills and
efficiency during training. They become more eligible for promotion. They become an
asset for the organization.
o There will be increased productivity - Training improves efficiency and productivity of
employees. Well trained employees show both quantity and quality performance. There
is less wastage of time, money and resources if employees are properly trained.
o Training makes employees more committed to the organization, if the employees see
the training as an investment in their future, when they are provided with growth,
advancement and learning opportunities.
o Training develops a line of able and skilled managers as it prepares them for complex
and higher level tasks.
o Trained employees enable the organization to face the competition easily.
o Trained employees can respond and adapt to the changing technology faster.
o Trained employees become more proficient and, thus, their own market value and
earning potential increases.
Training is crucial because it -
o Educates employees about the effective use of technology,

o Ensures competitive edge of the company in the market,
o Promotes safety and health awareness among employees,
o Creates opportunities for career development and personal growth, an important factor
in retaining workers
o Helps employers comply with laws and regulations of the country, and
o Improves productivity and profitability.
Methods of Training
Training is generally imparted in two ways:
On the job training - On the job training methods are those which are imparted to the
employees while conducting their everyday business. It is a simple and cost-effective
training method. The unskilled as well as semi-skilled employees can be trained by using
this training method. The employees are trained in actual working conditions. The motto of
such a training is “learning by doing.” The examples of such on-job training methods are
job-rotation, coaching, temporary promotions, etc.
Off the job training - Off the job training methods are those in which training is provided
away from the actual working conditions. It is generally used in case of new employees.
The examples of off-the-job training methods are workshops, seminars, conferences, etc.
Such methods are costly and are effective only if large number of employees have to be
trained within a short time period. Off the job training is also called as vestibule (reception
room) training, i.e., the employees are trained in a separate area (may be a hall, entrance,
reception area etc.) where the actual working conditions are simulated.
Steps in Employee Training Programme
Training programme involves the following steps:
1. Identifying the training needs- The training needs of each employee should be
identified. Programmes should be developed that are best suited to their needs.
2. Prepare the trainer- The trainer must do his homework well. He should know both what
to teach and how to teach. Time management is required by the trainer. Training should
be delivered in such a manner that the trainee should not lose the interest in the job.
3. Prepare the trainee- The trainee should remain active during training. He should know
the reason, why is he being trained. He should put across the trainer questions and
doubts in his mind. The trainee should be put at ease during the training programme.
4. Explain and demonstrate the operations- The trainer should explain the logical
sequence of the job. The trainer should perform the job himself and explain the trainee
the complete job he is supposed to perform. The trainee should be helped in
overcoming his mistakes and complex operations can be explained many times over.
Only when the trainee demonstrates that he can do the job himself in right manner, he is
left to himself. Through repetitive practices, the trainee acquires more and more skill.
5. Follow up and feedback- The trainee should be given feedback on how well he has
performed the job. He should be asked to give a feedback on the effectiveness of the
training programme.
4.5 Performance Appraisal and Counseling

Performance Appraisal
Performance appraisal deals with how organizations evaluate and measures its employees’
achievements and behaviors. It is an employee review by his manager where his work
performance is evaluated and strengths and weaknesses are identified so that the
employee knows his improvement areas. Performance appraisal is the right time to set new
goals and objectives for the employees.
It is is a systematic evaluation of the performance of the employees to assess how far the
employees are able to perform vis-à-vis management’s expectation from them and to
understand the abilities of a person for his growth and development.
Performance appraisal system allows the management categorizes employees into

performers and non-performers. It is primarily done to estimate the employees’ worth for the
organization.
Types of performance appraisal methods include comparative standards (such as, simple
ranking, paired comparison, forced distribution) and absolute standards (such as, critical
incidents, BARS, MBO).
Objectives of Performance Appraisal
o To generate quantifiable unbiased data on employees’ performance to determine their

compensation packages, wage structures, promotions and salaries raises.
o To identify the strengths and weaknesses of the employees to place right men in right
jobs.
o To maintain and assess the potential present in a person for grooming them further
growth and responsibilities.
o To provide a feedback to the employees regarding their performance and their relative
performance status vis-s-vis other employees belonging to his category.
o It serves as a basis for influencing working habits of the employees.
o To reassess and redesign the training programs for underperforming employees by
capturing the good habits and practices of the super performing employees.
Advantages of Performance Appraisal
o Promotion: Performance Appraisal helps the supervisors to chalk out the promotion
programs for efficient employees. In this regards, inefficient workers can be dismissed,
demoted, warned or encouraged to work better and learn faster to put themselves on
the fast track.
o Compensation: Performance Appraisal helps in chalking out compensation packages for
employees. Merit rating is possible through performance appraisal. Performance
Appraisal tries to assign economic worth to one’s performance. Compensation
packages, which include, bonuses, higher salaries, extra benefits, allowances and pre-
requisites are dependent on one’s performance appraisal. The criteria should be merit
rather than seniority.
o Employees’ Development: The systematic procedure of performance appraisal helps the

supervisors to frame training policies and programs. It helps to analyze strengths and
weaknesses of the employees so that new jobs can be designed for efficient employees.
It also helps in framing future development programs.
o Selection Validation: Performance Appraisal helps the supervisors to understand the

validity and importance of the selection procedure. The supervisors come to know about
the validity and thereby the effectiveness of the selection procedure, vis-à-vis the actual
performance of the employees. Suitable changes in selection procedures can be done
with this outcome in mind.
o Communication: For an organization, effective communication between employees and

employers is very important. Through performance appraisal, communication lines can
be established to know mutual expectations between the employees and the employers,
and knowing the extent to which these expectations are being met from both sides.
o Motivation: Performance appraisal serves as a motivation tool. Through evaluating

performances of employees, their efficiencies can be determined vis-a-vis the targets.
This motivates the employee for doing a better job and helps him to continually improve
his performance.
Following are the tools used by the organizations for Performance Appraisals of their
employees – Ranking, Paired Comparison, Forced Distribution, Confidential Report, Essay
Evaluation, Critical Incident, Checklists, Graphic Rating Scale, BARS, Forced Choice
Method, MBO, Field Review Technique, and Performance Test
1. Ranking Method
The ranking system requires the assessor to rank his subordinates on overall performance.
This simply consists of putting an employee in a rank order. In this method, the ranking of
an employee in a work group is done against that of other employees. The relative position
of each employee is tested in terms of his numerical rank in the group. It may also be done
by ranking a person on his job performance against an ideal member of the competitive
group.
Advantages of Ranking Method
o Employees are ranked according to their performance levels.

o It is easier to rank the best and the worst employees.
Limitations of Ranking Method
o “A complete man” is compared with another “complete man” in this method. In practice,
it is very difficult to compare individuals possessing different individual traits.
o This method speaks only of the position where an employee stands in his group. It does
not test anything about how much better or how much worse an employee is when
compared to another employee.
o When a large number of employees are working, ranking of individuals become a
difficult task.
o There is no systematic procedure for ranking individuals in the organization. The ranking
system does not eliminate the possibility of snap judgements.
2. Forced Distribution method
This is a ranking technique where assessors are required to allocate certain grades to
employees (e.g. superior, above average, average, below average etc.) or percentiles (e.g.
top 10 percent, bottom 20 percent etc). The number of categories to be formed and the
percentage of employees to be allotted to each category is a function of performance
appraisal design and format. The employees with outstanding merit may be placed at top
10% of the scale; worst employees may be placed at bottom 10% of the scale, average
employees may be placed between 33% and 66% of the scale, below average will belong
to put below 66% and above average will be put above 33% level. Then the employees are
rewarded, counselled or admonished and urged or warned to perform for retaining their
jobs.
Advantages of Forced Distribution

o This method tends to eliminate assessors’ bias
o By forcing the distribution according to pre-determined percentages, uniformity in scales
is ensured amongst different assessors.
Limitations of Forced Distribution

o The limitation of using this method in salary administration, however, is that it may lead
to low morale (because employees doesn’t know why he has been assigned a typical
slot), low productivity and high absenteeism amongst employees.
o Employees who feel that they are productive, but find themselves in lower grade than
expected, feel frustrated and exhibit over a period of time reluctance to work.
3. Critical Incident techniques
Under this method, the manager prepares lists of statements of very effective and
ineffective behaviors of an employee. These critical incidents or events represent the
outstanding or poor behavior of employees or the job he had done. The manager maintains
the logs of each employee, whereby he periodically records critical incidents of the workers
behaviors. At the end of the rating period, these recorded critical incidents are used in the
evaluation of the worker’s performance. Example of a good critical incident of a Customer
Relations Officer can be “March 12 - The Officer patiently attended to a customer’s
complaint. He was very polite to the customer and prompt in attending the customer’s
problem”
Advantages of Critical Incident techniques

o This method provides an objective basis for conducting a thorough discussion on
employees’ performances.
o This method avoids recentness bias in critical incident.
Limitations of Critical Incident techniques

o Many times negative incidents may be emphasized more than positive incidents.
o The supervisors have a tendency to unload a series of complaints about the incidents
during an annual performance review sessions.
o It results in very close supervision which may not be liked by the employees.
o The recording of incidents may be a chore for the manager concerned, who may be too
busy or may forget to do it or he might do it just for the sake of doing it all at the end of
the year. This leads to forgetting of many good deeds of the employees and venting of
their anger on personalities disliked by the employees.
4. Checklists and Weighted Checklists
In this system, a large number of statements that describe a specific job are given in a
checklist form. Each statement has a weight or scale value attached to it. While rating an
employee the supervisor checks all those statements that most closely describe the
behavior of the individual under assessment. The rating sheet is then scored by averaging
the weights of all the statements checked by the rater. A checklist is constructed for each
job by having persons who are quite familiar with the jobs. These statements are then
categorized by the judges and weights are assigned to the statements in accordance with
the value attached by the judges based on the relevance and importance for the
employees.
Behavioral checklists have a list of criteria that an employee should workup (develop) to be
a diligent worker. As the importance of different human behaviors differs according to the
type of a job, different checklists need to be made for different jobs. This method is quite
popular amongst employees, because the evaluation is done on the basis of individual
employee’s performance without any comparisons.
Advantages of Checklists and Weighted Checklists

o It is a most frequently used method in evaluation of the employees’ performance.
Limitations of Checklists and Weighted Checklists

o This method is very expensive and time consuming
o Assessor may be biased in distinguishing the positive and negative questions.
o It becomes difficult for the manager to assemble, analyze and weigh a number of
statements about the employees’ characteristics, contributions and behaviors’.
6. 360 degree appraisal
360 degree appraisal involves feedback of the manager, supervisor, team members and
any direct reports. In this method of appraisal, employees’ complete profile has to be
collected and assessed. In addition to evaluating the employees work performance and
technical skill set, an appraiser collects an in-depth feedback of the employees.
Advantages of 360 degree appraisal
o Offers a more comprehensive view towards the performance of employees and tries to
know specific reasons of their underperformances.
o Improves credibility of performance appraisal.
o Colleague’s feedback helps in strengthening self-development.
o Increases responsibilities of employees to their customers (because of the customer
feedback).
o The mix of ideas from different people can give a more accurate assessment.
o Opinions gathered from lots of staff are sure to be more convincing.
o Not only manager makes assessments on his staffs’ performances, but other colleagues
also make this assessment.
o People who undervalue themselves are often motivated by good feedback from others.
o If more staff members takes part in the process of performance appraisal, the
organizational culture of the company will become more honest.
Disadvantages of 360 degree appraisal
o It takes a lot of time, and is very complex in administration
o Exchange feedbacks can cause troubles and tensions amongst staff members.
o There is requirement for training and important effort in order to achieve efficient
working.
o It is very difficult to figure out the results from such a complex data.
o Feedback can be useless if it is not carefully dealt with, by eliminating irrelevant and
unobvious elements of the feedback.
o Can impose an environment of suspicion if the information is not openly and carefully
managed.
o Many times employees collaborate amongst themselves in giving favorable feedbacks.
This defeats the entire purpose of this exercise.
o Gaps between self-perceptions and others' perceptions do not motivate change: It's a
commonly held belief that if we see a gap between how we perceive ourselves and how
others perceive us, then we will be motivated to close that gap. But in reality people tend
to be more stubborn with their original behavior.
Who should be involved in 360 degree performance appraisal?
o Subordinates.
o Peers.
o Managers (i.e. superiors).
o Team members.
o Customers.
o Suppliers/ vendors.
o Anyone who comes into contact with the employee and can provide valuable insights
and information.
7. Management by objectives
This is an objective type of evaluation which falls under modern approach of performance
appraisal. In MBO method of performance appraisal, manager and the employee agree
upon specific and achievable goals with a set deadline. With this method, the appraiser can
define success and failure easily.
This method of performance appraisal is results-oriented. That is, it seeks to measure

employee performance by examining the extent to which predetermined work objectives
have been met. Usually the objectives are established jointly by the supervisor and
subordinate. Once an objective is agreed, the employee is usually expected to do the self-
audit; that is, to identify the skills needed to achieve those objectives. Typically they do not
rely on others to locate and specify their strengths and weaknesses. They are expected to
monitor their own development and progress.
Advantages of MBO appraisal
o The MBO approach overcomes some of the problems that arise because of the
difficulties faced by the managers while identifying the traits needed for doing a job
successfully.
o Instead of assuming traits, the MBO method concentrates on actual outcomes.
o If the employee meets or exceeds the set objectives, then he or she has demonstrated
an acceptable level of job performance. Employees are judged according to real
outcomes, and not on their potential for success, or on someone's subjective opinion of
their abilities.
o The guiding principle of the MBO approach is that direct results can be observed,
whereas the traits and attributes of employees, which may or may not contribute to
performance, may be just guessed or inferred.
o The MBO method recognizes the fact that it is difficult to neatly dissect all the complex
and varied elements that go to make up employees’ performance.
o MBO believes that the performance of employees cannot be broken up into subparts.
But the performance has to be observed and measured as a whole.
Advantages of MBO appraisal
o MBO methods of performance appraisal can give employees a satisfying sense of

autonomy and achievement. But on the downside, they can lead to unrealistic
expectations about what can and cannot be reasonably accomplished.
o Supervisors and subordinates must have very good "reality checking" skills to use MBO
appraisal methods. They will need these skills during the initial stage of objective
setting, and for the purposes of self-auditing and self-monitoring to avoid setting too low
targets.
o Unfortunately, research studies have shown repeatedly that human beings tend to lack
the skills needed to do their own "reality checking". Nor are these skills easily conveyed
by training. Reality itself is an intensely personal experience, prone to all forms of
perceptual bias.
o One of the strengths of the MBO method is the clarity of purpose that flows from a set of
well-articulated objectives. But this can be a source of weakness also. It has become
very apparent that the modern organization must be flexible to survive. Objectives, by
their very nature, tend to impose certain rigidity and reluctance to change when the
external environment changes.
o Of course, the obvious answer is to make the objectives more flexible and yielding. But
the price for flexibility is the loss of clarity. Changing objectives may cause confusion in
employees’ mind. It is also possible that flexible objectives may be distorted to disguise
or justify failures in employees’ performance.
8. Psychological appraisals
This appraisal method evaluates the employees’ intellect, emotional stability, analytical
skills and other psychological traits. This method makes it easy for the manager in placing
the employees in appropriate teams.
Professionally administered personality and psychological assessments can:
o Reduce the effects of personal bias in selecting, promoting, training and developing
people.
o Help identify individual strengths, limitations and career development potential.
o Allow an objective comparison between individuals on important job-related criteria.
o Encourage an informed rather than intuitive consideration of the person-job match.
o Assist managers to better understand how staff should be supervised to maximize
individual productivity and job satisfaction.
o Reduce absenteeism and turnover caused by the inappropriate placement of staff.
o Minimize organization’s costs associated with the screening of applicants and the
development of staff.
A cost-benefit analysis will show that psychological appraisal is economically and practically
feasible irrespective of the organization’s size, location, staffing needs or products or
services.
Some Applications of Psychological Appraisal
o Applicant Screening and Assessment.

o Team Building.
o Training Needs Analysis.
o Interpersonal Conflict Resolution.
o Person-Job Matching.
o Succession Planning.
o Career Development Planning.
o Performance Appraisal.
o Supervision Guidance.
o Exit Counselling.
Counselling Of Employees
Counselling is the discussion with an employee, who has some problem or the other, more
particularly emotional in nature. It is intended to help the employee to overcome the
emotional stress, so that he/she can get back to the main track of performance.
In organizations, the need for counselling may be for several reasons, namely, an
employee may fail to achieve the results or performance targets, or an employee may have
problems with the team leader, or simply an employee may fail to relate himself/herself to
the job as also with the organization. Because of such divergent needs for employee
counselling, its characteristics also differ. It may be an exchange of feelings between two
people (hence an act of communication), or help to an employee to overcome his/her
emotional problems (hence an act of problem solving), or to coach or guide an employee to
achieve his/her goals (hence a developmental support), etc.
Objectives of Counselling
Whatever may be purpose of counselling, objectives of counselling can be categorized into

six major areas as follows
Rendering advice - It is the function of coaching by the counsellor, who may be the
immediate boss or a professional. Here the counsellor listens to the problems of the
employees and then guides them to the right direction. Reassurance it is the function of
restoring the confidence of the employees, helping them to feel courageous, to gain
strength, and to develop positive thinking. In cases, where employees are entrusted with
challenging assignments, reassuring them is very important, to help them realize that they
can achieve the results.
Clarifying the thinking - It is the function of encouragement to the employees to be

rational and realistic. Employees often lose their emotional balance in executing their
assignments and jobs, and sometimes commit decisional errors. Helping them to be
rational by clarifying their way of thinking, puts them back into the realities and enables
them to achieve the results.
Release of emotional tension - It is the process of relief from frustration and stress. The
counsellor allows the employees to share their grief. In the process of sharing, employees
get relief from their emotional tensions. This does not lead to a solution by itself, but it
breaks the ice, allowing the counsellor to understand the possible ways for solution.
Communication - It is a process of sharing the information and understanding, through

upward and downward communication. Upward communication flows from the employees,
who bring their feelings and emotional problems to the notice of the management.
Downward communication flows from the counsellors, who help the employees get an
insight into the activities of the organization and how they can help the organization in
coping with the current situation.
Reorientation - It is a process of encouragement to bring internal changes in goals, values,

and mental models, helping employees to leverage their strengths and guarding against
their weaknesses to bring in line with organizations goals.
Types of Counselling:
Depending on the reasons for counselling, a counsellor can make use of several types of
counselling, as detailed below:
Directive counselling - In this type of counselling, the counsellor plays the role of an
empathetic listener and then takes decisions about the right courses of action for the
employees. The counsellor also motivates the employees to follow the suggested courses
of action.
Directive counselling is preferred in those cases, where the employees are unable to decide
their courses of action.
Non-directive counselling - The counsellor uses this type of counselling, not only to listen
but also to provoke the employees to explain the problems. On understanding the
problems, the counsellor determines the courses of action and then facilitates the
employees to identify on their own, the possible solutions to those problems. Since finding
solutions to problems is left to the employees who are being counselled, we also call it
'client-centered' counselling.
Non-directive counseling is for those who are knowledgeable and capable enough to
decide, once the problems are explained to them.
Participative or cooperative counselling - It is in between the earlier two types of

counselling. Here, both the counsellor and the counselled develop close mental
relationships, exchange ideas, feelings, knowledge, and information, to overcome the
problem of the counselee. Since the possible-solution inputs are also collected from the
counselee, we call it participative counselling.
Participative counselling is effective in cases where organizations are trying to change,

which may be for mergers and acquisitions, technological changes, business process
reengineering, policy related changes, etc.
In organizations, managers have to adopt suitable types of counselling depending on the

reasons, type of employees for whom the counselling is intended, and the underlying
situation that prevails at a particular point of time.
Most of the merger cases fail due to emotional blocks of the employees. Videocon's
success in transforming the Philips unit, after acquisition, is attributable to participative
counselling. All senior executives were initially told to put in 80 per cent of their time in
talking to people and helping them to get their doubts and apprehensions clarified.
This helped the company to enable the people to relate with the transformation process,
shedding their age-old legacy bound thoughts and beliefs. However, another Philips unit,
Plastic and Metalwork Factory, acquired by their employees could not be transformed for
change and finally it was sold off to Helvoet. Hence, the manager as counsellor has to
adopt a contingency (for the purpose) view of counselling, irrespective of his/her preferred
style.
Steps involved in the Counselling Process
Irrespective of the reasons and the style adopted for counselling, the counsellor has to
adopt certain common steps, to make the process successful.
Initiating - At this stage the counsellor establishes a rapport with the employee concerned,
developing mutual understanding and promoting openness. This ensures inculcation of
confidence in the mind of the person being counselled and in the process, to gain
acceptance from that person.
Exploring - At this stage the counselee is urged to describe in his/her own words, the
situation, feelings, problems, and the needs. Here, the counsellor endeavors to let the
counselee understand his/her own weaknesses and shortcomings and in the process
develop a sense of mutuality. Mutuality is positively relating and interacting with the people.
To promote mutuality, the counsellor has to have empathy in his communication,

negotiation and mediation skills. Also, his/her personal attitude should be that of caring and
respect for the counselee and should also show an eagerness to cooperate.
Framing of action plan - To make the counselling process successful, the counsellor has
to frame an action plan, duly charting the do's and don'ts.
Thus, counselling is used by organizations as a tool to help the employees to bring about
attitudinal changes in themselves and to adjust with the changing situations, duly promoting
the sense of mutuality.
However, it is also important to understand that counselling, per se, cannot improve the
work environment, or make the workers' productive. Along with the other tools, counselling
has to be used as a supplemental effort to bring about the required improvements and
changes in the behaviors of the employees.
4.6 Employees’ Reward Practices
Today organizations are showing a high degree of commitment towards reinforcement of
reward practices which are aligned with other HR practices and the goals of the
organization for attracting, retaining and motivating employees. Efficient reward practices
helps in attracting result driven professionals who can thrive and succeed in performance
based environments. Hence, it is a crucial motivator and may contribute towards the
enhancement of the productivity of the employees if implemented properly. For example,
Continental Airlines as a part of their turnaround strategy introduced on time bonus
incentive package according to which an employee will gain a bonus of $65 every month for
ensuring on time flight operations.
An effective reward system should be linked with the performance development system,
which focuses on performance based pay and offers ample learning opportunities along
with a healthy work environment. Variable pay can play a crucial role in boosting the
performance of the employees especially the star performers instead of the fixed pay
packages. Few such reward practices may take the forms of gain sharing, bonuses, team
based incentives, profit sharing, ESOP’s and equity based incentive awards.
An efficient management of reward system may have a beneficial effect upon the
performance in several ways - instilling a sense of ownership amongst the employees, may
facilitate long term focus with continuous improvement, reduces service operating costs,
promotes team work, minimizes employee dissatisfaction and enhances employees’
interest in the financial performance of the company. Few organizations like General
Motors, rewards their employees for attaining new skills which may add value to the
organizational performance and thereby facilitate job rotation, cross training and self-
managed work teams. Few organizations also recognize exceptional performance by
providing recognition awards and lump-sum merit awards for winning employee
commitment and attaining long term beneficial results. Example, TISCO, offers instant or on
the spot rewards, monthly rewards and annual rewards to its employees under its
‘Shabashi scheme’.
Rewards can be a vital source of motivation for the employees but only if it is administered
under right conditions. Few strategies which improve the effectiveness of rewards are given
below:
o Linking rewards with the performance

o Implement team rewards for the interdependent jobs.
o Ensuring that the rewards are relevant. Example Wal-Mart, rewards bonuses to the top
executives which is based on the company’s overall performance whereas the frontline
employees earn bonus on the basis of the sales figure or targets attained by their store.
o Ensuring that the rewards are valued by the employees. If they get something, which
they perceive as shortchange, will not succeed.
o Checking in advance the undesirable consequences of administration of any reward
practice.
Besides the monetary rewards, the contemporary employees desire for non-monetary
rewards which may be in the form of better career opportunities, skills development and
recognition programs. Many IT and project based organizations give much importance to
non-monetary rewards for maximizing employee satisfaction.
4.7 Legal Requirements and Regulation of Working Conditions
Regulation of Working Conditions and Employer's Liabilities for Health & Safety
The objective of the Factories Act 1948 is to regulate the conditions of work in
manufacturing establishments coming within the definition of the term "factory" as used in
the Act.
The act of 1948 is more comprehensive than the previous acts. It contains detailed
provisions regarding the health, safety and welfare of the workers inside factories, the
hours of work, the minimum age of the workers, leave with pay etc. This act has been
amended several times. The act is based on the .provisions of the Factories Act of Great
Britain passed in 1937. In 1976 the Act was amended extensively.
Application Of The Act
The Factories Act of 1948 came into force on 1st April 1949; It applies to factories, as
defined in the act, all over India, including the State of Jammu and Kashmir.
Provisions Regarding The Health Of The Workers

Sections 11 to 20 of the act contain certain provisions intended to ensure that the
conditions under .which work is carried on in factories does not affect the health of the
workers adversely.
The summary of the provisions are explained below :
1. Cleanliness. Every factory shall be kept clean and free from dirt, and the outflow of
drains etc. The floors must be cleaned. Drainage shall be provided. Inside walls,
partitions and ceilings must be repainted at least once in five years. When washable
water paint is used they must be painted once every three years and washed at least
every period of six months - Sec. 11, as amended in 1976.
2. Disposal of waste and effluents. The waste materials produced from the
manufacturing process must be effectively disposed of - Sec. 12.
3. Ventilation and Temperature. There must be provision for adequate ventilation by

the circulation of fresh air: The temperature must be kept at a comfortable level. Hot
parts of machines must be 'separated and insulated - Sec. 13.
4. Dust and Fume. If the .manufacturing process used gives off injurious or offensive
dust and fume steps must be taken so that they are not inhaled or accumulated. The
exhaust fumes of internal combustion engines must be conducted outside the factory -
Sec. 14.
5. Artificial humidification. The water used for this purpose must be pure. It must be
taken from some source of drinking water supply. The State Government can frame rules
regarding the process of humidification - Sec. 15.
.
6. Overcrowding. There must be no overcrowding in a factory. In factories existing
before the commencement of the Act there must be at least 350 cft. (or 55 cubic meters)
of space per worker. For factories built afterwards, there must be at least 500 cft. (or 75
cubic meters) of space. In calculating the space, an account is to be taken of space
above 14 ft. (or 5 meters) from the floor - Sec. 16.
7. Lighting. Factories must be well lighted. Effective measures must be taken to prevent
glare or formation of shadows which might cause eye strain - Sec. 17.
8. Drinking water. Arrangements must be made to provide a sufficient supply of
wholesome drinking water. All supply' points of such water must be marked "drinking
water". No such points shall be within 20 ft. (or 7.5 meters) of any latrine, washing place
etc. Factories employing more than 250 workers must cool the water during the hot
weather - Sec. 18
9. Latrines and Urinals. Every factory must provide' sufficient number of latrines and
urinals. There must be separate provision for male and female workers. Latrine and urinals
must be kept in a clean and sanitary condition. In factories. employing more than 250
workers, they shall be of prescribed sanitary types - Sec. 19.
Provisions Regarding The Safety Of Workers

Sections 21 to 40A, 40B and 41 of the Act lay down rules for the purpose of securing the
safety of workers. Summary of the provisions of the Factories Act regarding the safety of
the workers are stated below: (Sections 21 to 41).
1. Fencing of machinery. All dangerous machinery must be securely fenced e.g., moving
parts of prime movers and flywheels connected to every prime mover, electric generators.
etc. - Sec. 21.
2. Work on or near machinery in motion. Work on or near machinery in motion must be

carried out only by specially trained adult male workers wearing tightly fitting clothes - Sec.
22.
3. Employment of young persons on dangerous machines. No young person shall

work at any dangerous machine' unless he has been specially instructed as to the
dangers and the precautions to be observed. has received sufficient training about the
work and is under the supervision of some person having thorough knowledge and
experience of the machine - Sec. 23.
4. Striking gear and devices for cutting off power. In every factory suitable devices for
cutting off power in emergencies from running machinery shall be provided and
maintained in every workroom - Sec. 24.
5. Self-acting machines. Moving parts of a self-acting machine must not be allowed to

come within 45 cm of any fixed structure which is not part of the machine - Sec. 25.
6. Casing of new machinery. In all machinery installed after the commencement of the
act certain parts must be sunk, encased or otherwise effectively guarded e.g. set screws,
bolts, toothed gearing etc. - sec. 26.
7. Women and children near cotton Openers. Women and children must not be allowed
to work near cotton openers, except In certain cases - Sec. 27
8. Hoists, lifts, chains etc. Every hoist and lift must be so constructed as to be safe.
There are detailed rules as to how such safety is to be secured. There are similar
provisions regarding lifting machines. chains, ropes and lifting tackle - Sec. 28 & 29.
9. Revolving machinery. Where grinding is carried out, the maximum safe working
speed of the revolving machinery connected therewith must be notified. Steps must be
taken to see that the safe speed is not exceeded - Sec. 30.
10. Pressure plant. Where any operation is carried on at a pressure higher than the
atmospheric pressure, steps must be taken to ensure that the safe working pressure is not
exceeded - sec. 31.
.
11. Floors, stairs and means of access. All floors, steps, stairs, passage and gangways
shall be of sound construction and properly maintained. Handrails shall be provided where
necessary. Safe means of access shall be provided to the place where the worker will
carry on any work - Sec. 32.
12. Pits, sumps. Openings in floors etc. Pits. Sumps Openings in floors etc. must be
securely covered or fenced - Sec. 33.
13. Excessive weights. No worker shall be made to carry a load so heavy as to cause
him injury - Sec. 34.
14. Protection of eyes. Effective screen or suitable goggles shall be provided to protect
the eyes of the worker from fragments thrown off in course of any manufacturing process
and from excessive light if any - Sec. 35.
15. Precautions against dangerous fumes. No person shall be allowed to enter any
chamber, tank etc. where dangerous fumes are likely to be present, unless it is equipped
with a manhole or other means of going out. In such space no portable electric light of
more than 24 volts shall be used. Only a lamp or light of flame proof construction can be
used in such space. For people entering such space suitable breathing apparatus, reviving
apparatus etc. shall be provided. Such places shall be cooled by ventilation before any
person is allowed to enter - Secs. 36 and 36A.
16. Explosive or inflammable gas etc. where a manufacturing process produces

inflammable gas, dust, fume etc., steps must be taken to enclose the machines
concerned, prevent the accumulation of substances and exclude all possible sources of
ignition. Extra precautionary measures are to be taken where such substances are
worked at greater than the atmospheric pressure - Sec. 37.
17. Precaution in case of fire. Fire exits shall be provided. Windows and doors shall be
constructed to open outwards. The means of exit in case of the fire shall be clearly
marked in red letters. Arrangements must be made to give warning in case or fire - Sec.
38
18. Specifications of defectives etc. and safety of buildings and machinery. If any
building or machine is in a defective or dangerous condition, the inspector of factories can
ask for the holding of tests to determine how they can be made safe. He can also direct
the adoption of the measure necessary to make them safe. In case of immediate danger,
the use of the building or machine can be prohibited - Secs. 39 & 40.
19. Maintenance of Buildings. If the Inspector of Factories thinks that any building in a
factory, or any. part of it. is in such a state of disrepair that it is likely to affect the health
and welfare of the workers. he may serve on the occupier or manager or both in writing
specifying the measures to be done before the specified date. Sec. 40A.
20. Safety Officers. The State Government may notify to the occupier to employ a
number of Safety Officers in a factory (i) wherein one thousand or more workers are
ordinarily employed. or (ii) wherein any manufacturing process or operation which involves
the risk of bodily injury, poisoning. disease or any other hazard to health of the persons
employed in the factory - Sec. 40B.
21. Rules. The State Government may make rules providing for the use of such further
devices for safety as may be necessary. Sec. 41.
Provisions Regarding The Welfare Of Workers
Summary of the provisions of the Factories Act regarding the welfare of workers are
stated below :
1. Washing. In every factory adequate and suitable facilities for washing shall be provided
and maintained. They shall be conveniently accessible and shall be kept clean. There
must be separate provisions for male and female workers - Sec. 42.
2. Storing and drying. The State Government may make rules requiring the provision of
suitable facilities for storing and drying clothing - Sec. 43.
3. Sitting. Sitting facilities must be provided for workers who have to work in a standing
position. so that they may take rest when possible. When work can be done in a sitting
position efficiently the Chief Inspector may direct the provision of sitting arrangements.
Sec. 44.
4. First aid. Every factory must provide first aid boxes or cupboard. They must contain
the prescribed materials and they must be in charge of persons trained in first aid
treatment. Factories employing more than 500 persons must maintain an ambulance
roam containing the prescribed equipment and in charge of the prescribed medical and
nursing staff - Sec. 45.
5. Canteens. Where more than 250 workers are employed. the state Government may
require the opening of canteen or canteens for workers. Rules may be framed regarding
the food served. its management etc. - Sec. 46.
6. Shelters. In every factory where more than 150 workers are employed there must be
provided adequate and suitable shelters or rest rooms and a lunch room (with drinking
water supply) where workers may eat meals brought by them. Such rooms must be
sufficiently lighted and ventilated and must be maintained in a cool and clean condition.
The standards may be fixed by the State Government. - Sec. 47
7. Crèches. In every factory where more than 30 women a employed, a room shall be
provided for the use of the children (below 6 years) of such women. The room shall be
adequate size, well lighted and ventilated, maintained in a clean and sanitary condition
and shall be in charge of a woman trained in the care of children and infants. The
standards shall be laid down by the State Government - Sec. 48.
8. Welfare officers. Welfare officers must be appointed in every factory where 500 or
more workers are employed. The State Government may prescribe the duties,
qualifications etc. of such officers - Sec. 49.
9. Rules. The State Government may make rules regarding the welfare of workers - Sec.
50.
The Working Hours Of Adults
Weekly Hours. No adult worker shall .be required or allowed to work in a factory for more
than forty-eight hours in any week - Sec. 51.
Daily Hours. No adult worker shall be required or allowed to work in a factory for more
than nine hours in any working day. The daily maximum may be exceeded with the
previous approval of the Chief Inspector, to facilitate change of shifts - Sec. 54.
Intervals for Rest. The periods of work of adult workers in a factory each day shall be so
fixed that no period shall exceed five hours arid that no worker shall work for more than
five hours before he has had an interval for rest of at least half an hour. The State
Government or the Chief Inspector may, by order in writing, and for reasons stated therein,
increase the work period to six - Sec. 55.
Spread over. The periods of work of an adult worker in a factory shall be arranged that
inclusive of his intervals for rest under section 55, they shall not spread-over more than ten
and half hours in any day. The Chief Inspector may for specified reasons increase the
spread over up to twelve hours - Sec. 56.
Rules Regarding Employment Of Adults

Night Shifts. Where a worker in a factory works on a. shift which extends beyond
midnight, (a) his weekly holiday and compensatory holiday means a period of holiday for
24 consecutive hours beginning when his shift ends, and (b) the following day for him shall
be deemed to be the period. of 24 hours beginning when such shift ends and the hours he
has worked after midnight shall be counted in the previous day - Sec. 57
Overlapping Shifts. Work shall not be carried on in any factory by means of a system of
shifts so arranged. that more than one relay of workers is engaged in work of the same
kind at the same time. The State Government or the Chief Inspector may grant
exemption from this rule - Sec. 58.
Double Employment. No adult worker shall be required or allowed to work in any factory
on any day on which he has already been working in any other factory, save In such
circumstances as may be prescribed - Sec. 60.
Notice of Periods of Work. There must be displayed in every factory a notice showing
periods of work of adults, classification of workers in groups according to nature of their
work, shifts and relays etc. Change made in the system of work must be notified to the
Inspector before change. The manager of every factory must maintain a Register of Adult
Workers showing the name of each worker, the nature of his work, the group in which he is
included, the relay in which he is allotted etc. The hours of work of an adult worker- must
correspond with the notice referred to above and the Register - Sec 61, 62 & 63.
No adult worker shall be required or allowed to work in any factory unless his name and
other particulars have been entered in the register of adult workers - Sec. 62 (1A) added
by the Factories (Amendment) Act, 1976.
Exemptions. By sections 64 and 65, the State Government has been given power to
exempt for limited periods certain factories from compliance with some of the provisions
relating to hours of work and employment. Such exemptions are necessary in special
cases, for example in the case of workers engaged in urgent repairs or in preparatory
and complementary work. In some industries work if of an intermittent character and the
enforcement of all the rules stated above will create hardship. The nature of the work in
certain industries requires exceptional treatment, e.g., workers engaged in engine rooms
and boilers or in the printing of newspapers. The State Government may exempt persons
holding positions of supervision and management or in confidential positions in a factory
from the operation of the rules regarding working hours (except the rule against the
employment of women at night).
Confidential Position. The State Government may empower the Chief Inspector to
declare a person other than any person defined by such rules, as a person holding
position of supervision or management or employed in a confidential position in a factory,
if, the Chief Inspector is of opinion that he can be employed.
If any such person does not get more than Rs. 750 p.m. as wages, he will be entitled to
extra wages for overtime work - Sec. 64(1) added by The Factories (Amendment) Act,
1976.
Hours and Spread over. Any exemption granted under Sec. 65 (2) shall be subject to the
following conditions
(i) The total number of hours of work in any day shall not exceed twelve.
(ii) The spread over inclusive of intervals for rest, shall not exceed thirteen hours in any
one day.
(iii) The total number of hours of work in any week. including overtime, shall not exceed
sixty.
(iv) No worker shall be allowed to work overtime, for more than seven days at a stretch
and the total number of hours of overtime work in any quarter shall not exceed seventy five
- Sec. 65(3), Factories (Amendment) Act, 1976.
Quarter. This is a period of three consecutive months beginning on the 1st January, the
1st of April, the 1st of July or the 1st of October - Sec. 64.
Restrictions On The Employment Of Women

By section 66 the following restrictions have been imposed to women workers :
(a) Maximum daily work is 9 hours: No exemption from the provisions of Section 54
(which lays down that the maximum daily hours of work shall be nine hours) can be
granted in respect of any women.
(b) Prohibition of night work: No women shall be required or allowed to work in any
factory except between the hours of 6 a.m. and 7 p.m. The State Government may by
notification in the official Gazette vary the limits for any factory or group or class or
description of factories. But such variation must not authorize the employment of women
between the hours 10 p.m. and 5 a.m. A special amendment has been made in the law
to facilitate employment of women in night shifts for IT and BPO industry.
(c) Change of shift only after holiday: There shall be no change of shifts for women
except after a weekly holiday or any other holiday.
Exception: There is an exceptional case. The State Government may make rules
providing for the exemption from the aforesaid restrictions (wholly or partially or
conditionally) of women working in fish-curing or fish-canning factories. In factories,
mentioned above, the employment of women beyond the hours specified is necessary to
prevent damage to or deterioration in any raw material. But such rules shall remain in
force for not more than three years at a time.
Other restrictions: There are other restrictions on the employment of women workers :
1. Work on or near machinery in motion. No woman or young person shall be allowed to
clean, lubricate or adjust any part of the machinery while the prime mover or transmission
machinery is in motion or to work between moving parts, or between fixed and moving
parts of any machinery which is in motion - Sec. 22(2)
2. Cotton openers. No woman or child shall be employed in any part of a factory for
pressing cotton in which a cotton opener is at work. If the feed-end of a cotton opener is in
a room separated from the delivery-end by a partition extending to the roof or to such
height as the Inspector may in a particular case specify in writing, women and children
may be employed on the side of the partition where the feed-end is situated - Sec. 27
3. Excessive weights. The State Government may make rules prescribing the maximum
weights .which may be lifted, carried. or moved by adult men, adult women, adolescents
and children employed in factories or in any class or description of factories or in carrying
on any specified process - Sec. 34
4. Crèches. In every factory wherein more than thirty women workers are ordinarily
employed there shall be provided and maintained a suitable room or rooms for the use of
children under the age of six years of such women - Sec. 48
5. Dangerous operations. The State Government is empowered to make special rules for
the purpose of controlling and regulating factories which carry on operations exposing
women, young persons and other workers to a serious risk of bodily injury, poisoning or
disease - Sec. 87 (b)
EMPLOYMENT OF YOUNG PERSONS

Employment of Children. No child who has not completed his fourteenth year shall be
required or allowed to work in any factory - sec. 67
Certificate of Fitness and Token. A child who has completed his fourteenth year or an
adolescent shall not be required or allowed to work in any factory unless (a) he has been
granted a certificate of fitness which is in the custody of the manager, and (b) such child
or adolescent carries a token giving a reference to such certificate - Sec. 68
The Certificate of Fitness is a certificate granted to a child or adolescent by a Certifying

Surgeon after examination: The certificate is given to a child if the surgeon is satisfied that
he has completed his fourteenth year and has attained the prescribed physical standards.
The certificate is granted to an adolescent if the surgeon is satisfied that he has completed
his fifteenth year and is fit for a full day's we in a factory. The certifying surgeon must have
personal knowledge of the intended place of work and of the manufacturing process
involved. The certificate is valid only for a period of 12 months. It may be granted subject
to conditions (e.g., that of periodical re-examination). The certificate may be renewed and,
if necessary, revoked. Any fee pa: able for the certificate must be paid by the occupier of
the factory all must not be recovered from the young person or his parents or guardian.
Sec. 69.
An adolescent who has been granted a certificate of fitness ant who carries a token is
deemed to be an adult for the purposes of Chapters VI and VIII of the Act. (Ch. VI deals
with the hours of work of an adult and Ch. VIII deals with "annual leave). But no
adolescent who has not attained the age of seventeen years shall be employed or
permitted to work in any factory during night. "Night" means a period of at least 12
consecutive hours which shall include an interval of at least seven consecutive hours
falling between 10 p.m. and 7 a.m. An adolescent who has not been granted a certificate
of fitness, shall be deemed to be a child ~or the purposes of the act - Sec. 70.
Working hours for Children (Child employee is someone who has completed 15 years
of age, but not completed 18 years of age). The law regarding working hours for children
are stated below - Sec. 71
1. No child shall be employed or permitted to work in any factory
(a) for more than four and a half hours in any day;
(b) during the night
Explanation: For the purpose of this sub-section "night" shall mean a period of at least
twelve consecutive hours which shall include the interval between 10 p.m. and 6 a.m.
2. The period of work of all children employed in a factory shall be limited to two shifts
which shall not overlap or spread-over more than five hours each, and each child shall be
employed in only one of the relays which shall not, except with the previous permission in
writing of the Chief Inspector, be changed more frequently than once in a period of thirty
days.
3. The provisions of section 52 shall apply also to child workers, and in respect of any
child. (Sec. 52 relates to weekly holidays)
4. No child shall be required or allowed to work in any factory on any day on which he has
already been working in another factory.
Notice and Register. A notice must be displayed showing clearly the periods of work of
children - Sec. 72.
The manager of every factory must maintain a Register of child workers showing the name
of each child worker, the nature of his work, the group (if any) in which he is included, the
relay to which he is allotted and the number of his certificate of fitness - Sec. 73.
No child worker shall be required or allowed to work in any factory unless his name and
other particulars have been entered in the register of child workers - Sec. 73 (1A)
Factories (Amendment) Act, 1976.
The hours of work of a child must correspond with the Notice and the Register - Sec. 74
Medical Examination. Where an Inspector is of opinion that a person working as an adult

is a young person, or that a young person is not fit to work, he may direct the manager of
the factory to have the person medically examined by a certifying surgeon - Sec. 75.
Other rules regarding the employment of young persons. No young person shall
work at any dangerous machine unless he has been fully instructed as to the dangers
arising in connection with the machine and the precautions to be observed, and (a) has
received sufficient training in work at the machine or (b) is under adequate supervision by
a person who has a thorough knowledge and experience of the machine. The State
Government is to prescribe what machines are dangerous for the purpose of this section -
Sec. 23. Certain restrictions an adolescents and children are stated in Sections 22(2), 27,
34 and 87 (b)
The State Government may make rules regarding the forms of the Certificate of Fitness,
the procedure relating to their issue, and the physical standards to be attained by children
and adolescents Sec. 76
The provisions relating to the employment of young persons shall be in addition to the
provisions of the Children Act of 193 of 1960 and 1978 - Sec. 77
Child Labor
Rules regarding child labor are contained in the Factories Act, Mines Act etc. There are
also two general Acts on the subject. The Children (Pledging of Labor) Act (Act 11 of
1933) prohibits the making of agreements to pledge the labor of children and the employ-
ment of children whose labor has been pledged. The Children Act of 1938, 1960 and
1978 prohibit the employment of a child who has not completed his fifteenth year of age in
any occupation connected with the transport of passengers, goods or mails. The act also
prohibits the employment of a child, who has not completed his fourteenth year of age, in
the processes set forth in the schedule to the Act. Children between 15 and 17 can be
employed subject to certain restrictions as regards their periods of rest etc.
Holidays And Leave

The Factories Act provides for the following holidays, viz. Weekly holidays, Compensatory
holidays and Annual leave with wages according to certain rules. The provisions are
explained below.
Weekly Holidays. Section 52 provides that an adult worker shall have a holiday on the
first day of the week. But the manager of the factory may fix the holiday on any other day
which is with three days before or after the first day of the week in case of such
substitution; notice must be given to the Inspector of Factories and displayed in the
factory. No substitution can be made which will result in any worker working for more than
ten days consecutively without a holiday for a whole day. The State Government may
make rules providing for exemption from the above section in certain cases, e.g., for
urgent repairs.
The Weekly Holidays Act (Act XVIII of 1942) provides for the grant of weekly holidays to
persons employed in shops, restaurants and theatres. The Act can be applied to a State
by notification of the State Government.
Compensatory Holidays. Where as a result of the exemption of factory from the

operation of the role regarding weekly holidays, a worker is deprived of any weekly holiday
he shall be allowed within the month in which the holidays were due, or within two months
immediately following that month, compensatory holidays of equal number to the holidays
lost - Sec. 53.
Annual Leave with Wages. Sections 78 to 84 provide for the grant of a certain period of
leave with wages to workmen.
Every worker who has worked for a period of 240 days or more in a factory during a
calendar year shall be allowed during the subsequent calendar year, leave with wages for
a number of days calculated at the rate of
(i) If an adult, one day for every twenty days of work performed by him during the previous
calendar year;
(ii) If a child, one day for every fifteen days of work performed by him during the previous
calendar year.
Rules. Rules regarding the Annual Leave are summarized below :
1. When counting the number of days of work performed by a worker, the following are
to be included: (a) days of lay-of (b) maternity leave to a female worker, not exceeding
twelve weeks, and (c) the leave earned in the previous year. But the worker shall not
earn leave for these days.
2. The leave admissible under the aforesaid rule shall be exclusive of all holidays
whether occurring during or at either end of the period of leave.
3. A worker whose service commences otherwise than on the first day of January shall be
entitled to leave, with wages at the rate laid down above if he has worked for two-thirds of
the total number of days in the remainder of the calendar year.
4, If a worker is discharged or dismissed from service or quits his employment or is

superannuated or dies while in service, during the course of the calendar year, he or his
heir or nominee, as the case may be, shall be entitled, to wages in lieu of the quantum of
leave to which he was entitled Immediately before his discharge, dismissal, quitting of
employment, superannuation or death calculated at the rates specified in sub-section (1)
even If he had not worked for the entire period specified In sub-section (J) or sub-section
(2) making him eligible to avail of such leave, such payment shall be made
(i) Where the worker is discharged or dismissed or quits employment-before the expiry of
the second working day from the date of such discharge, dismissal or quitting; and
(ii) Where the worker is superannuated or dies while in service -before the expiry of two
months from the date of such superannuation or death. (Amended by the Act of 1976).
5. In calculating the leave period, fraction of leave for half a day or more shall be treated
as one day and fractions of lesser amount shall be omitted.
6. Leave earned, but not taken, can be carried forward to a succeeding year subject to a
limit of thirty days in the case of an adult and forty days in the case of a child. But earned
leave not allowed because of any scheme for leave in operation, can be carried forward
without limit.
7. Application for leave must be submitted to the manager not less than 15 days before
the date of commencement of leave. In the case of public utility service it must be made
not less than 30 days before such date. If a worker becomes ill and wants to avail himself
of the annual leave during the period of illness, he shall be granted leave even though the
application is not made before the period specified above.
8. The application for leave may be for the whole of the leave due or part of it. But earned
leave cannot be taken more than three times during the same year.
9. For the purpose of ensuring the continuity of work, the occupier or manager of the
factory may draw up a Scheme for regulating the grant of leave. The Scheme must be
agreed to by the 'Works Committee, if any, or the representatives of workers. It must be
lodged with the Chief Inspector and displayed in the factory.
10. An application for leave submitted in proper time shall not be refused unless the
refusal is in accordance with any leave scheme in operation.
11. The un-availed leave of a worker shall not be taken into consideration in computing
the period of any notice required to be given before discharge or dismissal
12. The State Government may exempt a factory from the operation of the above rules if it
is satisfied that its own leave rules provide benefits (the totality of benefits) which are not
less favorable to the workers than the statutory leave rules.
13. Where by virtue of any award, agreement (including settlement) or contract of service
the worker is entitled to a longer period of leave than that provided by the aforesaid rules,
he will be entitled to such longer leave.
14. The rules contained in these sections do not apply to railway Factory administered by
the Government which are governed by leave rules approved by the Central Government.
15. If an award, agreement (including settlement) or contract of Service provides for a

longer annual leave with wages than provided in this chapter, the quantum of leave, which
the worker shall be entitled to, shall be in accordance with such award, agreement or con-
tract of service, but in relation to matters not provided for in such .award, agreement or
contract of service or matters which are provided for less favorably therein, the provisions
of sections 79 to 82, so far as may be, shall apply (Added by the Amendment of 1976)
Wages during Leave Period.
For the period of leave allowed to a worker according to rules, he shall be paid at a rate
equal to the daily average of his total full-time earnings for the days on which he actually
worked during the month immediately preceding his leave. The average rate is to be
calculated, exclusive of any overtime and bonus, but inclusive of dearness allowance and
the cash equivalent of the advantage accruing through the concessional sale to the worker
of food-grains and other articles. The cash equivalent, referred to above, is to be
computed according to the method used when calculating the extra wages payable for
overtime work. Sec. 80.
lf the employment of a worker who is entitled to leave is terminated by the occupier of the
factory before he has taken the entire leave to which he is entitled, he must be paid wages
for the leave period not taken and such wages must be paid before the expiry of the
second working day after such termination. Similarly, if the worker quits his service after
having applied for and obtained leave, he must be paid wages (or the leave period and
such wages must be paid on or before the next pay day. The amount of wages payable
will calculated according to the provisions of Sec 80, 79(11)
A worker who has been allowed leave for not less than four days in the case of an adult
and five days in the case of a child, shall before his leave begins, be paid the wages due
for the period of leave allowed - Sec. 81
Wages for the leave period, if not paid by an employer, shall be recoverable as delayed
wages under the provisions of the Payment of Wages Act, 1936 - Sec. 82
Extra Wages For Overtime
(1) Where a worker works in a factory for more than nine hours on any day or for more
than 48 hours in any week, he shall in respect of overtime work, be entitled to wages at the
rate of twice his ordinary rate of wages - Sec 59(1)
(2) For the purpose of sub-section (1), "ordinary rate of wages means the basic wages
plus such allowances, including the cash equivalent of the advantage accruing through the
concessional sale to workers of food grains and other articles, as the worker is for the time
being entitled to, but does not include a bonus and wages for overtime work - Sec. 59(2)
(3) Where any workers in factory are paid on a piece rate basis, the time rate of their work
will include the following rules:
(i) if the workers bad been paid on the same or identical job during a month
immediately preceding a month during which overtime work was done, the time rate
shall be deemed to be equivalent to the daily average of their fulltime earnings for the
days of the overtime work. Also such time rates shall be deemed to be the ordinary
rates of wages of those workers.
(ii) In the case of a worker who had not worked in the immediately preceding calendar
month on the same or identical job, the time rate shall be deemed to be equivalent to
the daily average of the earning of the worker for the days on which he actually worked
in the week in which the overtime work was done.
Explanation For the purposes of this sub-section in computing the earnings for the days
on which the workers actually worked, the allowance include the cash equivalent in order
to buy food grains and other articles through concessional sale as the worker is for the
time being entitled to.
Exception - But any bonus or wages for overtime work payable in relation to the period
with reference to which the earnings are being computed shall not be included - Sec.
59(3)[Clauses (2) and (3) were substituted from the old Act by the Amendment of 1976]
(4 )The cash equivalent of the advantage accruing through the concessional sale to a
worker of food grains and other articles shall be computed as often as may be prescribed
on the basis of the maximum quantity of food grains and other articles admissible to a
standard family.
Explanation 1.-"Standard family" means a family consisting of the worker, his or her
spouse and two children below the age of fourteen years requiring in all three adult
consumption units.
Explanation 2.- "Adult consumption unit" means the consumption unit of a male above the
age of fourteen years; and the consumption unit of a female above the age of fourteen
years and that or a child below the age of fourteen years shall be calculated at the rates of
0.8 and 0.6 respectively of one adult consumption unit. Sec. 59(4).
(5) The State Government may make rules prescribing

(a) the manner in which the cash equivalent of the advantage accruing through the
concessional sale to a worker of food grains and other articles shall be computed; and
(b) the register that shall be maintained in a factory for the purpose of securing
compliance with the provisions of this section - Sec 59(5)
WAGES AND SALARY
Both these terms are used to denote payment made for service. Where the engagement
is for a period, is permanent or substantially permanent in character, and is for other than
manual or relative unskilled labor, the remuneration is generally called a salary. In
general, the word 'salary' 'is used for payment of services of a higher class and 'wages' is
confined to the earnings of laborers and artisans.
The High Court of Madras was of opinion that if the remuneration is to be paid daily or
weekly it can be called Wages; but where there is monthly payment and is fairly high,
considering the general standard of payment, it is to be called Salary.
Conceptually there is no difference between salary and wages both being a

compensation for a work done or service rendered, though ordinarily the former
expression is used in connection with services of non-manual type while the latter is used
in connection with manual services.
Obligations Of Workers
Section 111 lays down that no worker in a factory
(a) shall willfully interfere with or misuse any appliance, convenience or other things
provided in a factory for the purpose of securing the health, safety or welfare of the
workers therein,
(b) shall willfully and without reasonable cause do anything likely to endanger himself or
others; and
(c) shall willfully neglect to make use of any appliance or other thing provided in the
factory for the purposes of securing the health or safety of the workers therein.
If any worker contravenes any of the previsions of this section or of any rule or order made
there under he shall be punishable with imprisonment which may extend to 3 months or
with fine.
Other Provisions Of The Factories Act

A brief summary is given below of the other provisions of the Factories Act.
Departments as Factories. The State Government may, upon application, declare that for
the purposes of the Act, different departments or branches of a factory shall be treated as
separate factories or that two or more factories of the occupier shall be treated as the
same factory - Sec. 4. .
Exemption during Public Emergency. Factories or any class of factories may be

exempted from the operation of any of the provisions of the Act during a public emergency
(except that of Sec. 67, employment of children) for such periods and subject to such
conditions as the Government may think fit. The exemption is to be made by notification in
the official Gazette for a period not exceeding three months at a time - Sec. 5.
Explanation for the purposes of this section - 'public emergency' means a grave
emergency whereby the security of India or of any part of the territory thereof is
threatened, whether by war or external aggression or internal disturbance - Amendment of
1976.
Exemption of Public Institutions. The State Government may exempt subject to such
conditions as it may consider necessary, any workshop or workplace where a
manufacturing process is carried on and which is attached to a public institution
maintained for the purposes of education, training, research or reformation from all or any
of the provisions of the act. But no exemption is to be granted from the provisions relating
to hours of work and holidays unless there is a scheme relating to such matters
containing rules not less favorable to the workers than the provisions of the act - Sec. 86.
Dangerous Operations. The State Government is empowered to make special rules for
the purpose of controlling and regulating factories which carry on manufacturing process
or operation exposing workers to a serious risk of bodily injury, poisoning or disease.
Sec. 87. Rules have been made providing for medical examination, protection of
workers; restricting' and controlling the use of particular materials and processes ;
payment of fees for medical examination by the occupier ; welfare amenities ; sanitary
amenities ; measures to avoid imminent danger of poisons or toxicity.
Notifiable Accidents.
(1) The manager of a factory must send a notice to the authorities whenever an accident
occurs which causes death or which causes bodily injury preventing the worker from work-
ing for a Period of 48 or more hours or other types of injury which may be specified by
rules.
(2) Where a notice given under sub-section (1) relates to an accident causing death, the
authority to whom the notice is sent shall make an inquiry into the occurrence within one
month of the receipt of the notice or, if such authority is not the Inspector, cause the
Inspector to make an inquiry within the said period. .
(3) The State Government may make rules for regulating the procedure at inquiries under
this section.--Sec. 88. [Paras 2 and 3 had been added by the Amendment of 1976].
Notice of certain dangerous occurrences. Where in a factory any dangerous

occurrence of such nature as may be prescribed occurs, whether causing any bodily injury
or disability or not, the manager of the factory shall send notice thereof to such authorities,
and in such form and within such time, as may be prescribed.--Sec. 88A, Factories
(Amendment) Act, 1976.
Notifiable Diseases. The manager of a factory must send notice to the authorities,
whenever a worker contacts any of the diseases mentioned in the Schedule to the Act.
(These are known as Occupational Diseases. Examples: poisoning by lead, mercury,
phosphorus etc.; anthrax; silicosis; cancer of the skin; toxic anemia or jaundice etc.). The
medical practitioner attending the person, if any, shall without delay send a report to the
Chief Inspector in writing, stating the name of the person affected and other particulars -
Sec. 89.
Enquiry into Accidents and Diseases. The State Government may appoint a competent
person to enquire into the causes of any accident occurring in a factory or of a notifiable
disease, and may also appoint one or more persons possessing legal or special
knowledge to act as assessors in such enquiry. The person appointed to enquire can call
witnesses like a Civil Court and exercise any of the powers of an Inspector. He must
submit a report to the State Government, together with his observations. The report or
extracts therefrom may be published - Sec. 90.
Safety and Occupational Health Survey. The State Government or the Director General
of Factory Advice Service and Labor Institutes etc. can employ the Chief Inspector and
certain other persons to undertake safety and occupational health surveys. The occupier
and manager and all other persons shall afford all facilities for such survey, including
examination, testing of plant and machinery, collection of samples, other data, medical
examination of persons calculation of wages and extra wages for overtime work - Sec.
91A, added by The Factories (Amendment) Act, 1976.
Penalties and Procedures. Sections 92 to 106 lay down the rules regarding penalties for
offences against the Act.
Owner: The owner of any premises, let out for use as different factories, is responsible for
the provision and maintenance of common facilities and services, e.g., approach roads,
drainage, water supply, latrines etc.
Occupier: In most cases the occupier of the factory is responsible for offences committed
against the Act. But the occupier is exempted from liability if he can show that he has used
due diligence to enforce the execution of the act and that some other person committed
the offence without his knowledge, consent or connivance.
Where contravention of any of the provisions of Chapter IV or any rule made thereunder or
under Section 87 has resulted in an accident causing death or serious bodily injury, the
fine shall not be less than one thousand rupees in the case of an accident causing death,
and five hundred rupees in the case of an accident causing serious bodily injury.
Explanation In this section and in section 94 - "Serious bodily injury" means an injury
which involves, or in all probability will involve, the permanent loss of the use of, or
permanent injury to, any limb or the permanent loss of, or injury to sight or hearing, or the
fracture of any bone, but shall not include, the fracture of bone or joint (not being fracture
of more than one bone or joint) of any phalanges of the hand or foot - Sec. 92 added in the
Amendment of 1976.
Cognizance: No court can take cognizance of an offence under the act except on a
complaint by or with the previous sanction of an Inspector in writing. Only a Presidency
Magistrate or a Magistrate of the first class can try offences under the act. The complaint
must be filed within 3 months of the date when the commission of the offence came to the
knowledge of an Inspector. For disobeying a written order of an Inspector, complaint may
be filed within 6 months of the date when the offence was committed.
Presumption: A person found in the factory when the factory is going on or the machinery
is in motion, except during the time of meal or rest, is presumed to be employed in the
factory until the contrary is proved.
When in the opinion of the Court a person is prima facie underage, the burden shall be on
the accused to show that such person is not under-age.
Appeals. The manager or the occupier of a factory on whom an order in writing has been
served by an Inspector can appeal against it to the prescribed authority within thirty days -
Sec. 107
Notice. In certain cases (prescribed by the rules) abstracts of the Act and the rules are
required to be displayed in the factory. All notices under the Act must be displayed in
English and in a language understood by the majority of the workers employed therein.
They must be displayed in a conspicuous and convenient place at or near the main
entrance of the factory and must be maintained in a clean and legible condition. The
Chief Inspector may require the display of posters relating to the health, safety and
welfare of workers - Sec. 108.
Returns. The owners, managers and occupiers of factories are required by rules to
submit various returns and reports to the competent authority- Sec. 110
Power of the Central Government. The Central Government may give directions to a
State Government as to the execution of the provisions of the act - Sec. 113.
Abolition of Contract Labor. The provisions of this act shall have effect notwithstanding
anything inconsistent therewith contained in the Contract Labor (Regulation and Abolition)
Act, 1970 Sec. 119, added by the Factories (Amendment) Act, 1976.
4.8 Management by Objectives (MBO)
Management by Objectives (MBO) is a personnel management technique where managers
and employees work together to set, record and monitor goals for a specific period of time.
Organizational goals and planning flow top-down through the organization and are
translated into personal goals for organizational members. The technique was first
championed by management expert Peter Drucker and became commonly used in the
1960s.
Key Concepts
The core concept of MBO is planning, which means that an organization and its members
are not merely reacting to events and problems, but are instead being proactive. MBO
requires that employees set measurable personal goals derived from the organizational
goals. For example, a goal for a civil engineer may be to complete the infrastructure of a
housing subdivision within the next twelve months. His personal goal must align with the
organizational goal of completing the subdivision.
MBO is a supervised and managed activity so that all of the individual goals can be
coordinated to work towards the overall organizational goal. You can think of an individual,
personal goal as one piece of a puzzle that must fit together with all of the other pieces to
form the complete puzzle, the organizational goal. Goals are set down in writing annually
and are continually monitored by managers to check progress. Rewards are based upon
goal achievement.
Advantages
o It provides a means to identify and plan for achievement of goals. If you don't know what
your goals are, you will not be able to achieve them.
o Planning permits proactive behavior and a disciplined approach to goal achievement.
o It also allows you to prepare for contingencies and roadblocks that may hinder the plan.
Goals are measurable so that they can be assessed and adjusted easily.
o Organizations can also gain more efficiency, save resources, and increase
organizational morale if goals are properly set, managed, and achieved.
Disadvantages
o Application of MBO takes concerted effort.

o You cannot rely upon a thoughtless, mechanical approach, and you should note that
some tasks are so simple that setting goals makes little sense and becomes more of
silly, annual ritual. For example, if your job is snapping two pieces of a product together
on an assembly line, setting individual goals for your work isn't really necessary.
o There is often a focus on mere goal setting rather than developing a plan that can be
implemented.
o The organization often fails to take into account environmental factors that hinder goal
achievement, such as lack of resources or management support.
o Organizations may also fail to monitor for changes, which may require modification of
goals or even make them irrelevant.
o Finally, there is the issue of plain human neglect - failing to follow through on the goals.
4.9 Leadership, Group Dynamics and Management of Discipline
Leadership
According to the idea of transformational leadership an effective leader is a person who –
o Creates an inspiring vision of the future.

o Motivates and inspires people to engage with that vision.
o Manages delivery of the vision.
o Coaches and builds a team, so that it is more effective at achieving the vision.
Leadership brings together the skills needed to do these things. We'll look at each element
in more detail.
1. Creating an Inspiring Vision of the Future
In business, a vision is a realistic, convincing and attractive depiction of where you want to
be in the future. Vision provides direction, sets priorities, and provides a marker, so that you
can tell that you've achieved what you wanted to achieve.
To create a vision, leaders focus on an organization's strengths by using tools such as
o Porter's Five Forces (Supplier Power, Buyer Power, Competitive Rivalry, Threat of
Substitution, and Threat of New Entry),
o PEST Analysis (Political Factors, Economic Factors, Socio-Cultural Factors,
Technological Factors),
o USP Analysis (Finding Your "Competitive Edge"),
o Core Competence Analysis (Building Sustainable Competitive Advantage), and
o SWOT Analysis to analyze the current situation.
They try to foresee, how their industry is likely to evolve, and how their competitors are
likely to behave. They look at how they can innovate successfully, and shape their
businesses and their strategies to succeed in future marketplaces. They test their visions
with appropriate market research, and by assessing key risks using techniques such as
Scenario Analysis (Exploring alternative future scenarios).
Therefore, leadership is a proactive, problem solving, forward looking, and forward moving
attribute of a person, who commands people’s trust and their faith.
Once they have developed their visions, leaders must make them compelling and
convincing to their constituency. A compelling vision is one that people are able to see, feel,
understand, and embrace. Effective leaders provide a vivid picture of what the future will
look like when their visions have been realized. They tell inspiring stories, and explain their
visions in ways that everyone can relate to.
Here, leadership combines the analytical side of vision creation with the passion of shared
values, creating something really meaningful to the people being led.
2. Motivating and Inspiring People
A compelling vision provides the foundation for leadership. But it's leaders' ability to
motivate and inspire people that helps them deliver that vision.
For example, when you start a new project, you will probably have lots of enthusiasm for it,
so it's often easy to win support for the project at the beginning. However, it can be difficult
to find ways to keep your vision inspiring after the initial enthusiasm fades away, especially
if the team or organization needs to make significant changes in the way they do the things.
Leaders recognize this, and they work harder throughout the project to connect their
vision with people's individual needs, goals, and aspirations.
One of the ways they do this is through Expectancy Theory (Motivating the team by linking
their efforts with the outcome or rewards). Effective leaders link together two different
expectations:
o The expectation that hard work leads to good results.

o The expectation that good results lead to attractive rewards or incentives.
This motivates people to work hard to achieve success, because they expect to enjoy
rewards – both intrinsic and extrinsic – as a result.
Other approaches include restating the vision in terms of the benefits it will bring to the
team's customers, and communicating them the vision in an attractive and engaging way.
What's particularly helpful is, when leaders have the expert power. People admire and
believe in these leaders because they are experts in what they do. They have credibility,
and they've earned the right to ask people to listen to them and follow them. This makes it
much easier for these leaders to motivate and inspire the people they lead.
Leaders can also motivate and influence people through their natural charisma and appeal,
and through other sources of power, such as the power to pay bonuses or assign tasks to
people. However, good leaders don't rely too much on these types of power to motivate and
inspire others.
3. Managing Delivery of the Vision
This is the area of leadership that relates to management. Leaders must ensure that the
work needed to deliver the vision is properly managed – either by themselves, or by
dedicated managers or a team of managers to whom the leader delegates this
responsibility – and they need to ensure that leader’s vision is transferred successfully.
To do this, team members need performance goals that are linked to the team's overall
vision. And, for day-to-day management of delivering the vision, the Management-By–
Wandering-Around (MBWA) approach helps to ensure that what should happen, really
happens.
Leaders also need to make sure they manage change effectively. This helps to ensure that
the changes needed to deliver the vision are implemented smoothly and thoroughly, with
the support and backing of the people affected.
4. Coaching and Building a Team to Achieve the Vision
Individual and team development are important activities carried out by transformational
leaders. To develop a team, leaders must first understand team dynamics. Several well-
established and popular models describe this, such as Belbin's Team Roles approach, and
Bruce Tuckman's Forming, Storming, Norming, and Performing theory.
A leader will then ensure that team members have the necessary skills and abilities to do
their job and achieve the vision. They do this by giving and receiving feedback regularly,
and by training and coaching people to improve individual and team performance.
Leadership also includes looking for leadership potential in others. By developing
leadership skills within your team, you create an environment where you can continue to
success in the long term. And that's a true measure of great leadership.
In the transformational leadership model, leaders set direction and help themselves and
others to do the right thing to move forward in that direction. To do this they create an
inspiring vision, and then motivate and inspire others to reach that vision. They also
manage delivery of the vision, either directly or indirectly, and build and coach their teams
to make them stronger.
Mahatma Gandhi is considered as one of the greatest inspirational leaders ever born,
because he could successfully align the visions and aspirations of millions of Indians with
his vision of independent India.
Leadership style is the way a person uses his power to lead other people. There are a
variety of leadership styles, viz.
1. Autocratic Leadership
Autocratic leadership style is centered on the boss. In this leadership the leader holds all
authority and responsibility. In this leadership, leaders make decisions on their own without
consulting subordinates. They reach decisions, communicate them to subordinates and
expect prompt implementation. Autocratic work environment does normally have little or no
flexibility.
In this kind of leadership, guidelines, procedures and policies are all natural additions of an
autocratic leader. Statistically, there are very few situations that can actually support
autocratic leadership.
2. Democratic Leadership
In this leadership style, subordinates are involved in making decisions. Unlike autocratic
leadership, this headship is centered around subordinates’ contributions. The democratic
leader holds final responsibility, but he or she is known to delegate authority to other
people, who determine work projects.
The most unique feature of this leadership is that communication is active upward and
downward. With respect to statistics, democratic leadership is one of the most preferred
leadership, and it entails the following: fairness, competence, creativity, courage,
intelligence and honesty.
3. Strategic Leadership
Strategy is a plan of action designed to achieve a long-term or overall aim. In military

parlance, strategy is the art of planning and directing overall military operations and
movements in a war or battle for defeating the enemy with minimal efforts and loss of
manpower.
Strategic leadership refers to a manager’s potential to visualize, articulate, express and

transmit a strategic vision for the organization, and to motivate and persuade others to
understand his vision and cooperate with him in achieving it. It is the potential to influence
organizational members and execute organizational change. Strategic leaders create
organizational structures, allocate resources and ensure an ambiguous and enthusiastic
atmosphere in the organization.
The main objective of strategic leadership is to develop an environment in which employees
are able to visualize organization’s needs in the context of their own jobs. Strategic leaders
encourage the employees to follow their own ideas, so long as they fit into the overall
strategic vision of the company. Strategic leadership is having the ability to foresee the
broader picture of the future and assisting the employees in realizing their goals while
striving for the organization’s goals.
4. Transformational Leadership
Unlike other leadership styles, transformational leadership is all about initiating changes in
organizations to bring about a complete change in company’s identity and its work culture.
Transformational leaders motivate others to set much higher benchmarks for themselves
and encourage them to explore the alternative ways for doing their work and maximize the
performance of the whole organization. They set challenging goals for their team and
typically give higher performance themselves.
Transformational leaders tend to have more committed and satisfied followers because
they empower their team members.
5. Team Leadership
Team leadership is about working with the hearts and minds of all those involved. It also
recognizes that teamwork may not always get trust and cooperation of all team members.
The most challenging aspect of this leadership is, the team leaders many times fail because
of poor leadership qualities.
Team leadership involves visualizing the future of the team, determining the direction in
which the organization is heading and deciding the necessary actions to realize those
goals. The vision inspires and provides a strong sense of purpose and direction to the team
members.
6. Cross-Cultural Leadership
This form of leadership normally exists, when there are people belonging to diverse social
cultures and work ethics.
In this type of situations, the organizations need leaders who can effectively adjust their
leadership styles to work in different environs, and bring about a synergy between these
diverse cultures. Most of the multinational companies need cross-cultural leaderships
because they employ people from different nationalities and work cultures.
7. Facilitative Leadership
Facilitative leadership is too dependent on measurements and outcomes of the team’s

performance.
If the group is super performing, the facilitative leader keeps his hands off the process.
On the other hand, if the group is underperforming, he will be actively involved in helping
the group run its process efficiently. Effective facilitative leadership keeps monitoring the
group dynamics, offers process suggestions and intervenes to help the group stay on the
track whenever detours are noticed.
8. Laissez-faire Leadership
Laissez-faire leadership gives complete authority to the employees.
In this style of leadership, the subordinates are allowed to work, as they choose, with
minimal or no interference, as long as their actions are fitting into the broader picture of the
organizations goals.
Because looking up to the leader for direction is our basic instinct, this kind of leadership is
the least satisfying and least effective of all the management styles. In the absence of
proper leadership support the group often becomes directionless and many times total
confusion prevails in the group.
9. Transactional Leadership
This is a leadership style that maintains or continues the status quo. This leadership style
involves an exchange process, whereby followers get immediate rewards for carrying out
the leader’s orders. Transactional leadership can sound rather crude, with its singular focus
on exchange.
As being clear, having focus on expectations, and giving feedbacks are important aspects
of transactional leadership, it involves clarifying what is expected of followers; explaining
them how to meet such expectations; and allocating rewards that are contingent on meeting
those objectives.
10. Coaching Leadership
Coaching leadership involves teaching and supervising followers. A coaching leader is

highly operational in setting where the performance needs improvement. Basically, in this
type of leadership, followers are helped to improve their skills. Coaching leadership does
the following - motivates the followers, inspires and encourages them.
11. Charismatic Leadership
In this leadership, the charismatic leader manifests his or her magnetic personality. People
get attracted to such leaders and place higher importance to their leader’s expectations
than their own needs, values or beliefs. Charismatic leader attempts to transform followers’
values, beliefs, and their underlying normative orientation that structures their attitudes to
achieve the good for his organization, society or a country.
In the contrast, a populist leader might manipulate peoples’ emotions to achieve his own
personal goal.
12. Visionary Leadership
This form of leadership has the capacity to visualize the needs of the company, society or a
country much before it becomes a common place, and they take suitable actions to convert
that vision into a reality before anyone else can sense it.
Group Dynamics
People may underestimate the importance of society and group memberships on their lives.
Whilst people sometimes undertake solo journeys, yet by and large, much of our
experiences of life involves being engaged with others and groups. Within an organization
we do find number of groups. Individuals joining group (s) is a reality (may be formal or
informal groups). People work in groups quite frequently and in many different areas of their
life e.g. at work, school/college, sport, hobbies. The managers need to understand Group
Dynamics that can enable managers to adopt the right approach of interacting with them.
What is Group Dynamics?
Group dynamics deals with the attitudes and behavioral patterns of a group. Group
dynamics concern how groups are formed, what is their structure and which processes are
followed in their functioning. Thus, it is concerned with the interactions and forces operating
between groups.
Group dynamics is relevant to groups of all kinds-both formal and informal. For example,
the government has set up a Group of Ministers (GOM) for many governance issues, the
Supreme Court of India has 27 Group of judges committees overseeing the non-judicial
work in the apex court. In an organizational setting, the term ‘groups’ is very common and
the study of groups and group dynamics is an important area of study for optimizing
organizational and employees’ welfare.
What is a Group?
Every organization is a group in itself. A group refers to two or more people who share a
common meaning and evaluation of themselves and come together to achieve common
goals. In other words, a group is a collection of people who interact with one another,
accept rights and obligations as members and who share a common identity.
Characteristics of a Group: Regardless of the size or the purpose, every group has
certain common characteristics.
o Two or more persons make up a group

o It is a formal social structure (the rules of the game are defined)
o It has a common fate (they will swim together)
o It has common goals (their destiny is the same and they are emotionally connected)
o They generally have a face-to-face interaction (they will talk with each other) (What’s
Up is an exception)
o Group members are interdependent (each one is complimentary to the other)
o Member define their identity as a member of certain group (what one is, one who
belongs to a certain group)
o The members crave for recognition by others (yes, you belong to the group).
Process of or Stages in Group Development or Evolution:
Group Development is a dynamic process. How do groups evolve? This is a five stage
process - forming, storming, norming, performing, and adjourning.
Forming:
The first stage in the life of a group is concerned with forming a group. This stage is
characterized by members seeking either a work assignment (in a formal group) or other
benefit, like status, affiliation, power, etc. (in an informal
group). Members at this stage either engage in busy type of
activity or show apathy.
Storming:
The next stage in this group is marked by the formation of

dyads and triads. Group members reach out to familiar or
similar individuals and begin a deeper sharing of their self. At
this stage continued attention to any subgroup creates a
differentiation in the group and tensions may appear across
the dyads or triads. Pairing is a common phenomenon at this
stage. There may be conflicts about who’ll control the group.
Norming:
The third stage of group development is marked by a more

serious concern about group performance. The dyads and
triads begin to open up and reach out to other members in the
group. Efforts are made to establish various norms for group
performance. Members begin to take greater responsibilities
for their own group and relationships, and the authority
figures can afford to become a little relaxed. Once this stage
is complete, a clear picture will emerge about the hierarchy of
leadership. The norming stage is over with the freezing of the
group structure (organization structure of the group) and a
sense of group identity and camaraderie (easy familiarity and sociability) emerges.
Performing:
This is a stage of a fully functional group where members see themselves as a group and
start shouldering the duties of the group members. Each person makes a contribution and
the authority figure is also seen as a part of the same group. Group norms are followed and
collective pressure is exerted on each member to ensure the Group’s Effectiveness.
The group may redefine its goals in the light of the information from the external
environment and show an autonomous will to pursue those goals. The long-term viability of
the group is established and nurtured by the group members.
Adjourning:
In the case of temporary groups, like project teams, task forces, or any other such group,
which have a limited task at hand, also have a fifth stage, called as adjourning. The group
decides to disband. Some members may feel happy over the performance, and some may
be unhappy over the stoppage of meetings with group members. Adjourning may
sometimes be referred to as mourning, i.e. mourning the adjournment of the group.
Types of Groups:
One way to classify the groups is by way of formality - formal and informal. While formal
groups are established by an organization to achieve its goals, informal groups emerge
spontaneously. Formal groups may take the form of a command group, a task force, or a
functional group.
1. Command Groups:
Command groups are specified by the organizational chart and often consist of a
supervisor, and the subordinates who report to that supervisor. An example of a command
group is a market research firm’s CEO and the research associates working under him or
reporting to him.
2. Task Groups:
Task groups consist of people who work together to achieve a common task. Members are
brought together to accomplish a limited range of goals within a specified time period. Task
groups are also commonly referred to as task forces. The organization appoints the
members and assigns them goals and tasks to be accomplished. Examples of assigned
tasks are the development of a new product, the improvement of a production process, or
designing the syllabus under semester system. Other common task groups are ad hoc
committees, project groups, and standing committees. Ad hoc committees are temporary
groups created to resolve a specific complaint or develop a process. These groups are
normally disbanded after the group completes the assigned task.
3. Functional Groups:
A functional group is created by the organization to accomplish specific goals within an

unspecified time frame. Functional groups remain in existence even after the achievement
of the current goals and objectives. Examples of functional groups are, a marketing
department, a customer service department, or an accounting department.
Informal Groups
In contrast to the formal groups, the informal groups are formed naturally and in response
to the common interests and shared values. They are created for the purposes other than
the accomplishment of organizational goals, and they do not have a specific time frame.
Informal groups are not appointed by the organization and members can invite others to
join the group on their own.
Informal groups can have strong influences throughout an organization, which can either be
positive or negative. For example, employees who form an informal group can either
discuss how to improve a production process or how to create troubles to bring the
management to its knees. Informal groups can take the form of interest groups, friendship
groups (What’s up groups, Facebook friends), or reference groups.
i. Interest Group:
Interest groups usually continue over time and may last longer than general informal
groups. Members of interest groups may not be part of the same organizational department
but they are bound together by some other common interest.
The goals and objectives of the group are specific to each group and may not be related to
organizational goals and objectives. An example of an interest group would be a group of
ophthalmologists who come together for carrying out free cataract surgery on people who
cannot afford them.
j. Friendship Groups:
Friendship groups are formed by members who enjoy similar social activities, regional
identities, political beliefs, religious values, or other common bonds. The group members
enjoy each other's company and often meet after work to participate in these activities. For
example, a group of employees who form a friendship group for yoga or a laughter club, or
a Maharashtra Mandal, which has branches all over the world, or a kitty party of women,
who come together for lunch once a month.
k. Reference
Groups:
A reference
group is a type
of group that
people use to
evaluate
themselves.
The main
objectives of
reference groups are to seek social validation and social comparison. Social validation
allows individuals to justify their attitudes and values, while social comparison helps
individuals evaluate their own actions by comparing themselves to others. Reference
groups have a strong influence on members' behavior. Such groups are formed voluntarily.
Family, friends, and religious affiliations are strong reference groups for most individuals.
Factors Affecting Group Behavior:
The success or failure of a group depends upon factors, such as group members’
resources, group’s structure (group size, group roles, group norms, and group
cohesiveness), group’s processes (the communication, group’s decision making processes,
power dynamics, conflicting interactions, etc.) and group’s tasks (complexity and
interdependence).
1. Group Member Resources:
The members' money, knowledge, abilities, skills; and personality characteristics

(sociability, self- reliance, and independence) are the resources the group members bring in
with them. The group’s success depends upon these resources.
2. Group Structure
Group Size:
Group size can vary from two people to a very large number of people. Small groups of two
to ten are thought to be more effective because each member has ample opportunity to
take part and engage actively in the group. Large groups may end up wasting a lot of time
in deciding on processes and trying to figure out who should participate next.
Evidence supports the notion that as the size of the group increases, member’s satisfaction
increases up to a certain point. Increasing the size of the group beyond 10-12 members,
results in decreased satisfaction to the members. It becomes increasingly difficult for the
members of larger groups to identify with one another and experience cohesion of the
group.
Group Roles:
In formal groups, roles are always predetermined and assigned to members. Each role
shall have specific responsibilities and duties. There are, however, emergent roles that
develop naturally to meet the needs of the groups.
These emergent roles will often substitute the assigned roles as individuals begin to
express themselves and become more assertive. Group roles can then be classified into
work roles, maintenance roles, and blocking roles.
Work roles are task-oriented activities that involve accomplishing the group's goals. They
involve a variety of specific roles such as initiator, informer, clarifier, summarizer, and reality
tester.
Maintenance roles are social-emotional activities that help members maintain their
involvement in the group and raise their personal commitment to the group. The
maintenance roles are harmonizer, gatekeeper, consensus tester, encourager, and
compromiser.
Blocking roles are activities that disrupt the group. Blockers will stubbornly resist the group's
ideas, disagree with group members for personal reasons, and will have hidden agendas.
They may take the form of dominating discussions, verbally attacking other group
members, and distracting the group with trivial information or unnecessary humor. Often the
blocking behavior may not be intended as negative. Sometimes a member may share a
joke in order to break the tension, or may question a decision in order to force group
members to rethink the issue. The blocking roles are aggressor, blocker, dominator,
comedian, and avoidance behavior.
Role conflicts arise when there is ambiguity (confusion about delegation and no specific job
descriptions) between the intended role and the perceived role which leads to frustration
and dissatisfaction, ultimately leading to turnover (members leaving the group);
inconsistency between the perceived role and role behavior (conflict between work roles
and family roles); and conflicting demands from different sources while performing the task.
Group Norms:
Norms define the acceptable standards or boundaries of acceptable and unacceptable
behaviors, shared by group members. They are typically created in order to facilitate
group’s survival, make behaviors more predictable, avoid embarrassing situations, and
express the values of the group.
Each group creates its own norms. For example, norms about the work performance,
norms about dressing, norms about making comments in a meeting etc. Groups exert
pressure on their members to conform them to the group's standards. At times it may even
not let them perform at higher levels. The norms often reflect the level of commitment,
motivation, and performance of the group.
The majority of the group must agree that the norms are appropriate in order for the
behavior to be accepted. There must also be a shared understanding that the group
supports the norms. It should be noted, however, that members might violate group norms
from time to time. If the majority of members do not adhere to the norms, then they will
eventually change and will no longer serve as a standard for evaluating the behavior. Group
members who do not conform to the norms will be punished by being excluded, ignored, or
expelled from the group.
Group Cohesiveness:
Cohesiveness refers to the bonding of group members or their unity, feelings of attraction
for each other and a desire to remain as a part of the group. Many factors influence the
level of group’s cohesiveness, viz. agreement on group’s goals, frequency of interaction,
personal appeal, inter-group competition, favorable evaluation, etc.
The more difficult it is to obtain group membership the more cohesive the group becomes.
Groups also tend to become cohesive when they are in intense competition with other
groups or face a serious external threat to survival. Smaller groups and those who spend
considerable time together also tend to be more cohesive.
Cohesiveness in work groups has many positive effects, viz. worker satisfaction, low
turnover and absenteeism, and higher productivity. However, highly cohesive groups may
be detrimental to organizational performance if their goals are misaligned with
organizational goals.
Highly cohesive groups may also be more vulnerable to groupthink. Groupthink occurs
when members of a group exert pressure on each other to come to a consensus in decision
making. Groupthink results in careless judgments, unrealistic appraisals of alternative
courses of action, and a lack of reality testing.
Evidence suggests that groups typically outperform individuals when the tasks involved
require a variety of skills, experience, and decision making. Groups are often more flexible
and can quickly assemble, achieve goals, and disband or move on to another set of
objectives.
Many organizations have found that groups have many motivational aspects as well. Group
members are more likely to participate in decision-making and problem-solving activities
leading to empowerment and increased productivity. Groups complete most of the work in
an organization; thus, the effectiveness of the organization is limited by the effectiveness of
its groups.
1. Group Processes:
Decision-making in a group may be superior to individual’s decisions, because group

generates more information and knowledge, generates diverse alternatives, increases
acceptance of a solution, and increases legitimacy. But it is also true, that decision making
and consultation process in a group is quite time consuming.
Decisions may take longer lime, minorities may sometimes get dominated because the
votes of the members who are present at the time of voting are only counted, pressure is
applied on the group members to conform to group’s decisions, and none is directly
responsible for bad decisions. Group processes also include communication, conflict
management, and leadership.
Turning Groups into Effective Teams:
All teams are groups but not all groups are teams. Teams often are difficult to form because
it takes time for members to learn how to work together. People in every workplace talk
about building the team, working as a team, and my team, but few really understand how to
create the experience of team work or how to develop an effective team. Belonging to a
team, in the broadest sense, is a result of feeling part of something larger than oneself. It
has a lot to do with your understanding of the mission or objectives of your organization.
In a team-oriented environment, one contributes to the overall success of the organization.

One works with fellow members of the organization to produce these results. Even though
you have a specific job function and you belong to a specific department, you are unified
with other organization members to accomplish the overall objectives. The bigger picture
drives your actions, and your function exists to serve the bigger picture.
The teams are better equipped than groups, because they are more flexible and responsive
to dynamic environment. A work group has no opportunity to involve in collective works. It is
the work team whose members work intensely on a specific common goal using their
positive synergy, individual and mutual accountability, and complementing their skills.
Team-building helps to increase intra-group and inter-group effectiveness to bring members

together, make them share their perception of each other and understand each other's point
of view. Thus, resolve problems and work together in a cooperative and collaborative mode.
Teams can be of four types - problem-solving teams (only making suggestion), self-
managed teams (operate without a manager), cross-functional teams (a group of experts
from different specialties), and virtual team (members collaborate online).
In terms of their sizes, teams may be institutional (comprising of hundreds of members) and
operational (a small, cooperative group, in regular contact and contributes responsibly to
achieve task at hand).
Eight Cs for Team Building:
To show business results and profitability, ways are explored by the executives to improve
their productivity. Successful team building, that creates effective, focused work teams,
requires attention to each of the following:
1. Clear Expectations: The managers must clearly tell the team members of the expected
performance and the team members must understand the reason for its creation. For
meeting these expectations, the organization must support the team with resources of
people, time and money.
2. Commitment: Team members must participate in the team, feel that the team mission is
important, and show commitment to accomplishing the team’s mission and expected
outcomes. Commitment will come if team members perceive their service as valuable to the
organization and to their own careers.
3. Competence: Team members must have the knowledge, skill and capabilities, the
resources, strategies and support needed to accomplish its mission to address the issues
for which the team was formed.
4. Control: The team must have not only enough freedom and empowerment to feel the
ownership necessary to accomplish its charter, but also the accountability. There has to be
a defined review process.
5. Collaboration:
The team should understand group processes
and work effectively and cooperatively with
other members of the team. For it they have to
understand the roles and responsibilities of
team members, team leaders, and team
recorders.
6. Communication.
To make team members clear about the
priority of their tasks, and receive regular
feedbacks, team members must communicate
clearly and honestly with each other. Diverse
opinions must be welcomed and conflicts must
be taken up positively.
7. Creativity:
The team should value creative thinking, unique solutions, and new ideas; and reward
members who take reasonable risks to make improvements. If necessary, it should
provide the training, education, access to books and films, and field trips to stimulate
new thinking.
The creative development of new products, new technologies, new services, or new
organizational structures is possible because teams may have variety of skills needed
for successful innovation.
Team members can uncover each other's flaws and balance each other's strengths and
weaknesses. Managers should empower the team and make it accountable for the
innovation process.
8. Coordination:
Teams should understand the concept of internal customer to whom they provide a product
or a service. The team’s efforts need to be coordinated by a central leadership team that
assists the groups to obtain what they need for success.
The cross-functional and multi-department teams must work together effectively. The
organization should develop a customer-focused and process-focused orientation and
move away from traditional departmental thinking.
A little bit of time and attention on these aspects of team building ensures team’s
effectiveness and business’ success.
Informal Group:
In every organization along with formal groups there exist informal groups which emerge
naturally due to the response and common interests of the members who can easily identify
with the goals or independent activities of the informal groups.
Sometimes the efforts may be driven by a common goal that may compliment or work
against the goals of the formal group. An informal group can be defined as a group that
evolves spontaneously, not shown in the organization's structure, with the objective of
fulfilling personal and social need of its members.
Informal Group Vs Informal Organization:
An informal group is a voluntary group of people casually acquainted with each other for
their own personal fulfillment because they have some common and shared backgrounds,
characteristics and concerns (values) interests / hobbies / friendship).
Whilst it is easy to differentiate between a formal group and a formal organization, the
differences between informal group and informal organizations tend to be difficult. The
difference between informal organization and informal group is that informal organization is
a larger entity consisting of many informal groups in an organization.
Informal Organization = Ʃ Informal Groups
An informal group is the nucleus of informal organization. When an informal group adopts a
formally defined structure and group processes, it no longer remains an informal group.
Informal Group vs. Formal Group:
Characteristics of Informal Groups:
1. Creation: It is not created by the organization but springs up spontaneously.

2. Satisfaction of Needs: The needs which cannot be satisfied within the framework of formal
organization, like social and psychological needs of people, are satisfied in such informal
groups.
3. Voluntary Membership: Nobody is compelled to join an informal organization.
4. Multi-Group Membership: A member of an informal group can be a member of more than
one informal group to pursue different interests.
5. Systems and Processes: Members of such groups follow their own norms, leadership,
communication, etc. to remain cohesive. The communication channels are referred to as
'Grapevine'. Grapevine runs very fast to spread the information across the organization.
6. Leadership: Every informal group has a leader, selected by the group, and who is capable
of helping the group members to realize their goals. The moment it is realized that the
leader is incapable, he is replaced with a new leader.
Reasons for the Emergence of Informal Groups:
1. People working together may come together.

2. People with similar values, beliefs, attitudes, and interests often feel attraction to come
together.
3. Need satisfaction - to belong, to associate, etc.
4. Removal of monotony of routine tasks - to get rid of monotony and psychological fatigue,
job-related boredom and frustration provides an opportunity to behave in a natural and
relaxed manner.
5. Promotion of other interests and pursuit of goals - People join Rotary Club or Lions Club to
expand their contacts which may help them to satisfy their personal goals.
Benefits of Informal Groups:
o Blending with formal group allows people to work for the formal organization.
o Informal work group lightens the workload for the formal manager.
o Brings satisfaction and stability to the organization as a whole.
o Provides a useful channel of communication.
o Encourages managers to plan and act more carefully.
Limitations of Informal Groups:
1. Resistance to Change because they do not want to deviate from existing norms and learn
new ways.
2. Informal group provides most fertile ground for rumor mongering and malicious campaigns,
because of the lack of proper communication systems and ambiguous circumstances.
3. Since a member of an informal group is also a member of a formal group, at times it creates
role conflicts.
4. Creativity of group member is restricted because of strong pressure for conformity applied
by the group.
Management of Discipline
Employees’ discipline is the backbone of the industrial relations. In fact, the function
of management is to keep an enterprise going on smoothly, efficiently and profitably. To do
this you need a workforce that has to accept certain reasonable standards of behavior at
the workplaces. Effective employee performance depends on the willingness on the part of
the subordinates to carry out the orders of their superiors, to abide by the rules and
norms of the organization. The purpose of this part of the unit is to discuss and examine
what discipline is, what the various aspects of employee discipline are, and
how positive discipline can be acquired from the subordinates. We shall also examine the
judicial process of maintaining industrial discipline and how to deal with indiscipline among
industrial employees.
Concept and Meaning of Discipline
Discipline is the regulation and modulation of human activities to produce a controlled

performance. The real purpose of discipline is quite simple. It is to encourage employees to
confirm to established standards of job performance and to behave sensibly and safely at
the workplaces. Discipline is essential for organized group action.
Definition of Discipline
Webster's Dictionary gives three basic meanings to the word discipline, the first meaning
says that, “it is a training that corrects, molds, strengthens or perfects”. The second
meaning says that, “it is a control gained over the subordinates, by enforcing obedience”
and the third meaning says that, “it is punishment”. By combining the first and second
definitions you can interpret that, “discipline involves the conditioning or molding of the
behavior by applying rewards or penalties”. The third meaning is very narrow, because it
pertains only to the act of punishing the wrongdoers. Besides these broad definitions, there
are other definitions referring to the organizational life in particular.
Following are common definitions of discipline.
o Discipline is a procedure that corrects or punishes a subordinate because a rule of the

procedure has been violated.
o Discipline should be considered as a condition within an organization, where by
employees know what is expected from them in terms of the organization’s rules,
regulations, standards and policies and what are the consequences of their infractions.
Following are the characteristics of discipline:
 The objective of discipline is orderly behavior.

 Orderly behavior ensures synergy between the group members.
 Orderly behavior helps in attaining the organizational goals.
 When members voluntarily behave as per rules, there is no need for disciplinary action
on anyone. This is called self-discipline.
 When some members violate the rules and regulations, punitive actions are necessary to
correct them.
 Punishment serves two purposes: First, to directly punish an individual for an offence
and second, to set an example for others not to violate the rules and regulations. Those
employees who observe the rules, regulations and standards are rewarded in many ways.
And those who cannot stay in line or measure up to the performance standards are
penalized in such a way that they can clearly understand what acceptable performances
and acceptable behaviors are. Most employees recognize this system as a legitimate way
to preserve order & safety and to align the working of every member of the team towards
the same organizational goals and standards. For most employees, self-discipline is the
best discipline. It has been observed on many occasions, that the fault while invoking the
disciplinary action and impose penalties lies with the management as well as with the
individual worker. For that reason, a supervisor must resort to disciplinary action only after
everything else fails. Discipline should never be used as a show of authority or power by
the supervisor.
Major Aspects Discipline
Negative Discipline: Negative discipline involves force or an outward influence. It is the

traditional aspect of discipline and is identified with ensuring that subordinates adhere
strictly to rules, and punishment is meted out in the event of disobedience or indiscipline. As
you can see, in this perspective strict penalties are levied for the violation of rules. It is in
fact the fear of punishment that works as a deterrent in the minds of the subordinates.
Approaching discipline from this kind of a perspective has been proving increasingly
ineffective for various reasons.
Positive Discipline: In this type of discipline subordinates comply with the rules not from
fear of punishment, but from the desire to cooperate in achieving the common goal of the
organization. In positive discipline willingness to comply is the most important. The
emphasis here is on cooperative efforts to secure compliance to organizational norms. It
promotes emotional satisfaction instead of emotional conflict, and the increased
cooperation and coordination reduces the need for formal authority. This approach to
discipline will help us to achieve both individual needs of the subordinates and
organizational goals. It would therefore motivate your subordinates to work with zeal and
fulfil their needs. Positive discipline, in other words, calls for internalization by your
subordinates of the objectives and expected norms of behavior in your organization. The
positive concept of discipline assumes a certain degree of self-discipline.
Purpose and Objectives of Disciplinary Action
The purpose of the discipline according to Dessler, is to encourage employees to

behave sensibly at work, where being sensible means adhering to rules and
regulations of the organization. In an organization, rules and regulations serve about the
same purpose that federal laws do to the society. Disciplinary action is called for when one
of these rules or regulations are violated.
Steps Involved in Disciplinary Action
1. Issue of the Show-Cause Notice – The delinquent employees is served a Show-Cause

notice and an explanation is sought from him as to the reasons of his deviant behavior and
why disciplinary action should not be initiated against him. He is given a reasonable time
frame to reply to the Show-Cause notice. This charge-sheet should be drafted in a clear
and unambiguous language so that the workman does not have any difficulty in
understanding the charges that he is supposed to answer. Wherever possible, the relevant
clause of the company's standing orders should be mentioned in a Show-Cause notice. If
the charges relates to an incident, the date, time and place of the occurrence should be
mentioned. Proper care has to be taken in framing the Show-Cause notice for standing in
the court of law and the justification of the punishment would depend on the enquiry
conducted into the deviation mentioned in the Show-Cause notice. The Show-Cause Notice
should be in a language understood by the deviating employee. The Show-Cause Notice
framed against delinquent employee and duly signed by the disciplinary authority should be
served on him personally and an acknowledgement should be obtained from him. In case
the workman is absent or if he refuses to accept the charge-sheet when presented to him,
the same should be sent to his local and home addresses by post under-registered cover
with acknowledgements due, after getting his refusal attested by two witnesses. In case the
Show-Cause Notice is returned un-served with the remarks of the postal authorities; the
same should be kept intact without opening. In such cases the employer should display the
Show-Cause Notice on the notice board or act in accordance with the provisions of the
standing orders. In some cases, it may be necessary to publish the contents of the Show-
Cause Notice in a local newspaper having wide publicity.
2. Suspension Pending the Enquiry - In a cases where the charges leveled against a
workman are of serious nature and it is considered by the disciplinary authority that his
physical presence might endanger the safety of other workmen, or if it is feared that he
might intimidate other employees or tamper with the evidence, he may be suspended from
the duties until the disciplined committee gives its judgment. During the period of
suspension pending enquiry, the workman is given subsistence allowance as per rules.
3. Consideration of the Explanation Given by the Employee - After the Show-Cause

Notice has been served on a workman, he may submit his explanation:
o admitting the charges and requesting for mercy, Or

o denying the charges and requesting for an enquiry, or
o not submit any explanation at all, or
o requesting for more time to submit explanation.
In a case where the workman admits the charge which is of a minor nature and begs for
mercy, no enquiry is held and decision is taken accordingly on the Show-Cause Notice. If
however, the misconduct is serious enough to warrant discharge or dismissal, the
management should still arrange to hold a proper enquiry, the admission of the charges
notwithstanding. In case where the workman submits an explanation mentioning that the
charges leveled against him are false, baseless, motivated, concocted, etc., a proper
enquiry as per procedure should be held before awarding any punishment. When the
workman fails to submit any explanation within the specified time, the management should
take steps to hold a proper enquiry ex parte. When the workman concerned makes a bona
fide request on reasonable grounds for extension of time to submit explanation, the same
may be granted.
4. Notice for Holding an Enquiry - After giving due consideration to the explanation given
by the employee, or when no reply is received from him within the stipulated period, the
disciplinary authority should issue an order appointing an enquiry officer or an enquiry
committee to hold the enquiry into the Show-Cause Notice. The enquiry officer can be an
official of the company, or even an outsider, but care should be taken to appoint only such a
person as enquiry officer who is neither a witness nor is personally interested in any way in
the matter for which the Show-Cause Notice has been issued. It should also contain the
name of the management’s representative. Thereafter, the enquiry officer should issue a
notice of enquiry. This notice of enquiry should clearly mention the date, time and place of
enquiry. It should ask the workman to be present himself with his witnesses and
documentary evidence, if any for the enquiry. It should also be mentioned in the notice of
enquiry that if the workman fails to attend the enquiry on the appointed date and time, the
same will he held ex-parte. A reasonable period of time should be given to the workman for
preparing his defense before the enquiry is held.
5. Holding of the Enquiry
The object of holding an enquiry is to find out whether the workman is guilty of the charges
leveled against him in the Show-Cause Notice or not. In doing so, the enquiry officer gives
the workman a reasonable opportunity to defend himself by cross-examining the witnesses,
evidences and exhibits produced against him and by examining the witnesses,
documentary evidences in his defense. The workman concerned can also make statement
in his defense apart from what is stated in reply to the Show-Cause Notice. It should be
clearly understood that it is for the management's representative, i.e. enquiry officer to
prove the charges against a workman by adducing evidences during the enquiry and it is
not the workman who has to prove his innocence. Until the management is not able to
prove the charges against the workman, he is considered as not guilty.
6. The Enquiry
On the appointed date and time fixed for the enquiry, the following persons should be
present apart from the enquiry officer.
a) The Presenting Officer: He is a person who will lead the case from the management’s
side by providing witnesses and relevant documentary evidence in support of the charge.
He may himself be a witness, in which case he is the first person to be examined. The
presenting officer has a right to cross-examine the charge-sheeted workman as well as the
witness, documentary evidence produced by him.
b) Delinquent Employee: No enquiry can be said to have been held as per procedure in the
absence of the deviant employee. However if he refuses to take part in the enquiry after
presenting himself, or when he does not report for the enquiry despite receiving the notice
to him, the enquiry may proceed ex-parte, provided in the notice of the enquiry a specific
mention to that effect had been made. Also, if during the enquiry, the delinquent employee
withdraws himself, the same may be held ex-parte thereafter. In such a case it is not
advisable to postpone the enquiry and give another opportunity to the delinquent employee
rather than holding ex-parte enquiry. In a case, where the delinquent employee turns up for
the enquiry after some witnesses have been examined, it would be proper for the enquiry
officer to allow him to participate in the enquiry after recording this fact in the proceedings.
The enquiry officer should recall the witnesses who have already been examined in the
absence of the delinquent employee so that he gets an opportunity to cross-examine such
witnesses.
c) Representative of the Delinquent Employee: If the delinquent employee replies to the

charge-sheet or makes a subsequent request that he should be allowed to take a
knowledgeable co-worker of his choice to assist him in the enquiry, the same should
normally be allowed, union committee member of the recognized trade union is allowed to
attend an enquiry on the specific request of the workman, to either assist him or play the
role of an observer)
d) The Procedure of Enquiry: At the commencement of the enquiry, if the delinquent

employee is present, the enquiry officer should record the date, time and place of enquiry,
names of the persons present and obtain their signatures on the order-sheet. Thereafter, he
should proceed as follows: Read out and explain the charges and the reply of the charge-
sheet to the delinquent employee and get his confirmation to that effect. In case the
delinquent employee has not accepted the charge in reply to the charge-sheet he should be
asked if he pleads guilty of the charges. If the charges are admitted, that should be
recorded and signatures of all concerned, with date should be taken. A full-fledged enquiry
need not be held if the misconduct is of a minor nature. In case the charge, if proved, is
serious enough to warrant discharge or dismissal, the proper course is to hold the enquiry.
o Explain to the delinquent employee concerned the procedure to be followed in the

enquiry, viz. that the presenting officer will produce witnesses, documentary evidence,
exhibits in support of the charge and the delinquent employee will have the opportunity to
cross examine. There after the delinquent employee should be given opportunity to produce
his witnesses/ and the management representative will have a right to cross-examine them.
o The delinquent employee will have further opportunity to make statement, if any, in his
defense. At any stage of the enquiry, the enquiry officer can seek clarification from any
witness or the delinquent employee by putting questions to him. Neither the presenting
officer nor the delinquent employee can put leading questions to their respective witnesses.
o Witnesses in support of the charge are to be examined one by one in the presence of the
delinquent employee.
o The charge-sheeted workman is to be given an opportunity to cross-examine
management's witnesses. In case he declines to cross-examine any witnesses , an
endorsement to that effect should be recorded by the enquiry officer.
o The delinquent employee should be asked to produce his own witnesses one by one and
the presenting officer will be allowed to cross-examine them.
o The delinquent employee should be asked to give his statement after his witnesses are
examined and cross-examined. He may also produce documentary evidence, if any. In
case the delinquent employee declines to produce any witness, documentary evidence or
declines to give any statement, the enquiry officer should make a record to that effect in the
order-sheet and obtain signatures of all concerned. If the enquiry remains incomplete in the
first sitting and some more witnesses are required to be examined, it may be continued or
any other day mutually agreed by both sides. In such a case, the enquiry officer should
make a suitable endorsement in the order-sheet and obtain signatures of all concerned
o On each page of the enquiry proceedings, the signature with date of the charge-sheeted
workman, his representative, if any, the concerned witness and the management
representative should be taken. The concerned witness should sign on each page of his
statement only. The enquiry officer will sign on each page of the proceedings after
endorsing that the statement has been recorded by him and explained to the parties in their
language before they were asked to sign. If the delinquent employee refuses to put his
signature even after he had been asked to do so, the enquiry officer should make an
endorsement to that effect and get it attested by others present.
e) Ex-parte Enquiry: If on the day fixed for the enquiry, the delinquent employee does not
turn up, an ex-parte enquiry may be held by following the usual procedure. In such an
enquiry, the presenting officer has to lead the evidence against the charge-sheeted
workman. The enquiry officer, by putting questions to the witnesses, comes to a reasonable
conclusion about the validity or other wise of the charges. As stated earlier, it is advisable to
fix another date of enquiry, instead of holding an ex-parte enquiry on the first sitting itself.
The Enquiry Report:

After the enquiry is over the enquiry officer makes an appreciation of the evidence on
record and comes to his conclusion. If there is no corroborative evidence on a particular
point, the enquiry officer has to give his own reasons for accepting or rejecting the evidence
of such a witness. The enquiry report is a document which should clearly indicate whether
the charges leveled against the delinquent employee are proved or not. The conclusion of
the enquiry officer should be logical and based only on evidence brought out during the
enquiry. The enquiry officer may record clearly and precisely his conclusions with reasons
for the same. There is no place for any conjecture or surmises in the enquiry report. It
should be such that as per the evidence on record, any impartial man, not connected with
the case, should be able to come to the same conclusion as that of the enquiry officer.
7) Final Decision of the Disciplinary Authority

The enquiry report is submitted to the Disciplinary Authority. Before he takes a decision on
the findings of the enquiry officer, he is required to furnish a copy of the enquiry officer's
report to the concerned employee. If he agrees with the findings of the enquiry officer, and
after considering the gravity of the misconduct, and the past record of the delinquent
employee, an equitable action is taken. Based on the precedents, he may pass an order on
the quantum of punishment after recording his reasons for the same in writing. An order in
writing is passed to that effect and is communicated to the delinquent employee. In case
the disciplinary authority decides to punish the employee for his misconduct, the following
are the punishments.
There are two kinds of punishment:

i) Minor Punishments
a) Warning or Censure;
b) Fine (keeping the provisions of Section 8 of Payment of Wages Act in view); and
c) Withholding of annual increments (either with cumulative effect or non-cumulative effect).
ii) Major Punishments A ) Demotion; B) Discharge; and c) Dismissal

A letter communicating the order of discharge/dismissal should set out clearly the charge(s)
proved against the delinquent employee and the date from which the order is to become
effective. Normally, the order should be effective from the date of the order, unless there is
an express provision in the standing orders to the contrary.
8) Appeal
An employee can appeal against an order imposing upon him any of the penalties. The
appellate authority may confirm, enhance, reduce or set-aside the penalty.
9) Conclude
It is the employers right to direct its internal administration and maintain discipline.
However, before passing an order of discharge or dismissal, the employer has to arrange
for a fair and proper enquiry in consonance with the principles of natural justice. The reason
is that its decision may not be reversed by the adjudicator at a later date, if the workman
raises an industrial dispute challenging the order.
A domestic enquiry need not be conducted in accordance with the technical requirements
of a criminal trial, but they must fairly be conducted and in holding them, consideration of
fair play" and “natural justice” must govern the conduct of the enquiry officer. A domestic
enquiry must be conducted with an open mind, honesty and bona fides, with a view to
determine whether the charge framed against the delinquent employee are proven or not.
In today's context, no employer can discharge or dismiss a delinquent workman even for a
serious misconduct without following an elaborate procedure for taking disciplinary action.
An employer can be held guilty and penalized, if the adjudicator finds that there was want of
good faith or there was victimization or unfair labor practices or the management was guilty
of a basic error or violation of a principle of natural justice or on the grounds that the finding
was completely baseless or perverse.
Code of Conduct
To maintain harmonious relations and promote industrial peace, a Code of Conduct has
been laid down in the statute, which applies to both public and private sector enterprises. It
specifies various obligations on the management and the workers to promote cooperation
between them.
4.10 Motivation Theories
From the very beginning, when the human organizations were established, various thinkers
have tried to find out the answer to “What exactly motivates people to work?” Different
approaches applied by them have resulted in evolution a number of theories concerning
motivation. Those are discussed in brief here.
1. Maslow's Need Hierarchy Theory:
It is probably safe to say that the most well-

known theory on motivation is ‘Maslow's
need hierarchy’ theory. It is based on the
sequencing of human needs. Drawing
chiefly on his clinical experience, he
classified all human needs into a hierarchy
of physical and survival needs at the lowest
level of the pyramid to the psychological
needs at the higher levels of the pyramid.
In essence he believed that, once a need

at a certain level in the hierarchy is
satisfied, then getting more of that specific
need no longer serves to motivate him. To keep that person motivated thereafter, his need
at the higher level of the hierarchy has to be activated. Maslow identified five distinct levels
of needs in his hierarchy of needs.
1. Physiological Needs:
These needs are basic to human life for their survival. They include food, clothing, shelter,
air, water and basic necessities of life. These needs relate to the survival and maintenance
of human life. They exert tremendous influence on human behavior. These needs are to be
met first, at least partly before higher level needs emerge. Once physiological needs are
satisfied, more of these needs no longer motivates a person. If these needs are not
properly fulfilled, a person may fall sick, he might die or slip into destitution.
2. Safety Needs:
After adequately satisfying the physiological needs, the next level of the need gets
triggered. That need is the need for safety and protection. These needs find their
expressions in such desires as economic security and protection from physical harm.
Meeting these needs requires more amount of money. Therefore the individual is prompted
to work more and work harder. Similar to physiological needs, these needs also become
ineffective to keep him motivated, once safety needs are adequately satisfied.
3. Social Needs:
The Man is a social being. He is, therefore, interested in social interactions, companionship,
and belongingness to a family, to a work group, to an ethnic group, and to a nationality. It is
this socializing and belongingness, that drives people to work in groups and work as long
as their bodies permit. A beggar is lease bothered about this need, because his
physiological need itself may not have been adequately satisfied.
4. Esteem Needs:
These needs refer to the self-esteem and self-respect of a person. They include the needs
which reflect self-confidence, sense of worth, sense of achievement, sense of competence,
sense of knowledge and independence. The fulfillment of these needs leads to
consolidation of his self-confidence and instills a feeling of being useful to the organization.
However, the inability to fulfill these needs makes one feel inferior and unwanted in an
organization or a society.
5. Self-Actualization Needs:
This level represents the culmination of all, the lower level needs, intermediate needs, and
higher level needs of a person. In other words, the final step under the need hierarchy
model is the need for self-actualization. This refers to fulfillment or finding the purpose of
life. At these levels, people take up social causes to serve the society.
The term self-actualization was coined by Kurt Goldstein and that means, to become
actualized (animated) in what someone is really good at. In effect, self-actualization is the
force that drives a person to transform his perception of his self into reality.
According to Maslow, the human needs follow a definite sequence of domination. The
second need does not trigger, until the first needs is adequately satisfied. And the third
need does not emerge until the first two needs are adequately satisfied and so on.
The other side of the need hierarchy is that human needs are unlimited and the idea of
‘adequate satisfaction’ may be different for different people.
The drawbacks of Maslow’s Hierarchy of Needs are as follows:
o The needs may or may not follow a definite hierarchical order. Therefore, there may
be an overlapping of needs in the need hierarchy. For example, even if safety need is not
satisfied, the social need might emerge.
o The need priority model may not apply to all people, at all times, in all places.
o Researches show that man's behavior at any given time is mostly guided by a
multiplicity of factors.
o In case of some people, the level of motivation may be congenitally lower.
The intuitive logic and ease of understanding has made this theory very popular amongst
practicing managers.
2. Herzberg's Motivation Hygiene (Two-Factor) Theory:
The psychologist Frederick Herzberg extended the work of Maslow and proposed a new
motivation theory, popularly known as Herzberg's Motivation Hygiene (Two-Factor) Theory.
Herzberg conducted a widely reported motivational study on 200 accountants and

engineers employed by companies in and around Western Pennsylvania.
He asked these people to describe two important incidents at their jobs:
(1) When did he feel particularly good about his job, and
(2) When did he feel exceptionally bad about his job?
He used the ‘critical incident’ method for obtaining data.
The responses were
quite interesting and
fairly consistent. The
replies respondents
gave to, “when they felt
good about their jobs”
were significantly
different from the replies
they gave to “when they
felt bad about their jobs”.
The reported good

feelings were generally
associated with job
satisfaction, whereas the
bad feeling with job
dissatisfaction.
Herzberg labelled the job

satisfiers as motivators,
and he called the job
dissatisfies as hygiene
or maintenance factors. Taken together, the motivators and hygiene factors have come to
be known as Herzberg's two-factor theory of motivation
Herzberg felt that the opposite of satisfaction is not dissatisfaction. Because he felt that
removal of a dissatisfying characteristic from a job does not necessarily make the job
satisfying for an employee. He believed in the existence of a dual continuum. The opposite
of 'satisfaction' is 'no satisfaction' and the opposite of 'dissatisfaction' is 'no
dissatisatisfaction'.
According to Herzberg, today's motivators are tomorrow's hygiene, because the latter stop
influencing the behavior of a person when they get them. Accordingly, one's hygiene may
be the motivator for someone else.
The drawbacks of Herzberg's theory are as follows:
o People generally tend to take credit themselves when things go well and they blame
failure on the external environment.
o The theory basically explains job satisfaction and not the motivation.
o Even job satisfaction is not measured on an overall basis. It is quite likely that a person
may dislike part of his job, but still thinks that the job acceptable.
o This theory neglects situational variable that might motivate an individual.
The main applications of his recommendations are for planning and controlling of
employees’ output.
3. McClelland's Need Theory:
Another well-known need-based theory of motivation is the theory developed by McClelland

and his associates'. McClelland developed his theory based on Henry Murray's long list of
motives and manifest needs. McClelland's need-theory is closely associated with the
learning theory, because he believed that needs are learned or acquired by the type of
events people experience in their environment and culture.
He observed that people who acquire a particular need behave differently from those who
do not have.
His theory focuses on Murray's three needs - achievement, power and affiliation
In the literature, these three needs are abbreviated "n Ach", "n Pow", and "n Off"
respectively'.
They are defined as follows:
Need for Achievement:
This is the drive to excel, to achieve in relation to a set of standards, and to strive to
succeed. In other words, need for achievement is a behavior directed towards competition
with a set standards of excellence.
McClelland found that people with a high need for achievement perform better than those
with a moderate or low need for achievement, and observed regional / national differences
in achievement motivation.
Through his research, McClelland identified the following three characteristics of high-need
achievers:
o High-need achievers have a strong desire to assume personal responsibility for

performing a task or finding a solution to the problem.
o High-need achievers tend to set moderately difficult goals and take calculated risks.
o High-need achievers have a strong desire for performance feedback.
Need for Power:
The need for power is concerned with making an impact on others. The desire to influence
others. The urge to change people. And the desire to make a difference in people’s lives.
People with a high need for power are people who like to be in control of people and
events. This results in ultimate satisfaction to a person.
People who have a high need for power are characterized by:
o A desire to influence and direct others.

o A desire to exercise control over others.
o A concern for maintaining leader-follower relations.
Need for Affiliation:
The need for affiliation is defined as a desire to establish and maintain friendly and warm
relations with other people. The need for affiliation, in many ways, is similar to Maslow's
social needs.
The people with high need for affiliation have these characteristics:
o They have a strong desire for acceptance and approval from others.
o They tend to conform to the wishes of those people whose friendship and companionship
they value.
o They value the feelings of others.
The adjoining chart shows the
parallel relationship between the
needs in each of the theories.
Maslow refers to higher and lower
order needs, whereas Herzberg
refers to motivation and hygiene
factors.
4. McGregor's Participation Theory:
Douglas McGregor formulated two distinct images of a person based on his participation in
the work.
The first image is basically a negative one, labeled as Theory X, and the other is basically a
positive one, labeled as Theory Y.
Theory X is based on the following assumptions:
o People are by nature indolent. That is, they like to work as little as possible.
o People lack ambition, dislike responsibility, and prefer to be directed by others.
o People are inherently self-centered and indifferent to organizational needs and goals.
o People are generally gullible and not very sharp and smart.
Theory Y is based on the following assumptions:
o People are not by nature passive or resistant to organizational goals.

o They want to assume responsibility.
o They want their organization to succeed.
o People are capable of directing their own behavior.
o They have a need for achievement.
What McGregor tried to do through his theory X and Y, is to outline the extremes within
which the organizational man is usually seen to behave. The fact remains that no
organizational man would actually belong to either theory X or to theory Y. In reality, he
shares the traits of both the personalities.
What actually happens is that the person swings from one set of properties to the other with
the changes in his mood, motives and environment.
For McGregor, Theory X and Y are not opposite ends of the same continuum, but rather
two different continua in themselves. In order to achieve the most efficient production, a
combination of both theories may be appropriate.
McGregor's management theories closely relate to Maslow's hierarchy of needs, a model in

which motivation is used to achieve higher level needs (social, esteem, and self-
actualization) after basic psychological and safety need are met. Maslow believes that
higher level needs can be achieved through sense of achievement, having autonomy,
having feelings of self-worth, and realizing one's potential. McGregor agreed with Maslow
that self-actualization is the highest human need that ought to be achieved. That is why, he
was eager to promote Theory Y style of management which emphasizes self-motivation.
With the adoption of Theory Y practices, managers can create an environment where
workers can achieve their highest needs of esteem and self-actualization. Because of the
close supervision that Theory X managers adopt, these types of workers tend to lose their
autonomy and self-direction, therefore they are typically not motivated to achieve their
higher level needs.
5. Urwick's Theory Z:
Much after the propositions of theories X and theory Y by McGregor, the three theorists
Urwick, Rangnekar, and Ouchi propounded the third theory labeled as theory Z.
The two propositions in Urwicks's theory are:
o Each individual should know the organizational goals precisely and the amount of his
contribution through his efforts towards these goals.
o Each individual should also know, how meeting of the organizational goals is going to
satisfy his needs positively.
In Urwick's view, the above two make people ready to behave positively to accomplish both
organizational and individual goals.
However, Ouchi's Theory Z has attracted the lot of attention of management practitioners
as well as researchers.
Theory Z is based on the following four postulates:
o Strong Bond between Organization and Employees

o Employees’ Participation and Involvement
o No Formal Organization Structure
o Human Resource Development
Ouchi's Theory Z represents the Japanese management practices (group decision making,
social cohesion, job security, holistic concern for employees, etc.) In India, Maruti-Suzuki,
Hero-Honda, etc. use theory Z.
6. Argyris's Theory:
Argyris has developed his motivation theory based on the proposition, how management
practices affect the individual’s behavior and growth. In his view, the seven changes taking
place in an individual’s personality make him/her a mature person. In other words his
personality gets developed.
Argyris views that immaturity exists in individuals, mainly because of the organizational
settings and management practices such as task specialization, chain of command, unity of
direction, and span of management.
In order to make individuals grow mature, he proposes gradual shift from the existing
pyramidal organization structure, to a humanistic system. From existing rigid and
authoritative management system to the more flexible and participative management
system.
He stated that such situations will satisfy not only their physiological and safety needs, but
also will encourage them to make more use of their physiological and safety needs in
accomplishing the organizational goals.
7. Vroom's Expectancy Theory:
One of the most widely accepted explanations of motivation is offered by Victor Vroom in
his Expectancy Theory.
It is a cognitive process theory of motivation.

The theory is based on the notion that people
will be motivated to put in a high level of efforts
when they believe that there is a relationship
between the effort they put in, the performance
they achieve, and the rewards they receive.
The relationships between the idea of effort,

performance, and reward are shown in this
diagram.
Thus, the key constructs in the expectancy theory of motivation are:
o Valence: Valence, according to Vroom, means the value or strength one places on a
particular outcome or reward.
o Expectancy: It relates efforts to performance.
o Instrumentality: By instrumentality, Vroom means, the belief that performance is related
to rewards
Thus, Vroom's motivation can also be expressed in the form of an equation as follows:
Motivation = Valence x Expectancy x Instrumentality
Being a model multiplicative in nature, all the three variables must have high positive values
to imply motivated performance index.
If any one of the variables approaches zero level, motivation index also reaches zero level.
The drawbacks of Vroom's expectancy theory are as follows:
o Individual cognitively chooses the course of action that leads to the greatest degree of
pleasure or the smallest degree of pain. In reality it doesn’t happen this way.
o The assumption that people are rational and calculating makes the theory idealistic.
o The expectancy theory does not describe individual and situational differences.
o The valence or value people place on various rewards varies. For example, one
employee prefers salary to benefits, whereas another person prefers to just the reverse.
The valence for the same reward varies from situation to situation.
In spite of all these drawbacks, the greatest point in the expectancy theory is that, it
explains why significant proportion of the workforce exerts so low levels of efforts in
carrying out their job responsibilities.
8. Porter and Lawler's Expectancy Theory:
In fact, Porter and Lawler's theory is an improvement over Vroom's expectancy theory.
They proposed that, motivation does not equal satisfaction or performance.
The model suggested by them encounters some of the simplistic traditional assumptions
made about the positive relationship between satisfaction and performance. They proposed
a multi-variate model to explain the complex relationship that exists between satisfaction
and performance.
What is the main point in Porter and Lawler's model is that effort or motivation does not lead
directly to performance. It is in fact, mediated by abilities and traits and by role perceptions.
Ultimately, performance leads to satisfaction.
There are three main elements

in this model. Let us briefly
discuss them one by one.
Effort:
Effort refers to the amount of

energy an employee exerts on
a given task. How much effort
an employee will put in a task
is determined by two factors-
o Value of reward and
o Perception of effort-reward
probability.
Performance:
One's effort leads to his performance. Both may be equal or may not be. However the
amount of performance is determined by the amount of labor and the ability and role
perception of the employee. Thus, if an employee possesses less ability and/or makes
wrong role perception, his/her performance may be low in spite of his putting in great
efforts.
Satisfaction:
Performance leads to satisfaction. The level of satisfaction depends upon the amount of
rewards one achieves. If the amount of actual rewards meet or exceed perceived equitable
rewards, the employee will feel satisfied. On the country, if actual rewards fall short of
perceived ones, he/she will be dissatisfied.
Rewards may be of two kinds - intrinsic and extrinsic rewards. Examples of intrinsic
rewards are such as sense of accomplishment and self-actualization. As regards extrinsic
rewards, these may include working conditions and status. A fair degree of research
support that, the intrinsic rewards are much more likely to produce attitudes about
satisfaction that are related to performance.
There is no denying of the fact that the motivation model proposed by Porter and Lawler is
quite complex than other models of motivation. In fact motivation itself is not a simple
cause-effect relationship. In fact Porter and Lawler have attempted to measure complex
variables such as the values of possible rewards, the perception of effort-rewards
probabilities and role perceptions in deriving satisfaction.
They recommended that the managers should carefully reassess their reward system and
compensation structure. The effort-performance-reward-satisfaction should be made
integral to the entire system of managing men in the organization.
9. Elton Mayo’s Contribution
Mayo was the first person to plead for the understanding of workers' problems in the
context of growth of science and technology. He wished the management to understand the
problems of workers and make efforts to redress them.
His main contributions are discussed as follows:
1. Human Relations Approach:
Mayo is rightly called the father of human relations movement. His ideas were a milestone
and a turning point in human relations approach to management. He recognized the
importance of human beings in management. He said that human beings are complex and
influential input into organizational performance. The social and psychological needs of
human beings cannot be ignored, if management wants to enhance the productivity.
2. Non-Economic Awards:
The earlier assumption was that workers will work more if they are offered more monetary
incentives. Fredric Taylor was the main proponent of this approach. Elton Mayo said that
the techniques of economic incentives were not only inadequate but also unrealistic.
He was able to show that humane and respectful treatment, sense of participation and
belonging, recognition, morale, human pride and social interaction are sometimes more
important than pure monetary rewards.
3. Social Man:
Mayo developed a concept of 'social man'. He said that man is basically motivated by social
needs and obtains his sense of identity through relationships with others. He is more
responsive to the social forces of the informal group rather than managerial incentives and
controls. He also related productivity to a social phenomenon.
4. Organization as a Social System:
Mayo was of the view that informal relationships in the organization are more effective than
formal relationships. People form informal groups to give a vent to their feelings and seek
guidance for action from such groups.
In Mayo's words, "An organization is a social system, a system of cliques (An exclusive
circle of people with a common purpose), grapevines (Gossip spread by
spoken communication), informal status systems, rituals and a minute of logical, non-logical
and illogical behaviors" He was of the opinion that managers should maintain an equilibrium
between the logic of efficiency, demanded by the formal organization and the social rituals
demanded the informal organizations. He thought that besides logic and facts, people are
also guided by sentiments and feelings.
Hawthorne's experiments lacked of scientific and vigorous research. They were too narrow
to warrant generalizations. In spite of this, Mayo's work was a turning point in the
development of modern management thought.
4.11 Accident Prevention and Fatigue
According to International Labor Office statistics, 120 million occupational accidents occur
annually at workplaces worldwide. Of these, 210,000 are fatal accidents. Every day, more
than 500 men or women do not come home because they were killed in accidents at work.
In fact, these are numbers draw very little public attention, considering the fact that
accidents take a considerable economic toll on nations, companies and individuals.
During the past two hundred years, the knowledge about accidents has evolved
considerably. We have come far away from the simplistic models of categorizing behaviors
into safe and unsafe behaviors. The important observation is that, any two conditions which
by themselves are safe, may not necessarily be safe together. Workers are the connecting
link, as their behavior changes according to the environment and their physical
surroundings.
It has been observed that, when operators know that there is a mechanical device
protecting them in event of accidents, then they tend to become a little less cautious in their
behavior, unreasonably trusting the safety devices for their protection.
After understanding that humans, their tasks, their equipment and the environment make up
a dynamic system, we have made considerable progress towards effective accident
prevention.
In aviation industry and in other highly automated systems, increased automation may not
necessarily result in improved safety, because operators may not get enough practice to
keep their skills intact on highly automated devices. And when they then are called to
intervene, they might lack the competence or ability to do that job. Sometimes the operators
may not know the exact status of the serviceable parts of the machines they are operating.
This might result in hazardous situations. A technical improvement in the machinery or its
controls, without simultaneous improvement in operators’ skills, may not result in enhanced
safety.
Accident prevention has been traditionally based on learning from accidents and near
accidents (near misses). By investigating almost every accident, we are learning about the
causes of hazardous situations and taking suitable actions for mitigating or removing those
causes. The investigations might give us fairly good ideas about the causes of accidents.
However, this fact is usually relevant only for the specific cases investigated. In fact, there
may be situations or factors which contributed to the accident, but the investigators could
not relate those factors to the accidents that have happened. Generalizing the correlation
from one accident to other situations has to be done carefully.
A considerable progress has happened in the area of predictive safety management. A

number of techniques have been developed for industrial safety and risk analysis. These
techniques allow us to analyze industrial facilities for identification of potential hazards and
taking appropriate actions before anything goes wrong. Increasing popularity of simulators
in almost every walk of life, can be explained by the importance people have come to attach
to the safety of people and property.
The chemical and petrochemical industries have shown leadership in this area because of
the scale of their operation, the hazardous material they deal with, and the environmental
and financial consequences of the accidents in their factories. Because of the catastrophic
accidents like Bhopal gas leak and Chernobyl, the usage of modern predictive techniques
has substantially increased. Many governments have made safety audits mandatory for
almost every industry and place historically known for accidents, or where large number of
people gather for various purposes. Many countries have managed to reduce the fatal
occupational accidents by 60 to 70% during this period. Now, the challenge is to transfer
this knowledge to practical applications to ensure safety for everyone, at every place, and
at all the times.
One of the necessary steps involved in safety management is the idea of developing safety
culture in an organization.
It is possible to prevent occupational accidents by proper care, culture and analysis of the
past to manage the future.
Accident analysis
The purpose of any accident analysis is to get an insight into the causes of accident. In
dealing with occupational accidents, the magnitude of the problem can be judged from the
human, the environmental and the financial consequences of the accidents. The scale of
the problem differs from country to country, and from industry to industry.
Any accident is generally a chain of events which finally results in an undesired

consequence. It has been observed that human intervention at right times, might prevent
the injury or damage such a chain of events generally leads to. However, given the fact that
the potential of far more dangerous consequences exists in many situations, all such
possibilities must be considered while assessing the full extent of workplace risk, on the
basis of the presence of the risk factor and the frequency of accidents because of these
factors.
While dealing with accidents in the workplaces, one can estimate the magnitude of the
problem retrospectively, by comparing the number of accidents (rate of accidents) with the
severity of the accidents (enormity of the accident). However, for prospective analysis, due
consideration to the presence of risk factors in a workplace that might lead to accidents, is
necessary.
A comprehensive and precise view of the situation with respect to safety can be gained by
means of a system of reporting accidents and keeping their records for future analysis. This
analysis can give us a picture of the relationships between the presence of certain factors
and the occurrences of the accidents. In order to estimate the magnitude of the problem,
proper determination of risk factors is necessary. The information contained in the accident
records, such as, where the operators were when the accident occurred, or what they were
doing or handling, by what means, what damages or injuries happened and other details
around the place of the accident are of immense importance for preventing accidents.
Risk
Risk assessment must be done on the basis of the information about the past accidents
regarding, the number of accidents, the frequency of those accidents, the seriousness of
injuries, the loss to human life, the loss to property and environment, and the production
loss.
The assessment of risk identifies the exposure sources (exposure to harmful fumes,
radiations or noise) which causes gradual injury to humans and harmful conditions which
may cause an accident leading to sudden injury or a damage. Work performed at a height,
for example, will involve a risk of falling, with a serious injury as a consequence. But a
working with noisy machines over a long period of time may result in hearing loss.
There exists a good deal of common-sense on many types of risks, but many types of risks,
which are not obvious to common sense, may get overlooked at times. That is why, the
employee must be informed of the risks involved (e.g., that noise may cause hearing loss,
that certain solvents may be harmful if inhaled, and that certain lights may impair the
vision). Our knowledge about the types of risks is based on past events. However, it is one
thing to know what has happened in the past, and another to assess what will happen in the
future.
Factors Determining Risk
The factors which are relevant in determining the risk are:
o Factors which determine the presence of risks or potential risks.
o Factors which increase the possibility of such risks resulting into accidents or injuries
o Factors affecting the seriousness of accidents associated with these risks.
Exposure sources and occupational disorders
The concept of injuries due to exposure sources is often connected to the concept of
disease (or disorder) because, a disease can be seen to have happened because of the
exposure to certain agents over a short (acute exposure) or long (chronic exposure) period
of time. Chronic exposure agents are usually not immediately harmful, but they take effect
after a relatively consistent and longer period of exposure, whereas acute exposures show
their effects almost immediately.
Examples of exposure sources which may result in an injury in the form of a disease-like
condition are:
o Chemical exposures (solvents, cleaning agents, degreasing agents, etc.)
o Physical exposures (noise, radiation, heat, cold, inadequate lighting, lack of oxygen,
etc.)
o Physiological exposures (heavy loads, bad work postures or repetitive work)
o Biological exposures (viruses, bacteria, flour, animal blood or leather, etc.)
o Psychological exposures (work in isolation, threat of violence, changing working hours,

unusual job demands, etc.).
Harmful factors and occupational accidents
The concept of harmful factors is linked to occupational accidents, because this is where
damages occur and employees face instant injury. This type of action is easily identified
because the damage or an injury is immediately noticed as soon as it occurs. The difficulty
attached to this type of injury is the unexpected contact with the harmful factor.
Examples of harmful factors which may result in accidents are often linked to different forms
of power at the workplaces, such as:
o power that involves cutting with tools, saws and edged tools
o power that involves pressing with presses and clamping tools
o the conversion of kinetic power into impact
o falling objects
o heat and cold, electricity, sound, light, radiation and vibration
o toxic and corrosive substances
o moving of heavy loads or twisting of the body
o Mental and psychological stresses such as the threat of violence.
Controlling Exposures
Exposure sources or other harmful factors are to a great extent depend on the processes,
technologies, products and equipment used, but may also be depending on the way in
which the work has been organized. The controlling of exposure and mitigating the
seriousness of injuries to employees often depends on the following factors:
o Elimination / substitution safety measures - Workplace hazards in the form of exposure

sources or other harmful factors may be eliminated or mitigated by substitution (e.g., a
less harmful chemical may be use in place of a toxic chemical in a process
o Technical safety measures - These measures, often called engineering controls, consist
of separating persons from harmful factors by encapsulating those factors, or installing
barriers between employees and the factors to avoid injuries. e.g. automation, remote
control, usage of robots, usage of ancillary equipment and machine protection
(guarding).
o Organizational safety measures - Organizational safety measures, also known as

administrative controls, include separating persons from harmful factors, either by
means of special working hours or by segregating the employees. e.g. reduced
exposure time, preventive maintenance, encapsulating the individual workers with
personal protective equipment, and working in rotation to minimize exposure.
Controlling Human Conduct
What this means is that, safety and risk will at some point depend on factors which control
human conduct - namely, whether the individual has adequate knowledge, required skills,
enough opportunity and necessary will to ensure safety in the workplaces. The following
illustrates the role of these factors.
o Knowledge - Workers must first be aware of the types of risks, potential hazards and
elements of danger that may be present in the workplaces. This usually requires
education, training, simulation and job experience. The risks also need to be identified,
analyzed, recorded and described in a readily understandable language so that workers
know when they are in a specific risky situation and what consequences may result from
their actions.
o The opportunity to act - It must be possible for the workers to act safely. They should be
able to use their technical, organizational, physical and psychological capacities for
accident prevention. Positive support to the safety program must be readily available
from the management, supervisors and the colleagues. They should include their
concern for safety while designing their infrastructure, their work processes, usage of
tools, clearly defining their tasks, and providing unambiguous instructions on how the
equipment and materials are to be handled for safety.
o The will to act safely - Technical and organizational factors are important for workers’
readiness to behave in certain ways that will ensure safety, but social and cultural
factors are equally important. Many times people overlook safety, if they find safe
conduct is difficult to follow or if it is time-consuming, or if is not appreciated by the
management of his colleagues. Management must demonstrate its commitment to
safety, by taking appropriate steps to emphasize safety and showing a positive attitude
towards safe conduct of their employees.
The Information on the causes of accidents serves the following purposes:
o It can demonstrate where something may be going wrong and what corrective action
needs to be taken.
o It indicates the harmful factors that may cause accidents (or near misses) and also
describes the situations that result in damage and injuries.
o It identifies and describes the underlying circumstances that lead to the presence of
those hazards and risky circumstances, and the actions taken to alter or eliminate those
risks.
General information can be gathered by a thorough analysis of the damages, injuries and
the circumstances under which the accidents occurred. The information gathered from
other similar accidents may reveal very important cause and effect relationships.
Analysis of Individual Accidents
Analysis of individual accidents has two primary purposes:
o First, it can be used to determine the cause of an accident and the specific work factors
that contributed to it. The analysis may reveal the extent to which the risk has been
recognized.
o Second, one can get the knowledge that can be used for analysis of the similar
accidents.
The investigation report of the accident may include:
a. Identification of the workplace, the specific work, the work processes and the
technology used for carrying out that work
b. The nature and the seriousness of the accident.
c. The factors causing the accident, such as the exposure sources, the way in which
the accident occurred and the specific working condition that caused the accident
d. General conditions at the workplace.
Types of Analysis
There are five primary types of Analysis of accidents, each having a distinct purpose:
o Analysis and identification of where and which types of accidents occur. The goal is to
determine the incidence of the injuries associated with certain sectors, trade groups,
enterprises, processes and certain technologies.
o Analysis with respect to the corrective actions taken on the past accidents and the
occurrence of new types of accidents indicating presence of new risk elements.
o Analysis to prioritize the corrective actions depending on the degree of risk involved, by
calculating the frequency and seriousness of accidents. The goal is to establish a basis
for prioritization to determine where to focus the attention and utilize the resources.
o Analysis to determine how the accidents occurred and establish the underlying causes.
This information is necessary for selecting the corrective and preventive actions.
o Analysis for identifying special areas which normally go unnoticed.
Such analysis can be carried out at different levels, ranging from the individual enterprise to
the national level. Analysis at different levels is necessary for effective preventive actions.
Phases of the Analysis
Irrespective of the level at which the analysis is done, it will usually have the following
phases:
o Identification of places where the accidents occur in general
o Identification of the specific places at which such accidents occur
o Frequency and seriousness of the accidents
o Description of exposure sources or other harmful factors, that is, the direct causes of
damage and injury
o Examination of the underlying causal relation and causal progression.
Fatigue and Accidents
Fatigue is a message to the body to rest. It is not a problem if the person can and does rest.
However, if rest is not possible, fatigue can increase until it becomes distressing and
eventually overwhelming.
Fatigue is the state of feeling very tired, weary or sleepy resulting from insufficient sleep,
prolonged mental or physical work, or extended periods of stress or anxiety. Boring or
repetitive tasks can intensify feelings of fatigue. Fatigue can be described as either acute or
chronic.
Acute fatigue results from short-term sleep loss or from short periods of heavy physical or
mental work. The effects of acute fatigue are of short duration and usually can be reversed
by sleep and relaxation.
Chronic fatigue syndrome is the constant, severe state of tiredness that is not relieved by
rest. The symptoms of chronic fatigue syndrome are similar to the flu, last longer than six
months and interfere with certain activities. The exact cause of this syndrome is still
unknown.
Fatigue levels are not easily measured or quantified; therefore, it is difficult to isolate the
effect of fatigue on accident and injury rates.
Some research studies have shown that when workers have slept for less than 5 hours
before work or when workers have been awake for more than 16 hours, their chance of
making mistakes at work due to fatigue are significantly increased.
Fatigue is regarded as having an impact on work performance. Most accidents occur when
people are more likely to want sleep - between midnight and 6 am (that is, in nights), and
between 1-3 pm (that is, after lunch). And, indeed, sleep deficit has been linked to large
scale events such as the Exxon Valdez oil spill and the nuclear accident at Chernobyl.
Many conditions can lead to fatigue. For example, fatigue resulting from long hours of work
and a shorter length of time between work shifts is an important concern for the health and
safety of workers on extended workdays. Some researchers report that in many cases the
extended workday is more tiring than the eight-hour day. They often argue that workers will
be too tired by the end of ten or twelve hours and jeopardize their own well-being, and also
the safety of others on the job.
Others report that the eight-hour work schedule is tiring, particularly when many
consecutive shifts must be worked with few consecutive days off. The advantage of
properly designed extended workday schedules over eight-hour day schedules is that fewer
consecutive shifts are required and longer periods off between "workweeks" allow for better
rest. The longer time off may compensate for longer workdays, if the worker maintains
healthy and regular sleep patterns.
Another concern about the extended workday is that during the workweek, workers can
only do their job, eat and sleep. This creates two problems. First, most workers need a
certain amount of time to relax after work and before sleeping. When there are only twelve
or fourteen hours between shifts, this time is reduced. Second, workers with other types of
responsibilities such as child care may find the extended workday tiring because they still
have tasks to do when they return from work.
Many workplace factors make physical and mental demands of the workers that affect
health, mood, performance, safety and fatigue. Examples of such factors are job design,
lighting, air quality and workstations. Reduction in the source of fatigue helps workers to
deal with the demands of their work, including the work schedule. For example, a well-
designed tool, an extra rest break or a better chair can help reduce the overall demands of
a particular job.
Signs and symptoms of fatigue include:
o Tiredness,
o Sleepiness, including falling asleep against your will ("micro" sleeps),
o Irritability,
o Depression,
o Giddiness,
o Loss of appetite,
o Digestive problems, and
o Increased susceptibility to illness.
The effects of fatigue and their relationship to work
o Reduced decision making ability,

o Reduced ability to do complex planning,
o Reduced communication skills,
o Reduced productivity / performance,
o Reduced attention and vigilance,
o Reduced ability to handle stress on the job,
o Reduced reaction time - both in speed and thought,
o Loss of memory or the ability to recall details,
o Failure to respond to changes in surroundings or information provided,
o Unable to stay awake (e.g., falling asleep while operating machinery or driving a
vehicle),
o Increased tendency for risk-taking,
o Increased forgetfulness,
o Increased errors in judgement,
o Increased sick time, absenteeism, rate of turnover,
o Increased medical costs, and
o Increased accident rates.
Causes of fatigue
Work-related factors may include long work hours, long hours of physical or mental activity,
insufficient break time between shifts, inadequate rest, excessive stress or a combination of
these factors.
Sometimes, a sleep disorder may cause fatigue. You should ask your doctor or health
professional for more information. These conditions include:
Insomnia
People who suffer from insomnia often complain that they cannot fall asleep, or cannot stay
asleep for a full night. They may frequently wake up during the night, wake up too early, not
able to fall asleep at night, or have difficulty getting back to sleep if woken. Either way, they
do not feel rested. Insomnia can be either short term (in response to a stressful event or
change in environment) or long term.
Sleep Apnea
Most cases of sleep apnea are caused by a condition called "Obstructive Sleep Apnea".
Sleep apnea is a breathing disorder in which there are brief interruptions (lasting a
minimum of 10 seconds) in breathing during sleep. This condition is caused by a narrowing
(or collapse) of the throat or upper airway during sleep. This narrowing restricts or prevents
breathing while you are sleeping (air cannot flow into or out of your nose and mouth even
though your body continues to try to breathe). With sleep apnea, there are frequent
interruptions to sleep making your sleep unrestful. People often complain of early morning
headaches and excessive daytime sleepiness.
Symptoms of sleep apnea include: chronic, loud snoring, gasping or choking while sleeping,
excessive daytime sleepiness, and personality changes or difficulties thinking.
Restless Legs Syndrome
With restless legs syndrome, people report sensations of creeping, crawling, pulling, or
tingling which cause an irresistible urge to move their legs. This phenomenon usually
happens as a person is trying to fall asleep, making sleep difficult. Movements may also
occur during sleep, partially waking the person (even though they might not "notice") and
disrupting sleep patterns.
Narcolepsy
Narcolepsy is a rare condition associated with sudden sleep "attacks" where a person will
have an uncontrollable urge to sleep many times in one day.
Other Situations
Substances such as nicotine, caffeine, and alcohol can affect the quality of sleep. Caffeine
can remain in the body for about 3 to 7 hours and may affect sleep. Alcohol may shorten
the time to fall asleep, but it disrupts later in the night. Nicotine also can disrupt sleep and
reduce total sleep time.
Other substances such as over-the-counter medications or prescriptions may also affect

sleep. For example, long-acting benzodiazepines (drugs used to relieve anxiety or
insomnia) may contribute to daytime sleepiness.
How much sleep do people need?
It varies, but on average studies say we need at least 7.5 to 8.5 hours every day. Studies
have reported that most night workers get about 5 to 7 hours less sleep per week than the
day shift. (You can accumulate a sleep "debt", but not a surplus.)
Humans follow an "internal" or "biological clock" cycle of sleep, wakefulness, and alertness.
Although these "circadian" rhythms are influenced by external clues such as the sun setting
and rising, it is the brain that sets your pattern. Most cycles are 23-25 hours long and there
are natural dips or periods when you feel tired or less alert - even for those who are well-
rested.
How can a workplace help keep workers "alert"?
Fatigue is increased by:
o Dim lighting,
o Limited visual acuity (i.e., due to weather),
o High temperatures,
o High noise,
o High comfort,
o Tasks which must be sustained for long periods of time, and
o Work tasks which are long, repetitive, paced, difficult, boring and monotonous.
Workplaces can help by providing environments which have good lighting, comfortable
temperatures, and reasonable noise levels. Work tasks should provide a variety of interest
and tasks should change throughout the shift.
If extended hours/overtime are common, remember to consider the time required to

commute home, meal preparation, eating, socializing with family, etc. Workplaces may wish
to consider providing:
o On-site accommodations,
o Prepared meals for workers, and
o Facilities where employees can take a nap before they drive home or when they feel
sleepy.
Shift work and fatigue
Interest in the effects of shiftwork on people has developed because many experts have
blamed rotating shifts for the "human error" connected with nuclear power plant incidents,
air crashes, and other catastrophic accidents.
Alternating day, night and afternoon shifts are common in
o Industrial work
o Customs & immigration
o Mines
o Hospitals
o Protective services -- police, fire, ambulance
o Hospitality -- hotels, food service
o Health care
o Transportation services -- trucking, airlines
Shiftwork is also common in workplaces where technical processes cannot be interrupted

without affecting the product and/or where expensive equipment is used more profitably
when in constant operation. The overall prevalence of shift work is similar for women and
men. However, there are gender differences in shift work patterns by sector of employment.
Many more women than men work in the health care sector, while many more men than
women work in manufacturing.
Many workers find that shiftwork disrupts their family and personal life and leads to health
problems including chronic fatigue and gastrointestinal disorders. On the other hand, some
workers prefer shiftwork because it usually allows for more free time.
What are the effects on circadian rhythms?
Many human physical functions follow a daily rhythm or a 24-hour cycle. These cycles are
called circadian rhythms. The word circadian comes from the Latin "circa dies" which
means "about a day." Sleeping, waking, digestion, secretion of adrenalin, body
temperature, blood pressure, pulse and many other important aspects of body functions
and human behavior are regulated by this 24-hour cycle. These rhythmical processes are
coordinated to allow for high activity during the day and low activity at night.
Normally, the body uses cues from its processes and from the environment such as clock
time, social activities, the light/dark cycle, and meal times to keep the various rhythms on
track. For example, body temperature is highest during the afternoon and early evening
(6:00 p.m.) and lowest in the early morning (4:00 a.m. or just before sunrise). However, if
the person is working at night, the body temperature does not have as much variation
during a 24-hour period as it would normally. The temperature rhythm and other body
rhythms get out of sync: these rhythms also get out of phase with the person's activity
pattern. This disorientation can lead to feelings of fatigue and disorientation. "Jet lag" is a
term often used to describe these feelings.
Some rhythms adapt in two to three days while others change only after longer periods.
People adapt to new schedules at different rates as do the different rhythms. Total reversal
of circadian rhythms may never occur because on days off most people go back to a
"normal" day schedule. Frequent changes in schedule and disruption to circadian rhythms
can lead to chronic fatigue and other health problems.
What are the changes in sleep patterns?
Disruption of both the quality and quantity of the normal sleep is inevitable in shiftwork
particularly where night work is involved. The daytime sleep is seldom as deep or as
refreshing as sleep at night. The problem is greater if there is not a quiet, dark, comfortable
place to sleep. Even when disturbances are removed, a worker who returns home in the
morning may still find sleep impossible or less refreshing. This difficulty occurs because the
circadian rhythms are no longer synchronized. Being constantly tired is a typical complaint
of shift workers.
What are the gastrointestinal disorders associated with shiftwork?
Gastrointestinal and digestive problems such as indigestion, heartburn, stomachache and

loss of appetite are more common among rotating shift workers and night workers than
among day workers. It is less clear if more serious conditions such as peptic ulcers are
more common in shift workers. The irregular work, sleep and eating schedules are not
helpful for the proper care of ulcers.
Given the irregularity in type and timing of meals, it is not surprising that the night worker is
more likely to have a poorer diet. At night, the loss of appetite often leads to increased
snacking on "junk" food rather than eating a full, well-balanced meal. Feelings of fatigue
may encourage the consumption of beverages with caffeine (coffee, cola) to help the
worker stay awake.
What are the safety concerns associated with working shifts?
The Institute for Work and Health (IWH) reports that there is strong evidence that night,
evening, rotating and irregular shifts are associated with in increased risk of occupational
injury. This risk is associated with worker fatigue, and less supervision and co-worker
support during non-daytime shifts.
One study reported that night shift had the most incidents, followed by afternoon shifts
(least incidents in the morning shift). The risk of an incident was 20% more during the first
to second hour of a night shift, as well as a small raise between 3 and 4 am. More incidents
are reported on the 4th successive night shift than the first night shift.
What are some strategies for improvement?
The best solution to the problems of shiftwork would be to eliminate it but this is not often a
practical possibility. Shiftwork is likely to continue to be a reality for a large percentage of
workers.
There are two basic levels where improvements can be made:
o The organizational level - primarily through the design of shift schedules, education and
better facilities.
o The individual level - helping workers to get better sleep, a healthier diet, and the
reduction of stress.
What are some organizational approaches?
There are several approaches the organization can take to help reduce the effects of
shiftwork. There are also several important considerations for organizations.
o Shift Schedule Design: Optimizing the design of the shift schedule is the most effective
way of reducing the health and safety problems. Satisfaction with a particular shift
system is the result of a complicated balancing act that is the best compromise for
personal, psychological, social and medical concerns.
 Length of the rotation period (the number of days on any one shift before switching
to the next shift). The optimum length of the rotation period has been disputed.
 The most common system has a rotation period of one week, with five to seven
consecutive night shifts. However, since it generally takes at least seven days for
adjustment of the circadian rhythms, it is argued that just as adjustment starts to
occur, it is time to rotate to the next shift. Some schedule designers feel that a longer
shift rotation should be arranged so that the worker spends from two weeks to one
month on the same shift that would allow circadian rhythms to adjust. A problem
occurs when the worker reverts to a "normal" day/night schedule on days off, thus,
possibly cancelling any adaptation. Also, longer periods of social isolation may
result.
 Others suggest a rapid shift rotation where different shifts are worked every two to
three days. This system may reduce disruption to body rhythms because the
readjustment of circadian rhythms is minimized. It also provides time for some social
interaction each week.
 In the end individual differences and preferences, play the most important role.
o Direction of rotation of shifts. It is recommended that shifts rotate forward from day to
afternoon to night because circadian rhythms adjust better when moving ahead than
back.
o Start and Finish Times. Early morning shifts are associated with shorter sleep and
greater fatigue. It is advisable to avoid shift start times as early as 5 or 6 a.m. The social
customs and desires of the specific work force should be considered as well as the
availability of public transportation. The safety on the streets, in terms of crime and
violence, is another consideration.
o Length of rest between shifts. It is recommended that a rest period of at least 24 hours
occurs after each set of night shifts. The more consecutive nights worked, the more rest
time should be allowed before the next rotation occurs.
o Alternative forms of organizing work schedules. For example, extended work days of ten
or twelve hours have been used. It has the advantage of fewer consecutive night shifts
and longer blocks of time off. However, the additional fatigue from long work hours may
also have adverse effects. The physical and mental load of the task should be
considered when selecting the length of a work shift. Exposure to chemical or physical
agents should also be considered when selecting a shift system as well as ergonomic
hazards.
Additional Considerations
o Provide time off at "socially advantageous" times like weekends whenever possible.
o Start a special shift system if production demands result in extended periods of overtime
work.
o Inform shift workers of their work schedules well ahead of time so they and their families
and friends can plan activities. Allow as much flexibility as possible for shift changes.
Keep schedules as simple and predictable as possible.
Facilities: The provision of certain facilities can help the shift worker cope better.
o Give attention to the work environment. For example, good lighting and ventilation are
important on all shifts. Do not widely separate workstations so that workers at night can
remain in contact with one another.
o Provide rest facilities where possible. Whenever a person must remain at work after a
night shift to attend a meeting or a training session, providing rest facilities is advisable.
When a night worker is "on call" and must remain in the building, it is advantageous for
this person to be well rested rather than tired and bored.
o Provide healthy cafeteria services so a balanced diet can be maintained. The nutritional
needs differ between day shifts and other shifts because of circadian rhythms. Provide
educational and awareness materials on the benefits of eating a balanced meal.
o Consider offering facilities for social activities with the needs of the shift worker in mind.
Recreational opportunities are often minimal for workers on "non-day/night" shifts.
o Consider access to quality day-care for shift workers' children. Some strain on all family
members would be alleviated.
Education: Educate employees on the potential health and safety effects of rotational
shiftwork and what can be done to stop these effects. In particular, education in stress
recognition and reduction techniques is helpful.
What can the individual do to cope with shiftwork?
People who work shifts face many problems that others do not recognize. The difficulties
stem from the change in eating, sleeping, and working patterns. The following guidelines
can help people cope better.
Guidelines for Diet and Eating Patterns
o Maintain regular eating patterns as much as possible. Balanced, varied meals are very
important. Keep family meal times the same even though the work routine constantly
changes. Family meals may need to be altered in content to suit the shift worker.
o Time meals carefully. Afternoon workers should have the main meal in the middle of the
day instead of the middle of the work shift. Night workers should eat lightly throughout
the shift and have a moderate breakfast. This way they should not get too hungry while
sleeping during the day and digestive discomfort should be minimal.
o Pay careful attention to the type of food eaten. Drink lots of water and eat the usual
balance of vegetables, fruit, lean meat, poultry, fish, dairy products, grains and bread.
Eat crackers, nuts and fruit instead of pop and candy bars during work breaks. Reduce
the intake of salt, caffeine, and alcohol. Avoid greasy foods, particularly at night.
o Avoid excessive use of antacids, tranquilizers and sleeping pills. It is healthier to watch
what and when you eat, and use relaxation techniques to aid sleep.
o Relax during meals and allow time for digestion.
Sleep
o Sleep on a set schedule to help establish a routine and to make sleep during the day
easier. Some people may prefer to get a full period of rest just before the next work shift
(as it is with "normal day" work). Try different patterns of work and sleep to see which is
best for you.
o Make sure that family and friends are aware of and considerate of the worker's sleep
hours and needs. Ensure that the shift worker has a comfortable, dark, quiet place to
sleep during the day. Air conditioning, a telephone answering machine, and good blinds
on windows are recommended.
o Make time for quiet relaxation before bed to help get better sleep. Learn how to relax
using muscle relaxation, breathing techniques and so on. Use mental imagery to block
out unpleasant thoughts. If you still do not fall asleep after an hour, read a book or listen
to quiet music on the radio for a while. If sleep still does not come, reschedule sleeping
hours for later in the day. Limit commitments later in the day to allow for napping.
Other Important Considerations
o Pay attention to general physical fitness and good health habits.

o Find out about and understand the potential health and safety effects of shiftwork.
o Learn how to recognize and reduce stress through physical fitness, relaxation
techniques, yoga and so on.
o Take leisure seriously.
Extended Workday: Health & Safety Issues
What is meant by the extended work day?
Extended workdays refer to work schedules having longer than "normal" workdays.
However, there is no clear consensus about the length of the extended workday. Some
sources consider it to be between 8 to 12 hours in length, while others insist that the term
applies only when shifts are longer than 12 hours.
Usually workers on extended workday schedules work fewer than five days a week. When
the traditional thirty-six to forty-hour workweek is squeezed into three or four days, the
number of days worked in a row is decreased and the number of consecutive days off is
increased. This is not always the case; therefore, working on an extended workday
schedule does not automatically mean the same as a compressed workweek.
What are the issues surrounding "safety"?
An issue often raised is the effect of fatigue on workplace accident and injury rates. The
concern is that increased fatigue will contribute to accidents. While this concern seems
logical, it cannot be supported clearly with evidence. Of the few studies reporting accident
rates, some show an increase whereas others found no change in accident rates. It is clear
that an accident occurs as part of a process involving a combination of technical, personal,
behavioral, environmental and work process factors. The length of the workday, as it relates
to worker fatigue levels, is only one factor to consider when looking at what caused an
accident. Fatigue levels are not easily measured or quantified; therefore, it is difficult to
isolate the effect of extended workdays on any changes in accident and injury rates.
What are the issues surrounding "exposure to physical and chemical hazards"?
Exposure to physical and chemical hazards is always a health and safety concern. When
the workday is lengthened, the amount of exposure needs to be reevaluated to ensure that
acceptable levels are not exceeded. Areas of particular concern are exposures to
chemicals, noise, vibration, radiation, and extreme temperatures. Any method for
determining exposure levels for the extended workday should be used with caution and
under supervision. Expert advice may be necessary to determine acceptable exposures
and controls for an extended workday.
The proper and efficient use of personal protective equipment during an extended workday
should also be considered. For example, uncomfortable hearing protectors cannot provide
protection if workers find them uncomfortable and do not wear them when they should.
Comfort over the whole work shift is important to usage.
What are the issues surrounding “exposure to ergonomic hazards”?
Ergonomics is the branch of engineering in which work places are designed such that
workers have to face minimal fatigue, while giving maximum productivity. Ergonomic
hazards such as repetitive work or working in a sustained and or awkward posture
increases the risk of developing a musculoskeletal injury. Repeated or extended exposure
to these hazards causes the body to fatigue and muscles to be damaged. If the body does
not have sufficient rest, then the body, specifically the muscles, cannot repair themselves.
Damaged muscles can lead to injury through a cumulative loading effect or a onetime peak
loading effect.
When designing extended day work schedules, it is important to factor rest breaks and
alternate tasks that use opposing muscles groups to decrease the likelihood of sustaining a
musculoskeletal disorder.
What types of jobs are suitable for an extended workday?
The jobs that do not require a high degree of physical exertion or that have natural resting
periods may be most suitable for the extended workday schedule. For example, a machinist
who has cycle time between setups that allows reduced attention while the machine is
running can probably work a longer day. On the other hand, a data entry operator who must
continually enter data while sitting in one position and concentrating for long periods would
find the extended workday more difficult. People whose work involves creative activities
may benefit from this type of schedule as it allows them to work intensively on projects
while providing more time away to rest.
Workers on eight-hour rotational shiftwork schedules might prefer the extended workday
because it requires fewer consecutive night shifts and allows more recuperative time.
In spite of inconclusive studies and conflicting worker responses about the most suitable
length of work shifts, it is probably fair to say that heavy physical jobs and/or jobs that
demand sustained attention throughout the workday do not lend themselves well to
extended workday schedules. More suitable jobs would be those that require only light or
intermittent work.
A few guidelines for using an extended workday
First, find out if there is any legislation that requires government approval to schedule more
than eight hours of work per day and to average hours over longer periods. The legislation
may require the organization to show that workers are aware of and understand the
implications of the extended workday, and that workers genuinely want to work such a
schedule.
Some guidelines to consider when deciding whether to start or continue using an extended
workday schedule are:
o Consult workers about their desire to have a change in the work schedule and
specifically an extended workday.
o Consider the physical demands of jobs, occupational hazards such as chemicals or
noise exposures, and aspects of job design such as rest schedules. Changes in the
environment or job design can sometimes make an extended workday more acceptable.
o Consider the mental and emotional demands of the job. Work that requires constant
attention or intense mental effort may be less acceptable for the extended workday. Use
additional rest breaks or variation of job tasks to help decrease the strain of the
extended workday.
o Consider the workers and the other demands on their time. People who have other
significant responsibilities each day may require additional support such as child care
facilities. Seasonal demands may also have to be considered.
If the decision is made to try the extended workday, establish an experimental period.
Introduce the extended workday gradually to small groups to allow more flexibility and
better analysis of the situation. Evaluate the success of the new schedule by doing the
following:
o Monitor health and safety. Look for any changes in accident rates, health levels and
especially fatigue.
o Look for any changes in absenteeism rates. Although absences are not always a good
measure of health or ill health, an increase may suggest a problem. On the other hand,
a decrease may show that the extended workday is successful.
o Ask for workers' reactions and listen to their comments to find out how satisfied they are
with the extended workday, and how well they have accepted it and adapted to it.
4.12 Relations with Trade Unions
Employers and workers seem to approach employment from vastly different perspectives.
So how can the two sides reach any sort of agreement? The answer lies in unions. Unions
have played a role in the worker-employer dialogue for centuries, but in the last few
decades many aspects of the business environment have changed. With this in mind, it's
important to understand how unions fit into the current business environment, and what role
unions play in the modern economy.
What Are Unions?
Unions are organizations that negotiate with corporations, businesses and other
organizations on behalf of union members. There are trade unions, which represent
workers who do a particular type of job, and industrial unions, which represent workers in a
particular industry. The All India Trade Union Congress (AITUC) is the oldest trade union
federations in India and one of the five largest. It has been associated with the Communist
Party of India, Indian National Trade Union Congress (INTUC) is the trade union wing of the
Indian National Congress, and Bharatiya Mazdoor Sangh is the trade union wing of the
Bharatiya Janata Party
What Do Unions Do?
Trade union is a voluntary organization of workers pertaining to a particular trade, industry

or a company and formed to promote and protect their interests and welfare by collective
action. They are the most suitable organizations for balancing and improving the relations
between the employer and the employees. They are formed not only to cater to the workers'
demands, but also for inculcating in them the sense of discipline and responsibility.
They aim to:-
o Secure fair wages for workers and improve their opportunities for promotion and
training. They enter into collective bargaining with the employers for fair wages.
o Safeguard security of tenure and improve their conditions of service.
o Improve working and living conditions of workers.
o Provide them educational, cultural and recreational facilities.
o Facilitate technological advancement by broadening the understanding of the workers.
o Help them in improving levels of production, productivity, discipline and high standard of
living.
o Promote individual and collective welfare and thus correlate the workers' interests with
that of their industry.
In India, the first organized trade union was formed in 1918 and since then they have
spread in almost all the industrial centers of the country. The legislation regulating these
trade unions is the Indian Trade Unions Act, 1926. The Act deals with the registration of
trade unions, their rights, their liabilities and responsibilities as well as ensures that their
funds are utilized properly. It gives legal and corporate status to the registered trade unions.
It also seeks to protect them from civil or criminal prosecution so that they could carry on
their legitimate activities for the benefit of the working class. The Act is applicable not only
to the union of workers but also to the association of employers. It extends to whole of
India.
This act ensures harmonious industrial relations through:-
o Monitoring of industrial relations;
o Intervention, mediation and conciliation in industrial disputes in order to bring about

settlement of disputes;
o Intervention in situations of threatened strikes and lockouts with a view to avert the
strikes and lockouts;
o Implementation of settlements and awards.
According to the Trade Unions Act 1926, 'trade union' means "any combination, whether
temporary or permanent, formed primarily for the purpose of regulating the relations
between workmen and employers". The basic provisions of the Act are:-
o The Act provides for the registration of the trade unions with the 'Registrars of Trade
Unions' set up in different States. For registration of a trade union, seven or more
members of the union can submit their application in the prescribed form to the
Registrar of trade unions.
o The registered trade unions (workers & employers) are required to submit annual
statutory returns to the Registrar regarding their membership, general funds, sources of
income and items of expenditure and details of their assets and liabilities.
o The general funds of a registered trade union shall not be spent on any other objects
than those specified in the Act.
o No office-bearer or member of a registered trade union shall be liable to punishment

under the Indian Penal Code in respect of any agreement made between the members
for the purpose of furthering any such objective of the trade union as specified in the
Act, unless the agreement is an agreement to commit an offence.
o No suit or other legal proceeding shall be maintainable in any civil court against any
registered trade union or any office-bearer or member thereof in respect of any act done
in contemplation or furtherance of a trade.
o The account books of a registered trade union and the list of members thereof shall be
open to inspection by an office-bearer or member of the trade union at such times as
may be provided for in the rules of trade union.
o A person shall be disqualified for being chosen as, and for being a member of, the
executive or any other office-bearer or registered trade union if- (i) he has not attained
the age of eighteen years; (ii) he has been convicted by a court in India of any offence
involving moral turpitude and sentenced to imprisonment, unless a period of five years
has elapsed since his release.
o Every office-bearer or other person bound by the rules of the trade union shall be
punishable with the payment of fine, if:-
 Default is made on the part of any registered trade union in giving any notice or
sending any statement or other document as required by or under any provision
of this Act; or
 Any person willfully makes, or causes to be made, any false entry in, or any
omission from, the general statement or in or from any copy of rules or of
alterations of rules sent to the Registrar; or
o Any registered trade union may, with the consent of not less than two-thirds of the total
number of its members and subject to the provisions of of the Act, change its name.
o Any two or more registered trade unions may become amalgamated together as one
trade union with or without the dissolution or division of the funds of such trade unions or
any of them, provided that the votes of at least one-half of the members of each or every
such trade union entitled to vote are recorded, and that at least sixty percent of the
votes recorded are in favor of the proposal.
o When a registered trade union is dissolved, notice for the dissolution signed by seven
members and by the Secretary of the trade union shall, within fourteen days of the
dissolution, be sent to the Registrar and shall be registered by him if he is satisfied that
the dissolution has been effected in accordance with the rules of the trade union, and
the dissolution shall have effect from the date of such registration.
o However, the Trade Unions Act 1926 has been amended from time to time and the most
important being the Trade Unions (Amendment) Act, 2001. This Act has been enacted in
order to bring more transparency and to provide greater support to trade unionism in India.
Some of the salient features of the Trade Unions (Amendment) Act, 2001 are:-
o No trade union of workmen shall be registered unless at least 10% or 100, whichever is
less, subject to a minimum of 7 workmen engaged or employed in the establishment or
industry with which it is connected are the members of such trade union on the date of
making of application for registration.
o A registered trade union of workmen shall at all times continue to have not less than
10% or 100 of the workmen, whichever is less, subject to a minimum of 7 persons
engaged or employed in the establishment or industry with which it is connected, as its
members.
o A provision for filing an appeal before the Industrial Tribunal / Labor Court in case of
non-registration or for restoration of registration has been provided.
o All office bearers of a registered trade union, except not more than one-third of the total
number of office bearers or five, whichever is less, shall be persons actually engaged or
employed in the establishment or industry with which the trade union is connected.
o Minimum rate of subscription by members of the trade union is fixed at one rupee per
annum for rural workers, three rupees per annum for workers in other unorganized
sectors and 12 rupees per annum in all other cases.
o The employees who have been retired or have been retrenched shall not be construed
as outsiders for the purpose of holding an office in the trade union concerned.
o For the promotion of civic and political interest of its members, unions are authorized to
set up separate political funds.
o Hence, trade union legislation ensures their orderly growth, reduce their multiplicity and
promote internal democracy in the industrial organization and the economy. The trade
unions have thus acquired an important place in the economic, political and social set up of
the country.
4.13 Workers Participation in Management (WPM)
A process by which subordinate employees, either individually or collectively, become
involved in the decision making process at their workplaces.
Workers’ participation in Management (WPM) refers to the mental and emotional

involvement of an employee, which encourages him to contribute to the organization’s
goals and share the in responsibility of achieving them.
It means, sharing the decision-making power with the rank and file of the organization.
Workers’ participation in management is an essential ingredient of Industrial democracy.

The concept of workers’ participation in management is based on Human Relations
approach to Management which brought about a new set of values to labor and
management. Traditionally the concept of Workers’ Participation in Management (WPM)
refers to participation of non-managerial employees in the decision-making process of the
organization. Workers’ participation is also known as ‘labor participation’ or ‘employee
participation’ in management.
A clear and more comprehensive definition of WPM is given by the International Labor
Organization (ILO) –
“Workers’ participation may, broadly be taken to cover all terms of association of workers
and their representatives with the decision-making process, ranging from exchange of
information, consultations, decisions and negotiations to more institutionalized forms such
as the presence of workers’ members on management or supervisory boards or even
management by workers themselves”.
In India, WPM is implemented through Works Committees, Joint Management Councils

(JMCs), Shop Councils, Unit Councils and Joint Councils.
WPM is basically a system of communication and consultation, either formal or informal,

through which the workers of an organization are kept informed, as and when required,
about the affairs of the undertaking and through which they express their opinion and
contribute to decision-making process of management.
The following are the main characteristics of WPM:
1. Participation implies the practices which broadens the scope for employees’ share of
influence in decision-making process with simultaneous assumption of responsibility.
2. Participation presupposes willing acceptance of responsibility by the workers.
3. Workers participate in management not as individuals but as a group through their

representatives. And the group encourages their members to take responsibilities and meet
the expectations from WPA.
4. Worker’s participation in management differs from collective bargaining such, that the
former adopts ‘the management and workers approach’ for information sharing and
problem solving for achieving the good for all participants of the process; and the latter
adopts ‘management vs workers’ approach for hard negotiations on various issues. The
former may always result in win-win situations, but the later may sometimes result in win-
lose situation.
5. The basic rationale tor worker’s participation in management is that workers invest their
labor and their lives to their places of work. Thus, they contribute to the outcomes of
organization and truly participate in the wealth creation process. Hence, they have a
legitimate right to have a share in the decision-making process and shape the futures of
their organizations.
Objectives of WPM:
In India the objective of the government in advocating for workers’ participation in

management, as stated in the Industrial Policy Resolution 1956, is a part of its overall goal
of to creating a socialist economy, wherein the sharing of a part of the managerial powers
by workers was considered necessary. Therefore, the prime objective of WPM in India is to
ensure organizational effectiveness and the satisfaction of the employees.
The objectives of WPM are:
o Promote mutual understanding between management and workers, i.e., industrial

harmony.
o Establish and encourage good communication systems at all levels.
o Encourage a sense of belongingness among workers and facilitate them to correlate

their personal goals with those of the organizational goals.
o Help handle resistance to change.
o Induce a sense among workers to contribute their best for the cause of organization.
o Create a sense of commitment to decisions to which they are a party.
Levels of Participation: To what extent workers can participate in decision-making

process.
Informative Participation: This indicates willingness of the management to share

information with workers on issues concerned with workers. The sharing of Profit and Loss
Statements, Balance Sheets, Production schedules, General economic health of the
company, Competition, Strategic plans etc., are the examples of Informative Participation.
This is basically a one way process, because, in this the management unilaterally takes
decisions on issues concerned with workers.
Consultative Participation: In this type of participation, workers are consulted on issues

which are concerned with them. Here, the role of workers is restricted to give their views
only. However the acceptance and non-acceptance of these views depends on
management’s willingness and conviction. Nonetheless, it provides an opportunity to the
workers to express their views on matters involving their futures and places of work.
Associative Participation: Here, the role of the workers’ council is not just advisory in
nature. In this process pros and cons of each suggestion, are jointly discussed with the
management, and best possible decision is arrived at. In this the management is under a
moral obligation to accept and implement the unanimous decisions of the council.
Administrative Participation: in administrative participation, the decisions already taken

by the councils are jointly implemented by the workers and managers. The degree of
sharing of authority and responsibility with the workers is definitely more in this type if
participation.
Decisive Participation: Here, the decisions are taken jointly by the management and the
workers of an organization. In fact, this is the ultimate level of workers’ participation in
management.
Forms of Participation
Collective Bargaining: Collective bargaining results in collective agreements which lay

down certain rules and conditions of service in an establishment. Such agreements are
normally binding on the parties. Theoretically, collective bargaining is based on the principle
of balance of power, but, in actual practice, each party tries to outbid the other and get
maximum advantage by using, if necessary, threats and counter threats like; strikes,
lockouts and other direct actions.
Joint consultation: Joint consultation is a particular technique which is intended to achieve

a greater degree of harmony and cooperation by emphasizing matters of common interest.
Works Councils: These are exclusive bodies of employees, assigned with different
functions in the management of an enterprise. In some countries these councils have wider
decision-making powers like; appointment, promotion, salary fixation and also major
investment decisions.
Joint Management Councils and Committees: These bodies are consultative and
advisory in nature, and the decision-making is left to the top management. But, as they are
consultative and advisory in nature, neither the managements nor the workers take them
seriously.
Board Representation: The role of a worker representative in the board of directors is

essentially one of negotiating the worker’s interest with the other members of the board. At
times, this may result in tensions and friction inside the board room. The effectiveness of
workers’ representative at the board depend upon his ability to participate in the decision
making, his knowledge of the company affairs, his educational background, his level of
understanding and also on the number of worker representatives in the Board.
Workers Ownership of the Enterprises: complete control of management by workers

through an elected board and workers council. Now-a-days company’s stocks are issued to
the employees free of cost or at a discount to the market price to encourage part ownership
of the company, and recognize their efforts in creation of wealth for the company.
4.14 Workload Management
Although time seems to fly by, we all have the same 24 hours in a day. Then, how is it that
a few people are able to accomplish so much more than the majority of the population?
One possible explanation can be found in their ability to manage time more efficiently than
others. But how is it possible to cope with the flood of tasks that all require our immediate
attention? In a time where missing the deadlines is not acceptable, the time management
grid can help us to manage our available time more efficiently allow us to organize our
priorities much better than before.
The four quadrants approach
This approach makes use of four different quadrants that allow us to prioritize tasks vis-à-
vis their importance and urgency, helping us to decide whether we need to address the task
immediately or if it can be postponed.
As you can see from

the matrix, the tasks
are grouped into four
quadrants based on
their importance and
urgency.
o The important tasks contribute to the achievement of our goals.

o The urgent tasks require immediate attention. These tasks are often tightly linked to the
accomplishment of someone else’s goals. Not dealing with these tasks will produce
immediate consequences.
Quadrant I – important deadlines with high urgency - The first quadrant contains tasks
and responsibilities that need immediate attention.
The tasks in this quadrant are the tasks which were not foreseen, or the tasks which
became urgent because of delays. The former can be minimized by scenario planning,
simulation and imbibing awareness about safety amongst employees, and the latter can be
minimized by developing precise plans and close monitoring of their execution.
The first quadrant should contain only those tasks that require our immediate attention. This
space is reserved for emergencies and meeting extremely important deadlines.
o Crisis – accidents, strikes, enforcement notices, legal orders etc.

o Pressing problems – production bottlenecks, quality issues, shortages
o Deadlines given to the customers
o Emergencies – Strikes at the suppliers plants, war like situation in supplier’s country.
o Last-minute preparations
Quadrant II – long-term development and strategic planning - The second quadrant is

for items that are important, but do not require immediate action. The tasks in this quadrant
include, long-term strategic planning and policy making.
The items in this quadrant do not have a high urgency, but can play an important role in
shaping the future of the organization. This quadrant is not only reserved for strategic
planning on introducing new products, exploring new geographies, tapping new market
segments, but also on items related to employees’ health, their education, skill
development. Investing time on those areas, which are not urgent today, but are vital for the
future of the organization.
These tasks need close attention to avoid them from to becoming urgent tasks. This will
also stimulate us to finish our tasks in time.
o Strategic Planning
o Detailed planning
o Training
o Policy making
Quadrant III – distractions with high urgency – This includes tasks that are urgent, but
which are not important. These tasks should be minimized, delegated, outsourced, or even
discarded, if possible. These are the tasks which do not contribute to our output.
The third quadrant tasks appear to have a high urgency, but may not be important at all.
Some of these activities may not contribute any real value to the organizations. At times,
these activities are obstacles to meeting the goals of the organizations. It is better to
delegate or outsource these tasks or rescheduling them.
o Interruptions
o Meetings
Quadrant IV – activities with little or no value - The fourth quadrant contains tasks and
responsibilities that do not yield any value to the company. These tasks are neither
important, not urgent. Such tasks should be completely eliminated from the system.
This quadrant contains those activities that do not add any value to the organization - they
are time wasters, they are distractions
o Trivia
o Time wasters
o Attending Irrelevant meetings
o Reading irrelevant mails
While using the Important-Urgent matrix, it is necessary to maximize the time spent on
quadrant II tasks. This facilitates us to reduce quadrant I tasks, because many of them may
have come to quadrant I because of poor implementation of quadrant II tasks.
The objective of using the time management matrix is to question whether a certain activity
brings us closer to our goals or not. If this is the case, these responsibilities need to be
prioritized over those tasks that might demand our time but do not contribute to our goals.
We can delay the activities that do not contribute to any significant output until more
important tasks are finished.
4.15 The importance of effective communication
Introduction
Communication is an essential part of human interaction. The benefits of effective

communication are many and obvious as they enhance all aspects of our personal and
professional lives. Ineffective or misunderstood communications in our personal lives may
give rise to problems or embarrassing situations, but in our professional lives the results of
misunderstandings may have much more serious consequences. In the world of
international shipping, with seafarers from many nationalities sailing on the same ships
visiting ports all over the world, the effective communication between those on board and
those on the shore is of vital importance.
The importance of communications
‘Careless talk costs lives’, may sound dramatic, but it does illustrate the importance of
effective communication and the risks if they go wrong.
IMO analyses reports of casualties and accidents to see if there are any lessons to be
learnt from them. Communication difficulties often recur in these reports due in part to
cultural differences and language barriers. Some examples from recent analyses illustrate
the problems.
Tanker mooring accident - a 56,000 DWT Bahamian flag tanker was berthing at an oil
terminal in the UK when a mooring line parted and struck the crew of a mooring boat
causing serious injuries. Because all verbal communications between the master and crew
were in Korean, a language he did not understand, the pilot did not know that his intentions
had been mistaken until the accident occurred. The accident was caused because of the
breakdown of communications between the pilot and the ship’s master.
Bulk carrier grounding - a 36,000 DWT Panama flag bulk carrier was leaving port under
pilotage when it ran aground. The pilot’s attention was distracted and he failed to properly
monitor the actions of the helmsman. The result was that he failed to hear the helmsman’s
replies and the ship swung out of the channel and went aground. The accident was caused
because of the poor communications between the helmsman and pilot.
Passenger ship fire - a small fire spread throughout the ship and 158 people lost their lives.
All escape routes were filled with smoke and those unfamiliar with the ship needed the
assistance of crew and sign boards to find their way. The sign boards were not in a
language familiar to the passengers on board. Therefore they proved ineffective in
providing safety instructions to the passengers. The officers and many of the crew
members did not share a common language and the language of the crew was not the
same as most of the passengers. Although the fire was not related to poor communications
between officers and crew, the poor safety organization on board coupled with the inability
of the officers to communicate with all of the crew and the inability of the crew to
communicate with the passengers, exacerbated the situation.
These cases demonstrate the need for effective communications to ensure safe and
efficient ship operation.
Communication
What exactly is communication? If it is so important, then how do we ensure that when one
person talks to another, that the other person listens to him and understands what is said?
How do we know if the message (or sign) has not only been heard (or read) but also
understood? What can be done to limit the scope for mistakes and to enhance the
effectiveness of our communication?
It is well known that people speaking different languages can generally not converse at all
and even when people speak their own languages, they can often misinterpret spoken or
written messages. Many may recall the games where a message passed through a series
of people, becomes quite different from the original message, when it reaches the last
person in the chain, after being interpreted, re-worded, abbreviated, and expressed by
every person in the chain. And the reason why these messages get completely distorted
while passing from one person to another, is because we probably have too many ways of
expressing ideas.
For effective communication to happen, when the sender of a message communicates with
the intended recipient, there has to be a correlation between what the sender is thinking
about and what the receiver is thinking about. Texts or words, therefore, must be used in
such a way that one and only one interpretation can be drawn from it.
The solution to the breakdown in communication because of multiplicity of languages is to

use a common universally understood language.
Many times, the language usually used on board ship is the national language of the crew.
But, when there are crew members from different nationalities, it is always better to adopt a
single language, which is understood by all crew members for communication. But the
ocean going ships must conduct their ship to shore communications in a universally
understood language, because navigational and safety communications must be precise
and unambiguous to avoid confusion or error.
For example –
British English American (English)
Bonnet (car) Hood (something on a coat)

Boot (car) Trunk (a suitcase)
Petrol Gas (a fuel to cook on)
Trousers Pants (worn under trousers)
Waistcoat Vest (worn under a shirt)
Full stop Period (a length of time)
Football Soccer
Saucer Disk
So the answer in the maritime world is to use a ‘standard’ form of English where, as far as
possible, words convey only one meaning, so that the scope of miscommunication is
minimized.
English language, because it is the widely accepted and universally spoken, has been
adopted as a standard language for achieving effective communication on board, between
ships and ship to shore communications. Therefore, adequate knowledge of Standard
English language is not only a required for certification of seafarers, but also a key element
in ensuring a safe and efficient ship operation.
The meaning of Standard English in this context is, the one which is commonly accepted by
the seafaring community. The usage of different national or regional variations of the
English language may often lead to miscommunication and unsafe situations.
English language
So which English to choose if there are so many versions of the language?
The first ever IMO attempt to develop and agree a maritime vocabulary was adopted by
IMO in 1977 – it was called the Standard Marine Navigational Vocabulary (SMNV).
The SMNV was not intended to be mandatory for the seafarers, but it was expected that
through constant repetition on board ships and in training institutes, the phrases and terms
would become commonly accepted and used by the seafarers. In this way it was expected
that an acceptable form of maritime English would develop for the exchange of
communication between seafarers and between ships and shores.
In the early 1990’s IMO felt the need for more comprehensive standardized safety language
covering all major safety related verbal communications. After a long development period,
a compilation of Standard Marine Communication Phrases (SMCP) was adopted by the
Assembly in November 2001.
Advantages of a dedicated vocabulary
The maritime world, like many specialized areas of activity, has a language of its own. And
some of the words and phrases are unlikely to mean anything outside of the maritime world
or, if the words are understood literally, the reader may gain a wrong and possibly weird
understanding of the message. For example, forward spring – a rope; a gypsy – part of the
windlass; monkey island – on top of the wheelhouse etc. So any vocabulary chosen has to
be aimed closely to the real work of the seafarer if it is to be used and be useful to them.
And although being able to converse in English in all circumstances might be welcome, as
far as the seafarer training and education is concerned, it is more important for him or her to
be familiar with the words and phrases related to their work. In selecting those words and
phrases however a number of factors need to be considered:
o The time it takes to learn the vocabulary and the associated meanings; and
o The number of words and phrases an individual is expected to absorb.
These factors are unlikely to limit the number of phrases and words identified in a dedicated
vocabulary, but may have an effect on the ability of an individual to learn and use them in
the correct context. The number of different ideas that can be identified is very large,
particularly where it is possible to combine concepts or words together to form new
expressions.
The typical length of a message, for both sender and receiver, is ultimately restricted by the
amount of information that a person can handle at one time. Much longer sentences can be
understood, only if they can be easily decomposed into shorter sentences. Therefore, a
vocabulary made up of shore terms or phrases that can be combined to form a maritime
vocabulary, then it will probably have a greater chance of success. And if we want it to be
used and understood internationally, then we need to make its learning mandatory. The
STCW Convention is one such effort. It is not known, whether all native English speakers
are taught the SMCP as part of their training, so there is no misunderstanding when they
communicate with people from Non-English speaking countries.
The international framework has set a mandatory requirement for proficiency in English, a
standard maritime vocabulary, and guidance in the form of IMO model courses on
communication.
Conclusion
Effective communications are an essential ingredient to safe and efficient ship operations.
Communication can be achieved in many ways but the prime method for operational
communications is through speech. And when in an operational situation such as berthing
a ship or fighting a fire, it is vitally important that those involved can communicate
effectively. The international community has chosen the English language as the medium
for that communication and IMO has developed a standard vocabulary and the training
tools to deliver it.
5. Importance of economics in Marine Engineering study
5.1 Basic Economic Concepts
o Wants - Simply the desires of people. Wants are different from needs. Wants are a
means of expressing a perceived need. Wants are broader than needs.
o Needs: These are basic requirements for survival like food, water and shelter. In recent
years we have seen a shift of certain items from wants to needs (e.g. internet, cell
phone).
o Scarcity – Shortage of certain goods and services, vis-à-vis other goods or services.
Scarce goods and services are cornered by people who have the need of these goods
and services; who have the money to bid higher prices for them, and who have the will
to bid the higher prices for them.
o Factors of Production / Resources - these are those elements that a nation has at its
disposal to satisfy the needs of its citizens. How efficiently these factors are used,
determines the economic success of a nation. These factors are
 Land - natural resources

 Capital – money for investment
 Labor - the work force (number, age group, education, skills, work ethic etc.)
 Entrepreneurs - enterprising spirit e.g. people from Gujrat, Marwad, and Punjab in
India
o "Three Basic Economic Questions" for dealing with scarcity and efficient allocation of
resources.
 What to produce?
 How to produce?
 For whom to produce?
o Economics - Economics is the study of the mechanics behind the allocation of scarce
resources for production and distribution of the goods and services for which clear need
exists.
o Opportunity Cost - the cost of an economic decision. If the resources are used to
produce one thing, then some other thing may have to be foregone because of the
scarcity. The benefit we would have accrued by the alternative action is called the
opportunity cost.
o Free Products: Air and sunshine are the things which are plentiful in nature and no one
can claim ownership over them.
o Economists are interested in "economic products" - goods and services that are useful,
relatively scarce and transferable to the best bidder.
o Good: tangible commodity. These are bought, sold, traded and produced.
 Consumer Goods: Goods that are intended for final use by the ultimate consumer.
 Capital Goods: Items used in the creation of other goods. e.g. plant, machinery,
trucks, etc.
 Durable Goods: Any good that lasts for more than a year when used on a regular
basis.
 Non-Durable Goods: Any item that lasts less than a year when used on a regular
basis.
 Services: A work that is performed for someone. Service cannot be seen or stored.
They can be perceived and paid as per the level of satisfaction.
o Consumers: people who use these goods and services.
o Conspicuous Consumption – Unreasonably high consumption.
o Value: An assignment of worth. The assignment is usually based upon the utility
(usefulness) and scarcity of the item (supply and demand balance).
o Utility: capacity to be useful to the bidder.
o Paradox of value: assignment of the highest value to those things we need the least
(e.g. diamond), and the least value on the things we need the most (e.g. water).
o Wealth: the sum of the perceived economic values of those products that a nation or a
person owns.
o Productivity - the ability to produce large quantities of goods (economic products) with
least total inputs.
o Many countries are wealthy, because:
 They use their resource efficiently.

 They innovate continually to keep their productivity ahead of others.
 They invest in Human Capital (trained manpower)
Macroeconomics
Macroeconomics is a branch of the economics that studies how the aggregate economy
behaves. In macroeconomics, a variety of economy-wide factors such as, inflation, rate of
growth, national income, gross domestic product, per capita income and unemployment are
thoroughly examined.
Those working in the field of macroeconomics study aggregate indicators of different

sectors of the economy and correlate them to one another to understand the behavior of
the economy functions. Macroeconomists develop economic models for explaining the
relationships between a variety of factors such as consumption, inflation, savings,
investments, international trade and finance, exchange rate, national income and output. In
short, microeconomics analyzes how individual agents act, and how these agents’ behavior
affects quantities available in certain markets and their prices in those markets. These
macroeconomic models are used by the governments to assess their economic policies.
Macroeconomics studies economic cycles to determine the long-term economic growth,

growth rates in the national income, population growth, long-term demand and supply
imbalances, and economic policy formation. Macroeconomics, in its present form, was
popularized by John Maynard Keynes. Keynes offered an explanation for Great Depression
after WWII, when goods remained unsold and workers remained unemployed, a situation
that perplexed classical economists. Keynes' theory explained why markets may not clear
even at lower prices.
Microeconomics
Microeconomics is a branch of economics that analyzes the market behavior of individual
consumers and companies in an attempt to understand the decision-making processes of
companies and households. It is concerned with the interaction between individual buyers
and sellers and the factors that influence the choices made by buyers and sellers. In
particular, microeconomics focuses on patterns of supply and demand and the
determination of price and output in individual markets (e.g. automobile industry).
5.2 The Demand Analysis
Both, our common sense and a careful scientific observation shows that the amount of a
commodity people buy depends on its price. The higher the price of an article, while other
parameters remaining constant, the fewer number of units consumers would be willing to
buy. The lower the market price, the more the number of units bought.
There exists a definite relationship between the market price of a good and the quantity
demanded of that good, while other things remaining constant. This relationship between
price and quantity bought is called the demand schedule, or the demand curve.
Law of downward-sloping demand: When the price of the commodity is raised (and other
things are held constant), buyers tend to buy less of that commodity. Similarly, when the
price is lowered, other things remaining constant, the quantity demanded increases.
The quantity demanded tends to fall as price rises for two primary reasons.
First is the substitution effect. When the price of the good rises, we will substitute other
similar goods for it {as the price of Tur dal (Arhar dal) rises, we may shift to masoor dal, if
moong dal is more expensive than Tur dal}.
Second, the reduced-income effect. When a prices go up, we may have to spend higher
amount on our basic necessities, leaving lesser amount in our hands for spending on other
goods. That is, we find ourselves somewhat poorer than what we were before. If petrol
prices double, we have in effect less real income, therefore we will naturally curb our
consumption of petrol and also other goods.
Does the market demand curve obey the law
of downward-sloping demand? It certainly
does. If prices drop, for example, the lower
prices attract new customers through the
substitution effect. In addition, a price
reduction will induce extra purchases of goods
by the existing consumers through both the
income rise and the substitution effects.
Conversely, a rise in the price of a good will
cause some of us to buy less.
Forces behind the Demand Curve
What determines the market demand curve for

Tur dal or petrol or computers?
A whole array of factors influence how much

will be demanded at a given price, viz. average level of income, the size of the population,
the prices, the availability of substitute goods, individual and social tastes, and special
social influences.
 The average income of consumers is a key determinant of demand of anything. As

people’s income rises, individuals tend to buy more of almost everything, even if
prices don’t change. Automobile purchases tend to rise sharply with higher levels of
income. Implementation of Seventh Pay Commission recommendations is going
boost the demand of almost everything.
 The size of the market – measured, for example in terms of population, clearly
affects the market demand curve. Mumbai’s 22 million people tend to buy 4 times
more Tur dal and cars than do Pune’s 6 million people.
 The prices and availability of related goods influences the demand for a commodity.
A particularly important connection exists among substitute goods, ones that tend to
perform the same function, such as Tur dal and Moong dal, pens and pencils, small
cars and large cars, or petrol and CNG. Demand for good A tends to be low if the
price of substitute product B is low. (For example, if the prices of Tablet computers
falls, will that increase or decrease the demand for smartphones)
 In addition to these objective elements, there is a set of subjective elements called
tastes or preferences of people. Taste represents a variety of cultural and historical
influences. They may reflect genuine physiological or psychological needs (food,
clothes, shelter, love, care and entertainment) and they may include contrived needs
(deliberately created rather than arising naturally or spontaneously) for example –
cigarettes, alcohol and drugs. They may also contain a large element of tradition or
religion (eating beef is popular in west, but taboo in India).
 Finally, special influences will affect the demand for particular goods. The demand
for umbrellas is high in rainy Mumbai, but low in dry Jaipur. The demand for air
conditioners will rise in summer, the demand for automobiles will be low where public
transportation is plentiful and getting a parking place is a nightmare. In addition,
expectations about future economic conditions, particularly prices, may have an
impact on demand.
Shifts in Demand
Why does the demand curve shift?

The answer is, it shifts, because a few factors,
other than the good’s price, change. For
example, implementation of Seventh Pay
Commission recommendations is going put
more money in the hands of government
employees. Therefore, even if the prices of
cars have remained same, still there will be
more number of people willing to buy the cars.
This will result in demand for higher quantities,
at the same price level. Therefore shifting the
curve to the right.
Note that the shift means that more cars will

be bought at every price point.
When there are changes in factors other than

the good’s own price, which affects the quantity purchased, we refer to these changes as
shifts in demand. Demand increases when the quantity demanded at each price point
increases, and vice versa.
5.3 Supply Analysis
The supply side of a market typically involves the terms on which businesses willing to
produce and sell their products. The supply of tomatoes tells us the quantity of tomatoes
that will be sold at each tomato price point.
Forces behind the Supply Curve
In examining the forces determining the supply curve, the fundamental point to grasp is that
producers supply commodities for profit and not for fun or charity. One major element
underlying the supply curve is the cost of production. When production costs for a good are
low relative to the market price, it is profitable for producers to supply a great deal of that
good. When production costs are high relative to price, firms produce a little of that good, or
switch to the production of other products, or may simply go out of business.
Production costs are primarily

determined by the prices of inputs
and technological advances. The
prices of inputs and technological
advances. The prices of inputs
such as labor, energy, or
machinery obviously have a very
important influence on the cost of
producing a given level of output.
An equally important determinant

of production costs is
technological advances, which
consists of changes that lower the
quantity of inputs needed to
produce the same quantity of
output. Such advances include
everything from scientific
breakthroughs to better
application of existing technology
or simply reorganization of the
flow of work, which ultimately reduces the net cost of production. These advances enable
the car makers to produce more automobiles at the same selling price (because their profit
margin has increased).
The supply is also influenced by the prices of related goods, particularly goods that are
alternative outputs of the production process or the infrastructure. If the prices of one
production option rises, the production of another option will decrease. For example, if the
prices of onion rises, then farmers will divert a part of their land which is used for producing
tomatoes to onion crop. Similarly, auto companies typically make several different car
models in the same factory. If there’s more demand for one specific model, and if its profit
margin is better than other models, then they will switch more of their assembly lines to
making that specific model, and the supply of other models will decrease. Similarly, if the
demand and price of trucks rises, the entire factory can be converted for making trucks, and
the supply of cars can be decreased, reduced or outsourced.
Government policy also has an important impact on the supply curve. Environmental and
health consideration determine what technologies can be used, while taxes and minimum-
wage laws can significantly raise input prices. Governments’ trade policies have a major
impact upon supply. For instance, when a free-trade agreement opens up the Indian market
to Bangladeshi textile mills, the total supply of clothing in the India increases.
Shifts in Supply
When changes in factors other

than a good’s own price affect the
quantity supplied, we call these
changes as shifts in supply.
If the introduction of a cost-saving

computerized design and
automated manufacturing
reduces the labor required to
produce cars, or if autoworkers
take a pay cut to beat recession,
the supply increases at the same
price level.
Similarly, when genetically

engineered cotton variety BT
Cotton was introduced in India,
the crop loss because of pest
attacks almost ceased, and the
yield substantially increased and
consequently increasing the
cotton supply at the same price point.
Similarly, if there were lower production costs in Japan, or if Indian government repeals
certain environmental regulations on emissions, the supply of automobiles in India at each
price point will automatically increase.
5.4 Equilibrium of Supply And Demand
The supply and demand continuously interact with each other to produce an equilibrium
price and equilibrium quantity, or attain a market equilibrium. The market equilibrium comes
at that price and quantity where the forces of supply and demand are in balance. At the
equilibrium price, the amount that buyers want to buy is just equal to the amount that sellers
want to sell. The reason we call this
level as equilibrium price is because,
when the forces of supply and
demand are in balance, there is no
reason for the prices to rise or fall, as
long as other things remain
unchanged.
A market equilibrium comes at the

price at which quantity demanded
equals quantity supplied. At that
equilibrium, there is no tendency for
the price to rise or fall. The
equilibrium price is also called the
market-clearing price, because the
entire quantity available for sale is
bought over by the buyers.
Effects of a Shift in Supply or Demand
The analysis of the supply-and-demand

can do much more than tell us about
the equilibrium price and quantity. It can
also be used to predict the impact of
changes in economic conditions on
prices and quantities.
As mentioned earlier, the

implementation of Seventh Pay
Commission recommendations is going
to substantially increase the salaries of
government employees. Additionally,
they will be getting substantial sums as
arrears from January 2016. They will go
to the market with this extra cash for
buying cars, air conditioners and
houses. This is going to boost the
demand of almost everything, and shift
the demand curve to the right.
Therefore, at every price point, higher
quantities will be demanded.
Now the supply curve, which has remained unchanged, will start interacting with the new
demand curve, which has shifted to the right, to arrive at the equilibrium price. This will
result in an equilibrium price, which will be at higher prices and also at higher quantities.
Similarly, suppose a spell of bad weather or drought destroys the crop of wheat. This
situation suddenly shrinks the supply of wheat to the market, even though the prices remain
same. Therefore, at the same price point, lower quantity is supplied to the market. That will
shift the supply curve of wheat to the left.
Now the demand curve which has remained
unchanged, will start interacting with the new
supply curve, which has shifted to the left, to
arrive at the equilibrium price. This will result in
an equilibrium price, which will be at higher
prices, but at lower quantities.
The price continues to rise until, at the new

equilibrium price, the quantity demanded and the
quantity supplied are once again equal. Thus a
bad harvest (or any leftward shift of the supply
curve) raises prices and also lowers the quantity
demanded.
Suppose that new banking technology lowers the

costs of operations for the banks, what should
happen to the prices of houses or the cars? As the costs of operation of the banks come
down, they would be willing to extend higher credit at the same interest rates. This will shift
the supply curve to the right, pushing the interest rates lower.
Now the lower interest rates will start attracting the home buyers for borrowing, even though
the prices of houses have remained unchanged. This scenario will shift the demand curve
of the houses to the right. This shifted demand curve will interact with the supply curve to
arrive at the new equilibrium, which will be at higher price level and also higher sale of
houses.
Therefore, lowering of interest rates will increase the prices of cars, houses, education and
almost everything for which people borrow money.
Why the equilibrium prices are lower, when demand curve shifts to the left or the supply
curve shifts to the right, and why the equilibrium quantities are lower or higher respectively?
We can also use our supply-and-demand apparatus to examine how changes in demand
affect the market equilibrium. Suppose that there is a sharp increase in family incomes, so
everyone wants to buy iconic smartphones. This is represented as a “demand shift” in
which, at every price, consumers demand a higher quantities of smartphones. The demand
shift produces a shortage of those smartphones at the old price. A scramble for those
phones ensues, with long lines at the stores of those phones. Prices are bid upward until
supply and demand come back into balance at a higher price.
For both examples of shifts, a shift in supply and a shift in demand, a variable underlying
the demand or supply curve has changed. In the case of supply, there might have been a
change in technology, or input prices of raw materials or may be cheaper Chinese labor (if
production is shifted to China). For the demand shift to happen, one of the factors affecting
consumer demand, either income, or the population, or the prices of related goods, or
tastes may have changed and thereby shifted the demand schedule.
Therefore, when the elements of underlying demand or supply change, a shifts in demand
or supply curves happen, and a new market equilibrium of price and quantity is established.
Interpreting changes in Price and Quantity
Suppose that you go to the store and see that the price of bread has doubled. Does the
increase in price mean that the demand for bread has risen, or does it mean that bread has
become more expensive or uneconomical to produce?
Economist face these questions whenever the price changes happen. They have to find
out, whether the situation reflects a change on the supply side or the demand side.
Sometimes, especially in simple situations, looking at the prices and quantities
simultaneously, gives you a clue about whether it’s the supply curve that has shifted or the
demand curve. For example, a rise in the prices of bread accompanied by a decrease in
quantities sold, suggests that the supply curve has shifted to the left (a decrease in supply).
A rise in prices accompanied by an increase in quantities sold indicates that the demand
curve for bread has probably shifted to the right (an increase in demand).
Rationing By Prices
Let us now take stock of what the market mechanism accomplishes. By determining the
equilibrium prices and quantities, the market allocates or rations out the scarce goods of the
society among the best bidders for various possible uses.
Who does the rationing? Planning commission? Parliament? The Prime Minister? No! The
marketplace, through its continual interaction of supply and demand schedules, does the
rationing. This is rationing by purse - that is, the highest bidder will have the first claim on
that good or service. The richer will be able to have almost everything, the money can buy,
and the poorer will have to opt for substitution, or reduced consumption, or go on social
welfare (LPG, Kerosene subsidy in India)
What goods are produced? This question is best answered by the signals from the market
prices. High oil prices stimulates oil production, whereas low wheat prices drive productive
resources out of wheat production. Those who have the most rupee votes have the highest
influence on what goods are produced or not produced.
For whom are goods produced? The power of the purse dictates the distribution of incomes
and consumptions. Those with higher incomes end up with larger houses, better clothing,
and exotic vacations. When backed up by cash, the most urgently felt needs get fulfilled
through the demand curve.
5.5 Elasticity of Demand
The Price Elasticity of Demand (sometimes simply called price elasticity) measures how
much the quantity demanded of a good changes when its price changes. The precise
definition of price elasticity is the percentage change in quantity demanded divided by the
percentage change in price.
Goods vary enormously in their price elasticity, or sensitivity to price changes. When the
price elasticity of a good is high, we say that the good has “elastic” demand, which means
that its quantity demanded responds greatly to price changes. When the price elasticity of a
good is low, it is “inelastic” and its quantity demanded responds little to price changes.
For necessities like food, fuel, shoes and prescription drugs demands tend to be inelastic,
because people have to buy those goods, irrespective of what the price is. Such items
cannot be forgone easily when their prices rise. By contrast, you can easily substitute with
other goods, when prices of luxury goods like iPhone 7, Pepe Jeans, and Parker Pens rise
in prices.
Goods that have ready substitutes tend to have more elastic demand than those that have
few substitutes. When wheat for example becomes expensive, people might opt for a little
cheaper variety of wheat, instead of shifting to Jowar or Bajra.
The length of time that people have to respond to price changes, also plays a key role in
determining the elasticity. But in the long run, however, you might adjust your behavior to
the higher prices of, for example petrol. Here you can buy a smaller and more fuel-efficient
car, ride a bicycle, take the train, move closer to work, or carpool with other people.
Economic factors determine the magnitude of price elasticity for individual goods. Elasticity
tends to be higher for luxury goods, and for goods where substitutes are available, or when
consumers have more time to adjust their behavior.
Elasticity and Revenue
Many businesses want to know whether raising prices will raise or lower revenues. This
question is of strategic importance for many businesses like airlines, TV channels, and
smartphones. They have to decide, whether it is worthwhile to raise prices and whether the
higher prices will be able to make up for lower demand, for maintaining the revenue targets.
1. When demand is price-inelastic, the quantity demanded more or less remains constant.
Therefore, a price increase increases total revenue (PxQ), and price decrease
decreases total revenue. Because people have to buy food items, whatever is the price.
2. When demand is price-elastic, a price increase decreases the quantity demanded, and
a price decrease increases the quantity demanded. This might change the revenue
(PxQ).
3. In the borderline case of unit-elastic demand, a price decrease leads to no change in
total revenue.
5.5 Price Elasticity of Supply
Of course, consumption is not the only thing that changes when prices go up or down.
Businesses also respond to price changes in their decisions about how much to produce
and at what price. Economists define the price elasticity of supply as the responsiveness of
the quantity supplied of a good to its market price. More precisely, the price elasticity of
supply is the percentage change in quantity supplied divided by the percentage change in
price.
What factors determine supply elasticity? The major factor influencing supply elasticity is
the ease with which production in the industry can be increased in response to prices. If all
inputs can be readily found at the going market prices, as is the case with textile industry,
then output can be vastly increased or decreased with increase or decrease in prices. This
would indicate that supply elasticity is relatively large in case of textiles. On the other hand,
if the production capacity is severely limited, as is the case for gold mining or oil extraction
or oil refining, then even in case of sharp increases in the prices of gold or petroleum, the
production cannot be vastly increased, indicating inelastic supply side.
Another important factor in supply elasticities is the time period under consideration. A
given change in price tends to have a larger effect on the quantities supplied, as the time
for suppliers to respond to price rise increases. For very short immediate period after the
price rise, the firms may not be able to increase their input factors like, labor, raw material,
machinery, plant & buildings, and may be capital, therefore the supply may get constrained
and become price inelastic for a shorter immediate period. However, as time passes, and
businesses can hire more labor, build new factories, find efficient methods and expand their
production capacity, the supply will increase, and the supply elasticities will become larger.
5.6 Impact of Tax on Price and Quantity
Why government imposes taxes is because it needs money (purchasing power) to meet the
expenses needed to run various government schemes, build roads, hospitals, schools and
colleges, and pay salaries of the government employees. Taxes enable the government to
collect money and meet the expenses.
Governments levies taxes on a wide variety of commodities, automobiles, soaps, clothing,

restaurants, cigarettes, alcohol, salaries and profits of the companies. Supply-and-demand
analysis can help us know, who is going to bear the real impact of the tax and how tax
change will affect the supply.
Many economists and environmentalists advocate much higher taxes on petrol and diesel
to suppress consumption and save the environment. They feel that higher taxes would curb
consumption, reduce pollution and restrict our import of crude oil.
The economists would like to know the ultimate effect of a change in tax on a particular
good on the demand-supply dynamics of that good. The ultimate economic effect means,
the real effect of the tax on the incomes of producers and consumers, and who actually
bears the burden of the tax rise.
It is quite possible that the burden of the tax is shifted forward to the consumers, if the retail
price of petrol goes up by the Rs 5 because of tax. If suppose consumers cut back their
petrol consumption because of this indirect price rise, the total revenue, that is PxQ, may
diminish, resulting in reduced tax collection instead of increasing it.
That is why, the actual impact of tax increases needs to be thoroughly assessed from the
supply-and-demand analysis before implementation.
Governments prefer to tax certain items like cigarettes, and alcohol to suppress their
consumption, as they are harmful to the health of people. Most of the people, who consume
these products, lose their health, and land up in government run hospitals for their
treatment, ultimately increasing the expenses of the government. The government levies
higher tax on these items to make the originator to indirectly pay for the consequences of
consuming certain products.
Similarly, governments levy higher taxes on automobiles, to suppress the consumption of

petrol and diesel to protect the environment. But, during adverse periods like recessions,
the governments might reduce the excise duties on automobiles to increase their sale to
stimulate the employment scenario to turn the economic cycle.
5.7 Importance of economics in Marine Engineering study
Baltic Dry Index
The Baltic Dry Index (BDI) is a number issued daily by the London-based Baltic Exchange.
It is not restricted to Baltic Sea countries, but the Index tracks worldwide international
shipping prices of various dry bulk cargoes.
The index provides an assessment of the prices of transporting major raw materials by sea.
It takes into account 26 major shipping routes for ships plied on a time charter as well as on
voyage basis, covering Handymax, Panamax, and Capesize dry bulk carriers, for carrying a
range of dry commodities including coal, iron ore and grain.
How it works
Every working day, the Baltic Exchange seeks from the brokers around the world, the
information on how much it would cost to book various types of cargoes on various routes
(for example, how much it would cost for transporting 1,00,000 tons of iron ore from New
York to Hong Kong, or 10,00,000 tons of rice from Bangkok to London).
The index is made up of an average of the Baltic Supramax, Panamax, and Capesize
indices. These indices are based on professional assessments made by a panel of
international shipbroking companies.
The BDI factors in the four different sizes of oceangoing dry bulk transport vessels.
Ship Classification Dead % of % of Dry

Weight World Bulk
Tons Fleet Traffic
Capesize
Big ships, which have to circumnavigate Cape of Good
100,000+ 10% 62%
Hope in South Africa. They can’t pass through
Panama canal because of their extra width.
Panamax
60,000-
Narrower ships, which can pass through Panama 19% 20%
80,000
canal.
45,000-
Supramax 37%
59,000
18%
15,000-
Handysize 34%
35,000
The BDI is based on US dollars, therefore it also gets influenced by changes in the value of
the US dollar. The index can be accessed on a subscription basis directly from the Baltic
Exchange as well as from major financial information and news services such as Reuters
and Bloomberg.
Why economists and stock markets read it?
Most directly, the index measures the demand for shipping capacity versus the supply of
dry bulk carriers. The demand for shipping varies with the amount of cargo that is being
traded or moved in various markets. During recessions, the demand for cargo would be
lower. This would in turn affect the demand for carriers. Therefore, during recessions the
freight rates will go down and during booms they will go up. The Baltic Dry Index will move
up or down accordingly.
During recessions old and inefficient ships are scrapped. As the business goes down, the
revenue (cash) stream of the shipping companies dries down. Many shipping companies go
bankrupt and close down. Under these circumstances, a few shipping companies resort to
selling their excess vessels to generate cash for running their day-to-day businesses. As
more and more ships come to the market to be sold off, their prices too start sliding down
because of the demand and supply mismatch. The shipping companies with healthy
balance sheets, will see this as an opportunity, and buy good ships at dirt cheap rates.
Their this strategy ensures healthy profit margins and good return on investment.
2005 to 2009
2009 to 2016
The supply of cargo ships is generally both tight and inelastic, because it takes at least two
years to build new ships, and ships are too expensive to take out of circulation, if the
demand drops, because there is no place to berth them at the ports and even if they are
available, they will not be free of cost for the shipping companies. Airlines can park
unneeded jets in the deserts, but ships have to be parked near ports. So marginal
increases in demand can push the index higher quickly, and marginal demand decreases
can cause the index to fall rapidly. e.g. "if you have 100 ships competing for 99 cargoes,
rates go down, whereas if you've 99 ships competing for 100 cargoes, rates go up. In other
words, small fleet changes and logistical matters can crash rates..." The index indirectly
measures global supply and demand for the commodities shipped aboard dry bulk carriers,
such as cement, coal, metallic ores, steel, and grains.
Because dry bulk primarily consists of primary materials that function as raw
material inputs to the production of intermediate or finished goods, such as
concrete, electricity, steel, and food, the index is also seen as an efficient economic
indicator of future economic growth and production. The BDI is termed a leading
economic indicator because it predicts future economic activity.
Because it provides an assessment of the price of moving the major raw materials by sea, it
provides both a rare window into the highly opaque shipping market and an accurate
barometer of the volume of global trade, without any political interference.
Another index, the HARPEX, focuses on containers freight. It provides an insight on the
transport of a much wider base of containerized commercial goods.
Impact of 2008 financial crisis
On 20th May 2008 the index reached its record high level since its introduction in 1985,
reaching 11,793 points, but half a year later, on 5th Dec 2008, the index had dropped by
94%, to 663 points, the lowest since 1986. What this means is, if you had sent a parcel on
20th May 2008, it would have cost you $ 11793, but the same parcel sent to the same place,
could be sent at $ 663 on 5th Dec 2008. 94% cheaper. These low rates moved dangerously
close to the combined operating costs of vessels, fuel, and crews.
At these levels it was impossible for many shipping companies to recover their cost of
operation. This, combined with the collapsing price of raw commodities (forcing them also
into losses) created a perfect storm for the world's maritime commerce.
By January 30, 2010 it had recovered to 2848, a level that was considered as more
reasonable at that point of time.
As on 28th July 2016, the index was at 679. It has recovered to this level after touching a
low of 290 on 10th of Feb 2016. That is 96% below the peak level, which was seen almost 8
years back.
Following report, which appeared in The Shipping Herald on 1st June 2016 gives us the
present scenario
Mothballed ships in SE Asia show pain inflicted by oil slump
Not everyone in shipping is bemoaning the industry’s worst crisis in living memory: a cluster
of companies that help preserve equipment and provide security for vessels parked around
Southeast Asia are busier than they have been for years.
A popular lay-up anchorage near Indonesia’s Batam Island, a short hop from Singapore, is
growing crowded, and firms such as Ocean Ship care and Brubay Ship care are running out
of space at another at Brunei Bay, near Labuan, off northern Borneo.
“Where do we go next? It’s a good question, because we are trying to explore some other
areas also,” said Kanen Senasendram, base manager at Ocean Ship care, which operates
in Brunei Bay. He says he may need to hire more staff.
The industry is battling chronic oversupply, languishing oil prices and lackluster container
shipments as China’s weaker growth weighs on global trade.
And the worst is yet to come this year, as large deliveries loom of vessels – such as those
that tow oil rigs or ships that service drilling units – ordered during boom times in 2013-
2014.
Wilhelmsen Ship Management, part of Norwegian-based global shipping and logistics

group Wilhelmsen Holding ASA, said it has about 60 ships in its lay-up care in Brunei Bay,
the highest since the depths of the global financial crisis in 2009.
“This is the busiest I have seen the lay-up industry for a long time, probably since at least
1993,” said Phil Shearer, managing director of shipping services firm Marine Assurance.
“1993 was bad, but the container and bulk markets were not down.”
OIL GLUT
Soaring output has left global oil markets awash with crude, causing traffic jams of tankers
at ports in the Middle East, China and global storage hub Singapore, as buyers take
advantage of cheap fuel.
But the glut has also driven oil prices down by up to 70 percent since 2014, making deep-
water drilling unprofitable and prompting companies to cut back drastically on new
exploration.
That has sharply reduced demand for offshore vessels such as drill ships, and also for oil
rigs.
While some are stacking up in anchorages around the North Sea, West Africa and the
United States, the biggest lay-up hub is in Southeast Asian waters around Singapore, a
location free from cyclonic storms due to its proximity to the equator.
About 1,300 offshore support vessels are lying idle worldwide, among them about 600
platform supply vessels (PSVs) and anchor handling tug supply vessels (AHTS), Lee Keng
Lin, chief operating officer at PACC Offshore Services Holdings (POSH) told Reuters.
Most of the ships clogging these maritime parking lots are in so-called cold lay-up,
meaning they are basically shut down and their crew signed off – a tacit admission from the
owners that they do not expect any work for them for at least a year.
For companies with strong balance sheets the market turmoil represents an opportunity to
replace old fleets cheaply, Marine Assurance’s Shearer said.
STACK OR SCRAP?
“Cold stacked” vessels still require maintenance – from dehumidifying interiors and
greasing exposed metal to putting security guards on board.
But for certain offshore support vessels (OSVs) that can cost up to $9,000-a-day to operate,
ship management company Thome Group estimates running costs can be cut by 80
percent.
Currently 5,480 such vessels are in operation, totaling 10.1 million deadweight tons
according to Clarkson, the British shipping services firm. Another 450 vessels, equivalent to
12.5 percent of the current fleet in tonnage are on order, with the majority set for delivery
this year.
At the same time, charter rates are tumbling, hitting companies such as POSH and Pacific
Radiance. Average charter rates for a large anchor handling OSV are down to about
$16,000 per day, less than half the level in 2014, Clarkson data showed.
“The problem is the oversupply. There is a lot of old tonnage out there. And what has to
happen is – people need to scrap,” said Phillip Chamberlain, chief operating officer at
Thome Offshore Management.
But that is easier said than done, as there is very little scrap value in OSVs. A medium-
sized OSV could yield around 2,000 tons of scrap metal, compared with 42,000 tons for a
very large crude carrier (VLCC) – a difference of between $500,000 and $11 million based
on current scrap prices, shipping data showed.
Crude prices have rebounded about 85 percent since hitting 12-year lows of around $27 a
barrel in the first quarter, supported by falling U.S. production, and climbed above $50 a
barrel last week for the first time in 2016.
That could bring some offshore vessels back into service. A recovery in oil prices to $65-70
a barrel would start to reactivate idled vessels, said shipbroker Banchero Costa.
Still prices remain less than half their level in mid-2014 and world oil supply remains in a
glut.
For now, Ocean Ship care’s Senasendram is requesting the authorities for more space to
stack ships.
“Most of the owners know that Brunei Bay is full. But some owners still send enquiries, for
them we have to say: sorry. They have to find other places.”
6. Production function, Law of return, Economics of scale
6.1 Isoquant and Isocost curves

An isoquant is a curve that shows all the combinations of inputs that yield the same level of
output. ‘Iso’ means equal and ‘quant’ means quantity. Therefore, an isoquant represents a
constant quantity of output. The isoquant curve is also known as an “Equal Product Curve”
or “Production Indifference Curve” or Iso-Product Curve” Or “constant production curve”.
Isoquant indicates various combinations of two factors of production which give the same
level of output. The assumption behind the factors of productive resources is that, any two
factors are substitutable e.g. labor is substitutable for capital and vice versa. But, in reality
no two factors are perfect substitutes of each other. This indicates that one factor can be
used a little more and the other factor a little less, without changing the level of output.
Example of an Isoquant Schedule
Combinations of Labor and Units of Labor Units of Capital Output of Cloth

Capital (L) (K) (meters)
A 5 9 100
B 10 6 100
C 15 4 100
D 20 3 100
The above table is based on the

assumption that only two factors of
production, namely, Labor and
Capital are used for producing 100
meters of cloth.
Combination A = 5L + 9K = 100
meters of cloth
Combination B = 10L + 6K = 100

meters of cloth
Combination C = 15L + 4K = 100

meters of cloth
Combination D = 20L + 3K = 100

meters of cloth
The combinations A, B, C and D show the possibility of producing 100 meters of cloth by
applying various combinations of labor and capital. Thus, an isoquant schedule is a
schedule of different combinations of factors of production yielding the same quantity of
output.
An iso-product curve is a graphical representation of various combinations of inputs say

labor (L) and capital (K) which give an equal level of output per unit of time. Output
produced by different combinations of L and K is say, Q, then Q=f (L, K)
Thus, an isoquant is a curve showing all combinations of labor and capital that can be used
to produce a given quantity of output.
Isoquant Map
An isoquant map is a set of

isoquants that shows the
maximum attainable output from
any given combination inputs.
Properties of Isoquants
1. An isoquant lying above and to the

right of another isoquant represents a
higher level of output. This is because of
the fact that on the higher isoquant, we
have either more units of one factor of
production or more units of both the
factors. In this figure points A and B lie
on the isoquant IQ1 and IQ2
respectively.
At point A we have = OX1 units of Labor

and OY1 units of capital.
At point B we have = OX2 units of Labor

and OY1 units of capital.
Though the amount of capital (OY1) is the same at both the points, point B is having X1X2
units of labor more. Therefore, it will
yield a higher output.
2. Two isoquants cannot intersect each

other - If they intersect each other,
there would be a contradiction and we
will get inconsistent results. This can
be understood with the help of this
figure.
3. No isoquant can touch either of the axes -
If an isoquant touches the X-axis it would
mean that the commodity can be produced
with OL units of labor and without any unit of
capital.
Point K on the Y-axis implies that the

commodity can be produced with OK units
of capital and without any unit of labor.
However, this is wrong because the firm
cannot produce a commodity with one factor
alone.
4. Isoquants need not be parallel -

The shape of an isoquant depends
upon the marginal rate of technical
substitution. Since the rate of
substitution between two factors need
not necessarily be the same in all the
isoquant schedules, they need not be
parallel.
The segment P1S1 is the

economically feasible portion
of the isoquant for IQ. If we
consider the feasible portions
for all isoquants, then the
region comprising of these
portions is called the
economically feasible region of
production. A producer will
always try to operate in this
region. The lines OP1P2 and
OS1S2 are called ridge lines.
They give the boundary of the
economically feasible region of
production. The businesses
should operate within these
ridge lines to run their businesses profitably.
Isocost Curves
Isocost means constant cost curves. In economics an isocost line shows all combinations of
inputs which cost the same total amount. Although it is similar to budget constraint, the use
of isocost line is for cost-minimization in production, instead of utility-maximization. For
example, two production inputs, labor and capital, with fixed unit costs of inputs, the
equation of isocost line is
rK+wL=C
Where w is the wage rate, r is the

rental (interest) rate of capital, K
is the amount of capital used, L is
the amount of labor used, and C
is the total cost of utilizing those
inputs in those quantities.
The absolute slope of the isocost

line equals the ratio of unit costs
of labor and capital. The slope is:
−w/r
The isocost line is combined with the isoquant map to determine the optimal production
point at any given level of output. The point of tangency between any isoquant and an
isocost line gives the lowest-cost combination of inputs that can produce the level of output
associated with that isoquant. That is, it gives the maximum level of output that can be
produced for a given total cost of inputs. A line joining tangency points of isoquants and
isocosts (with input prices held constant) is called the expansion path.
Least Cost Factor Combination or Optimal Combination of Inputs
The firms can achieve maximum

profits by choosing that combination
of factors which will cost it them the
least. The choice is based on the
prices of factors of production at a
particular time. The firm can maximize
its profits either by maximizing the
level of output for a given cost or by
minimizing the cost of producing a
given output. In both cases the factors
will have to be employed in optimal
combination at which the cost of
production will be minimum. The least
cost factor combination can be
determined by imposing the isoquant
map on isocost line. The point of
tangency between the isocost and an
isoquant is an important but not a necessary condition for producer’s equilibrium. The
essential condition is that the slope of the isocost line must equal the slope of the isoquant.
Thus at a point of equilibrium, the marginal physical productivities of the two factors must
be equal to the ratio of their prices. The isoquant must be convex to the origin.
If all points of tangency of
various isoquants are
connected by a straight line,
the line is known as the
expansion path or a price
factor curve of a firm. It is
the locus of points of
producer’s equilibrium
resulting from changes in
total outlays while keeping
factor prices constant. It
shows how the proportions
of the two factors used
might be changed as the
firm expands.
A relative cheapening of one of the factors compared to that of another will extend the
isocost line to the right. If one of the factors becomes relatively dearer, the isocost line will
contract inward to the left. If the relative price of labor falls, the isocost line EF in Panel will
extend to the right as EG and if it rises, the isocost line EF will contract inward to the left as
EH. If the equilibrium points L, M, and N are joined by a line, the resulting curve is called as
the price-factor curve.
The Principle of Marginal Rate of Technical Substitution
The principle of marginal rate of technical substitution (MRTS) is based on the production
function where two factors can be substituted in variable proportions in such a way as to
produce a constant level of output.
The marginal rate of technical substitution between two factors С (capital) and L (labor), is
the rate at which L can be substituted for С in the production of good X without changing
the quantity of output. As we move along an isoquant downward to the right, each point on
it represents the substitution of labor for capital.
MRTS is the loss of certain units of capital which will

just be compensated for by additional units of labor at
that point. In other words, the marginal rate of
technical substitution of labor for capital is the slope
or gradient of the isoquant at that point. The marginal
rate of technical substitution is AS/SB, at point G, it is
BT/TG and at H, it is GR/ RH.
The Laws of Returns to Scale
The laws of returns to scale refer to the effects of a

change in the scale of factors (inputs) upon output in
the long-run, when the combinations of factors are
changed in same proportion. If by increasing two
factors, say labor and capital, in the same proportion, the output increases in exactly the
same proportion, then there are constant returns to scale. For example, 10% rise in
consumption of both factors, increases the output by 10%. If in order to secure equal
increases in output, both factors are increased in larger proportionate units, there are
decreasing returns to scale. For example, 15% rise in consumption of both factors,
increases the output by 10%. If in order to get equal increases in output, both factors are
increased in smaller proportionate units, there are increasing returns to scale. For example,
10% rise in consumption of both factors, increases the output by 15%.
The returns to scale can be shown diagrammatically on an expansion path “by the distance
between successive ‘multiple-level-of-output’ isoquants, that is, isoquants that show levels
of output which are multiples of some base level of output, e.g., 100, 200, 300, etc.”
Returns to a factor
Returns to a factor relates to the short period production function when one factor is varied
while keeping the other factor fixed, in order to have a higher output. For example, if capital
remains constant and labor rises by 10% for resulting in 5% rise in output. This shows that
the marginal returns of the variable factor, labor, has diminished. On the other hand, returns
to scale relate to the long period production function when a firm changes its scale of
production by changing one or more of its factors.
For profit maximization firms faces two choices of optimal combination of factors (inputs).
First, to minimize its cost for a given output; and second, to maximize its output for a given
cost. Thus the least cost combination of factors refers to a firm producing the largest
volume of output from a given cost and producing a given level of output with the minimum
cost when the factors are combined in an optimum manner.
The Law Of Diminishing Returns
The law of diminishing returns says that we will get less and less extra output when we add
additional doses of input while holding other inputs fixed. In other words, the marginal
product of each unit of input will decline as the amount of that input increases, holding all
other inputs constant.
The law of diminishing returns expresses a very basic relationship. As more of an input,
such as labor is added to a fixed amount of land, machinery, and other inputs, the labor has
less and less of the other factors to work with. The land gets more crowded, the machinery
is overworked, and the marginal product of labor declines.
Diminishing returns are a key factor in explaining why many countries in Asia are so poor.
Living standards in crowded India or Bangladesh are low because there are so many
workers per acre of land and not because farmers are ignorant or fail to respond to
economic incentives.
6.2 The Concept of cost
The outflow of money is called cost.
In order to understand the meaning of cost let us take the example of a farmer who is
producing paddy (rice). You know that, it normally takes 5 to 6 months to produce paddy.
The production of paddy involves the following:
a. Getting the land for cultivation

b. Using labor to prepare the land and make it suitable for growing the crop. This includes
ploughing the land, sowing seeds, fertilizing and irrigating, harvesting, and finally
winnowing.
c. Send paddy to milling.
d. Transporting rice to godowns and mandis.
How does the farmer get the land? It may be his ancestral land, or he might take the land
on rent, or he might buy it. Suppose, he hires 5 acres of land at Rs. 5,000 rent for the entire
period of his use.
The farmer also needs laborers to work on the field for 5 months. Let us say the he hires 4
laborers. In the first two months he uses the laborers to plough the land, sow seeds,
transporting the saplings and transplanting them by hand, fertilizing and irrigating the field.
The wage rate prevailing in the market on an average is say, Rs. 75 per worker per day.
The farmer uses only two laborers for two months to look after the standing crop. When the
time of harvesting arrives, he again hires 4 laborers for 15 days. What is the total amount
paid to the laborers by the farmer?
First, 4 laborers work for two months or sixty days. So at Rs. 75 per worker it comes to 75 ×
4 × 60 = Rs.18,000. Then two laborers work for two months. This comes to 75 × 2 × 60 =
Rs.9000. Finally 4 laborers worked for 15 days. This comes out to be 75 × 4 × 15 =
Rs.4,500. The total money paid to the laborers was 18,000 + 9,000 + 4.500 = Rs.31,500
To grow the crop, the farmer uses some raw materials such as seeds, water, fertilizer,
pesticides etc. for which he spends, say, Rs. 3,000. He also uses tractor for which he pays
rent of Rs. 2500. After harvesting the farmer produces, say, 30 quintals of rice.
Now, calculate the total money spent by the farmer to produce rice? We can do it in the
following manner.
Items Expenditure
(Rs.)
Rent paid to Landlord 5,000
Wages to labor 31,500
Raw materials 3,000
Service of Tractor 2,500
Total 42,000
We can say that, the farmer spent Rs.42,000 to produce 30 quintals of rice.
Definition of Cost
Cost is defined as the money spent by the producer to purchase (or hire) factors of
production and raw materials to produce goods and services.
The expenditure, which has been considered above, is basically the actual cash out-goes
for purchasing the factors of production and raw materials. This much money is directly
spent by the farmer for producing 30 quintals of rice. Therefore, Rs. 42000 is his direct
expenditure.
Additionally, he is spending a considerable amount of his time on his farm, a few of his
family members too are helping him in managing of the farm. He would have to give a
salary to these people, if he had hired them from outside. Secondly, suppose the land was
owned by the farmer. He would otherwise have to give rent for hiring the same plot of
agricultural land. All these expenditures are called indirect expenditures.
The costs can be grouped together in following four headings.

a. Fixed cost
b. Variable cost
c. Explicit cost
d. Implicit cost
a. Fixed Cost
Once the land is obtained for cultivation, the farmer must pay rent for it, irrespective of
whether he’s producing anything on it or not. Therefore, whether or not the farmer cultivates
on the entire 5 acres of land, or the part of it, or doesn’t cultivate there at all, he has to pay
rent for the entire 5 acres of land. Therefore, the expenditure done on land is fixed in
nature. Hence, the land is a fixed factor of production here.
Therefore, fixed cost is defined as the expenditure, on hiring or purchasing fixed factors of
production or inputs, which are mandatory in nature and which has nothing to do with the
level of production of goods or services, is called a fixed cost. Similarly, rent paid for the
use of a tractor may also be a fixed cost, if he’s hiring it on a time charter.
b. Variable Cost
In the above example, the farmer paid Rs. 31,500 towards wages for laborers and Rs.3000
for purchase of raw materials. How much wages are paid depends on how many laborers
are hired. Labor as a factor of production, can be varied in response to the need. In this
example, we used 4 laborers in first two months and 2 for the next two months, because in
the beginning the amount of work was more and more laborers were needed. Accordingly
more amount of money, i.e. Rs.18000, was spent. But when the amount of work was less
during the next two months, only 2 laborers were hired and accordingly the wage bill
decreased to Rs.9000.
Hence, payment towards wages can be varied depending on the requirement. Therefore it
is a variable cost. We can define variable cost as the expenditure done on the variable
factors of production or inputs.
c. Explicit Cost
Both the rent and wages paid by the farmer and the expenditure done on raw materials are
called explicit costs. Explicit cost is defined as the money actually spent on both fixed and
variable factors of production and raw materials. These are actual payments and are
systematically calculated and recorded separately. Bills, receipts and vouchers exist with
respect to such expenditures.
d. Implicit Cost
Besides purchasing factors of production and raw materials, the producer also uses his own
factors and materials for producing goods and services. For this he does not pay any
money to himself. But he bears this expenditure indirectly.
Similarly, if a farmer uses his own tractor to plough the land. If he had hired the tractor from
somebody else, he would have to pay rent for this. In that case it would have become
explicit cost of the farmer. Let us say the rent for using the services of a tractor is Rs. 3000
for a particular period of time. Therefore the farmer can earn Rs.3000 if he gives his tractor
on rent to others. But, if he uses it for himself, then he is consuming a production factor
worth Rs. 3000 for production of rice. Such a cost, where the expenditure is done indirectly,
is called an implicit cost of production. The economic value of such a factor is calculated on
the basis of market value of a comparable factor.
Total and Average Cost
Total cost is the sum of fixed cost and variable costs.
Therefore, Total Cost (TC) = Fixed Cost + Variable Cost
Average cost is the ratio of total cost to the total output.
Therefore, Average Cost (AC) = Total Cost / Total Output.
Average Cost is the cost per unit of output.
Marginal Cost (MC)
If the producer wants to increase output, then he has to engage extra units of labor. And
extra units of labor will incur extra expenditure on wages paid to the laborers. As a result
the total cost of production will increase.
Therefore, the increase in total output will happen with increase in total cost of production.
Therefore, marginal cost is the increase in the total cost of production for increasing the
production by one extra unit of the output.
Comparing Marginal Cost and Average Cost
Average cost is per unit cost of the entire output, whereas marginal cost is additional cost
for producing one extra unit of the output.
6.3 The concept of revenue
The inflow of money is called revenue.
Revenue is defined as the amount a person receives by selling a certain quantity of the
commodity during the period under review. e.g. quarterly or annual revenue.
The revenue is calculated by multiplying the price and quantity of the commodity sold
during the period under review.
Therefore, Revenue = Price of the Commodity × Quantity of the Commodity sold
Total Revenue TR = Price P × Quantity Q
The farmer produced 30 quintals of rice. Let us assume that the selling price of rice is Rs.
1600 per quintal in the market. When the farmer sells all his rice, then he will earn 1600 ×
30 = Rs. 48,000 as revenue.
Another term used for revenue is ‘sales proceeds’ or simply ‘Sales’.
You must remember that each and every commodity has its own price. A retailer sells
different commodities to many buyers. Therefore, his total revenue for a specific period will
be the total amount coming in due to the sale of all those commodities in that period.
Average Revenue (AR)
Average Revenue is the revenue per unit of the good sold.
Average Revenue AR = Total Revenue TR / Quantity sold Q
Average Revenue and Average Price of the commodity may be same for single commodity
companies.
Marginal Revenue (MR)
Marginal Revenue (MR) is defined as the increase in total revenue due to the increase of
one extra unit in the sale of the output. Average revenue and Marginal Revenue will be
same, if prices remain fixed. But if a company resorts to discounts for increasing the
revenue, then Marginal Revenue will diminish.
Therefore average revenue is calculated for the entire sale, whereas the marginal revenue
is calculated for one extra unit of sale.
Profit
Both revenue and cost are important concepts in economics. While cost is the expenditure
done (money outgo) to produce a good or service, the revenue is the money received
(money in-come) by selling that good or service.
Therefore, cost symbolizes sacrifice made by the producer and revenue symbolizes gains
for the producer. By getting the required revenue from sale of the commodity the producer
is able to recover the cost he has incurred on producing the output.
Therefore, the producer earns a profit, when his revenue exceeds his cost.
Therefore, profit is the surplus of revenue over the total cost of production.
Profit = Total Revenue – Total Cost.
Marginal Profit
The rise in profit for one unit extra sold over the existing sale is called marginal profit.
Therefore, Marginal Profit = Marginal Revenue – Marginal Cost
6.4 Cost-Output Relationship
A proper understanding of the nature and behavior of costs is a must for the regulation and
control of the cost of production. The cost of production depends on money forces and an
understanding of the functional relationship of cost to various forces will help us to take
various decisions. Output is an important factor, which influences the cost.
The cost-output relationship plays an important role in determining the optimum level of
production. Knowledge of the cost-output relation helps the manager in cost control,
anticipate profit, and decide the pricing and promotion strategies. The relationship between
cost and its determinants is described as the cost function.
C= f (S, O, P, T ….)
Where;
C= Cost (Unit or total cost)

S= Size of plant or scale of production
O= Output level
P= Prices of inputs
T= Technology
Considering the period under consideration, the cost function can be classified as
(1) short-run cost function and

(2) long-run cost function.
In economics theory, the short-run is defined as that period during which the physical
capacity of the firm remains fixed and the output can be increased only by overusing the
existing capacity.
6.5 Cost curves in the shorter period
The cost concepts used in the cost behavior are Total cost, Average cost, and Marginal
cost.
In the short-run there will not be any change in Fixed Cost. Hence changes in total cost
implies the changes in the Variable Cost only.
Total Total Average

Units of Total cost TC Average Average
fixed variable variable cost Marginal
Output = fixed cost AFC cost AC =
cost cost AVC cost MC
Q (TFC + TVC) = (TFC / Q) (TC/Q)
TFC TVC = (TVC / Q)
0 – – 60 – – – –
1 60 20 80 20 60 80 20
2 60 36 96 18 30 48 16
3 60 48 108 16 20 36 12
4 60 64 124 16 15 31 16
5 60 90 150 18 12 30 26
6 60 132 192 22 10 32 42
The above table represents the cost-output relationship. The table is prepared on the basis
of the law of diminishing marginal returns. The fixed cost Rs. 60 May include rent of factory
building, interest on capital, salaries of permanently employed staff, insurance etc. The
table shows that fixed cost is same at all levels of output but the average fixed cost, i.e., the
fixed cost per unit, falls continuously as the output increases. The expenditure on the
variable factors (TVC) is at different rate. If more and more units are produced with a given
physical capacity the AVC will fall initially, declining up to 3rd unit, remaining constant up to
4th unit and then rising. It implies that variable factors produce most efficiently around firm’s
optimum capacity than at any other level of output. This happens because machines start
getting overworked (needing frequent maintenance), and after all purchasing quantity
discounts are exhausted.
But the rise in AC is felt only after they start rising. In the table ‘AVC’ starts rising from the
5th unit onwards whereas the ‘AC’ starts rising from the 6th unit only. So long as the ‘AVC’
declines, ‘AC’ also declines and ‘AFC’ continues to fall with an increase in the Output. As
soon as the rise in ‘AVC’ becomes
more than the decline in ‘AFC’, the
total cost begins to rise.
Thus the table shows an

increasing returns or diminishing
cost in the first stage and
diminishing returns or diminishing
cost in the second stage and
followed by diminishing returns or
increasing cost in the third stage.
The short-run cost-output

relationship can be shown
graphically as per this graph.
In the above graph the “AFC’ curve continues to fall as output rises because of its spread
over more and more units of output. But AVC curve (i.e. variable cost per unit) first falls and
then rises due to the law of diminishing returns. The behavior of “ATC’ curve depends upon
the behavior of ‘AVC’ curve and ‘AFC’ curve. In the initial stage of production both ‘AVC’
and ‘AFC’ decline and hence ‘ATC’ also decline. But after a certain point ‘AVC’ starts rising.
If the rise in variable cost is less than the decline in fixed cost, ATC will still continue to
decline, otherwise ATC begins to rise. Thus the end of ‘ATC’ curve turns up and gives it a
U-shape. That is why ‘ATC’ curve are U-shaped. The lowest point in ‘ATC’ curve indicates
the least-cost combination of inputs. Where the total average cost is the minimum and
where the “MC’ curve intersects ‘AC’ curve, It is not be the maximum output level rather it is
the point where per unit cost of production will be at its lowest.
6.6 Cost curves in the longer period
Longer run is a period, during which all inputs are variable, including the fixed ones for the
shorter run. In the longer run a firm can change its output according to its demand. Over a
longer period, the size of the plant can be changed, unwanted buildings can be sold off, and
the staff strength can be increased or decreased. The longer run enables the firms to
expand the scale of their operation by installing, outsourcing or purchasing larger quantities
of all the inputs. Thus in the longer run, all factors of production become variable in nature.
The longer run cost-output relation, therefore implies the relationship between the total cost
and the total output. In the longer run cost-output relationship is influenced by the law of
returns to scale.
In the long run a firm has a number of options with respect to the scale of operations. For
each scale of production
or plant size, the firm has
an appropriate shorter run
average cost curve. The
short-run average cost
(SAC) curve applies to
only one plant whereas
the long-run average cost
(LAC) curve takes into
consideration many
plants.
The long-run cost-output

relationship is shown
graphically with the help
of “LCA’ curve.
To draw on ‘LAC’ curve we have to start with a number of ‘SAC’ curves. In the above figure
it is assumed that technologically there are only three sizes of plants – small, medium and
large, ‘SAC1’, for the small size, ‘SAC2’ for the medium size plant and ‘SAC3’ for the large
size plant. If the firm wants to produce ‘OP’ units of output, it will choose the smallest plant.
For an output beyond ‘OQ’ the firm wills optimum for medium size plant. It does not mean
that the OQ production is not possible with small plant. Rather it implies that cost of
production will be more with small plant compared to the medium plant.
For an output ‘OR’ the firm will choose the largest plant as the cost of production will be
more with medium plant. Thus the firm has a series of ‘SAC’ curves. The ‘LCA’ curve drawn
will be tangential to the entire family of ‘SAC’ curves i.e. the ‘LAC’ curve touches each
‘SAC’ curve at one point, and thus it is known as envelope curve. It is also known as
planning curve as it serves as guide to the entrepreneur in his planning to expand the
production in future. With the help of ‘LAC’ the firm determines the size of plant which yields
the lowest average cost of producing for a given volume of output it anticipates over a
longer period of its existance.
6.7 Determination of price under free markets
Prices are determined in a free market economy through the interactions of supply and
demand in the marketplace, where demand is the quantity of a product that buyers are
willing to purchase at a given price and supply is the quantity of a product that sellers can
sell to the buyers at a given price. Supply and demand are the important factors to consider
as stakeholders will always try to find the best allocation of their resources.
The laws of supply and demand are very simple. If all factors are equal, the higher a price is
for a good, the less willing the buyers will be to pay the price for that good and, therefore,
the smaller the quantity of the good will be demanded. Similarly, the higher a price is for a
good, the more willing the producer will be to produce that good and, therefore, the higher
the quantity of the good will be supplied.
The term free market economy primarily means a system where the buyers and sellers are
solely responsible for the choices they make. In a way, free market gives the absolute
power to prices to determine the allocation and distribution of goods and services. These
prices, in turn, are fixed by the forces of supply and demand of a respective commodity. In
cases of demand falling short of the supply of a respective commodity, the price will fall as
opposed to a price rise when the supply is inadequate to meet the growing demand of a
good or service. Free market economy is also characterized by free trade without any tariffs
or subsidies imposed by the government.
The role of the government of a nation is only limited to controlling the law and order of a
country and to ensure that a 'fair price' is charged by the sellers without any rigging or
cartelization. Therefore, the government, having no role in administering the price of a
commodity, has to ensure that the prices taken by the sellers is true and commensurate
with the one determined by the forces of demand and supply.
The basic feature of the free market economy is that only people with sufficient control over
resources and wealth, in have a privilege to purchase goods and services, often priced
higher in a free economy. Price, which is the only allocating and distributing factor in a free
market economy. Therefore, it
places the poor in a
disadvantageous position, who are
gradually thrown out of the system
without any access to the basic
needs for living.
Thus it deems absolutely imperative

that a country like India, having a
large number of poor, have a public
distribution system in place with
subsidized prices being fixed by the
government to take care of the poor.
Free market economy is considered
as the most efficient or optimum
mechanism to allocate the country’s
resources, with wealth or income as
the only yardstick. Free market
economy is often associated with a
Capitalistic Economy, which means
production by privately owned
enterprises.
6.8 Price control by governments
As explained earlier, the equilibrium price of a commodity is determined by the free play of
the forces of demand and supply of the commodity without any intervention of the
government. But sometimes the prices so determined are very high when there is a
shortage of some commodities in the market. In such situations some consumers cannot
afford to buy certain essential commodities due to their high prices. Therefore, in order to
protect the interest of its citizens, the government fixes the price of the commodity at a
lower level than that determined by the forces of demand and supply or the equilibrium
price.
In the same way when there is bumper crop of certain food grains, the price of food grains
are pushed to a lower level. At this price the farmers are unable to even recover their cost
of production. Therefore, the farmers get badly affected by heavy fall in prices. In such
cases the government fixes the prices of the food grains higher than the equilibrium price in
order to protect the interest of the farmers. This is called minimum support price, or MSP. If
no one is willing to buy the commodity at this price, the government buys the entire offered
quantity at MSP, and sells it through the fair price shops.
Therefore, sometimes the government does not allow the free play of the forces of demand
and supply for determination of the prices of certain commodities in order to protect the
interest of consumers or producers. Government can fix the price of the commodity either
below the equilibrium price or above the equilibrium price. Such a price is called
administered
price (Government determined price). Administered price may be in the form of:
o Control Price
In order to protect the interests of consumers government fixes the maximum price of
the commodity. This maximum price is generally lower than the equilibrium price. This is
called control price or ceiling price. This price is fixed by the government because poor
people cannot afford to buy the commodity at equilibrium price. This situation arises
when the production of a commodity is less than its demand. As the price of the
commodity fixed by the government is less than the equilibrium price, it may create
excess demand of the commodity which means the buyers are willing to buy more than
what the sellers are willing to sell at the fixed price. In India government has a control
price or ceiling price
Mechanism for certain commodities which it considers essential for the masses. For
examples some goods such as wheat, rice, sugar, kerosene oil etc. have a control price.
Due to excess demand for the commodity at ceiling price government resorts to
rationing of that commodity. Rationing means fixing of quota per head or per family per
month. This price fixed by government to safeguard the interests of the consumers, is
called the control price.
Due to excess demand of the commodity at ceiling price, the problem of black marketing
of that commodity may also arise. Black marketing is a situation in which the seller
illegally charges the price of the commodity which is much higher than the control price
to a buyer who is willing to pay higher for cornering extra quantity of the good, over and
above what has been allocated to him. The problem of black marketing can be solved
through dual price policy which will be discussed in the later part of this lesson.
o Support Price
Sometimes, in order to protect the interests of producers, especially farmers, the

government fixes the minimum price of the commodity which has to be paid to the
producers. This price is generally higher than the equilibrium price. This problem arises
when the producers do not cover even their cost of production at equilibrium price. This
price fixed by government to safeguard the interests of the producers, is called the
support price. It may create the situation of excess supply of the commodity. It means
the sellers are willing to produce more than what the buyers are willing to buy.
In India low price of food grains such as wheat, rice etc. adversely affects the farmers.
They may lose their interest in farming. This may result in acute shortage of food grains
in the country. Therefore, the system of support price is usually followed in case of
agricultural products. The system of support prices assures the farmers that they will be
able to sell their products at least at this price. In case of excess supply of the
commodity at support price government is ready to purchase any quantity of the
commodity to make buffer stock of the commodity.
o Token Price
There are some goods and services which are considered necessary for the existence
of life e.g. medical services, health services and education services. Poor people are
unable to make use of these services at prevailing market prices. Therefore,
government and some private ‘Charitable Institutions’ provide these services at a price
which is much below even their cost of production. Such a price is called token price for
these goods and services. The tuition fees charged in government schools is much
below the cost incurred per student by the government.
Token price is charged in order to prevent the wasteful use of these services. Many
people think that something that is free, is worthless. Otherwise these services can be
made available free of cost also. If these services are provided free some people may
try to stay in hospital for a longer period in order to get free shelter and free food.
o Dual Price
As explained earlier, that price control may lead to the shortage of the commodity
because sellers are not willing to supply adequate quantities of the commodity at the
price fixed by the government as the price is lower than the equilibrium price. This may
also lead to black marketing of the commodity.
To avoid this situation the government adopts a dual price policy. Under this policy a
part of the production of the good is sold at control price through fair price shops and the
remaining part is sold at prevailing market price which is determined by the forces of
demand and supply (for example LPG cylinders) At this market price any quantity of the
commodity can be bought by the consumer. For example government sells wheat, rice
and sugar to BPL (Below poverty line) card holder at control price through fair price
shops and the producers are also allowed to sell their remaining production at
equilibrium price in open market.
Effect of Taxes and Subsidies on Market Price
Governments impose various types of taxes on production and sales of the commodities
and also on the imports of raw materials in the form of excise duty, sales tax and import
duty respectively. These taxes are paid to the government by producers, sellers and
importer of these commodities. They recover them from the buyers of these commodities.
Therefore these taxes increase the market price of these commodities. If the government
increases the rate of these taxes, the market price of the commodities will also increase. On
the other hand if the government gives subsidy to the producers to sell some goods at a
lower price in order to make the commodity available to the common men at a reasonable
price. Thus an increase in subsidy leads to decrease in market price of the commodity. For
example, government gives subsidy on kerosene oil, and cooking gas or LPG.
A few communist countries like China, have an altogether government regulated system.
The prices of goods and services are completely administered by the government right from
the support price fixed at which the government procures raw agricultural products from the
farmers. This system often results in misallocation of resources. That is, farmers producing
what consumers don’t want and what consumers want, producers do not want to supply.
Capitalistic Economies have the biggest advantage of giving people what they desire rather
than giving everyone what they do not want. Success of countries who have free markets is
evident from the economic growth rates in USA, the Scandinavian countries, Germany and
France. Countries such as India and China, by allowing liberalization of its trade to some
extent and practicing free market principles have brought about more efficiency among its
domestic producers and increased its growth rate remarkably.
Free market existing side by side with socialism, like limited regulation of prices by the
government to protect the poor, can be an ideal system for a developing country like India.
Public Distribution System (PDS)
Poor people cannot afford to buy even the essential commodities at their market price. To
help these people, one of the methods adopted in India is public distribution system. Under
this system essential commodities like wheat, rice, sugar etc. are made available to the
common man at cheaper rate through fair price shops called ration shops. These
commodities are sold through an identification paper called ration card. Following are the
essential elements of public distribution system in India.
1. Subsidy: Government gives subsidies on the commodities sold through public distribution
system. Therefore, the prices of the commodities sold under this system are relatively
lower.
2. Fixed quantity (Rationing): Government fixes the quantity (quota) per head per month on
the basis of minimum requirement of a person. Every household is issued a ration card
mentioning the number of persons in the family. Every household can buy the fixed quantity
of the commodity according to the number of persons in the family from the fair price shops.
3. Fair price shops (FPS): Government sells these commodities through fair price shops
popularly known as ration shops. These shops are opened in all parts of the country. The
government supplies these commodities to the owner of these shops according to the
number of ration cards registered with each shop. The owner of these shops are paid a
commission on their total sales.
4. Of late most of the well to do people are staying away from the ration shops, because of
quality issues and timely unavailability of the goods.
6.9 Types of Markets
A market is a system, which facilitates exchange of goods and services between sellers
and buyers. While a few parties may exchange their goods and services for goods and
services instead of money, called barter system. But most of the markets rely on sellers
offering their goods and services (including labor) in exchange of money from buyers. It can
be said that a market is the process by which the prices of goods and services are
established. Markets facilitate trade and enables the distribution and allocation of resources
in a society. Markets allow any tradable item to be evaluated and appropriately priced. A
market emerges more or less spontaneously or may be constructed deliberately by human
interaction in order to enable the exchange of rights or ownership of services and goods.
Markets of varying types can spontaneously arise whenever a party has interest in a good
or service that some other party can provide. Similarly, there can be a black market, where
goods are exchanged illegally. Amazon, Flipkart or eBay are virtual market places, in which
buyers and sellers do not physically interact for transaction. Similarly Bombay Stock
Exchange BSE or National Stock Exchange NSE are the market places for exchanging of
stocks, bonds and securities issued by various companies. A market can be organized as
an auction house, or as a private electronic market like Multi Commodities Exchange of
India MCX, or as a commodities wholesale market, or as a shopping center.
Markets vary in form, scale (volume) and geographic reach (location), and types of
participants, as well as the types of goods and services traded.
The following is a list of types of markets:
Physical consumer markets
o Retail markets: vegetable markets, fish markets, animal markets and grocery stores
o Supermarkets, hypermarkets and discount stores
o Auction markets: process of buying and selling goods or services by offering them up for
bidding, and selling them to the highest bidder
o Used goods markets such as flea markets
o Temporary markets such as fairs
Physical business markets
o Wholesale markets: sale of goods to retailers and large consumers

o Markets for intermediate goods used in production of other goods and services
o Labor markets: where people sell their labor to businesses in exchange of a wage
o Auction markets: process of buying and selling goods or services by offering them up for
bidding, and selling them to the highest bidder
o Temporary markets such as trade fairs
Non-physical markets
o Media markets (broadcast market): Television, newspapers and Internet content

o Internet markets (electronic commerce): trading in products or services online
o Artificial markets created by regulation to exchange rights of derivative products like
carbon trading.
Financial markets
Financial markets facilitate the exchange of liquid assets.

o The stock markets, for the exchange of shares of companies
o And the bond markets
o Currency markets are used to trade one currency for another
o The money market is the global market for lending and borrowing
o Futures markets, where contracts regarding future delivery of goods are exchanged
Unauthorized and illegal markets
o Grey markets (parallel markets): is the trade of a commodity through distribution

channels which are legal, but are unofficial, unauthorized, or unintended by the original
manufacturer.
o Markets in illegal goods such as the market for illicit drugs, illegal arms.
o Betting markets are a type of speculative market in which the goods exchanged are
futures on the occurrence of certain events.
Mechanisms of markets
In economics, a market that runs under laissez-faire (without anyone’s intervention) is

called a free market, it is "free" from the government intervention, in a sense that the
government makes no attempt to intervene through taxes, subsidies, minimum wages, or
price ceilings. However, market prices may be distorted by a seller or sellers with monopoly
power, or a buyer with monopsony power. Such price distortions can have an adverse
effect on market participant's welfare and reduce the efficiency of market outcomes. Also,
the relative level of organization and negotiating power of buyers and sellers remarkably
affects the functioning of the market.
Markets are a system, and all systems have a definite structure. The structure of a well-
functioning market is defined by the theory of perfect competition. Well-functioning markets
of the real world are never perfect, but basic structural characteristics can be approximated
for real world markets, as follows:
o Many small buyers and sellers

o Buyers and sellers have equal access to information
o Products are comparable
For a market to be competitive, there must be more than a single buyer or seller. It has
been suggested that two people may trade, but it takes at least three persons to have a
market, so that there is competition in at least one of its two sides. However, competitive
markets, as understood in formal economic theory, rely on much larger numbers of both
buyers and sellers. A market with a single seller and multiple buyers is a monopoly. A
market with a single buyer and multiple sellers is a monopsony. These are "the polar
opposites of perfect competition".
Market occupies a unique position in the modern complex monetary organization. Adam
Smith in his ‘Wealth of Nations’, rightly points out, that division of labor is limited by the
extent of the market. Market helps the producers to take basic economic decisions on what
to produce, and how much to produce. Market significantly affects the producers,
consumers, and the various other sections of the society.
The market is the characteristic phenomenon of economic life. The constitution of markets
and market prices are the central problems of economics.
In ordinary language, “market” refers to a place where commodities are bought and sold.
For example, a cotton market, tea market, wheat market, gold market, share market and so
on.
In economics, “market” refers to a group of buyers and sellers taking part in the exchange
of a commodity. The buyers and sellers may be scattered within a country or may be
abroad. However, there must be some means of communication between them.
Features of a Market
1. Consumers and sellers - The existence of buyers and sellers. The number of buyers and
sellers may be large or small.
2. Contact - Existence of some contact among the buyers and sellers. The contact may be
direct or indirect through brokers.
3. A Commodity - There is commodity to deal with. In the case of different commodities,

there will be different markets.
4. A Price - There should be a price for the commodity that is bought and sold in the
market.
Factors Affecting the Size of a Market
The size or extent of a market depends upon various factors. These factors can be broadly
divided under two heads.
o Nature of the commodity and

o General conditions
Nature of the commodity Affecting the Demand for a Commodity
(a) Wide demand - A commodity, which is in universal demand, will have a wide market.
The classic example is fuel oil. On the other hand, a commodity, which is local in character,
will have a limited market. For example: regional films.
(b) Durability - A commodity, which is durable in nature, will have a wide market. Goods like
gold, silver, etc., have very wide markets since such commodities can be preserved for a
long time and can be transported without any damage. On the other hand perishable
commodities like vegetables, flowers and milk have only limited markets. However, the
development of processing facilities, refrigeration and airlifting has greatly increased the
size of the market for perishable goods also.
(c) Portability - Another pre-requisite for a wide market is that the commodity should be
easily portable. It must be small but possess a high value. Goods like machines and cotton
textiles are easily portable and so they command wide markets. On the other hand, bricks
and stones enjoy only a narrow market.
(d) Grading and Sampling - Grading means dividing the goods based on quality. Sampling
means a part representing the whole. Goods, which are amenable to grading and sampling
generally, command an international market. Grading helps the purchasers to identify the
quality of the product without the inspection.
(e) Adequate supply - To have wider market the commodities should have an adequate
supply. However, rare pictures and paintings though they could not be supplied in plenty
enjoy international markets because of their prestige value.
General Conditions Affecting the Demand for a Commodity
(a) Peace and Security - The existence of political stability, peace and security are of vital
importance for smooth trade. If the law and order situation in a country deteriorates due to
political unrest and the revolutionary attitudes of certain groups, markets will get hampered.
(b) Stable Currency and Efficient Financial Institutions - With the help of well-developed
banks and other financial institutions, marketing can be profitably and easily carried on over
wide and extensive areas. In the modern world, international trade occupies an important
place. The extent of international trade depends upon the value of the home currency and
the confidence it inspires among foreigners.
(c) Government Policy - The import and export policy of the government has also a
considerable impact on the size of the market. If the government imposes many restrictions
in the form of quotas and duties, trade will be affected. Likewise, restrictive policies of the
importing country will also have an adverse effect on the exporting country.
(d) Transport and Communication - A properly developed transport system in the form of
roads, railways, steamships and airplanes is highly useful for the widening of both internal
and international trade. Likewise, efficient means of communications like posts and
telegraphs, telephones etc., help the traders to keep in touch with their distant markets and
send information regarding market trends.
(e) Degree of division of labor - The splitting of tasks among different people and groups is
called division of labor. According to Adam Smith, the division of labor depends upon the
extent of the market. But in a sense, the extent of the market also depends upon division of
labor. Division of labor by reducing the average cost of production increases the size of the
market. Division of labor is essential to economic progress because it allows people to
specialize in particular tasks. This specialization makes workers more efficient, which
reduces the total cost of producing goods or providing a service. Additionally, by making
people become skilled and efficient at a smaller number of tasks, division of labor gives
people time to experiment with new and better ways of doing things.
6.11 Pricing under perfect competition
Market price is determined by the equilibrium between demand and supply in a market
period of a very short duration.
The market period is a period in which the maximum that can be supplied is limited by the
existing stock.
The market period is so short that more cannot be produced in response to increased
demand. The firms can sell only what they have already produced.
This market period may be an hour, a day or a few days or even a few weeks depending
upon the nature of the product. For example, in the case of perishable commodities like
fish, this market period may be a day (if there is no cold storage facility available), and for
cotton textile industry it may be a few weeks. What will be the nature of the supply curve in
a market period? Two cases are prominent - one is that of perishable goods and the other
is that of non- perishable durable goods which can be reproduced.
Market Price of a Perishable Commodity:
In the case of perishable commodities like fish, the supply is

limited by the available quantity on that day, and it cannot
be kept back for the next period (if there is no cold storage
facility available), and therefore, the whole of it must be sold
away on the same day, whatever the price may be. The
figure shows the supply curve of fish. Which will be a
vertical straight line MS, when OM is the quantity of fish
available on that day?
DD is the market demand curve. With perfect competition

between buyers and sellers, an equilibrium price OP will be
determined at which the quantity demanded is equal to the
available supply. That is, equilibrium price will be
established at the point where downward sloping demand curve DD intersects the vertical
supply curve MS.
Now suppose that there is a sudden increase in demand from DD to D’D’. With the supply
of fish remaining unchanged, the larger demand will raise the market price sharply from OP
to OP’. On the contrary, if there is a decrease in demand from DD to D’-D”, the price will fall
and the quantity sold will remain the same.
Market Price of Non-Perishable and Reproducible Goods:
In case of non-perishable but reproducible goods, supply curve cannot be a vertical straight
line throughout its length, because some of the goods can be preserved or kept back from
the market and carried over to the next market period. There will then be two critical price
levels.
The first, if price is very high the seller will be prepared to sell the whole stock. The second
level is set by a low price at which the seller would not sell any amount in the present
market period, but will hold back the whole stock for some better time. The price below
which the seller will refuse to sell is called the Reserve Price.
Given the two price levels, one at which the seller is prepared to sell the whole stock and
the other at which he will refuse to sell at all, the amount which he will offer for sale will vary
with price. Given his anticipation of future price and intensity of his need for cash, etc., he
will be prepared to supply more at a higher price than at a lower one. The supply curve of a
seller will, therefore, slope upward to the right. Beyond a price at which he is prepared to
sell the whole stock, the supply curve will be a vertical straight line whatever the price.
In the figure SRFS’ is the supply curve of the durable

goods while OQ is the total amount of the stock of the
goods. Up to price OP’, the quantity supplier varies with
price so that at a higher price more is supplied than at a
lower one. At the price OS, nothing is sold, the whole stock
being held back. Therefore, SF portion of the supply curve
slopes upwards from left to right.
At price OP’, the whole of the stock is offered for sale, and
beyond the price OP’, the quantity supplied remains the
same whatever the price. Therefore, beyond the price OP’,
the market supply curve will be vertical straight line (FS’).
DD is the demand curve which slopes downwards from left
to right. Market price comes to settle at OP, because at this
price the quantity demanded is equal to the quantity supplied. At this equilibrium price OP,
OM amount from the stock is sold, while the rest of the stock, i.e., MQ (= RC) is held back
from the market.
Suppose now the demand increases from DD to D’D’, the price will rise to OP’, and the
whole stock OQ will be sold off. If now the demand, further increases from D’D’ to some
higher level, the quantity supplied or sold will remain the same, i.e., equal to OQ, and only
the price will rise so that, at the new equilibrium level, the quantity demanded is equal to the
available supply. If the demand decreases from DD to D”D”, the price will fall to OP”, and
the amount sold will decrease to OM’.
Since, in a perfectly competitive market, the product is homogeneous and no buyer has any
preference for a particular seller, therefore, a single uniform market price will be established
in the market. Once the market price is determined, an individual seller in the market will
take the price as given or constant. Thus, the demand curve which is downward sloping for
all sellers becomes a single horizontal straight line for a single seller, i.e. it is a perfectly
elastic curve at the level of the prevalent market price.
One important conclusion that follows from the above analysis of price determination in the
market period is that costs of production do not enter into the calculation of the sellers, and,
therefore, have little influence on the market price.
Determination of Short-Run Price:
In the short run, a firm is in equilibrium at the output at which price equals marginal cost.
Therefore, during the short runs, fixed costs are disregarded while making the decision of
whether to produce or not. This is because fixed costs have to be borne whether there is
any production or not.
Therefore, it is the average variable cost rather than the average total cost which is of
importance, while deciding whether to produce or not in the short run. If the price falls below
the minimum average variable cost, then even in the short run firms will shut down to
minimize losses. Thus, the minimum average variable cost sets the minimum limit to the
price in the short run, since at prices below it no amount of output will be produced.
The determination of the short-run price can be
explained with the help of this graph. Here DD is the
demand curve facing the industry. The demand curve
as usual slopes downwards from left to right. In the
graph, MPS is the market period supply curve and SRS
is the short-run supply curve of the industry.
If there is a given increase in demand from DD to D’D’

the market price will rise sharply from OP to OP’, supply
of output remaining unchanged. Under the stimulus of
this increased demand, the firm will increase production
by making intensive use of the existing fixed capital
equipment and by increasing the amount of variable
factors.
It must be recalled that, in the short period, no change in fixed capital equipment can be
made, nor can new firms enter the industry. The supply of the commodity will increase as a
result of the expansion of output by the existing firms in response to an increase in demand.
Therefore, in the short run, price will fall to OP” at which new demand curve D’D’ intersects
the short-run supply curve SRS. Thus OP” is the short-run price, which is higher than the
original market price OP, but not as high as the second market price of OP’. The quantity
supplied has also increased from OM to OM’. Thus, in the short run, larger quantity of the
commodity is sold and price is not quite so high as it was in the market period.
Determination of Normal Price
Market price may fluctuate due to a sudden change either on the side of supply or on that of
demand. A big arrival of fish, for instance, may depress its price in a particular market. A
sudden heat wave may raise the price of ice. These are, however, temporary influences
and cause temporary disturbances in the market value.
In the absence of such disturbing causes, the price tends to come back to a certain level.
This level itself may not be a fixed point for all times. But if the techniques and scale of
production remain more or less constant, then this level may be taken as a fixed anchor
around which, in its day-to-day movements, the market price oscillates. This level is called
“normal” price.
‘Normal’ or ‘Natural’ value of a commodity is that value, which economic forces would tend
to bring about in the long run. It may be pointed out that ‘normal’ prices are not the same
thing as ‘average’ prices, unless prices are constant. Normal prices are those prices to
which one may expect prices to tend, whereas average prices will be an arithmetical
average of all actual prices. They will not only be influenced by fortuitous fluctuations and
oscillations, but will also take account of the general trend towards the ‘normal’ prices.
In order to describe how long-run equilibrium is brought about and thus normal price is
determined it is useful to refer to the market period and short-run period also. As we have
stated above, the market period is so short that no adjustment in the output can be made.
There is a given amount of the stock of the good on hand, and, in case of a perishable
good, it must be sold at whatever price the market will bring. Thus, in the market period or
very short run, costs of production have no influence on price.
The short-run period, on the other hand, is sufficient to allow the firms to make limited
output adjustment. If there is an increase in demand, the firms will expand output using
existing equipment to the point where new price equals marginal cost. As shown already,
the new short-run price will be higher than the price before the increase in demand but not
as high as the market price, and the output will be larger.
In the long period, however, supply conditions are fully adapted to meet the new demand
conditions. If there is a sudden and once-for-all increase in demand, the firms in the long
run will expand output by increasing the services of variable as well as of the fixed factors
of production. They may enlarge their old plants or build new plants. Moreover, in the long
run, new firms can also enter the industry and thus add to the supplies of the product.
In the long period, average variable cost is of no

particular relevance, since in the long-run all factors
are variable and none is fixed. In this period, all costs
ever incurred by the firm must be covered and hence
all are price-determining. Price in the long-run or
normal price, under perfect competition, therefore,
must be equal to the minimum long-run average cost.
Here Price OP= LAC = LMC.
We have seen that a firm under perfect competition is

in long-run equilibrium at the output where Price = MC
= AC. If the price is above the minimum long-run
average cost, the firms will be making abnormal profits
and, in the long run, new firms will enter the industry to
compete away these profits and the prices will fall to
the level where it is equal to the minimum long-run average cost. Nor can the price fall
below the minimum average cost, since in that situation the firms will be incurring losses
and, in the long-run, if these losses persist, some of them will leave the industry, and
thereby the price will rise to the level of minimum average cost so that in the long run firms
are earning only normal profits.
Thus, we see that if the price is above or below the minimum long-run average cost,
adjustment takes place in the output largely by the entry or exit of firms so that new price
once again equals the minimum average cost. But whether this long-run minimum average
cost is equal to or is higher or lower than the previous one depends on whether the industry
in question is constant cost, increasing cost (automobiles, because of pollution concerns) or
decreasing cost industry (smartphones). How the normal price is determined under
conditions of diminishing returns, constant returns and increasing returns is explained
below.
Influence of Laws of Returns on Normal Price
The influence of the laws of returns on the normal price brings out clearly the importance of
the time element in the theory of value. The scale on which a commodity is produced
affects its cost of production. But, during a very short period, the scale cannot be changed
and hence cost of production remains unaffected. Thus cost of production, in the very short
period, can have no influence on market price. The laws of returns can exert influence only
in the long run, and can, therefore, affect only the normal price.
Let us suppose that the demand for a commodity increases. The market price, i.e., the price
at the moment, must rise. The producer will try to increase the supply with the existing
equipment to take advantage of the rise. Although supply will increase in the short period to
some extent, yet it will not be enough to bring the price down to the old level. Hence, price
will remain high somewhat. But we cannot be sure about the normal price, i.e., the price in
the long run. In order to find out what will happen to the price in the long run, we must know
the particular law of return to which the industry is subjected to.
Normal Price in Increasing Cost Industry
Suppose the industry which produces the commodity is subject to the law of diminishing
returns (or increasing cost industry), e.g., coal or automobiles. Now, when demand has
increased, the market price of coal will rise. The producer will increase the supply to take
advantage of this rise. The scale of production will increase. But, because the law of
diminishing returns prevails in the industry, the large the output, the higher will be its cost of
production.
Thus, the additional supplies are obtained at a higher cost. This means that the price in the
long run will be higher. The normal price will rise. This will be the case with all agricultural
products like wheat, rice, sugar-cane, and the products of other extractive industries, like
mining and fishing.
Let us illustrate it diagrammatically. The supply curve SS’ in

the graph shows diminishing returns (or increasing costs)
when more coal is produced. The rise m demand is shown by
the new (dotted) curve dd’ in place of the old DD’.
The old equilibrium price PM shifts to a new one P’M’ as a

result of increased demand. If demand for coal increases the
price will immediately rise. The price will rise even more for
the inputs and bottlenecks will start showing up in the
production processes. Therefore, the increased production
will be obtained at a higher cost. This is due to the law of
diminishing returns, for the more you produce the more is the
cost, and the less you produce, the less is the cost.
In the above diagram, the old price was PM for quantity OM and it rises to P’M’ when OM”
is demanded and produced. In the same manner, it can be easily shown that a decrease in
demand for coal will reduce the price much more. This is so because reduced production
will be obtained at a lower cost when the law of diminishing returns operates.
Normal Price in Decreasing Cost Industry
Suppose the industry is subject to the law of increasing returns to decreasing cost industry,
e.g., cloth or smartphones. Suppose the demand for clothes increases due to a rise in the
standard of living or increase in population. The increase in demand means higher market
price; the higher price leads to production on a larger scale.
The larger the scale, the lower the cost on account of the
operation of the law of increasing returns in cloth. When,
therefore, demand has increased permanently, the normal
price will fall. This will happen in the case of all manufactured
and machine-made goods like smartphones, cars, cycles,
soap, biscuits, fountain pens, radio-sets, etc.
This change can be illustrated with the help of a graph. Here,

the supply curves SS’ shows that cloth is manufactured
under the law of decreasing cost or of increasing returns.
The cost falls with increased production. The rise in demand
is shown by the new (dotted) curve dd’.
The old equilibrium price was PM but with the rise in demand to dd’, the price falls to P’M’,
the new equilibrium price. In the same manner, a little thinking will snow that if the demand
for a commodity the production of which is subject to the law of increasing returns falls,
normal price will rise, as reduced production will be obtained at a higher cost per unit.
Normal Price in Constant Cost Industry
In case, the industry is subject to the law of constant returns, the cost of production remains
the same whatever be the scale of production. The change in demand will no doubt lead to
a change in supply. The scale of production will be altered, but the cost per unit will remain
the same. Such a condition does not persist for any length of time and occurs only when
the laws of increasing and decreasing returns are equally balanced. In such cases,
therefore, for a period of time the normal price remains unchanged.
To illustrate diagram metrically let us suppose the supply

curve SS’ represents the production of a commodity like
wheat under the law of constant returns for a period when
the tendency towards diminishing returns is checked by
improved methods. DD’ is the old demand curve, while the
rise in demand is shown by the dotted curve dd’.
The rise in demand does not affect the price. The old price
PM is equal to the new price P’M.
6.12 Monopoly, Monopolistic competition and oligopoly
A modern economy has many different types of industries. However, an economic analysis
of the different firms or industries within an economy is simplified by first segregating them
into different models based on the amount of competition within the industry. There are 4
basic market models: pure competition, monopolistic competition, oligopoly, and pure
monopoly. Because the competition among the last 3 categories is limited, these market
models are often referred to as imperfect competition.
In a purely competitive market, there are large numbers of firms producing a standardized
product. Market prices are determined by consumer demand; no supplier has any influence
over the market price, and thus, the suppliers are often referred to as price takers. The
primary reason why there are many firms is because there is a low barrier of entry into the
business. The best examples of a purely competitive market are agricultural products, such
as corn, wheat, and soybeans.
Economists assume that there are a number of different buyers and sellers in the
marketplace. This means that we have competition in the market, which allows prices to
change in response to the changes in supply and demand. Furthermore, for almost every
product there are substitutes, so if one product becomes too expensive, a buyer can
choose a cheaper substitute instead. In a market with many buyers and sellers, both the
consumer and the supplier have equal (in fact, limited) ability to influence the prices.
In some industries, there are no substitutes and there is no competition. In a market that
has only one or few suppliers of a good or service, the producer(s) can control the prices,
meaning that a consumer does not have any option; he cannot maximize his or her total
utility and has a very little influence over the prices of goods.
A Monopoly
A monopoly is a market structure in which there is only one producer or a seller of a

product. In other words, the single business is controlling the entire industry. Entry into such
a market is restricted because of high costs of entering in these businesses or other
barriers, which may be economic, social or political interference. For example, a
government can create a monopoly over an industry that it wants to control, such as
electricity or LPG. Another reason for the barriers against entry into a monopolistic industry
is that only one entity may have an exclusive right to natural resources. For example, in
Saudi Arabia the government has sole control over the oil industry. A monopoly may also
form when a company has a copyright or patent that prevents others from entering the
market. A few years back Microsoft had a virtual monopoly on the desktop operating
systems, called Windows. Because many computer users have standardized on software
products that are compatible with Microsoft's Windows operating system, most of the
market is effectively locked in, because the cost of using a different operating system, both
in terms of acquiring new software that will be compatible with the new operating system
and because the learning curve for new software is steep, people are willing to pay
Microsoft's high prices for Windows.
Monopolistic competition
Monopolistic competition is much like pure competition in that there are many suppliers and
the barriers to entry are rather low. However, the suppliers try to achieve some price
advantages by differentiating their products from other similar products. Most consumer
goods, such as health and beauty aids, fall into this category. Suppliers try to differentiate
their product as being better so that they can justify higher prices or to have a larger market
share than the competition. Monopolistic competition is only possible, however, when the
differentiation is significant or if the suppliers are able to convince consumers that they are
significant by using advertising or other methods that would convince consumers of a
product's superiority. For instance, suppliers of toothpaste may try to convince the public
that their product makes teeth whiter or helps to prevent cavities or periodontal disease.
An oligopoly
In an oligopoly, there are only a few firms that make up an industry. This select group of
firms has control over the prices and, like a monopoly; an oligopoly has high barriers to
entry. The products that the oligopolistic firms produce are often nearly identical and,
therefore, the companies, which are competing for market share, are interdependent as a
result of market forces. Assume, for example, that an economy needs only 100 widgets.
Company X produces 50 widgets and its competitor, Company Y, produces the other 50.
The prices of the two brands will be interdependent and, therefore, similar. So, if Company
X starts selling the widgets at a lower price, it will get a greater market share, thereby
forcing Company Y also to lower its prices.
Pure Competition
There are two extreme forms of market structure: a monopoly and, its exact opposite, a
perfect competition. Perfect competition is characterized by many buyers and many sellers,
many products that are similar in nature and, as a result, many substitutes available for
almost each product. Perfect competition means there are few, if any, barriers to entry or
exit for new companies, and prices are determined by supply and demand. Thus, producers
in a perfectly competitive market are subject to the prices determined by the market and do
not have any leverage or undue advantage. For example, in a perfectly competitive market,
should a single firm decide to increase its selling price of a good, the consumers can just
turn to the nearest competitor for a better price, causing any firm that increases its prices to
lose market share and profits or return to lower prices by reducing the prices or offering
discounts.
Monopsony
A monopsony, sometimes referred to as a buyer's monopoly, is a market condition similar

to a monopoly except that a large buyer, not a seller, controls a large proportion of the
market and drives prices down.
A monopsony occurs when a single firm has market power in employing its factors of
production. It acts as a sole purchaser for multiple sellers, driving down the price of seller
inputs through the amount of quantity that it demands.
In situations where monopsony occur, sellers often engage in price wars to entice the single
buyer's business, effectively driving down the price and increasing the quantity. Sellers that
get caught in a monopsony are known to race to the bottom, losing any power they
previously had over supply and demand.
The buyer is so large and has so much power in buying that sellers have no choice but to
agree to its terms.
Monopsony takes many different shapes and sizes, but most commonly occur when a
single employer controls an entire labor market. When this happens, the sellers, in this case
the potential employees compete on wages for the few jobs available, driving down
employee costs for the business.
The technology industry is a great example of this type of monopsony. With only a few large
tech companies in the market for engineers, major players like Cisco and Oracle have been
accused of colluding and choosing not to compete with each other on the wages they offer
technical positions. This, in turn, suppresses wages so that the major tech companies
realize lower operating costs and higher profits. This example also highlights the fact that a
group of companies can act as a monopsony.
Another example of a monopsony involves the input suppliers of a large company. If, using
a hypothetical situation, auto manufacturers consolidated into a single conglomerate, the
resulting business entity would have a large amount of power over its suppliers. All the tire
companies and rubber companies would compete with each other to win the auto
manufacturers business. Producers of plastics, steel and other metals would also compete
with each other to provide the best price to the large conglomerate. It's easy to see through
this example that a monopsony, similar to a monopoly, can have adverse effects on an
economy. However, consumers can benefit if the monopsony passes along its savings
rather than keeping it as additional profit to itself.
An Act to provide, keeping in view of the economic development of the country, for the
establishment of a Commission to prevent practices having adverse effect on competition,
to promote and sustain competition in markets, to protect the interests of consumers and to
ensure freedom of trade carried on by other participants in markets, in India, and for
matters connected therewith or incidental thereto.
Competition Commission of India
To ensure free and fair markets, the Competition Commission of India was established in
year 2002.
Its vision statement says - “To promote and sustain an enabling competition culture through
engagement and enforcement that would inspire businesses to be fair, competitive and
innovative; enhance consumer welfare; and support economic growth.”
Its mission statement says - Competition Commission of India aims to establish a robust
competitive environment through:
o Proactive engagement with all stakeholders, including consumers, industry, government

and international jurisdictions.
o Being a knowledge intensive organization with high competence level.
o Professionalism, transparency, resolve and wisdom in enforcement.
It endeavors to do the following:
o Make the markets work for the benefit and welfare of consumers.
o Ensure fair and healthy competition in economic activities in the country for faster and
inclusive growth and development of economy.
o Implement competition policies with an aim to effectuate the most efficient utilization of
economic resources.
o Ensure alignment other regulatory laws in tandem with the competition law.
o Spread the information on benefits of competition among all stakeholders to establish
and nurture competition culture in Indian economy.
7. Money
7.1 Types of Money
Money can be described as a token or a payment option which is used in our society to
settle debts and to pay for the services and commodities which are provided to us. In other
words, money is the medium of exchange in our society which has also been accepted by
the law. Money plays a pivotal role in any country’s economy.
The main functions of money are:
o It is a medium of exchange.
o It gives purchasing power to the consumer to pay for goods and services.
o It is a unit of account.
o It is a unit measure of value.
o It is a standard of deferred payment.
o It is a store of value
o It is transferable
There are several kinds of money varying in liability and strength. The society has modified
the money at different times and in this way several types of monies have been introduced.
When there was ample availability of metals, metal money came into existence. later it was
substituted by the paper money. At different times, several commodities were used as the
medium of exchange. So, it can be said that according to the needs and availability of the
means, the kinds of money has changed over the period of time.
There are four major types of money:
o Commodity Money
o Fiat Money
o Fiduciary Money
o Commercial Bank Money
Commodity Money
It is the simplest form of money which is used in barter system where the valuable
resources fulfill the functions of money. The value of this kind of money comes from the
value of resource used for the purpose. It is only limited by the scarcity of the resources.
This money has intrinsic value.
Whenever any commodity is used for the exchange purpose, the commodity becomes
equivalent to the money and is called commodity money. There are certain types of
commodities, which are used as the commodity money. Among these, there are several
precious metals like gold, silver, copper and platinum.
Fiat Money
The word fiat means the “Sovereign Command”. Fiat currency is the kind of money which
doesn’t have any intrinsic value and it can’t be converted into valuable resource. The value
of fiat money is determined by the government which makes it a legal instrument for all
transactions. The fiat money needs to be controlled, because it may affect the entire
economy of a country if it gets misused. Today Fiat money is the basis of all the modern
monetary systems. The real value of fiat money is determined by the market forces of
demand and supply. The first use of fiat money was recorded in China around 1000 AD.
Since then, it has been used by various countries, concurrently with commodity currencies.
e.g. Rupee, Dollar, Euro, Pound.
Fiduciary Money
Today’s monetary system is highly fiduciary (the holding of something in trust for another).
Whenever, any bank assures the customers to pay in different types of money and when
the customer can sell the promise or transfer it to somebody else, it is called the fiduciary
money. Fiduciary money is finally paid in gold, silver or paper money. Cheques and Bank
Drafts are the examples of fiduciary money. Both are a kind of tokens used in place of
actual money and carry the same value.
Commercial Bank Money
Commercial Bank money or demand deposits are the claims against financial institutions
that can be used for the purchase of goods and services. A demand deposit account is an
account from which funds can be withdrawn at any time by a cheque or cash can be
withdrawn without giving the bank or a financial institution any prior notice. Banks have the
legal obligation to return the funds held in demand deposits immediately upon demand or
‘at call’. Demand deposit withdrawals can be performed in person, via cheques or bank
drafts, using automatic teller machines (ATMs), or through internet banking.
There are many other types of money like the credit money, electronic money, coin and
paper money, fractional money and representative money as discussed below:
Fractional Money
It is a hybrid type of money which is backed by a commodity, but has a fiat money for
transaction purpose. If the commodity loses its value then the fractional money converts
into Fiat money.
Representative Money
It represents a claim on a commodity and it can be redeemed for that commodity in a bank.
It is a token or paper money that can be exchanged for a fixed quantity of commodity. Its
value depends on the commodity it backs.
Coins
Metals of particular weight are stamped into coins. There are various precious metals like
gold, silver, bronze, copper whose coins have been used in human history. The minting of
coins is controlled by the state.
Paper Money
Paper money doesn’t have any intrinsic value. Like a fiat money, it is backed by
government order to be treated as legal tender through which value exchange can happen.
Governments print the paper money according to the requirements of the government. It is
tightly controlled activity, as it can affect the economy of the country and it’s trading
partners.
Bit Coins
Bitcoin is a form of digital currency, created and held electronically. No one controls it.
Bitcoins aren’t printed, like dollars or euros – they’re produced by people, and increasingly
businesses, running computers all around the world, using software that solves
mathematical problems. It’s the first example of a growing category of money known as
cryptocurrency.
7.2 Functions of Money
1. Primary Functions (Main or Basic Functions): Primary Functions include the most
important functions of money, which it must perform in every country. These are:
(i) Medium of Exchange:
Money, as a medium of exchange, means that it can be used to make payments for all
transactions of goods and services. It is the most essential function of money. Money has
the quality of general acceptability. Therefore, all exchanges take place in terms of money.
1. This function has removed the major difficulty of lack of double coincidence of wants
(finding someone who wants what I have, and who also has what I want) and
inconveniences associated with the barter (exchange of goods) system.
2. Use of money allows purchase and sale to be conducted independently of one another
and in different periods of time.
3. This function of money facilitates trade and helps in conducting transactions in an

economy.
4. Money has no power to satisfy human wants, but it commands power to purchase those
things, which have a utility to satisfy human wants.
(ii) Measure of Value (Unit of Value):
Money as measure of value means that money works as a common denomination, in which
values of all goods and services are expressed.
1. By reducing the value of all goods and services to a single unit (i.e. price), it becomes
easier to find out the exchange ratios between them and comparing their prices.
2. This function facilitates maintenance of business accounts, which would be otherwise

impossible.
3. Money helps in calculating relative prices of goods and services. Due to this reason, it is
regarded as a Unit of Account. For instance, ‘Rupee’ is the unit of account in India, ‘Pound’
in England and so on.
2. Secondary Functions (Subsidiary or Derivative Functions)
These refer to those functions of money which are supplementary to the primary functions.
These functions are derived from primary functions and, therefore, they are also known as
‘Derivative Functions’.
The major secondary functions are:

(i) Standard of Deferred Payments:
Money as a standard of deferred payments means that money acts as a ‘standard’ for
payments, which are to be made in future. Every day, millions of transactions take place in
which payments are not made immediately. Money encourages such transactions and
helps in capital formation and economic development of the economy.
This function of money is significant because:
1. Money as a standard of deferred (postponed) payments has simplified the borrowing and
lending operations.
2. It has led to the creation of financial institutions.
(ii) Store of Value (Asset Function of Money):
Money as a store of value means that money can be used to transfer purchasing power
from present to future. Money is a convenient way to store wealth. Although wealth can be
stored in any other form, money is the most economical and convenient way of storing it. By
storage, it provides security to individuals to meet contingencies, unpredictable
emergencies and to pay future debts. Under barter system, it was difficult to use goods as a
store of wealth due to perishable nature of some goods and high cost of storage due to
space requirement, theft, care and maintenance required.
Money as store of value has the following advantages:
1. Money is available in fractional denomination, ranging from Rs 1 to Rs 1,000.
2. Money is easily portable. So, it is easy and economical to store money as its storage
does not require much space.
3. Money has the merit of general acceptability. Therefore, it can be easily exchanged for
goods at all times.
4. Savings in terms of money are much more secured than in terms of goods.
Money has overcome the drawbacks of barter system in the following manner
1. Medium of Exchange:
As a medium of exchange, money has removed the major difficulty of lack of double
coincidence of wants in barter system. It separates the acts of sale and purchase of goods
and services and helps both the parties in obtaining maximum satisfaction. A buyer can buy
goods through money and a seller can sell goods for money.
2. Measure of value:
Under Barter system, different goods were of different values and there was no common
denomination to express their exchange ratios. But, money is the measuring rod which
expresses the value of other commodities. It becomes easier to compare the relative values
of any two commodities.
3. Store of Value:
Under Barter system, it is very difficult to store goods for future use. Most of the goods are
perishable and their storage requires huge space and transportation cost. But, money can
be easily stored for future use. It is the most convenient and economical means of storing
earnings and wealth. It has the merit of general acceptability and its value remains stable
as compared to other goods.
4. Standard of deferred payments:
Barter system lacks suitable standard of deferred payments which creates difficulty in credit
transactions. Borrower may not be able to arrange goods of exactly the same quality at the
time of repayment. On the other hand, due to general acceptability of money, future
payments are expressed in terms of money. Money has simplified the borrowing and
lending operations and encouraged capital formation.
Money is demanded for three motives:
(a) Transaction Motive;
(b) Precautionary Motive; and
(c) Speculative Motive.
7.3 Types and Causes of Inflation
Inflation is defined as a sustained increase in the general level of prices of goods and
services. It is measured as an annual percentage increase. As inflation rises, every rupee
you own buys a smaller quantity of a good or service. The value of a rupee does not stay
constant when there is inflation.
Inflation is the rate at which the general level of prices for goods and services is rising and,
consequently, the purchasing power of the currency is falling. Central banks attempt to limit
inflation, and also avoid deflation, in order to keep the economy running smoothly.
As a result of inflation, the purchasing power of a unit of currency falls. For example, if the
inflation rate is 10%, then a kilogram of rice that costs Rs 50 in a given year will cost Rs 55
the next year. As goods and services require more money to purchase, the implicit value of
50
that money falls. Therefore, the purchasing power of money has diminishes to 55 = 91%
The population of any country grows at a certain pace. The governments of those countries
have to take certain steps to increase the production capacity of the things which are
necessary for comfortable living of their citizens. For example, food, clothing, computers,
smartphones, cars, fuel, houses, schools and hospitals etc. If some of these things are not
possible to be produced in those countries, then these countries have to at least produce
certain things, which can be exchanged for above things. For example, Saudi Arabia can’t
8.00 produce food grains,
but it produces ample
Production of Necessities
7.00 of petroleum oil to
Population Growth
import all the things it
6.00
can’t produce itself.
5.00
If a country could
4.00 have consistently
managed to ensure
3.00
these necessities for
2.00 its growing population
on a continual basis,
1.00 then there would
have been a continual
0.00
0 5 10 15 20
equilibrium between
demand and supply
of these necessities, and the prices would have remained stagnant forever.
But the governments do not produce these goods. They can only ensure a suitable
environment, under which entrepreneurs would be eager to produce those goods in those
countries and supply them to the consumers anywhere in the world. In general, the
population growth outpaces the growth in production of necessities, and the prices
gradually keep rising consistently over a period of time. This is the primary reason for any
type of inflation. If the governments provide business friendly atmosphere, if they ensure
safety of property and personnel, if they ensure law and order, and if there is a political
stability, more and more entrepreneurs would start their factories in those countries. This
will more or less ensure that the augmentation in the production capacities of the
necessities is in tandem with the growth in population.
But there is always a
time lag between
increase in demand
and necessary
increase in supply and
the availability of
necessities always
falls short of the
demand for those
necessities. This is the
primary reason for a
consistent rise in
prices of all
commodities over a
period of time. The
countries with
presence of desirable environment for the business, have a very low inflation. But a few
African countries ravaged by political instability have had inflation in double or triple digits.
The graph shows a long-term supply curve, and continuously shifting demand curves
because of rising population. The countries like United States have been able to manage
their inflation at 3.2%, but India has reported 7% average inflation in the same period.
The Reserve Bank of India uses core inflation data to decide its monetary policy {interest
rates, capital reserve ratios (CRR) and statutory reserve ratios SLR)}. Its monetary policy
goals include – moderation in long-term interest rates, ensuring price stability and
minimizing unemployment rate. All these goals are intended to promote a stable financial
environment. The RBI clearly communicates long-term inflation goals to ensure a steady
long-term rate of inflation, which in turn maintains price stability in the markets. Price
stability, or a relatively constant level of inflation, allows businesses to plan their future
strategies, since they know what to expect in future. Minimum unemployment does not
mean zero unemployment, as at any given point of time there will be some people who
simply do not want to work.
Definition and impact of inflation
What is inflation?
Inflation occurs when the general level of prices is consistently rising over a period of time.
Today, we calculate inflation by using consumer price indices – which are weighted
averages of the prices of thousands of individual products, which different segments of the
population consumes in various proportions. If the consumer price index (CPI) measures
the cost of a market basket of consumer goods and services with reference to the cost of
that bundle of goods during a particular base year. Then it is called consumer price index
(CPI) based inflation. Similarly there can be wholesale price index (WPI) based inflation. At
present Indian government is using 2001 as a reference year (therefore, for year 2001 CPI
= 100) for measuring the inflation. In 2016, this index has risen to 277, giving us average
annual inflation of 7%. Therefore, if Basmati rice is costing Rs 100 today, in year 2001 it
must have cost us Rs 36 and it may cost us Rs 200 in 2026.
Various Strains of Inflation
Low inflation
It is characterized by prices that rise slowly and predictably. This type of inflation happens,
because of the time lag between increased demand and corresponding increase in supply.
By the time business augment their production capacity to take care of the increased
demand, the demand increases further ahead. This situation perpetually keeps the demand
ahead of the supply. If the demand is marginally ahead of the supply, low levels of inflation
happens. For example, 3.2% in USA and 7% in India. We might define this as single-digit
annual inflation rates. Here the prices are relatively stable, people trust money because it
retains its value from month to month and year to year. People are willing to write long-term
contracts in money terms (housing loans and fixed deposits) because they are confident
that the relative prices of goods they buy and sell will not get too far out of line. Most
industrial countries have experienced low inflation over the last decade.
Galloping Inflation
Inflation in the double-digit or triple-digit range of 20 to 200 percent a year is called

galloping inflation or “very high inflation.” Galloping inflation is relatively common,
particularly in countries suffering from weak governments, war or revolution. Many Latin
American countries, such as Argentina, Chile, and Brazil, had inflation rates of 50 to 700
percent per year in the 1970s and 1980s.
Once galloping Inflation becomes entrenched, serious economic distortions arise in the
economy. Generally, most contracts get indexed to a price index or to a foreign currency
like the dollar. In these conditions, money loses its value very quickly, and people prefer to
hold only the bare-minimum amount of money needed for daily transactions. Financial
markets wither away, as capital flees abroad. People hoard goods, buy houses, and do not
lend money at low nominal interest rates.
Hyperinflation
While economies seem to survive under galloping inflation, a third and deadly strain takes
hold when the cancer of hyperinflation strikes the economy. This generally happens in
countries torn apart by lawlessness, strife and war. Nothing good can be said about a
market economy in which prices are raising a million or even a trillion percent per year.
Under this the money becomes worthless and people prefer to exchange goods for goods.
Inertial Inflation
In modern industrial economies like the United States, inflation has great momentum and
tends to persist at the same rate over a very long period of time.
Demand-Pull Inflation
One of the major source of inflation is the change in aggregate demand. We have seen that
changes in private investment, government spending, or net exports can change the
aggregate demand and push the output beyond its real potential. Demand-pull inflation
happens when aggregate demand rises more rapidly than the economy’s productive
potential, pulling prices up to equilibrate supply and demand. In effect, demand dollars are
competing for the limited supply of commodities and bid up their prices. As unemployment
falls and workers become scarce, wages are bid up and the inflationary process
accelerates.
One important factor behind demand pull inflation is rapid money-supply growth
(implementation of seventh pay commission). Increases in the money supply increases
aggregate demand, which in turn increases the price level.
Cost-Push Inflation
Inflation resulting from rising costs during periods of high unemployment and
underutilization of resources is called cost-push inflation.
7.4 Functions of Commercial Banks

Commercial banks provide banking services to businesses and consumers through a
network of branches. These banks are in business to make a profit for their owners and
they are usually public limited companies managed by shareholders. In India, however,
most of the top commercial banks are owned by the government. But many private
commercial banks have been established in the recent years.
Commercial banks are all-purpose banks that perform a wider range of functions such as
accepting demand deposits, issuing cheques against saving and fixed deposits, making
short-term business and consumer loans, providing brokerage services, buying and selling
foreign exchange and so on.
The primary functions of commercial bank are accepting deposits from the public and
granting credit to all sectors of the economy after making provisions for reserves as per the
RBI regulations.
Apart from receiving and lending functions, commercial banks undertake various secondary
or incidental functions such as agency services and general utility services.
Functions of Commercial Banks
Primary functions
 Collection of deposits
 Making loans and advances
Collection of deposits: The primary function of commercial banks is to collect deposits

from the public. Such deposits are of three main types: current, saving and fixed.
A current account is used to make payments. A customer can deposit and withdraw
money from the current account subject to a minimum required balance. If a customer
overdraws the account, he may be required to pay interest to the bank. Cash credit facility
is allowed in the current account. Current accounts do not yield any interest. Current
accounts are generally maintained by businesses and commercial entities.
A Savings account is an interest yielding account. Deposits in savings account are used
for saving money. Savings bank account-holder is required to maintain a minimum balance
in his account to avail of cheque facilities. Saving accounts are generally maintained by
individuals.
Fixed or term deposits are used by the customers (both individuals and commercial
entities) to save money for a specific period of time, ranging from 7 days to 3 years or more.
The rate of interest is related to the period of deposit. For example, a fixed deposit with a
maturity period of 3 years will give a higher rate of return than a deposit with a maturity
period of 1 year. But money cannot be usually withdrawn from these deposits before the
due date. Some banks also impose penalty if the fixed deposits are withdrawn before the
due date. However, the customer can obtain a loan from the bank against their fixed
deposit receipts.
Loans and advances: Commercial banks have to mandatorily keep a certain portion of
their deposits as legal reserves. These are Cash Reserves (this is a specified minimum
fraction of the total deposits of customers, which commercial banks have to hold in cash or
keep as deposits with RBI) and Statutory Liquidity (Loans given to the government). The
balance is used to make loans and advances to the borrowers. Individuals and firms can
borrow this money and banks make profits by charging interest on these loans. Commercial
banks make various types of loans such as:
1. Loan to a person or to a firm against some collateral, called secured loan. As per the
guidelines of the RBI, every bank is supposed to lend a part of their loan portfolio to
the priority sectors like agriculture and allied activities, micro and small enterprises,
poor people for housing, students for education and other low income groups.
2. Cash credit is a type of short term loan provided to companies to fulfill their working
capital requirement.
3. Overdraft is a facility given by the bank to companies, to withdraw money "more"
than the balance available in their respective accounts.
4. Loan by discounting bills of exchange. If a customer sells something to someone
else on credit, the bank gives him loan against the amount receivable. Bank’s
lending against such receivables is called discounting. The banks deduct the interest
for the credit period and release the balance. (therefore they discount the bill)
Secondary functions
 Agency services
 General utility services
Agency Services: The customers may give standing instruction to the banks to accept or
make payments on their behalf. The relationship between the banker and customer is that
of Principal and Agent. The following agency services are provided by the bankers:
1. Payment of rent, insurance premium, telephone bills, installments on hire purchase,

etc. The payments are obviously made from the customer’s account. The banks may
also collect such receipts on behalf of the customer.
2. The bank collects cheques, drafts, and bills on behalf of the customer.
3. The banks can exchange domestic currency for foreign currencies as per the
regulations.
4. The banks can act as trustees / executors to their customers. For example, banks
can execute the will after the death of their clients, if so instructed by the latter.
General Utility Services: The commercial banks also provide various general utility
services to their customers. Some of these services are discussed below:
1. Safeguarding money and valuables: People feel safe and secured by depositing
their money and valuables in the safe custody of commercial banks. Many banks
look after valuable documents like house deeds and property, and jewelry items.
2. Transferring money: Money can be transferred from one place to another. In the
same way, banks collect funds of their customers from other banks and credit the
same in the customer’s account. RTGS & NEFT are very popular modes of money
transfer these days.
3. Merchant banking: Many commercial banks provide merchant banking services to
the investors and the firms. The merchant banking activity covers project advisory
services and loan syndication, corporate advisory services such as advice on
mergers and acquisitions, equity valuation, disinvestment, identification of joint
venture partners and so on.
4. Automatic Teller Machines (ATM): The ATMs are machines for quick withdrawal of
cash. In the last 10 years, most banks have introduced ATM facilities in metropolitan
and semi-urban areas. The account holders as well as credit card holders can
withdraw cash from ATMs.
5. Traveler’s cheque: A traveler’s cheque is a printed cheque of a specific
denomination. The cheque may be purchased by a person from the bank after
making the necessary payments. The customer may carry the traveler’s cheque
while travelling. The traveler’s cheques are accepted in banks, hotels and other
establishments.
6. Credit Cards: Credit cards are another important means of making payments. The
Visa and Master Cards are operated by the commercial banks. A person can use a
credit card to withdraw cash from ATMs as well as make payments to trade
establishments.
In developing countries like India commercial banks perform certain promotional

(developmental) activities. For example, nationalized banks in India provide credit to the top
priority sectors of the economy such as agriculture, and small-scale and cottage industries.
In this way commercial banks help to promote the socio-economic development of the
country.
7.5 Functions of Central Banks
The Reserve Bank is a central bank of India. It was established on April 1, 1935 in
accordance with the provisions of the Reserve Bank of India Act, 1934.
The Preamble of the Reserve Bank of India describes the basic functions of the Reserve
Bank as "...to regulate the issue of Bank Notes and keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency and credit system
of the country to its advantage."
Functions of a Central Bank:
A central bank performs the following functions,
1. Regulator of Currency:
The RBI is the bank of issue. It has the monopoly on note issue. Notes issued by it circulate
as legal tender money. It has its issue department which issues notes and coins to
commercial banks. Coins are manufactured in the government mint but they are put into
circulation through the central bank.
Central banks follow different methods of note issue in different countries. The central bank
is required to keep a certain amount of gold and foreign government securities against the
issue of notes.
The monopoly on issuing of notes vested in the central bank ensures uniformity in the notes
issued, which helps in facilitating exchange and trade within the country. It brings stability in
the monetary system and creates confidence among the public. The central bank can
restrict or expand the supply of cash according to the requirements of the economy. Thus it
provides elasticity to the monetary system. By having a monopoly on note issue, the central
bank also controls the banking system by being the ultimate source of cash. Last but not
the least, by entrusting the monopoly of note issue to the central bank, the government is
able to earn profits from printing notes whose cost is very low as compared with their face
value.
2. Banker, Fiscal Agent and Adviser to the Government:
Central banks everywhere act as bankers, fiscal agents and advisers to their respective
governments. As banker to the government, the central bank keeps the deposits of the
central and state governments and makes payments on behalf of governments. But it does
not pay interest on governments deposits. It buys and sells foreign currencies on behalf of
the government.
It keeps the stock of gold of the government. Thus it is the custodian of government money
and wealth. As a fiscal agent, the central bank makes short-term loans to the government
for a period not exceeding 90 days. It floats government loans, pays interest on them, and
finally repays them on behalf of the government. Thus it manages the entire public debt.
Whenever the government is in need of money, it issues a postdated security to the RBI
and borrows money against it. The RBI in tern sells these postdated securities to the
commercial banks. Therefore, the amount borrowed from the RBI is actually borrowed from
the public, because commercial banks actually take public’s saving as deposits. The central
bank also advises the government on such economic and money matters as controlling
inflation or deflation, devaluation or revaluation of the currency, deficit financing, balance of
payments, etc. The Central banks all over the world operate as bankers to the government
not only because it may be more convenient and economical to the government, but also
because of the intimate connection between public finance and monetary affairs.
3. Custodian of Cash Reserves of Commercial Banks:
Commercial banks are required by law to keep reserves equal to a certain percentage of
both time and demand deposits liabilities with the central banks. It is on the basis of these
reserves that the central bank transfers funds from one bank to another to facilitate the
clearing of cheques. Thus the central bank acts as a custodian of the cash reserves of
commercial banks and helps in facilitating their transactions. There are many advantages of
keeping the cash reserves of the commercial banks with the central bank.
Firstly, the centralization of cash reserves in the central bank is a source of strength to the
banking system of a country.
Secondly, centralized cash reserves can serve as the basis of a large and more elastic
credit structure than if the same amount were scattered among the individual banks.
Thirdly, centralized cash reserves can be utilized fully and most effectively during periods of
seasonal strains and in financial crises or emergencies.
Fourthly, by varying these cash reserves the central bank can control the credit creation by
commercial banks. During tight monetary policies, the RBI increases the CRR, so that
banks are left with lesser cash for lending to private borrowers.
Lastly, the central bank can provide additional funds on a temporary and short term basis to
commercial banks to overcome their financial difficulties.
4. Custody and Management of Foreign Exchange Reserves:
The central bank keeps and manages the foreign exchange reserves of the country. It is an
official reservoir of gold and foreign currencies. It sells gold at fixed prices to the monetary
authorities of other countries. It also buys and sells foreign currencies at international
prices. Further, it fixes the exchange rates of the domestic currency in terms of foreign
currencies. If it wants to make dolor cheaper, then it will start selling dollors, and if wants to
make rupees cheaper, then it will start buying dollors.
It holds these rates within narrow limits in keeping with its obligations as a member of the
International Monetary Fund and tries to bring stability in foreign exchange rates. Further, it
manages exchange control operations by supplying foreign currencies to importers and
persons visiting foreign countries on business, studies, etc. in keeping with the rules laid
down by the government.
5. Lender of the Last Resort:
By granting accommodation in the form of credits to the commercial banks, and financial
institutions, the central bank acts as a lender of the last resort.
The central bank lends to such institutions in order to help them in times of stress so as to
save the financial structure of the country from collapsing. It acts as a lender of the last
resort through discounting houses on the basis of treasury bills, government securities and
bonds at the RBI base rate.
The other method is to give temporary accommodation to the commercial banks or discount
houses directly at the market rate. Thus the central bank as lender of the last resort is a big
source of cash and also influences prices and market rates.
6. Clearing House for Transfer and Settlement:
As bankers’ bank, the central bank acts as a clearing house for transfer and settlement of
mutual claims of commercial banks. Since the central bank holds reserves of commercial
banks, it transfers funds from one bank to other banks to facilitate clearing of cheques. This
is done by making transfer entries in their accounts on the principle of book-keeping. To
transfer and settle claims of one bank upon others, the central bank operates a separate
department in big cities and trade centers. This department is known as the “clearing
house” and it renders the service free to commercial banks.
When the central bank acts as a clearing agency, it is time-saving and convenient for the
commercial banks to settle their claims at one place. It also economizes the use of money.
It is not only a means of economizing cash and capital but is also a means of testing at any
time the degree of liquidity which the community is maintaining.
7. Controller of Credit:
The most important function of the central bank is to control the credit creation power of
commercial bank in order to control inflationary and deflationary pressures within this
economy. For this purpose, it adopts quantitative methods and qualitative methods.
Quantitative methods aim at controlling the cost and quantity of credit by adopting bank rate
policy, open market operations, and by variations in reserve ratios (CRR and SLR) of
commercial banks.
Qualitative methods control the use and direction of credit. These involve selective credit
controls and direct action. By adopting such methods, the central bank tries to influence
and control credit creation by commercial banks in order to stabilize economic activity in the
country.
Besides the above noted functions, the central banks in a number of developing countries
are entrusted with the responsibility of developing a strong banking system to meet the
expanding requirements of agriculture, industry, trade and commerce.
Accordingly, the central banks possess some additional powers of supervision and control
over the commercial banks. They are the issuing of licenses; the regulation of branch
expansion; to see that every bank maintains the minimum paid up capital and reserves as
provided by law; inspecting or auditing the accounts of banks; to approve the appointment
of chairmen and directors of such banks in accordance with the rules and qualifications; to
control and recommend merger of weak banks in order to avoid their failures and to protect
the interest of depositors; to recommend nationalization of certain banks to the government
in public interest; to publish periodical reports relating to different aspects of monetary and
economic policies for the benefit of banks and the public; and to engage in research and
train banking personnel etc..
7.6 Features of Money
General Acceptability:-
The main quality of good money is its general acceptability. It should be commonly
acceptable for the sale and purchase of goods and services. Anything, which is acceptable
in a certain payment but not generally acceptable, cannot be regard as good money. If
people lose confidence in money and refuse to accept it in payments, it will not work as
money any further. It practically happened in Kuwait during the gulf war, when people
refused to accept Kuwaiti Dinars in payments.
Stability of Value:-
Good money is that whose value is fairly stable. Frequent changes in the value of money
will inject the element of instability in economy and people will lose confidence in it.
Moreover, money is a standard for measuring the values of other goods and services. If its
own value is not stable, how can it measure the values of other goods properly?
Portability:-
Good money should have the quality of portability. It is possible only if it contains huge
value in small bulk. This quality of money makes best use of money possible. Paper money
is considered good money as it can be shifted easily from one place to another. The advent
of internet has phenomenally increased its portability.
Divisibility:-
Another quality of good money is that it should be capable of making small purchases. It is
possible only if the money is divisible into small units.
When money is divisible into small units, the consumer will get maximum satisfaction with
his limited income by equating the marginal utility of all the purchased commodities. Paper
money possesses this quality. A thousand rupee note can be changed into the notes of
small denominations. It enables a person to make small purchases.
Durability:-
Good money is that which is durable and long lasting. It should not deteriorate rapidly with
the passage of time. Gold and silver coins are more durable as compared to paper money.
A paper can last only for few months if it remains in circulation and a coin can work as a
medium of exchange for many years.
Storability:-
Money should be storable without any fall in value. The value of money should not
depreciate with the passage of time. This quality of money will encourage savings and
investment.
Communicability:-
Communicability is an essential quality of good money. An ordinary person should be able

to judge the correctness of money. It is possible only if the various units of money are
identical. Paper notes and modern coins of different denominations are identical in size and
color; therefore they can be recognized very easily.
Money Supply
They're basically measures of how much "portable" wealth exists at a certain minimum level
of liquidity (convertibility into cash).
M0 is material currency (cash itself); all notes, coins, specie and bearer certificates
convertible on demand (which includes, by definition, depositor reserves of banks which
must be kept in physical cash).
M1 includes M0 plus the balance of all deposit accounts which can be instantly converted
into cash of equal value (known as "cash equivalent"). This is more than M0 (up to 10 times
M0 in fact) because a fundamental principle of economics is that there doesn't have to be
enough paper money in existence to cover everyone's bank deposits, because the entire
economy won't want their accounts cashed and closed at the same time. So, M1 includes
some "fake money" (created by bank deposits), but in the working economy it changes
hands as if it were physical cash.
M2 is M1 plus all other depositor accounts that can be readily (within 30 days) converted to
physical cash of equal value (known as "near-cash"). This includes all savings, money
market etc. accounts, and also certain short-term investments. So, this is wealth that may
not be instantly convertible, but can be guaranteed to retain its worth during a conversion
happening very soon. This measure of money is not commonly referenced anymore
because the 30-day period is seen as arbitrary; if there's any restriction on conversion to
cash, it's not guaranteed to be "instantly available" and so it is not considered as a cash
equivalent; any subdivision beyond that is just a function of time.
M3 is M2 plus all other investment instruments that can be converted into cash, but which
may have significant restrictions on a timely conversion and/or a lack of guarantee that the
investment's stated worth will be retained in the conversion to cash. So, M3 also includes
the worth of the equity and bonds markets denominated in a particular currency, as well as
the value of some types of futures contracts and options and virtually all "institutional"
investments (as regulations often prohibit the "dumping" of such large holdings onto the
market in one transaction, and even if allowed would likely not result in an equitable
conversion to cash). It's the widest classification of "money" typically used, as beyond this
point it becomes hard to tell the real difference, in a worth and convertibility perspective,
between stores of value and fixed assets.
Type of money M0 MB M1 M2 M3 MZM

Notes and coins in circulation (outside Federal Reserve Banks and the
✓ ✓ ✓ ✓ ✓ ✓
vaults of depository institutions) (currency)
Notes and coins in bank vaults (Vault Cash) ✓
Reserve Bank credit (statutory required reserves and excess reserves
✓
not physically present in banks – maintained with RBI)
Traveller’s checks of non-bank issuers ✓ ✓ ✓ ✓
Demand deposits ✓ ✓ ✓ ✓
Other checkable deposits (OCDs), which consist primarily of
Negotiable Order of Withdrawal (NOW) accounts at depository ✓ ✓ ✓ ✓
institutions and credit union share draft accounts.
Savings deposits ✓ ✓ ✓
Time deposits less than Rs100,000 and money-market deposit accounts
✓ ✓
for individuals
Large time deposits, institutional money market funds, short-term
✓
repurchase and other larger liquid assets
All money market funds ✓
M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is
referred to as the monetary base, or narrow money.
MB: is referred to as the monetary base or total currency. This is the base from which other
forms of money (like checking deposits) are created and is traditionally the most liquid
measure of the money supply.
M1: Bank reserves are not included in M1.
M2: Represents M1 and "close substitutes" for M1. M2 is a broader classification of money
than M1. M2 is a key economic indicator used to forecast inflation.
M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the
RBI. However, there are still estimates produced by various private institutions.
MZM: Money with zero maturity. It measures the supply of financial assets redeemable at
par on demand. Velocity of MZM is historically a relatively accurate predictor of inflation.
The ratio of a pair of these measures, most often M2 / M0, is called an (actual, empirical)
money multiplier.
Fractional-reserve banking
CRR (Cash Reserve Ratio) - As per the latest RBI guidelines, 4% of the total bank deposits
are supposed to be maintained in cash or cash equivalents for taking care of withdrawal
pressures from depositors.
SLR (Statutory Liquidity Ratio) - As per the latest RBI guidelines, 21.5% of the total bank
deposits are supposed to be used for giving loan to the government. This loan is initially
given by the RBI in exchange of a promissory note issued by the government. These
promissory notes are called securities or gilts. Commercial banks purchase these securities
from the RBI at the market rates.
The balance 76.5% of the total deposits is allowed to be used for giving loans by the
commercial banks. If one banks loan becomes another bank’s deposit, a large sum of
money gets created in the banking system. This is called fractional banking. The different
forms of money in government money supply statistics arise from this practice of fractional-
reserve banking. Whenever a bank gives out a loan in a fractional-reserve banking system,
a new sum of money is created. This new type of money is what makes up the non-M0
components in the M1 to M3 statistics.
In short, there are two types of money in a fractional-reserve banking system:

o central bank money (obligations of a central bank, including currency and central bank
depository accounts)
o commercial bank money (obligations of commercial banks, including checking accounts
and savings accounts)
In the money supply statistics, central bank money is MB while the commercial bank money
is divided up into the M1 to M3 components. Generally, the types of commercial bank
money that tend to be valued at lower amounts are classified in the narrow category of M1
while the types of commercial bank money that tend to exist in larger amounts are
categorized in M2 and M3, with M3 having the largest proportion.
In the India, a bank's reserves consist of Indian currency held by the bank (also known as
"vault cash") plus the bank's balances in Reserve Bank accounts. For this purpose, paper
currency on hand and balances in RBI accounts are interchangeable (both are obligations
of the government). Reserves may come from any source, including the government funds
market, deposits by the public, and borrowing from the RBI itself.
A reserve requirement is a ratio a bank must maintain between deposit liabilities and
reserves. Reserve requirements do not apply to the amount of money a bank may lend out.
The ratio that applies to bank lending is its capital requirement or capital adequacy ratio.
How much own capital the bank should have for every rupee it lends out.
7.7 Capital Markets
The Functions of the Financial System
o The Financial system facilitates transfer of resources across time, across sectors, and
across regions. This allows investment to be assigned to most productive user, rather
than wasting up where it is least needed. Another example is Japan, which has a high
saving rate. It transfers resources to China, India and many other countries, which have
better investment opportunities. This transfer occurs through both loans and direct
foreign investments.
o The financial system manages risks for the economy. It transfers risks from individuals
and individual business entities, to the insurance companies in return for a premium.
The insurance company in return transfers its risk to other insurance companies, and
shares the premium with them.
o The financial system pools and subdivides funds depending upon the need of the
individual saver or investor in the form of mutual funds.
o The financial system performs an important clearinghouse function, which facilitates
transactions between payers (buyers) and payees (sellers).
Financial Assets
o Money is a very special asset. It gets its value through the physical assets it can buy.
o Savings accounts are deposits with banks, usually guaranteed by governments.
o Government securities are bills and bonds (loans) of the central, state, and local
governments. They guarantee repayment of principal on maturity and pay interest along
the way. These securities are considered the safest of all investment options.
o Equities (shares) are ownership rights to companies. They yield dividends, which are
paid from the companies’ profits.
o Financial derivatives are new forms of financial instruments whose values are based on
or derived from the values of other assets. One important example is a stock option,
which is an instrument whose value depends upon the value of the stock to which it is
benchmarked.
o Pension funds represent ownership in the assets that are held by companies or pension
plans. Workers and companies contribute to these funds during working years, and the
funds are then drawn down to pay pensions during retirement.
Real vs Nominal Interest Rates
The nominal interest rate (sometimes also called the money interest rate) is the interest rate
on money in terms of money.
The real interest rate is corrected for inflation and is calculated as the nominal interest rate
minus the rate of inflation.
Any Capital Market has two logical

segments viz. primary market and
secondary market.
A primary market is that segment

of the market where new securities
are issued. These issues may not
just be equity issues (shares), they
can also be debt securities issued
by companies in the form of bonds
and debentures.
However, a secondary market is that segment of the market where trading (buying and
selling) of securities issued in primary market takes place.
An efficient capital market of a country has many important players each playing a vital role
in smooth functioning of the market. Above is the pictorial representation of the constituents
in any mature capital market.
Stock Exchange:
A stock exchange is a body which facilitates trading of securities (shares, bonds,

debentures, derivatives, and currencies). In simple terms it's a place where above
mentioned financial instruments are bought and sold. There are a number of major stock
exchanges around the world and each of them plays a part in determining the overall
economic condition of the world. National Stock Exchange (NSE) and Bombay Stock
Exchange (BSE) are the major stock exchanges of India.
The equities (shares) and debentures (a type of unsecured debt) of companies listed on
these exchanges are bought and sold on these exchanges at prices governed by the forces
of demand and supply. Stock exchanges basically serve as primary markets where
corporations, governments, municipalities, and other incorporated bodies can raise capital
by attracting savings of the investors for raising their production capacities; and secondary
markets where investors can sell their securities (shares) to other investors for cash, thus
reducing the risk of investment and maintaining liquidity in the system. Stock exchanges
impose stringent rules, listing requirements, and statutory requirements that are binding on
all listed and trading parties. The shares of a few Indian companies are also traded on
foreign stock exchanges.
Merchant Bankers:
A merchant banker is responsible for offering consultation services for mergers and
acquisition, capital raising via equity or debt, giving advice to businesses that plan to enter
the international market and helping small businesses expand for a bigger target market.
Investors:
Investors are the most important part of the capital market as they are the ones who invest
their savings while subscribing to the financial instruments issued by the business through
like IPOs (Initial Public Offering), FPOs (Follow-on Public Offering), Right Issues etc.
Stock Brokers:
A stock broker is responsible for buying and selling securities on behalf of both retail and
individual clients through a stock exchange. Brokers are the members of the stock
exchanges. One cannot directly trade securities on stock exchanges and have to do it
through the registered stock brokers.
Depositories:
The financial instruments issued by the issuers are issued in dematerialized (electronic)
from. A securities depository is like a bank which maintains investor's accounts having
securities such as shares, mutual fund units, bonds etc. The primary function of a
depository is to facilitates the exchange of securities and maintain the book entry. In simple
words a depository helps in transferring the ownership of securities from one account to
another when trade takes place between the buyer and the seller of the security. The
National Securities Depository Ltd (NSDL) and the Central Depository Services India Ltd
(CDSL) are both share depositories (A place where shares are stored) in India.
Depository Participants:
As an investor you never deal with a depository directly but indirectly through a depository
participant (DP) which is a member of the depository. All major banks and stock brokers are
members of country's security depository. For example ICICI Securities, India Infoline,
Reliance Money, Religare Capital etc are depository participants of NSDL and CSDL in
India.
Market Regulator:
Like any major industry all mature capital markets have respective regulators such as SEC
in USA, SEBI in India.
Issuers:
Issuers (businesses, governments, municipal corporations) are the issuers of securities like
shares, bonds etc. They raise capital from investors and usually employ merchant bankers
who advise them on the timing, pricing, market etc.
A capital market deals with medium term and long term funds. It refers to all facilities and
institutional arrangements for borrowing and lending term funds (medium term and long
term). The demand for long term funds comes from private business corporations, public
corporations and the government. The supply of funds comes largely from individual and
institutional investors, banks and special industrial financial institutions and Government.
What is a stock market index and how is it calculated?
A stock market index is a numerical representation of the prices of a basket (portfolio) of

stocks which is used to track the collective performance of the economy. NIFTY is the
weighted average of 50 major shares traded on the National Stock Exchange (NSE) and
SENSEX is the weighted average of 30 major shares traded on the Bombay Stock
Exchange (BSE). The main purpose of an index is to track the performance of stocks which
represents the entire market or the economy.
Almost all major stock exchanges in the world have their own stock markets and indices to
track the performance of their economy and specific sectors.
Gilt Market
The postdated assurance certificates, which are issued by the government for its loan from
the RBI are called gilts. The RBI in tern sells these securities to commercial banks. Gilt
market refers to the market for these securities, which carry fixed rates of interest, and
which are issued at face value. The commercial banks are supposed to maintain certain
percentage of their deposits as Statutory Liquidity Ratio (SLR) in the form of government
securities. Commercial banks buy and sell these securities to maintain this ratio. The RBI
plays an important role in facilitating these transactions through gilt market. At present this
SLR is 21.5% and CRR is 4%, and the repo rate, the interest rate at which the RBI lend
money to banks is 6.5% per annum.
Development Financial Institutions
Development financial institutions are set up to meet the medium and long-term
requirements of industry, trade and agriculture. Functionally, all-India institutions can be
classified as term-lending institutions (IFCI Ltd., IDBI, IDFC Ltd., IIBI Ltd.) extending long-
term finance to different industrial sectors, and refinancing institutions (NABARD, SIDBI,
NHB) extending refinance to banking as well as non-banking intermediaries.
Financial Intermediaries
Financial Intermediaries include merchant banks, Mutual Funds (Mutual fund is an

investment vehicle that is made up of a pool of funds collected from many investors for the
purpose of investing in securities such as stocks, bonds, money market instruments and
similar assets.), leasing companies etc. they help in mobilizing savings and supplying funds
to capital market.
Foreign Capital
Indian government has liberalized the Foreign Direct Investment (FDI) and Foreign Portfolio
Investors (FPI) in the country. This not only brings in foreign capital in the country, but also
foreign technology which is important for economic development of the country. The capital
market makes it possible to attract foreign capital. Indian firms are able to attract capital
from overseas markets by way of bonds and securities.
7.8 National Income
The Economy of India is the seventh-largest economy in the world measured by nominal
GDP and the third-largest by purchasing power parity. The country is classified as a newly
industrialized country, one of the G-20 major economies, a member of BRICS and a
developing economy with an average growth rate of approximately 7% over the last two
decades. Maharashtra is the wealthiest Indian state and has an annual GDP of US$220
billion, nearly equal to that of Portugal, and accounts for 12% of the Indian GDP followed by
the states of Tamil Nadu (US$140 billion) and Uttar Pradesh (US$130 billion). India's
economy became the world's fastest growing major economy in the last quarter of 2014,
replacing the People's Republic of China.
The long-term growth prospective of the Indian economy is positive due to its young
population, corresponding low dependency ratio, healthy savings and investment rates, and
increasing integration into the global economy. The Indian economy has the potential to
become the world's 3rd-largest economy by the next decade, and one of the largest
economies by mid-century. And the outlook for short-term growth is also good as according
to the IMF, the Indian economy is the "bright spot" in the global landscape. India also
topped the World Bank’s growth outlook for 2015-16 for the first time with the economy
having grown 7.6% in 2015-16 and expected to grow 8.0%+ in 2016-17.
India has one of fastest growing service sectors in the world with annual growth rate of
above 9% since 2001, which contributed to 57% of GDP in 2012-13. India has become a
major exporter of IT services, BPO services, and software services with $167.0 billion worth
of service exports in 2013-14. It is also the fastest-growing part of the economy. The IT
industry continues to be the largest private sector employer in India. India is also the fourth
largest start-up hub in the world with over 3,100 technology start-ups in 2014-15. The
agricultural sector is the largest employer in India's economy but contributes to a declining
share of its GDP (17% in 2013-14). India ranks second worldwide in farm output. The
Industry sector has held a constant share of its economic contribution (26% of GDP in
2013-14). The Indian automobile industry is one of the largest in the world with an annual
production of 21.48 million vehicles (mostly two and three wheelers) in FY 2013-14. India
has $600 billion worth of retail market in 2015 and one of world's fastest growing E-
Commerce markets.
India's two major stock exchanges, Bombay Stock Exchange and National Stock Exchange
of India, had a market capitalization of US$1.71 trillion and US$1.68 trillion respectively as
of Feb 2015, which ranks 11th & 12 largest in the world respectively according to the World
Federation of Exchanges. India is also a home to world's third largest billionaires pool with
111 billionaires in 2016 and fourth largest number of ultra-high-net-worth households that
have more than 100 million dollars.
Gross Domestic Product (GDP)

IMF states that "GDP measures the monetary value of final goods and services - that is,
those that are bought by the final user - produced in a country in a given period of time (say
a quarter or a year)." Therefore, gross domestic product is the money value of all final
goods and services produced within the domestic territory of a country during a year.
This is the monetary value of all the finished goods and services produced within a
country's borders in a specific period of time. GDP includes all private and public
consumption, government consumption, investments (in capital goods like factories,
machinery, buildings, roads, hospitals, schools and colleges etc.) and net exports (exports
minus imports) that occurs
within a defined territory.
Put simply, GDP is a broad
measurement of a nation’s
overall economic output.
Total GDP can also be
broken down into the
relative contribution of each
industry or sector of the
economy to the total
economic output.
Gross domestic product
can be calculated using the
formula GDP = C + G + I + NX
Where, C is equal to all private consumption, or consumer spending, in a nation's economy,
G is the sum of government’s spending, I is the sum of all the country's investment,
including businesses capital expenditures and NX is the nation's total net exports,
calculated as total exports minus total imports (NX = Exports - Imports).
GDP is commonly used as an indicator of the economic health of a country, as well as a
gauge of a country's standard of living. Since the mode of measuring GDP is uniform from
country to country, GDP can be used to compare the productivity of various countries with a
fairly high degree of accuracy. Adjusting for inflation from year to year allows for the
seamless comparison of current GDP measurements with measurements from previous
years or quarters. In this way, a nation’s GDP from any period can be measured as a
percentage relative to previous years or quarters. When measured in this way, GDP can be
tracked over long spans of time and used in measuring a nation’s economic growth or
decline, as well as in determining if an economy is in recession.
GDP’s popularity as an economic indicator in part stems from its measuring of value added
through economic processes. For example, when a ship is built, GDP does not reflect the
total value of the completed ship, but rather the difference in values of the completed ship
and that of the materials used in its construction. Therefore, if a ship is costing Rs 100, and
if the cost of the inputs is Rs 75, then the economic value added is Rs 25. Measuring total
value instead of value added would greatly reduce GDP’s functionality as an indicator of
progress or decline, specifically within individual industries and sectors. GDP can also be
used as an economic indicator of the failure or success of the economic policies of the
government. For example, India’s GDP increased by 7.9% in year 2015-16, while China’s
increased by 7.7%, Japan’s increased by 1.6%, and that of UK increased by 1.7% during
the same period.
Services sector is the largest sector of India. Gross Value Added (GVA) at current prices for
Services sector is estimated at 61.18 lakh crore INR in 2014-15. Services sector accounts
for 52.97% of total India's GVA of 115.50 lakh crore Indian rupees. With GVA of Rs. 34.67
lakh crore, Industry sector contributes 30.02%. While, Agriculture and allied sector shares
17.01% and GVA is around of 19.65 lakh crore INR.
Gross National Product (GNP)
At any given point of time, any country will have a part of its capital, private as well public,
deployed in foreign countries. For example, ONGC operated oil fields in Russia, and Tata’s
produce steel in the UK. All these investments will generate profits, which will be repatriated
to India in the form of dividends. Gross National Product is the total market value of all final
goods and services produced annually in a country plus net factor income from abroad.
Thus, GNP is the total measure of the flow of goods and services at market value resulting
from current production during a year in a country including net factor income from abroad.
The GNP can be expressed as GNP = GDP + NFIA (Net Factor Income from Abroad)
or GNP=C + I + G + ( X – M ) + NFIA
Net National Product (NNP)

As the infrastructure gets used up in production, it’s economic worth drops from year to
year, because its efficiency goes down due to wear and tear, or a new technology might
render the existing infrastructure uneconomical or useless for production. (For example,
machinery for producing black & white televisions) Therefore, the GNP has to be reduced
by the extent to which the worth of the infrastructure has dropped. This drop in economic
worth of the infrastructure is called depreciation. Net National Product is the market value of
all final goods and services after deducting depreciation. It is also called National Income at
market price. When charges for depreciation are deducted from the gross national product,
we get it. Thus,
The NNP can be expressed as NNP = GNP - Depreciation
or NNP = C + I + G + (X-M) + NFIA - Depreciation
National Income (NI)
As the cost of capita, that is the interest paid to the lenders, and taxes paid on the goods
are sheer ‘on paper’ additions of economic value, they have to be deducted from the NNP
to know the actual economic value addition, called National Income. Similarly, many
governments gives cash assistance to a section of their underprivileged population (food
through PDS or LPG) or to encourage a specific industry (solar water heaters and solar
power plants), is called a subsidy. Because of this subsidy, the economic worth of the
output appears lower than what it actually is. Therefore, the subsidy component also needs
to be added to NNP while calculating the National Income. National Income is also known
as National Income at factor cost. National income at factor cost means the sum of all
incomes earned by resources’ suppliers on their contribution of land, labor, capital and
managerial abilities used for this year’s production. Therefore, the sum of the incomes
received by the factors of production in the form of rent, wages, interest and profit is called
the National Income.
The NI can be expressed as NI = NNP + Subsidies - Interest and Taxes
Per Capita Income (PCI)

Per capita income or average income measures the average income earned per person in
a country in a specified year. It is calculated by dividing the National Income by its total
population.
The PCI can be expressed as PI = NI / Total Population
India is 7th largest economy in the world with its National Income of $ 2027964 million, but
134th in terms of per capita income $1617. Whereas, United States tops the list because of
its National Income of $ 17611491 million, but comes 6th with per capita income of $ 55837.
Therefore, India’s higher population makes its per capita income only 3% of United States.
Disposable Income (DI)

The income left after the payment of direct taxes from personal income (called personal
income tax) is called Disposable Income. Disposable income means actual income which
can be spent on consumption by individuals and families. Thus, it can be expressed as:
The DI can be expressed DI = PCI - Direct Taxes
DI = Consumption Expenditure + Household Savings
7.9 Overview of Macroeconomics
Macroeconomics is the study of the behavior of the economy as a whole.
These goals frame the central macroeconomic questions:
1. Why do output and employment sometimes fall, and how can unemployment be
reduced?
2. What are the sources of price inflation, and how can it be kept under control?
3. How can a nation increase its rate of economic growth?
All economies face inevitable tradeoffs among these goals. Increasing the rate of growth of
output over the long run may require greater investment in education and capital, but higher
investment requires lower current consumption of items like food, clothing, and recreation.
Additionally, policy makers are sometimes forced to rein in the economy through
macroeconomic policies when it grows too fast, or when unemployment falls too low, in
order to prevent rising inflation.
Objectives and Instruments of Macroeconomics

Output - The ultimate objective of economic activity is to provide the goods and services
that the population desires.
The most comprehensive measure of the total output in an economy is the gross domestic
product (GDP). GDP is the measure of the market value of all final goods and services –
cars, TVs, Smartphones, and so on – produced in a country during a year. There are two
ways to measure GDP. Nominal GDP is measured in actual market prices. Real GDP is
calculated in constant or invariant prices.
Real GDP is the most closely watched measure of output; it serves as the carefully
monitored pulse of a nation’s economy.
Despite the short-term fluctuations seen in business cycles, the economies generally exhibit
a steady long-term growth in real GDP and an improvement in living standards; this process
is known as economic growth.
Potential GDP represents the maximum sustainable level of output that the economy can
produce. When an economy is operating at its potential, there are high levels of utilization
of the labor force and the capital stock. When output rises above potential output, price
inflation tends to rise, while a below-potential level of output leads to high unemployment.
Potential output is determined by the economy’s productive capacity. It depends upon the
inputs available (capital, labor, land, etc.) and the economy’s technological efficiency.
Potential GDP tends to grow steadily because inputs like labor and capital and the level of
technology change quite slowly over time. By, contrast, actual GDP is subject to large
business-cycle swings if spending patterns change sharply.
During business downturns, actual GDP falls below its potential and unemployment rises. A
recession is a period of significant decline in total output, income, and employment, lasting
from 6 months to a year and more, and marked by widespread contractions in many sectors
of the economy. A severe and protracted downturn is called a depression. Output can be
temporarily above potential output during booms and wartime as capacity limits are
strained, but the high utilization rates bring rising inflation and are usually brought to an end
by monetary or fiscal policy.
High Employment or Low Unemployment - Of all the macroeconomic indicators,
employment and unemployment are most directly felt by individuals. People want to be able
to get high-paying jobs without searching or waiting too long, and they want to have job
security and good benefits. In macroeconomic terms, these are the objectives of high
employment.
The unemployment rate tends to reflect the state of the business cycle: when output is
falling, the demand for labor falls and the unemployment rate rises.
Price Stability - The third macroeconomics objective is to maintain price stability. This term
means that the overall price level is either unchanged or rising very slowly.
To track prices, government statisticians construct price indexes, or measures of the overall
price level. An important example is the consumer price index (CPI), which measures the
average price of goods and services bought by consumers.
A deflation occurs when prices decline (which means that the rate of inflation is negative).
At the other extreme is a hyperinflation, a rise in the price level of a thousand or a million
percent a year.
Price stability is important because a smoothly functioning market system requires that
prices accurately and easily convey information about relative scarcities.
The tools of Macroeconomic Policy

Governments have certain instruments that they can use to alter the macroeconomic
activity.
Fiscal Policy - Fiscal Policy denotes the use of taxes and government expenditures.
Government expenditures come in two distinct forms. First there are government
purchases. These comprise spending on goods and services – purchase of defense
equipment, construction of roads, salaries for government employees, and so forth. In
addition, there are government transfer payments or subsidies, which boost the incomes of
targeted groups such as elderly or the unemployed.
The other part of fiscal policy, taxation, affects the overall economy in two ways. To begin
with, taxes affect people’s incomes. By leaving households with more or less disposable or
spendable income, taxes tend to affect the amount people spend on goods and services as
well as the amount of private savings. Private consumption and saving have important
effects on investment and output in the short and long run.
Monetary Policy - The second major instrument of macroeconomic policy is monetary
policy, which the government conducts through managing the nation’s money supply, credit
creation, and banking system.
By changing the money supply, the RBI can influence many financial and economic
variables, such as interest rates, stock prices, housing prices, and foreign exchange rates.
Restricting the money supply leads to higher interest rates and reduced investment, which,
in turn, causes a decline in GDP and lower inflation. If the central bank is faced with a
business downturn, it can increase the money supply and lower interest rates to stimulate
economic activity.
8. Taxation
8.1 Direct and indirect taxes
Principles of Taxation
1. The benefit principle: Individuals should be taxed in proportion to the benefit they
receive from government programs. Just as people pay personal money in
proportion to their consumption of goods and services, person’s taxes should be
proportional to his or her usage of public goods and services.
2. The ability-to-pay principle: The amount of taxes people pay should be proportional
to their income or wealth. The higher the wealth or income, the higher will be the
taxes. The ability-to-pay principle raises funds from higher-income groups to
subsidize the consumption of poorer groups.
For example, if the construction of a new bridge is funded by tolls on the bridge, that’s a
reflection of the benefit principle, since you pay for the bridge only when you use it. But if
the bridges were funded from income-tax collections, that would be an example of the
ability-to-pay principle, because your contribution is happening, irrespective of whether you
are using the bridge or not..
Progressive Taxes: With progressive taxes, individuals with higher incomes pay higher
percentage of their incomes as tax. In India, a person pays no income tax, if his taxable
income is less than Rs 2.5 Lakh; but pays 30% of his income as tax if his income is above
Rs 10 Lakh. Therefore, not only do the higher-income families pay a larger income tax, but
it in fact they pay a higher fraction of their income as tax.
Regressive Taxes: Regressive tax takes a larger fraction of income in taxes from poor
families than it does from rich families. The goods and services tax is paid on the goods
and services consumed by individuals or families. As the consumption remains more or less
same for any individual or a family, the poorer end up paying higher percentage of their
income as goods and services tax, than the rich people.
Taxation System in India
India has a well-developed tax structure with clearly demarcated authorities between
Central Government, State Governments and the local bodies (Municipal corporations /
Councils).
Central Government levies taxes on income (except tax on agricultural income, which the
State Governments are entitled to), customs duties, central excise and service tax.
Value Added Tax (VAT), stamp duty, state excise duty, land revenue duty and professional
tax are levied by the State Governments.
Local bodies are entitled to levy tax on properties, octroi and charge for for utilities like
water supply, drainage etc.
Indian taxation system has undergone tremendous reforms during the last seven decades.
The tax rates have been rationalized and tax laws have been simplified resulting in better
tax compliance, wider tax base, ease of tax payment and better enforcement. The process
of rationalization of tax administration is an ongoing process in India.
Direct Taxes
In case of direct taxes, the tax is collected directly in the name of the person or a
commercial establishment. Income tax and wealth tax are the examples of the direct taxes.
Here the tax burden directly falls on the individual taxpayer.
Income tax
According to Income Tax Act 1961, every person, who is an assessee and whose total
income exceeds the maximum exemption limit prescribed in the union budget, shall be
obliged to pay the income tax at the rates prescribed in the Finance Act. Such income tax
shall be paid on the total income of the previous financial year in the relevant assessment
year. For taxation purpose, the Financial Year (F.Y.) in India is 1 st April of the current
calendar year to 31st March of next calendar year, with the Assessment Year (A.Y.) from 1st
April of the next calendar year to 31st March of next of the next calendar year. Therefore
A.Y. for F.Y. 2016-17 (1st Apr 2016 to 31st March 2017) will be 2017-18 (1st Apr 2017 to 31st
March 2018).
Assessee means a person or a commercial establishment who is liable to pay income tax
under the Income Tax Act. The income tax department assigns a Permanent Account
Number (PAN) to each assessee. Commercial establishments, who are supposed to deduct
the tax of their employees and suppliers before making the payment, are issued Tax
Deduction and Collection Account Number (TAN) in addition to PAN. It is mandatory for any
commercial establishment to deduct the tax at source (TDS), and deposit the same in the
account of the income tax department.
Income tax is an annual tax imposed separately for each assessment year. It is mandatory
for every assessee to file his income tax returns for any financial year before 31 st July of
that year. That is within four months after the financial year closes.
It is common misconception amongst Merchant Navy professionals (mariners) that they are
not required to file their income tax returns, because their entire income is exempted from
taxation in India. But, as per income tax statute, every person having a PAN is supposed to
file his or her income tax returns. There are various types of Income Tax Return (ITR) forms
available on the website of the income tax department. The assessee is supposed to
choose a right form for himself depending upon the sources of his income, and separately
show the income that is exempt from taxation in India. The declaration of their tax exempt
income in this way, keeps their income free from any income tax related litigations in future
and make high value purchases of future completely hassle-free.
The total income of an individual is determined on the basis of his residential status in India.
For tax purposes, an individual may be resident, non-resident or not ordinarily resident.
Resident
An individual is treated as resident in a financial year if he or she is present in India:
o For 182 days or more during the financial year or

o For 60 days during the financial year and 365 days during the preceding four financial
years. Individuals fulfilling neither of these conditions are treated as non-residents.
Not Ordinarily Resident
A resident who was not present in India for 730 days during the preceding seven years or
who was non-resident in nine out of ten preceding years is treated as not ordinarily
resident.
Non-Residents
Non-residents are taxed only on income that is received in India or if it arises or is deemed
to arise in India. A person not ordinarily resident is taxed like a non-resident Indian but is
liable to pay tax on income accruing abroad if it is from a business controlled in or a
profession set up in India.
Status Indian Income Foreign Income

Resident and ordinarily resident Taxable Taxable
Resident but not ordinary resident Taxable Not taxable
Non-Resident Taxable Not taxable
Personal Income Tax
Personal income tax is levied on the net taxable income of the assessee by Central
Government and is administered by Central Board of Direct taxes under the Ministry of
Finance in accordance with the provisions of the Income Tax Act.
Income Tax Slab Rates for FY 2016-17
Income tax slab for individual tax payers & HUF (less than 60 years old) (both men &
women)
Income Slab Tax Rate

Income up to Rs 2,50,000 No Tax
Income from Rs 2,50,000 – Rs 5,00,000 10%
Income from Rs 5,00,000 – 10,00,000 20%
Income more than Rs 10,00,000 30%
Surcharge: 12% of income tax, where total income exceeds Rs.1 crore.
Cess: 3% on total of income tax + surcharge.
Income tax slab for senior citizens (60 years old or more but less than 80 years old)

Income from Rs 3,00,000 – Rs 5,00,000 10%
Income from Rs 5,00,000 – 10,00,000 20%
Income tax slab for super senior citizens (80 years old or more)
Income up to Rs 5,00,000 No tax
Income from Rs 5,00,000 – 10,00,000 20%
Tax upon Capital Gains
Capital gains is the profit that the investor realizes when he sells the capital asset for a
price higher than its purchase price. The transfer of capital asset must be made in the
previous year. This is taxable under the head ‘Capital Gains’ and there must exist a capital
asset, transfer of the capital asset and profit or gains arising from the transfer.
A capital gains tax (CGT) is a tax on capital gains, the profit realized on the sale of a non-
inventory (stocked for consumption) asset that was purchased at a cost amount that was
lower than the amount realized on the sale. The most common capital gains are realized
from the sale of stocks, bonds, precious metals and properties like land & houses.
Capital Gain Tax on Property:
Selling a house attracts tax and it is charged on the amount gained from the sale and not
on the entire amount realized. If you sell the property in three years; that is within 36
months; then it is termed as a short-term capital gain and will be taxed directly as per the
income slab you fall under. It attracts a flat 20 percent tax.
The long-term gain arising from the sale of a capital asset is exempt under Section 54 and
54F if invested in purchase or construction of a house property subject to certain conditions.
To get the exemption, the taxpayer has to purchase the residential house within a period of
1 year before or 2 years after the transfer of the original house. Under construction
properties must be completed within 3 years from the date of transfer of the original house.
The investment on the house property must be situated in India. This will apply to the
assessment year 2015-2016 and for the subsequent years.
You can also save the tax by investing the capital gains in special Capital Gains Account
Scheme (CGAS) with the bank or invest in specified bonds such as Rural Electrification
Corp. Ltd. and National Highways Authority of India within 6 months from the date of sale of
the property.
For making it easy for taxation, the capital assets are classified into ‘Short-Term Capital
Asset; and ‘Long-Term Capital Asset’.
 Short-Term Capital Asset:
If the shares and securities are held by the taxpayer for a period not more than 36
months preceding the date of its transfer will be treated as a short-term capital asset.
However, for the securities on which the ‘Securities transaction Tax’ has been paid,
this period is 12 months.
 Long- Term Capital Asset:
If the taxpayer holds the shares and securities for a period exceeding 36 months
before the transfer is treated as a long-term capital asset. However, for the securities
on which the ‘Securities transaction Tax’ has been paid, this period is 12 months.
Tax on Capital Gains:
Calculation of tax is dependent upon the type of capital gain.
o Calculation of tax on short-term capital gains is simpler than that on long-term gains.
For short-term gains, the gain is added to the total income and then the income tax is
calculated based on the tax bracket of the assessee.
o Calculation of tax on long-term capital gains is a slightly trickier business. Since

long-term capital assets are held for longer periods, inflation also factors in while
computing tax on long-term capital gains. This is done by indexation.
Indexation is the process of adjusting prices based on a standard index so as to factor in

the inflation rate also while calculating profits earned on sale of assets. Indexation is
important because prices generally do not remain flat and tend to vary with time; hence,
computing profits based on the original price of an asset is not an accurate measure of
profit. Indexation takes into account the inflation and gives us a more reasonable figure for
long-term capital gains. The difference between the selling price and the inflation adjusted
cost, called indexed cost, is the real profit from the sale. The tax on this profit is then
calculated based on the tax bracket of the assessee.
There is an option of not going the complicated route of indexation and directly computing
capital gain tax. In this case, only 10% of the non-indexed capital gain is charged as tax.
Individuals are free to choose to use indexation and pay 20% tax or ignore indexation and
pay 10% on their capital gains.
Corporate tax
The taxability of a company's income depends on its domicile. Indian companies are
taxable in India on their worldwide income. Foreign companies are taxable on income that
arises out of their Indian operations, or, in certain cases, income that is deemed to arise in
India. Royalty, interest, gains from sale of capital assets located in India (including gains
from sale of shares in an Indian company), dividends from Indian companies and fees for
technical services are all treated as income arising in India.
Minimum Alternative Tax (MAT)
Normally, a company is liable to pay tax on the income computed in accordance with the
provisions of the income tax Act, but the profit and loss account of the company is prepared
as per provisions of the Companies Act. There were large number of companies who had
book profits as per their profit and loss account but were not paying any tax because
income computed as per provisions of the income tax act was either nil or negative or
insignificant. In such case, although the companies were showing book profits and
declaring dividends to the shareholders, they were not paying any income tax. These
companies are popularly known as Zero Tax companies. In order to bring such companies
under the income tax act net, section 115JA was introduced w.e.f assessment year 1997-
98.
Fringe Benefit Tax (FBT)
Fringe Benefit Tax (FBT) is an additional income tax payable by the employers on value of
fringe benefits provided or deemed to have been provided to the employees. Fringe
Benefits are defined as any privilege, service, facility or amenity directly or indirectly
provided by an employer to his employees (including former employees) by reason of their
employment and includes expenses or payments on certain specified heads.
Dividend Distribution Tax (DDT)
Any amount declared, distributed or paid by a domestic company by way of dividend shall
be chargeable to dividend tax. Only a domestic company (not a foreign company) is liable
to pay this tax. Tax on distributed profit is in addition to income tax chargeable in respect of
total income. It is applicable whether the dividend is interim or otherwise. Also, it is
applicable whether such dividend is paid out of current profits or accumulated profits.
Rate of dividend distribution tax to be raised from 12.5 per cent to 15 per cent on dividends
distributed by companies; and to 25 per cent on dividends paid by money market mutual
funds and liquid mutual funds to all investors.
Securities Transaction Tax (STT)
Securities Transaction Tax or turnover tax, as is generally known, is a tax that is levied on
taxable securities transaction (buying and selling of shares).
Wealth Tax
Wealth tax, in India, is levied under Wealth-tax Act, 1957. Wealth tax is a tax on the
benefits derived from property ownership. The tax is to be paid year after year on the same
property on its market value, whether or not such property yields any income.
Wealth tax is not levied on productive assets, hence investments in shares, debentures,
UTI, mutual funds, etc are exempt from it. The assets chargeable to wealth tax are Guest
house, residential house, commercial building, Motor car, Jewellery, bullion, utensils of
gold, silver, Yachts, boats and aircrafts, Urban land and Cash in hand (in excess of Rs
50,000 for Individual & HUF only).
Double Taxation Relief
Double Taxation means taxation of the same income of a person in more than one country.
This results due to countries following different rules for income taxation. There are two
main rules of income taxation i.e. (a) Source of income rule and (b) residence rule.
As per source of income rule, the income may be subject to tax in the country where the
source of such income exists (i.e. where the business establishment is situated or where
the asset / property is located) whether the income earner is a resident in that country or
not.
On the other hand, the income earner may be taxed on the basis of the residential status in
that country. For example, if a person is resident of a country, he may have to pay tax on
any income earned outside that country as well.
Further, some countries may follow a mixture of the above two rules. Thus, problem of
double taxation arises if a person is taxed in respect of any income on the basis of source
of income rule in one country and on the basis of residence in another country or on the
basis of mixture of above two rules.
Bilateral Relief
The Governments of two countries can enter into Double Taxation Avoidance Agreement
(DTAA) to provide relief against such Double Taxation, worked out on the basis of mutual
agreement between the two concerned sovereign states. This may be called a scheme of
'bilateral relief' as both concerned powers agree as to the basis of the relief to be granted
by either of them.
Unilateral relief
The above procedure for granting relief will not be sufficient to meet all cases. No country
will be in a position to arrive at such agreement with all the countries of the world for all
time. The hardship of the taxpayer however is a crippling one in all such cases. Some relief
can be provided even in such cases by home country irrespective of whether the other
country concerned has any agreement with India or has otherwise provided for any relief at
all in respect of such double taxation. This relief is known as unilateral relief.
Indirect Taxes
Central Sales Tax (CST)
Central Sales tax is generally payable on the sale of all goods by a dealer in the course of
inter-state trade or commerce or, outside a state or, in the course of import into or, export
from India.
The ceiling rate on central sales tax (CST), a tax on inter-state sale of goods, has been
reduced from 4 per cent to 3 per cent in the current year.
Value Added Tax (VAT)
VAT is a multi-stage tax on goods that is levied across various stages of production and
supply with credit given for taxes paid on inputs at each stage of Value addition.
Introduction of state level VAT is the most significant tax reform at state level. The state
level VAT has replaced the State Sales Tax.
Goods and Services GST
The Goods and Services Tax is a comprehensive indirect tax on manufacture, sale and
consumption of goods and services throughout India, to replace taxes levied by the central
and state governments. Goods and Services Tax would be levied and collected at each
stage of sale or purchase of goods or services based on the input tax credit method. This
method allows GST-registered businesses to claim tax credit to the value of GST they paid
on purchase of goods or services as part of their normal commercial activity. Taxable goods
and services are not distinguished from one another and are taxed at a single rate in a
supply chain till the goods or services reach the consumer. Administrative responsibility
would generally rest with a single authority to levy tax on goods and services. Exports
would be zero-rated and imports would be levied the same taxes as domestic goods and
services adhering to the destination principle.
The introduction of Goods and Services Tax (GST) would be a significant step in the reform
of indirect taxation in India. Amalgamating several Central and State taxes into a single tax
would mitigate cascading or double taxation, facilitating a common national market. The
simplicity of the tax should lead to easier administration and enforcement. From the
consumer point of view, the biggest advantage would be in terms of a reduction in the
overall tax burden on goods, which is currently estimated at 25%-30%, free movement of
goods from one state to another without stopping at state borders for hours for payment of
state tax or entry tax and reduction in paperwork to a large extent.
Excise Duty
Central Excise duty is an indirect tax levied on goods manufactured in India. This is
basically a manufacturing tax. Excisable goods have been defined as those, which have
been specified in the Central Excise Tariff Act as being subjected to the duty of excise.
Customs Duty
Custom or import duties are levied by the Central Government of India on the goods
imported into India. The rate at which customs duty is levied on the goods depends on the
classification of the goods determined under the Customs Tariff. The Customs Tariff is
generally aligned with the Harmonised System of Nomenclature (HSL).
Service Tax
Service tax was introduced in India way back in 1994 and started with mere 3 basic
services viz. general insurance, stock broking and telephone. Today the counter services
subject to tax have reached over 100. There has been a steady increase in the rate of
service tax. From a mere 5 per cent, budget 2016 has proposed to impose a Cess, called
the Krishi Kalyan Cess at 0.5% on all taxable services. The latest effective service tax today
is 15%. At present almost 60% of India’s GDP comes from services.
8.2 Government Budgets
A government budget is a government document presenting the government's proposed
revenues (income from various sources) and spending (expenditures for various purposes)
for a financial year that is often passed by the legislature, approved by the chief executive
or president and presented by the Finance Minister to the nation.
Therefore, a national budget is a proposal of revenues and expenditures a government
expects for a given fiscal (financial) year.
Government’s Revenue (Income)
There are three sources from where the government gets money. The first two are revenue
sources, and the last one is borrowings and capital asset sales.
1. Revenue Receipts or Tax Revenue: This is the tax that the government collects in the
form of corporation tax, personal income tax, Wealth Tax, Customs, Excise, Service Tax,
GST etc.
2. Non Tax Revenue: These are the things like interests on bonds held (most of the
countries hold bonds issued by United States), dividends from PSUs like State Bank of
India, BHEL and NTPC. They are revenue sources meaning they don't have to be repaid
and are much smaller than the tax revenues.
3. Capital Receipts: This includes recoveries of loans given to various governments. This
also includes borrowings of the government like the market loans, short term borrowings,
external commercial borrowing etc. These loans have to be finally paid back.
Government’s Expenditure (Outgo)
Government spending or expenditure includes all government consumption, investment,
and transfer payments (subsidies). Current expenditure includes government acquisition of
goods and services to fulfill immediate needs of the government (food and ammunition for
defense) and salaries of government employees. Whereas government’s acquisition of
goods and services intended to create future benefits, such as spending on roads, schools,
colleges, hospitals and R&D, is called as government investment (or capital formation).
These two types of government spending, that is on final consumption and on gross capital
formation, together constitute one of the major components of gross domestic product of
any country.
Government budgets are of three types:
o Balanced Budget (when government’s revenue and expenditure are equal) – Balance
budget keeps the inflation low and moderates interest rates and keeps them predictable,
making it easier for businesses and individuals to invest. This predictability increases
savings and investment, and helps the economy grow faster over a longer period of
time. Lower inflation also helps in managing trade deficits. But, if a country rigidly
pursues a balanced budget policy regardless of the circumstances, the economic
downturns may become needlessly painful. A cyclically balanced budget is a budget that
is not necessarily balanced year-to-year, but is balanced over the economic cycle,
running a surplus in boom years and running a deficit in lean years, with these offsetting
over time.
o Surplus Budget (when anticipated revenue exceeds the expenditure) - A surplus
budget means income of the government is more than its expenditure. It indicates that
the government is unable to utilize its resources on investment and consumption. If
resources are not invested, then there is no point in taxing the people more. These
excess resources have to be parked in high yielding income schemes to avoid losses to
the nation. If they are consumed unnecessarily it may lead to inflation. If additional
income is not invested in capital formation, then there may be economic down turn in
future, leading to fall in employment and recession. Therefore it is always advisable to
run moderate deficit budgets to sustain adequate growth in the economy.
o Deficit Budget (when anticipated expenditure is greater than the revenue) - Under this
situation government borrows from its population. The government issues promissory
notes to the RBI, called sovereign securities and bonds, to borrow from the RBI. The
RBI in turn sells these promissory notes to the commercial banks. The commercial
banks are supposed to give 21.5% of their deposits to the government as loan. To
satisfy this responsibility commercial banks buy the above mentioned promissory notes.
During recessions the governments try to run deficit budgets by increasing its
expenditure on capital formation, to invigorate the economy. As deficit financing adds
money to the system, may be without commensurate additions of goods and services,
there is always a risk this money chasing limited goods and stoking inflation. To avoid
this, the governments try to contain their deficits to the minimum. The Indian
government had set a target of 3.9% of GDP for the year ended on 31 st March 2016.
Therefore, government budgets should be balanced over the economic cycles. During
recessions governments should run deficits and surplus during booms. Increasing
government spending and decreasing taxes can minimize the painful effects of a recession.
Once an economy moves into a growth cycle, the governments should shift its perspective
and try to run a budget surplus by decreasing spending and increasing taxes. By balancing
deficits in recessions and surpluses in growth, the governments can obtain the benefits of a
balanced budget without facing the risks of making recessions worse due to spending and
revenue limitations.
8.3 Economic Development and Growth
During initial few years of independence, the economic development of India was
dominated by socialist-influenced policies, state-owned enterprises, and extensive
regulations. However, this scenario changed mid-1980s, when India began opening up its
market through economic liberalization. The Indian economic development got a boost
through its economic reforms in 1991 and again through its renewal in the 2000s. Since
then, the face of economic development of India has changed completely.
The economic reform of 1991 played a pivotal role in the economic development of India.
Reaping its benefit, the growth of the country reached around 7.5% in the late 2000s. It is
also expected to double the average income within a decade.
The collapse of the Soviet Union, India's major trading partner, and the Gulf War, caused a
spike in oil prices, and resulted in a major balance-of-payments crisis (the difference in total
value between payments into and out of a country over a period) for India, which found
itself facing the prospect of defaulting on its loans. India asked for a $1.8 billion bailout loan
from the International Monetary Fund (IMF), which in return demanded opening up of
India’s economy.
In response to this situation, the then Prime Minister Narasimha Rao, along with his finance
minister Manmohan Singh, initiated the economic liberalization of 1991. The reforms did
away with the License Raj (an elaborate system of licenses, regulations and accompanying
red tape to set up and run businesses in India), reduced tariffs and interest rates and
dismantled many public monopolies (by privatization), allowing automatic approval of
foreign direct investment FDI in many sectors. Since then, the overall thrust of liberalization
has remained the same, although no government has attempted to take on powerful lobbies
such as trade unions and farmers on contentious issues like reforming labor laws and
reducing agricultural subsidies. By the turn of the 21st century, India had progressed
towards a free-market economy, with a substantial reduction in state control of the economy
and increased financial liberalization. This has been accompanied with increases in life
expectancy, literacy rates and food security, although urban residents have benefited by
this process more than the rural residents.
While the credit rating (reliability rating) of India was hit by its nuclear tests in 1998, it has
since been raised to investment level in 2003 by S&P and Moody's. India enjoyed high
growth rates for a period from 2003 to 2007 with growth averaging 9% during this period.
Growth then moderated due to the global financial crisis starting in 2008. In 2003, Goldman
Sachs predicted that India's GDP at current prices would overtake France and Italy by
2020, Germany, UK and Russia by 2025 and Japan by 2035, making it the third largest
economy of the world, behind the US and China. India is often seen by most economists as
a rising economic superpower and is believed to play a major role in the global economy in
the 21st century.
The economy of India is the seventh-largest economy in the world measured by nominal
GDP and the third-largest by purchasing power parity (PPP) The country is classified as a
newly industrialized country, one of the G-20 major economies, a member of BRICS and a
developing economy with an average growth rate of approximately 7% over the last two
decades. Maharashtra is the wealthiest Indian state and has an annual GDP of US$220
billion, nearly equal to that of Portugal, and accounts for 12% of the Indian GDP followed by
the states of Tamil Nadu (US$140 billion) and Uttar Pradesh (US$130 billion). India's
economy became the world's fastest growing major economy in the last quarter of 2014,
replacing the People's Republic of China.
The long-term growth prospects of the Indian economy is positive due to its young
population, corresponding low dependency ratio, healthy saving and investment rates, and
increasing integration into the global economy. The Indian economy has the potential to
become the world's 3rd-largest economy by the next decade, and one of the largest
economies by mid-century. And the outlook for short-term growth is also good as according
to the IMF, the Indian economy is the "bright spot" in the global landscape. India also
topped the World Bank’s growth outlook for 2015-16 for the first time with the economy
having grown 7.6% in 2015-16 and expected to grow 8.0%+ in 2016-17.
India has the one of fastest growing service sectors in the world with annual growth rate of
above 9% since 2001, which contributed to 57% of GDP in 2012-13. India has become a
major exporter of IT services, BPO services, and software services with $167.0 billion worth
of service exports in 2013-14. It is also the fastest-growing part of the economy. The IT
industry continues to be the largest private sector employer in India. India is also the fourth
largest start-up hub in the world with over 3,100 technology start-ups in 2014-15. The
agricultural sector is the largest employer in India's economy but contributes to a declining
share of its GDP (17% in 2013-14). India ranks second worldwide in farm output. The
Industrial sector has held a constant share of its economic contribution (26% of GDP in
2013-14). The Indian automobile industry is one of the largest in the world with an annual
production of 21.48 million vehicles (mostly two and three wheelers) in FY 2013-14. India
has $600 billion worth of retail market in 2015 and one of world's fastest growing E-
Commerce markets.
India's two major stock exchanges, Bombay Stock Exchange and National Stock Exchange
of India, had a market capitalization of US$1.71 trillion and US$1.68 trillion respectively as
of Feb 2015, which ranks 11th & 12 largest in the world respectively according to the World
Federation of Exchanges. India is also home to world's third largest Billionaire’s pool with
111 billionaires in 2016 and fourth largest number of ultra-high-net-worth households that
have more than 100 million dollars.
India's Economic Development: Role of States
India is world's 7th largest economy and also the 3rd largest in terms of purchasing power
parity adjusted exchange rates. It is the 140th largest in the world on per capita income
(122nd with PPP adjusted exchange rates). The growth rates for the states like Gujarat
(8.8%), Haryana (8.7%) and Delhi (7.4%) are considerably higher than other states like
Bihar (5.1%), Uttar Pradesh (4.4%) and Madhya Pradesh (3.5%).
Agriculture
Agriculture, along with other allied sectors like fishing, forestry, and logging play a major
role in the economic development in India. In 2005, these sectors accounted for almost
18.6% of the GDP. India holds the second position worldwide in terms of farm output. It also
generated work for 60% of the total workforce. Though, currently seeing a steady decline of
its share in the GDP, it is still the largest economic sector of the country.
In India, a steady growth has been observed in the yields per unit area of all the crops since
1950. And the reason behind this is the fact that, special emphasis was given on agriculture
in the five-year plans. In 1965, the country saw green revolution. Improvements came in the
various areas like irrigation, technology, provision of agricultural credit, application of
modern agricultural practices and subsidies.
India has done considerably well in agriculture and allied sectors. The country is the world’s
largest producer of tea, coconut, cashew nuts, black pepper, turmeric, ginger and milk.
India also has the largest cattle population in the world. It is world’s second largest producer
of sugar, rice, wheat and inland fish. It is in the third position in the list of tobacco producers
in the world. India also produces 10% of the overall fruit production in the world, holding the
first position in banana and sapota (chikku) production.
Industrial Output
India occupies 14th position in the world in industrial output. The manufacturing sector
along with gas, electricity, quarrying and mining account for 27.5% of the country’s GDP. It
also employs 17% of total workers. The economic reforms of 1991 brought a number of
foreign companies to the Indian market. As a result, it saw the privatization of several public
sector industries. Expansion in the production of FMCG (Fast-moving Consumer Goods)
took place. Indian companies started facing foreign competitions, including the cheap
Chinese imports. However, they managed to handle it by cutting down their costs,
refurbishing their management, modernizing their technology and focusing on new product
designs.
Services
In services output, India occupies 15th spot in the world. Around 23% of the total workforce
in India works in service industry. This is also the sector which provides quick growth with a
growth rate of 7.5% during 1991-2000 from 4.5% in 1951-80. With a substantial growth in IT
sector, a number of foreign companies are showing interests in India’s service exports as
India has got low cost structure, abundant educated and highly skilled work force. Besides
this, ITES-BPO sector has also become a big source of employment for youths.
Banking and Finance
Since liberalization, India has seen substantial banking reforms. On one hand, one could
see the mergers of banks, competitiveness and reducing government interference, on the
other hand one can also see the presence of several private and foreign players in the
banking and insurance sectors. Currently the banking sector in India has got maturity in
terms of supply, reach and the product range. The Indian banks are also said to have clean,
transparent and strong balance sheets comparing to their Asian counterparts.
8.4 Features of underdevelopment with reference to India.
1. Low Income:
India stood 140th in the ranking with per capita GDP (Gross National Product) of $1,617 in
2015, and roughly one third of its population is living below the poverty line. On worldwide
scale, income inequalities between the developed and underdeveloped countries are quite
prominent.
According to the International Monetary Fund, the average per capita GDP of top ten
countries is $ 76027, and that of bottom ten countries is $ 1085. These figures give us a
clear idea about the disparity in their economic development.
2. Predominance of Agriculture:
Agriculture contributes around 17 percent to the Gross Domestic Product (GDP) of India,
but it provides employment to around 50 per cent of the workforce. Therefore, the
agricultural productivity per unit of labor is quite low in India.
3. Rapid Population Growth Rate and High Dependency Ratio:
Higher rate of population growth has also contributed to this underdevelopment of India,
because population brings down the per capita income of the country. India’s rate of
population growth rate was 1.64% per year and 17.64 % in a decade of 2001-2011, which
is still very high as compared to the developed economies. Dependency ratio refers to the
ratio of dependent population (non-working) to total population. In India dependency ratio is
around 52.45% which is on a higher side compared to developed countries. This is
happening because of high birth rates and typical India social circumstances.
4. Mass Poverty:
According to United Nations Development Program’s (UNDP) Global Human Development

index 2015, with the score of 0.609 India is ranked 130th among 188 countries. Human
Development Index (HDI) is based on Life expectancy at birth, Expected years of schooling,
Mean years of schooling, Gross national income, (GNI) per capita, and GNI per capita rank.
The report says 51.1 per cent of Indians suffer from multidimensional poverty, with 27.8
percent under extreme poverty.
5. Unemployment and Underemployment:
Unemployment is a phenomenon of all economies whether developed or underdeveloped.

But nature and degree of unemployment is different in developed and underdeveloped
economies.
In developed economics most of the unemployment is cyclical which arises because of

fluctuations in business cycles. In underdeveloped economies like India, chronic
unemployment results from the structural defects in the economy.
Moreover, underemployment is widespread in underdeveloped countries.

Underemployment is a condition in which a person is getting work but not according to
his/her capacity, ability and educational qualifications.
Unemployment Rate in India averaged 7.32 percent from 1983 until 2013, reaching an all-
time high of 9.40 percent in 2009 and a record low of 4.90 percent in 2013. The
unemployment rate measures the number of people actively looking for a job as a
percentage of the labor force.
Accelerating job creation is one of the major economic agendas of the Modi government.
The Make in India campaign focuses on 25 sectors of the economy for job creation and skill
enhancement. It has set up a dedicated skill development ministry to focus on imparting
skills to millions of youth to make them employable. It is estimated that 12 million youth
enter the country's workforce each year and only 5 per cent of this are skilled workforce.
6. Inequality:
Inequality in distribution of income and wealth is observed in almost every country, but it is
widely spread in underdeveloped economies. The difference in the wealth share held by
India’s poorest 10 per cent and the richest 10 per cent is so enormous that richest 10 per
cent hold 370 times the share of wealth that it’s poorest 10 percent hold. That is, if the
richest 10 percent had held 37 percent of the wealth of all Indians put together, then
poorest 10 percent would have held just 0.1 percent.
7. Scarcity of Capital:
Capital is considered as the most important factor of production in the development of an

economy. In underdeveloped economies like India, capital availability per person is very low
which results in low productivity and low per capita income. Low per capita income again
results in low savings, low investment and low capital formation, triggering another cycle of
scarcity of capital.
Thus Underdeveloped Countries (UDCs) are caught in the trap of vicious circle of poverty
because of this low capital formation. Lack of capital does not allow an economy to
introduce the modern technologies. Thus, economy becomes technologically regressive
and internationally uncompetitive.
India’s saving rates have risen from 14 percent of GDP in 1966, to 31.1 percent of GDP in
2014. This rise in savings is fueling the capital formation cycle in India.
8. Balance of Payments (BoP):
BoP is a systematic record of all economic transactions like trade of goods, trade of
services, unilateral transfers, foreign investment, etc. between a country and rest of the
world. BoP of a country is also an indicator of development or underdevelopment of the
country.
BoP of UDCs like India shows that these countries export primary (agricultural) products
and raw materials and import final products and technologies from developed countries.
They invite foreign capital to fill their investment deficiency. India’s BoP is generally
unfavorable i.e., it faces deficit in BoP. To fill this deficit it has to borrow from other
countries and international organizations like IMF, World Bank, ADB, etc. In lieu of loans,
these organizations interfere in policy matters.
10. Social Peculiarities:
High illiteracy rate, male dominated society, joint family system, fatalism (the belief that all
events are predetermined and therefore inevitable.), lack of entrepreneurship, casteism,
communalism, widespread child labor, etc. are some characteristics of Indian society which
distinguish it from developed societies.
8.5 Globalization of Indian economy
Indian economy had experienced major policy changes since early 1990s. The new
economic reforms, popularly known as, Liberalization, Privatization and Globalization (LPG
model) were aimed at making the economy fast growing and globally competitive. The
series of reforms undertaken with respect to industrial sector, trade and financial sector
were aimed at making the economy more efficient.
With the reforms process to liberalize the Indian economy, which started in July of 1991, a
new door was opened for the Indian economy. These reforms have had a tremendous
impact on the overall economic development of almost every sector of the economy, and its
effects have been felt by almost every Indian. These reforms have integrated the Indian
economy with the global economy in a true sense.
These reforms have brought about a sea change in the Indian mindset, and has boosted
the aspirations of millions of people. Foreign Direct Investment (FDI) has played an
important role in our rapid economic growth and Foreign Institutional Investment (FII) has
made our stocks market vibrant and efficient.
The process of globalization not only includes opening up of the world trade, deployment of
advanced means of communication, internationalization of financial markets, growing
importance of MNCs, unrestricted migration of labor, which generally means free movement
of persons, goods, capital, data and ideas. The term globalization refers to the integration of
economies of the world through unrestricted trade and finance, mutual exchange of
technology and know-how, free inter-country movement of labor and respect for intellectual
property rights. India did this by opening up the economy to foreign direct investment in
different sectors of industry, removed constraints and obstacles to the entry of MNCs,
allowed Indian companies to enter into collaborations with foreign companies, and also
encouraged Indian companies to set up joint ventures abroad, reformed the export-import
policies by switching over from quantitative restrictions to tariffs and import duties.
The trigger for reforms in year 1991 was the gulf war of 1990. As petroleum oil prices had
gone through the roof, the Indian economy was in deep crisis by July 1991, because India
imports most of its petroleum requirement. The foreign currency reserves (which are
needed for paying imports) had plummeted to almost $1 billion; Inflation had roared to an
annual rate of 17 percent; fiscal deficit was very high and had become unsustainable, and
foreign investors and NRIs had lost confidence in Indian Economy. Capital was flying out of
the country and India close to defaulting on loan repayments. These economic compulsions
at home and abroad called for a complete overhauling of our economic policies and
programs to boost our national income.
This was achieved through:
Devaluation: The exchange rate of Indian Rupee was lowered (more rupees per dollar) by
18-19 percent against major currencies. In fact, this measure was taken in order to resolve
the BOP crisis. This devaluation made Indian good cheaper vis-à-vis foreign goods.
Disinvestment: Under disinvestment, most of the public sector undertakings have been
sold off to private players. The money so raised has been used for augmenting the
infrastructure.
End of License Raj: Barring a few sensitive sectors, private companies were allowed to
produce whatever they want and as much they want. This resulted in intense competition
amongst the producers. Competition forced them to use advanced manufacturing
techniques to drive down the cost of production. The benefits of cost reduction were
transferred to the consumer. This led to exponential growth of the market.
Reforms in labor laws: Labor laws reforms were expected to bring in efficiency, and ease
recruiting and retrenchment of the work force as per the economic cycles and the needs of
the businesses. Not much progress has been done on this front because of the resistance
from trade unions and work culture in India. The process of reforming the labor laws is still
ON.
Opening up various sectors to FDI & FII: Foreign capital (that is saving) was solicited for
augmenting the infrastructure in the country.
Introduction of GST: Goods and Services Tax bill has been passed by the central
government. GST will make the taxes more or less uniform, and facilitate free movement of
the goods and services throughout the country.
Rationalizing tariffs: The customs duties on various items were brought in line with World
Trade Organization agreement to lower trade barriers around the world, and thus facilitate
increased global trade.
These reforms have propelled the GDP growth rates from 1.06% in 1991 to 7.57% in 2015,
after touching 10.3% in 2010.
9. Domestic and foreign trade
9.1 Basis of International Trade
Trade is the exchange of goods and services between two entities. International trade is the
exchange between entities in two different countries. These people or entities trade in
goods and services, because they believe that they benefit from this exchange.
People have engaged in trade for thousands of years. Ancient history provides us with rich
examples such as the Silk Route - the land and water trade routes that covered more than
four thousand miles and connected the Mediterranean with Asia.
International trade is the exchange of capital, goods, and services across international
borders or territories, which could involve the activities of the government and individuals. In
most countries, such trade represents a significant share of their gross domestic product
(GDP). While international trade has been present throughout history its economic, social,
and political importance has been on the rise in recent centuries.
Trading globally gives consumers and producers the exposure to new markets and
products. Almost any type of product can be found in the international market. Services like
tourism are also traded in the international markets. A product that is sold to the global
market is call as export, and a product that is bought from the global market is called as
import. Imports and exports are accounted for in any country's current account in the form
of balance of payments.
Industrialization, advanced technologies, faster modes of transportation, globalization,

multinational corporations, and outsourcing has impacted the international trading system.
Without international trade, nations would be limited to the goods and services produced
within their own borders. International trade is, in principle, not different from domestic trade
as the motivation and the behavior of parties involved in a trade do not change
fundamentally regardless of whether trade is across a border or inside. The main difference
is that international trade is typically more expensive than domestic trade because of
additional transportation cost, tariffs, and delays at the borders and also because of the
differences in languages, legal systems or social cultures.
Another difference between domestic and international trade is that factors of production
such as capital and labor are typically more mobile within a country than across countries
because of people’s comfort levels and visa-free travel. Thus international trade is mostly
restricted to trade in goods and services, and to a little lesser extent to trade in capital, labor
or other factors of production. Trade in goods and services can serve as a substitute for
trade in factors of production, because, instead of importing a factor of production, the
country can import goods that make intensive use of that factor of production. An example
is the import of labor-intensive goods by the United States from China. Instead of importing
Chinese labor, the United States imports goods that were produced with Chinese labor.
o Trade can bring benefits by letting the countries exploit their comparative advantages
and reap the benefits of scale economies and ensure competition, offer greater variety
of products and ensure price stability in markets.
o The gains from trade are not likely to be evenly distributed, either within or between
countries, hence the opposition to free trade by a few parties.
o The political decisions are never whether to trade or not to trade, but they are whether to
impose certain barriers to trade or not. The arguments for protection may be on
economic, job loss or food security grounds. However, trade barriers are not the most
efficient methods to achieve these objectives.
o Trade liberalization can take place within multilateral, bilateral or regional arrangements.
Regional trade arrangements are becoming increasingly popular now a days because of
its speed of implementation and cultural and historic similarities between neighboring
countries. However, implementing trade arrangements in agriculture are often becoming
problematic in nature.
The Economic Gains from Trade
International trade flows have steadily increased over hundreds of years and they have
accelerated since the World War II. This is surely not just because transport and
communications facilities have improved, but it must also be because wider benefits that
are derived from trade. The gains from international trade are -
o The increase in total quantity of goods and services available (increased availability)
o The diversity of goods and services available (diversification) and
o The stability in the supply and prices of goods and services (stability)
9.2 Trade theories
To better understand how modern global trade has evolved, it’s important to understand
how countries traded with one another historically. Over time, economists have developed
theories to explain the mechanisms of global trade. The main historical theories are called
classical theories and they are from the country perspective or country-based. However,
modern trade theories from firm perspective or company-based. Both of these theories put
together, classical and modern, are called international trade theories.
Classical or Country-Based Trade Theories
Mercantilism Theory
Developed in the sixteenth century, mercantilism was one of the earliest efforts to develop
an economic theory. This theory stated that a country’s wealth was determined by the
amount of its gold and silver holdings. In its simplest sense, mercantilists believed that a
country should increase its holdings of gold and silver by promoting exports and
discouraging imports. In other words, if people in other countries buy more from you
(exports) than they sell to you (imports), then they have to pay you the difference in gold
and silver. The objective of each country was to have a trade surplus, or a situation where
the value of exports are greater than the value of imports to avoid a trade deficit, or to avoid
a situation where the value of imports is greater than the value of exports.
A closer look at world history from the 1500s to the late 1800s helps explain why
mercantilism flourished. The 1500s marked the rise of new nation-states, whose rulers
wanted to strengthen their nations by building larger armies and powerful national
institutions. By increasing exports and trade, these rulers were able to amass more gold
and wealth for their countries. They encouraged exports, and discouraged imports by
putting certain restrictions on imports. This strategy is called protectionism and it is still
used today by many countries.
Nations expanded their wealth by using their colonies around the world in an effort to
control more trade and amass more wealth. The British colonial empire was one of the
more successful examples of this; it sought to increase its wealth by using raw materials
from far of places like the Americas and India. France, the Netherlands, Portugal, and
Spain were also successful in building large colonial empires that generated extensive
wealth for their governing nations.
Although mercantilism is one of the oldest trade theories, it still remains part of the main-
stream thinking. Countries such as Japan, China, Singapore, Taiwan, and even Germany
still encourage exports and discourage imports through neo-mercantilism, in which the
governments follow protectionist policies in the form of restrictions on imports and give
subsidies to domestic-industries to enable them to export at lower prices. Most of the
countries have adopted some form of protectionist policies to protect their key industries
and create jobs in their countries. Although many companies seek protectionist policies
under different pretexts, the consumers may be at a disadvantage under protectionism. The
burden of subsidies given to the exporters, finally falls on the taxpayers in the form of higher
taxes and because of import restrictions on certain goods consumers have to pay higher
prices for those goods produced domestically. The supporters of free-trade highlight, how it
benefits all members of the global community, while protectionist policies only benefit only
select industries, at the expense of consumers and other companies.
Absolute Advantage Theory
In 1776, Adam Smith questioned the mercantile theory of that time in his book ‘The Wealth
of Nations’. Adam Smith offered a new trade theory called ‘Absolute Advantage Theory’,
which focused on the ability of a country to produce some goods more efficiently than
another country. He felt that the trade between countries shouldn’t be regulated or
restricted by government policy or intervention. He felt that trade should flow naturally
according to the market forces. In a hypothetical two-country world, if Country A could
produce a good cheaper and faster than Country B, then Country A has the advantage over
Country B. Similarly, if Country B was better at producing another good, it should focus on
specialization in production of that good. By specialization countries would be able to
generate efficiencies, because their labor force would become more skilled in doing those
tasks by doing them repetitively. Production would also become more efficient, because
there would be an incentive to put in place faster and better methods of production to
increase the market share.
Adam Smith’s theory reasoned that with increased efficiencies, people in both countries
would be benefitted and trade should get a boost. His theory stated that a nation’s wealth
shouldn’t be judged by how much gold and silver it had but rather by the living standards of
its people.
Comparative Advantage Theory
The challenge to the absolute advantage theory was that some countries may be better at
producing both the goods and, therefore, have an advantage in many areas. In contrast,
another country may not have any useful absolute advantages. To answer this challenge,
David Ricardo, an English economist, introduced the theory of comparative advantage in
1817. Ricardo reasoned that even if Country A had the absolute advantage in the
production of both products, specialization and trade could still occur between two
countries.
Comparative advantage occurs when a country cannot produce a product more efficiently
than the other country; however, it can produce that product better and more efficiently than
it does with other goods. The difference between these two theories is subtle. Comparative
advantage focuses on the relative productivity differences, whereas absolute advantage
looks at the absolute productivity.
Let’s look at a simplified hypothetical example to illustrate the subtle difference between
these principles. Deepa Parekh is a Dalal Street lawyer who charges Rs 5000 per hour for
her legal services. It turns out that she can also type faster than the administrative
assistants in her office, who are paid Rs.200 per hour. Even though she clearly has the
absolute advantage in both skill sets, should she do both jobs? No. For every hour Miranda
decides to type instead of do legal work, she would be giving up Rs 4800 of her income.
Her productivity and income will be higher if she specializes in the higher-paid legal
services and hires the most qualified administrative assistant, who can type faster. By
having both she and her assistant concentrate on their respective tasks, their overall
productivity, as a team is higher. This is comparative advantage. A person or a country will
specialize in doing what they do relatively better. In reality, the world economy is more
complex and consists of more than two countries and products. Barriers to trade may exist,
and goods must be transported, stored, distributed, damaged and spoilt. However, this
simplistic example demonstrates the basis of the comparative advantage theory.
Heckscher-Ohlin Theory (Factor Proportions Theory)
The theories of Adam Smith and David Ricardo didn’t help countries determine which
products would give them an advantage. Both these theories assumed that free and open
markets would lead countries and producers to determine which goods they could produce
more efficiently than others. In the early 1900s, two Swedish economists, Eli Heckscher
and Bertil Ohlin, focused their attention on how a country could gain comparative
advantage by producing products that utilized the factors that were in abundance in that
country. Their theory is based on a country’s factors of production - land, labor, and capital,
which provide the funds for investment in plants and equipment. They determined that the
cost of any factor or resource was a function of supply and demand. Factors that were in
great supply relative to demand would be cheaper; factors in great demand relative to
supply would be more expensive. Their theory, also called the factor proportions theory,
stated that countries would produce and export goods that required resources or factors
that were in greater supply than the demand and, therefore, cheaper production factors. In
contrast, countries would import goods that required resources that were in shorter supply
than the demand in those countries.
For example, China and India are home to large pool of cheap labor. Hence labor intensive
industries like IT, BPO, ITES, textiles, and garments have flourished in these countries.
Leontief Paradox
In the early 1950s, Russian-born American economist Wassily W. Leontief studied the US
economy closely and noted that the United States was abundant in capital and, therefore,
should export more capital-intensive goods. However, his research, using actual data
showed the opposite - the United States was importing more capital-intensive goods.
According to the factor proportions theory, the United States should have been importing
labor-intensive goods, but instead it was actually exporting them. His analysis became
known as the Leontief Paradox because it was the reverse of what was expected by the
factor proportions theory. In subsequent years, economists observed that, at that point of
time, the labor in the United States was available in steady supply and it was more
productive than the labor in many other countries. Hence it made sense to export labor-
intensive goods for United States. Over the decades, many economists have used various
theories and have collected data to explain the paradox. However, one thing is certain that
international trade is a complex phenomenon and it is impacted by numerous and often-
changing factors. Therefore, trade cannot be really explained neatly by one single theory,
and more importantly, our understanding of international trade theories is still evolving.
Firm-Based Trade Theories or Modern Trade Theories
In contrast to classical, country-based trade theories, this category of modern firm-based

trade theories emerged after World War II and was developed in large part by business
school teachers, and not by economists. The firm-based theories evolved with the growth of
the multinational companies (MNCs). The country-based trade theories couldn’t adequately
explain the expansion of MNCs or intra-industry trade, which is trade between industries
located in two different countries. For example, Japan exports Toyota vehicles to Germany
and imports Mercedes-Benz automobiles from Germany, or Jaguar imports automobile
components from India and exports Jaguars to India.
Unlike the country-based theories, firm-based theories incorporate other factors, such as a
distinct product or a distinct service, including brand (popularity of Gucci apparels in India)
and customer loyalty (McDonald’s burgers), technology (Nuclear Reactors), and quality
(iPhone), into the understanding of trade flows.
Country Similarity Theory
Swedish economist Stefan Linder developed the country similarity theory in 1961, as he
tried to explain the concept of intra-industry trade. Linder’s theory proposed that consumers
in countries that are in the same or similar stage of development would have similar
preferences. In this firm-based theory, Linder suggested that companies first produce for
domestic consumption. Whenever they explore export markets, they often realize that those
markets that appear similar to their domestic markets, in terms of customer preferences,
and they offer similar potential for success. Linder’s country similarity theory then states
that most trade in manufactured goods will be happening between countries with similar per
capita incomes, and intra-industry trade will be common there. This theory is often most
useful in understanding the trade in goods where brand names and product reputations are
important factors in the buyers’ decision-making and purchasing processes.
Product Life Cycle Theory
Raymond Vernon, a Harvard Business School professor, developed the product life cycle
theory in the 1960s. The theory, originating in the field of marketing, stated that a product
life cycle has three distinct stages: (1) new product, (2) maturing product, and (3)
standardized product. The theory assumed that production of the new product will occur
completely in the home country of its innovation. In the 1960s this was a useful theory to
explain the manufacturing success of the United States. After World War II US emerged as
a dominant player globally in manufacturing in many industries.
It has also been used to explain how the personal computers (PC) went through its product
life cycle. The PC was a new product in the 1970s (manufactured in the US) and developed
into a mature product during the 1980s and 1990s (manufactured in the US and a few
developed countries). Today, the PC is in the standardized product stage (commoditized),
and most of the manufacturing now is happening only in low-cost countries of Asia and
Mexico. As the product gets commoditized, many players enter these businesses, which
create intense competition, and drives down the prices. To maintain profitability, these
businesses then migrate their manufacturing to low cost countries.
The product life cycle theory has been less able to explain current trade patterns where
innovation and manufacturing is happening around the world. For example, global
companies are even carrying out their research and development activities in developing
countries, where highly skilled manpower and research facilities are available at cheaper
rates. Although research and development is typically associated with new product stage
and therefore carried out in the home countries, these developing or emerging-market
countries, such as India and China, offer both highly skilled labor and world class research
and development facilities at a substantial cost advantage for global companies.
Global Strategic Rivalry Theory
Global strategic rivalry theory emerged in the 1980s and was based on the work of
economists Paul Krugman and Kelvin Lancaster. Their theory focused on MNCs and their
efforts to gain a competitive advantage against other global firms in their industry. Firms will
encounter global competition in their industries and in order to gain market share, they must
develop their competitive advantages. The ways through which firms can obtain sustainable
competitive advantages are called the barriers to entry into that industry. The barriers to
entry refer to the obstacles a new firm may face when trying to enter into a specific industry
or a market. The barriers to entry that corporations may exploit include:
o Research and Development capabilities,

o Ownership of intellectual property rights,
o Economies of Scale (large customer base and lower cost of production),
o Unique business processes and extensive experience in the industry, and
o The control of resources (ownership of mines) or favorable access to raw materials.
Porter’s National Competitive Advantage Theory
In the continuing evolution of international trade theories, Michael Porter of Harvard

Business School developed a new model to explain national competitive advantage in
1990. Porter’s theory stated that a nation’s competitiveness in an industry depends on the
capacity of the industry to innovate and upgrade. His theory focused on explaining why
some nations are more competitive in certain industries. To explain his theory, Porter
identified four determinants that he linked together. The four determinants are (1) local
market resources and capabilities, (2) local market demand conditions, (3) local suppliers
and complementary industries, and (4) local firm characteristics.
1. Local market resources and

capabilities (factor conditions). Porter
recognized the value of the factor
proportions theory, which considers a
nation’s resources (e.g., natural
resources and available labor) as key
factors in determining what products a
country will import or export. Porter
added to these basic factors a new list of
advanced factors, which he defined as
skilled labor, investments in education,
technology, and infrastructure. He felt
that these advanced factors are
providing a country a sustainable
competitive advantage.
2. Local market demand
conditions. Porter believed that a
sophisticated home market is critical to
ensuring ongoing innovation, thereby
creating a sustainable competitive
advantage. Companies whose domestic markets are sophisticated, trendsetting, and
demanding, forces continuous innovation and the development of new products and
technologies on them. Many sources believe that the demanding US consumers have
forced the US software companies to continuously innovate, thus creating a
sustainable competitive advantage in software products and services.
3. Local suppliers and complementary industries. To remain competitive, large global
firms benefit from having strong, efficient, and supportive related industries to provide
the inputs required by the industry. Certain industries cluster geographically, which
provides transportation efficiencies and productivity.
4. Local firm characteristics. Local firm characteristics include firm’s strategy, industry
structure, and industry rivalry. Local strategy affects a firm’s competitiveness. A
healthy level of rivalry between local firms will spur innovation and competitiveness.
In addition to the four determinants of the diamond, Porter also noted that government and
chance play a part in the national competitiveness of industries. Governments can, by their
actions and policies, increase the competitiveness of firms and sometimes entire industry.
For example, tax breaks for IT industry during formative period.
Porter’s theory, along with the other modern, firm-based theories, offers an interesting
interpretation of international trade trends. Nevertheless, they remain relatively new and
minimally tested theories.
Which Trade Theory Is Dominant Today?
The theories covered here have helped economists, governments, and businesses to better
understand the international trade and know how to promote, regulate, and manage
international trade. Many countries do not have absolute advantage in many areas of
production or services. Similarly, the factors of production are not uniformly distributed all
over the world. Some countries have a disproportionate advantage of some factors over
other countries. For example, the United States has ample arable land that can be used for
a wide range of agricultural products. It also has extensive access to capital, while its labor
pool may not be the cheapest, but it is one of the best educated in the world. These
advantages in the factors of production have helped the United States become the largest
and richest economy in the world. Nevertheless, the United States also imports a vast array
of goods and services, as US consumers use their wealth to purchase what they need and
want - much of which is now manufactured in other countries that have sought to create
their own comparative advantages through cheap labor, land, or production costs. Similarly,
most of the oil reserves of the world are concentrated in a few gulf countries, but they do
not have any other natural resource with them. These countries utilize their vast export
income to import everything they need.
As a result, it’s not really clear whether any one theory is dominant around the world today.
In practice, governments and companies use a combination of these theories to both
interpret trends and develop their strategies.
9.3 Free Trade vs Protection
The foreign trade policies are basically concerned with whether to adopt a free trade policy
or protect the domestic industry, or to adopt a mix of the two. If the policy of protection is
adopted, then question arises whether protection should be in the form of tariffs on imports
or through the fixation of quota or through licensing of imports. In India certain political
parties and groups have been advocating the use of ‘Swadeshi’ which in essence meant
that domestic industries should be protected against the low-priced imports of goods.
Adam Smith advocated free trade and recommended that tariffs should be eliminated to
avail of the advantages of free trade. Classical economist David Ricardo in his work “The
Principles of Political Economy and Taxation” also defended free trade to promote effi-
ciency and productivity in the global economy. Both felt that it pays a country to specialise
in the production of those goods that it can produce more economically than any other
country and import those goods that it can obtain at lesser cost or price than it would cost to
produce them at home. This means that they should specialise according to the absolute
cost advantage at home. However, Comparative Cost Theory is based on the relative
efficiency or comparative cost of production of some other good, if a country can maximize
its profits by producing that good instead of producing something else.
Despite the classical arguments for free trade to promote efficiency and well-being of the
people, various countries have been following the protectionist agenda which militates
against free trade. By imposing heavy tariffs on imports of goods or by fixing quotas of
imports they are preventing free trade to take place between countries.
Trade Policy: Tariffs and Quotas:
Despite many benefits of free trade, the various countries have put up barriers to trade to
protect their domestic industries. A number of instruments are being used to protect the
domestic industries from foreign competition, such as tariffs and quotas. The tariffs and
quotas are being imposed on imports as well as exports depending upon the political need.
India bans export of onion during crop failures (to protect the consumer’s interests), or bans
it’s import when there is a bumper crop of onions (to protect the farmers interests).
1. Tariffs:
Tariffs are excise duties (manufacturing taxes) imposed on imported goods. The objective
of imposing tariffs may be either raising the revenue for the Government or providing
protection to the domestic industries.
Therefore, there are two distinguished types of tariffs
(1) Revenue tariffs, and
(2) Protective tariffs.
Revenue tariffs are usually imposed on the imports of those products which are not
produced domestically (hence there is no question of protecting the domestic industry). The
rates of revenue tariffs are generally smaller, but they yield larger revenue to the
Government because of wider imports (For example, import of petroleum oil in India. In
USA, tariffs are imposed on tin, coffee and bananas which are not produced in that country.
Therefore their basic purpose is to provide revenue to the Government.
Protective tariffs, on the other hand, are imposed to provide protection to the domestic
producers from foreign competition. The rates of these tariffs are not so high as to
completely prohibit their imports into the country. The tariffs are calibrated such, that the
rise in prices of their products after the imposition of tariffs, makes the product less
attractive to the domestic consumer. Under this situation the consumer will still buy those
items if he perceives value in that item even at their higher prices. (For example, popularity
of Mercedes cars and iPhones in India)
2. Import Quotas:
Import quotas are another instrument used to check free trade. Import quotas refer to the
maximum quantities of goods which may be permitted to be imported during any period of
time. They are also referred to as quantitative restrictions on imports. Quotas are more
effective method of reducing trade than tariffs.
A given commodity may be imported in a relatively large quantities in spite of high tariffs but
low quotas totally stop the imports of the commodity beyond the fixed import quota
sanctioned for that commodity. Since international negotiations to reduce trade barriers
have tended to focus on tariffs, various countries are resorting to non-tariff barriers to free
trade.
Effects of a Tariff:
Let us now examine the economic effects of tariffs used as to protect domestic industries.
We use partial equilibrium approach represented by supply and demand analysis to
examine the effects of tariffs. Let us take a product, say computers, in which India may be
having a comparative disadvantage.
In the graph we have drawn domestic demand

and supply curve Dd and Sd respectively of
computers in India. In the absence of foreign
trade, domestic equilibrium price OPd is settled at
which quantity of computers equal to OQ is
demanded and sold. Assume now that the Indian
economy is now opened to trade with USA, which
has a comparative advantage in the production of
computers.
Suppose OPw represents the international price

at which USA sells computers. We assume that
when the Indian economy is opened to free trade,
it will import computers from the USA at this
international price OPw. Therefore, the free trade
price is OPw.
It will be seen from the figure that at free trade

price OPw, the domestic demand (or
consumption) for computers is OH and the domestic producers are ready to supply only
quantity equal to ON. Therefore, with free trade, out of the total quantity OH sold of
computers, domestic production will be equal to ON, and the quantity equal to NH will be
imported.
Consumption Effect:
Now suppose that in order to protect domestic computer industry India imposes a tariff on
computers to lift its selling price to Pt , that is tariff equal to = (Pt - Pw) per computer. As a
result price of computer in India will rise to OP t. The imposition of tariff and consequently
rise in the price of computers in India will have a variety of effects.
First, as shall be seen from the figure that at a higher price OPt, the consumption of
computers in India will decline to OL computers as the higher price causes buyers of
computers to move up the demand curve Dd. This is a consumption effect of the tariff. It
follows that the Indian consumers of computers have been badly hurt by the imposition of
tariff on computers.
As a result of tariff, they pay (Pt - Pw) more per computer. Besides, tariff induces them to
buy fewer computers with the result that they reallocate a part of their expenditure to
substitute products or forgo their purchase of computers altogether.
Production Effect:
Second, tariff benefits Indian producers of computers as they will now be able to sell their
computers at a higher price OPt instead of a free trade price OPw. Further, at a higher price
OPt, they will produce and supply more computers by moving up the domestic supply curve
Sd.
It will be seen from the figure that at price OPt, domestic producers of computers raises
domestic production and quantity supplied, from ON to OM. This is the production effect of
tariff. It should be further noted that the increase in domestic production of computers by
NM implies that some scarce resources will be bid away from other presumably more
efficient industries to production of computers.
Trade Effect:
Third, as a result of imposition of tariff by India, American producers will be hurt. It may be
noted that American producers would not get the higher price OPt as the higher price is due
to the tariff which will be pocketed by the Indian Government. For American producers price
of computers will remain at OPw. Since due to rise in price to OPt, domestic production
increases to OM and domestic consumption falls to OL, and the imports of computers fall
from NH to ML. This is trade effect of tariff.
Revenue Effect:
Now, the important effect which is yet to be examined is whether economic well-being of
the nation will increase as a result of the imposition of tariffs. The answer is in the negative.
Of course, the Indian Government will gain from tariff equal to the revenue it collects from
tariff.
With rise in prices by (Pt - Pw) per computer and the import of computers reduced to ML, (or
ab) the total revenue of the Government from tariff will be equal to the shaded area abGC.
This is the revenue effect of tariff. This revenue from tariff obtained by the Government is
essentially a transfer of income from the consumers to the government and does not
represent any net change in the nation’s well-being (therefore it is just a cash transfer from
people to the government, without any economic value addition). Therefore, the
government gains a portion of what consumers lose.
But the effects of tariffs go beyond the basis of partial equilibrium analysis of demand and
supply. The imposition of tariff on computers will reduce export earnings of American
computer industry. The industry in which it has a comparative advantage. Because of lower
exports of computers, the production of computers will be reduced in the USA.
This will cause the resources to be shifted from relatively more efficient computer industry
to relatively inefficient industries of the USA in which it has a comparative disadvantage.
Thus tariffs cause misallocation of resources.
Therefore specialisation and unfettered world trade based on comparative advantage would
lead to the efficient use of world’s resources and an expansion of the world’s real output.
The effect of protective tariffs is the reduced world trade. Therefore, besides specific effects
upon consumers and producers, tariffs diminish the world’s real output as well.
GDP Effect
As the domestic production increases from ON to OM, and as the price rises from P w to Pt,
the economic value of the output increases from ON x OP w to OM x OPt. Therefore, the
nation’s GDP increases by (OM x OPt - ON x OPw). Therefore, imposition of tariffs also
helps the governments to increase their GDP and also improves the employment scenario.
Effect of Quotas:
Quotas are quantitative restrictions on the quantity or value of a commodity to be imported

into a country during a period. Since quota limits the imports of a commodity, it reduces
supply of a commodity in a country as compared to the free trade.
Like tariffs, quotas raise the prices of imported goods and encourages domestic production
of those goods. But in case of quotas, the government does not collect any revenue.
Quotas may be imposed against imports from all countries or used against the imports of
only a few countries.
Economic effects of quota are graphically shown in the graph, where DM and SM are
domestic demand and supply curves of a commodity respectively. In the absence of free
trade, the price of the commodity in the country is PA. Suppose the world price of the
product is PW.
Under free trade, at price Pw of the

commodity the domestic producers
of a country will produce OQ1 quan-
tity but as domestic demand of the
product at price Pw is OQ3 the
quantity Q1 Q3 represents the
imports at the world price Pw. Now
assume that the Government
imposes a quota and fixes the
quantity of the product equal to
Q1Q2 to be imported.
With this, the total supply of the

product in the domestic market will
be more to the extent of the
imported quantity. That is, the
supply curve will shift to the right,
away from the domestic supply
curve SM by the quantity equal to the distance Q1Q2. Incorporating the quota equal to Q1Q2
we draw a new supply curve (SM+ Quota) which lies to the right of the free-trade supply
curve SM. The new supply curve disappears below Pw, because below that price no import
takes place.
It will appear from the graph that interaction of the supply curve (SM + Quota) with the
domestic demand curve DM determines price Pd which is higher than the world price Pw and
below the domestic price PA. It will be seen from this graph, that difference AB between
demand and domestic supply at price Pd is exactly equal to the fixed quota of Q1Q2 quantity
of imports.
It is thus clear that, like tariffs, fixation of quota has served to limit trade and raise the
prices. It will therefore have same effects as we have explained in case of tariffs. It may
however be noted that, unlike tariff, in case of quota the Governments do not collect any
revenue for themselves.
Advantages of free trade:
1. Increase in output and social well-being of the people from specialisation:
By specialising in the production of certain goods in which countries are relatively more
efficient, they export a part of their production and import certain goods in which other
countries are comparatively more efficient.
This processes of specialisation and exchange of goods facilitates efficient allocation of

scarce resources to produce higher output at lower cost to ensure well-being of the entire
humanity. International Division of Labour and International Trade expect countries to
export those goods in which they are comparatively more efficient and import those goods
in which other countries are comparatively more efficient.
2. Gains from Economies of Scale:
Adam Smith highlighted that any specialisation gets limited by the size of its market.
If a country does not trade with others, then its firms will produce goods just to meet the
domestic demand. And if the domestic demand of a certain product is lesser, then most of
the companies will be able to afford cheaper technologies, which are less efficient and
resource intensive, resulting in higher unit cost of production.
Free trade allows countries to produce far more than the domestic demand, thus expanding
the market for their goods, and facilitating the producers to adopt faster and resource frugal
technologies, resulting in lower unit cost of production and large production base.
3. Rapid economic growth:
Free trade is an engine of growth for any country, because it stimulates the overall
economic growth. The countries like Japan, Taiwan, South Korea, Singapore, Hong Kong
and China have prospered under their export emphasis.
How free trade promotes economic growth
A. Raising the rates of saving and investment - Increase in real national income leads to
higher levels of saving in an economy. Higher level of savings results in a higher rate of
investment and capital formation. This in turn stimulates the economic growth. Therefore,
higher levels of saving make it easier for the developing countries to break ‘the circle of
poverty’ in their countries.
B. Import of capital goods – Free Trade permits import of capital goods in exchange of
export of consumer goods or surplus raw materials, accelerating economic growth. Imports
of capital goods raise its productive capacity. Free trade also enables countries to borrow
from other countries to finance their import of capital goods.
C. Transfer of technology - If different countries had worked in isolation, then the

technologies developed in one country would have remained confined to those countries.
Under free trade technological progress behaves like a chain reaction – that is,
technologies are developed by someone, licenced to someone, and are improvised by
someone else. Therefore, free trade encourages research & development, and enhances
diffusion of technologies all over the world.
D. Promotes Competition and Prevents Monopoly - Free trade promotes competition and
prevents the emergence of monopolies. In the absence any competition, companies do not
have any incentive for innovation or product differentiation. They continue to use inefficient
technologies, which have higher per unit cost of production. Free trade compels the
producers to keep customer’s interests before their own. It offers the consumers a wide
range of options to choose from. The increase in efficiency and adoption of improved
technologies lower the prices of products, increases demand, boosts production, improves
employment, and hence contributes to economic growth.
E. Political Gains from Free Trade - Free trade improves the standard of living of the trading
countries and consolidates their mutual interdependence. This reduces friction between
them and most of the disputes see peaceful ends. The prosperity that free trade brings,
often results in internal peace and political stability in a country.
Major barriers to free trade are
o The imposition of tariffs (i.e. duties on imports and subsidies for exports)
o The fixation of import quotas
o The licensing of imports
Protection is sought under following pretexts
Nationalism - Sometimes the feeling of patriotism appeals people of a certain country to

give preference to products of their domestic industries over foreign products. In India
‘Swadeshi Movement’ was meant to appeal Indians to buy ‘Made in India’ products to
protect indigenous industries by imposing taxes, quotas and licencing of imports and
providing subsidies to domestic industries. This policy deny the gains from trade such as
increased productive efficiency and greater social well-being, stimulus to growth, higher
(better) capital formation and spread of advanced technology. Thus, nationalistic trade
policies in reality act contrary to our national interests by promoting inefficiency and slower
(inferior) capital formation.
Protecting jobs - Some people believe that protection preserves domestic jobs. They
argue that, as the prices of imported goods are lower, the domestic producers would not be
able to compete with them and may be bade out of the market and destroy jobs from
domestic industries. But, an important economic principle is that exports must pay for
imports. If imports are suppressed by imposing barriers, the exports may not get adequately
financed by the importers. For example, many raw materials and capital goods are imported
to by export oriented industries. Therefore, if imports are restricted, exports too will fall. This
will lead to the decline of jobs in export oriented industries offsetting increase of jobs import-
substituting industries. Secondly, when imports are restricted to protect domestic industries,
other countries are likely to retaliate and are likely to impose restrictions on their imports.
This will have a cascading effect and many more industries would get affected, leading to
job losses and may be recession.
Protecting Infant Industry - A powerful argument in support of protection, especially in the
context of developing countries, is that infant industries should get protection from low-
priced imports from mature and well-established industries of the developed countries until
they achieve production efficiency and economies of scale. However, it is quite possible
that protected industries would not strive for efficiency and lowering their cost. Whereas,
under free trade, only those industries will survive which are efficient and have a lower cost
of production. Before the setting-up of Maruti Udyog with Japanese collaboration, Indian car
industry was fully protected with heavy duties on imports of cars.
Preventing dumping of goods - The other important argument for protection is that
foreign producers compete unfairly by dumping the goods in another country. Dumping is a
form of price discrimination when producers of a country sell goods just above their variable
cost. This strategy gives them higher production volumes and wider global market. They
recover their fixed cost from their local market by charging higher prices to their domestic
customers. Sometimes the governments give them export subsidies. In this case, these
companies sell even below their variable costs. This strategy helps these countries in their
capital formation and job creation. Of course, consumers in the importing country get
benefitted, but the industries in the importing country suffer, because they are unable to
compete with the ‘dumped goods’. ‘Predatory pricing’ is another form of dumping in which
foreign firms sell their goods in other countries much below their cost to establish a clear
monopoly by ‘driving out’ competitors from the market. Once the local industries are driven
out out, they raise their prices to obtain monopoly profits.
Correcting Balance of Payments - Correcting deficit in balance of payments is also cited

as a justification for imposing tariffs or fixing of import quotas. This appears as a valid
argument for providing protection. But, the solution for disequilibrium in the balance of
payments is automatically taken care of by suitable adjustments in the exchange rates,
suitable fiscal and monetary policies to lower domestic cost of production to boost the
exports.
Diversion of Income - Income from one section of the society is diverted to another
section of the society through barriers to trade. By providing protection to domestic
producers, their profits are raised at the expense of their consumers who could very well
have bought low-priced imported goods. Therefore, protection diverts income in favour of
the domestic producers, that is, from one factor to another. According Heckscher-Ohlin
Model of International Trade, trade benefits the abundant factor and harms the scarce
factor. It is therefore the scarce factor that demands protection from the government against
imports so that its income doesn’t decrease. This implies that the workers, the owners of
labour, and capitalists tend to take opposite views on protection.
In some countries one of the objectives of economic policy is to redistribute the income
from the rich to the poor. This is done by imposing higher tariffs on import of luxury goods
and levying tariffs on export of necessities. Higher import tariffs on luxuries reduce the
incomes of the rich as they would pay taxes to the government, and higher taxes on exports
of the necessities ensure supplies of these goods to the domestic market at lower domestic
prices to the benefit of the poor.
It may however be noted that direct taxes, such as income tax, are considered as better
methods of redistributing the income among various sections of the society than the
commercial policies.
9.4 Balance of Payments (BoP)
The balance of payments, also known as the balance of international payments, of a
country is the record of all economic transactions between the residents of that country and
the rest of the world in a particular period (over a year). These transactions are collectively
made by individuals, business entities and government bodies. Thus the balance of
payments includes all external visible and non-visible transactions of a country. It
represents a summation of country's current demand and supply of the claims on foreign
currencies and foreign claims on its currency. These transactions include payments for the
country's exports and imports of goods, services, financial capital, and financial transfers
(repatriation of savings by Indians working abroad). It is prepared in a single currency,
typically the domestic currency for the country concerned. Sources of funds for a nation,
such as exports or the receipts of loans and investments, are recorded as positives or
surplus items. Uses of funds, such as payments for imports or investments abroad, are
recorded as negative or deficit items.
When all components of the BOP accounts are included they must add up to zero with no
overall surplus or deficit. For example, if a country is importing more than it exports, its
trade balance will be in deficit, but the shortfall will have to be counterbalanced in some
other way – such as by funds earned from its foreign investments or by utilizing their central
bank reserves of foreign currency or by receiving loans from other countries.
While the overall BOP accounts will always balance when all types of payments are
included, imbalances are possible on individual elements of the BOP, such as the current
account, the capital account (excluding the central bank's reserve account), or the sum of
the two. Imbalances in the latter sum can result in surplus countries accumulating wealth,
while deficit nations become increasingly indebted. The term balance of payments often
refers to this sum. A country's balance of payments is said to be in surplus, if sources of
funds (such as export of goods and sale of bonds to foreigners) exceed application of funds
(such as paying for imported goods and purchase of foreign bonds). There is a balance of
payments deficit, if the sources of funds are lesser than the application of funds. A BOP
surplus is results in accumulation of foreign exchange by the central banks.
Under fixed exchange rate systems, the central bank neutralizes fund flows by buying up
foreign currency with local currency or by selling foreign currency to buy the local currency,
thus preventing the fund flows from affecting the exchange rates between the country's
currency and other currencies. In this case, the net change in the central bank's foreign
exchange reserves is called the balance of payments surplus or deficit.
Under managed floats, the exchange rates are allowed to vary within certain limits.
Whereas, under purely floating exchange rates or purely flexible exchange rates the central
banks do not intervene at all to defend their currencies. The rates are set by the market
forces of demand and supply. The central bank's foreign exchange reserves remain
constant, and the balance of payments becomes zero.
Components of Balance of Payments
The current account shows the net amount a country is earning. It is the sum of the balance
of trade (net earnings on exports minus payments for imports), factor income (earnings on
foreign investments minus payments made to foreign investors) and cash transfers by
people working abroad. It is called the current account; because it covers the transactions
for the ‘present day’ and they don't give rise to any claims on future incomes of a country.
Whereas the capital account records the net change in ownership of the foreign assets
located within a country. It includes the foreign currency reserves of the central bank, and
the loans and investments between the country and the rest of world (but it does not the
future interest payments and dividends that the loans and investments yield - those are the
earnings and are recorded in the current account of the country). If a country purchases
more foreign assets (like machinery) than the assets it sells to other countries, the capital
account is said to be negative or in deficit.
The capital account excludes the central bank’s foreign exchange operations. Sometimes
the reserves account of the central bank is classified as "below the line" account and
therefore not reported as part of the capital account. Any current account surplus is
balanced by a capital account deficit of equal size and a current account deficit is balanced
by a corresponding capital account surplus. By the principles of double entry accounting, an
entry in the current account gives rise to an entry in the capital account, and in aggregate
the two accounts automatically balance.
Visible trade records imports and exports of physical goods called the merchandise
balance. Invisible trade records international buying and selling of services.
Causes of Deficits BoP
Some of the major important causes of deficit in balance of payments are Economical,
Political and Social in nature.
1. Economic Factors:
Exchange rates - If the currency is overvalued, imports will be cheaper and exports will be
expensive. Therefore, there will be a rise in imports and a fall in the exports.
Developmental activities - Developing countries depend on developed nations for supply of

machines, technology and other equipment. This leads to increased levels of imports and
negligible exports, thereby resulting in a deficit in the BOP account.
Economic growth - If there is an increase in national income, people will tend to have more
disposable income to consume luxury goods. If domestic producers cannot meet the
domestic demand, consumers will have to import goods from abroad. Therefore if there is
fast economic growth there tends to be a significant increase in the quantity of imports.
Decline in Competitiveness: A decline in manufacturing competitiveness leads to a decline

in the export manufacturing, and rise in deficit in the balance of trade.
High rate of inflation - When there is higher inflation in the domestic economy, then foreign
goods become relatively cheaper as compared to domestic goods. This increases imports
and causes a deficit in the BOP.
Recession in other countries – During recessions or negative economic cycles, the trading
partners may have to reduce their imports. This worsens the current account.
Domestic boom: When the domestic economy is going through a phase of boom, then
domestic production may be unable to satisfy the domestic demand. This leads to a deficit
in BOP due to increase in imports.
Fall in export demand – A fall in demand for country’s goods in the foreign markets due to
the emergence of alternatives, leads to deficits in the balance of payments.
Import of Services - Underdeveloped countries import services like IT from developed
countries, for which they have to pay huge amounts of money. It leads to a deficit in the
BOP.
2. Political Factors:
Law and order problems – Social instability leads to large capital outflows and reduced
inflows, thus creating deficits in the BOP.
Political disturbances - Frequent changes in the government, inadequate support to the

government in parliament discourages inflow of capital. This leads to a deficit due to higher
outflows than inflows.
3. Social Factors:
Demonstration Effect - When the people of underdeveloped countries are exposed to the
life styles of the people in advanced countries, they start adopting foreign pattern of living.
Due to this their imports increase and adversely affect the balance of payments.
Change in tastes, preferences, fashion and trends – Increased liking for foreign goods at
the expense of local goods leads to a deficit in the balance of payments.
There are conflicting views as to the primary cause of BOP imbalances, with US having by
far the biggest deficit at present. The conventional view is that current account factors are
the mainly responsible for the deficit – these include the exchange rates, government's
fiscal deficits, business competitiveness, and the willingness of the consumers to borrow for
extra consumption. But a few believe that the primary driver is the capital account, where a
global savings glut runs ahead of the available investment opportunities, and is pushed into
the US resulting in excess consumption and asset price inflation in the US.
Steps to Correct Deficit in BoP
Sustained or prolonged deficit has to be settled by short term loans or depletion of capital
reserve such as foreign exchange and gold.
Following are remedial actions for the short term:
Export promotion: Exports should be encouraged by granting various incentives to the

exporters.
Discouraging imports: By undertaking import substitution and imposing suitable tariffs on

imported goods imports can be suppressed.
Reducing inflation: Inflation discourages exports and encourages imports. Therefore,

governments should take suitable steps to increase the domestic production of goods to
check inflation and lower prices in their countries.
Exchange control: Governments should manage their foreign exchange reserves by

introducing suitable policies.
Devaluation of domestic currency: It means intentionally reducing the exchange value of

domestic currency. This makes domestic goods cheaper for the foreigners. Devaluation is
done by the governments where they have a fixed exchange rate system. Here care needs
to be taken to avoid rise in internal prices (because of scarcity due to exports) due to
devaluation.
Depreciation: Like devaluation, depreciation leads to fall in external purchasing power of
home currency. Depreciation occurs in a free market system wherein demand for foreign
exchange far exceeds the supply of foreign exchange in foreign exchange market of a
country.
9.5 Exchange Rates
Under convertibility of a currency there are authorized dealers of foreign currency who
function on a currency exchange. The exporters or anybody, who receive foreign currency,
go to these dealers and get their dollars exchanged for rupees at the prevailing rates of
exchange. Similarly, importers and anybody, who need foreign exchange, go to these
dealers and get their rupees converted into foreign exchange.
Currency convertibility means that currency of one country can be converted into the
currency of another country at the certain rate of exchange. If the exchange rate is
determined by the forces of demand and supply of the currency, then it is called free
convertibility. If it is predetermined by the governments, it is called fixed rate convertibility.
And if the exchange rates are allowed to float within a certain price band, then it is called
managed float.
As per the basic principles of economics, the factors of production should be available to
the most deserving producer at the right time, at the right place, and in a right quantity.
Therefore, for a faster growth of world trade and rapid capital flows between countries, free
convertibility of a currency is a must. Without free and unrestricted convertibility of
currencies, trade and capital flows between countries cannot happen smoothly.
The Bretton Woods system was the first example of a fully negotiated monetary order
intended to govern monetary relations among independent nation-states. The chief features
of the Bretton Woods system were an obligation for each country to adopt a monetary
policy that maintained the exchange rate (± 1 percent) by tying its currency to gold and the
ability of the IMF to bridge temporary imbalances of payments and address the lack of
cooperation among countries to prevent competitive devaluation of the currencies. To
maintain the exchange rates of their currencies in terms of dollar or gold, various countries
had imposed several controls on the usage of their foreign reserve. They restricted usage
of the foreign exchange and allocated it among different users depending on their priorities.
Therefore, the currency was converted into foreign exchange on the basis of officially fixed
exchange rates.
After Bretton Woods system collapsed in 1971, various countries switched over to the
floating foreign exchange rate system. Under floating exchange rate system, exchange
rates between different national currencies were expected to be determined through the
market forces of demand and supply. However, various countries still imposed restrictions
on free convertibility of their currencies in view of their balance of payment situation.
Current Account and Capital Account Convertibility
A currency may be convertible on both current and capital accounts.
A currency may be convertible only on current account, when it can be freely exchanged at
the prevailing market rates for exports and imports of merchandise and invisibles.
Whereas capital account convertibility refers to inflows of foreign portfolio capital for
purchasing shares of Indian companies (FII – Foreign Institutional Investment), direct
investment flows for investing in power projects and startups (FDI - Foreign Direct
Investment), borrowed foreign funds in terms of bonds, and dividends and interest payable
on them. A currency is freely convertible on capital account, when it can be exchanged for
these purposes at the prevailing market determined exchange rates without seeking any
permission from the government. Therefore, the dividends, capital gains, interest
received, and profits earned on investments get converted into US dollars at prevailing
market exchange rates before repatriating them.
As capital account involves a very large sum compared to current account, capital account
convertibility is very risky and makes foreign exchange rates more volatile, is was
introduced in India long after the introduction of convertibility on current account. When
exchange rates of country are relatively stable, deficits in balance of payments remain
under control and enough foreign exchange reserves are available with the Central Bank.
Convertibility of Indian Rupee
In the seventies and eighties many countries switched over to the free convertibility of their
currencies. As a part of economic reforms initiated in 1991 rupee was made partly
convertible in 1992 under “Liberalized Exchange Rate Management scheme in which 60
per cent of all receipts on current account could be converted freely into rupees at market
determined exchange rates quoted by the authorized dealers, whereas 40 per cent of it was
supposed be surrendered to the Reserve Bank of India at the officially fixed exchange rate
for meeting government’s foreign exchange needs and imports of essential commodities.
Therefore, partial convertibility of rupee on current account basically meant a dual
exchange rate system. Full convertibility of rupee at that stage was risky at that stage
because of large current account deficit.
As the exchange rate of rupee remained stable, even after partial convertibility of rupee was
introduced, from March 1993, rupee was made convertible for all trades in merchandise
and from March 1994, even invisibles and remittances from abroad were allowed to be
freely convertible at the market determined exchange rates. However, on capital account
the rupee remained nonconvertible even at that time.
Capital account convertibility means the freedom to convert rupees into foreign currency
and back for capital transactions. India has current account convertibility but not capital
account convertibility.
Advantages of Currency Convertibility
1. Encourages International Trade: As the exchange rates get continuously adjusted to

their real economic value, excessive imports will lead to depreciation of the domestic
currency making exports attractive and excessive exports will lead to appreciation of the
domestic currency making imports attractive. This continuous interaction of exports and
imports keep the exchange rates in equilibrium. If importers or exporters notice an arbitrage
opportunity between domestic prices of certain goods and the prices of those goods in
other countries at the prevailing exchange rate, they will import or export those goods as
the case may be. Goods keep moving from one country to another, until the arbitrage
opportunity disappears or until imported goods have a distinct advantage, like a specific
brand (iPhone) or a geographical origin (Alphonso mangoes).
2. Encouragement to import substitution: If the domestic producers notice an arbitrage

opportunity between the prices of imported goods and anticipated prices of those goods if
produced locally, then they will put in place the infrastructure to produce them locally,
eliminating the need for imports.
3. Incentive to send remittances from abroad: As the exchange rates are purely
determined by the markets, the remittances of foreign exchange by the Indians working
abroad are repatriated without waiting for any administrative action (such as devaluation of
the domestic currency). Transparent exchange rate mechanism suppresses illegal
remittances and smuggling.
4. A self – balancing mechanism: Another important merit of currency convertibility lies in
its self-balancing mechanism. When balance of payments is in deficit due to higher imports,
the domestic currency depreciates giving boost to exports to rebalance the BoP. Similarly,
when balance of payments is in surplus due to higher exports, the domestic currency
appreciates giving boost to imports to rebalance the BoP. In this way, the deficit in balance
of payments gets automatically corrected without any intervention from the government or
their central bank.
5. Specialization in accordance with the comparative advantage: Currency

convertibility ensures production in accordance with comparative advantage and resource
endowment. The comparative advantage throws up arbitrage opportunities. Many countries
strive to keep the arbitrage opportunities intact, by specializing and innovating to keep their
cost of production lower (manufacturing in China) or by keeping their product offering way
ahead of others (for example, Mercedes cars). It is only under currency convertibility; true
purchasing power of the domestic currency can be discovered. Thus, currency convertibility
ensures specialization and international trade on the basis of comparative advantage from
which all countries benefit.
6. Integration of World Economy: Currency convertibility integrates the domestic

economy with the world economy by discovering true purchasing power of the domestic
currency vis-à-vis the currency of trading partners. This helps in identifying the true
arbitrage opportunities. As under currency convertibility there is easy access to foreign
exchange, it greatly helps in the growth of trade and capital flow between the countries. The
expansion in trade and capital flows between countries ensures rapid economic growth of
the world economy.
Capital Account Convertibility of Rupee
As explained above, under Capital Account Convertibility any Indian company is entitled to
convert freely its Indian financial assets into foreign financial assets and vice-versa, at an
exchange rate determined by the foreign exchange market.
In a way, capital account convertibility removes all the restrains on international flows into
India’s capital account. There is a basic difference between current account convertibility
and capital account convertibility. In the case of current account convertibility, it is important
to have a transaction – importing and exporting of goods, buying and selling of services,
inward or outward remittances, etc. involving payment or receipt of one currency against
another currency. In the case of capital account convertibility, a currency can be converted
into any other currency without any transaction.
The Tarapore Committee defined capital account convertibility as the freedom to convert
local financial assets with foreign financial assets and vice-versa at market determined
rates of exchange. In a simple language, capital account convertibility allows anyone to
freely move his capital from local currency into foreign currency and vice-versa. The
purpose of capital convertibility is to give foreign investors an easy market to move in and
move out their capital and to send a strong message to the outside world that Indian
economy is strong enough and that it has sufficient foreign currency reserves to meet any
flight of capital from the country to any extent.
The Benefits of Capital Account Convertibility:
1. Availability of large funds to supplement domestic resources and thereby promote

economic growth.
2. Improved access to international financial markets and reduction in the cost of capital.
3. Incentive for Indians to acquire and hold international securities and assets, and
4. Improvement of the financial system in the context of global competition.
5. Freedom to convert local financial assets into foreign ones at market-determined
exchange rates.
6. Free exchange of currency at market-determined exchange rates and unrestricted
mobility of the capital.
7. Beneficial for any country because inflow of foreign investment increases, as the risk of
outflow diminishes.
The flip side though, is that it could destabilize the economy due to massive capital flows in
and out of the country during adverse times.
Why full capital account convertibility of rupee is still a distant dream
Capital account convertibility of the rupee is a distant dream for India because
macroeconomic parameters have to be stabilized before it is implemented. The low current
account deficit needs to be sustained over a long period of time and the fiscal deficit needs
to be contained within a reasonable limit.
It is believed that India should embrace capital account convertibility if it has to become a
top global economy.
9.6 Functions of I.M.F, World Bank, and W.T.O.
The International Monetary Fund (IMF)
It is an organization of 189 countries, working to foster global monetary cooperation, secure

financial stability, facilitate international trade, promote high employment and sustainable
economic growth, and reduce poverty around the world.
Created in 1945, the IMF is governed by and accountable to the 189 countries that make up
its near-global membership.
Why the IMF was created and how it works
The IMF, also known as the Fund, was conceived at a UN conference in Bretton Woods, in
July 1944 to build a framework for economic cooperation to avoid a repetition of the
competitive devaluations that led to the Great Depression of the 1930s.
The IMF’s responsibilities are
The IMF's primary purpose is to ensure the stability of the international monetary system -
the system of exchange rates and international payments that enables countries (and their
citizens) to transact with each other.
Surveillance: To maintain stability and prevent crises in the international monetary system,
the IMF reviews country policies and national, regional, and global economic and financial
developments through a formal system known as surveillance. The IMF advises its 188
member countries to adopt policies that foster economic stability, reduce vulnerability to
economic and financial crises, and raising living standards of the people. It provides
bulletins on World Economic Outlook, Global Financial Stability Report, and Fiscal Monitor.
Financial assistance: IMF financing provides its members breathing room to correct their
balance of payments problems. Member countries design their fiscal adjustment programs
as per IMF guidelines - continued financial support is conditional upon effective
implementation of these programs.
Technical assistance: The IMF provides technical assistance and training to help member
countries strengthen their capacity to design and implement effective policies. Technical
assistance is offered in several areas, including tax policy and administration, expenditure
management, monetary and exchange rate policies, banking and financial system
supervision and regulation, legislative frameworks, and statistics.
Special Drawing Rights SDRs
The IMF issues an international monetary reserve currency called Special Drawing Rights
(SDRs) that can supplement the official reserves of member countries. Created in response
to concerns about the limitations of gold and dollars as the sole means of settling
international accounts, SDRs augment international liquidity by supplementing the standard
reserve currencies. An SDR is essentially an artificial currency used by the IMF and is a
basket of national currencies. The IMF uses SDRs for internal accounting purposes,
because it gives and settles its loans in terms of SDRs. SDRs are issued by the IMF to its
member countries and are backed by the full faith and credit of the member countries'
governments.
SDR is a prospective claim against the freely usable currencies that belong to the IMF
member states. The IMF member states that hold SDRs can exchange them for freely
usable currencies by either agreeing among themselves for voluntary swaps, or by the IMF
instructing countries with stronger economies or larger foreign currency reserves to buy
SDRs from the less-endowed members. IMF member countries can borrow SDRs from its
reserves at favorable interest rates, mostly to adjust their balance of payments to favorable
positions. Besides acting as an auxiliary reserve asset, the SDR is the unit of account of the
IMF. Its value, which is summed up in U.S. dollars, is calculated from a weighted basket of
major currencies: Japanese yen, U.S. dollars, Sterling and the Euro.
Resources of the IMF
The primary source of the IMF's finance is its members’ quotas, which broadly reflect
members’ relative position in the world economy. In addition, the IMF can borrow
temporarily to supplement its quota resources.
Governance and organization of the IMF
The IMF is accountable to its member country’s governments. At the top of its
organizational structure is the Board of Governors, which consists of one Governor and one
Alternate Governor from each member country, generally from the central bank or the
ministry of finance. The Board of Governors meets once a year at the IMF / World Bank
Annual Meetings. Twenty-four of the Governors sit on the International Monetary and
Financial Committee (IMFC) and normally meet twice a year.
The IMF's day-to-day work is overseen by its 24-member Executive Board, which
represents the entire membership; this work is guided by the International Monetary and
Financial Committee (IMFC) and supported by the IMF staff. The Managing Director is the
head of the IMF staff and Chairman of the Executive Board and is assisted by four Deputy
Managing Directors.
The World Bank
The World Bank is an international financial institution that provides loans to developing
countries for capital programs. It comprises two institutions: the International Bank for
Reconstruction and Development (IBRD), and the International Development Association
(IDA). The World Bank is a component of the World Bank Group, which is part of the United
Nations system. The World Bank's official goal is the reduction of poverty. However,
according to its Articles of Agreement, all its decisions must be guided by a commitment to
the promotion of foreign investment and international trade and to the facilitation of Capital
investment.
The World Bank is a vital source of financial and technical assistance to developing
countries around the world. It is not a bank in the ordinary sense but a unique partnership to
reduce poverty and support development around the world. The World Bank Group
comprises five institutions managed by their member countries.
Established in 1944, the World Bank Group is headquartered in Washington, D.C. It has
more than 10,000 employees in more than 120 offices worldwide.
Financial Products and Services
It provides low-interest loans, zero to low-interest credits, and grants to developing

countries. These support a wide array of investments in such areas as education, health,
public administration, infrastructure, financial and private sector development, agriculture,
and environmental and natural resource management. Some of our projects are co-
financed with governments, other multilateral institutions, commercial banks, export credit
agencies, and private sector investors. It also provides or facilitates financing through trust
fund partnerships with bilateral and multilateral donors. Many partners have asked the Bank
to help manage initiatives that address needs across a wide range of sectors and
developing regions.
Innovative Knowledge Sharing
It offers support to developing countries through policy advice, research and analysis, and
technical assistance. Its analytical work often underpins World Bank financing and helps
inform developing countries’ own investments. In addition, it supports capacity development
in the countries it serves. It also sponsors, hosts, or participates in many conferences and
forums on issues of development, often in collaboration with partners.
To ensure that countries can access the best global expertise and help generate cutting-
edge knowledge, the Bank is constantly seeking to improve the way it shares its knowledge
and engages with clients and the public at large.
Its Key priorities include:
Results: It continues to sharpen its focus on helping developing countries deliver

measurable results.
Reform: It is working to improve every aspect of its work - how projects are designed, how
information is made available (Access to Information), and how to bring its operations
closer to client governments and communities.
Open Development: It offers a growing range of free, easy-to-access tools, research and
knowledge to help people address the world's development challenges. For example, the
Open Data website offers free access to comprehensive, downloadable indicators about
development in countries around the globe. It also has made the ‘World Bank Live’ - live
discussions open to participants worldwide - a key part of its Spring and Annual Meetings
with the International Monetary Fund.
The World Bank Group has set two goals for the world to achieve by 2030:
o End extreme poverty by decreasing the percentage of people living on less than $1.90 a
day to no more than 3%
o Promote shared prosperity by fostering the income growth of the bottom 40% for every
country
Key focus areas of the World Bank are
o Eradicate Extreme Poverty and Hunger: From 1990 through 2004, the proportion of
people living in extreme poverty fell from almost a third to less than a fifth. Although
results vary widely within regions and countries, the trend indicates that the world as a
whole can meet the goal of halving the percentage of people living in poverty. Africa's
poverty, however, is expected to rise, and most of the 36 countries where 90% of the
world's undernourished children live are in Africa. Less than a quarter of countries are
on track for achieving the goal of halving under-nutrition.
o Achieve Universal Primary Education: The percentage of children in school in
developing countries increased from 80% in 1991 to 88% in 2005. Still, about 72 million
children of primary school age, 57% of them girls, were not being educated as of 2005.
o Promote Gender Equality: The tide is turning slowly for women in the labor market, yet
far more women than men - worldwide more than 60% – are contributing but unpaid
family workers. The World Bank Group Gender Action Plan was created to advance
women's economic empowerment and promote shared growth.
o Reduce Child Mortality: There is some improvement in survival rates globally;
accelerated improvements are needed most urgently in South Asia and Sub-Saharan
Africa. An estimated 10 million-plus children under five died in 2005; most of their
deaths were from preventable causes.
o Improve Maternal Health: Almost all of the half million women who die during
pregnancy or childbirth every year live in Sub-Saharan Africa and Asia. There are
numerous causes of maternal death that require a variety of health care interventions to
be made widely accessible.
o Combat HIV/AIDS, Malaria, and Other Diseases: Annual numbers of new HIV
infections and AIDS deaths have fallen, but the number of people living with HIV
continues to grow. In the eight worst-hit southern African countries, prevalence is above
15 percent. Treatment has increased globally, but still meets only 30 percent of needs
(with wide variations across countries). AIDS remains the leading cause of death in Sub-
Saharan Africa (1.6 million deaths in 2007). There are 300 to 500 million cases of
malaria each year, leading to more than 1 million deaths. Nearly all the cases and more
than 95 percent of the deaths occur in Sub-Saharan Africa.
o Ensure Environmental Sustainability: Deforestation remains a critical problem,
particularly in regions of biological diversity, which continues to decline. Greenhouse
gas emissions are increasing faster than energy technology advancement.
o Develop a Global Partnership for Development: Donor countries have renewed their
commitment. Donors have to fulfill their pledges to match the current rate of core
program development. Emphasis is being placed on the Bank Group's collaboration with
multilateral and local partners to quicken progress toward the MDGs' realization.
World Trade Organization (WTO)
The World Trade Organization (WTO) is the only global international organization dealing
with the rules of trade between nations. At its heart are the WTO agreements, negotiated
and signed by the bulk of the world’s trading nations and ratified in their parliaments. The
goal is to help producers of goods and services, exporters, and importers conduct their
business.
There are a number of ways of looking at the World Trade Organization. It is an

organization for trade opening. It is a forum for governments to negotiate trade agreements.
It is a place for them to settle trade disputes. It operates a system of trade rules.
Essentially, the WTO is a place where member governments try to sort out the trade
problems they face with each other.
The WTO was born out of negotiations, and everything the WTO does is the result of
negotiations. The bulk of the WTO’s current work comes from the 1986–94 negotiations
called the Uruguay Round and earlier negotiations under the General Agreement on
Tariffs and Trade (GATT). The WTO is currently the host to new negotiations, under the
‘Doha Development Agenda’ launched in 2001.
Where countries have faced trade barriers and wanted them lowered, the negotiations have
helped to open markets for trade. But the WTO is not just about opening markets, and in
some circumstances its rules support maintaining trade barriers — for example, to protect
consumers or prevent the spread of disease.
At its heart are the WTO agreements, negotiated and signed by the bulk of the world’s
trading nations. These documents provide the legal ground rules for international
commerce. They are essentially contracts, binding governments to keep their trade policies
within agreed limits. Although negotiated and signed by governments, the goal is to help
producers of goods and services, exporters, and importers conduct their business, while
allowing governments to meet social and environmental objectives.
The system’s overriding purpose is to help trade flow as freely as possible — so long as
there are no undesirable side effects — because this is important for economic
development and well-being. That partly means removing obstacles. It also means ensuring
that individuals, companies and governments know what the trade rules are around the
world, and giving them the confidence that there will be no sudden changes of policy. In
other words, the rules have to be ‘transparent’ and predictable.
Trade relations often involve conflicting interests. Agreements, including those painstakingly
negotiated in the WTO system, often need interpreting. The most harmonious way to settle
these differences is through some neutral procedure based on an agreed legal foundation.
That is the purpose behind the dispute settlement process written into the WTO
agreements.
While the WTO is driven by its member states, it could not function without its Secretariat to
coordinate the activities. The Secretariat employs over 600 staff, and its experts — lawyers,
economists, statisticians and communications experts — assist WTO members on a daily
basis to ensure, among other things, that negotiations progress smoothly, and that the rules
of international trade are correctly applied and enforced.
Functions of WTO are
Trade negotiations - The WTO agreements cover goods, services and intellectual
property. They spell out the principles of liberalization, and the permitted exceptions. They
include individual countries’ commitments to lower customs tariffs and other trade barriers,
and to open and keep open services markets. They set procedures for settling disputes.
These agreements are not static; they are renegotiated from time to time and new
agreements can be added to the package. Many are now being negotiated under the Doha
Development Agenda, launched by WTO trade ministers in Doha, Qatar, in November
2001.
Implementation and monitoring - WTO agreements require governments to make their
trade policies transparent by notifying the WTO about laws in force and measures adopted.
Various WTO councils and committees seek to ensure that these requirements are being
followed and that WTO agreements are being properly implemented. All WTO members
must undergo periodic scrutiny of their trade policies and practices, each review containing
reports by the country concerned and the WTO Secretariat.
Dispute settlement - The WTO’s procedure for resolving trade quarrels under the Dispute
Settlement Understanding is vital for enforcing the rules and therefore for ensuring that
trade flows smoothly. Countries bring disputes to the WTO if they think their rights under
the agreements are being infringed. Judgements by specially appointed independent
experts are based on interpretations of the agreements and individual countries’
commitments.
Building trade capacity - WTO agreements contain special provision for developing
countries, including longer time periods to implement agreements and commitments,
measures to increase their trading opportunities, and support to help them build their trade
capacity, to handle disputes and to implement technical standards. The WTO organizes
hundreds of technical cooperation missions to developing countries annually. It also holds
numerous courses each year in Geneva for government officials. Aid for Trade aims to help
developing countries develop the skills and infrastructure needed to expand their trade.
Outreach - The WTO maintains regular dialogue with non-governmental organizations,

parliamentarians, other international organizations, the media and the general public on
various aspects of the WTO and the ongoing Doha negotiations, with the aim of enhancing
cooperation and increasing awareness of WTO activities.
Fundamental Principles of WTO
Non-discrimination - A country should not discriminate between its trading partners and it
should not discriminate between its own and foreign products, services or nationals.
More open - Lowering trade barriers is one of the most obvious ways of encouraging trade;
this barrier include customs duties (or tariffs) and measures such as import bans or quotas
that restrict quantities selectively.
Predictable and transparent - Foreign companies, investors and governments should be

confident that trade barriers should not be raised arbitrarily. With stability and predictability,
investment is encouraged, jobs are created and consumers can fully enjoy the benefits of
competition — choice and lower prices.
More competitive - Discouraging ‘unfair’ practices, such as export subsidies and dumping
products at below cost to gain market share; the issues are complex, and the rules try to
establish what is fair or unfair, and how governments can respond, in particular by charging
additional import duties calculated to compensate for damage caused by unfair trade.
More beneficial for less developed countries - Giving them more time to adjust, greater
flexibility and special privileges; over three-quarters of WTO members are developing
countries and countries in transition to market economies. The WTO agreements give them
transition periods to adjust to the more unfamiliar and, perhaps, difficult WTO provisions.
Protect the environment - The WTO’s agreements permit members to take measures to
protect not only the environment but also public health, animal health and plant health.
However, these measures must be applied in the same way to both national and foreign
businesses. In other words, members must not use environmental protection measures as
a means of disguising protectionist policies.
10. Shipping Routes & Ports
10.1 Major shipping routes

Tankers, bulk carriers and container ships are the most important means of transportation
of our time. Each year they carry billions of tones of goods along a few principal trade
routes. Containerization has revolutionized global cargo shipping, bringing vast
improvements in efficiency. The maritime boom could continue, despite the economic crisis.
Growth through globalization
Throughout history the oceans have been important to people around the world as a means
of transportation. Unlike a few decades ago, however, ships are now carrying goods rather
than people. Since the rise of intercontinental air travel, sea travel has become limited to
shorter trips (ferry services across the Baltic and North Seas, the Mediterranean, Japan and
Southeast Asia) and recreational cruises. The latter have recently experienced a
tremendous boom and represent an increasingly lucrative source of tourist income. As
markets became increasingly globalized, shipping volumes soared. From the 1950s to the
latest global economic crisis, the growth rate of international trade was almost consistently
twice that of economic activity as a whole. From 2000 to 2008 world trade increased by an
average 5.4 per cent each year, while economic activity, as measured by the global Gross
Domestic Product (GDP), increased by only 3 per cent per annum. Due to the spectacular
rise of trade vis-à-vis economic growth, world trade since the 1950s has more than trebled
to 45 per cent of the global GDP, while goods destined for the processing industry have in
fact more than quadrupled.
With respect to the value of the goods, about 23 per cent of world trade is between
countries with a common border. This percentage has remained fairly constant over recent
decades. Between continents, however, it differs a great deal depending on their level of
development. In Europe and North America the proportion is the highest at 25 to 35 per
cent. This trade is predominantly transacted by road and rail. Cargo between countries
without a common border is carried mainly by sea, although increasing quantities of
manufactured goods are being forwarded by air. Growth rates for air freight are more than
double those for shipping in recent years. Which mode of transport handles how much
cargo depends on the (relative) transportation costs and the value-to-weight ratio of the
goods – the higher the value per unit of weight, the less significant the cost of
transportation. Punctuality and reliability are considered more important for valuable
commodities.
According to research by economists, higher-income households purchase higher-quality

products. The residents of wealthy countries therefore tend to buy more quality goods.
Accordingly, rising incomes influence the demand for transport in three ways. First, quality
goods are more expensive. Their value-to-weight ratio is therefore higher and the cost of
transporting them is lower compared to their value. Second, as incomes rise, consumers
are more likely to purchase certain expensive products and fancy goods. At the same time
they expect to receive the articles within a very short time. Third, the delivery period itself is
a key element of product quality, having an increasing influence on purchasing decisions;
customers are no longer prepared to tolerate long delays. All of these factors have
contributed to the even higher growth rates of air freight in comparison to shipping.
What fuels maritime traffic
As mentioned, the main reason behind the massive increase in shipping was the growth in
world trade. But institutional and technological factors also had a role to play. In the past,
the liberalization achievements of GATT and its successor the WTO provided a new
momentum to world trade. China’s economic opening to the outside world, which led to
their admission to the WTO in 2001, was also very significant – its exports quadrupled
within 5 years. Another example of integrated markets boosting international trade is a
trebling of exports from Mexico to the USA within 6 years of NAFTA being established.
The appetites of the industrial nations and newly-industrializing emerging economies,

particularly China and India, for energy and mineral resources led to increasing quantities of
goods being transported from far-distant countries. The information and communications
technology revolution dramatically reduced the costs of mobility and accessibility. It allowed
new network connections and production processes such as just-in-time production,
outsourcing and offshoring, and provided a tremendous stimulus to logistics. As a result of
rising demand, transportation costs fell. Ships increased in size. Economies of scale were
exploited. Furthermore, there were technological advances and organizational
improvements in port management – of general cargo traffic, for instance. Of overriding
importance was containerization, the greatest transportation revolution of the 20th century.
The increasing spread of open ship registries, most notably embraced initially by Panama
and Liberia, allowed the shipping companies to combine the relatively low capital costs in
the industrial countries with the low labour costs for seafarers from developing countries like
the Philippines. It became possible to compensate for sharply rising labour costs, especially
in the industrial nations. Furthermore, by changing to an open registry, ship-owners could
avoid very costly regulations (such as national labour and employment laws). It is hardly
surprising, therefore, that according to UNCTAD, the ten top open and international
registries accounted for about 55 per cent of the global merchant fleet in 2008. In 1950 this
figure was only 5 per cent. This development has helped shipping to become a genuine
global economic sector. As far as ownership structure is concerned, however, it is far less
global. A few countries own the bulk of the fleet. About 54 per cent of world tonnage
(measured by carrying capacity or “deadweight tonnage”, dwt) is controlled by owners
(shipping companies) in Japan (16.0), Greece (15.3), Germany (9.5), China (8.4) and
Norway (4.5). In July 2009 the global merchant fleet consisted of a total of 53,005 vessels,
made up of 31 per cent traditional general cargo ships, 27 per cent tankers, 15 per cent
bulk carriers, 13 per cent passenger liners, 9 per cent container ships, and 5 per cent other
vessels. In terms of carrying capacity in dwt, however, the great variation in ship sizes gives
quite a different picture. From this perspective tankers and bulk carriers each account for 35
per cent, container ships 14 per cent, general cargo ships 9 per cent and passenger liners
less than 1 per cent. In all, the global merchant fleet has a capacity of just under 1192
million dwt.
Modern ships – large, fast and highly specialized
Marine innovations have helped to fuel the growth of maritime freight traffic. The following
are significant:
SIZE: The average size of ships has increased substantially. Larger vessels reduce the
shipping costs per load unit for crew, fuel, demurrage, insurance, and servicing and ship
maintenance. Port authorities must respond to increasing vessel sizes by expanding port
infrastructure (wharfage, transport connections inland) and improving port access (e.g. by
deepening fairways). Therefore they too face increasing costs. This can bring the owners –
usually the State or local authorities – into financial difficulty: the capital investment is
usually funded from the public purse, but the full costs are not passed on to port users.
SPEED: The average speed of a merchant ship is about 15 knots (1 knot = 1 nautical mile
per hour = 1853 metres per hour), or 28 kilometres per hour, the equivalent of about 670
kilometres a day. Newer ships are capable of 25 to 30 knots (45 to 55 kilometres per hour).
Marine propulsion has improved considerably since the invention of the screw propeller,
particularly the double propeller. This development reached its peak in the 1970s.
Achieving even higher speeds is a challenge and is likely to prove extremely expensive.
Experts are therefore predicting only limited increases to average commercial shipping
speeds.
DESIGN: Ship design has changed radically – from timber to steel to vessels built mainly of
aluminum and composite materials. Design innovations were aimed at dramatically
reducing fuel consumption and construction costs while increasing safety at the same time.
SPECIALIZATION: Specialization in the shipbuilding industry has brought massive changes

to ocean shipping. Special ships have increasingly been constructed for different types of
freight:
o Tankers for crude oil, petroleum products, chemicals, liquid gas and fruit juice
concentrate;
o Bulk carriers for bulk goods such as ores, coal, grain;
o Bulk carriers for large-volume unit loads such as motor vehicles and iron;
o Refrigerated vessels (reefers) for fruit from the Southern Hemisphere;;
o General cargo ships;
o Container ships, which are increasingly taking on the tasks of general cargo ships on
long-haul routes;
o Ferries for shipping trucks as well as roll-on/roll-off (Ro-Ro) ships, which carry
articulated lorries to drive the cargo onto the ship. These two are taking over the tasks of
general cargo vessels on short-haul routes.
By speeding up cargo handling, specialization has been responsible for reducing the costs
per transported unit. Where special ships can be utilized to capacity, therefore, economies
of scale have been achieved.
AUTOMATION: Various automation technologies have been introduced to shipbuilding and

ship operations, including self-loading/unloading systems, computerized navigation, and the
global positioning system (GPS). Automation has markedly reduced the number of crew
needed and at the same time substantially improved safety standards. According to data
service provider “IHS Fairplay”, total vessel losses (due to accidents or sinking) have
declined from more than 200 a year in the mid-1990s to about 150 now – a remarkable
improvement in safety when measured against the sharp rise in fleet numbers. Maritime
freight traffic was booming for many years. The amount of cargo transported by sea
exceeded the 8 billion tone mark for the first time in 2007. Global shipping had therefore
doubled since 1990 (an average annual increase of over 4 per cent). Transport capacity,
too, virtually doubled in the same period to almost 33 trillion tonne-miles.
The global recession in 2008/2009 triggered a massive slump in world trade and,
accordingly, shipping. Following a modest rise of nearly 3 per cent in 2008 – trade
nosedived by about 14 per cent in 2009. Freight rates fell to historic lows on many sub-
markets. As at the beginning of 2009 about 9 per cent of bulk carriers worldwide lay idle,
unutilized, in ports, this capacity is coming back only slowly to the market in the 2010
recovery.
What ships carry – Oil, containers, and dry cargo
Ocean shipping can roughly be divided into two sub-markets – on the one hand liquid cargo
such as oil and petroleum products, on the other dry cargo. Dry cargo is made up of bulk
goods, the five most important being iron ore, coal, grain, phosphates and bauxite. Other
dry cargo consists of bulk materials such as non-ferrous metal ores, feed and fertilizers,
and particularly a variety of goods packaged in smaller transportation units. The latter are
labelled as general cargo and shipped on liners, i.e. vessels with scheduled sailings, chiefly
in containers. Liner shipping usually offers its services according to fixed conditions that are
agreed on between competitors at so-called liner conferences.
The single most significant type of cargo worldwide is crude oil, which alone accounts for
roughly a quarter of all goods transported by sea. The major importers are the European
Union, the United States of America and Japan. All three are supplied by the Middle East,
the most important oil-producing region. North America also obtains oil from West Africa
and the Caribbean, while Europe imports from North and West Africa. The main shipping
lanes therefore stretch westward from the Arabian Gulf around the Cape of Good Hope or
through the Suez Canal, and from Africa northward and westward to Europe and North
America. Others connect the Arabian Gulf to East Asia and the Caribbean to the Gulf Coast
of the United States.
Of course, crude oil is not the only commodity transported by sea. Smaller, specialized
ships (product tankers) carry processed petroleum products from major peripheral refinery
locations to the consumption areas of North America and Japan. This amounted to about
815 million tones worldwide in 2007. In terms of quantity, iron ore and coal are significant
dry-bulk goods. Iron ore is transported over long distances in very large ships, mainly from
Brazil to Western Europe and Japan, and from Australia to Japan. The most important coal
routes are from the major export countries of Australia and South Africa to Western Europe
and Japan and also from Colombia and the East Coast of the United States to Western
Europe, as well as from Indonesia and the West Coast of the United States to Japan. Most
of the coal transported is utilized as steam coal to generate electricity in power stations. A
third is used as coking coal for smelting in the iron and steel industry. Dry bulk goods also
include grain and oil-bearing seeds (wheat, barley, rye, oats, sorghum and soya beans).
Here however, the quantities and direction of transport routes fluctuate much more than
other vital commodities depending on harvest seasons and yields. The USA, Canada,
Argentina, Australia and France are the major grain exporters. Africa and East Asia are
major importers due to frequent local shortages. Although the main grain producers (the
United States, Russia, China and India) retain most or even all of their production in their
own country, what remains for global trade is still enough to include grain among the bulk
commodities.
Increased international division of labor, in motor vehicle production for instance, has led to
general cargo such as cars and parts accumulating in such large quantities that entire
shiploads can be forwarded on specialized ships outside the scheduled liner services.
Large car carriers and special tankers for chemicals or fruit juice concentrate also belong to
this special shipping sector, operating on contracted routes. Today most other dry cargo is
transported in container ships. These standardized containers have brought a flood of
technical innovations (such as special cranes at transshipment points) and fundamental
organizational innovations in their wake. Being standardized, they can be transported with
any mode of transport and rapidly transferred to trucks or railway cars fitted with the
appropriate equipment. From an economic point of view this has dramatically reduced
transportation costs, mainly as a result of faster loading and unloading. Capital investment
along the entire transport chain was necessary to ensure the containers were used
efficiently, considerably increasing capital intensity. In contrast, labor intensity was
sustainably reduced, as fewer dockworkers were needed for loading and unloading. Since
1985 global container shipping has increased by about 10 per cent annually to 1.3 billion
tonnes (2008). During the same period its share of the total dry cargo transportation rose
from 7.4 per cent to a quarter. A total of 137 million containers, measured in TEU, were
transported in 2008. This quantity, however, decreased again in 2009 by 10 per cent.
Typically the cost of transporting a TEU containing more than 20 tonnes of freight from Asia
to Europe is roughly the same as a one-way Economy Class flight along the same route.
This weight in everyday goods such as electrical appliances in most cases represents a
transportation cost of less than 1 per cent of the selling price.
Key shipping routes
If all commercial goods are taken into account it becomes clear that there is a relatively
small number of principal transport routes, and these pass through only a few areas of the
oceans. The busiest are the approaches to the ports of Europe and East Asia, particularly
Japan but also Shanghai, Singapore and Hong Kong, and the United States. The East
Coast of the United States in particular is a major sender and receiver of cargo. Narrow
straits further concentrate maritime traffic. Bottlenecks include the Straits of Dover,
Gibraltar, Malacca, Lombok and Hormuz, and the Cape of Good Hope at the southern tip of
Africa. Traffic builds up in these areas, making ships vulnerable to attack by pirates.
Cargo imbalances are a typical feature of the traffic with Asia – depending on the trade
balance. Much more cargo is being shipped from Asia than in the opposite direction. This
imbalance is particularly notable on the Pacific route, at almost 10 million TEU (Twenty Foot
Equivalent Unit) is the unit of the capacity of a container ship). From Asia to Europe it is
almost 8 million TEU. The North Atlantic traffic between the highly-developed economies of
North America and Europe, however, are much better balanced, registering a difference of
barely 2 million TEU. The reason for this situation is that since the mid-1980s so many
manufacturing processes have been relocated from the traditional industrial countries to the
developing nations and emerging economies, particularly China and the countries of South
East Asia. With the prevailing exchange rates, China in particular has become the cheap
“workshop of the world”. This process has been promoted by the introduction of the
container and the corresponding increase in shipping productivity. The transportation costs
between where goods are manufactured and where these goods are consumed have been
reduced considerably. Dry cargo such as automobile and machinery parts – until now
transported by conventional means – has been increasingly containerized, contributing to
the growth in container traffic. Until the global economic downturn the demand for new
ships was great, but as the effects of the crisis were felt the tide turned and many
companies cancelled their orders. All the same we can assume that even more marine
transport capacity will become available in the near future as new ships are delivered,
overtaking demand. Freight rates are therefore unlikely to recover from their current all-time
lows any time soon.
A sea lane, sea road or shipping lane is a regularly used route for vessels on oceans and
large lakes. In the age of sails they were not only determined by the distribution of land
masses but also the prevailing winds, whose discovery was crucial for the success of long
voyages. Sea lanes are very important for trade by sea. Shipping lanes are the busiest
parts of the sea, thus being a useful place for stranded boaters whose boats are sinking or
people on a life raft to boat to, and be rescued by a passing ship.
There are potentially an infinite number of maritime shipping routes that can be used for
commercial circulation, but the configuration of the global system is relatively simple. The
main axis is a circum-equatorial corridor linking North America, Europe and Pacific Asia
through the Suez Canal, the Strait of Malacca and the Panama Canal.
Maritime routes are a function of obligatory points of passage, which are strategic locations,
of physical constraints (coasts, winds, marine currents, depth, reefs, ice) and of political
borders. As a result, maritime routes draw arcs on the earth water surface as
intercontinental maritime transportation tries to follow the great circle distance. Main
shipping lanes are those supporting the most important commercial shipping flows servicing
major markets. Secondary shipping lanes are mostly connectors between smaller markets.
In part due to physiography, geopolitics and trade specific locations play a strategic role in
the global maritime network. They are labeled as strategic passages and can be classified
into two main categories:
Primary passages are the most important since without them there would be limited cost
effective maritime shipping alternatives which would seriously impair global trade. Among
those are the Panama Canal, the Suez Canal, the Strait of Hormuz and the Strait of
Malacca, which are key locations in the global trade of goods and commodities.
Secondary passages support maritime routes that have alternatives, but would still involve
a notable detour. These include the Magellan Passage, the Dover Strait, the Sunda Strait
and the Taiwan Strait.
Types of Maritime Routes
Maritime routes are structured according to the type of commercial service they support,
which comes in three main categories:
Port-to-port - Involves a more or less regular service between two ports, often moving
back and forth with unidirectional freight flows, which involve empty backhaul. This structure
has the disadvantage of offering limited connectivity and mainly represents movements of
raw materials such as oil, minerals and grain, between zones of extraction and main
consumption markets. They are usually chartered ships that load in one port and discharge
their cargo in one to three ports in proximity.
Pendulum - This type of route is characterizing containerized cargo and involves a regular
itinerary between sequences of ports where the maritime shipping line seeks to optimize
their ship use by electing to service ports having important trade relations. A set of ports
along one seaboard are serviced and then an ocean is crossed with the process being
repeated along another seaboard. The term pendulum refers to the shipping service moving
back and forth between two maritime ranges. The most significant pendulum routes are
between East Asia, North America and Western Europe, the three main poles of the global
economy.
Round-the-World - Involves servicing continuously a sequence of ports, often in both

directions, so that the sequence involves a trip around the world. A limited amount of ports
per continent are serviced. This type of maritime route strictly concerns container shipping
and involves a series of transshipment hubs where regional cargo is collected.
Trade Routes
Trade between an origin group of countries and a destination group of countries is referred
to as a trade route.
Top Trade Routes (TEU shipped) 2013
West East North South
Route Total
Bound Bound Bound Bound
Asia-North America 7,739,000 15,386,000 23,125,000
Asia-North Europe 9,187,000 4,519,000 13,706,000
Asia-Mediterranean 4,678,000 2,061,000 6,739,000
Asia-Middle East 3,700,000 1,314,000 5,014,000
North Europe-North
2,636,000 2,074,000 4,710,000
America
Australia-Far East * 1,072,016 1,851,263 2,923,279
Asia-East Coast South
621,000 1,510,000 2,131,000
America
North
Europe/Mediterranean-
795,000 885,000 1,680,000
East Coast South
America
North America-East
656,000 650,000 1,306,000
Coast South America
Serving the Trade Routes
There are almost 500 liner shipping services providing regularly scheduled service (usually
weekly) that enables goods to move between ports along the many trade routes of the
world.
Route Services
Far East- North America 73
North Europe- Far East 28
Far East- Mediterranean 31
North Europe- North America 23
Mediterranean- North America 21
Europe- Mid- East/ South Asia 40
North America-Mid-East/South Asia 10
Far East- Mid- East/South Asia 72
Australasia 34
East Coast South America 26
West Coast South America 48
South Africa 24
West Africa 60
Total 490
10.2 Types of ports
A port is a location on a coast or shore containing one or more harbors where ships can
dock and transfer people or cargo to or from land. Port locations are selected to optimize
access to land and navigable water, for commercial demand, and for shelter from wind and
waves. Ports with deeper water are rarer, but can handle larger, more economical ships.
Since ports throughout history handled every kind of traffic, support and storage facilities
vary widely, may extend for miles, and dominate the local economy. Some ports have an
important military role.
Ports often have cargo-handling equipment, such as cranes (operated by longshoremen)

and forklifts for use in loading ships, which may be provided by private interests or public
bodies. Often, canneries or other processing facilities will be located nearby. Some ports
feature canals, which allow ships further movement inland. Access to intermodal
transportation, such as railroads and highways, is critical to a port, so that passengers and
cargo can also move further inland beyond the port area. Ports with international traffic
have customs facilities. Harbor pilots and tugboats may maneuver large ships in tight
quarters when near docks.
The terms "port" and "seaport" are used for different types of port facilities that handle
ocean-going vessels, and river port is used for river traffic, such as barges and other
shallow-draft vessels.
Inland port - An inland port is a port on a navigable lake, river (fluvial port), or canal with
access to a sea or ocean, which therefore allows a ship to sail from the ocean inland to the
port to load or unload its cargo. An example of this is the St. Lawrence Seaway which
allows ships to travel from the Atlantic Ocean several thousand kilometers inland to Great
Lakes ports like Duluth-Superior and Chicago.
Fishing port - A fishing port is a port or harbor for landing and distributing fish. It may be a
recreational facility, but it is usually commercial. A fishing port is the only port that depends
on an ocean product, and depletion of fish may cause a fishing port to be uneconomical. In
recent decades, regulations to save fishing stock may limit the use of a fishing port,
perhaps effectively closing it.
Dry port - A dry port is an inland intermodal terminal directly connected by road or rail to a
seaport and operating as a center for the transshipment of sea cargo to inland destinations.
Warm-water port - A warm-water port is one where the water does not freeze in
wintertime. Because they are available year-round, warm-water ports can be of great
geopolitical or economic interest. Such settlements as Dalian in China, Vostochny Port,
Murmansk and Petropavlovsk-Kamchatsky in Russia, Odessa in Ukraine, Kushiro in Japan
and Valdez at the terminus of the Alaska Pipeline owe their very existence to being ice-free
ports. The Baltic Sea and similar areas have ports available year-round thanks to
icebreakers beginning in the 20th century, but earlier access problems prompted Russia to
expand its territory to the Black Sea.
Seaport - A seaport is further categorized as a "cruise port" or a "cargo port". Additionally,

"cruise ports" are also known as a "home port" or a "port of call". The "cargo port" is also
further categorized into a "bulk" or "break bulk port" or as a "container port".
Cruise home port - A cruise home port is the port where cruise-ship passengers board (or
embark) to start their cruise and disembark the cruise ship at the end of their cruise. It is
also where the cruise ship's supplies are loaded for the cruise, which includes everything
from fresh water and fuel to fruits, vegetables, champagne, and any other supplies needed
for the cruise. "Cruise home ports" are a very busy place during the day the cruise ship is in
port, because off-going passengers disembark their baggage and on-coming passengers
aboard the ship in addition to all the supplies being loaded. Currently, the Cruise Capital of
the World is the Port of Miami, Florida, closely followed behind by Port Everglades, Florida
and the Port of San Juan, Puerto Rico.
Port of call - A port of call is an intermediate stop for a ship on its sailing itinerary. At these
ports, cargo ships may take on supplies or fuel, as well as unloading and loading cargo
while cruise liners have passengers get on or off ship.
Cargo port - Cargo ports, on the other hand, are quite different from cruise ports, because
each handles very different cargo, which has to be loaded and unloaded by very different
mechanical means. The port may handle one particular type of cargo or it may handle
numerous cargoes, such as grains, liquid fuels, liquid chemicals, wood, automobiles, etc.
Such ports are known as the "bulk" or "break bulk ports". Those ports that handle
containerized cargo are known as container ports. Most cargo ports handle all sorts of
cargo, but some ports are very specific as to what cargo they handle. Additionally, the
individual cargo ports are divided into different operating terminals which handle the
different cargoes, and are operated by different companies, also known as terminal
operators or stevedores (A laborer who loads and unloads vessels in a port).
10.3 Ports of India
India has a coastline spanning 7516.6 kilometers, forming one of the biggest peninsulas in
the world. According to the Ministry of Shipping, around 95 per cent of India's trading by
volume and 70 per cent by value is done through maritime transport. It is serviced by 13
major ports, 200 notified minor and intermediate ports. The total 200 non-major ports are in
the following States:- Maharashtra (48); Gujarat (42); Tamil Nadu (15); Karnataka (10);
Kerala (17); Andhra Pradesh (12); Odisha (13); Goa (5); West Bengal (1); Daman and Diu
(2); Lakshadweep (10); Pondicherry (2); and Andaman & Nicobar (23).
Government of India plans to modernize these ports and has approved a project called
Sagarmala. The ports and shipping industry in India plays a vital role in sustaining growth in
the country’s trade and commerce. The Indian Government has allowed Foreign Direct
Investment (FDI) of up to 100 per cent under the automatic route for port and harbor
construction and maintenance projects. The government has also initiated National
Maritime Development Program (NMDP), an initiative to develop the maritime sector with a
planned outlay of US$ 11.8 billion.
Indian government has a federal structure, and according to its constitution, maritime
transport is to be administered by both the Central and the State governments. While the
central government's shipping ministry administers the major ports, the minor and
intermediate ports are administered by the relevant departments or ministries in the nine
coastal states of Andhra Pradesh, Odisha, West Bengal, Tamil Nadu, Port Blair , Kerala,
Karnataka, Goa, Maharashtra and Gujarat. Several of these 187 minor and intermediate
ports have been identified by the respective governments to be developed, in a phased
manner, a good proportion of them involving public-private partnership.
Shipping
Major ports handled over 74% of all cargo traffic in 2007. All major ports, except one
Ennore Port are government administered, but private sector participation in ports has
increased. There are also 7 shipyards under the control of the central government of India,
2 shipyards controlled by state governments, and 19 privately owned shipyards.
As of 2000, there were 102 shipping companies operating in India, of which five were
privately owned and based in India and one was owned by Shipping Corporation of India.
There were 639 government-owned ships, including 91 oil tankers, 79 dry cargo bulk
carriers, and 10 cellular container vessels. Indian-flagged vessels carried about 15 percent
of overseas cargo at Indian ports for financial year 2003.
Cargo Handled Vessel Traffic

Container Traffic
(FY2014-15) (FY2012-13)
Name % Increase % Increase % Increase
million '000
(over previous Nos (over previous (over previous
tonnes TEUs
FY) FY) FY)
Kandla 92.50 6.31% ↑ 2,734 0.74% ↑ 29 -75.42% ↓
Paradip 71.01 4.42% ↑ 1,279 -4.96% ↓ 9 -30.77% ↓
JNPT 63.80 2.36% ↑ 2,588 -11.25% ↓ 4,161 -2.30% ↓
Mumbai 61.66 4.18% ↑ 1,949 -5.25% ↓ 41 -14.58% ↓
Visakhapatnam 58.00 -0.85% ↓ 2,066 -16.36% ↓ 263 6.48% ↑
Chennai 52.54 2.81% ↑ 1,928 -5.63% ↓ 1,468 -4.68% ↓
Kolkata 46.29 11.86% ↑ 3,155 -0.91% ↓ 563 -6.17% ↓
Cargo Handled Vessel Traffic
Container Traffic
(FY2014-15) (FY2012-13)
Name % Increase % Increase % Increase
million '000
(over previous Nos (over previous (over previous
tonnes TEUs
FY) FY) FY)
Mangalore 36.57 -7.11% ↓ 1,096 -5.11% ↓ 50 4.17% ↑
Tuticorin 32.41 13.17% ↑ 1,292 -13.40% ↓ 508 6.72% ↑
Ennore
30.25 10.66% ↑ 475 23.38% ↑ -- --
(corporate)
Kochi 21.60 3.39% ↑ 1,367 -1.09% ↓ 351 4.78% ↑
Mormugao 14.71 25.32% ↑ 473 39.75% ↑ 22 10.00% ↑
All Indian Ports 581.34 4.65% ↑ 20,402 -6.95% ↓ 7,465 -3.10% ↓
10.4 Fishing
Fishing in India is a major industry in its coastal states, employing over 14 million
people. Fish production in India has increased more than tenfold since independence.
According to the Food and Agriculture Organization (FAO) of the United Nations, fish
output in India doubled between 1990 and 2010.
India has 7517 kilometers of marine coastline, 3,827 fishing villages, and 1,914
traditional fish landing centers. India's fresh water resources consist of 195,210
kilometers of rivers and canals, 2.9 million hectares of minor and major reservoirs, 2.4
million hectares of ponds and lakes, and about 0.8 million hectares of flood plain
wetlands and water bodies. As of 2010, the marine and freshwater resources offered a
combined sustainable catch fishing potential of over 4 million metric tons of fish. In
addition, India's water and natural resources offer a tenfold growth potential in
aquaculture (farm fishing) from 2010 harvest levels of 3.9 million metric tons of fish, if
India were to adopt fishing knowledge, regulatory reforms, and sustainability policies
adopted by China over the last two decades.
The marine fish harvested in India consist of about 65 commercially important

species/groups. Pelagic (Open Ocean) and midwater species contributed about 52% of
the total marine fish in 2004.
India is a major supplier of fish in the world. In 2006 the country exported over 600,000
metric tons of fish, to some 90 countries, earning over $1.8 billion. Shrimps are one of
the major varieties exported. The giant tiger prawn (Penaeus monodon) is the dominant
species chosen for aquaculture, followed by the Indian white prawn (Fenneropenaeus
indicus). Shrimp production from coastal aquaculture during 2004 stood at
approximately 120,000 tonnes. Farmed shrimp accounted for about 60% of shrimp
exported from the country.
Marine and freshwater catch fishing combined with aquaculture fish farming is a rapidly
growing industry in India. In 2008 India was the sixth largest producer of marine and
freshwater capture fisheries, and the second largest aquaculture farmed fish producer in
the world. Fish as food—both from fish farms and catch fisheries—offers India one of
the easiest and fastest way to address malnutrition and food security.
Despite rapid growth in total fish production, a fish farmers’ average annual production
in India is only 2 tons per person, compared to 172 tons in Norway, 72 tons in Chile, and
6 tons per fisherman in China. Higher productivity, knowledge transfer for sustainable
fishing, continued growth in fish production with increase in fish exports have the
potential for increasing the living standards of Indian fishermen. As of 2010, fish harvest
distribution was difficult within India because of poor rural road infrastructure, lack of
cold storage and absence of organized retail in most parts of the country. In 2013, with
access to Sri Lankan waters closed after the defeat of the Liberation Tigers of Tamil
Eelam, Indian fishers quickly overfished their own waters and production plummeted.
10.5 Major sea fishing zones
A fishery is an area with an associated fish or aquatic population which is harvested for
its commercial value. Fisheries can be wild or farmed. Most of the world's wild fisheries
are in the ocean.
Oceans occupy 71 percent of the Earth's surface. They are divided into five major
oceans, which in decreasing order of size are: the Pacific Ocean, Atlantic Ocean, Indian
Ocean, Southern Ocean, and Arctic Ocean. Over 70 percent of the world catch from the
sea comes from the Pacific Ocean.
Fish
Area Volume Mean Max
Coastline Capture
Ocean million % million % Depth Depth %
km Million
km2 km3 km km
Tonnes
Pacific Ocean 155.6 46.4 679.6 49.6 4.37 10.924 135,663 84.234 71.0
Atlantic Ocean 76.8 22.9 313.4 22.5 4.08 8.605 111,866 24.045 20.3
Indian Ocean 68.6 20.4 269.3 19.6 3.93 7.258 66,526 10.197 8.6
Southern
20.3 6.1 91.5 6.7 4.51 7.235 17,968 0.147 0.1
Ocean
Arctic Ocean 14.1 4.2 17.0 1.2 1.21 4.665 45,389
Totals 335.3 1370.8 4.09 10.924 356,000 118.623
Pacific Ocean
The Pacific Ocean is the largest of the world's oceans, extending from the Arctic in the
north to Antarctica in the south. Covering 169.2 million square kilometers, it is larger
than all of the Earth's land area combined. The Pacific contains 25,000 islands (over half
the islands in the world), most of which are south of the equator. The Pacific's greatest
asset is its fish. The shoreline waters of the continents and the more temperate islands
yield herring, salmon, sardines, snapper, swordfish, and tuna, as well as shellfish.
Atlantic Ocean
The Atlantic Ocean is the second-largest ocean covering 106.4 million square
kilometres with a coastline of 111,000 kilometres. It occupies about one-fifth of the
Earth's surface. The ocean has some of the world's richest fishing resources, especially
in the waters covering the shelves. The major species of fish caught are cod, haddock,
hake, herring, and mackerel. The most productive areas include the Grand Banks of
Newfoundland, the shelf area off Nova Scotia, Georges Bank off Cape Cod, the
Bahama Banks, the waters around Iceland, the Irish Sea, the Dogger Bank of the North
Sea, and the Falkland Banks. Eel, lobster, and whales have also been taken in great
quantities. Because of the threats to the ocean environment presented by oil spills,
marine debris, and the incineration of toxic wastes at sea, various international treaties
exist to reduce some forms of pollution.
Indian Ocean
The Indian Ocean is the third largest ocean, covering 73,556,000 square kilometers, or
about twenty percent of the water on the Earth's surface. Small islands dot the
continental rims.
The ocean's continental shelves are narrow, averaging 200 kilometres (120 mi) in width.
An exception is found off Australia's western coast, where the shelf width exceeds 1,000
kilometres (620 mi). The average depth of the ocean is 3,890 metres (12,760 feet). The
remaining 14% is layered with terrigenous sediments. Glacial outwash dominates the
extreme southern latitudes.
The warmth of the Indian Ocean keeps phytoplankton (unicellular algae) production low,
except along the northern fringes and in a few scattered spots elsewhere; life in the
ocean is thus limited. Fishing is confined to subsistence levels. Its fish are of great and
growing importance to the bordering countries for domestic consumption and export.
Fishing fleets from Russia, Japan, South Korea, and Taiwan also exploit the Indian
Ocean, mainly for shrimp and tuna. Endangered marine species include the dugong,
seals, turtles, and whales. Oil and ship pollution threatens the Arabian Sea, Persian
Gulf, and Red Sea.
Southern Ocean
The Southern Ocean is the fourth-largest ocean, covering 20,327,000 square

kilometers. It is typically between 4,000 and 5,000 meters deep with only limited areas
of shallow water. The Antarctic continental shelf is narrow and unusually deep, its edge
lying at up to 800 meters, compared to a global mean of 133 meters.
The Antarctic Circumpolar Current moves perpetually eastward — chasing and joining
itself, and at 21,000 kilometers is the world's longest ocean current, transporting 130
million cubic meters per second — 100 times the flow of all the world's rivers. The
Antarctic ice pack fluctuates from an average minimum of 2.6 million square kilometers
in March to about 18.8 million square kilometers in September.
Fauna: squid, whales, seals, krill, various fish
Increased solar ultraviolet radiation resulting from the Antarctic ozone hole has reduced
marine primary productivity (phytoplankton) by as much as 15% and has started
damaging the DNA of some fish. Illegal, unreported, and unregulated fishing, especially
the landing of an estimated five to six times more Patagonian tooth fish than the
regulated fishery, likely affects the sustainability of the stock. Long-line fishing for tooth
fish causes a high incidence of seabird mortality.
The International Whaling Commission prohibits commercial whaling south of 40

degrees south (south of 60 degrees south between 50 degrees and 130 degrees west).
Japan does not recognize this and they carry out an annual whale-hunt which they say
is for scientific research. See Southern Ocean Whale Sanctuary. The Convention for the
Conservation of Antarctic Seals has limited seal-hunting. The Convention on the
Conservation of Antarctic Marine Living Resources regulates fishing in the region.
Arctic Ocean
The Arctic Ocean is the smallest of the world's five major oceans and the shallowest.
Almost completely surrounded by Eurasia and North America, it is largely covered by
sea ice throughout the year. Its temperature and salinity vary seasonally as the ice
cover melts and freezes; its salinity is the lowest on average of the five major seas, due
to low evaporation, heavy freshwater inflow from rivers and streams, and limited
connection and outflow to surrounding oceanic waters with higher salinities. In summer
the icepack shrinks about fifty percent.
Endangered marine species include walruses and whales. The area has a fragile
ecosystem which is slow to change and slow to recover from disruptions or damage.
The Arctic Ocean has relatively little plant life except for phytoplankton. Phytoplankton is
a crucial part of the ocean and there are massive amounts of them in the Arctic.
Nutrients from rivers and the currents of the Atlantic and Pacific oceans provide food for
the Arctic phytoplankton.
10.6 Offshore oil producing zones
Extensive surveys have been conducted by ONGC in the offshore areas of Kuchchh,
Khambhat, Konkan, Malabar and Coromandal coasts, Krishna-Godavari delta and
Sunderbans. Success on commercial scale has been achieved at Mumbai High,
Bassein and Aliabet.
1. Mumbai High:
The greatest success achieved by the ONGC with respect to offshore surveys for oil
was that of Mumbai High in 1974. It is located on the continental shelf off the coast of
Maharashtra about 176 km north-west of Mumbai.
Here the rock strata of Miocene age covers an area of 2,500 sq km with estimated
reserves of about 330 million tonnes of oil and 37,000 million cubic metres of natural
gas. Production on commercial scale began in 1976. Oil is taken from a depth of over
1,400 metre with the help of a specially designed platform known as Sagar Samrat.
The discovery of Mumbai High has revolutionised the oil production in India. The share
of Mumbai High in the total oil production of India has shot up considerably. This area
produced 85 lakh tonnes of oil in 1982 which rose to over 189 lakh tonnes or over 62
per cent of all India in 1991-92.
Production from this field declined between 1989-90 and 1993-94 due to over
exploitation. Remedial measures have been taken to enhance the production and the
declining trend has been reversed since 1994-95. In 2002-03 this area produced 215.73
lakh tonnes of oil which was about two-thirds of total production of India.
2. Bassein:
Located to the south of Mumbai High, this is a recent discovery endowed with reserves
which may prove to be higher than those of the Mumbai High. Huge reserves have been
found at a depth of 1,900 metre. Production has started and is expected to pick up fast.
3. Aliabet:
It is located at Aliabet Island in the Gulf of Khambhat about 45 km off Bhavnagar. Huge
reserves have been found in this field. A sum of Rs. 400 crore has already been spent
on this field. Commercial production is expected to start soon.
East Coast:
The basin and delta regions of the Godawari, the Krishna and the Cauvery rivers hold
great potential for oil and gas production. As such these are both on-shore and off-shore
areas where extensive exploration has been conducted during the last few years. The
Rawa field in Krishna- Godawari off-shore basin is expected to produce 1 to 3 million
tonnes of crude oil annually.
In 2002-03, Tamil Nadu produced 3.95 lakh tons of oil which was slightly more than the
one per cent of the total oil production of India. The Narimanam and Kovilappal oilfields
in the Cauvery on-shore basin are expected to produce about 4 lakh tonnes of crude oil
annually. A 5 lakh tonne refinery is being set up at Panaigudi near Chennai to refine
crude oil from this area.
Andhra Pradesh produces less than one per cent of the total crude oil of India. Oilfields
have recently been discovered in the Krishna-Godavari basin. The oilfield near Amolpur
is expected to yield 3,600 barrels of crude oil per day.
10.7 India's overseas Trade
10.8 Special Economic Zones
A Special Economic Zone (SEZ) is a geographical region that has economic laws more
liberal than a country's typical economic laws. It is a trade capacity development tool, with a
goal to promote rapid economic growth by using tax and business incentives to attract
foreign investment and technology. By offering privileged terms, Special Economic Zones
attract investment and foreign exchange, spur employment and boost the development of
improved technologies and infrastructure.
In India, Special Economic Zones are being established in an attempt to deal with
infrastructural deficiencies, procedural complexities, bureaucratic hassles and barriers
raised by monetary, trade, fiscal, taxation, tariff and labor policies. Since country-wide
development of the infrastructure is expensive and implementation of structural reforms
would require time, (Special Economic Zones/Export Processing Zones) are being
established as industrial enclaves for expediting the process of industrialization.
One of the earliest and most famous Special Economic Zone was founded by the
government of the People's Republic of China under Deng Xiaoping in the early 1980s.
Government of India in April 2000 announced the introduction of Special Economic Zones
policy in the country. As of 2007, more than 500 Special Economic Zones have been
proposed, 220 of which have already been created. This has raised the concern of the
World Bank, which questions the sustainability of such a large number of Special Economic
Zones.
Tracing Indian economic reforms
In India several attempts have been made to liberalize the system of economic
management. In 1980s, the Indian Government focused on reorganizing low-efficient state-
run enterprises and partial disinvestment, relaxing the control on private enterprises and
foreign capital, introducing competitive mechanisms, reducing protection for domestic
industries, promoting and importing advanced technological equipment from abroad etc.
In 1991, the reformed trade and industrial policy eliminated licensing requirements for
private domestic and foreign investment in certain industries and relaxed the restrictions
under the Monopolies and Restrictive Trade Practices Act on expansion, diversification,
mergers and acquisitions by large firms and industrial houses. Special Economic Zones
came in pursuance of this export led growth strategy.
Special Economic Zones were announced by the Government of India in April 2000 as a
part of the Export-Import policy of India. The government realized the need to enhance
foreign investment, promote exports from the country and at the same time provide a level
playing to the domestic enterprises, while ensuring manufacturers to be competitive
globally.
The Special Economic Zones as announced by the Government of India in 2000 were
deemed to be foreign territory for the purposes of trade operations, duties and tariffs. These
zones were to provide an internationally competitive and hassle free environment for
exports. Units were allowed be set up in Special Economic Zone for manufacture of goods
and rendering of services. All import/export operations of the Special Economic Zone units
were on self-certification basis. Anything could be imported duty free but sales in the
Domestic Tariff Area by Special Economic Zone units were subject to payment of full
Custom Duty and as per import policy in force. Further Offshore banking units were being
allowed to be set up in the Special Economic Zones. The policy provided for setting up of
Special Economic Zones in the public, private, joint sector or by State Governments.
On 31st August 2004 the Department of Commerce announced the Foreign Trade Policy
2004-2009 to create an appropriate institutional framework and policy environment for
facilitation and growth of external trade. The basic objective of this policy was to double
India's share of global merchandise trade by 2009 and make exports an effective
instrument of economic growth and employment generation. The Special Economic Zone
Act, 2005 and the Special Economic Zone Rules, 2006 were introduced under this policy, to
regulate and promote the development of these industrial enclaves.
The Act designated the Special Economic Zones a duty free enclave to be treated as
foreign territory only for trade operations and duties and tariffs. Under the Act, no license is
required for import and no routine examination is to be conducted by the custom authorities
of the export/import cargo. To aid backward and forward integration of the economy, the Act
provides exemptions to Special Economic Zone units and Special Economic Zone
developers from all indirect taxes, including basic customs duty, countervailing duty,
education cess, and direct taxes while at the same time domestic sales are subject to full
customs duty and import policy in force. The Act provided the freedom to subcontract. It
also permitted manufacturing, trading and service activities in the Special Economic Zones.
India and China: Whether on a Level Platform
Success stories of large and small developing countries can be explained by the growth of
world trade and opening up of these economies with market based deregulation. But from
any in-depth scrutiny one finds that the reform package under the broad heading of
"liberalization" is very different from country to country. There is no standard recipe of a
"reform package". A lot of factors influence the performance of Special Economic Zones in
a country e.g. economic history, location, industries, state policy etc. Since India has
adopted the idea of the special economic zones from China it becomes pertinent to study
the history of economic development in India and China.
China's success can be ascribed largely because of its effective population control. In the
pre-reform days, both in China and India top priority was given to equity, removing poverty
and increasing the social aspects of standards of living. This, however, was attempted in
China under a total state-controlled economy and in India with the public sector playing a
dominant role along with the market forces. Both the economies adopted a strategy of
import substitution and heavy industry growth. China over time, realized that maintaining
high standards of living becomes difficult unless efficiency in the use of resources is
increased. Its attempt to maintain equity through forced saving and administered directives
resulted in social unrest, which came to a breaking point after the controversial Cultural
Revolution. The key objective of present reform in China is to bring incentives back in the
economy by increasing the role of the market with minimum changes in their political
institutions. This is defined in China as an experiment in a socialistic market economy.
In India, heavy import substitution lead to increased inefficiency in production and

generation of surplus for maintaining the tempo of equity measures as a result social
development became impossible. This led to heavy borrowing, culminating in a balance of
payments crisis. To meet the crisis, this new economic policy in India was initiated.
China's success in attracting foreign direct investment and becoming one of the top
exporting countries of the world hinged on the careful implementation of its Special
Economic Zone policy. Size, location, flexible labour laws and stable policies were the
factors primarily responsible for making Chinese Special Economic Zones attractive to
foreign investors. In India, the fiscal concessions being offered to developers and units are
the primary driving force.
Chinese government started building Special Economic Zones way back in 1979. The idea
behind the Special Economic Zones was to experiment with liberal policies in certain ear-
marked regions while insulating the rest of the economy from their influence. The
government identified huge tracts of land, near the coastal region, and started building
mega cities with all required infrastructure. Stringent labour laws applicable in China were
relaxed in these regions and foreign investment was encouraged by offering concessions
and promising of stability.
In 1980 four Special Economic Zones namely, Shenzhen, Zhuhai, Shantou and Xiamen
were opened up. In 1984, fourteen coastal cities were opened up as a further step. In 1985,
three delta areas along the Yangtze River and Pearl River and in the southern part of Fujian
province as well as several other places were opened up. In the following years, Hainan
Island, Pudong New Area in Shanghai, five big cities along the Yangtze River, eighteen
provincial capitals and a part of inland and border cities were opened up. These zones were
created initially as experimental stations to adjust and watch their operations vis-à-vis open
market interactions.
Though India had a head-start in the direction by building its first export processing zone in
1969 with certain minimum infrastructure and fiscal sops, it could not muster enough
political will to build full-fledged Special Economic Zones with foreign territory status in the
matters of international trade till the turn of the century. As opposed to five mega Special
Economic Zones built by the Chinese government (the largest being Shenzhen built over
49,500 hectares), India opened its doors to private players and allowed sector-specific
Special Economic Zones to develop on just 10 hectares of land. As a result, more than 500
Special Economic Zones have been proposed, 220 of which have already been created.
The economies of scale, which seems to have worked so well in China by reducing
production costs, may not have the same effect in the Indian Special Economic Zone.
In China, the government chose the location for Special Economic Zone s with a lot of
thought with all five located near the coastal region. This made it easier for the Special
Economic Zone units to export their products and import inputs. In India, Special Economic
Zones are being built all over the country, wherever land can be acquired by the
developers. This has also led to allegations of land-grabbing and conversion of productive
agricultural land by developers. As a result, Centre has made it mandatory that all
proposals should have a certificate from the state governments notifying that the land being
used is non-agricultural for at least 90%.
Flexibility in labor laws, which played an important role in attracting foreign investors, is
absent in the Indian Special Economic Zones. This is one of the prices India has to pay for
the advantages of a federal democratic government. India has, however, tried to make up
for all the disadvantages by offering attractive fiscal sops. Tax holidays for Special
Economic Zones in India are longer and steeper than those given by China. This had given
rise to some dissent from the finance ministry which had complained that the fiscal loss
would be immense. In fact the scheme has generated a difference of opinion between the
Finance and Commerce Ministries.
While the former is voicing its concerns about possible revenue loss from the tax privileges
for the Special Economic Zones, the latter is stoutly defending the policy with statistics
suggesting minimal losses and highlighting eventual gains in terms of employment and
revenues.
Reserve Bank of India has also expressed its concerns about the revenue losses and the
uneven pattern of development. Reserve Bank of India insisted on factoring the revenue
implications of the taxation benefits. The revenue loss for the Government in providing
incentives may be justified only if the Special Economic Zone units ensure forward and
backward linkages with the domestic economy. Also, as resources are being diverted from
the less developed, growth will not be uniform.
One of the most basic difference between the Special Economic Zone model adopted in
China and India is that the Chinese Special Economic Zone initiative is government driven,
whereas Indian Special Economic Zones are driven by private sector . In China , the State
acquires the land and develops the required infrastructure, while private enterprises are
invited to set up units. Under such a system, land continues to be under the ownership of
the State. In India, however, private entities are being involved in developing the Special
Economic Zone infrastructure. As a result, Land is being acquired by the State and handed
over to private developers.
Current Controversy
The Economic Survey of 2006-07 highlighted the fact that Special Economic Zones are
testing grounds for the implementation of liberal market economy principles. At the same
the survey emphasized on some apprehensions against the Special Economic Zones:
Generation of little new activity as there may be relocation of industries to take advantage
of tax concessions, Revenue loss, Large-scale land acquisition by the developers, may lead
to displacement of farmers with meager compensation, Acquisition of prime agricultural
land, having serious implications for food security, Misuse of land by the developers for real
estate and Uneven growth aggravating regional inequalities.
The Survey also mentioned that many of these apprehensions, however, could be
addressed through appropriate policies and safeguards.
A major controversy surrounding the implementation of the Special Economic Zone scheme
has been the ruthless manner adopted for acquiring land. News reports highlighted protests
across the country against acquisition of lands for the purpose of establishing Special
Economic Zones. The "SEZ No More" campaign gained momentum after the bloody
chapter in Nandigram.
Since, developing Special Economic Zones involves massive displacement of farmers, it is

essential that a systematic approach should be followed for ensuring balance of interests.
Consequently, state governments have been advised that in land acquisition for Special
Economic Zones, first priority should be for acquisition of waste and barren land and if
necessary single crop agricultural land. If perforce a portion of double-cropped agricultural
land has to be acquired to meet the minimum area requirements, especially for multi-
product Special Economic Zone, the same should not exceed 10 % of the total land
required for the Special Economic Zone.
The government has also announced the new National Policy on Rehabilitation and
Resettlement 2007. This policy would provide land-for-land compensation for acquisition of
land for development purposes, including Special Economic Zones, and employment to at
least one person from each affected family. A National Rehabilitation Commission would be
set up by the Central Government, which would be duly empowered to exercise
independent oversight over the rehabilitation and resettlement of the affected families.
Further, wage employment would be provided to the willing affected persons in the
construction work in the project. The policy also ensures housing benefits including houses
to the landless affected families in both rural and urban areas.
Adequate provisions have been made for financial support to the affected families for
construction of cattle sheds, shops, working sheds; transportation costs, temporary and
transitional accommodation, comprehensive infrastructural facilities and amenities in the
resettlement area including education, health care, drinking water, roads, electricity,
sanitation, religious activities, cattle grazing, and other community resources.
The benefits expressed in monetary terms have been linked to the Consumer Price Index,
and the same shall also be revised suitably at appropriate intervals. Special provision has
been made for providing life-time monthly pension to the vulnerable persons, such as the
disabled, destitute, orphans, widows, unmarried girls, abandoned women, or persons above
50 years of age (who are not provided or cannot immediately be provided with alternative
livelihood).
A strong grievance redressal mechanism has been prescribed, which includes standing
R&R Committees at the district level, R&R Committees at the project level, and an
Ombudsman duly empowered in this regard. The R&R Committees shall have
representatives from the affected families including women, voluntary organizations,
Panchayats, local elected representatives, etc. Provision has also been made for post-
implementation social audits of the rehabilitation and resettlement schemes and plans.
For effective monitoring of the progress of implementation of R&R plans, provisions have
been made for a National Monitoring Committee, a National Monitoring Cell, mandatory
information sharing by the States and Union Territories with the National Monitoring Cell,
and Oversight Committees in the Ministries/Departments concerned for each major project.
For ensuring transparency, provision has been made for mandatory dissemination of
information on displacement, rehabilitation and resettlement, with names of the affected
persons and details of the rehabilitation packages. Such information shall be placed in the
public domain on the Internet as well as shared with the concerned Gram Sabhas and
Panchayats by the project authorities. This policy aims at striking a balance between the
need for land for development purposes and protecting the interests of land owners and
other displaced people.

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Economics & Management Science

Prepared as per Indian Maritime University syllabus of

Prof. Pradeep Prabhu

I hope this book will help them achieve this objective.

Prof. Pradeep Prabhu

1. Introduction to Management Principles & Practices

1.1. Fundamental Principles of Sound Management

2. Accounting & Financial Management

2.1. Methods of Capital formation

3. Production & Operations Management

3.1. Factors of production

4. Human Resource Development

4.1. The personnel Function,

5. Importance of economics in Marine Engineering study

5.1. Basic economic concepts

6. Production function, Law of return, Economics of scale

6.1. Isoquant and Isocost curves

7.1. Types of Money

8.1. Direct and indirect taxes

9. Domestic and foreign trade

9.1. Basis of International Trade

10. Shipping Routes & Ports

10.1. Major Shipping Routes

o As a part of the investment decision – whether to commit additional resources on this

o Quantitative or Mathematical Approach

Quantitative or Mathematical Approach or Management Science Approach:

Mathematics has been universally accepted as an important tool for management

The basic features of systems approach are as under:

o A system consists of interacting elements. It is a set of inter related and inter-dependent

Contingency or Situational Approach

Thus behavior within an organization is contingent on environment, and if a manager wants

Contingency approach is an improvement over the systems approach. The interactions

Contingency views are ultimately directed towards suggesting organizational designs

Features of Contingency Approach:

Fayol’s Principles of Management

The scientific approach to management is known as the classical theory of management.

3. Reorganization of supervision: - concepts of separation of planning and doing and

Division of responsibility: - introduction of functional foremanship made division of

Management is social process involving

Henry Fayol describes management as -

Even though theoretical purposes it may be convenient to separate the function of

o Manpower Planning (estimating the man power requirement)

Direction has following elements:

Therefore controlling has following steps:

o Establishment of standard performance.

According to Urwick, “Planning is a mental predisposition to do things in an orderly way, to

Steps in Planning Function

Planning function of management involves following steps:-

a. Planning requires a systematic approach.

2. Establishment of Planning Premises

3. Choice of alternative course of action

4. Formulation of derivative plans

6. Follow up/Appraisal of plans

Organizing is the function of management which follows planning. It is a function in which

A manager performs organizing function with the help of following steps:-

1. Identification of activities - All the activities which have to be performed in a concern

According to Theo Haimann, “Staffing pertains to recruitment, selection, development and

Nature of Staffing Function

1. Staffing is an important managerial function- Staffing function is the most

Direction has got following characteristics:

1. Pervasive Function - Directing is required at all levels of organization. Every manager

According to Brech, “Controlling is a systematic exercise which is called as a process of

According to Donnell, “Just as a navigator continually takes reading to ensure whether he is