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?

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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.

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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

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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.

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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

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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.

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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

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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.

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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.

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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

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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

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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= 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

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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.

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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.

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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

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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.

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(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

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Average Fixed Cost 12 10 8 C o st R s. 6 4 2 0 1 2 3 4 5 Output 6 7 8 ?

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(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.

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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

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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.

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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.

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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.

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