Lesson plan -1

INTRODUCTION:-

The word economics is derived from two Greek word oikus & nemein , oikus means “household” and nemein means “management” i.e. household management.

Economics as a science, not science but a social science ,deals with the problem of allocation of scarce resources among the competing ends and giving maximum satisfaction at minimum cost.

In engineering ,an engineering economists draws some of accumulated knowledge of engineering and economics to identify the alternative uses of limited resources and select the preferred course of actions and evaluates by using different mathematical model, cost data, experiences , judgments etc .

History:-

Before 1940s,All the engineers were mainly concerned with the design, construction, operation of machines , structure, prossess.they paid little attention to human resources .

scientific discoveries and scientific inventions contributed to the expansion of engineering responsibilities and the concerns.

Engineers are now expected to generate novel technological solutions, along with making skillful financial analysis, analysis of work safety, environmental effects, consumer protection, resource conservations etc .

This thinking suggest that the main mission of engineers are to transfer the natural resources for the benefits of human race.

DEFINATION:-ENGINEERING ECONOMICS as such an economics which deals with the methods that enables one to make economic decisions towards evaluation of design and engineering alternatives, it helps in examining the relevance of a project, estimating its value, and justifying it from engineering point of view.

In other word Engineering economics is the application of economic techniques to the evaluation of design and engineering alternatives.

the role of engineering economics is to assess the appropriateness of a given project, estimate its value, and justify it from an engineering standpoint.

Role of engineering economy

Satisfaction of the physical and economic environments is linked through production and construction processes. Engineers need to manipulate systems to achieve a balance in attributes in both the physical and economic environments, and within the bounds of limited resources. Following are some examples where engineering economy plays a crucial role:

1. Choosing the best design from various types of design.2. Should the now in use be replaced with a new one. 3. With limited capital available, which investment alternative should be

accepted?4. How many units of production have to be sold before a profit can be

made?5. Are there any differential cash flow pattern which is preferable.6. Are the benefits from the project is large enough to make its

In the final evaluation of most ventures, economic efficiency takes precedence over physical efficiency because projects cannot be approved, regardless of their physical efficiency, and economical infeasiblity, or if they do not constitute the "wisest" use of those resources which they require

SCOPE OF ECONOMICSThe knowledge of economics is gradually expanding. It is no more a branch of knowledge that deals only with the production and consumption. However, the basic thrust still remains on using the available resources efficiently while giving the maximum satisfaction or welfare to the people on a sustainable basis.

Given this, we can list some of the major branches of economics as under:

Microeconomics: This is considered to be the basic economics. Microeconomics may be defined as that branch of economic analysis which studies the economic behaviour of the individual unit, may be a person, a particular household, or a particular firm. It is a study of one particular unit rather than all the units combined together. microeconomics is also described as price and value theory, the theory of the household, the firm and the industry. Most production and welfare theories are of the microeconomics variety.2. Macroeconomics: Macroeconomics may be defined as that branch of economic analysis which studies behaviour of not one particular unit, but of all the units combined together.

Macroeconomics is a study in aggregates. Hence it is often called Aggregative Economics.It is, indeed, a realistic method of economic analysis, though it iscomplicated and involves the use of higher mathematics.

In this method, we study how the equilibrium in the economy is reached consequent upon changes in the macro-variables and aggregates.The publication of Keynes’ General Theory, in 1936, gave a strong impetus to the growth and development of modern macroeconomics.

3.International economics: As the countries of the modern world are realising the significance of trade with other countries, the role of international economics is getting more and more significant now a days.

4. Public finance: The great depression of the 1930s led to the realisation of the role of government in stabilising the economic growth besides other objectives like growth, redistribution of income, etc. Therefore,a full branch of economics known as Public Finance or the fiscal economics has emerged to analyse the role of government in the economy. Earlier the classical economists believed in the laissez faire economy ruling out role of the government in economic issues.

5. Development economics: As after the second world war manycountries got freedom from the colonial rule, their economics required different treatment for growth and development. This branch developed as development economics.

6.Health economics: A new realisation has emerged from human development for economic growth. Therefore, branches like health economics are gaining momentum. Similarly, educational economics is also coming up.

7. Environmental economics: Unchecked emphasis on economic growth without caring for natural resources and ecological balance, now, economic growth is facing a new challenge from the environmental side. Therefore, Environmental Economics has emerged as one of the major branches of economics that is considered significant for sustainable development.

ECONOMIC GOALS

1. sustainable employment: People willing to work should be able to find jobs reasonably quickly. Widespread unemployment is demoralising and it represents an economic waste. Society forgoes the goods and services that the unemployed could have produced.2. Price stability: It is desirable to avoid rapid increases or decreases in the average level of price.

3.Efficiency: When we work, we want to get as much as we reasonably can take out of our productive efforts. For this, efficient technology becomes quite useful.

4. An equitable distribution of income: When many live in affluence, no group of citizens should suffer stark poverty. Given this, developing countries are strategizing goals like participatory growth and inclusive growth.

5. Growth: Continuing growth, which would make possible an even higher standard of living in the future, is generally considered an important objective.

6.Economic freedom and choice: Any economy should grow and develop in such a manner that people should get more choices and there should not be any outside pressure on their choices.

7.Economic welfare: Economic policies should be pursued in such a manner that welfare of the people or the social benefits get maximised.

8. Sustainable development: It has become a major challenge for economists to carry on the process of economic growth in such a manner that the resources are optimally utilized not only for intergenerational equity but also for sustainable development in quiteDifferentiate between micro economics and macro economics

Microeconomics is the study of particular markets, and segments of the economy. It looks at issues such as consumer behavior, individual labor markets, and the theory of firms.

Macro economics is the study of the whole economy. It looks at ‘aggregate’ variables, such as aggregate demand, national output and inflation.

Micro economics is concerned with: Supply and demand in individual markets Individual consumer behavior. Individual labor markets – e.g. demand for lab our, wage determination. Externalities arising from production and consumption.

Macro economics is concerned with Monetary / fiscal policy. e.g. what effect does interest rates have on whole economy? Reasons for inflation, and unemployment, Economic Growth, International trade and globalization Reasons for differences in living standards and economic growth between countries. Government borrowing

 

NATURE & SCOPE OF ENGINEERING ECONOMICS:-

It covers topic like law of demand & supply, demand & supply elasticity , concept of short run & long run cost , law of variable proportion , return to scale, time value of money, interest formulas , engineering alternatives , annual equivalence method and cost benefit analysis, variance analysis, process costing , break even analysis , function of commercial bank and RBI , money market and export import policy.

Lesson plan -2

THEORY OF DEMAND

The demand in economics means both the desire to purchase as well as the ability to pay for the good.

Demand is different from the quantity demanded. Demand is the quantities that the buyers are willing and able to buy at alternative prices during the given period of time whereas quantity demanded is a specific amount that buyers are willing and able to buy at on price.

Nature of demand for a product

 

With the normal goods the demand has a negative relationship. It means as the price of a Commodity falls the quantity demanded for the product goes up.

Individual Demand ,Market Demand

The consumer equilibrium condition determines the quantity of each good the individual consumer will demand. As the example above illustrates, the individual consumer's demand for a particular good—call it good X—will satisfy the law of demand and can therefore be depicted by a downward sloping individual demand curve.

The individual consumer, however, is only one of many participants in the market for good X. The market demand curve for good X includes the quantities of good X

demanded by all participants in the market for good X. The market demand curve is found by taking the horizontal summation of all individual demand curves. For example, suppose that there were just two consumers in the market for good X, Consumer 1 and Consumer 2. These two consumers have different individual demand curves corresponding to their different preferences for good X. The two individual demand curves are depicted in Figure , along with the market demand curve for good X.

The market demand curve for good X is found by summing together the quantities that both consumers demand at each price. For example, at a price of $1, Consumer 1 demands 2 units while Consumer 2 demands 1 unit; so, the market demand is 2 + 1 = 3 units of good X. In more general settings, where there are more than two consumers in the market for some good, the same principle continues to apply; the market demand curve would be the horizontal summation of all the market participants' individual demand curves.

The market demand curve for good X is found by summing together the quantities that both consumers demand at each price. For example, at a price of $1, Consumer 1 demands 2 units while Consumer 2 demands 1 unit; so, the market demand is 2 + 1 = 3 units of good X. In more general settings, where there are more than two consumers in the market for some good, the same principle continues to apply; the market demand curve would be the horizontal summation of all the market participants' individual demand curves.

Determinants of demand

The demand for X commodity is affected by the following factors

• Price of the commodity

• Prices of related goods

• Income of the consumer

• Tastes and preferences of the consumer

• Expectation of a price change of the commodity

• Population

• Income distribution

Lesson plan -3-'Law of Demand'

DEFINITION of 'Law of Demand'

A microeconomic law that states, all other factors being equal, as the price of a good or service increases, consumer demand for the good or service will decrease, and vice versa. The law of demand says that the higher the price, the lower the quantity demanded, because consumers’ opportunity cost to acquire that good or service increases, and they must make more tradeoffs to acquire the more expensive product.

The chart below depicts the law of demand using a demand curve, which is always downward sloping. Each point on the curve (A, B, C) reflects a direct correlation between quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and the price will be P1, and so on. 

 

The law of demand summarizes the effect price changes have on consumer behavior. For example, a consumer will purchase more pizzas if the price of pizza falls. The opposite is true if the price of pizza increases.

The law of demand is one of the most fundamental concepts in economics. It works with the law of supply to explain how market economies allocate resources and determine the prices of goods and services.

Limitations

he law of demand does not apply in every case and situation. The circumstances when the law of demand becomes ineffective are known as exceptions of the law. Some of these important exceptions are as under.

1. Geffen goods:

Some special varieties of inferior goods are termed as Giffen goods. Cheaper varieties of this category like bajra, cheaper vegetable like potato come under this category. Sir Robert Giffen or Ireland first observed that people used to spend more their income on inferior goods like potato and less of their income on meat. But potatoes constitute their staple food. When the price of potato increased, after purchasing potato they did not have so many surpluses to buy meat. So the rise in price of potato compelled people to buy more potato and thus raised the demand for potato. This is against the law of demand. This is also known as Giffen paradox.

2. Conspicuous Consumption:

This exception to the law of demand is associated with the doctrine propounded by Thorsten Veblen. A few goods like diamonds etc are purchased by the rich and wealthy sections of the society. The prices of these goods are so high that they are beyond the reach of the common man. The higher the price of the diamond the higher

the prestige value of it. So when price of these goods falls, the consumers think that the prestige value of these goods comes down. So quantity demanded of these goods falls with fall in their price. So the law of demand does not hold good here.

3. Conspicuous necessities:

Certain things become the necessities of modern life. So we have to purchase them despite their high price. The demand for T.V. sets, automobiles and refrigerators etc. has not gone down in spite of the increase in their price. These things have become the symbol of status. So they are purchased despite their rising price. These can be termed as “U” sector goods.

4. Ignorance:

A consumer’s ignorance is another factor that at times induces him to purchase more of the commodity at a higher price. This is especially so when the consumer is haunted by the phobia that a high-priced commodity is better in quality than a low-priced one.

5. Emergencies:

Emergencies like war, famine etc. negate the operation of the law of demand. At such times, households behave in an abnormal way. Households accentuate scarcities and induce further price rises by making increased purchases even at higher prices during such periods. During depression, on the other hand, no fall in price is a sufficient inducement for consumers to demand more.

6. Future changes in prices:

Households also act speculators. When the prices are rising households tend to purchase large quantities of the commodity out of the apprehension that prices may still go up. When prices are expected to fall further, they wait to buy goods in future at still lower prices. So quantity demanded falls when prices are falling.

7. Change in fashion:

A change in fashion and tastes affects the market for a commodity. When a broad toe shoe replaces a narrow toe, no amount of reduction in the price of the latter is sufficient to clear the stocks. Broad toe on the other hand, will have more customers even though its price may be going up. The law of demand becomes ineffective.

Lesson plan -4 Elasticity of demand

ELASTICITY OF DEMAND

Elasticity of demand may be defined as the degree of responsiveness or sensitiveness of quantity demand of goods to responsiveness or sensitiveness of demand determinants

Elasticity of demand= Responsiveness change in quantity demanded by Responsiveness change in demand determinants.

Determinants of Ed are

1. Price elasticity.

2. Income elasticity.

3. Cross elasticity

4. Promotional elasticity.

Price elasticity of demand is the degree of responsiveness of demand to a responsiveness of change price.

Price elasticity of demand=

• Symbolically it can b e represented as:

Ep=elasticity of price

P=original price

Q=original quantity

Dq=change in quantity

D p=change in price

Price elasticity can be of following types

1. Perfectly elastic demand:

The demand is said to be perfectly .elastic when a very insignificant change in price leads to an infinite change in quantity demanded. A very small fall in price causes demand to rise infinitely. Likewise a very insignificant rise in price reduces the demand to zero. This case is theoretical which is never found in real life.

2. Perfectly inelastic demand:

The demand is said to be perfectly inelastic when a change in price produces no change in the quantity demanded of a commodity. In such a case quantity demanded remains constant regardless of change in price. The amount demanded is totally unresponsive of change in price. The elasticity of demand is said to be zero.

3. Relatively more elastic demand:

The demand is relatively more elastic when a small change in price causes a greater change in quantity demanded. In such a case a proportionate change in price of a commodity causes more than proportionate change in quantity demanded. If price changes by 10% the quantity demanded of the commodity change by more than 10% i.e. 25%. The demand curve in such a situation is relatively flatter.

4. Relatively inelastic demand:

It is a situation where a greater change in price leads to smaller change in quantity demanded. The demand is said to be relatively inelastic when a proportionate change in price is greater than the proportionate change in quantity demanded. For example If price falls by 20% quantity demanded rises by less than 20% i.e 15%.

5. Unitary elastic demand:

The demand is said to be unit when a change in price produces exactly the same percentage change in the quantity demanded of a commodity. In such a situation the percentage change in both the price and quantity demanded is the same. For example if the price falls by 25% the quantity demanded rises by the same 25%. It takes the shape of a rectangular hyperbola. Numerically elasticity of demand is said to be equal to 1.(ed = 1).

Lesson plan-5-Measurement of elasticity of demand

1) The Percentage Method:

The price elasticity of demand is measured by its coefficient Ep. This coefficient Ep measures the percentage change in the quantity of a

commodity demanded resulting from a given percentage change in price. thus

Where q refers to quantity demanded, p to price and ∆ to change. If E p> 1, demand is elastic. If Ep < 1, demand is inelastic, it Ep = 1 demand is unitary elastic.

This shows elastic demand or elasticity of demand greater than unitary.

Note: The formula can be understood like this:

∆q =q2 –q1 where <72 is the new quantity (30 kgs.) and q1 the original quantity (10 kgs.)

∆p – p2- P1 where p2 is the new price (Rs. 3) and <$Ep sub 1> the original price (Rs. 5)

In the formula, p refers to the original price (p,) and q to original quantity (q1). The opposite is the case in example (ii) below, where Rs. 3 becomes the original price and 30 kgs. as the original quantity.

(ii) Let us measure elasticity by moving in the reverse direction. Suppose the price of X rises from Rs. 3 per kg. to Rs. 5 per kg. and the quantity demanded decreases from 30 kgs. to 10 kgs. Then

2) The Point Method:

Prof. Marshall devised a geometrical method for measuring elasticity at a point on the demand curve. Let RS be a straight line demand curve in Figure 11.2. If the price falls from PB(=OA) to MD(=OC). the quantity demanded increases from OB to OD. Elasticity at point P on the RS demand curve according to the formula is: E p = ∆q/∆p x p/q

Where ∆ q represents changes in quantity demanded, ∆p changes in price level while p and q are initial price and quantity levels.

From Figure 11.2

∆ q = BD = QM

∆p = PQ

p = PB

q = OB

Substituting these values in the elasticity formula:

With the help of the point method, it is easy to point out the elasticity at any point

along a demand curve. Suppose that the straight line demand curve DC in Figure 11.3

is 6 centimetres. Five points L, M, N, P and Q are taken oh this demand curve. The

elasticity of demand at each point can be known with the help of the above method.

Let point N be in the middle of the demand curve. So elasticity of demand at point.

The Arc Method:

We have studied the measurement of elasticity at a point on a demand curve. But when elasticity is measured between two points on the same demand curve, it is known as arc elasticity. In the words of Prof. Baumol, “Arc elasticity is a measure of the average responsiveness to price change exhibited by a demand curve over some finite stretch of the curve.”

Any two points on a demand curve make an arc. The area between P and M on the DD curve in Figure 11.4 is an arc which measures elasticity over a certain range of price and quantities. On any two points of a demand curve the elasticity coefficients are likely to be different depending upon the method of computation. Consider the price-quantity combinations P and M as given in Table 11.2.

Table 11.2: Demand Schedule:

Point Price (Rs.) Quantity (Kg) P 8 10

M 6 12

If we move from P to M, the elasticity of demand is:

Thus the point method of measuring elasticity at two points on a demand curve gives different elasticity coefficients because we used a different base in computing the percentage change in each case.

To avoid this discrepancy, elasticity for the arc (PM in Figure 11.4) is calculated by taking the average of the two prices [(p1, + p2 1/2] and the average of the two quantities [(p1, + q2) 1/2]. The formula for price elasticity of demand at the mid-point (C in Figure 11.4) of the arc on the demand curve is

Lesson plan -6-Theory of supply

Supply Schedule - A Supply Schedule is a table which shows how much one or more firms will be willing to supply ay a particular price.

It is a table listing or showing the exact quantities of a single type of goods or services that potential sellers would offer to sell at varying prices during a particular time period.

Example of Supply Schedule

Table A

Price Quantity

Supplied

1 12

2 28

3 42

4 52

5 60

We can also say that Supply Schedule is a depiction in tabular form, of price and quantity supplied at a point of time keeping other* factor constant. (*Price of related goods, Condition/Technology in Production, Seller’s Expectations etc.)

Supply Curve

It is a curve that shows relationship of price and quantity supplied graphically or we can say the relationship of price and quantity supplies that can be exhibited graphically is termed as Supply Curve.

Keeping other factors constant the Supply Curve depicts the relationship between two variables only. These are:

• Price

• Quantity Supplied.

For example: - By plotting the data given above in Table A (Supply Schedule), we can get or draw a supply Curve which is as follows.

LESSION-7 Elasticity of supply

Price Elasticity of Supply measures the responsiveness of quantity supplied to change in price, as percentage change in Quantity Supplied induced by percentage change in Price.  

Percentage   –   Change   Method     

 According to this method Price Elasticity of supply (Es) is measured as under:‐  

 

Price Elasticity of Supply (Es)                =   % Change in Quantity Supplied /

  % Change in Price 

  

Where

Q – Change in Quantity supplied Q – initial Quantity Supplied

P – Change in Price P - Initial Price

a) Unitary Elasticity or Es=1

In this situation the supply curve slopes upward in a straight line which starts from point of origin. This shows the percentage change in Quantity supply is exactly equals to percentage change in price.

b) Greater than Unitary Elasticity or Es ≥ 1

When a straight line upward sloping curve starts from Y-axis, then this is a case of Unitary Elasticity. This depicts that percentage change in quantity supplied is greater than percentage change in price.

c)

Less than Unitary Elasticity or Es ≤ 1

When a straight line upward sloping curve starts from X-axis then this is a case of less than Unitary Elasticity. This represents that percentage change in quantity supplied is less than percentage change in price.

(d) Perfectly Inelastic Supply or Es = 0

It is a situation where there is no change in supply regardless of change in price. It shows that supply remain unchanged with the change in price. In such situation supply curve is vertical straight line curve.

e) Perfectly Elastic Supply or Es = ∞

In this situation supply is infinite corresponding to a particular price of the commodity. Accordingly a slightest fall in price caused an infinite change in supply, reducing it to zero. In this case supply curve is horizontal straight line.

Es=∞

 

Lesson plan-8-Determination of Market Price under perfect competition

Definition of Market

"Economist understand by the term market, not any particular market place in which things are bought and sold, but eh whole of any region in which buyers and sellers are in such close contact with one another that prices of the same goods tend to equality, easily and quickly."

Types of Market

On the basis of degree of competition markets are classified as follows:

a) Perfect competition

b) Pure competition- Competition

Pure competition is a part and parcel of perfect competition. According to Chamberlin, "a market becomes pure when monopoly is kept away."

Pure competition has certain conditions of perfect competition. They are

1) Large number of sellers

2) Large number of buyers

3) Free entry and exist

4) Homogeneous product

5) Single Price

c) Monopoly- Monopoly – Meaning and its Features

'Mono' means single and poly means 'seller'. Thus monopoly means single seller who has complete control over the supply of the commodity. There is no close substitute of the commodity. Due to absence of competition, monopolist is a price maker and not a price taker.

According to H.L. Ahuja, "Monopoly is said to exist when one firm is the sole producer or seller of a product which has no close substitute."

According to Chemberlin, "A monopoly refers to a single firm, which has control over the supply of a product, which has no close substitute.

1) Single seller

2) No close substitute

3) Barriers to entry

4) No distinction between firm and industry

5) Control over the market supply

6) Price maker

7) Profit maximization

8) Price discrimination

d) Monopolistic competition- Definition : According to Chamberlin, "Monopolistic competition refers to competition among a large number of sellers producing close but not perfect substitute."

"When markets, which have a large number of producers producing differentiated products which are close substitute to each other, engage in non price competition, we call it as a Monopolistic Competitive market."

Following are the features of Monopolistic Competition

1) Fairly large number of buyers

2) Fairly large number of sellers

3) Product differentiation

4) Close substitute

5) Selling cost

6) Free entry and exit

7) Demand curve of the seller

8) Concept of group

Meaning:

The perfect competition is the structure of market in which there are large no. of buyers and sellers. They produce or sell homogenous product. In this market, firm is price taker and market is price maker because price of commodity is determined on the basis of market demand and supply. So, the price of particular commodity remains same everywhere in an economy.

 

Characteristics / Assumptions of perfect competition market:

 

1. Large no. of sellers and buyers:In this market there is assumed large no. of buiyers and sellers. A buyer and seller in the very small part and seller cannot influence in the market price.

2. Products homogeneity:The products produced in the industry are supposed to be homogeneous. Different units of a commodity are similar in content, quality, price, smell, packaging, etc.

3. Free entry and exit of firm:There is no barrier on entry of a new firm to the industry and there in no any restriction on exit of firm from the industry.

4. Profit maximization:In this market, all firm wants to maximize its profit.

5. No government regulation:Government doesn’t influence in this market. There is no licensing system, no tax and subsidy. Government has no role in this type of market.

6. Perfect mobility of factors of production:There is assumed that factor of production are free to move from one place to other, one industry to other and one occupation into another.

7. Perfect knowledge:It assumes that under perfect competition market buyers and sellers are aware about prevailing market prices. They are also aware of future market condition.

 

Price and Output determination under perfect competition market:

 

In the perfect competition market there is large no. of buyers and sellers. Price is determined by market forces and industry. It means market price is determined on the basis of market demand and market supply. The price determined by market/industry is accepted by all the firms. They just adjust their output according to the equilibrium position of firms. The process of price and output determination is explained by the help of given figures.

On the given figure, first of all price and output determination of industry is shown. In the first figure, demand and supply curves are interested at point E. That point determines the equilibrium price of industry i.e. OP and equilibrium price of output of industry i.e. OQ. Suppose, when the price increases from P to P2 then demand is P2K and supply is P2L, it means there is excess supply of goods. So, price tends to decline at OP. On the other hand, when price decreases from P to P1 there is excess demand equal to area MN. It tends to increase price OP so that equilibrium price of market price is OP. The market price is accelerated by all the firms but they are capable to adjust their output according to the equilibrium price of a firm. So, in short run, firm may obtain super normal profit or normal profit or loss.

 

The firm A, by producing equilibrium output i.e. OQ1 at OP price, the firm has been obtaining super normal profit. Firm B, by producing OQ2 output at OP has been obtaining normal profit. The firm C, by producing OQ3 output at OP price has been obtaining loss. But in the long run, every firm always obtains only the normal profit.

Lesson plan 9 : Time analysis Short Period-Short Run-time duration withen 1year

Long Period-Long Run-time duration is more than one year

Long Run Costs

Long run costs are accumulated when firms change production levels over time in response to expected economic profits or losses. In the long run there are no fixed factors of production. The land, labor, capital goods, and entrepreneurship all vary to reach the the long run cost of producing a good or service. The long run is a planning and implementation stage for producers. They analyze the current and projected state of the market in order to make production decisions. Efficient long run costs are sustained when the combination of outputs that a firm produces results in the desired quantity of the goods at the lowest possible cost. Examples of long run decisions that impact a firm's costs include changing the quantity of production, decreasing or expanding a company, and entering or leaving a market.

Short Run Costs

Short run costs are accumulated in real time throughout the production process. Fixed costs have no impact of short run costs, only variable costs and revenues affect the short run production. Variable costs change with the output. Examples of variable costs include employee wages and costs of raw materials. The short run costs increase or decrease based on variable cost as well as the rate of production. If a firm manages its short run costs well over time, it will be more likely to succeed in reaching the desired long run costs and goals. 

Differences

The main difference between long run and short run costs is that there are no fixed factors in the long run; there are both fixed and variable factors in the short run . In the long run the general price level, contractual wages, and expectations adjust fully to the state of the economy. In the short run these variables do not always adjust due to the condensed time period. In order to be successful a firm must set realistic long run cost expectations. How the short run costs are handled determines whether the firm will meet its future production

Lession plan -10 production function

The relation between inputs and output of a firm has been called the ‘Production Function’. Thus, the theory of production is the study of production functions. The production function of a firm can be studied by holding the quantities of some factors fixed, while varying the amount of other factors.

This is done when the law of variable proportions is derived. The production function of a firm can also be studied by varying the amounts of all factors. The behaviour of production when all factors are varied is the subject-matter of the laws of returns to scale. Thus, in the theory of production, the study of (a) the law of variable proportions and (b) the laws of returns to scale is included

Isoquants

    Isoquants are termed as equal product curves and are similar to the indifference curve of the thesis of consumer’s behaviour. An Isoquant depicts all those input combinations which are competent of manufacturing the same level of productivity.

   . As an Isoquant depicts are combinations of inputs which are capable of manufacturing an equal productivity, the manufacturer would be indifferent among them. Thus another name that is frequently provided to the parity commodity curves is production indifference curve.

    The concept of Isoquant can be meagrely known from the below presentation. It is assumed that two aspects labour and capital are being employed to produce a commodity. Each of the aspect combinations P, Q, R, S and T manufactures the same level of productivity. Each of the aspect with factor combination P comprising of 10 units of labour and 100 units of capital manufactures the offered 1000 units of productivity.

    Likewise, combination Q comprising of 20 units of labour and 80 units of capital, R combination comprising of 30 units of labour and 60 units of capital, combination S comprising of 40 units of labour and 40 units of capital whilst combination T comprises of 50 units of labour and 20 units of capital are competent of producing the same volume of productivity.

    The diagrams represents the plotted points of the given combinations and by combining them we procure an Isoquant depicting that each combination depicted on it can manufacture 1000 units of productivity.

Factor Combination Labour Capital P 10 100Q 20 80R 30 60S 40 40T 50 20

Even though the Isoquants are looking similar to the indifference curve of the thesis of consumer’s behaviour and it structure, there is one significant dissimilarity among the two. An indifference curve depicts all those combinations of two commodities

which provide the same contentment or utility to a consumer but no attempt is made to state the degree of utility it stands for in precise quantitative modes.

    This is for the reason that the cardinal measurement of satisfaction or utility in unmistakable terms is not feasible. This is the reason why normally label indifference curves by ordinal numbers as I, II, III etc depicting that a higher indifference curv

e depicting a greater level of contentment than a lower one, but the information as to by how much one level of contentment is huger then another is not specified.

Alternatively, we can label Isoquants in the physical units of productivity without any complexity. Manufacturing of a decent being a physical occurrence tends itself meagrely to complete measurement in physical units. Since every Isoquant depicts definite level of manufacturing, it is feasible to say by how much one Isoquant depicts huger or lesser manufacture than another.

     In the second diagram we have drawn an Isoquant map or equal product map with a set of four Isoquants which represent 1000, 1200, 1400 and 1600 units of productivity correspondingly. Then, from this group of Isoquants it is very simple to decide by how much manufacture level on one Isoquant curve is huger or lesser than an another.

PROPERTIES OF ISOQUANT

1. An isoquant lying above and to the right of another isoquant represents a higher level of output.

This is because of the fact that on the higher isoquant, we have either more units of one factor of production or more units of both the factors. This has been illustrated in figure 3. In figure 3, points A and B lie on the isoquant IQ1 and IQ2 respectively.

2. Two isoquants cannot cut each other

Just as two indifference curves cannot cut each other, two isoquants also cannot cur each other. If they intersect each other, there would be a contradiction and we will get inconsistent results. This can be illustrated with the help of a diagram as in figure 4. 3. Isoquants are convex to the origin

An isoquant must always be convex to the origin. This is because of the operation of the principle of diminishing marginal rate of technical substitution. MRTS is the rate at which marginal unit of an input can be substituted for another input making the level of output remain the same.

4. No isoquant can touch either axis

If an isoquant touches the X-axis it would mean that the commodity can be produced with OL units of labor and without any unit of capital. .

Isoquants are negatively sloped

An isoquant slopes downwards from left to right. The logic behind this is the principle of diminishing marginal rate of technical substitution. In order to maintain a given output, a reduction in the use of one input must be offset by an increase in the use of another input.

Lesson plan 11 The law of variable proportions

The law of variable proportions states that as the quantity of one factor is increased, keeping the other factors fixed, the marginal product of that factor will eventually decline. This means that upto the use of a certain amount of variable factor, marginal product of the factor may increase and after a certain stage it starts diminishing. When

the variable factor becomes relatively abundant, the marginal product may become negative.

Assumptions: The law of variable proportions holds good under the following conditions:

Constant State of Technology: First, the state of technology is assumed to be given and unchanged. If there is improvement in the technology, then the marginal product may rise instead of diminishing.

Fixed Amount of Other Factors: Secondly, there must be some inputs whose quantity is kept fixed. It is only in this way that we can alter the factor proportions and know its effects on output. The law does not apply if all factors are proportionately varied.

Possibility of Varying the Factor proportions: Thirdly, the law is based upon the possibility of varying the proportions in which the various factors can be combined to produce a product. The law does not apply if the factors must be used in fixed proportions to yield a product.

Illustration of the Law: The law of variable proportion is illustrated in the following table and figure. Suppose there is a given amount of land in which more and more labour (variable factor) is used to produce wheat.

Units of Labour Total Product Marginal Product Average Product

1 2 2 2

2 6 4 3

3 12 6 4

4 16 4 4

5 18 2 3.6

6 18 0 3

7 14 -4 2

8 8 -6 1

It can be seen from the table that the marginal product of labour initially rises and beyond the use of three units of labour, it starts diminishing. The use of six units of labour does not add anything to the total production of wheat. Hence, the marginal product of labour has fallen to zero. Beyond the use of six units of labour, total product diminishes and therefore marginal product of labour becomes negative. Regarding the average product of labour, it rises up to the use of third unit of labour and beyond that it is falling throughout.

Three Stages of the Law of Variable Proportions: These stages are illustrated in the following figure where labour is measured on the X-axis and output on the Y-axis.

Stage 1. Stage of Increasing Returns: In this stage, total product increases at an increasing rate up to a point. This is because the efficiency of the fixed factors increases as additional units of the variable factors are added to it. In the figure, from the origin to the point F, slope of the total product curve TP is increasing i.e. the curve TP is concave upwards upto the point F, which means that the marginal product MP of labour rises. The point F where the total product stops increasing at an increasing rate and starts increasing at a diminishing rate is called the point of inflection. Corresponding vertically to this point of inflection marginal product of labour is maximum, after which it diminishes. This stage is called the stage of increasing returns because the average product of the variable factor increases throughout this stage. This stage ends at the point where the average product curve reaches its highest point.

Stage 2. Stage of Diminishing Returns : In this stage, total product continues to increase but at a diminishing rate until it reaches its maximum point H where the second stage ends. In this stage both the marginal product and average product of labour are diminishing but are positive. This is because the fixed factor becomes inadequate relative to the quantity of the variable factor. At the end of the second stage, i.e., at point

M marginal product of labour is zero which corresponds to the maximum point H of the total product curve TP. This stage is important because the firm will seek to produce in this range.

Stage 3. Stage of Negative Returns : In stage 3, total product declines and therefore the TP curve slopes downward. As a result, marginal product of labour is negative and the MP curve falls below the X-axis. In this stage the variable factor (labour) is too much relative to the fixed factor.

Importance and Applicability of the Law of Variable Proportion:

The Law of Variable Proportion has universal applicability in any branch of production. It forms the basis of a number of doctrines in economics. The Malthusian theory of population stems from the fact that food supply does not increase faster than the growth in population because of the operation of the law of diminishing returns in agriculture.

Ricardo also based his theory of rent on this principle. According to him rent arises because the operation of the law of diminishing return forces the application of additional doses of labour and capital on a piece of land. Similarly the law of diminishing marginal utility and that of diminishing marginal physical productivity in the theory of distribution are also based on this theory.

Lesson plan 12 Lows of return to scale

The Laws of Returns to Scale:

The laws of returns to scale can also be explained in terms of the isoquant approach. The laws of returns to scale refer to the effects of a change in the scale of factors (inputs) upon output in the long-run when the combinations of factors are changed in some proportion. If by increasing two factors, say labour and capital, in the same proportion, output increases in exactly the same proportion, there are constant returns to scale. If in order to secure equal increases in output, both factors are increased in larger proportionate units, there are decreasing returns to scale. If in order to get equal increases in output, both factors are increased in smaller proportionate units, there are increasing returns to scale.

The returns to scale can be shown diagrammatically on an expansion path “by the distance between successive ‘multiple-level-of-output’ isoquants, that is, isoquants that show levels of output which are multiples of some base level of output, e.g., 100, 200, 300, etc.”

Increasing Returns to Scale:

Figure 24.11 shows the case of increasing returns to scale where to get equal

increases in output, lesser proportionate increases in both factors, labour

and capitals are required.

It follows that in the figure:

100 units of output require 3C +3L

200 units of output require 5C + 5L

300 units of output require 6C + 6L

So that along the expansion path OR,

OA > AB > BC. In this case, the production function is homogeneous of degree greater than one.

The increasing returns to scale are attributed to the existence of indivisibilities in machines, management, labour, finance, etc. Some items of equipment or some activities have a minimum size and cannot be divided into smaller units. When a business unit expands, the returns to scale increase because the indivisible factors are employed to their full capacity.

Increasing returns to scale also result from specialisation and division of labour. When the scale of the firm expands there is wide scope for specialisation and division of labour. Work can be divided into small tasks and workers can be concentrated to

narrower range of processes. For this, specialized equipment can be installed. Thus with specialization, efficiency increases and increasing returns to scale follow.

Further, as the firm expands, it enjoys internal economies of production. It may be able to install better machines, sell its products more easily, borrow money cheaply, procure the services of more efficient manager and workers, etc. All these economies help in increasing the returns to scale more than proportionately.

Decreasing Returns to Scale:

Figure 24.12 shows the case of decreasing returns where to get equal increases in output,

larger proportionate increases in both labour and capital are required.

It follows that:

100 units of output require 2C + 2L

200 units of output require 5C + 5L

300 units of output require 9C + 9L

So that along the expansion path OR, OG < GH < HK.

In this case, the production function is homogeneous of degree less than one.

Returns to scale may start diminishing due to the following factors. Indivisible factors

may become inefficien

t and less productive. The firm experiences internal diseconomies. Business may become unwieldy

and produce

problems of supervision and coordination. Large management creates difficulties of control and rigidities.

To these internal

diseconomies are added external diseconomies of scale. These arise from higher factor prices or from diminishing productivities

Constant Returns to Scale:

Figure 24.13 shows the case of constant returns to scale. Where the distance between the

isoquants 100, 200 and 300 along the expansion path OR is the same, i.e., OD = DE = EF.

It means that if units of both factors, labour and capital, are doubled, the output is doubled.

To treble output, units of both facters are trebled.

It follows that:

100 units of output require 1 (2C + 2L) = 2C + 2L

200 units of output require 2(2C + 2L) = 4C + 4L

300 units of output require 3(2C + 2L) = 6C + 6L

The returns to scale are constant when internal economies enjoyed by a firm are neutralised by

internal diseconomies so that output increases in the same proportion. Another reason is the

balancing of external economies and external diseconomies. Constant returns to scale also result

when factors of production are perfectly divisible, substitutable, homogeneous and their supplies

are perfectly elastic at given prices.

That is why, in the case of constant returns to scale, the production function is homogeneous

of degree one.

Lecture No. 13

Assignment and dscussion-1

Lecture No. 14

Surprise Test-1

Lecture No. 15

Time value of money

The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity is called the time value of money. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. Thus, at the most basic level, the time value of money demonstrates that, all things being equal, it is better to have money now rather than later.

But why is this? A Rs100 bill now has the same value as a Rs100 bill one year from now, doesn't it? Actually, although the bill is the same, you can do much more with the money if you have it now because over time you can earn more interest on your money.

By receiving Rs10,000 today (Option A), you are poised to increase the future value of your money by investing and gaining interest over a period of time. If you receive the money three years down the line (Option B), you don't have time on your side, and the payment received in three years would be your future value. To illustrate, we have provided a timeline:

If you choose Option A, your future value will be Rs10,000 plus any interest acquired over the three years. The future value for Option B, on the other hand, would only be Rs10,000. So how can you calculate exactly how much more Option A is worth compared to Option B? Let's take a look.

LESSION-16

1. Single Payment Factors

. F/PThe fundamental factor in engineering economy is the one that determines the amount of money F accumulated after n periods from a single present worth, P, with interest compounded one time per period.

Fn = P(1+i)n

(1+i)n is called the single-payment compound amount factor, SPCAF or the F/P factor.

F = P (1 + i)n, F/P

i = interest rate, %

n = number of periods

F the future worth is what is being sought

Given: A crankshaft company is trying to decide whether to upgrade now for Rs150,000 or in 3years at 12% per annumFind: How much will it cost them in 3 years?

F = P(F/P, 12%, 3) = 150,000(1.4049)

F = Rs21,0735

For present value( P):

P = F[ ] , P/F

[ ] is called the single payment present worth factor, SPPWF, or the P/F factor.

Both factors are for single payments.

B. Standard NotationStandard notation has been adopted for all factors, which includes: two cash flow

symbols, the interest rates and the number of symbols. It is always in the general form:

i = interest rate, %

n = number of periods

P=F*

P = F[1/(1+.12)10] , P/F is called the single payment present worth factor, SPPWF, or the P/F factor.

Given: The carmaker Renault will have to pay Rs7000 in 3 years at 15% per annum

Find: What is the Rs7000 worth today.

P=F*

p=7000*

P = F(P/F, 15%, 3) = 7000 (.6575)

P = 4,602.50

Lesson-18

2. Uniform Series: Present worth Factor, P/A,

Note that A, the annuity, begins in year 1 i.e. not year 0. P, the present worth, is calculated in year 0.

P = A [ ] i0, P/AThe term in brackets is the is the uniform series present worth factor, USPWF,

P/A. P/A is used to calculate the equivalent P value in year 0 for a uniform end of period series of A values beginning at the end of period 1 and extending for n years.

Examples:Given: An amusement park intends to pays $55,000 per year for 5 years at 15% per annum interest.

Find: Using the same amount of money, how much is that today.

P = A(P/A, 15%, 5) = 55,000(3.3522)

P = $184,371

Given: You won the lottery, $1,000,000 payable over 20 years at 10% interest, $50,000 a year for 20 years.

Find: How much are you going to get now?

P = A(P/A, 10%, 20) = 50,000(8.5136)

P= $425,680.

Uniform series Capital Recovery Factor, A/P

If A is sought:A = P [ ], A/P

The term in the brackets is the Capital Recovery Factor, CRF, A/P. The CRF calculates the equivalent uniform annual worth A over n years for a given P in year 0 when the interest rate is i.

Given: Abank gives a loan to purchase an equipment of $1,000,000 at 12% interest,compounded annualy.this amount should be repaid in 10 yearly equal instalments.find the inatalment amount?.

Find: Translate the above, calculate A/P,

A uniform series end of period payment

P the present worth is that is known

12% is the interest rate

10 is the number of time periods

(A/P, 12%, 10) = = = =

(A/P, 12%, 10) = .17698

A = P(A/p, 12%, 10) = 1000,000(.17698)

P= $176980.

Equal payment series Sinking Fund Factor, A/F

A = F [ ], A/FThe expression in brackets is the sinking fund factor, A/F; it determines the

uniform annual series that is equivalent to a given future worth.

(A/F, 12%, 10) = A = F [ ], A/F = = =

(A/F, 12%, 10) =F*.05698

Given: A moving company wants to buy a new truck for $250,000 in 4 years and interest rates are 12% per year.

Find: How much should they set aside each year?

A = F(A/F, 12%, 10) = $250,000(.05698)

A = $14245

Equalpayment series compound amount factor/future value of an annuty.

F = A [ ], F/A

The term in brackets is called the uniform series compound amount factor, USCAF, F/A. The future amount, F, occurs in the same period as the last A.

Given: A moving company wants to buy a new truck for $14245 for 10 years and interest rates are 12% per year.

Given: (F/A, 12%, 10)

Find: Translate the above, calculate F/A

A uniform series end of period payment

F the future worth is what is being sought

F = A [ ], F/A

12% is the interest rate

10 is the number of time periodsF = A [ (1+.12) 10 -1 ] F/A

.12

F/A = A*17.5487

F/A=14245*17.5487=$250,000

Arithmetic Gradient Factors, A/G

An arithmetic gradient is a cash flow series that either increases or decreases by a constant amount, the gradient. The cash flow changes by the same amount each period. Each year-end amount is different although the increase is constant.

Example-a series of payment would be uniformlyincreasing in Rs200,Rs250,Rs300 and Rs350 occuring at the end of the first,secand,third and fourth year respectively similarly, decraesing series will be rs200,Rs150,Rs100,Rs50 occuring at the end of the first,secand,third and fourth year respectively in each case the equalmpayment series provides the base with a constant annual increase/decreaseat the end ofeach year.

And can be illustrated as A’,A+G’,A+2G’,.....A+(N-1)G.

Here N is the duration of the series(N=4.) The uniform series can be evaluated by calculating F or P of each individual payment. And the result should be added.in anather methid the calculation can made simple by converting the series to an equivalent annuity of equal paymentsA.

The present worth at year 0 of only the gradient is equal to the sum of the present worths of the individual values, where each value is a future amount.

A = A1+G [ - ]

The expression in brackets is called the arithmetic gradient uniform series factor, A/G.

The F/A factor, arithmetic gradient future worth factor is derived by

F = A [ ], F/A

The base amount, PA, the present worth, must be added to the gradient. The base amount in the uniform series, A that begins in year 1 and extends through year n is represented by PA. The gradient, PG, is added to or subtracted from PA to yield the total,

Given: (P/G, 12%, 10)

Find: Translate the above, calculate P/G, calculate A/G, Verify the answers using the tables.

P the present worth is that is known

G the amount of increase or decrease in a series of payments

12% is the interest rate

10 is the number of time periods

(A/G, 12%, 10) = [ - ] = [ - ] = 8.333 - = 8.3333 – 4.7488(A/G, 12%, 10) = 3.5848

(A/G, 12%, 10) = 3.5847

Lesson plan 17

Cash Flow Diagram: The Basic Concept

A cash flow diagram allows you to graphically depict the timing of the cash flows as well as their nature as either inflows or outflows.

Such a diagram is very easy to construct. We start with a simple horizontal time line....

...and then add arrows to represent the inflows (arrows pointing from the line) or outflows (arrows pointing to the line) of cash ...

Although this concept seems simple enough, it is not without controversy. My use of arrows differs from that used by some financial textbooks. In these texts you'll often find that an "up" arrow represents money received and a "down" arrow money paid out.

To compare alternatives that provide the same service over extended periods of time when interest is involved, we must reduce them to an equivalent basis that is dependent on: ---If two alternatives are economically equivalent, then they are equally desirable.

Equivalence factors are needed in engineering economy to make cash flows (CF) at different points in time comparable. For example, a cash payment that has to be made today cannot be compared directly to a cash flow that must be made in 5 years.

Since the time value of money changes according to:

1.The interest rate, 2.The amount of money involved, 3.The timing of receipt or payment, 4. The manner in which interest is compounded,

We need a way to reduce CF's at different times to an equivalent basis. Equivalence factors allow us to do so.

Principles of Equivalence

Equivalent cash flows have the same economic value at the same point in time. Cash flows that are equivalent at one point in time are equivalent at any point in

time. Conversion of a cash flow to its equivalent, at another point in time must reflect

the interest rate(s) in effect for each period between the equivalent cash flows.

Equivalence between receipts and disbursements: the interest rate that sets the receipts equivalent to the disbursements isthe actual interest rate (IRR).

Economic equivalence is established, in general, when we are indifferent between a future payment, or series of payments, and a present sum of money.

Notation and Cash Flow Diagrams (CFDs)

The following notation is utilized in formulas for compound interest calculations:

I = effective interest rate per interest periodN = number of compounding periods P = present sum of money; the equivalent value of one or more cash flows at a reference point in time called present F= future sum of money; the equivalent value of one or more cash flows at a reference point in time called future A = end-of-period cash flows (or equivalent end-of-period values) in a uniform series continuing for a specified number of periods, starting at the end of the first period and continuing through the last period

1. The Horizontal line is a time scale, with progression of time moving from left to right. The period (e.g., year, quarter, month) labels can be applied to intervals of time rather than to points on the time scale.

2. The arrows signify cash flows and are placed at the end of the period. If a distinction needs to be made, downward arrows represent expenses (negative cash flows or cash outflows) and upward arrows represent receipts (positive cash flows or cash inflows).

3. The cash flow diagram is dependent on the point of view. The situations shown in the figure were based on the cash flows as seen by the lender. If the directions of all arrows had been reversed, the problem will have to be diagrammed from borrower's viewpoint.

Cash Flow Diagram

LESSION-20 PRESENT WORTH ANALYSIS OF EQUAL-LIFEALTERNATIVESIn present worth analysis, the P value, now called PW, This converts all future cash flows to time zero. This makes it easy to determine the economic advantage of one alternative over another.

The PW comparison of alternatives with equal lives is straightforward. If both alternatives are used in identical capacities for the same time period, they are termed equal-service alternatives.For mutually exclusive alternatives the following guidelines are applied:

Steps-1-Estimate the intrest rate that the firm wishes to earn on its investment.2-Determine the service life of the project3-Ascertain the cash inflow over each service life.4-Find out cash over flow over each service period5-calculate the net cash flows.

Selection If PW>0 the proposal is accepted.IfPW<0 the project is rejectedIf PW=0 the project is indifferent to the investment

Revenue based method-Present Worth of Equal-life AlternativesExample :XYZ Car rental company is considering purchasing onetype of compact car to replenish its fleet. Two companiesare offering this kind of car. Which option should XYZchoose if their MARR is 10% per year?

Company A Company BPurchase cost $12,000 $14,000Annual inflows $900 $500

Salvage value $4,000 $5,000Life (Years) 3 3Solution:PWA=-12,000+900(P/A,10%,3)+4,000(P/F,10%,3)=-12,000+900*2.4869+4,000*0.7513=$ -6756.60PWB = -14,000 +500*(P/A,10%,3)+5,000(P/F,10%,3)=-14000+500*2.4869+5000*0.7513=$ -9000.05PWB < PWA, XYZ should choose car made

Coct based methodPresent Worth of Equal-life AlternativesExample 5.2:XYZ Car rental company is considering purchasing onetype of compact car to replenish its fleet. Two companiesare offering this kind of car. Which option should XYZchoose if their MARR is 10% per year? Company A Company BPurchase cost $12,000 $14,000Maintenance Cost $900 $500Salvage value $4,000 $5,000Life (Years) 3 3Solution:PWA=-12,000-900(P/A,10%,3)+4,000(P/F,10%,3)=-12,000-900*2.4869+4,000*0.7513=$ -11,233.01PWB = -14,000 -500*(P/A,10%,3)+5,000(P/F,10%,3)=$ -11,486.95PWB < PWA, XYZ should choose car made

LESSION-21 Future Worth (FW) for Project Evalutaion

Financial decisions require consideration of projected revenues and expenditure over period of time being considered. Performing a Cost/Benefit Future value measures what today's money would be worth at a specified time in the futureassuming a certain discount rate

Present value measure what money at a specified period of time in the future would be worth if valued in terms of today's money.

Future worth (FW) method is alternative to PW method. FW is based on the equivalent worth of all cash inflows and outflows at the end of the study period at an interest rate that is generally the MARR. Decision made using FW and PW will be the same.Steps-1-Estimate the intrest rate that the firm wishes to earn on its investment.

2-Determine the service life of the project3-Ascertain the cash inflow over each service life.4-Find out cash out flow over each service period5-calculate the net cash flows.

Selection If FW>0 the proposal is accepted.If FW<0 the project is rejectedIf FW=0 the project is indifferent to the investment

Revenue based methodExample: A $4500 investment in a new conveyor system is projected to improve throughout and increasing revenue by $14000 per year for five years. The conveyor will have an estimated market value of $4000 at the end of five years. Using FW and a MARR of 12%, is this good investment?FW = -$45000(F/P, 12%, 5 + $14000(F/A, 12%, 5) + $4000 = $13635.70Hence a good investment.

Example2: A company purchased a store chain for $75 million three years ago. There was a et loss of $10 million at the end of year 1 of ownership. Net cash flow is increasing with an arithmetic gradient of $5 million per year starting the second year, and thi pattern is expected to continue for the foreseeable future. Expected MARR of 25% per year...The comapany has just been offered $159.5 million to sell the store. Use FW analysis to determine if the MARR will be realized at this selling price...FW = -75(F/P, 25%, 3) - 10((F/P, 25%, 2) - 5(F/P, 25%, 1) + 159.5 = -8.86millionThe offer must be for at least $246.81 million to make the MARR.

Cost based methodExample: company A $45000 investment in a new power mechine system is projected to improve throughout and increasing cost by $14000 per year for five years. The conveyor will have an estimated market value of $4000 at the end of five years. Using FW and a MARR of 12%, is this good investment?FW = -$45000(F/P, 12%, 5 - $14000(F/A, 12%, 5) + $4000 = -$164232

Example2: B company purchased a store chain for $75 million three years ago. There was a et loss of $10 million at the end of year 1 of ownership. Net cash flow is increasing with an arithmetic gradient of $5 million per year starting the second year, and thi pattern is expected to continue for the foreseeable future. Expected MARR of 25% per year...The comapany has just been offered $159.5 million to sell the store. Use FW analysis to determine if the MARR will be realized at this selling price...FW = -75(F/P, 25%, 3) - 10((F/P, 25%, 2) - 5(F/P, 25%, 1) + 159.5 = -8.86millionHence company a is good ,because its cost is less than BLESSION-22equvalentAnnual worth –under this method all receipts and disbursements occuring over a period are converted to anuniform yearly amount Annual worth analysis measure an investment worth on annual basis. It helps to seek consistency of report format, determine the unit cost and facillitate the unequal project life comparison. AW is easily understood as the results are reported in $/time period. EAW=PW(i)[i(1=i)n/(1+i)n-1]

Example-a company invest in one of the two mutuallyexclusive alternativesthe life period is 15 yearsand assuming i=20%Paticulars Alternative-A Alternative-BInitial cost Rs100000 110000Annual equal return 70,000 80,000Salvage value 10,000 20,000Determine better alternative?SolutionAlternative-ANPW(20%)=-P+R(P/A,i,n)+S(P/F,i,n)=-100,000+70,000(4.6755)+10,000(.0649)=Rs227,934EAW(20%)=NPW(A/P,i,n)=Rs227,934(0.2139)=48,775.082

Alternative-B

NPW(20%)=-P+R(P/A,i,n)+S(P/F,i,n)=-110,000+80,000(4.6755)+20,000(.0649)

=Rs485,338EAW(20%)=NPW(A/P,i,n)=Rs485338 (0.2139)=Rs103,813.79Alternative 2 is higher than alternative 1 the former sould be accepted.

LESSION-23Rate of returnMinimum rate of return-it is nthe rate set by the organisation for its investers investment which he must pay it to their invester.External rate of return-it is the rate of return that can be obtained by exploiting the economic condition of the countryInternal Rate of Return (IRR)- is the discounted rate that equates the present value of a projected cash inflows to the present value of the project's costs. The discount rate which sets the NPV of all cash flows equal to 0. Helps to determine the YIELD on an investment.NPV = 0 = initial investment + Cash flow year 1/(1+IRR) + ... so onSteps of calculation

1- Find out theNPW at lowest persentage trail2- Find out the NPW at Highest Persentage trail3- Find IRR

Formula-IRR=LTP+[+NPWLTP/NPWLTP-NPWHTP]*HTP-LTP

Internal Rate of Return (IRR) is the discounted rate that equates the present value of a projected cash inflows to the present value of the project's costs. The discount rate which sets the NPV of all cash flows equal to 0. Helps to determine the YIELD on an investment.NPV = 0 = initial investment + Cash flow year 1/(1+IRR) + ... so on

LESSION-24Example: An investment of a new machine requires $345000 and the estimated market value of the machine after 6 years is $115000. Annual revenue attributable to the new machine will be $120000. Whereas additional annual expenses will be $22000. Determine the IRR if the corporation ;s MARR is 20%...PW = 0 = -345000+(120000-22000)(P/A,i%,6)+(120000-22000)(P/A,i%,6)when i=20%, PW=19413when i=25%, PW=-25621hence i=22.16%

External Rate of Return (ERR) takes into account the interest rate, external to a project at which net cash flows generated by a project over its life can be reinvested. This is usually the MARR.

Lesson plan-25DEFINITION of 'Cost-Benefit Analysis'

A process by which business decisions are analyzed. The benefits of a given situation or business-related action are summed and then the costs associated with taking that action are subtracted. Some consultants or analysts also build the model to put a dollar value on intangible items, such as the benefits and costs associated with living in a certain town. Most analysts will also factor opportunity cost into such equations. MUST be used when there are multiple alternatives to choose from!

The equation is still…

B-C ratio = Equivalent Benefits/Equivalent Costs

B-C ratio=(Bp/P+Cp)+(BF/PF+PC)+(BA/PA+C)

=

To start with, we need an interest rate that is comparable to theMARR.In the public sector, this can be: the interest rate from the banks onthe borrowed capitals; the opportunity cost of capital to the taxpayers;the yield of the bonds issued to finance the project.The next step is to identify three items regarding a public project:_ Benefits_ Costs_ DisbenefitsExample. Extension of runways. Consider the interest rate as 12% andthe period as 20 yrs.Costs:Initial cost: 80000,000Anual power sales: 6000,000Annual flood control saving: 3000,000Annual irrigation benifits: 5,000,000Annual recreation benifits: 2000,000Benefits:Annual operating and maintainance cost:3000,000Life of the project 50 years

Total Annual Benifits=Flood control saving+irrigation benifits+recreation benifits

=3000000+5000000+2000000=100,000,000

PW of Benifits=10,000,000(P/A,12%,50)=10,000,000(8.3045)

=83,045,000

Present Worth of cost=IC+PW of AOMC-Pwof Power sales

=80,000,000+3,000,000*(P/A,12%,50)-6,000,000(P/A,12%,50)

=8,000,000+3,000,000*8.3045-6,000,000(8.3045)

=55,086,500

B-C ratio=83,045,000/55,086,500=1.508

LESSION-26

Factors Affecting Depreciation Expense

There are four main factors to consider when calculating depreciation expense:

1. The cost of the asset 2. The estimated salvage value of the asset. Salvage value (or residual value) is the

amount of money the company expects to recover, less disposal costs, on the date the asset is scrapped, sold, or traded in.

3. Estimated useful life of the asset. Useful life refers to the window of time that a company plans to use an asset. Useful life can be expressed in years, months, working hours, or units produced.

4. Obsolescence should be considered when determining an asset's useful life and will affect the calculation of depreciation. For example, a machine capable of producing units for 20 years may be obsolete in six years; therefore, the asset's useful life is six years.

Factors Affecting the Depreciation Method

A company is free to adopt the most appropriate depreciation method for its business operations. Accounting theory suggests that companies use a depreciation method that closely reflects the operations' economic circumstances. So, companies can choose a method that allocates asset cost to accounting periods according to benefits received from the use of the asset. Most companies use the straight-line method for financial reporting purposes, but they may also use different methods for different assets. The most important criteria to follow: Use a depreciation method that allocates asset cost to accounting periods in a systematic and rational manner.

The causes of depreciation

Depreciation is a ratable reduction in the carrying amount of a fixed asset. Depreciation

is intended to roughly reflect the actual consumption of the underlying asset, so that the

carrying amount of the asset has been greatly reduced to its salvage value by the time

its useful life is over. But why do we need depreciation at all? The causes of

depreciation are:

Wear and tear. Any asset will gradually break down over a certain usage period,

as parts wear out and need to be replaced. Eventually, the asset can no longer

be repaired, and must be disposed of. This cause is most common for production

equipment, which typically has a manufacturer's recommended life span that is

based on a certain number of units produced. Other assets, such as buildings,

can be repaired and upgraded for long periods of time.

Perishability. Some assets have an extremely short life span. This condition is

most applicable to inventory, rather than fixed assets.

Usage rights. A fixed asset may actually be a right to use something (such as

software or a database) for a certain period of time. If so, its life span terminates

when the usage rights expire, so depreciation must be completed by the end of

the usage period.

Natural resource usage. If an asset is natural resources, such

as an oil reservoir, the depletion of the resource causes

depreciation (in this case, it is called depletion, rather than

depreciation). The pace of depletion may change if a

over the life of assets.

     Depreciation is a process of allocation.

     Cost to be allocated = acquisition cot - salvage value

Depreciation     Depreciation is a systematic and rational process of distributing the cost of tangible assets

A variation on the depreciation concept is the destruction of or damage to equipment. If

this happens, the equipment must be written down or written off to reflect its reduced

value and possibly shorter useful life. Another variation is asset impairment, where the

carrying cost of an asset is higher than its market value. If impairment occurs, the

difference is charged to expense, which reduces the carrying amount of the asset.

When there is damage to or impairment of an asset, it can be considered a cause of

depreciation, since either event changes the amount of depreciation remaining to be

recognized.

LESSION-27

Total cost is the sum of fixed and variable costs. Variable costs change according to the quantity of a good or service being

produced. The amount of materials and labor that is needed for to make a good increases in direct proportion to the number of goods produced. The cost "varies" according to production.

Fixed costs are independent of the quality of goods or services produced. Fixed costs (also referred to as overhead costs) tend to be time related costs including salaries or monthly rental fees.

Fixed costs are only short term and do change over time. The long run is sufficient time of all short-run inputs that are fixed to become variable.

variable cost

A cost that changes with the change in volume of activity of an organization.

fixed cost

Business expenses that are not dependent on the level of goods or services produced by the business.

Total Cost

In economics, the total cost (TC) is the total economic cost of production. It consists of variable costs and fixed costs. Total cost is the total opportunity cost of each factor of production as part of its fixed or variable costs .

Variable Costs

Variable cost (VC) changes according to the quantity of a good or service being produced. It includes inputs like labor and raw materials. Variable costs are also the sum of marginal costs over all of the units produced (referred to as normal costs). For example, in the case of a clothing manufacturer, the variable costs would be the cost of the direct material (cloth) and the direct labor. The amount of materials and labor that is needed for each shirt increases in direct proportion to the number of shirts produced. The cost "varies" according to production.

Fixed Costs

Fixed costs (FC) are incurred independent of the quality of goods or services produced. They include inputs (capital) that cannot be adjusted in the short term, such as buildings and machinery. Fixed costs (also referred to as overhead costs) tend to be time related costs, including salaries or monthly rental fees. An example of a fixed cost would be the cost of renting a warehouse for a specific lease period. However, fixed costs are not permanent. They are only fixed in relation to the quantity of production for a certain time period. In the long run, the cost of all inputs is variable.

Economic Cost

The economic cost of a decision that a firm makes depends on the cost of the alternative chosen and the benefit that the best alternative would have provided if chosen. Economic cost is the sum of all the variable and fixed costs (also called accounting cost) plus opportunity costs.

Distinguish between marginal and average costs

The marginal cost is the cost of producing one more unit of a good. Marginal cost includes all of the costs that vary with the level of production. For

example, if a company needs to build a new factory in order to produce more goods, the cost of building the factory is a marginal cost.

Economists analyze both short run and long run average cost. Short run average costs vary in relation to the quantity of goods being produced. Long run average cost includes the variation of quantities used for all inputs necessary for production.

When the average cost declines, the marginal cost is less than the average cost. When the average cost increases, the marginal cost is greater than the average cost. When the average cost stays the same (is at a minimum or maximum), the marginal cost equals the average cost.

marginal cost

The increase in cost that accompanies a unit increase in output; the partial derivative of the cost function with respect to output. Additional cost associated with producing one more unit of output.

average cost

In economics, average cost or unit cost is equal to total cost divided by the number of goods produced.

Marginal Cost

In economics, marginal cost is the change in the total cost when the quantity produced changes by one unit. It is the cost of producing one more unit of a good. Marginal cost includes all of the costs that vary with the level of production. For example, if a company needs to build a new factory in order to produce more goods, the cost of building the factory is a marginal cost. The amount of marginal cost varies according to the volume of the good being produced. Economic factors that impact the marginal cost include information asymmetries, positive and negative externalities, transaction costs, and price discrimination. Marginal cost is not related to fixed costs. An example of calculating marginal cost is: the production of one pair of shoes is $30. The total cost for making two pairs of shoes is $40. The marginal cost of producing the second pair of shoes is $10.

Average Cost

The average cost is the total cost divided by the number of goods produced. It is also equal to the sum of average variable costs and average fixed costs. Average cost can be influenced by the time period for production (increasing production may be expensive or impossible in the short run). Average costs are the driving factor of supply and demand within a market. Economists analyze both short run and long run average cost. Short run average costs vary in relation to the quantity of goods being produced. Long run average cost includes the variation of quantities used for all inputs necessary for production.

In economics, "short run" and "long run" are not broadly defined as a rest of time. Rather, they are unique to each firm.

LESSON PLAN -28

Assignment and dscussion-2

LESSON PLAN -29 COST SHEET A cost sheet is a statement stating components of total cost of a product.

understanding the type of cost sheets and the format in which they are prepare for a period, say weekly, monthly, yearly or for a specific purpose say tender prices.

INFORMATIONS FURNISH BY COST SHEET

A cost sheet furnishes information about total cost, components of total cost that is its bifurcation into prime cost, factory cost, cost of production, cost of goods sold, then cost per unit is ascertained that can details of various components of cost, item wise cost per unit, changes in the stock position, cost of goods sold detail and finally profit and loss position. 3. COMPONENTS OF COST SHEET

Prime cost=Opening stock of raw material + raw material purchased for the period – closing stock of raw material = raw material consumed +accumulation of all direct wages or direct labor or direct expenses. Total factory cost = Prime cost + Factory overheads Indirect material like oil, Greece or clips used in manufacturing of a product.

Indirect labor, they helps in the manufacturing process, Like supervisor, foreman salary. Indirect expenses means they are ancillary expenses to carry on the manufacturing process.

Total factory cost = Prime cost + Factory overheads In case of unfinished units, they are called work in progress, so we need to make an adjustment in the factory cost for work in progress.

We need to add opening work in progress units, less closing work in progress. So we find out factory cost in net. Factory cost + Office and administrative expenses = Cost of Production Office and administrative expenses- are salaries of administrative staff, office rent, taxes of administrative accommodation,

postage, telegram, stationary, lighting of administrative buildings, depreciation of office appliances, so this constitute our cost of production. Total cost =cost of production+selling and distribution costwhen I add selling and distribution expenses to this cost, I will ascertain the total cost, now what are selling and distribution expenses? They are travelers commission, advertisements, rents, rates, taxes of sales office, depreciation of sales office appliances, cost of participation in industrial fairs and exhibition, cost of free gifts, cost of free after sales services and normal bad debts.

LESSON PLAN -30

we have ascertained total cost by classifying and analyzing the cost as per their functions and in the prescribed format of cost sheet. Thank you.

Lesson plan-31 Break-even point analysis

Explanation of break-even point:

The point at which total of fixed and variable costs of a business becomes equal to its total revenue is known as break-even point (BEP). At this point, a business neither earns any profit nor suffers any loss. Break-even point is therefore also known  as no-profit, no-loss point or zero profit point. Calculation of break-even point is important for every business because it tells business owners and managers how much sales are needed to cover all fixed as well as variable expenses of the business or the sales volume after which the business will start generating profit. The computation of sales volume required to break-even is known as break-even analysis. The concept explained above can also be presented as follows:

Assumptions-

1.0 It assumes that fixed costs remain the same at different level of activity

2.0 It assumes that the total cost line is shown as a straight line when in actual fact, costs do not usually vary in direct proportion to volume. Each unit produced and sold may not necessarily incur the same variable cost as attempts to sell more units may increase the variable cost at a faster rate than activity

3.0 It assumes that revenue is perfectly variable with activity, showing a straight line on the break-even chart which is unrealistic as very often in order to increase sales volume, it may be necessary to give extra discount or reduce the selling price. The

sale revenue line will therefore no longer be linear but curved.

4.0 Break-even charts are only true within the minimum and maximum ranges of activity. Any attempt to determine figures outside this range of activity is not valid

5.0 Break-even analysis assumes that all units produced are sold

6.0 Break-even chart has a life span as the nature of variable and fixed cost change with time. It would then be necessary to construct new charts based on different circumstances

7.0 In a multi-product firm, each possible product mix will tend to incur different costs so that with any change in the product mix, a new break-even chart is required. Thus in a break-even chart of such firm, the sales mix is assumed to remain constant throughout its level of activity

8.0 It assumes as in conventional accounting that monetary values are stable. In order to establish the break-even point in real terms it may be necessary to adjust revenues and costs to current purchasing powers.

Graphical presentation (Preparation of break-even chart

The graphical presentation of dollar and unit sales needed to break-even is known as

break-even chart 

Explanation of the graph:

1. The number of units have been presented on the X-axis (horizontally) where as dollars have been presented on Y-axis (vertically).

2. The straight line in red color represents the total annual fixed expenses of $15,000.

3. The blue line represents the total expenses. Notice that the line has a positive or upward slop that indicates the effect of increasing variable expenses with the increase in production.

4. The green line with positive or upward slop indicates that every unit sold increases the total sales revenue.

5. The total revenue line and the total expenses line cross each other. The point at which they cross each other is the break-even point. Notice that the total expenses line is above the total revenue line before the point of intersection and below after the point of intersection. It tells us that the business suffers a loss before the point of intersection and makes a profit after this point.  The break-even point in the above graph is 2,000 units or $30,000 that agrees with the break-even point computed using equation and contribution margin methods above.

6. The difference between the total expenses line and the total revenue line before the point of intersection (BE point) is the loss area. The loss area has been filled with pink color. Notice that this area reduces as the number of units sold increases. It means every additional unit sold before the break-even point reduces the loss.

7. The difference between the total expenses line and the total revenue line after the point of intersection (BE point) is the profit area. The profit area has been filled with green color. Notice that this area increases as the number of units sold increases. It means every additional unit sold after the break-even point increases the profit of the business.

 Limitations-

1. First and foremost limitation of this analysis is that it does not take into account demand side related problems and in this competitive world the emphasis should first on demand and then decision should be taken whether to product that product or not. So for example if breakeven point of a particular product is coming 150 units and company produces 200 units taking into account breakeven point but future demand for that product falls to 100 units than whole exercise of this analysis becomes futile.

2. Fixed costs are assumed to be constant irrespective of production while doing this analysis which sometimes can lead to wrong estimate as fixed costs sometimes changes with changes in production.

3. It requires a separate department or team of people to carry this operation leading to extra expenditure for an organization.

4. If a company does not focus on sales but keep focusing on cost side issues than it can never grow, it’s like a salaried individual who keeps thinking about how to reduce personal expenditure instead of thinking how to increase sources of income.

5. If complete data on cost structure of a product is not available than there is no benefit of doing this analysis as it would yield incorrect result.

Lesson plan-32

DETERMINATION OF BREAK EVEN POINT IN TERMS OF QUANTITY

The BREAK EVEN POINT can be calculated by

1- In terms of physical unity (in quantity)

Q=physical output of the firm

QBEP=output at BEP

P=price per unit/average revenue

TR=total revenue=P*Q

TFC= total fixxed cost

TVC=total variable cost=Q*AVC

TC= total cost=TFC+TVC

AFC=average fixed cost

AVC=average variable cost

AC=average cost=AVC+AFC

We know that at BEP

TR=TC

Applying TR=P*QBEP and TC=TFC+TVC we get

P*QBEP= TFC+TVC

=TFC+(QBEP*AVC)(senceTVC= QBEP *AVC)

P*QBEP- QBEP *AVC=TFC

QBEP(P-AVC)=TFC

QBEP= TFC/(P-AVC)=TFC/ACM

Hence the break-even quantity will be

QBEP=Total Fixed Cost/Average Contribution Margin

2- In terms of sales value.

BEP(sBEP)=Total Fixed Cost/ Contribution Margin to sales ratio

BEP(sBEP)=[TFC/(P-AVC)]/P

BEP(sBEP)=TFC/1-(AVC/P)

BEP(sBEP)=TFC/1-(TVC/TR)

Applying P=(TR/Q) AND AVC=(TVC/Q) in original BEP(sBEP) formula.

3- BEP as percentage of capacity

percentage BEP=TFC/(P-AVC)/Qmax*100

percentage BEP= QBEP/ Qmax*100

Lesson plan-33 Commercial bank

A commercial bank is a type of bank that provides services such as accepting deposits, making business loans, and offering basic investment products.

Commercial bank can also refer to a bank or a division of a bank that mostly deals with deposits and loans from corporations or large businesses, individual members of the public (retail banking).

Contents

The name bank derives from the Italian word banco "desk/bench", used during the Renaissance era by Florentine bankers, who used to make their transactions above a desk covered by a green table cloth.

Some have suggested, in Ancient Roman Empire, where moneylenders would set up their stalls in the middle of enclosed courtyards called macella on a long bench called a bancu, from which the words banco and bank are derived.

Role of commercial banks;

Commercial banks engage in the following activities:

Processing payments via telegraphic transfer, EFTPOS, internet banking, or other

Issuing bank drafts and bank cheques Accepting money on term deposit Lending money by overdraft, installment loan, or other Providing documentary and stady, guarantees, performance bonds, securities

underwriting commitments and other forms of off-balance sheet exposure.

Cash management and treasury merchant banking and private equity financing

Traditionally, large commercial banks also underwrite bonds, and make markets in currency, interest rates, and credit-related securities, but today large commercial banks usually have an investment bank arm that is involved in the aforementioned activities .

Functions

Commercial banks perform various functions:

Commercial banks accept deposits-from public especially from its clients, including

Current deposit-in case of current deposit one can with drow many times from the account and bank does not gives any intrest againest the deposit on current account.

saving account deposits-in this type of deposit certain restriction on withdrowals and intrest is verry low than fixed deposit

recurring account deposits, -money in this account is deposited in instalment basis for a fixed period and repaid to depositer along with intrest on the date of maturity.

fixed deposits. –it is a one time deposit and can not withdrown before maturity .the on such deposit is verry high than other types of deposit.

Home safe deposit-under this schime a safe is supplied to the depositer to keep it at home and put this small saving in it periodically the safe is taken to the bank where the amount is kept in it is credited to his account

provides loan

Commercial banks provide loans and advances of various forms, including an money at call-loan –are sanctioned at a short notice,of one day to 14 day.

Generally made to other banks overdraft facility-some time bank gives such facility to its customer and intrest

charged on over draft amopunt. cash credit, -is granted againes current assets such as share bonds,stocks.

Intrest is charged only on amount withdrown. bill discounting, term loan-some time bank grants medium and long term loans to its customer

and the loan period is more than one year and the intrest is charged on entire amount of loan

etc. They also give demand and demand and term loans to all types of clients against proper security.

Credit creation -Credit creation is most significant function of commercial banks. While sanctioning a loan to a customer, they do not provide cash to the borrower. Instead, they open a deposit account from which the borrower can withdraw. In other words, while sanctioning a loan, they automatically create deposits, known as a credit creation from commercial banks.

Along with primary functions, commercial banks perform several secondary functions, Agency functions are

To collect and clear checks, dividends and interest warrant. To make payments of rent, insurance premium, etc. To deal in foreign exchange transactions. To purchase and sell securities. To act as trustee, attorney, correspondent and executor. To accept tax proceeds and tax returns.

Utility functions include:

To provide safety locker facility to customers. To provide money transfer facility.

To issue traveller's cheque. To act as referees. To accept various bills for payment: phone bills, gas bills, water bills, etc. To provide merchant banking facility. To provide various cards: credit cards, debit cards, smart cards, etc.

Other Functions

Some of the in i t iat ives taken by Banks include:

i . restructur ing of the system of bank inspect ions i i . int roduct ion of of f-s i te survei l lance,

i i i . s trengthening of the role of statutory auditors and iv. strengthening of the internal defences of supervised inst i tut ions.

Current Focus

supervis ion of f inancial inst i tut ions consol idated account ing legal issues in bank frauds divergence in assessments of non-performing assets and supervisory rat ing model for banks.

Lesson plan-34

Role of commercial bank in developing economy

The Banking Sector has for centuries now formed one of the pillars of economic prosperity. Land, Labor, capital and entrepreneurs are the basic economic resources available to business. However, to make the use of these resources, a business requires finance to purchase of the land, hire labor, pay for capital goods and pay for individuals with specialized skills. Detail role of commercial banks in economic development is given below:

Capital Formation

Commercial banks help in increasing the rate of capital formation in a country. Capital formation means increase in number of production units, technology, plant and machinery. They finance the projects responsible for increasing the rate of capital formation.

Trade & Industrial Development

The commercial banks provide capital, technical assistance and other facilities to businessmen according to their need the countries, which concentrated on industrial sector made rapid economic development. South Korea, Malaysia, Taiwan, Hong Kong and Indonesia have recently developed their trade & industrial sector with the help of commercial banks.

Agriculture Development

Commercial banks finance the most important sector of the developing economics i.e. agriculture.short, medium and long-term loans are provided for the purchase of seeds and fertilizer, installation of tube wells, construction of warehouses, purchase of tractor and thresher etc. they also financed to othert neglectyed sector. It has reduced unemployment on one hand and increased the facility employment on the other hand. Remote areas are linked to main markets through developed transport system.

Development of Foreign Trade

Commercial banks help the traders of two different countries to undertake business. Letter of credit is issued by the importer’s bank to the exporters to ensure the payment. The banks also arrange foreign exchange.

More Production

A good banking system ensures more production in all sectors of the economy. It increases the production capabilities of the economy by strengthening capital structure and division of labor

Increase in Saving

Commercial banks persuade the people to save more. Different saving schemes with attractive interest rates are introduced for this purpose. Number of bank branches is opened in urban and rural areas.

Assistance to Government

By providing funds to government for development programs, the commercial banks share the government for economic stability.

Increase in Employment

A country’s economic prosperity depends on the development of trade, commerce industry, agriculture, transport and communication etc. These sectors are financed by the commercial banks and employment opportunities are increasing.

Saving in Metallic Reserve

Cheques and drafts etc works like money. In this way the need of precious metals to make coins reduces and metallic reserve of the country can be utilized on other important matters

Credit Creation

Commercial banks are called the factories of credit. They advance much more than what the collect from people in the form of deposits. Through the process of credit creation, commercial banks provide finance to all sectors of the economy thus making them more developed than before.

Proper use of Money

People deposit their saving in the banks, so the scattered money becomes a huge amount in the way, which can be used for different projects in a proper way.

Increase in Investment

Commercial banks mobilize savings of the people. They make them available to the farmers, traders and industrialists for the development of agriculture, trade and industry.

Success of Monetary Policy

Under the supervision of central bank, all scheduled commercial banks make effort for the success and objectives of monetary policy. This joined effort of commercial banks makes the economic development possible.

Use of Modern Technology

The use of modern technology in less developed countries is only possible in the presence of developed commercial banking as it can be the main source of their funds.

These funds are utilized for the import of modern technology from developed countries.

Export Promotion Cells

In order to boost the exports of the country, the banks have established export promotion cells for the information and guidance to the exporters.

Economic Prosperity

Economic prosperity of a country depends on number of factors including the development of commercial banking. A sound banking system promotes the economic status of the people by providing them short, medium and long-term loans.

Sound Banking System for Underdeveloped Countries

A sound and efficient banking system, which undertakes the responsibility of promoting economic growth in underdeveloped economies, must possess the following features:

(i) The system of branch banking is most suitable for the underdeveloped countries. More and more branches should be opened in rural and backward areas to encourage saving as well as banking habits in these areas.

(ii) The system of unit banking may be developed in the limited area, particularly in bigger cities to meet the local financial requirements of trade and industries. This will, on the one hand, reduce pressure on big banks and, on the other hand, check concentration of financial power in the hands of a few banks.

(iii) The banking system in the less-developed countries must aim at encouraging capital formation by increasing the rates of savings and investment in these economies.

(iv) The banking system in the underdeveloped countries should provide easy and cheap remittance facilities to enable the movement of fund from one place to another so as to promote trade and industry.

(v) The loan policy of banks in the underdeveloped countries should be rationalised in such a way that loans for productive purposes should be encouraged and loans for conspicuous consumption and for speculative activities should be discouraged.

(vi) The loan policy in underdeveloped countries should also not be restricted to short-term loans alone. The banks should also provide medium-term and long-term loans to developmental activities in these countries.

(vii) The banks should meet the different and changing needs of the underdeveloped countries. Credit facilities should be extended to the priority sectors, like agriculture and small-scale industries.

(viii) Efficient functioning of the banks will inspire public confidence in the banking system and popularize banking activities. This requires trained and efficient banking staff.

In short, comprehensive structural and functional changes in the banking system of the underdeveloped countries are needed. Only after these changes, the banks can be expected to play a proptypes of banks in indiaer

types of banks in india

Although banking is said to have originated in the affluent cities of Italy in the 14th century, it was introduced in India in the late 18th century. The first banks to come up in the country were Bank of Hindustan (1770), The General Bank of India (1786), and the State Bank of India (1806). The banking system has come along way and the banking sector has witnessed a rapid growth in the country in the past few decades. The Reserve Bank of India functions as the central bank and has a control over all the nationalized banks of the country.

There are various types of banks and they can be divided into some of the following categories:

Savings banks: These banks function with the intention to culminate saving habits among people, especially those who belong to low income groups or those who are salaried. The money these people deposit in the banks are invested in securities, bonds etc. These days, many commercial banks perform the dual functions of savings bank. The postal department is also in a way a saving bank.

Commercial banks: These banks function to help the entrepreneurs and businesses. They give financial services to these businessmen like debit cards, banks accounts, short term deposits, etc. with the money people deposit in such banks. They also lend money to businessmen in the form of overdrafts, credit cards, secured loans, unsecured loans and mortgage loans to businessmen. The commercial banks in the country were nationalized in 1969. So the various policies regarding the loans, rates of interest and loans etc are controlled by the Reserve Bank. These days, the commercialized banks provide some services given by investment banks to their clients.

The commercial banks can be further classifies as: public sector bank, private sector banks, foreign banks and regional banks.

1. The public sector banks are owned and operated by the government, who has a major share in them. The major focus of these banks is to serve the people rather earn profits. Some examples of these banks

include State Bank of India, Punjab National Bank, Bank of Maharashtra, etc.

2. The private sector banks are owned and operated by private institutes. They are free to operate and are controlled by market forces. A greater share is held by private players and not the government. For example, Axis Bank, Kotak Mahindra Bank etc.

3. The foreign banks are those that are based in a foreign country but have several branches in India. Some examples of these banks include; HSBC, Standard Chartered Bank etc.

4. The regional rural banks were brought into operation with the objective of providing credit to the rural and agricultural regions and were brought into effect in 1975 by RRB Act. These banks are restricted to operate only in the areas specified by government of India. These banks are owned by State Government and a sponsor bank. This sponsorship was to be done by a nationalized bank and a State Cooperative bank. Prathama Bank is one such example, which is located in Moradabad in U.P.

Cooperative banks: These banks are controlled, owned, managed and operated by cooperative societies and came into existence under the Cooperative Societies Act in 1912. these banks are located in the urban as well in the rural areas. Although these banks have the same functions as the commercial banks, they provide finance to farmers, salaried people, small scale industries, etc. and their rates of interest of interest are lower as compared to other banks.

There are three types of cooperative banks in India, namely:

1. Primary credit societies: These are formed in small locality like a small town or a village. The members using this bank usually know each other and the chances of committing fraud is minimal.

2. Central cooperative banks: These banks have their members who belong to the same district. They function as other commercial banks and provide loans to their members. They act as a link between the state cooperative banks and the primary credit societies.

3. State cooperative banks: these banks have a presence in all the states of the country and have their presence throughout the state.

Investment banks: These are financial institutions that provide financial and advisory assistance to their customers. Their clients can be individuals, businesses, or government organizations. They assist their customers to raise funds when required. These banks act as the underwriters for their customers when they want to raise capital by issuing securities. In some cases, they also help their customers to issue securities.

When there is a merger or an acquisition, they provide their customers with the necessary support like marketing, foreign trading, foreign exchange, sale of equities, fixed income instruments etc. Apart from raising capital, these banks render valuable financial advise to their customers and various kinds of businesses. Some examples of these banks include, Bank of America, Barclays Capital, Citi Bank, Deutsche Bank etc.

Specialized banks: These provide unique services to their customers. Some such banks include, foreign exchange banks, development banks, industrial banks, export import banks etc. These banks also provide huge financial support to businesses and various kinds projects and traders who have to import or export their goods or services.

Central bank: The central bank is also called the banker's bank in any country. In India, the Reserve Bank of India is the central bank. The Federal Reserve in USA and the Bank of England in UK function as the central bank. This bank makes various monetary policies, decides the rates of interest, controlling the other banks in the country, manages the foreign exchange rate and the gold reserves and also issues paper currency in a country. The monetary control is the primary function of a central bank in most countries and so they are considered as the lender of last resort to various commercial banks.

Foreign banks:

RBI has been keen on allowing foreign banks a larger role in the Indian banking system

since February 2005, when it first issued the road map for presence of foreign banks in

India. In May 2012, the government also facilitated the process by proposing to exempt

foreign banks from the 30 per cent tax on capital gains and stamp duty while converting

branches into a new entity. RBI has also mandated foreign banks with 20 and more

branches to achieve priority sector targets and sub-targets at par with their domestic

counterparts.

Developing corporate bond markets:

Developing corporate bond markets is an important link in a well developed financial

market. Although the government has taken some steps in this direction, a lot more

needs to be done.

Unique Identification (UID) project:

Among the many initiatives, the government's UID project is likely to have significant

impact. Given the numbers out of the reach of organised banking, it can prove to be

transformational by giving banks an access to a large untapped customer base. The

whole range of government payments - under subsidies and benefits of various welfare

schemes - will be routed through banks.

Lesson plan-35

Central bank

In every country there is one organization which works as the central bank. The function of the central bank of a country is to control and monitor the banking and financial system of the country. In India, the Reserve Bank of India (RBI) is the Central Bank.

The RBI was established in 1935. It was nationalised in 1949. The RBI plays role of regulator of the banking system in India. The Banking Regulation Act 1949 and the RBI Act 1953 has given the RBI the power to regulate the banking system.

The RBI has different functions in different roles. Below, we share and discuss some of the functions of the RBI.

FUNCTIONS OF RBI RBI performs many functions, some of them are:-

1.    Issue Of Currency Notes :-Under section 22 of RBI Act, the bank has the sole right to issue currency notes of

all denominations except one rupee coins and notes. The one-rupee notes and coins and small coins are issued by Central Government and their distribution is undertaken by RBI as the agent of the government. The RBI has a separate issue department which is entrusted with the issue of currency notes.

2.    Banker To The Government :-The RBI acts as a banker agent and adviser to the government. It has obligation to

transact the banking business of Central Government as well as State Governments. E.g.:- RBI receives and makes all payments on behalf of government, remits its funds, buys and sells foreign currencies for it and gives it advice on all banking matters. The bank makes ways and meets advances of the government. On behalf of central government it sells treasury bills and thereby provides short-term finance.

3.    Banker’s bank And Lender Off Last Resort :-RBI acts as a banker to other banks. It provides financial assistance to scheduled

banks and state co-operative banks in form of rediscounting of eligible bills and loans and advances against approved securities.RBI acts as a lender of last resort. It provides funds to bank when they fail to get it from other sources. It also acts as a clearing house. Through RBI, banks make interbanks payments.

4.    Controller Of Credit :-RBI has power to control the volume of credit created by banks. The RBI through its

various quantitative and qualitative techniques regulates total supply of money and bank credit in the interest of economy. RBI pumps in money during busy season and withdraws money during slack season.

5.    Exchange control And Custodian Of Foreign Reserve :-RBI has the responsibility of maintaining fixed exchange rates with all member

countries of IMF. For this, RBI has centralized all foreign exchange reserves (FOREX). RBI functions as custodian of nations foreign exchange reserves. It has to maintain external valu of Rupee. RBI achieves this aim through appropriate monetary fiscal and trade policies and exchange control.

6.    Collection And Publication Of Data :-The RBI collects and complies statistical information on banking and financial

operations of the economy. The Reserve Bank Of India’ Bulletian is a monthly publication. It not only provides information, but also results of important studies and

investigations conducted by reserve bank are given. ‘The Report on currency and finance’ is an annual publication. It provides review of various developments of economic and financial importance.

7.    Regulatory And Supervisory Functions :-The RBI has wide powers of supervision and control over commercial and co-

operative banks, relating to licensing, establishment, branch expansion, liquidity of Assets, management and methods of working, amalgamation, re-construction and liquidation. The supervisory functions of RBI have helped a great in improving the standard of banking in India to develop on sound lines and to improve the methods of their operation.

8.    Clearing House Functions :-The RBI acts as a clearing house for all member banks. This avoids unnecessary

transfer of funds between the various banks.

9.    Development And Promotional Functions :-The RBI has helped in setting up Industrial Finance Corporations of India (IFCI),

State Financial Corporations (SFCs), Deposit Insurance Corporation, Agricultural Refinance and Development Corporation (ARDC), units Trust of India (UTI) etc. these institutions were set up to mobilize savings, promote saving habits and to provide industrial and agricultural finance.

RBI has a special Agricultural Credit Department (ACD) which studies the problems of agricultural credit. For this Regional Rural banks, Co-operative, NABARD etc. were established. The RBI has also taken measures to promote organized bill market to create elasticity in Indian Money Market in order to satisfy seasonal credit needs.

Thus RBI has contributed to economic growth by promoting rural credit, industrial financing, export trade

RBI is the Regulator of Financial System

The RBI regulates the Indian banking and financial system by issuing broad guidelines and instructions. The objectives of these regulations include:

Controlling money supply in the system, Monitoring different key indicators like GDP and inflation, Maintaining people’s confidence in the banking and financial system, and Providing different tools for customers’ help, such as acting as the “Banking

Ombudsman.”

Monetary Policy

The RBI formulates monetary policy twice a year. It reviews the policy every quarter as well. The main objectives of monitoring monetary policy are:

Inflation control Control on bank credit Interest rate control

The tools used for implementation of the objectives of monetary policy are:

Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), Open market operations, Different Rates such as repo rate, reverse repo rate, and bank rate.

Lesson plan-36

Policy of credit expansion

The main aim of credit expaintion is to maintain sufficient currency and credit facilities for the economy of country and this can be achived by following measures as follows.

1.Revision of open market operations-

  any of the purchases and sales of government securities and sometimes commercial paper by the central banking authority for the purpose of regulating the money supply and credit conditions on a continuous basis. Open-market operations can also be used to stabilize the prices of government securities, When the central bank purchases securities on the open market, the effects will be (1) to increase the reserves of commercial banks, a basis on which they can expand their loans and investments; (2) to increase the price of government securities, equivalent to reducing their interest rates; and (3) to decrease interest rates generally, thus encouraging business investment. If the central bank should sell securities, the effects would be reversed.

liberalisation of bill market schime-with the liberalisation schime RBI helps the commercial banks to recives additional funds to meet the increasing credit requirments of their borrowers and including export bills in bill market schime it provides credit facilities to exporters liberaly.Facilities to priority sectors.- RBI allowes commercial banks and credit co operative socities to borrow additional funds in order to provide finance to MSME sector consists of Micro, Small and Medium Enterprises under Manufacturing and Services Sector as per MSMED Act as under,.Refinance And Rediscounting Facilities-Now RBI engaged inproviding selective Refinance And Rediscounting Facilities by allowing banks to refinance equal to one

persents of demsand and lime libilities at the rate of ten persent per annum.this facilities are also availabile for food prosessing credit and export credit cases.Credit facilities through financial institutions-Rbi has been instrumental in establishment of various financial institutions such as IDBI,IFCI,IRCI,ICICI,SFC,ARDC,NABARD etcto provide long term and medium term loans for development.Deficit financing- bank some times provides finance to govt to meet their budgetary deficitthis was mede change in reserve requirments of the reserve bank and it can hold in two ways.

By keeping 40%of its reserve in the form of gold or freign exchanges Modifying the miniumum reserve system and keeping the minimum reserve need

of rupees 115crore with the provion of minimum requirments.Anti-inflationary fiscal policy-In the processes of anty inflationary fiscal policy RBI provides suffiecient credit for the development of industory and trade to streng then the production secter to meet the demand of the marmet.Allocation of credit-bank play an important role in allocating credit to different secter of the economy of the country.bank provides most of its credit facilities to the priority secter of the economy of the country through their selective credit control policy and the differential intrest rate schime and also provides credit to public secter on the basis of statutary requirments and other means.OBJECTIVES OF MONETARY POLICY OF INDIA -

Monetary policy / monetary management is regarded as an important tool of economic management in India. RBI controls the supply of money and availability of bank credit and cost of money, that is, the rate of Interest.

The main objective of monetary policy in India is ‘growth with stability’. Monetary Management regulates availability, cost and use of money and credit. It also brings institutional changes in the financial sector of the economy. Following are the main objectives of monetary policy in India :-

1.    Growth With Stability :-Traditionally, RBI’s monetary policy was focused on controlling inflation through

contraction of money supply and credit. This resulted in poor growth performance. Thus, RBI have now adopted the policy of ‘Growth with Stability’. This means sufficient credit will be available for growing needs of different sectors of economy and at the same time, inflation will be controlled within a certain limit.

2.    Regulation, Supervision And Development Of Financial Stability :-Financial stability means maintaining confidence in financial system instead of

shocks.Threats to financial stability can come from internal and external shocks. Such shocks can destabilized by the country’s financial system. Thus, thye role of RBI’is to role in maintaining confidence in financial system through proper regulation and controls, without sacrificing the objective of growth. Therefore, RBI is focusing on regulation, supervision and development of financial system.

3.    Promoting Priority Sector :-Priority sector includes agriculture, export and small scale enterprises and weaker

section of population. RBI with the help of bank provides timely and adequately credit at affordable cost of weaker sections and low income groups. RBI, along with NABARD, is focusing on microfinance through the promotion of Self Help groups and other institutions.

4.    Generation Of Employment :-Monetary policy helps in employment generation by influencing the rate of

investment and allocation of investment among various economic activities of different labour Intensities.

5.    External Stability :-With the growth of imports and exports India’s linkages with global economy are

getting stronger. Earlier, RBI controlled foreign exchange market by determining eaxchange rate. Now, RBI has only indirect control over external stability through the mechanism of ‘managed Flexibility’, where it influences exchange rate by buying and selling foreign currencies in open market.

6.    Encouraging Savings And Investments :-RBI by offering attractive interest rates encourage savings in the economy. A high

rate of saving promotes investment. Thus the monetary management by influencing rates of interest can influence saving mobilization in the country.

7.    Redistribution Of income And Wealth :-By control of inflation and deployment of credit to weaker sectors of society the

monetary policy may redistribute income and wealth favouring to weaker sections.

8.    Regulation Of NBFIs:-Non – Banking Financial Institutions (NBFIs), like UTI, IDBI, IFCI plays an important

role in deployment of credit and mobilization of savings. RBI does not have any direct control on the functioning of such institutions. However it can indirectly affects the policies and functions of NBFIs through its monetary policy.

etc.

Police of credit controlIn India, the legal framework of RBI’s control over the credit structure has been provided Under Reserve Bank of India Act, 1934 and the Banking RegulationAct, 1949. Quantitative credit controls are used to maintain proper quantity of credit or money supply in market. Some of the important general credit control methods are:-

1.    Bank Rate Policy :-Bank rate is the rate at which the Central bank lends money to the commercial banks

for their liquidity requirements. Bank rate is also called discount rate. In other words

bank rate is the rate at which the central bank rediscounts eligible papers (like approved securities, bills of exchange, commercial papers etc) held by commercial banks.

Bank rates have been changed several times by RBI to control inflation and recession. Now the bank rate has been reduced to 6% p.a.

2.    Open market operations :- It refers to buying and selling of government securities in open market in order to

expand or contract the amount of money in the banking system.This technique is superior to bank rate policy. Purchases inject money into the banking system while sale of securities do the opposite. During last two decades the RBI has been undertaking switch operations. These involve the purchase of one loan against the sale of another or, vice-versa.

3.    Cash Reserve Ratio (CRR)The cash Reserve Ratio (CRR) is an effective instrument of credit control. Under the

RBl Act of, l934 every commercial bank has to keep certain minimum cash reserves with RBI. The RBI is empowered to vary the CRR between 3% and 15%. A high CRR reduces the cash for lending and a low CRR increases the cash for lending. Now CRR is 6%.

4.    Statutory Liquidity Ratio (SLR)Under SLR, the government has imposed an obligation on the banks to ,maintain a

certain ratio to its total deposits with it in the form of liquid assets like cash, gold and other securities. The RBI has power to fix SLR in the range between 25% and 40%.

5.    Repo And Reverse Repo RatesIn determining interest rate trends, the repo and reverse repo rates are becoming

important. Repo means Sale and Repurchase Agreement .Repo rate helps commercial banks to acquire funds from RBI by selling securities and also agreeing to repurchase at a later date.

Reverse repo rate is the rate that banks get from RBI for parking their short term excess funds with RBI. Repo and reverse repo operations are used by RBI in its Liquidity Adjustment Facility.

5. Margin Requirements :-A loan is sanctioned against Collateral Security. Margin means that proportion of the value of security against which loan is not given. Margin against a particular security is reduced or increased in order to encourage or to discourage the flow of credit to a particular sector. It varies from 20% to 80%. For agricultural commodities it is as high as 75%. Higher the margin lesser will be the loan sanctioned.

6. Discriminatory Interest Rate (DIR)Through DIR, RBI makes credit flow to certain priority or weaker sectors by charging concessional rates of interest. RBI issues supplementary instructions regarding granting

of additional credit against sensitive commodities, issue of guarantees, making advances etc. .

7.      Directives:-The RBI issues directives to banks regarding advances. Directives are regarding the purpose for which loans may or may not be given.

      Direct ActionIt is too severe and is therefore rarely followed. It may involve refusal by RBI to rediscount bills or cancellation of license, if the bank has failed to comply with the directives of RBI.

8. Moral SuasionUnder Moral Suasion, RBI issues periodical letters to bank to exercise control over credit in general or advances against particular commodities. Periodic discussions are held with authorities of commercial banks in this respect.

LIMITATIONS OF MONETARY POLICY1.       Huge Budgetary Deficits :-

RBI makes every possible attempt to control inflation and to balance money supply in the market. However Central Government's huge budgetary deficits have made monetary policy ineffective. Huge budgetary deficits have resulted in excessive monetary growth.

2.       Coverage Of Only Commercial Banks :-Instruments of monetary policy cover only commercial banks so inflationary pressures caused by banking finance can be controlled by RBI, but in India, inflation also results from deficit financing and scarcity of goods on which RBI may not have any control.

3.       Problem Of Management Of Banks And Financial Institutions :-The monetary policy can succeed to control inflation and to bring overall development only when the management of banks and Financial institutions are efficient and dedicated. Many officials of banks and financial institutions are corrupt and inefficient which leads to financial scams in this way overall economy is affected.

4.       Unorganised Money Market :-Presence of unorganised sector of money market is one of the main obstacle in effective working of the monetary policy. As RBI has no power over the unorganised sector of money market, its monetary policy becomes less effective.

5.       Less Accountability:-At present time, the goals of monetary policy in India, are not set out in specific terms and there is insufficient freedom in the use of instruments. In such a setting, accountability tends to be weak as there is lack of clarity in the responsibility of governments and RBI.

6.       Black Money :-

There is a growing presence of black money in the economy. Black money falls beyond the purview of banking control of RBI. It means large proposition of total money Supply in a country remains outside the purview of RBI's monetary management.

7.       Increase Volatility :-The integration of domestic and foreign exchange markets could lead to increased volatility in the domestic market as the impact of exogenous factors could be transmitted to domestic market. The widening of foreign exchange market and development of rupee - foreign exchange swap would reduce risks and volatility.

8.       Lack Of Transparency :-According to S. S. Tarapore, the monetary policy formulation, in its present form in India, cannot be continued indefinitely. For a more effective policy, it would be necessary to have greater transparency in the policy formulation and transmission process and the RBI would need to be clearly demarcated.

Lesson plan-37 Indian financial system:Money Market :-

Organised Money Market is not a single market, it consist of number of markets. The most important feature of money market instrument is that it is liquid. It is characterised by high degree of safety of principal. Following are the instruments which are traded in money market

1)        Call And Notice Money Market :-

The market for extremely short-period is referred as call money market. Under call money market, funds are transacted on overnight basis. The participants are mostly banks. Therefore it is also called Inter-Bank Money Market. Under notice money market funds are transacted for 2 days and 14 days period. The lender issues a notice to the borrower 2 to 3 days before the funds are to be paid. On receipt of notice, borrower have to repay the funds.

In this market the rate at which funds are borrowed and lent is called the call money rate. The call money rate is determined by demand and supply of short term funds. In call money market the main participants are commercial banks, co-operative banks and primary dealers,Discount and Finance House of India (DFHI), Non-banking financial institutions like LIC, GIC, UTI, NABARD etc. are allowed to participate in call money market as lenders.

2)        Treasury Bill Market (T - Bills) :-

This market deals in Treasury Bills of short term duration issued by RBI on behalf of Government of India. At present three types of treasury bills are issued through auctions, namely 91 day, 182 day and364day treasury bills. State government does not issue any treasury bills. Interest is determined by market forces. Treasury bills are available for a minimum amount of Rs. 25,000 and in multiples of Rs. 25,000. Periodic auctions are held for their Issue.

Commercial Banks, Primary Dealers, Mutual Funds, Corporates, Financial Institutions, Provident or Pension Funds and Insurance Companies can participate in T-bills market.

3)        Commercial Bills :-

Commercial bills are short term, negotiable and self liquidating money market instruments with low risk. A bill of exchange is drawn by a seller on the buyer to make payment within a certain period of time. Generally, the maturity period is of three months. Commercial bill can be resold a number of times during the usance period of bill. The commercial bills are purchased and discounted by commercial banks and are rediscounted by financial institutions like EXIM banks, SIDBI, IDBI etc.

4)        Certificate Of Deposits (CDs) :-

CDs are issued by Commercial banks and development financial institutions. CDs are unsecured, negotiable promissory notes issued at a discount to the face value. The scheme of CDs was introduced in 1989 by RBI. The main purpose was to enable the commercial banks to raise funds from market. At present, the maturity period of CDs ranges from 3 months to 1 year. They are issued in multiples of Rs. 25 lakh subject to a minimum size of Rs. 1 crore. CDs can be issued at discount to face value. They are freely transferable but only after the lock-in-period of 45 days after the date of issue.

In India the size of CDs market is quite small.

In 1992, RBI allowed four financial institutions ICICI, IDBI, IFCI and IRBI to issue CDs with a maturity period of. one year to three years.

5)        Commercial Papers (CP) :-

. Commercial Papers wereintroduced in January 1990. The Commercial Papers can be issued by listed company which have working capital of not less than Rs. 5 crores. They could be issued in multiple of Rs. 25 lakhs. The minimum size of issue being Rs. 1 crore. At present the maturity period of CPs ranges between 7 days to 1 year. CPs are issued at a discount to its face value and redeemed at its face value.

6)        Money Market Mutual Funds (MMMFs) :-

A Scheme of MMMFs was introduced by RBI in 1992. The goal was to provide an additional short-term avenue to individual investors. In November 1995 RBI made the scheme more flexible. The existing guidelines allow banks, public financial institutions and also private sector institutions to set up MMMFs. The ceiling of Rs. 50 crores on the size of MMMFs stipulated earlier, has been withdrawn. MMMFs are allowed to issue units to corporate enterprises and others on par with other mutual funds. Resources mobilised by MMMFs are now required to be invested in call money, CD, CPs, Commercial Bills arising out of genuine trade transactions, treasury bills and government dated securities having an unexpired maturity upto one year. Since March 7, 2000 MMMFs have been brought under the purview of SEBI regulations. At present there are 3 MMMFs in operation.

7)        The Repo Market ;-

Repo was introduced in December 1992. Repo is a repurchase agreement. It means selling a security under an agreement to repurchase it at a predetermined date and rate. Repo transactions are affected between banks and financial institutions and among bank themselves, RBI also undertake Repo.

8)        Discount And Finance House Of India (DFHI)

In 1988, DFHI was set up by RBI. It is jointly owned by RBI, public sector banks and all India financial institutions which have contributed to its paid up capital.It is playing an important role in developing an active secondary market in Money Market Instruments. In February 1996, it was accredited as a Primary Dealer (PD). The DFHI deals in treasury bills, commercial bills, CDs, CPs, short term deposits, call money market and government securities.

II.      Unorganised Sector Of Money Market :-

The economy on one hand performs through organised sector and on other hand in rural areas there is continuance of unorganised, informal and indigenous sector. The unorganised money market mostly finances short-term financial needs of farmers and small businessmen. The main constituents of unorganised money market are:-

1)       Indigenous Bankers (IBs)

Indigenous bankers are individuals or private firms who receive deposits and give loans and thereby operate as banks. IBs accept deposits as well as lend money. They mostly operate in urban areas, especially in western and southern regions of the country. The volume of their credit operations is however not known. Further their lending operations are completely unsupervised and unregulated. Over the years, the significance of IBs has declined due to growing organised banking sector.

2)       Money Lenders (MLs)

They are those whose primary business is money lending. Money lending in India is very popular both in urban and rural areas. Interest rates are generally high. Large amount of loans are given for unproductive purposes. The operations of money lenders are prompt, informal and flexible. The borrowers are mostly poor farmers, artisans, petty traders and manual workers. Over the years the role of money lenders has declined due to the growing importance of organised banking sector.

3)       Non - Banking Financial Companies (NBFCs)

They consist of :-

1.        Chit Funds

Chit funds are savings institutions. It has regular members who make periodic subscriptions to the fund. The beneficiary may be selected by drawing of lots. Chit fund

is more popular in Kerala and Tamilnadu. Rbi has no control over the lending activities of chit funds.

2.       Nidhis :-

Nidhis operate as a kind of mutual benefit for their members only. The loans are given to members at a reasonable rate of interest. Nidhis operate particularly in South India.

3.        Loan Or Finance Companies

Loan companies are found in all parts of the country. Their total capital consists of borrowings, deposits and owned funds. They give loans to retailers, wholesalers, artisans and self employed persons. They offer a high rate of interest along with other incentives to attract deposits. They charge high rate of interest varying from 36% to 48% p.a.

4.        Finance Brokers

They are found in all major urban markets specially in cloth, grain and commodity markets. They act as middlemen between lenders and borrowers. They charge commission for their services.

DEFICIENCIES OF INDIAN MONEY MARKET

Indian money market is relatively underdeveloped when compared with advanced markets like New York and London Money Markets. Its' main features / defects are as follows

1.    Dichotomy:-

A major feature of Indian Money Market is the existence of dichotomy i.e. existence of two markets: -Organised Money Market and Unorganised Money Market. Organised Sector consist of RBI, Commercial Banks, Financial Institutions etc. The Unorganised Sector consist of IBs, MLs, Chit Funds, Nidhis etc. It is difficult for RBI to integrate the Organised and Unorganised Money Markets. Several segments are loosely connected with each other. Thus there is dichotomy in Indian Money Market.

2.    Lack Of Co-ordination And Integration :-

It is difficult for RBI to integrate the organised and unorganised sector of money market. RBT is fully effective in organised sector but unorganised market is out of RBI’s control. Thus there is lack of integration between various sub-markets as well as various institutions and agencies. There is less co-ordination between co-operative and commercial banks as well as State and Foreign banks. The indigenous bankers have their own ways of doing business.

3.    Diversity In Interest Rates :-

There are different rates of interest existing in different segments of money market. In rural unorganised sectors the rate of interest are high and they differ with the purpose and borrower. There are differences in the interest rates within the organised sector also. Although wide differences have been narrowed down, yet the existing differences do hamper the efficiency of money market.

4.Seasonality Of Money Market :-

Indian agriculture is busy during the period November to June resulting in heavy demand for funds. During this period money market suffers from Monetary Shortage resulting in high rate of interest. During slack season rate of interest falls &s there are plenty offunds available. RBI has taken steps to reduce the seasonal fluctuations, but still the variations exist.

5.    Shortage Of Funds :-

In Indian Money Market demand for funds exceeds the supply. There is shortage of funds in Indian Money Market an account of various factors like inadequate banking facilities, low savings, lack of banking habits, existence of parallel economy etc. There is also vast amount of black money in the country which have caused shortage of funds. However, in recent years development of banking has improved the mobilisation of funds to some extent.

6.    Absence Of Organised Bill Market :-

A bill market refers to a mechanism where bills of exchange are purchased and discounted by banks in India. A bill market provides short term funds to businessmen. The bill market in India is not popular due to overdependence of cash transactions, high discounting rates, problem of dishonour of bills etc.

7.    Inadequate Banking Facilities :-

Though the commercial banks, have been opened on a large scale, yet banking facilities are inadequate in our country. The rural areas are not covered due to poverty. Their savings are very small and mobilisation of small savings is difficult. The involvement of banking system in different scams and the failure of RBI to prevent these abuses of banking system shows that Indian banking system is not yet a well organised sector.

8.    Inefficient And Corrupt Management :-

One of the major problem of Indian Money Market is its inefficient and corrupt management. Inefficiency is due to faulty selection, lack of training, poor performance appraisal, faulty promotions etc. For the growth and success of money market, there is need for well trained and dedicated workforce in banks. However, in India some of the bank officials are inefficient and corrupt.

MEASURES TO STRENGTHEN THE INDIAN MONEYMARKET:-

On the recommendations of S. Chakravarty Committee and Narasimhan Committee, the RBI has initiated a number of reforms.

1.    Deregulation Of Interest Rates :-

RBI has deregulated interest rates. Banks have been advised to ensure that the interest rates changed remained within reasonable limits. From May 1989, the ceiling on interest rates on call money, inter-bank short-term deposits, bills rediscounting and inter-bank participation was removed and rates were permitted to be determined by market forces.

2.    Reforms In Call And Term Money Market :-

To provide more liquidity RBI liberalized entry in to call money market. At present Banks and primary dealers operate as both lenders and borrowers. Lenders other than UTI and LIC are also allowed to participate in call money market operations. RBI has taken several steps in recent years to remove constraints in term money market. In October 1998, RBI announced that there should be no participation of non-banking institutions in call / term money market operations and it should be purely an interbank market.

3.    Introducing New Money Market Instruments:-

In order to widen and diversify the Indian Money Market, RBI has introduced many new money market instruments like 182 days Treasury bills, 364 days Treasury bills, CD3 and CPs. Through these instruments, the government, commercial banks, financial institutions and corporates can raise funds through money market. They also provide investors additional instruments for investments.

4.    Repo :-

Repos were introduced in 1992 to do away. With short term fluctuations in liquidity of money market. In 1996 reverse repos were introduced. RBI has been using Repo and Reverse repo operations to influence the volume of liquidity and to stabilise short term rate of interest or call rate. Repo rate was 6.75% in March 2011 and reverse repo rate, was 5.75%.

5.    Refinance By RBI :-

The RBI uses refinance facilities to various sectors to meet liquidity shortages and control the credit conditions. At present two schemes of refinancing are in operations :- Export credit refinance and general refinance.

RBI has kept the refinance rate linked to bank rate.

6.    MMMFs:-

Money Market Mutual Funds were introduced in 1992. The objective of the scheme was to provide an additional short-term avenue to the individual investors. In 1995, RBI modified the scheme to allow private sector organisation to set up MMMFs. So far, three MMMFs have been set up one each by IDBI, UTI and one in private sector.

7.    DFHI:-

The Discount and Finance House of India was set up on 25th April 1988. It buys bills and other short term paper from banks and financial institutions. Bank can sell their short term securities to DFHI and obtain funds in case they need them, without disturbing their investments.

8.    The Clearing Corporation Of India Limited (CCIL) :-

CCIL was registered in 2001 under the Companies Act, 1956 with the State Bank of India as Chief Promoter. CCIL clears all transaction in government securities and repos reported on NDS (Negotiated Dealing System) of RBI and also Rupee / US $ foreign exchange spot and forward deals.

9.    Regulation Of NBFCs:-

In 1997, RBI Act was amended and it provided a comprehensive regulation for non bank financial companies (NBFCs) sector. According to amendment, no NBFC can carry on any business of a financial institution including acceptance of public deposit, without obtaining a Certificate of Registration from RBI. They are required to submit periodic returns to RBI.

10.  Recovery Of Debts:-

In 1993 for speedy recovery of debts, RBI has set up special Recovery Tribunals. The Special Recovery Tribunals provides legal assistance to banks to recover dues.

Lesson plan-38Indian financial system:Capital market

Capital market

Capital markets are financial markets for the buying and selling of long-term debt or equity-backed securities. These markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments Financial regulators, such SEBI oversee the capital markets in their jurisdictions to protect investors against fraud, among other duties.

Modern capital markets are almost invariably hosted on computer-based electronic trading systems; most can be accessed only by entities within the financial sector or the treasury departments of governments and corporations, but some can be accessed directly by the public. There are many thousands of such systems, most serving only small parts of the overall capital markets.

Entities hosting the systems include stock exchanges, investment banks, and government departments. Physically the systems are hosted all over the world,

A key division within the capital markets is between the primary markets and secondary markets.

In primary markets, new stock or bond issues are sold to investors, often via a mechanism known as underwriting. The main entities seeking to raise long-term funds on the primary capital markets are governments (which may be municipal, local or national) and business enterprises (companies). Governments tend to issue only bonds, whereas companies often issue either equity or bonds. The main entities purchasing the bonds or stock include pension funds, hedge funds, sovereign wealth funds, and less commonly wealthy individuals and investment banks trading on their own behalf.

In the secondary markets, existing securities are sold and bought among investors or traders, usually on an exchange, over-the-counter, or elsewhere. The existence of secondary markets increases the willingness of investors in primary markets, as they know they are likely to be able to swiftly cash out their investments if the need arises.

A second important division falls between the stock markets (for equity securities, also known as shares, where investors acquire ownership of companies) and the bond markets (where investors become creditors).

Difference between money markets and capital markets

The money markets are used for the raising of short term finance, sometimes for loans that are expected to be paid back as early as overnight.

Whereas the capital markets are used for the raising of long term finance, such as the purchase of shares, or for loans that are not expected to be fully paid back for at least a year.

Funds borrowed from the money markets are typically used for general operating expenses, to cover brief periods of illiquidity. For example a company may have inbound payments from customers that have not yet cleared, but may wish to immediately pay out cash for its payroll.

When a company borrows from the primary capital markets, often the purpose is to invest in additional physical capital goods, which will be used to help increase its income. It can take many months or years before the investment generates sufficient return to pay back its cost, and hence the finance is long term.

Money markets and capital markets form the financial markets as the term is narrowly understood. The capital market is concerned with long term finance. In the widest

sense, it consist of a series of channels through which the savings of the community are made available for industrial and commercial

Examples of capital market transactions

A government raising money on the primary markets

When a government wants to raise long term finance it will often sell bonds to the capital markets.. The leading bank would underwrite the bonds, and would often head up a syndicate of brokers, some of whom might be based in other investment banks. The syndicate would then sell to various investors. For developing countries, a multilateral development bank would sometimes provide an additional layer of underwriting, resulting in risk being shared between the investment bank(s), the multilateral organization, and the end investors.

A company raising money on the primary markets

When a company wants to raise money for long term investment, one of its first decisions is whether to do so by issuing bonds or shares. If it chooses shares, it avoids increasing its debt, and in some cases the new shareholders may also provide non monetary help, such as expertise or useful contacts. On the other hand, a new issue of shares can dilute the ownership rights of the existing shareholders, and if they gain a controlling interest, the new shareholders may even replace senior managers. From an investor's point of view, shares offer the potential for higher returns and capital gains if the company does well. Conversely, bonds are safer if the company does poorly, as they are less prone to severe falls in price, and in the event of bankruptcy, bond owners are usually paid before shareholders.

investment banks by using a direct public offering, though this is not a common practice as it incurs other legal costs and can take up considerable management time. [8][12]

Trading on the secondary markets

Most capital market transactions take place on the secondary market. On the primary market, each security can be sold only once, and the process to create batches of new shares or bonds is often lengthy due to regulatory requirements. On the secondary markets, there is no limit on the number of times a security can be traded, and the process is usually very quick. With the rise of strategies such as high-frequency trading, a single security could in theory be traded thousands of times within a single hour. Transactions on the secondary market don't directly help raise finance, but they do make it easier for companies and governments to raise finance on the primary market, as investors know if they want to get their money back in a hurry, they will usually be easily able to re-sell their securities. Sometimes however secondary capital market transactions can have a negative effect on the primary borrowers - for example, if a

large proportion of investors try to sell their bonds, this can push up the yields for future issues from the same entity

There are several ways to invest in the secondary market without directly buying shares or bonds. A common method is to invest in mutual funds or exchange-traded funds. It's also possible to buy and sell derivatives that are based on the secondary market; one of the most common being contract for difference - these can provide rapid profits, but can also cause buyers to lose more money than they originally invested.

LESSON PLAN-39

Asignment-3 and Discussion-3

LESSON PLAN-40

Semister Questions to be discussed