Lecture -1 Business A business is an economic activity.
Transforming a set of inputs into a set of output is the essence of
economic activity. Through the process of transformation, the value
of the output generated must exceed the value of input utilized.
Creation of net value addition is the basic objective of all such
activities. On the input side we have reference to men, materials,
management etc. By output we have reference to various kinds of
goods and services. Goods can be consumer goods, public goods,
merit goods, and non merit goods. The purpose of any economic
activity such as production and final consumption is to create
Surplus or profit. Some of the NGOs & NBOs (Non-Business
Organisations) may not aim at private profits, they aim at social
benefits. All organizations are organizing activities which are
either commercially profitable or socially desirable. For an
economist, all these organizations represent economic enterprises.
We can say that business is an organized effort to provide goods
and services to make profit. What is Economics all about: Economics
is the study and evaluation of economic problems. Each and every
economic problem is a problem of choice and valuation. In business
several decisions are to be taken. For example, a production unit
has to decide- what to produce? When to produce? for Whom to
produce? Why to produce?
1
In the same way, a finance enterprise dealing with funds
confronts the issues when to raise finds? Where from? Where to
direct the use of these funds? At what Risk and Returns
combinations funds are to be raised? What should be maturity and
other terms and conditions with regard to loans disbursed or
deposits mobilized? In the same way a company has to decide how
many people are to be recruited? For what post and position?
Through direct recruitment or internal promotion. To retire a
person or replace? To train develop existing employees towards
promotion and transfer or to hire trained personnel? In the same
way, a marketing firm has to resolve whether to sell or market? At
what price? Whether to provide after sales service or not? What
should be the target group/territory? Should there be any price
discount or not? Should deferred payments be allowed or not? Should
the focus be on domestic or export market? Should the sales
promotion be aggressive or defensive? Should special efforts be
made towards sales promotion or not? In all of the above examples,
the decision problems represent an area of Choice? The question of
choice arises as and when means (resources) are adjusted to ends
(wants). The purpose of economic activity is to satisfy maximum
possible ends by sacrificing minimum possible resources. Human
wants have fundamental characteristics:2
1. Wants are unlimited 2. Wants can be graded in order of their
intensity. Resources fundamental characteristics are: 1. Resources
are limited in supply. 2. Resources have alternative uses.
Unlimited ends and limited means together present the problem of
choice. Economic Concepts: Concepts have references to terms like
Scarcity, activity, optimality Demand, Supply Price Costs, Profits
etc. Each concept has a specific connotation in a specific context
for example Demand in the context of a market means buyers
willingness and ability to purchase. Economic Precepts: Several
concepts together can be built into a precept. Precept stands for
proposition, principle, policy, proscription. A few precepts:(i)
(ii) (iii) (iv) (v) Scarcity lies at the root of every economic
problem. Demand is always at a price. Optimal allocation of scarce
resources is the essence of Supply is in response to the price
prevailing in a market. Firms objective is to maximize profits.
management.
3
What is Business Economics all about: Based on the above, we can
conclude logically that (i) (ii) (iii) (iv) Economics as a
discipline provides precepts. The concepts and precepts together
furnish us the tools and techniques of analysis. Economic analysis
is used as an aid to understand business practices and business
environment Such understanding facilitates business decision
making. a set of concepts and
Business Economics attempts to indicate how Business Policies
are firmly rooted in economic principles. Business economics tabes
a pragmatic approach towards facilitating and integration between
economic theory (Principles) and business practices (Policies).
Business Economics Uses: (a) Microeconomic Analysis of the business
unit. (b) Macroeconomic Analysis of the business Environment
Business Economics is more comprehensive and broad based than
managerial Economics which is mostly microeconomics with high
degree of analytic rigour through sophisticated tools and
techniques of Econometrics and operations research
4
Various forms of Economic Analysis 1. Micro V/s Macro
Analysis:-
In micro economic analysis we focus on individual units like a
consumer, a producer, a firm, an industry, a single price or a
single commodity. We analyse the behaviour of one market variable
at a time it is step by step analyse. Such an analysis helps us to
understand behaviour of a single thing, other things remaining the
same. In macro economic analysis we study the system as a whole,
not the individuals but the total. We focus on the form and
functioning of the economy as an aggregate system. Accordingly our
variables are national income, national consumption, expenditure,
total investment expenditure, total money supply, general price
level, overall employment and output levels. For understanding
economic problems like unemployment, we find micro economics very
relevant Microeconomics theory includes theory of demand, theory of
production,
Theory of price determination, Theory of profit & capital
budgeting . Macroeconomic theories include theory of national
income, theory of economic growth, international trade and monetary
mechanism, study of state policies and their repercussion on the
private business activities. 2. Positive V/s normative Economic
Analysis:Economic analysis is the basis of an economic policy. Most
of the business polices of an economic unit, like a firm are based
on micro economic principles.5
Most are based on macro economic principals. However, neither
the business sector can overlook the impact of national and global
economic policies of the govt. nor the economy can overlook the
impact of business policies framed by a particular (individual or
group) management. This implies that the distinction between micro
and macro analysis narrows down further as and when the policy
implication of various principles are worked out. To the extent
economic analysis (Positive Economics) and Economic Policy
(Normative Economics) are inseparable, micro and macro analysis
must go together. Positive Economics is What is there Normative
economics is What ought to be there? 3. Short Run V/s Long Run
Economic Analysis:Economists analyse their problems with reference
to objective & constraints. In Short Run analysis, some
constraints are variable while others are fixed. In Long Run
Analysis all the constraints are variable & adjustable. 4.
Partial V/s General Equilibrium Analysis:Partial equilibrium
analysis in economics means when at a time one part of the system
is being analysed, assuming that other parts to be constant
parameters. E.g. D = f (P, Pr, y, t.) The assumption of other
things remaining constant may be eventually relaxed and then the
inter dependence among consumers, among producers and between
consumers and producers is studied to derive the welfare
implications of a situation of balance of market forces. This is
the system of General Equilibrium analysis.6
5. Static V/s Comparative Static V/s Dynamic Analysis:Both
microeconomic analysis of partial or general type may be either
static, comparative static or dynamic. In static analysis, the
reference is to an adjustment at a point of time; preferences,
techniques and resources are, therefore, assumed constant.
In comparative static analysis, two or more static states i.e.
shifting equilibrium situations may be studied so as to identify
the single process of adjustment. In dynamic analysis, we study
adjustment path followed over a period of time such that successive
changes in tastes, techniques and resources over ling run can be
taken care of.
Business Economics by M.Adhikari.
7
Lecture 2 Definitions of Economics In its infancy, Economics was
called political Economy. The aim of political Economy is to show
the way in which wealth is produced, distributed and consumed.
J.B.Say Economics is the study of nature, causes and growth of
national wealth Adam Smith But Adam Smith paid too much attention
to wealth as if wealth was every thing. No attention was paid to
man for whom wealth is really meant. No doubt, wealth is the centre
of all economic activities. But it is only a mean to an end, the
end being human welfare . Economics is thus regarded as a science
of man rather than of wealth. Alfred marshall (1990) shifted
emphasis from production of wealth to
distribution of wealth (welfare). According to him Economics is
a study of mans action in the ordinary business of life, it
enquires how he gets his income and how he uses it. Thus it is on
one side a study of wealth and on the other a more important side,
a part of the study of man. Study of man occupies the prominent
place in the Economics. However, we confine our study to those of
his action which relate to wealth i.e. how wealth is produced and
used. How it is exchanged and distributed in the community. Thus it
covers consumptions, production, Exchange- Distribution.8
According to Marshal the primary object and end of Economics is
the promotion of material welfare, which is part of human welfare.
(Human welfare also includes political, social, religious and other
activities of mankind, not amenable to quantitative measurements)
Criticism: 1. Marshall was concerned with the material goods.
However non-material goods are also equally important for the
promotion of human welfare. The services of teachers, doctors,
lawyers, actors, singers etc are nonmaterial goods, which have been
excluded by Marshall. 2. Marshall limited his study to those
activities which increase human welfare. He treats economics an
normative science i.e. outcome can be improved upon. He excluded
the production of guns. Cigarettes, opium, wine, poison- harmful
drugs from the subject of economics. But these are scarce in
relation to demand for them. Economists have to study the pricing
problems & other aspects of such goods, whether they enhance
human welfare or not. Scarcity Definition: Man has unlimited wants
Resources are limited Resources have alternative uses Wants have
hierarchy
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According to Robin Economics studies the problems which have
arisen because of the scarcity of the resources. Robins believes
that all human activities whether it is the production of the
commodities or services of teachers, doctors, actors dancers,
exhibit a clear relationship between ends and scare means.
According to him: Economics studies human behaviour as a
relationship between ends and scarce means which have alternative
uses. When time and means for achieving ends are limited and
capable of alternative application and the ends are capable of
being distinguished in order of importance, then behaviour
necessarily assumes the form of choice i.e. it has an economic
aspect. Robbins definition has broadened the scope of Economics
narrowed down by the welfare definition. Many other economists have
also defined economics. Economy is a study of those principles on
which the resources of a community should be so regulated and
administered as to secure communal ends without waste. Wichsteed
Economics is a social science concerned with the administration of
scarce resources. Scitovosky
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Economics is the study of principales governing the allocation
of scare means among competing ends when the objective of
allocation is to maximize the attainment of the ends. Criticism The
idea of welfare is missing in the definition. Growth Oriented
Definition: P.A. Samuelson gave a modified version of scarcity
definition which is growth oriented. Economics is the study of how
man and society choose, with or without the use of money, to employ
scarce productive resources which have alternative uses, to produce
various commodities over time and distribute them for consumption
now and in the future among various people and groups of society.
It analyses the costs and benefits of improving patterns of
resource allocation. Managgerial Economics by D.D. Chaturveds S.L.
Gupta Anand Mittel
11
Micro V/s Macro Economics Micro is derived from the Greek word
micros which means small. Thus micro economics is the theory of
small. It is the microscopic study of the economy. The term macro
is derived from the Greek word macros which means large. Macro
economics also called Income Theory is concerned with the analysis
of the economy as a whole and its large aggregates or averages such
as total national income and output, total employment, aggregate
demand and supply and the general price level.
Importance of Macro Economics: 1. Formulation & Execution of
Economic Policies :- Economic polices for the removal of the
poverty, the unemployment and the price instability are based upon
aggregate requirements. 2. Functioning of the Economy:-
Macroeconomics gives us an idea of how a complex economic system
functions 3. Study the Economic Development 4. Study of welfare 5.
Theory of Inflation & Deflation 6. International Comparisons.
Interdependence of Micro & macro Economics:Neither of the two
is complete without the other. Demand of the product for a firm or
industry depends upon the total employment, income and demand of
the entire country for this product. The wages of the firm is
related to and depends upon wages to other firm in the industry.
Therefore every price, wage and income depends in some way or the
other, upon the prices of all12
other products, wages of all workers and income of all other
individuals in the country respectively. Prosperity and well being
of individual economic units can be ensured only if the performance
of the whole economy is excellent.
Difference between Micro macro Economics:In spite of very close
relationship between two braches of economics, they differ from
each other fundamentally. 1. It is possible for an individual to
become rich by finding bundles of rupee notes but no nation can
become richer by printing notes. 2. Savings may be virtue for an
individual but if every body starts savings, there will be
deficiency of aggregate demand. 3. An individual can buy more of a
commodity at a given price. But if many individuals try to buy
more, the price will shout up. Business Economics by D.D.
Chaturveds S.L.. Gupta Sumitra Pal.
13
Lecture -3 Contribution and Application of Business Economics to
Business Business Economics is useful in decision making by
business firms regarding the least cost input mix, product mix,
production technique, level of output, price for the product,
investment decisions, amount of advertising out lay etc. It
involves, tools, techniques, principles and theories by business
firms for decision making and forward planning by establishing
plans for the future. Business Economics consists of the use of
economics modes of thought to analyse business situations. It is
applied economics to solve decision problems at the firm level.
Scope of Business EconomicsDemand Analysis & forecasting
(Demand Decisions) Cost & Production Analysis (Input-output
Decisions)
Profit Analysis Profit Maximization Alternative Theories
Risk & Uncertainty Analysis, Economic Forecasting &
Planning
Investment Analysis (Project Appraisal & Investment
Decisions)
Market Structure Pricing Policies (Price-output Decisions)
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Lecturer 4 Opportunity Cost Opportunity Cost is the income
foregone which a businessman could expect from the second best
alternative use of his resources. For example if an entrepreneur
uses his capital in his own business he foregoes interest which he
might earn by purchasing debentures of other companies or by
depositing his money with joint stock companies for a period.
Further more if an entrepreneur uses his labour in his own business
he foregoes his income (salary) which he might have earned by
working as a manager in another firm.
Similarly by using productive assets (Land & Building) in
his own business he sacrifices his market rent. These foregone
incomes- interest, salary and rent are called opportunity Costs or
Transfer Costs. Also opportunity cost in called Implicit cost or
Imputed Cost Accounting Profit = Total Revenue Explicit Cost or
A.F. = T.R - (W + R + I + M) Wages Rent Interest Materials
Cost.
Pure Profit/ Economic Profit = Total Revenue - (Explicit Cost +
Implicit Cost)
If a machine can produce either X or Y the opportunity cost of
producing a given quantity of X is therefore the quantity of Y
which it would have produced. If that machine can produce 10 units
of X or 20 units of Y, the opportunity cost of IX is 2Y.15
In macrosense, the opportunity cost of more guns in an economy
is less butter. Continued diversion of funds to defense spending
amounts to a heavy tax on alternative spending on growth &
development.
Managerial Economics By D.N. Divedi
16
Lecturer 5 Time Value of Money One of the fundamental ideas in
economics is that a Rupee tomorrow is worth less than a Rupee
today. This is because of two reasons. (i) (ii) The future is
uncertain The interest rate inflation
Todays Rs.100= 00 can be invested at 8% interest so that one
year after today Rs100 will become Rs.108= 00. Another way of
saying the same thing is that Rs.100 one year hence is not equal to
Rs.100 = 00 of today, but less than that. But how much money today
is equal to Rs.100 one year hence. To find it out we shall have to
find out the relevant rate of interest which one would earn if one
decides to invest the money. Suppose the rate of interest is 8%.
Then we shall have to discount Rs.100 at 8% in order to ascertain
how much money today will become Rs.100 one year after. The formula
is P.V. = Rs100 1+i Where P.V. = Present Value & I = Rate of
interest. In our case P.V. = 100 = 100 1 + .08 = Rs. 92.59 1 +
.08
As a cross check Rs. 92.59 x 1.08 = Rs.100 = 00 i.e. Rs. 92.59
deposited at 8% today will become Rs. 100 = 00 after one year.
17
The same reasoning applies to longer periods. A sum of Rs. 100 =
00 two years from now is worth P.V. = 100 (1 + i)2 = 100 (1 +08)2 =
100 1.1664 = Rs. 85.73
This time value of money in called Discounting Principle If a
decision affects costs and revenues at future dates, it is
necessary to discount those costs and revenues to present values
before a valid comparison of alternatives is possible. Suppose a
firm is going to receive Rs.40,000 per year for next three years
and firm can earn 10% from fixed Deposits. Then the Present Value
can be computed as P.V. = .= = B1 (1+0.10) 40,000 + 1.10 + B2
40,000 1.21 + + B3 (1+.10)3 40,000 1.301 (1 + 0.10)2
36360.40 + 33058.0 + 30,052.40
Marginalism v/s Instrumentalism Incremental Analysis stresses on
total costs and total revenue resulting from changes in prices,
products, processes, investments etc. Incremental costs and
incremental revenue are the two basic concepts in this analysis.
Incremental cost is the changes in total cost resulting from a
decision.
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The Decision criteria according to this concepts is Accept a
particular decision if it increase revenue more than it increases
cost as assessed from the point of view of the total enterprise.
Incremental cost = New Total Cost Old Total Cost = Change in Cost
I.C. = C2- C1 = C
The difference between old & new revenue is incremental
revenue. Incremental Revenue = New Total Revenue Old Total Revenue
= Change in Revenue I.R. = R2- R1 = R Incremental concept has some
relationship with marginal concept of economics. (a) Marginal
Analysis is more useful when the cost and revenue functions are
curvilinear. To find out small changes, marginal analysis is more
appropriate than the incremental concept. (b) Incremental concept
is not associated with a single unit change. It can be associated
with a change in any member of units. But marginal analysis is
related only to a unit change. (c) In selecting best product mix,
least cost input mix, optimum input level & optimum maturity of
assets, marginal analysis is superior to incremental reasoning. (d)
But incremental reasoning in more useful in linear functions.
Marginal analysis is a special case of incremental reasoning.
19
As implied by incremental reasoning a decision is sound if it
increases revenue more than the costs or reduces costs more than
the revenue.
Principles of Managerial Economics by Dr. B. Prabhakra
Shishib
20
Lecture - 6 RISK, RETURN & PROFITSRI R 18 16 14 12 Rate of
Return 10 7.5 8 A 6 4 2 0 B C C" D RII
3.5
6
9
Risk
Risk Return trade off function or Indifference curve R indicates
that the manager or investor is indifferent among 7.5% rate of
return with Risk = 0; 10% return on an investment with Risk = 3.5
(Pt.B), 14% return on an investment with Risk = 6 (Point C) and 18%
Return on an investment with Risk = P (Point) Thus Risk Premium at
Point B is 2.5% (10 -7.5) Risk Premium at Point C is 6.5% (14-7.5%)
and at Point D is (18-7.5) 10.5% A more risk averse manager or
Investor (Curve R ) requires a higher premium while a less risk
averse one (with Curve R") requires a smaller Risk Premium for each
level of Risk. The higher the Risk, the higher the return. If an
investor invests Rs.100 in the Bank in F.D. he will get Rs.110
after one year (Assuming interest rote to be21
10%). But if he invests in the stock market Rs.100, he may get
Rs.200 after one year (higher returns) but he may totally loose his
principal amount even. Market Forces & Equilibrium
At O P Price, demand of the buyers is OL, while sellor are ready
to sell ok quantity. (OK>OL) i.e. There is excess supply. In
this situation there will be a competition among the sellers. On
the contrary at 0T prices demand will be ON units where as supply
will be OM units. In this case demand will be more than supply
& prices will tent to increase. At Point E there will be
equilibrium of Demand supply. This will be equilibrium price.
22
Lecture -7 Cardinal Utility Approach Utility is a property
common to all commodities and services desired by a person. It has
no physical or material existence and so it is not inherent in a
commodity. As long as a commodity has some use i.e. a capacity to
satisfy consumer want, it has utility. Thus utility can be defined
as the want satisfying power of the commodity. It relates to inner
sentiments and emotions and resides in the mind of the consumer.
Utility is subjective in nature. Utility is not usefulness. Alcohol
may be harmful for health, but, it is paid for since it possesses
utility. Concept of utility is legally, morally, socially and
ethically neutral. Utility is expected satisfaction and
satisfaction is realised utility. When a consumer plans the
purchase of a commodity he actually compares the price he is going
to pay and the utility he is expecting from it. Utility can exist
without consumption but satisfaction will necessarily come only
after actual consumption. However for most of the goods expected
satisfaction is nearly same as realized satisfaction hence utility
& satisfaction are mostly used synonymously. Measurement of
Utility The nineteenth century economists believed that utility was
measurable just as the weight, height and temperature of objects.
The consumer was assumed to possess a cardinal measure of utility.
In this approach, utility is considered to be objectively
measurable. A psychological unity of measuring utility was used
called Util.
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Because util can not be taken as a standard unit for
measurement, as it will vary from individual to individual, hence
Marshall suggested the measurement of utility in terms of monetary
units. Marginal Utility Marginal Utility is the utility of last
unit or the addition to total utility by the consumption of one
additional unit of the commodity for example the total utility of
consuming ten units of some commodity is the total satisfaction
that those ten units provide. The marginal utility of the tenth
units consumed is the satisfaction added by the consumption of that
unit. It is the difference in total utility between consumption of
ten units and nine units. Symbolically Mu10 = Tu10 Tu9 or In
general Mun = Tun Tun-1 Where Mun is the marginal utility of nth
unity. Tun = Total utility of n units. Tu n-1 = Total utility of
(n-1) units. Marginal utility can also be defined as increase in
total utility (Tu), when the quantity of the commodity is increased
by a small amount (Q). Mu = Tu Q When change in quantity of the
commodity is 1, the above formula reduces to Mu = Tu Or Mun = tun
Tun-1
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Initially marginal utility of a commodity is positive due to a
feeling of an urge for the commodity. However as the process of
consumption is continued, a point of saturation is reached.
Consequently, marginal utility becomes zero. Thereafter marginal
utility will become negative. Total Utility Total utility (Tu)
presents the sum of numbers of units consumed. It is the sum of the
marginal utilities associated with the consumption of successive
units. If the consumer derives utility worth Rs.100, Rs.90 &
Rs.80 from the first second & third unit of the commodity, the
total utility of the commodity for the consumer = Rs.270 Tun = Mu1
+ Mu2 +Mun. = Mu.
25
Average Utility Anis obtained by dividing total utility by the
number of units of the commodity. Au = Tu Q Relationship among
Total Utility, Marginal Utility & A.U. No. of Total Utility
Marginal Utility Average Utility Units 1 2 3 4 5 6 7 8 (Tu) 10 18
24 28 30 30 28 24 (Mu) 10 8 6 4 2 0 -2 -4 (Au) 10 9 8 7 6 5 4 3
When the total utility reaches its maximum value, marginal
utility become zero. (Point of satiety). When consumption is
expanded beyond the point of satiety, the total utility starts
falling because marginal utility turns negative.
26
Relationship among Total Utility, Marginal Utility & A.U.35
30 25 20 15 10 5 0 -5 -10 1 2 3 4 5 6 7 8 9
TuSeries1 Series2 Series3
AU Mu
Unlike marginal utility, average utility is always positive,
since it is a ration of two non-negative values Tu & Q.
27
Lecture -8 When average utility attains maximum value, it is
equal to marginal utility. Law of Diminishing Marginal Utility It
is a general human behavior that as one gets more and more units of
the same commodity, the utility from the successive units (marginal
utility) goes on diminishing. If the consumer continues with the
consumption he will develop a dislike for the commodity. Law The
utility which a consumer derives from the consumption of each
additional unit of a commodity keeps decreasing with every increase
in the stock of the commodity which he already has
Assumption 1. Rationality :- Consumer is rational and he aims at
the maximization of his utility subject to the constraint imposed
by his given income. 2. Cardinal Utility :- Utility is measurable
and it can be quantified. It can be added, subtracted, multiplied
& divided. 3. Independence of Utility:- Utilities of different
commodities are independent of one another. 4. Continuous
Consumption Process :- The law assumes that there is no time gap
between the consumption of two successive units of the commodity.
It there is a discontinuity in the consumption, the intensity of
want get revived.
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5. Homogenous Units of Commodity :- If a delicious ripe mango,
is eaten after consuming an unripe mango, the second mango may give
greater utility. 6. No. Change in Personal, Social & Mental
Conditions of Consumer :His income, tastes, fashions & habits
should not change. 7. Constancy of Marginal Utility of Money ;-
I.e. marginal utility of money is constant. If the unit of
measurement itself varies, then it will give different results in
different circumstances for the same quantity of good.
Importance of Law 1. Basis of Law of Demand : The price which a
consumer is prepared to pay for a commodity depends upon the
marginal utility and not on the total utility. He would like to by
additional units of the commodity only at a lower price. Thus a
consumer is ready to pay higher price for the initial units and
lessor for the additional ones. 2. Explanation of Diamond/ Water
Paradox :Since water is available in plentiful quantity its
marginal utility is low or even zero. Therefore its price is very
low, yet it is essential for human existence. On the other hand,
diamond being a scarce commodity commands a higher price due to its
higher marginal utility, though not essential for human
existence.
29
Suppose the quantity of Diamond available is OQ D and that of
water in OQw. Now Diamond will command a Price P D QD with total
utility equal to OA PD QD . Water will command a price of Pw Qw
with total utility equal to OBPw Qw. Water will command a price
PwQw. Hence the price a consumer would be willing to pay for
diamond is high, but, it has lower total utility vis--vis water.
Price reflects marginal utility while total utility determines the
use-value of the commodity.
30
Consumer Equilibrium (One Commodity)
If the commodity consumed by the consumer is available free of
cost, he will carry on consuming the commodity upto the point,
where his total utility from that commodity is maximum. He stops
the consumption of the commodity at the point of satiety i.e. where
the marginal utility is equal to zero. When a consumer pays price
for the utility he derives from the additional unit of commodity
with the utility he scarifies in terms of the price paid for that
unit of commodity. Thus consumer is in equilibrium when marginal
utility & price are equal.
31
Lecture - 9 Law of Equi- marginal utility (Consumer Equilibrium
for more than one commodity.) A consumer spends his income on many
goods & services. How he should distribute his total income
among these goods and services, so that he may be in equilibrium.
(He attains maximum possible level of utility). Let the prices of
two goods A & B be PA & PB respectively. From law of
diminishing M.U. it can be deducted that the consumer is in
equilibrium, when the quantity of the commodity is purchased in
such a way that M.U. derived from it is equal to the price paid for
it multiplied by the marginal utility of money to the consumer. MUA
= PA MUB = PB -------------- (1) -------------- (2)
Where = marginal utility of money to the consumer MUA = MUB
Marginal PA PB utilities of all the commodities should be
proportional to their From (1) = MUA PA = MUB PB
If price of good A is twice that of good B MU A has to be twice
MUB. respective prices.
32
= MUA PA
=
MUB PB
Thus equilibrium condition can also be stated as : The consumer
is in equilibrium when the marginal utility of money to the
consumer ( ) is equal to the ratios of marginal utilities of two
commodities & their respective prices. Now if MUA/ PA is
greater than MUB/ PB, the consumer will substitute good A for good
B. As a result of increase in the quality of A and decrease in the
quality B, MU A/ PA will fall and MUB/ PB will go up. The consumer
will continue the substitution till MUA/PA becomes equal to MUB/PB
when he will be in equilibrium. The Consumer spends his money
income in such a way that the last rupee spent on each commodity
gives him equal amount of utility. But this does not mean spending
of equal amount of money on each commodity. This only means that
marginal utilities of commodities and their respective prices are
proportional. MUA = PA Also PA MUB = PB MUA = MUB MUc = MUm PC PA
PB
33
Lecture -31 Type of Costs 1. Money Cost The amount spent in
terms of money for the production of a commodity is called money
cost.
2. Real Cost The mental and physical efforts and sacrifices
undergone with a view to producing a commodity plus money cost is
its Real Cost. 3. Accounting/ Business Cost Accounting costs refers
to cash payments which firms make for factor and non factor inputs,
depreciation and other book beeping entries. 4. Opportunity Cost
The opportunity cost is the cost of next best alternative foregone.
It is also called alternative cost. 5. Economic Cost Economic cost
includes both accounting costs and opportunity costs of self owned
and self employed resources. 6. Social Costs The social cost is the
total cost to society of an economic activity. Social costs such as
pollution and noise are not taken by firms in determining their
price levels.
34
7. Private Cost Private costs is the cost incurred by an
individual firm for producing a commodity. It includes both the
explicit cost as well as implicit cost. (A) Fixed Cost Table 1.
Quantity of output (units) 0 1 2 3 4 5 6 7 8 Fixed cost (Rs.) 10 10
10 10 10 10 10 10 10
Total fixed cost remains fixed irrespective of no. of units
produced.
35
Fixed Cost12 10 Cost Rs. 8 6 4 2 0 1 2 3 4 5 6 7 8 9 Output
Series2
(B) Variable Cost Quantity of output (units) 0 1 2 3 4 5 6 7 8
Variable Cost (Rs.) 0 10 18 24 28 32 38 46 62
36
Variable Cost70 60 Cost Rs. 50 40 30 20 10 0 1 2 3 4 5 6 Output
7 8 9 Series2
(C) Total Cost
Short Run total cost is the sum of total fixed cost and total
variable cost.
37
(D) Average Fixed Cost Average fixed cost is per unit fixed
cost. It is total fixed cost divided by output A.F.C. = F.C. Q.
Since fixed cost is constant, the greater the output, the lower
will be the fixed cost per unit output. Average Fixed Cost Output
(Units) 0 1 2 3 4 5 6 7 8 Fixed Cost Rs. 10 10 10 10 10 10 10 10 10
Average Fixed Cost 10 5 3.3 2.5 2.0 1.7 1.4 1.2
38
Average Fixed Cost 12 10 8 C o st R s. 6 4 2 0 1 2 3 4 5 Output
6 7 8 ?
39
(E) Average Variable Cost A.V.C. = T.V.C. Q Output (Units) 1 2 3
4 5 6 7 8 Total V.C.( Rs.) 10 18 24 28 32 38 46 62 Average Variable
Cost(Rs) 10 9 8 7 6.4 6.3 6.6 7.8
Av erage Variable Cost12 10 Cost Rs. 8 6 4 2 0 1 2 3 4 5 6 7 8
Output Series2 Series3
(F) Average Total Cost/Average Cost/A.C.
40
Average cost is total cost divided by the output. It measures
the average unit cost of all inputs both fixed & variable.
A.V.C. = T.C. Q Units of Output 1 2 3 4 5 6 7 8 A.V.C. 10 5 3.33
2.50 2.00 1.70 1.40 1.20 A.F.C. 10 9 8 7 6.4 6.3 6.6 7.8 A.C. 20 14
11.3 9.5 8.4 8.0 8.0 9.0 = A.F.C. + A.V.C.
Average Total Cost/Average Cost/A.C.25 20 Cost 15 10 5 0 1 2 3 4
5 Output 6 7 8
Series4
A.C A
Average cost has been falling upto 7th unit, because both A.F.C.
& A.V.C. are also falling. It is minimum at sixth unit and is
constant between 6 th & 7th unit. Thereafter it begins to rise
because A.V.C. is rising. Reason being that when output increases,
initially law of increasing returns or41
diminishing costs applies. When output becomes optimum, the law
of constant returns or constant costs applies. After a point when
production in increased, law of diminishing returns or increasing
costs set in. consequently the curve beings to move upwards.
Why is the short run average cost curve u shaped :(1)
Interaction of Average Fixed Cost and Average Variable Cost As the
production increase, average fixed cost goes on falling. In the
initial stages of production, average variable cost also goes on
falling. Consequently, the aggregates of these two costs i.e.
average cost also falls and reaches its minimum. In this situation,
the firm is making full use of its production capacity. The firm is
having optimum output. The optimum output refers to that level of
output which corresponds to the lowest per unit cost of production
as at point A. If firm produces more than or beyond this point, no
doubt, average fixed cost will continue to fall. But average
variable cost will begin to rise. Rising average variable cost
makes the average cost to rise also. It is so because after
reaching its minimum level, rate of increase in average variable
cost is much more than rate of decrease in average fixed cost.
Future Scenario of Indian Banking, Industry Banking is the key
sector of any economy. Economic growth of any country has to meet
certain national objectives. Banking can influence such direction.
Under
42
the U.P.A. Govt., an over whelming emphasis is being placed on
inclusive growth. Banking can influence this growth. By enhancing
resources in this direction. The prosperity of a nation is linked
closely with the vitality of its banking system. The recent
financial crisis of the world has shown how critical is the proper
functioning of the banking system across the physical boundaries of
the world. This crisis has highlighted the degree of global
integration of financial markets The negative impact of meltdown of
the economics of developed world on Indian economy is obvious. In
the present dynamic business environment, the banking industry in
India has to be better prepared to face the challenges of the
present and the future. Banking sector in India currently suffer
from many weaknesses such as low recovery of credit, poor risk
management practices, trade union pressures, political
interference, unprofitable branches etc. some of the major
challenges facing the banks are (1) Management of N.P.A.s
Non-performing assets are those assetts that cease to generate
income for banks. An asset is considered to have gone bad when the
borrower has defaulted on principal and interest repayment for more
then one quarter or 90 days. NPAs consist of sub-standard assetts,
doubtful assetts and loss assetts and assets generally turn into
NPAs when they fail to yield income during certain period. Doubtful
assetts will become substandard assetts after 18 months and finally
when these are found irrecoverable then these funds become loss
assetts. One of the main cause for large portfolio of NPAs with
banks is that often lending is not linked to productive investment.
During last decade, since the increase in retail lending, NPAs in
this sector is a major cause for concern. Many banks are rethinking
about their of portfolio diversification.
43
Another major cause of NPAs is the non inter linking of recovery
of credit with the product sale. The volume of banked credit
stacked in sick industries, farmers, retail customers in the
evidence of this malady. The legal enviournment of the country does
not help the situation either. The No. of pending judicial cases in
the courts have reduced to a stage to a stage where the Prime
Minister and C.J.I. are forced to intervene. Also because of the
policy of priority sector lending, Banks are forced to lend even
when the risk perception of the repayment capacity is high. The
causes of NPAS can be summarized as follows 1. Faulty lending
policies 2. Priority sector lending 3. Faulty credit management 4.
Defective credit recovery mechanism 5. Lack of professional ethics
in the work force. 6. Time lag between sanctions and disbursements
7. Lack of strong legal mechanism. 8. Political intervention at
local level. 9. Cheating by the borrower. The banks with high NPAs
will loose the competitive advantage because of the following
reasons. 1. Increased cost of capital 2. Adversely affects capital
adequacy norms. 3. Reduced ROA. 4. Reduced value of shares 5.
Reduced credit expansion44
6. Reduced Risk taking abilities. 7. Poor brand image of the
bank NPAs in the global context Table 1 Table 1: Non-performing
Loan at Global Level: Countries NPLs (US $ billion) Share in Global
(percent) Japan 330 China 307 Taiwan 19.1 Thailand 18.8 Philippines
9.0 Indonesia 16.9 India 30 Korea 15.0 Total 745.8 Asia 1000
Germany 283 Turkey 8.0 Global 1300 Source: Global NPL Report
2004Table- 2 Ratio of Non-performing loans to Total Loans Countries
Brazil Chile Mexico U.S. Japan France Greece Italy Russia Turkey
Argentina China 1998 10.2 1.5 11.3 1.0 5.4 6.3 13.6 9.1 17.3 6.7
5.3 1990 8.7 1.7 8.9 0.9 5.8 5.7 15.5 8.5 13.4 9.7 7.1 28.5 2000
8.4 1.7 5.8 1.9 6.1 5.0 12.3 7.7 7.7 9.2 8.7 22.4 2001 5.7 1.6 5.1
1.4 6.6 5.0 9.2 6.7 6.3 29.3 13.2 19.8 2002 5.3 1.8 4.6 1.6 8.9 5.0
8.1 6.5 6.5 17.6 17.5 25.5 Percentage 2003 5.7 1.8 3.7 1.3 7.2 4.9
8.4 6.1 14.2 22.7 22.045
25.4 23.6 1.5 1.5 0.7 1.3 2.3 1.2 57.4 76.9 21.8 0.6 100.0
India 14.4 14.7 12.7 11.4 Indonesia 48.6 32.9 18.8 11.9 Korea
7.4 8.3 6.6 2.9 Malaysia 18.6 16.6 15.4 17.8 Philippines 11.0 12.7
14.9 16.9 Thailand 42.9 38.6 17.7 10.5 Sri Lanka 16.6 16.6 15 16.9
Bangladesh 40.7 41.1 34.9 31.5 Pakistan 23.1 25.9 23.5 23.3 Germany
4.5 4.6 5.1 4.9 U.K. 3.2 3.0 2.5 2.6 Source: Global Financial
Stability Report, April 2004, IMF
10.4 5.8 1.9 15.9 15.4 15.8 15.7 28 23.7 5 2.6
8.8 2.3 14.8 15.2 15.5 13.9 20.7 2.2
The analysis of Table- 1 reveals that globally 76.9% of NPAs are
in Asian region. China and Japan alone contributed almost 50
percent of global NPAs. From Table- 2 it is very clear that
although NPAs are decreasing every year in India. Bu the problem
still persists. Because of the loan waver scheme for farmers which
was recently announced, the numbers of NPAs will make it look much
worse. Also there will be effect of many stimulus packages being
given in order to revise the economic growth. Some people in the
industry are of the opinion that high levels of NPAs in China &
Japan are indirect subsidies provided by the Banking sector to the
industries. These NPAs provide unfair advantage to the industries
of these countries. This, according to their opinion, puts Indian
industry at a competitive disadvantage. 2. Higher Capital
Requirements As a regulator, R.B.I. monitors asset quality and
capital adequacy norms along the lives of Basel II accord. Many of
the public sector banks have entered their market to tap more
capital to enhance their capital base. Capital46
is the life blood that keeps banks alive and provides banks with
the ability to alesorb shocks in the event of any losses. Thus
point has been amply proved in the recent past during financial
turmoil. A higher capital adequacy ratio will drive the banks
towards greater efficiency. To take advantage of economics of
scale, India needs fewer larger banks rather than many smaller
banks. But this large size will ask for more capital with more
emphasis an inclusive growth, the banks will be expanding their
operations further into rural areas. Higher provisioning
requirements on mounting NPAs will also of advesely affect capital
adequacy. Only S.B.I. has covered 40,000 villages in one year.
Capital infusion to the tune of Rs.20,000 Crore is required. State
Bank of India Rural Initiatives Unbanked village covered Tiny Cards
rolled out Cards issued No frills\ accounts 3. Risk Management
Banking sector is very risk by its nature. There is always a threat
of depreciating assets and increasing liabilities. More and more
interlink ages of global financial system quickly transmits the
vulnerability of one player to other players. Banks generally face
three types of risks. (a) Credit Risk (b) Market Risk (c)
Operational Risk.47
March 2008 12,515 12 states 2.07 lakh 11.79 lakh
March 2009 52,782 19 states 21 lakh 25.1 lakh
Target 2010 1,00,000 ---100 lakh 40 lakh
Market risk arises because of variations in interest rates,
foreign exchange rates etc. operational risk is associated with
losses resulting from faulty internal processes, people, systems as
well as external enviournment. As operational risk in a major
challenge for any banks, they have to keeps 15% of their net income
to protect themselves against this type of risk, according to Basel
II norms. Basel I norms gave the same risk weightage to a
particular class of borrowers. All the above mentioned risks have
increased in recent years and are likely to increase further due to
more exposure of banks to retail lending, volatility in the forex
markets and interest rats regimes and people greed. Risk management
in likely to become more and more critical for the competitiveness
of any bank. Fortunately I.T. can help the banks in a big way in
risk management Credit Information Bureau India Ltd.(CIBIL) is the
step in the right direction management Information System
development will lead to better risk management in future. The
importance of I.T. tools like M.I.S. will become more critical with
the Govt. objective of more inclusive growth. There may be
different emerging segments of society and industry which require
priority lending. The Govt. may give directions to the banks
accordingly. This will make risk management more critical. 4.
Customer Relationship Management One of the major challenge for the
banks is going to be to retain the customers.
48
Profit per Customer
Length of time customer has been with the Bank The essence of
C.R.M. in banking is to after the right produce at the right time
through a proper delivery channel. As the banking sector still in
mostly in the hands of public sector, of in a |Public Sector
Mindset which needs changing Come tomorrow Syndrome has to be
broken. Recently S.B.T. had taken & major exercise |Parivartan
to change the general attitude of its employees towards customers.
The parameters set by an XL RI stud show that the customer service
has improved significantly. Bed will it be sustained. Only time
will tell. It is much more costly to get a new customer than to
retain the present one with the entry of private players in the
banking sector, the competition in likely to increase further which
will give competitive advantage to those banks which will take
customers more seriously. Customer in the king is long gone
Customer is god is the survival rule. Although Indian banks have
done reasonably well during the present financial crisis of the
world markets, the emerging competition amongst banks in India well
improve their workings in all areas of operations. Bibliography 1.
The chartered Accountant June 2008. 2. Indian Management July 2008
3. Business India August 2009.49
4. K.C. Shekhar Banking Theory and Practice Vikas Publishing
House Pvt. Ltd. New Delhi 2009 5. Jyotsna Sethi Elements of Banking
and Insurance PHI Pvt. Ltd. New Delhi December 2008.
50