Balbharati solutions for Secretarial Practice 12th Standard HSC Maharashtra State Board
Finance is related to money and money management.
Finance is the management of monetary affairs of the company
Corporation finance deals with the acquisition and use of capital by business corporation.
Company has to pay taxes to government.
Fixed capital refers to any kind of fixed assets.
Working capital refers to the excess of current assets over current liabilities.
Manufacturing industries have to invest huge amount of funds to acquire fixed assets.
When the population is increasing at high rate, certain manufacturers find this as an opportunity to expand business.
The sum of all current assets is gross working capital.
Capital structure means mix up of various sources of funds in desired proportion.
|Group ‘A’||Group ‘B’|
|a) Capital budgeting||1) Sum of current assets|
|b) Fixed capital||2) Deals with acquisition and use of capital|
|c) Working capital||3) Fixed liabilities|
|d) Capital structure||4) Sum of current liabilities|
|e) Corporate finance||5) Fixed assets|
|6) Investment decision|
|7) Financing decision|
|8) Deals with acquisition and use of assets|
|9) Mix up of various sources of funds|
|10) Product mix|
|Group ‘A’||Group ‘B’|
|a) Capital budgeting||1) Investment decision|
|b) Fixed capital||2) Fixed assets|
|c) Working capital||3) Sum of current assets|
|d) Capital structure||4) Mix up of various sources use of assets|
|e) Corporate finance||5) Deals with acquisition and use of capital|
A key determinant of success of any business function. – Finance
The decision of finance manager which ensures that firm is well capitalised. – Financing Decision
The decision of finance manager to deploy the funds in systematic manner – Investment decision
Capital needed to acquire fixed assets which are used for longer period of time. – Fixed Capital
The sum of current assets. – Working Capital
The excess of current assets over current liabilities. – Gross working capital
The process of converting raw material into finished goods. – Product Cycle
The boom and recession cycle in the economy. – Business cycle
The ratio of different sources of funds in the total capital. – Capital structure
The internal source of financing. – Retained earnings
The business will require huge funds, if assets are acquired on lease basis.
Land and Building
Plant and Machinery
Equity Share Capital
Preference Share Capital
Initial planning of capital requirement is made by finance Manager.
When there is boom in economy, sales will Increase
The process of converting raw material into finished goods is called Production cycle.
During recession period sales will Decrease.
|Group ‘A’||Group ‘B’|
|a) Financing decision||1) __________________|
|b) __________________||2) Longer period of time.|
|c) Investment decision||3) __________________|
|d) __________________||4) Circulating capital|
|e) Combination of various sources of funds||5) __________________|
(To have right amount of capital, Deploy funds in systematic manner, Fixed capital, Working capital, Capital structure)
|Group ‘A’||Group ‘B’|
|a) Financing decision||1) To have a right amount of capital|
|b) Fixed capital||2) Longer period of time.|
|c) Investment decision||3) Deploy funds in systematic manner.|
|d) Working Capital||4) Circulating capital|
|e) Combination of various sources of funds||5) Capital structure|
According to Henry Hoagland, “Corporate finance deals primarily with the acquisition and use of capital by a business corporation.”
Fixed capital is that portion of capital which is invested in fixed assets such as land, building, furniture, etc.
Gartenberg defines it as “The excess of current assets over current liabilities.”
The process of converting raw material into finished goods is called production cycle.
According to R. H. Wessel, “The long term sources of funds employed in a business enterprise.”
Finance is needed to pay interest to debenture holders.
When there is boom in economy sales will increase
Debenture is an acknowledgment of loan raised by company.
Preference shares carry dividend at fixed rate.
(a) The business firm has access to the capital market to fulfill its financial needs. The firm has multiple choices of sources of financing.
(b) Different types of securities like shares, debentures, etc. can be issued to raise funds. Funds may also be borrowed from financial institutions and lenders. The finance manager must ensure that the firm is well capitalised.
(a) Investment decisions refer to the decisions regarding utilization of funds raised by the firm. It relates to the selection of assets in which funds are to be invested.
(b) The funds can be invested in two types of assets, namely:
• Long term assets or fixed assets
• Short term assets or current assets
(a) Fixed capital refers to capital invested in fixed assets. Fixed Capital is invested in long term assets such as land, building, equipment, etc.
(b) Investor invests money in fixed capital to make a future profit. Fixed capital is usually required at the time of the establishment of the company.
(a) Working capital is the capital that is used to carry out the day to day business activities. The business firm has to arrange capital for making an investment in short term assets such as cash, account receivable, inventory, etc.
(b) The capital invested in these assets is referred to as Working Capital. Investor invests money in working capital for getting an immediate return.
The management of ‘Maharashtra State Road Transport Corporation’, wants to determine the size of working capital.
Being a public utility service provider, will it need less working capital or more?
Being a public utility service provider, will it need more Fixed Capital?
Give one example of public utility service that you come across on day-to-day basis.
Being a public utility service provider, it will need less working capital.
Yes. Being a public utility service provider, it will need more fixed capital.
BEST Brihanmumbai Electric Supply and Transport undertaking is an example of public utility service.
A company is planning to enhance its production capacity and is evaluating the possibility of purchasing new machinery whose cost is 2 crore or has alternative of machinery available on lease basis.
What type of asset is machinery?
Capital used for purchase of machinery is fixed capital or working capital?
Does the size of a business determine the fixed capital requirement?
Machinery is a fixed asset. This is because it stays with a company for a long period of time.
Capital used for the purchase of machinery is fixed capital. It is the capital that stays in the company almost permanently.
Yes, the size of a business determines the fixed capital requirement. Large size business has high fixed capital requirements and vice versa.
|Fixed Capital:||Working Capital|
|(1) Meaning: Fixed capital refers to any kind of physical capital i.e. fixed assets.||Working capital refers to current assets minus current liabilities.|
|(2) Nature: It stays in business almost permanently i.e. for more than one accounting year.||It stays in business for a short period of time. Thus, working capital is circulating capital.|
|(3) Purpose: Fixed Capital is invested in long term assets such as land, building equipment, etc.||Working capital is invested in short term assets such as cash, account receivable, inventory, etc.|
|(4) Sources: Fixed Capital funding can come from issuing shares, debentures, long term loans, etc.||Working Capital funding can come from short term loans, deposits, trade credit, etc.|
|(5) Objective of investor: Investor invests money in fixed capital to make a future profit.||Investor invests money in working capital for getting an immediate return.|
|(6) Risk Involved: Risk involved in fixed capital is high||The risk involved in working capital is less as compared to fixed capital.|
“A firm’s capital structure is the relation between the debt and equity securities that makes up the firm’s financing of its assets”.
There are four basic components of capital structure. They are as follows :
It is the basic source of financing activities of the business. Equity shares are shares which get dividend and repayment of capital after it is paid to preference shares. They own the company. They bear the ultimate risk associated with ownership. They carry dividends at a fluctuating rate depending upon the profits.
Preference shares carry preferential right as to payment of dividends and have priority over equity shares for return of capital when the company is liquidated. These shares carry dividends at a fixed rate.
It is an internal source of financing. It is nothing but a ploughing back of profit.
It comprises the following:
It is an acknowledgement of loans raised by the company. Company has to pay interest at an agreed rate.
Term loans are provided by the bank and other financial institutions. They carry a fixed rate of interest.
Manufacturing industries and public utilities have to invest a huge amount of funds to acquire fixed assets. While the Trading business may not need huge investments in fixed assets.
Where a business firm is set up to carry on large scale operations, its fixed capital requirements are likely to be high. It is because most of their production processes are based on automatic machines and equipment.
There are business firms which are formed to carry on production or distribution on a large scale. Such businesses would require more amount of fixed capital.
If an entrepreneur decides to acquire assets on a lease or on a rental basis, less amount of funds for fixed assets will be needed for the business.
‘‘corporate finance deals primarily with the acquisition and use of capital by business corporation.’’
The term corporate finance also includes financial planning, study of the capital market, money market and share market. It also covers capital formation and
The business firm has access to the capital market to fulfill its financial needs. The firm has multiple choices of sources of financing. The firm can choose whether it wants to raise equity capital or debt capital. Firms can even opt for a bank loan, public deposits, debentures, etc. to raise funds. The finance manager ensures that the firm is well capitalised i.e. they have the right amount of capital and that the firm has the right combination of debt and equity.
Once the business firm has gained access to capital, the finance manager has to take a decision regarding the use of the funds in a systematic manner so that it will bring a maximum return for its owners. For this, the firm has to take into consideration the cost of capital. Once they know the cost of capital, the firm can deploy or use the funds in such a way that returns are more than the cost of capital.
(a) Finance is the life-blood of the organisation.
The business firm has access to the capital market to fulfill its financial needs.
(b) The firm has multiple choices of sources of financing. Different types of securities like shares, debentures, etc. can be issued to raise funds.
(c) Funds may also be borrowed from financial institutions and lenders. The finance manager must ensure that the firm is well capitalised.
(d) Thus, it is rightly justified that the firm has multiple choice of sources of financing.
There are various factors affecting the requirement of fixed capital. Some of them are as follows:
(a) Nature of Business: The nature of business plays a vital role in determining fixed capital requirements.
For instance, a manufacturing company needs more fixed capital as compared to a trading company. This is because the trading company does not need a plant, machinery, etc.
(b) Size of business: The companies which are operating at large scale require more fixed capital as they need more machinery and other assets.
Whereas, small scale business needless amount of fixed capital. Hence, the size of the firm, either in terms of its assets or sales, affects the need for fixed capital.
(c) Scope of business: The scope of business is the maximum extent up to within which a business can act or perform its business activities.
If the scope of business is vast, it needs higher fixed capital. For instance, a company involved in multiple activities like manufacturing processing, and assembling usually needs a substantial amount of fixed capital. Similarly, if the scope of business is limited, then it requires less fixed capital.
For instance, if a company does only assembling activities, it needs a fewer amount of fixed capital.
(d) The extent of lease or rent: If companies can arrange financial and leasing facilities easily then they require less fixed capital as they can acquire assets on easy instalments instead of paying a huge amount at one time.
On the other hand, if the easy loans and leasing facilities are not available then more fixed capital is needed as companies will have to buy plants and machinery by paying huge amounts together.
(e) Choice of Technique: Those manufacturing enterprises which make use of modern and automatic machines need a large amount of fixed capital.
On the other hand, those enterprises in which production is carried out mainly through labour, need less fixed capital.
Fixed capital refers to capital invested in fixed assets. Fixed Capital is invested in long term assets such as land, building, equipment, etc.
Investor invests money in fixed capital to make a future profit. It is permanent capital.
Fixed capital is usually required at the time of the establishment of the company.
However, existing companies may also need such capital for their:
Expansion and development, Replacement of equipment, etc.
Thus, it is rightly justified that, fixed capital stays in the business almost permanently as it is invested in fixed assets.
Capital structure constitutes two words i.e.
capital and structure. ‘Capital’ refers to the investment of funds in the business while ‘structure’ means the arrangement of different components in proper proportion.
Thus, capital structure means ‘mix-up of various sources of funds in desired proportion’. A company can raise its capital from different sources i.e. owned capital or borrowed capital or both.
The owned capital consists of equity share capital, preference share capital, reserves, and surplus. On the other hand, borrowed capital are debentures, loans, etc. The proportion of different sources are used in the capital structure.
Thus, it is rightly justified that, capital structure is composed of owned funds and borrowed funds.
There are various factors affecting the requirement of working capital. Some of them are as follows:
(a) Nature of business: The requirement of working capital depends on the nature of business. The nature of business is usually of two types:
• Manufacturing Business and
• Trading Business.
– In the case of a manufacturing business, it takes a lot of time in converting raw material into finished goods. Therefore, more working capital is required.
– On the contrary, in the case of trading business, the goods are sold immediately after purchasing, or sometimes the sale is affected even before the purchase itself. Therefore, less working capital is required.
(b) Size of Business: There is a direct link between working capital and the size of the business.
In other words, more working capital is required in the case of a big organisation. Whereas, less working capital is required in the case of a small organisation.
(c) Business cycle: The need for working capital is affected by various stages of the business.
During the boom period, the demand for a product increases, and sales also increase. Thus, more working capital is required.
During the depression period, the demand declines and it affects both the production and sales of goods.
Thus, less working capital is required.
(d) Production cycle: Production cycle means the time involved in converting raw material into a finished product. When the period of the production cycle is more, more working capital will be needed.
On the contrary, when the period of the production cycle is less, less working capital will be needed.
(e) Volume of Cycle: This is the most important factor affecting the size of working capital. The volume of sale and the size of working capital are directly related to each other. For instance, if the volume of sales is more, there is an increase in the amount of working capital. But if the volume of sales is less, there is a decrease in the amount of working capital.
In the functional management of a business enterprise, importance is given to production, finance, marketing, and personnel activities. Among all these activities, the utmost importance is given to financial activities. The importance of corporate finance may be discussed as follows
1. Helps in decision making: Most of the important decisions of business enterprises are determined on the basis of the availability of funds. It is difficult to perform any function of a business enterprise independently without finance. Every decision in the business is needed to be taken keeping in view of its impact on profitability. There may be a number of alternatives but the management is required to select the best one which will enhance profitability. A business organisation can give a green signal to the project only when it is financially viable. Thus corporate finance plays a significant role in the decision making process.
2. Helps in Raising Capital for a project: Whenever a business firm wants to start a new venture, it needs to raise capital. A business firm can raise funds by issuing shares, debentures, bonds, or even by taking loans from the banks.
3. Helps in Research and Development: Research and Development must be undertaken for the growth and expansion of the business. Detailed technical work is essential for the execution of projects. Research and Development is a lengthy process and therefore funds have to be made available throughout the research work. This would require continuous financial support.
4. Helps in smooth running of business firms: A smooth flow of corporate finance is needed so that salaries of employees are paid on time, loans are cleared on time, the raw material is purchased whenever required, sales promotion of existing products is carried out smoothly and new products can be launched effectively.
5. Brings coordination between various activities: Corporate finance plays a significant role in the control and coordination of all activities in an organisation. For e.g. Production will suffer if the finance department does not provide adequate finance for the purchase of raw materials and meeting other day-to-day financial requirements for a smooth running of production unit. Due to this, sales will also suffer and consequently, the income of concern, as well as rate of profit, will be affected. Thus the efficiency of every department depends upon effective financial management.
6. Promotes expansion and diversification: Modern machines and modern techniques are required for expansion and diversification. Corporate finance provides money to purchase modern machines and technologies. Therefore finance becomes mandatory for the expansion and diversification of a company.
7. Managing Risk: Company has to manage several risks, such as sudden fall in sales, loss due to natural calamity, loss due to strikes, etc. The company needs financial aid to manage such risks
8. Replace old assets: Assets such as plant and machinery become old and outdated over the years. They have to be replaced by new assets. Finance is required to purchase new assets.
9. Payment of dividend and interest: Finance is needed to pay a dividend to shareholders, interest to creditors, banks, etc.
10. Payment of taxes/fees: Companies have to pay taxes to the Government such as Income Tax, Goods and Service Tax (GST), and fees to the Registrar of Companies on various occasions. Finance is needed for paying taxes and fees.
Working capital is the capital that is used to carry out the day to day business activities. The business firm has to arrange capital for making an investment in short term assets such as cash, account receivable, inventory, etc.
The capital invested in these assets is referred to as ‘Working Capital. An investor invests money in working capital for getting an immediate return.
According to Gerstenbergh, “Working capital is the excess of current assets over liability”. This approach is called Net Working Capital.
There are no precise standards to measure working capital adequacy. Management has to determine the size of working capital in the light of certain aspects of the business firm and the economic environment within which the firm operates.
1. Nature of business: Firms engaged in manufacturing essential products of daily consumption would need relatively less working capital as there would be constant and sufficient cash inflow in the firm to take care of liabilities. Likewise, public utility concerns have to maintain small working capital because of continuous flow of cash from their customers.
2. Public utility concern: These concerns provide services such as transport, gas, electricity, etc.
On the contrary, if the business is dealing with luxurious products, it requires a huge amount of working capital, as sale of luxurious items are not frequent.
Trading/merchandising firms that are concerned with the distribution of goods have to carry big inventories of goods to meet customer’s demand and have to extend credit facilities to attract customers. Hence they need a large amount of working capital.
Merchandising firms are those which are concerned with buying and selling of goods, either as wholesaler or retailer, without altering the physical form of goods.
3. Size of business: The size of the business also affects the requirement of working capital. A firm with large scale operations will require more working capital.
4. The volume of sales: This is the most important factor affecting the size of working capital. The volume of sales and the size of working capital are directly related to each other. If the volume of sales increases, there is an increase in the amount of working capital and vice versa.
5. Production cycle: The process of converting raw material into finished goods is called production cycle.
If the period of the production cycle is longer, then the firm needs more amount of working capital. If the manufacturing cycle is short, it requires less working capital.
6. Business cycle: When there is a boom in the economy, sales will increase. This will lead to an increase in investment in stocks. This requires additional working capital. During a recession, sales will decline and hence the need for working capital will also decline.
7. Terms of purchases and sales: If the firm does not get credit facility for purchases but adopts a liberal credit policy for its sales, then it requires more working capital. On the other hand, if credit terms of purchases are favourable and terms of credits sales are less liberal, then the requirement of cash will be less. Thus working capital requirements will be reduced.
8. Credit control: Credit control includes factors such as the volume of credit sales, the terms of credit sales, the collection policy, etc. If a credit control policy is sound, it is possible for the company to improve its cash flow. If credit policy is liberal, it creates a problem of the collection of funds. It can increase the possibility of bad debts. Therefore a firm requires more working capital. The firm making cash sales requires less working capital.
9. Growth and Expansion :
The working capital requirement of a firm will increase with the growth of a firm. A growing company needs funds continuously to support large scale operations.
10. Management ability :
The requirement of working capital is reduced if there is proper co-ordination between the production and distribution of goods. A firm stocking on heavy inventory calls for a higher-level for working capital.
11. External factors :
If financial institutions and banks provide funds to the firm as and when required, the need for working capital is reduced.
|Group A||Group B|
|a. Pen and ink|
b. Perfectly elastic supply
c. Reward of entrepreneur
d. Income method
e. Credit control
|1. Factor cost method (3)|
2. Profit (2)
3. Joint demand (1)
5. Horizontal supply curve
6. Commercial bank
7. Vertical supply curve (4)
8. Central bank (5)
i. Micro economics deals with the economic behaviour of various economic units in the economy, such as particular firms, particular households, prices of individual products, wages in particular industry, etc.
ii. It studies the economic behaviour of individual firms, households, industry, product pricing and factor pricing as well as allocation of resources.
iii. Thus it studies in detail about a tree and not the forest as whole.
Marginal cost is the additional cost incurred in the production of one more unit of a good or service.
It is derived from the variable cost of production, given that fixed costs do not change as output changes, hence no additional fixed cost is incurred in producing another unit of a good or service once production has already started.
(3) Natural monopoly
The monopoly power is acquired by a firm due to natural advantages such as good location, control over scarce resources, etc.
Normally, the monopolists would change higher price of the goods
Entrepreneur is the person who plans, organized, directs and controls the process of production.
Entrepreneur takes various activities including managerial functions and other risks such as uncertainty bearing, innovation and dynamic changes in the economy.
Entrepreneur gets profit for his entrepreneurial activities in the business. Profit is fluctuating, uncertain and sometimes even zero or negative.
General equilibrium deal with the behavior of demand, supply and price in the whole economy.
macro economy deals with the behavior or large aggregates and their functional relation ship.
All the commercial banks are mandatorily required to keep a certain percentage of their deposits, other than cash reserve ratio (CRR), with the Central Bank.
The Central Bank acts as a clearing house for the commercial banks. As a clearing house, it settles inter-bank claims and reduces the need for cash reserves by the commercial banks.
Microeconomics is known as ‘price theory’.
Microeconomics studies how prices of goods and services are determined in commodity market and how prices of factors of production are determined in the factor market.
Hence, microeconomics is also known as price theory
1. Utility is ethically neutral this is because the concept of utility has no ethical consideration.
2. Ethically neutral – The concept of utility has no ethical consideration: It is morally neutral. A commodity which possesses utility may satisfy any want. It does not make any difference between good, bad, moral or immoral etc.
3. e.g. Knife has utility for a housewife to cut vegetables and for a killer to harm somebody.
When consumers buy about the same amount of commodity whether the price drops or falls, then the demand is called inelastic demand.
For example demand for petrol for a cab driver is inelastic.
Thus the demand for a commodity depends on the nature of Commodities, Commodities may be either necessaries or, luxuries.
Normally, elasticity of demand for necessaries is inelastic and for luxurious demand tends to the elastic.
Old age pension is transfer income.
It is because transfer income refers to the income received by a person without contributing anything in the production in the period when a person get it.
Old age pension is received by person after retirement therefore old age pension is transfer income.
Answer: The consumer does not spend the entire increase in his income on consumption.
Rather, a portion (generally fixed) of the increase in income is kept as savings. Thus, as the income increases, savings also increase.
This relationship between the savings and income is depicted in a functional form by the savings function.
The savings function can be expressed as:
S = f(y)
Central bank is an apex bank that controls the entire banking system of a country and controls the supply of money in the economy through its various monetary policies.
The Central bank is a banker, agent and financial adviser to the government.
It manages the account of the government by transacting government funds, it buys and sells the securities of the government and maintains foreign reserves for the government.
|Individual Demand||Market Demand|
|1.Meaning It refers to the quantity of a commodity purchased by an individual at different prices, at a given time and place.|
2.Presentation Individual demand can be presented wit the help of ‘Individual demand schedule, and ‘individual demand curve’.
3.Factors affecting Factors affecting individual demand are: – price, disposable income of the individual, taste, habits, credit facilities, etc.
4.Scope It is narrow in scope as it is part of market demand.
It refers to the total quantity of a commodity purchased at different prices by all consumers together in the market at a given time and place.
Market demand can be presented with the help of ‘Market demand schedule, and ‘market demand curve’
Factors affecting market demand are: – Size and growth of population , composition of the population –age structure and sex ratio, etc
It is broader in scope as it includes all individual demand
|Extension of supply||Contraction of Supply|
|MeaningA rise in supply caused by rise in the price while other factors remaining constant is called expansion (extension) of supply.||A fall in supply caused by fall in price while other factors remaining constant is called contraction of supply.|
|Equilibrium Point: In expansion in supply, the equilibrium point moves upwards from the left to the right on the same supply curve.|
In contraction in supply, the equilibrium point moves downwards from the right to the left on the same supply curve.
Micro economics uses slicing method for in-depth study of economic units.
It divides or slices the economy into smaller units, (such as individual households, individual firms, etc) for the purpose of in-depth study.
Macroeconomics uses lumping method for the purpose of economic study.
Under lumping method we study the general price level, and not prices of individual products.
|Personal Income||Disposable Income|
|Personal income is the sum of all incomes actually received by an individual or household from all the sources during a given year.||There are other personal taxes which are not considered when calculating personal income. In order to derive disposable personal income we must subtract these personal taxes from personal income.|
|PI = Disposable Income + Personal Income Taxes.||DI = Personal Income – Personal Income Taxes.|
|DIRECT TAX||INDIRECT TAX|
|1. Meaning |
It is directly paid by tax payers. Or it is deducted form the income of the tax payers.
The direct taxes include personal income tax, corporate tax, capital gain tax, wealth tax, etc.
3. Principles of equity
Direct taxes follow the principle of equity (social justice). Higher income people are taxed at a higher rate, and middle income people are taxed at lower rate. The lower income people are normally exempted form direct tax.
4. Share of Taxes
In India, the share of direct taxes is on the rise. In 2008-09, the share of direct taxes was estimated at 55% of the total tax revenue of Central Government.
|It is indirectly paid by tax payers. It is include in the price of goods and services.|
The indirect taxes include customs duty, excise duty, VAT, service Tax, etc.
Indirect taxes lack the principle of equity. For instance, in the case of mass consumption goods, all consumers (whether rich or poor) have to pay the same rate of indirect taxes like excise duty.
In India, the share of indirect taxes is on the decline. In 2008-09, the share of indirect taxes was estimated at 45% of the total tax revenue of Central Government.
|Basis of difference||Full bodied money||Token coins|
|1. Definition||Full bodied money refers to money whose intrinsic value (value of the metal) is equal to the face value of the engraving on the currency.||Token coins are those whose face value is more than its intrinsic value.|
Made up of
|It is made up of precious metals.||It is made up of cheaper metals.|
|3. Examples||Gold coins, silver coins etc.||Aluminium coins, nickel coins etc.|
Business Decision Making: Micro economic theory help businessman to determine their price policy, maximum level of output and achievement of maximum productivity from factors combination.
Business and Production planning: Micro economic policy helps in preparing and planning of business policy, expansion of business and making investment decisions to achieve maximum output and peoductivity.
To understand the working of the economy:It helps us in understanding the working of a free enterprise economy. It gives us an idea about how major economic decisions are taken in a market economy.
Helpful in the efficient employment of resources:It suggests economizing, that is how efficiently the scarce available resources can be utilized in production process in an economy.
Helps in International Trade:Micro economics is used to explain gains from internal trade, external trade, foreign exchange, balance of payment, disequilibrium and in the determination of exchange rate.
Basis of welfare economics: The entire structure of micro economics has been built on the basis of price theory which is an important constituent of micro economics. It suggests the conditions of efficiency and explains how it can be achieved. It helps in improving the standard of living of population.
Helpful in understanding the consequences of taxation: Imposition of tax leads to reallocation of resources from one place to another. Micro economics explains how imposition of different types of direct and indirect taxes lead to attainment of social welfare.
Tool for evaluating economic policies:It helps the states and central government to frame economic policies like price policy, taxation policy etc. It also explains the condition of efficiency in production and consumption.
Construction and use of models:Micro economics construct and uses simple models in order to understand the actual economic phenomenon. It uses abstract models to explain the economic phenomenon.
The Geometric method measures the elasticity of demand at different points on the demand curve and is also known as the Point method of measuring the elasticity of demand.
Let us consider the figure given below, where AB is a demand curve. C is the specific point on the demand curve. It divides the demand curve into two segments, upper segment CA and lower segment CB.
Elasticity of demand at point C is the ratio between lower segment and upper segment.
ed= CB (lower segment from C) / CA (Upper segment from C)
The elasticity of demand at different points on a straight line demand curve can be derived by this method.
Pure competition is a part and parcel of perfect competition. According to Chamberlin, “a market becomes pure when monopoly is kept away.”Pure competition has certain conditions of perfect competition.
They are 1) Large number of sellers 2) Large number of buyers 3) Free entry and exist 4) Homogeneous product 5) Single Price
1) Large number of sellers/sellers are price takersThere are many potential sellers selling their commodity in the market. Their number is so large that a single seller cannot influence the market price because each seller sells a small fraction of total market supply. The price of the product is determined on the basis of market demand and market supply of the commodity which is accepted by the firms, thus seller is a price taker and not a price maker.
2) Large number of buyers:There are many buyers in the market. A single buyer cannot influence the price of the commodity because individual demand is a small fraction of total market demand.
3) Free entry and exit: New firms can enter and exit the market without any restrictions.
4) Homogeneous product:Firms produce and sell identical units of a given product, in purelycompetitive market, i.e., units of a commodity produced by each of them is uniform, in respect of size, shape, colour, quality, etc. Thus commodities have perfect substitute for each other.
5) Single price: In Pure Competition all units of a commodity have uniform or a single price. It is determined by the forces of demand arid supply.
Meaning: -Entrepreneurs is regarded as the ‘captain of an industry’ it is the Entrepreneurs who co-ordinates or combines, organise different factors of production. He not only organises, but also control directs supervises and administers the productive activities. Thus, the work of Entrepreneurs is rather tough complex and complicated. So, it requires special ability and experience.
1. Efficiency: –He should be highly intelligent, able and efficient so as to tackle day to day problems arising in business.
2. Organisation: – He should be a good organiser. He should have the ability to combine al factors of production optimally i.e. in such a way that the cost of production is minimum. Thus he should be a well co-ordinator.
3. Supervision: –He should be an efficient supervisor. He should be well equipped with supervising the working of factors inputs. He should be a good initiator of business. He should put right person in a right job.
4. Policy Maker: – He should be a good policy maker. He should be able to make entire business policies such as policy regarding input, size of the firm, sales, advertisement payments of remuneration to the factors etc.
5. Decision Maker: –He should be a quick decision maker. He should have the capacity to take quick decisions regarding location of industry, investment, product to be produced, price of it, cost of production, nature of production sales, etc. because delay in taking decision may result in financial losses to the firm.
6. Self Confident: -He should be confident and should be able to develop confidence in others regarding his integrity and honesty of purpose. It will help in building up and marinating good will and reputation to his firm in the market.
7. Innovator: -He should be a good innovator. He should introduce new techniques of production which minimise cost of production and should explore new raw material and market for his product.
Statement of the Law: -The law of diminishing Marginal utility states that (other thing being equal) s the number of units consumed of commodity increases, the marginal utility of that commodity diminishes. In other words, as the consumption of good increases, the marginal utility derived from successive units of a given commodities goes on diminishing.
Definition: -In he words of Marshal the Law states that, “The additional benefit which a person derives from a given increase of his stock of a thing, diminishes with every increase in the stock that he already has”
|Units of consumption||Total Utility (T.U)||Marginal Utility(M.U)|
The schedule shows that with every increase in the units of Consumption, the total utility is increasing.
It reaches Maximum with the 5th& 6th unit and remains the same, but with 7th unit the total utility decreases from 30-28.
The Marginal Utility can be derived from total utility. It is observed the Marginal Utility is falling continuously. It reaches zero and then become negative.
The Marginal Utility is Zero when total utility is Maximum and Marginal utility is negative when total utility is falling.
X- Axis represents units of consumption and Y-Axis represents Marginal Utility. Various points from the table are plotted on graph. Join those points we can get a curve known as Marginal utility curve. The curve slopes down wards from left to right. It touches X- axis and becomes negative. It is observed from the diagram that at 6th unit of consumption the marginal utility becomes zero, when the total utility becomes maximum. It is the point of Satiety i.e. the want is completely satisfied and its intensity is nil. With the 7th unit of consumption the total utility started falling and the Marginal Utility becomes negative.
Meaning: -The Concept of Monopolistic competition was introduced by E.H Chamberlin in his book “Theory of Monopolistic competition” Monopolistic competition refers to a market structure, in which a large number of firms sell a differentiated product. “The competition is keen among many firms making or producing very similar products.” Thus, Monopolistic competition refers to the competition among large number of sellers producing close but not perfect substitutes to each other. There exists competition among large number of sellers. At the same time, they have some degree of Monopoly power in the market, as they sell differentiated product.
1. Large number of sellers: – There are many sellers or firms in a monopolistic competition. A single seller is not large enough to influence the market. Each one may, to a certain extent, follow an independent price and output policy without disturbing others.
2. Product Differentiation: – Product is differentiated in monopolistic competition. Products differ from each other in many ways. Product differentiation can be take place in the form of brand name and trade mark. Products may be differentiated in terms of colour, size, design, taste, etc.
3. Close substitutes: – Even though the products are differentiated, they are very close substitutes. For example, as far as brands are concerned, there are many close substitutes for products like soaps and garments. However they are not perfect substitutes as in perfect competition.
4. Selling cost: – firms in a monopolistic competition promote sales by incurring selling cost. Selling cost includes all types of costs incurred to promote sales. Selling cost is usually incurred in the form of advertisement, exhibitions, gifts, free samples and so.
5. Freedom of Entry and Exit: – Another important feature of monopolistic competition is the freedom of entry and exists of firms. A firm is free to enter the market to produce which is a substitute for the existing products. There exist freedom of entry and exit of firms in the market.
6. Price Maker: – Under Monopolistic competition the firm is a price maker. The firm has some control over the price cue to product differentiation. Thus, there are price differentials between the firms producing close substitutes.
7. Nature of demand curve: – The demand curve for the products of each firm is downward sloping. This means that an individual firm can sell more by reducing the price.
8. Two dimensional competitions: – Under Monopolistic competition, the competition among the sellers take place in two dimensional.
i. Price competition: – Under Price competition the firms compete with each other by lowering the price of the product to take advantage of higher sales.
ii. Non Price competition: – Under Non price competition the firms compete with each other by making variation in the product or through selling cost. Through this each seller tries to capture the market.
Micro Economics basically deals with
i) Theory of product pricing
ii) Theory, of factor pricing (Microtheory of distribution) .
iii) Theory of economic welfare
1. Product Pricing: -The theory of product pricing explains how the relative prices of cotton cloth, rice, car and thousands of other commodities are determined. Price of a commodity depends upon the forces of demand and supply. Therefore, analysis of demand and supply side is necessary in order to explain the process of determination of price. Study of demand side covers the analysis of consumer’s behavior and study of supply side, covers the analysis of conditions of production, cost and behaviour of firm & industry. So, theory of product pricing is subdivided into theory of demand & theory of production & cost.
2. Factor Pricing:- Theory of factor pricing i.e. Theory of distribution explains how wages (price for the use of labour) rent (payment for the use of land), interest (Price for the use of capital), profits (the reward for the entrepreneur are determined.
3. Theory of welfare:- Theory of welfare basically deals with efficiency in the allocaton of resources. Efficiency in the allocation of resources is attained when it results in maximization of satisfaction of people. Economic efficiency involves three efficiencies :
i) Efficiency m production – Efficiency in production means producing maximum possible amount of goods, from the given amount of resources.
ii) Efficiency in consumption – Efficiency in consumption means distribution of produced goods & services among the people for, consumption, in such away as to maximize total satisfaction of society.
iii) Efficiency in the direction of production i.e. overall economic efficiency – Efficiency in the direction of production means production of those goods which are most desired by the people.
Micro economic theory shows under what conditions these efficiencies are achieved. We may conclude that Micro Economics is mainly concerned with price theory and allocation of resources. It seeks, to examine the following basic economic questions:
a) What goods are produced with and in what quantities?
b) Who will produce them & how ?
c) To whom & how the wealth so produced shall be distributed?
d) How shall resources be allocated to production & consumption in efficient manner?
The subjective factors concerned are:
(1) behavior patterns fixed by the psychology of human nature.
(2) the institutional arrangements of the modern social order, and social practices relating to the behaviour patterns of business firms with respect to wage and dividend payments and retained earnings, and the institution controlling the distribution of income.
Human behaviour regarding consumption and savings out of increased income depends on psychological motives.
First, there are motives which “lead individuals to refrain from spending out of their incomes.”
1. The Motive of Precaution: The desire to build up a reserve against unforeseen contingencies.
2. The Motive of Foresight: The desire to provide for anticipated future needs, e.g., in relation to old age, family education, etc.
3. The Motive of Calculation: The desire to enjoy interest and appreciation, because a larger real consumption, at a later date, is preferred to a smaller immediate consumption.
4. The Motive of Improvement: The desire to enjoy a gradually increasing expenditure since it gratifies the common instinct to look forward to a gradually improving standard of life rather than otherwise.
5. The Motive of Independence: The desire to enjoy a sense of independence and the power to do things.
6. The Motive of Enterprise: The desire to secure a mass de man over to carry on speculation or establish business projects.
7. The Motive of Pride: The desire to possess or to bequeath a fortune.
8. The Motive of Avarice: The desire to satisfy pure miserliness, i.e., unreasonable, but insistent abstinence from expenditure as such.
To this, Keynes adds a corresponding list of motives on consumption such as enjoyment, short-sightedness, generosity, miscalculation, ostentation and extravagance.
1. Demand Loan: -In a demand loan account, the entire amount is paid to the debtor at one time, either in cash or by transfer to his savings bank or current account. No subsequent debit is ordinarily allowed except by way of interest, incidental charges, insurance premiums, expenses incurred for the protection of the security etc. Repayment is provided for by instalment without allowing the demand character of the loan to be affected in any way. There is usually a stipulation that in the event of any instalment, remaining unpaid, the entire amount of the loan will become due. Interest is charged on the debit balance, usually with monthly rests unless there is an arrangement to the contrary. No cheque book is issued. The security may be personal or in the form of shares, Govt. paper, fixed deposit receipt, life insurance policies, goods, etc.
2. Term Loan: – When a loan is granted for a fixed period exceeding three years and is repayable according to the schedule of repayment, it is known as a term loan. The period of term loan may extend up to 10 years and in some cases up to 20 years. A term loan is generally granted for fixed capital requirements, e.g. investment in plant and equipment, land and building etc. These may be required for setting up new projects or expansion or modernization of the plant and equipment. Advances granted for purchasing land / building / flat (Apartment house) are term loans.3.
3. Overdraft: – An overdraft is a fluctuating account wherein the balance sometimes may be in credit and at other times in debit. Overdraft facilities are allowed in current accounts only. Opening of an overdraft account requires that a current account will have to be formally opened, and the usual account opening form completed. Whereas in a current account cheques are honored if the balance is in credit, the overdraft arrangement enables a customer to draw over and above his own balance up to the extent of the limit stipulated. For example, if there is a credit balance of Rs.40,000/- in a customer’s current account and an overdraft limit of Rs. 50,000/- is sanctioned to the party, he can draw cheques up to Rs. 90,000/-. There is no restriction, unlike in the case of loans, on drawing more than once. In fact, as many drawings and repayments are permitted as the customer would desire, provided the total amount overdrawn, i.e. the debit balance at any time does not exceed the agreed limit. This is a satisfactory arrangement from the customer’s point of view. He need not hesitate to pay into the account any moneys for fear that an amount once paid in cannot be drawn out or borrowed again, unlike in a loan account. As in the case of a demand loan account, the security in an overdraft account may be either personal or tangible. The tangible security may be in the form of shares, government paper, life insurance policies, fixed deposit receipts etc. i.e. paper securities. A cheques book is issued in an overdraft account.
4. Cash Credit: –A cash credit is essentially a drawing account against credit granted by the bank and is operated in the same way as a current account in which an overdraft limit has been sanctioned. The principal advantages of a cash credit account to a borrower are that, unlike the party borrowing on a fixed loan basis, he may operate the account within the stipulated limit as and when required and can save interest by reducing the debit balance whenever he is in a position to do so. The borrower can also provide alternative securities from time to time in conformity with the terms of the advance and according to his own requirements. Cash credits are normally granted against the security of goods e.g. raw materials, stock in process, finished goods. It is also granted against the security of book-debts. If there is good turnover both in the account and in the goods, and there are no adverse factors, a cash credit limit is allowed to continue for years together. Of course a periodical review would be necessary.
5. Bills Purchased: –Bills, clean or documentary, are sometimes purchased from approved customers in whose favour regular limits are sanctioned. In the case of documentary bills, the drafts are accompanied by documents of title to goods such as railway receipts or bills of lading (BOL). Before granting a limit, the creditworthiness of the drawer is to be ascertained. Sometimes the financial standing of the drawees of the bills are verified, particularly when the bills are drawn from time to time on the same drawees and/or the amounts are large. Although the term “Bills Purchased” seems to imply that the bank becomes the purchaser / owner of such bills, it will be observed that in almost all cases, the bank holds the bills (even if they are indorsed in its favour) only as security for the advance. In addition to any rights the banker may have against the parties liable on the hills, he can also fully exercise a pledgee’s right over the goods covered by the documents.6. Bills Discounted Usance bills, maturing within 90 days or so after date or sight, are discounted by banks for approved parties. In case a bill, say for Rs. 10,000/- (approx. $223 USD) due 90 days hence, is discounted today at 20% per annum, the borrower is paid Rs. 9,500/- (approx. $211 USD), its present worth. However the full amount is collected from the drawee on maturity. The difference between the present worth and the amount of the bill represents earning of the banker for the period for which the bill is to run. In banking terminology this item of income is called “discount”.
Capital budget of the government can be decomposed into the following two categories:
a. Borrowings – Borrowing of funds by the government creates a liability on it. Therefore, the receipts from the borrowing activities of the government are treated as capital receipts.
b. Recovery of loans – The central government often offers loans to the state governments and union territories for various purposes. The recovery of such loans forms a part of the receipts for the government.
c. Other receipts –. These include disinvestment and small savings. Disinvestment refers to selling a part or whole of the shares of the enterprises that are owned by the government. As disinvestment results in the reduction of government assets, it is treated as capital receipts. Similarly, small savings lead to an increase in the government liabilities as they include the money of the public deposited in post offices, national savings certificates etc.
It refers to that government expenditure, which causes a reduction in the government liabilities as well as creates assets for the government.
a. Expenditure on purchasing shares or bonds.
b. Expenditure on buying buildings or machinery.
c. Loans granted to the state government, union territories or the public companies.
1. Subjective or Psychological concept: – Utility is a psychological concept. It differs from person to person. The utility of a good cannot be same for all individuals. For example (1) Cigarette has much utility to a smoker, rather than that of a Non – smoker. (2) Walking stick has much utility to an old man, rather than that of a young man.
2. Relative concept: – Utility of a commodity changes from time to time and place to place. For example (1) Woollen clothes has more utility in Kashmir, than in Mumbai. (2) Umbrella has more utility in rainy season, than in summer.
3. Different from Usefulness: – Utility indicates the power of goods to satisfy human wants; irrespective whether the goods is useful or harmful. Certain goods have utility but they are not useful. For e.g.: -narcotics or drugs like cocaine may have utility for some people who use them to get rid of tension, and strees. But in general, such products are harmful, as it affects the health and wealth of a person.
4. Different from satisfaction: – Utility is not same as that of satisfaction. Utility is not same as the satisfaction. Utility is the power of commodity which a consumer expects before consuming a commodity. But satisfaction is something which he realise after consuming it.
5. Different from pleasure: – A commodity may have utility but need not give pleasure. For ex: Bitter medicine does not give pleasure. Yet it cures the disease.
6. Cannot be measured cardinally: – Utility, being a subjective concept, cannot be measured numerically. But it can only be measured ordinally, i.e. in the order of preference.
7. Utility is intangible: – Utility is intangible in nature. It has no physical existence. One cannot touch it or see it. It can be felt only by the use if the commodity.
Demand is influenced by the following factors.
1.Price : Price is one of the most important factors that affect demand. When price rises demand falls, and when price falls demand rises.
2.Income: Income is yet one more important factor that affects demand. Demand depends upon income of individuals in the society. Normally, Demand rises with increasing income of the society.
3.Population: An increase in population, leads to an increase in market demand for goods and services.
4.Tastes, Habits and Fashions : Some factors such as taste, habit of consumers affect demand; in the market.
5. Prices of Substitute and Complementary Goods: Demand changes due to changes in the prices of substitute and complementary goods. For example demand for tea changes because of change in the price of coffee. Similarly, demand for motor cars changes , because of change in the price of petrol.
6.Distribution of Income : Unequal distribution of income and wealth would lead to less demand for goods and services. i.e. demand depends on the distribution of National Income and Wealth.
7.Expectation about Future Price : If consumers expect a fall in the price of a commodity in the near future, they will demand less at present price and vice versa: It shows that expectations about the future prices affect demand.
8.Advertisement: The goods which are advertised powerfully on, radio; television and newspapers, etc., push up demand. Advertisement is an important factor today that affects demand.
9.Taxation Policy: Government’s taxation policy affects demand. For example, a change in income tax will change consumer’s disposable income arid therefore demand.
1.Anticipation about future price: –If the sellers anticipate a future rise in price, they may withhold the supply with a view to earn more profits in the future. Even if the price is high, sellers are not ready to release the goods in anticipation of further rise in price, expecting to make huge profits.
2. Labour Supply: -Workers normally prefer leisure after reaching certain amount of wage level. Therefore, after reaching that high level of wages, the labour supply will decline, even if they are offered more wages so, the supply of labour becomes a backward bending curve, indicating that initially the supply of labour is directly related to wage, but after a particular limit of wag level, the supply of labour becomes inversely related to wage.
3.Need for urgent funds: A businessman may face an urgent need for funds, and as such he may sell out more goods even at lower prices. This is an exception to the law of supply
4.Change in Fashion: If some goods become out of fashion, the sellers may sell such goods at a throw away prices to clear off these goods. This is also an exception to the law of supply.
5.Perishable goods: the sellers have to dispose of the perishable goods like meat, fish, fruits, flowers etc., even if the price falls. They can not wait for longer time for the price to rise, in order to increase supply.
6.Period of recession: – During recession period the sellers are forced to sell the goods are low prices. This is because during recession, the purchasing power of the people is very low.
i) Standard of deferred payments – In the modern economy many transactions take place without instant payments. The debtors make a promise to make payments on some future date. Such future payments are possible because of money. Under Barter System taking loan was easy, but its repayment was difficult because loans were in the form of grains or cattle. Money facilitates lending and borrowings, because the borrowings are in the form of money and the repayment are also in the form of money. Due to general acceptability, stability of value compared to other goods, durability etc., money acts as a standard of deferred payments.
ii) Store of value – Money works as a store of value. Along with satisfaction of present wants, provision for satisfaction of future wants is equally important. It requires savings from the current earnings. Money is a convenient means through which savings can be done easily:
According to Lord J.M. Keynes, “money is a link between the present and the future.” Money serves as a store of value because money has purchasing power. It can be used to purchase real assets like land, house etc. and financial assets like shares, debentures, bonds, etc
General Functions/General Utility Services: The commercial banks also provide following general utility services to the general public.
1) Safe Deposit Vault:Safe deposit vault facility is available to the general public to enable them to keep there valuables, such as shares, gold, silver ornaments etc. There is a separate section in the bank, where lockers are provided in various sizes at payment of a fixed rent.
2)Remittance of funds/Transfer of money:An important function performed by commercial bank is remittance of funds, banks remit money from one place to another or even from one country to another. This facility is more useful to traders. Remittance of funds is done by telegraphic transfer, mail transfer, demand draft etc.
3)Letters of credit:The commercial banks issue letters of credit to enable the traders to buy goods on credit. A letter of credit is a document or order by a banker in one place, authorizing some other banker in some other place, to honour the drafts or cheques of the person whose name appears in the document. The amount is chargeable to the issues of the letter of credit.A bank’s letter of credit helps a businessman, because of the better credit standing of a bank compared with his personal credit.
4)Reference/Status Report:The commercial bank also gives confidential reports on third party about its financial standing, mode and frequency of payments etc.
5) Underwriter/UnderwritingThe commercial bank also acts as an underwriter for issue of shares and debentures of any public and private limited company.The banks guarantee the purchase of certain proportion of shares, if not sold in the market.
6) Dealings in foreign exchange:By keeping separate foreign exchange department, bank deals in foreign exchange. Commercial bank offer services for converting one currency into another. Banks make profit in foreign exchange transactions. In India, Reserve Bank of India has a, strict control on this function.
7) ATM facility, credit card, debit card:It is an electronic delivery system. It is a convenient method of withdrawing money from bank without going to the bank through automated/ automatic teller machines. It enables people to do their banking transactions at any hour of the day.
Credit card is a plastic card issued by bank to its customers. It facilitates the card holders to use it for purchase on credit or draw cash.
Central Bank as Bankers’ Bank -The Central Bank functions as a leader and coordinator of commercial banks in the country. In this capacity, the Central Bank performs the following functions in relation to commercial banks in the country:
a) The Central Bank acts as a Custodian of Cash Reserves of commercial banks in the country Every commercial bank keeps certain percentage of its cash with the Central Bank of the country. At present keeping a certain percent of cash reserve as a deposit with the Central Bank, is legally made compulsory.
This enables the Central Bank.
1) To have control over the total amount of credit creation by commercial banks in the country and thus on the total quantity of money in circulation.
2} By varying, the legal minimum cash reserve which every commercial bank must keep with the Central Bank and which is not available to commercial banks as basis of credit creation, the Central Bank can manipulate the quantity of money, that is in circulation in the economy according to the policy it has formulated.
b) The Central Bank acts as a “Clearing House”Since all commercial banks keep deposit accounts with the Central Bank, the Central Bank is in a position to act as clearing house for commercial banks.Take an illustration. There is not one commercial bank in the country but there are several commercial banks. Customers of Bank ‘A’ may draw cheques in favour of persons who have accounts with commercial Bank `B’ and customers with accounts in bank ‘B’ may draw cheques in favour of persons who have accounts in commercial bank ‘N. Let us suppose that in one month as a result of above transactions bank ‘A’ owes ` 50 lakhs to bank ‘B’ and bank ‘B’ owes ` 40 lakhs to bank ‘A’. Now bank ‘A’ draws a cheque in favour of bank ‘B’ for` 10 lakhs only on the central bank of the country, where all commercial banks have their accounts.
Bank ‘A’s account is debited by ` 10 lakhs and bank ‘B’s account is credited by ` 10 lakhs. Thus the clearing house system’ which becomes possible because all commercial banks keep their accounts with the central bank of the country, economizes use of cash and facilitates adjustment of dues between commercial banks by the Central Bank, with convenience to all commercial banks.
c) The Central Bank advices commercial banks Advices them if their activities are harmful to commercial banking and provides accommodation by lending funds in case of difficulties.
d) Lender of the last resort: The commercial banks operate on the basis of low cash reserve system. If there is a great demand for cash by the depositors, even a well managed commercial bank can run into difficulty. This is because, with low cash reserves, it will not be able to meet a sudden and large demand for cash. The Central Bank comes to their rescue at such times. It is the ultimate source of financial assistance to commercial banks. Just as people go to commercial banks when they want loans, commercial banks go to the Central Bank of the country in times of their financial difficulties. Thus, `the lender of the last resort’ function of the CentralBank helps to control panic and infuses confidence among the banks as well as the public. Hence, during the financial difficulties or crisis, commercial banks can always depend upon the Central Bank for the required assistance.
1. No change in income level of the consumer: if the law of demand is to operate, consumers’ income remain constant. If there is rise in income, people may demand more at higher prices.
2. No change in Consumer’s Taste, Preference and habit: -It is assumed that consumers’ habits, preferences, attitudes etc. remain unchanged. In other words, there is no change in consumers’ choice for the product.
3. No change in prices of substitute goods: -A change in the price of substitutes will affect the demand for the commodity. If the price of substitutes fall much more the price of the commodity, people may not demand more of that commodity even at lower prices.
4. No introduction of any substitutes: –it is also assumed that there is no introduction of any new substitutes in the market.
5. No anticipation of price change in future: -It is also assumed that people do not anticipate any further change in the price in the near future. If people expect a further rise in price, they may demand more even the existing high price. Similarly, if people expect a further fall in price, they may not buy more even at the existing low price.
6. No change in Size, sex and age composition of the population: -It is assumed that the size and composition of the population remain unchanged. After all, it is the population of a country that constitute the total market demand for a product. So any change in the size and composition of population of a country affect the total market demand for a product.
7. No change in the taxation policy of the government: – Government policies on direct and indirect taxes have great impact on demand for various goods and services. Therefore, it is assumed that there is nochange in government policy on taxation.
Types of Price Elasticity of Demand
1. Infinite / Perfectly Elastic Demand When a change in price leads to infinite change in quantity demanded, it is known as, infinite elastic demand. When demand is infinite elastic, demand curve is horizontal straight line parallel to X axis. Symbolically Ed = a, Perfectly elastic demand is only a theoretical possibility.Infinite/Perfectly Elastic Demand Curve
2. Perfectly Inelastic -Demand Irrespective of change in price, demand remains the same, if is called as perfectly inelastic demand. For example, as shown in the figure at price OP demand is OD, whereas at price OP1 (Higher) and OP2 (Lower) the demand is OD only. It means demand does not change at all. When demand is perfectly inelastic the demand curve is represented by a vertical straight line parallel to Y axis as shown in diagram. Symbolically, Ed=O.In practice such situation occurs occasionally such as demand for salt.Perfectly Inclastic Demand Curve Fig. No. 3.63.
3. Unitary Elastic Demand: –When a change in price leads to proportionate change in quantity demanded then demand is unitary elastic. For example, if price falls by 50% the demand will rise by 50%. In figure the change in price is PP1 and change in demand is QQ1. Both the change are equal to each other. So the demand curve DD1, shows unitary elastic demand. Symbolically, Ed- 1.Unitary Elastic Demand Curve Fig. No. 3.7When the demand curve slopes steadily towards the X axis or is a rectangular hyperbola demand is unitary elastic.
4. Relatively Elastic Demand: -When proportionate change in demand is greater than the change in price, the demand is said to be relatively elastic, for example, if price falls by 50% the demand rises by 75%. In the figure, change in demand QQ1 is greater than the change in price PP1. Hence, the demand curve DD1 shows elastic demand.Symbolically, Ed >1.Relatively Elastic Demand CurveFig. No. 3.8In this type the slope of demand curve is flatter.
5. Relatively Inelastic Demand When percentage change in demand is less than percentage change in price, the demand is relatively inelastic. For example, if price falls by 50%, the demand will rise by 25%, i.e., less than percentage change in price. In the above figure, the change in price is from OP to OP1 is greater than change is demand from OQ to OQ1.Relatively Inelastic Demand Curve Fig. No. 3.9 Therefore, DD is the demand curve which represents inelastic demand. Symbolically, Ed < 1. The slope of demand curve is steeper.
1) Transfer payments: Individuals get pension, unemployment allowance, but whether these should be included in national income is difficult problem. On one hand, these earnings are a part of individual income and, on the other, they are government expenditure. Therefore, these transfer payments are ignored from national income.
2) Income of foreign firms: According to IMF view-point, income of a foreign firm, should be included in the national income of the country, where the firm actually undertakes production work. However, profits earned by foreign firms are credited to the parent concern.
3) Unpaid services:National income is always measured in money, but there are a number of goods and services which are difficult to be assessed in terms of money.
For example, painting as ahobby. by an individual, the bringing up of children by the mother, these services are not included in national income as remuneration is not given to them. Also services of housewives and the services provided out of love, affection; mercy, sympathy and charity are not included in national income, as they are not paid for. By excluding all such services from it, the national income will work out to be less than what it actually is.
4) Incomes from illegal activities:Income earned through illegal activities such as gambling, black marketing, theft, smuggling etc., is not included in national income. Such goods and services do have value and meet the needs of the consumers. Thus to that extent national income is underestimated.
5) Treatment of government sector: Government provides a number of public services like defense, public administration, law and order etc. Measuring the market value of such government services is difficult; as the real value of these services is not known, therefore it has become a convention to treat all such services as final consumption. Hence, it is included in national income.
6) Production for self consumption: Goods produced for self consumption such as food grains, vegetables and other farm products do not enter in the market. But the value of such goods should be estimated at the rate of market price that have been marketed and should be included in national income.
7) Changing price levels: The difficulty of price changes arise in the national income estimate, when the price level in the country rises, the national income also shows an increase even though the production might have fallen and when price level falls., National Income may show a decrease even though production may have increased.
1) Problem of double counting: The greatest difficulty in calculating the national income is of double counting. It arises from the failure to distinguish properly, between a final and an intermediate product. It so happens, the national income would work out to be many times the actual. For example, flour used by a bakery is an intermediate product and that by a household the final product.
2) Existence of non-monetized sector: There is a large non-monetized sector, in-the developing economy like India. Agriculture, still being in the nature of subsistence farming in the developing countries, a major part of the output is consumed at the farm itself and a part of production is partly exchanged for other goods and services. Such production and consumption cannot be calculated in national income.
3) Lack of occupational specialization: There is the lack of occupational specialization, which makes the calculation of national income by product method difficult. For instance, besides the crop, farmers in a developing country are engaged in supplementary occupations like dairy farming, poultry farming, cloth making etc. But income from such productive activities may not be revealed and thus is not included in the national income estimates.
4) Inadequate and unreliable data: Adequate and correct production and cost data are not available in a developing country, such data relate to crops, fisheries, animal husbandry, forestry, the activities of petty shopkeepers, construction workers, small enterprises etc. That is why, national income of a country will not show at its actual. For estimating national income by income method, data on unearned incomes and on persons employed in the service sector are not available. Data on consumption and investment expenditures of the rural and urban population are also not available for the estimation of national income. Moreover, there is no machinery for the collection of data in such countries.
5) Capital gains or losses: Capital gains or losses, which accrue to the property owners by increases or decreases in the market value of their capital assets or changes in demand, are not included in the gross national product, because these changes do not result from current economic activities.
6) Depreciation: The calculation of depreciation on capital consumption is one more difficulty. Depreciation refers to wear and tear of capital assets, due to their use in the process of production. Depreciation of capital assets will depend on technical life of the asset, the intensity of its use, nature of the asset, regular and careful maintenance etc. There are no uniform, common or accepted standard rates of depreciation applicable to the various capital assets. In case of depreciation, one has to make many reasonable assumptions, which involve an element of subjectivity. So it is difficult to make correct deductions for depreciation.
7) Valuation of inventories:Raw materials, intermediate goods, semifinished and finished products in the stock of the producers are known as inventory. All inventory changes, whether negative or positive, are included in the gross national product. Any mistake in measuring the value of inventory, will distort the value of the final production of the producer. Therefore, valuation of inventories requires careful assessment.
8) Illiteracy and Ignorance: Majority of the small producers in developing countries are illiterate and ignorant; and are not in a position to keep any account of their productive activities. So they cannot give information about the quantity or value of their output. Hence, the estimates of production and earned income are simply guesses.
Meaning: –It is the total output of goods and services produced and supplied in the economy during a given period of time. It is an important element of macroeconomic analysis. Aggregate supply depends on the availability and use of factors of production like natural resources (N), Labour (L), Capital (K), and the state of technology (T).
Definition: – According to J.M Keynes “Aggregate supply refers to the total quantity of goods and services which can be produced with available factors of production, i.e., land, labour, capital, and organization”.
Thus aggregate supply = f (N, L, K, T)
N = Natural resources (which is considered to be constant)L = Stock of Capital (which is considered variable)K = Supply of labour (which is considered to be constant)T = State of Technology (which is considered to be constant)
The main determinants of the aggregate supply are briefly explained as follows:-
1. Natural Resources: -Natural Resources refer to all kinds of resources, which are freely available in the nature and used in the process of production. They include land, climatic conditions, rainfall, water resources, sunshine, and minerals deposits. Etc. total production of goods and services in the economy depends on the availability of natural resources as well as their utilization. Since it is difficult to change the size of the natural resources, they are considered to be constant.
2. Supply of Labour: –It refers to total labour force and human resources (HR) available and used in the production of goods and services in the economy. The supply of labour depends on the size of the population, age composition of the population, education and training of the labour force. The size of and efficiency of the labour are very essential for increasing production. It is assumed that the supply of labour can be changed in the short run.
3. Capital: –Capital is the produced means of production. It is a man-made factor of production. The aggregate supply of goods and services produced in the country depends on the availability and use and quality of capital. Therefore, more the capital more is the supply of goods, and less capital available, less would be the supply. The stock of capital is considered to be constant in short period.
4. State of Technology: -The state of technology implies the application of modern and advanced techniques and methods in the production process. The application of improved technology increase overall productivity. In the short term, the state of technology is assumed be constant.