Managerial

Economics
&
Financial Analysis
 MEFA SYLLABUS
UNIT – I 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 in
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 – II Demand and Supply Analysis:

• Elasticity of Demand: Elasticity, Types of Elasticity, Law of 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, Supply Function & Law of Supply.
UNIT- III Production, Cost, Market Structures & Pricing:

• Production Analysis: Factors of Production, Production Function, Production

Function with one variable input, two variable inputs, Returns to Scale.

• Cost analysis: Types of Costs. Market Structures: Nature of Competition, Features

of Perfect competition, Monopoly, Oligopoly, and Monopolistic Competition.
Pricing: Types of Pricing, Product Life Cycle based Pricing, Break Even Analysis, and
Cost Volume Profit Analysis.

UNIT - IV Financial Accounting:

Accounting concepts and Conventions, Accounting Equation, Double-Entry system of
Accounting, Rules for maintaining Books of Accounts, Journal, Posting to Ledger,
Preparation of Trial Balance, and Preparation of Final Accounts.
UNIT - V Financial Analysis through Ratios:

Concept of Ratio Analysis, Liquidity Ratios, Turnover Ratios, Profitability Ratios,

Proprietary Ratios, Solvency, Leverage Ratios (simple problems)
Unit – 1 Introduction to Business & Economics
 Unit – 1 Introduction to Business & Economics
Introduction of Business:
The activity which deals with production and exchange of goods and
services with the aim of earning profits is refered as Business.

A Person engaged in business is called a Businessman or

Entrepreneur.

Similarly a firm established for the purpose of carrying a business

called as Enterprise or Business Unit.

Definition:
Business may be defined as a human activity directed towards
producing or acquiring wealth through buying and selling of
goods”. — L. H. Haney.
 Characteristics or Features of Business
(1) Exchange of Goods and Services: Business involves dealing in goods and
services , there must be exchange of goods and services between seller and
buyer for a Price.

(2) Economic Activity: Business is an economic activity which means business is

done with a object of earning money or livelihood.

(3) Profit Earning: The main purpose of every business unit is to earn profits. It is
essential for survival, growth, expansion of the business.

(4) Continuous in Nature: The activities of business are continuous and recurring
in nature. A single transaction involving buying and selling is not business.

(5) Risk or Uncertainty: Business involves high risk and uncertainties like change
in prices, fashions, change in government policy etc. Thus a business man
should minimize risks by proper planning and future forecast.
 Structure of Business

After deciding to start a business, next question arises what type of

business i have to start either by individually or with the support
of friends, small or big business.

A business structure refers to the organization of a company in

regards to its legal status. Choosing the most appropriate business
structure creates a legal recognition for your trade. Example like
National , International, MNC’s .

There are a couple of structures which are commonly used to

incorporate a business they are as follows.
(1) Sole Proprietorship
(2) Partnership firm
(3) Joint Stock Company----Private Company
--- Public Company
Sole Proprietorship or Sole Trader
 Types of Business Entities
(1) Sole Proprietorship or Sole Trader :

The sole trader is the simplest, oldest and natural form of business organization.
‘Sole’ means one. ‘Sole trader’ implies that there is only one trader who is the
owner of the business.

A Business unit which is owned managed and controlled by a single individual is

known as a Sole trading concern. He brings his own capital or borrow money
from others to start the business, he only manages the business and enjoys all
profits and bears all losses of the business.

Features 
• It is easy to start a business under this form and also easy to close.
• He introduces his own capital. Sometimes, he may borrow, if necessary
• He enjoys all the profits and in case of loss, he lone suffers.
• He has unlimited liability which implies that his liability extends to his personal
properties in case of loss.
 Sole Proprietorship or Sole Trader
Features
 
• He has a high degree of flexibility to shift from one business to the other.

• Business secrets can be guarded well

• There is no continuity. The business comes to a close with the death, illness or
insanity of the sole trader. Unless, the legal heirs show interest to continue the
business, the business cannot be restored.

• He has total operational freedom. He is the owner, manager and controller.

• He can be directly in touch with the customers.

 Advantages of Sole Proprietorship/ Sole Trader
The sole trading concern has the following advantages.

(1) Easy Formation: Sole Proprietorship is easy to start , it does not require any
legal formalities or registration.
(2) Business Secrecy: A sole trader can maintain business secrets ,he does not
share trade secrets with anybody else and does not publish his accounts.
(3) Direct Motivation: There is a direct relationship between efforts and rewards.
The more efforts a sole trader puts in business the more profits he will earn.
(4) Quick Decisions: All the important decisions are taken by one person. Thus
the decision making process is quick and prompt.
(5) Direct contact with Customers: As the sole proprietorship is a small business
it can have direct contact with customers and employees.
(6) Flexibility: A sole trading concern is a highly flexible type of organization. As
it is a small unit change can be made easily without any efforts and legal
formalities.
 Disadvantages of Sole Proprietorship/ Sole Trader
The following are the disadvantages of sole trader form:

(1) Unlimited liability: The liability of the sole trader is unlimited. It means that the
sole trader has to bring his personal property to clear off the loans of his
business. From the legal point of view, he is not different from his business.
(2) Limited amounts of capital: The resources a sole trader can mobilize cannot be
very large and hence this naturally sets a limit for the scale of operations.
(3) No division of labour: All the work related to different functions such as
marketing, production, finance, labour and so on has to be taken care of by the
sole trader himself. There is nobody else to take his burden. Family members
and relatives cannot show as much interest as the trader takes.
(4) Uncertainty: There is no continuity in the duration of the business. On the
death, insanity of insolvency the business may be come to an end.
(5) Lack of specialization: The services of specialists such as accountants, market
researchers, consultants and so on, are not within the reach of most of the sole
traders.
(6) More competition: Because it is easy to set up a small business, there is a high
degree of competition among the small businessmen and a few who are good
in taking care of customer requirements along can service.
Partnership
 Partnership
A Partnership is an association of two or more persons who come together to carry
on business and to share its profits and losses.
The Partnership business is the result of expansion of sole trader or limitations of
sole proprietorship.
Definition:
Indian Partnership Act, 1932 defines partnership as the relationship between two
or more persons who agree to share the profits of the business carried on by all
or any one of them acting for all.
 
Features
•  Two or more persons: There should be two or more number of persons.
• There should be a business: Business should be conducted.
• Agreement: Persons should agree to share the profits/losses of the business
• Carried on by all or any one of them acting for all: The business can be carried
on by all or any one of the persons acting for all. This means that the business
can be carried on by one person who is the agent for all other persons. Every
partner is both an agent and a principal. Agent for other partners and principal
for himself. All the partners are agents and the ‘partnership’ is their principal.
 Partnership
Features

• Unlimited liability: The liability of the partners is unlimited. The partnership

and partners, in the eye of law, and not different but one and the same. Hence,
the partners have to bring their personal assets to clear the losses of the firm, if
any.

• Division of labour: Because there are more than two persons, the work can be
divided among the partners based on their aptitude.

• Personal contact with customers: The partners can continuously be in touch

with the customers to monitor their requirements.

• Flexibility: All the partners are likeminded persons and hence they can take any
decision relating to business.
 Kinds of Partners
KINDS OF PARTNERS
The following are the different kinds of partners:
(1) Active Partner
(2) Sleeping Partner
(3) Nominal Partner
(4) Partner by Estoppel
(5) Partner by Holding out
(6) Minor Partner
 Kinds of Partners
The following are the different kinds of partners:
 
(1) Active Partner: Active partner takes active part in the affairs of the
partnership. He is also called working partner.

(2) Sleeping Partner: Sleeping partner contributes to capital but does not take part
in the affairs of the partnership.

(3) Nominal Partner: Nominal partner is partner just for namesake. He neither
contributes to capital nor takes part in the affairs of business. Normally, the
nominal partners are those who have good business connections, and are well
places in the society.

(4) Partner by Estoppels: Estoppels means behavior or conduct. Partner by

estoppels gives an impression to outsiders that he is the partner in the firm. In
fact be neither contributes to capital, nor takes any role in the affairs of the
partnership.
 Kinds of Partners
(5) Partner by holding out: If partners declare a particular person (having social
status) as partner and this person does not contradict even after he comes to
know such declaration, he is called a partner by holding out and he is liable for
the claims of third parties. However, the third parties should prove they
entered into contract with the firm in the belief that he is the partner of the
firm. Such a person is called partner by holding out.

(6) Minor Partner: Minor has a special status in the partnership. A minor can be
admitted for the benefits of the firm. A minor is entitled to his share of profits
of the firm. The liability of a minor partner is limited to the extent of his
contribution of the capital of the firm.
 Advantages of Partnership
The following are the advantages of the partnership from:

(1) Easy formation: It is easy to start and register a partnership. No legal formalities

are required a simple agreement among partners is sufficient to start the business.
(2) Availability of larger amount of capital: The Capital of partnership firm is
contributed by more than one partner, Thus It results in large amount of capital.
(3) Division of labour: The different partners come with varied backgrounds and skills.
This facilities division of labour.
(4) Sharing of risk: The risk of business is shared by all the partners. The burden of
every partner is less compared to a sole trader.
(5) Personal contact with customers: There is scope to keep close monitoring with
customers requirements by keeping one of the partners in charge of sales and
marketing. Necessary changes can be initiated based on the merits of the proposals
from the customers.
(6) The positive impact of unlimited liability: Every partner is always alert about his
impending danger of unlimited liability. Hence he tries to do his best to bring
profits for the partnership firm by making good use of all his contacts.
 Disadvantages of Partnership
The following are the disadvantages of partnership:
(1) Formation of partnership is difficult: Only like-minded persons can start a
partnership. It is sarcastically said,’ it is easy to find a life partner, but not a
business partner’.
(2) Liability: The partners have joint and several liabilities beside unlimited liability.
Joint and several liability puts additional burden on the partners, which means
that even the personal properties of the partner or partners can be attached.
Even when all but one partner become insolvent, the solvent partner has to
bear the entire burden of business loss.
(3) lack of harmony : It is difficult to maintain harmony among the partners
because they have different opinions and may not agree on all the matters this
may cause disputes among the partners.
(4) Limitation on Transfer of share: A Partner cannot transfer his share to an
outsider without the consent of all the partners.
(5) Instability: The partnership firm suffers from instability and uncertainty. It may
be dissolved easily on the death, insolvency or insanity of any of the partners.
LIMITED LIABILITY COMPANY
 Joint Stock Company
The joint stock company emerges from the limitations of partnership such as
joint and several responsibility, unlimited liability, limited resources, and
uncertain duration and so on.

The word company has a Latin origin, com means ‘come together’ pany means
‘bread’. Joint stock company means people come together to earn their
livelihood by investing in the stock of the company jointly.

ACCORDING TO L.H.HANEY
“joint stock company is a voluntary association of individuals for profit, having a
capital divided into transferable shares, the ownership of which is the
condition of the membership”.

Section 3 (1) of the Companies Act, 1956 defines “a company as a company

formed and registered under the Act or an existing company.
 Features of Joint Stock Company
This definition brings out the following features of the company:
 (1) Artificial person: The Company has no form or shape. It is an artificial person
created by law. It is intangible, invisible and existing only, in the eyes of law.

(2) Separate legal existence: it has an independence existence, it separate from its
members. It can acquire the assets. It can borrow for the company. It can sue
other if they are in default in payment of dues, breach of contract with it, if any.
Similarly, outsiders for any claim can sue it. A shareholder is not liable for the
acts of the company. Similarly, the shareholders cannot bind the company by
their acts.

(3) Voluntary association of persons: The Company is an association of voluntary

association of persons who want to carry on business for profit. To carry on
business, they need capital. So they invest in the share capital of the company.
(4) Limited Liability: The shareholders have limited liability i.e., liability limited to
the face value of the shares held by him. In other words, the liability of a
shareholder is restricted to the extent of his contribution to the share capital of
the company. The shareholder need not pay anything, even in times of loss for
the company, other than his contribution to the share capital.
 Features of Joint Stock Company
(5) Capital is divided into shares: The total capital is divided into a certain number
of units. Each unit is called a share. The price of each share is priced so low that
every investor would like to invest in the company. The companies promoted by
promoters of good standing (i.e., known for their reputation in terms of
reliability character and dynamism) are likely to attract huge resources.
(6) Transferability of shares: In the company form of organization, the shares can
be transferred from one person to the other. A shareholder of a public
company can cell sell his holding of shares at his will. However, the shares of a
private company cannot be transferred. A private company restricts the
transferability of the shares.
(7) Common Seal: As the company is an artificial person created by law has no
physical form, it cannot sign its name on a paper; so, it has a common seal on
which its name is engraved. The common seal should affix every document or
contract; otherwise the company is not bound by such a document or contract.
(8) Perpetual succession: ‘Members may comes and members may go, but the
company continues for ever and ever’ A. company has uninterrupted existence
because of the right given to the shareholders to transfer the shares.
 Features of Joint Stock Company
(9) Ownership and Management separated: The shareholders are spread over the
length and breadth of the country, and sometimes, they are from different
parts of the world. To facilitate administration, the shareholders elect some
among themselves or the promoters of the company as directors to a Board,
which looks after the management of the business. The Board recruits the
managers and employees at different levels in the management. Thus the
management is separated from the owners.
(10) Winding up: Winding up refers to the putting an end to the company. Because
law creates it, only law can put an end to it in special circumstances such as
representation from creditors of financial institutions, or shareholders against
the company that their interests are not safeguarded. The company is not
affected by the death or insolvency of any of its members.
(11) The name of the company ends with ‘limited’: it is necessary that the name
of the company ends with limited (Ltd.) to give an indication to the outsiders
that they are dealing with the company with limited liability and they should be
careful about the liability aspect of their transactions with the company.
 KINDS OF COMPANIES
The Companies Act 2013 provides for a variety of companies registered
under the act. These companies are as follows:
(1) Based on Incorporation:
(A) Chartered Company: A Chartered Company is created by the Royal
Charter of the statet.The Charter contains the rights , privileges and
powers to be used by the Chartered Company.
For Example: British East India Company formed in England to trade
with India and the East.
(B)Statutory Corporation: A Statutory Corporation is created by an Act of
the state Legislature or Parliament. The objective, Powers,
Responsibilities are clearly defined in this Act.
Eg: R.B.I., Industrial Development Bank of India, APSRTC, FCI etc.
(C) Registered Company: A Registered Company is one that is registered
under Indian Companies Act 1956. A Registered Company may be a
Public Limited Company, Private ltd company,Company limited by
guarantee or an Unlimited co.
 KINDS OF COMPANIES
(2) Based on Public Interest:
(A) Private Company: According to Section 3 of the Indian
Companies Act, a private company means a company that has
a minimum paid up capital of one lakh rupees or such higher
paid up capital as may be prescribed, and by its articles.
(i) Restricts the right of transfer its shares, if any
(ii) Minimum number of its members are 2 & maximum 50.
(iii) Prohibits any invitation to the public to subscribe any shares
or debentures of the company
(iv) Prohibits any invitation or acceptance of deposits from
persons other than its members.
(v) The name should necessarily end with the words private
limited ( Pvt, Ltd).
 KINDS OF COMPANIES
(2) Based on Public Interest:
(A) Public Company: This means a company that
(i) Is not a private company
(ii) Has a minimum paid up capital of 5 lakhs rupees or such
higher paid up capital as may be prescribed.
(iii) Allows transfer of its shares
(iv) Minimum 7 maximum unlimited members
(v) Can issue the prospectus to raise the capital
(vi) The name of the public company ends with the word Limited
(Ltd).
 KINDS OF COMPANIES
(3) On the basis of Controlling Interest:
(A) Holding Company: A Holding Company is a company that controls the
composition of the board of directors of another company or holds more
than half of the nominal value of the equity share capital of another
company.

(B) Subsidiary Company: The Other company that is controlled by the

holding company is called Subsidiary company.

( C ) Government Company:
Section 617 of the Indian Companies Act define a government company as
“any company in which not less than 51% of the paid up share capital is
held by the Central Government or by any State Government or Partly by
Central Government & partly by one or more of the State governments.
Examples: HMT, State Trading Corporation, National Industrial Development
Corporation, National Small Industries Corporation & so on.
 KINDS OF COMPANIES
(4) Kinds of companies based on Liability:
Based on liability, the companies can be divided into 3 types:
(i) Unlimited Company
(ii) Limited Company
(iii) Companies limited by guarantee

(5) Kinds of companies based on Nationality:

Based on Nationality the companies can be divided into two types:
(iv) Foreign Company: A Foreign Company is a company
incorporated outside India but established a place of business
within India.
(v) Indian Company: A Company incorporated in India under the
Indian Companies Act, 1956.
 Theory of Firm
The theory of firm consists of a number of economic theories that explain and
predict the nature of firm, company, or Corporation , including its existence,
behavior , structure and relationship to the market.

The theory of firm aims to answer these questions:

(1) Existence: Who do firms emerge? Why are not all transactions in the
economy mediated over the market?
(2) Boundaries: Why is the boundary between firms and the market located
exactly there with relation to size and output variety? Which transactions are
performed internally and which are negotiated on the market?
(3) Organization: Why are firms structured in such a specific way, for example as
to hierarchy or decentralization? What is the interplay of formal and informal
relationships?
(4) Heterogeneity of firm actions / performances: What drives different actions
and performances of firms?
 Theory of Firm
Types of theories are
1. Transaction cost theory
(2) Managerial theories
(3) Behavioural theories
 Sources of Capital for a Company
Method of Finance is the type of finance used such as a loan or a mortgage. The
source of finance would be where the money was obtained form .

The following are the common methods of finance they are

(1) Long Term Finance
(2) Medium Term Finance
(3) Short Term Finance

Sources of Finance: The following are the different sources of finance.

(4) LONG TERM FINANCE: Long term finance refers to that finance available for a
long period say three years and above. They are used to purchase Fixed assets
such as Land & Buildings, Plant & Machinery and so on.
Sources of long term finance are :
(i) Own Capital: Irrespective of the form of organisation such as Soletrader,
Partnership or a Company, the Owners of the business have to invest their
own finances to start the business.
 SOURCES OF LONG TERM FINANCE
(ii) SHARE CAPITAL: Normally in the case of a company, the capital is raised by
issue of shares. The capital so raised is called Share Capital. The share capital is
of two types they are

(a) PREFERENCE SHARE CAPITAL: Capital raised through issue of preference

share is called Preference share capital. A Preference shareholder enjoys two
rights over equity shareholders
(i) A right to receive fixed rate of dividend and
(ii) A right to return of Capital.

(b) EQUITY SHARE CAPITAL: Capital raised through issue of equity share is called
Equity Share Capital. The Equity share holders are the real owners of the
company. They have voting rights and also they are entitled for the share in
the whole surplus of the profits.
 SOURCES OF LONG TERM FINANCE

(3) RETAINED PROFITS: The retained profits are the profits remaining after all the
claims. It is used particularly in times of growth and expansion.

(4) LONG TERM LOANS: These are specialized financial institutions offering long
term loans, provided the business proposal is feasible. The promoters should
be able to offer assets of the business as security to avail loan.

(5) DEBENTURES: Debentures are the loans taken by the company, It is a

certificate issued by the company under its common seal acknowledging the
receipt of loan. A Debenture holder is the creditor of the company, He is
entitled to a fixed rate of interest on the debenture amount.
 SOURCES OF MEDIUM TERM FINANCE

(II) MEDIUM TERM FINANCE:

Medium term finance refers to such sources of finance where the repayment is
normally over one year and less than three years. This is normally utilized to
buy or lease motor vehicles, computer equipment etc. The sources of medium
term finance are as given below:
(a) BANK LOANS: Bank loans are extended at a fixed rate of interest. Repayment
of the loan and interest are decided at the beginning of issuing the loan.
(b) PUBLIC DEPOSITS: The Company may accept deposits (Fixed deposits) from
public for a medium term period.
(c) BONDS: The Company issue bonds for a medium term period
(d) FINANCIAL INSTITUTIONS: Company can borrow from other financial
institutions also
 METHODS AND SOURCES OF MEDIUM TERM FINANCE
& SHORT TERM FINANCE

(III) SHORT TERM FINANCE: Short term finance is that finance which is available
for a period of less than one year. The following are the sources of short term
finance.
(a) BANK OVERDRAFT: This is a special arrangement with the banker where the
customer can draw more than what he has in his saving / Current account
Interest is charged on the amount withdrawn.
(b) TRADE CREDIT: This is a short term credit facility extended by the creditors to
the debtors. Normally it is common for the traders to buy the materials and
other supplies from the suppliers on credit basis.
(c) ADVANCE FROM CUSTOMERS: It is customary to collect full or part of the
order amount from the customers in advance.
(d) INTERNAL FUNDS: Internal funds are generated by the firm itself by way of
secret reserves, depreciation provisions, Taxation provisions, and so on to
meet the urgencies.
 Non Conventional Sources of Finance
The following are the different types of Non conventional sources of finance

(1) LEASE FINANCING:

A Lease is a contractual agreement between the owner of an asset and the party
which wants to use the asset.

Under , the agreement the owner of the asset (called Lessor) gives the right to use
the asset to the other party (called Lessee) on rent. So, it can be called renting
of an asset.

The Lessee pays a fixed periodic amount called lease rental to the lessor for the use
of the asset.

The terms and conditions relating to the lease are given in the lease contract. At the
end of the period the asset goes back to the lessor.
 Merits of Lease Financing
Following are the merits of lease financing
(1) Saving of Capital:
(2) Avoiding risk of obsolescence:
(3) Saving in Tax:
(4) Easy source of Finance:
(5) Minimum Delay:
 Merits of Lease Financing
Following are the merits of lease financing

(1) Saving of Capital: Leasing enables a firm to acquire the use of an asset
without making capital investment in buying the asset. Capital is used for other
important works

(2) Avoiding risk of obsolescence: The risk of obsolescence of assets is borne by

the Owner Lessor and the Lessee can replace them.

(3) Saving in Tax: The rental paid for leasing assets is allowed as expenditure in
income statement , thus saving tax on this amount.

(4) Easy source of Finance: Leasing provides an easy source of finance. There is
no need to mortgage the asset since its ownership remains with the Lessor.

(5) Minimum Delay: Usually, Leasing companies take much less time in
processing the Lease proposal as compared to time taken by Commercial banks
for providing loan facilities.
 Limitations of Lease Financing
The Limitations of Lease financing are as follows

(1) Higher Cost: The lease rentals are high in cost and has also the cost of risk of
obsolescence. It is thus financing at higher cost.

(2) No alteration in asset: As the lessee is not the owner of the asset, he cannot
make any change in the asset.

(3) Renewal effect: In case the lease is not renewed, it may adversely effect
normal business operations.

(4) Loss of ownership incentives: There are certain advantages of owning the
asset, such as depreciation and investment allowance. In case of lease, the
Lessee is not entitled to such benefits.
 (2) Hire Purchase Finance
Hire Purchase means a transaction where goods are purchased and sold on the
terms that
i) Payment will be made in installments along with interest.
ii) Possession of the goods is given to the buyer immediately and
iii) Property (ownership) in the goods remains with the vendor till the last
installment is paid.
iv) The seller can take back goods in case of default in payment of any instalment.

Characteristics of a Hire purchase:

The main characteristics of a hire purchase agreement are as below:
(1) The payment is to be made by the Hirer (buyer) to the Hiree (seller), usually in
installments over a specified period of time.
(2) The possession of the goods is transferred to the buyer immediately.
(3) The property in the goods remains with the Hiree (Seller) till the last
instalment is paid. The ownership passes to the buyer (Hirer) when he pays all
instalments.
(4) The instalments in hire purchase include interest as well as repayments of
principal.
 Franchising
Franchising is a form of licensing in which the parent company (Franchisor) grants
another independent identity (Franchisee) the right to do business in a
prescribed manner.
The Franchisee sells franchisors products or services trades under the franchisor’s
trade mark or trade name and benefits from the franchisor’s trade mark .
Features :
(1) The franchisor owns a patent or trade mark and allows the franchisee to use it
under a license.
(2) There is generally an agreement between the Franchisor and Franchisee and
agreed terms and conditions are implemented.
(3) The Franchisee owns the business and makes capital investments
(4) The Franchisee is paid an initial amount and then a regular fee for the license.
There may be an agreement to pay a percentage on sales revenue or profits on
monthly or annual basis.
(5) The Franchisor may arrange for the training of employees of the franchisee.
This is very common in restaurants and fast food chains.
(6) The Franchisee will follow the policies of the Franchisor regarding modes of
operation of business.
 Benefits from Franchising
The Franchisor and Franchisee benefit from franchising contracts as follows:

(1) Expansion of Business: Franchisor can expand the business in a short time.

(2) Financial Benefits : The Franchisor gets certain lump sum amount in the
initial period and later gets certain percentage on sales revenue. Thus he is able
to get financial benefits.

(3) Increase in Goodwill: With the expansion of business the goodwill and
reputation of franchisor will improve. The brand of the products gets better
acceptance.
 Economics
Economics is a study of human activity both at individual and national level.

The economists of early age treated economics merely as the science of wealth

Adam smith the father of economics defined economics as the study of nature and
uses of national wealth.

Dr Alfred Marshall defined Economics as a mans actions in the ordinary business

of life, it enquires how he gets his income and how he uses it.

Prof Lionel Robbins defined Economics as the science which studies human
behavior as a relationship between ends and scarce means which have
alternative uses.
 Micro Economics
•The study of an individual consumer or a firm is called Micro Economics.
• Micro Economics deals with behavior and problems of single individual and of
micro organization.
Importance of Micro Economics:
(1)To understand the working of the economy: Micro Economics has many uses. The
greatest of these uses is the understanding of the operation of the economy.
(2)To provide tools for the economic policies: Micro Economics provides the
required tolls for the formulation of economic policies.
(3)Helpful in International Trade: After studying the relative advantages and
disadvantages in production and trade of a commodity is not possible to formulate
proper trade policy(Export and Import Policy).
(4)Helpful to the business executive: The consumer behavior, probable changes in
demand, availability of resources etc are important tools to a business executive.
 Macro Economics
The study of aggregate or total level of economic activity in a country is called
Macro Economics.

It studies the flow of economic resources or factors of production (such as land,

labour, capital, organization & technology) from the resource owner to the
business firms & then from the business firms to households.

It deals with the total aggregates, for instance , Total Income, Total Employment,
Total Investment etc.

IMPORTANCE OF MACRO ECONOMICS:

(1) To know the working of an economy: The study of macro economics is a must to
understand the functioning of an economy.
(2) To solve employment related problems: Unemployment is a major issue across all
the nations in the world today. But, the nature of unemployment differs from
country to country and from time to time. To solve this problem Macro economics
is very much useful.
 Macro Economics
IMPORTANCE OF MACRO ECONOMICS:

(3) To formulate suitable economic policies: Macro economic helps the planner
sand economists to formulate suitable economic policies.

(4) Provides solution to monetary problems: Macro economics helps in finding

solutions to the money related problems in the economy.

(5) To promote Economic Welfare: Macro economic suggests measures for

economic welfare or well being of the society.
 Concepts and importance of National Income
Introduction:
National Income is the measure of all the goods and services that are produced by a
country during a given period of time which are counted without any
duplication.
The term National Income is used interchangeably with the terms National Product
or National Dividend, National Output and National Expenditure .

Definitioin:
National Income includes that income which can be measured in terms of money.

Concepts of National Income:

There are many Concepts of National Income they are as follows.

(1) Gross Domestic Product (GDP):

The total value of goods produced and services rendered within a country during a
year is called as Gross Domestic Product.
 Concepts and importance of National Income
(2) Gross National Product (GNP): Is market value of final goods and services
produced in a year by the residents of the country within the domestic territory
as well as abroad.
GNP is the value of goods and services that the country's citizens produce
regardless of their location.

(3) Net National Product (NNP): NNP = GNP – DEPRECIATION

Depreciation means wear & tear of the goods produced it doesn’t add any value to
the current years produce and hence is deducted from GNP.

(4) Net Domestic product (NDP):

NDP = GDP – DEPRECIATION

Net Domestic Product (NDP) measures the net book value of all the final goods
and services produced within a country geographically during a given period.
 Concepts and importance of National Income
(5) Per Capita Income:
Per Capital Income is the average income of the individuals in a nation in a given
period of time .
Per Capital Income of a year = National income of that year
Population of that year

(6) Disposable Income : Disposable income refers to the income which the people
get actually to spend. All of the income that an individual gets is not disposable
because a part of it is to be paid in the form of Income tax and other taxes.
Disposable Income = Personal Income – Personal taxes

(7) Perosnal Income: It is defined as the total income received by the individuals
of a nation from all the sources of income.
Perosnal income includes salaries, wages, commission and fees, bonus,
dividends, etc.
 Concepts and importance of National Income
(8) Real Income: Since National Income does not reveal the real state of the
economy. The concepts of Real Income has been used. To find out the Real
Income of the economy, a base year is selected and the price level of that year
is assumed to be 100.
Real Income = Money Income X 100
Price Index
• NOTE DOWN THE NAMES OF THESE THEORIES, THIS WILL BE YOUR ASSIGNMENT.. YOUNEED TO
PREPARE NOTES ON THIS
• Profit maximization theory
• Baumols theory of sales revenue maximization
• Marris Hypothesis of Maximization of Growth Rate----- Owners --- max profits, market share
• Managers -- better pay, job security, growth
• Maximizing balanced growth of the firm- demand for company’s product, growth rate of capital
supply to the company
• Behavioural Theories --- satisfactory behaviour
• Two models: Simons Satisficing Model --- lack of full information and uncertain ----- cost in acquiring
information
• Set an aspiration level--- tries to achieve it
• Model developed by Cyert and March- information inadequate and uncertainity, business or a
company has to satisfy its stakeholders
• Stakeholders - shareholders, employees, government,suppliers, customers, financiers, society
• Stakeholders have different goals
• Company should meet multiple goals by multiple decision making
 Measurement of National Income
(1) Production Method:
The most direct method of arriving at an estimate of a country’s national output
or income is to add the output figures of all firms in the economy to get the
total value of the nation’s output.
The outputs can be grouped into certain product categories corresponding to
industries or to sectors (such as the primary sector, secondary sector and the
tertiary sector)
The sum total of products produced in all sectors is the total output of the nation.

(2) Income Method: Under this method National Income is measured as a flow
of factor incomes. Income received by basic factors like labor, capital, land
and entrepreneurship are summed up.
Land: Land gets rent
Labour : Labour gets wages and Salaries
Capital: Capital gets Interest
Entrepreneurship: Gets profits as their remuneration
The sum total of all these incomes are added to know the National Income.
This approach is also called as income distributed approach.
 Measurement of National Income
(3) Expenditure Method:

• It indicates disposal of income in terms of consumption expenditure

or investment expenditure.

• This method is known as the final product method. In this method,

national income is measured as a flow of expenditure incurred by the
society in a particular year. The expenditures are classified as
personal consumption expenditure, net domestic investment,
government expenditure on goods and services and net foreign
investment.
 Importance of National Income
1. Economic Policy:
• National income figures are an important tool of macroeconomic analysis and
policy.
• National income estimates are the most comprehensive measures of aggregate
economic activity in an economy.
• It is through such estimates that we know the aggregate yield of the economy
and can lay down future economic policy for development.

2. Economic Planning:
• National income statistics are the most important tools for long-term and short-
term economic planning. A country cannot possibly frame a plan without
having a prior knowledge of the trends in national income. The Planning
Commission in India also kept in view the national income estimates before
formulating the five-year plans.
 Importance of National Income
 3. Economy’s Structure:
• National income statistics enable us to have clear idea about the structure of
the economy. It enables us to know the relative importance of the various
sectors of the economy and their contribution towards national income. From
these studies we learn how income is produced, how it is distributed, how
much is spent, saved or taxed.

 4. Inflationary and Deflationary Gaps:

• National income and national product figures enable us to have an idea of the
inflationary and deflationary gaps. For accurate and timely anti- inflationary and
deflationary policies, we need regular estimates of national income.

5. Budgetary Policies:
• Modern governments try to prepare their budgets within the framework of
national income data and try to formulate anti-cyclical policies according to the
facts revealed by the national income estimates. Even the taxation and
borrowing policies are so framed as to avoid fluctuations in national income.
 Concepts and importance of National Income
6. National Expenditure:
• National income studies show how national expenditure is divided between
consumption expenditure and investment expenditure. It enables us to provide
for reasonable depreciation to maintain the capital stock of a community. Too
liberal allowance of depreciation may prove harmful as it may unnecessarily
lead to a reduction in consumption.
 7. Distribution of Grants-in-aid:
• National income estimates help a fair distribution of grants-in-aid by the federal
governments to the state governments and other constituent units.
 8. Standard of Living Comparison:
• National income studies help us to compare the standards of living of people in
different countries and of people living in the same country at different times.
 9. International Sphere:
• National income studies are important even in the international sphere as
these estimates not only help us to fix the burden of international payments
equitably amongst different nations but also enable us to determine the
subscriptions and quotas of different countries to international organisations
like the UNO, IMF, IBRD. etc.
 Concepts and importance of National Income
10. Defence and Development:
• National income estimates help us to divide the national product between
defence and development purposes. From such figures we can easily know how
much can be spared for war by the civilian population.

 11. Public Sector:
• National income figures enable us to know the relative roles of public and
private sectors in the economy. If most of the activities are performed by the
state, we can easily conclude that public sector is playing a dominant role.
 INFLATION
Inflation means a continuous rise in the general price level over a long period of
time.
Types of Inflation:
(1) Demand Pull Inflation and (2) Cost Push Inflation

(I) Demand Pull Inflation: The Demand Pull Inflation occurs when the aggregate
demand increases much more rapidly than the aggregate supply.
The demand pull inflation is caused by monetary and real factors.
(a) Monetary factors: An important reason of demand pull inflation is increase in
money supply in excess of increase in potential output.
(b) Real factors: The real factors that cause demand pull inflation are as follows
(i) Increase in government spending given the tax revenue.
(ii) Upward Shift in export function and
(iii) Downward shift in the Import function.
 INFLATION
(2) Cost Push Inflation : The Cost push inflation is caused by the monopoly power
exercised by some monopoly groups of the society like labour unions, and
firms in monopolistic and oligopolistic market setting.
The Cost Push Inflation may be classified on the basis of supply side factors as follows:
(i) Wage Push Inflation: Wage push inflation is attributed to the exercise of
monopoly power by labour unions to get the money wages enhanced above
the competitive labour market wage rate. Labour Unions force the firms to
increase their money wages above the competitive level without a matching
increase in labour productivity.
(ii) Profit Push Inflation: Another supply side factor that is said to cause
inflation is the use of monopoly power by the monopolistic and oligopolistic
firms to enhance their profit margin , which causes rise in price and inflation.
(iii) Supply Shock inflation: Another variant of cost push inflation is the supply
shock inflation. Supply shock is a sudden, unexpected disturbance in the
supply position of some major commodities or key industrial inputs. The
inflation occurs generally due to sudden rise in the prices of high weightage
items in the price index number , for instance ,food prices due to crop failture
and prices of some key industrial inputs like coal, steel, cement oil and basic
chemicals.
 MONEY SUPPLY IN INFLATION
The money supply measures the total amount of money in the economy at a
particular time. It includes actual notes and coins and also any deposits which
can be quickly converted into cash.
If the money supply increase faster than the real output , then prices will increases
causes inflation.

Supplying the money in the market is the sole responsibility of the Central Bank of
the country (Reserve Bank of India in case of India) . RBI prints the currency
and supplies money in the economy.

Supply of money decides the rate of inflation in the economy. If supply of money
increases in the economy then inflation starts rising and vice versa.

In India money supply is done on the basis of minimum reserve system since 1956
The RBI require holding a reserve of gold and foreign securities and it is
empowered to issue currency to any extent.
 BUSINESS CYCLE
The alternating periods of expansion and contraction in economic activity has been
called Business Cycles. They are also known as Trade Cycles.
J.m. Keynes writes, “ A trade cycle is composed of periods of good trade
characterized by rising prices and low unemployment percentages with periods
of bad trade characterized by falling prices and high unemployment
percentages”.

Features of Business Cycles:

(1) Business cycles occur periodically
(2) It has been observed that fluctuations occurs not only in level of production but
also simultaneously in other variables such as employment , investment,
consumption , rate of interest and price level.
(3) Another important feature of Business Cycles is that Investment and
consumption of durable consumer goods such as cars, houses, refrigerators are
affected most by the cyclical fluctuations.
(4) Profits fluctuate more than any other type of income.
 PHASES OF BUSINESS CYCLE
A Business Cycle is generally divided into four phases:
(1) Expansion or Prosperity or the Upswing
(2) Recession or Upper Turning Point
(3) Depression or Downswing or Contraction
(4) Recovery or Revival or Lower Turning Point

(I) DEPRESSION: In trade Cycle, Depression is the unfavorable and

frightening phase wherein output and employment have a considerable fall.
As output and employment rapidly decline in depression, the prices and wages also
fall. It is a bad experience for both producers and the workers.

(2) RECOVERY: Recovery phase of trade cycle display the upward movement of
output and employment from depression phase. Recovery is a result of new
demand for plant and equipment that emerge from consumer goods industries.
The Capital goods expire after sometime and require replacement, which
results in recovery process.
 PHASES OF BUSINESS CYCLE
(3) PROSPERITY: Recovery phase has a multiplier effect because rise in output
and incomes create a significant increase in aggregate spending. Due to
increase in effective demand and income, the process becomes self reinforcing.

(4) RECESSION : The prosperity phase comes to an end due to specific

movements in the private enterprise economy prevailing in boom conditions.
a) When price increases wages tend to fall, this results in decline of purchasing
power of workers.
b) When Production is expanded, it involves shortages of some inputs and
obstruction in production.
c) The factor and the product prices are increased due to excessive demand for
labour and materials.
When firms involved in losses, the production schedules by firms are terminated,
workers are removed and orders are cancelled.
 Nature of Managerial Economics
• Managerial economics is, perhaps, the youngest of all the social sciences. Since it
originates from Economics, it has the basis features of economics, such as
assuming that other things remaining the same (or the Latin equivalent ceteris
paribus).
• This assumption is made to simplify the complexity of the managerial phenomenon
under study in a dynamic business environment so many things are changing
simultaneously.
• This set a limitation that we cannot really hold other things remaining the same. In
such a case, the observations made out of such a study will have a limited purpose
or value. Managerial economics also has inherited this problem from economics.
•  Further, it is assumed that the firm or the buyer acts in a rational manner (which
normally does not happen). The buyer is carried away by the advertisements, brand
loyalties, incentives and so on, and, therefore, the innate behaviour of the consumer
will be rational is not a realistic assumption.
• Unfortunately, there are no other alternatives to understand the subject other than
by making such assumptions. This is because the behaviour of a firm or a consumer
is a complex phenomenon.
The other features of managerial economics are explained as below:

• Close to microeconomics: Managerial economics is concerned with finding

the solutions for different managerial problems of a particular firm. Thus, it is
more close to microeconomics.
• Operates against the backdrop of macroeconomics: The macroeconomics
conditions of the economy are also seen as limiting factors for the firm to
operate. In other words, the managerial economist has to be aware of the
limits set by the macroeconomics conditions such as government industrial
policy, inflation and so on.
• Normative statements: A normative statement usually includes or implies the
words ‘ought’ or ‘should’. They reflect people’s moral attitudes and are
expressions of what a team of people ought to do. For instance, it deals with
statements such as ‘Government of India should open up the economy. Such
statement are based on value judgments and express views of what is ‘good’
or ‘bad’, ‘right’ or ‘ wrong’.
• Prescriptive actions: Prescriptive action is goal oriented. Given a problem
and the objectives of the firm, it suggests the course of action from the
available alternatives for optimal solution.
• Applied in nature: ‘Models’ are built to reflect the real life complex
business situations and these models are of immense help to managers for
decision-making. The different areas where models are extensively used
include inventory control, optimization, project management etc. In
managerial economics, we also employ case study methods to
conceptualize the problem, identify that alternative and determine the best
course of action.
• Offers scope to evaluate each alternative: Managerial economics provides
an opportunity to evaluate each alternative in terms of its costs and
revenue. The managerial economist can decide which is the better
alternative to maximize the profits for the firm.
• Interdisciplinary: The contents, tools and techniques of managerial
economics are drawn from different subjects such as economics,
management, mathematics, statistics, accountancy, psychology,
organizational behavior, sociology and etc.
• Assumptions and limitations: Every concept and theory of managerial
economics is based on certain assumption and as such their validity is not
universal. Where there is change in assumptions, the theory may not hold
good at all.
 Role of a Managerial Economist

• He studies the economic patterns at macro-level

and analysis it’s significance to the specific firm he
is working in.
• He has to consistently examine the probabilities of
transforming an ever-changing economic
environment into profitable business avenues.
• He assists the business planning process of a firm.
• He also carries cost-benefit analysis.
• He assists the management in the decisions pertaining to internal
functioning of a firm such as changes in price, investment plans,
type of goods /services to be produced, inputs to be used,
techniques of production to be employed, expansion/ contraction
of firm, allocation of capital, location of new plants, quantity of
output to be produced, replacement of plant equipment, sales
forecasting, inventory forecasting, etc.
• In addition, a managerial economist has to analyze changes in
macro- economic indicators such as national income, population,
business cycles, and their possible effect on the firm’s
functioning.
• He is also involved in advising the management on public
relations, foreign exchange, and trade. He guides the firm on the
likely impact of changes in monetary and fiscal policy on the
firm’s functioning.
• He also makes an economic analysis of the firms in competition.
He has to collect economic data and examine all crucial
information about the environment in which the firm operates.
• The most significant function of a managerial economist is
to conduct a detailed research on industrial market.
• In order to perform all these roles, a managerial
economist has to conduct an elaborate statistical analysis.
• He must be vigilant and must have ability to cope up with
the pressures.
• He also provides management with economic information
such as tax rates, competitor’s price and product, etc.
They give their valuable advice to government authorities
as well.
• At times, a managerial economist has to prepare speeches
for top management.