MANAGERIAL ECONOMICSBYProf. Pradeep DatarM.A. (Economics)Published bySymbiosis Center for Distance Learning,Pune. Symbiosis Center for Distance Learning (SCDL)No part of this book may be reproduced or copied or transmitted in any form without prior permission of the publisher.April 2004

PREFACE Dear Reader, This book on Managerial Economics is written to present a simple text to the students who have limited exposure to Economics and are pursuing a programme in management studies.The book is also designed to provide standard reading materials especially for the students of M. B. A., M. M. M., C.A., Diploma and Degree Courses in Business Management. This book will satisfy the needs of the students who are pursuing a Distance Learning Programme in management studies. The book, I hope, would also help refresh the practicing managers. The book mainly lays emphasis on the applied part of the principles of Economics. Thetext of the book relies on standard works on the subject. I am deeply indebtedto my teachers as well as colleagues, for inspiring me to write this book. To cap it all, my special thanks to the Director and the respected staff of SymbiosisCenter for Distance Learning (SCDL) for their kind cooperation. Prof. Pradeep Datar Pune. April, 2004

ABOUT THE AUTHOR The author of this book is a Lecturer in the Department of Economics at S.P. College, Pune since 1980. He has written a few books on Economicsboth in English and Marathi. He has also been associated as a visiting faculty at various management institutes in and around Pune. As a member of the visitingfaculty, he has been teaching a variety of subjects related to Economics, such as Managerial Economics at Master in Marketing Management Course., D. B. M.; Degree in Hotel Management and Catering Technology; Economics of Labour at M.P.M., Indian Economic Environment at M.M.M. level etc. All these courses are affiliatedto Pune University. Furthermore, he has also worked as a visiting faculty at SIMS, Pune; teaching Managerial Economics to PGDBM students and delivered lectureson Monetary Economics to the students pursuing a course in M. A. Economics. Theauthor has judiciously used his wide academic experience, knowledge and observation about the current economic affairs at Global and Indian level, to present updated information which can immensely benefit the students pursuing a programmein Management Studies. Mrs. Swati Chaudhari Director - S. C. D. L.

CONTENTSChapter No. 1 2 3 4 5 6 7 8 9 Introduction to Managerial Economics Types of business Organizations Profit Demand Analysis Production and Costs Pricing and output determination in different markets Cost- Benefit Analysis Macro Economic Analysis Government and Private Business Reference Book TITLE Page No. 1 17 65 83 141185 257 285 319 351

Chapter 1INTRODUCTION TO MANAGERIAL ECONOMICSPreview Introduction, Definition of Managerial Economics, Nature and Scope of Managerial Economics, Significance of Managerial Economics, Economic Problem.INTRODUCTION Managerial Economics generally refers to the integration of economic theory with business practice. While economics provides the tools which explain various concepts such as Demand, Supply, Price, Competition etc. Managerial Economics applies these tools to the management of business. In this sense, Managerial Economics is also understood to refer to business economics or applied economics. Managerial Economics lies on the border line of management & economics. Itis a hybrid of two disciplines and it is primarily an applied branch of knowledge. Management deals with principles which help in decision making under uncertainly and improve effectiveness of organization. Economics on the other hand provides a set of propositions for optimum allocation of scarce resources to achievethe desired objectives. 1. 1. Definitions of Managerial EconomicsProf. Spencer Sigelman : Managerial Economics deals with integration of economictheory with business practice for the purpose of facilitating decision making and forward planning by management. Prof. Hague : Managerial Economics is concerned with using logic of economics, mathematics & statistics to provide effectiveways of thinking about business decision problems. Prof. Joel Dean : The purposeof Managerial Economics is to show how economic analysis can be used in formulating business polices.2.3.Introduction to Managerial Economics1

4.Prof. Mansfield : Managerial Economics attempts to bridge the gap between the purely analytical problems that intrigue many economic theories and the problems ofpolicies that the management must face. Mc Nair and Meriam : Managerial economics consists of the use of economic modes of thought to analyse business situations.5.The definitions given above highlight the following points : i) ii) iii) iv) v)Economic theory provides the basis for the decision making process. There is some difference between the generalizations based on abstraction and actual practices. Besides economic theory, mathematics & statistics help in decision-making. An attempt is made to arrive at generalizations regarding business policies. Since decisions have repercussions on the working of firms in future, and most firmsenvisage to continue operations over a period of time, forward planning becomesan important element.The problem of decision making arises whenever a number of alternatives are available For example : What should be the price of the product? What should be thesize of the plant to be installed? How many workers should be employed? What kind of training should be imparted to them? What is the optimal level of inventories of finished products, raw mater spare parts, etc.? The significance of a goodsystem of forward planning can be appreciated from the fact that it helps in selecting the plant to be installed and it is not possible to change its capacityas and when required. Also different production process require different skillswhich have to be provided. Similarly, based on the long-term plans, funds haveto be arranged : either procured from outside or retained out of the earnings ofthe firm. Economics provides the solution to some of these problems to enable the firm to achieve its objective. For example, the demand for a product is influenced by factors such as (i) the distribution of income, (ii) prices of relatedproducts, and (iii) data on demand at some future point of time facilitates thetask of forward planning. Similarly, the theoretical explanation of the problemof input-mix (the ratio in which machines, men and other resources are to be employed) is provided by production function along with the prices of inputs. Thisindirectly facilitates the choice regarding the technique of production to be employed and the plant to be installed. 2Managerial Economics

The propositions of economics, however, require to be modified keeping in mind the constraints of availability of requisite data and the time at the decision-maker. 2. 1. Nature of Managerial Economics : It is true that managerial economicsaims at providing help in decision-making by firms. For this purpose, it drawsheavily on the propositions of micro economic theory. Note that micro economicsstudies the phenomenon at the individuals level : behavior of individual consumers, firms. The concepts of micro economics used frequently in managerial economics are : (i) elasticity of demand, (ii) marginal cost, (iii) marginal revenue, (iv) market structures and their significance in pricing policies, etc. Some of these concepts, however, provide only the logical base and have to be modified inpractice. Micro economics assists firms in forecasting. Note that macro economictheory studies the economy at the aggregative level and ignores the distinguishing features of individual observations. For example, macro economics indicatesthe relationship between (i) the magnitude of investment and the level of national income, (ii) the level of national income and the level of employment, (iii)the level of consumption and the national income, etc. Therefore, the postulatesof macro economics can be used to identify the level of demand at some future point in time, based on the relationship between the level of national income andthe demand for a particular product. For example, there is a relationship between the level of national income and demand for electric motors. Also, the demandfor durable goods such as refrigerators, air-conditioners, motor cars depends upon the level of national income. Managerial Economics is decidedly applied branch of knowledge. There fore, the emphasis is laid on those propositions which are likely to be useful to the management. Managerial Economics is prescriptive innature and character. It recommends that a thing should be done under alternative conditions. For example, If the price of the synthetic yarn falls by 50%, itmay be desirable to increase its use in producing different types of textiles. Thus, managerial economics is one of the normative sciences and reflects upon thedesirability or otherwise of the propositions. For example if the analysis suggests that the benefit-cost ratio of a large plant is less than that for a smaller plant and the benefit-cost ratio is used as the criterion for project appraisal it is recommended that the firm should not install a large plant. Contrast this with the positive sciences which state the propositions without commenting upon what should be done. For example, if the distribution of income has become more uneven, it is stated without indicating what should be done to correct this phenomenon. Managerial Economics, to the extent that it uses economic thought, isa science, but it is an applied science. Economic thought uses deductive logic (if X is true, then Y is2.3.4.5.Introduction to Managerial Economics3

true). For example, if the triangles are congruent, their angles are equal. To have confidence in the findings, the propositions deduced are subjected to empirical verification. For example, empirical studies try to verify whether cost curves faced by a firm are really Ushaped as suggested by the theory. Furthermore, there is an attempt to generalize the propositions which provide a predictive character. For example, empirical studies may suggest that for every 1% rise in expenditure on advertising, the demand for the product shall increase by 0.5%. Fromthe above it follows that managerial economics uses a scientific approach. In practice, some firms may use simple rules based on past experience. However, thequality of discussions made can be improved using a systematic approach. This isattempted in managerial economics. 3. Scope of Managerial Economics :The scope of Managerial Economics is so wide that it embraces almost all the problems & areas of the manager and the firm. It deals with demand analysis and forecasting, production function, cost analysis, inventory management advertising price system, resource allocation, capital budgeting etc. While an in-depth treatment is given to these aspects in the relevant chapters, a cursory treatment ofthese aspects has been attempted here, merely to explain the scope of the subject. 1.Demand analysis and forecasting :It analyses carefully and systematically the various types of demand which enable the manager to arrive at a reasonable estimate of demand for products of his company. He takes into account such concepts as income elasticity and cross elasticity. When demand is estimated, the manager does not stop at the stage of assessing the current demand but estimates future demand as well. This is what is meant by demand forecasting.2.Production Function :We know that resources are scarce and also have alternative uses. Inputs play avital role in the economics of production. The factors of production, otherwisecalled inputs, may be combined in a particular way to yield the maximum output.Alternatively, when the price of inputs shoot up, a firm is forced to work out acombination of inputs so as to ensure that this combination becomes least costcombination. In this way, the production function is pressed into service by managerial economics.3.Cost Analysis :Cost analysis is yet another area studied by managerial economics. For instance,determinants of cost, methods of estimating costs, the relationship between cost & output, the forecast of cost and profit-these are very vital to a firm. Managerial Economics4Managerial Economics

touches these aspects of cost-analysis, an effective knowledge and application of which is cornerstone for the success of a firm. 4.Inventory Management :An inventory refers to stock of raw materials which a firm keeps. Now the problem is how much of the inventory is ideal stock. If it is high, capital is unproductively tied up, which might, if the stock of inventory is reduced, be used forother productive purposes. On the other hand, if level of inventory is low, production will be hampered. Therefore, managerial economics will use such methods as ABC analysis, a simple simulation exercise and some mathematical models with aview to minimize the inventory cost. It also goes deeper into such aspects as the need for inventory control; it classifies inventories and discusses the costsof carrying them.5.Advertising :It may sound strange when we say that advertising is an area which managerial economics embraces. While the copy, illustration, etc., of an advertisement are the responsibility of those who get it ready for the press, the problems of cost,the methods of determining the total advertisement costs and budget, the measuring of the economic effects of advertising these are the problems of the manager.To produce a commodity is one thing; to market it is another. Yet the massage about the product should reach the consumer before he thinks of buying it. Therefore, advertising forms an integral part of decision-making and forward planning.6.Price System :It has already been pointed out that the pricing system as a concept was developed by economics and it is widely used in managerial economics. The central functions of an enterprise are not only production but pricing as well. While the cost of production has to be taken into account while pricing a commodity, a complete knowledge of the price system is quite essential to determination of price. For instance, an understanding of how a product has to be priced under differentkinds of competition, for different markets is essential to the pricing of thosecommodities. An understanding of the pricing of a product under conditions of Oligopoly is also essential. Pricing is actually guided by considerations of costplus pricing and the policies of public enterprises. Further, there is such a thing as price leadership and non-price competition. It is clear from these factsthat the price system touches upon several aspects of managerial economics andaids or guides the manager to take valid and profitable decisions.7.Resources Allocation :Scarce resources obviously have alternate uses. How best can these scarce resources be allocated to competing needs? The aim, of course, is to achieve optimization. ForIntroduction to Managerial Economics5

this purpose, some advanced tools, such as linear programming, are used to arrive at the best course of action for a specified end. Generally speaking, two kinds of problems are of the utmost importance and concern to the manager. First, how should he arrive at an optimum combination of inputs in order to get the maximum output? Secondly, when the prices of inputs increase, what type of sub-situation should he resort to? Or, alternatively, what type of combination of inputs should he work out in order to ensure the least-cost combination? 8.Capital Budgeting :This is another area which calls for a thorough understanding on the part of themanager if he is to arrive at meaningful decisions. Capital is scarce, and it costs something. Now the problem is how to arrive at the cost of capital; how toensure that capital becomes rational; how to face up to budgeting problems; howto arrive at investment decisions under conditions of uncertainty; how to effecta cost-benefit analysis, etc. These areas cannot be ignored by any manager. Itis obvious form the foregoing discussion that managerial economics is applied economics. It makes use of the tools which have been developed not only be economics but by other disciplines as well. The subject matter of managerial economicscovers two important areas, namely, decision-making and forward planning. Thesetwo areas are essential to every stage of planning, production, marketing, etc.Managerial economics, therefore, plays a vital role in the successful business operations of a firm.Some other areas covered by Managerial Economics are : 1. 2. 3. 4. Linear programming, its assumptions and solutions. Decision making under risk and uncertainty. Profit planning and investment analysis. Sources of information on new projects, methods of project appraisal, social benefit cost analysis etc. Significanceof Managerial Economics./ How Does Economics Contribute to Management?:While performing his functions, a manager has to take a number of decisions in conformity with the goal of the firm. Many of the decisions are taken under the condition of uncertainty and therefore involve risk. Uncertainty and risk arise mainly due to uncertain behaviour of the market forces, i.e. the demand and supply, changing business environment, government policy, external influence on the domestic market and social and political changes in the country. The complexity of the modern business would add complexity to the business decision - making. However, the degree of uncertainty and risk can be greatly reduced if market conditions could be predicted with a high degree of reliability.6Managerial Economics

Taking appropriate business decisions requires a clear understanding of the technical and environmental conditions under which decisions are to be taken. Application of economic theories to explain and analyse the technical conditions and the economic environment in which a business undertaking operates contributes a good deal to the rational decision-making. Economic theories have therefore gained a wide application to the analysis of practical problems of business. With thegrowing complexity of business environment, the usefulness of economic theory as a tool of analysis and its contribution to the process of decision- making hasbeen widely recognized. Prof. Baumol has pointed out three main contributions of economic theory to business economics. First, one of the most important thingswhich the economic (theories) can contribute to the management science is building analytical models which help in recognizing the structure of managerial problems, eliminating the minor details which might obstruct decisionmaking, and in concentrating on the main issue. Secondly, economic theory contributes to the business analysis a set of analytical methods which may not be directly applied to specific business problems but they do enhance the analytical capabilities of the business analyst. Thirdly, economic theories offer clarity to the various concepts used in business analysis, which enables the managers to avoid conceptual pitfalls. 5. Economic Problem :THE SOURCE OF ECONOMIC PROBLEMS Resources and scarcity The resources of a society consist not only of the free gifts of nature, such as land, forests and minerals, but also of human capacity, both mental and physical, and of all sorts of man-made aids to further production, such as tools, machinery and buildings. It issometimes useful to divide those resources into three main groups : 1. 2. 3. All those free gifts of nature, such as land, forests, minerals, etc., commonly called natural resources and known to economists as LAND; All human resources, mental and physical, both inherited and acquired, which economists call LABOUR; andAll those man-made aids to further production, such as tools, machinery, plantand equipment, including everything man-made which is not consumed for its own sake but is used in the process of making other goods and services, which economists call CAPITAL.These resources are called FACTORS OF PRPDUCTION because they are used in the process of production. Often a fourth factor, ENTEPRENEURSHIP (from the French word entrepreneur, meaning the one who undertakes tasks), is distinguished. The entrepreneur is the one whoIntroduction to Managerial Economics7

takes risks by introducing both new products and new ways of making old products. He organizes the other factors of production and directs them along new lines.(When it is not distinguished as a fourth factor, entrepreneurship is includedunder labour.) The things that are produced by the factors of production are called commodities. Commodities may be divided into goods and services : goods aretangible, as are food grains, cars or shoes; services are intangible, as they are valued because of the services they confer on their owners. A car, for example, is valued because of the transportation that it provides and possibly also forthe flow of satisfaction because of the transportation that it provides and possibly also for the flow of satisfaction the owner gets from displaying it as a status symbol. The total output of all commodities in one country over some period, usually taken as a year, is called Gross National Product, or often just National Product. In most societies goods and services are not regarded as desirablein themselves; no great virtue is attached to piling them up endlessly in warehouses, never to be consumed. Usually the end or goal that is desired is that individuals should have at least some of their wants satisfied. Goods and servicesare thus regarded as means by which the goal of the satisfaction of wants may bereached. The act of making goods and services is called production, and the actof using these goods and services to satisfy wants is called consumption. Anyone who helps to produce goods or services is called a producer, and anyone who consumes them to satisfy his or her wants is called a consumer. The wants that canbe satisfied by consuming goods and services may be regarded, for all practicalpurposes in todays world, as insatiable. In relation to the known desires of individuals for such commodities as better food, clothing, housing, schooling, holidays, hospital care and entertainments, the existing supply of resources is woefully inadequate. It can produce only a small fraction of the goods and servicesthat people desire. This gives rise to one of the basic economic problems : theproblem of scarcity. Every nations resources are insufficient to produce the quantities of goods and services that would be required to satisfy all of its citizens wants. Most of the problems of economics arise out of the use of scarce resources to satisfy human wants. 6. Meaning of Economic Problem :Now, if we put together the four characteristics namely, human wants are unlimited, that human wants vary in their intensity, that means or resources are relatively limited, and they have alternative uses, but if used to satisfy one want, the same means cannot be used to satisfy any other want it becomes clear that every man begins to face the problem of economizing his means. The problem of economy is how to use the relatively limited resources8Managerial Economics

with alternative uses in the face of unlimited wants. Naturally, everyone will so try to use his relatively limited resources with alternative uses that he getsmaximum satisfaction out of his resources. In view of limited resources and unlimited wants, he will try to satisfy those wants which are most urgent or intense and then those wants slightly less urgent and so on thus sacrificing the satisfaction of those wants which are lower on the scale of preference for which he may not have resources. This is the problem of economy how to economics or make the maximum use of limited resources. In the light of the above situation, LionelRobbins writes : Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses. Economic Problem at the Family Level Almost in every community, family is the basic unit of social organization. Just as, every individual has to face the basic economic problem namely unlimited wants and limited means with alternative uses exactly in thesame way, every family, poor or rich, Indian, European and American, ancient ormodern, finds that it has unlimited wants (e.g. food grains, clothing, shelter,education of children, medicines during sickness, insurance, tax-payment, guests, recreation, religious and social ceremonies, etc.) ; but the resources at itsdisposal are relatively limited. Every family, poor or rich, therefore faces the basic economic problem how to make the best use of the limited resources so asto secure maximum satisfaction out of them. The Indian family may be thinking in terms of Rs.5,000/- which may be its monthly income, whereas an average American family earning U.S. $ 5,000 a month may be thinking in terms of that as a fairly big amount. But as we have observed, each family in relation to its wants, finds that the resources at its disposal are limited, that they have alternativeuses and therefore the problem of economizing them must be faced. No family canavoid this basic economic problem. Economic Problem at the Universal Level Or Economic Problem A Universal Problem The same basic economic problem unlimited wants and relatively limited resources - arises at all levels of human organization. Thus whether we are thinking of a Grampanchayat, or of Zilla Parishad, or of aclub or hospital or university or the national government, all have to face thesame basic economic problem. Thus whether it is the Government of India or theGovernment of the richest country namely the United States, the problem of economy is always there. The Government of India with an annual revenue of about Rs.1,00,000/- corers has innumerable demands on its resources such as meeting mounting defense expenditure, expanding expenditure in respect of development that isto be brought about in various sectors like agriculture, industries, transport,education and so on and so forth, with no limit on its increasing wants. The Government of India therefore continually facesIntroduction to Managerial Economics9

the basic problem of economy of how to make the best use of its limited resources. In the some way, the Federal Government of the United States, the richest government, faces the same basic economic problem. Though in absolute terms, its annual revenues are enormous running into billions or trillions of dollars, its needs are also unlimited expanding and modernizing defense forces, establishing military bases all over the world giving economic and military assistance to friendly countries, meeting expanding expenditure on space and military research, exploring oceans and so on and so forth. And therefore even the richest Governmentof the United States is always confronted by the same basic economic problem unlimited wants and limited resources with alternative uses. Every nation, poor orrich, small or great, with small population or with huge population, has to facethis basic economic problem; no nation can ever escape it. Thus there is something universal about the problem of economy. The basic problem of economy arises inthe case of an aboriginal, a villager, a city dweller, in the case of the pooras also the rich, in the case of an Indian, a Frenchman and an American, in thecase of associations like clubs, schools, hospitals and government organizationsright from the village level to the national level. The problem of economy wasthere in ancient times and it is there before everybody at present. The problemof economy unlimited wants and limited means with alternative uses has been forever confronting mankind. The economic problem is a universal problem. Economic problem does not recognize boundaries of caste, creed, colour , religion, cultureBasic Economic Problems Seven more general questions that must be faced in alleconomies, whether they be capitalist, socialist or communist, & mixed are explained below. 7. 1) Seven Questions faced by all economies : What commodities arebeing produced and in what quantities? This question arises directly out of thescarcity of resources. It concerns the allocation of scarce resources among alternative uses (a shorter phrase, resource allocation, will often be used). The question What determines the allocation of resources or resource allocation? have occupied economists since the earliest days of the subject. In free market economies, most decisions concerning the allocation of resources are made through the price system. The study of how this system works is the major topic in the THEORYOF PRICE. By what methods are these commodities produced? This question arisesbecause there is almost always more than one technically possible way in which goods and services can be produced. Agricultural goods, for example, can be produced by farming2)10Managerial Economics

a small quantity of land very intensively, using large quantities of fertilizer,labour and machinery, or farming a large quantity of land extensively, using only small quantities of fertilizer, labour and machinery. Both methods can be used to produce the same quantity of some good; one method is frugal with land butuses larger quantities of other resources, whereas the other method uses large quantities of land but is frugal in its use of other resources. The same is trueof manufactured goods; it is usually possible to produce the same output by several different techniques, ranging from ones using a large quantity of labour andonly a few simple machines to ones using a large quantity of highly automated machines rather than another, and the consequences of these choices about production methods, are topics in the THEORY OF PROCDUCTION. 3) How is societys output of goods and services divided among its members? Why can some individuals and groups consume a large share of the national output while other individuals and groups can consume only a small share? The superficial answer is because the formerearn large incomes while the latter earn small incomes. But this only pushes the question one stage back. Why do some individuals and groups earn large incomeswhile others earn only small incomes? Economists wish to know why any particular division occurs in a free market society and what forces, including governmentintervention, can cause it to change. Such questions have been of great concernto economists since the beginning of the subject. These questions are the subject of the THEORY OF DISTRIBUTION. When they speak of the division of the national product among any set of groups in the society, economists speak of THE DISTRIBUTION OF INCOME. 4) How efficient is the societys production and distribution? This questions quite naturally arises out of question 1, 2 and 3. Having asked what quantities of goods are produced, how they are produced and to whom they aredistributed, it is natural to go on to ask whether the production and distribution decisions are efficient. The concept of efficiency is quite distinct form theconcept of justice. The latter is a normative concept, and a just distributionof the national product would be one that our value judgments told us was a goodor a desirable distribution. Efficiency and inefficiency are positive concepts.Production is said to be inefficient if it would be possible to produce more ofat least one commodity without simultaneously producing less of any other by merely reallocating resources. The commodities that are produced are said to be inefficiently distributed if it would be possible to redistribute them among the individuals in the society and make at least one person better off without simultaneously making anyone worse off. Questions about the efficient of production and allocation belong to the branch of economic theory called WELFARE ECONOMICS.Introduction to Managerial Economics11

Questions 1 to 4 are related to the allocation of resources and the distributionof income and are intimately connected, in a market economy, to the way in which the price system works. They are sometimes grouped under the general heading of MICRO ECONOMICS. 5) Are the countrys resources being fully utilized, or are some of them lying idle? We have already noted that the existing resources of any county are not sufficient to satisfy even the most pressing needs of all the individual consumers. Surely if resources are so scarce that there are not enough ofthem to produce all of those commodities which are urgently required, there canbe no question of leaving idle any of the resources that are available. Yet oneof the most disturbing characteristics of free market economies is that such waste sometimes occurs. When this happens the resources are said to be involuntarily unemployed (or, more simply, unemployed). Unemployed workers would like to have jobs, the factories in which they could work are available, the managers andowners would like to be able to operate their factories, raw materials are available in abundance, and the goods that could be produced by these resources are urgently required by individuals in the community. Yet, for some reason, nothinghappens : the workers stay unemployed, the factories lie idle and the raw materials remain unused. The cost of such periods of unemployment is felt both in terms of the goods and services that could have been produced by the idle resources,and in terms of the effects on people who are unable to find work for prolongedperiods of time. Why do market societys experiences such periods of involuntaryunemployment which are unwanted by virtually everyone in the society, and can such unemployment be prevented from occurring in the future? These questions havelong concerned economists, and have been studied under the heading TRADE CYCLE THEORY. Their study was given renewed significance by the Great Depression of the1930s. In the USA and the United Kingdom, for example, this unemployment was never less than one worker in ten, and it rose to a maximum of approximately one worker in four. This meant that, during the worst part of the depression, one quarter of these countries resources were lying involuntarily idle. A great advancewas made in the study of these phenomena with the publication in 1936 of the General Theory of Employment, Interest and Money, by J. M. Keynes. This book, and the whole branch of economic theory that grew out of it, has greatly widened thescope of economic theory and greatly added to our knowledge of the problems of unemployed resources. This branch of economics is called MACRO ECONOMICS. 6) Is the purchasing power of money and savings constant, or is it being eroded becauseof inflation? The worlds economies have often experienced periods of prolonged and rapid changes in price levels. Over the long swing of history, price levels have sometimes risen and sometimes fallen. In recent decades, however, the courseof prices has almost always been upward. The 1970s, 1980s and 1990s saw a period ofManagerial Economics12

accelerating inflation in Europe, the United States and in most of the world, more particularly in the less developed countries. Inflation reduces the purchasing power of money and savings. It is closely related to the amount of money in the economy. Money is the invention of human beings, not of nature, and the amountin existence can be controlled by them. Economists ask many questions about thecauses and consequences of changes in the quantity of money and the effects ofsuch changes on the price level. They also ask about other causes of inflation.7) Is the economys capacity to produce goods and services growing from year to year or is it remaining static? Why the capacity to produce grows rapidly in someeconomies, slowly in others, and not at all in yet others is a critical problemwhich has exercised the minds of some of the best economists since the time of Adam Smith. Although a certain amount is now known in this field, a great deal remains to be discovered. Problems of this type are topics in the THEORTY OF ECONOMIC GROWTH.Introduction to Managerial Economics13

Exercise : 1. 2. 3. 4. 5. Define Managerial Economics. Explain the Nature and Scope of Managerial Economics. What is the Significance of Marginal Economics? What is an economics problem? There is something Universal about and economic problem Discuss.14Managerial Economics

NOTESIntroduction to Managerial Economics15

NOTES16Managerial Economics

Chapter 2TYPES OF BUSINESS ORGANISATIONSPreview Introduction, A firm, plant, Industry, Types of Business organizations Proprietary Firms, Partnership Firms, Joint Stock Companies, Public Sector Undertakings, Co-operative Societies ,Non-profit organizations, Business Organization in new millennium, Organization Goals Profit Maximization, sales Maximization,Satisfying Theory, other goals or objectives of firms.INTRODUCTION Organisation of production requires bringing together various factors of production and coordinating the efforts of all the participants in the process of production. The level at which this is done is the level of a firm. Production with the profit motive is modern concept, in the sense that it has becomedominant only after the Industrial Revolution. Before the Industrial Revolution, most of the economies of the world were agricultural economies. The profit motive was always a secondary motive in an agricultural economy. But in modern times the profit motive became the only dominant motive of production. A firm is a unit of production where production is done with the sole aim of profit maximization. 1. Definition of a firm as a producing unit.For the sake of understanding this concept of the firm, let us study some definitions of the firm given by eminent economists. 1. 2. 3. Hansn : The firm may bedefined as an independently administered business unit. "A firm is a centre of control where the decisions about what to produce and how to produce are taken.""A firm is a business unit which hires productive resources for the purpose of producing goods and services."Types of Business Organisations17

4.Harvey Leibenstein : A firm is " an independent organization whose destiny is determined by the magnitude of the aggregate pay off and in which the aggregate pay off depends directly on its performance and especially on the production and sale of services or goods." In the words of Prof. Lipsey, "The firm is defined asthe unit that uses factors of production to produce commodities that it then sells either to other firms, to households or to the central authorities (meaninggovernment, public agencies etc.) The firm is thus the unit that makes the decisions regarding the employment of factors of production and the output of commodities." How much to consume is decided by the households. In keeping with preferences of the consumers, the firms decide how much to produce, how to produce etc.Through advertisements, a firm may try to increase its sales, but the decisionsto buy belong to the buyers. The decisions regarding choice of techniques and quantify of a commodity are taken by the firm. The firm is assumed to take consistent decisions in relation to the choice open to it. The internal problems regarding the process of decision - making i.e. who reaches decision, how are they reached etc. are ignored. We take firm as a single unit - smallest possible unit.It is taken as our atom of behavior on the demand side. Again, just as the household is assumed to seek satisfaction maximization, the firm is assumed to seek maximization of its profits. The firm may be a proprietorship firm or a partnership firm or a Multi-National Corporation. That it is a unit of decision - makingis our criterion. Therefore, for an economist, Tata Engineering and Locomotive Company Ltd. is a firm. Again, what form of business organization and managementexperts? An economist assumes that the firm is internally properly organized andis capable of taking decisions.5.From the above definitions, it will be seen that there is a substantial difference in all these definitions and still in their own way they describe the firm correctly. This is so because these economists have given prominence to the questions which were more important for them or for their country or when they were writing, and so if we study the various features of firm as revealed by these definitions, the concept will be more clear. The following features of a firm emergefrom these definitions: 1) It is a centre where decisions about what, where, how and how much to produce are taken. It is a centre where the means of production are hired or purchased and used for production. It is a centre, where the success of production is reviewed in its entire context and decisions are taken.2) 3)18Managerial Economics

4)It is a centre, where the means of production are collected, the production is done, and the sale and distribution of production is also affected. It is a centre, where all the decisions about production are taken. These include decisions regarding the distribution of the product, advertising, sale and those regardingfacing competition also.5)From the above features of a firm, it will be clear that a firm has to perform several functions simultaneously - i.e. to produce a commodity, to sell and distribute the commodity, to advertise the commodity and to perform all those thingswhich will be required to survive competition. To cap it all, the firm is expected to make as much profits as possible. Theoretically speaking, a firm is expected to organize all the factors of production in the most profitable manner. If one studies the structure and function of modern firm the above definitions willappear to be too simple, because in modern times the firm is expected to performso many other functions. Formerly, the entrepreneur was taken to be an independent factor of production. Even today the entrepreneur is no doubt a very important factor of production but he has become so highly indispensable that it is very difficult to separate him from the production unit of the firm because ultimately the will to produce is provided by the entrepreneur. The mere presence of all the factors of production and a market does not guarantee production. The willbe to produce is very important and it cannot be separated from the entrepreneur. Thus, the entrepreneur becomes inseparable from the firm. 2. The firm and theindustryFor understanding the difference between a firm and an industry, it would be advisable to understand the nature of a competitive industry. A competitive industry has three basic characteristics: (a) Large number of firms, (b) Homogeneous product; and (c) Freedom of entry and exit. In a competitive industry, there is alarge number of firms so that the action of a single firm has no effect on the price and output of the whole industry. Every firm therefore enjoys the freedom to increase or decrease its output substantially by taking the price of the product as given. Secondly, every firm in a purely competitive industry, it must be making a product which is accepted by customers as being identical with that madeby all the other producers in the industry. This is known as the condition of homogeneity. This ensures that all firms have to charge the same price. The buyers, of course, are to decide that the product is the same. The buyers should notfind any real or imaginary differences between the products sold by any two pairs of firms, Finally, there should be no barriers to the entry of new firms (or exit of old firm) to (or from) the industry.Types of Business Organisations19

We considered competitive industry because we wanted to contrast such an industry with a monopoly. Under monopoly, there is only one firm producing a product. Entry into the industry is not free; because if entry of an additional firm is allowed, it no longer remains a monopoly. Thus, under monopoly, the firm is the industry or the distinction between the firm and the industry disappears under conditions of monopoly. Between these two extremes, we get a wide range of marked structures where there are more than one firms product. Strictly speaking, all firms producing the same i.e. homogeneous product make an industry and whatever all such firms supply becomes the supply of the industry. In practice, however, wespeak of the cotton textile industry, though all cotton textile units do not produce identical textile products. Though the sugar produced by sugar factories might have different grades of quality, we speak of one sugar industry. Similarly, we speak of the automobile industry, steel industry, cement industry and so on. It should, therefore, be clear that all firms, producing a given product, together make an industry. 3. The firm and the plantA plant is a technical unit of a given capacity of output. For example, we speakof sugar plant What is it? It is nothing but an assembly of several machines, linked together (not necessarily physically but by processes also) capable of producing a given quantity of sugar per day. There is, for example, a weighing system which weighs the sugarcane, the conveyor system what takes the cane for crushing, the crushing machinery, and the machinery for removing impurities and so on, until finally sugar is filled in gunny bags. This whole plant taken together is capable of producing a given quantity of one product sugar. A plant thus produces any one product, obviously in cooperation with other factors of production.A sugar plant will produce sugar in co-operation with workers, managers, technicians etc. and after the necessary amounts of raw material; other chemicals and fuel are supplied to it. The firm, on the other hand, is an economic unit. The decisions are taken by the firm. What quality of sugar is to be produced, how muchof it is to be produced, to which market it should be sold and from which farmers the sugarcane should be purchased etc. are decisions to be taken by the firm.It is not necessary that a firm has only one plant. Thus, for example, a sugarfactory (i.e. a firm engaged in the production of sugar) may have a sugar plant,an alcohol plant (i.e. a distillery), a cattle - feed plant (producing cattle feed out of bagasse) - all under one management. When we say one management, we are implying one firm though there are various plants, it is also possible that aplant supplies goods to more than one firms. The difference, basically, is thatbetween a technical unit and an economic unit.20Managerial Economics

One last word about a firm. We speak of the producer or the entrepreneur. Whenever we speak of a producer or an entrepreneur we imply a firm that takes decisions. Internally the decisions might be taken by a group of directors, managers ora sole proprietor - our unit on the supply side is the firm. 4. Types of Business OrganisationsIntroduction:A business organization is concerned with how production and sale of a commodityare organized. In this chapter, we study various forms of business organization.lTypes of Business Organization :The main types of business organization are as follows: i) ii) iii) iv) v) vi) vii) ix) A. One -man Business or Individual or Sole Proprietorship or ProprietaryFirms. Partnership Joint Stock Company Joint Hindu Family Firms Co-operative Organizations State Enterprise/Public Enterprises Joint Sector Organizations Business Organizations of the New Millennium Private Sector :viii) Non-Profit Organizations andIn a capitalist economy, the first four types of business organizations are setup in the private sector. The private sector is owned by private individuals, families or groups of individuals. It is characterized by private ownership in themeans of production, economic freedoms and profit motive. In addition to the first three types of business organization, there are also Joint Hindu Family Firms in the private sector in India and Business Organizations of the New Millennium. B. Public Sector :The public sector includes public or state enterprises like railways, post sandtelegraphs, etc. The public sector is owned and controlled by the State. In India we have also a number of public enterprises like Hindustan Machine Tools, LifeInsurance Corporation, Bharat Heavy Electrical Ltd. etc. They are constituted as companies, public corporations and departmental undertakings.Types of Business Organisations21

C.Co - operative Sector :There are many co-operative organizations in the private sector. But they are non-capitalist in nature, e.g., Co-operative credit societies, consumers co-operative societies, producers cooperative societies, service societies, etc. D. Joint Sector :Joint sector organizations or enterprises are jointly owned by the public and private sectors. But day-today management is left to the private sector. The following chart indicates various forms of business organization: Types of Business OrganizationPrivate SectorPublic SectorJoint Sector(7) State Enterprises(8) Public Private OrganizationsCapitalist FormNon - Capitalist Form1) Proprietary Firms 6) Co-operative or Proprietorship Organizations 2) Partnership 3) Joint-Stock Company 4) Joint-Hindu Family Firms 5) Business Organizationsof the New Millennium Let us now study the types of business organizations as given in the above chart. 1. SOLE PROPRIETORSHIP OR PROPRIETARY FIRMS :(A) Definition : Individual or sole proprietorship which is also called sole trader ship or single entrepreneurship or proprietary firms is the most common, thesimplest and the oldest form of business organization. In such a unit, a singleman called proprietor organizes a business. It is owned, managed, controlled and directed by him.22Managerial Economics

He fixes the amount of capital to be invested, (his own or borrowed), uses his own labour and that of his family members, hires factors, whenever necessary, organizes production as efficiently as possible and markets the product at the highest possible prices. He assumes full responsibility for all business risks. He alone enjoys all profits, if he is successful and suffers all losses, if his business fails. (B) Characteristics: The definition of sole proprietorship Proprietary Firm gives its characteristics or features which are as follows: (i) Ownership by a Single Person: A single person initiates a business whose ownership liesin his hands. He enjoys full powers to fix the lay-out of his business firm. Organization and Control: A single person organizes and manages his business according to his experience and efficiency. He has full powers to conduct his businessin any manner he likes. He need not consult any one. He is also not required totake approval or agreement from others.(ii)(iii) Capital: The owner uses his own capital. He may also borrow capital to invest it in his business and thereby expand it. (iv) No Sharing of Profits and Losses: All the profits of business earned by the owner are enjoyed by him alone. These profits of business are not shared with other persons. On the other hand, if there are losses, he has to bear them alone entirely. Unlimited Liability: Hisliability is unlimited for all his debts. If he fails to clear his business debts, all his private property can be attached by his creditors. Easy to Form: Itcan be easily set up. It is not subject to any special legislation. So no legalformalities are involved in starting such a concern by any person who is of major age, i.e. 18 years and above.(v)(vi)(vii) Legal Status: A sole trading concern cannot be legally separated from itsowner or proprietor. The owner and organization are the same. The life of such aconcern depends upon the life of its proprietor. This type of organization is found in agriculture, retail trade, hotel, printing press, tailoring etc.(C) Merits and Demerits of Sole Proprietorship or Proprietary Firm :MERITS OF PROPRIETORSHIP OR PROPRIETARY FIRM : (i) Easily Started: Such a concern can be easily started without any legal formalities. There is also little government interference. Also it is simple to manage and control andTypes of Business Organisations23

requires a small amount of capital for generally it adopts labour - intensive techniques. He can also get finance on personal credit. (ii) Prompt Action: The proprietor can take quick decisions and prompt action regarding his business, itslocation, method of production etc. He need not consult others about these problems.(iii) Personal Interest: He would always take personal interest in the businesswith a view to finding out causes of loss and waste of resources. He would thentake measures to remove them. Thus he would maximize his profits. (iv) Requirements of Consumers: He has direct contact with his customers, so he can personallyattend to all their requirements. He can produce goods according to their desires, tastes and needs. His attempts to meet their needs will help him to increasehis sales and profits. Thus it is suitable for small business. (v) Cordial Relations: He has direct and continuous contact with his employees. So he can establish cordial relations with them. This is because he will be in a continuous touch with them. He can also supervise them directly. Hence any scope for conflict between workers and himself can be avoided.(vi) Efficiency, Hard Work and Direct Gain: He will always attempt to work hard,efficiently and continuously. This helps to enjoy maximum profits and avoid anyloss for his liability is unlimited. (vii) Business Secrecy : He can carry on his business in secrecy. He is not required to give publicity to the activities of his concern nor disclose his profits to the public. He can also make use of any new idea for his business. (viii) Winding Up: Just as a sole trader can easilystart a business, so also he may easily wind up his business at any time. (ix)Economy in Expenses : Its overhead expense are low. Hence it is economical. Thenumber of employees employed by him is low. Hence the working expenses can be minimized. (x) Flexibility and Elasticity : Any change in business can be easily introduced without consulting any body. So it is flexible and elastic. It can easily and quickly adapt to changes in the market conditions.(xi) Transferability : It is easily transferable to heirs. (xii) Self - Employment : It promotes self-employment, self-reliance, development of one s personality, self-confidence etc.24Managerial Economics

(xiii) Lower Tax Burden : It is also subject to lower tax burden than other forms of business organizations. (xiv) Concentration of Wealth : It helps prevent concentration of wealth and income in the hands of a few persons. DEMERITS OF PROPRIETORSHIP OR PROPRIETARY FIRM : (i) Limited Capital : The amount of capital which an individual can command is limited. He has to depend mainly on his own savings. So it would be difficult for him to expand his business activities much. Itmay also be difficult for him to raise additional capital by borrowing from banks. Hence the size of his business is small. Unlimited Liability and Risks : Itmay be very risky for him to invest in a particular business. This is because ifhe adopts a wrong policy, he may lose everything and also become insolvent. This is because his liability is unlimited. This implies that if his debts exceed his business assets and if he suffers a loss, he will have to use his private property to clear his debts. So the unlimited liability restricts his business activities.(ii)(iii) Lack of Skill for Efficient Management : It may not also be possible for him to attend personally to all the activities of his concern such as correspondence, maintaining accounts, advertisements, supervision, arrangement of finance etc. He cannot undertake all activities alone efficiently. Further his business activities may be spread in different places and he may not possess all the qualities and skill required for an efficient management, supervision and control. (iv) Limited Ability of Management : The limited managerial ability may make it difficult for a sole proprietor to face competition in his business which is subjected to many changes. (v) No Economies of Scale : A sole trader cannot secure many of the economies of large - scale production such as purchase of raw materials at low prices, advantages of specialization etc., and minimize its cost of production or running business.(vi) Weakness in Bargaining and Competition : On account of the limitations of capital, ability and skill, the proprietor is likely to remain weak in respect ofbargaining and competition. (vii) Wrong Decisions : All the decisions about hisbusiness are taken by the sole proprietor. Some of his decisions may prove to be wrong. This may involve him in losses and ruin. (viii) Closure on Death : Sucha concern may be closed on the death of the proprietor. This is because he maynot have heirs to run it or they may not like to continue in his business. Hencethe business may not be continued.Types of Business Organisations25

2.PARTNERSHIP :(A) Definition and Meaning : The Indian Partnership Act, 1932, defines the partnership as "the relation between two or more persons who have agreed to share profits of a business carried on by all or any one of them acting for all."The English Partnership Act, 1890, defines partnership as "the relation which subsists between persons carrying on a business in common with a view to profit."So a partnership refers to an organization owned and managed by two or more persons. They pool their capital and undertake all risks associated with their business. Thus there is joint ownership, management, control and risk - taking. The persons who own the partnership concern are called "partners" Collectively, all partners constitute a "firm".(B) Characteristics or Features of a Partnership Firm :(i) Contract : It is formed voluntarily by an agreement between two or more persons carrying on a particular business for common benefit. It may also be formedto carry on certain trade, profession or lawful occupation. Age Limit : Only persons who have attained the major status can become partners. In other words, minors cannot become partners.(ii)(iii) A Partnership Deed : A partnership is formally based upon a partnership deed or agreement. It indicates the names of partners, the shares of individual partners in the capital, their rights and duties, proportion for sharing profits and losses by each of them etc. (iv) Registration : The registration of a partnership firm is voluntary. It may or may not be registered. However, if the partners so desire, it can be registered at any time. (v) Joint - Ownership : The partners are joint owners of the property of the firm. Its property must be used onlyfor the business purpose for which the partnership was formed. It cannot be used by any partner for his personal purposes.(vi) Joint - Management : All the partners enjoy equal rights of management. Soevery partner can participate in management. But for the sake of convenience, asingle partner may be given right to manage the firm. (vii) No Remuneration : Noremuneration is paid to any partner for services rendered by him to the firm. Each partner is supposed to work in the best possible manner for promoting the interest of the firm.26Managerial Economics

(viii) Statutory Limit or Number of Partners : It consists of minimum two persons and maximum 20 persons in the case of general business and maximum 10 personsin the case of banking. (ix) Business Activity : Any business selected by the partners can be undertaken. All of them or any of them can carry on business activity for all. (x) Sharing of Profit and Losses : There is a sharing of profits and losses. Profits can be distributed according to the partnership agreement or the capital ratio. Profit may be shared equally by partners, if nothing is mentioned in the partnership deed. A manager who is an employee of the firm may also be given a part of the profits.(xi) Mutual Confidence and Faith : A partnership is based upon mutual confidenceand trust of partners in each other or one another. Every partner must be honest regarding the partnership dealings and should provide all the facts and information regarding their business to all partners. (xii) Combination of Capital, Abilities and Skill : In a partnership firm, some offer capital, some management and organizational abilities and others, technical skills etc. (xiii) Working andDormant Partners : Some of the partners who provide only capital, and enjoy limited liability as in England are called Sleeping or Dormant or Special Partnerswhile others who run and manage the concern are called Active or Working or General Partners. But, in India all partners have unlimited liability. (xiv) Unlimited Liability : The liability of all partners is unlimited. Hence all partners are, jointly and severally, held responsible for the losses or debts of the firm to the full extent of their personal assets. Creditors are entitled to attach assets of any one partner or those of others so as to recover their dues. (xv) NonTransferability of Interest : A partner cannot transfer his powers or rights toany third party to do any work of the firm on his behalf. If he cannot do it himself, he has to retire from the partnership firm. However, a partner may admit another person as a new partner if other partners give their consent. (xvi) Principle of Agency : Every partner carries on business activities on behalf of the firm. So he binds the firm and other partners for every commitment that he makesin conducting business. Likewise he is bound by the business activities of the other partners. Thus every partner becomes a principal at one time and an agent of the firm at another time. Hence a partnership firm can be run by one or more partners acting on behalf of all partners.Types of Business Organisations27

(xvii)Dissolution : A partnership firm may not last long. It may be dissolved byany partner after giving a written notice to other partners and a new partnership may be formed by the remaining partners. It may also be dissolved due to thedeath of a partner or due to an adjudication of a partner as an insolvent. Suchpartnership firms are found among builders, solicitors, chartered accountants, small factories etc. (C) MERITS AND DEMERITS OF PARTNERSHIP : MERITS OF PARTNERSHIP : (i) (ii) Easy to Form : A partnership firm can be easily formed. Its formation does not involve legal formalities. More or Additional Capital : Under the partnership, more funds can be raised by all partners to start a business on a large scale. Because of the reputation of the partners and their contacts, it willnot be difficult for a partnership concern to borrow from banks on easy terms.(iii) Greater Efficiency due to Division of Labour : There is a greater efficiency in the working of partnership concerns because different partners can be assigned those tasks for which they are best suited as per their qualifications, experience, abilities, talents and aptitude. Thus, there would be specialization inthe task of every partner. (iv) Expansion of Business : A partnership firm canexpand its business by admitting more partners and raising more capital from them and thereby attempt to earn more profits. (v) Flexibility : It is also quite flexible and capable of adapting itself to changed circumstances of business by means of quick decisions and prompt action by the partners, i.e. it can quickly adapt itself to change in demand for its product, by increasing and decreasing its business operations and by changing its business policy. Thus the organizational structure of a partnership firm is flexible. The decision taking by a partnership firm does not involve any legal procedure. Its operations are not also subject to any restriction by a government. (vi) Co-operation : It may elicit full co-operation from workers by keeping a close touch with them, by understanding and solving their difficulties. (vii) Advantages of Large-scale Production : It can secure all the advantages of large scale production such as advantages of division of labour, bulk purchases of raw materials at lower price, best use of machinery etc. (viii) Business Secrecy : All the activities of partnership concernsneed not be given any publicity. Hence they can carry on their activities undersecrecy so far as the outsiders are concerned. It is not compulsory for a partnership concern to publish its profit and loss account and its balance sheet. Outsiders are not given its business secrets. 28Managerial Economics

(ix) Business Risks and Rewards : Business risks are equally shared by all the partners. In case business fails, they would suffer losses. But if it succeeds, they will enjoy profits. Hence, they will try to manage it efficiently and make their business profitable by putting the assets of the firm to the best uses so as to avoid waste. (x) Close Watch : Every partner has a right to take part in the partnership business. Since there is unlimited liability, every partner will keep a close watch on the activities of other partners so that losses are avoidedand profits are maximized. Thus the interest of every partner is protected.(xi) Unlimited Liability : Since there is unlimited liability, the business status of a partnership firm is raised. Hence it will be easy for it to get loans from financers. (xii) Management and Organizational Abilities : In a partnership firm, there is a combination of capital, abilities and skill. Some partners offercapital. Some partners are experts in management and organization. Some of thempossess technical skill. As a result of the pooling of the expert services of all partners, it is possible to run a partnership firm efficiently. (xiii) Dissolution : In case a partner is not happy with the working of his partnership firm,he can legally dissolve it. He can do so by giving a written notice to the other partners indicating his decision to resign from it. (xiv) Mutual Consent : Allthe business decisions are taken with mutual consent of all partners. They holdmutual consultations and discussions on important matters. Thus every partner benefits form the advice of other partners. As a result, their wisdom is pooled for the benefit of the firm. DEMERITS OF PARTNERSHIP (i) Unlimited Liability andNo Risk Business : On account of the principle of unlimited liability, any bad or irresponsible partner may ruin all the partners. This is because his activities will be binding on all other partners. Every partner runs a considerable riskfor any one of them is, jointly or severally, held responsible for the debts orlosses of the firm. Further due to unlimited liability, the partners may not undertake any risk in business or take any hasty step to expand business. Hence thespirit of enterprise is checked. Limited on Size of Business : It is also difficult to increase the size of business on account of limited amount of capital which the partners can raise or provide from their own sources. A partnership firmcannot also admit more than 20 members for raising additional resources. This limitation on the number of partners restricts the growth of a partnership form.(ii)Types of Business Organisations29

(iii) Short - Lived : A partnership can be dissolved by any partner by giving awritten notice to other partners. So this type of business is short-lived. Alsodefault, bankruptcy or insanity of any one of the partners leads to dissolutionof the firm unless a provision is made in the partnership deed to the contrary.(iv) Non - Transferability : A share in a partnership firm cannot be transferredby any partner without the consent of all the partners. He cannot also transferhis powers or rights to any third party to do any work of the firm on his behalf. (v) Differences of Opinion : The partners may not agree upon certain mattersof business policy. There might by differences of opinion, clashes of interest,mistrust, disputes etc. Such differences among partners may result in dissolution of partnership firms.(vi) No Trust : The activities of a partnership firm are kept secret from outsiders. It is not required to publish its accounts. It is also not subject to legalrestrictions. Hence people may not fully trust a partnership concern. (vii) NoGovernment Control : There is no government control or supervision on the activities of a partnership concern. Hence there is lack of public confidence in suchconcerns. (viii) Leakage of Important Information : Some of the partners may leak important information to outsiders. This may happen when there are differencesof opinion among the partners. Hence it may be difficult to maintain business secrecy in a partnership firm. (ix) Joint Liability and Dishonest Activities of Some Partners : The activities of a partner are binding on the partnership firm.Some partners may not behave properly. Some of them may be dishonest. Hence theymay misuse their rights and bring the firm into difficulties and ruin its business. As a result, the honest and efficient partners will have to suffer losses.3. JOINT - STOCK COMPANY :Introduction : In a modern economy, the predominant form of business organization is the Joint - Stock Company which is called Corporation in the U. S. A. Suchform of business organization is necessary to undertake any business or industryon a large scale. This is because it overcomes the drawbacks of sole proprietorship and partnership. (A) Definition : In the words of Mr. Kuchhal, a joint -stock company is "an incorporated association which is an artificial legal person,having independent legal entity, with a perpetual succession, a carrying a limited liability." As per the Indian Companies Act of 1956, a joint - stock companyis a company which has a permanent paid-up or nominal share capital or a fixed amount of capital divided into shares held and transferable as stock by shareholders who are its members. 30Managerial Economics

Thus a joint-stock company is a voluntary incorporated association of shareholders or stockholders who contribute to the common stock, (i.e., capital) of whichthey are the owners. But all of them do not directly manage it. It is managed bysome directors elected by shareholders. Their liability is limited to the valueof shares held by them. They share in profits and losses.(B) How Is It Formed ? : Minimum seven persons have to come together to start ajoint stock company. Those who take initiative to start it are called promoters.The promoters of a company have to get it incorporated by filing with the Registrar of Companies various documents such as Memorandum of Association, Articlesof Association, Prospectus, List of Persons who have agreed to act as directorsetc. The Memorandum of Association : This gives information about the company, namely, its place of location, its objects, the amount of capital to be raised etc. The Articles of Association : This gives us information about the rules and regulations and bye-laws of the company. The Registrar of Joint - Stock Companiesis given these documents. After going through these documents, the Registrar issues a Certificate of Incorporation. After this, the company comes into existence.Hence the registration of a joint - stock company is compulsory. (C) Features ofa Joint - Stock Company :(i) Voluntary Organization : A joint - stock company is a voluntary organizationor association of shareholders. Legal Person : It is a legal or an artificial person as a result of law. It has no physical existence. But it functions as a separate and independent legal person. It is distinct from its shareholders and its directors.(ii)(iii) Perpetual Succession : It has a perpetual or continuous succession under the law because it continues to exist even if some shareholders or directors dieor become insolvent or leave the company by transferring their shares. (iv) Common Seal : It has a common seal to be affixed on its contracts and legal documents. (v) Open Membership : Its membership is open to any person in any part of a country.(vi) Limited Liability : Liability of shareholders is limited to the nominal value of shares held by them.Types of Business Organisations31

(vii) Free Transferability of Shares : The shareholders are free to transfer orsell their shares to any person. (viii) Management by Elected Board of Directors: It is owned by its shareholders. But it is managed by a Board of Directors elected by shareholders. (ix) Fragmented Rights of Ownership : the shareholders enjoy a fragmented right of ownership due to shares purchased by them. (x) Dividends : The profits of a joint - stock company are annually distributed as dividends among its shareholders.(D) How is Capital Raised By a Joint Stock Company?:(a) Methods of Raising Capital : A company raises its capital in two ways, namely, (i) (ii) Through the sale of shares or stocks and Through the sale of bonds or debentures.Sale of shares of stocks (b) Types of Share Capital : A company divides its share capital as : (i) (ii) Registered or Authorized Capital, Issued Capital and(iii) Paid - up Capital. (i) (ii) Authorized Capital : Authorized Capital refersto the maximum amount which can be raised by a company by selling shares. Thismay be, say, Rs. 20 crores. Issued Capital : Issued Capital refers to that partof the authorized capital which is issued to the public for subscription by dividing into shares. This may be, say, Rs. 16 crores.(iii) Subscribed Capital : Subscribed Capital refers to that part of the issuedcapital which is actually subscribed by the public. This may be say, Rs. 14 crores. (iv) Paid - up Capital : Paid - up Capital refers to that part of the subscribed capital which the public directly pay-up to the company, as a part paymentof the value of their shares. This may be, say, Rs. 10 crores. The remaining amount of the subscribed capital is paid after further calls from the company.(c)Types of Shares : The capital of a company can be divided into three types of shares : (i) (ii) Equity or Ordinary Shares, Preference Shares and(iii) Deferred Shares. 32Managerial Economics

(i)Equity or Ordinary Shares : Such shares form the main basis of the finance of acompany. The holders of such shares get dividend only after the preference shareholders are paid out of its profits. Hence they bear maximum risk. This is because they do not get any dividend if the company does not make any profit. At times when profits are high, they get much more than the rate of dividend paid to preference shareholders. The ordinary shareholders have the right to vote to electthe Board of Directors of the Company. They have also the right to vote on policy decisions of the company. Hence they control the affairs of their company.(ii)Preference Shares : These shareholders enjoy a preferential or prior right overequity shareholders to the profit of a company. They are entitled to a fixed rate of dividend after paying interest on debentures and before any dividend is paid to equity shareholders. However, preference shares are classified as : (a) (b)(c) (d) (a) Simple or Non-Cumulative Preference Shares, Cumulative PreferencesShares, Participating Preference Shares and Redeemable Preference Shares.Simple or Non-Cumulative Preference Shares : People holding such shares are entitled to a fixed rate of dividend only in the year in which profits are made. They get the dividend before it is paid to other types of shareholders. CumulativePreference Shares : Such shareholders are entitled to a fixed rate of dividend even when there are no profits in any year. These claims will stand as arrears tobe paid first out of subsequent year s profit before it is paid to other typesof shareholders. Participating Preference Shares : The holders of such shares are paid a fixed rate of dividend before it is paid to other classes of shareholders. They are also entitled to participate in the balance of profits,in a certainproportion along with equity shareholders, after reasonable claims of these equity shareholders are met. Redeemable Preference Shares : Capital raised by issuing such shares must be paid back after a certain period of time either out of profits or by raising fresh capital by issuing new shares or by selling some of the assets of the company.33(b)(c)(d)Types of Business Organisations

The preference shareholders do not enjoy normal voting rights. However they havea prior claim on the assets of the company in the event of its liquidation. (iii) Deferred Shares : They are called the Promoters or Management s of Foundersshares. The holders of such shares are paid dividend last out of the profits left after meeting the claims of ordinary and preference shareholders and the reserve funds. Normally they are issued to promoters of a company but they may alsobe issued to public. If dividend paid to other classes of shareholders is restricted, the deferred shareholders will enjoy a bigger share of profits. But if there are no profits, they do not get anything. The deferred shareholders enjoy special or preferred voting rights. But the Indian Companies Act. Of 1956, has eliminated the system of issuing deferred shares by public limited companies. However a private limited company can issue deferred shares also. Sale of Bonds or Debentures Debentures : A company may also raise additional finance by borrowing from the public for a specific period of time, say, 15 to 25 years, at a particular rate of interest. This is done by issuing debentures or bonds. A debenture isan undertaking by a company to repay the borrowed money on or before the specified date at a particular interest rate, irrespective of profit or loss made by the company. The capital raised by selling debentures is like taking loans form the public. Hence, a debenture-holder is a creditor of a company with no voting right. As such, he cannot directly interfere with the activities of its management.A Debenture may be classified as (i) secured and (ii) simple.(i) (ii)A secured debenture is secured against the assets or property of a company. A simple debenture is not secured against its assets or property.A company is also free to issue convertible debentures which can be converted into equity shares after a period of time, say, 5 to 10 years, at a ratio fixed inadvance. (E)Types of Joint - Stock Companies :On Ownership Basis, all types of the registered companies in the private sectorcan be classified as : (a) (b) Public Limited Companies and Private Limited Companies.Managerial Economics34

In the public sector, we have government companies in which 51% of the paid-up share capital is held by the government. (F) Distinction Between Private LimitedCompanies and Public Limited Companies (Limited By Shares) : (1) A private limited company can be formed with two to fifty members maximum excluding employee shareholders of the company. But a public limited company can have any number of the members of the public but it should have a minimum 7 members. Public limitedcompanies are required to issue prospectus before allotting shares. But it is not necessary in the case of private limited companies. Public limited companies must submit statutory reports to the Registrar of Companies. But private limitedcompanies are not required to do so. A public limited company has to send its duly audited accounts to its shareholders. But a private limited company is not required to publish its accounts for the information of the public. However a private limited company must send three certified copies of its balance sheet to theRegistrar of Companies. The shares of a private limited company cannot be freely transferred on stock exchanges. But the shares of public limited companies canbe freely transferred on stock exchanges. The share of a private limited company openly invites public to subscribe to its shares or debentures. But a privatelimited company cannot appeal to the public to do so. A private limited companycan start its business after it is registered. But a public limited company cando so only after it gets a certificate for commencement of business. A private limited company should have minimum two directors. But a public limited company must have at least three directors. A private limited company may increase its number of directors without the government s approval. But a public limited company can do so only after getting the government s approval.(2)(3)(4)(5)(6)(7)(8)(9)(10) In the case of a public limited company only an individual can be appointedas its manager. But a private limited company can appoint a firm a as its manager.Types of Business Organisations35

(11) A private limited company can issue different classes of shares with disproportionate voting rights. But there are restrictions in this respect on a publiclimited company. A partnership may be converted into a private limited companyto enjoy the advantages of limited liability. (G) Management of Joint - Stock Companies : There is separation between ownership and management in a joint-stockcompany. Its ownership is in the hands of shareholders. But they do not manage it directly. They elect a Board of Directors which manages the company. The policies of the company are laid down by the directors. These policies are executed by salaried managers and executives. (H) Merits and Demerits of Joint-Stock Companies : MERITS OF JOINT - STOCK COMPANIES : (i) Limited Liability : The principleof limited liability is applicable to a joint-stock company. Hence we write word "Ltd." after the name of a company. Since the liability of shareholders is limited, risk faced by them are reduced. Hence even if a company suffers losses, they need not pay more than the face value of shares purchased by them. So the creditors of the company cannot make personnel attachments on their private property. Hence people are induced to invest their money in such companies. Large Amount of Capital : Large - scale production is facilitated under the company form ofbusiness organization. This is because it is easy for a company to raise a large amount of capital, by accepting fixed deposits from the public. Thus the savings of the people can be productively used.(ii)(iii) Transfer of Shares : The shares of a company are transferable whenever onelikes. Hence it would encourage small savers to invest in the shares of companies. If they do not like to keep their funds in a particular company, they wouldbe free to sell their shares on stock exchange and invest in some other companies. Thus the money of a share holder is not blocked. At the same time, this doesnot affect the company in any way. This is because the sales of shares of a company by some are counterbalanced by the purchase of these shares on a stock exchange by others. (iv) Shares of Different Varieties : The shares of a company areof different types, namely, equity shares, simple preference shares, cumulativepreference shares etc. The equity shares may be purchased by people who want take greater risks. On the other hand, those who do not want to take any risk may invest in cumulative preference shares. Thus, by providing a wide choice to shareholders, it is possible for a company to raise a large amount of capital. 36Managerial Economics

(v)Risky Enterprises : A joint-stock company can start a risky enterprise. This isbecause the risks associated with a business are greatly reduced due to the limited liability of shareholders and a small value of the shares of each shareholder. Further an individual may purchase shares of different companies so as to minimize the loss still further. So even if there is a loss in the case of one company, the individual shareholders may not be affected much.(vi) Less Danger of Misappropriation of funds : There is a less danger of misappropriation of funds. This is because the audited accounts of the companies mustbe published. (vii) Combination of Capital and Business Abilities : Many individuals possessing a large amount of capital and not having capacities to start andrun a business can invest in companies. Other persons, having no capital but possessing capacities to manage a business, can secure jobs as managers and executives in companies. (viii) Efficient Management : In a joint-stock company, the ownership and management are separated. The shareholders are owners but they do not manage it. It is managed by experts in different fields, who work under the direction of the Board of Directors. (ix) Economies of Scale : A joint - stock company can enjoy the economics of scale such as advantages of specialization anddivision of labour etc. by making full use of managerial skills and abilities and other factors of production. (x) Continuity and Stability : Since it has a perpetual succession, a company continues to carry on its business even if some ofthe original shareholders leave the company or die or become insolvent. So it ispermanent and stable in nature. So the business activities can be undertaken with a long-term objective.(xi) Legal control : Since companies are subject to rules and regulations of theCompanies Act, they are supposed to work in the interest of their shareholders.(xii) Democratic Management : There is democratic management in a joint-stock company. This is because the directors are elected by shareholders from time to time. The elected board of directors manage the company successfully because of their wide experience, abilities and efficiencies. (xiii) Research : Because of its continuous existence and a large amount of resources at its disposal, a company can conduct research and experiments, and apply the fruits of research to industrial uses. This will enable it to improve the quality of its product, reduceits cost of production and thereby enjoy good profits in due course. DEMERITS OFJOINT - STOCK COMPANIES : (i) Lack of Personal Interest and Inefficient Management : The actual management of a joint - stock company is in the hands of salaried executives. They have no personal interest in the functioning of their company. Hence they may not always manage the 37Types of Business Organisations

affairs of their company efficiently. Some of them might even leak out secrets of their company to rival companies. (ii) Indifference of Shareholders and Oligarchy : On account of their : limited liability, many of the shareholders are indifferent. They may not take an active part in the affairs of their company. Theyare also scattered. They are interested only in dividend. So a few big shareholders manage to get directorships and take all decisions. So, in actual life, there is oligarchy rather than democracy in the management of a company. Further these few directors manage to remain in power by some means or the other and enjoyvast powers of management and decision making. So shareholders are owners only in name. (iii) Promotion of self - interests and misuse of power by directors : Afew big directors, who control the affairs of the company, try to promote theirown interests in various ways at the cost of other shareholders. Further when the directors are dishonest, they may commit some frauds and cheat and exploit the shareholders. They may also purchase inputs from their friends and relatives at high prices and resort to other corrupt practices. They may also claim excessive fees. (iv) To Risky Ventures : the directors may be inclined to start very risky enterprises which may fail. Hence they will involve the shareholders in losses. (v) Extravagance : The directors may not behave in a responsible manner. They may spend in an extravagant way.(vi) Favouritism : The selection of the staff to work in various departments maynot be made by directors or managers on the basis of merit, but on the basis offavouratism, influence, personal relations etc. They may employ their friends and relatives in high posts paying high salaries. Hence the general working of acompany is likely to suffer. (vii) Unethical Practices : Directors possess inside information of the working of their company. Hence they may dispose of their shares at high prices by creating an impression that their company is going to make good profits when, in fact, the things are otherwise. So those who buy such shares will suffer losses. In the opposite case, when a company is likely to makegood profits, they may try to create an impression that it would suffer losses.This impression will induce other shareholders to sell their shares. They buy them through their agents. Hence they can get all the profits for themselves. Thetransferability and marketability of shares is also responsible for unhealthy speculative activities on stock exchanges on the part of some directors. As a result, the interests of shareholders are ignored with the result that a large number of them may be ruined.38Managerial Economics

(viii) Conflict : There is no close personal contact between employees and management. Hence there is likely to be a conflict between employees and the management. At times, this may result in strikes and lockouts. So the company s output would suffer causing thereby a loss to the shareholders. (ix) Political Corruption : A number of joint-stock companies may pay a large amount of money as donations to political parties. They are given for the personal benefit of directors and / or for the benefit of the company at the cost of the public. (x) Concentration of Economic Power and Wealth and Inefficient Management : Most of the important