Aero Befa

UNIT-I.
INTRODUCTION TO MANAGERIAL
ECONOMICES
• Definition,
• Nature and scope of business economics;
• Demand analysis;
• Demand determinants,
• Law of demand and its exceptions;
• Elasticity of demand: Definition, types,
• Measurement and significance of elasticity of demand,
• Demand forecasting,
• Factors governing demand forecasting.
Business Economics
Topics :
• Why Economics-Introduction
• Meaning and Definition
• Types of Economics
• Nature of Economics
• Scope of Economics
• Relation with other Disciplines
• Fundamental Principles of Economics
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Why Economics-Introduction
• Study of how people choose to use resources.
• Resources include the time , machine ,money material and talent
of people, land, buildings, equipment, and other tools on the hand,
• The knowledge of how to combine them to create useful
products/goods and services.
• It is the social science that studies the production, distribution and
consumption of goods and services
• In short, economics includes the study of labour, land, and

investments, money, income, and production, and of taxes and
government expenditures.
• Economists seek to measure well-being, to learn how well-being
may increase overtime, and to evaluate the well-being of the rich
and the poor.
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Meaning and Definition
Economics: ‘A queen of Social Sciences’
Economics = ‘OKIOS’+ ‘NOMOS’ ( Greek Words)
‘OIKOS’ = ‘HOUSE’
‘NOMOS’= MANAGEMENT
According to J.S.Mill Economics is “ The practical science of
production and distribution of wealth”
‘It is the study of how people produce and spend income’
“Managerial Economics is the integration of economic theory with
business practice for the purpose of facilitating decision making and
forward planning by management”
-Spencer and Siegel man
“The applications of economics theory and methodology to business
administration practice”.
E. F. Brigham 4
Types of Economics
Micro Economics: ‘It is the study of particular firms, households,
individual prices, wages, incomes, individual particular
industries, industries.”
Some of the theories which come under Micro Economics,
• –Theory of Individual/Market Demand.
• –Theory of Production \and Cost.
• –Theory of Markets and Price.
• –Theory of Profit, etc.…
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Types of Economics
Macro Economics: ‘It deals not with individual quantities as such
but with aggregates of these quantities, not with
individual incomes but with national income.’
Some of the theories which come under Macro Economics,
– Theory of total output and employment.
– Theory of Inflation.
– Theory of trade cycles
– Economic growth, etc.…
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Microeconomics vs Macroeconomics
Microeconomics Macroeconomics
Microeconomics studies Macroeconomics studies a nation’s economy, as

individual economic units well as its various aggregates.
Microeconomics primarily deals Macroeconomics is the study of aggregates such

with individual income, output, as national output, income, as well as general
price of goods, etc. price levels.
Microeconomics focuses on Macroeconomics focuses on upholding issues

overcoming issues concerning the like employment and national household
allocation of resources and income.
price discrimination.
Microeconomics accounts for Macroeconomics account for the aggregated

factors like demand and supply of demand and supply of a nation’s economy.
a particular commodity.
Microeconomics vs Macroeconomics
Microeconomics Macroeconomics
Microeconomics offers a picture of Macroeconomics helps ensure optimum utilisation of
the goods and services that are the resources available to a country.
required for an efficient economy. It
also shows the goods and services
that might grow in demand in
future.
Microeconomics helps point Macroeconomics help determine the equilibrium

how equilibrium can be achieved at levels of employment and income of the nation.
a small scale.
Microeconomics also focuses on The primary component of macroeconomic problems
issues arising due to price variation is income.
and income levels.
Examples:- Examples:-
Consumer equilibrium. National income and savings.
Output generated by an individual General price level.
organisation. Aggregated demand as well as supply.
Individual income and savings. Poverty.
Rate of unemployment.
BUSINESS ECONOMICS
Managerial Economics as a subject gained popularity in USA after the
publication of book “Managerial Economics ” by Joel Dean in 1951.
Managerial Economics refers to the firm’s decision making process.
It could be also interpreted as “ Economics of Management”.
Managerial Economics is also called as “Industrial Economics” or “Business

Economics”.
Joel Dean observes managerial economics shows how economic analysis can be
used in formulating policies.
In the words of PAPPAS AND HIRSHEY

“Managerial Economics applies economic theory and methods to business and
administrative decision-making. Because it uses the tools and techniques of
economic analysis to solve managerial problems, managerial economics links
traditional economics with decision sciences to develop important tools for
managerial decision-making”.
Nature of Economics
 Close to micro economics-finding solutions for different managerial problems of a
particular firm (production schedules)
 Operates against the backdrop of macro-economics- macro economics conditions of the

economy are also seen as limiting factors for a firm to operate .(industry policy and
inflation)
 Normative statements-one problem with normative statements is that they cannot be

verified by looking at facts ,because they mostly deals with the future.
 Perspective action-suggest the course of action from the available alternatives for
optimal solution
 Applied in nature- case study method to conceptualize problem
 Offers scope to evaluate each alternative –cost and revenue
 Interdisciplinary- different subjects
 Assumptions and limitations –validity is not universal (changes)

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Scope of Business Economics
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scope of business economics
The scope of business economics is quite wide. Business economics

involves the application of various economic tools, theories, and
methodologies for analyzing solving different business problems.
Two Categories
There are two categories of business issues to which economic theories
can be directly applied, namely:
Microeconomics applied to internal or operational issues
Macroeconomics applied to external or environmental issues
Scope of Micro Economics
Microeconomics applied to internal or operational issues
 Demand analysis and forecasting
 Cost and benefit analysis (CBA)
 Pricing decisions, policies, and practices
 Profit maximization
 Capital management
 Risk and Uncertainty Analysis

Scope of Macroeconomics
 The type of economic system stage of business cycle is the general trends in national
income, employment, prices, saving and investment.
 Government’s economic policies like industrial policy, competition policy, monetary

and Fiscal policy, price policy, foreign trade policy and globalization policies.
 Working of financial sector and capital market
 Socio-economic organizations like trade unions, producer and consumer unions and
cooperatives.
 Social and political environment: Business decisions cannot be taken without

considering these present and future environmental factors.
 Business decisions cannot be taken without considering these present and future
environmental factors. As the management of the firm has no control over these
factors, it should ne-tune its policies to minimise their adverse effects
Relation with other Disciplines
1. Business Economics and Traditional Economics:
2. Business Economics and Accounting:
3. Business Economics and Operational Research:
4. Business Economics and Marketing:
5 Business Economics and Production Management:
6. Business Economics and Personnel Management
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Demand Analysis
Meaning Of Demand: Demand for a commodity refers to the quantity

of the commodity which an individual consumer or a household is
willing to purchase per unit of time at a particular price. Demand for a
commodity implies-
• Desire of the consumer to buy the product,
• His willingness to buy the product, and
• Sufficient purchasing power in his possession to buy the product.
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Determinants of Demand
.
Income
Number of
Price
Buyers
Determinants
Expectations
Supply?
about future
Taste
s
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Demand Function
A mathematical expression of the relationship between quantity
demanded of the commodity and its determinants is known as the
demand function.
When this relationship relates to the demand by an individual

consumer it is known as individual’s demand function, while if it
relates to the market it is called market demand function.
 f ( P X , Y , P1 ,....... P n  1 , T , A, E y , E p ,
Q d x
u )
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Individual Demand Function
• Q dx refers to the quantity demanded of the product X, ex., ice-
cream ban
• P x refers to the price of the product X
• Y refers to the level of household income
• P P refer to the price of all the other ‘related’ products in
1,...., n-1
economy ( related products include substitutes and
Compliments) T refer to the tastes of the consumer
• A refer to advertising
• E y refer to consumer’s expected future income
• Ep refers to consumer’s expectations about future prices
• U refers to all those determinants which are not covered in the
list
of determinants given above.
 f (P X , Y , P1 ,....... P n  1 , T , A, E y , E p ,
Q d x
u)
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Market Demand Function
Where:
All are the same as in the individual’s demand function.
While,
• P refers to population (which reflects the size of the
market)
• D refers to distribution of consumers in various categories
depending upon income, age, sex, etc.
 f ( P X , Y , P1 ,....... P n  1 , T , A , E y , E p , P, D,
Q dx
u)
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Law of Demand
Meaning: Law of demand states that higher the price lower the
quantity demanded, and vice versa, other things being constant.
Qdx  f (p)
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The assumptions of the law of demand
 No expectation of future price changes or shortages

 No change in consumer’s preferences
 No change in the price of related goods
 No change in consumer’s income
 No change in size, age composition and sex ratio of the populati
on
 No change in the range of goods available to the consumers
 No change in government policy
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Exceptions of the law of demand
Exceptions to the law of demand that with a fall in price, the demand also falls and
there is an increase in demand with an increase in price.
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1.Giffen Goods
Giffen Goods is a concept that was introduced by Sir Robert Giffen. These
goods are goods that are inferior in comparison to luxury goods.
However, the unique characteristic of Giffen goods is that as its price
increases, the demand also increases. And this feature is what makes it
an exception to the law of demand.
The Irish Potato Famine is a classic example of the Giffen goods concept.
Potato is a staple in the Irish diet. During the potato famine, when the
price of potatoes increased, people spent less on luxury foods such as
meat and bought more potatoes to stick to their diet. So as the price of
potatoes increased, so increased in demand, which is a complete reversal
of the law of demand.
2.Veblen goods:-This exception to the law of demand is associated with the

doctrine propounded by Thorsten Veblen. A few goods like diamonds etc are
purchased by the rich and wealthy sections of the society. The prices of
these goods are so high that they are beyond the reach of the common man.
The higher the price of the diamond the higher the prestige value of it. So
when price of these goods falls, the consumers think that the prestige value
of these goods comes down. So quantity demanded of these goods falls with
fall in their price. So the law of demand does not hold good here.
3. Conspicuous necessities:
Certain things become the necessities of modern life. So we have to
purchase them despite their high price. The demand for T.V. sets,
automobiles and refrigerators etc. has not gone down in spite of the increase
in their price. These things have become the symbol of status. So they are
purchased despite their rising price. These can be termed as “U” sector
goods.
4. Ignorance:
A consumer’s ignorance is another factor that at times induces him to purchase
more of the commodity at a higher price. This is especially so when the
consumer is haunted by the phobia that a high-priced commodity is better in
quality than a low-priced one.
5. Emergencies:
Emergencies like war, famine etc. negate the operation of the law of demand. At
such times, households behave in an abnormal way. Households accentuate
scarcities and induce further price rises by making increased purchases even at
higher prices during such periods. During depression, on the other hand, no fall
in price is a sufficient inducement for consumers to demand more.
6.Future changes in prices:

Households also act speculators. When the prices are rising households tend to
purchase large quantities of the commodity out of the apprehension that prices
may still go up. When prices are expected to fall further, they wait to buy goods
in future at still lower prices. So quantity demanded falls when prices are falling.
7. Change in fashion:
A change in fashion and tastes affects the market for a commodity. When a
broad toe shoe replaces a narrow toe, no amount of reduction in the price of the
latter is sufficient to clear the stocks. Broad toe on the other hand, will have
more customers even though its price may be going up. The law of demand
becomes ineffective.
Elasticity of Demand
Most of the times , it is not enough to understand the increase or
decrease in price and its consequential impact of change in the
quantity demanded.
It is necessary to find out the extent of increase or decrease in each
variables for taking certain managerial decisions.
Definition : “ The percentage change in quantity demanded caused

by one percent change in the demand determinant under
consideration , while other determinants are held constant.”
E= Percentage change in quantity demanded of good X

Percentage change in determinant Z
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Symbolically it may be stated as
E= percentage change is quantity demanded of good X

Percentage change in determinant Z
Symbolically it may be stated as
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.
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Measurement of Elasticity of demand
Perfectly elastic demand
Perfectly inelastic demand
Relatively elastic demand
Relatively inelastic demand
Unit elasticity of demand
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Perfectly Elastic Demand(EP = ∞) :When a slight change in price
causes a great change in quantity demanded, the value of elasticity of
demand tends to be infinity and demand is said to be infinite or
perfectly elastic. Examples:-Luxurious goods -Gold, High end cars
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Perfectly inelastic demand: (EP = 0): If quantity demanded becomes
completely unresponsive to price changes, the coefficient tends to be
zero. In this case, whatever the price, even if it is zero, quantity
demanded will remain fixed at a particular level. The demand curve,
thus, becomes parallel to the vertical axis and demand is said to be
completely (perfectly) inelastic.
Examples:-Life saving drugs
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Relatively elastic demand(EP > 1):Relatively elastic demand refers
to when the proportionate change in the demand is greater than
the proportionate change in the price of the good. Examples:-
Tv,Refrigerator
Example:-Normally, demand is elastic for luxury goods. Let the price of gold per gm
decline from Rs. 160 to Rs. 140. As a result, demand for gold rises from 1,000
kilograms to 2,000 kilograms. Thus, EP = 1,000/1,000 ÷ 20/160 =
1,000/20 .160/1,000 = 8 Since elasticity of demand for gold is greater than one,
gold is a luxury item. 34
Relatively inelastic demand(EP < 1):: The demand is said to be
relatively inelastic when the change in demand is less the change in
the price.
Example:-Demand is inelastic for necessary goods.
Suppose that following a drop in the price of wheat from paisa 40 per kilogram to paisa 20
per kilogram,
demand for wheat rises from 1,600 kilograms to 2,000 kilograms. This means
EP = 400/160 0÷ 20/40 = 400/20. 40/1,600 = 0.5
Thus, wheat has an inelastic demand since EP < 1 and wheat is a necessary article
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Unit Elasticity: The elasticity in demand is said to be unity when the
change in demand is equal to the change in price.
Example:-Suppose that the price of a commodity declines from Rs.

200 to Rs. 100 per kilogram. As a result, demand for that commodity
rises from 400 kilograms to 800 kilograms. Thus, EP = 400/400 ÷
100/100 = 400/100. 100/400 = 1
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Types of Elasticity of Demand
Price Income
Elasticity of Elasticity of
Demand Demand
Cross Advertising
Elasticity of Elasticity
Demand of
Demand
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Price Elasticity of Demand
The measure of relative responsiveness of quantity demanded curve is
known as price elasticity of demand. It can be represented
mathematically as , price elasticity of demand.
E= Percentage changein quantity demanded

of good X Percentage change in price of
= go
Qod/ Q P1
  P / P   .
Q P
 
1
Q1 . 1
Minus sign is put to make the
Q 1valueof
P e absolute.
P Q1
Where q1 and p1 are originally price and quantity respectively , and
new q2 p2 are new quantity and price respectively.
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Income elasticity of demand
Income Elasticity
The income elasticity of demand is the degree of
responsiveness of the quantity demanded to a change
in the consumer’s income.
Symbolically,
Income Elasticity of Demand Types
1. Positive income elasticity of demand

It refers to a condition in which demand for a commodity rises with a rise in
consumer income and declines with a decline in consumer income.
Commodities with positive income elasticity of demand are normal goods.
The upward slope implies that the rise in income contributes to a rise in
demand and vice versa. There are three forms of positive income elasticity of
demand stated as follows:
Unitary – The positive income elasticity of demand will be unitary if the
proportionate change in the amount of a product demanded equals the change
in consumer income in due proportion.
More than unitary – The positive income elasticity of demand will be more than
unitary if the proportionate change in the amount of a product demanded is
higher than the change in consumer income in due proportion.
Less than unitary – If the change in the amount of a product demanded in due
proportion is less than the change in consumer income in due proportion,
positive income elasticity of demand will be less than unitary.
2. Negative income elasticity of demand
It refers to a condition in which demand for a commodity decreases with a rise in
consumer income and increases with a fall in consumer income. Inferior goods are such
commodities. For example, the demand for millet will decrease if the income of
consumers increases since they will prefer to purchase wheat instead of millet. Thus,
millet is an inferior good to wheat for customers.
The downward slope implies that the increase in income contributes to a fall in
demand, and a decrease in income causes a rise in demand.
3. Zero income elasticity of demand

It corresponds to the situation when there is no impact of rising household income
on commodity production. Such goods are termed essential goods. For example, a
high-income consumer and a low-income consumer will need salt in the same
quantity.
Cross Elasticity of Demand
It is defined as a change in the quantity of demand for one commodity to the change
in the quantity of demand to other commodities is called cross elasticity of demand.
Usually, this type of demand arises with the involvement of interrelated goods such
as substitutes and complementary goods.
Cross elasticity of demand formula is as follows:
Ec = Proportionate Change in Purchase of CommodityX
Proportionate Change in the Price of CommodityY
For example, if two commodities are called substitutes, when the price of one
commodity falls, the demand for another commodity decreases. If the price of one
commodity rises in demand, so does the price of another commodity, such as tea
and coffee.
Types of Cross Elasticity of demand
Substitute goods:
When the cross elasticity of demand for good X relative to the price of
good Y is positive, it means the goods X and Y are substitutes to each
other. It implies that in response to an increase in the price of good Y,
the quantity demanded of good X has increased as people start
consuming product X as the price of good Y goes up.
Substitute goods For example, suppose a 10% increase in the

price of tea results in an increase in demand for coffee by 15%. This
shows that the goods are substitutes for each other.
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Complementary goods: When the cross elasticity of demand for good
X relative to the price of good Y is negative, it means the goods are
complementary to each other. It implies that in response to an
increase in the price of good Y, the quantity demanded of good X has
decreased due to the increase in the price of Y.
Complementary goods For example, suppose the 10%

increase in the prices of Android phones results in a decline in the
quantity demanded of Apps by 15%. This relation shows that the
goods are complementary to each other.
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Unrelated goods: When the cross elasticity of demand for good X
relative to the price of good Y is zero, it means goods are unrelated to
each other. It implies that there is no relationship between these both
goods.
Unrelated goods For example, suppose the 5% increase in the
prices of coke results in no change in quantity demanded of butter.
This shows that the goods are unrelated to each other
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Advertising Elasticity of Demand
4.Advertising Elasticity of Demand
It is defined as the responsiveness of the change in demand

to the change in promotional expense is known as the
advertising elasticity of demand. It can be expressed by using
below the elasticity of demand formula.
Ec = Proportionate Change in Demand
Proportionate Change in Advertising Expenditure

Factors Governing Elasticity of Demand
Elasticity is governed by a number of factors. Change in any on of
these factors is likely to affect the elasticity of demand. These factors
are:
a) Nature of the Product
b) Time Frame
c) Degree of postponement
d) Number of alternative uses
e) Tastes and preferences of the consumer
f) Availability of close substitutes
g) In case of complementary goods
h) Level of prices
i) Availability of subsidies
j) Expectation of prices
k) Durability of the product
l) Government policy
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Significance of the Elasticity of Demand
(i) Importance in taxation policy. As regards its practical advantages, the concept has
immense importance in the sphere of government finance. When a finance minister levies
a tax on a certain commodity, he has to see whether the demand for that commodity is
elastic or inelastic.
If the demand is inelastic, he can increase the tax and thus can collect larger revenue. But if
the demand of a commodity is elastic, he is not in a position to increase the rate of a tax. If
he does so, the demand for that commodity will be, calculated and the total revenue
reduced.
(ii) Price discrimination by monopolist. If the monopolist finds that the demand for his
commodities is inelastic, he will at once fix the price at a higher level in order to maximize
his net profit. In case of elastic demand, he will lower the price in order to increase, his sale
and derive the maximum net profit. Thus we find that the monopolists also get practical
advantages from the concept of elasticity.
(iii) Price discrimination in cases of joint supply. The concept of elasticity is of great
practical advantage where the separate, costs of Joint products cannot be measured. Here
again the prices are fixed on the principle. "What the traffic will bear" as is being done in
the railway rates and fares.
Significance of the Elasticity of Demand
(iv) Importance to businessmen. The concept of elasticity is of great importance to

businessmen. When the demand of a good is elastic, they increases sale by towering its
price. In case the demand' is inelastic, they are then in a position to charge higher price for a
commodity.
(v) Help to trade unions. The trade unions can raise the wages of the labor in an industry
where the demand of the product is relatively inelastic. On the other hand, if the demand,
for product is relatively elastic, the trade unions cannot press for higher wages.
(vi) Use in international trade. The term of trade between two countries are based on the
elasticity of demand of the traded goods.
(vii) Determination of rate of foreign exchange. The rate of foreign exchange is also
considered on the elasticity of imports and exports of a country.
(viii) Guideline to the producers. The concept of elasticity provides a guideline to the
producers for the amount to be spent on advertisement. If the demand for a commodity is
elastic, the producers shall have to spend large sums of money on advertisements for
increasing the sales.
(ix) Use in factor pricing. The factors of production which have inelastic demand can obtain a
higher price in the market then those which have elastic demand. This concept explains the
reason of variation in factor pricing.
Demand Forecasting
Demand forecasting is a technique that is used for estimation of what can be the
demand for the upcoming product or services in the future.
 It is a process in which probable demand for a product or service is

estimated for the future period of time.
It implies the study of past demand which is used as historical data for that product
or service in the present market conditions.
 It helps the business in the estimation of total sales and revenue

by using scientific methods and facts in the foreseeable future.
Critical business assumptions like turnover, profit margins, cash flow, capacity
planning, capital expenditure, risk assessment etc. are dependent on it.
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Demand Forecasting
Example : – Suppose, a manufacturing company had sales of 1200,
1400 and 1600 units during January, February and March. Now, it
can be forecasted that approximately 1400 units would be demanded
for next month based on the average sales of the last three month’s
data assuming other things the same.
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Types of Demand Forecasting
Active demand Short term

Passive demand demand Long term demand
forecasting forecasting forecasting forecasting
External or
Internal or group
national group Macro-level Industry-level
demand
demand forecasting forecasting
forecasting
forecasting
Firm-level Product line

forecasting forecasting
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1.Active demand forecasting:If your business is in a growing phase or
if you’re just starting out, active demand forecasting is an excellent
choice. An active forecasting model takes into studying your market
research, marketing campaigns, and development plans.
2.Passive demand forecasting: Passive demand forecasting is

the simplest forecasting model, in which you use sales data from the
past to predict the future. You should apply data from the same
season to predict sales. This is appropriate for those whose business
has seasonal fluctuations.
3.Short term demand forecasting: In short term demand forecasting,

forecasting is done for a shorter period of 3 months to 12 months.
The demand pattern and the effect of the strategic decisions on
customer demand are analyzed under this.
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4.Long term demand forecasting: When forecasting is carried out for
a period of more than 12 months, such forecasting is known as long
term demand forecasting. Long term forecasting is helpful in suitable
capital planning, business strategy planning, sales and management
planning etc.
5.External or National group forecasting: The forecasting carried out

by a company’s research wing or by outside consultants is known as
external group forecasting. It deals with the trends in general
business.
6.Internal or Company group forecasting: It refers to the forecasting

estimation by the operations of a particular enterprise such as
production group, sales group and financial group. It includes a
forecast for annual sales, forecast of operating profit, forecast of cash
resources and forecast of a number of employees etc.
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7.Macro-level forecasting: In this, the broad market operations are
analyzed and then forecasting is carried out in macro economic
environment. It is measured by an appropriate index of industrial
production, national income or expenditure.
8.Industry-level forecasting: This type of forecasting is prepared by

different trade associations based on the survey of consumers’
intention and analysis of statistical trends.
9.Firm-level forecasting: This forecasting is prepared from the

viewpoint of managers and is related to an individual firm.
10.Product line forecasting: This forecasting is related to the product

or products being produced by the firm. It helps the firm to decide
which of the products should have priority in the allocation of the
firm’s limited resources. 70
Why forecast ?
․ To plan for the future by reducing uncertainty.
․ To anticipate and manage change.
․ To increase communication and integration of planning
teams.
․ To anticipate inventory and capacity demands and manage lead
times.
․ To project costs of operations into budgeting processes.
․ To improve competitiveness and productivity through
decreased costs and improved delivery and
responsiveness to customer needs.
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IMPORTANCE
Factors Affecting Demand Forecasting
Price of Goods: Demand estimation is highly dependant on the price of goods or services.
The pricing policy and fluctuation in the present price can give an idea of change in
demand for that particular commodity.
Type of Goods: The kind of commodity, its features and usability determines the
customer base it is going to cater. The demand for existing goods can be easily estimated
by following the previous sales trend, competitors’ analysis and substitutes available.
Whereas, the demand for a new product on the market is difficult to predict.
Competition: The level of competition in the market supports the process of demand
forecasting. It is easy to predict sales in a less competitive market, whereas the same
becomes difficult in a market where the new firms can freely enter.
Technology: The demand for any product or service changes drastically with the
advancement in technology. Therefore, it is essential for an organisation to be aware of
technological development while forecasting the demand for any commodity.
Economic Perspective: Being updated with economic changes and growth is necessary for
demand forecasting. It assists the organisation in preparing for future possibilities and
analysing the impact of economic development on sales.
Demand forecasting Methods
The Methods Of Demand Forecasting Can Be Classified As:
Qualitative/ Survey Methods:
 Survey of Buyer’s Choice
 Collective Opinion Method
 Market Experiment Method
 Expert Opinion Method
 Barometric Method
Quantitative/ Statistical Methods:
 Trend Projection
 Barometric Method
 Regression Analysis
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Qualitative vs Quantitative
Qualitative methods of Demand Forecasting Quantitative methods of demand
forecasting
Qualitative methods are those which are These are the methods that make use of
based upon surveys, interviews and opinions. statistical tools to predict the future demand
of the product.
Time series analysis, barometric method and
Qualitative methods include specialist regression method fall under the quantitative
opinion, Delphi method, consumer survey methods of demand forecasting.
and market experiments methods of demand
forecasting.
The quantitative methods emphasizes on the
The qualitative methods rely on the use of past sales data along with various
opinion of different groups of people who are factors influencing the demand to estimate
associated with the product to predict the the future demand of the product.
future demand
If the forecasting is carried out with short Long-term forecasts are usually undertaken
term purpose then in such case qualitative through the quantitative methods of demand
methods are preferred. forecasting.
Qualitative/ Survey Methods:
1] Survey of Buyer’s Choice
When the demand needs to be forecasted in the short run, say a year, then the most
feasible method is to ask the customers directly that what are they intending to buy in the
forthcoming time period. Thus, under this method, potential customers are directly
interviewed. This survey can be done in any of the following ways:
a. Complete Enumeration Method: Under this method, nearly all the potential buyers are
asked about their future purchase plans.
b. Sample Survey Method: Under this method, a sample of potential buyers are chosen
scientifically and only those chosen are interviewed.
c. End-use Method: It is especially used for forecasting the demand of the inputs. Under
this method, the final users i.e. the consuming industries and other sectors are identified.
The desirable norms of consumption of the product are fixed, the targeted output levels
are estimated and these norms are applied to forecast the future demand of the inputs.
Demand forecasting Methods- Qualitative
2. Collective Opinion Method
Under this method, the salesperson of a firm predicts the estimated future sales in
their region. The individual estimates are aggregated to calculate the total
estimated future sales. These estimates are reviewed in the light of factors like
future changes in the selling price, product designs, changes in competition,
advertisement campaigns, the purchasing power of the consumers, employment
opportunities, population, etc.
3.Market Experiment Method

Another one of the methods of demand forecasting is the market experiment
method. Under this method, the demand is forecasted by conducting market
studies and experiments on consumer behavior under actual but controlled, market
conditions.
Certain determinants of demand that can be varied are changed and the
experiments are done keeping other factors constant. However, this method is very
expensive and time-consuming.
Demand forecasting Methods
4.Expert Opinion Method
Apart from salesmen and consumers, distributors or outside experts may also e
used for forecasting. In the United States of America, the automobile companies get
sales estimates directly from their dealers. Firms in advanced countries make use of
outside experts for estimating future demand. Various public and private agencies
all periodic forecasts of short or long term business conditions.
5.Delphi Method: A variant of the survey method is Delphi method. It is a

sophisticated method to arrive at a consensus. Under this method, a panel is
selected to give suggestions to solve the problems in hand. Both internal and
external experts can be the members of the panel. Panel members one kept apart
from each other and express their views in an anonymous manner. There is also a
coordinator who acts as an intermediary among the panelists. He prepares the
questionnaire and sends it to the panelist. At the end of each round, he prepares a
summary report. On the basis of the summary report the panel members have to
give suggestions. This method has been used in the area of technological
forecasting. It has proved more popular in forecasting. It has provided more popular
in forecasting non-economic rather than economic variables.
. 66
Demand forecasting Methods- Quantitative or Statistical Methods
1.Trend Projection Method/Time series: A well-established firm would have

accumulated data. These data are analyzed to determine the nature of existing
trend. Then, this trend is projected in to the future and the results are used as the
basis for forecast. This is called as time series analysis. This data can be presented
either in a tabular form or a graph. In the time series post data of sales are used to
forecast future
2.Regression Analysis: Regression and correlation are used for forecasting demand.
Based on post data the future data trend is forecasted. If the functional relationship
is analyzed with the independent variable it is simple correction. When there are
several independent variables it is multiple correlation. In correlation we analyze the
nature of relation between the variables while in regression; the extent of relation
between the variables is analyzed. The results are expressed in mathematical form.
Therefore, it is called as econometric model building. The main advantage of this
method is that it provides the values of the independent variables from within the
model itself.
67
Demand forecasting Methods- Quantitative or Statistical Methods
3.Barometric Method
This method is based on the past demands of the product and tries to project the
past into the future. The economic indicators are used to predict the future trends
of the business. Based on future trends, the demand for the product is forecasted.
An index of economic indicators is formed.
There are three types of economic indicators, viz. leading indicators, lagging
indicators, and coincidental indicators.
The leading indicators are those that move up or down ahead of some other series.
The lagging indicators are those that follow a change after some time lag. The
coincidental indicators are those that move up and down simultaneously with the
level of economic activities.
Simple trend projections are not capable of forecasting turning paints. Under Barometric
method, present events are used to predict the directions of change in future. This is done
with the help of economics and statistical indicators. Those are (1) Construction Contracts
awarded for building materials (2) Personal income (3) Agricultural Income. (4)
Employment (5) Gross national income (6) Industrial Production (7) Bank Deposits etc
Production – Concept meaning
Production is a process of converting an input into a more valuable

output. The analysis of demand is mainly used for planning
production processes and determining the level of production.
For equilibrium , supply should be equal to demand. Production is
an aspect of the supply side of the market.
In other words , production implies the creation of utilities – from
utility ,place utility , time utility and service utility.
101
Definition
Prof J R Hicks defines production as “any activity whether physical or
mental which is directed to the satisfaction of other people’s wants
through exchange”.
This definition brings out the following features of production
(1) Both physical and mental activity is production;
(2)It must satisfy other people’s wants. For example, if a

farmer produces for his consumption, it is not productive activity;
(3)There must be exchange. For example, if a teacher

teaches without receiving salary, it is not regarded as production.
71
Factors of Production
Production of wealth is done by factors of production. These factors of
production have been divided into four: Land, Labour, Capital and
Organization.
• Land represents free gifts of nature. It includes agricultural land, building sites,
mines, fisheries, forests, etc. Only those free gifts which are subject to human
ownership and control are included under ‘land’.
• Labor represents human element in production. It includes physical and

mental effort. All efforts undertaken to earn income are called labor. Labor
includes all workers from street sweepers to professors and engineers.
• Capital represents man made instruments of production – machines,

plants, tools, factory buildings, etc. All wealth which is used to produce
wealth is called capital.
• Organization consists of combining factors and undertaking uncertainties of

modern production. The organizer starts production units. He controls
production. He decides what to produce and how much to produce. He bears
risks and uncertainties of production. 72
Production function
The production function says that output is a function of inputs. It
states the functional relationship between physical inputs and
physical outputs.
As Stigler defines “the production function is the name given

to the relationship between the rates of productive services and the
rates of output of the production”
Algebraically the production function can be written as:

O = f(N, L, K, T)
• Here, ‘O’ stands for output and N, L, K, T stand for natural

resources, labor, stock of capital and state of technology. It shows
that the rate of output P is function (f) of inputs N, L, K, T.
73
Uses of Production function
• To obtain Maximum output
• Helps the producers to determine whether employing

variable inputs /costs are profitable
• Highly useful in long run decisions
• Least cost combination of inputs and to produce an output
74
Types ofProduction
Types of Production function
function
Type
s
Short –Run
(Inputs kept constant Long – Run
(Varying all inputs)
One input (Labour)
is varied)
Law of variable Law of returns to

proportion scale
106
Production function
76
Production function- components
• The law of variable proportions is as follows: “If a producer
increases the units of a one variable factor while keeping other
factors fixed, then initially the total product increases at an
increasing rate, then it increases at a diminishing rate, and finally
starts declining.”
• The law of returns to scale explains the proportional change in

output with respect to proportional change in inputs.
• In other words, the law of returns to scale states when there

are a proportionate change in the amounts of inputs, the behavior
of output also changes.
77
The law of variable proportions
ASSUMPTIONS OF LAW
1. Constant state of Technology: It is assumed that the state of technology will be
constant and with improvements in the technology, the production will improve.
2. Variable Factor Proportions: This assumes that factors of production are variable.
The law is not valid, if factors of production are fixed.
3. Homogeneous factor units: This assumes that all the units produced are identical in
quality, quantity and price. In other words, the units are homogeneous in nature.
4. Short Run: This assumes that this law is applicable for those systems that are
operating for a short term, where it is not possible to alter all factor inputs.
Production function Table
For Example:-To get a clear picture of the stages of variable proportion, we take the
example of agriculture. Let us assume that keeping land as a fixed factor, the production
of variable factor i.e., labour can be shown with the help of the following table:
109
Graphical Representation of Three Stages of Law of Variable Proportions
Stages
Law of Variable proportions
Stage of Stage -1 Stage-2 Satge-3

production
Total product Initially Increases at a Decreases
increases an decreasing
increasing rate and
rate and later becomes
increases at a maximum
decreasing
rate
Average Increases and Decreases Continues to
product reaches decrease
maximum
Marginal Increases and Continues to Becomes
product reaches a fall and negative
maximum and becomes zero
starts falling
Production in the long-run-Law of returns to scale
In the long run the fixed inputs like machinery, building and other factors will change
along with the variable factors like labour, raw material etc. With the equal percentage
of increase in input factors various combinations of returns occur in an organization.
Returns to scale: the change in percentage output resulting from a percentage change
in all the factors of production. They are increasing, constant and diminishing returns to
scale.
114
RETURNS TO SCALE TABLE
RETURNS TO SCALE
STAGES OF RETURNS TO SCALE
Stage I: The total production increased at an increasing rate. We refer to this as

increasing stage
where the total product, marginal product and average production are increasing.
Stage II: The total production continues to increase but at a diminishing rate until it
reaches the next stage. Marginal product, average product are declining but are positive.
The total production is at the maximum level at the end of the second stage with a zero
marginal product.
Stage III: In this third stage total production declines and marginal product becomes
negative. And the average production also started decline. Which implies that the change
in input factors there is a decline in the over all production along with the average and
marginal
STAGE-1
INCREASING RETURNS TO SCALE
STAGE-2-CONSTANT RETURNS TO SCALE
CONSTANT RETURNS TO SCALE
STAGE-3-DIMINISHING RETURNS TO SCALE
DIMINISHING RETURNS TO SCALE
ISO QUANTS-Production function with two variable inputs
93
Assumptions of Isoquants
• There are only two factors of production.
• The two factors can substitute each other up
to certain limit.
• The shape of the isoquants depends upon

the extent of substitutability of the two inputs.
• The technology is given over a period
94
ISOQUANT SCHEDULE
Isoquant curve
Properties of Isoquant
Isoquants are Negatively Sloped : They normally slope from left to
right means they are negatively sloped . The reason is when the
quantity of one factor is reduced , the same level of output can be
achieved only when the quantity of other is increased
Higher Isoquants Represents Larger Output :
Higher isoquant is one that is further from he point of origin. It
represents a larger output hat is obtained by using either same
amount of one factor and the greater amount of both the factors
No Two Isoquants Intersect or Touch each other : Isoquant do no
intersect or touch each other because they represent different level of
output
Isoquants are convex to the origin : In most production processes the
factors of production have substitutability. Labor can be substituted for
capital and ice versa .
•however the rate at which one factor is substituted for the other in
production process i.e. marginal rate of technical substitution (MRTS)
also tends to fall
97
Iso cost
• Isocosts refers to that cost curve that represents the
combination of inputs that will cost the producer the
same amount of money.
• In other words, each isocost denotes a particular level of total
cost for a given level of production.
• If the given level of production changes, the total cost
changes and thus the isocost curve moves upwards. And
vice versa.
98
What is Economies of scale?
 Economies of scale are the cost advantages that a
business obtains due to expansion.
 Economies of scale refer to the lowering of per unit costs as a firm grows bigger.
 When economists are talking about economies of scale,they are
usually talking about internal economies of scale.
 These are the advantages gained by an individual firm
by increasing its size i.e having larger or more plants.
128
Cont..
100
Cont..
• .
129
Examples of Economies of Scale
The most common example of economies of scale is the supermarket store; they can
buy products in bulk at a lower cost due to their large capacity. Therefore, they enjoy
the benefit of reduced average cost.
Another example can be that of an airline company which invests millions in buying a
new plane. If there are only a few customers, the airline will have to charge a very
high fee to breakeven. However, it serves millions of customers and therefore, can
recoup its charges by charging much less. Thus, it results in reduced average cost by
an increased level of production of services.
Internal economies of scale
1.Internal economies of scale :-

• Internal economies of scale happens due to factors internal to
the firm.
• For example, investment in highly efficient machinery, hiring of
the specialized workforce or holding a patent over something
unique like production machinery. It leads to a reduction in
average cost and competitive advantage.
133
Types of Internal Economies of scale
1.Technical Economies of Scale: This occurs when an organisation invests in modern
technology which helps in lowering the cost of production. It enables an organisation to
produce a large number of goods in a lesser period.
2.Financial Economies of Scale: This occurs when large organisations take a loan with a low
rate of interest. The banks easily give them loans since they have good credibility.
3.Managerial Economies of Scale: This occurs when large organisations employ people
with a special skill set which helps to maximize the profits of the organisation like an
accountant or manager.
4.Marketing Economies of Scale: This occurs when large organisations increase their
budget. They can then spread their market by setting up branches or buy more raw
materials in bulks with lesser price.
Type
s
• .
134
External economies of scale
 External economies of scale :- External economies of scale are
achieved due to external factors such as tax reductions, government subsidies,
improves transportation network, etc.
 For instance, suppose the government wants to increase steel
production. In order to do so, the government announces that all steel producers
who employ more than 10,000 workers will be given a 20% tax break resulting from
an industry growing in size.
Thus, firms employing less than 10,000 workers can potentially
lower their average cost of production by employing more workers.
This is an example of an external economy of scale – one that affects an
entire industry or sector of the economy.
106
External economies of scale-Types
1. Transportation and Communication
Concentration of firms provides better communication system for all. Rail, road facilities
become available to all, the transport system reduces cost.
2. Skilled Labor
With the concentration of firms skilled labour is available to all the firms because people
living in the nearby areas get technical training.
3. Facility of Workshop
Concentration of firms provides incentive for the technical persons to establish their
workshops and hence, all the firms benefit from these, because they need not to incur costs
in establishing the workshops.
4. Helping Industry
This economy arises because of concentration of firms. In local industry it becomes possible
to split up some of the processes which are taken over by specialist firms. For example in
Faisalabad with the textile mills dying factories, designing centers, ginning factories and 140
calendaring plants have been established.
External economies of scale-Types
5. Research and Experiment

In local industry, research and development are centralized. Each individual firm needs
not to spend a separate amount on research and development. They benefit from
common pool.
6. Banking Facility
The basic aim of a commercial bank is to maximize profits and for this they need deposits
and provide credit to the traders, businessmen and Industrialists etc. In a localized
industry or business centers bank opens their branches and all the firms benefit from
banking and credit facility. The banking system helps in promoting trade and business.
Diseconomies of scale
Diseconomies of scale occur when a business grows so large that the costs per unit
increase. As output rises, it is not inevitable that unit costs will fall. Sometimes a business
can get too big!
Reasons for dis-economies of scale
Reasons for dis-economies of scale
 Poor communication in a large firm. It can be hard to communicate ideas and new
working practices.
 Alienation: Working in a highly specialized assembly line can be very boring if

workers become de-motivated. In a large firm, there is an increased gap between
top and bottom e.g. call centres
 Lack of control: when there is a large number of workers it is easier to escape with
not working very hard because it is more difficult for managers to notice shirking.
Break-even analysis
Break-even analysis is of vital importance in determining
the practical application of cost functions.
• It is a function of three factors, i.e. sales volume, cost and
profit.
• It aims at classifying the dynamic relationship existing
between total cost and sale volume of a company.
• It is also used to determine when your business will be
able to cover all its expenses and begin to make a profit.
• I t is also known as “cost-volume-profit analysis”.
• It helps to know the operating condition that exists when a
company ‘breaks-even’, that is when sales reach a point equal to all
expenses incurred in attaining that level of sales.
• This concept has been proved highly useful to the company
executives in profit forecasting and planning and also in examining
the effect of alternative business management decisions. 111
Break-even analysis
The break-even point (B.E.P.) of a firm can be found out in two ways. It
may be determined in terms of physical units, i.e., volume of output
or it may be determined in terms of money value, i.e., value of sales.
112
Break-even analysis
.Output in Total Total Total Total
units Revenue Fixed Variable Cost
Cost Cost
0 0 150 0 150
50 200 150 150 300
100 400 150 300 450
150 600 150 450 600 BEP
200 800 150 600 750
250 1000 150 750 900
300 1200 150 900 1050
154
Break-even analysis
114
115
Assumptions of BEP
 All costs are classified into two – fixed and variable.

 2. Fixed costs remain constant at all levels of output.
 3. Variable costs vary proportionally with the volume of output.
 4. Selling price per unit remains constant in spite of competition or change in the
volume of production.
 5. There will be no change in operating efficiency.
 6. There will be no change in the general price level.
 7. Volume of production is the only factor affecting the cost.
 8. Volume of sales and volume of production are equal. Hence there is no unsold
stock.
 9. There is only one product or in the case of multiple products. Sales mix remains
constant.
116
Uses of Break-even analysis
• Information provided by the Break Even Chart can be understood more easily then
those contained in the profit and Loss Account and the cost statement.
• Break Even Chart discloses the relationship between cost, volume and profit. It
reveals how changes in profit. So, it helps management in decision-making.
• It is very useful for forecasting costs and profits long term planning and growth
• The chart discloses profits at various levels of production.
• It serves as a useful tool for cost control.
• It can also be used to study the comparative plant efficiencies of the industry.
• Analytical Break-even chart present the different elements, in the costs – direct
material, direct labour, fixed and variable overheads.
160
Limitations of BEP
 In the break-even analysis, we keep everything constant. The
selling price is assumed to be constant and the cost function is
linear. In practice, it will not be so.
 In the break-even analysis since we keep the function constant, we
project the future with the help of past functions. This is not
correct.
 The assumption that the cost-revenue-output relationship is linear
is true only over a small range of output. It is not an effective tool
for long-range use.
 Profits are a function of not only output, but also of other factors
like technological change, improvement in the art of management,
etc., which have been overlooked in this analysis.
118
 When break-even analysis is based on accounting data, as it
usually happens, it may suffer from various limitations of such data
as neglect of imputed costs, arbitrary depreciation estimates and
inappropriate allocation of overheads. It can be sound and useful
only if the firm in question maintains a good accounting system.
 Selling costs are specially difficult to handle break-even analysis.
This is because changes in selling costs are a cause and not a result
of changes in output and sales
 Because so many restrictive assumptions underlying the
technique,
of computation of a break-even point is considered an
approximation rather than a reality.
119
 The simple form of a break-even chart makes no provisions for
taxes, particularly corporate income tax.
 It usually assumes that the price of the output is given. In other
words, it assumes a horizontal demand curve that is realistic under
the conditions of perfect competition.
 Matching cost with output imposes another limitation on break-
even analysis. Cost in a particular period need not be the result of
the output in that period.
120
Determination of BEP
The following key terms used in determination of break even-point
Selling price= Fixed cost + variable cost + Profit

Selling price – Variable cost = Fixed Cost + profit
= Contribution
Contribution per unit = Selling price per unit – variable cost per unit.
Contribution margin ratio = Selling price – variable cost / selling price
BEP( in units) = Fixed Cost/ Contribution margin per unit

( where contribution margin per unit = Selling price per unit – variable
cost per unit )
BEP (in value) = Fixed costs/ Contribution margin ratio

( where contribution margin ratio is the ratio of contribution margin
per unit to selling price per unit)
121
The Marginal rate of technical substitution (MRTS)
MRTS in economics refers to the Marginal Rate of Technical Substitution which is

termed as the slope of isoquant.
The marginal rate of technical substitution (MRTS) is an economic theory that illustrates
the rate at which one factor must decrease so that the same level of productivity can
be maintained when another factor is increased.
(or)
The marginal rate of technical substitution (MRTS) examines the level where one input
can be replaced for another resource with production remaining constant.
K = Capital.
L = Labor.
MP = Marginal products of each input.
(∆K÷∆L) = Amount of capital that can be reduced when labour is increased (typically by
one unit)
How MRTS Works
How MRTS Works

The marginal rate of technical substitution ascertains the amount of cost which a
specific input can be replaced for another resource of production while
maintaining a constant output. Therefore, the marginal rate of technical
substitution explains when a producer is planning to replace one input of
production with the next one.
The company may choose several combinations of inputs that can be alternatively
substituted to produce the same level of output. The pair of inputs determined
by the management must be able to achieve the best results.
For example, when factor A can produce a maximum quantity of output than
factor B with the same cost incurred, the producer may end up choosing factor A
instead of B.
Principle of Marginal Rate of Technical Substitution
Principle of Marginal Rate of Technical Substitution
The marginal rate of technical substitution focuses on the rate at which the
producer combines two inputs of production and substitutes one factor by
decreasing it further upon every consecutive substitution. Generally, the marginal
rate of technical substitution specifies the rate at which factors of production can be
substituted without any change in the unit of output.
For example, the MRTS of labor for the unit of capital is the inputs of capital that can
be switched with one input of labor with the output level being constant.
The principle states that one input of production decreases with every subsequent
replacement by another factor of production. This decline, combined with a
constant level of output, is known as the principle of diminishing marginal of
technical substitution.
How Marginal Rate of Technical Substitution Diminishes
How Marginal Rate of Technical Substitution Diminishes

The marginal rate of technical substitution diminishes when the producer keeps on substituting one
resource of production with another input of production. The following are the main factors as to
why the MRTS diminishes over time during production.
1. Scarcity of the factor of production

Continuous substitution of one factor of production with another one causes inadequacy of the input
of production being replaced. In this case, the factor being substituted will not be able to deliver
maximum contribution for systematic production. Hence, although more inputs of capital were made,
the MRTS declined with successive substitutions.
2. Imperfect substitution of factors of production

It is impossible for two factors of production to substitute each other perfectly since their usage in
the production process is different. Besides, if the two factors could substitute perfectly, a decrease
or an increase in either of them cannot cause any change in the MRTS.
The marginal rate of technical substitution allows the management to determine the factors that can
provide the highest cost-efficient combination for producing a specific quantity of output and find a
production point where the combined factors are minimized to decrease the cost of production.
least cost combination of inputs.
The cost line or budget line for production is called the isocost line. The first
order conditions state that the variable factors are combined in an optimal
manner when the ratio of marginal products is equal to the ratio of factor
prices. This optimal combination is called the least cost combination of inputs.
Cost and Types of costs
The cost denotes the amount of money that a company spends on

the creation or production of goods or services.
127
Cost and Types of costs
Actual cost
Opportunity cost
Sunk cost
Incremental cost
Explicit cost
Implicit cost
Book cost
Out of pocket cost
Accounting costs
Economic costs
Direct cost
Indirect costs
Controllable costs
Non Controllable Costs
Historical and Replacement costs
Shutdown Costs
Abandonment Costs
Urgent Costs
Business and Full Cost
Fixed Costs
Variable Costs
Total ,Average and Marginal Cost
Short Run Cost
Long Run Cost
The Cobb-Douglas (CD) production function
The Cobb Douglas production function, given by American economists, Charles W. Cobb
and Paul. H Douglas, studies the relation between the input and the output.
The cobb douglas production function is that type of production function wherein an
input can be substituted by others to a limited extent.
For example, capital and labour can be used as a substitute of each other, however to a
limited extent only. Cobb Douglas production function can be expressed as follows:
Q = AKa Lb
Where,
A = positive constant
a and b = positive fractions
b = 1–a
Another way of expressing Cobb- Douglas production function is:

Q = AKa L1-a
The Cobb-Douglas (CD) production function
Let us take up an example to understand the calculations involved in the cobb-Douglas

function.
Assume A = 40, a = 0.3 and b= 0.7 , K = 3 and L = 5
Therefore,
Q = 40 (3)0.3 (5)0.7
log Q = log 40 + 0.3 log 3 + 0.7 log 5
log Q = 1.6020 + (0.3 X 0.4771) + (0.7 X 0.6989)
log Q = 1.6020 + 0.1431 + 0.4892
log Q = 2.2343
Now, we will take the antilog of the above to get the value of Q. antilog log Q = antilog
2.2343
Q = 171.5141
The Cobb-Douglas (CD) production function properties
.The main attributes of the Cobb Douglas production function are discussed as follows:
 It enables the conversion of the algebraic form into log linear form, represented as
follows:
log Q = log A + a log K + b log L
 This production function has been estimated with the help of linear regression
analysis.
 It acts as a homogeneous production function, whose degree can be calculated by the

value obtained after adding values of a and b. If the resultant value of a+b is 1, it
implies that the degree of homogeneity is 1 and indicates the constant returns to
scale.
 It makes use of parameters a and b, which signifies the elasticity coefficients of output
for inputs, labour and capital, respectively. Output elasticity coefficient is the change in
output that occurs due to adjustment in capital while keeping labour at constant.
 It depicts the non-existence of production at zero cost.

Assumptions
1.If either labor or capital vanishes, then so will production.
• 2. The marginal productivity of labor is proportional to the

amount of production per unit of labor.
• 3. The marginal productivity of capital is proportional to the

amount of production per unit of capital.
Market
• They can participate sale and purchase
• Market does not refer to a particular place or location
• It refers to an institutional relationship between purchasers and
sellers
• Market is an agreement which links buyers and sellers
• A market can be of different types
• The market differ from one another due to differences in the
number of buyers , number of sellers, nature of product,
influence over price, availability of information, conditions of
supply etc.
158
Market Structure
• Market structure refers to the nature and degree of
competition in the market for goods and services. The
structures of market both for goods market and service
(factor) market are determined by the nature of
competition prevailing in a particular market.
• The types of market structures include- Perfect
Competition, Monopoly, Monopolistic Competition,
Oligopoly, Duopoly.
• Market structure is best defined as the organizational and other
characteristics of a market.
159
Features of Market structure
• The number of firms (including the scale and extent of foreign
competition)
• The market share of the largest firms (measured by the
concentration ratio – see below)
• The nature of costs (including the potential for firms to exploit
economies of scale and also the presence of sunk costs which
affects market contestability in the long term)
• The degree to which the industry is vertically integrated - vertical
integration explains the process by which different stages in
production and distribution of a product are under the ownership
and control of a single enterprise. A good example of vertical
integration is the oil industry, where the major oil companies own
the rights to extract from oilfields, they run a fleet of tankers,
operate refineries and have control of sales at their own filling
stations.
160
Features of market structure
• The extent of product differentiation (which affects cross-
price elasticity of demand)
• The structure of buyers in the industry (including the possibility of
monopsony power)
• The turnover of customers (sometimes known as "market churn")
– i.e. how many customers are prepared to switch their supplier
over a given time period when market conditions change. The rate
of customer churn is affected by the degree of consumer or brand
loyalty and the influence of persuasive advertising and marketing
161
Types of market structures
Perfect
Monopoly
competition
Monopolistic
Oligopoly
competition
162
Comparison of market structure
230
Perfect Competition
It is a market structure where large number sellers and buyers are involved in buying and
selling of goods at equilibrium price which is fixed by the industry. Good sold in this
market are homogenous in nature and have no substitutes. Sellers are price takers as they
sell their products at equilibrium price only. This market is hypothetical and is myth as no
such market exists actually. It is based on number of hypothetical conditions like no
transport cost, no advertisement cost, full knowledge of markets among buyers and
sellers etc.
164
Perfect Competition features
1.Many Sellers : There are many sellers or firms selling a commodity in the market. Their
number is so large that any single seller or firm cannot influence a given market price. So
an individual seller or a firm is a price-taker.
2.Many Buyers : There are many actual buyers. Their number is so large that any single
buyer cannot influence a given market price. This is because his individual demand is a
very small fraction in the total market demand so buyer is also a price-taker.
3.Homogeneous Products : All firms or producers produce and sell identical products i.e.
same in respect of size, shape, color, packaging, etc. So there is no difference in between
various products, which are perfect substitutes for each other.
4.Free Entry and Exit:-There is perfect freedom for new firms or sellers to enter a market or
an industry without any legal, economic, or any other type of restrictions or barriers,
Likewise, the existing producers or sellers are free to leave the market.
Perfect Competition features
5.Perfect Knowledge: -There is perfect knowledge on the part of the buyers and sellers
regarding the market conditions especially regarding the prevailing market price and
quantity of supply. So a single price would prevail (exists) for a commodity in the entire
market.
6.Perfect Mobility of Factors of Production: - The factors of production are perfectly free
to move from one firm to another or from one industry to another or from one region to
another or from one occupation to another. This ensures freedom of entry and exit for
individuals and firms.
7.Transport Costs: -It is assumed that there are no transport costs. The transport costs
incurred by buyers and sellers to take the advantage of price changes, in a market, are
ignored.
8.Non-Intervention by the Government:-It is assumed that the government does not interfere
with the working of a market economy, i.e. it does not interfere with the economic activities in
the form of controls on the supply of raw materials, tariffs, subsidies, rationing, licensing etc.
• Examples :-Potatoes are sold in
markets where all vendors sell
homogenous products at homogeneous
prices.
• Example- Potato is soldat markets etc. where
all vendors sell homogenous
• products, i.e. potato.
167
price and output determination in the short run under Perfect competition.
Short Run equilibrium :Short-run is a period of time in which all factors of production
cannot be changed. Some factor will remain fixed. In short period equilibrium following
two conditions should be satisfied for the firm.
The Marginal Revenue (MR) is equal to Marginal Cost (MC) i.e. MR=MC
The Marginal Cost (MC) curve should cut Marginal Revenue (MR) curve from
below.
In the short run different following equilibrium position are settled down.
price and output determination in the short run under Perfect competition .
A. Super Normal Profit (AR > AC):Super normal profit is also

known as Abnormal Profit. The firm is in equilibrium at point E
where MR=MC. With OQ as the equilibrium output. OP is the
price. Average Revenue is EQ and Average Cost is BQ. Therefore
profit can be calculated as follow :
Profit = Total Revenue (TR)–Total Cost (TC)
Total Revenue (TR) = Average Revenue x Quantity

= EQ x OQ
= OPEQ
Total Cost (TC) = Average Cost x Output

= BQ x OQ
= OABQ
Profit = TR –TC
= Area OPEQ – Area OABQ
Profit =Area APEB

price and output determination in the short run under Perfect competition.
B.Loss (AR < AC) :When Average cost is more than Average
Revenue firm makes loss. The loss of firm shown in following
figure :
Loss = Total Cost (TC) – Total Revenue (TR)

= EQ x OQ
= OPEQ
= BQ x OQ
= OABQ
Loss = TC –TR
= Area OABQ – Area OPEQ
Loss = Area PABE
Average revenue is less than Average cost (AR < AC) the firm is making loss. Thus
firn in above figure suffer losses which are PABE.
price and output determination in the short run under Perfect competition
Normal Profit (AR = AC) :The firm at equilibrium will make normal
profit if at equilibrium point AR=AC i.e. AC curve is tangent to AR

= EQ x OQ
= OPEQ
= EQ x OQ
= OPEQ
Hence Total Revenue (TR) = Total Cost(TC) i.e. Area
OPEQ = Area OPEQ the firm is making normal
profit.
price and output determination in the Long run under Perfect
competition
Long Run Equilibrium :Long run is a period on which all factors of production are variable.
When some firms are earning super normal profit (AR > AC) in the short run it attracts
large number of firms into the industry. As a result output increases resulting in fall in
market price and supernormal profit will be wiped away and the normal profit will
continue in the long run.
When some firm suffers losses (AR <AC) in the short run they start leaving industry in the
long run. Reduction in the number of firms leads to contraction of industry’s output. As a
result price increases and due to this all losses will be wiped away and only normal profit
will continue in the long run.
price and output determination in the Long run under Perfect
competition
In long run the firm is in equilibrium at the point where the LMC = LMR at the
same time LAC = LAR. If it is assumed that all the firms are facing the similar cost
conditions all the firms are in equilibrium at the point where all will earn only
normal profit with LAC = LMC = LAR = LMR
2. Imperfect competition:
Imperfect competition is a competitive market situation where there are many sellers,
but they are selling heterogeneous (dissimilar) goods as opposed to the perfect
competitive market scenario. ... If a seller is selling a non identical good in the market,
then he can raise the prices and earn profits.
A. Monopoly
• The word ‘Monopoly’ is derived from two words ‘Mono’ which
means single and ‘Poly’ which means sellers. Hence monopoly is a
market situation in which there is one seller of product who
controls the entire market supply’.
Features
• 1. Single producer or seller: Monopoly is the market structure
where only one seller is involved in business activities. He has full
control over his business. He is the sole authority to take decision
regarding production and pricing policies.
• 2. No Distinction between Firm and the industry: In this market

there is no distinction between firm and industry as it is featured
with one seller. There are no competitors. So the distinction
between firm and industry disappears.
175
Features of Monopoly
3.No close substitute: Monopoly market does not face competition there is no close
substitute available for his product. The monopolist produces all the output in a market.
4. Absence of competition: There is no competition for monopoly. So the product sold by

monopolist has no substitute or complementary product. Cross elasticity of demand is zero
in monopoly market.
5. Price maker: Monopoly is a price maker being having control over his business. He does
carry price discrimination by charging various prices to different consumers.
6. Complete control : Monopoly has complete control over the production and market
supply. Decision about production is the sole decision of his. Entry to new firms are
restricted.
7.Downward Sloping demand curve : Monopolist faces a downward sloping demand curve
which indicates that it can sell more at a lower price.
Monopoly
• Gillette is a razor blade that

enjoys monopoly in market
because every consumer
purchases this brand and
this is a trusted brand.
• Gillette Mach 3 turbo
sensitive and Gillette
fusion are latest
version.
177
price and output determination in the short run under Monopoly.
Short Run Equilibrium :
1. Super Normal Profit : If the Average Revenue (AR) is greater than Average Cost (AC) (AR
> AC) the monopoly firm will earn supernormal profit. Profit of monopolist is shown in
following diagram.
price and output determination in the short run under monopoly.
Profit = Total Revenue (TR) – Total Cost (TC)

= AQ x OQ
= OPAQ

= CQ x OQ
= OBCQ
Profit = TR –TC
= Area OPAQ – Area OBCQ
Profit = Area BPAC

Hence the monopolist enjoys supernormal profit of BPAC and this is also as monopoly
profit
2.Losses :If the Average Revenue (AR) is less than Average Cost (AC) (AR < AC) the
monopoly firm will suffer from losses. Loss of monopolist is shown in following diagram.

= AQ x OQ
= OPAQ

= CQ x OQ
= OBCQ
Loss = TC –TR
Profit = Area PBCA
price and output determination in the short run under monopoly
3. Normal Profit :The monopoly firm at equilibrium will make normal profit if at
equilibrium point AR=AC i.e. AC curve is tangent to AR.
price and output determination in the short run under monopoly

= AQ x OQ
= OPAQ

= AQ x OQ
= OPAQ
Monopoly firm in short run may also earn normal profit if SAC is tangent to the AR at
equilibrium point (E). If in short run monopolist firm earn normal profit monopolist will
not produce the output. Monopolist always wants supernormal profit.
price and output determination in the long run under monopoly .
Long Run Equilibrium : Monopoly is associated with profits and it is called monopoly profit.
This applies to the long run equilibrium under monopoly. The monopolist will always make
profit in the long run where monopolist is not under pressure to operate on the existing
plant scale.
Above diagram shows the profit of monopolist in long run. Monopolist produced and sold
OQ quantity at price OP. For this output long run average cost (LAC) is CQ and total cost is
OBCQ while total revenue OPAQ. In long run monopolist earn profit area BPAC.
Monopolistic Competetion
• Monopolistic competition is a type of imperfect competition such
that one or two producers sell products that are differentiated
from one another as goods but not perfect substitutes
(such as from branding, quality, or location).
• Monopolistic competition was introduced by Prof. E.H. Chamberlin

and Prof. Mrs. Joan Robinson. Monopolistic competition is the type
of market structure where there exist monopoly on one side and
perfect competition on other side. Simply we can also say that it is
a mixture of monopoly and perfect competition.
185
Features of Monopolistic competition
Large number of firm :In a Monopolistic competition there is relatively large number of
firms each satisfying a small share of the market demand for the product. As there are
large number of firms there exists stiff competition between them. But the size of the
firm will be relatively small.
Product Differentiation : In a Monopolistic competition the products produced by various

firms are not identical but slightly different from each other, which means the products
are not same but are similar and hence their prices are not much different. They are close
substitutes of each other.
Selling Cost : Firms in Monopolistic competition incur expenditure to promote sales,

which is called as ‘Selling Cost’. Selling cost is incurred in the form of advertisement like
on T.V., Radio, Press, Exhibitions, free samples etc. Selling cost tries to influence
consumers demand and promote sales.
Features of Monopolistic competition
4. Free entry and exist : In a Monopolistic competition it is easy for the new firms to
enter and the existing firm to leave it. Free entry means that when in the industry
existing firms are making supernormal profit new firms enter in the industry and the
losses will compel them to leave the industry or group.
5. Absence of Interdependence : Under Monopolistic competition firms are large but

not their size. They are too small. It means every firm has its own policies like
production, output, price policy etc. Thus the policy of an individual firm cannot
influence the policy of other firms which means all firms are independent but not
interdependent.
6. Concept of Group : In Monopolistic Competition the word ‘industry’ loses its

significance as Prof. Chamberlin has used the word ‘Group’ which means number of
producers whose goods are fairly close substitutes.
7. Nature of Demand Curve :-In a Monopolistic competition the demand curve slopes
downward from left to right, which an individual firms can sell more by lowering price.
DD curve of monopolistic always slopes negatively.
Monopolistic competition
• Shoes are produced by many
producers but consumers may
feel that a particular company
is branded or the quality
produced by one company
is better than the other.

• be
Different
easily company’s shoes
differentiated
despite differentiatio can
each
produc n and
t
substitute for remains
the rival product.
close
188
Monopolistic Competition
• There is no pure competition
• Shoes come under monopolistic competition because there
are many producers and consumers choose
according to the brand, quality, location, trademark,
design, color, packaging, etc. and not on the basis of price only.
189
price and output determination in the short run under monopolistic competition
Short Run Equilibrium :

A firm under monopolistic completion faces three situations i.e. supernormal profit,
loss, and normal profit.
1.Super Normal Profit :Super Normal Profit : If the Average Revenue (AR) is greater
than Average Cost (AC) (AR > AC) the monopoly firm will earn supernormal profit. Profit
of monopolistic firm is shown in following diagram.
Profit = Total Revenue (TR) – Total Cost (TC) Total Revenue
(TR) = Average Revenue x Quantity

= AQ x OQ = Area OPAQ

= CQ x OQ = Area OBCQ
Profit = TR –TC
Profit = Area BPAC

Hence the monopolist enjoys supernormal profit of BPAC and this is also as
monopoly profit.
2. Losses : If the Average Revenue (AR) is less than Average Cost (AC) (AR < AC) the
monopoly firm will suffer from losses. Loss of monopolistic firm is shown in
following diagram.
price and output determination in the short run under monopolistic
competition

= AQ x OQ
= OPAQ

= CQ x OQ
= OBCQ
Loss = TC –TR
Profit = Area PBCA

price and output determination in the short run under monopolistic
competition
Normal Profit : The monopolistic firm at equilibrium

will make normal profit if at equilibrium point
AR=AC i.e. AC curve is tangent to AR.


Monopolistic firm in short run may also earn normal

profit if SAC is tangent to the AR at equilibrium
point (E). If in short run monopolist firm earn
normal profit monopolist will not produce the
output. Monopolist always wants supernormal
profit.
price and output determination in the long run under monopolistic
competition
Long Run Equilibrium under Monopolistic competition
The equilibrium of a firm under monopolistic completion is

shown in the figure below
In long run firms working under monopolistic completion earn

only normal profits.
Above diagram shows the normal profit of monopolistic

firm in long run. Monopolistic firm produced and sold OQ
quantity at price OP. For this output long run average cost
(LAC) is AQ and total cost is OQAP while total revenue
OQAP. In long run monopolist earn profit area BPAC.
Oligopoly
Oligopoly is a market situation where there are only few sellers in a given line at production.
Mr. Feller defines Oligopoly as “Competition among the few”. In this type of market the firm
may be producing either homogeneous products or may be having product differentiation in
the given line of production.
• Examples:-Earlier Maggi used to enjoy monopoly in this sector but with the
entry of the other three companies Maggi now comes in oligopoly.
• These four companies majorly rule the market in instant noodles
so they come in oligopoly.
• Maggi noodles, Sun feast yippee magic noodles, Horlicks foodles,
Knorr soupy noodles.
Features:-
Few Sellers:-Under Oligopoly there are few sellers producing or supplying either
homogeneous products or differentiated products.
Interdependence:-The firms have a high degree of interdependence in their business
policies about fixing of price and determination of output.
Advertisement & selling cost :-Advertisement and selling cost have strategic importance
to the firms under oligopoly. Each firm tries to attract maximum number of consumers
towards its products by spending huge amount of money on advertisement and publicity.
Features Of Oligopoly
4.High Cross elasticity’s of demand:-Under Oligopoly the firms have a high degree of
cross elasticity’s of demand. So there is always a fear of retaliation by the rivals. For
e.g. if coke reduces its price by 2 Rs. Pepsi may retaliate by reducing its price by 3 Rs
5.Constant Struggle:-Competition is of unique type in a Oligopolistic market. Here
competition consists of constant struggle of rivals against rivals (competitors).
6.Lack of Uniformity:-In Oligopoly the size of the firms are not uniform. Some firms
are very big in size and some firms are very small in size. Uneven sizes of firms are
found in this market.
7.Price Rigidity:-In Oligopoly market each firm sticks to its own price. This is because
it is in constant fear of retaliation by the rivals if it reduces the price.
8.Kinked Demand Curve:-According to Mr. Paul Sweezy firm is an Oligopolistic market
have Kinky demand curve. This is because when a firm changes its price the other
firms also change their price. Hence the demand curve of an Oligopolistic is not
definite it goes on changing.
Three Important Models of Oligopoly are as :
(1) Price and output determination under collusive oligopoly.
(2) Price and output determination under non-collusive oligopoly.
(3) Price leadership model.
Duopoly
• A situation in which two companies own all or nearly all of the
market for a given product or service.
• It is a specific type of oligopoly where only two producers exist in
one market. In reality, this definition is generally used where only
two firms have dominant control over a market.
• In the field of industrial organization, it is the most commonly
studied form of oligopoly due to its simplicity.
198
Duopoly
• In the market Pepsi and Coca-coal rule in soft drinks. So they
come under Duopoly.
• Other soft drinks are also there but these two companies cover
the large share in soft drinks market.
199
Market Structures
Perfect Monopoly Monopolistic Oligopoly
Competition competition
Numbers Large sellers and Single seller and Many sellers and A few sellers
large buyers large buyers many buyers and large buyers
Product Homogeneous Particular or Heterogeneous Homogeneous

specialist or
heterogeneous
price Equilibrium Price Independent Interdependent
price(fixed by discrimination pricing policy pricing policy
industry where
Demand =Supply
Seller A price taker A price maker A price dictator Price imitator
Demand Horizontal to X Slopes Slopes Kink demand
curve axis downward downward(Flatter) curve(Price
(Steeper) Rigidity)
Known as Perfect Imperfect Imperfect Imperfect
competition competition competition competition
existence It is unreal market It is restricted It is in existence It is existence
Entry and Free entry and No entry Free entry and exit Entry prohibited
exit exit
Special Assumption Remote Group concept Price rigidity
feature based competitors (Chamberlin) (to stop
competitors)
Substitutes Number of No substitute Number of A few
Business organisation
Business organisation refers to all necessary arrangements required to conduct a

business.
It refers to all those steps that need to be undertaken for establishing

relationship between men, material, and machinery to carry on business efficiently for
earning profits. This may be called the process of organising.
The arrangement which follows this process of organising is called a business

undertaking or organisation.
A business undertaking can be better understood by analysing its characteristics.

 Distinct Ownership
 Lawful Business
 Separate Status and Management
 Dealing in goods and services
 Continuity of business operations
 Risk involvement
Factors affecting the choice of Form of business Organisation:
 Easy to start and easy to close

 Division of labour
 Large amount of resources
 Liability
 Secrecy
 Transfer of ownership
 Ownership, management and control
 Continuity
 Quick decision making
 Personal contact with customers
 Flexibility
 Taxation
Business and new economic environment
Imagine you want to do business. Which are you interested in?

For example, you want to get into InfoTech industry. What can you
do in this industry? Which one do you choose? The following are
the alternatives you have on hand:
• You can bye and sell
• You can set up a small/medium/large industry to manufacture
• You can set up a workshop to repair
• You can develop software
• You can design hardware
• You can be a consultant/trouble-shooter
250
Business and new economic environment
• If you choose any one or more of the above, you have chosen
the line of activity. The next step for you is to decide whether.
• You want to be only owner (It means you what to be sole
trader) or
• You want to take some more professionals as co-owners along
with you (If means you what to from partnership with others as
partners) or
• You want to be a global player by mobilizing large resources
across the country/world
• You want to bring all like-minded people to share the benefits
of the common enterprise (You want to promote a joint stock
company) or
• You want to involve government in the IT business (here you
want to suggest government to promote a public enterprise!)
To decide this, it is necessary to know how to evaluate each of
these alternatives. 251
Sole trader
• The sole trader is the simplest, oldest and natural form of
business organization. It is also called sole proprietorship. ‘Sole’
means one. ‘Sole trader’ implies that there is only one trader
who is the owner of the business.
• Examples:- Restaurants, Supermarkets, pan shops, medical
shops, hosiery shops etc.
• Features:
• It is easy to start a business under this form and also easy to
close.
• He introduces his own capital. Sometimes, he may borrow, if
necessary
• He enjoys all the profits and in case of loss, he lone suffers.
• He has unlimited liability which implies that his
liability extends to his personal properties in case of loss.
205
Sole trader
• He has a high degree of flexibility to shift from one business to
the other.
• Business secretes can be guarded well
• There is no continuity.
• The business comes to a close with the death, illness
or insanity of the sole trader.
• Unless, the legal heirs show interest to continue the business,
the business cannot be restored.
• He has total operational freedom. He is the owner, manager
and controller.
• He can be directly in touch with the customers.
• He can take decisions very fast and implement them promptly.
• Rates of tax, for example, income tax and so on
are comparatively very low
206
Advantages of Sole trader
 1.Easy to start and easy to close: Formation of a sole trader from of

organization is relatively easy even closing the business is easy.
 2. Personal contact with customers directly: Based on the tastes
and preferences of the customers the stocks can be maintained.
 3. Prompt decision-making: To improve the quality of services to
the customers, he can take any decision and implement the same
promptly. He is the boss and he is responsible for his business
Decisions relating to growth or expansion can be made promptly.
 4. High degree of flexibility: Based on the profitability, the trader
can decide to continue or change the business, if need be.
 5. Secrecy: Business secrets can well be maintained because there
is only one trader.
207
Advantages of Sole trader
6.Low rate of taxation: The rate of income tax for sole traders is relatively very low.
7. Direct motivation: If there are profits, all the profits belong to the trader himself. In
other words. If he works more hard, he will get more profits. This is the direct
motivating factor. At the same time, if he does not take active interest, he may stand
to lose badly also.
8. Total Control: The ownership, management and control are in the hands of the sole
trader and hence it is easy to maintain the hold on business.
9. Minimum interference from government: Except in matters relating to public

interest, government does not interfere in the business matters of the sole trader. The
sole trader is free to fix price for his products/services if he enjoys monopoly market.
10. Transferability: The legal heirs of the sole trader may take the possession of the
business
Disadvantages of Sole trader
• 1.Unlimited liability: The liability of the sole trader is unlimited. It
means that the sole trader has to bring his personal property to clear
off the loans of his business. From the legal point of view, he is not
different from his business.
• 2. Limited amounts of capital: The resources a sole trader can
mobilize cannot be very large and hence this naturally sets a limit
for the scale of operations.
• 3. No division of labour: All the work related to different functions
such as marketing, production, finance, labour and so on has to be
taken care of by the sole trader himself. There is nobody else to take
his burden. Family members and relatives cannot show as much
interest as the trader takes.
• 4. Uncertainty: There is no continuity in the duration of the
business. On the death, insanity of insolvency the business may be
come to an end. 209
Disadvantages of Sole trader
5.Inadequate for growth and expansion: This from is suitable for only small size, one-
man-show type of organizations. This may not really work out for growing and expanding
organizations.
6. Lack of specialization: The services of specialists such as accountants, market

researchers, consultants and so on, are not within the reach of most of the sole traders.
7. More competition: Because it is easy to set up a small business, there is a high degree
of competition among the small businessmen and a few who are good in taking care of
customer requirements along can service.
8. Low bargaining power: The sole trader is the in the receiving end in terms of loans or
supply of raw materials. He may have to compromise many times regarding the terms
and conditions of purchase of materials or borrowing loans from the finance houses or
banks.
Partnership
• Partnership is an improved from of sole trader in certain
respects. Where there are likeminded persons with resources,
they can come together to do the business and share the
profits/losses of the business in an agreed ratio.
• Persons who have entered into such an agreement are
individually called ‘partners’ and collectively called ‘firm’. The
relationship among partners is called a partnership.
• Indian Partnership Act, 1932 defines partnership as the
relationship between two or more persons who agree to share
the profits of the business carried on by all or any one of them
acting for all.
211
Features
Relationship: Partnership is a relationship among persons. It
is relationship resulting out of an agreement.
Two or more persons: There should be two or more number of
persons.
There should be a business: Business should be conducted.
Agreement: Persons should agree to share the profits/losses of
the business
Carried on by all or any one of them acting for all: The business
can be carried on by all or any one of the persons acting for all.
This means that the business can be carried on by one person who
is the agent for all other persons. Every partner is both an agent
and a principal. Agent for other partners and principal for himself.
All the partners are agents and the ‘partnership’ is their principal.
212
Features
The following are the other features:
(a) Unlimited liability: The liability of the partners is unlimited. The partnership and
partners, in the eye of law, and not different but one and the same. Hence, the
partners have to bring their personal assets to clear the losses of the firm, if any.
(b) Number of partners: According to the Indian Partnership Act, the minimum number
of partners should be two and the maximum number if restricted, as given below:
• 10 partners is case of banking business
• 20 in case of non-banking business
(c) Division of labour: Because there are more than two persons, the work can be
divided among the partners based on their aptitude.
(d) Personal contact with customers: The partners can continuously be in touch with
the customers to monitor their requirements.
(e) Flexibility: All the partners are likeminded persons and hence they can take any
decision relating to business.
Partnership deed
• The written agreement among partners is called
the partnershipdeed’. It contains ‘the terms and conditions
the
governing the working of partnership. following
The contents of the partnership deed. are
• Names and addresses of the firm and partners
• Nature of the business proposed
• Duration
• Amount of capital of the partnership and the ratio
for contribution by each of the partners.
• Their profit sharing ration (this is used for sharing losses also)
214
Partnership deed
• Rate of interest charged on capital contributed, loans taken
from the partnership and the amounts drawn, if any, by the
partners from their respective capital balances.
• The amount of salary or commission payable to any partner
• Procedure to value good will of the firm at the time
of admission of a new partner, retirement of death of a
partner
• Allocation of responsibilities of the partners in the firm
• Procedure for dissolution of the firm
• Name of the arbitrator to whom the disputes, if any, can be
referred to for settlement.
• Special rights, obligations and liabilities of partners(s), if any
260
Kinds of partners
• Active Partner: Active partner takes active part in the affairs of
the partnership. He is also called working partner.
• Sleeping Partner: Sleeping partner contributes to capital but
does not take part in the affairs of the partnership.
• Nominal Partner: Nominal partner is partner just for
namesake. He neither contributes to capital nor takes part in
the affairs of business. Normally, the nominal partners are
those who have good business connections, and are well places
in the society.
• Partner by Estoppels: Estoppels means behavior or conduct.
Partner by estoppels gives an impression to outsiders that he is
the partner in the firm. In fact be neither contributes to capital,
nor takes any role in the affairs of the partnership
216
Kinds of partner
Partner by holding out: If partners declare a particular person
(having social status) as partner and this person does not
contradict even after he comes to know such declaration, he is
called a partner by holding out and he is liable for the claims of
third parties.
However, the third parties should prove they entered into
contract with the firm in the belief that he is the partner of the
firm. Such a person is called partner by holding out.
Minor Partner: Minor has a special status in the partnership. A
minor can be admitted for the benefits of the firm. A minor is
entitled to his share of profits of the firm.
The liability of a minor partner is limited to the extent of his
contribution of the capital of the firm.
217
Rights of partner
• To take part in the management of business
• To express his opinion
• To share equally the profits of the firm in the absence of any
specific agreement to the contrary
• To receive interest on capital at an agreed rate of interest from
the profits of the firm
• To receive interest on loans, if any, extended to the firm.
• To be indemnified for any loss incurred by him in the
conduct of the business
• To receive any money spent by him in the ordinary and proper
conduct of the business of the firm
218
Advantages
 1.Easy to form: Once there is a group of like-minded persons and good

business proposal, it is easy to start and register a partnership.
 2. Availability of larger amount of capital: More amount of capital can be

raised from more number of partners.
 3. Division of labour: The different partners come with varied backgrounds

and skills. This facilities division of labour.
 4. Flexibility: The partners are free to change their decisions, add or drop a
particular product or start a new business or close the present one and so
on.
Advantages
• Personal contact with customers: There is scope to keep close
monitoring with customers requirements by keeping one of the
partners in charge of sales and marketing. Necessary changes
can be initiated based on the merits of the proposals from the
customers.
• Quick decisions and prompt action: If there is consensus
among partners, it is enough to implement any decision and
initiate prompt action. Sometimes, it may more time for the
partners on strategic issues to reach consensus.
• The positive impact of unlimited liability: Every partner is
always alert about his impending danger of unlimited liability.
Hence he tries to do his best to bring profits for the partnership
firm by making good use of all his contacts.
220
Disadvantages
• Formation of partnership is difficult: Only like-minded persons
can start a partnership. It is sarcastically said,’ it is easy to find a
life partner, but not a business partner’.
• Liability: The partners have joint and several liabilities beside
unlimited liability. Joint and several liability puts additional
burden on the partners, which means that even the personal
properties of the partner or partners can be attached. Even
when all but one partner become insolvent, the solvent partner
has to bear the entire burden of business loss.
• Lack of harmony or cohesiveness: It is likely that partners
may not, most often work as a group with cohesiveness. This
result in mutual conflicts, an attitude of suspicion and crisis of
confidence. Lack of harmony results in delay in decisions and
paralyses the entire operations
221
Disadvantages
• Limited growth: The resources when compared to sole trader, a
partnership may raise little more. But when compare to the
other forms such as a company, resources raised in this form of
organization are limited. Added to this, there is a restriction on
the maximum number of partners.
• Instability: The partnership form is known for its instability.
The firm may be dissolved on death, insolvency or insanity of
any of the partners.
• Lack of Public confidence: Public and even the financial
institutions look at the unregistered firm with a suspicious eye.
Though registration of the firm under the Indian Partnership
Act is a solution of such problem, this cannot revive public
confidence into this form of organization overnight. The
partnership can create confidence in other only with their
performance
222
Joint stock Company
• The joint stock company emerges from the limitations of
partnership such as joint and several liability, unlimited liability,
limited resources and uncertain duration and so on.
• Normally, to take part in a business, it may need large money
and we cannot foretell the fate of business. It is not literally
possible to get into business with little money.
• Against this background, it is interesting to study the
functioning of a joint stock company.
• The main principle of the joint stock company from is to
provide opportunity to take part in business with a low
investment as possible say Rs.1000.
• Joint Stock Company has been a boon for investors with
moderate funds to invest.
223
Joint stock company
• The word ‘ company’ has a Latin origin, com means ‘ come
together’, pany means ‘ bread’, joint stock company means,
people come together to earn their livelihood by investing in
the stock of company jointly.
• Lord justice Lindley explained the concept of the joint stock
company from of organization as ‘an association of many
persons who contribute money or money’s worth to a common
stock and employ it for a common purpose.
224
Features of Joint stock company
• Artificial person: The Company has no form or shape. It is an
artificial person created by law. It is intangible, invisible and
existing only, in the eyes of law.
• Separate legal existence: it has an independence existence,
it separate from its members. It can acquire the assets. It can
borrow for the company. It can sue other if they are in default
in payment of dues, breach of contract with it, if any.
• Similarly, outsiders for any claim can sue it. A shareholder is
not liable for the acts of the company. Similarly, the
shareholders cannot bind the company by their acts.
• Voluntary association of persons: The Company is an
association of voluntary association of persons who want to
carry on business for profit. To carry on business, they need
capital. So they invest in the share capital of the company.
270
Features
•Capital is divided into shares: The total capital is divided into a
certain number of units. Each unit is called a share. The price of
each share is priced so low that every investor would like to invest
in the company. The companies promoted by promoters of good
standing (i.e., known for their reputation in terms of reliability
character and dynamism) are likely to attract huge resources.
•Transferability of shares: In the company form of organization,
the shares can be transferred from one person to the other. A
shareholder of a public company can cell sell his holding of shares
at his will. However, the shares of a private company cannot be
transferred. A private company restricts the transferability of the
shares.
•Common Seal: As the company is an artificial person created by
law has no physical form, it cannot sign its name on a paper; so, it
has a common seal on which its name is engraved. The common
seal should affix every document or contract; otherwise the
company is not bound by such a document or contract.
271
Formation of joint stock company
There are two stages in the formation of a joint stock company.
They are:
(a) To obtain Certificates of Incorporation
(b) To obtain certificate of commencement of Business
Certificate of Incorporation: The certificate of Incorporation is just
like a ‘date of birth’ certificate. It certifies that a company with
such and such a name is born on a particular day.
Certificate of commencement of Business: A private company
need not obtain the certificate of commencement of business. It
can start its commercial operations immediately after obtaining
the certificate of Incorporation.
The persons who conceive the idea of starting a company and
who organize the necessary initial resources are called promoters.
The vision of the promoters forms the backbone for the company
in the future to reckon with.
227
Cont….
• The promoters have to file the following documents, along with
necessary fee, with a registrar of joint stock companies to
obtain certificate of incorporation:
• (a) Memorandum of Association: The Memorandum of
Association is also called the charter of the company. It outlines
the relations of the company with the outsiders. If furnishes all
its details of clause such as
• Name clause
• situation clause
• objects clause
• Capital clause
• subscription clause duly executed by its subscribers
228
Cont…
• Articles of association: Articles of Association furnishes the
byelaws or internal rules government the internal conduct of
the company.
• The list of names and address of the proposed directors and
their willingness, in writing to act as such, in case of registration
of a public company
• A statutory declaration that all the legal requirements have
been fulfilled. The declaration has to be duly signed by any one
of the following: Company secretary in whole practice, the
proposed director, legal solicitor, chartered accountant in whole
time practice or advocate of High court.
229
Advantages
• Mobilization of larger resources: A joint stock company
provides opportunity for the investors to invest, even small
sums, in the capital of large companies. The facilities rising of
larger resources.
• Separate legal entity: The Company has separate legal
entity. It is registered under Indian Companies Act, 1956.
• Limited liability: The shareholder has limited liability in
respect of the shares held by him. In no case, does his liability
exceed more than the face value of the shares allotted to him.
• Transferability of shares: The shares can be transferred to
others. However, the private company shares cannot be
transferred.
• Liquidity of investments: By providing the transferability of
shares, shares can be converted into cash.
•
230
Advantages
• Inculcates the habit of savings and investments: Because the
share face value is very low, this promotes the habit of saving
among the common man and mobilizes the same towards
investments in the company
• Institutional confidence: Financial Institutions prefer to deal
with companies in view of their professionalism and financial
strengths.
• Professional management: With the larger funds at its
disposal, the Board of Directors recruits competent and
professional managers to handle the affairs of the company in a
professional manner.
• Growth and Expansion: With large resources and professional
management, the company can earn good returns on its
operations, build good amount of reserves and further consider
the proposals for growth and expansion 231
Disadvantages
• Formation of company is a long drawn procedure: Promoting a
joint stock company involves a long drawn procedure. It is
expensive and involves large number of legal formalities.
• High degree of government interference: The government
brings out a number of rules and regulations governing the
internal conduct of the operations of a company such as
meetings, voting, audit and so on, and any violation of these
rules results into statutory lapses, punishable under the
companies act.
• Inordinate delays in decision-making: As the size of the
organization grows, the number of levels in organization also
increases in the name of specialization.
• The more the number of levels, the more is the delay in
decision-making. Sometimes, so called professionals do not
respond to the urgencies as required. It promotes delay in
administration, which is referred to ‘red tape and bureaucracy’.
232
Disadvantages
• Lack or initiative: In most of the cases, the employees of the
company at different levels show slack in their personal
initiative with the result, the opportunities once missed do not
recur and the company loses the revenue.
• Lack of responsibility and commitment: In some cases, the
managers at different levels are afraid to take risk and more
worried about their jobs rather than the huge funds invested in
the capital of the company lose the revenue.
• Lack of responsibility and commitment: In some cases, the
managers at different levels are afraid to take risk and more
worried about their jobs rather than the huge funds invested in
the capital of the company.
• Where managers do not show up willingness to take
responsibility, they cannot be considered as committed. They
will not be able to handle the business risks. 233
Cooperative Society
• It is a voluntary association of people or business to
achieve a an economic goal with a social
perspective
• Its aim is to serve the interest of the poorer sections of society
through the principle of self-help and mutual help.
• The main objective is to provide support to the members.
• Nobody joins a cooperative society to earn profit. People come
forward as a group, pool their individual resources, utilize them
in the best possible manner, and derive some common benefit
out of it.
234
Cooperative Society
• A Co-operative Society can be formed as per the provisions of
the Co-operative Societies Act, 1912.
• At least ten persons above of 18 years, having the capacity
to enter into a contract with common economic objectives, like
farming, weaving, consuming, etc. can form a Co-operative
Society.
• If object of the society is creation of funds to be lent to its
members, all the members must be residing in the same town,
village or group of villages or all members should be of same
tribe, class, caste or occupation, unless Registrar otherwise
directs.
280
Cooperative Society
• The provision of minimum 10 members or residing in same
town/village etc. is not applicable if a registered society is
member of another society.
• The Statement of Objects and reasons states as follows:
• Cooperative Society can be established for purpose of credit,
production or distribution.
• Agricultural credit societies must be with unlimited liability.
Unlimited society is not best form of cooperation for
agricultural commodities.
• Unlimited society can distribute profits with permission of
State Government.
236
Cooperative Society
• The last word in name of society should be ‘Limited’, if the
Society is registered with limited liability. If a society has limited
liability, any individual member of such society cannot have
share capital more than one fifth of total capital.
• An individual member cannot have interest in shares
exceeding Rs 1,000. This restriction of 20% shares or Rs 1,000
shares value is not applicable to a registered society which is
member of another society.
• Thus, if a registered society is member of another society, it
can hold shares exceeding 20% or exceeding Rs 1,000 in value.
237
Cooperative Society
• A registered cooperative society can hold property, enter into
contracts, institute and defend suit and other legal proceedings
and to do all things necessary for the purposes of its
constitution.
• A registered society can give loans only to its members.
However, it can give loan to another registered society with
permission of Registrar.
• A society with unlimited liability cannot lend money on
security of movable property without sanction of registrar.
• State Government, by issuing a general or special order, can
prohibit or restrict lending of money on mortgage of
immovable property by any registered society or class of
registered society.
238
Types of cooperative society
• Consumers’ Co-operative Society: These societies are formed
to protect the interest of general consumers by making
consumer goods available at a reasonable price.
• They buy goods directly from the producers or
manufacturers and thereby eliminate the middlemen in the
process of distribution. Kendriya Bhandar, Apna Bazar and
Sahkari Bhandar are examples of consumers’ co-operative
society.
• Producers’ Co-operative Society: These societies are formed
to protect the interest of small producers by making available
items of their need for production like raw materials, tools and
equipments, machinery, etc.
• Handloom societies like APPCO, Bayanika, Haryana
Handloom, etc., are examples of producers’ co-operative
society. 239
• Co-operative Marketing Society: These societies are formed by
small producers and manufacturers who find it difficult to sell
their products individually.
• The society collects the products from the individual
members and takes the responsibility of selling those products
in the market. Gujarat Co-operative Milk Marketing Federation
that sells AMUL milk products is an example of marketing co-
operative society.
• Co-operative Credit Society: These societies are formed to
provide financial support to the members.
• The society accepts deposits from members and grants them
loans at reasonable rates of interest in times of need.
• Village Service Co-operative Society and Urban Cooperative
Banks are examples of co-operative credit society.
240
• Co-operative Farming Society: These societies are formed by
small farmers to work jointly and thereby enjoy the benefits of
large-scale farming.
• Lift-irrigation cooperative societies and pani-panchayats are
some of the examples of co-operative farming society.
• Housing Co-operative Society: These societies are formed to
provide residential houses to members.
• They purchase land, develop it and construct houses or flats
and allot the same to members.
• Some societies also provide loans at low rate of interest to
members to construct their own houses.
• The Employees’ Housing Societies and Metropolitan Housing
Co-operative Society are examples of housing co-operative
society.
241
Characteristics
• Open membership: The membership of a Co-operative Society is
open to all those who have a common interest. A minimum of ten
members are required to form a cooperative society. The Co
operative societies Act do not specify the maximum number of
members for any co-operative society. However, after the formation
of the society, the member may specify the maximum number of
members.
• Voluntary Association: Members join the co-operative society
voluntarily, that is, by choice. A member can join the society as and
when he likes, continue for as long as he likes, and leave the society
at will.
• State control: To protect the interest of members, co-operative
societies are placed under state control through registration. While
getting registered, a society has to submit details about the
members and the business it is to undertake. It has to maintain
books of accounts, which are to be audited by government
auditors. 287
Characteristics
• Sources of Finance: In a co-operative society capital is contributed by
all the members. However, it can easily raise loans and secure grants
from government after its registration.
• Service motive: Co-operatives are not formed to maximize profit like
other forms of business organization. The main purpose of a Co-
operative Society is to provide service to its members. For example,
in a Consumer Cooperative Store, goods are sold to its members at a
reasonable price by retaining a small margin of profit. It also provides
better quality goods to its members and the general public.
• Separate Legal Entity: A Co-operative Society is registered under
the Co-operative Societies Act. After registration a society becomes a
separate legal entity, with limited liability of its members. Death,
insolvency or lunacy of a member does not affect the existence of a
society. It can enter into agreements with others and can purchase or
sell properties in its own name. 243
Advantages
• Easy Formation: Formation of a co-operative society is very
easy compared to a joint stock company. Any ten adults can
voluntarily form an association and get it registered with the
Registrar of Co-operative Societies.
• Open Membership: Persons having common interest can
form a co-operative society. Any competent person can become
a member at any time he/she likes and can leave the society at
will.
• Democratic Control: A co-operative society is controlled in a
democratic manner. The members cast their vote to elect their
representatives to form a committee that looks after the day-
to-day administration. This committee is accountable to all the
members of the society.
244
Advantages
• Limited Liability: The liability of members of a co-operative
society is limited to the extent of capital contributed by them.
Unlike sole proprietors and partners the personal properties of
members of the co-operative societies are free from any kind of
risk because of business liabilities.
• Elimination of Middlemen’s Profit: Through co-operatives
the members or consumers control their own supplies and
thus, middlemen’s profit is eliminated.
• State Assistance: Both Central and State governments
provide all kinds of help to the societies. Such help may be
provided in the form of capital contribution, loans at low rates
of interest, exemption in tax, subsidies in repayment of loans,
etc.
• Stable Life: A co-operative society has a fairly stable life and
it continues to exist for a long period of time. Its existence is
not affected by the death, insolvency, lunacy or resignation of
any of its members. 290
Capital Budgeting
• Capital budgeting is made up of two words ‘capital’ and
‘budgeting.’ In this context, capital expenditure is the spending
of funds for large expenditures like purchasing fixed assets and
equipment, repairs to fixed assets or equipment, research and
development, expansion and the like. Budgeting is setting
targets for projects to ensure maximum profitability.
• Capital refers to the financial resources that businesses can use
to fund their operations like cash, machinery, equipment and
other resources. These are the assets that allow the business to
produce a product or service to sell to customers.
• Budgeting is the process of creating a plan to spend your
money. This spending plan is called a budget.
247
Capital Budgeting
• Capital budgeting is a process of evaluating investments and huge
expenses in order to obtain the best returns on investment.
• An organization is often faced with the challenges of selecting
between two projects/investments or the buy vs replace decision.
• Ideally, an organization would like to invest in all profitable projects
but due to the limitation on the availability of capital an
organization has to choose between different
projects/investments.
248
Capital Budgeting
• Capital budgeting as a concept affects our daily lives. Let’s
look at an example-
• Your mobile phone has stopped working! Now, you have two
choices: Either buy a new one or get the same mobile repaired.
• Here, you may conclude that the costs of repairing the mobile
increases the life of the phone. However, there could be a
possibility that the cost to buy a new cell phone would be
lesser than its repair costs.
• So, you decide to replace your cell phone and you proceed
to look at different phones that fit your budget!
249
Objectives of capital budgeting
• Capital expenditures are huge and have a long-term effect.
Therefore, while performing a capital budgeting analysis an
organization must keep the following objectives in mind:
1. Selecting profitable projects
• An organization comes across various profitable projects
frequently. But due to capital restrictions, an organization
needs to select the right mix of profitable projects that will
increase its shareholders’ wealth.
2. Capital expenditure control
• Selecting the most profitable investment is the main objective
of capital budgeting. However, controlling capital costs is also
an important objective. Forecasting capital expenditure
requirements and budgeting for it, and ensuring no
investment opportunities are lost is the crux of budgeting.
250
Objectives of capital budgeting
• Identifying the Right Source of Funds: Locating and selecting
the most appropriate source of fund required to make a long-
term capital investment is the ultimate aim of capital
budgeting. The management needs to consider and compare
the cost borrowing with the expected return on investment for
this purpose.
251
Features of capital budgeting
• Huge Funds: Capital budgeting involves expenditures of high value
which makes it a crucial function for the management.
• High Degree of Risk: To take decisions which involve huge financial
burden can be risky for the company.
• Affects Future Competitive Strengths: The company’s future is
based on such capital expenditure decisions. Sensible investing can
improve its competitiveness, whereas a wrong investment may
lead to business failure.
• Difficult Decision: When the future is dependent on capital
budgeting decisions, it becomes difficult for the management to
grab the most appropriate investment opportunity.
252
Features of capital Budgeting
• Estimation of Large Profits: Any investment decision taken by the
company is made with the perspective of earning desirable profits
in the long term.
• Long Term Effect: The effect of the decisions taken today, whether
favorable or unfavorable, will be visible in the future or the long
term.
• Affects Cost Structure: The company’s cost structure changes with
the capital budgeting; for instance, it may increase the fixed cost
such as insurance charges, interest, depreciation, rent, etc.
• Irreversible Decision: A decision once taken is tough to be
amended since it involves a high-value asset which may not be sold
at the same price once purchased
253
Factors affecting capital budgeting
• Capital Structure: The capital structure, i.e., the
composition
company’s of shareholder’s funds and borrowed funds,
determines its capital budgeting decisions.
• Working Capital: The availability of capital required by the
company to carry out day to day business operations influences its
long-term decisions.
• Capital Return: The management estimates the expected return
from the prospective capital investment while planning the
company’s capital budget.
• Availability of Funds: The company’s potential for capital budgeting
is dependent on its dividivent policy, availability of funds and the
ability to acquire funds from the other sources.
254
Factor
s
• Earnings: If the company has a stable earning, it may plan for
massive investment projects on leveraged funds, but the same
is not suitable in case of irregular earnings.
• Lending Policies of Financial Institutions: The terms on which
financial institutions provide loans such as interest rates, collateral,
duration, etc. contributes to capital budgeting decisions.
• Management Decisions: The decision of the management to take a
risk and invest funds in high-value assets or holding some other
plan, also determines the capital budgeting of the company.
• Project Needs: The company needs to consider all the essentials of
a new project. Also, the means to fulfil the requirements along
with the estimate of the related expenses should be clear.
255
Factor
s
• Accounting Methods: The accounting rules, principles and
methods of the company is another factor considered while capital
budgeting to frame the reporting of such expenses and revenue to
be generated in future.
• Government Policy: The restrictions imposed and the exemptions
allowed by the government to the companies while investing in
capital nature, impacts the company’s capital budgeting decisions.
• Taxation Policy: The taxation procedure and policy of the country
also influences the long-term investment decision of the firm since
additional capital will be required for such expenses.
• Project’s Economic Value: The total cost estimated for the long-
term investment and the capacity of the company determines the
capital budgeting decisions.
256
Capital budgeting process
Evaluating and
Identifying
assembling
investment Decision making
investment
opportunities
proposals
Capital budgeting
Performance review Implementation
and appointment
257
• Identifying Potential Investment Opportunities: The company has
various options for capital employment on a long-term basis. In the
initial stage, the management needs to analyze the strengths and
weaknesses of every project for foreseeing the potential of each
option.
• Evaluating and Assembling Investment Proposals: In the next step,
the management assembles and compiles all the investment
proposals on the grounds of cost, risk involvement, future profits,
return on investment, etc.
• Decision Making: Now, the company needs to decide as to which
investment option it may select to suit its pocket and yield a high
profit for the company in the long run.
258
• Capital Budgeting and Apportionment: The next step is to classify
the investment as per its duration. The long-term investment is
generally considered under capital budgeting. This step helps in
monitoring the performance of an individual investment.
• Implementation: After the apportioning of the long-term
investment, the company comes into action for the execution of its
decision. To avoid complications and excess time-consumption, the
management should lay out a detailed plan of the project in
advance.
• Performance Review: The last but the most crucial step is the
follow-up and analysis of the project’s performance. While the
company’s operations are steady, the management needs to
measure and correlate the actual performance with that of the
estimated one to figure out the deviation and take corrective
actions for the same. 259
Capital budgeting decisions
Accept/ reject
decisions
Mutually exclusive
project decisions
Capital rationing
decision
260
Capital budgeting decisions
• Accept / Reject Decision: This type of arrangement is fundamental
and mostly applies to the independent projects which are not
affected by the acceptance possibility of other projects. The
projects which generate a high rate of return or cost of capital are
accepted, and the plans which do not fulfil the criteria are rejected.
• Mutually Exclusive Project Decision: These projects compete with
one another, i.e., the possibility of accepting one project excludes
the acceptance of the other.
• Capital Rationing Decision: The term itself explains that the
limitation of capital dominates such decisions. In a situation
where the firm has multiple investment options demanding
huge funds, the management rank the projects on specific
criteria; such as the rate of return of each project. Then, the
projects with the highest percentage of profit or those which
fulfil the requirements most can be selected.
261
Capital budgeting techniques/ Methods
.
309
Payback period Method
1. This method is the simplest and most widely used method.
2. Payback period is the time required to recover the
initial investment.
3. A firm is always interested in knowing the amount of time
required to recover its investment.
4. It is based on the concept of cash flow and is a non-discounting
technique.
263
Payback method
When Cash inflows are even/equal
• When cash inflow of all year is equal, we use the following
formula
• Payback period = Initial investment/ Annual cash inflow
When cash inflows are uneven
• When cash inflows of each year is different we use the formula
below
• Payback period = E + B/C
• Where,
• E = Year immediately Preceding to year of recovery
B = Amount left to be recovered
• C = Cash inflow during the year of final recovery
•Note: Before using these values we must find cumulative cash
inflows
264
Merits of payback method
1. It is easy to calculate and simple to understand.
2. It is useful in case of those industries where there is a lot of
uncertainty and instability because it lays emphasis on the speedy
recovery of investment.
3. Many firms want to recover their investment as quickly as
possible. This method is more appropriate for them to know how
quickly they could get their investments back.
4. It Measures liquidity of the investment.
265
Demerits of payback method
1. This method neglects cash flows
occurring after the payback period: This
earned after the recovery of
method doesthe not
cost of investment.the
consider
projectsamount
Some may have higher
of cashprofit
inflows after the payback
period.
2. This method does not consider the time value of money.
3. This method does not consider the risk associated with
the project.
4. This method ignores interest factor which is considered
very important in taking
• sound investment decision.
266
Payback method
Post Payback period: The duration in excess of payback
period till economic life of a project.
• Post Payback period = Economic life – payback period
Post Payback Profitability: The amount of profit, which a project
could earn after the recovery of initial investment is called as payback
profitability.
• Post Payback Profitability = Total Earning from project –
Payback amount
Post profitability index: Percentage of
Payback extra over initial investment (payback
earning
amount).
• Post Payback profitability index = 𝑷 𝒐 𝒔 𝒕 𝑷 𝒂 𝒚 𝒃 𝒂 𝒄 𝒌
𝑷𝒓𝒐𝒇𝒊𝒕
×𝟏 𝟎 𝟎
Initial investment
267
Accounting rate of return
• Accounting Rate of Return (ARR) is the average net income an
asset is expected to generate divided by its average capital cost,
expressed as an annual percentage. The ARR is a formula used
to make capital budgeting decisions. They typically include
situations where companies are deciding on whether or not to
proceed with a specific investment (a project, an acquisition,
etc.) based on the future net earnings expected compared to
the capital cost.
• ARR= Average Net Profit
Average net investment
Where:
• Average Annual Profit = Total profit over Investment Period /
Number of Years
• Average Investment = (Book Value at Year 1 + Book Value at End of
Useful Life) / 2
268
Accounting rate of return- Merits
1. It is simple and easy to calculate.
2. It takes into account all the savings over the entire period
of investment.
3. It is based on accounting profit rather than cash inflow.
Accounting profit can be easily obtained from financial
statements.
4. It measures the benefit in percentage which makes it easier
to
compare with other projects.
5. This method helps to distinguish between projects where
the timing of savings is approximately the same.
269
Demerits- Accounting rate of return
1. This method ignores the time value of money.
2. Like Payback period, this method also ignores risk factor.
3. This method is based on accounting profits rather than cash flows.
In order to maximize the wealth of shareholders, cash flows
should be taken for calculation
4. This method ignores the size of investment. Sometimes ARR may
be the same for different projects but some of them may involve
huge cash flows.
270
NPV method
1. The NPV Method is a discounted cash flow technique.
2. This method compares cash inflows and cash
outflows occurring at different time period.
3. Themajor characteristic of this method is that it takes
into account the time value of money and all cash inflows
and outflows are converted to present value
271
Calculation of NPV
1. Cash inflows and outflows are determined.
2. A discount rate or cut-off rate is determined. This rate is also
called as costof capital, required rate of return, the target rate of
return, hurdle rateetc.
3. With the help of this rate of return, present value of cash inflows
are calculated. For this purpose, Present Value Factor should be
calculated at a given rate with the help of this formula
PVF = 1/ (1+r)n or Or it could be taken from the PVF table.
4. Cash inflows of each year is then multiplied with Present Value
Factor (P.V.F.)
5. Discounted cash inflow of all years is added. In this way, the
Present Value of all Cash inflow is obtained. Finally, NPV
is calculated by deducting PV of cash outflow from PV of
cash
• inflows
272
• NPV = P.V. of cash inflows –PV of cash outflows
Advantages of NPV
1. This method recognizes the time value of money.
Cash inflows arising at different time interval are
discounted to present values.
2. This method recognizes risk involved in the project with the
help of discounting rate.
3. This method is best for mutually exclusive projects where only
one project is tobe selected among many.
4. This method is considered best for wealth maximization of
shareholders as it is based on cash inflow rather than
accounting profit.
5. It considers total benefits arising out of project till the end of the
project.
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Disadvantages of NPV
1. It requires difficult calculation.
2. The NPV technique requires the predetermination of
required rate of return, which itself is a difficult
job. If that rate is not correctly taken, then the whole
exercise of NPV may give wrong result.
3. It does not provide a measure of projects own rate of return,
rather it evaluates a proposal against an external variable i.e.
minimum rate of return.
4. This method may not provide satisfactory results in case of
projects having different amount of investment and
different economic life.
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Profitability index
• This method is also known as Benefit-cost-ratio method . It is
based on net present value method and calculates the benefit
on per rupee investment.
• Profitability index= PV of cash inflow
• PV cash outflow
• Decision Criteria :
• 1. if there is only one project
if PI is more than 1 Accept
If PI is less than 1 Reject
if PI is 0 indifferent
2. if more than one project , the project with higher NPV should
be selected.
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Merits
• It is superior to NPV method
• It gives due consideration to the time value of money and cost
involved in the project.
• PI techniques gives better result in case of projects having
different outlays.
• In PI all cash flows are considered including working capital
used and released , salvage value is also considered.
• This method is considered best for wealth maximization of
shareholders as it is based on cash inflow rather than
accounting profit.
• It considers total benefits arising out of project till the end of
the project.
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Demerits
• The information generated is based on estimates instead
of facts.
• It may not provide correct decision-making criteria for certain
projects
• The tool ignores what is called the “sunk cost.”
• It can be difficult to estimate opportunity costs.
• The profitability index often relies on optimism.
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Internal rate of return
1. IRR is also known as Time-adjusted rate of return.
2. IRR is the rate at which NPV of a project becomes zero.
3. In other words, we could say that IRR is the rate at which
present value of cash inflows and present value of cash outflows
will be equal.
4. In this technique, unlike net present value, we are not given
a discount rate. The
• discount rate is to be ascertained by trial and error
procedure.
278
• .
326
• .
327
Key points
1. This method is based on trial and error. We should keep in mind that we need
two rates, one rate higher to PV Factor and another rate lower to PV factor and
then we need to calculate NPVs at those rates. NPV at one rate should be
negative and NPV at one rate should be positive.
2. We should also keep in mind
• Lower the rate, higher the NPV
• Higher the rate, lower the NPV
3. Suppose NPV is Negative at 10% discount rate. Now, we need another NPV
which should be Positive. So, going by the above rule, we should now calculate
NPV at a rate which is lower to 10%. We should continue lowering the rate till
we do not get a positive NPV. Generally difference of two percent is considered
good. So, here we could get a positive NPV at 8% discount rate.
4. If two rates are given in the question, we simply need to calculate the NPV at
both the rates and apply those values in the formula. (This is much better haha)
328
Merits IRR
• .
329
Demerits of IRR
• It involves complicated trail and calculation
• It makes an implied assumption that the future cash inflows of
a proposal are reinvested at a rate equal to IRR.
• This assumption is not true as the firms are able to reinvest
only at a rate available in the market.
• Many times it may yield multiple rates.
Accounting is the recording of financial transactions along
with storing, sorting, retrieving, summarizing, and
presenting the results in various reports and analyses.
Accounting is also a field of study and profession dedicated
to carrying out those tasks.
334
The accounting cycle
Accounting starts with recording transactions. Business transactions—any activity or
event that involves your business’s money—need to be put into your company’s
general ledger. Recording business transactions this way is part of bookkeeping.
Bookkeeping is the first step of what accountants call the “accounting cycle”: a process
designed to take in transaction data and spit out accurate and consistent financial reports.
The accounting cycle has six major steps:

1.Analyze and record transactions Collect any invoices, bank or credit statements, and
receipts from business transactions.
2.Post journal entries to the ledger It’s time to take those documents and start making
journal entries for your transactions. Journal entries have three components of a
transaction: when it happened, what it was for, and how much it was. Some businesses
use single-entry accounting where only the expense or revenue is entered. But more
common is double-entry accounting, which records each transaction in two accounts:
where money is coming from and where it’s going.
.
The accounting cycle
3.Prepare an unadjusted trial balance At the end of a reporting period, list all of your
business’s accounts and figure out their balances.
4.Prepare adjusting entries at the end of the period When you need to update entries you’ve
already made, you prepare adjusting entries. For example, if a client is late on paying an
invoice and you offer a 5% discount to help them pay, you would enter the discount as an
adjusting entry as opposed to changing the entry you’ve already made.
5.Prepare an adjusted trial balance After entering in adjusting entries, you’re left with an
adjusted trial balance. This information is now ready to be turned into financial statements.
6.Prepare financial statements Finally, all the information you’ve collected is converted
into your financial statements. These reports are succinct summaries of all your business’s
financial activity.
Objectives of Accounting
To maintain a systematic record of business transactions
Accounting is used to maintain a systematic record of all the financial transactions in a book
of accounts.
For this, all the transactions are recorded in chronological order in Journal and then posted to
principle book i.e. Ledger.
To ascertain profit and loss
Every businessman is keen to know the net results of business operations periodically.
To check whether the business has earned profits or incurred losses, we prepare a “Profit &
Loss Account”.
To determine the financial position
Another important objective is to determine the financial position of the business to check
the value of assets and liabilities.
For this purpose, we prepare a “Balance Sheet”.
To provide information to various users
Providing information to the various interested parties or stakeholders is one of the most
important objectives of accounting.
It helps them in making good financial decisions.
To assist the management
By analyzing financial data and providing interpretations in the form of reports, accounting
assists management in handling business operations effectively.
Characteristics of Accounting:
(1) Identifying financial transactions and events
Accounting records only those transactions and events which are of financial nature.
So, first of all, such transactions and events are identified.
(2) Measuring the transactions
Accounting measures the transactions and events in terms of money which are considered
as a common unit.
(3) Recording of transactions
Accounting involves recording the financial transactions inappropriate book of accounts such
as Journal or Subsidiary Books.
(4) Classifying the transactions
Transactions recorded in the books of original entry – Journal or Subsidiary books are
classified and grouped according to nature and posted in separate accounts known as
‘Ledger Accounts’.
Characteristics of Accounting:
(5) Summarizing the transactions

It involves presenting the classified data in a manner and in the form of statements,
which are understandable by the users.
It includes Trial balance, Trading Account, Profit and Loss Account and Balance Sheet.
(6) Analyzing and interpreting financial data
Results of the business are analyzed and interpreted so that users of financial
statements can make a meaningful and sound judgment.
(7) Communicating the financial data or reports to the users
Communicating the financial data to the users on time is the final step of Accounting
so that they can make appropriate decisions.
Different Branches of Accounting
(a) Financial accounting:

Financial Accounting is that branch of accounting which involves identifying,
measuring, recording, classifying, summarizing the business transactions, i.e. it
involves the steps from Identifying, Recording of transactions to
Summarization, and communicating the financial data.
(b) Cost accounting:
Cost Accounting is that branch of accounting which is concerned with the
process of ascertaining and controlling the cost of products or services.
(c) Management accounting
Management accounting refers to that branch of accounting which is concerned
with presenting the accounting information in such a way that helps the
management in planning and controlling the operations of a business and in
decision making.
Steps of the Accounting Process
Accounting process is the process of collecting, recording, classifying, summarizing and

communicating financial information to the users for judgment and decision-making. The
following steps are involved in accounting process:
(1) Identification: It is the process of identifying and analyzing business transactions.

(2)Recording: For recording, we use ‘Journal’ or Subsidiary Books.
(3) Classification of transactions: Classification means segregation of transactions on the
basis of nature and posting them in a format known as Ledger Account.
(4) Summarization: It includes preparation of Trial Balance and Financial Statements.
(5) Analysis & Interpretation: It includes an assessment of the financial reports and
making some meaningful conclusions.
(6) Communicating information to the users: It includes sharing the financial reports and
interprets results to the users of financial statements.
Bookkeeping, Accounting and Accountancy.
Define the term Bookkeeping, Accounting and Accountancy.

Bookkeeping Book Keeping is a part of Accounting
and it is the process of identifying,
measuring, recording and classifying
the financial transactions.
Accounting Accounting is a wider concept and
actually, it begins where Book
Keeping ends. It includes
summarizing, interpreting and
communicating the financial data to
the users of financial statements.
Accountancy Accountancy refers to systematic
knowledge of the principles and the
techniques which are applied in
Accounting.
Difference Between Bookkeeping and Accounting
Parameters Bookkeeping Accounting
Scope Bookkeeping involves In addition to bookkeeping,
identifying, measuring, Accounting also includes
recording & classifying summarizing, interpreting and
financial transactions in the communicating the financial
ledger accounts. data to the users of financial
statements.
Objective The main aim is to maintain The main aim is to ascertain

systematic records of the profitability and financial
financial transactions. position of the business.
Stage It is a primary stage of It is a second stage and begins

accounting where book-keeping ends.
Nature of job This job is in routine and This job is analytical in

repetitive in nature. nature.
Level of skills Bookkeeping does not require It requires specialized skill to
special skills. It is performed analyze, so it is performed by
by Junior Staff. senior staff.
Advantages of Accounting
1. Provide information about financial performance
Accounting provides factual information about financial performance during a given
period of time
Like, profit earned or loss incurred over a period and financial position at a particular
point of time.
2. Provide assistance to management
Accounting helps management in business planning, decision making and in exercising
control.
For this, it provides financial information in the form of reports.
3. Facilitates comparative study
By keeping systematic records and preparation of reports at regular intervals, accounting
helps in making a comparison.
4. Helps in settlement of tax liability
Systematic accounting records help in settlement of various tax liabilities. Such as –
Income Tax, GST, etc.
5. Helpful in raising loan
Banks and Financial Institutions grant a loan to the firm on the basis of appraisal of the
financial statement of the firm.
6. Helpful in decision making
Accounting provides useful information to the management for taking decisions.
Users of Accounting Information
(A) Internal Users

Owners: Owners contribute capital in the business and thus they are exposed to
maximum risk. So, they are always interested in the safety of their capital.
Management: Accounting information is used by management for taking various
decisions.
Employees: Employees are interested in the financial statements to assess the ability
of the business to pay higher wages and bonuses.
Users of Accounting Information
(B) External Users
Banks and financial institutions: Banks and Financial Institutions provide loans
to business. So, they are interested in financial information to ensure the safety
and recovery of the loan.
Investors: Investors are interested to know the earning capacity of business and
safety of the investment.
Creditors: Creditors provide the goods on credit. So they need accounting

information to ascertain the financial soundness of the firm.
Government: The government needs accounting information to assess the tax

liability of the business entity.
Researchers: Researchers use accounting information in their research work.
Consumers: They require accounting information for establishing good

accounting control, which will reduce the cost of production.
System of accounting
There are following two systems of recording transactions in the books of accounts:
Double Entry System
Single Entry System
Double-entry system
The double entry system is based on the Dual Aspect Principle.
Every transaction has two aspects, ‘a Debit’ and ‘a credit’ of an equal amount.
This system of accounting recognizes and records both aspects of the transaction.
Single entry system

Under this system, both aspects are not recorded for all the transactions.
Either only one aspect is recorded or both the aspects are not recorded for all the
transactions.
Advantages of the Double-entry System
1.Scientific system
As compared to the other systems, this system of recording transactions is more scientific and useful to achieve the
objective of accounting.
2.A complete record of the transaction
• Since both the aspects of transactions are considered there is a complete recording of each and every
transaction.
• Using these records we are able to compute profit or loss easily.
3.Checks arithmetical accuracy of accounts
Under this system, by preparing a Trial Balance we are able to check the arithmetical accuracy of the records.
4.Determination of profit/loss and depiction of financial position
• Under this system by preparing ‘Profit & Loss A/c’ we get to know about the profit earned or loss incurred.
• By preparing the ‘Balance Sheet’ the financial position of the business can be ascertained, i.e. position of assets
and liabilities is depicted.
5.Helpful in decision making
Administration and management are able to take decisions on the basis of factual information under the double-
entry system of accounting.
Accounting Concepts and Conventions
Accounting Concepts refer to the basic assumptions, rules and principles which work as the basis of recording of
business transactions and preparing accounts.
1.Business Entity : This concept assumes that business has distinct and separate entity from its owners. Thus, for the
purpose of accounting, business and its owners are to be treated as two separate entities.
• So for example, if the owner brings in additional capital into the business, we will treat this as a liability on the
balance sheet of the business.
2. Money Measurement : The concept of money measurement states that only those transactions and happenings in an
organization, which can be expressed in terms of money are to be recorded in the book of accounts. Also, the records of
the transactions are to be kept not in the physical units but in the monetary units.
• So for example, if the company underwent a major management overhaul this would have no effect on the
accounting records. This concept is actually one of the major drawbacks of accounting.
3.Going Concern : The concept of going concern assumes that a business firm would continue to carry out its
operations indefinitely (for a fairly long period of time) and would not be liquidated in the near future.
So it justifies the financial statements as a part of a continuous series of statements. The current statements are tentative
and only reflect the financial position of that particular period of time.
Accounting Concepts
4.Accounting Period : Accounting period refers to the span of time at the end of which the financial
statements of an enterprise are prepared to know whether it has earned profits or incurred losses during
that period and what exactly is the position of its assets and liabilities, at the end of that period.
5. Cost Concept : The cost concept requires that all assets are recorded in the book of accounts at their
cost price, which includes cost of acquisition, transportation, installation and making the asset ready for
the use.
6.Dual Aspect : This concept states that every transaction has a dual or two- fold effect on various
accounts and should therefore be recorded at two places. The duality principle is commonly expressed in
terms of fundamental accounting equation, which is : Assets = Liabilities + Capital
So let us see an example of this in action. Say the business buys an asset worth Rs 10,000/-. So now the
Fixed Assets of the company will increase bt 10,000/-. But at the same time, the bank or cash balance will
reduce by 10,000/-. And so the transaction will have a dual effect in accounting. And also the Balance
Sheet will stay balanced.
Accounting Concepts
7.Realisation Concept
According to the realization accounting concept, revenue is only recognized when it is realized. Now revenue is the
cash inflow for a business arising from the sale of goods or services. And we assume this revenue as realized only when
it legally arises to be received. So in simpler terms, the profit earned will be recorded when it is actually earned.
8. Matching Concept
This concept states that the revenue and the expenses of a transaction should be included in the same accounting
period. So to determine the income of a period all the revenues and expenses (whether paid or not) must be included.
The matching accounting concept follows the realization concept. First, the revenue is recognized and then we match
the costs associated with the revenue. So costs are matched with revenue, the reverse would be an incorrect system.
9. Full Disclosure : This concept requires that all material and relevant facts concerning financial performance of an
enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes.
Accounting Conventions
Accounting conventions refer to common practices which are universally followed in recording and
presenting accounting information of the business entity.
10] Consistency Concept

Once the company decides on a certain accounting policy it should not be frequently changed.
Unless there is a statutory requirement or it allows better representation of the accounts
accounting policies should be consistent for long periods of time. This allows users to make inter-
firm and inter-period comparisons. Also, frequent changes in policies may be to manipulate the
accounts and this must be prevented.
11] Conservatism Concept

This accounting concept promotes prudence in accounting. It states that profit should not be
included until it is realized. However, losses even those not realized but with the remote possibility
of occurring should be included in the financial statements. So all losses are recognized – those that
have occurred or are even likely to occur. But only realized profits are recognized.
Accounting Conventions
12] Materiality Concept

Materiality states that all material facts must be a part of the accounting process. But
immaterial facts, i.e. insignificant information should be left out. The materiality of a
transaction will depend on its nature, value and its significance to the external user. If
the information can affect a person’s investing decision then it is definitely a material
fact.
13] Objectivity Concept

Finally, we come to the last accounting concept – objectivity. This concept states the
obvious assumption that the accounting transaction recorded should be objective, i.e.
free from any bias of the person recording it. So each transaction should be verifiable
by supporting documents like vouchers, bills, letters, challans, certificates, invoices etc.
A journal
In the process of accounting and book-keeping, a journal is a record of financial

transactions where transactions of a business are ordered by date.
A journal is defined as the book of original entry while the definition is more
appropriate when the transactions were written in a journal prior to manually posting
them to their respective accounts.
There are a variety of journals like the sales journal, purchases journal, cash receipts
journal, cash disbursements journal, and a general journal.
Functions of Journal
Analytical Function:
At the time of recording a transaction in the journal, each transaction is analysed
into the debit aspect and the credit aspect. This helps in understanding how each
transaction will affect the business.
Recording Function:
This is a business language which helps to keep the record of the transactions based
on the principles. Recording entry is supported by a brief narration, which explains
every transaction in a layman’s language.
Historical Function:
Journal book contains a chronological record of the recording of transactions for
future references. This will further help the business to analyse their past
performance and chalk out their future possibility.
Advantages of the Journal
• Journal records all the financial transactions of a business in one place on the time
and date basis.
• The transactions are recorded, in support with a bill, to check the authenticity of
each of these journal entries with their bills.
• There is a less chance to avoid transactions as in a journal we record each and

every transaction on a date basis.
• The accountant writes each journal entry’s narration below every journal entry, so
that another auditor can audit it without any confusion.
• In a journal, we record these transactions which help in deep analysis of the two
accounts on the basis of a double entry system, and this prevents a minimum
chance of mistake in the journal.
ledger accounts
• Journal posts the transactions in their respective ledger accounts. Without
making this journal, an accountant will be unable to make the ledger
accounts.
• In case of a mistake in the ledger accounts, this can be easily rectified with the
help of a journal or by passing a rectified journal entry in the journal.
• All the opening journal entries, closing journal entries and all other
transactions which cannot be recorded in any other subsidiary books, can be
recorded in the journal proper.
• Even in accounting software, journals are required. Accounting software can

make an auto system of posting the journal entries to the ledger by their
automatic processing system.
• There is a single column of ledger folio, which is very helpful for checking the
reference of each account’s posting with its own original journal entry.
Format of Journal
•Particulars: This column indicates the accounts which are affected, i.e. debited or credited, by the transaction. In the very first line, we
write the account which is debited and then in the extreme right of the same line and column we write Dr. which indicates Debit.In the
next line, after leaving some space, we write the account which is credited starting with the preposition ‘to’. A small narration for the
respective transaction is given in the third line which explains the entry in the brackets, and it starts with the word ‘being’.
•Voucher Number: In this column, we enter the number written on the voucher of the concerned transaction.
•Date: In this column, we mention the date of the transaction along with the month in which the transaction took place. The year is
indicated at the top only once and not repeated with every date.
•L.F. or Ledger Folio: As we know that transactions entered in the journal are then taken to the Ledger, in their respective accounts. In
this column, the page number concerning the entry in the ledger is mentioned.
•Dr. Amount: The amount to be debited for a particular entry is written in the same line, where the debited account is indicated.
•Cr. Amount: The amount to be credited for a particular entry is written in the same line, where the concerned credited account is
written.
All the columns are to be filled at the time of recording the transaction in the journal, except the ledger folio column which is filled when
the transaction is posted to the ledger.
The journal entries may extend to multiple pages, and so both the two columns are totalled at the end of each page, with the word Total
c/f, i.e. carried forward. Further, at the beginning of the next page, the amounts in debit and credit columns in the previous page is written
with the words Total b/f, i.e. brought forward. Finally, on the last page of the entry, the Grand Total is written, and the columns are
totaled.
Meaning and Features of Ledger
• All the accounts recognized on the basis of transactions recorded in different

journals will be opened and maintained in a separate book called Ledger.
• So a ledger is a book of account; in which all types of accounts relating to

assets, liabilities, capital, expenses and revenues are maintained. It is a
complete set of accounts of a business enterprise.
• Ledger is in a book with pages consecutively numbered. It can also be a

bundle of sheets.
• All the items from the journal are recorded in ledger accounts and this process
is known as posting entries from Journal to ledger accounts.
Features of Ledger Account
• Ledger book is an accounts book to which various transactions of an enterprise
are posted under different accounts.
• It follows the double-entry system.
• It is also known as the Principal book of account as it is the book of final entry
of transactions after the journal or all-purpose books.
• In the ledger, all the types of accounts relating to assets, liabilities, capital and
revenue are maintained.
• It is the only record of the business transaction classified into relevant accounts.
• It facilitates the preparation of financial statements in future.
Types of Ledger Accounts

General Ledger-
A general ledger is the master collection of all the accounts that summarize all
transactions occurring within an enterprise. There may be a small set of ledgers
that fall under the general ledger. The general ledger is used to record all the
transaction in the financial statements of the business.
It comprises of a debit and credit entry for every transaction recorded into it, in
order to match the total of debit and credit balance. It has to match in order to
prepare the financial statements from it.
They are of two types-
Nominal Ledger- As the name suggests it contains all nominal accounts i.e.
expense, losses, incomes and gains. Examples – Salaries, Sales, Purchases, Returns
Inward/Outward, Rent, Stationery, Insurance, Depreciation, etc.
Private Ledger- Private ledger consists of accounts which are confidential in nature
such as capital, drawings, salaries, etc. These accounts are only accessible by
selected individuals.
Purchase Ledger
Purchase ledger records all the transactions the company has done with the suppliers.It
shows which purchases are paid and which are outstanding. If the purchasing volume is
relatively low, then there is no need for a purchase ledger. Instead, this information is
recorded directly within the general ledger.
Each account will generally have a credit balance and this shows the amount owed to a
supplier by the business. Sum of all the money owed by a business to its suppliers is known
as Accounts payable.
Sales Ledger-
If the business just has one customer, it will not need to maintain a sales ledger but just one
account in the Nominal ledger will be enough. But, there are many businesses which sell in
credit and have many customers, for them maintaining a sales ledger is very important.
This account records all the transactions in which the goods have been sold to the customer
in credit. Sum of all the money which has been given on credit is called Accounts
receivable.
Importance of Ledger Balance
Core information about business
Ledger provides a comprehensive report of all the transactions which helps the business to
look through the expenses and incomes. If there are any discrepancy is found amongst both,
then necessary actions are taken.
Knowledge of book value of assets

Ledger is a hub of all the assets related records of the business.it keeps a separate account
for each asset and all the transactions relating to it. Book value of any asset can be derived
from the ledger any time.
Useful for management

Information given by the ledger accounts is used further in financial statements to derive the
company’s growth or reasons for any loss. Management can make effective decisions based
on it.
Reason for the disparity in expenses or incomes

The ledger records all the expenses of the business and all the incomes too. So if their is any
difference in their balance, then they have to reevaluate and fix the problem.
Posting
Posting-
• Every journal entry will have to be posted into all separate and respective accounts which
have been debited and credited in the journal entry. For example, for purchase machinery,
machinery a/c is debited and purchases a/c is credited in the journal. When this entry is
posted in the ledger, it must be posted in machinery a/c and as well as in Sales Account.
• Posting will be done on the debit side of the account which has been debited in the
journal book, and the credit side of the account which has been credited in the journal
book. In case of the above example of the machinery purchase, posting will be made on
the debit side of machinery a/c Account, as it has been debited in a journal and the credit
side of Purchases a/c as it had been credited in the journal.
• Date of the transaction has to be put in the date column. The method of recording the
date in the ledger is the same as in a journal.
• While posting on the debit side of an account, in the particulars column we should write
the name of the account which had been credited in the journal and add the word 'To'
before the name.
Posting
• Similarly while posting on the credit side of an account, we should put the name of the
account which has been debited in the-journal and add the word 'By' before the name. In
case of the above example, we shall write 'To purchases A/c' in particulars column on the
debit side of Cash Account; and 'By Machinery A/c' in particulars column on the credit
side of the Sales Account.
• Posting in both sides, debit and credit should have entries then only a ledger account is
complete.
• In the folio column, we have to mention the page number of the journal where the
concerned journal entry is recorded. At the same time, the page number of the ledger
accounts will be entered in the ledger folio.' column in the journal so as to complete the
cross-reference.
• The amount is written in the journal entry must be entered in both the amount columns
of ledger account.
Posting
Purchased goods for cash Rs 6000
Received
Posting cash from Karthik Rs 2000
Sold goods for cash Rs 3500
Deposited into bank Rs 30000
Paid Rent Rs 4000
Sold goods to hari Rs 3000

Trial Balance
Trial balance is an accounting or bookkeeping report that

lists balances from a company’s general ledger accounts.
The debit balances ‘and the credit balances are listed under
their respective fields. The sum of these columns should be
the same.
The preparation of trial balance occurs periodically, mostly

at the end of every accounting period. The primary purpose
of producing this statement is to confirm that there are no
unequal journal entries in the books which can hamper the
process of preparing any financial report.
Rule of Trial Balance
Rule of Trial Balance

The trial balance rules that you have to follow while
preparing one is –
All assets must be on the debit side
All expenses and losses must be on the debit side
All liabilities must be on the credit side
All income and gain must be on the credit side
Trial Balance Items List
Trial Balance Items List

The list of debit and credit items in trial balance is as
follows –
The debit side of it will feature entries from accounts like
assets, drawings accounts, expense accounts, cash
balance, bank balance, losses, purchases, and sundry
debtors, among others.
The credit side of it will feature entries from liabilities,

capital accounts, income accounts, sales, sundry creditors,
gains and reserves.
Methods of Preparing A Trial Balance
Methods of Preparing A Trial Balance

There are two chief methods of preparing trial balance, these are –
Total method: Here, entries from each debit and credit side are
summed up and then placed at the bottom of each side. The total of
each column should be the same.
Balance method: Here, the balances of every ledger accounts are

presented in the trial balance.
Advantages of Trial Balance
The benefits of trial balance are –

Arithmetical Accuracy: Trial balance indicates the arithmetical
accuracy of the accounts of a company. Due to the double-entry
system, every transaction has two equal yet opposite entries at
every step. Hence, at every point, the debit side must match the
credit side. Moreover, trial balance lists accounts as per date.
Comprehensive: Trails balance is technically a summary of all
ledgers. Hence, it offers a more holistic view of a company’s accounts
and transactions within a specific period.
Prerequisite for Preparing Financial Statements: Every company
needs to know its financial status at the end of a fiscal year, and trial
balance is quintessential in that respect. Its streamlines the process
of preparing other financial statements. Shareholder of a company
often asks for it as it offers a comprehensive study of the accounts of
a company.
Trading and Profit and Loss Account
Trading and Profit and Loss Account
A trading account can be called an investment account which contains securities and
cash. Generally, a trading account refers to a trader’s main account. The investors tend
to buy and sell the assets frequently, thus their accounts are subject to special
regulation for this. The assets which are held in a trading account are separated from
others which may be part of a long-term buy and hold strategy.
Profit and Loss Account

The profit and loss abbreviated as the P&L statement is a financial statement that
summarizes the revenues, the costs, and the expenses that are being incurred during a
specified period, usually in a fiscal year. The P&L statement aligns with the income
statement, which records information about a company's ability or its inability to
generate profit by increasing the sales revenue, by reducing costs, or both. The P&L
statement is also referred to as a statement of profit and loss, income
statement, statement of operations, etc.
Format of Trading, profit and Loss Account
Profit and Loss Account Format
Once a trading account is finished, the profit and loss account is readied. This final
account is also known as an income statement in some companies. It is started as soon as
the gross profit or gross loss from the table made earlier is transferred.
All indirect expenses, including salary, office and administrative expenses, rent, wages
and costs on marketing and advertising, are mentioned on the debit side.
All indirect incomes, including dividends received on shares, interests earned, profits
earned on asset sales and recovered debts go to the credit side.
Format of P&L Account
Trading vs Profit and Loss Accountant
Balance Sheet
Balance Sheet depicts the financial position of the firm that is confirmed at
the end of the accounting year.
A balance sheet is a financial statement that reports a company's assets, liabilities,

and shareholder equity.
This shows the balances of the real and the personal accounts of the
business at the date of preparing the final accounts. The debit side being
the liabilities side, shows the Capital, reserves and surplus, also the long-
term and current liabilities. The credit side is known as the assets side which
shows the fixed assets, investments and the current assets of the firm. The
total of both sides must be at last equal.
Importance of Balance sheet
•Shows the financial position of an organization during a specific time frame.
•Growth of a company can be evaluated by comparing the balance sheet of the previous
years.
•Displays what an organization owns and owes.
•Potential shareholders and investors can gain insight into an entity’s liquidity position
before buying shares or investing.
•Enables shareholders and investors to check whether the company will be able to pay
divined.
•Provides additional information regarding the short-term financial position of a firm.

For example, subtracting the current liabilities from the current assets will show the net
working capital, which is the funds required to meet the regular activities (rent, wages,
utility bills, etc.) of a company.
•One of the features of a balance sheet is that it acts as a crucial document when
applying for credit with a bank or other types of financial institutions.
Balance Sheet
Balance Sheet Format
Dupont chart/ DuPont Analysis
DuPont Analysis is a financial ratio analysis that determines the

ability of the company to increase its return on equity ratio. It
breaks down the return on equity into a detailed form to overcome
the shortcoming of ROE. The DuPont Analysis model has three
components for return on equity calculation. They are asset
turnover, profit margin, and financial leverage.
Dupont chart
The formula for DuPont Model
As we for the DuPont model.
Equation 1:
ROE = Net Income / Average Equity Shareholders
Equation 2:
On multiplying and dividing the equation 1 with net sales and average total
assets
ROE = Net Income / Average Equity Shareholders x Net Sales / Net Sales x
Average Total Assets / Average Total Assets
Equation 3:
On multiplying the equation 1 and 2, we get
ROE = Net Income / Net Sales x Net Sales / Average Total Assets x Average
Total Assets / Average Equity Shareholders
•Profit margin is also known as net profit margin. The net profit less
preference dividend must be used for calculation.
•Average total assets are the total of the assets at the beginning and at the end
of the period, divided by 2.
•The shareholder’s equity and total asset value can be found in the balance
sheet. The net sales and net income are available in the income statement.
Ratio analysis
 Meaning of Ratio: It is an arithmetical expression of relationship between two

interdependent or related items.
Ratio analysis is a process to scrutinise and compare financial data of a

company using its financial statements.
It is a study of relationship among various financial factors in a business.
ii. It is a technique of analysing the financial statements with the help of

accounting ratio.
iii. It is a process of determining and interpreting relationships between items of

financial statements to provide a meaningful understanding of the financial
performance and position of an enterprise.
Objectives of Ratio Analysis:
i. It simplifies understanding of financial information presented in the

financial statement.
ii. ii. It helps in determining short-term and long-term solvency of the

business.
iii. iii. It helps in assessing the operating efficiency of the business.
iv. iv. It analyses profitability of the business.
v. v. It helps in comparative analysis which can be either intra-firm or inter

firm comparisons.
Advantages of Ratio Analysis:
i. Tool for analysis of Financial Statements: It helps the users of financial statements
to analyse the financial position of an enterprise. Such users can be bankers,
investors, creditors, etc. who are concerned about the performance of an
enterprise.
ii. Simplifies Accounting Data: It simplifies understanding of accounting information
presented in the financial statement. Calculation of ratios summarises briefly the
results of detailed and complicated information.
iii. Assessment of Operating Efficiency of Business: Operating efficiency can be

determined by assessing and evaluating liquidity, solvency and profitability of an
enterprise. Calculation of ratios helps in determining and evaluating such aspects.
Advantages of Ratio Analysis:
Assists in Forecasting: Calculation, analysis and comparison of ratios helps in
business planning and forecasting. This is because the trend of ratios being
calculated acts as a guide for future planning.
v. Identifies Weak Areas: Calculation and analysis of various ratios help to

identify and interpret the favourable and unfavourable ratios which can are
used to identify the weak areas or unfavourable factors in the enterprise.
Enterprise can then work upon such areas or factors to improve the
performance.
vi. Facilitates Inter-firm and Intra-firm Comparison: When a firm compares its
performance with that of other firms or with its industry standards in general, it
is known as Inter-firm Comparison or Cross Sectional Analysis. On the other
hand, if the performance of different units is belonging to the same firm is to be
compared, it is known as Intra-firm Comparison. Accounting ratios are widely
used for such comparisons.
Limitations of Ratio Analysis
i.Reliability of Ratios: Since, ratios are calculated based on the financial information, if
the information available is not correct ratios calculated using such information will also
be incorrect. Therefore, such ratios are not completely reliable to make any future
decisions for an enterprise.
ii. Only Quantitative Factors considered: Calculation of ratios takes into consideration
only quantitative factors and all the related qualitative factors are ignored, which may
be important for future decision making of an enterprise.
iii. No Standard Ratio: In order to determine whether a ratio is favorable or adverse,

there should be a standard with which the ratio can be compared. However, there is no
single standard against which the ratio can be compared.
iv. Non Comparable: It is possible that different firms belonging to the same industry
may follow different policies and procedures for the purpose of accounting. The
amounts computed using such different policies and procedures will also be different.
Therefore, ratios calculated by such firms will not be comparable as the information
used in calculating such ratios by the different firms is not the same.
Limitations of Ratio Analysis
v. Price Level Changes Ignored: It is necessary to understand that comparability of

the ratios depends upon the change in the price levels. However, such change in
price levels is not considered in accounting variables from which ratios are
computed.
vi. Window Dressing: If the accounts are manipulated in order to window dress
the financial performance and position of the business, the information available
for computing ratios will not be accurate. This will lead to incorrect ratios being
computed which in turn will affect the decisions taken based on analysis of such
incorrect ratios.
vii. Personal Bias: Since, preparation of financial statements is highly influenced

by personal judgments, accounting ratios computed based on such information is
also not free from such limitation.
Types of Ratios:
Types of Ratios: Ratios are classified based on following aspects:
i. Liquidity (short-term solvency): These are the ratios which show the
ability of the enterprise to meet its short-term financial obligations. It
includes: a. Current Ratio b. Quick Ratio
a. Current Ratio
It is a ratio which calculates the relationship between the current assets and
current liabilities.
Formula:
Current Assets
Current Ratio = Current Liabilities
Liquid ratio/Quick ratio/Acid test ratio
Liquid ratio/Quick ratio/Acid test ratio This ratio establishes relationship

between liquid assets and current liabilities and is used to measure the
firm’s ability to pay the claims of creditors immediately. This ratio is a
better indicator of liquidity and 1 : 1 is considered to be ideal.
REMAINING CHECK LECTURE NOTES

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UNIT-I.

• In short, economics includes the study of labour, land, and

Microeconomics studies Macroeconomics studies a nation’s economy, as

Microeconomics primarily deals Macroeconomics is the study of aggregates such

Microeconomics focuses on Macroeconomics focuses on upholding issues

Microeconomics accounts for Macroeconomics account for the aggregated

Microeconomics helps point Macroeconomics help determine the equilibrium

Managerial Economics is also called as “Industrial Economics” or “Business

In the words of PAPPAS AND HIRSHEY

 Operates against the backdrop of macro-economics- macro economics conditions of the

 Normative statements-one problem with normative statements is that they cannot be

 Applied in nature- case study method to conceptualize problem

 Offers scope to evaluate each alternative –cost and revenue

 Interdisciplinary- different subjects

 Assumptions and limitations –validity is not universal (changes)

The scope of business economics is quite wide. Business economics

Microeconomics applied to internal or operational issues

 Demand analysis and forecasting

 Cost and benefit analysis (CBA)

 Pricing decisions, policies, and practices

 Risk and Uncertainty Analysis

 Government’s economic policies like industrial policy, competition policy, monetary

 Working of ­financial sector and capital market

 Social and political environment: Business decisions cannot be taken without

Meaning Of Demand: Demand for a commodity refers to the quantity

When this relationship relates to the demand by an individual

 No expectation of future price changes or shortages

2.Veblen goods:-This exception to the law of demand is associated with the

6.Future changes in prices:

Definition : “ The percentage change in quantity demanded caused

E= Percentage change in quantity demanded of good X

E= percentage change is quantity demanded of good X

Perfectly elastic demand

Perfectly inelastic demand

Relatively elastic demand

Relatively inelastic demand

Unit elasticity of demand

Example:-Demand is inelastic for necessary goods.

Example:-Suppose that the price of a commodity declines from Rs.

E= Percentage changein quantity demanded

1. Positive income elasticity of demand

3. Zero income elasticity of demand

Ec = Proportionate Change in Purchase of CommodityX

Proportionate Change in the Price of CommodityY

Substitute goods For example, suppose a 10% increase in the

Complementary goods For example, suppose the 10%

4.Advertising Elasticity of Demand

It is defined as the responsiveness of the change in demand

Ec = Proportionate Change in Demand

Proportionate Change in Advertising Expenditure

(iv) Importance to businessmen. The concept of elasticity is of great importance to

 It is a process in which probable demand for a product or service is

 It helps the business in the estimation of total sales and revenue

Active demand Short term

Firm-level Product line

2.Passive demand forecasting: Passive demand forecasting is

3.Short term demand forecasting: In short term demand forecasting,

5.External or National group forecasting: The forecasting carried out

6.Internal or Company group forecasting: It refers to the forecasting

 Working of financial sector and capital market