Business Economics and Financial Analysis

Transcription

1 Unit-1 BUSINESS AND ECONOMICS Business: A business is an organizational entity and legal entity made up of an association of people, be they natural, legal, or a mixture of both who share a common purpose and unite in order to focus their various talents and organize their collectively available skills or resources to achieve specific declared goals and are involved in the provision of goods and services to consumers. A business can also be described as an organisation that provides goods and services for human needs. Business is the activity of making one's living or making money by producing or buying and selling products (such as goods and services). Business is "any activity or enterprise entered into for profit. It does not mean it is a company, a corporation, partnership, or has any such formal organization, but it can range from a street peddler to General Motors. A company or association of persons can be created at law as legal person so that the company in itself can accept limited liability for civil responsibility and taxation incurred as members perform (or fail) to discharge their duty within the publicly declared "birth certificate" or published policy. Because companies are legal persons, they also may associate and register themselves as companies often known as a corporate group. When the company closes it may need a "death certificate" to avoid further legal obligations. Businesses serve as conductors of economic activity, and are prevalent in capitalist economies, where most of them are privately owned and provide goods and services allocated through a market to consumers and customers in exchange for other goods, services, money, or other forms of exchange that hold intrinsic economic value. Businesses may also be social nonprofit enterprises or state-owned public enterprises operated by governments with specific social and economic objectives. Features of Business: Given below are the key characteristics or features of any business: Dealing Goods & Services: Business deals with goods and services. The goods may be consumer goods such as sweets, bread, cloth, shoes, electronics etc. They may be producer's goods such as machinery, equipment, etc. which are used to further produce another set of goods for consumption. Business also deals with services such as accounting, transport, warehousing, banking, insurance, etc., which are intangible and invisible goods.

2 Production and Exchange: You can call an economic activity a 'business' only when there is production or transfer or exchange or sale of goods or services for value. If goods are produced for self-consumption or presentation as gift, such activities shall not be treated as business. In a business activity, there must be two parties i.e., a buyer and a seller. Such activity should concern with the transfer of goods or exchange of goods between a buyer and a seller. The goods may be bartered or exchanged for money. Continuity and regularity in Dealings: A single transaction shall not be treated as business. An activity is treated as business only when it is undertaken continually or at least recurrently. A business is believed to be a going concern. To understand this, assume that you sell your house for profit; it is not considered as business. Only when you start buying houses and selling them to others on a regular basis, this activity can be classified as business. Profit Motive: Earning profit is the primary motive of business. This is not to undermine the importance of the social objectives or human element in the business activity. In fact a business will flourish only when it is able to serve its customers to their satisfaction. Profits are essential to enable the business to survive, to grow, expand, and to get recognition. By reinvesting the profits the business increases its capital and contributes to the wealth of the owners. Usage of Resources: Any business need one or many of the four productive factors or resources namely land, labour, capital and enterprise to earn profit from the business. All the four resources are always in limited supply (scarcity) and the business must use them efficiently and effectively to produce goods and services. These resources allow for the creation of a product and/or service that customers buy for a value/price. Element of Risk: This is not true that all businesses make profits from day one, in every business; the possibility of incurring a loss is inherent in the nature of business. This possibility of incurring loss is termed as risk. The element of risk exists due to a variety of factors which are outside the control of the business enterprise. There are two kinds of risks; one whose probability can be calculated and can be insured like losses due to fire, floods, theft, etc. and the other whose probability cannot be calculated and which cannot be insured against, e.g. changing technology, fall in demand etc. Any business has to recognize this risk environment, survive within these risk constraints and need to bear the risk if they happen. Business Objectives: All business activity is self-interested and competitive, and this competition may benefit people and society when it leads resources to be employed in their most profitable use. Business Organizations are economic in nature but they also have human and social aspect associated with them. Some of the main economic of any business enterprise are:

3 Economic objectives Earning of satisfactory profits and fair return on investment for stakeholders Exploring new markets and Creation of new customers Growth and expansion of business operations of the firm Making innovations and improvements in goods and services Social objectives Supply of quality goods and services at reasonable costs Providing goods and rescannable prices Ensure that fair returns to investors Providing employment opportunities to the people in the country Human objectives Fair deal to employees in terms of wages and incentives Providing better working conditions and environment to the employees Provide job satisfaction Provide the employees more growth opportunities Structures of Business Firm The following are the different business structures in India: 1. Sole Proprietorship 2. Partnership Firm 3. Private Limited Company 4. Public Limited Company 5. Limited Liability Partnership What is a Firm? A firm is a business organization, such as a corporation, limited liability company or partnership, that sells goods or services to make a profit. What is the 'Theory of the Firm? The theory of the firm is the microeconomic concept founded in neoclassical economics that states that firms (including businesses and corporations) exist and make decisions to maximize profits. Firms interact with the market to determine pricing and demand and then allocate resources according to models that look to maximize net profits. In the theory of the firm, the behavior of a particular business entity is said to be driven by profit maximization. This theory governs decision making in a variety of areas including resource allocation, production technique, pricing adjustments and quantity produced.

4 The theory of the firm goes along with the theory of the consumer, which states that consumers seek to maximize their overall utility. In this case, utility refers to the perceived value a consumer places on a good or service, sometimes referred to as the level of happiness the customer experiences from the good or service. Example, when consumers purchase a good for $10, they expect to receive a minimum of $10 in utility from the purchased good. Modern takes on the theory of the firm sometimes distinguish between long-run motivations, such as sustainability, and short-run motivations, such as profit maximization. The theory is always being analyzed and adapted to suit changing economies and markets. Early economic analysis focused on broad industries, but as the19th century progressed, more economists began to look at the firm level to answer basic questions about why companies produce what they do, and what motivates their choices when allocating capital and labor. Risks Associated with the Theory of the Firm's Profit Maximization Goal Modern takes on the theory of the firm take such facts as low equity ownership by many decision makers into account; some feel that chief executive officers (CEOs) of publicly held companies are interested in profit maximization as well as in goals based on sales maximization, public relations and market share. Solely focusing on profit maximization comes with a level of risk in regards to public perception and a loss of a sense of goodwill between the business and other individuals or entities. Further risk exists when a firm focuses on a single strategy within the marketplace. If a business relies on the sale of one particular good for its overall success, and the associated product fails within the marketplace, this can lead to a financial collapse of that particular company or department within a company. For example, Sega, a gaming console producer, had success with its Sega Genesis console. Sega subsequently released the Dreamcast in Japan in 1998 and in the United States in Firstday U.S. sales reached $100 million. However, the Dreamcast couldn't play DVDs like the rival PlayStation 2, which led to the Dreamcast's eventual failure within the marketplace. Even after a price drop, consumer interest did not rekindle, and Sega's gaming console division ultimately fell. Case: A firm may seek to maximize profits subject to limitations on the availability of essential inputs (skilled labour, land, capital and raw materials) and legal constraints (minimum wage laws, health and safety, and pollution). Value of the firm = Present value of expected future profits

5 Types of Business Entities: I. PRIVATE SECTOR 1. Sole Trading Concern: A sole-trader is a person who carries on business exclusively by and for himself, he is not only the owner of the capital of the undertaking, but is usually to organise and manage and takes all the profits or responsibility for losses. Characteristics of Sole Proprietorship: (i) Individual Initiative: This business is started by the initiative of a single person. He prepares the blue prints of the venture and arranges various factors of production. He may employ other person for assistance but ultimate authority and responsibility lies with him. All the profits and losses are taken by the single individual. (ii) Unlimited Liability: In sole trade business liability is unlimited. The proprietor is responsible for all losses arising from the business. The liability is not limited only to his investments in the business but his private property is also liable for business obligations. (iii) Management and Control: The proprietor manages the whole business himself. He prepares various plans and executes them under his own supervision. There may be some persons to help him but ultimate control lies with the owner. (iv)motivation: One person is the sole owner of the business. He takes all profits and bears losses, if any. There is a direct relationship between efforts and reward. If he works more, he will earn more. He is motivated to expand his business activities. He will not like to enter speculative business because the risk involved is more.

6 (v) Secrecy: All important decisions are taken by the owner himself. He keeps all the business secrets only to himself. Business secrets are very important for small business. By retaining business secrets he avoids competitors entering the same business. (vi)proprietor and proprietorship are one: Legally, the sole trader and his business are not separate entities. Loss in his business is his loss and liabilities of the business are his liabilities. (vii) Owners and business exist together: In sole-trade business there is no separate existence of the business with the owner. The business and owner exist together. The business is dissolved if the owner dies, becomes insolvent or is removed from the scene. (viii)limited area of operations: A sole-trade business has generally a limited area of operations, the reason being the limited resources and managerial abilities of the sole trader. He can arrange limited funds only and will be able to supervise a small business. Since all decisions are to be taken by the proprietors, so the area of business will be limited with his management abilities. (ix) Free from Legal Formalities: A sole trade business can be started without performing any legal formalities. It does not require any formation or registration. (x) Discretionary start and end: Sole trader can start the business as per his will and similarly can dissolve it as per his discretion. (xi) Freedom in Selection of Trade: A sole trader is free to decide the type of business activity he wants to start. He is not supposed to consult anybody for taking such decisions. (xii) Distribution of Profits: A sole trader is the single owner of the business; he takes all the profits himself. He puts all his efforts into the business and takes all the fruits of his labour. Advantages of Sole Trader Control: Sole traders maintain full control of their business. Running it how they please without the interference of others. Profit retention: Sole traders retain all the profits of their business. Private data: Information about sole traders is kept private, unlike that of limited companies which is necessarily made public after registration with Companies House. Specialist: Often a small business, sole traders can offer a more personal service with local roots and ties. This can be more appealing to potential customers in the local community. Personal: Because there is no need to confer with other decision makers, sole traders can make decisions quickly and act on them swiftly, providing for the needs of their customers. Disadvantages of Sole Trader Liability: Sole traders are not seen as a separate entity by the law. Therefore, they are subject to unlimited liability. This means if the business gets into debt, the business owner is liable. In the worst case, this may mean a person risks their home, personal savings and any other assets they have

7 both in and outside of the business. Finance: Sole traders often find it difficult to raise finance to fund their business. They may truggle with expansion in the future. Reverse economies of scale: Sole traders will be unable to take advantage of economies of scale in the same way as limited companies and larger corporations, who can afford to buy in bulk. This might mean that they have to charge higher prices for their products or services in order to cover the costs. Decision making: All decisions must be made by the sole trader. There is no room for help by others. So the success or failure of the business rests on one person. 2. Joint Hindu Family Business The Joint Hindu Family Business is a distinct form of organisation peculiar to India. Joint Hindu Family Firm is created by the operation of law. It does not have any separate and distinct legal entity from that of its members. The business of Joint Hindu Family is controlled under the Hindu Law instead of Partnership Act. The membership in this form of business organisation can be acquired only by birth or by marriage to a male person who is already a member of Joint Hindu Family. Characteristics of Joint Hindu Family Business: Governed by Hindu Law: The business of the Joint Hindu Family is controlled and managed under the Hindu law. Management: All the affairs of a Joint Hindu Family are controlled and managed by one person who is known as Karta or Manager. The Karta is the senior most male member of the family. He works in consultation with other members of the family but ultimately he has final say. The members of the family have full faith and confidence in Karta. Only Karta is entitled to deal with outsiders. But other members can deal with outsiders only with the permission of Karta. Membership by Birth: The membership of the family can be acquired only by birth. As soon as a male child is born in family, he becomes a member. Membership requires no consent or agreement. Liability: Except the Karta, the liability of all other members is limited to their shares in the business. The Karta is not only liable to the extent of his share in the business but his separate property is equally attachable and amount of debt can be recovered from his separate property. Permanent Existence: The death, lunacy or insolvency of any member of the family does not affect the existence of the business of Joint Hindu Family. The family goes on doing its business. Implied Authority of Karta: In a joint family firm, only Karta has the implied authority to contract debts and pledge the credit and property of the firm for the ordinary purpose of the businesses of the firm.

8 Minor also a Partner: In a partnership, minor cannot become co-partner though he may be admitted to the benefit of partnership. In a Joint Hindu Family firm minor is a partner. Dissolution: The Joint Hindu Family Business can be dissolved only at the will of all the members of the family. Any single member has no right to get the business dissolved. Advantages of Joint Hindu family business: Easy to Start: It is very easy to start the Joint Hindu Family Business. No legal formalities are required to be faced, such as registration. It requires no agreement. Efficient Management: The management of Joint Hindu Family Business is centralised in the hands of Karta of family. In this business, Karta takes all decisions and gets them implemented with the help of other member. No other member interferes in his management. Secrecy: In Joint Hindu Family Business, all the decisions are taken by the Karta himself. He is in a position to keep all the affairs to him and maintains perfect secrecy in all matters. Prompt Decision: The Karta is the only person who exercises control and direction over the business. He may not consult anyone in taking decisions. This ensures prompt or quick decisions. Being the sole master, he takes prompt decisions and makes advantage of the opportunity. Economy: For the success of any business, economy is a must. It is well- balanced and maintained in Joint Hindu Family Business. The Karta of family spends money with great caution and economy. Credit Facilities: In Joint Hindu Family Business the credit facilities are more. One reason for this is that liability of the Karta is unlimited. Karta is having personal relations with others, which are also helpful in raising credit. Natural Love between Members: In Joint Hindu Family Business, it is the natural love and affection which the members are having for each other. Disadvantages of Joint Hindu family business: Limited Membership: The membership of the business is limited to the members of family only. No outsider can become the member of Joint Hindu Family Business. Limited Sources of Capital: The capital is limited only upto the resources of one family. This is not sufficient to meet the business requirements for expansion. Thus the size of the business remains small. The Karta cannot take the advantage of economies of large size due to limited finance. Limited Managerial Skill: All the managerial functions which are essential for the successful operation of a business are performed by the Karta of the family. The Karta may not be able to perform all managerial functions because of limitation of time, energy and skills. Because of limited scale of operations and financial resources, it may not be feasible to secure the services of experts in different fields like purchasing, production and marketing.

9 Unlimited Liability: The liability of the Karta is unlimited. The Karta is not only liable to the extent of his share in the business but his separate property is equally attachable and amount of debt can be recovered from his separate property. This factor puts a ceiling on the growth and expansion of the business. Misuse of Power: The management of a Joint Hindu Family Business is centralised in the hands of Karta of the family. No other member can interfere in his management. This may lead to the misuse of power and the Karta may use the power for his personal interest. 3. Partnership Firm The Indian Partnership Act, 1932, Section 4, defined partnership as the relation between persons who have agreed to share the profits of business carried on by all or any of them acting for all. Features of Partnership Firm: More Persons: As against proprietorship, there should be at least two persons subject to a maximum of ten persons for banking business and twenty for non-banking business to form a partnership firm. Profit and Loss Sharing: There is an agreement among the partners to share the profits earned and losses incurred in partnership business. Contractual Relationship: Partnership is formed by an agreement-oral or written-among the partners. Existence of Lawful Business: Partnership is formed to carry on some lawful business and share its profits or losses. If the purpose is to carry some charitable works, for example, it is not regarded as partnership. Utmost Good Faith and Honesty: A partnership business solely rests on utmost good faith and trust among the partners. Unlimited Liability: Like proprietorship, each partner has unlimited liability in the firm. This means that if the assets of the partnership firm fall short to meet the firm s obligations, the partners private assets will also be used for the purpose. Restrictions on Transfer of Share: No partner can transfer his share to any outside person without seeking the consent of all other partners. Principal-Agent Relationship: The partnership firm may be carried on by all partners or any of them acting for all. While dealing with firm s transactions, each partner is entitled to represent the firm and other partners. In this way, a partner is an agent of the firm and of the other partners. Advantages of Partnership Firm Easy Formation: Partnership is a contractual agreement between the partners to run an enterprise. Hence, it is relatively ease to form. Legal formalities associated with formation are minimal. Though, the registration of a partnership is desirable, but not obligatory.

10 More Capital Available: We have just seen that sole proprietorship suffers from the limitation of limited funds. Partnership overcomes this problem, to a great extent, because now there are more than one person who provide funds to the enterprise. It also increases the borrowing capacity of the firm. Moreover, the lending institutions also perceive less risk in granting credit to a partnership than to a proprietorship because the risk of loss is spread over a number of partners rather than only one.. Combined Talent, Judgment and Skill: As there are more than one owners in partnership, all the partners are involved in decision making. Usually, partners are pooled from different specialised areas to complement each other. For example, if there are three partners, one partner might be a specialist in production, another in finance and the third in marketing. This gives the firm an advantage of collective expertise for taking better decisions. Thus, the old maxim of two heads are better than one aptly applies to partnership. Infusion of Risk: You have just seen that the entire losses are borne by the sole proprietor only but in case of partnership, the losses of the firm are shared by all the partners as per their agreed profitsharing ratios. Thus, the share of loss in case of each partner will be less than that in case of proprietorship. Flexibility: Like proprietorship, the partnership business is also flexible. The partners can easily appreciate and quickly react to the changing conditions. No giant business organisation can stifle so quick and creative responses to new opportunities. Tax Advantage: Taxation rates applicable to partnership are lower than proprietorship and company forms of business ownership. Disadvantages of Partnership Firm: Unlimited Liability: In partnership firm, the liability of partners is unlimited. Just as in proprietorship, the partners personal assets may be at risk if the business cannot pay its debts. Divided Authority: Sometimes the earlier stated maxim of two heads better than one may turn into too many cooks spoil the broth. Each partner can discharge his responsibilities in his concerned individual area. But, in case of areas like policy formulation for the whole enterprise, there are chances for conflicts between the partners. Disagreements between the partners over enterprise matters have destroyed many a partnership. Lack of Continuity: Death or withdrawal of one partner causes the partnership to come to an end. So, there remains uncertainty in continuity of partnership. Risk of Implied Authority: Each partner is an agent for the partnership business. Hence, the decisions made by him bind all the partners. At times, an incompetent partner may lend the firm into difficulties by taking wrong decisions. Risk involved in decisions taken by one partner is to be borne by other partners also.

11 4. Joint Stock Company A joint stock company is an artificial person, created by law with a fixed capital divisible into transferable shares with perpetual succession and common seal. Features of Joint Stock Company Artificial Person: A Joint Stock Company is an artificial person as it does not possess any physical attributes of a natural person and it is created by law. Thus it has a legal entity separate from its members. Separate legal Entity: Being an artificial person a company has its own legal entity separate from its members. It can own assets or property enters into contracts, sue or can be sued by anyone in the court of law. Its shareholders cannot be held liable for any conduct of the company. Perpetual Existence: A company once formed continues to exist as long as it is fulfilling all the conditions prescribed by the law. Its existence is not affected by the death, insolvency or retirement of its members. Limited liability of shareholders: Shareholders of a joint stock company are only liable to the extent of shares they hold in a company not more than that. Their liability is limited by guarantee or shares held by them. Common Seal: Being an artificial person a joint stock company cannot sign any documents thus this common seal is the company s representative while dealing with the outsiders. Any document having common seal and the signature of the officer is binding on the company. Transferability of Shares: Members of a joint stock company are free to transfer their shares to anyone. Capital: A joint stock company can raise large amount of capital by issuing its shares. Management: A joint stock company has a democratic management which is managed by the elected representatives of shareholders, known as directors of the company. Membership: To form a private limited company minimum number of members prescribed in the companies Act is 2 and the maximum number is 50. But in the case of public limited company the minimum limit is 7 and no limit on maximum number of members. Formation: Generally a company is formed with the initiative of group of members who are also known as promoters but it comes into existence after completing all the formalities prescribed in Companies Act 1956.

12 Types of Joint Stock Company: 1. Chartered Company: Formerly in Great Britain, the government, through Royal Charter formed companies for specific purposes, e.g. East India Company. A chartered company is regulated by the terms of its charter. In India, such companies are foreign companies. 2. Statutory Company: A company or corporation, formed by an act of the legislature, is called the statutory company. Examples are Reserve Bank of India. Industrial Finance Corporation, Life Insurance Corporation, etc. 3. Registered Company: A company must be registered under the Companies Act. After registration, the Registrar of Companies issues a certificate of incorporation. After that, the company becomes a registered company. Broadly there are two types of registered companies, such as: 4. Limited Company: A limited liability company is a company whose liability of each member is limited to the face value of the shares held by him and the capital of the company is divided into a number of shares. This type of company is of two types, viz-private Limited Company, and Public Limited Company. (a) Private Limited Company: A Private Limited Company means a company which by its articles of associations: Restricts the right to transfer the shares; Minimum number of members is 2 to maximum 200. Limits the number of its members to fifty excluding persons who are in the employment of the company; and Prohibits any invitation to the public to subscribe for the share or debentures of the company. (b) Public Limited Company: It is a voluntary association of at least seven or more persons, authorized and recognized under the law as a separate legal entity apart from its owners who agree

13 on the supply capital and share the profits and losses. A public limited company may be of two types, viz. a company limited by shares and a company limited by guarantee. Minimum number of members is 7 and maximum is unlimited. (c) Company Limited by Shares: In this company, there is a share capital, and each share has fixed nominal value, which the shareholder pays at a time or by installments. A shareholder is not liable to pay anything more than the fixed value of the shares subscribed; whatever may be the liabilities of the companies. Most of the companies in Bangladesh belong to this class. (d) Company Limited by Guarantee: In Such a company, each member promises to pay a fixed sum of money in the event of liquidation of the company. This amount is called the guarantee. Sometimes the members are required to buy a share of a fixed value and also give a guarantee for a further sum in the event of liquidation. There is no liability to pay anything more than the value of the share (where there is a share) and the guarantee. 5. Unlimited company: In these companies, the liability of the shareholder is unlimited as in partnership firms. Such companies are permitted under the Companies Act but are non-existent. 6. Government Company: A government company is a company in which not less than 51% of the paid-up share is held by the Central or State Government or partly by both central and state governments. Since the government has the majority of the share so all the management of the company is taken over by the government authority. Nepal Dairy Development Corporation, Janakpur Cigarette factory, Birgunj Sugar Mill Ltd. etc. are some example of the government companies. 7. Non-government Company:. The company is owned, managed and controlled by the private sector. It needs to follow some legal formalities from registration of the company. The government does not interfere in the regular managerial activities. Kumari Bank Limited, General Finance Company are some example of the non-government company. 5. Co-operative societies The co-operative movement has been necessitated to protect the interests of weaker sections of society. The co-operative form of organisation is a democratic set up run by its members for serving the interests of them. It is self help through mutual help. The philosophy behind co-operative movement is All for each and each for all. Co-operative societies are voluntary associations started with the aim of service to members. Hubert Calvert says, Co-operation is a form of organisation wherein persons voluntarily associated together as human beings on the basis of equality for the promotion of the economic interest of themselves.

14 One aspect of a vast movement which promotes the voluntary association of individuals having common economic needs who combine towards the achievement of the common economic ends they have in view and who bring into his combination a moral effort and a progressively developing realisation is the achievement of economic ends. Formation of a Co-Operative Society: A co-operative society must be formed under the Co-operative Societies Act, 1912 or under the relevant state co-operative society s law. A co-operative society can be formed by at least 10 adult members. The members willing to form a society must have common bond among them. They may be the residents of same locality, employees of some organization, belonging to some group having affinity etc. The application for forming a society must have the following information: Name and address of the society. Aims and objectives of the society. Names and addresses of members of the society. Share capital and its division. Mode of admitting new members. A copy of the bye laws of the society. The required documents are filed with the Registrar of Societies. The Registrar scrutinizes the documents; if these are as per requirements then the society s name is entered in the register. A certificate of registration is also issued to the society. The society will become a corporate body from the date mentioned in the certificate. Advantages of Co-operative Society: Easy Formation: Formation of a co-operative society is very easy compared to a joint stock company. Any ten adults can voluntarily form an association and get it registered with the Registrar of Co-operative Societies. Open Membership: Persons having common interest can form a co-operative society. Any competent person can become a member at any time he/she likes and can leave the society at will. Democratic Control: A co-operative society is controlled in a democratic manner. The members cast their vote to elect their representatives to form a committee that looks after the day-to-day administration. This committee is accountable to all the members of the society. Limited Liability: The liability of members of a co-operative society is limited to the extent of capital contributed by them. Unlike sole proprietors and partners the personal properties of members of the co-operative societies are free from any kind of risk because of business liabilities.

15 Elimination of Middlemen s Profit: Through co-operatives the members or consumers control their own i Supplies and thus, middlemen s profit is eliminated. ii State Assistance: Both Central and State governments provide all kinds of help to the societies. Such help may be provided in the form of capital contribution, loans at low rates of interest, exemption in tax, subsidies in repayment of loans, etc. iii Stable Life: A co-operative society has a fairly stable life and it continues to exist for a long period of time. Its existence is not affected by the death, insolvency, lunacy or resignation of any of its members. Disadvantages of Co-operative Society: Limited Capital: The amount of capital that a cooperative society can raise from its member is very limited because the membership is generally confined to a particular section of the society. Again due to low rate of return the members do not invest more capital. Government s assistance is often inadequate foremost of the co-operative societies. Problems in Management: Generally it is seen that co-operative societies do not function efficiently due to lack of managerial talent. The members or their elected representatives are not experienced enough to manage the society. Again, because of limited capital they are not able to get the benefits of professional management. Lack of Motivation: Every co-operative society is formed to render service to its members rather than to earn profit. This does not provide enough motivation to the members to put in their best effort and manage the society efficiently. Lack of Co-operation: The co-operative societies are formed with the idea of mutual co-operation. But it is often seen that there is a lot of friction between the members because of personality differences, ego clash, etc. The selfish attitude of members may sometimes bring an end to the society. Dependence on Government: The inadequacy of capital and various other limitations make cooperative societies dependant on the government for support and patronage in terms of grants, loans subsidies, etc. Due to this, the government sometimes directly interferes in the management of the society and also audits their annual accounts. II. PUBLIC SECTOR Meaning: A state-owned enterprise in India is called a Public Sector Undertaking (PSU) or a Public Sector Enterprise. These companies are owned by the union government of India, or one of the many state or territorial governments, or both. The company stock needs to be majority-owned by the government to be a PSU. PSUs may be classified as Central Public Sector Enterprises (CPSEs),

16 public sector banks (PSBs) or State Level Public Enterprises (SLPEs).CPSEs are companies in which the direct holding of the Central Government or other CPSEs is 51% or more. They are administered by the Enterprises. As on 13 September 2017 there are 8 Maharatnas, 16 Navratnas and 74 Miniratnas. There are nearly 300 CPSEs (central public sector enterprises) in total.

17 1. Departmental Undertaking Meaning: Under departmental form of organisation, a public enterprise is run as a separate fullfledged ministry or as a major sub-division of a department of the Government. For example: The Indian Railways are managed by the Ministry of Railways. Post and Telegraph services are run as a department, in the Ministry of Communication. All India Radio, Doordarshan are other examples of departmental undertakings. Features of Departmental Undertaking: (i) Formation: A departmental undertaking is established either as a separate full-fledged ministry or as a sub-division of a ministry (i.e. department) of the Government. (ii) No Separate Entity: A departmental undertaking does not have an independent entity distinct from the Government. (iii) Ultimate Responsibility with the Minister: The ultimate responsibility for the management of a departmental undertaking lies with the minister concerned; who is responsible to the Parliament or State Legislature for the affairs of the departmental undertaking. The minister, in turn, delegates his authority downwards to various other management levels, in the departmental undertaking. (iv) Governmental Financing: The departmental undertaking is financed through annual budget appropriations by the Parliament or the State Legislature. The revenues of the undertaking are paid into the treasury. (v) Accounting and Audit etc. as Applicable to Government Departments: The departmental undertaking is subject to the normal budgeting, accounting and audit procedures, which are applicable to Government departments. (vi) Managed by Civil Servants: The departmental undertaking is managed by civil servants, who are subject to same service conditions as applicable to civil servants of the Government. (vii) Sovereign Immunity: A departmental undertaking cannot be sued at all, without the consent of the Government. Advantages of Departmental Undertaking: (i) Easy Formation: It is easy to set up a departmental undertaking. The departmental undertaking is created by an administrative decision of the Government, involving no legal formalities for its formation. (ii) Direct and Control of Parliament or State Legislature: The departmental undertaking is directly responsible to the Parliament or the State legislature through its overall head i.e. the minister concerned. (iii) Secrecy Maintained: The departmental undertaking can maintain secrecy of important policy matters; as the Government can withhold any information, in public interest.

18 (iv) Lesser Burden of Tax on Public: Earnings of departmental undertaking are paid into Government treasury, resulting in lesser tax burden on the public. (v) Instrument of Social Change: Government can promote economic and social justice through departmental undertakings. Hence, a departmental undertaking can be used by the Government, as an instrument of social change. (vi) Lesser Risk of Misuse of Public Money: As the departmental undertaking is subject to budgeting, accounting and audit procedures of the government; the risk of misuse of public money is relatively less. Disadvantages of Departmental Undertaking: (i) Read-Tape and Bureaucracy: Departmental undertaking is run in a way other departments of the Government are run. Its management and functioning are subject to excessive red-tap and bureaucracy. (Red-tape means unnecessary and complicated officials rules which prevent things from being done quickly). As a result, the departmental undertaking loses all flexibility desired of a business enterprise. (ii) Incidence of Additional Taxation: Losses incurred by a departmental enterprise are met out of the treasury. This very often necessitates additional taxation the burden of which falls on the common man. (iii) Lack of Competition: A departmental undertaking often enjoys monopoly in its field. As a result, it tends to become indifferent to the quality and price of its goods and services; and may not hesitate to exploit the society. (iv) Casual Approach to Work: As officers of a departmental undertaking are subject to frequent transfers; they develop a sense of casual approach to work. As a result, the operational efficiency of the undertaking suffers a lot. (v) Political Influence: A departmental undertaking is subject to excessive political influence. Its fate depends on the balance of power between the ruling party and the opposition. As such, a departmental undertaking becomes a political organisation rather than an economic or business organisation. (vi) Lack of Professional Management and Fear of Criticism: A departmental undertaking is managed by civil servants, who do not possess professional management skills. Moreover, these managers could not afford to be innovative, because of a fear of criticism by the minister or the Parliament. (vii) Financial Dependence: A departmental undertaking is financially dependent on the Government s budgetary allocations. As such, it cannot have its own independent long range investment decisions, which may bring enormous prosperity to the undertaking.

19 2. Statutory Corporations Meaning of Public Corporation: A public corporation is that form of public enterprise which is created as an autonomous unit, by a special Act of the Parliament or the State Legislature.Since a public corporation is created by a Statute; it is also known as a statutory corporation. In India, the Reserve Bank of India, Damodar Valley Corporation, State Trading Corporation, Industrial Development Bank of India, Industrial Finance Corporation are some of the corporations created by special acts of Parliament. Features of Public Corporation: (i) Special Statute: A public corporation is created by a special Act of the Parliament or the State Legislature. The Act defines its powers, objectives, functions and relations with the ministry and the Parliament (or State Legislature). (ii) Separate Legal Entity: A public corporation is a separate legal entity with perpetual succession and common seal. It has an existence, independent of the Government. It can own properly; can make contracts and file suits, in its own name. (iii) Capital Provided by the Government: The capital of a public corporation is provided by the Government or by agencies controlled by the government. However, many public corporations have also begun to raise money from the capital market. (iv) Financial Autonomy: A public corporation enjoys financial autonomy. It prepares its own budget; and has authority to retain and utilize its earnings for its business. (v) Management by Board of Directors: Its management is vested in a Board of Directors, appointed or nominated by the Government. But there is no Governmental interference in the day-today working of the corporation. (vi) Own Staff:A publication corporation has its own staff; whose appointment, remuneration and service conditions are decided by the corporation itself. (vii) Service Motive: The main objective of a public corporation is service-motive; though it is expected to the self-supporting and earn reasonable profits. (viii) Public Accountability: A public corporation has to submit its annual report on its working. Its accounts are audited by the Comptroller and Auditor General of India. Annual report and audited accounts of a public corporation are presented to the Parliament or State Legislatures, which is entitled to discuss these. Advantages of Public Corporation: (i) Bold Management due to Operational Autonomy: A public corporation enjoys internal operational autonomy; as it is free from Governmental control. It can, therefore, run in a businesslike manner. Management can take bold decisions involving experimentation in its lines of activities,

20 taking advantage of business situations. (ii) Legislative Control: Affairs of a public corporation are subject to scrutiny by Committees of Parliament or State Legislature. The Press also keeps a watchful eye on the working of a public corporation. This keeps a check on the unhealthy practices on the part of the management of the public corporation. (iii) Qualified and Contented Staff: Public corporation offers attractive service conditions to its staff. As such it is able to attract qualified staff. Because of qualified and contented staff, industrial relations problems are not much severe. Staff has a motivation to work hard for the corporation. (iv) Tailor-Made Statute: The special Act, by which a public corporation is created, can be tailormade to meet the specific needs of the public corporation; so that the corporation can function in the best manner to achieve its objectives. (v) Not Affected by Political Changes: Being a distinct legal entity, a public corporation is not much affected by political changes. It can maintain continuity of policy and operations. (vi) Lesser Likelihood of Exploitation: The Board of Directors of a public corporation consists of representatives of various interest groups like labour, consumers etc. nominated by the Government. As such, there is lesser likelihood of exploitation of any class of society, by the public corporation. (vii) Reasonable Pricing Policy: A public corporation follows a reasonable pricing policy, based on cost-benefit analysis. Hence, public are generally satisfied with the provision of goods and services, by the public corporation. Limitations of Public Corporation: (i) Autonomy and Flexibility, Only in Theory: Autonomy and flexibility advantages of a public corporation exist only in theory. In practice, there is a lot of interference in the working of a public corporation by ministers, government officers and other politicians. (ii) Misuse of Monopolistic Power: Public corporations often enjoy monopoly in their field of operation. As such, on the one hand they are indifferent to consumer needs and problems; and on the other hand, often do not hesitate to exploit consumers. (iii) Rigid Constitution: The constitution of a public corporation is very rigid. It cannot be changed, without amending the Statute of its formation. Hence, a public corporation could not be flexible. (iv) Low Managerial Efficiency: Quite often civil servants, who do not possess management knowledge and skills, are appointed by the government on the Board of Directors, of a public corporation. As such, managerial efficiency of public corporation is not as much as found in private business enterprises. (v) Problem of Passing a Special Act: A public corporation cannot be formed without passing a special Act; which is a time consuming and difficult process. Hence, the scope for setting up public

21 corporations is very restricted. (vi) Clash of Divergent Interests: In the Board of Directors of public corporation, conflicts may arise among representatives of different groups. Such clashes tell upon the efficient functioning of the corporation and may hamper its growth. 3. Government Company Meaning: A Government company is one in which not less than 51% of the paid-up share capital is held by the Central Government or a State Government or jointly by both. A Government company may either by wholly owned by the Government, in which case 100% capital is provided by Government; or may be owned by the Government (holding minimum of 51% share-capital) and private concerns/individuals (holding maximum of 49% share capital). In the latter case, a government company is known as a mixed ownership company. Hindustan Machine Tools, State Trading Corporation, Hindustan Steel Ltd., Hindustan Aeronautics etc. are some examples. Features of a Government Company: (i) Registration Under the Companies Act: A Government company is formed through registration under the Companies Act, 1956; and is subject to the provisions of this Act, like any other company. However, the Central Government may direct that any of the provisions of the Companies Act shall not apply to a Government company or shall apply with certain modifications. (ii) Executive Decision of Government: A Government company is created by an executive decision of the Government, without seeking the approval of the Parliament or the State Legislature. (iii) Separate Legal Entity: A Government company is a legal entity separate from the Government. It can acquire property; can make contracts and can file suits, in its own name. (iv) Whole or Majority Capital Provided by Government: The whole or majority (at least 51%) of the capital of a Government company is provided by the Government; but the revenues of the company are not deposited into the treasury. (v) Majority of Government Directors: Being in possession of a majority of share capital, the Government has authority to appoint majority of directors, on the Board of Directors of a government company. (vi) Own Staff: A Government company has its own staff; except Government officials who are sent to it on deputation. Its employees are not governed by civil service rules. (vii) Free from Procedural Controls: A Government company is free from budgetary, accounting and audit controls, applicable to Government undertakings. (viii) Accountability to the Parliament/State Legislature: The Annual Report of a Government company is placed before the Parliament or the State Legislature.

22 Advantages of Government Company: (i) Easy Formation: A Government company can be easily formed under the Companies, Act, just by an executive decision of the government. (ii) Internal Autonomy: A government company can manage its affairs independently. It is relatively free from ministerial control and political interference, in its day-to-day functioning. (iii) Private Participation: Through Government company device, the government can avail of the management skills, technical know-how and expertise of the private sector and foreign countries. For example, the Hindustan Steel Limited has obtained technical and financial assistance from the U.S.S.R., West Germany and the U.K. for its steel plants at Bhilai, Rourkela and Durgapur. (iv) Easy to Alter: Objectives and powers of the Government Company can be changed by simply altering the Memorandum of Associating of the company, without seeking the approval of the Parliament. (v) Discipline: The Government Company is subject to provisions of the Companies Act; which keeps the management of the company active, alert and disciplined. (vi) Professional Management: A Government company can employ professionally qualified managers; because it has its own personnel policies. (vii) Public Accountability: The Annual Report of a Government company is presented to the Parliament/ State Legislature. These reports can be discussed and debated there. Limitations of Government Company: (i) Board of Directors Packed with Yes-Men : On the Board of Directors of a government company, there are Government appointed directors (Government being the major shareholder); who are yes-men of the Government. They are unable to run the company, in a businesslike manner. (ii) Autonomy Only in Name: Independent character of a Government company exists only in name. In reality, politicians, ministers, Government officials, interfere excessively in the day-to-day working of the government company. (iii) A Fraud on Companies Act and Constitutions: A Government company is criticized as being a fraud on the Companies Act and on the Constitution. This criticism is valid on the ground that the Government can exempt a Government company from application of several provisions of the Companies Act. Again, the Parliament is not taken into confidence, while creating a Government company. (iv) Fear of Exposure: The annual report of the government company is placed before the Parliament/State Legislature. The working of the company is exposed to Press criticism: Therefore, management of the Government Company often gets demoralized and may not take initiative to come out with and implement something innovative.

23 (v) Lack of Expertise in Deputationists: The key personnel of a Government company are often deputed from Government departments. These deputatiosnists generally lack expertise and commitment; leading to lower operational efficiency of the government company. (vi) Selfish Functioning: The Government Company works neither for the government nor for the public at large. It serves the personal interests of people who work in the company and who dictate policies of the company. Sources of Capital for a Company Capital or Business Finance: 1. Capital is the money, credit, and other forms of funding that build wealth 2. Wealth in the form of money or assets, taken as a sign of the financial strength of an individual, organization, or nation, and assumed to be available for development or investment. 3. Accounting: Money invested in a business to generate income. 4. Economics: Factors of production that are used to create goods or services and are not themselves in the process. Need for Capital: 1. For the purchase of land, building, office, shop, warehouse, etc. 2. For the construction of the factory 3. For the purchase of machine, materials and raw materials 4. For the purchase of furniture 5. For procuring commercial services 6. For purchasing the stationery 7. For the payment of salaries and wages to employees 8. For daily expenses 9. For the modernization and expansion of business unit 10. It is very essential to provide for provision of finance for contingencies. Types and Sources of capital

24 I. Time Period Point of View 1. Long-term finance A business unit has the necessity of business finance for different time periods. Some of the finance is required for certain purposes permanently, or for more than 10 years. The purpose of this type of finance is for the purchase of land, building, machineries and other fixed assets and for the expansion and modernization of unit or for the purchase of modern machineries and technology or for the purchase of new industrial unit. Finance invested in this way is known as long-term finance. Uses of long term finance: a) Long-term finance is useful to become self-reliant in activities like production. b) Long-term finance is useful for reducing cost by undertaking large-scale economic activities and to sustain the competition. c) Risk is very high in the gigantic capital investment plans. So, the element of competition is low and profitability element is high. For this reason only, long-term finance is deadly required for these high profitable plans. d) In the long-term the investment in fixed assets can be recovered in the form of income. For this long-term finance-becomes helpful. Sources of long-term i. Equity share, ii. Preference share, iii. Debenture iv. Ploughing back of profit, v. Long-term loan, vi. Depreciation fund and other funds, etc. 2. Medium-term finance Generally, requirements of finance for the time-period of more than 5 years but less than 10 years are termed as medium-term finance. For the production and marketing management expenditure of unit and for the purchase and maintenance of tools, etc. medium-term finance is required. Uses of Medium-term finance a) The purpose of this type of finance is necessary for salaries, wages, administrative expenses, transportation facilities, etc. b) Economic gains can be earned by utilising medium-term finance for the purchase of right or more quantity of materials. c) This type of finance is useful for tools, for the formation of security system and for research.

25 Sources of medium-term finance Preference share Debenture Public deposit Bank loan Special type of loans from industrial financial institutes, etc. 3. Short-term finance: Short-term finance includes financial requirements from 1 up to 5 years and sometimes even financial requirements of less than one year that means of certain months or days. Uses Short-term finance a) This finance is even used for unexpected or accidental requirements of those circumstances for which no provision has been made. b) Sometimes receipts are not as per calculations, so for the payment of expenses short-term finance is useful. c) Short-term finance is proved to be useful when depositors apply for the refund before due date. d) Short-term finance is useful for taking advantage of short-term business chances. This finance is useful for bidding for tender, for doing job-work or for supplying goods according to the conditions laid down in export order. Sources of short-term finance Trade credit cash-credit Public deposits of short duration Bank overdraft Private lending persons or firms by proper planning of cash II. FORM POINT OF VIEW 1. Fixed capital: The Capital which is used for the purchase of fixed assets. Ex: Plant, Machinery. 2. Working capital: The capital which is used for satisfy the day to day activities of the business. Ex. Purchase of raw material, salaries, wages and other expenses II. OWNERSHIP POINT OF VIEW 1. Owner s Funds: When the owners of the unit invest their own capital in business, it is, known as owner s funds. Generally, for managing the long-term and medium-term requirements owner s funds are used.

26 Sources of owner s funds: Share capital/owners capital investment Ploughing back of profit Fund created by the provision of depreciation Reserves and other funds. 2. Borrowed Funds: When the unit gets finance by creating debt, it is known as borrowed funds. Generally, for managing medium-term and short-term requirements, borrowed funds are collected. Finance is procured through those sources which are suitable for various time-periods for which expenses are also to be made and each source has its own cost. Sources of borrowed funds: Debenture / Bond Long-term loan from financial institutes Loan from Industrial banks Loan from banks Cash credit Bank overdraft Public deposits Private lending institutes / persons. Non-Conventional Sources of Finance Non-conventional finance is use of modified loan terms or eligibility requirements that allow lending to borrowers with limited financial resources. 'Non conventional' refers to the financial mechanisms employed, and not necessarily to the financial institutions who employ them. 1. Venture Capital: Venture capital (VC) is a type of private equity, a form of financing that is provided by firms or funds to small that are deemed to have high growth potential, or which have demonstrated high growth (in terms of number of employees, annual revenue, or both).

27 2. Angel Funding An angel investor (also known as a business angel, informal investor, angel funder, private investor, or seed investor) is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. A small but increasing number of angel investors invest online through equity crowd funding or organize themselves into angel groups or angel networks to share research and pool their investment capital, as well as to provide advice to their portfolio companies. ECONOMICS Definition of 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. The reason for this is clear. Every one of us in involved in efforts aimed at earning money and spending this money to satisfy our wants such as food, Clothing, shelter, and others. Such activities of earning and spending money are called Economic activities. Economics is a social science concerned with the production, distribution and consumption of goods and services. It studies how individuals, businesses, governments and nations make choices on allocating resources to satisfy their wants and needs, and tries to determine how these groups should organize and coordinate efforts to achieve maximum output. Definitions: It was only during the eighteenth century that Adam Smith, the Father of Economics, defined economics as the study of nature and uses of national wealth. Dr. Alfred Marshall, one of the greatest economists of the nineteenth century, writes Economics is a study of man s actions in the ordinary business of life. Prof. Lionel Robbins defined Economics as the science, which studies human behaviour as a relationship between ends and scarce means which have alternative uses. With this, the focus of economics shifted from wealth to human behaviour. Significance of Business Economics: 1. Business economics is concerned with those aspects of traditional economics which are relevant for business decision making in real life. These are adapted or modified with a view to enable the manager take better decisions. Thus, business economic accomplishes the objective of building a suitable tool kit from traditional economics. 2. It also incorporates useful ideas from other disciplines such as psychology, sociology, etc. If they are found relevant to decision making. In fact, business economics takes the help of other disciplines having a bearing on the business decisions in relation various explicit and implicit constraints subject

28 to which resource allocation is to be optimized. 3. Business economics helps in reaching a variety of business decisions in a complicated environment. Certain examples are (Importance of Economics): What products and services should be produced? What input and production technique should be used? How much output should be produced and at what prices it should be sold? What are the best sizes and locations of new plants? When should equipment be replaced? How should the available capital be allocated? 4. Business economics makes a manager a more competent model builder. It helps him appreciate the essential relationship characterising a given situation. 5. At the level of the firm. Where its operations are conducted though known focus functional areas, such as finance, marketing, personnel and production, business economics serves as an integrating agent by coordinating the activities in these different areas. 6. Business economics takes cognizance of the interaction between the firm and society, and accomplishes the key role of an agent in achieving the social and economic welfare goals. It has come to be realised that a business, apart from its obligations to shareholders, has certain social obligations. Business economics focuses attention on these social obligations as constraints subject to which business decisions are taken. It serves as an instrument in furthering the economic welfare of the society through socially oriented business decisions. Nature and Scope of Business Economics: Nature of Business Economics: 1. It is the study of economics of firms: Economic concepts and principles 2. It uses macro economic analysis: Understanding National income, expenditure, business cycle and business policies. 3. Business economics is Practical (pragmatic): Concerned with practical problems, performance and results 4. It is a micro economics: Study of individual unit s behavior and problems 5. It s an art and science: Art: Develops the best way doing things. 6. Science: Establishes relationship between CAUSES and EFFECTS. 7. Aims at helping the management: Supports the management -To take corrective actions -To make policies for future

29 Scope of Economics: As regards the scope of business economics, no uniformity of views exists among various authors. However, the following aspects are said to generally fall under business economics. 1. Demand Analysis and Forecasting 2. Cost and production Analysis. 3. Pricing Decisions, policies and practices. 4. Profit Management. 5. Capital Management. These various aspects are also considered to comprise the subject matter of business economic. 1. Demand Analysis and Forecasting: A business firm is an economic organisation which transforms productive resources into goods to be sold in the market. A major part of business decision making depends on accurate estimates of demand. A demand forecast can serve as a guide to management for maintaining and strengthening market position and enlarging profits. Demands analysis helps identify the various factors influencing the product demand and thus provides guidelines for manipulating demand. Demand analysis and forecasting provided the essential basis for business planning and occupies a strategic place in managerial economic. The main topics covered are: Demand Determinants, Demand Distinctions and Demand Forecasting. 2. Cost and Production Analysis: A study of economic costs, combined with the data drawn from the firm s accounting records, can yield significant cost estimates which are useful for management decisions. An element of cost uncertainty exists because all the factors determining costs are not known and controllable. Discovering economic costs and the ability to measure them are the necessary steps for more effective profit planning, cost control and sound pricing practices. Production analysis is narrower, in scope than cost analysis. Production analysis frequently proceeds in physical terms while cost analysis proceeds in monetary terms. The main topics covered under cost and production analysis are: Cost concepts and classification, Cost-output Relationships, Economics and Diseconomies of scale, Production function and Cost control. 3. Pricing Decisions, Policies and Practices: Pricing is an important area of business economic. In fact, price is the genesis of a firm s revenue and as such its success largely depends on how correctly the pricing decisions are taken. The important aspects dealt with under pricing include. Price Determination in Various Market Forms, Pricing Method, Differential Pricing, Product-line Pricing and Price Forecasting. 4. Profit Management: Business firms are generally organised for purpose of making profits and in

30 the long run profits earned are taken as an important measure of the firm s success. If knowledge about the future were perfect, profit analysis would have been a very easy task. However, in a world of uncertainty, expectations are not always realised so that profit planning and measurement constitute a difficult area of business economic. The important aspects covered under this area are: Nature and Measurement of profit, Profit policies and Technique of Profit Planning like Break-Even Analysis. 5. Capital Management: Among the various types business problems, the most complex and troublesome for the business manager are those relating to a firm s capital investments. Relatively large sums are involved and the problems are so complex that their solution requires considerable time and labour. Often the decision involving capital management is taken by the top management. Briefly Capital management implies planning and control of capital expenditure. The main topics dealt with are: Cost of capital Rate of Return and Selection of Projects. Conclusion: The various aspects outlined above represent major uncertainties which a business firm has to reckon with viz., demand uncertainty, cost uncertainty, price uncertainty, profit uncertainty and capital uncertainty. We can therefore, conclude that the subject matter of business economic consists of applying economic principles and concepts to deal with various uncertainties faced by a business firm. Branches of Economics Microeconomics: Focuses on the actions of individual agents within the economy, like households, workers, and businesses. The study of an individual consumer or a firm is called microeconomics (also called the Theory of Firm). Micro means one millionth. Microeconomics deals with behavior and problems of single individual and of micro organization. Managerial economics has its roots in microeconomics and it deals with the micro or individual enterprises. It is concerned with the application of the concepts such as price theory, Law of Demand and theories of market structure and so on. Features of Micro Economics: Study individual behaviour Analyse and allocate the resources available Focus on market behaviour Economic welfare

31 Study on products pricing Determines factors pricing Partial equilibrium model Uses slicing method Helps in government policies Others Macroeconomics: It looks at the economy as a whole. It focuses on broad issues such as growth of production, the number of unemployed people, the inflationary increase in prices, government deficits, and levels of exports and imports. The study of aggregate or total level of economic activity in a country is called macroeconomics. It studies the flow of economics resources or factors of production (such as land, labour, capital, organisation and technology) from the resource owner to the business firms and then from the business firms to the households. It deals with total aggregates, for instance, total national income total employment, output and total investment. It studies the interrelations among various aggregates and examines their nature and behaviour, their determination and causes of fluctuations in the. It deals with the price level in general, instead of studying the prices of individual commodities. It is concerned with the level of employment in the economy. It discusses aggregate consumption, aggregate investment, price level, and payment, theories of employment, and so on. Though macroeconomics provides the necessary framework in term of government policies etc., for the firm to act upon dealing with analysis of business conditions, it has less direct relevance in the study of theory of firm. Features of Macro Economics: Study aggregates Focus on hole market behaviour Uses lumping method Income theory Employment theory General equilibrium model Helps in government policies Use to study the micro economic theory Overall study of economic status Study the inflation Others

32 National Income Definition of National Income: The labour and capital of country acting on its natural resources produce annually a certain net aggregate of commodities, material and immaterial including services of all kinds. This is the true net annual income or revenue of the country or national dividend. National income is an outstanding example of macroeconomic analysis. It deals with aggregate or the economy as a whole. National income presents the picture of the overall performance of the economy as a whole in the course of time i.e. a year. Features of National income: 1] National income is a macro-economic concept: National income is an outstanding example of macroeconomic analysis. It deals with aggregate or the economy as a whole. National income presents the picture of the overall performance of the economy as a whole in the course of time ie a year. 2] National income is a flow concept: National income is a flow of goods and services which are actually produced. It is a flow concept in the process of production, income generation and expenditure. It is expressed as National product = National dividend = National expenditure 3] National income is a realized flow: National income is a realized flow of goods and services i.e. final goods and services which are actually produced.

33 4] National income includes all the goods and services produced in the economy: National income includes all the final goods and services produced in the economy i.e. consumer goods, producer s goods and services of all kinds produced in the economy in the current year. 5] National income is the money valuation of goods and services: The value of goods and services produced in the economy, in the current year, is expressed in terms of their market price. This is measured annually. 6] National income includes the value of final [not intermediate] goods and services: National income includes the value of final goods and services only. In order to avoid double counting national income does not include the value of intermediate goods and services as it is already included in the value of final goods and services. 7] National income includes the value of economic/productive activity: National income includes the value of activities that are exchanged for money. Ex: Services of housewives are ignored. 8] National income is the net aggregate value: National income is the net/actual aggregate value of goods and services produced in the economy. Therefore the value of depreciation ie wear and tear of capital in the process of production is deducted from the gross value. 9] Net income from abroad is included: While calculating national income the net income from international trade is included i.e. from exports and imports and from receipts and payments from foreign trade and foreign transactions. 10] Transfer incomes are ignored: In order to avoid double counting transfer incomes like old age pension, unemployment benefits, scholarships etc are ignored in calculation of national income. 11] Indirect taxes are deducted while calculating national income: National income is expressed at market price which is inclusive of indirect taxes. Indirect taxes are a transfer of money from the consumers through the producers to the government. In order to avoid double counting indirect taxes are deducted from national income at market prices. 12] Subsidies are added while calculating national income: National income is expressed at market price which does not include subsidies. Subsidies are a transfer of money from the government through the producers to the consumers. In order to calculate national income accurately subsidies are added to national income at market prices. 13] National income is a mathematical expression: NI = NI (mp) IT +S. 14] Financial Year: National income is always expressed with reference to a time period, in India the financial year, i.e. 1 st April to 31 st March every year. The Importance of National Income Measuring national income is crucial for various purposes: 1. The measurement of the size of the economy and level of country s economic performance

34 2. To trace the trend or the speed of the economic growth in relation to previous year(s) also in other countries 3. To know the composition and structure of the national income in terms of various sectors and the periodical variations in them 4. To make projections about the future development trend of the economy 5. To help government formulate suitable development plans and policies to increase growth rates 6. To fix various development targets for different sectors of the economy on the basis of the earlier performance 7. To help businesses to forecast future demand for their products 8. To make international comparison of people s living standards Concepts of National Income: (1) Gross Domestic Product (GDP): GDP is the total value of goods and services produced within the country during a year. This is calculated at market prices and is known as GDP at market prices. Dernberg defines GDP at market price as the market value of the output of final goods and services produced in the domestic territory of a country during an accounting year. There are three different ways to measure GDP: 1. Product Method 2. Income Method 3. Expenditure Method The Product Method: In this method, the value of all goods and services produced in different industries during the year is added up. The Income Method: The people of a country who produce GDP during a year receive incomes from their work. Thus GDP by income method is the sum of all factor incomes: Wages and Salaries (compensation of employees) + Rent + Interest + Profit. Expenditure Method: This method focuses on goods and services produced within the country during one year. GDP by expenditure method includes: Consumer expenditure on services and durable and non-durable goods (C) Investment in fixed capital such as residential and non-residential building, machinery, and inventories (I) Government expenditure on final goods and services (G) Export of goods and services produced by the people of country (X) Less imports (M). That part of consumption, investment and government expenditure which is spent on imports is subtracted from GDP. Similarly, any imported component, such as raw

35 materials, which is used in the manufacture of export goods, is also excluded. Thus GDP by expenditure method at market prices = C+ I + G + (X M) Where (X-M) is net export which can be positive or negative. GDP at Factor Cost: GDP at factor cost is the sum of net value added by all producers within the country. Since the net value added gets distributed as income to the owners of factors of production, GDP is the sum of domestic factor incomes and fixed capital consumption (or depreciation). Thus GDP at Factor Cost = Net value added + Depreciation. GDP at factor cost includes: i. Compensation of employees i.e., wages, salaries, etc. ii. Operating surplus which is the business profit of both incorporated and unincorporated firms. [Operating Surplus = Gross Value Added at Factor Cost Compensation of Employees Depreciation] iii. Mixed Income of Self- employed. Conceptually, GDP at factor cost and GDP at market price must be identical/this is because the factor cost (payments to factors) of producing goods must equal the final value of goods and services at market prices. However, the market value of goods and services is different from the earnings of the factors of production. In GDP at market price are included indirect taxes and are excluded subsidies by the government. Therefore, in order to arrive at GDP at factor cost, indirect taxes are subtracted and subsidies are added to GDP at market price. Thus, GDP at Factor Cost = GDP at Market Price Indirect Taxes + Subsidies. (2) Net Domestic Product (NDP): NDP is the value of net output of the economy during the year. Some of the country s capital equipment wears out or becomes obsolete each year during the production process. The value of this capital consumption is some percentage of gross investment which is deducted from GDP. Thus Net Domestic Product = GDP at Factor Cost Depreciation. Nominal and Real GDP: When GDP is measured on the basis of current price, it is called GDP at current prices or nominal GDP. On the other hand, when GDP is calculated on the basis of fixed prices in some year, it is called GDP at constant prices or real GDP. Nominal GDP is the value of goods and services produced in a year and measured in terms of rupees (money) at current (market) prices. In comparing one year with another, we are faced with the problem that the rupee is not a stable measure of purchasing power. GDP may rise a great deal in a

36 year, not because the economy has been growing rapidly but because of rise in prices (or inflation). (3) Gross National Product (GNP): GNP is the total measure of the flow of goods and services at market value resulting from current production during a year in a country, including net income from abroad. GNP includes four types of final goods and services: i. Consumers goods and services to satisfy the immediate wants of the people; ii. Gross private domestic investment in capital goods consisting of fixed capital formation, residential construction and inventories of finished and unfinished goods; iii. Goods and services produced by the government; and iv. Net exports of goods and services, i.e., the difference between value of exports and imports of goods and services, known as net income from abroad. In this concept of GNP, there are certain factors that have to be taken into consideration: First, GNP is the measure of money, in which all kinds of goods and services produced in a country during one year are measured in terms of money at current prices and then added together. (4) Net National Product (NNP): NNP includes the value of total output of consumption goods and investment goods. But the process of production uses up a certain amount of fixed capital. Some fixed equipment wears out, its other components are damaged or destroyed, and still others are rendered obsolete through technological changes. All this process is termed depreciation or capital consumption allowance. In order to arrive at NNP, we deduct depreciation from GNP. The word net refers to the exclusion of that part of total output which represents depreciation. So NNP = GNP Depreciation. (5) Personal Income (PI): Personal income is the total income received by the individuals of a country from all sources before payment of direct taxes in one year. Personal income is never equal to the national income, because the former includes the transfer payments whereas they are not included in national income. Personal income is derived from national income by deducting undistributed corporate profits, profit taxes, and employees contributions to social security schemes. These three components are excluded from national income because they do reach individuals. But business and government transfer payments, and transfer payments from abroad in the form of gifts and remittances, windfall gains, and interest on public debt which are a source of income for individuals are added to national income. Thus Personal Income = National Income Undistributed Corporate Profits Profit Taxes Social Security Contribution + Transfer Payments + Interest on Public Debt.

37 Thus Personal Income = Private Income Undistributed Corporate Profits Profit Taxes. (5.1) Disposable Income: Disposable income or personal disposable income means the actual income which can be spent on consumption by individuals and families. The whole of the personal income cannot be spent on consumption, because it is the income that accrues before direct taxes have actually been paid. Therefore, in order to obtain disposable income, direct taxes are deducted from personal income. Thus Disposable Income=Personal Income Direct Taxes. But the whole of disposable income is not spent on consumption and a part of it is saved. Therefore, disposable income is divided into consumption expenditure and savings. Thus Disposable Income = Consumption Expenditure + Savings. If disposable income is to be deduced from national income, we deduct indirect taxes plus subsidies, direct taxes on personal and on business, social security payments, undistributed corporate profits or business savings from it and add transfer payments and net income from abroad to it. Thus Disposable Income = National Income Business Savings Indirect Taxes + Subsidies Direct Taxes on Persons Direct Taxes on Business Social Security Payments + Transfer Payments + Net Income from abroad. (5.2) Real Income: Real income is national income expressed in terms of a general level of prices of a particular year taken as base. National income is the value of goods and services produced as expressed in terms of money at current prices. But it does not indicate the real state of the economy. It is possible that the net national product of goods and services this year might have been less than that of the last year, but owing to an increase in prices, NNP might be higher this year. On the contrary, it is also possible that NNP might have increased but the price level might have fallen, as a result national income would appear to be less than that of the last year. In both the situations, the national income does not depict the real state of the country. To rectify such a mistake, the concept of real income has been evolved. In order to find out the real income of a country, a particular year is taken as the base year when the general price level is neither too high nor too low and the price level for that year is assumed to be 100. Now the general level of prices of the given year for which the national income (real) is to be determined is assessed in accordance with the prices of the base year. For this purpose the following formula is employed. Real NNP = NNP for the Current Year x Base Year Index (=100) / Current Year Index Suppose is the base year and the national income for is Rs. 20,000 crores and the index number for this year is 250. Hence, Real National Income for will be =

38 20000 x 100/250 = Rs crores. This is also known as national income at constant prices. (5.3) Per Capita Income: The average income of the people of a country in a particular year is called Per Capita Income for that year. This concept also refers to the measurement of income at current prices and at constant prices. For instance, in order to find out the per capita income for 2001, at current prices, the national income of a country is divided by the population of the country in that year. Importance of National Income 1. Economic policy: National income figures are an important tool of macro-economic 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 lay down future economic policy for development. 2. Economy s structure: National income statistics enable us to have a correct 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 and how it is distributed, how much is spent, solved or taxed. 3. 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. The national income estimate before formulating the five year plans. 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. National expenditure: National income studies show as to how national expenditure is dividend 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. 6. 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. 7. Standard of living: 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. 8. 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 nation income estimates. Even the taxation and borrowing policies are so framed as to avoid fluctuations in national income.

39 9. 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. 10. Defense and development: National income estimates help us to divide the national product between defense and development purposes. From such figures, we can easily know how much can be spread for war by the civilian population. INFLATION What is inflation? The term "inflation" originally referred to a rise in the general price level caused by an imbalance between the quantity of money and trade needs. In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money a loss of real value in the medium of exchange and unit of account within the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time. The opposite of inflation is deflation (negative inflation rate). Inflation is defined as a rise in the general price level. Inflation is a quantitative measure of the rate at which the average price level of a basket of selected goods and services in an economy increases over a period of time. Often expressed as a percentage. Inflation indicates a decrease in the purchasing power of a nation's currency. Causes of Inflation 1. Changes in money supply, the national debt 2. Changes in disposable income, demand pull effect, cost push effect 3. Changes in business and consumer expenditure 4. Changes in demand of goods and services and exchange rates 5. Increase in government expenditure 6. Agriculture price policy of the government 7. Deficit financing 8. Inadequate rise in industrial production Types of Inflation Economists distinguish between two types of inflation: 1. Demand-Pull Inflation 2. Cost-Push Inflation

40 Both types of inflation cause an increase in the overall price level within an economy. Demand-pull inflation: It occurs when aggregate demand for goods and services in an economy rises more rapidly than an economy's productive capacity. One potential shock to aggregate demand might come from a central bank that rapidly increases the supply of money. The increase in money in the economy will increase demand for goods and services. In the short run, businesses cannot significantly increase production and supply remains constant. Cost-push inflation: It occurs when prices of production process inputs increase. Rapid wage increases or rising raw material prices are common causes of this type of inflation. The sharp rise in the price of imported oil during the 1970s provides a typical example of cost-push inflation. Rising energy prices caused the cost of producing and transporting goods to rise. Higher production costs led to a decrease in aggregate supply and an increase in the overall price level because the equilibrium point.

41 Money Supply in Inflation (Quantity theory of Money): Money: When prices rise, it is rarely because products are more valuable, but rather because the money used to buy them is less valuable. Thus, inflation is more about the value of money than about the value of goods. An increase in the overall price level is equivalent to a proportionate fall in the value of money. If P is the price level (the value of goods and services measured in money) then 1/P is the value of money measured in terms of goods and services. If prices double, the value of money has fallen to ½ its prior value. The value of money is determined by the supply and demand for money. If we ignore the banking system, the RBI controls the money supply. Money demand reflects how much wealth people want to hold in liquid form. While money demand has many determinants, in the long run one is dominant - the price level. People hold money because it is a medium of exchange. If prices are

42 higher, more money is needed for the same transaction, and the quantity of money demanded is higher. Money supply and money demand need to balance for there to be monetary equilibrium. Monetary equilibrium is shown in Exhibit 1 for money supply MS1 at point A. Recall that the value of money measured in goods and services is 1/P. When the value of money is high, the price level is low and the quantity of money demanded is low. Therefore, the money demand curve slopes negatively in the graph. Since the RBI fixes the quantity of money, the money supply curve is vertical. In the long run, the overall level of prices adjusts to equate the quantity of money demanded to the quantity of money supplied. Suppose the RBI doubles the quantity of money in the economy from MS1 to MS2. There is now an excess supply of money at the original price level. Since people now are holding more money than they desire, they will rid themselves of the excess supply of money by buying things - goods and services or bonds. Even if people buy bonds (lend money), the bond issuer (borrower) will take the money and buy goods and services. Either way, an injection of money increases the demand for goods and services. Since the ability of the economy to produce goods and services has not changed, an increase in the demand for goods and services raises the price level. The price level will continue to rise (and the value of money will fall) until the quantity of money demanded is raised to the level of the quantity of money supplied (point B). That is, the price level adjusts to equate money supply and money demand. Thus, the conclusions of the quantity theory of money are: 1. The quantity of money in the economy determines the price level (and the value of money) 2. An increase in the money supply increases the price level, which means that growth in the money supply causes inflation. M*V= P*T where, M = Money supply V = Velocity of money P = Price level T = volume of the transactions BUSINESS CYCLE The business cycle or economic cycle and or trade cycle is the downward and upward movement of Gross Domestic Product (GDP) around its long-term growth trend. The length of a business cycle is the period of time containing a single boom and contraction in sequence.

43 Phases of business cycle: 1. Expansion: The line of cycle that moves above the steady growth line represents the expansion phase of a business cycle. In the expansion phase, there is an increase in various economic factors, such as production, employment, output, wages, profits, demand and supply of products, and sales. In addition, in the expansion phase, the prices of factor of production and output increases simultaneously. In this phase, debtors are generally in good financial condition to repay their debts; therefore, creditors lend money at higher interest rates. This leads to an increase in the flow of money. In expansion phase, due to increase in investment opportunities, idle funds of organizations or individuals are utilized for various investment purposes. Therefore, in such a case, the cash inflow and outflow of businesses are equal. This expansion continues till the economic conditions are favorable. 2. Peak: The growth in the expansion phase eventually slows down and reaches to its peak. This phase is known as peak phase. In other words, peak phase refers to the phase in which the increase in growth rate of business cycle achieves its maximum limit. In peak phase, the economic factors, such as production, profit, sales, and employment, are higher, but do not increase further. In peak phase, there is a gradual decrease in the demand of various products due to increase in the prices of input.

44 The increase in the prices of input leads to an increase in the prices of final products, while the income of individuals remains constant. This also leads consumers to restructure their monthly budget. As a result, the demand for products, such as jewellery, homes, automobiles, refrigerators and other durables, starts falling. 3. Recession: As discussed earlier, in peak phase, there is a gradual decrease in the demand of various products due to increase in the prices of input. When the decline in the demand of products becomes rapid and steady, the recession phase takes place. In recession phase, all the economic factors, such as production, prices, saving and investment, starts decreasing. Generally, producers are unaware of decrease in the demand of products and they continue to produce goods and services. In such a case, the supply of products exceeds the demand. Over the time, producers realize the surplus of supply when the cost of manufacturing of a product is more than profit generated. This condition firstly experienced by few industries and slowly spread to all industries. This situation is firstly considered as a small fluctuation in the market, but as the problem exists for a longer duration, producers start noticing it. Consequently, producers avoid any type of further investment in factor of production, such as labor, machinery, and furniture. This leads to the reduction in the prices of factor, which results in the decline of demand of inputs as well as output. 4. Trough: During the trough phase, the economic activities of a country decline below the normal level. In this phase, the growth rate of an economy becomes negative. In addition, in trough phase, there is a rapid decline in national income and expenditure. In this phase, it becomes difficult for debtors to pay off their debts. As a result, the rate of interest decreases; therefore, banks do not prefer to lend money. Consequently, banks face the situation of increase in their cash balances. Apart from this, the level of economic output of a country becomes low and unemployment becomes high. In addition, in trough phase, investors do not invest in stock markets. In trough phase, many weak organizations leave industries or rather dissolve. At this point, an economy reaches to the lowest level of shrinking. 5. Recovery: As discussed above, in trough phase, an economy reaches to the lowest level of shrinking. This lowest level is the limit to which an economy shrinks. Once the economy touches the lowest level, it happens to be the end of negativism and beginning of positivism. This leads to reversal of the process of business cycle. As a result, individuals and organizations start developing a positive attitude toward the various economic factors, such as investment, employment, and production. This process of reversal starts from the labor market.

45 Consequently, organizations discontinue lying off individuals and start hiring but in limited number. At this stage, wages provided by organizations to individuals is less as compared to their skills and abilities. This marks the beginning of the recovery phase. In recovery phase, consumers increase their rate of consumption, as they assume that there would be no further reduction in the prices of products. As a result, the demand for consumer products increases. In addition in recovery phase, bankers start utilizing their accumulated cash balances by declining the lending rate and increasing investment in various securities and bonds. Similarly, adopting a positive approach other private investors also start investing in the stock market As a result, security prices increase and rate of interest decreases. Price mechanism plays a very important role in the recovery phase of economy. As discussed earlier, during recession the rate at which the price of factor of production falls is greater than the rate of reduction in the prices of final products. Therefore producers are always able to earn a certain amount of profit, which increases at trough stage. The increase in profit also continues in the recovery phase. Apart from this, in recovery phase, some of the depreciated capital goods are replaced by producers and some are maintained by them. As a result, investment and employment by organizations increases. As this process gains momentum an economy again enters into the phase of expansion. Thus, a business cycle gets completed. Features of Business Cycle