PREFACE

I feel happy in placing this material on Business Economics and Financial Analysis
concerned to various departments of Engineering, Business Economics deals with economic behavior
of small units which may be an individual consumer or a business firm or an industry whereas financial
analyses reveals the statement containing profit or loss. In addition to this, it shows its assets and
liabilities. The basic concepts of economics are essential to understand the business aspects. The
subject matter is organized in a logical sequence. This material helps to understand the concepts clearly
with easy language, particularly to those students who come from science background. This effort,
wherever necessary, is made keeping numerical examples and diagrammatical explanation.

Keeping in view of these considerations, I tried my level best to shape this material in such a
way that it becomes easy to understand and deliver. Even then, if there are any suggestions from any
quarter, it would be a most welcome gesture.

I would like to thank the management for giving this opportunity.

Dr.G. Bal Rangaiah

Professor in MBA
BIET, Hyderabad.
 Index

Category: Names of units Page.no

Unit-1 : Introduction to Business and Economics 01 to 47

Unit-11 : Theory of Demand and Supply 48-90

Unit-111: Production, |Cost, Market

Structures and Pricing 91-174

Unit -1V: Financial Accounting 175-214

Unit-V: Financial analysis through Ratios 215-232

 Unit-1

Introduction to Business and Economics

1) What is meant by business? Explain the types of business entities?

A business can be described as an organization or an enterprising entity that

engages in professional, commercial, or industrial activities. There can be different types of businesses
depending on various factors. Some are for profit, while some are non-profit. Similarly, their ownership
also makes them different from each other. For instance, there are sole proprietorship, partnerships,
corporations and more. Business is also the efforts and activities of a person who is producing goods or
offering services with the intent to sell them for profit.

Business definition:

Business refers to an enterprising entity or organization that carries out professional

activities. They can be commercial, industrial or others. For profit business entities do business to earn
profits, while non-profit ones do it for a charitable mission business ownership includes partnerships,
sole proprietorship, corporations etc. Business can be small scale or large scale. Some of the biggest
business in the world is Amazon and Wal-Mart.

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 India has been identified as one of the fastest growing major economics in the
world its service industry being the key contributor. India is going through a phase of extraordinary
economic liberation and is encouraging foreign direct investment by granting more accessibility to its
massive and diverse market. For these reasons, many companies are now targeting expansion by
starting their own business in India. Foreign investors can register various types of business entities in
India. Depending on the purpose, goals, initial investment and the duration (short term/ long term) of
business, investors can decide the structure for their business. Read on to learn more about opening
your company in India andthe types of business entities in India.

a) Sole proprietorship:

This is a business run by one individual for their own benefit. It is the simplest
form of business organization. Proprietorship has no existence apart from owners. The liabilities
associated with the business are the personal liabilities of the owner and the business terminates upon
the proprietor’s death. The proprietor undertakes the risk of the business to the extent of their assets,
whether used inthe business or personally owned.

Single proprietors include professional people, service providers and retailers who are in
business of themselves. Although a sole proprietorship is not a separate legal entity from its owners, it
is a separate entity for accounting purpose. Financial activities of the business (e.g. receipt of fees) are
maintained separately from the person’s personal financial activities (e.g. house payment)

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 b) Partnership:

A general partnership is an agreement expressed or implied between two or more persons who
join together to carry a business venture for profit. Each partner contributes money, property, labor or
skill, each share in the profits or loss of the business and each has unlimited personal liability for the
debts of the business.

Limited partnership, limit the personal liability of individual partners for the debts of the
business according to the amount they have invested. Parterres must file a certificate of limited
partnership with state authorities.

c) Limited liability company (LLC) :

An LLC is hubris between a partnership and cooperation. Members of an LLC have operational
flexibility and income benefits similar to a partnership, there are significant legal and statutory
difference. Consultation with a attorney to determine the best entity is recommended

d) Corporation:

A corporation is a legal entity, operating under state low, where scope of activity
and name are restricted by its charter. Articles of incorporation must be filed with the state to establish
a corporation. Stockholders are protected from liability and their stockholders who are also employees
may be able to take advantage of some tax free benefits such as health insurance. There is double
taxation with a C corporation, first through taxes on profits and second on taxes on stockholders
„dividends (as capital gains)

e) Small business corporation (S. Corporation):

Subchapter S-Corporations are special closed corporations (limits exist on the number of
members) created to provide small corporations with a tax advantage, if IRS code requirements are
met. Corporate taxes are waived and reposted by the owners on their individual federal income tax
return avoiding the „double taxation, of regular corporation.
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 f) Public Limited company:

A public limited company in India has of three directors, a minimum of shareholders and can
have a maximum of unlimited shareholders. It can either be listed in a stock exchange or remain
unlisted. Once the company is listed a public limited company in a stock exchange, its shareholders can
freely trade the company share. Since it is separate legal entity, the company‟s existence is not affected
by retirement, death, or insolvency of its shareholders. Incorporating such types of entities can be
difficult and time-consuming.

g) Private limited company:

A private limited company in India is a privately held small business entity and considered as an
independent legal entity on incorporation. It has a minimum of one and a maximum of fifty
shareholders. Unlike public limited companies, private limited companies cannot publicly trade it
shares. It can have a minimum of two and a maximum of fifty directors.

h) Joint-venture company in India:

A joint venture (JV) as the name suggests is a new business entity created through a
partnership between foreign and Indian investors, in which the partners jointly share the profits, losses
management responsibilities and operation expenses. The advantages of joint ventures are that the
foreign company can utilize the well-established contact network, distribution, marketing channels and
available financial resources of the Indian partners. A JV also offers the investors to jointly manage the
risks involved with the business and limit their individual exposure by sharing liabilities.

i) One person company:

A one person company (OPC) : A one person company is newly introduced type of company in
India since 2013. Incorporating on OPE is only permitted to a resident of India. No foreigner can
incorporate an OPC. An OPC can be owned by single owners. It was introduced to encourage

4
individual entrepreneurs to start their own business. This is a type of a private company and likewise
can feature as separate legal entity.

j) Branch office:

Foreign companies engaged in manufacturing and trading activities abroad can set up branch office
in India. Branch offices are not allowed to carry out manufacturing activities on their own but can
subcontract those to Indian manufacturers before commencing operations; the branch office requires an
approval from the Reserve Bank of India (RBI) commencing activities of any nature are not allowed
for a branch office.

k) Non-governmental organization (NGO):

Non-Govt. organization or non-profit company is a citizen-based association that operates

independently of the Gavel usually, to serve some special purpose. These organizations are not
intending towards gaining profits and work for promoting a cause or development projects for the
betterment of society.

2) Examine the conventional sources of capital for a company?

Corporation often need to raise external funding or capital in order to expand their
business into new markets or locations. It also allows them to invest in research and development (R &
D) or to fend off the competition. And while companies do aim to use the profits from ongoing
business operations to fund such projects, it is often more favorable to seek external lenders or
investors to do so.

Despite all the differences among the thousands of companies in the world across various
industry sectors, there are only a few sources of funds available to all firms. Some of the best places to
look for funding are retimed earnings, debt capital and equity capital. In this captor, we examine each
of these sources of capital and what they mean for corporations.

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A) Retained Earnings:

Companies generally exist to earn profits by selling a product or service for more than its costs to
produce. This is the most basic source of funds for any company and hopeful, the primary method that
brings in money to the firm. The net income left over after expanses and obligation is known as retimed
earnings (RE) paid out to shareholders as dividends. Retained earnings increase when the companies
earn more, which allows them to tap into a higher pool of capital, when companies pay more to
shareholders, retained earnings drop.

These funds can be used to invest in projects and grow the business. Retained earnings provide
several advantages for business. They are follows.

a) Using the retained earnings means companies do not owe anyone anything.
b) They are an inexpensive from of financing. The cost of capital of using retimed earnest is what
is called the opportunity cost. This is what company’s make shareholders give up by not getting
dividend. And corporations save on using retained earnings compared to issuing bonds because they
are not obligated to pay interest to bond holders.
c) Corporate management can decide to use all or part of the company’s earnings to pass on to
shareholders. The leadership team can then decide how to use whatever funds to be reinvested back
into the company.
d) The do not dilute ownership.
But here are cons to use retained earnings to projects and fuel corporate growth. For instance,
a) Shareholders can lose value even with retained earnings that are reinvested back into the
company. That is because there is change; they would not result in higher profits.
b) There is also the argument that using retained earnings is not cost effective because they do not
actually belong to company. Instead, they belong to shareholders.

Pros cons
a) Do not owe anything. a) Loss of value of shareholders.
b) Inexpensive from financing. b) earnings actually belong
c) Feasibility to use retained shareholders.
Earnings s management desires.

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 d) Do not dilute ownership.

B) Debt Capital:

Companies can borrow money just like individuals – and they do. Using barrowed capital to fund
projects and fuel growth is not uncommon. They are several instances when debt capital comes in
handy, for short-term needs. And business that is deemed high growth needs a lot of capital and they
need it fast. Borrowing money can be dome privately through traditional loans through a bank or other
lender or public through a debt issue.

Debt capital comes in the form of traditional loans and debt issues are known as corporate bonds. They
allow a wide number of investors to become lenders or creditors to the company. Just like consumers,
companies can reach out to bank, other financial institutions and other lenders to access the capital they
need. This gives them a leg up because.
a) Borrowing money allows a tax deduction on any interest payments made to banks and other
lenders.
b) Interest costs tend to be less expensive than other sources of capital.
c) It can help boost corporate credit scores which is especially beneficial for new companies.
d) Because the funds are borrowed, there is no need to share profits with investors.

But there are down falls to using debt capital. For instance,

a) The main consideration for borrowing money is that the principal and interest must be paid to
the lenders or bond holders. This may be problematic when profits are scarce.
b) A failure to pay interest or replay the principle can result in default or bankruptcy.

Pros Cons

a) Interest on financing a) companies are obligated to repay.

Tax deductible. Lenders.
b) Interest costs less than b) Failure to repay can result in
Other sources of capital. Default or bankruptcy.

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c) Profit –sharing is not necessary.

C) Equity capital:

A company can raise capital by selling off ownership in the form of shares to investors who
become stockholders. This is known as equity funding. Private corporations can raise capital by
offering equity stokes to family and friends or by going public through initial public offering (TPO).
Public companies can make secondary offerings if they need to raise more capital. The benefits of this
method are:
a) There is nothing to repay. This is because this type of financing relies on investors not creditors.
b) It allows companies with poor credit histories to raise money.

Disadvantages of equity capital include:

a) Dilution:
Equity shareholders also having voting rights which means that a company forfeits or dilute some of its
control as it sells off more shares. This includes small business and startups that bring venture
capitalists to help fund their companies.
b) Costs.

Equity capital tends to be among the most expensive forms of capital as

investors may expect a share capital.

c) There are not tax benefits like the ones offered by debt financing.
d) Internal headaches: - Bringing in outside financing can lead to increased tensions as investors
may not agree with management views of where the company is leading.
Pros cons
a) No payment a) dilution in ownership
b) Do not need a good credit b) Investors expect share of profits.
History. c) No tax benefits
d) possibility of tension
Between investors and
Management.

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 3) Explain the non-conventional sources of finance for a company?

Entrepreneurs can turn to a variety of sources of finance, the

establishment or expansion of the business. Common source of business capital includes personal
savings, loans from friends and relatives, loans from financing institutions such as bank or credit
unions, loans from commencing finance companies, advances form venture of capital firm or
investment clubs, loans from small business administration and other Govt. agencies and personal or
corporate credit cards. But for some businesspeople, these sources of financial are wither unavailable or
available with restrictions or provisions that are either impossible for the company to meet or deemed
excessive by the business owner. In such instance, the capital hungry entrepreneur has the option of
pursuing a number of non-rational financing sources to secure the money that his or her company
needs. Some of the more common nontraditional financing source include selling assets, borrowing
against the cash value of life insurance policy and taking out a second mortgage on a hoe or other
property.

a) Selling assets:

Some entrepreneurs choose to sell some of their personal or business affects in order to finance the
opening or continued existence of their enterprises. Generally business owners who have already
established the variability of their firms and are looking to expand their operations do not have to take
this sometimes dramatic coerce of actions since their records will oftenallow them to secure capital
from other sources, either private or public. Whether selling personal or business assets, the small
business owner should take a rational approach. Dome entrepreneurs desperate to secure money, end up
selling business assess that are important to basic business operations. In such instances, the
entrepreneurs may end up accelerating rather than halting the demise of his or her business. Only non-
essential equipment’s and inventory should be sold. Similarly, care should be taken in the selling of
personal assets. Items like boats antiques etc. can fetch a decent price. But before embarking on this
course of action, the entrepreneur should objectively study whether the resulting income will be
sufficient or whether the entrepreneur financial straits are an indication of fundamental flows.

9
b) Borrowing against the cash value of your life insurance:

Entrepreneurs who have a whole life policy have the option of borrowing against the policy (this is not
an option for holders of term insurance). This can be an effective means of securing capital provided
that the owner has held the policy for several years, thus giving it some cash value. Insurer may let
policy holders borrow as much as 90 percent of the value of the policy. As long as the policyholder
continues to meet his or her premium payment obligations the policy. As long as the policyholder
continues to meet his / her premium payment obligations, the policy will remain intact. Interest rates on
such loans are generally not outrageous, but if the policyholder dies during the period in which he or
she has a loan on the policy benefits are usually dramatically reduced.

c) Second Mortgage:

Some entrepreneurs secure financing by taking out second mortgage on their home. This risk
alternative does provide the homeowner with a couple of advantage, interest on the mortgagee is tax
deductible and is usually lower than what he or she would pay with a credit card or an unsecured loan.
But if the business ultimately fails, their method of financing could result in the loss of your home.
Using a second mortgage as a vehicle for financing a company is very risk and is best for people who
want to borrow all the money t need at one time and secure fixed equal payments.

d) Other possible sources of financing:

Some entrepreneurs obtain financing for growth and expression through franchising or licensing.
Basically, they get money by selling the rights to a unique business or product to other companies.
Other small business owners are able to form alliance or partnership with other firms that have a vested
interest in their success, such as customers, suppliers or distributors. These business owners may obtain
funds from their partners through co-operative work agreements, barter arrangements or trade credit.
The internet provides another potential source of leads for loans from non-traditional sources.

Experts recommended using non-traditional financing to start a business or provide funds

during the periods of rapid growth but emphasize the small business owners should consider it

10
temporary arrangements. The use of non-traditional financing is a last resort move and a business
owner should make every effort possible the limit the time frame during which such finance

4) Examine the significance of Economics?

Scarcity definition:
Prof. Robbins, economist, removed the logical inconsistencies and inadequacies of
earlier definitions but also formulated his own definition as “study of human behavior as relationship
between ends and scarce means which have alternative uses”. From this definition, it is understood that
problems are arising due to difference in between ends and scare means such as land, labor, capital,
organization etc.

As per Malthus, economist, population is increasing at geometrical ratio, while production is

increasing at arithmetical ratio. In other words, demand exceeding supply which in turn leads to origin
of economic problems. By using economic models, balance is to be maintained in between ends and
means. The same situation may apply to a country like India. If it is so, Robinson definition goes in
wrong way.

Criticism
Robbins, economist, says that the difference in between ends and scarce means that prevails not only in
the present period, but also, even in the case of future. However, Samuelsson, economist, did not accept
the definition given by Robbins. He says that future is uncertain, and this situation may become vice-
versa. For instance, developed countries, once they were poor countries, but today they are called as
developed countries.

Growth definition:

The main objective of economics is to improve the standard of living of the people by
removing poverty unemployment and income inequalities. Taking all these factors into consideration,
Prof. Samuelsson defined economics as “study of how people and society ends up choosing with or
without the use of money, to employ scarce productive resources that could have alternative uses to
produce various commodities over time and distribute them for consumption purpose in the present or
future among the individual or group of society”. From this definition, it is understood that Samuelson
11
not only takes present situation but also future situation which is uncertain. Growth of an economy
depends upon the utilization of resources. Moreover, balance is to be maintained in between present
and future.

Criticism:

Samuelson’s definition can be applied to developed countries such as America England, Japan,
Australia etc. but not underdeveloped countries like India, Srilanka, Banagladesh,etc. As per the theory
of effective demand explained by J.M. Keynes, Indian Govt. spend lot of money to remove the poverty,
unemployment, regional inequalities but it led to origin of inflation, more unemployment, regional
inequalities etc. Overall, it can be said that Prof. Samuelson definition is superior to the Robbinson
definition because, it considers of future time.

The various authors from traditional to modern gave different definitions. However, in ordinary
language it can be defined as “ Economics is a science deals with production, distribution and
consumption of goods services.” From this definition, it is understood that economics studies not only
three factors but also other factors which as follows. These factors are revealed by classical authors.
a) Production
In common usage, production means manufacturing a commodity is known as production. It is not the
case in economic terms. In economic terms, production means creating want satisfying power to
commodity or creasing new utility to the existing commodity is known as production. It is a process in
which raw materials converted into final goods which satisfy the human wants. In other words, it
indicates the relation between output and inputs. Economics deals with a) what to produce? B) How
much to produce) to whom it is to be produced?

b) Distribution
In ordinary language, distribution refers to transportation of goods and services from one
place to another place. However, it is not the case in economic terms. In economic terms, distribution
means “remuneration of factors of production such as rent, wages, interest, and profit.

c) Consumption
In normal language, full-filling desires are known as consumption. However, it is not case in
economic terms. In economic terms, extracting utility from goods services is known as consumption. A
consumer always tries to get maximum satisfaction or utility by spending limited income on various
12
commodities. Minimum cost and maximum utility is the motto of an consumer. The production of a
firm depends on the consumption pattern of the buyers.

Modern authors are revealing that Economics deals with not only three factors but also other
factors which are as follows.

a) Public finance
It is a science deals with the analysis of income and expenditure of public authorities. Govt. gets
income from various sources such as taxes and non-taxes while expenditure is meant for removal of
poverty, unemployment and regional imbalances.

b) International trade
International trade becomes a part of economics. The trade that occurs in between two or more than
two countries is known as international trade. If exports are greater than the imports, it is indication for
favorable situation. The subject of international trade studies the concepts like foreign exchange,
balance of payments and so on.

c) Income and Employment

Economics deals with aggregate variables like national income, employment, total investment and so
on. The national income can be derived by adding of income of individuals and institutions. The per
capita income can be derived by dividing the national income of a country with its population. The
level of employment also depends on the expansion of economic activities. Increasing of income and
employment is indication for growth and development of the economy.

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 5) Differentiate microeconomics from macroeconomics?

Ranger Frisch, noble laureate, made a distinction between micro and macroeconomics in
1933. However, importance came to macroeconomics, after depression prevailed in the county of
America in 1930.

Microeconomics

Study of economic behavior of small units of economy such as individual consumer or

individual firm or industry is known as microeconomics. It studies how an individual buyer spends his
limited income on various goods and services to maximize his satisfaction or utility. The
microeconomics in another way is called as price theory which brings balance in between supply and
demand of commodities. The motto of seller is different from motto of buyers. Both are going in
opposite direction. However, a price both are coming to an agreement that point is called as equilibrium
of market. The theory of microeconomics can be divided into different categories.

Micro economic theory

Product pricing factor pricing Theory of

Or economics
Theory of welfare
Distribution
Theory of Theory of
Demand production
Rent Wages interest Profit
Cost and
Revenue
Microeconomics deals with 1) what goods should be produced 2) where they are to be produced 3)
How they are to be distributed 4) How the consumption pattern is to be expanded and so on.

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 Microeconomics helps to understand the working of free market economy. Capitalistic
economy is indication for laissez-faire economy. Microeconomics studies about free economy.
Wherever sellers and buyers come to an agreement at a particular price that price is called as
equilibrium price. Moreover, it deals with allocation of resources. The economic policies of state Govt.
such as income taxes, sales tax and exchange duty help to bring maximum welfare of the people.

Macro economics

Study of economic behavior of combination of small units of economy such as national income, total
employment, total investment, general price etc. is known as macroeconomics. It does not study about
individuals but studies about aggregates. For instance, study of growth of national income comes under
the category of macroeconomic variable. The importance of macroeconomics came in 1930, due to
prevailing situation of depression in America. J.M Keynes wrote a book on “the general theory of
employment, interest, money in 1936 in which he mentioned how to recover the economy from
depression through the following effective demand.

Macroeconomics theory

Theory Theory Theory Theary Theary

Of of theory of of of
Income General Fluctuations economic distribution
And Price or growth (factor prices)
Employ. Level business
And cycle
Inflation
Theory Theory
Of of
Consumption. Investment

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Importance:

It helps to understand the working of the economy in the form of aggregates. It helps to make
economic policies which in turn help to solve the economic problems such as population explosion,
inflation, balance of payments and so on.

Conclusion

Micro and macroeconomics are like a coin of tail and head. The behavior of aggregates is
derived from taking behavior of individual units. For example, law of demand and law of supply.
Similarly, the national income is derived by adding of incomes of individuals. It implies that neither
micro nor macro is independent one, but both are interdependent.

6) Explain the various concepts of national income?

Ans: The gross national product is the measure of the flow of goods and services at market

value resulting the current production during a year in a country, including net income from abroad.
GNP includes four types of final goods and services 1) consumer's goods and services to satisfy the
immediate wants of the people. 2) Gross private domestic investment in capital goods consisting of
fixed capital formation, residential construction, and inventories of finished and unfinished goods. 3)
goods and services produced by a government and 4) net exports of goods and services i.e. the
difference between value of exports and imports of goods services, known as net income from abroad.

A) Gross National Production (GNP):

GNP = C + I + G + (X - Z) + (R - P)
C = Private consumer expenditure
I= Gross domestic private investment
G = Govt. expenditure on goods and services
(X-Z) = Net foreign investment
R = Receipts from other countries

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P = Payments to other countries

B) Net National Production (NNP):

GNP includes the value of total output of consumer goods and capital goods. However, the process of
production uses up a certain amount of fixed capital. Some fixed equipment wears out and its other
components are damaged or destroyed and still others are rendered absolute through technological

changes. All this process is turned as depreciation or capital consumption allowance. In order to arrive
at NNP, the depreciation is to be deducted from GNP.

NNP = GNP - Deprecation

C) National Income:

Net national production includes income earned by factors of production such as rent, wages, interest,
and profits. It is also called national income. In other words, it can be calculated at market price. If the
indirect taxes and subsides are deducted from NNP, we can derive national income.

NI = NNP - Indirect Taxes + Subsidies

Indirect taxes refer to excise duty and sales tax whereas subsidies denote the incentives which are given
for expansion of industries in the rural areas. The subsidies are given to new entrepreneurs who are
going to start the small-scale industries in the rural areas.

D) Personal Income:

The total income received by individuals of an economy from all sources, is known as personal income.
The personal income is never equal to national income. The personal income is derived by deducting
the undistributed corporate profits, profit taxes, employees‟ contributions to social security schemes
and transfer payments which includes old age pensions and unemployment doll from national income.

PI = NI - Undistributed corporate profits - (profit taxes + employee’s contributions to social security

schemes) + transfer payments + interest on public debt.

E) Disposable personal income:

Disposable personal income means the actual income received by individuals and families. The whole

17
of personal income cannot be spent on consumption because it is the income that occurs before
deducting personal taxes. Therefore, we must deduct direct taxes from personal income, then we are
able to derive disposal personal income. Contribution of wealth and income taxes is known as personal
taxes.

DPI = PI - Personal taxes

F) Personal Outlay:

The personal outlay refers to the money which is meant ready for expenditure. When the personal
savings are to be deducted from disposal personal income, then we can derive personal outlay.

PO = DPI - Savings

G) Per Capital Income:

The average income of the people of a country in another way it is called as per capita income for that
year. For instance, to find out the per capita income of a particular year at current prices, the national
income of a country is divided by the population of a country in that year, then we are able to derive
per capital income.

PCI = National Income / Population

This concept enables us to know the average income of a country which in turn determines the standard
of living of the people of a country. However, it is not very reliable because in every country due to
unequal distribution of national income a major portion of it goes to the richer sections of the society
and thus income received by the common man is lower than the per capita income of rich man.

7) Explain the measurements of national income?

An: The money value of goods and services produced by a nation usually a year is called as
national income. This value can be expressed in terms of output or income or expenditure. Moreover,
the income and expenditure of an economy will flow as circular manner and finally they are equal at
macro level. They are four methods available to measure the national income.

A) Production Method:

The production method in another way is called as output method. Under this method, the economy is

18
divided into different sectors such as agricultural, industry and service sector. To measure the national
income, we must consider the value of goods and services produced by various sectors of the economy.
The gross national income is obtained by aggregating the value of production which is coming from
various sectors of the economy.

Final Product:

When calculating the money value of goods and services concerned to a particular sector, we must
consider either the value of consumer goods or capital goods but not intermediate good. For instance,
cotton is a indication for capital good, while cloth is indication for consumer good but thread is
concerned to intermediate good. If you take the value of intermediate good the calculation of national
income goes in wrong way. In calculation, the multiplying the quantity of each product by the price to
find the total value. In this way, the money value of all goods and services is obtained, which can be
represented in form of equation.

Y = Px + Qy + Rz

Y = National income

P, Q, R = Represents Quantity of various products, X, Y, Z denotes prices of various products

Limitations:

While calculating the gross national income, we must consider certain precautions to avoid
double accounting, we must take the value of final production. Moreover, the current year production is
to be considered rather than previous year. Otherwise, it leads to over estimation. The agricultural
production kept for consumption by the formers should also be considered at prevailing market prices.
Along with, unpaid services of housewives should be considered while calculating the national income.
The difference in between the exports and imports of goods and services is to be added for the national
income.

B) Income Method:

In this method, we can derive national income by adding the income of individuals and
institutions which are existing in an economy or by adding the remunerations of factors of productions
such as rent, wages, interests, and profits. However, the transfer payments, gifts and cash subsidies

19
received by the people or institutions, are not added to the factor's income. In this way national income
is calculated.

Y = (W + R + I + N) + (X - Z) + (R - P)
y = National Income
W = Wages
R = Rent
I = Interest
N = Profit
X = Exports
Z = Imports

R = Receipts
P = Payments

Limitations:

The transfer payments such as unemployment allowances, personal gifts and pensions are not to
be included in the national income, because they do not represent earning from productive services.
Similarly, scholarships of students, earnings from gambling, lottery prize - winning are not to be
included in the national income. Along with, the voluntary services provided by NGOs and social
institutions are not to be included in the national income. The environment related to health voluntary
organizations, which are contributing to the economy are to be included in the national income,
otherwise it leads to under estimation of national income.

C) Expenditure Method:

The national income can be calculated by taking expenditure of individuals, institutions and
government made on goods and services during a particular year. Individuals spend their income on
consumer or capital goods. Similarly, in the case of business institutions and government organizations.

Besides, in the case of foreign sector, the same method is to be applied. In this way GNP can be
derived asGNP = C + I + G + E

20
C = Consumption Expenditure

I = Investment Expenditure

G = Govt. Expenditure

E = Expenditure on Foreign Sector (X - Z)

Limitations:

The expenditure which spent on purchasing old shares and bonds from other people or business
institutions should not be included in the national income, because it represents financial transfer of
investment but not real investment. Similarly, expenditure on second-hand goods should not be
included because it is not representing the present year. Along with expenditure on intermediate goods
should be eliminated, otherwise it leads to double counting. The transfer payments such as old age
pension and unemployment

8) What are the difficulties and limitations in the estimation of national income?

To calculate the national income of a country, there are various problems which
are arising can beshown here.

Difficulties

a) National income always measured in money, but there are several goods and services which are
difficult to be assessed in terms of money e.g., painting as a hobby by an individual, the
bringing up of children by mother are not included it. By excluding all such services from it, the
national income will work out to be less than what it is.

b) The greatest difficulty in calculating the national income is of double counting, which arises
from the failure to distinguish properly between a final and an intermediate product. There
always exists the fear of a good or a service being included more than once. If it so happens, the
national income will work out to be many times the actual. Flour used by a bakery is an
intermediate product and that by a household the final product. To solve this difficulty, only the
final goods and services are considered, and that is not so easy a task.

21
 c) Income earned through illegal activities such as gambling, or illegal earnings from other means
etc. Is not included in national income. Such goods and services do have value and meet the
needs of the consumers. But by leaving them out, the national income works out to less than the
actual.

d) There are difficulties of including transfer payments in the national income. Individuals get
pension, unemployment allowance and interest on public loans, but whether these should be
included in national income is a difficult problem. To avoid this difficulty, there are to be
deducted from national income.

e) When we deduct capital depreciation from GNP, the resulting measure is NNP. Depreciation is
a charge on profits which lowers nation income. But the problem of estimating the current
depreciated value of a piece of capital whose expected life is fifty years is very difficult.

f) Another difficulty in calculating national income is that of price changes which fail to keep
stable the measuring rod of money for national income. When the price level in the country
rises, the national income also shows an increase even though the production might have fallen.
On the contrary, with a fall in price level, the national income shows a decline even though the
production might have gone up. These difficulties are to be found in calculation of national
income.

g) In calculating the national income, a good number of public services are also taken which
cannot be estimated correctly. How should the police and military services be estimated? In the
days of war, the forces are active, but during peace they rest in cantonments. Similarly, to
estimate the contribution made to national income by profits earned on irrigation and power
projects in terms of money is also a difficult problem.

Problems
In a developing economy, complete and reliable information relating to the various methods of
estimating national income are not available due to the following problems.

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a) Non-monetized sector
There is a large non-monetized sector in a developing economy. This is the subsistence sector in
rural areas in which a large portion of production is partly exchanged for the other goods and is partly
kept for personal consumption. Such production and consumption cannot be calculated in national
income.
b) Lack of occupational specialization
There is lack of occupational specialization in such a country which makes the calculation of
national income by product method difficult. Besides the crop, farmers in developing country are
engaged in supplementary occupations like dairying, poultry, cloth making, etc. But income from such
productive activities is not included in the national income estimates.
c) Non-market transactions
People living in rural areas in a developing country can avoid expenses by building their own huts,
tools, implements, garments and other essential commodities. Similarly, people in urban areas having
kitchen gardens produce vegetables which they consume themselves. All such productive activities do
not enter the market transactions and hence are not included in the national income estimates.

d) Illiteracy
Most people in such a country are illiterate and they do not keep any accounts about the production
and sales of their products. Under the circumstances, the estimates of production and earned incomes
are simply guessing.

e) Non-availability of data

Adequate and correct production and cost data are not available in a developing country. Such data
relate to crops, forestry, fisheries, animal husbandry, and the activities of petty shopkeepers, small
enterprises, construction workers, etc. For estimating national income by the income method, data on
unearned incomes and on persons employed in the service sector are not available. Moreover, data on
consumption and investment expenditure of the rural and urban population are not available for the
calculation of national income.

23
 9) Define trade or business cycle? Examine the different phases of trade cycle?

An: In ordinary language, trade or business cycle can be defined as, "the regular fluctuations
that occur in employment, income, output and price level" is known as trade or business cycle.

However, Keynes defined as "a trade cycle is composed of period of good trade characterized by rising
prices and low unemployment percentages, altering with periods of bad trade characterized by falling
prices and higher unemployment percentage." From this definition it is understood that inflation is
better than deflation, but it must be at lower level. It seems to be that inflation helps for the growth of
the economy rather than

Trade cycle is a part of capitalistic system. It refers to the phenomenon of cyclical booms and
depression. The fluctuations in economic activity create a lot of uncertainty and spread from one
economy to another economy. Trade cycles affect the economic growth, such as create problems of
inflation and unemployment affecting the socioeconomic and political status of a country.

Phases of Business Cycle:

The phases can be divided into four parts. 1) Expansion or prosperity 2) Recession or upper turning
point 3) Contraction or depression and 4) Revival or recovery. The phases are recurrent and uniform in
the case of different cycles. However, no phase has definite time interval. A cycle passes through a
recovery and prosperity phase, rises to a peak, decline through a recession and depression phase and
reaches trough. The characteristics of business cycle can be shown from the following diagram.

24
Recovery:

As result, the level of employment, income and output rise steadily in the economy. In
early stage of revival phase there is a considerable idle capacity prevails in the economy so that output
increases without a proportionate increase in total costs. As time goes on, output becomes less elastic.
Under these conditions‟ prices rise, profit increase and business expectations are improved. Thus, the
cumulative process of increase in investment, employment, output, income, prices will increase and
becomes self-enforcing. Ultimately, revival enters the prosperity phase.

Prosperity:

In this stage, output, employment, and income will increase. This situation leads to rising of
wages, salaries, interest rates and so on. The gap between the increasing the prices and cost of
production, leads to profits. The economy leads to the optimization. Later profits expectations further
increase and investment increases which is helped liberally by bank credit. This situation helps to

increase the demand for consumer goods and further rising the price level. Which in turn leads to
considerable expansion ofeconomic activities. This situation encourages the retailers, whole sales, and
manufacturers. In this way, economy reaches a high level of production which is known as peak or
boom or prosperity.

Recession:

The recession starts when there is downward situation from peak which is of a short duration. The
prices fall during this period. As a result, the profit margin declines. Some firms are closed. Investment,
employment, and income declines. The recession may be mild or severe. However, it leads to sudden
explosive situation arises due to banking system or down fall of the stock exchange index. A recession,
once started, tends to build upon itself like a forest fire tend to destructive situation.

Depression:

Recession leads to a situation of depression, when there is general declines in economic activity. It
leads to reduction of production of goods and services, employment, income, demand, and prices. This
leads to reduction of bank deposits. Thus, despite, the general reduction of output, it leads to
depression. The general fall in prices, profits, wages, interest rate, consumption expenditure,
investment, and bank deposits. Due to this situation, industries come to close which is in another way is

25
called as depression.

10) Examine the various theories of trade cycles?

a) Classical Theory:

The classical economists assumed that the cyclical fluctuations are confined to short period but not
long period where the price mechanism brings equilibrium in between market supply and market
demand. It is the economy of laisse faire where sellers and buyers bring equilibrium through the price
mechanism.

b) Hatrey’s Monetary Factors:

According to Professor R.G. Awtrey, trade cycle is a purely monetary phenomenon. He says that there
are two factors i.e. one is monetary and another one is non-monetary. The influence of nonmonetary
factors such as strikes, floods, earthquakes, droughts, wars, etc. make cause partial responsible for trade
cycles but major one is monetary factors, like credit facilities provided by financial institutions.

c) Schumpeter's Innovations:

Joseph Schumpeter explained that innovations are responsible for fluctuations in an economy.
Innovations such as new product, the new raw materials, opening new markets, new methods of
production etc. are responsible for fluctuations. According to Schumpeter, there are fluctuations
occurring more and more in capitalistic economy rather than other economies. When the new
commodities become old commodities which in turn leads to depression. When new commodities
enter into the market, it leads to origin of prosperity.

d) Keynes’s MEC factor:

Keynes, author, reveals that marginal efficiency of capital (MEC) is responsible for fluctuations in the
economy. Marginal efficiency of capital in another way is called as expected rate of profits of an
entrepreneur. If MEC is greater than rate of interest, profits will increase which in turn leads to origin
of prosperity. When the rate of interest exceeds the MEC, it leads to depression.

e) Hick's Model:

As per Hicks investment is divided in to two categories i.e. autonomous and induced investment.
According to Hicks autonomous investment is meant for welfare of the economy i.e. in the form of
26
infrastructure facilities. It does not lead to economic fluctuations. However, induced investment is
responsible for fluctuations. When induced investment increases which intern leads to prosperity.
When it falls, leads to depression. The induced investment is responsible for occurring fluctuations in
capitalistic economy.

f) Kaldor's Model:

Nichols Kaldor built a model taking saving and investment as a basis. He shows the reason for stability
and instability of the economy. According to Kaldor when saving exceeds the investment which in
turn leads to depression and vice versa. When investment exceeds the saving, it leads to property.
When both are equal, it leads to level of balance.

11) Define inflation? What are the determinant factors of inflation?

Ans: In ordinary language, inflation can be defined as "increasing the price level or decreasing the
value of money is called as inflation. But Hatrey defines as "the issue of too much currency" is called
as inflation. However, the author namely Dalton defined in another way that "too much money chasing

too few goods." Later, Crowther defined in another way that "it is a state in which the value of money
is falling i.e. prices are rising" From these definitions, we will come to conclusion that excess of money
over the output, leads to origin of inflation.

Causes of Inflations:

Inflation occurs when the aggregate demand exceeds the aggregate supply of goods and services. It can
be analyzed from factors which leads to increase in demand for commodities.

Factors affecting Demand:

There are different factors influencing on the side of the demand.

a) Increasing money supply:

Inflation is caused by an increase in the supply of money which in turn leads to increase aggregate
demand. There is direct relationship existing between money supply and higher price level.

b) Increase in disposable Income:

The demand for goods and services will increase when the disposable income increases. When the
27
taxes are reduced by the government it leads to increase of quantity of money in the hands of people.
Due to this purchasing power of people will increase which intern leads to increase in prices of
commodities.

c) Increasing the public Expenditure:

In modern days responsibilities of the government are increasing. Keeping the welfare of the people,
government spending more and more on infrastructure facilities which are primarily needed for the
economy. Whatever spending for these purposes quantity of money supply is going on increasing.

d) Increasing in consumer spending:

When the income of the consumers increases, normally they spend more and more spend on goods and
services. It happens due to demonstration affect. The demonstration effect means imitating others. Due
to this, even though income is constant, consumption will increase.

e) Cheap monetary Policy:

As per monetary policy if the rate of interest falls, more money is taken by public for business purpose
which in turn leads to increasing of money supply into the economy.

f) Deficit Finance:

When the Government expenditure exceeds the revenue is called as deficit finance. It helps to
increase money supply in the economy.

g) Expansion of Private Sector:

The private sector dominates over the public sector, due to this more money enters the economy
because more activities are taken by private sector rather than public sector.

h) Black Money:

The money which is not taxed by govt. is known as black money. Most people are trying to go for
evasion and avoidance. Due to his, more money entering the economy.

i) Repayment of Public Debt:

28
The debts which were taken by the government are repaid by the govt. then more money enters the
economy.

j) Increasing the exports:

When exports increase, more foreign currency will enter the economy, which intern helps to increase
the quantity of money.

Factors affecting Supply:

There are certain factors which operate on the opposite side and tend to reduce the quantity of output of
the economy.

A) Shortage of factors of Production:

The factors of production such as labor, raw material, power supply etc. are scarce in the
economy. This situation reduces the industrial as well as agricultural production. In this way, output
becomes scarce.

a) Natural Calamities:

Natural calamities such as floods and drought affect the production either in the case of agricultural or
industrial. This scarcity of production leads to origin of inflation.

b) Artificial Scarcities:

To get more profits, traders are hording certain commodities for getting more profits. It shows
that there is certain output available in the market, but traders are responsible for artificial scarcity.

c) Increasing in Exports:

Whatever produced in a country in which some commodities are exporting to other countries. Due
to this, domestic production decreases. Export also helps to create scarcity of production.

12) Differentiate demand - pull inflation from cost - push Inflation?

Ans: The value of aggregate demand exceeds the value of aggregate supply over
the full employment level is known as inflationary gap prevails. The larger the gap between aggregate

29
demand and aggregate supply leads to origin of rapid inflation. Thus, Keynes used the notion of the
inflationary gapto show a rise in prices. When quantity of money increases, its first affect is on the rate
of interest which tends to fall. A fall in the interest rate would in turn increase investment which would
rise aggregate demand. This leads to increasing the prices of commodities which can be represented
with the help of diagram.

This supply and demand of commodities are represented on ox-axis, while prices of the commodities
are shown on oy-axis. The supply and demand curves are intersecting at the point of Q1 where the
prices are confined to OP1. When the demand increases from D1 to D3, the prices of the commodities
are also increasing from OP1 to OP3. Demand for commodities is increasing due to growth of
population. Hence, it is called as demand-pull inflation.

30
Cost-push Inflation:

The basic cause of cost push inflation is the rise in money wages more rapidly than the productivity of
labor. In advanced countries, trade unions are very powerful. They bring pressure on employers to
increase the wages considerably in excess of increase in the productivity of labors, thereby rising cost
of production of commodities, employers in turn, rise prices of their products. Due to higher wages,
workers capable to purchase more commodities rather than previous situation. On the other hand, the
increasing prices induce unions to demand still higher wages. In this way, cost-spiral continuous,
thereby leading to cost-push or wage-push inflation, which can be understood from the following
diagram.

The supply and demand of commodities are represented on ox-axis, while price of the commodities is
shown on oy-axis. When the wages increase due to pressure of trade union, the supply of commodities
falls from OM1 to OM2 which in turn leads to increasing the prices of commodities from M1P1 to
M2P2 level. These prices are increasing due to increasing the cost of production which includes higher
wages, raw material cost, profit cost and so on. In this way, it is called as cost-push inflation.

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 13) Examine the Inflationary Gap?

Ans. The concept of inflationary gap was explained by J.M. Keynes. who
says that an inflationary gap as excess of planned expenditure over the available output? The classical
economists explained inflation as mainly due to increase in the quantity of money, given the level of
full employment. Keynes on the other hand described it that the excess of expenditure over the income
at the full employment level. The larger the aggregate expenditure, the larger the gap and the more
rapid of inflation occurs. Given a constant average propensity to save, rising money income at full
employment level would lead to an excess of demand over supply and then leads to consequent of
inflationary gap. Thus, Keynes used the concept of inflationary gap to show the main determinates that
cause rise of prices.

The inflationary gap is explained with the help of following example. Suppose, the gross national
product at pre-final price is 270 corers. Of these 90 corers spent by government for the purpose facing
the natural calamities. Thus, 180 corers available to the public welfare. However, the gross national
income at current prices, is available 300 corers in which 50 corers spent for the purpose of taxes and
another 50 corers is saved. The remaining values of 200 crores is called as disposable income which
can be shown in the form of the following table.

Table

INFLATIONARY GAP

Supply of Money Demand for Money

a) Gross National Production = 250 a) Gross Nation income = 300 cores.

b) Expenditure on natural Taxes = 50
Calamities. = 100 = 250

c) Availability of money = 150 Savings = 50

Disposable income = 200

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 From the table, it is understood that demand for money exceeds the supply of money i.e. 200
corers - 150 corers = 50 corers which is the excess of money prevailing in the economy which in turn leads to
increasing the prices of commodities. The table is converted into the diagram, which is as follows:

Income is represented on horizontal axis, while expenditure is shown on vertical axis. When the expenditure is
having C + I, the price level is confined to P1 Y1. When the income is constant, the expenditure increases to C
+ I to C + I + I1, the prices of commodities are increasing from P1Y1 to P2Y1. Whatever is happening in
between P1P2 is an indication for inflationary gap. To reduce the inflation, there are two options i.e. one is
increasing the output or another one is reducing the money supply. Increasing the output is long term process,
therefore, reducing the money supply can be taken up by using the technique of monetary and fiscal policies.
Then, the prices will come to normal situation of Y1P1. In this way inflationary gap can be controlled.

14) Examine theory of Phillips Curve?

Ans. A.W. Phillips, British economist, who is the first author, explained this theory. He examines the
relationship between rate of unemployment and money wages. He derived the empirical relationship between
the prices of commodities and unemployment.

33
Normally, when unemployment is there in the economy, entrepreneurs will pay less wages. Even the workers
express their willingness to work at lower wages. On the other hand, when un-employment at lower-level
money wages will be at higher level. Phillips conclusion based on above argument that the relation between rate
of unemployment and wages would be highly non-linear which can be represented in the form of diagram.

The rate of unemployment is represented on horizontal axis while wages are represented on vertical axis. The
curve is convex to the origin which shows that percentage change in money wages rises with decrease in the un-
employment rate. It shows that there is trade-off between the rate of change in money wage and rate of
unemployment. When the un-employment is more, wages are less. When the un-employment is less, wages are
high. The Phillips curves shows inverse relationship exists in between the rate of unemployment and wages.

15) Examine the consequences of inflation?

Ans.: The impact of inflation falls on economic, political, social and moral disruption of society. The effect of
inflation can be studied on the side of production and distribution.

a) Effect on Production:

An expansion of money supply in an underdeveloped economy will result in a slow and gradual rise in prices.
The production in such an economy does not increase in the same proportion as the money supply enters the
economy.

34
A) Lack of Saving:

In the inflation period, whatever money received by individuals i.e. affecting to spend the consumer goods. Due
to this savings will be reduced.

B) Scarcity of Foreign Capital:

The inflation which reaches the danger level affects the foreign capital. The foreigners who are willing to invest
money in underdeveloped countries will reduce their investment.

C) Lack of Capital Accumulation:

When inflation is there in the economy, it helps to reducing the saving which in turn helps to reduce the
investment.

D) Uncertainty of Business:

When the prices rise, consumers purchase less as per the law of demand. Due to this, business organizations
will invest less money. Finally, it leads to depression of the economy.

E) Scarcity of Consumer Goods:

Due to the inflation, prices of essential commodities will increase. In view of this, the raw materials will
transfer from essential commodities to luxurious goods, creating further shortage of consumer goods.

F) Hoarding of Essential Goods:

Inflation helps to hoarding of essential goods by the traders as well as consumers. The traders hoard the stock of
commodities, by expecting prices will increase further in the future. Similarly, the consumers also purchase the
essential commodities which are stocked in their houses forecasting further increase in their prices. In this way
essential goods becomes scarcity in the market.

G) Mechanism of Price:

The inflation affects the smooth working of price mechanism of the economy. The raw material also becomes
costly. Due to this, production decreases.

35
The inflation affects the distribution of real income particularly the poor and middle-clas people because they
are living object of poverty.

A) Debtors & Creditors:

During the inflation period debtors gain, while creditors will lose. When money is given in the form of loans the
value of money is more, while money is repaid, the value of money is less. In this way, it happens.

B) Salaried Persons:

The persons who get the salaries, will suffer because salaries would not increase on par with increase in the
prices of commodities,

C) Fixed Income Groups:

Those who are having fixed income either by agricultural or industrial sources will suffer much.

D) Businessmen:

The businessmen or traders are benefited during the inflation period, due to increasing the price of commodities.

E) Agriculturists:

The agriculturists suffer much during the inflation period, because of prices of agricultural commodities would
not increase on par with the essential commodities. However, the prices of essential commodities are increasing
abnormally.

F) Investors:

The investors who are keeping money in the form of shares and securities will be benefited. Because the value
of shares and securities will be increases. However, the investors who are keeping money in the form of fixed
deposits will suffer lot off because rate of interest will not increase to that extent.

A) Other Factors:

Inflation creates political instability by giving blow to businessmen. The businessmen follow illegal activities to
get more profits.

36
16) Examine the nature and scope of Business Economics?

Hynes, Mote, and Paul define business economics as “Economics applied in decision-making” They
consider this as a bridge between the abstract theory and managerial practice. However, Michael R.
Baye defines business economics in another way that “The study of how to direct scarce resources in a
way that most efficiently to achieves a managerial goal. Authors namely Brigham and Pappas believe
that business economics is “the application of economic theory and methodology to business
administration practice”.

Management:

Management is the science and art of getting things done through people in formally organized
groups It is necessary that every organization is well managed to enable it to achieve its desired goals.
Management includes a number of functions: planning, organizing, staffing, directing, and controlling.
The manager, while directing the efforts of his staff, communicates to them the goals, objectives,
policies, and procedures, coordinates their efforts motivates them to sustain their enthusiasm: and leads
them to achieve the corporate goals.

Manager:

A manager gets things done, through people in an organization. He directs the resources such as
men, materials, machines, money and technology. A manager is responsible for achieving the targeted
results. The manager‟s task is to maximize the profits of the firm. In the process of fulfilling this task, he
has to take several decisions such as planning the production, fixing the selling price, adding a particular
product or dropping it from the product line and the like. Knowledge of economics is essential for a
manager to optimize costs and revenues for the firm.

37
Scope of Business Economics:

The main focus in managerial economics is to find an optimal solution to a given business
problem. The problem may relate production, reduction or control of costs, determination of price of
given product or service, make or buy decisions, inventory decisions, capital management or profits
planning and management, investment decisions or human resource management. While all these are the
problems, the managerial economist makes use of the concepts, tools and techniques of economics and
interrelated disciplines to final an optional solution to a given managerial problem. This concepts is
explained in this way as follows.

Managerial decision areas

Concepts and techniques of
managerial economics applied
to
a) Production
b) Reduction of cost
c) Determination of price For optimum solutions.
d) Inventory decisions.
e) Capital management.
f) Profit planning
g) Investment decision.

Business economics is concerned with the economic behavior of the. At each stage of economic
decision variable, certain assumptions are made. For instance, we assume that the firm always tries to
maximize profit. The concept and techniques of economics set from work within which the managerial
economist functions. The economist is concerned with analysis of the economy as a whole the business
economist is essentially concerned with making decisions in the context of a single firm.

The main area of Business Economics:

a) Demand decision:

The analysis and forecasting of demand for a given product and service is the first task of the
business economist. The behavioral implications such as the needs of the customers, responses to a
given change in the price or supply are analyzed in a scientific manner. The impact of changes in
prices, income levels and prices of alternative product/ services are assessed and accordingly the
decisions are taken to maximize the profits. Demand at different price levels at different points of
time is forecast to plan the supply accordingly and intimate changes in price, if necessary, to enlarge
the customer base and gain more profits. Determination of elasticity of demand and demand
forecasting constitute the strategic issues that the managerial economist handles to a scientific way.
38
 b) Input-output decision:

Here, the costs of imputes in relation to output are studied to optimize the profits. Production
function and cost functions are estimated given certain parameters. The behavior of costs at different
levels of production is assessed here. Some costs fixed, some are semi-variable and others are erectly
variable. The quantity of production increases, remains constant or decreases with additional
increase in the inputs. This decision deals with changes in the production, following changes in
inputs which could be substitutes or complementary. The entire focus of this decision is to optimize
theoutput at minimum cost. It is necessary for the manager to know the relationship between the cost
and output both in the short-run and long-run to position his products amidst the competitive
environment.

c) Price- output decision:

Here, the production is ready, and the task is to determine price these in different market situations such
as perfect market and imperfect markets ranging from monopoly, monopolistic, competition, duopoly, and
oligopoly.

The features of these markets and how price is determined in each of these competitive situations is
studied here. The pricing policies, methods, strategies, and practices constitute crucial part of the study of
managerial economics.

d) Profit-related decisions:

Here, we employ the techniques such as break-even analysis, cost reduction and cost control and ratio
analysis to ascertain the level of profits. In breakeven analysis, we are concerned with profit planning and
control. We determine breakeven point beyond which the firm states getting profits. In other words, if the firm
produces less than breakeven point, it loses. We can also plan the production needed to attain a given level of
profits in the short-run. Cost reduction and cost control deal with the strategies to reduce the wastage and
hereby reduce the costs. These indirectly enhance the level of profits. Ratio analysis helps to determine the
liquidity, solvency and profitability of the activities of the firm. There are certain ratios used to analyze and
interpret the profitability of the firm given a set of accounting data.

39
Investment decisions:

Investments decisions are also called capital budgeting decisions. These involve commitment of large
funds which determine the fate of the firm. These decisions are irreversible. Hence the manager needs to be
more attentive while committing his scarce funds, which have alternative uses. The allocation and utilization of
the investments is of paramount importance. Capital has a cost. IT is expensive. Hence, it is to be utilized in
such a way as to maximize the return on the capital invested. It is necessary to study the cost of capital, choice
of capital structure and investment projects before the funds are committed.

17) Examine the role of Business Economist?

As we all aware that business economics is the application of economic theory and methodology to
business. Business economics is a field where it uses economic theory and quantitative methods to analyze
business enterprises. Business involves decision making. Decision making means the process of selecting one
out two or more alternative course of action. Business economics is concern with economic issues and problems
related to business organization, business management and b business strategy. The role of business economist
can divide into different categories.

a) Identify various business problems:

Various companies face many problems such a labor problem, pricing problems and other problems
related to Govt. controls and restrictions. The basic job of business economist is to identify various problems
that are uplifting a company, final out various reasons behind these problems, analyze their effects on the
functioning of the company and finally suggest rational alternatives and corrective measures to be taken by the
management. Also, it is the duty to design various course of action to maintain and improve existing systems.
b) Providing a quantitative base for decision making and forward planning:

The business economics with his vast experience has to provide a quantitative base for decision
making, policy making and forward planning in a business. Business economist helps to study the in-depth
knowledge of the various factors, controllable and non-controllable with influence the working of a business
unit.

40
 Business economist helps in planning, production and marketing employing the latest organizational
model and develops management technique to maximize output and minimize operating cost of the firm.

18) Advisory to the company:

The business economist advises the businessman on all economic and no-economic matters. By virtue
of business economist experience it helps to analyze various problems related with volume of investment, sales
promotion, competitive conditions, financing positions, labor relation and Govt. policies so that he it will help
to secured to business while doing every activity.

Business economist must be in touch with fast changing technological development and suggest the most
suitable information technology to be adopted by the company.

d) Knowledge about the environment factors which affects the business:

In order to make the business more viable and profitable the business economist should have detailed
knowledge and information about the environment of a company. Broadly speaking the environment factors are
divided in two parts.

a. Business economist (external factors)

b. Business operations (Internal factors)

Business economist helps to study all factors and force and beyond the control of individual business
enterprises and its management which will help to maintain the business as stable business operation helps to
study those factors and force which operate, will within the company and influence its operations which can
minimize the cost of business

41
 18) Examine the multidisciplinary nature of business economics?
Many new subjects aver evolved in recent years due to the interaction among the basic discipline, while
there are many such new subject in natural and social sciences. Business economics can be taken as the best
example of such a phenomenon among social sciences. Hence it is necessary to trace its costs and relationship
with other dissiliences.

A) Relation with Economics:

\The relation between Business economics and economic theory may be viewed from the point of two
approaches to the subject viz, Micro economics and macro economics. Micro economics is the study of the
economic behavior of individuals, firms, and other such micro organization. Business economics is rooted
in micro economic theory. Business economics makes use to several micro economic concepts such as
managerial cost, material revenue, elasticity of demand as well as price theory and theories of of market
structure to name only a few macro theory on the other hand is the study of the economy as a whole. It
deals with the analysis of national income the level of employment, general price level, consumption and
investment in the economy and even matters related to international trade, money, public finance etc.

The relationship between business economics and economic theory is like that of engineering science
to physics or of medicine to biology. Business economics has an applied bias and its wider scope lies in
applying economic theory to solve real life problem of enterprises. Both business economics and economics
deal with problem of scarcity and resource allocation.

a) Business Economics and Accounting:

Business economics has been influenced by the developments in management theory and accounting
techniques. Accounting refers to the recording of pecuniary transactions of the firm in certain books. A
proper knowledge of accenting technique is very essential for the success of the firm because of profit
maximization is the major objective of the firm.

Business economics requires proper knowledge of cost and revenue information and them
classification. A student of business economics should be familiar with the generation, interpretation
and use of accounting data. The focus of accounting within the firm is fast changing from the concept of
store keeping to that if Business decision making, this ahs resulted in a new specialized area of study
called Business accounting.

b) Business Economics and Mathematics:

The use of mathematics is significance in business in view of its profits maximization of goal long
with optimizing use of resources. The major problems of the firm is how to minimize cost for
maximization profit or how to optimize sales. Mathematical concepts and technique are widely used in

42
economic logic to solve these problems. Also mathematical methods help to estimate and predict the
economic factors for decision making and forward planning.

Mathematical symbols are more convenient to handle and understand various concepts like
incremental cost, elasticity of demand etc. Geometrically, Algebra and calculus are the major branches
of mathematic which are of use in business economics. The main concepts of mathematics like
logarithm and exponential, vectors and determinants; input-out models etc. are widely used. Besides
these usual tools, more advanced techniques designed in the recent years viz, liner programming,
inventory models and game theory fine wide application in business economics.

c) Business economics and statistics:

Business economics needs the tools of statistics in more than one way. A successful business
must correctly estimate the demand for his product. He should be able to analyses the impact of various
in tastes. Fashion and changes in income on dead only then he can adjust his output. Statistical methods
provide and sure base for decision-making. Thus, statically tools are used in collecting data and
analyzing them to help in decision making process.

Statistical tools like the theory of probability and forecasting help the firm to predict the feature
coerce of event. Business economics also make use of correlation and multiple regressions in related
variables like price and demand to estimate the extent of dependence of one variable on the other. The
theory of probability is very useful in problems involving uncertainty.

d) Business economics and operation research:

Taking effective decisions is the major concern of both business economics and operation
research. The development of techniques and concepts such as liner programming, inventory models
and game theory is due to the development of this new subject of operation research in the postwar
period. Operation research is concerned with the compels problems arising out of the management of
men, machines, materials and money.

Operation research provides scientific models of the system and it helps business economists in
the field of product development, material management and inventory control, quality control,
marketing and demand analysis. The varied tools of operation research are helpful to business
economists in decision making.

e) Business economics and theory of Decision making:

The theory of decision making is a new field of knowledge grown in the second half of this
century. Most of the economic theories explain a single goal of the consumer i.e profit maximization for
the firm. But the theory of decision-making is developed to explain multiplicity of goals and lot of
uncertainty.

As such this new bench of knowledge is useful to business firm, which have to take quick
decision in the case of multiple goals. Viewed this way the theory of decision making is more practical
and application oriented then the economic theories.

43
f) Business Economics and Computer Science:

Computers have changes the way of the world functions and economic or business activity is no
exception. Computers are used in date and accounts maintenance, inventory and stock controls and
supply and demand predictions. What used to take days and moths is done in few minibus or house by
the computers. In fact computerization of business activity on a large scale has reduced workload of
business personal. In most countries a basic knowledge of computer science, is a compulsory program
for managing trainees

g) Business Economics and Psychology:

\Consumer psychology is the basis on which managerial economist acts upon. How the customer
reacts to a given change in price or supply and its consequential effect on demand/ profits in customer
reacts to a given change in price or supply and its consequential effect on demand/ profits is the man
focus of study in managerial economics. We assume that the behavior of the consumer is always
rational, which in reality is not so> Psychology contributes towards understanding the behavioral
implications, attitude and motivations of each of the microeconomic variables such as consumer
supplier/ seller, investor, worker or an employee.

To conclude, business economics which is an offshoot traditional economics, has gained strength
to be a separate branch of knowledge. It strength lies in its ability to integrate ides from various
specialized subjects to gain a proper perspective for decision making.

A successful business economics must be a mathematician, a statistician and economics. He must

be also able to combine philosophic methods with historical methods to get the right prospective only
them, he will be good at predictions. In short, business practice with the help of allied sectors.

44
 Self-Assessment Questions.

i. Multiple choice questions. Each question carries ½ mark.

1. What is the major objective of a business firm?

a. Expansion of business. b) Profit motive c) Output motive d) All.

2. In short run, firms can adjust their production by changing them.

a. Fixed factors b) variable factors c) semi-fixed factors. d) all.

3. Which of the following pairs of goods is an example of substitutes?

a. Tea and sugar b) tea and coffee c) shirt and pant. D) car and petrol.

4. Consumption of additional apples after reaching the saturation point leads to

a. Fall in total utility and increase in marginal utility.
b. Increase in total utility and marginal utility.
c. Fall in total utility leading marginal utility to become negative.
d. Total utility to become negative and marginal utility tending to fall.

5. Which of the following has highest consumer surplus?

a. Necessities b) luxury goods c) comforts d) conventional necessities.

6. The consumer, according to economic analysis, is expected to behave.

a. Rationally b) emotionally c) carefully d) indifferently

7. Consumer surplus means.

a. The area outside the budget line.
b. The difference between AR and MR
c. The difference between the maximum amount a person is willing to pay for a good and
its market price.
d. The area inside the budget line.

45
A contraction is the upward movement along a demand curve, indicating that lower quantity demanded for a
given change in the price of the good. What is this change?

a) Decrease. b) increase c) infinite change. D) negligible change

8. Total utility is maximum when.

a. Marginal utility is maximum.
b. Marginal utility is minimum.
c. Marginal utility is zero.
d. Marginal utility is less than average utility.

9. In case of Geffen‟s goods, the demand curve.

a. Slopes downwards. b) slopes upwards
b. Intersects supply curve.
c. Meets cost curve.

ii. Fill in the blanks suitably. Each question carries ½ mark.

1. As consumption patterns set the direction for production decisions,

consumption is said to ---
-----------production.
2. deals with consumer behavior.
2. The additional utility derived from consumption of an additional unit is
called-------
3. The of diminishing marginal utility states that the marginal utility goes
on -------------------------------------------------------------------------------- other
things remaining the same.
4. According to the law of equi-marginal utility, consumer is said to be in
equilibrium when ----
obtained.
5. The difference between the that the consumer is prepared to pay and the
price he is exactlypaying is called--------
6. The curve which reveals that certain combinations of goods and
services which yields himthe same utility is called-----------
7. Indifferent curves are to origin.
8. When consumer maximize his utility within a given budget, he is said to be
in -------
9. Goods which are used for further processing are called---------
46
 Answers for multiple choice questions:
1) c, 2) b, 3) b, 4) c, 5) a, 6) a, 7) b, 8) b, 9) c, 10) b,

Answers for fill in the blanks:

1) precedes 2) consumption 3) marginal utility. 4) diminishing

5) marginal utilities, equal 6) consumer surplus. 7) Indifference curve. 8) convex.
9) equilibrium. 10) demand.

Short answer questions.

a. Business economics.
b. Microeconomics.
c. Macro Economics.
d. Inflation.
e. Deflation.
f. National income.
g. Trade cycles.

Essay Type Questions.

a) Examine the nature and scope of Business Economics?
b) Explain the types of business entities?
c) Examine the source of capital?
d) Explain the concepts of national income?
e) Differentiate demand pull inflation from cost push inflation?

f) Examine the phases of trade cycles

47
 Unit-II

Demand and Supply Analysis

1. Examine the law of diminishing marginal utility analysis?

The study of consumer behavior occupied an important place in economics. This theory was explained by
the author namely Alfred Marshall. He says that utility can be measured. The term utility refers to the want
satisfying capacity of goods and services. The basic principles which are concerned to the consumers can be
explained in this manner. The purchasing of a commodity depends upon the price which in turn depends upon
marginal utility of the commodity. As per economical terms, utility can be divided into two categories that is
cardinal and ordinal utility. The cardinal utility reveals that the utility can be measured, whereas the ordinal
utility reveals that utility cannot be measured. Taking the cardinal utility as a basis, Marshall formulated a
theory that theory is called as law of diminishing marginal utility analysis which depends on certain
assumptions

Assumptions

1) Consumer must be rational

2) Marginal utility of a commodity can be measured.However, it can be measured hypothetical or
imaginary only.
3)Marginal utility of a commodity depends on its quantity of commodity (MUx = f ( Qx )
3) Marginal utility of a commodity changes every time, but marginal utility of money is constant.
4) The commodity which is used for consumption must have the same nature of quantity and quality.
5) There should not be time gap between the consumption of one commodity to another commodity.

Explanation of law
This law explains the relationship that is existing in between the quantity and utility of the commodity.
In other words, it can be said that Mux= f (Qx ). Human wants unlimited even though, wants are unlimited; a
want is having limitation. If a person consumes a commodity, the marginal utility of that commodity
diminishes. Taking this laws a basis, author namely
Alfred Marshall defines this law as “more we have a thing, less is the satisfaction or utility that we derive
from additional unit of it”. From this definition, it is understood that if a consumer takes a commodity, the
marginal utility of that commodity decreases continuously. For instance, let us assume that a consumer has
nature of hunger at 2.00 p.m., instead of food, he takes fruits of apple continuously, and then the marginal
utility of that commodity is going on decreases or diminishes which can be verified from the following table.

Table-1

48
 Apple Total utility Marginal utility
1 20 20
2 35 15
3 45 10
4 50 5
5 50 0
6 45 -5
7 35 10

From the table, it is understood that utility is divided into two categories that is total and marginal
utility. The total utility is derived by adding of marginal utilities of all commodities whereas the marginal
utility of a commodity can be derived from the following formula.
TUn = TUn-TUn-1
Nth = N –N-1
4th= 4 -4-1
4th = 4-3
4th= 50-45= 5
The marginal utility of 4th unit or apple is 5 units. From the table, it is understood that total utility
becomes maximum when the marginal utility becomes zero. Taking the table as a basis, diagram can be
explained.

The total utility is represented on OY axis, while apples are shown on OX axis. When a consumer
takes the apple one after another the marginal utility of the commodity diminishes. Hence,the marginal utility
curve is falling from left to right towards downward direction. When marginal utility curve intersects the OX
axis that point indicates that marginal utility is zero. After words, it becomes negative.

Limitations
This law does not apply for rare commodities whose marginal utility increases when its quantity
increases.
49
 1. This law does not apply in the case of reading of books.
2. This law applies for commodities which are having the nature of divi

Importance of law
a) This law is the basis for determination of price of the commodity. For instance, diamond is having
more price, because its marginal utility is more.
b) Taking this law as a basis, income tax imposing on rich people whose marginal utility of money is
less.
c) As per this law, more tax is imposing on the commodities which are having nature of perfectly
inelastic.In another way, they are called as luxurious goods. Similarly, more tax will be imposed on
harmful commodities such as tobacco, alcohol, cigarettes etc. Intension of the Govt. is to reduce the
consumption of these goods rather than getting of income.
d) Taking this law as basis, leftist organizations are making a statement that “excess of money which
is in the hands of rich people must be transferred to poor people to bring equality between them.
e) This law explains the variations that are prevailing in between value-in-use and value-in exchange.
The commodities which are having the nature of value-in-use but not value-in-exchange are called
as free commodities. The commodities which are having the nature of value-in-use and value-in-
exchange are called as economic commodities. The value-in exchange in another way is called as
marginal utility. The price of the commodity depends on the marginal utility. If a commodity is
having more marginal utility, price also will be more and vice versa. The commodity which is
having marginal utility is called as economic commodity.

2. Explain the law of Equi-marginal utility analysis?

This law was explained by Alfred Marshall who says that a consumer would not purchase a single
commodity when he goes to vegetable market. He will try to purchase more than one commodity. If a
consumer purchases more than one commodity, it comes under the category of Equi-marginal utility analysis.
Marshall defines the Equip-marginal utility analysis as “ if a person has a thing which can be put for several
uses and he will distribute it among these uses in such a way it has the same marginal utility for it, if it had a
greater marginal utility in one use than the other, he would gain by taking away some of it from second use
and applying it to the first” From this definition it is understood that consumer is substituting one commodity
for another to derive the maximum utility.

Assumptions

This law is depending on sum assumptions which are as follows.

1. The income of the consumer must be constant
2. The prices of two commodities must be constant
3. The motto of the consumer is to get maximum satisfaction
4. The marginal utility of money must be constant
5. The prices of substitution goods must be constant
6) The marginal utility of a commodity must have the nature of divisibility
Taking all these assumptions as a basis, equi-marginal utility analysis can be verified.

50
Application of this law:

The normal tendency of any consumer is to get maximum utility or satisfaction by spending limited
income on various commodities which can be observed from the following table

Table-1

Money MUx MUY

1 20 16
2 18 14
3 16 12
4 14 10
5 12 8
6 10 6
7 8 4
8 6 2

For instance, let us assume that a consumer is having Rs 8 in his pocket and he wants to spend on two
commodities that is on apple and banana. The commodity of X meant for apple and commodity of Y meant
for banana. By purchasing two commodities (Fruits), he wants to get maximum satisfaction. By spending his
total income (Rs 8) on apple; hecan get 104 units of total utility. Instead of this, by spending of Rs 8 on
banana, he can get 72 units of total utility. If he applies the principle of equi-marginal utility analysis that is
spending Rs 5 towards the apple and remaining Rs 3 towards the banana, he can get (80+42) =122 maximum
utility. In other words, it can be said that

Mux/Py =12/1
M u y/Px = 12/1
Diagram:

Taking the table as a basis, we can draw the diagram which is as follows.

51
 The price of the commodity is represented on OY axis, while the quantity of money is shown on OX axis.
As per the diagram, OM1 quantity of money spends on OY commodity (Banana) and reaming amount of
M1M2 spends on OX commodity (Apples). In this way, the final rupee spending towards two commodities
gives same level of utility of Q1 and Q2.The price of thecommodities becomes equal to Q1 and Q2.Therefore,
it is indication for equi- marginal utility analysis.

MUy/Py =Q1M1/OP1=12/1

MUx/Py = Q2M2/OP1=12/1

Limitations;

1. This law does not apply for the consumer whose income increases
2. This law applies for rational consumers
3. This law does not apply for the commodities which are having the nature of indivisibility

4) This law cannot be applied when the taste and preference of the consumer changes.

Importance;

This law helps not only to the consumer, even for house owner, or Govt. or producer of a firm.When a
consumer goes to vegetable market, he will apply theEqui-marginal utility analysis to derive the optimum
utility or satisfaction by spending limited income. A house owner gets limited income, but responsibilities
are more. In this situation, by applying this principle, he gets maximum utility.Similarly,Govt. also gets
limited income by way of taxes and other sources, but responsibilities are more. In this way, Govt. allocates
the money taking this law as a basis.This law applies even to the producer who allocated money for
purchasing of labor and machinery which are substituted one for another to reduce the cost of production.

3) “Derivation of demand curve from utility analysis” comment.

52
 The utility analysis studies the relationship that exists in between utility and quantity of commodity. In
another words, it can be expressed as MUx = f (Qx) which shows the inverse relationship between utility and
quantity of the commodity. When the quantity of a commodity increases, its marginal utility decreases which
can be verified from the fowling diagram.

Diagram ‘A’

The marginal utility and quantity of a commodity are represented on OY and OX axis respectively.
When the quantity of X increases from OM1 to OM2 marginal utility of the commodity is also decreasing
from OR1 to OR2. The marginal utility curve is falling from left to right towards downward direction.

Diagram ‘B’

The price and quantity of a commodity are shown on OY and OX axis respectively. As per the
diagram, first commodity is giving higher level of satisfaction or utility for which we are paying higher price
that is Op1, while for second commodity, we are paying less price that is OP2, because we are assuming that
second commodity is giving less utility.
The marginal utility curve is falling from left to right towards down direction. Similarly, the demand
curve is also falling from left to right towards downward direction. Hence, there is no variation in between
53
marginal utility curve and demand curve. Both are same. Hence, marginal utility curve in another way, is
called as demand curve. It is indication for derivation of demand curve from utility analysis.

4) What is meant by consumer’s surplus? How it is related to Engel theory?

This theory primarily explained by author namely Dupit, but later it was elaborated by Alfred Marshall.
He defines the consumer’s surplus as “Excess of price which a consumer willing to pay rather than go without
it over that which he actually does pay is the economic measure of surplus satisfaction. . From this definition,
it is understood that the price which a consumer to pay for a commodity is always less than willing price. This
difference leads to surplus. Examples for consumer surplus are newspaper, post card, salt pocket etc. which
can be verified from the following table.

Table-1

Quantity Marginal Market price Consumer’s

utility (Willing (Actual price) price
price)
1 10 4 6
2 8 4 4
3 6 4 2
4 4 4 0
5 2 4 -2
6 1 4 -3

From the table, it is understood that a consumer purchases a commodity up to the point where
marginal utility becomes equal to the price of the commodity. As per the table, he will purchase only 4
commodities where MUx becomes equal to PUx. Later, price of the commodity becomes more than the
marginal utility. If a consumer purchases more than 4 commodities, he loses the consumer surplus.
As per the table, a consumer is willing the pay of Rs 28 for 4 commodities, but he is paying Rs 16,
then consumer surplus leads to origin of 12 units which can be verified from the following diagram.

54
 The price or MU of a commodity is represented on OY axis while quantity of
commodities is represented on OX axis. As per the diagram, a consumer is willing to OR price, but actual
price is confined to OP.In this way, the total revenue becomes to the level of ORQM in which the total cost of
OPQM is to be deducted, the remaining balance leads to surplus of RQP. This is method by which we can
derive the consumer surplus.

Importance

a) Taking the consumer’s surplus as a basis, income tax is imposed on the rich people, because the
marginal utility of last rupee is very less for them. In addition, this, Govt. imposes more tax on the
luxurious goods which are purchased by the rich people.
b) The consumer’s surplus is the basis for determination of price discrimination by the monopolist.
For instance, electricity charges are having variation from home consumption to industrial
consumption. The charges will be higher on the electricity which is used for industrial purpose
rather than home consumption.
c) Taking this theory as a basis, more prices imposed on the harmful commodities by the Govt. The
motto of Govt. is to reduce the consumption of these commodities rather than getting of more
income.

Earnest Engel, German satiation, made an empirical survey on the consumption pattern of households
in 1960. The commodities are divided into three categories, i.e., necessaries, comforts, luxuries etc. When the
income of German people increases, normally they spend on necessaries. when their income further
increases, they spend on comforts. When their income future increases, they spend on luxurious goods. In the
case of luxurious goods, proportional relationship is going to be existing in between income and expenditure.

55
 The expenditure and income of the households are represented on OY and OX axis respectively. In the
case of necessaries, the curve of X is going towards downward direction and finally intersecting the OX axis.
It implies that when income increases, spending towards the necessaries is going on decreasing. However, in
the case of comforts, it is constant while it is proportional in the case of luxurious goods. These are the
variations prevailing in the market. This was the spending pattern of German people on various goods.

5)What is meant by demand? Explain law of demand and its exceptions?

Demand is a concept having more value in the day-to-day life. The supply of a
commodity depends on its demand. A commodity is demanded by everyone who thinks that it is useful to
satisfy his want. In uneconomical terms, demand can be defined as “demand is desire backed by the
purchasing power of money and willingness to Pay”. From this definition, it is understood that mere desire does
not become demand. For instance, a poor man is having a desire to go by plain, but he is not having money in
his pocket, then it does not become demand. Similarly, a rich man is having money in his pocket, but he is not
having desire to go by plain, then it does not become demand. However, desire itself becomes demand, but it
must be accompanied by purchasing power of money and willingness to pay. Demand is depending on so many
factors which are as follows.

D = f (P, Y, Sp, T, Po, C l)

D = demand
F = function
P = Price of the commodity
Y = Income of the consumer
Sp= Prices of substitution goods
T = Taste and preference of the consumer
56
 Po= Population
Cl = climate

It is assumed that there is no change in other factors except the price of the commodity. Then
equation becomes as

D = f (P) – Price demand

The relationship that is existing in between price and quantity demanded of a commodity is known
as price demanded which can be divided into two categories i.e., individual and market demand.

Individual demand

The purchasing capacity of an individual in another way is called as individual demand. The behavior of
individual person can be analyzed from the following table.

Table
----------
Price Quantity demanded.
-------- ------------------------
Rs 5 1
Rs 4 2
Rs 3 3
Rs 2 4
Rs 1 5

From the table, it is understood that when the price of a commodity is having Rs 5, a consumer purchases1
commodity, while it falls to Rs 1, consumer purchases5 commodities. It shows that there is inverse relationship
that existing in between price and quantity demanded. Taking the table as a basis, it can be converted into a
form of diagram.

57
 The price and quantity demanded are represented on OY and OX axis respectively. When the price of
commodity is having OP1, the quantity demanded is confined to OM1 level, while price of the commodity falls
from OP1 to OP2, the quantity demanded increases from OM1 to OM2. By adding points of Q1 and Q2, we
able to derive the demand curve which falls from left to right towards downward direction. In other words, there
is inverse relationship is existing in between the price and quantity demanded.

Market demand

The opinion of large number of consumers in another way is called as market demand which can be
analyzed from the following table

Table

Price A B C A+B+C (Market)

Rs 5 1 2 3 6 M.T
Rs 4 2 3 4 9“
Rs 3 3 4 5 12 “
Rs 2 4 5 6 15 “
Rs 1 5 6 7 18 “

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 From the table, it is understood that when the price of sugar is having Rs 5, consumers throughout the market
purchasing 6 million tons of sugar, when the price falls to Rs 1, consumers purchasing 18 million tons of sugar.
Taking the table as a basis, it can be converted into diagram which is as follows.

The Price and quantity are represented on Oy and OX axis respectively. The quantity demanded of a
commodity is confined to OM1, when the price of the commodity is having OP1. When the price falls from
OP1 to OP2, the quantity demanded increases from OM1 toOM2. It shows that there is a inverse relationship
existing in between the price and quantity demanded. Taking market demand as a basis, we are able to make
law of demand as “being other things are constant, when the price of commodity falls more will be demanded,
price increases less will be demanded”.

Exceptions to law of demand

The law of demand applies to large number of commodities which existing in the market. However, it does
not apply for certain commodities which are as follows.

a) Geffen paradox

This law of demand cannot be applied for necessary commodities such as rice, bread, and wheat and so on.
When the price of rice increases, consumers will reduce the expenditure on comforts, and they will transfer that
amount towards the purchase of rice. In this case when price increases, demand also increases which can be
explained through the help of diagram.

59
 The price and quantity demanded are represented on OY and OX axis respectively. When the price of rice
is having OP1 quantity demanded is confined to OM1. If price of rice increases to OP, the demand of rice
increases from OM1 to OM2. In the case of necessary commodity, the demand curve falls from left to right
towards upward direction. This is the theory primarily explained by the author namely Sir Robert Geffen.
Therefore, it was designated on his name as Geffen paradox. It becomes against to the law of demand.

b) Veblen goods

Veblen, economist, reveals that the law of demand cannot be applied in the case of luxurious goods which
are meant for status. These are commodities purchased by rich people. If the prices of luxurious goods increase,
the demand for these commodities does not fall. In this case, the demand curve falls from left to right towards
upwards direction which becomes against the law of demand.

c) Speculation

In the case of speculation also the demand curve falls from left to right towards upward direction. For
instance, paddy comes in the month of November and December of every year. Traders, forecasting, will
purchase more and more of paddy even though its prices increases thinking that prices will increase further in

60
coming days. In this case, the demand curve falls from left to right towards upward direction which becomes
against to the law of demand

d) Future expectations

The consumers expect that the prices of necessaries commodities such as rice, oil, onion etc., will increase when
the floods or drought prevails in the country. Knowing this situation, consumers will purchase more of
necessaries, even though prices increase. If it is so, it becomes against to the law. In this situation, demand
curve falls from left to right towards upward direction.

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 6)What are the determinant factors of demand?

These factors which are influencing demand are as follows.

a) The price of a commodity

The price of a commodity influences the quantity of purchasing of a commodity. Normally, quantity
demanded of a commodity increases when price falls, and decreases when the price increases. There is inverse
relationshipexisting in between the price and quantity demanded of commodity.

b) Income of the consumer

Income of a consumer also influences the quantity demanded of a commodity. A consumer purchases
more commodities when income increases and less commodity when income falls. It shows that there is a direct
relationship exist in between the income and quality demanded.

c) Taste and preference of the consumer

The taste and preference of the consumer also influences the quantity demanded of a commodity. When a
consumer is very particular about a commodity, he will purchase more, even though its price increases. If he is
not interest, he would not purchase even though price falls.

d) Income distribution

The distribution of income also influences the purchasing capacity of a commodity. When the income
is distributed equally among the society, the propensity to consume of the people will increase. The propensity
to consume of poor people is always more than that rich people.

5) What is the shape of income demand curve in the case of superior and inferior
goods?

The income demand explains the relationship that is existing in between consumer‟s income
and quantity demanded of a commodity. Income demand is different in the case of superior goods.

62
Superior goods

In the case of superior goods, income demand curve falls from left to right towards upward direction which can
be shown with help of diagram.

The income and quantity demanded of a commodity are shown on OY and OX axis respectively. Example for
superior goods are color TV, Refrigerator, cars etc. The quantity demanded of a commodity is confined to OM1
when the consumer income is confined to OR1. When the income of consumer increases from OR1 to OR2, the
quantity demanded increases OM1 to OM2. It shows that there is direct relationship exists between income and
quantity demanded. Hence, demand curve falls left to right towards upward direction.

Inferior goods
In the case of inferior goods, the demand curve falls from left to right towards downward direction which can
be shown in the form of diagram.

63
 The income and quantity demanded are represented on OY and OX axis respectively. For example, salt
pocket, match box come under inferior goods. In the case of inferior goods, consumer Purchase less
commodities when income increases. It shows that there is inverse relationship existing in between consumer‟s
income and quantity demanded of a commodity.

7)What is the shape of cross demand curve in the case of substitution and
complementary goods?

The shape of crossed demand curve has variation from substitution goods to complementary goods.

Substitution goods

In the case of substitution goods cross the demand curve falls from left to right towards upward direction.
Example for substitution goods are coffee and tea.

The price of Y and quantity demanded of X are represented on OY and OX axis respectively. Normally a
consumer Purchases tea to the level of OM1 when that price of coffee is confined to OP1. If the price of coffee
increases from OP1 to OP2, then the demand for the tea increases from OM1 to OM2. If the price of coffee falls
to OP3, the quantity of purchasing tea decreases to OM3. It shows that there is inverse relationship exists in
between the price of coffee and quantity demanded of tea.

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Complementary goods

In the case of complementary goods cross demand curve falls from left to right towards downward direction.
Example for complementary goods are cup and saucer. It can be observed from the following diagram.

The price of cup and quantity demanded of saucer are represented on OY and OX axis respectively. The
quantity demanded of saucer is confined to OM1 level when the price of cup is OP1. When the price of cup
increases from OP! to OP2, the quantity of demanded of saucer falls from OM1 to OM2. Similarly, the quantity
demanded of saucer increases from OM1 to OM2, when the price of cup falls from OP1 to OP3. It shows that
there is indirect relationship exists in between the price of cup and quantity demanded of saucer. In this case,
the cross-demand curve falls from left to right towards the downward direction.

8)What is meant by elasticity of demand? Examine the various types of elasticity of

demand?

The law of demand simply reveals that if there is a change in the price of the commodity, it leads to change in
the quantity demanded. However, it does not reveal how much change is occurring in purchasing a commodity
due to change in the price. In other words, it does not reveal the proportional relationship that is existing in
between the price and quantity demanded. To know the proportional relationship, we must go for the concepts
namely elasticity of demand. Degree of responsiveness in quantity demand of commodity due to change in its
price is known as elasticity of demand. For instance, commodity of X and Y are having the same price. Having
this situation, consumers purchase equally the two commodities. When the price of X and Y falls equally, then
consumers purchase more of X rather than Y. If it is so, variations prevailing in between them. However, these
variations cannot be studied by taking the instrument of elasticity of demand.

65
Types of elasticity of demand

The ratio of percentage change in quantity demanded of a commodity due to percentage change in its price is
known as elasticity of demand which can be divided into five categories.

a) Perfectly inelastic demand

The change in price does not lead to change in quantity demanded of commodity is known as perfectly inelastic
demand which can be verified from the following table.
Table

Price Quantity demanded

10 10
15 10
20 10
25 10
30 10

From the table, it is understood that when the price of a commodity is having Rs 10, a consumer
purchases 10 commodities. When it increases from Rs 10 to Rs 20, even then a consumer purchases only 10
commodities, it is known as perfectly inelastic demand. It is always horizontal to Oy axis which can be verified
from the following diagram.

66
 The price and quantity demanded are represented on OY and OX axis respectively. When the price of the
commodity increases from OP1 to OP2, no change is arising in the case of quantity demanded of a commodity.
If it is so, it is called as perfectly inelastic demand curve.

b) Perfectly Elastic demand

When a consumerism preferred to purchase more commodities at the same price, it is said to be perfectly
elastic demand which can be verified from the following diagram.

Table

Price Quantity demanded

10 10
10 20
10 30
10 40
10 50
10 60

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 From the table, it is understood that there is no change in the price of the commodity, but more quantities
purchased at the same price. If it is so, it is called as perfectly elastic demanded which is always horizontal to
OX axis. It can be verified from the following diagram.

The price and quantity demanded are represented on OY and OX axis respectively. The quantity demanded is
confined to OM1 when the price is OP1. The purchasing of commodities increases from OM1 OM2 even
though price is the same. If it is so, it is called as perfectly elastic demand curve.

c) Unitary Elastic demand

When the percentage change in quantity demanded is equal to percentage change in the price of the
commodity is known as unitary elasticity of demand which is always convex to the origin. It can be verified
from the following diagram.

68
 The price and quantity demanded are represented on OY and OX axis
respectively. When the price of a commodity is having Rs 5 , the quantity demanded is confined to 1
commodity. When the price falls from Rs 5 to Rs 1, the quantity demanded of a commodity increases from 1
commodity to 5 commodities. If it is so,it is known as unitary elasticity of demand. In other words, whatever
changes arises in the priceof the commodity, equally change arises in quantity of demand of commodity is
known as unitary elasticity demand curve which isalways convex to the origin.

d) Relatively inelastic demand

When the percentage change in quantity demanded of a commodity is less than the
percentage change in the price, it is said to be relatively inelastic demand. It falls from left to right towards the
downward direction whichcan be verified from the following diagram.

69
 The price and quantity demanded are represented on OY and OX axis respectively. The price
of a commodity is having Rs 5, a consumer purchase 1commdity. when the price falls to Rs 1, if a consumer
purchase 3 commodities, it is said to be relatively inelastic demand.

e) Relatively elastic demand

When the percentage change in quantity demanded of a commodity is more than the
percentage change in the price of a commodity, it is said to be relatively elastic demand which can be
represented in the form of diagram.

The price and quantity demanded of a commodity are represented on OY and OX axis respectively. The price
of a commodity is having Rs 5 a consumer purchases 1 commodity. When it falls to Rs 1, if a consumer
purchases 20 commodities, it is said to be perfectly elastic demand curve which falls from left to right towards
downward direction.

9)Examine the various methods applied for measurements of elasticity of demand?

The various methods applied for measuring the price elasticity of demand. They are as follows.

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 a) Total outlay or expenditure method

This method was explained by Alfred Marshall who says that response of total expenditure due to change in
the price of the commodity is known as total outlay method which can be observed from the following table.
Table
Price Quantity demanded Total Expenditure Elasticity
10 1 10
9 2 18
8 3 24 Ed>1
7 4 28
6 5 30
5 6 30 Ed=1
4 7 28
3 8 24
2 9 18 Ed<1
1 10 10

Table reveals that when the price of a commodity is having Rs 10, a consumer purchases 1
commodity. When the price of the commodity falls to Rs 7, a consumer purchases 4 commodities, then total
expenditure increases from Rs 10 to Rs 28 which shows that there is inverse relationship exists in between the
total expenditure and price of the commodity. If it is so, it is called as relatively elasticity of demand when the
price of the commodity has Rs 6, a consumer purchases 5 commodities when it falls to Rs 5, if consumer
purchases of 6 commodities, it is said to be unitary elasticity. It shows that there is no change in total
expenditure even though price of a commodity changes. Hence, the elasticity that is prevailing in between 6 and
5 is indication for unitary elasticity (Ed=1). When the price falls from Rs 5 to Rs 1, the total expenditure also
falls from Rs 30 to Rs 10, is known as relatively inelasticity of demand It shows that there is direct relationship
existing in between price and total expenditure. Hence, it is said to be as relatively inelasticity of demand which
can be represented in the form of diagram.

71
 The price and total expenditure are represented on OY and OX axis respectively. The
area that is falling in between AB is an indication for relatively elasticity of demand, because inverse
relationship exists in between the total expenditure and the price of the commodity. The area that is falling in
between BC indication for unitary elasticity of demand because when the price falls, the quantity demanded
increases, but total expenditure is the same. Then, it is said to be unitary elasticity of demand. The area that is
falling in between CD indication for relatively inelasticity of demand where direct relationship is existing in
between the price and total expenditure. If demand curve is tangent to OY axis at the point of A which is
indication for perfectly elasticity of demand, while demand curve tangent to OX axis at the point D which is
indication for perfectly inelasticity of demand. In this way, five types of elasticity are shown on the same
demand curve.

b) Point or Geometrical Method.

This theory was elaborated by Alfred Marshall who says that the following formula is applied to measure the
elasticity of demand.

Elasticity of demand = Lower segment of the demand curve/ Upper segment of the demand curve.

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Taking this formula as basis, five types of elastic ties can be measured on the same demand curve which is as
follows

The price and quantity demanded of commodity are represented on OY and OX axis
respectively. The elasticity of demand is equal to 1 at the point P1 where the lower segment of the demand
curve is equal to upper segment of the demand curve. Therefore, it is indication for unitary elasticity of demand.
Similarly, if the demand curve is tangent to OY axis at the point of P5 which indication for perfectly elasticity
of demand is, while it is tangent to OX axis, at the point of P3 which indication for perfectly inelasticity of
demand is. In other words, let us assume that if the demand curve is having 10 centimeters, the elasticity of
demand at the point P1, becomes unitary elasticity, that is 5/5=1. Similarly, when the demand cure is tangent to
OY axis, it implies the elasticity of demand is perfectly elasticity, because it becomes 10 / 0 =0. When the
demand curve is tangent to OX axis, it is indication for perfectly elasticity because it becomes 0 /10 = 0.
However, at the point of P4, we find relatively elastic, because as per the formula, it becomes relatively elastic
nature because it becomes 8 /2 = 4 which indicates for relatively elastic while it becomes relatively inelastic at
the point of P2 where it becomes 2 / 8 = 0.25.

c) Arc or proportional method

The responsiveness of demand due to change in the price of the commodity is known as proportional method
which can be represented in the form of equation.

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Ed = Proportionate change in quantity demanded / Proportionate change in the price of the commodity

Ed = Change in quantity demanded /change in the initial demand

Ed = change in the price/ change in the initial price

Ed = dQ/Q ; dP/P

Taking the help of formula, we can measure the elasticity of demand.

d) Relatively elasticity of demand

When the price of X is having Rs 10, quantity demanded is confined to 100 commodities. When the price falls
from Rs 10 to Rs 5, the quantity demanded increases from 100 to 200 commodities. If it is so, what type of
elasticity is prevailing? Find out with the help of formula.

74
As per formula,

Ed =dQ /Q; dP/P

Ed = 200-100/100‟ 10-5/10

Ed = 100/100;10/5

Ed = 100/100 ‟ 5/10 =2

Ed >1. It is greater than unitary. Then, it is called as relatively elasticity of demand

e) Unitary elasticity of demand

If the price of Y is having Rs 10, a consumer purchases 5 commodities. When the price of Y increases, to Rs12.
if a consumer purchases 4 commodities. If it is so, what type of elasticity prevails in the case of Y commodity?
It can be verified from the following formula.

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As per formula,

Ed = dQ /Q; dP/P

Ed = 5-4/5; 12-10/10

Ed = 1/5; 2/10

Ed = 1. It is indication for unitary elasticity of demand.

f) Relatively inelasticity of demand

If the price of Z commodity is having of Rs 20, a consumer purchases 5 commodities.
When the price of commodity increases to Rs 40, if a consumer purchases only 4 commodities. If it is so, find
out what type of elasticity is prevailing? It can be verified from the following formula.

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As per formula,

Ed=dQ /Q; dP/P

Ed = 5-4/5; 40-30/20

Ed = 1/5;20/20

Ed = <1. It is called relatively inelasticity of demand.

(Supply analysis)

10)Examine the law of supply and its exceptions?

The concept of supply has more value in day-to -day life. The behavior of seller or producer can be analyzed
in this chapter. To determine the price of the commodity, it requires the help of supply as well as demand.
Marshall, economists, defines the supply as “the various quantities of commodity that are offered for sale at
different prices in a given period is known as supply. From this definition that is understood that more
commodities are sold at higher price and vice-versa.
Determinant factors
There are different factors influencing the supply which are as follows.

S = f (P, Fp, Fo, T, G )

S = Supply

F = function

P = Price of the commodity

Fp = prices of factors of production.

P = Prices of other goods

Tc = Technology of a firm

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 All these factors influence the supply. However, being other things are constant, let us verify how the price of
a commodity will influence the quantity of supply? Then equation becomes like S = f (P). The relationship that
is existing between the price and quantity of supply is known as supply price which can be further divided into
two categories that is individual supply curve and market supply.

Individual supply

The opinion of single seller in another way is called as individual supply which can be verified from the
following table.

Table
---------

Price Quantity of supply

5 5
4 4
3 3
2 2
1 1

From the table, it is understood that when the price of commodity has Rs 5, a seller sells 5 commodities while it
falls to Rs1, a seller sells 1 commodity. It shows that there is a direct relationship exists between price and
quantity offered which can be represented in the form of diagram.

78
 The price and quantity of supply are shown on OY and OX axis respectively. When the price is OP1, quantity
of supply is confined to OM1, while it increases from OP1 to OP2, the quantity offered also increases from
OM1 to OM2. Hence, the supply curve falls from left to right towards the upward direction.

Market supply

The behavior of large number of sellers in another way is called as market supply which can be verified from
the following table.
Table
Price Seller‟ A‟ Seller „B‟ Seller‟ C‟ A+B+C
Market
5 5 6 7 18 M.T
4 4 5 6 15 “

3 3 4 5 12 “
2 2 3 4 9 “
1 1 2 3 6“

Table reveals that when the price of a commodity is having Rs 5, all sellers offering 18 million tons of sugar in
the market, while it falls from Rs 5 to Rs 1, the quantity of offering decreases from 18 million tons to 6 million
tons which can be verified from the following diagram.

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 The price and quantity of supply are represented on OY and OX axis respectively. If the price of the
commodity increases from OP1 to Op2, the quantity of offering increases from OM1 to OM2 which shows that
there is a direct relationship is existing between the price and quantity offered. Hence, the supply curve is
falling from left to right towards upward direction. Taking the market supply curve as a basis, we can make law
of supply that” being other things are constant, when the price of commodity increases, more well be supplied,
price decreases less will be supplied.” This law applies for majority of commodities which exist in the day-to-
day life. However, it does not apply in the case of certain commodities.

Exceptions

a) Rare commodities

The law of supply cannot be applied in the case of rare commodities. For instance, Raphael, great painter,
drawn 4 paintings and later on passed away. Then supply of commodities becomes constant. Moreover, no other
painter is unable to draw as like the Raphael. If it is so, supply becomes perfectly inelastic which can be verified
from the following table.

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 Table

Price Quantity of supply

1000 4
2000 4
3000 4
4000 4

Table reveals that when the price of a commodity is having Rs 1000, the quantity of supply is confined to 4
commodities. When the price increases to Rs 5000, even then the supply is confined to 4 commodities. It shows
that there is a change in price but nothing changes arising in quantity supply which can be verified from the
following diagram.

The price and quantity of supply are represented OY and OX axis respectively. When the price of rare
commodity is having OP1, the quantity offered is confined to OM. When the price increases from OP1 to OP2,
the quantity offered is confined to OM only. There is a change arising in price, but nothing change is arising in
quantity of supply. Therefore, the supply curve becomes horizontal to OY axis which becomes against to the
law of supply.

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Service of labor

As per the expert‟s opinion, a labor cannot work more than eight hours ina day. After 8hrs, even though
wages increase, a labor is unable to extent his services which can be understood from the following table.

Table

Wages of labor Hours of service

Rs 500 4
Rs 800 5
Rs 1000 8
Rs 1500 6
Rs 2000 5

For instance, when the wages increase from Rs 500 to Rs 1000, service of labor is extending from 4 hours to 8
hours. After 8hrs when the wages increase from Rs 1500 to Rs2000, he is unable to extend his services. Taking
the table as a basis, diagram can be drawn

The wages and hours of service are represented on OY and OX axis respectively. When the wages is OP1,
service is extended up to OM1. When the wages increase from OP! to OP2, the extending of service has fallen
from OM1 to OM2 which becomes backward bending curve. It is against to the low of supply.

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 11)Examine the extension and contraction of supply?

The law of supply reveals that if there is a change in price, it leads to change in quantity of offered. However, in
the case of contraction and extension, we find there is no change in the price of the commodity, but change
arises in supply. It happens due to change in other factors such as taste and preference of the consumers, climate
standard of living of the people etc.

The price and quantity of supply are represented on OY and OX axis respectively. When the price of
commodity has OP1, the supply of commodity in a particular periodic increasing from OM1 to OM2 but
another time itis decreasing from OM1 to OM3. If it happens like this, it is called as extension and contraction
situation.

12)Examine the equilibrium of market?

In ordinary language, wherever the sellers and buyers gather in a place, that place is known as market.
However, it is not case in economic terms. In economic terms, without gathering in a place, it becomes market.
As per economical terms, supply and demand, together, becomes market. The supply refers on the side of seller
whose opinion is different from buyer. The motto of seller is to get profit whereas the motto of buyer is to get
maximum benefit, both are going in opposite direction. However, at a price, both are coming to an agreement
that price is known as equilibrium price. Let us see, how both are coming to an agreement, which can be
verified from the following table.
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 Table
----------
Price Quantity of demand Quantity of supply
5 100 500
4 200 400
3 300 300
2 400 200
1 500 100
When the price of commodity has Rs 5, the quantity demanded is confined to 100 commodities whereas the
quantity of supply is confined to 500. It implies that the opinion of sellers is different from opinion of buyers.
The sellers want to sell more commodities at higher price whereas buyer want to purchase more commodities at
lower price. However, both are going in opposite direction. Finally, both are coming to an agreement at a price
of Rs 3 where seller willing to sell 300 commodities, while buyers willing to buy 300 commodities. Hence, this
price is known as equilibrium price.

The price and quantity of supply and demand are represented on OY and OX axis respectively. The
market supply curve is going towards the upward direction while the demand curve is going downward
direction because the opinions of both are different. As per diagram, buyers and sellers are coming to an
agreement at price of OP which is called as equilibrium of price. In this regard, author namely Marshall is

84
comparing with a particular simile that “to cut a piece of cloth, it requires two blades of scissor similarly to
determine the price of the commodity, it requires the help of supply and demand equally.”

13)What is meant by demand forecasting? Examine the types of forecast?

The main motto of any firm is to get profits. It depends on sales quantity of a firm. The
sales forecast determines the quantity of production. The production involves the use of various inputs. The
demand forecasting is very crucial for business organization.
A forecast is a prediction of future. The effective decision of organization depends on forecasting. Author
namely Caniff and Still defines forecasting as “demand forecasting is an estimate of sales during a specified
future period which is tied to a proposal of marketing plan, and it assumes a particular set of uncontrollable and
competitive forces”

Types of forecasting
There are two kinds of forecast a) passive forecast and b) active forecast. The passive forecast predicts the
future demand in the absence of any change or action by the firm while active forecast is estimation of future
demand taking into consideration of various factors, for instance, T.V company takes no policy change to
influence future sales. If it is so, it is called as passive forecasting. If a company takes some action or change
with an intention to influence the demand of commodity, it is called as active forecast. In this way, a firm tries
to predict its sales volume at different price at different places for its product.

14)Examine the forecasting methods

In the case of subjective method, expenditure market intelligence and judgment power are
considered in making demand forecast. The subjective method further divided into different categories.

a) Consumer’s survey method

This is the demand forecasting method by which investigator collects the information from
customers directly or by sending pre-designed questioner to them. If it is not possible to collect information
directly, then the opinion of experts, salesmen, distributers, wholesale, retailers is ascertained to know to
views of consumers. The investigators will gather information regarding the price or quantity or quality of the
commodities. According to their opinion, commodities are to be modified.

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b) Seller’s opinion method

Another demand forecasting method applied when new product introducing in the market or
extending old product into the new areas for which information is gathered. In this regard, few people who
belong to whole sales are selected. However, sample of selection of whole sales depends on random basis. This
sample represents on behalf whole market. Based on opinions of customer, the modification is to be taken in
manufacturing of commodities.

c) Expert opinion method

This method is known as “Delphi Technique” which requires panel of experts. The experts are asked of
various questions concerned to commodities produced by an organization. Normally this method applied for
new product introducing in the market.

d) Trend method

This method in another way is called as “least square method”. As per this method, the data is
converted into a form of graphs which depicts the demand for commodity. This line can be drawn based on
data. Normally, initial period of organization and the present period of organization will be taken into
consideration. After drawing the line, it is verified whether it is having the nature of linear or non-linear.

e) Leading indicator method

The method is used for long-term purpose. For instance, bank rate which influences one side of bank deposits
on the other side influence of investment. The motto of lender (deposits) is different from barrower (investment)
. Therefore, information is to be gathered from lenders as well as borrowers regarding saving and investment
when both are equilibrium which in turn leads to stability of the economy.

86
f) Controlled experiments

This method refers to collecting of information concerned to sales and determinant factors of production. The
determinant factors can be categorized as price of commodity cost of production, climate, standard of living etc.
on which data is to be collected. Similarly, sales of commodity depend on the quantity and quality of product on
which data is to be collected. In this way, whatever the data is collected comes under the category of controlled
experiments.

87
 Self-assessment Questions.

1. Multiple choice questions. Each question carries ½ mark.

1) Demand forecasting is not governed by.

a) Forecasting level b) degree of orientation. c) degree of competition. D) market support.

2) Which of the following forecast for total dementor a particular product helps to provide a
basis to seek short term finances?
a) Long rum. B) short run c) medium rum. D) none of the above.

3) The total estimate of different trade associations can also be viewed as

a) Firm‟s forecast. B) industry level c) national level d) global level.

4) Which of the following forecasts is worked out bare on the levels of income and savings of
the consumers?
a) Firm level b) industry level c) national level d) global level.

5) Market demand is not affected by.

a) Demography factors. b) economic factors. c) social factors d) political factors.

6) The features of a good forecasting method is

a) Complexity b) economy. C) demographics. D) unavailability.

The demand curve slopes.

a) Upwards b) downwards. c) linear. D) none of the above.

7) Market potential is
a) Minimum possible level of demand.
b) B) lower limit to market demand.
c) Declining limit to market demand
d) Maximum possible level of demand.

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 8) The market demand for a given marketing effort is called.
a) Estimated demand.
b) Market potential
c) Market structure.
d) Law of demand.

9) Which of the following is not a demand forecasting method?

a) Moving averages method.
b) Static approach
c) Simultaneous equations method.
d) Judgmental approach.
10) Survey method is considered more advantageous.
a) When the buyers are in large numbers.
b) When buyers are inaccessible.
c) When the consumers do not slide to their intentions.
d) When the product is new to the market for which no data previously exists.

2. Fill in the blanks. Each question carries ½ mark.

1) Demand forecasting is relatively easier in case of --------- Products.

2) Where total number of customers in the population are studied, ------methods said to be
employed.
3) In case of producers‟ goods, where the number of consumers are ------ survey of buyers‟
intentions method can be advantageously used.
4) To assess the demand for a new product, find out the demand for a related existing product
and --------- the demand for the new product.
5) The market demand for a given marketing effort is called. ----------
6) Census method is also called ---------- method.
7) Name an organization that conducts survey periodically----------

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 8) Export opinion method does not involve any --------- on the part of export.
9) The method where trend line can be fitted based on the available data is called --------
10) When the past data is arranged chronologically ---------- emerge.

Answers for Multiple choice questions.

1) d, 2) b, 3) c, 4) c, 5) c, 6) c 7) b, 8) d, 9) a, 10) b.

Answers for fill up the blanks.

1) Established 2) census 3) limited 4) project. 5) market forecast 6) total

consummation.

7) ORG-Marg 8) accountability. 9) least squared method. 10) time series.

3. Short-answer questions.
a) Law of demand.
b) Market demand.
c) Price elasticity of demand.
d) Income elasticity of demand.
e) Crossed demand.
f) Demand forecasting
g) Geffen paradox.
h) Veblen goods
i) Law of supply.

4. Essay type questions.

a) Explain the law of demand and its expectations?
b) Examine the various types of elasticity of demand?
c) Examine the point or geometrical measurement of elasticity of demand?
d) Explain the importance of demand forecasting?
e) Examine the law of supply and its expectations.
f) Explain the elasticity of supply/

90
 Unit-III

Production, Cost, Market structures &Pricing.

1) Explain the importance of production function?

In traditional production theory, resources used to produce a product are known as factors of
production. Factors of production are now termed as inputs which may mean the use of the services of land,
labor, capital, and organization in the process of production. The tern output refers to the commodity produced
by the various inputs. Production theory concerns itself with the problems of combining various inputs, given
the state of technology, to produce a stipulated outp0ut. The technological relationships between inputs and
outputs are known as production functions. It deals with production theory in the traditional manner while the
modern approach in terms of the iso-quant- is cost analysis.

Production Function
The production function expresses a functional relationship between quantities of
inputs and outputs. It shows how and to what extent output changes with variations inputs during a specified
period. In the words of Stigler, “The production function is the name given to the relationship between rates of
input of productive services and the rate of output of product. It is the economist‟s summary of technical
knowledge. “Basically, the production function is a technological or engineering concept which can be
expressed in the form of a table, graph and equation showing the amount of output obtained from various
combinations of inputs used in production, given the state of technology. Algebraically, it may be expressed in
the form of an equation as

P = f (L, La, C, O, T)
P = Output
L = Land
La = Labor
O = Organization
T = Technology
F = Functional relationship
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The production function with many inputs cannot be depicted on a diagram. Economists, therefore, use a two-
input production function. If we take two inputs, labor and capital, the production function assumes the form.

P = f ( L, C )

The production function is shown in the form of diagram as follows.

The production function as determined by technical conditions of production is of two types, it may be rigid or
flexible. The former relates to the short-run and the latter to the long-run.

In the short run, the technical conditions of production are rigid so that the various inputs used to
produce a given output are in fixed proportions. However, in the short run, it is possible to increase the
quantities of one input while keeping the quantities of other inputs constant to have more output. This aspect of
the production function is known as the law of variable proportions.

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 In the long run, it is possible for a firm to change all inputs up or down in accordance with its
scale. This is known as returns to scale. The returns to scale are constant when output increases in the same
proportion as the increase in the quantities of inputs. The returns to scale are increasing when the increase in
output is more than proportional to the increase in inputs. They are decreasing if the increase in output is less
than proportional to the increase in inputs.
Let us illustrate the case of constant returns to scale with the help of our production function.

P = f (L, La, C, O, T)

Given T constant, and if the quantities of all inputs such as L, La, C, O, are increased,
then P also increases par ally is known as constant returns to scale. If the increase the output is more than the
inputs, it is known as increasing returns to scale. If the increase in the output is less than the inputs, it is known
as decreasing returns to scale.
Conclusion
The production function exhibits technological relationship between physical inputs and outputs and is
thus said to belong to the domain of engineering. Prof. Stigler does not agree with this commonly held view.
The function of an entrepreneur is to start out the right type of combination of inputs for the quantity of output
he desires. For this he must know the prices of his inputs and the technique to be used for producing a specified
output within a specified period. All these technical possibilities are derived from applied sciences but cannot
be worked out by engineers alone. The production function is, in fact, “the economist‟s summary of
technological knowledge”, as pointed out by Prof. Stigler.

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 2) Examine the law of variable proportions?
Or

Explain the law of diminishing returns?

The law of variable proportions occupied an important place in economic theory. It explains the relationship
that existing in between output and inputs. However, author namely Marshall defined the law as “an increase in
the labor applied in the cultivation of land causes in general a less than proportionate increase in the amount
produce raised unless it happens to coincide with an improvement in the art of agriculture”. From the definition,
it is understood that if variable capital that is labor increases in the cultivation of land being other things are
constant, causes in general to diminishing of production. This law supported by empirical evidence which
occupies an important place in the economic theory. The law is depending on sum assumptions.

Assumptions

a) This theory applies for short period only.

b) It applies only for agriculture.
c) There is no change in technology.
d) Labor is a variable factor and other factor are remaining constant.
e) The variable factor has nature of homogeneous.

Explanation of law

Taking all these assumptions as a basis, it can be studied. The production is divided into three categories that is
total, average, and marginal production. The changes of output are explained in three different stages i.e.
increasing, diminishing and negative returns. Let us assume that a person has purchased 10 hectors of land by
spending an amount of Rs 10 lakes. Despite this, for construction of bore well, he spends an amount of Rs 2
lakes which in turn lead to total fixed cost of Rs 12 lakes. Having this situation, now a question arises in the
mind of landowner how many labors (variable factor) are required for cultivation of land every day. Taking this
law as a basis, he determines number of labors which can be verified from the following table.

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 Table

Units of Labor. Total production Average Marginal production

production
1 3 3 3
2 7 3.5 4
3 12 4 5
4 16 4 4
5 19 3.8 3
6 21 3.5 2
7 22 3.1 1
8 22 2.7 0
9 21 2.3 -1
10 1.9 1.9 -2

From the table, it is understood that when the labors are increased in the cultivation of land, causes to
increase not only in marginal product even the average and total production. This type of situation is happing up
to the 3rd labor. Therefore, in this stage increasing returns are occurring that means profits are increasing. In the
second stage, when the quantity of labor increases, the marginal as well as average production is decreasing.
However, total production is increasing. Thus, the second stage is called as diminishing returns. In other words,
profits are decreasing. However, in the third stage all are decreasing. Hence, third stage is called as negative
stage where loss is occurring to the landowner. Having this situation, the landowner decides to be in the second
stage where the profits maximum. It implies that taking marginal production of labor as a basis, the landowner
decides to engage 7 labors every day for cultivation of 10 hectors of land. In other words, the contribution of
labor is more than the wages received from the landowner. In other words, it is called as origin of surplus.
However, the contribution of 8th labor is zero because the contribution of labor that is marginal production and
wages received from the landowner both are equal. Taking this law as basis, when the landowner engages 8th
labor, he will neither get profit nor loss. Thus, after analyzing the situation, the landowner will engage
accurately only 7labors every day for cultivation of 10 hectors of land. Taking the table as basis, it can be
converted into diagram which clarifies the further.

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 The production and number of labors are represented on OY and OX axis respectively. In the first stage, total,
average, marginal productions are increasing. In other words, profits are increasing. Wherever marginal and
average production curves intersect at point of Q, which is indication of second stage where profits are falling
towards down wards. In the third stage, all the curves i.e., TP, AP, and MP are declining. In other words, loss is
occurring. Knowing this situation, landowner never prefers either to stay in the first or third stage but prefers to
stay in the second stage where the profits are maximum. In another way, it is called rational production
decision.

Importance

a) This law applies not only agriculture but also other sectors such as industrial and service sectors.
b) In the case of India, population is increasing at geometrical ratio whereas food production is increasing
at arithmetical ratio. This difference leads to origin of diminishing returns.
c) This law has a great significance for underdeveloped countries where agriculture is the main occupation.
This theory explains why migration of labors takes place from agriculture sector to other sectors.

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d) As a result of technological progress, developed countries achieved growth rate which can be verified
from thefollowing diagram.

The average production and variable factor are represented on OY and OX axis respectively. The
developed countries such as America, Australia, and England etc. achieved growth rate from point B to E.
However, this progress is confined to short run only. In the case oflong run diminishing returns occurs.

3) What is meant by Equal production curve or Iso-quant curve?

The combination of labor and capital which yields same level of output is known as equal production or iso-
quant curve. Inputs are required to produce the output. In this connection, labor and capital become the inputs.
To produce the commodity, various combinations of inputs are required. The motto of entrepreneurs is to get
more profits with minimum cost. Let us verify the definition of production with the help of table.

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 Table
--------
Combination Labor Capital Output
A 12 1 100

B 8 2 100

C 5 3 100

D 3 4 100

E 2 5 100

From the table, it is understood that 1 unit of capital and 12units of labor yields the total output of 100 units.
Similarly, 2 units of capital and 8 units of labor also yields total output of 100 units. It shows that combination
of factors is changing but the total output is the same which can be verified from the following diagram.

The labor and capital are represented on OY and OX axis respectively. The
combination of A consisting of 12 units of labor and 1 unit of capital which yield 100 units of output whereas
the other combination of B which consisting of 2 units of capital and 8 units of labor which yields 100 of
output. It shows that combination is
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Changing but the level of output is the same. Therefore, the iso-quant curve or equal production curve is falling
from left to right towards the downward direction.

Marginal rate of technical substitution

When the iso-quant or equal production is convex to the origin, it implies that the principle
of marginal rate of technical substitution (MRTS) is applied. In another words, it can be said that one factor is
substituted for another. Therefore, it is called as substitution principle which can be verified from the table.
Table
Combination Labor capital MRTSxy=-dY
/dydy/dx
A 12 1 -
B 8 2 1 :4
C 5 3 1: 3
D 3 4 1: 2
E 2 5 1: 1

From the table, it is understood that to get one more unit of capital, 4 units of labor must forgo. Later,
forgoing of labor for capital is going on decreasing such as 3, 2, 1 etc. In another words, substitution principle is
being applied. Taking the table as a basis, it can be converted into diagram which is as follows.

The capital and labor are represented on OY and OX axis respectively.

Slope of IQ at the point of B =SA/SB=MRTSxy

B = 12-8/2-1= 4/1=4

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 It is to be noted that the MRTS is equal to the ratio of marginal physical product of the two factors of capital
and labor. When there is a shift from one point to another on the iso-quant, some quantity of labor is to be
forgoing to get additional quantity of capital. In this way, units of labor are to be given up. As the quantity of
capital increases, the amount of labor must decrease. In other words, it is called asMRTSxy= -dy /dx.

4) Examine the properties of iso-quant or Equal production curve?

The properties of indifference curve are divided into different categories which are as follows.
a) It should be convex to the origin.
As per the law, the iso-quant must be convex to the origin, then only the principle of marginal rate of
substitution of Y for X is applied. Then only, it becomes iso-quant or equal production curve. When IQ curve
goes toward right side, it indicates higher level of satisfaction or utility.

b) It should not be concave to the origin.

When it is concave to the origin, it becomes against to the law. The principle of marginal rate of technical
substitution cannot be applied. Moreover, forgoing of Y for X increases which becomes against to the law.It can
be verified form the following diagram.

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 The capital and labor are represented on Oy and OX axis respectively. As per the law, when a producer uses
of more labor, capital must decrease. In other words, inverse relationship is existing in between labor and
capital. The forgoing of labor for capital is going on increasing which becomes against to the law. Therefore, it
should not be concave to the origin.

c) It should not be straight line falling from left to right towards downward direction.
The iso-quant must be convex to the origin, and then only the law of substitution principle is applied. When
it is straight line falling from left to right towards downward direction, it becomes against to law which can be
verified from following diagram.

The capital and labor are represented on OY and OX axis respectively. When the iso-quant curve falls from
left to right, it implies that forgoing of labor is constant for getting one more unit of capital which is against to
the law. As per the law, forgoing of labor must decrease for getting of more units of capital. Hence, it becomes
against to the law.

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 d) It should not be horizontal to OX axis.

If it is so, Iso -quant should not be straight line to the OX axis which can be verified.

From the diagram, it is understood that Labor is confined to 12 units, whereas capital is confined to 1 unit.
This combination gives some level of production. As per law, when capital increases, the number of labors is to
be decreased However, it is not happening in this regard. Hence, it becomes against to the law.

e) It should not be vertical to Oy axis.

When indifference curve is vertical to OY axis, it becomes against to the law which can be verified from the
following diagram.

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The labor and capital are represented on OY and OX axis respectively. In the initial stage, one unit of capital
and 12 units of labor yield 100 units of output. As per the diagram, capital becomes constant while labor
increases from 12 unit to 17 units which certainly must give higher level of satisfaction. However, it is showing
same level of Production. If it is so, it becomes against to the law.

g) Explain about iso-cost line or budget line?

The iso-cost represents various combinations of imputes of capital and labor which leads same level of cost.
The motto of entrepreneurs is to produce more output with minimum cost. Let us assume that a producer has Rs
100 in the pockets. He wants to spend on two factors namely labor and capital. Let us assume that price of
capital Rs 20 while cost of labor Rs 10. Having this situation, let use how a producer spends total amount of
Rs100 on two factors namely capital and labour through this diagram.

Table-1
Combination Capital Labor Total output
A 5 0 100
B 1 8 100
C 2 6 100
D 3 4 100
E 4 2 100
F 0 10 100

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 From the table, it is understood that by spending Rs 100, a producer can purchase different combination of
capital and labor. The combination of capital and labor changing but total amount is the same. The table is
converted into diagram which is as follows.

The capital and labor are shown on OY and OX axis respectively. At the point of A, 4 units of labor and 3
units of capital require the amount or Rs 100. Similarly, different combination of labor and capital changes but
the amount of money is the same. By adding all the points, we can derive the curve that curve is called as iso-
cost line or budget line which falls from left to right.

5)Examine the equilibrium of producer?

An iso-quant explains the various combinations of capital and labor which yields the same level of output.
Similarly,an iso-cost line represents various combinations of inputs of capital and labor which requires the same
amount of money. The main motto of any producer is to get maximum output with minimum cost. Wherever,
the iso-product and iso-cost lines are tangent at a point of Q which indicates the equilibrium of producer which
can be shown with the help of diagram.

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 The capital and labor are represented on OY and OX axis respectively. The equation of MRTSxy = -dy/dx is
an indication for equilibrium of the producer. The formula of MRTSxy represents the substitution of labor for
capital to produce equal level of output while Py/Px represents price of capital and labor which requires equal
amount which is in another way is called as iso-cost line. Both curves are tangent at that point of Q where IQ2
curve is tangent to budget curve which is indication for equilibrium of Producer. The motto of producer is to get
maximum production with minimum coat.

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 6)What is meant by returns to scale? Explain the various types of returns to scale?

Returns to scale tell us how production changes in response to an increase in all inputs
in the long run. An industry can exhibit constant returns to scale, increasing returns to scale or decreasing
returns to scale.

Study of whether efficiency increases with increase in all factors of production is

important for both businesses and policymakers. It tells businesses about their optimal production level, and it
lets policymakers determine whether the industry will consist of large number of small producers or a small
number of large producers.

Law of diminishing returns tells us what happens when one input increases while other inputs stay the same. It
is most relevant in the short run. evetime scale in which at least one factor of production is constant in the long
run, all factors of production can be changed, and it is then when the returns to scale become relevant.

There are three possibilities for total production function when all inputs increase (a)
Increasing at increasing rate. (b) increase at a fixed rate or (c) increase at a decreasing rate. These three
possibilities result in three forms of returns

a) Increasing returns to scale

.In industries subject to increasing returns to scale, a 1% increase in total inputs will result in a more than 1%
increase in total product i.e. total product increases at a rate higher than the rate in which all inputs increase.
Increasing returns to scale are also referred to as economics of scale.

You must be wondering whether it is not against the law of diminishing returns. It is not because the law of
diminishing returns is applicable only in short run for only a change in one input but the returns to scale
determine change in total production response to changes in all inputs. Causes of increasing returns to scale
include specialization of labor, synergies, etc.

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 The capital and labor are represented on OY and OX axis respectively. In the initial stage, combination of 3
units of capital and 4 units of labor produces 100 units of output. To produce additional of 100 units of
production, it requires additional 2 units of capital and 2units of labors. It implies that to produce additionally of
100 units of production, it requires less of inputs. Therefore, it is indication for increasing returns to scale.

b) Constant returns to scale

Constant returns to scale mean that product changes proportionately with increase in all inputs. In
other words, the percentage increase in total product under the constant returns to scale is the same as
the percentage increase in all inputs.

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The labor and capital are represented on OY and OX axis respectively. Initial stage to produce 100 units of
output it requires3 units of capital and 4 units of labor. However, to produce addition output of 100 units, it
requires same units of capital and labor. If it is so, it is called as constant returns to scale.

Examples:
Constant returns to scale prevail in very small businesses. For example, let us consider a car wash in
which one car wash takes 30 minutes. If there is one wash space (hydraulic jack) and two workers running two
8- hour shifts, total product would be 32. If there are two wash spaces and four workerlike. when inputs double,
total washes possible rise to 64 (=4x60/30) and so on.

c) Diminishing returns to scale

The law of diminishing marginal returns states that with every additional unit in one factor of
production, while all other factors are held constant, the incremental output per unit will decrease at some point.
The law of diminishing marginal returns does not necessarily mean that increasing one factor will decrease
overall total production, which would be negative returns, but this outcome usually occurs.

Reducing the impact of the law of diminishing marginal returns may require discovering
the underlying causes of production decreases. Businesses should carefully examine the production supply
chain for instances of redundancy or production activities interfering with each other.

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 By reversing the law of diminishing returns, if production units are removed from one
factor, the impact on production is minimal for the first few units and may result in substantial cost savings. For
example, if restaurant removes a few cooks rather than hiring more, it may realize cost savings without
experiencing significantly diminished production.

The labor and capital are represented on OY and OX axis respectively. In the initial stage to produce 100 units
of output, it requires 4 units of capital and 2 units of labor. Similarly, to produce additional 100 units of output,
it requires 6 units of capital and 4 units of labor. It shows that to produce additional unit of production, it
requires the of Rs160. However, in the initial stage, it requires on Rs100. To produce additional 100 units, cost
is going on increasing which is indication for decreasing returns to scale.

Example:
For example, a restaurant hiring more cooks while keeping the same kitchen space can increase total
output to a point, but every additional cook takes up apace, eventually leading to smaller increases in output as
there are too many cooks in the kitchen. The total output can decrease at some point, resulting in negative
returns if too many cooks get in each other‟s way and eventually become unproductive.

In the case of industry, increasing returns occurs in the beginning, later on it leads to constant returns and
finally it leads to diminishing returns which can be verified from the following diagram.

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 The marginal production and scale of production are represented on OY and OX axis respectively. In the case
ofa firm, increasing returns occurs in the begging. Later on, it leads to constant and finally leads to origin of
decreasing. In other word, initially cost will decrease, later it becomes constant and finally leads to increasing of
cost. Due to this the variations of returns occurs.

7)Examine the Cobb-Douglas production function?

Many actual production functions have been examined by economists to measure

relations between changes in physical inputs and physical outputs. A famous statistical production function is
the one associated with the names of professor C. W. Cobb and P.H. Douglas. In its original form, the Cobb-
Douglas function applied to the whole of manufacturing in U.S.A. However, it can be applied to a sector of the
economy such as manufacturing or to the whole economy.

Cobb-Douglas function can be stated as follows:

P = b L k +CL 1-k ; in which

P = Actual output

L = Labor

C = capital

b= Number of units of labor

k = exponent of labor

1-k = exponent of capital

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 Number of studies was made in the 1920‟s and 1930‟s by Cobb-Douglas. Director and others, which
showed that the Cobb – Douglas function of k and 1-k was found almost to be correct. However, in 1937 David
founded proposed that the restricted function of
P = b L k C1-k

be abandoned for one in which, the exponent for capital was independently determined.
According to Durand, the use of k and 1-k function assumed the existence of constant returns. Instead, if the
exponent of capital is independently determined, it would then be possible for the sum of the exponents to be
either greater or less than unity and hence to show the actual returns to scale which may be increasing,
diminishing or constant. Hence another formula of cobb-Douglas function is

P = b L k C1
Three of the four time series studied by Douglas showed that the sum of k and 1 was
slightly less than unity suggesting the possibility of diminishing returns. However, Douglas found that the
deviation from unity was very insignificant indeed. For instance.

k= .63 or 64

j= .34

k + j = .97 or 98

If both factors of production were increased by 1% then the total product would normally
increase during a given period by 97 to 98 per cents and if the sight suggestion of diminishing returns is
disregarded and if the most probable sum of the exponents is equal to unity, then an increase of 1% in quantities
of both labor and capital would normally result in a corresponding increase of 1% in product. A one-per cent
increase in the quantity of labor alone would normally be accompanied during a given period, by an increase of
approximately 2/3 of 1% in the product; and an increase of 1% in the quantity of capital alone would normally
be accompanied by an approximate increase of 1/3 of 1% in the product.

In Cobb-Douglas function, the sum of the exponents shows the degree of „returns to scale‟
in production:
k + j> 1 increasing returns to scale

k + j = 1 constant returns to scale

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 k + j < 1 decreasing returns to scale

The sum of these co-efficient shows the degree of homogeneity of the function. If k+ j is equal
to unity. We say that the production function is homogeneous of the first degree.

Under these conditions (i.e. k + j = 1) the elasticity of marginal productivity curves for a
given factor is equal in the reciprocal of the exponent foe the other factors, i.e.

eL = 1 / 1-k and e C = 1/ 1- j

It follows that the approximate elasticity of the formal marginal productivity curve for labor
would seem to be not far from 3.0 and for capital to be around1.5.

It is interesting to observe the numerical affinity between the technical co-efficient of the exponential
production function and the independent aggregative statistic on factor shares in nation income. Not only do the
factor shares tend to be constant, but they also tend to give the same value of the production coefficients. In this
respect, Douglas research has been testing of marginal productivity theory of wages as well as a good
description of production technology. Douglas and others made time series and cross section studies for
manufacturing industry of the U.S.A., Canada, Australia, New Zealand, and south Africa. Douglas was struck
by the similarity of result on the whole. The labor exponent was about two-thirds, and the capital exponent was
one-third. As already mentioned, there was slight evidence of diminishing returns to scale, but the exponents
seemed to be unity, of sampling errors were considered. An implication of the Cobb-Douglas function that
labor‟s share of national product tends to be constant under competitive market conditions. Their function has
many interesting properties that make it a very convenient choice and it graduates data on output and input well.

8)Examine the Linear Production function?

Or
Explain the Linear Programming?

Linear Programming is a mathematical device developed by the mathematician George

Dantzig in 1947 for planning the diversified activities of the U.S Air force connected with the problem of
supplies to the forces. Linear or mathematical programming, also known as activity analysis. It has been
further developed in its application to the economic theory of the firm, managerial economics, inter-
regional trade, general equilibrium analysis, welfare economics, and to development planning. In the

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analysis that follows, the Linear Programming techniques is applied to the theory of the firm.

Linear Programming is a mathematical technique for the analysis of optimum decisions subject to certain
constraints in the form of linear inequalities. Mathematically speaking, it applies to those problems which
require the solution of maximization or minimization problems subject to a system of linear inequalities
stated in terms of certain variables. Linear programming may thus be defined as a method to decide the
optimum combination of factors (inputs) to produce a given level of output. It is also used by a firm to
decide between a variety of techniques to produce maximum output.

The application of linear programming technique to any problem rests on certain conditions and
generalizations. Firstly, there is a definite objective. It may be the maximization of profits or output or the
minimization of costs. In other words, a quantity is maximized, its s negative quantity is minimized.
Every maximization problem has its dual problem that of minimization. The original problem is the
primal problem which always has its dual If the primal problem pertains to maximization, the dual
involves minimization and vice versa. Secondly, there should be alternative production processes for
achieving the objective. The concept of process or activity is the most important in linear programming.
A process is a specific method of performing an economic task. It is some physical operation e.g.,
consuming something, storing something, selling something, throwing something and manufacturing
something in a particular manner. The technique of linear programming enables the decision-making
agency to choose the most efficient and economical process in attaining the objective.

Application to the theory of the Firm.

The neo-classical theory of the firm analyses theproblem of decision – making with one or
two variables at a time. It is concerned with one production process at a time. The production function in
linear programming, goes beyond these limited fields of economic theory. It takes into consideration the
various capacity limitations and the bottlenecks which arise in the process of production. It makes a
choice among the various complex productive processes so as to minimize costs or maximize profits.
Assumptions
The linear programming analysis of the firm is based upon the following assumptions.

• The decisions making body is faced with certain constraints or resource restrictions. They
may be credit, raw material, and space constraints on its activities. Type of constraints, in
fact, depends upon the nature of problem. Mostly, they are fixed factors in the production
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 process.
• It assumes a limited number of alternative production processes.
• It assumes linear relations among the different variables which implies constant
proportionality between inputs and output within a process.
• Input-output prices and co-efficient are given and constant. They are known with certainty.

Mathematical and Graphic Solutions:

We attempt below a complete description and working of some problems of linear

programming mathematically and graphically.

A) Maximization of Revenue:

Take a firm that produces two products X and Y at given prices of Rs12 and
Rs15 respectively for each unit To produce product X, the firm requires 12 units of input A. 6
units of input B and 14 units of input C. Product Y requires 4 units of input A, 12 units of B
and 12 units of input C. Total available inputs in each case are 48 units of A. 72 units of B and
84 units C. The input-output data for this problem.

Table
Input-output Data

Category Number of inputs Number of inputs Total inputs available

Required to produce required to produce in Each case
one unit of output one unit of output.
Input X units Y units Units
A 12 4 48
B 6 12 72
C 14 12 84
Net revenue per unit Rs 12 RS 15 --
of product

Every linear programming problem has three parts to start with. They are as follows.

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The objective function:

The objective function states that if the two products X and Y bring the revenue of Rs.12 and Rs15 per unit,
how much of these products be produced so that the firm earns the maximum revenue. It can be written as
Mas: R = 12X +15Y

The constraints: The above table can now be transformed in the form of equations signifying the constraints or
restraints within which the firm operates. These are known as structured constraints.

First, we take input A. The maximum available quantity of input A is 48 units. But the
product of X and Y amounts of the two products cannot be greater than 48 nits. Mathematically, since 12X +
4Y cannot be greater than 48 units, the constraints imposed by input a would be 12X + 4Y≤48. With the same
reasoning we can have the constraints in terms of inequalities for input B and C. Thus the three structural
constraints in our problem can be written as:

12X + 4Y ≤ 48

6X + 12Y ≤ 72

14X + 12Y ≤84

Where X and Y are our choice variables viz, units of inputs.

The Feasible Region:

The shows that all the points in the shaded area bounded by the three lines intersecting
each other would satisfy the three inequalities which can be seen from the following diagram.

115
 In the diagram, Units of X is shown on OX axis, while Unit of Y is represented on OY
axis. At point S, line EF intersects line CD and at T, line Cd intersects AB. Thus, the shaded area OBTSC which
lies below and to the left of the three lines intersecting at points S and T satisfies the inequalities of the three
equations. This shaded area is called the feasible region of production and every point within the region or on
the boundary of the region represents the feasible solution to our problem.

The Optimal solution:

Out of the various points B, T, S, C which represents the feasible solution. We must find out the optimal point
that would maximize the revenue of the firm. How to get this point algebraically?

We know the coordinates to points B and C from Equations (1) and ( 2) whereby OB= 4X,
and OC= 6Y. To determine the coordinates of point T, we treat Equations (1) and (3) as simultaneous equations
because the lines AB and EF representing them intersect at T and solve them as

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 12X + 4Y = 48 --------- (1)

14 X + 12Y = 84 ------- (3)

By multiplying equation (1) by 3 and subtracting the latter from it, we ave

36X + 12Y = 144

14X + 12Y = 84

22X - = 60
X = 2.73
By substituting this value of X in equation (1), we obtain

12 x 2.73 + 4Y = 48

32.76 +4Y = 48

4Y = 48-32.76

4Y = 15.24

Y = 3.81
Thus, the coordinates of point T are X=2.73 and Y =3.81. Similarly, we can solve the
coordinates of point S with equation (3) and (2) which arrive at X =1.5 and Y =5.25

14 X + 12Y = 84 ------ (3)

6X + 12Y = 72 ------- (2)

8X + 0 = 12

X = 12/8 = 1.5

14 x 1.5 + 12Y = 84

21 + 12Y = 84

12Y = 84-21 =63

Y = 63/12 =5.25
Y = 5.25
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 In order to find the optimal combination of X and y, we substitute the values of X
(Rs.12) and Y ( Rs 15) into the values of the coordinates of the various corner points arrived at in the
above pares.

At B, we have X=4 and Y=0, and substituting these in the objective function.

(Rs) R – 12X + 15Y, we have

(Rs12) (4) + (Rs15) (0) – Rs 48 ------------------------ 1

At T, we have X=2.73 and Y = 3.81 and similarly obtain

(Rs 12) (2. 73) + (Rs. 15) (3.81) = R 89.91 ------------- 2

At S, we have X=1.5 and Y = 5.25 and we obtain

(Rs.12) (1.5) + (Rs.15) (5.25) =96.75 ----------------- 3

At C, we have Y=6, and X =0, and we get

(Rs.12) (0) + (Rs15) (6) – Rs90 ------------------------ 4

From the above equation, we find that equation (3) gives the maximum revenue of Rs.
96.75. This shows that given the prices of the two products X and Y, and given the number of inputs
(Minimum cost) the total revenue ( maximum Profit) of the firm is maximized at point S which is the
optimal point subject to the given conditions.

9)What is meant by cost? Explain the various types of cost?

The term „cost‟ has a wide variety of meanings. The normal concept cost most widely used
is the „money cost‟ of production which relates to money expenditure of a firm on wages and salaries paid to
labor, payments occurred on machinery and equipment, payment for materials, power, light, and transportation
etc., payments for rent and insurance and payments to government by way of taxes. Money costs, therefore,

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relate to money always by a firm on factors of production which enable the firm to produce and sell a product.
Every producer is interested only in money costs.

Value or price of a product depends upon its demand and supply. Demand is concerned with
the behavior of the consumer and supply with the behavior of the producer of the product. But the supply of a
commodity or service depends primarily on its cost. It is cost of production in relation to price that guides a firm
to produce or not to produce, how much to produce and sell and whether to expand or contract the output. The
cost of production can be divided into different categories which are as follows.

Types of cost

a) Nominal cost

The nominal costs in another way are called as monetary costs which includes cost of
machinery, buildings, fuel, transport, interest, insurance, labor cost and so on. These costs are paid by concern
firm when it produces the output. When these costs are paid in the form of money is known as monetary costs
which include implicit and explicit costs. When the factors of production brought from outside for which prices
are paid that prices are known as explicit costs whereas the factors which belongs to its owners‟ factors for
which prices are to bepaid that price are called as implicit cost. The combination of explicit and implicit costs is
known as monetary costs.

b) Real cost

Another concept of cost is real cost. According to Marshall, money payments are made to factors of production
to compensate for utilities of rendering their services. The exertions of all the different kinds of labor that are
directly or indirectly involved in making it: together with the business or rather the waiting‟s required, for
saving the capital used in making all these efforts and sacrifices, together will be called the real costs of
production of commodity. Marshall is speaking her if the disutility, the pain of the discomfort involved for labor
when it is engaged in production and of the unpleasantness involved in saving and capital accumulation The
concept of real cost, though of some importance from the social point of view, takes precision since it is
expressed in subjective terms.

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 c) Opportunity cost.

A concept of cost, which has been popularized by the American writers and which is now widely used in
„opportunity cost‟ or alternative cost. The cost of production of any unit of a commodity A is the value of the
factors of production used in producing that unit. The value of these factors production is measured by the best
alternative use to which they might have been put, had a unit of A not been produced. In other words, the cost
of any factor unit could yield in the production of other goods. Since a firm must pay to owners of factor units
what these units can secure in alternative occupations, the costs are known as alternative or opportunity costs.

d) Fixed costs

We assume that in the sort run, there are some factors which are necessarily fixed and those which are freely
variable. The fixed factors that is machinery and the superior types of labor and the costs corresponding to such
factors are called fixed costs. Marshall called the fixed costs as supplementary costs or overhead costs. These
costs are fixed in the sense that they do not arrange in the short period. They are called supplementary, or
general or indirect costs and they are overhead costs because they are common for all units produced and not
special to any of them.

e) Variable costs.

The second set of factors in the short run refers to available factors etc., those factors which are freely
variable. They are raw materials, ordinary labor paid on work or daily basis, power and fuel, etc., The costs
corresponding to these factors are variable costs. Marshall called variable costs as prime costs or direct costs or
special costs. He included three main items under prime cost. The money cost of the raw material, wages of that
of labors spend in producing a certain output and the extra wear and tear of plant. Prime costs are direct costs
because the amount of volume of output coming from a firm will depend directly upon them. Since they
fluctuate of the volume of output, they are also called variable costs.

f) Explicit and Implicit costs:

The total cost of production, of any good can be said to include „expenditure‟ or ex‟ explicit costs and
non-expenditure or „implicit costs. Expenditure or outlay costs are those which are paid ty the employer to

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owners of the factor units which do not belong to employer himself. These costs are of the nature of contraction
payments, and they consist of wages and salaries paid, payments for raw materials, interest on borrowed capital
funds, rent on hired land and taxes paid to the Govt. and non-expenditure or implicit costs arise when factor
units are owned by employer himself. The employer in not obligated to anyone else to obtain these factors. The
two normal non-expenditure costs are depreciation and as average or normal return on the money capital
supplied by the investment holders in the case of small business units, the wages of the entrepreneur or
organizer himself will have to be included in this category. Expenditure on the explicit since they are paid to
factors outside the firm while non-expenditure cost is implicit and hence, they are imputed costs. But the latter
costs are the real costs, in the real sense of the term since the factors units owned by owner himself can supplied
to other producers for a contractual sum if they are used in the business of the organizer himself.

g) Cost-concepts

The expenditure on the fixed factor such as management, rent on business premises is treated as constant at Rs
200, irrespective of the volume of output. The expenditure on the variable factors increases but not at the same
rate. First, there are increasing returns of production or in other words, to produce a given quantity, lesser
amount is required. For instance, in our example, the unit can be produced with Rs 50 spent on variable factor
units, but to produce the nest two commodities RS 80 on variable factor units. It shows to produce additional
commodities variable cost in going on decreasing which can be observed from the following table.

Table
-------------
Production TFC TVC TC
1 200 50 250
2 200 80 280
3 200 100 300
4 200 110 310
5 200 115 315
6 200 125 325
7 200 140 340
8 200 184 384
9 200 280 480
10 200 370 570

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 From the table, it is understood that fixed cost is not changing but the variable cost is changing along with
the increasing of production. When the production increases, parallel the variable cost is also increasing. Due to
this, total cost is also increasing. It is increasing means due to variable but not total cost.

The costs and output are represented on OY and OX axis respectively. The total fixed cost is always
horizontal to OX axis. Even the production is not taken up, one must bear the fixed costs but not the variable
cost which arises when production starts. An amount spending towards the purchasing the raw material, wages
of labors, and electricity charges comes under the category of variable costs. The variable cost cure starts from
beginning. The combination of fixed and variable costs becomes total costs which fall from the left to right
towards upward direction.

10)What is meant by average cost? Examine the various types of average costs?

The cost is word refers to money spending on inputs which are made by a firm or an
organization. When a firm is going to manufacture a particular commodity, it has to spend money on various
raw materials. Whatever spends on inputs that comes under the category of total cost which includes the
variable and fixed cost. The variable cost refers to spending money towards raw material and service of labors
whereas the money spending towards the purchasing of land and machinery and building comes under the
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 category of fixed cost. The combination of variable and fixed cost is known as total cost. We are able to derive
the average cost by dividing the total cost by quantity of output. The average cost can be divided into different
categories which are as follows.

Average cost curves:

All cost curves are having the nature of „U” shape. Why they are having “U” shape can be understood from
the following table.
Table

Q TFC TVC TC AFC AVC AC MC

1 200 50 250 200 50 250 -
2 200 80 280 100 40 140 30
3 200 100 300 66.6 33.5 100 20
4 200 110 310 50 27.5 77.5 10
5 200 115 315 40 23 63 5
6 200 125 325 33.3 20.8 54.1 10
7 200 140 340 38.5 20 48.5 15
8 200 184 384 25 23 48 44
9 200 270 479 22.2 30 52.3 86
10 200 370 570 20 37 57.7 100

From the table, it is understood that fixed cost is having nature of constant while variable cost is having variation.
Similarly, average production curves are having the nature of “U-shaped which can be verified from the following diagram.

Short-run cost curves:

The firm has an appropriate short-run average cost curve. The pattern of these short run average cost corves is
shown in the diagram. We assumed that technological change is not there. It is constant. On the basis of it, the
short-run average cost curve is shown.

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 The costs and output are represented on OY and OX axis respectively. The average cost curves decreasing in
the beginning and later, increases. Overall, the average cost curves are having the nature of “U” shape.

Long-run average cost

The combination of short-run costs leads to origin of long-run cost curve which can be represented in the
form of diagram. This curve shows the least cost of producing each possible output. It shows that the lowest
possible average cost of producing any output when it is having adequate time to make all desirable changes
and adjustment. But when it considers the possibility of adjustment in the scale of operation, long run cost data

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are necessary. There is also called as envelope since it supports or envelopes a series of the short average cost
curves from below. s

The costs and output are represented on OY and OX axis respectively. The combination of different short run
cost curves leads to origin of long-run average cost curve. The long-run cost curve is having the nature of „U‟
shape which can be derived by adding of short-run average cost curves.

11)What is meant by revenue curves? Examine the types of revenue curves

concerned to perfect competition?

The term revenue refers to the receipts obtained by a firm for the scale of certain
quantities of commodities at various prices. The revenue of a firm with its costs determines the profit.
The motto ofany firm is to get profits. The revenue can be divided into different categories that is total
revenue, average revenue, and marginal revenue.

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a) Nature of revenue curves under perfect competition

In the case of perfect completion, there is a place for large number of sellers and buyers. They
together determine the price of the commodity that price is called as equilibrium price which cannot be
changed by a single seller or buyer. They must accept the price which is fixed in the perfect competition,
because the part of single seller or buyer is negligible. Moreover, whatever the commodity exchanging
in the perfect competition is confined to nature of homogeneous which can be observed from the
following table.

Table
-----------

Total Average Marginal

Quantity Price
Revenue Revenue Revenue
1 20 20 20 20
2 20 40 20 20
3 20 60 20 20
4 20 80 20 20
5 20 100 20 20

From the table, it is understood that when the quantity of commodity increases the total revenue
increasing from Rs 20 to 100. However, the marginal revenue is the same confined to Rs 20. Taking the
table as a basis, we can convert into a form of diagram which is as follows.

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 The total revenue and total output are represented on Oy and OX axis respectively. As
per the diagram, when quantity of commodities increases the total revenue also increases. However, the
price of the commodity, average and marginal revenue curves are the same which can be shown with
help of diagram.

Diagram ’A’
This diagram indicates the equilibrium of industry. The combination of firms is known as
industry or perfect completion. In the case of industry all firms would sell the commodities for one
price. Similarly, whether the price fixed in the perfect competition or industry that the price must be
accepted by a single firm.
Diagram ‘B’
This diagram is meant for a firm. In the case of a firm, the average revenue curve,
marginal revenue, price of the commodity etc. are the same. It means that no difference is there in
between the price of the commodity, average revenue, and marginal revenue. All are the same.
Therefore, they are horizontal to ox axis.
In another words, it can be said that whatever the price prevailing in industry or perfect
completion that price must be accepted by single firm. That is why all firms which are existing industry
will get normal profits. In other words, the price of the commodity must be always equal to average cost
(P=AC) which in turn leads to get normal profits. In perfect completion, the entire firms which are
existing in industry will get normal profits. These profits, in another way are called long-run profits.
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 12) Examine the various types of revenue curves concerned to imperfect competition?

In the case of perfect competition, there is place for large number of sellers and buyers.
However, in the case of imperfect competition, sellers divided into different categories. If there is single
seller and large number of buyers existing in a market that market is called as monopoly. If are two
sellers and large number of buyers exist in a market that market is known as duopoly. It is the same in
the case of oligopoly and monopolistic competition. All these categories come under the category of
imperfect competition. In the case of imperfect competition, price of the commodity is not constant.
When they want to sell more commodities, they must reduce the price of the commodity which can be
verified from the following table.

Table
-----------

Total Average Marginal

Quantity Price
Revenue Revenue Revenue
1 20 20 20 20
2 18 36 18 16
3 16 48 16 12
4 14 56 14 8
5 12 60 12 4
6 10 60 10 0
7 8 56 8 4

From the table, it is understood that a firm must reduce the price, to sell more commodities in
the market. When the quantity of sales increases the revenue also increases. However, the average and
marginal revenue curves fall from left to right towards downwards which can be verified from the
following diagram.

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The total revenue and quantity of commodities are represented on oy and ox axis respectively. The total
revenue increases up to a point, later, it decreases. However, it is different in the case of average and
marginal revenue curves fall from left to right towards downward direction which can be understood
from the following diagram.

The AR and MR are represented on oy axis while output is represented on ox axis. The
marginal revenue curve falls below the average revenue curve. It implies that to sell more commodities,
a firm must reduce the price of commodity. It is the situation of imperfect competition. s
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 13) What is meant by monopoly? Examine the various types of monopoly?

In normal language, wherever a single seller and large number of buyers are existing in a market is
known as monopoly. However, Salvatore, economists, defines in another way that “it is form of market
organization in which there is single firm selling a commodity for which there is no close substitutes”.
From this definition, it is understood that monopolist whatever he produces for which there is no
substitution in the market. In the case of monopoly, there is no difference in between firm and industry,
both are the same. Moreover, there is no place for the firms to inter or to leave the industry, because
only one firm which is in another way is called as industry. Therefore, it is called as single firm industry.
The motto of monopolist is to get more profits for which, he controls either the price or quantity of
output but unable to control both at a time.

Types of monopoly

The types of monopoly can be divided into different categories which are as follows.

a) Private and public monopoly

A firm function under the control of an individual or group of persons is called as

monopoly whose motto is to get abnormal profits whereas another firm which function under the control
of public authority is known as public monopoly whose motto is the welfare of the people.

b) Pure and limited monopoly

Whether the monopolist manufacturing a commodity for which if there is no substitution in
the market, it is known as pure monopoly whereas more substitution commodities are there in the
market, it is known as limited monopoly. The pure monopoly in another way is called as absolute
monopoly whereas limited monopoly in another way is called as relative monopoly.

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c) Simple and discriminative monopoly

If a firm whatever producing a commodity that commodity is going to sells for one price for
all customers, it is known as simple monopoly while the same commodity selling for different prices for
different customers, it is known as discriminative monopoly. For instance, railway charges, cinema
tickets, electricity charges etc.

d) Natural and Artificial monopoly

When nature itself providing some natural resources in a country is known as natural
monopoly. For instance, diamonds are more and more available in south Africa. Similarly, petrol is
available in Arab countries. All Arab countries formulated as association that association is called as oil
petroleum exporting countries (OPEC) which is the indication for artificial monopoly. If association
functions, there is a place for one price for one barrel of petroleum. If it is so, it is called as artificial
monopoly.

e) Legal and technical monopoly

When a firm produces a commodity on which it has patent right, no other firm has no right to
keep the same name. If it is so, it is called as legal monopoly. Similarly, a firm manufacture a
commodity using specific innovation technology is an indication for technological monopoly. No other
firm do not right to use the technology. If it is, it becomes against to the law.

14)Explain the equilibrium of monopoly industry?

Or
Examine how price is determined in monopoly firm?

Monopolist whatever produces a commodity for which if there is no substitution in the

market it is known as monopoly. In the case of monopoly, there is no difference in between a firm or an
industry, both are the same. Therefore, it is called as single firm industry. The main motto of monopolist
is the get abnormal profits. Hoverer, it can be achieved in the case of long run, because time is enough to
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adjust the situation. It cannot be achieved in the case of short period. To get abnormal profits, he must
control either the price of a commodity or quantity of output, but he is unable to control both at a time.
The commodity which is manufactured by a firm, or an industry is having nature of inelastic, he will fix
the higher price for it. If it is having the nature of elastic, he will fix lower price. In the case of
monopoly, the average revenue curve falls from left to right towards downward direction. Moreover, the
MR curve falls below the AR curve. Let us see how the monopolist gets abnormal profits in the case of
long run. However, this law is depending on some assumptions which are as follows.
Assumptions
1) There must be single seller.
2) There should not be close substitution goods.
3) The motto of a firm must be abnormal profits.
4) There should not be threat from competitors.
5) The principle of simple monopoly is followed.
Taking all these assumptions as a basis, we can study the behavior of a firm.

Equilibrium of monopoly –long- run.

In the case of long run, a firm or an industry has enough time to adjust the situation in
between supply and demand. In the case of monopoly,
AR is falling from left to right towards downward direction and MR curve falls below the AR. The AR
curve in another way is called as demand curve which falls from left to right towards direction. It
indicates that when monopolist wants to sale commodities, he must reduce the price of the commodities
which can be observed from the following diagram.

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 The price and output are represented on OY and OX axis respectively. As per the
diagram, monopoly output is confined to the level of OM and each commodity has OP price. The total
revenue is confined to OPCM. The total cost is derived by multiplying the total output of OM with the
cost of OR, then total cost becomes to the level of ORBM. If total cost of ORBM is deducted from
OPCM, the remaining balance leads to the rectangular area of PCBR which is indication for abnormal
Profit. For instance, monopolist produces a commodity to the exact of 1000 and each commodity is sold
for Rs10. Then total revenue becomes RS 10000. Each commodity requires Rs 5 to produce each
commodity, then the total cost becomes (1000*5) =Rs 5000. If we deduct that cost from the total
revenue Rs 10000, the remaining balance leads to origin of profits Rs 5000 which can be verified from
the help of table

Table

Price Quantity Total Revenue

Rs. 10 1000 Rs. 10000
OP OM OPCM
Cost Quantity Total Cost
Rs. 5 1000 Rs. 5000
OR OM OROM
Total Revenue Total Cost Profit
Rs. 10000 Rs. 5000 Rs. 5000
OPCM ORBM PCBR

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 From the diagram, it is understood that monopolist manufacturing OM quantity of
commodities and selling each commodity for OP price. Then, the total revenue is confined to OPCM in
which the total cost of ORBM is to be deducted. The remaining balance leads to the level of PCBR
which is indication for abnormal profit of monopolist.

Short run – Abnormal loss

In the case of short- period, a firm or an industry may get loss, because time is not enough to adjust the
situation. In the case of short run, the average cost is above the AR curve which leads to origin of loss
that can be analyzed through this diagram.

The price/cost/revenue is shown on the OY axis while output is represented on OX axis. The condition
of MC=MR, determines the maximum output of a firm. Wherever, MC curve intersect MR curve the
point (Q) is indication for equilibrium. As per diagram, the total cost of ORBM1 is greater than total
revenue of OPCM1. Dur to this loss is confined to RBCP. When a firm gets loss, then AC curve is
always above the price which is turn leads to loss for the monopolist.

Short run-normal profits

In short period, there is a place to get only normal profits, because time is short that is why situation
can be adjusted. when the average cost is tangent to average revenue curve that situation leads to get of
normal profits which can be verified through this diagram.

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 The cost/revenue/price is shown on OY axis, whereas the output is represented on OX axis.
When a firm gets normal profits, then the price of a commodity is always equal to average cost. In other
words, P=AC. As per the diagram, the price of the commodity is confined to OP level, whereas the
quantity of output is OM. This situation leads to get the normal profits.

Importance of monopoly
There is need to study the importance of monopoly. Normally, Govt. will impose more tax
on these commodities which are having the nature perfectly inelastic and less tax on those commodities
which are having nature of elastic. Overall, monopolist always tries to get abnormal profits in the long
run.

15) Define the price discrimination? Explain the various types of price
discrimination?

In normal language, charging of different prices for different customers for the
same commodity is known as price discrimination. However, it is not the case in economic terms. In
economic terms, Robbins, economist, defines as” the act of selling the same article produced under
single control at different prices to different buyers is called as price discrimination” From this
definition, it is understood that the same commodity is sold for different prices for different customers.

Types of price discrimination

The price discrimination can be divided into different categories which are as follows.
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Personal services

In the case of personal services, the price can be discriminated from one person to another person. For
instance, a doctor charges higher fee for rich people and lower rate of fee for poor people.

a) Place of services

In this category, same product is sold for different prices. In this case, lower prices are imposed in
rural areas while higher prices are imposed in urban areas. Similarly, goods are sold at higher prices
wherever they are having inelastic nature and lower prices for having the nature of elastic. In the same
manner, goods are sold at higher price in domestic market and lower price in international market. If it is
so, it is called as dumping theory which is indication for price discrimination.

b) Uses of services.
In this case, the same commodity is sold at different prices for various uses. For instance, electricity
charges are imposed at lower level when it is used at home consumption while higher charges are
imposed when it is used in industrial level.

c) Difference of production

The price discrimination depends on product deferential basis, that is Brook Bond or Lipton tea are
having higher prices rather than ordinary company product.

d) Time factor

Time also influences the price discrimination. Normally, coal drinks are higher prices in summer and
lower price in winter season.

e) Age, sex, and status

The price of commodity depends on different factors. When adults do journey in RTC buses, charges
will be more and for children charges will be less. Similarly, telephone charges during morning and
night times
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In addition to this, students, Govt. employees and physically handicapped persons are having variation
of charges for bus passes.

5) Examine, how the price discrimination leads to origin of profits?

So far, we have assumed that a monopoly firm will charge uniform prices for all its customers. But a
characteristic features of monopoly pricing is the instance of price discrimination through charging
different prices from different customers for the same commodity at the same time.

Pigou speaks of three types of price discrimination. Discrimination of the first degree will obtain if the
monopoly firm fixes different prices. The different buyers and different prices for the different units
which buyers may prepared to buy. The idea behind this kind of discrimination is enables the
discriminating monopolist to get maximum income from each of the buyer. We can put the same idea in
different way- different prices for different uses are charged so as to eliminate the whole of consumers
surplus which might rise under uniform price for all the units and for all the Buyers. Discrimination of
second degree will obtain if the monopoly firm chares different prices of different buyers and different
priced for different units of the same commodity but not at maximum possible rates but at a lower lever-
the monopolist will leave a certain amount of consumers surplus with the consumers. Discrimination of
the third degree-the most common type in practice-obtains when the monopoly firm charges different
prices from different buyers by classifying the into different sub-groups or markets.

a) First degree discrimination

If monopolist follows the principles of simple monopoly, he will get lower profits. However, by
following the price discrimination, he gets more profits. How he is able to get more profits can be
understood from the following table
Table
--------

Price Quantity Demand

Rs. 10 1
Rs. 9 2
Rs. 8 3
Rs. 7 4
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Let us assume that in the monopolist sells each kg of sugar for Rs7. By selling 4 kg of sugar, he gets of
Rs 28, but consumer willing to Rs 36 for 4 kg of sugar. This deviation leads to get of consumer‟s
sample.

Willing price - Actual price= Consumer‟s surplus

34 28 6

In this way, consumers surplus is confined to 6 units.

The price and quantity demanded are shown on OY axis and OX axis respectively. When the
monopolist changes OP Price for each commodity, the consumer‟s surplus leads to PRQ which can be
derived in the manner.
Willing price Actual price consumer‟s surplus
ORQM OPQM PRQ

The consumer surplus become equal to PRQ. . To reduce the consumer surplus, the price
discrimination is to be followed by seller which can be verified from the following diagram.

138
The price and quantity of commodities are represented on OY and OX axis respectively. In this diagram,
monopolist trays to bring the consumers surplus to the level of zero. He sells the first commodity to the
Price of Rs 10, second commodity to the price of Rs 9 and third, fourth to Rs 8 and Rs7 respectively. In
this way, he will collect to the extent of Rs 34. If it is so, consumer‟s surplus becomes zero which can be
verified from the following methods.

Willing price - Actual price consumer‟s surplus

34 34 0
ORQM ORQM0 0

It shows that the actual price is equal to willing price. The balance leads to „o‟
which is indication for consumer surplus.

b) Second degree discrimination

In the second-degree discrimination, monopolist can reduce the consumer‟s surplus to some
extent but not to the level of zero. If it is so, it is called as second-degree discrimination which can be
observed from the following diagram.

139
The price and quantity demanded are represented on OY and OX axis respectively. Seller charges OP1
Price for consumer A, OP2 price for consumer B, OP3 price for consumer C. In this way by
discriminating the of the commodity, seller reduces consumer surplus. Reducing the consumer‟s surplus
in this way is called as second-degree discrimination.

c) Third degree discrimination

When a monopolist sells a commodity for higher price in domestic market and lower price in
the international market is known as dumping theory or third-degree discrimination which can be
observed from the following diagram.

140
The price and quantity of commodities are represented on A, B, and D diagram respectively.

Domestic market

Diagram „A‟ represents domestic market were OM! Quantity of commodities is sold for OP1
price. The total profits are confined to P1C1B1R1. As per the law of demand, when the price is more,
less will be purchased and vice-versa

International market

Diagram „B‟ represents international market where monopolist charging lower price OP2 for
the commodities. The total profit is confined to the rectangular area of P2C2BR2. Normally, when
excess of commodities are there in domestic market that commodities are sold for lower price in the
international market to recover the investment. Otherwise, it becomes dead investment.

Total market
Diagram „C‟ represent combination of selling commodities of domestic as well as international level.
The total profits are confined to the level of ABQ. Let us assume that 1000 commodities are produced in
the market in which 400 commodities are sold in domestic market for higher price and remaining 600
commodities are sold in international market for lower price. The same commodity selling for different
prices in different market is known as price discrimination.

Importance

a. Taking this law as a basis, monopolist chargers‟ higher price where the commodities
whichare having the nature of inelastic and impose lower price when they are having
nature of elastic.
b. This theory helps to bring balance between rich and poor. Monopolist will charge higher
pricefor the commodities which are purchased by rich people and lower price for the
commodities purchased by poor people.
c. Income inequalities can be reduced by following price discrimination method.

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16) Examine the Cournot’s theory of duopoly market?

This theory was explained by A. A. Cournot, French economist, in 1938. Duopoly is special
case of oligopoly in which there are only two sellers exist in the market. In the initial stage, both are
independent, and no agreement exists between them. Even though there are independent, if one changes
in the price of output that will affect the other firm and may set a chain of reaction. This law is
depending on some assumptions.

Assumptions
A) There must be two sellers.
B) They must produce and sell a homogeneous commodity like mineral water.
C) There must be large number buyers.
D) The cost of production is assumed to be zero.
E) Each seller knows the market demand of his product.
F) The entry of new firms is blocked.

Explanation

Taking all these assumptions as a basis, duopoly theory can be analyzed. Let us assume
that there are two mineral water firms, i. e., A and B. If firm A is there, it becomes monopoly. When
firm B enters in the market monopoly becomes duopoly market which can be examined from this
diagram.

142
 The price and output are represented on OY and OX axis respectively. In the
beginning, when the seller A is there in the market, it is called as monopoly. The output of seller ofA is
confined to P1C1M1O, then D1D1 is the demand curve and MR1 is the marginal revenue curve which is
intersecting the OX axis at the point of M1. After knowing this situation, seller B enters in the market,
then the remaining demand curve left to B is C1D1 and marginal revenue curve becomes C1MR2. After
entering the seller B, the output of seller A is reduced from P1C1M1O to P2C2M2O. It shows that
output of seller A is reduced, and output B increased which happens due to competition. Finally, both
are coming to an agreement to sharing equally the total output of market which can be represented in
another diagram.

143
 The price and quantity of output are represented on OY and OX axis respectively. For instance, seller
A is producing 1000 commodities. Knowing this situation, seller B enters in the market and produces the
extent of 300 commodities and remaining of 700 commodities by seller A. Later, 700 commodities
manufactured by seller B and remaining 300 commodities by seller A. This is the competition prevails
in between them. Finally, both sellers are coming to an agreement to share equally the total output of the
market, i. e., 500 commodities by seller A and remaining 500 commodities by seller B. As per the
diagram, OM! Of output shared by seller A and remaining of M1M2 of output is left to seller B. In other
words, both are producing equally the output of 500.

17) Explain the Edge worth’s theory of duopoly market?

Edge worth, economist, did not accept the theory explained by Cournot. He says that price is
responsible to bring an agreement between them that can be understand from the following diagram.

144
 The price and output are represented on OY and OX axis respectively. Left side refers to
seller A and right side refers to seller B. If seller A is there in the market, it is called as monopoly. In the
beginning, seller A fixes the price of the commodity to the level of OP1 and captures the total market.
Knowing this situation, seller B reduces the price of the commodity as OP2 which is less than price of
seller A. Now the total market comes into the hands of seller B. Knowing this situation, seller A reduces
the price of the commodity further to the level of OP3, then total market goes into the hands of seller A.
This situation happens due to competition among the Two sellers. Finally, both sellers come to an
agreement at a particular price that price is called equilibrium price.

18) Examine the Chamberlin’s theory of duopoly market?

This is the theory explained by author namely Prof. Chamberlin who says that agreement
happens in between the profit rather than other aspects. However, Chamberlin explaining his theory,
taking the help of Cournot‟s diagram as basis which was modified some extent.

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 The price and output are represented on OY and OX axis respectively. Let us assume that
seller A gets a total profit of Rs 5000 by selling 1000 commodities for the price of Rs 10. To
manufacture each commodity, it requires cost of Rs 5. The total revenue is confined to Rs 10,000 and
total cost comes to level of Rs 5000. The deviation between total revenue (Rs10,000) and total cost (Rs
5000) leads to origin of Rs 5000 profit. Before the arrival of seller B, seller A is getting the total profits
of Rs 5000. Knowing this situation, Tries toenter the market. He captures the market to some extent.
Due to this, the market of A reduces, and market of seller B increases. Finally, both are coming to an
agreement in the case of total profit of Rs 5000 in which seller A shares of Rs 2500 and seller B shares
of Rs 2500 equally. If they are coming to an agreement means, it implies that they are coming to an
agreement not only in price but also in output. As per this theory, each seller must produce 500
commodities and sell each commodity for the price Rs 10. Having this situation, each seller gets Rs
2500 as a profit.

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19) What is meant by Oligopoly? What are the types of oligopolies?

The term of “oligopoly” is derived from Greek word of „OLIGOS‟ which means few. If there
are few sellers in the market is known as oligopoly. The oligopoly firm may produce either
homogeneous or heterogeneous goods. The oligopoly is the situation that lies in between monopoly and
monopolistic competition.

Types of oligopolies
i
A) Perfect oligopoly

If all firms which exist in the industry produce same level of output is known as perfect or pure
oligopoly. For instance, copper, iron and steel, aluminum etc.

B) Differentiated oligopoly.

All the firms which are existing under the category of oligopoly industry produce heterogeneous
goods is known as differential oligopoly. For instance, passengers‟ cars, cigarettes etc.

C) Collusive oligopoly

All the firms which are existing in industry having an any agreement concerned to price is known as
collusive oligopoly.

D) Non-collusive oligopoly

All the firms which are existing in the industry follow different prices for their respective products is
known as non-agreement or non- collusive oligopoly.

20) Examine the features of oligopoly?

The oligopoly industry has certain special characteristics which are as follows.

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 d. Interdependence

The firms which exist in the oligopoly industry have nature of interdependence either in the case of
price or quantity of output. The action of a firm is related to another firm. Each firm will take steps
against the other firm. The profit of one firm is affected by the actions of another firm. The competition
arises among the firms which exist in oligopoly industry.

e. Selling costs
There is place for selling costs in the oligopoly industry. They are needed for improvement of sales
and to withstand among the competition. Each firm of oligopoly industry must spend certain amount
towards the advertisement.
f. Non-price competition

The price competition does not prevail in the oligopoly industry. If any firm raises the price of the
commodity, other firms do not follow. Similarly, if any firm reduces the price other forms also will
follow. If it is so, no firm can sell additional commodities in the market.

g. No barriers to entry

The oligopoly is an industry where there is no restriction for the firms either to enter or to leave the
industry. In the long run all firms which existing industry will get more than normal profits.

h. Indeterminate demand curve

The exact behavior of producer cannot be determined in the oligopoly industry. The demand curve of
each firm is uncertain. The firms are interdependence and reaction of rivals can be predicted. If one firm
changes, the other firm also react. Hence, the demand curve of a firm can not be predicted accurately.

i. Few firms

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 The combination of few firms is known as oligopoly industry. Each firm has significant share in total
output. Each firm carefully watches the activity of other firms.

j. Group behavior

Each form is unable to take its own decision regarding the price and output. It prefers to protect the
interest of all firms.

k. Nature of product

Even though a firm becomes a part of oligopoly industry, it enjoys monopoly power by
differentiating product with good number of customers.

21) Examine the price determination of oligopoly?

Or
Explore the kink demand curve or Price rigidity?

Paul M. Sneezy has used the technique of the kinky demand curve that is demonstrate price rigidity
under oligopoly. In the case of price rigidity, it is not affected by the rival firms. The firm will lose
considerable to the rival and its sales will greatly reduce. The firm will, therefore, think twice before
raising the price.

Kink demand

Under oligopoly with product differentiation, if a firm increases its price, it will not lose all its
customers because some of the customers accustomed to brand of product. Therefore, the demand
prevailing for this commodity is not perfectly inelastic. On the other hand, if one firm raises the price of
a commodity being elastic. Thus, for the firms which do not increase the price, the demand curve of
oligopoly industry becomes kink at a point which can be examined from the following diagram.

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 The price / cost / revenue and output are represented of OY and OX axis respectively. The price of
P1M1 that is prevailing in the oligopoly industry cannot be changed. Hence, it is called as price rigidity.
Similarly, the demand is having the nature of elastic up to the point of P1 and later, it becomes inelastic.
The demand curve is having nature of kink at the point of P1. Therefore, it is called as kink demand
curve. It implies that whatever the price prevails in the oligopoly industry that cannot be changed,
because if one firm increases the price the other firms do not follow. Similarly, if any one firm reduces
the price, other firms will follow. Therefore, whichever the firm reduces the price; it cannot sell more
commodities. Hence, all the firms which exist in the industry must follow one price only. Even though
all firms are selling for same price, one firm gets abnormal profits; another firm gets loss due to
variation of cost of production. The firm which reduces the cost of production will get more profits
rather than other firms which unable to reduce the cost of production. Therefore, the cost curves namely
MC1, MC2, MC3 etc., are having variation from one firm to another firm.

We can conclude this section on price rigidity under oligopoly by making the
observations:

(a) The kinky demand curve analysis shows that there is a tendency to price rigidity under oligopoly
conditions so as to eliminate uncertainty.

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(b) Price rigidity continues to exist even when the cost of production falls or when there is a decline in
demand ( in other words, oligopoly firms may not like to reduce the price even if reductions in cost
and demand warrant such a fall in price)

(c) Price may be raised in response to rising costs or increased demand.

Limitations

A) This theory explains about the price rigidity. However, in real life it cannot be seen.

B) When the price leader dominates the market, there is no place for the price stability. In real life,
every firm is having the variation price and output.

C) There is no place for price rigidity when a heterogeneous prevailing in the market.

D) When the depression prevails in the market, there is no place for price rigidity.

21) Define the monopolistic competition? What are its characteristics?

This theory was explained by E.H. Chamberlin in 1933 who wrote a book “economics of
imperfect competition” in which he mentioned the importance of monopolistic competition. He defines
the monopolistic completion as “it is a market structure in which there are many firms selling closely
related products”. In other words, it can be said that it is extreme situation in between monopoly and
perfect competition. The characteristics of monopolistic competition can be divided into different
categories which are as follows.

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Characteristics

a) Large number of sellers and buyers

In monopolistic competition, there is place for large number of sellers and buyers. The large
number of sellers in another way is called as large number of firms. Combination of firms is called as
industry. The sellers and buyers together determine the price of the commodity that price cannot be
changed by a single seller or a buyer. They must accept the price that is fixed in the industry.

b) Product differentiation
Each firm which is in oligopoly industry produces a commodity which is differentiated
from the rival‟s product. In another words, each firm has monopoly power over the product. Even
though each firm is having the of monopoly, but commodes produce by various firms are closely related
either in the case of color, shape, quality, etc., However, they are not perfect substitutes such as lux, hum
am, pears etc., Even a firm increases by small amount in the price of commodities which are habituated
for the product, consumers will purchase them rather than purchasing other relatively cheaper products.

c) Freedom of entry and exist of firms.

The monopolistic competition in another way is called as industry. There is a freedom for the
firm to enter or to leave the industry. Normally, when the existing firms are getting the profits that
situation will attract the new firms to enter the industry. If existing firms getting the loss, some other
firms leave the industry. Having this situation, all firms which exist in the industry will get normal
profits in the case of long run.

a. Selling costs

In monopolistic competition due to product differentiation, selling costs are essential to push
up the firm‟s sales as against other similar products. The money which spending on marketing, sales
promotion, advertisement is known as selling costs. The costs are divided into two categories that is
fixed and variable costs. The cost spending towards remembering the existing customers is known

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information cost whereas spending towards the capturing the new customers is known as manipulative
costs.

b. Lack of perfect knowledge

Buyers and sellers do not have perfect knowledge about the market situation. Selling costs influences
the consumers to purchase those commodities which are advertised in the media. The commodities
which are manufactured in the industry are closely related. It implies that there is no perfect knowledge
between sellers and buyers.

c. Price decision
In monopolistic completion, every firm is having the nature of monopoly. Every firm is price maker
by differentiating the product. The price and output are having the variation from one firm to another
firm that is why, there is no place for uniformity.

22) Examine the price determination of monopolistic competition?

Or
Explain the equilibrium of monopolistic industry?

The competition among the monopolies is known as monopolistic competition which is in

another way is called as industry. Every firm which exists in the industry will try to get profits either
changing the price or quantity of output or both. Firms have freedom either to enter or leave the
industry. Normally, when the existing the firms get profits, knowing this situation, new forms will enter
the market. When existing firm get loss, some firm leaving the industry. It is helping in the case of short
period.

Long-run equilibrium—Normal profits

In the case of long run, all firms which are existing in the industry will get normal profits. In
the case of long run the price of the commodity must always equal to the average cost of production
which can be verified from the following the diagram.

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 The price/cost/revenue and output are represented on OY and OX axis respectively. The
firms which exist in the industry have the nature of monopoly. In the case of monopoly AR falls from
left to right towards downward direction while MR curve falls below the AR curve. In the case of long
run, all firms which are existing in the industry will get normal profits. It is happening due to having the
nature of P =AC where the price of the commodity equal to the average cost.

Short run- Abnormal profits

However, in the case of short run, all firms which exist in the industry will get abnormal profits. It is
happening due to excess of demand over the quantity of supply. In the short run, supply cannot be
increased, due to this price. Hence, all firms which are exist in the industry will get abnormal profit.

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 The price and output are represented on OY and OX axis respectively. The total revenue
is confined to OPEM while the total cost is limited to ORBM. The difference leads to the level of PCBR
profits. In short run, the price of the commodity is always greater than the average cost (P>AC) which in
turn leads to origin of abnormal profits.

Short period- abnormal loss

In short period, there is no place to enter or leave the industry by the firms. Therefore, every
firm which exists in industry must get loss. In other words, when the market supply exceeds the market
demand, this situation leads to decrease the price of the commodity which in turn helps to get abnormal
loss. In other words, when the average cost exceeds the price of the commodity which in turn leads to
get loss which can be verified from the following diagram.

The price and output are represented on OY and OX axis respectively. In short period,
cost exceeds the price of the commodity (AC>P) which in turn leads to get loss. It is indication for un-
favorable situation. As per the diagram, the total cost in confined to ORBM while total revenue is
limited to OPCM, the remaining area of RBCP is indication for loss which is happening in the case of
short period.

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23)Explain the role of selling costs in monopolistic completion?

The importance of selling costs was explained by author namely E.H. Chamberlin
who says that selling cost are having place in monopolistic competition rather than monopoly and
perfect competition. The costs are divided into two categories i.e., production cost and selling cost. All
markets having the nature of production costs but in monopolistic competition we will find additional
costs that costs are called as selling costs. The production cost refers to commodity to demand whereas
selling cost refers to demand to commodity. In the case of production cost, bringing the necessary
commodities to the near of public is the problem but automatically purchased by the consumers while in
the case of selling costs bringing the consumers near to these commodities is the problem. To bring the
consumers near to goods and services requires the advertisement. Whatever spending towards
advertisement that cost becomes selling cost. For instance, spending towards advertisement, salesmen‟s
salaries, gifts etc., come under the category of selling cost.

a) Informative advertisement

The amount which spends towards informing the existing customers is known as informative
advertisement. This advertisement is meant for giving general and technical information for the existing
customers. For instance, advertisement by the tea brand or the coffee brand etc.
b) Manipulative advertisement

The amount spent by a firm to capture the new customers is known as manipulative
advertisement. For instance, advertisement through the newspapers, radio, and T.V etc. comes under this
category.

Equilibrium of firm- selling costs

The selling costs are compulsory costs from the point of monopolistic competition.
However, these costs are not required in other markets of monopoly, duopoly, and oligopoly. In the
case of monopolistic competition, it is required due to having the nature of closed substitution goods
prevailing in the market. In this situation, more money must be spent towards the advertisement which
can be verified from the following diagram.

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 The price/cost/revenue and production are represented on OY and OX axis respectively.
The OX axis itself represents MC=MR which is the condition required for equilibrium. Let us assume
that in the initial stage, Rs 5000 spends towards advertisement and capture the consumers to the extent
of Ra 1000 and gets the profit to the extent of Rs 25000. Expecting further a firm spends Rs 10000
towards the advertisement and capturing of additional consumer to the extent of Rs2500 and getting of
profit to the extent of Rs 50000. Further expecting of additional customers, a firm spends Rs 15000
towards the advertisement. In this way if a firm captures 2600 consumers and profit is confined to Rs
52000. If it is so, it shows that addition expenditure on advertisement is confined to Rs 5000 and gaining
of profit is limited to Rs 2000 only. It shows that cost is more than the revenue. Having various
alternatives, a firm decides to spend every year to the extent of Rs 10000 only. Therefore, the second
stage is called as optimum decision for selling costs. A firm would not stop at first stage but not enter in
to the third stage. A firm always tries to be in the second stage which helps to capture more customers
Therefore, second stage is called as optimum selling cost theory. In the case of diagram, the second
stage profits are confined to rectangular area of P2C2B2R2 which is in another way indication for
maximum profits of

The firms which exist in an industry produce closely substitution goods which in turn lead to origin of
competition. When the competition is there, each firm must spend towards the advertisement to capture
the consumers. A firm cannot survive in the market, without spending towards the advertisement.
Whatever spending for capturing the consumer is known as selling costs. From the point of consumer, it
is the waste cost. The burden of selling cost primarily bearing by the producer but later, it is shifting to
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the consumer through the price of the commodity. However, the final burden falls on the consumers. It
can be said that the selling costs becoming compulsory costs from the point of producer but waste costs
from the consumers.

24)Examine the type of pricing?

Pricing strategies are different approaches that business takes a figure out what the
cost of their goods and services should be. To choose the appropriate pricing strategy, companies
consider factor like current product demand, cost of goods sold, and consumer behavior and market
conditions.

They are different types of pricing strategies depending on the company‟s goals.
Some want to maximize profit margined while other wants to gain market share and find new customers
in there are. And then, there are other businesses that simply want to get rid of old inventory. They are
12 types of pricing strategies. These different types of pricing strategies can help grow your business,
earn more sales, and maximize profits. Here are some common pricing strategies to consider as part of
your broader marketing strategies.

a. Penetration pricing:

It is difficult for a business to enter a new market and immediately capture market
here, but penetration pricing can help. The penetration pricing strategy consists of selling a much
lower price then competitors to earn initial sales. These low prices can drown in new customers and
divert revenue from competitors.

This strategy is meant to jump start sales and wold not be effective for your long-term
growth. You will likely take a monetary loss at first in exchange for higher sales volume and brand
recognition. As you eventually raise prices to be more in line with the market, prepare for some
customers to drop off as they continue to look for the cheapest option. You can combat customer
churn up front with strategies that turn those new buyers into loyal customers.

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Pro: Market penetration is much easier than entering with an average price and you can quickly earn
new customers.

Con: It is not sustainable in the long-run and should only be a short term pricing strategies.

Example: A new café opens up in town and offers coffee that 30% cheaper than any other café in
the area. They also focus on excellent customer service and implement a loyalty program that offers
every tenth coffee for free. When customer demand has built up, the café slowly starts increasing the
coffee price to a more profitable level. This gives customers a change to build taste for the coffee
and other products and enjoy the great service as they work towards their free tenth coffee. Many of
them will keep coming back as the price raises.

b. Skimming pricing:

Business that charge maximizes prices for a new productivity and gradually reduces the
price over time follows a price skimming strategy. In this type of pricing strategy, prices drop as
products end their life cycle and become less relevant. Business that sell higher-tech or novelty
products typically use price skimming.

Pro: You can maximize profits of new products make up for production costs.

Con: customers may become frustrated that they purchased at a higher price and watch as the price
gradually declines.

Example: A home entertainment store stats selling the latest, most advanced television well above
market price. Prices then gradually decrease over the year as newer products come to market.

c. High- low pricing:

High-low pricing is similar to skimming, except the price drops at defend rate. With
the high-low pricing method, their price of product drops significantly al at once rather than at a
gradual pace. Retail business that sell seasonal products typically use a high-low strategy, often
using a promotion to clear stock they would not be able to sell for much longs.

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Pro: You can clear your inventory of out of data products by discounting them and putting them on
clearance.

Con: customers may wait for impending sales rather than purchasing at full price.

Example: a boutique clothing store sells women‟s sundress at a high price during the summer and
then puts them on clearance once autumn arrives.

d. Premium pricing:

Premium pricing occurs when prices are set higher than the rest of the market to create
perceived value, quality, or luxury, if your company has a positive brand perception, and a loyal
customer‟s base. You can often charge a premium price for your high quality, branded products.

This type of pricing strategy works especially well if your target audience include early
adopters who like to be ahead of the pack. Companies that sell luxury, high-tech or exclusive
products especially within the fashion or tech-industry often use a premium pricing strategy.

Pro: Profit margins are higher since you can charge much more than your production costs.

Con: This type of pricing strategy only works if customers perceive your product as premium.

Example: A beauty builds up credibility within its market ( such as vial world of mouth or online
review) and offers its services for 30% higher than its competitors.

e. Psychological pricing:

Psychological pricing strategies play on the psychology of consumers by slightly

altering price, product placement or product packaging. Some psychological pricing techniques
include offering‟ by two, get one half off‟ deal or setting the price to $9.99 rather than $ 10 ( well, it
is cheaper than $10 is not it?). Some business also uses artificial time constraints to speed customers
into stores, such as one day or limited time sales.

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 Nearly any type of business can use this strategy, but retail and restaurant business most
commonly employ this method as it creates the perception of getting a bargain.

Pro: You can sell more products by slightly tweaking your sales tactics without losing profits.

Con: some customers may perceive it as being trickle or sales which could potentially tarnish your
reputation or lead to missed sales.

Example: A restaurant sets a gourmet hamburgers price at $ 12.95 to lure customers into purchasing
at a perceived lower price compared to $13.

f. Bundle pricing:

Bundle pricing is a type of promotional pricing where two or more similar products or
services are sold together for one price. Bundling is a affection way to up sell additional products to
customers or add value to their purchase. Restaurants, beauty salons, and retile stores are among the
many business that apply this type of pricing strategy.

Pro: customers discover new products they were not initially planning to buy and many end up
purchasing them again.

Con: products that are sold within a bundle will be brought less oftem individually since customers
are saving money on bundle purchase.

Example: A taco cantina sells tacos, tortilla chips and salsa individually but offers a discounted price
if customers buy an entire meal with all of these items.

g. Competitive pricing:

The competitive pricing strategy sets the price of your products or service at the current
market rate. Your pricing is determined by all other products in your industry, which helps you to
stay competitive if your business is in a saturated industry. You can also decide to price your

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 products above or below the market rate, as long as it is still within the range of price set by all
competitors in your industry.

With the advent of e-commerce, it is now easy to compare prices before purchasing end 96
percent of consumers do. This gives you an opportunity to win over customers with a price slightly
below the market average.

Pro: you can maintain market shore in a competitive market and attract customers who are interested in
paying slightly less than your competitive rates.

Con: you need to diligently water average market prices to maintain a competitive advantage for
price conscious consumers.

Example: A landscaping company compares its prices to local competitions. It then rates the price
for its most popular service, a lawn maintenance package, below the market average to affect price-
sensitive customers.

h. Cost – plus pricing:

Cost-plus pricing involves taking the amount it cost you to make the product and increase
that amount by set percentage to determine the final price. You can work backwards to determine
your markup percentage by first figuring out low much you want to profit each product sold.

Pro: profits are more predictable since your settings you markup price to a fixed percentage.

Con: since this type of pricing strategy does not account for external factors, like your competitors‟
pricing or market demand, you may miss out on sales if you set your markup percentage too high.

Example: a pizza shop adds up the cost of its ingredients and labor, then sets the pizza price to revive
a 200% profit margin.

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 i. Dynamic pricing:

Dynamic pricing matches the current market demand for a product. Also known as
demand pricing this pricing strategy most often occurs when the product at hand fluctuates on a daily
or even hourly basis. Industries like hutches, airlines, and event ventures set different prices daily
and apply their strategy to maximize profits.

Pro: you can increase overall revenuers by raising price when demand is on the rise.

Con: dynamic pricing require complex algorithms that smell business may not have the ability to
manage.

Example: .|A boutique hotel raise its room rents for one weekend because there is a popular summer
festival in town.

j. Economy pricing:

Economy pricing consistently undercuts competitors with the goal of making a profit
through high sales volume. This type of priding strategy usually goes hand- in hand with low
production costs. It works well in the commodity goods sector and is used by companies like Wal-
Mart and a Costco.

Pro: You are likely be making much on each items so you will need to sell more goods than usual.
Also, if you do not manage your pricing carefully, you might create the perception of a low-value
product or business.

Example: A superstore sells a generic brand of tea for 10% less than its grocery store competitors.

k. Fermium pricing:

Fermium pricing offers a basic product or service for free, and then encourages
customers to upgrade to the paid, premium version to access more features or choices. Potential customers get a

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taste of what the product or service can do for them and again insight into your company. This popular strategy
for software business and membership based organization.

Pro: You‟re building trust and educating potential customers about your product. You also get their contact
details so you can stay in touch through email market.

Con: you do not make money from every customer immediately and money users may choose not to upgrade.

Example: a software company offers basic virus protection for free with option to upgrade to several other tiers
of progressively higher levels of online security.

L) Loss-leader pricing:

Loss – leader pricing brings customer to your store to buy a highly discounted productmo (
the loss leader). While they are them, they might buy other full price items they did not plan on –
which school more than make up for the loss of the original product.

Pro: This type of pricing strategy customers who might not otherwise visit you store and express
them to your full range of products.

Con: Some customers will only buy the loss leader product ( and possibly many of them) so you
need to watch your profit and stock levels closely.

Example: A supermarket offers bread at a very low price on Fridays, attracting people who might
then do all their shopping for the week.

There are many types of pricing strategies and it‟s critical to find the right fit for your
business. To begin, determine your business goals. Then select the pricing method that will help you
meet those objectivities-whether it is maximizing profits, obtaining market share, clearing inventory,
or a combination of these. Once you have your pricing strategies, you can focus on how to grow
your business further.

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 25)Examine the product life cycle pricing?

The product life cycle pricing is an important pricing strategy that allows companies to forecast and
improves the sales. The life cycle has several stages, from launch to declination, in which the product may
behave different in the market. If you are a sales or marketing professional, you may want to learn more about
product life cycle.

What is product life cycle pricing?

Product life cycle pricing is a strategy for selling products in which pricing correlates with a product‟s
correlation in its life cycle. There are four phases within the life cycle, including launch, growth, maturity and
decline. Business use product life cycle pricing to better understand, how discounts, clearance prices, new
versions and marketing can affect their sales in each phase. A company may choose to strategic differently
depending on the market and how its product sells.

Here are the four of a product life cycle and how sales for a product may look in each one.

a) Launch or development stage:

The launch phase or development portion of the life cycle, is when the company first
introduce the product to the market. During this time, the business may record few sales, as the consumers
within the market maybe reluctant to purchase a new product. This can be especially true when a product is
unique, resulting in lower competition but slower market situation.

b) Mid or maturity stage:

The maturity stage or the regular pricing phase, represents a plateau in the products sales and
awareness. This is the time in the product life cycle were the product shows acceptable sales and profits. This
may be the phase of the cycle where there the product shows acceptable sales and profits. This may be the phase
of the cycle where there is the highest level of competition.

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c) Late or declination stage:

Experts may also call the last stage in the product life cycle the clearance phase. It is during
this phase that consumers may choose an alternative product. Many companies plan to remove the product from
production during this stage, as there is less demand for product In this stage, business may even lose money by
continuing to produce the product.

Benefits of life cycle priding:

a) In prove marketing strategies: Understanding life cycle pricing can aid marketing teams in correctly pricing
and marketing products to achieve opting sales.

b) Enhanced customer loyalty: By offering discounts or cleanse at the best time during the product life cycle,
companies can increase customers loyalty.

c) Increased profits: Knowing how to price a product at each phase of its life allows business to correctly predict
when and how much consumers may pay for their products, increasing their to the profits.

d) A more reputed brand: When business follow life cycle pricing, consumers may relay on them for sales or
discounts and consider them to be refutable and reliable for pricing.

e) Reliable sales forecasting: Understanding how consumers view your product at each phase of cycle can allow
you to better calculate what sales projections may be throughout the products‟ life.

f) Improved decision-making: companies can use life cycle pricing to support their decision making for altering,
discounting or decreasing the price for their items.

.
26)Explain the break-even analysis?

The main aim of any business firm or organization is to get maximum profits. To get
maximum profits, a firm try‟s to reducing the cost of production. However, the break-even analysis
mainly covers the point of reducing the cost of production. To manufacturing a commodity, it requires

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cost which includes fixed and variable cost. The fixed cost does not change either in the case of short or
long period. However, the variable cost depends on production. If production increases, the variable cost
increases. If product falls, the variable cost also decreases which can be shown with the help of diagram.

The various costs and output of a firm are represented on OY and OX axis
respectively. The fixed cost curve is horizontal to OX axis which does not change either in the case of
short run or long run. Whatever spending towards the construction of building, machine, equipment etc.
comes under category of fixed cost while spending towards the purchasing of raw material, wages of
labor, electricity charges etc. comes under the category of variable cost. When the organization is going
to function, there is a place for the variable cost. If it is not functioning, no need to bear of variable cost.
Therefore, the variable cost starts from the origin. The combination of fixed and variable cost becomes
total cost (TC = TFC+ TVC). The total revenue curve starts from origin. If a firm starts to sell the
commodities, then only there is a place of origin of revenue. That is why; the TR curve starts from the
origin. Wherever TR and TC curves intersect each other that point (E1) is indication for breakeven
analysis. It is neither indicates for profits nor loss. Hence, it is called as break-even analysis.

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A firm – single product

If a firm producing single product, then the breakeven point can be calculated by taking
total sales volume. Let us assume that the sale price of a commodity is Rs50, the variable cost is Rs30
and fixed cost is Rs 50,000. Having this situation, it is to be calculated in this manner.

Breakeven point = Total fixed cost / Unit contribution

B.E. P = 50,000 / 50-30
= 50,000/20
As per this formula a firm must produce 2500 commodities not to get loss.

A firm – multiple products

When a firm produces more than one commodity, it is to be followed other methods as
B.E.P = total fixed cost / P/v ratio
P/v (profit value ratio) =selling price –variable cost/selling price. 100
As per the example P/v ratio=50-30/50 X 100
P/v 40%

B.E.P = Total fixed cost/P/v ratio

B.E.P = 50,000/40 X 100
Sales value =1, 25,000

If a firm wants to get neither loss and nor profit, it must sell the worth of Rs 1,25, 000.
This value of amount can be derived in another form as

Sales value = minimum output. Selling price

1, 25,000 = 2500 x 50

For instance, a firm wants to get Rs 2, 40,000 as a profit. If it is so, how such value of
commodities must be sold in the market? It can e calculated in this manner by using the following
formula.

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 B.E.P = total cost ofexpected profits / P/v ratio

P/v = Contribution /selling price x100

For instance,
a) Selling the worth of commodities = 12,00,000
b) Variable cost = 7,50,000
c) Fixed cost = 3,60,000
d) Expected profit = 2,40,000
P/v ratio = 12, 00,000 – 7, 50,000 /12,00,000 x 100
P/v ratio = 4,50,000 / 12,00,000 .100
P/v ratio = total fixed cost /P/v ratio. 100
= 3, 60,000 / 37. 50 x 100
= 9,60,000
a) To get total profits Rs 2,400,00
Selling = total fixed cost + expected profit / P/v ratio
= 3, 60,000 + 2, 40,000 / 37.50 x 100
To get total profit Rs 2,400,00, a firm must sell the worth of Rs 16,00,00 of commodities.

Margin of safety

This difference between willing to sell and actual to sell is known as margin of safety. If
actual selling is greater than willing to sell, then margin of safety will be more and vice-versa.
For instance, a firm wants to get a profit of Rs 2, 40,000. Having P/v ratio is 25%
Margin of safety Rs 2, 40,000 /25 .100
If a firm wants to get Rs 2,40,000 as profit, it must sell the worth of commodities Rs 8,00,000.
If distance is more, profit s will increase. As per the diagram, the distance that is falling in between
M1 M2 is indication for margin of safety. If distance is more, profits will be more. If distance is less,
profits will be less.
Incidence of angle
The distance that is falling in between TR and TC is indication for incidence of angle. As per
the diagram, it is equal to distance that is falling between A and B.

169
 Breakeven Analysis

a) It is useful to determine the optimum level of output. If it is less than optimum level, profits will be
reduced.

b) It helps for expansion of business.

c) It helps how to reduce the cost of production.
d) This analysis helps to take decision of various aspects.
e) It helps to determine whether the firms with stand.
.

27)What is meant by administrated price? Explain the various type of administrative

price?

An administered price is one that is imposed by the state or a state institution in place e of a price to be
set by the market. It is a requirement imposed on undertakings by Governments or other public
authorities. Such prices are usually driven by the intentions of regulators to remedy / prevent market
failures and similar situations, which are likely to lead to undesirable macroeconomic and non-economic
consequences. The prices prescribed imperatively by the public authorities, obscure microeconomic
analysis as they are driven by the incentives, which are hard to internalization equilibrium modeling.
The instances of administrated prices are common and hardly avoidable as they are usually legally valid
and have strong societal legitimacy appeal. For competition law, administered prices are the exogenous
factors, which are capable of changing the outcomes of the assessment of anticompetitive practices.

As per classical economists, the price of commodity is determined by the supply and demand of the
commodities. When the prices of an essential commodities are very higher level, more people unable to
purchase the commodities. Similarly, when the prices of commodities are at lower lever, the producers
are unable to recover the cost of production. Having this situation, intervention of Govt. becomes must.
It is the duty of Govt. to protect consumers as well as producers by maintaining the minimum and
maximum price which is known as administrative price.

170
 Administrated price

The administrated price can be divided into different categories.

a) Controlled price

To protect the interest of the poor people, Govt. fixes the lower price for certain commodities such as
rice, wheat, sugar, kerosene, oil, etc. the price which is fixed by Govt. is always less than the cost of
production. The byers can purchase more commodities when their prices are at lower level. The prices
of necessary commodities fixed by Govt. are known controlled price.

b) Support price

Sometimes, there is need to protect the farmers who cultivate the paddy, wheat, etc. The farmers will get
lower prices, when abundant of crop arises in the market. In this situation, there is need to protect the
farmers by the Govt. otherwise farmers would not cultivate food crops and will go for commercial crops.
In certain situations, govt. protects the farmer by giving support price for the food crops.

c) Token price

There are certain commodities which are needed for service of human beings such as medical
services, health services, education services etc. The poor people are unable topurchase these services
for higher market prices. In this regard, Govt. and same private charitable institution provide these
services at lower price than the cost of production. This type of price is known as token price.

d) Dual price

Govt. will come forward to maintain the dual price. The same commodity having two prices is known
as dual price. For instance, rice is available for open price for higher price. The same commodity has
lower price in the ration shops. It is indication for dual price. It shows that one price is meant for poor
people and another price is meant for rich people.

171
 Self-assessment questions

1. Multiple choice questions. Each question carries ½ mark.

1) Which of the following refers to the expenditure incurred to produce a particular product or
service?
a) Profit b) price c) capital d) cost.

2) Which of the following normally includes the cost of raw materials, labor and other
expenses?
a) Demand b) total revenue c) total cost d) profit.

3) The difference between the total revenue and total cost is called.
a) Cost of production b) cost of capital c) profit d) capital.

4) Which of the following is defined as a period of adequate length during which a company
may alter all factors of production which high degree of flexibility?
a) Short run. B) long run. C) semi short d) semi long.

5) The costs associated with the variation in the utilization of fixed plant or other facilities are
called.
a) Long run costs b) short run costs. C) medium run costs. D) none of the above.

6) Long run cost curves are called.

a) Operating curves b) fixed curves c) variable curves. D) planning curves.

7) Shot run cost curves are called.

a) Operating curves. B) fixed curves c) variable curves d) planning curves.

8) Variable costs are differentiated from fixed costs based on the degree of their relation to the
rate of output.

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 a) Substitutability. B) variability. C) profitability d) interoperability.

9) Which of the following are fixed in the short run?

a) Variable costs b) semi variable costs c) fixed costs. D) semi fixed costs.

10) Fixed cost per unit changes with.

a) Volume of scales b) profit c) production. D) volume of production.

2. Fill in the blanks.
a) The relationship between the variable cost and volume of production is----------
b) The cost of the best alternative foregone is called ---------
c) Telephone bill is an example of ---------- costs.
d) Additional to costs as a result of change in the level of business activity is called--------------
e) The expenses that do not have cash outflow are called -------
f) The salary of a manger is an example of----------
g) Timing of cash flows are determined in ------- costs.
h) The costs that have been incurred and cannot be controlled are called------
i) Cost of direct labor is an example of-------- cost.
j)studies the effect of changing the size of plant upon its cost in the long-run.

3. Shot-answer questions.
a) Production function.
b) Returns to scale.
c) Factors of production.
d) Short run costs
e) Long run costs
f) Fixed costs
g) Variable costs
h) Opportunity cost
i) Simple monopoly.
j) Discriminating monopoly.
k) Break even point.
l) Duopoly.

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 m) Oligopoly
n) Selling costs
o) Skimming price.
p) Penetrating price.

4. Essay type questions.

a) Explain the law of variable proportion?
b) Examine the returns to scale of industrial sector?
c) Explain the various types of costs?
d) Examine the life cycle-based pricing?
e) Explain the Break-even analysis?
f) Examine the equilibrium of monopoly industry?
g) Explain the importance of selling cost of monopolistic competition?
h) Differentiate skimming price from penetrating price?
i) Examine the features of perfect competition?
Answers for multiple choice questions.

1) d, 2) c, 3) c, 4) b, 5) b, 6) d, 7) a, 8) b, 9) c, 10) d.

Answers for fill in the blanks.

a) Directly proportional
b) Opportunity cost
c) Semi-fixed or semi-variable cost.
d) Incremental costs.
e) Book costs.
f) Out -of – pocket costs.
g) Economic costs.
h) Historical or sunk or book costs.
i) Variable costs
j) Cost -out relationship.

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 Unit- IV

FINANCIAL ACCOUNTING

1) Define Accounting?

Every business organization wants to know the position of the firm, whether they are acquiring profit or loss at
the end of the period. For this purpose, they need profit and loss statement. To prepare these statement firm has to
maintain the accounts. It is a principle means of communicating financial information to owners, lenders, mangers and
others who have an interest in enterprises. It is a major tool in decision making.

American Institute of certified Public Accountants (AICPA) defines accounting as

an art of recoding, classifying and summarizing in a significant manner and in terms of money
and events which are, in part at least of a financial character and interpreting the results thereof.
a) Art of recording involves writing the financial transitions, immediately after they
occur in theaccounting records.
b) Art of classifying involves a classification of such data under appropriate heads of account
such assales, purchases, salaries, assets and so on.
c) Art of summarizing in a significant manner consists of presenting such classified data in
such waythat is useful to the internal and external end –users of accenting statements.
d) Accounting principles or standards are generally rules adopted in
accounting. These principles enable standardization in recording and reporting of financial
information. They are developed for common usage to ensure uniformity and understand
ability. Accounting principles are categorized into two parts as mention below.

Accounting principle

Accounting concept Accounting convent

2) What are the functions of accounting?

Accounting deals with recording, classifying, summarizing, analyzing and

interpreting the financial transitions and communicating the end results to the interested
parties. The functions of accounting are as follows.
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a) Recording:
Recording is a primary function of accounting. It mainly deals with
recording all the financial transitions of business in a sequential order. All financial
transitions are recorded in a book called as ‘Journal’. Journal is further divided into many
subsidiary books and the number of subsidiary books to be maintained depends upon
nature and size of the business.
b) Classifying:
Classification deals with an intention to group of the related entries of one
place. Ledger account is the book where in all the similar entries are recorded. Ledger
contains different accounts on different pages and accordingly related entries are recorded
under one particular account. It helps in indentifying the total expenditure incurred in one
specific account.
c) Summarizing:
Summarizing includes presenting the classified data in an acceptable and
practical manner which is useful to both the internal and the external users of accounting
statements. The process of summarizing involves preparing trail balance. Income
statement and the balance sheet.
d) Associated with financial transitions:
In accounting only those transitions are recorded ,which are financial in
nature and are in terms of money. Transitions which are not expressed in terms of money
and are non- financial in nature are not recorded in the books of account.
e) Analyzing and interpreting:
Analyzing and interpreting is the last function of accounting. The financial
data which was recorded earlier is now being analyzed and interpreted so that it can be
effectively used by the end users in making various decisions related to the financial
condition and profitability of the business. The data is also useful in preparing the future
plans and designing the policies for accomplishing those plans.
f) Communicating:
When accounting information is thoroughly analyzed and interpreted, it
must be communicated in an effective manner to the right person. The accounting
information can be communicated by preparing and distributing the accounting
information can be communicated by preparing and distributing the accounting reports
which includes the income statement and the balance sheet along with some additional
information to the form of ratios, graphic, funds flow statement, etc. An accountant must
176
 effectively utilize the innovative and imaginative abilities in the price.

3) Explain in detail the various accounting concepts?

Accounting is based on few concepts which allows assumptions or rules

for recording the transitions. Some important accounting concepts are as follows.
a) Separate entity concept:
In accounting, proprietor treats its business as a separate entity so that his
business transitions does not get mixed up with his personal life. If business and personal
activities are mixed up then it would be difficult to derive draw meaningful accounting
information. The separate entity concept is applicable to all forms of business
organizations for the accounting purpose. Usually, this concept seems to be unreasonable
but it is very useful in drawing out the accounting information.
b) Going concern concept:
In this concept, the proprietor assumes that business will continue for a
longer period of time in future. There is no intention of winding up the business in the near
future. In this concept, accountant values the assets by calculating depreciation on the
basis of expected life instead of the market values and be does not take into account the
forced sale value of assets.
c) Money measurement concept:
The concept implies that only monetary transitions are taken into consideration at
the time of preparation of accounting records. Books of account does not consider any
transition which cannot be expressed in terms of money even though it may be useful for
business but it is not recorded in the books of account.
d) Cost concept:
The cost concept is similar to going concern concept. This concept implies that.
* Only the actual price of the asset is being recorded in books of accounts and
* This actual cost is considered as a basis for further calculations of asset. This concept
explains that an asset is recorded at its cost at the time of purchese but as the time passes
on the value gets reduced due to depreciation charged on it. The preparation and
presentation of financial statements becomes flawless and impartial with the help of cost
concept.
e) Dual aspect concept:
The dual aspect concept is
177a primary concept of accounting, it implies that
 every business transition has two-fold effect i.e. dual effect. The double effect of this
concept can be expressed in form of an accounting equation as.
Capital + Liabilities = Assets
Or
Capital = Assets – Liabilities
This equation can also be written as.
Equities = Assets
Hence, accounting equation explains the 4relationship between equit5ies and assets. It
implies that every debit has a xredit which is equal to the sum of the debit.
e) Accounting period concept:
This concept explains that even through the life of business is very long but
proprietor must calculate its position regularly after certain period of time usually after oe
year, this is known as accounting period. At the end of very accounting period, accountant
is supposed to prepare the income ‘ statement which displays the profit or loss earned
during the accounting period and the balance sheet which shows the financial condition of
the business till the last day of the accounting period. During the preparation of the
statement, the capital and revenue expenditures must be taken carefully.
f) Periodic matching of costs and revenue concept:
The matching concept is based on the accounting period concept. According to
this concept, a business in order to achieve its prime objective of profit maximization
should always maintain a match between the costs and revenue within the accounting
period. The term ‘matching; refers to the adequate association of related revenues and
expenditures.
g) Realization concept:
According to this concept revenue is generated only through sales. The ploint of
time when the property in goods is passed on to buyer and wen he is legally entitled liable
to pay, it is considered as sales. The realization concept is not applicable for hire-purchase
and contracts account.

4) Examine the various accounting conventions?

Accounting conventions involves those rituals and practices which helps the
accountant in the preparation of accounting statements. Some of the important accounting
178
conventions are.
a) Convention of Conservatism:
Accounting to this convention, accountant must adopt the policy of playing safe and
follow the rule “ anticipate no profit but provide for all possible losses”
This implies that accountant must make a provision for all possible or expected losses
but unearned or unrealized profit must not be included. When convention of conservatism is
used inventory is valued at lower price, either at cost or market price and provision is made for
bad or doubtful debts.
The main objective of this convention is to misrepresent the true financial position
of the company in order to show lower the income and understated assets and liabilities.
b) Convention of full disclosure:
According to this convention, financial statements amust provide the complete
and true information about the company. Financial statements must be prepared in
accidence to the laws so that it can be effectively used by proprietors, present and potential
creditors and investors. The convention of full disclosure adds notes to the accounting
statements.
c) Convention consistency::
According to this convention, a company must follow same accounting practices and
methods from one period to another.
Any changing the accounting practices would result in several problems in
calculating the true financial position of the company.
If suppose for calculating depreciation a company follows a straight line
method in one company follows a straight line method in one year and diminishing reducing
balance method in another year, it becomes difficult to evaluate and compare the true financial
position of the company. If any advanced technique is introduced, it must be metioned clearly
in the financial statements.
d) Convention of materiality:
According to this convention, 5the accountant must give importance to material
details and must avoid unnecessary /unimportant details. Kohler defined ‘ materiality
means the characteristic attaching to a statement, fact or item whereby its disclosure or
method of giving it expression would be likely to influence the judgment of a reasonable
person.

179
5) Explain the importance of accounting equations?

An accounting equation is a statement of equality between the resources and the

sources which finance the resources and is expressed as under.
Resources = Sources of Finance.
Resources mean the assets:
The assets refer to the tangible object ( e.g. land and building,
plant and machinery, furniture, investments, stock, debtors, bank balance, cash balance) or
intangible rights ( e.g. patents, trademarks, copyright) owned by an enterprise and carrying
probable benefits.
Sources of finance mean equities:
Sources of finance mean equalities and includes internal source
or internal equity ( e.g. capital ) and external source or external equity ( i.e. are the financial
obligations of an enterprise otter than the owners funds. Thus, the aforesaid accounting
equation may be expressed as follows.
Total assets = total equities
Or Assets = internal equity + External equity.
Or Assets = |capital + liabilities.
Since, the liability holders have a definite and prior claim against the assets, the capital is
also called as a residual of assets over liabilities and may be expressed as follows.
Capital = Assets – Liabilities.
This equation is fundamental in the sense that it gives foundation to the double –entry
book keeping. This equation holds good for all transitions and events and at all periods of
time since every transition and event has two aspects.
Procedure for developing an Accounting Equation:
An accounting equation may be developed by taking the steps as follows.
Step-1: Ascertain the variables ( i.e. assets, liabilities or capital) of an equation affected by a
transition.
Step-11: Find out the effect (interims of increase or decreases) of a transition on the
variables of an equation.
Step-111: Show the effect on the appropriate side of an equation and ensure that the total of
right hand side is equal to the total of left hand side.

180 objectives of book keeping?

6) Define book keeping? What are the
 Book- Keeping is an activity concerned with the recording of financial data relating to
business operations in a significant and orderly manner. Book Deeping is the record making
phase of accounting. Accounting is based on a careful and an efficient book-keeping system.
Book-keeping-Definitions:
Book-deeping is defined by different authors. A few of such definitions are
given below. Carter in his Advanced Accounts defined book-keeping as “ the science and art
of correctly recording in both books account are those business transations that result in the
transfer money or money’ worth”.
According to B. G. Vickery “ In his ‘principles and practice of book-keeping’
defined book keeping as ‘ the art of recording pecuniary or business transactions in a regular
and systematic manner.
According to Kohler in his book ‘ A dictionary for Accountant’s defined book-
keeping as the ‘ process of analyzing classifying and recording transactions in accordance
with preconceived plan’.
Objectives of book-keeping:
a) Book-keeping is concerned with recording of the financial transitions of business
in a methodical manner so that information on any point in relation to them may
be quickly obtained.
b) Book-keeping activity is responsible for keeping all the financial records of a
business ( or only a minor sequent such as maintenance of the customer’s
accounts)
c) Book-keeping is to prepare original books of accounts tral balance and final
accounts.
d) To avoid financial frauds in business entity.

7. What do you understand by double entry system? Discuss its features?

Double entry also allows for the accounting equation (assets = liabilities + owner’s equity) to
always be in balance. In our example involving advertising expense, the accounting equation remained in
balance because expenses cause owner’s equity to decrease. In that example, the asset cash decreased and
the owner’s capital account within owner’s equity also decreased.
A third aspect of double entry is that the amounts entered into the general ledger accounts as debits
must be equal to the amounts entered as credits.
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Features of double entry system:
a) Set Rules- Every transation is recorded as per the set rules of personal, real and nominal accounts.
For this purpose every transation is divided in two parts.
b) Entry in two accounts- each transation affects two accounts whether it is a cash or credit transation.
c) Scientific system- Each transation is divided in two parts which are personal and impersonal and then
the rules of these accounts are applied. Since it has certain rules, it can be called as a scientific
system.
d) Preparation of trail balance- under double entry system, a trail balance is prepared to check the
arithmetical accuracy of the accounts. If the total of debit Colum is equal to the total of credit
column, then it means the accounts are arithmetically accurate.
e) Preparation of final accounts- under double entry system, the final accounts are prepared through
which one can know the profit and loss earned during the year. It also tells the final position of the
business on the date of preparation of final accounts.
f)
7) Who are users of financial accounting?

a) Owners: Owners want to know about the profits. They want to know how their business is going
on.
b) Creditors or financial institutions: Creditors or financial institutions are those who lend finances
to the business firm. They want to know whether their funds are safe or not. They use accenting
information to judgethe creditworthiness of a business firm. They wish to know whether the firm is
capable of paying interest fromtime to time or not.
c) Managers: Managers use accenting information to report to the owners or shareholders. From
accentinginformation, they can know whether their decisions are effective or not.
d) Government or tax authorities: Government is interested in taxes. From accounting
information, itassesses the tax liability of a firm, based on the net profits craned for a particular
period.
e) Employees: Employees are personally interested in the accounting information to know if they
can putforth their claims for better wages or better facilities.

182
 8) Briefly explain the classification of accounts?

a) Personal Account:

These are accounts opened in the name of persons, firms, and companies with whom the firm
deals. The rule governing personal accounts is „debt the receiver and credit the giver. This rule can be
explained with thefollowing examples.

Example: suppose X buys goods worth Rs 6000 from us. This is not a cash transition. This is credit
transition.So X is our detour as he is receiving the goods. So, debit X accounts, in our books.

b) Real Account:

There are accounts opened in the name of assets such as land and buildings, plant and
machinery, furniture, and fixtures etc. The rule governing real account is; debt what comes in and
credit what goes out.

c) Nominal Account:

This is also called fictitious account. It exists only for namesake. Nominal accounts cannot be
seen. Nominal accounts are those which are opened in the name of expenses, losses, profits, incomes
and gains. These cannot be physically seen. They can be felt. The rule governing nominal accounts is;
debt all expensesand loses and credit all incomes and gains.

9) Define accounting process. Explain the steps involves in accounting process?

Accounting consists of a number of sequential steps of activities. Those include

indentifying, recording, classifying, summarizing and communicating financial transitions. The
sequence of the steps to be followed in accounting activities is known as accounting process. The
accounting process takes the form of a cycle. The sequential steps of accounting activities are taken in
cyclical order. The cyclical order starts from the beginning of the transition till financial results are
derived by preparing final accounts at the end of the accounting year.
Steps in the accounting process:
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 The accounting process is actually three separate types of transitions that are intended to
record business traditions into the accounting records and then aggregate this information into financial
statements. The transition types are:
a) The first transition type is to ensure that reversing entries from the previous period have,
in fact, been reversed.
b) The second group is comprised of the steps needed to record individual business
transitions in the accounting records.
c) The third group is the period-end processing required closing the books and producing
financial statements.

10)Explain the various parts of accounting process?

There are three parts of the accounting process given below.

A) Beginning of period p0rocessing:

Verify that all transitions designated as reversing entries in preceding periods
have actually been reversed. These transitions are usually flagged as being reversing
entries in the accounting software, so the reversal should be automatic. Nonetheless,
examine the accounts at the beginning of the period, to verify the reversals. It is quite
possible that a reversing flag was not set and so an entry must be reversed manually, with
a new journal entry.
Individual transitions:
The steps required for individual transitions in the accounting process are:
B) Identify the transition:
First, determine what kind of transition it maybe. Example are buying goods from
suppliers, selling products to customers, paying employs, and recording the receipt of
cash from customers.
a) Prepare document:
There is frequently a business document to be prepared or recognized to initiate the
transition, such as an invoice to a customer or an invoice from a supplier.
b) Identify accounts:
Every business transition is recorded in an account in the accounting database, such asa
revenue, expense, asset, liability or stockholders’ equity account; identify which accounts
are to be used to record the transition.

184
 c) Record the transaction:
Enter the transition in the accounting system. This is done either with a journal entry or
an on-line standard transition form (such as is used to record cash receipts against open
accounts receivable). In the latter case, the transition forms record information in a
predetermined set of accounts (which can be overridden).
These four steps are the part of the accounting process used to record individual
business traditions in the accounting records.
C) Period-end Processing:
The remaining steps in the accounting process are used to aggregate all of the
information created in the preceding steps and present it in the formal of financial
statements. The steps are:
a) Prepare trail balance:
The trail balance is simply a listing of the ending balances in every account.
The total of all the debits in the trail credits if not, there was an error in the
entry of the original transitions that must be researched and corrected.
b) Adjust the trail balance:
It may be necessary to adjust the trail balance, either to correct errors or to
create allowances of various kinds, or to accrue for revenues or expenses in
the period.
c) Prepare adjusted trail balance:
This is the original trail balance, plus or minus all adjustments
subsequently made.
d) Prepare financial statements:
Create the financial statements from the adjusted trail balance. The asset,
liability and shareholders’ equity line items from the balance sheet, while
the revenue expense line items from the income statement.
e) Close the period:
This aversion of the trail balance should have zero account balances for all
revenue and expense accounts.
In reality, any accounting software package will automatically create all
versions of the trail balance and the financial statements, so the actual steps
in the accounting process may be considerably reduced. Instead, the steps
used in a computerized environment are likely to be”
a) Prepare financial statements:
185
 Information is automatically compiled from the general ledger by the
accounting software.
b) Close the period:
The accounting staff closes the accounting period that has just been
completed, and opens the new accounting period. Doing so prevents
current period transitions from being inadvertently entered into the prior
accounting period. In a multi-division company, it may be necessary to
complete this period closing step in the software for each subsidiary.

11)What is journal? Explain the objectives of journal?

A journal is known as a primary book of accounts or a book of original entry. With the
increase in the size of business, the number of business transactions also increases. It is
very difficult for a human being to remember all those transactions. Therefore, to overcome
this drawback, journal in prepared. Although, as stand above, the transactions can be
recorded directly in the ledger. But such procedure will be cumbersome and confusing.
Under the process, it will be very difficult to locate a tradition after several recordings. But
in journal, the reinsertions can easily be located as it provides chronological record of
transactions.
Defintions:
According to L.C. Cropper, “ a journal is a book employed to classify or sor out trandations
in a form convenient for their subsequent entry in the ledger”.
According to Roland, “Journal means a day book, diary or a log book. It is called prime
subsidiary book of double entry system”.
Objectives of journal:
a) Complete record of each transition:
Date- wise complete record of each business transition is recorded in the journal.
Summary of each transition is also written which is know as narration. The narration is
helpful in getting full information about the transition.
b) As a proof:
Journal is treated as a proof in the eye of the court for getting down the disputes among
two or more parties. In some countries like France, Italy, Germany etc, it is mandatory
to prepare ledger from journal.
c) Correct knowledge:
d) Explain the Performa or format of journal?
186
 Journal
Date Particulars Ledger Folio Amount Amount
Dr. Cr.

The description of the above columns is as follows

a) Date: The date on which a particular transition takes place is recorded her. The year is
written on the top and the month and dates are written afterwards.
b) Particulars: The two aspects of transactions ,i.e. debit and credit are recorded in first
two lines. Every debit aspect is written in the first line with a word ‘Dr’ at the end of
columns. ‘the second line starts with ‘To’ and the credit aspect iw written in this line.
The second line starts a few spaces away from the margin of the first line, ‘Cr’ is not
written at the end of this column.
c) .Ledger folio or L.F : Ledger folio is the page number of the ledger on which the
correspond entry is posted. It shows whether an entry has been posted or not. If a page
number does not appear against an entry, it indicates that the entry has not been posted
to ledger.
d) Debit amount: the amount to be debited is recorded against debit amount in this column.
e) Credit amount: The amount to be credited is recorded against credit amount in this
column.

187
 Example-1

12) Journalize the following transitions in the books of Madhu and prepare necessary ledger
accounts?

2016 January, 1. Madhu commenced with Rs 15,000/-

2. Paid into bank Rs. 10,000/-
3. Purchased goods from „B‟ for Rs 2000/-
4. Returned goods to „B‟ for Rs. 200/-
5. Paid to „B‟ in full settlement of A/c Rs. 1,700/-
7. Received interest from the bank Rs. 750/-
9. Sold goods for cash Rs. 7,000/-
12. Sold goods of Don for Rs. 4.000/-

15. Received goods worth Rs.100/- from don with a

complaint aboutDamage.
16. Paid salaries Rs. 400/-
17. Entertainment Rs.50/-
20. Received a cheque from Don Rs. 500/-
25. Issued a cheque for Rs. 100/- towards rent to landlord.

188
 Solution:

( in the books of Madha) Journalisation

Date Particulars LF Amount Amount

Dr. Cr.

2016 Jan 1. Cash account Dr 15,000

15,000
To Madhu‟s capital A/c
(being the business commenced)

“ 2. Bank account Dr 10,000

To cash 10,000
(being the cash deposited into Bank)

“3. Purchase A/c Dr 2000

To „B‟ account 2000
( being goods purchased
From „B‟ on credit)
“ 4. B‟s account Dr 200
To purchase return account 200
( being the goods returned
to B on account of damage)

189
 “ 5. B‟s account Dr 1800
To cash account 1700
To discount 100
( Being the payment
In full settlement)

“ 7. Cash account Dr 750

To interest from bank 750
( being the cash received
Towards interest)
“ 9. Cash account Dr 7000
To sales account 7000
( being goods sold for cash)

“ 12. Don‟s account Dr 4000

To sales account 4000
( being the goods sold)

“ 15. Sales returns account Dr 100

To don‟s account 100
( Being goods returned by
Don received)
“ 16. Salaries account Dr 400
To cash account 400
( being salaries paid)
“ 17. Entertainment account Dr 50
To cash account 50
(being the entertainment
Expenses incurred)
“ 20.Don A/c Dr 500
To cash account 500
(Being cheque received
From Don)

190
 “ 25. Rent account Dr 1000
To bank account 1000
(being the rent
Paid by cheque)

Total 42,850 42,850

13) Define ledger? Explain the advantages of ledger?

Ledger is a book where the journalized transitions are being classified. Ledger is a set of
accounting and includes all the accounts of business i.e. personal, nominal or real.
A company can maintain ledger in two forms ie. Bound ledger and losse-leaf ledger. The
process of transferring the debit and credit items from the journal to the ledger in their respective
accounting is known as posting. Posting must be made/ done before the preparation of final
accounts. The accounts which are active in nature must be updated on the timely basis.

Advantages of ledger:
The main advantages of ledger are as follows:
a) Knowledge of business results:
With the help of ledger the important information relating to business can easily be
obtained the business transactions relating to an item are recorded in the form of separate
accounting ledger in such a way as their effect on assets, liabilities and capital can easily be
understood.
b) Knowledge of incomes and expenses:
A separate account is opened for each item of income and expense. Thus, it enables to
understand that, what are the sources of income and where the amount is spent.

c) Helpful in preparing trail balance:

Ledger is also helpful in the preparation of trial balance. Without preparing the ledger,
trial balance cannot be made.

d) Helpful in preparing final accounts:

It is mandatory for the businessman to prepare final accounts. Ledger helps in preparing
the final accounts as the total or balances of acconts appear in trading A/c, P/K A/c and
balance sheet.

e) Overcoming the limitations of journal:

Ledger fulfills all those objects which lack in journal. Journal does not provide complete
description of all the transitions relating to an account in classified and summarized form, but
the ledger provides it.

14) How is posting done in ledger accounting?

191
 The book keeper posts the transitions from journal to the ledger by using any of the
following methods.

a) Book keeper can post any specific side either debit or credit first and post all the transitions of
that side in the ledger accounts. For instance, if the credit side is selected then all the entries
of the credit side must be posted into the ledger first.

b) Bookkeeper can post entries on basis of specific account and can complete all the debits and
credits of that specific account and then move onto the other account.

c) Bookkeeper can post entries in accounts in a sequence of journal entries. This method is
effective as entries are posted as and when they are recorded in the journal.

Similar to ledger folio (L.F) in journal, a column of folio is prepared in ledger also
for recording the page number of journal from which the posting is being done it is called as
L.F ( journal folio) The perform of a ledger account is as follows.

Dr. Name of the accout Cr.

Date Particulars L.F Amount Date Particulars L.F Amount

The following rules and principles should be kept in mind while posting:

a) An account has two sides Debit and Credit. Debit side is marked as Dr. at the top of left
hand side and right hand side is marked as Cr. At the top.
b) Name of the account is mentioned at the top in the centre of the account. The account in
the centre of it.
c) All postings on debit side starts with ‘to’ and credit side with ‘By’
d) All transitions relating to an account are recorded at one place in that particular account.
e) The A/c word is not written after the name of personal account.
f) If an account is debited in journal, then posting is made on the debit side of the account in
which posting is made with the name and amount appearing in the credit of journal entry
and vice-versa.

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 14)Examine Preparation of Ledger Accounts?

Cash account
Dr Cr
Date Particulars F Date Particulars F Amount
Amount Rs
2016 Jan 2. By Bank
RS 10,000
2016 Jan 1. To Madhu A/c “ 5. B‟s A/c
15,000 1700
7. to interest A/c “ 16. By salary A/c
750 400
9. to sales A/c “ 17. B entertainment A/c 50
7,000 By balance c/d
10,600

-- ---

22,750
22,750
Feb 1. To balance b/d
10,600

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 Madhu account
Dr Cr
Date Particulars F amount Date particulars F
Rs Amount
2016 Jan 31. To balance c/d 15,000
RS
--- 2016 Jan 1. By cash account 15,000

------
15,000
--------
15,000

Feb 1. By balance b/d

15,0000

Interest from Bank Account

Dr
Cr
Date Particulars F Amount Date Particulars F Amount
Rs Rs
2016 Jan 31. To balance c/d 750 2016 Jan 7. By cash account 750

750 750
Feb 1. By balance b/d 750

194
 Discount account

Dr Cr
Date Particulars F Amount Date Particulars F Amount
Rs Rs
2016 Jan 31 To balance c/d 100 2016 Jan 5. By B account 100

100 100

Feb 1. By balance b/c 100

Sales Account
Dr
Cr
Date Particulars F Amount Date Particulars F Amount
Rs Rs
2016 Jan 31. To balance c/d 11,000 2016 Jan 9. By cash amount 7,000
“ 12. By don account 4,000

11,000 11,000

31. By balance b/d 11,000

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 Don account
Dr Cr
Date Particulars F Amount Date Particulars F Amount
Rs Rs
2016 Jan 12. To sales A/c 4,000 2016 Jan 15. By sales returns A/c 100
― 20. By cash A/c 500
― 31. By balance c/d 3,400
---------
4,000 -
Feb 1. By balance b/d 3,400 4,000

Purchases \Returns Account

Dr Cr
Date Particulars F Amount Date Particulars F Amount
Rs Rs
2016 Jan 31. To balance c/d 200 2016 Jan 4. By B account 200

200 200

Feb 1. By balance b/d 200

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 Bank Account
Dr Cr
Date Particulars F Amount Date Particulars F Amount
Rs Rs
Date Jan 2, To cash A/c 10,000 2016 Jan 25. By rent 1000
20. To \don A/c 500 By balance c/d 9500

10,500 10,500

Feb 1 To balance b/d 9,500 -

Dr Rent Account Cr
Date Particulars F Amount Date Particulars F Amount
Rs Rs
2016 Jan 25 To bank A/c 1000 2016 Jan 31 By balance c/d 1000

1000 1000

Feb 1 By balance b/d 1000

Salaries Account
Date Particulars F Amount Date Particulars F Amount
Rs Rs
2016 Jan 16 To cash A/c 400 2016 Jan 31 By balance c/d 400

400 400

Feb 1. By balance b/d 400

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 Entertainment Account
Dr Cr
Date Particulars F Amount Date Particulars F Amount
Rs Rs
2016 Jan 17 To cash A/c 50 2016 Jan 31 By balance c/d 50

- 50
50 -------

Feb 1 By balance b/d 50

Purchasing Account
Br Cr
Date Particulars F Amount Date Particulars F Amount
Rs Rs
2016 Jan3 To B A\c 2000 2016 Jan 31 By balance c/d 2000

2000 2000

- Feb 1 By balance b/d 2000

Sales returns Account

Dr Cr
Date Particulars F amount Date Particulars F Amount
Rs Rs
2016 Jan 15 To don A/c 100 2016 Jan 31 By balance c/d 100

100 100

Feb 1 By balance b/d 100

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 B‟s Account
Dr Cr
Date Particulars F Amount Date Particulars F Amount
Rs RS
2016 Jan 4 To purchase 2016 Jan 4 To purchase A/c 2000
Return A/c 200
5 To cash A/c 1,700
5 To discount A/c 100

2000 2000

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 15) Taking the balance sheet of ledger account, c a n y o u make trail balances for the
month ofJanuary,31, 2016.
Different accounts Debit balances Credit balances
Rs Rs
Cash account 10,600

Madhu capital account - 15,000

Interest from bank account - 750

Discount account - 100

Sales account - 11,000

Don account 3,400 -

Purchase returns account - 200

Bank account 9,500 -

Rent account 1,000 -

Salaries account 400

Entertain account 50 -

Purchases account 2000 -

Sales returns account 100 -

Total 2,7050 2,7050

16)Define the trail balance? What the objectives or trail balance?

Trail balance is a worksheet in which the balances of all ledgers are compiled into debit
and credit columns. Under the double entry system, the total of debits must be equal to total of credits.
This worksheets helps in evaluating whether or not the total debits for the period are equal to total
number of credits generated for the same period.

Every businessman prepares the traial balance after journal and ledger. It is tradition to
prepare the trail balance before the preparation of the final accounts. It serves as a tool to detect errors. If
the trail balance is balanced, it means there are no mathematical errors in the ledger. However this does
not mean that there are no errors ina company’s accounting system. By preparing trail balance on a
regular basis makes it possible to quickly identify a specific accounting period where the imbalance took
place and correct if quickly. Therefore, many businessmen choose to prepare a trail balance on monthly
200
basis.

Definitions of trail balance:

According to carter, “trail balance is a statement of debit and credit balances derived from the ledger,
including cash and bank balances”

Objectives of trial balance:

The objective of preparing trial balance is as follows.

a) Checking the Arithmetical accuracy: One of the main objective or advantage of preparing the trial
balance is to check the arithmetical accuracy of the ledger postings before the preparation of final
accounts.

b) Knowledge of balances: A main objective for preparing the trail balance is to know the balances of
different accounts.

c) Full proof of recording: Another objective of preparing the trail balance is to know whether the
double entry for all the transitions is complete or not,. It is revealed by tallying of trail balance.

d) To take comparative decisions: By comparing the balances of two or more years of different
accounts, the comparative decisions can be taken.

e) Preparation of final accounts: Every businessman wants to check the arithmetical accuracy of the
accounts before the preparation of final accounts. It is done with the help of traial balance. If the trial
balance agrees, it means the accounts are arithmetically accurate.

f) Detection of errors: Preparation of trial balance is also helpful in detecting the errors, e.g. error in
totaling, error of omission and commission, etc.

16) Explain the Pro forma of Trial balance?

Trial Balance as on ----

Date Particulars L.F Amount Amount
Dr. Cr.

a) Name of account; Names of all the accounts are given in this column.
b) Ledger Folio: It is the page number of the ledger on which a particular account is opened.
c) Debit amount: In these columns, the balance of that account will be shown that has debit
balance or the total of the debit side of the account will be written.
d) Credit Amount: In this column, the balance of that account will be shown that has credit
balance or the total of the credit side will be written.

Importance points to remember while preparing trial balance.

a) All assets have debit balance and all liabilities have credit balance.
b) Capital account has credit balance.
c) Closing stock is not included in trial balance.
d) All incomes and gains appear in the debit column of trial balance.
e) Drawing account has debit balance.
f) Purchases and sales return account has debit balance and sales account and purchases return
account has credit balance.
g) If a difference in the debit and credit column appears, it is transferred to suspense account.
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 17) Make a trail balance as on 31.12.2016 ?

Particulars Rs

Sundry debtors 32,000

Stock (1.1.2016) 22, 000

Cash in hand 35

Cash at bank 1,545

Plant and machinery 17,500

Sundry credit 10,650

Trade expenses 1,075

Sales 2,34,000

Salaries 2,225

Carriage outwards 400

Rent 900

Bills payable. 7, 500

Purchases 2,18,870

Discounts (Dr) 1,100

Capital 79,500

Business premises 34,500

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 Trial Balance as on December 31, 2016.

Particulars Dr (Rs) Cr (Dr)

Sundry debtors 32,000

Stock (1.1.2016) 22, 000

Cash in hand 35

Cash at bank 1,545

Plant and machinery 17,500

Sundry credit - 10,650

Trade expenses 1,075

Sales - 2,34,000

Salaries 2,225

Carriage outwards 400

Rent 900

Bills payable - 7, 500

Purchases 2,18,870

Discounts (Dr) 1,100

Capital - 79,500

Business premises 34,500

- Total = 3,32,150 3,32,150

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18) Define final accounts? What are the objectives of final accounts?

One of the main objectives of maintaining accounts is to know the profit or loss made by the
business organization in a particular period. This period may be a year, half year to quarter of a year
for non statutory business concerns; it will be as per the convenience of the trader. But in general it is
at the end of either calendar year or financial year. Further one must know that by mere preparation of
trial balance one may not be able to find out the profit or loss of a business entity. Hence it is needed
to prepare the final accounts.
The tern final accounts means statements, which result finally from the preparation accounts
showing the profit earned or loss suffered by the firm and the financial state of affairs of the firm at
the end of the period concerned. As already stated, the statement showing the profit or loss is known
as profit and loss account and the statement showing the financial state of affairs is called the balance
sheets. The student must realize that in every concern, big or small, the accountant will be required to
prepare these statements. Therefore, those who lean accountancy should become proficient in this. It is
the trial balance that is the basis of these two statements and unless the student has mastered the
preparation of the various books and ledger accounts and also of the trial balance, he will not be able
to fully grasp the significance of the profit and loss account and the balance sheet and master the
technique of preparing them.
Objectives:
The main objectives of preparation of final accounts are:
a) The ascertain the profit or loss of the business for a particular period( By preparing trading and
profit and loss account)
b) To find out the financial position of the business concern on a specified data or period. ( by
preparing of the balance sheet)

19) What are the features of final accounts?

a. Based on facts: on the basis of the facts and transactions recorded in accounting books,
The final accounts are usually being prepared.
b. Implements accounting conventions: Accounting conventions act as the basis for
preparing the final accounts statements. For instance, closing stock valuation at the
market price of cost price whichever is less.
c. Follows accounting assumptions: the final accounts are prepared on the basis of few
accounting assumptions such as going concern assumption, money measurement
assumption.
d. Laid on personal opinion judgments and estimates: the final accounts are laid on the
personal opinion, judgments and estimates like creation of provision for doubtful debts,
valuation of the closing stock either of cost price or at market price whichever is less.

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 20) Examine the Final Accounts of sole proprietor?

The process of preparing final accounts of dole proprietor is of two stages: (a) Trading and profit and
loss account and (b) Balance sheet.

Preparation of trading and profit and loss account:

Trading and profit and loss account shows the gross profit ( or gross loss) and net profit (or net loss)
respectively for the given accounting period. Trading and profit and loss account consists of two parts: (a)
Trading account (b) Profit and loss accent.

Trading account:

Trading account shows gross profit or gross loss for the end of a given accounting period. Gross
profit or gross loss is the excess of sales revenue over the cost of goods sold.

Gross profit = Net sales – Cost of goods sold.

If the cost of goods sold is more than the sales revenue, it results in gross loss.

Items to be considered in trading accounts are:

a) Opening stock
b) Purchases less purchase returns (returns outwards)
c) Wages.
d) Carriage inwards
e) Fuel and power
f) Sales less sales returns.
g) Any other direct expenses such as freight, spent on raw materials.
h) Closing stock given as additional information (adjustments)

While preparing trading account for a manufacturing concern, consider only such factory expenses
that increase the cost of goods manufactured, such as fuel and power, heating and lighting, etc. In other
words, gross profit is arrived at after considering all factory expenses.

205
 Example: 1.
From the following extract of trial balance, from the books of Kamal, for the year ending December
31 2016, prepare a trading account.

Trial balance as on December 31,2016

Particulars (Rs) (Rs)

Sales 3,25,000

Purchases 2,40,000

Freight 5,000 -

Sales retunes 5,000 -

Purchase returns - 5,000

\wages 40,000 -

Salaries 20,000 -

Carriage inwards 10, 000 -

Opening stock (1.1.2016) 25,000 -

Total = 3,45,000 3,30.600

Adjustments: Stock as on 31, 12.2016 was Rs 40,000

206
Solution: Dr Cr

Rs Rs

To opening stock. 25,000 By sales 3,25,000

Less: sales return 5,000 3,20,000

To purchases 2,40,000
Less purchase
Returns 5,600 2,34,400 By closing stock 40,000

To wages 40, 000

To carriage inwards 10,000

To freight 5,000

To gross profit transferred 45,600

To profit and loss ------------ ------------
account Total= 3,60,000 3,60,000

Note: Salaries given in trail balance is not considered here. Salaries is office expense and hence it is transferred
to profit and loss account. Trading account considers only expenses and receipts at the factory.

Profit and Loss Account:

Profit and loss account shows net profit or net loss for the end of a given period.

From the gross profit (or gross loss) from trading account, deduct all expenses relating to office,
selling and distribution departments. Add all non-operating income such as commission or rent received,
interest received etc.

Profit and loss account considers only revenue expenditure such as those incurred in :

a) Maintaining the capital asset.

b) Running business from time to time.
c) Selling and distributing the goods of the business they deal in

The details of expenses and incomes entered in profit and loss account are furnished in the following former of
profit and loss account: the format shows the accounting treatment also.

To put it this brief, Net profit= Gross profits + Other income – Expenses. Here all expenses relating
to office, selling and distribution are considered.
207
Example:1 Prepare (a) trading account and (b) profit and loss account from the followingBharath‟s trial balance
for the year ending 31.3,2016.
21) Explain the trail balance sheet of Bharat?

In the books of Bharat

Trial Balance
As on 31.3.2016

Particulars Rs Rs.

rawings Discounts 4000

allowed.Discounts 1500

received.Office -

expenses 2000 500

Manufacturing expenses 1200

Bills payable. 17000

Bills receivable 10000

Cash in hand 4800

Cash at bank 30800

Office rent 3600

Bharath‟s capital -

Machinery 60,000

Stock (1.4.2016) 32,000 2,00,000

Wages 1,00,000

Carriage inwards 1000

Salaries 10,000

Factory rent 4800

Repairs 800

208
Fuel and power 5,000

Furniture 11000

Buildings 80000

Sundry debtors 40000

Sales - 4,07,200

Purchases 2,44,000

Creditors - 25,000

Returns inwards (sales return) 7,200 -

Returns outwards (purchase returns) 4000

Total 653700 653700

Adjustments: closing stock Rs 40,000/-

209
( in the books of Bhaath)
Trading account for the year ending 31.1.2016.
Dr Cr
Rs Rs
By sales 4,07, 200
To opening stock 32,000 Less: 7.200 4,00,000

To purchases 2,44,000 By closing stock 40,000

Less purchase
Returns 4,000 2,40,000

To wages 1,00,000

To carriage inwards 1000

To manufacturing expense 1200

To fuel and power 5000

To factory rent 4800

To gross profit transferred

To profit and loss account 56000

Total 4,40,000 4,40,000

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 Profit and loss A/c for the year ending 31.3.2016.
Dr Cr
Rs Rs

To salaries 10,000 By gross profit 56,000

To repairs 800 By discount received 500

To discounts allowed 1500

To office expenses 2000

|To office rent 3,600

To net profit transferred to

Capital account 38,000

Total = 56,500 56,500

Balance sheet:

Balance sheet is a statement of assets and liabilities of a business as on a given date. It shows a true
and fair view of financial position of a business as on a given date.

Balance sheet is a statement (it is not an account. Hence, it does not have debit side or credit side).
It has two sides: Liabilities side and assets side: Balance sheet portrays accounting equation wherein Assets+=
Equity (owner‟s equity or capital and creditors‟ equity or outside liabilities). In other words, under double-entry
system, assets must always be equal to capital and liabilities.

211
 22) Prepare balance sheet for the accounting information given in the previous example.
Solution: ( in the books of Bharath)
Balance sheet
As on 31.3.2016

Dr Cr

Liabilities Rs Rs Assets Rs. Rs

Long-term liabilities: Fixed Assets

Bharath‟s capital: 2,00,000 - Buildings 80,000

Add: net profit from

P and L account 38,000 - Plant and machinery 60,000

2,38,600 furniture and fixtures 11,000

Less: drawings 4,000 2,34,600

Current Liabilities Current assets

Sundry creditors 25,000 Stock 40,000

Bills payable 17,000 Sundry debtors 40,000

Bills receivables 10,000

Cash at bank 30,800

Cash in hand 4,800

|total = 2,76,600 2,76,600

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 Self-assessment questions

1. Multiple choice questions.

1) The process of identifying, measuring, and communicating economic information to permit

informed judgment and decisions by the users of the information is called.
a) Auditing b) cost accounting c) accounting. D) management accounting.

2) Accounting helps to
a) Show technical position for a given period.
b) Dislocate the information to different parties.
c) Monitor the business activities.
d) Calculate marginal costing for a given period.

3) Creditors or financial institutions use the accounting information to analyze.

a) Interest rates. B) financial status. C) creditworthiness. D) owners or shareholder‟s
position.

4) Managers use accounting information to report to

a) Company employees b) CFO c) CEO d) owners or shareholders.

5) The financial statements comprise.

a) Trading account, balance sheet. B) balance sheet, ledger c) journal, ledger
e) Trading account, profit and loss account, balance sheet.

6) The trading and profit and loss account is also called as.
a) Account statement b) income statement c) balance statement d) cost statement.

7) Which of the reveals the financial position of the business Firm in terms of its assets and
liabilities.
a) Ledger b) balance sheet. C) profit and loss account. D) trail balances.

213
8) Which of the following aims of ascertaining and controlling the costs of a product, service or
a department?
a) Management accounting b) financial accounting. C) cost accounting d) accounting
cycle.

9) Cost accounting refers to the application principles, methods, and techniques in the
ascertainment of costs.
a) Management accounting b) financial accounting c) exclusive control purposes. d)
management, financial accounting.

10) Cost accounting is more used for

a) Internal control purposes. b) external control purposes. c) exclusive control purposes. d)
marginal costing.

Answers for multiple choice questions.

1) C, 2) c, 3) c, 4) d, 5) d, 6) b, 7) b, 8) c, 9) c, 10) a) .
Short answer questions.
a) Journal
b) Ledger
c) Real account
d) Nominal account.
e) Personal account.
f) Double entrybookkeeping.
g) Sales book cash book capital expenditure.
h) Capital receipt.
i) Trading account.
j) Profit and loss account.
k) Balance sheet.
l) Trail balance.

214
 Unit-V
FINANCIAL ANALYSIS THROUGH RATIOS

1) Define the ratio analysis? Examine the different types of ratios?

Ratio analysis is the process of determining and interpreting numerical

relationships based on financial statements. By computing ratios, it is easy to understand the financial position
of the firm. Ratio analysis is used to focus on financial issues such as liquidity, profitability and solvency of a
given firm.

Liquidity refers to how well the firm is in a position to meet its short-term
commitments such as payment of salaries, taxes and so on. Profitability refers to how capable the firm is
conducting its business operations in a profitable manner. Solvency refers to the firms position to meet its long-
term commitments such as repayment of long-term loans and so on.

What is meant by Ratio?

It refers to the numerical or quantitative relationship between two variables which are
comparable. It is an expression derived by dividing one variable by the other. It is a ststical measure that
provides an insight into the relationships between two variables. Ratios used rightly may even develop
understanding and stimulate thinking. Ratios can be expressed in terms of percentage, proportions and quotients
also.

The utility or ratio is based on its selection. The ratio selected should math with the purpose.
Use te standard ratios to avoid misinterpretation. Items selected for computation of ratio should be related so as
to provide meaningful results. The quantity demanded for a particular product when studied in relation to
income of the consumer provides meaningful results.

215
Types of Ratios:

The ratios can broadly be classified into four categories.

2. Liquidity ratios
3. Profitability ratios
4. Capital structure ratios.
5. Activity ratios.

A) Liquidity Ratio:

Liquidity ratios express the ability of the firm to meet its short-term commitments as and when they become
due. Creditors are interested to know whether the firm will be in a position to meet its commitments on time or
not. If the firm is not in a position to meet its short-term commitments such as payment of taxes, wages and
salaries and son, then it cannot continue in business for long despite, its strong capital base. Liquidity ratios help
in identifying the danger signals for the firm in advance. Apart from the firm itself, all the financing companies
offering short term finances are interrelated in these ratios.

a) Current ratio:

Current ratio is the ratio between current assets and current liabilities. The firm is said to be
comfortable in its liquidity position if the current ratio is 2:1. It is almost considered as a yardstick to
assess short-term liquidity. However, it may vary from one industry sector to the other. In other words,
for every rupee of current liability, there should be two rupees worth current assets. The interests of the
creditors are safeguarded if the current ratio is at least 2:1.

Current ratio = current assets / current Liabilities.

The current assets include stock, debtors, bills receivable, cash at bank, cash in hand, prepaid
expenses, income yet to be received and so on. All these are short term assets. The current liabilities are
creditors, bank overdraft payable in a period less than one year duration, bills payable, outstanding
expenses, incomes received in advance, all provisions, dividends payable and so on. All these are
current liabilities.

216
b) |Quick ratio:
Quick ratio is also called acid test ratio. It measures the firm‟s ability to convert its current assets
quickly into cash in order to meet its current liabilities. It is the ratio between liquid assets and liquid
liabilities. It supplements the information given by current ratio.

|Quick ratio = quick assets / current liabilities

Where quick asses = current assets – (stock + prepaid expenses)

|Quick assets are those assets that can be converted intocash quickly. These are also called liquid
assets. Since stock cannot be sold quickly, it is not included in the list of quick assets. All current assets
except stock and prepaid expenses, if any, are called quick or liquid assets. The standard for the ratio is
1:1. In other words, for every rupee of quick liability, there should be one-rupee worth quick asset.
Quick ratio provides a hard and rigorous measure of short-term liquidity.
Exampel-1:
From the following Balance Sheet of XYZ co. L td., calculate liquidity ratios.
Balance sheet of XYZ Co.Ltd.
As on 31.12.2016
(Rs in thousand)
Liabilities Rs Assets RS

Preference shares capital 100 Land and buildings 225

Equity shares capital 150 Plant and Machinery 250

General reserve 250 Furniture and fixtures 100

Debentures 400 Stock 250

Creditors 200 Debtors 125

Bills payable (over draft) 50 Cash at bank 250

Outstanding expenses 50 Cash in hand 125

Profit and loss account 100 Prepaid expenses 50

Bank loan (long term) 200 Marketable securities 125

Total = 1500 1500

217
Solution:
Calculation of current ratio:

From the above balance sheet, identify the current assets and current liabilities.

The current assets include stock (250), debtors (125), cash at bank (250) ,cash in hand (125),
prepaid expenses(50) and marketable securities (125). The total of these is 925.
The current liabilities include creditors (200, bank overdraft (50), and outstanding expenses
(50). The total of these is 300.
Current ratio = current assets / current liabilities

= 925 / 300
= 3.08 :1
For every one rupee of current liabilities, there is Rs 3.08 worth current assets. The liquidity position is
satisfactory as it is more than the standard of 2:1

Calculation of Quick ratio:

Now identify the quick assets: exclude stock and prepaid expenses from the list of
current assets. In this case, the quick assets are 925- (250 + 50) = 625

Quick ratio = quick assets /current liabilities

= 625 / 300
= 2.08
Since this also is above the standard of 1:1, short-term liquidity position of the company is
satisfactory.

218
B) Profitability Ratio:

Profitability ratios throw light on how well the firms is organizing its activities in a profitable
manner. The owners expect reasonable rate of returns on their investment. The firm should generate
enough profits not only to meet the expectations of the owners, but also to finance the expansion
activities.

a) Gross profit ratio:

Gross profit ratio is the ratio between gross profit to sales during a given period. It is expressed
in terms of percentage. Gross profit is the difference between the net sales and the cost of goods
sold.
Gross Profit Ratio = (Gross profit / sales) x 100

Gross profit should be adequate to cover the operating expense and to provide fixed
charge, dividends, and reserves. There is no fixed norm to judge the gross profit ratio. The higher the
gross profit ratio, the better it is. Gross profit is affected by several factors such as cash profits or
cash losses, stock losses, mark ups or mark downs, purchase process, stock valuation, expenses, and
so on. For instance, if the mark up or profit margin is high, the gross profit is high. For any reason,
goods have to be disposed off at throwaway prices or mark down, this affects the gross profit.

Example-1:

Suppose the net sales is 50,000 for a firm and cost of goods sold is Rs 20,000. The gross profit
ratio is calculated as below.

Gross profit ratio = (30,000 / 50,000) x 100

= 60 percent.
In other words, 60 percent of its sales is the gross profit.

219
b) Net profit ratio:
Net profit ratio is the ratio between net profits after taxes and net sales. It indicates what
portion of sales is left to the owners after operating expenses. Non-operating income such as interest
on investments, gain on sale of fixed assets and so on are added to the operating profit and non-
operating expenses such as loss on sale of fixed assets and so on are deducted from such profits. This
is the net profit after adjusting non-operating income and non-operating expenses.

Net profit ratio = (net profit after tases / Net sales) x 100
Example-1:
Suppose the net sales is 50,000 for a firmand cost of goods sold is Rs 20,000. The details of
expenses are as given below.

Administrative expenses: Rs 3000

Selling and distribution expense: Rs 4000
Loss on sale of fixed asset: Rs 4000
Interest on investment: Rs 2000
Taxes 20% --
Calculation of net profits.
( in Rs)
Sales 50,000
Less cost of goods sold. 20,000

Gross profit 30,000

Less administration expenses 4000
Selling and distribution expenses 4000 8000

Net profit 22,000

Add: interest on investments (non-operating income) 2000

20,000
Less: loss on sale of asset(damage) 3000

17,000
Taxes @ 20% 3,400

Net profit after taxes: 13,600

Net profit after taxes:
Net profit ratio = (13,600 / 50,000) x 100
= 27.2%

220
 The higher the net profit ratio, the better is the profitability and vice versa. This ratio is widely
used as a measure of overall profitability. It should be used along with operating ratio for better
interpretation.

c) Operating ratio:

Operating ratio is the ratio between costs of goods sold plus operating expenses and the
net sales. This expressed as a percentage to net sales. The higher the operating ratio, the lower is the
profitability and vice versa.

Operating ratio = (Operating expenses / Net sales) x 100

Where operating expenses = (cost of goods sold+ administrative expenses + selling and
distribution expenses). In other words, it can be expressed as 20,000 + 4000 +4000 =28,000

= 50,000 – 28,000 = 22,000

= 22,000 / 50,000 x100

= 44 percent.

Administrative expenses cover all office and management expenses such as salaries, office
rent, insurance, director‟s fee, legal expenses, and so on. Selling and distribution expenses include salaries to
sales staff, advertising, travelling expenses, cost of samples and so on.

Operating ratio of 44 percent means the firm has remaining 56 percent of sales revenue as
profit. It is always desirable to have a low operating ratio.

Operating expenses are more in manufacturing firms than in service rendering firms. In
manufacturing firms, the operating ratio ranges from 75 to 85 percent of the sales. The non-manufacturing
organizations find their operation ratio anywhere between 40 to 60 percent.

C) Solvency ratio (Leverage or capital structure ratios)

Capital structure ratio or leverage ratios is defined as „the financial ratio, which focusses on
the long-term solvency of the firm. The long-term solvency of the firm is always reflected in its ability to
meet its long-term commitments such as payment of interest periodically without fail, repayment of
principle as ad when due.

221
All the financial institutions offering long-term fiancés are interested in these ratios. The following are the
most commonly used capital structure ratios.

a) Debt-equity ratios:
Debt – equity ratio is the ratio between outsiders‟ funds (debt) and insider‟s funds (equity).
This is used to measure the firm‟s obligations to creditors in relating to the owners‟ funds. It is a
measure of solvency. The yardstick for this ratio is 1:1. In other words, for every rupee of debt, there
should be one-rupee worth internal funds.

Debt-equity ratio is calculated as follows,

Debt Equity ratio = (Debt / Equity ratio)

Or
(Outsiders funds / insiders or shareholders‟ funds)

Example-1:
Calculate Debt-Equity ratio from the data given.
The following are the outsiders‟ funds.

Outsiders‟ funds = Debentures Rs. 4,00,000 + Rs 1,50,000 + General Reserve Rs 2,50,000 + Profit and
loss Account Rs 1,00,000.

= 6,00,000.

Insiders‟ funds = Rs. 6,00,000

(preference share capital Rs 1,00,000 + Equity share capital Rs 1,50,000 + General Reserve Rs 2,50,000
+ profit and loss account Rs 1,00,000)

Debt equity ratio = 6,00,000 / 6,00,000

= 1:1
Debt equity ratio of 1:1 means that for every Rs 1.00 of debt, there is an equity fund of
Rs 1. Which meets the standard yardstick of 1:1. This is satisfactory.

222
b) Interest Coverage ratio:

Interest coverage ratio is calculated to judge the firm‟s capacity to pay the interest on
debt it borrows. It gives as idea of the extent the firm‟s earnings may contract before it is unable to pay
interest payments out of current earnings. It is a very important ratio for the financial institutions to
judge the ability of the borrower to service the loan from the current year‟s profits. The higher the ratio,
better it is. In other words, a higher ratio implies that the company has no problems in paying interest.

Interest coverage ratio is calculated as follows.

Interest coverage ratio = (Net profit before interest and taxes / fixed interest charges)

The more the number of times of coverage, the better is the solvency position of the borrower.

Example-1:

The earnings before interest and taxes (EBIT) of a company is Rs 5,60,000. Its fixed
commitments include payment of 10 percent on 7000 debentures of Rs 100 each. It is subject to tax of
30 percent per annum.

Calculate interest coverage ratio.

Net profit before interest and taxes = Rs 5,60,000

Fixed interest charges on the debentures = (7000 x100) x 10 percent

= Rs 70,000
Interest coverage ratio = (5,60,000/ 70,000)

= 8 times.
Interest coverage ratio of 8 times means that the net profit earnings are 8 times to the
fixed interest charges payable during the year.

The more the number of times the coverage, the safer is the investment. Extending finances to such a
company getting a net profit covering 8 times of its fixed charges, is a safe bet for the lender.
223
D) Activity Ratio:

Activity ratios express how active the is in terms of selling its stocks, collecting its receivables
and paying its creditors. These are as follows.

a) Inventory Turnover Ratio:

In is also called stock turnover ratio. It indicates the number of times the average stock is being
sold during it given accounting period. It establishes the relation between the cost of goods sold during
a given period and the average amount of inventory outstanding during that period. The bigger the
inventory turnover ratio, the better is the performance of the firm in selling its stocks.

It helps in determine the liquidity of the firm by giving the rate at which inventories are
converted into sales and then to cash. It also helps the financial manager to design an appropriate
inventory policy so as to avoid piling of inventories. It is calculated as given below.

Inventory turnover ratio = cost of goods sold / average inventory

Where cost of goods sold = sales – gross profit.

Average inventory is the average of opening stock at the beginning of the year and the
closing stock at the end of the year that is.

Average stock = Opening stock + closing stock / 2.

A high inventory turnover ratio implies the efficiency of the firm whereas a low inventory
turnover ratio indicates that the firm is not in a position to clear its stocks.

From the inventory turnover ratio, we can also determine the inventory holding period. It is
determined as given below.

224
 Inventory holding period = 365 days / inventory turnover ratio

Example-1:

A firm sold goods worth Rs 5,00,000 and its gross profit is 20 percent of sales value. The
inventory at the beginning of the year was Rs 16,000 and at end of the year was 14,000. Compute
inventory turnover ratio and also the inventory holding period.

Calculation of inventory turnover ratio: To calculate inventory turnover ratio, we need cost of goods
soldand average stock.

Cost of goods sold = sales – Gross profit

Gross profit = 20 % of sales value i.e., Rs 1,00,000

Cost of goods sold = Rs 5,00,000 – Rs 1,00,000

= Rs 4,00,000

Average inventory = (16,000 + 14,000) / 2

= Rs 15,000
Inventory turnover = cost of goods sold / average inventory
= 4,00,000 / 15,000

= 26.66 times.
This means that during the year, the average stock is being sold 26.66 times.

Inventory holding period = 365 days / inventory turnover ratio

= 365 days / 26.66

= 13.69 or 14 days approximately.

225
Debtor’s Turnover Ratio:

Debtors turnover ratio reveals the number of times the average debtors are
collected during a given accounting period. In other words, it shows how quickly te firm is in a
position to collect its debts. It is necessary to keep close monitoring orf realization of debts
because it directly affect the working capital position. In case, the firm is not in a position to
collect its debts, to meet the working capital requirements, it has to borrow paying interest.
This further erodes the profitability. The successful companies maintain the aged list of the
debtors showing the details of when to collect, how much to collect and from which debtor.

Debtors‟ turnover ratio is calculated as given below.

Debtors‟ turnover ratio = credit sales / average debtors

Where credit sales refer to goods sold on credit. Average debtors is the average of
opening andclosing balances of debtors for the given accounting period.

A higher debtor’s turnover ratio explains that the firm is efficient in collecting its
debtswhereas lower ratio signifies its inefficiency.

Debt Collation Period:

Debt collection period refers to the time taken to collect the debts. From
debtors‟ turnover ratio, we can find out the debt collection period as follows.

Debt collection period = 365 days / Debtors‟ turnover ratioThe lesser the time,

more is the efficiency of the firm and vice versa.

226
Exmple-1:

A firm‟s sales during the year were Rs 4,00,000 pf 60 percent were on credit basis. The
balance of debtors at the beginning and end of the year were 25,000 and 15,000 respectively.
Calculate debtors „turnover ratio of the firm. Also find out debt collection period.
Solution:

Credit sales = 60 % of 4,00,000

= 2,40,000
Average debtors = (Opening balance of debtors + closing balance of debtors) / 2

= (25,000 + 15,000) / 2

= 20,000

Calculation of debtor‟s turnover ratio= 2,00,000 / 20,000

= 12 times
In this example, the firm is collecting its average debtors = 12 times during the given
accounting period.

= 365 days / Debtors‟ turnover ratio

= 365 / 12

= 30.41 days
On an average the firm is taking around 31 days to collect its debts.

227
b) Creditors Turnover Ratio:

Creditor’s turnover ratio reveals the number of times the average creditors are paid
during a given accounting period> in other words, it shows how promptly the firm is in a position to pay
its creditors. It is necessary to keep close monitoring of payments schedules because it directly affects
the working capital position. In case, the firm is not in a position to pay its creditors, it will affect the
good will or further supplies may be cut off. To be on safe side, most of the firms motioning the aged
list of the creditors which provides the details of when to pay, how much to pay and to whom to pay.

Creditors turnover ratio is calculated as given below:

Creditors turnover ration = credit purchases / average creditors = Opening payments

+Closing Payment/2

From this, we can also determine the creditors payment period by using the given formula:

Creditors payment period = 365 days / credit turnover ratio.

Calculate creditors turnover ratio = 2,00,000/20,000=10

Average Creditors = 25,000+15000/2=20,000

Creditors payments = 360/10=37 days

228
 Self- assessment questions
1. Multiple choice questions.

1) Which would a business be most likely to use its solvency?

a) Gross profit ratio. B) debtors‟ collection period. C) current ratio. D) debt-
equity ratio.

2) Which of the following is useful to see if fixed assets are used efficiently in the
business?
a) Gross profit ratio. b) Debtors‟ collection period. c) current ratio. d) asset
turnover ratio.

3) Which of the following measures company’s (current assets-stock) current liabilities?

a) Acid test ratio b) current ratio. c) debtor collection period. d) stock turnover
ratio.

4) What do you understand from acid test ratio?

a) Liquidity has improved. b) liquidity has declined. c) profitability has improved
d) profitability has declined.

5) Inter-firm comparison is useful only when.

a) Two firms belong to the same industry.
b) The data belongs to the same period of the study.
c) There is increase or decrease in variables of study.
d) Two firms to the same industry and the data is available for the same period of
study.
6) Current ratio of the two firms reveals that.
a) Liquidity of muscat firm is lower than that of Dubai firm.
b) Liquid of Dubai firm is lower than that Muscat firm.
c) Performance of Dubai firm is better than Muscat firm.
d) Performance of Muscat firm is better than Dubai firm.

229
7) Debtors‟ collection period reveals that.
a) Dubai firm is efficient in collection debts.
b) Muscat firm is efficient in collecting debts
c) Dubai firm has more sales than Muscat firm.
d) Dubai firm has a greater number of debtors than muscat firm.

8) Net profit margin reveals that.

a) Dubai firm has less overheads than Muscat firm.
b) Profitability of Dubai firm is better than Muscat firm.
c) The Dubai from is overall better than Muscat firm.
d) Muscat firm is more solvent than Dubai firm.
9) Stock turnover ratio indicates that.
a) Sales of Dubai firm is more than Muscat firm.
b) Sales of Muscat firm is more than Dubai firm.
c) Dubefirm sells its stocks faster than Muscat firm.
d) Muscat firm sells its stock faster than Dubai firm.

10) If average collection periodic more, it means.

a) Better collection of receivables.
b) Poor collection of receivables.
c) Average collection of receivables.
d) Satisfactory collection of receivables.

Answers for multiple choice questions.

1) d, 2) d, 3) a, 4) b, 5) d, 6) a, 7) b, 8) a, 9) b, 10) c.

Short answer questions.

a) Liquidity ratios.
b) Turnover ratios.
c) Profitability rates.
d) Leverage ratios.
e) Activity rates.

230
 SM504MS: BUSINESS ECONOMICS AND FINANCIAL ANALYSIS
111Year B.Tech. EEE1-sem LT P C
3003

Course Objective: To lean the basic business types, impact of the economy on business and the firms
specifically. To analyze the business from the financial perspective.

Course outcome: the impact of economic variables on the Business. The demand, supply, production,
cost, market structure, pricing aspect are learnt. The students can study the firms‟ financial position by
analyzing the financial statements of a company.

Unit-1: Introduction to Business and Economics:

Business: structure of business firm, Theory of firm, Types of Business entities, Limited liability companies,
sources of capital for a company, non-conventional sources of finance.

Economics: significance of economics, Micro and Macro economic concepts, concepts and importance
of national income, Inflation, Money supply and Inflation, Business cycle, Features and phases of
business cycle. Nature and scope of business economics: Role of business economist. Multidisciplinary
nature of business economics.

Unit-11: Demand and Supply analysis:

Elasticity of demand: Elasticity, Types of elasticity, Law od demand, Measurement and significance of
elasticity of demand, factors affecting elasticity of demand, Elasticity of demand in decision making,
Demand forecasting, Characteristics of good demand forecasting, Steps in demand forecasting, Methods
of demand forecasting. Supply Analysis: Determinants of supply, supp0ly function and law of supply.

231
Unit-111: Production, Cost, Market Structures & Pricing:

Production analysis: factors of production, production function, production function with one variable
input, two variable inputs, Returns to scale, Different types of production functions. Cost analysis:
Types of costs, short run and long run cost functions. Market Structures: Nature of competition, features
of perfect competition, Monopoly, oligopoly, Pricing: Types of pricing, product life cycle based pricing,
Break Even- Analysis, cost volume profit analysis.

Unit-1V: financial accounting:

Accounting concepts and conventions, accounting equation, double -entry system of accounting, rules
for maintaining books of account, Journal, Posting to ledger, preparation of trail balance, Elements of
Financial statements, preparation of final accounts.

Unit-V: Financial Analysis through Ratios: Concept of ratio analysis, importance, liquidity ratios,
turnover ratios, Profitability Ratios, proprietary ratios, solvency, Leverage ratios- analysis and
interpretation (simple problems)

232
 a. Debentures
b. shares

c. Loans
Subject Code No: SM402MS SET 1A d. commercial paper
5. GNP stands for, [ ] SET No.1A
BHARAT INSTITUTE OF ENGINEERING AND TECHNOLOGY a. Gross net product
III B.Tech. I Sem., I Mid-Term Examinations, - November-2022 b. gross national product
Subject Name :BEFA
Objective Exam c. Gross national production
Name: Hall Ticket No. d. gross net production
Answer All Questions. Time: 30m
Marks: 10 X ½ = 5. 6. A refers to the situation when a
Choose the correct alternative: lesser an equipment to a lessee who does not
1. is an association of two or more come under the jurisdiction of the lesser
than two persons to carry out the business territory. [ ]
jointly. [ ]
a. Sole enterprise a. Financial lease
b. partnership b. operating lease

C. limited liability company c. Cross border lease

d. Joint stock Company d. leveraged lease
2. is the sum of market value of all
final goods and services that are produced in a 7. is also known as odd-time
country during a given period of time, usually factoring. [ ]
one year. [ ]
a. Recourse factoring
a. Gross national product
b. gross domestic product b. maturity factoring

c. gross value added c. Disclosed factoring

d. net national product d. full factoring
3. phase of business cycle shows the
upward movement of output and employment 8. NNP stands for, [ ]
from depression phase. [ ] a. Net national product
a. Depression phase b. nation’s net production
b. recovery phase c. Net national production
C. Prosperity d. none of above
d. recession
4. is not a long-term source of finance 9. is a company which has a
for a company. [ ] minimum paid-up capital of ₹1,00,000 or such
higher paid up capital as may be prescribed and
by its articles. [ ]

233
 Bharat institute of Engineering and Technology.
Ibrahimpattam- 501510, Hyderabad.
WWW. Biet.ac. in.

Class: 11-1 CSE( AI&ML) Marks-20

Subject- BEFA.
Mock test Examination, December, 22
Part-A: (Objective 10 marks)

1) Multiple Chaise:

Write the questions and the answers in our answer scripts.

1. It is a form of business organization which is engaged in some business activities

a) Business agents. b) Business organization. c) Business owner. d) Business partner

2. The capital of a company is determined by

a) Debentures capital b) long-term capital c) Short term capital d) Both of b and c.

3. Who is the father of economics?

a) Hex Muller. b) Adams smith. c) Marl Max. d) None of these above.

4. The book which is at the center price of the study of macroeconomics was written by
a) Prof. J.M. Keynes b) Prof. Ben ham c) Prof. Samveison . d) Prof. Baumol.

5. The business economic theory is concerned with the management techniques to achieve.
a) Maximization of total revenue from sales.
b) Maximization of cost of production.
c) Maximize profit from the business unit.
d) All the above.

234
6. Demand is determined by.
a) Price of the product.
b) Relative price of other goods.
c) Tastes and habits.
d) All the above.

7. The law of demand states that an increase in the price of a good.

a) Increase the supply of that good
b) Decreases the quantity demanded for that good.
c) Increases the quantity supplied of that good.
d) None of these answers.
8. In the price of a good is above the equilibrium price.
a) There is a surplus and the price will rise.
b) There is a shortage and the price will fall.
c) The quantity demanded is equal to the quantity supplied and the price remains unchanged.
d) There is a surplus and the price will fall.
9. Which of the following would causes a demand curve for a goods to be price inelastic?
a) The good luxury.
b) There are a great number of substitutes for the goods.
c) The good is a necessary.
d) The good is inferior goods.
10. Demand for a commodity depends on.
a) Price of that commodity.
b) Price of related goods.
c) Income.
d) All the above.

11) Fill in the blank ( 05 marks).

1. Business economics mainly deals with the --------------- behavior of the firm.
2. Micro economics is also known as -----------------------
3 is a work relating to production, buying, selling of goods and services.
4 is a single person, owns, manage and control all the activities of the business.
5. Short term source of finance is also known as -------------
235
 6 refers to predicting consumer future demand for product.
7 is a mathematical relationship between quantity demanded of a goods and its
determinates.
8. The ------------- is generally more elastic than the short-run demand.
9 --------------is an arrangement of statistical data in a chronological form.
10. The demand forecasting which can be dome during a time period of one year is called --------
forecasting.

111) Answer any two of the following questions descriptive 10 marks.

S.no Questions Cos Mapping Blooms PLOs PSOs

Taxonomy
Mapping Mapping
(BT) level

1. Define CO1 L1 PLO9,PO10, PLSO1

Business. Po11
Remembering PSO3
Examine the
types of
business

Entities.

2. Explain the CO1 L1 PO9, PO10. LPSO1, PSO3

various PO11
Remembering
definitions of
economics

3. Define inflation. CO2 L2 PO9, PO10. LPSO1, PSO3

PO11
Differentiate understanding
Demand pull
inflation from
cost plush
inflation.

236
 Bharat institute of Engineering and Technology.
Ibrahimpattam- 501510, Hyderabad.
WWW. Biet.ac. in.

Class: 11-1 CSE( AI&ML) Marks-20

Subject- BEFA.
Assignment – 1: December, 22
Part-A: (Objective 10 marks)

!. Answer the following question in detail.

1) Explain a Problem on journal entry?

2004, January--- Example:

1. Madhu commenced with Rs. 15,000/-

2. Paid into bank Rs . 10,000/-
3. Purchased goods from „B‟ for Rs 2000/-
4. Returned goods to „B‟ for Rs200/-
5. Paid to „B‟ in full settlement A/C Rs 1700/-
6. Received interest from the bank Rs750/-

237
Solution;

( in the books of Madhu)

Journalisation

Date Particulars LF Amount Amount

Dr. Cr.
2004 Jan 1 Cash amount Dr 15000
To Madhu‟s A/C
(Being the business
commenced)
15000
2 Bank account Dr 10000
To cash
(Being the cash
deposited into bank)
10000

3 Purchases A/C Dr 2000

To purchase returns
account. 2000

4 B‟s account Dr 200

To purchase returns
account
(Being the goods
retuned to B on
account of damage)
200

238
 5 B‟s account Dr 18000
To cash 1700
To discount
( Being the payment in full settlement) 100
6 Cash account Dr 750
To interest from bank 750
( Being the cash received towards
Interest)

Total 45,950 45,950

Explain a problem of Trail balance?

Example:
Make a trail balance as on 31.12.2004 from the following information.

Particulars Rs
Sundry debtors 32,000
Stock(1.1.2004) 22,000
Cash in hand 35
Cash at bank 1,545
Plant and machinery 17,500
Sundry creditors 10,650
Trade expenses 1,075
Sales 2,34,500
Salaries 2,225
Carriage outwards 400
Rent 900
Bills payable 7,500
Purchases 2,18,870
Discounts (Dr) 1,100
Capital 79,500
Business Premises 34,500

239
 Trail Balance as on December 31.2004
Particulars Dr (Rs) Cr(Rs)

Sundry debtors 32,000

Stock(1.1.2004) 22,000
Cash in hand 35
Cash at bank 1,545
Plant and machinery 17,500
Sundry creditors 10,650
Trade expenses 1,075
Sales
Salaries 2,34,500
Carriage outwards 2,225
Rent 400
Bills payable 900
Purchases 7,500
Discounts (Dr) 2,18,870
Capital 1,100
Business Premises 79,000
34,500
Total 3,32,150
3,32,000

2) What is ratio analysis and explain the objectives and uses of ratio analysis?

Ratio analysis is the process of determining and interpreting numerical relationships based on
financial statements. By computing ratios, it is easy to understand the financial position of the firm.
Ratio analysis is used to focus on financial issues such as liquidity, profitability and solvency of a given
firm.

240
 There is no standard list of ratios used for financial analysis. A ratio can be conceptualized based
on the need. There is significant variation in the ratios used in different firms of the same industry. Even
the formula used for a given ratio may differ slightly. It is because the need of these firms is different.
Interpretation refers to to evaluating the ratio in terms of the laid out standards or norms.
Nature of the industry/sector and identifying the possible cause for improvement or decline in
performance of the company. An insight into the logical functioning of business and the knowledge of
cause and effect relationship among the given variables in the micro and macro business environment
will enhance the quality of interpretation. Interpretation is to be made with meticulous care because
future decisions are based on the results of interpretation.

3) Examine the classification of the various ratio analyses?

The ratios can broadly be classified in to four categories.

A) Liquidity ratios
B) Activity ratios
C) Capitals structure ratios
D) Profitability ratios

A) Liquidity ratio:

Liquidity ratios explore the ability of the firm to meet its short-term commitments as and
when they become due. Creditors are interested to know whether the firm will be in a position to meet its
comments on time or not. If the firm is not in a position to meet its short-term commitments such as payment of
taxes, wages and salaries, and so on. Then it cannot continue in business for long despite its strong capital base.
Liquidity ratios help in identifying the danger signals for the firm in advance. Apart from the firm itself, all the
financing companies offering shor-term finances are interested in these ratios.
Liquidity ratios are divided into two categories i.e Current ratio and quick ratio.

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B) Activity ratio:

Activity ratios express how active the firm is in terms of selling its stocks, collecting its
receivables and playing its creditors. There are three types:
a) Inventory turnover ratio
b) Debtors turnover ratio.
c) Creditor‟s turnover ratio.

C) Capital structure ratios (solvency ratio)

Capital structure ratios can divided into two categories
a) Debt-equity ratio
b) Interest coverage ratio.

D) Profitability ratios:
Profitability ratios throw light on how well the firm is organizing its activities in a
profitable manner. The owner expect reasonable rate of return on their investment. The firm
should generate enough profits not only to meet the expectations of the owners but also to
finance the expansion activities.
The following are the eight ratios most commonly used to explain profitability.
a) Gross profit ratio
b) Net profit ratio
c) Operating ratio
d) Return on investment (ROI)
e) Earnings per share
f) Dividend yield
g) Price /earnings ratio
h) Earning power.

!) Choose the correct alternative ( 05 marks)

1) Accounting is the art of -------------------- Answer I(D)
2) Stock is a---------------asset? “ (B)
3) A ---------------Is a business with two or more owners. “ ( C)

242
4) Final accounts consisting of ------------------- “ (D)
5) What is micro economics? --------------- “ (B)
!!) Fill in the blanks ( 05 Marks)
1) Accounting is the language of business
2) In the book of ledger JF stands for Journal Folio.
3) Debt receiver and Credit the giver in the rule of personal accounts
4) Double entry system explains the two fold effect of every transition.
5) The person who lends the money to the debtors is called creditor.
6) Final accounts for the year of 2014.
Balance Sheet
Debit balances(Dr) Credit balances(C r) Rs
Opening stock 3600 Sales 24,000
Wages 2000 Creditors 1600
Bank loan 880 Capital 8000
Coal and cake 600 Cash at bank 1020
Purchase 1500
Repairs 400
Carriage 300
Income tax paid 300
Debtors 4000
Lease hold premises 1200
Cash in had 40
Plant 1500
Loose tools 360
Lighting 460
Misc receipts 120
Office ex 500
Office furniture 120
Patent 200
Good will 3000
Total 34,620 34,620

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Subject code: SM504MS Set-1.

BHARAT INSTITUTE OF ENGINEERING AND TECHNOLOGY

B.Tech-111 year, 1 semester: EEE-11 Mid-Term. Examinations, January-2022.

Subject name: BEFA Time: 30 m.

Name : Hall Ticket No

!) Answer all the multiple choice questions. Each question carries ½ marks 10 x ½ = 5.

1. Who is the father of economics?

a) Max. Muller. B) Adam Smith c) Karl Max. d) None of these above.
2. Which branch of economics studies about unemployment, illiteracy, national income tax?
a) Micro economics b) Macro economics c) W2ealth economics d) Fiscal economics.
3. Demand is determined by
a) Price of the product b) relative price of other goods.
b) Tastes and habits. D) All of the above.
4. Which of the following would causes a demand curve for a goods to be price inelastic?
a) The goods luxury. B) There are a great number of substitutes for the goods.
b) The good is a necessity. D) The goods is an inferior goods.
5. Which of the following is a factor affecting production?
a) Fixed inputs. b) Variable inputs. c) Technology. D) All of the above.
6. Under the perfect competition, price is determined by the interaction of total demand and what?
a) Total supply b) Total cost. c) Total utility. d) Total production.
7. The system of keeping incomplete record is known as.
a) Single entry. b) Double entry. c) Dual entry. d) none of these.
8. Profit is only an estimate in this system.
a) Nominal system. b) Double entry system. c) Single entry system. d) none of these.
9. Which of the following is not included in current assets?
a) Debentures b) stock c) cash at bank d) cash in hand.

244
10. Higher the ratio, the favorable it is, doesn‟t stand true for .
a) Operating ratio. b) Liquidity ratio. c) Net profit ratio. d) Stock turnover ratio.

!!) Fill in the blanks. Each question carries ½ marks. 10 x ½ = 5.

1. Business economics mainly deals with the -------------- behavior of the firm.

2. Micro economics is also known as --------------------------

3. The ----------------- is generally more elastic than the short-run demand.

4.are the cost that do not vary with the changes in output.

5.is the important form of imperfect competition.

6. Balance sheet is a statement of assets and --------- of a business.

7.are assets which are purchased for permanent use in the business.

8. Recording two aspects of each transactions is known as --------- system.

9. The main purpose of ---------- ratio is to measure the ability of the firm to pay its current liabilities.

10. The term ----------- means ability of a concern to meet its long-term obligations.

245
Subject code: SM504MS Set-1

BHARAT INSTITUTE OF ENGINEERING AND TECHNOLOGY

B.Tech-111 year, 1 semester: EEE-11 Mid-Term. Examinations, January-2023.

Subject name: BEFA Time: 60 m.

Name : Hall Ticket No

!) Answer any two questions. Each question carries five marks. 2 x 5 = 10

1. Examine the nature and scope of business economics?

2. Explain the various type of elasticity of Demand?

3. Examine the law of variable proportion?

4. Differentiate personal account from real account?

5. Differentiate gross profit ratio from net profit ratio with illustrations?

246
 Set-2

BHARAT INSTITUTE OF ENGINEERING AND TECHNOLOGY

B.Tech-111 year, 1 semester: EEE-11 Mid-Term. Examinations, January-2022.

Subject name: BEFA Time: 30 m.

Name : Hall Ticket No

!) Answer all the multiple choice questions. Each question carries ½ marks 10 x ½ = 5.

1. Demand is determined by
a) Price of the product b) relative price of other goods.
b) Tastes and habits. d) All of the abov
2. Who is the father of economics?
b) Max. Muller. B) Adam Smith c) Karl Max. d) None of these above.
3. Which branch of economics studies about unemployment, illiteracy, national income tax?
b) Micro economics b) Macro economics c) W2ealth economics d) Fiscal economics.
4. Which of the following is a factor affecting production?
a) Fixed inputs. b) Variable inputs. c) Technology. D) All of the above
5. Which of the following would causes a demand curve for a goods to be price inelastic?
c) The goods luxury. B) There are a great number of substitutes for the goods.
d) The good is a necessity. D) The goods is an inferior goods.
6. Under the perfect competition, price is determined by the interaction of total demand and what?
b) Total supply b) Total cost. c) Total utility. d) Total production.
7. Which of the following is not included in current assets?
a) Debentures b) stock c) cash at bank d) cash in hand
8. The system of keeping incomplete record is known as.
b) Single entry. b) Double entry. c) Dual entry. d) none of these.
9. Profit is only an estimate in this system.
b) Nominal system. b) Double entry system. c) Single entry system. d) none of these.
247
10. Higher the ratio, the favorable it is, doesn‟t stand true for .
b) Operating ratio. b) Liquidity ratio. c) Net profit ratio. d) Stock turnover ratio.

!!) Fill in the blanks. Each question carries ½ marks. 10 x ½ = 5.

1. The main purpose of ---------- ratio is to measure the ability of the firm to pay its current liabilities.

2. The term ----------- means ability of a concern to meet its long-term obligations.

3. Business economics mainly deals with the -------------- behavior of the firm.

4. Micro economics is also known as --------------------------

5.are assets which are purchased for permanent use in the business.

6. Recording two aspects of each transactions is known as --------- system.

7. The ----------------- is generally more elastic than the short-run demand.

8.are the cost that do not vary with the changes in output.

9.is the important form of imperfect competition.

10. Balance sheet is a statement of assets and --------- of a business.

248
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