CA Foundation Study Material – Page 3

CA Foundation Business Economics Study Material – Demand Forecasting

January 8, 2023

CA Foundation Business Economics Study Material Chapter 2 Theory of Demand and Supply – Demand Forecasting

Demand Forecasting

Meaning:

Demand forecasting is an estimate of the future market demand for a product. The process of forecasting is based on reliable statistical data of past and present behaviour, trends, etc.
Demand forecasting cannot be hundred per cent correct. But, it gives a reliable estimates of the possible outcome with a reasonable accuracy.
Demand forecasting may be at international level or local level depending upon area of operation, cost, time, etc.

Usefulness:

Demand forecasting is an important function, of managers as it reduces uncertainty of environment in which DECISIONS are made. Further, it helps in PLANNING for future level of production. Its significance can be stated as follows:

Production Planning: Demand forecasting is a pre-requisite for planning of production in a firm. Expansion of production capacity depends upon likely demand for its output. Otherwise, there may be overproduction or underproduction leading to losses.
Sales Forecasting: Sales forecasting depends upon demand forecasting. Promotional efforts of the firm like advertisements, suitable pricing etc. should be based on demand forecasting.
Control of Business: Demand forecast provide information for budgetary planning and cost control in functional area of finance and accounting.
Inventory Control: Demand forecasting helps in exercising satisfactory control of business inventories like raw-materials, intermediate goods, semi-finished goods, spare parts, etc. Estimates of future requirement of inventories is to be done regularly and it can be known from demand forecasts.
Capital Investments: Capital investments yield returns over many years in future. Decision about investment is to be taken by comparing rate of return on capital investment and current rate of interest. Demand forecasting helps in taking investment decisions.

Types of forecasts:

Macro-level forecasting deals with the general economic environment prevailing in the economy as measured by the Index of Industrial Production (IIP), national income and general level of employment, government expenditure, consumption level, consumers spending habits, etc.

Industry-level forecasting refers to forecasting the demand of a good of a particular industry as a whole.
E.g.- Demand for two-wheelers in India.
Firm-level forecasting refers to forecasting the demand of a good of a particular firm.
E.g.- Bajaj motor cycle.

Based on time period, demand forecasting may be-

Short-term demand forecasting normally relates to a period not exceeding a year. It is also called as ‘operating forecast’. It is useful for estimating stock requirement, providing working capital, etc.
Long-term demand forecasting may cover one to five years, depending on the nature of the firm. It provides information for taking decisions like expansion of plant capacity, man-power planning, long-term financial planning, etc.

Demand Distinctions

1. Producer’s goods and Consumer’s Goods

The goods which are used for the production of other goods are called producer’s goods. E.g. Machines
The goods which are used for final consumption are called consumer’s goods. E.g. readymade clothes, toothpaste, soap, house etc.

2. Durable goods and Non-durable goods

Goods can be further divided into durable and non-durable goods.
Durable goods are those which can be consumed more than once and yield utility over a period of time.
– Producer’s Durable Goods – E.g.- Building, Plant, Machinery etc.
– Consumer’s Durable Goods – E.g.- Cars, TV, Refrigerators, etc.
Non-durable goods are those which cannot be consumed more than once. These will meet only the current demand.
– Producer’s Non-durable Goods – E.g.- raw material, fuel, power, etc.
– Consumer’s Non-durable Goods – E.g.- milk, bread, etc.

3. Derived demand and Autonomous demand

The demand for a commodity is said to be derived when its demand depends on the demand for some other commodity. In other words, it is the demand which has been derived from the demand for some other commodity called “parent product”.
E.g. The demand for bricks, cement, steel, sand, etc. is derived demand because their demand depends on the demand for houses. Producer goods and complementary goods have derived demand.
When the demand of a commodity is independent of the demand for other commodity, then it is called autonomous demand.

4. Industry demand and Company demand

The total demand of a commodity of a particular industry is called industry demand.
E.g. the total demand for shoes in the country.
The demand for the commodity of a particular company is called company demand.
E.g. shoes produced by BATA.

5. Short-run demand and long-run demand

When the demand respond immediately to price changes, income changes etc. is referred as short-run demand.
When the demand still exist as a result of changes in pricing, sales promotion, quality improvement etc. after enough time is allowed to let the market adjust to the new situation is called long-run demand.

Factors affecting demands for non-durable goods
The factors which affects the demand of NON-DURABLE CONSUMER GOODS are as follows:-

Disposable Income: The income left with a person after paying direct taxes and other deductions is called as disposable income. Other things being equal, more the disposable income of the household, more is its demand for goods and vice versa.
Price: The demand for a commodity depends upon its price and the prices of its substitutes y and complements. The demand for a commodity is inversely related to its own price and the price of its complements. The demand for a commodity is positively related to its substitutes.
Demography: This involves the characteristics of the populations, human as well as non human which use the given product. E.g. – If forecast about the demand for toys is to be made, we will have to estimate the number and characteristics of children whose parents can afford toys.

Factors affecting the demand for consumer durable goods

Long time use or replacement: For how long a consumer can use a good depends on the factors like his status, prestige attached to good, his level of money income, etc. Replacement of a good depends upon the factors like the wear and tear rate, the rate of obsolescence, etc.
Special Facilities: Some goods need special facilities for their use. E.g. Roads for cars, electricity for T.V., refrigerators etc. The expansion of such facilities expands the demand for such goods.
Joint use of a good by household: As consumer durables are used by more than one person, the decision to purchase may be influenced by family characteristics like size of family, age and sex consumption.
Price and Credit facilities: Demand for consumer durables is very much influenced by their prices and credit facilities like hire purchase, low interest rates, etc. available to buy them. More the easy credit facilities higher is the demand for goods like two wheelers, cars TVs. etc.

Factors affecting the demand for producer goods

The demand for producer or capital goods is a derived demand. It is derived from the demand of consumer goods they produce.
The forecasting of a capital good depends upon the following factors:
– Increase in the price of substitutable factor increases the demand for capital goods.
– The existing stock of the capital goods.
– Technology advancement leading to reduced cost of production.
– Prevailing rates of interest etc.

Methods of Demand Forecasting

There is no easy method to predict the future with certainty. The firm has to apply a proper mix of methods of forecasting to predict the future demand for a product. The various methods of demand forecasting are as follows:

1. Survey of Buyer’s intentions: In this method, customers are asked what they are planning to buy for the forthcoming time period usually a year.

This method involve use of conducting direct interviews or mailing questionnaire asking customers about their intentions or plans to buy the product.

The survey may be conducted by any of the following methods:

Complete Enumeration where all potential customers of a product are interviewed about what they are planning or intending to buy in future. It is cumbersome, costly and time consuming method.
Sample Survey where only a few customers are selected and interviewed about their future plans. It is less cumbersome and less costly method.
End-use method or Input-output method where the bulk of good is made for industrial manufactures who usually have definite future plans.

This method is useful for short-term forecasts.
In this method burden of forecasting is put on the customers.

2. Collective opinion Method: The method is also known as sales force opinion method or grass roots approach.

Under this method, salesmen are asked to estimate expectations of sales in their territories. Salesmen are considered to be the nearest persons to the customers retailers and wholesalers and have good knowledge and information about the future demand trend.
The estimates of all the sales-force is collected are examined in the light of proposed changes in selling price, product design, expected competition, etc. and also factors like purchasing power, employment, population, etc.
This method is based on first hand knowledge of the salesmen. However, its main drawback is that it is subjective. Its accuracy depends on the intelligence, vision and his ability to foresee the influence of many unknown factors.

3. Expert Opinion Method (Delphi Method): Under this method of demand forecasting views of specialists/experts and consultants are sought to estimate the demand in future. These experts may be of the firm itself like the executives and sales managers or consultant firms who are professionally trained for forecasting demand.

The Delphi technique, developed by OLAF HEMLER at the Rand Corporation of the
U.S.A. is used to get the opinion of a number of experts about future demand.
Experts are provided with information and opinion feedbacks of other experts at different rounds and are repeatedly questioned for their opinion and comments till consensus emerges.
It is a time saving method.

4. Statistical Method: Statistical method have proved to be very useful in demand forecasting. Statistical methods are superior, more scientific, reliable and free from subjectively. The important statistical methods of demand forecasting are:

Trend Projection Method: The method is also known as Classical Method. It is considered as a ‘naive’ approach to demand forecasting.
- Under this, data on sales over a period of time is chronologically arranged to get a ‘time series’. The time series shows the past sales pattern. It is assumed that the past sales pattern will continue in the future also. The techniques of trend projection based on, time series data are Graphical Method and Fitting trend equation or Least Square Method.
Graphical Method: This is the simplest technique to determine the trend.
- Under this method, all values of sales for different years are plotted and free hand curve is drawn passing through as many points as possible. The direction of the free hand curve shows the trend.
- The main drawback of this method is that it may show trend but not measure it.
Fitting Trend Equation/Least Square Method: This method is based on the assumption that the past rate of change will continue in the future.
- It is a mathematical procedure for fitting a time to a set of observed data points in such a way that the sum of the squared deviation between the calculated and observed values is minimized.
- This method is popular because it is simple and inexpensive.
Regression Analysis: This is a very common method of forecasting demand.
Under this method, a quantitative relationship is established between quantity demanded (dependent variable) and the independent variables like income, price of good, price of related goods, etc. Based on this relationship, an estimate is made for future demand.
It can be expressed as follows-
Y = a + b X
Where
X, Y are variables a, b are constants

5. Controlled Experiments: Under this method, an effort is made to vary certain determinants of demand like price, advertising, etc. and conduct the experiments assuming that the other factors remain constant.

The effect of demand determinants on sales can be assessed either by varying then in different markets or by varying over a period of time in the same market.
The responses of demand to such changes over a period of time are recorded and are used for estimating the future demand for the product.
This method is used less as it is expensive and time consuming.
This method is also called as market experiment method.

6. Barometric Method of forecasting: This method is based on the assumption that future can be predicted from certain events occurring in the present. We need not depend upon the past observations for demand forecasting.

There are economic ups and downs in an economy which indicate the turning points. There are many economic indicators like income, population, expenditure, investment, etc. which can be used to forecast demand. There are three types of economic indicators, viz.

Coincidental Indicators are those which move up and down simultaneously with aggregate economy. It measures the current economic activity. E.g.- rate of unemployment.
Leading Indicators reflect future change in the trend of aggregate economy.
Lagging Indicators reflect future changes in the trend of aggregate economic activities.

CA Foundation Business Economics Study Material – Elasticity of Demand

January 8, 2023

CA Foundation Business Economics Study Material Chapter 2 Theory of Demand and Supply – Elasticity of Demand

Elasticity of Demand

Elasticity of demand is defined as the responsiveness or sensitiveness of the quantity demanded of a commodity to the changes in any one of the variables on which demand depends.
These variables are price of the commodity, prices of the related commodities, income of the consumers and many other factors on which demand depends.
Accordingly, we have price elasticity, cross elasticity, elasticity of substitution, income elasticity and advertisement elasticity.
Unless mentioned otherwise, it is price elasticity of demand which is generally referred.

Price Elasticity of Demand

Price elasticity measures the degree of responsiveness of quantity demanded of a commodity to a change in its price, given the consumer’s income, his tastes and prices of all other goods.
It reflects how sensitive buyers are to change in price.
Price elasticity of demand can be defined “as a ratio of the percentage change in the quantity demanded of a commodity to the percentage change in its own price”.
It may be expressed as follows:
Rearranging the above expression we get:
Since price and quantity demanded are inversely related, the value of price elasticity coefficient will always be negative. But for the value of elasticity coefficients we ignore the negative sign and consider the numerical value only. .

The value of elasticity coefficients will vary from zero to infinity.

When the coefficient is zero, demand is said to be perfectly inelastic.
When the coefficient lies between zero and unity, demand is said to be inelastic.
When coefficient is equal to unity, demand has unit elasticity.
When coefficient is greater than one, demand is said to elastic.
In extreme cases co-efficient could be infinite.

The degrees (types) of price elasticity of demand

Price elasticity measures the degree of responsiveness of quantity demanded of a commodity to a change in its price. Depending upon the degree of responsiveness of the quantity demanded to the price changes, we can have the following kinds of price elasticity of demand.

1. Perfectly Inelastic Demand: (E_p = 0):

When change in price has no effect on quantity demanded, then demand is perfectly inelastic. E.g. – If price falls by 20% and the quantity demanded remains unchanged then,
E_p = 0/20 = 0. In this case, the demand curve is a vertical straight line curve parallel to y-axis as shown in the figure.
The figure shows that, whatever the price, quantity demanded of the commodity remains unchanged at OQ.

2. Perfectly Elastic Demand: (E_p = ∞):

When with no change in price or with very little change in price, the demand for a commodity expands or contracts to any extent, the demand is said to be perfectly elastic. In this case, the demand curve is a horizontal and parallel to X-axis.
The figure shows that demand curve DD is parallel to X-axis which means that at given price, demand is ever increasing.

3. Unit Elastic Demand: (E_p = 1):

When the percentage or proportionate change in price is equal to the percentage or proportionate change in quantity demanded, then the demand is said to be unit elastic. E.g. If price falls by 10% and the demand rises by 10% then, Demand Curve DD is a rectangular hyperbola curve suggesting unitary elastic demand.
E_p= 10/10 = 1

4. Relatively Elastic Demand: ( E_p> 1):
ca-foundation-business-economics-study-material-elasticity-of-demand-6
When a small change in price leads to more than proportionate change in quantity demanded then the demand is said to be relatively elastic E.g. If price falls by 10% and demand rises by 30% then, E_p = 30/10 = 3 > 1. The coefficient of price elasticity would be somewhere between ONE and INFINITY. The elastic demand curve is flatter as shown in figure.

Demand curve DD is flat suggesting that the demand is relatively elastic or highly elastic. Relatively elastic demand occurs in case of less urgent wants or if the expenditure on commodity is large or if close substitutes are available.

5. Relatively Inelastic Demand: (E_p< 1):

When a big change in price leads to less than proportionate change in quantity demanded, then the demand is said to be relatively inelastic. E.g. If price falls by 20% and demand rises by 5% then, E_p = 5/20 = 5 < 1 The coefficient of price
elasticity is somewhere between ZERO and ONE. The demand curve in this case has steep slope.

Demand curve DD is steeper suggesting that demand is less elastic or relatively inelastic. Relatively inelastic demand occurs in case compulsory goods ie. necessities of life.

Measurement of price elasticity of demand

The different methods of measuring price elasticity of demand are:

The Percentage or Ratio or Proportional Method,
The Total Outlay Method,
The Point or Geometrical Method, and
The Arc Method.

1. The Percentage Method
This method is based on the definition of elasticity of demand. The coefficient of price elasticity of demand is measured by taking ratio of percentage change in demand to the percentage change in price. Thus, we measure the price elasticity by using the following formula
ca-foundation-business-economics-study-material-elasticity-of-demand-8

If the coefficient of above ratio is equal to ONE or UNITY, the demand will be unitary.
If the coefficient of above ratio is MORE THAN ONE, the demand is relatively elastic.
If the coefficient of above ratio is LESS THAN ONE, the demand is relatively inelastic.

2. The Total Outlay or Expenditure Method or Seller’s Total Revenue Method

The total outlay refers to the total expenditure done by a consumer on the purchase of a commodity. It is obtained by multiplying the price with the quantity demanded. Thus,
Total Outlay (TO) = Price (P) × Quantity (Q)
TO = P × Q
In this method, we measure price elasticity by examining the change in total outlay due to change in price.
Dr. Alfred Marshall laid the following propositions:

When with the change in price, the TO remains unchanged, E_p = 1.
When with a rise in price, the TO falls or with a fall in price, the TO rises, E_p > 1.
When with a rise in price, the TO also rises and with a fall in price, the TO also falls, E_p> 1

ca-foundation-business-economics-study-material-elasticity-of-demand-9

However, total outlay method of measuring price elasticity is less exact. This method only classifies elasticity into elastic, inelastic and unit elastic.
The exact and precise coefficient of elasticity cannot be found out with this method.

3. The Point Method or Geometric Method

The point elasticity method, we measure elasticity at a given point on a demand curve.
This method is useful when changes in price and quantity demanded are very small so that they can be considered one and the same point only.
E.g. If price of X commodity was Rs. 5,000 per unit and now it changes to Rs. 5002 per unit which is very small change. In such a situation we measure elasticity at a point on
Diagrammatically also we can find elasticity at a point by using the formula—

Figure:

The figure shows that even though the shape of the demand curve is constant, the elasticity is different at different points on the curve.
If the demand curve is not a straight line curve, then in order to measure elasticity at a point on demand curve we have to draw tangent at the given point and then measure elasticity using the above formula.
We can also find out numerical elasticities on different points.

4. The Arc Elasticity Method

When there is large change in the price or we have to measure elasticity over an arc of the demand curve, we use the “arc method” to measure price elasticity of demand.
The arc elasticity is a measure of the “average elasticity” ie. elasticity at MID-POINT that connects the two points on the demand curve.
Thus, an arc is a portion of a curved line, hence a portion of a demand curve. Here instead of using original or new data as the basis of measurement, we use average of the two.
The formula used is

Determinants of price elasticity of demand

Price elasticity of demand which measures the degree of responsiveness of quantity demanded of a commodity to a change in price (other things remaining unchanged) depends on the following factors:—

1. Nature of commodity:

The demand for necessities of life like food, clothing, housing etc. is less elastic or inelastic because people have to buy them whatever be the price.
Whereas, demand for luxury goods like cars, air-conditioners, cellular phone, etc. is elastic.

2. Availability of Substitutes:

If for a commodity wide range of close substitutes are available ie. if a commodity is easily replaceable by others, its demand is relatively elastic. E.g. Demand for cold drinks like Thumbs-up, Coca-cola, Limca, etc.
Conversely, a commodity having no close substitute has inelastic demand. E.g. Salt (but demand for TATA BRAND SALT is elastic.)

3. Number of uses of a commodity:

A commodity which has many uses will have relatively elastic demand.
E.g. Electricity can be put to many uses like lighting, cooking, motive-power, etc. If the price of electricity falls, its consumption for various purposes will rise and vice versa.
On the other hand if a commodity has limited uses will have inelastic demand.

4. Price range:

If price of a commodity is either too high or too low, its demand is inelastic but those which are in middle price range have elastic demand.

5. Position of a commodity in the budget of consumer:

If a consumer spends a small proportion of his income to purchase a commodity, the demand is inelastic. E.g. Newspaper, match box, salt, buttons, needles.
But if consumer spends a large proportion of his income to purchase a commodity, the demand is elastic E.g. Clothes, milk, etc.

6. Time period:

The longer any price change remains the greater is the price elasticity of demand.
On the other hand, shorter any price change remains, the lesser is the price elasticity of demand. .

7. Habits:

Habits makes the demand for a commodity relatively inelastic. E.g. A smoker’s demand for cigarettes tend to be relatively inelastic even at higher price.

8. Tied Demand (Joint Demand):

Some goods are demanded because they are used jointly with other goods. Such goods normally have inelastic demand as against goods having autonomous demand.
E.g. Printers & Cartridges.

Knowledge of the concept of elasticity of demand and the factors that may change it is of great IMPORTANCE in practical life. The concept of elasticity of demand is helpful to-

Business Managers as it helps then to recognise the effect of price change on their total sales and revenues. The objective of a firm is profit maximization. If demand is ELASTIC for the product, the managers can fix a lower price in order to expand the volume of sales and vice versa.
Government for determining the prices of goods and services provided by them. E.g.- transport, electricity, water, cooking gas, etc. It also helps governments to understand the nature of response of demand when taxes are raised and its effect on the tax revenues. E.g.- Higher taxes are imposed on the goods having INELASTIC DEMAND like cigarettes, liquor, etc.

Income Elasticity of Demand

The income elasticity of demand measures the degree of responsiveness of quantity demanded to changes in income of the consumers.
The income elasticity is defined as a ratio of percentage change in the quantity demanded to the percentage change in income.

The income elasticity of demand is POSITIVE for all normal or luxury goods and the income elasticity of demand is NEGATIVE for inferior goods. Income elasticity can be classified under five heads:-

ca-foundation-business-economics-study-material-elasticity-of-demand-16

Zero Income Elasticity:
- It means that a given increase in income does not at all lead to any increase in quantity demanded of the commodity.
- In other words, demand for the commodity is completely income inelastic or E_y = 0
- Commodities having zero income elasticity are called NEUTRAL GOODS.
- E.g. – Demand in case of SALT, MATCH BOX, KEROSENE OIL, POST CARDS, etc.
Negative Income Elasticity:
- It means that an increase in income results in fall in the quantity demanded of the commodity or E_y < 0.
- Commodities having negative income elasticity are called INFERIOR GOODS.
- E.g. – Jawar, Bajra, etc.
Unitary Income Elasticity:
- It means that the proportion of consumer’s income spent on the commodity remains unchanged before and after the increase in income or E_y = 1. This represents a useful dividing line.
Income Elasticity Greater Than Unity:
- It refers to a situation where the consumers spends GREATER proportion of his income on a commodity when he becomes richer. E_y > 1,
- E.g. In the case of LUXURIES like cars, T.V. sets, music system, etc.
Income Elasticity Less Than Unity:
- It refers to a situation where the consumer spends a SMALLER proportion of his income on a commodity when he becomes richer. E_y < 1,
- E.g. In the case of NECESSITIES like rice, wheat, etc.

Cross elasticity of demand

Many times demand for two goods are related to each other.
Therefore, when the price of a particular commodity changes, the demand for other commodities changes, even though their own prices have not changed.
We measures this change under cross elasticity.

The cross elasticity of demand can be defined “as the degree of responsiveness of demand for a commodity to a given change in the price of some RELATED commodity” OR “as the ratio of percentage change in quantity demanded of commodity X to a given percentage change in the price of the related commodity Y”. Symbolically:
ca-foundation-business-economics-study-material-elasticity-of-demand-17

Cross elasticity of demand can be used to classify goods as follows:-

Substitute Goods: E.g.: Tea and Coffee. The cross elasticity between two substitutes is always POSITIVE. If cross elasticity is infinite, the two goods are perfect substitute and if it is greater than zero but less than infinity, the goods are substitutes.
Independent Goods: E.g.: Pastry and Scooter. The two commodities are not related. The cross elasticity in such cases is ZERO.
Complementary Goods: E.g.: Petrol and Car. If the price of petrol rise, its demand falls and along with it demand for cars also falls. The cross elasticity in such cases is NEGATIVE

Advertisement or Promotional Elasticity of Demand

Demand of many goods is also influenced by advertisement or promotional efforts.
It means that the demand for a good is responsive to the advertisement expenditure incurred by a firm.
The measurement of the degree of responsiveness of demand of a good to a given change in advertisement expenditure is called advertisement or promotional elasticity of demand.
It measures the percentage change in demand to a give ONE PERCENTAGE change in advertising expenditure. It helps a firm to know the effectiveness of its advertisement campaign.
Advertisement elasticity of demand is POSITIVE. Higher the value, higher is change in demand to change in advertisement expenditure.

The value of advertisement elasticity varies between zero and infinity. If-

E_a = 0, no change in demand to increase in advertisement expenditure
E_a > 0 but < 1, less than proportionate change in demand to a change in advertisement expenditure
E_a = 1, change in demand is equal to change in advertisement expenditure
E_a > 1, higher rate of change in demand than change in advertisement expenditure

CA Foundation Business Economics Study Material – Law of Demand

January 8, 2023

CA Foundation Business Economics Study Material Chapter 2 Theory of Demand and Supply – Law of Demand

The Law of Demand

The Law of Demand expresses the nature of functional relationship between the price of a commodity and its quantity demanded.
It simply states that demand varies inversely to the changes in price i.e. demand for a commodity expands when price falls and contracts when price rises.
“Law of Demand states that people will buy more at lower prices and buy less at higher prices, other things remaining the same.” (Prof. Samuelson)
It is assumed that other determinants of demand are constant and ONLY PRICE IS THE VARIABLE AND INFLUENCING FACTOR.
Thus, the law of demand is based on the following main assumptions:—
1. Consumers income remain unchanged.
2. Tastes and preferences of consumers remain unchanged.
3. Price of substitute goods and complement goods remain unchanged.
4. There are no expectations of future changes in the price of the commodity.
5. There is no change in the fashion of the commodity etc.
The law can be explained with the help of a demand schedule and a corresponding demand curve.
Demand schedule is a table or a chart which shows the different quantities of commodity demanded at different prices in a given period of time.
Demand schedule can be Individual Demand Schedule or Market Demand Schedule.

Individual Demand Schedule is a table showing different quantities of commodity that ONE PARTICULAR CONSUMER is willing to buy at different level of prices, during a given period of time.

ca-foundation-business-economics-study-material-law-of-demand

Market Demand Schedule is a table showing different quantities of a commodity that ALL THE CONSUMERS are willing to buy at different prices, during a given period of time.

ca-foundation-business-economics-study-material-law-of-demand-1
(Assumption: There are only 2 buyers in the market)

Both individual and market schedules denotes an INVERSE functional relationship between price and quantity demanded. In other words, when price rises demand tends to fall and vice versa.

A demand curve is a graphical representation of a demand schedule or demand function.

A demand curve for any commodity can be drawn by plotting each combination of price and demand on a graph.
Price (independent variable) is taken on the Y-axis and quantity demanded (dependent variable) on the X-axis.

ca-foundation-business-economics-study-material-law-of-demand-2

Individual Demand Curve as well as Market Demand Curve slope downward from left to right indicating an inverse relationship between own price of the commodity and its quantity demanded.
Market Demand Curve is flatter than individual Demand Curve.

Reasons for the law of demand and downward slope of a demand curve are as follows:—

1. The Law of Diminishing Marginal Utility:

According to this law, other things being equal as we consume a commodity, the marginal utility derived from its successive units go on falling.
Hence, the consumer purchases more units only at a lower price.
A consumer goes on purchasing a commodity till the marginal utility of the commodity is greater than its market price and stops when MU = Price ie. when consumer is at equilibrium.
When the price of the commodity falls, MU of the commodity becomes greater than price and so consumer start purchasing more till again MU = Price.
It therefore, follows that the diminishing marginal utility implies downward sloping demand curve and the law of demand operates.

2. Change in the number of consumers:

Many consumers who were unable to buy a commodity at higher price also start buying when the price of the commodity falls.
Old customers starts buying more when price falls.

3. Various uses of a commodity:

Commodity may have many uses. The number of uses to which the commodity can be put will increase at a lower price and vice versa.

4. Income effect:

When price of a commodity falls, the purchasing power (ie. the real income) of the consumer increases.
Thus he can purchase the same quantity with lesser money or he can get more quantity for the same money.
This is called income effect of the change in price of the commodity.

5. Substitution effect:

When price of a commodity falls it becomes relatively cheaper than other commodities.
As a result the consumer would like to substitute it for other commodities which have now become more expensive.
E.g. With the fall in price of tea, coffee’s price remaining the same, tea will be substituted for coffee.
This is called substitution effect of the change in price of the commodity.
Thus, PRICE EFFECT = INCOME EFFECT + SUBSTITUTION EFFECT as explained by Hicks and Allen.

Exceptions to the Law of Demand

Law of Demand expresses the inverse relationship between price and quantity demanded of a commodity. It is generally valid in most of the situations.
But, there are some situations under which there may be direct relationship between price and quantity demanded of a commodity.

These are known as exceptions to the law of demand and are as follows:—

1. Giffen Goods:

In some cases, demand for a commodity falls when its price fall and vice versa.
In case of inferior goods like jawar, bajra, cheap bread, etc. also called “Giffen Goods” (known after its discoverer Sir Robert Giffens) demand is of this nature.
When the price of such inferior goods fall, less quantity is purchased due consumer’s increased preference for superior commodity with the rise in their “real income” (Le. purchasing power).
Hence, other things being equal, if price of a Giffen good fall its demand also falls.
There is positive price effect in this case.

2. Conspicuous goods:

Some consumers measure utility of a commodity by its price i.e. if the commodity is expensive they think it has got more utility and vice versa.
Therefore, they buy less at lower price and more of it at higher price.
E.g. Diamonds, fancy cars, dinning at 5 stars, high priced shoes, ties, etc….
Higher prices are indicators of higher utilities.
A higher price means higher prestige value and higher appeal and vice versa.
Thus a fall in their price would lead to fall in their quantities demanded. This is against the law of demand.
This was found out by Veblen in his doctrine of “Conspicuous Consumption” and hence this effect is called Vebleri effect or prestige effect.

3. Conspicuous necessities:

The demand for some goods is guided by the demonstration effect of the consumption pattern of a social group to which the person belongs.
E.g. Television sets, refrigerators, music systems, cars, fancy clothes, washing machines etc.
Such goods are used just to demonstrate that the person is not inferior to others in group.
Hence, inspite of the fact that prices have been continuously rising, their demand does not show tendency to fall.

4. Future changes in prices:

When the prices are rising, households tend to purchase larger quantities of the commodity, out of fear that prices may go up further and vice versa.
E.g. – Shares of a good company, etc.

5. Irrational behaviour of the consumers:

At times consumers make IMPULSIVE PURCHASES without any calculation about price and usefulness of the product. In such cases the law of demand fails.

6. Ignorance effect:

Many times households may demand larger quantity of a commodity even at a higher price because of ignorance about the ruling price of the commodity in the market.

7. Consumer’s illusion:

Many consumers have a wrong illusion that the quality of the commodity also changes with the price change.
A consumer may contract his demand with a fall in price and vice versa.

8. Demand for necessaries:

The law of demand does not hold true in case of commodities which are necessities of life. Whatever may be the price changes, people have to consume the minimum quantities of necessary commodities. E.g.- rice, wheat, clothes, medicines, etc.

DEMAND CURVE FOR ABOVE EXCEPTIONS IS POSITIVELY SLOPED

Expansion and Contraction of Demand

(changes in quantity demanded. Or movement along a demand curve)

The law of demand, the demand schedule and the demand curve all show that
– when the price of a commodity falls its quantity demanded rises or expansion takes place and
– when the price of a commodity rises its quantity demanded fall or contraction takes place.
Thus, expansion and contraction of demand means changes in quantity demanded due to change in the price of the commodity other determinants like income, tastes, etc. remaining constant or unchanged.
When price of a commodity falls, its quantity demanded rises. This is called expansion of demand.
When price of a commodity rises, its quantity demanded falls. This is called contraction of demand.
As other determinants of price like income, tastes, price of related goods etc. are constant, the position of the demand curve remains the same. The consumer will move upwards or downwards on the same demand curve.

Figure : Expansion and Contraction of Demand

In the figure

At price OP quantity demanded is OQ.
With a fall in price to OP₁, the quantity demanded rises from OQ toOQ₁,. The coordinate point moves down from E to E₁This is called ‘expansion of demand’ or ‘a rise in quantity demanded’ or ‘downward movement on the same demand curve’.
At price OP quantity demanded is OQ.
With a rise in price to P₂, the quantity demanded falls from OQ to OQ₂. The coordinate point moves up from E to E₂. This is called ‘contraction of demand’ or ‘a fall in quantity demanded’ or ‘upward movement on the same demand curve’.
Thus, the downward movement on demand curve is known as expansion in demand and an upward movement on demand curve is known as contraction of demand.

Increase and Decrease in demand (changes in demand OR shift in demand curve)

When there is change in demand due to change in factors other than price of the commodity, it is called increase or decrease in demand.
It is the result of change in consumer’s income, tastes and preferences, changes in population, changes in the distribution of income, etc.
Thus, price remaining the same when demand rises due to change in factors other than price, it is called increase in demand. Here, more quantity is purchased at same price or same quantity is purchased at higher price.
Likewise price remaining the same when demand falls due to change in factors other than price, it is called decrease in demand. Here, less quantity is purchased at same price or same quantity is purchased at lower price.
In above cases demand curve shifts from its original position to rightward when demand increases and to leftward when demand decreases. Thus, change in demand curve as a result of increase or decrease in demand, is technically called shift in demand curve.

ca-foundation-business-economics-study-material-law-of-demand-4
Figure : Increase and Decrease in Demand

In the figure

Original demand curve is DD. At OP price OQ quantity is being demanded.
As the demand changes, the demand curve shifts either to the right (D₁D₁) or to the left (D₂D₂)
At D₁D₁, OQ₁, quantity is being demanded at the price OP. This shows increase in demand (rightward shifts in demand curve) due to factor other than price.
At D₂D₂, QO₂ quantity is being demanded at the price OP. This shows decrease in demand (leftward shift in demand curve) due to a factor other than price.
When demand of a commodity INCREASES due to factors other than price, firms can sell a larger quantity at the prevailing price and earn higher revenue.
The aim of a advertisement and sales promotion activities is to shift the demand curve to the right and to reduce the elasticity of demand.

CA Foundation Business Economics Study Material – Basic Problems of an Economy and Role of Price Mechanism

January 8, 2023

CA Foundation Business Economics Study Material Chapter 1 Nature and Scope of Business Economics – Basic Problems of an Economy and Role of Price Mechanism

Basic Problems of an Economy

We know that human wants are unlimited and resources are scarce.
The problem of scarcity of resources is not only faced by individuals but also by the society at large.
This gives rise to the problem of how to use scare resources so as to serve best the needs of the society.
This economic problem is to be dealt with in all the economic systems whether capitalist or socialist or mixed.
The central problems relating to allocation of resources are:
- What to produce and how much to produce?
- How to produce?
- For whom to produce?
- What provision should be made for economic growth?

What to produce and how much to produce?

An economy has millions commodities to produce.
It has to decide what commodities are to be produced and how much.
E.g. – To produce luxury goods or consumer goods, etc.
Here, the guiding principle is to allocate the resources in the production of goods in such a way that maximizes aggregate utility.

How to produce ?

There are many alternative techniques to produce a commodity. ‘
Choice has to be made between capital intensive technique or labour intensive technique of production.
The choice of technique will depend upon —
- availability of various factors of production, &
- the prices of factors of production.
Such techniques of production has to be adopted that makes best use of available resources.

For whom to produce?

Who will consume the goods and services that are produced in the economy?
Whether a few rich or many poor will consume?
Goods and services are produced for those people who can purchase them or pay for them.
Paying capacity depends upon income or purchasing power.

What provisions should be made for economic growth?

A society cannot afford to use all its scarce resources for current consumption only.
It has to provide for the future as well so that high economic growth can be achieved.

Therefore, an economy has to take decisions about rate of savings, investment, capital formation, etc.

Meaning of Economic System

An economic system comprises the totality of forms through which the day to day economic process is at work. It refers to the mode of production, exchange, distributions and the role which government play in economic activity. There are three types of economic systems Capitalism, Socialism and Mixed Economy ‘

CAPITALIST ECONOMY

Capitalistic economic systems is one in which all the means of production are privately owned.
The owners of property, wealth and capital are free to use them as they like in order to earn profits.
The central problems about what, how and for whom to produce are solved by the free play of market forces.

Characteristics of Capitalist Economy:

There is right to own and keep private property by individuals. People have a right to acquire, use, control, enjoy or dispose off it as they like.
There is right of inheritance ie. transfer of property of a person to his legal heirs after his death.
There is freedom of enterprise ie. everybody is free to engage in any type of economic activity he likes.
There is freedom of choice by consumers ie. consumer is free to spend his income on whatever goods or services he wants to buy and consume.
Entrepreneurs or producers in their productive activity are guided by their profit motive. Thus profit motive is the guiding force behind all the productive activity.
There is stiff competition among sellers or producers of similar goods. There is competition among all the participants in the market.
Price mechanism is an important feature of capitalist economy were the price is determined through the interaction of market forces of demand and supply.

Merits of Capitalist Economy:

Capitalism works through price mechanism and hence self regulating
In capitalism there is greater efficiency and incentive to work due to two motivating force namely private property and profit motive.
Faster economic growth is possible.
There is optimum allocation of productive resources of the economy.
There is high degree of operative efficiency.
Cost effective methods are employed in order to maximise profits.
Consumers are benefited as large range of quality goods at reasonable prices are available from which they makes the choice. This also results in higher standard of living.
In capitalism there is more innovations and technological progress and country benefits from research and development, growth of business talent, etc.
Fundamental rights like right to private property and right to freedom are preserved.
It leads to emergence of new entrepreneurial class who is willing to take risks.

Demerits of Capitalist Economy:

In capitalism there is vast economic inequality and social injustice which reduces the welfare of the society.
There is precedence of property rights over human rights.
Cut-throat competition and profit motive work against consumer welfare leading to exploitation of consumers.
There are wastage of resources due to duplication of work and cut-throat competition.
Income inequalities lead to differences in economic opportunities. This lead to rich becoming richer and poor becoming poorer.
There is exploitation of labour.
More of luxury goods and less of wage goods are produced leading to misallocation of resources. .
Unplanned production, economic instability in terms of over production, depression, unemployment, etc. are common in a capitalist economy.
Leads to creation of monopolies.
Ignores human welfare because main aim is profit.

SOCIALIST ECONOMY

The concept of socialism was given by Karl Marx and Frederic Engels in their work ‘The Communist Manifesto’ published is 1848. A socialist economy is also called as “Command Economy” or a “Centrally Planned Economy.”

In a socialist economy, all the property, wealth and capital is owned by State. There is no private property.
State organises all economic activities. It owns, controls and manages the production units; it distributes the goods among the consumers; it decides the size and direction of investment.
The state works for the welfare of the people and not for profit.

Characteristics of Socialist Economy:

There is collective ownership of means of production Le. all the important means of production are state owned.
It is a centrally planned economy. All the basic decisions relating to the working and the regulation of the economy are taken by central authority called planning commission.
- Production and distribution of goods is ensured through planning on preferences deter-mined by the state. So freedom from hunger is guaranteed but, consumer’s sovereignty is restricted.
There is social welfare in place of profit motive. Those goods and services are given top priority which is in the interest of largest number of people.
- Price policy is guided by the aims of social welfare than profit motive.
There is lack of competition because it avoid duplication of efforts and wastage of resources. Hence, competition is done away.
Socialism tries to ensure equitable distribution of income through equality of opportunities. Thus, right to work is guaranteed but choice of occupation is restricted.

Merits of Socialist Economy:

Social justice is maintained by equitable distribution of income and wealth and by providing equal opportunities to all.
Balanced economic development is possible. Central planning authority allocate resources according to the plans and priorities.
There are no class conflict and community develops a co-operative mentality.
Unemployment is minimized, business fluctuations are eliminated resulting in stability.
Right to work is ensured and minimum standard of living is maintained.
There is no exploitation of consumers and workers.
Wastage of resources are avoided due to planning resulting in better utilization of resources and maximum production.
Citizens feel secure as there is social security cover for them.
Demerits of Socialist Economy:
There is predominance of bureaucracy resulting in inefficiency and delays.
There is no freedom of individuals as it takes away basic rights also like right of private property.
Workers are not paid according to their personal efficiency and productivity. This acts as disincentive to work hard.
Prices are administered by the state.
State monopolies may be created and may become uncontrollable. This will be more dan¬gerous than monopolies under capitalism.
The consumers have no freedom of choice.

MIXED ECONOMY

Mixed economy combines the features of both capitalism and socialism. The concept is designed to incorporate best of both. The main characteristics/features are:—

There is co-existence of both private and public sector ie. economic resources are owned by individuals and state.
- State open those enterprises which are in the interest of the’society as a whole.
- Private sector moves to those enterprises which produce higher profit.
There is co-existence of free price mechanism and economic planning.
- Price mechanism is however curtailed through measures like price control, administered prices etc.
- Planning is done through incentives like concessions, subsidies, etc. and disincentives like high rate of taxes, strict licensing etc.
In mixed economy social welfare motive gets due importance particularly in case of poor and backward classes.
Eg. Subsidised hospital, food articles, education etc.; social security schemes like old age pension, reservation of jobs, laws in the interest of workers, consumers, human, children etc.
There is freedom to joint any occupation, trade or service according to the education, training, skills and ability.
There is freedom of consumption. People are free to consume goods and services of their choice and in the quantity they can afford.

Merits of Mixed Economy:

Merits of capitalist economy and socialist economy are found in mixed economy.
There is right of private property and economic freedom. This results in incentive to work hard and capital formation.
Price mechanism and competition induces the private sector in efficient decision making and better resource allocation.
There is freedom of occupation and consumption.
Encourages enterprise and risk taking.
Leads to development of technologies through research and development.
Economic and social equality is more.

However, mixed economy suffers from uncertainties, excess control by state, poor implementation of plans, high taxes, corruption, wastage of resources, slow growth, lack of efficiency, etc. There are possibilities of private sector growing, disproportionately if state does not maintain a proper balance between public and private sectors.

CA Foundation Business Economics Study Material – Nature and Scope of Business Economics

January 6, 2023

CA Foundation Business Economics Study Material – Nature and Scope of Business Economics

Nature of Business Economics

The subject matter of Economics is broadly divided into two major parts namely:—
Micro-Economics, and Macro-Economics
Before dealing with nature of Business Economics, it is necessary to understand the difference between the two.

1. Micro-Economics – Micro means a ‘small part’. Therefore, Micro-economics study the behaviour of small part or a small component or different individuals and organisations of a national economy. It examines how the individual units take decision about rational allocation of their scarce resources.

Micro-Economics covers the following:

Theory of Product Pricing;
Theory of Consumer Behaviour,
Theory of Factor Pricing;
The economic conditions of a section of people;
Behaviour of firms; and
Location of industry.

2. Macro-Economics – Macro means ‘large’. Therefore, macro-economics deals with the large economic activity. It study the economic system of a country as a whole ie. overall condition of an economy. It is a study of large aggregates like total employment, the general price level. Total output, total consumption, total saving and total investments. It also analyses how these aggregates change over time.

Macro-Economics covers the following:

National Income and National Output;
The General Price Level and interest rates;
Balance of Trade and Balance of Payments;
External value of currency ie. exchange rate;
Overall level of savings and investments ie. capital formation; and
The level of employment and rate of economic growth.

Business Economics is primarily concerned with Micro-Economics. However, knowledge and understanding of Macro-economic environment is also necessary. This is because macro-economic environment influence individual firm’s performance and decisions.

As already seen Business Economics enables application of economic knowledge, logic, theories and analytical tools. It is Applied Economics that fills the gap between economic theory and business practice. The following will describe the nature of Business Economics:

Business Economics is a Science: Science is a systematised body of knowledge which trace the cause and effect relationships. Business Economics uses the tools of Mathematics, Statistics and Econometrics with economic theory to take decisions and frame strategies. Thus, it makes use of scientific methods.
Based on Micro-Economics: As Business Economics is concerned more with the decision making problems of a particular business establishment. Micro level approach suits is more. Thus, Business Economics largely depends on the techniques of Micro-Economics.
Incorporates elements of Macro Analysis: A business unit is affected by external environment of the economy in which it operates. A business units is affected by general price level, level of employment, govt, policies related to taxes, interest rates, industries, exchange rates, etc. A business manager should consider such macro-economic variables which may affect present or future business environment.
Business Economics is an Art: It is related with practical application of laws and principles to achieve the objectives.
Use of Theory of Markets & Private Enterprise: It uses the theory of markets and resource allocation in a capitalist economy.
Pragmatic Approach: Micro-Economics is purely theoretical while, Business Economics is practical in its approach.
Inter-disciplinary in nature: It incorporates tools from other disciplines like Mathematics, Statistics, Econometrics, Management Theory, Accounting, etc.
Normative in Nature: Economic theory has been developed along two lines – POSITIVE and NORMATIVE.

A positive science or pure science deals with the things as they are and their CAUSE and EFFECTS only. It states ‘what is’? It is DESCRIPTIVE in nature. It does not pass any moral or value judgments.

A normative science deals with ‘what ought to be’ or ‘what should be’. It passes value judgments and states what is right and what is wrong. It is PRESCRIPTIVE in nature as it offers suggestions to solve problems. Normative science is more practical, realistic and useful science.

Business Economics is normative in nature because it suggests application of economic principles to solve problems of an enterprise, However, firms should have clear understanding of their environment and therefore, it has to study positive theory.

Scope of Business Economics

The scope of Business Economics is wide. Economic theories can be directly applied to two types of business issues namely—

Micro-economics is applied to operational or internal issues off a firm.
Macro-economics is applied to environment or external issues on which the firm has no control.

1. Micro-economics applied to operational or internal issues
Issues like choice of business size of business, plant layout, technology, product decisions, pricing, sales promotion, etc. are dealt by Micro-economic theories. It covers—

Demand analysis and forecasting
Production and Cost Analysis
Inventory Management
Market Structure and Pricing Analysis
Resource Allocation
Theory of Capital and Investment Decisions
Profitability Analysis
Risk and Uncertainty Analysis.

2. Macro-economics applied to environmental or external issues
The major economic factors relate to—

the type of economic system
stage of business cycles
the general trends in national income, employment, prices, saving and investment.
government’s economic policies
working of financial sector and capital market
socio-economic organisations
social and political environment.

These external issues has to be considered by a firm in business decisions and frame its policies accordingly to minimize their adverse effects.

CA Foundation Business Economics Study Material – Introduction

January 6, 2023

CA Foundation Business Economics Study Material Chapter 1 Nature and Scope of Business Economics – Introduction

WHAT IS ECONOMICS ABOUT?

The word ‘Economics’ is derived from the Greek word ‘Oikonomia’ which means household management. Till 19th century, economics was known as ‘Political Economy’. In 1776, Adam Smith published his book entitled “An Inquiry into the Nature and Causes of the Wealth of Nations” which is considered as the first modern work of Economics.

Every individual, every society and every country in this world faces the problem of making CHOICE. This is because of two facts—

Human wants are unlimited; and
The means (resources) to satisfy unlimited wants are relatively scarce and these scarce resources have alternative uses.

As a result we are confronted with the problem of making choice of wants to be satisfied or the choice among the uses of resources. Thus, we are faced with the problem of allocation of resources to various uses.

The definition of Economics is however is narrow because it concentrates only at present i.e., how to use relative scarce resources to satisfy unlimited human wants. So it gives the picture of a society with fixed resources, skills and productive capacity, deciding what type of goods and services to be produced and how to distribute among the members of society.

However, over a period of time growth takes place. With growth there is increase in the resources and improvement in the quality of resources. But this growth in production and income is not smooth. It is through ups and downs. Economics, therefore, deals not only with how a country allocates its scarce productive resources but also with increase in the productive capacity of resources and with the reasons which led to sharp fluctuations in the use of resources.

Economics gives us understanding on economic issues like changes in the price of a commodity, changes in general price level of goods and services, poverty, level of unemployment, etc. The understanding of such helps us to decide the models and frameworks that can be applied in different situations. The tools of economics helps us to choose the best course of action from various alternatives available. However, economic problems are of complex nature and are affected by economic forces, political set-up, social norms, etc. Thus, economics does not guarantee that all problems will be solved appropriately but it helps us to examine the problem in right perspective and find suitable measures to deal with it.

Meaning of Business Economics

Business Economics is also referred to as Managerial Economics. It is application of economic theory and methodology.
Every business involves decision-making as survival and success depends on sound decisions.
Decision making means the process of –
- evaluating various course of action,
- making rational judgment on the basis of available information, and
- selecting i.e. making choice of a suitable alternative by decision maker.
Decision making is not simple and straight forward. It has become very complex due to ever changing business environments, growing competition, large scale production, big size of business houses, complex laws, cost awareness, etc. In other words the economic environment in which the firm operates is very complex and dynamic.
Business Economics provides a scientific base to the professional management of a business activity. It provides tools like budgeting, market analysis, cost-benefit analysis, etc. which can be scientifically applied to take sound business decisions. Thus, Business Economics is a sub-branch of Economics which aims at the scientific application of economic knowledge, logic, theories and tools to take rational business decisions. Thus, it is an APPLIED ECONOMICS.
Business Economics is closely connected with both viz., Micro-Economic Theory as well as Macro-Economic Theory. It is also useful to the managers of ‘not-for-profit’ organisations.

DEFINITIONS OF BUSINESS ECONOMICS

“Business Economics in terms of the use of economic analysis in the formulation of business policies. Business Economics is essentially a component of Applied Economics as it includes application of selected quantitative techniques such as linear programming, regression analysis, capital budgeting, break-even analysis and cost analysis.” – Joel Dean
“Business Economics is concerned with the application of economic laws, principles and methodologies to the managerial decision making process within a business firm under the conditions of risks and uncertainties.” – Evans Douglas

CA Foundation Business & Commercial Knowledge Study Material Chapter 5 Organizations Facilitating Business – Test Questions

January 6, 2023

CA Foundation Business & Commercial Knowledge Study Material Chapter 5 Organizations Facilitating Business – Test Questions

1. Which of the following is not a regulatory body:
(a) SEBI
(b) RBI
(c) CCI
(d) SIDBI

2. Which of the following is not a development bank:
(a) IFCI
(b) IRDAI
(c) SIDBI
(d) NABARD

3. Give the full forms of the following:
(a) IFCI
(b) IRDA
(c) CCI
(d) SIDBI

4. SEBI was set up to regulate:
(a) Imports and exports
(b) Insurance Sector
(c) Capita markets
(d) Agriculture

5. Which of the following is the banker’s bank
(a) SIDBI
(b) EXIMbank
(c) IDBI
(d) RBI

6. Which of the following seeks to check monopolies
(a) RBI
(b) CCI
(c) SEBI
(d) IRDA

7. Which of the following is not a method of credit control
(a) CRR
(b) SLR
(c) Moral Session
(d) FBI

CA Foundation Business & Commercial Knowledge Study Material – Indian Development Banks

January 6, 2023

CA Foundation Business & Commercial Knowledge Study Material Chapter 5 Organizations Facilitating Business – Indian Development Banks

A development bank may be defined as “a multipurpose institution which shares entrepreneurial risk, changes its approach in tune with the industrial climate and encourages new industrial projects to bring about speedier economic growth.

The concept of development banking is based on the assumption that mere provision of finance will not bring about entrepreneurial development. Development banks provide a package of financial and non-financial assistance. Their activities include discovery of new projects, preparation of project report, provision of funds, technical assistance and managerial advice. These institutions do not compete with the conventional institutions but supplement them. Therefore, development banks are called ‘gap fillers’. They serve as motive engines of industrial development. As catalysts of economic growth they provide injections of capital, enterprise and management.

The distinctive features of a development bank are as follows:

It provides medium and long-term finance.
It is ‘project oriented’ rather than ‘security oriented’.
It acts as a ‘partner in progress’ by guiding, supervising and advising the entrepreneurs.
It provides both equity capital and debt capital.

Industrial Finance Corporation of India (IFCI)

The IFCI was set up under the IFCI Act on July 1, 1948. On July 1, 1993 it was converted into a public limited company. This was done to enable the IFCI to reshape its business strategies with greater authority, to tap the Capital market for funds to expand its equity base and to provide better customer services. It is now named IFCI Ltd.

Objects – IFCI has been set up for “making medium and long-term credits more readily available to industrial concerns in India, particularly in circumstances where . normal banking facilities are inappropriate or recourse to capital issue methods is impracticable”. The corporation aims at assisting industrial concerns which have carefully considered schemes for manufacture or for modernisation and expansion of a plant for the purpose of increasing their productive efficiency and capacity. Now, public sector undertakings can also avail of assistance from the corporation.

IFCI provides project finance, merchant banking, suppliers’ credit, equipment leasing, finance to leasing and hire-purchase concerns, etc. and promotional services. The corporation gives priority to development of backward areas, new entrepreneurs and technocrats, indigenous technology, ancillary industries, cooperative sector, import substitution and export promotion.

The focus of IFCI is on providing financial assistance to public companies and cooperative societies engaged in manufacturing, mining, shipping, hotel business, etc.

Functions, Scope and Forms of Assistance

Granting loans and advances to or subscribing to debentures of industrial concerns.
Guaranteeing loans raised by industrial concerns from the capital market, scheduled banks or State cooperative banks.
Providing guarantees in respect of deferred payments for imports of capital goods manufactured in India.
Guaranteeing with the approval of the Central Government, loans raised from or credit arrangements made by industrial concerns with any bank or financial institution outside India.
Underwriting the issue of shares and debentures by industrial concerns.
Subscribing directly to the shares and debentures of industrial concerns.
Acting as an agent of the Central Government and World Bank in respect of loans sanctioned by them to industrial concerns in India.
Participating along with other all India term lending institutions, in the administration of the Soft Loan Scheme for modernisation and rehabilitation of sick industries.
Providing financial assistance on concessional terms for setting up industrial projects in backward areas notified by the Central Government.
Providing guidance in project planning and implementation through specialised agencies like Technical Consultancy Organisations.

The financial assistance is available for setting up of new projects as well as for the expansion, diversification, and modernisation of existing units. IFCI Ltd. also provides financial assistance to industrial concerns not tied to any project. The following schemes of assistance have been introduced for this purpose: (i) Equipment leasing, (ii) Suppliers’ credit, and (iii) Buyers’ credit. Indirect finance is provided as assistance to leasing companies. Now IFCI also provides short-term loans for working capital purposes.

Industrial Development Bank of India (Now IDBI Ltd.)

The Industrial Development Bank of India (IDBI) was set up as an apex institution and it started its operations with effect from July 1, 1964. It was set up as a statutory corporation under Industrial Development Bank of India Act, 1964. The needs of rapid industrialisation, long-term financial needs of heavy industry beyond the resources of the then existing institutions, absence of a central agency to coordinate the activities of other financial institutions and gaps in the financial and promotional services were the main causes behind the establishment of the IDBI. The Bank represents an attempt to combine in a single institution the requirements of an expanding economy and need for a coordinated approach to industrial financing. The setting up of the IDBI is thus an important landmark in the history of institutional financing in the country IDBI was established as a wholly owned subsidiary of the Reserve Bank of India. But in 1976 the ownership of IDBI was transferred to the Central Government.

In March, 1994 the IDBI Act was amended to permit the Bank to issue equity- shares in the capital market. The majority of its shares are still owned by the Government.

Objects – The objectives of the IDBI are to:

co-ordinate, regulate and supervise the activities of all financial institutions providing term finance to industry;
enlarge the usefulness of these institutions by supplementing their resources and by widening the scope of their assistance;
provide direct finance to industry to bridge the gap between demand and supply of long-term and medium-term finance
to industrial concerns in both public and private sectors;
locate and fill up gaps in the industrial structure of the country;
adopt and enforce a system of priorities so as to diversify and speed up the process of industrial growth. The Bank has been conceived of as a development agency that will ultimately be concerned with all questions or problems relating to industrial finance in the country.

Functions – The main functions of the IDBI are as follows:

subscribing to the shares and bonds of financial institutions and guaranteeing their under¬writing obligations;
refinancing term loans and export credits extended by other financial institutions;
granting loans and advances directly to industrial concerns;
guaranteeing deferred payments due from and loans raised by industrial concerns;
subscribing to and underwriting shares and debentures of industrial concerns;
accepting, discounting and rediscounting bona fide commercial bills or promissory notes of industrial concerns including bills arising out of sale of indigenous machinery on deferred payment basis;
financing turnkey projects by Indians outside India and providing credit to foreigners for buying capital goods from India;
planning, promoting and developing industries to fill gaps in the industrial structure of the country. The Bank may undertake promotional activities like marketing and investment research, techno-economic surveys, etc.;
providing technical and managerial assistance for promotion and expansion of industrial
undertakings;
coordinating and regulating the activities of other financial institutions.

Besides providing assistance to industry directly, IDBI also provides assistance to industries through other financial institutions and banks. IDBI provides project finance for new projects and for expansion, diversification and modernisation of existing projects. IDBI also provides equipment finance, asset credit, corporate loans, working capital loans, refinance, rediscounting, and fee based services (e.g., merchant banking, mortgage, trusteeship, forex services).

Thus, the Bank performs financial, promotional and coordinating functions. As an apex institution in the field of development banking, the IDBI supplements and coordinates the activities of various National and State level financial institutions in the country.

The IDBI has been given wide powers and it enjoys full operational autonomy. The Bank can provide financial assistance directly as well as through other institutions to all types of industrial concerns irrespective of their size or form of ownership. There are no maximum or minimum limits on the amount of assistance or security. The Bank has the freedom to deal with any problem relating to industrial development in general and industrial finance in particular.

The IDBI has created a special fund known as Development Assistance Fund to assist industrial concerns which are not able to get assistance from normal sources. It makes available foreign funds to industrial concerns.

Small Industries Development Bank of India (SIDBI)

SIDBI was set up on April 2, 1990 under a special Act of Parliament, as a wholly owned subsidiary of the IDBI. SIDBI took over the outstanding portfolio of IDBI relating to the small scale sector worth over Rs. 4,000 crores. It has taken over the responsibility of administering Small Industries Development Fund and National Equity Fund which were earlier administered by IDBI. SIDBI was delinked from the IDBI through the SIDBI (Amendment) Act, 2000 with effect from March 27, 2000. Its management vests with an elected Board of Directors.

Objectives – SIDBI was envisaged’as “the principal financial institution for the promotion, financing and development of industry in the small scale sector and to coordinate the functions of other institutions engaged in the promotion, financing and developing industry in the small scale sector and for matters connected therewith or incidental thereto”.

Thus, financing, promotion, development, and coordination are the basic objectives of SIDBI.

Functions – SIDBI’s main functions are:

Refinancing loans and advances extended by primary lending institutions to small scale industrial units.
Discounting and rediscounting bills arising from sale of machinery to or manufactured by industrial units in the small scale sector.
Extending need capital soft loan assistance under National Equity Fund, Mahila Udyam Nidhi, Mahila Vikas Nidhi and through specified agencies.
Granting direct assistance and refinance for financing exports of products manufactured in small scale sector.
Extending support to State Small Industries Development Corporations (SSIDCs) for providing scarce raw materials to and marketing the end products of industrial units in the small scale sector.
Providing financial support to National Small Industries Corporation (NSIC) for providing leasing, hire-purchase and marketing support to industrial units in the small scale sector.

Export-Import (EXIM) Bank of India

Two major institutions which provide finance to exporters are the Export-Import Bank of India, and the Export Credit Guarantee Corporation.

The Export-Import Bank of India was established on January 1,1982 under an Act of Parliament for the purpose of financing, facilitating and promoting India’s foreign trade. It is the principal financial institution for coordinating the working of institutions engaged in financing exports and imports.

Mission – The mission of Exim Bank is “to develop commercially viable relationships with externally oriented companies by offering them a comprehensive range of products and services to enhance their internationalisation efforts”.

Objectives – The main objectives of the Exim Bank are as follows:

To translate India’s foreign trade policies into concrete action plans.
To assist exporters to become internationally competitive by providing them alternate financing solutions.
To develop mutually beneficial relationships with international financial community. .
To forge close working relationships with other export financing agencies, multilateral funding agencies and investment promotion agencies.
To initiate and participate in debates on issues central to India’s international trade.
To anticipate and absorb new developments in banking, export financing and information technology.
To be responsive to export problems of Indian exporters and pursue policy resolutions.

Exim Bank concentrates on medium and long-term financing, leaving the short-term financing to commercial banks. The Bank has developed a global network through strategic linkages with World Bank, Asian Development Bank and other agencies

Functions:
The Exim Bank provides a wide range of financial facilities and services. Some of these are summarised below:

1. Pre-Shipment Credit: This credit is provided to buy raw materials and other inputs required to produce capital goods meant for exports. It meets temporary funding requirement of export contracts. Exim Bank offers pre-shipment credit for periods, exceeding 180 days. Exporters can also avail of pre-shipment credit in foreign currency for imports of inputs needed for manufacture of export products.

2. Supplier’s Credit: Exim Bank offers supplier’s credit in rupees or foreign currency at post-shipment stage to finance exports of eligible goods and services on deferred payment terms. Supplier’s credit’s available both for supply contracts and project exports which includes construction, turnkey or consultancy contracts undertaken overseas.

3. Finance for Exports of Consultancy and Technology Services: A special credit facility is avail¬able to exporters of consultancy and technology services on deferred payment terms. The services include transfer of technology/know-how, preparation of project feasibility reports, providing personnel for rendering technical services, maintenance and management contracts, etc. .

4. Finance for Project Export Contracts: This scheme is meant to finance rupee expenditure for execution of overseas project export contracts such as for acquisition of materials and equipment, mobilisation of personnel, payments to be made to staff, sub-contractors, and to meet project related overheads. The amount involved is usually in excess of Rs. 50 lakhs and the maximum period of loan is four years.

5. Credit to Overseas Entities: Overseas buyers can avail of Buyer’s Credit for importing eligible goods from India on deferred payment basis. Exim Bank also extends Lines of credit to overseas financial institutions, foreign governments and their agencies for enabling them to provide term loans for importing eligible goods from India.

6. Finance for Export-Oriented Units: Exim Bank offers several facilities to export-oriented units (EOUs). Some of these are:

Project Finance – Exim Bank offers term loans for setting up new units and for modernization expansion of existing units. The Bank also extends 100 per cent refinance to commercial banks for term loans sanctioned to an EOU.
Equipment Finance – Exim Bank offers a line of credit for Indian/foreign production equipment, including equipment for packaging, pollution control, etc. It also provides term loans to vendors of EOUs to enable them to acquire plant and machinery and other assets required for increasing export capability. Such finance is given for non-project related capital expenditure of EOUs.
Working Capital Finance – Exim Bank provides term loans both in rupees and foreign currency to help EOUs meet their working capital requirements. Short-term working capital finance is provided for imports of eligible inputs.
R&D Finance – Exim Bank offers term loans to EOUs for development of new technology as well as to develop and/or commercialise new product process applications.
Import Finance – Term loans in Indian rupees/foreign currency are available to Indian manufacturing companies for import of consumable inputs, canalised items, capital goods, plant and machinery, technology and know-how.
Export Facilitation – Exim Bank offers term finance and non-funded facilities to Indian companies to create infrastructure facilities for developing Indian’s foreign trade and thereby enhance their export capability. Software exporters can get term loans to set up/expand software training institutes and software technology parks. This facility is ‘ also available to Indian companies involved in development of ports and port related services.
Export Marketing Finance – Term loans are offered to assist the firms in export marketing and development efforts. Desk/field research, overseas travel, quality certification, product launch are the typical activities eligible for finance under this schemes. Finance is also given to support export product development plans with focus on industrialised market.
Underwriting – Exim Bank extends underwriting facility to help the firms raise finance from capital markets. It also issues guarantees to facilitate export contracts and import transactions.

7. Finance for Joint Ventures Abroad

Overseas Investment Finance – Any Indian promoter making equity investment abroad in an existing company or in a new project is eligible for finance under the scheme. Assistance is provided both in terms of loans and guarantees.
Asian Countries Investment Partners Programme – This programme seeks to promote joint ventures in India between Indian companies and companies from other Asian countries. Finance is provided at various stages of project cycle, viz., sector study, project identification, feasibility study, proto-type development, setting up project, and technical and managerial assistance.

Exim Bank also offers a wide range of information, advisory and support services which help exporters to evaluate international risks, exploit export opportunities and improve competitiveness.

National Bank for Agriculture and Rural Development (NABARD)

NABARD was established on December 15, 1981 under the NABARD Act. It started functioning on July 1, 1982. It was set up to provide credit for the promotion of agriculture, cottage and village industries, handicrafts and other rural crafts and other economic activities in rural areas with a view to promote Integrated Rural Development Program (IRDP) and to secure prosperity in rural areas.

OBJECTIVES:

to serve as a financing institution for institutional credit (both long term and short term) for promoting economic activities in rural areas.
to provide direct lending to any institution as approved by the Central Government.

Functions:

1. CREDIT FUNCTIONS:

providing short term credit to State Cooperative Banks, Regional Rural Banks and other RBI approved financial institutions for the following activities:
- Seasonal agricultural operations
- marketing of crops
- pisciculture activities
- production/procurement and marketing of co-operative weavers and rural artisans, i.e. individuals and societies.
- production and marketing activities of industrial co-operations.
providing medium term credit to State Cooperative Banks, State Land Development Banks, Regional Rural Banks and other RBI approved financial institutions for converting short-term agricultural purposes.
Providing long term credit to State Land Development Banks, Regional Rural Banks, Commercial Banks, State cooperative Banks and other approved financial institutions.
refinancing cottage/village and small scale industries located in rural areas.

2. DEVELOPMENT FUNCTIONS:

Co-coordinating the operations of rural credit institutions
developing expertise to deal with agricultural and rural development efforts
acting as an agent to the Government and RBI for business transactions in relevant areas and provide facilities for training, research and dissemination of information in rural banking and development
contributing to the share capital of eligible institutions (e) providing direct loans to centrally approved cases.

3. REGULATORY FUNCTIONS:

inspecting Regional Rural Banks and Cooperative Banks other than the Primary cooperative Banks
recommending for RBI approval opening of a new branch by Regional Rural Banks or Cooperative Banks
asking Regional Rural Banks and Cooperative Banks to file returns and documents.

CA Foundation Business & Commercial Knowledge Study Material – Indian Regulatory bodies

January 6, 2023

CA Foundation Business & Commercial Knowledge Study Material Chapter 5 Organizations Facilitating Business – Indian Regulatory bodies

Government of India has constituted several bodies to regulate and control business activities for protecting the interests of various stakeholders. Similarly, several development banks have been established to assist in the establishment and growth of business enterprises. These regulatory bodies and development banks are described in this chapter.

Indian Regulatory Bodies
Regulation and Control of business and related activities are necessary to ensure health growth and to safeguard the interests of various sections of the society. Some of the regulatory bodies in India are given below:

Securities and Exchange Board of India (SEBI)

In order to protect the interests of investors the Government of India constituted the Securities and Exchange Board of India (SEBI) in April, 1988. It is meant to be a supervisory body to regulate and promote the securities market in the country.

Objectives: The main objectives of SEBI are as under:

to promote fair dealings by the issuers of securities and to ensure a market place where they can raise funds at a relatively low cost;
to provide a degree of protection to the investors and safeguard their rights and interests so that there is a steady flow of savings into the market;
to regulate and develop a code of conduct and fair practices by intermediaries like brokers, merchant bankers, etc. with a view to making them competitive and professional.

Thus, the basic objectives of SEBI are to protect the interests of investors in securities and to pro-mote the development of, and to regulate, the securities markets.

Functions: SEBI performs the following functions:

1. Protective Functions – In order to protect the common investor, SEBI undertakes the following activities:

It prohibits fraudulent and unfair trade practices on stock exchanges.
It prohibits insider trading.
It undertakes steps to educate investors.
It promotes fair practices and code of conduct in securities market.
It is empowered to investigate cases of insider trading, impose fines and imprisonment.
It has issued guidelines for preferential allotment of shares.

2. Developmental Functions – These functions are as follows:

Training intermediaries in stock market.
Developing capital markets through internet trading, permitting stock exchanges to market/ IPO and making underwriting optional.

3. Regulatory Functions:

Prescribing rules and regulations for merchant bankers, underwriters and registrars.
Registering and regulating stock brokers, sub-brokers, etc.
Registering and regulating the working of mutual funds.
Regulating takeover of companies.
Conducting inquiries and audits of stock exchanges.

Reserve Bank of India (RBI)

Every country has a Central Bank as an apex body to supervise and control the banking sector. Reserve Bank of India is India’s Central Bank. It was set up under the Reserve Bank of India Act, 1934. It began its operations on April 1, 1935. It is managed by a Board of Governors headed by the RBI Governor.

The functions performed by the Reserve Bank of India may be classified broadly into three categories –

traditional central banking functions,
supervisory functions, and
development functions.

The central banking functions are given below:

1. Issue of Bank Notes: Under the RBI Act, the RBI has the monopoly (sole right) to issue bank notes of all denominations. The RBI has a separate Issue Department to make issues of currency notes. It has adopted the minimum reserve system of note issue.

2. Banker to Government: The Reserve Bank acts as the banker, agent and adviser to Government of India:

It maintains and operates government deposits.
It collects and makes payments on behalf of the government.
It helps the government to float new loans and manages the public debt.
It sells for the Central Government treasury bills of 91 days duration.
It makes ‘Ways and Means’ advances to the Central and State Governments for periods not exceeding three months.
It provides development finance to the government for carrying out five year plans.
It undertakes foreign exchange transactions on behalf of the Central Government.
It acts as the agent of the Government of India in the latter’s dealings with the International institutions.
It advises the government on all financial matters such as loan operations, investments, agricultural and industrial finance,
banking, planning, economic development, etc.

3. Bankers’ Bank: The RBI keeps the cash reserves of all the scheduled banks and is, therefore, known as the ‘Reserve Bank’. The scheduled banks can borrow in times of need from RBI. The RBI acts not only as the bankers’ bank but also the lender of the last resort by providing rediscount facilities to scheduled banks. The RBI extends loans and advances to banks against approved securities.

4. Controller of Credit: A major function of the RBI is to formulate and administer the country’s monetary policy. The RBI controls the volume of credit created by banks in India. It can ask any particular bank or the entire banking system not to lend against particular type of securities or for a particular purpose. The RBI controls credit in order to ensure price stability and economic growth.

5. Custodian of Foreign Exchange Reserves: The RBI acts as the custodian of India’s reserve of international currencies. In addition, RBI has the responsibility of maintaining exchange rate of the rupee and of administering the exchange controls of the country.

6. Clearing House Facility: As a clearing house, the central bank settles the claims of commercial banks and enables them to clear their dues through book entries. It makes debit and credit entries in their accounts for convenient adjustment of their daily balances with one another.

7. Collection and Publication of Data: The central bank conducts surveys and publishes reports and bulletins. It may provide staff training facilities to the personnel of commercial banks. It maintains relations with international financial institutions such as World Bank, IME etc.

Regulatory and Supervisory Functions:

The RBI is the supreme banking authority in the country. Every bank has to get a licence from the RBI to do banking business in India. The licence can be cancelled if the stipulated conditions are violated. Each scheduled bank is required to send a return of its assets and liabilities to the RBI. In addition, the RBI can call for information from any bank. It also has the power to inspect the accounts of any commercial bank. Thus, the RBI controls the banking system through licensing, inspection and calling for information.

The RBI has been given wide powers of supervision and control over commercial and cooperative banks. It can carry out periodical inspections of the banks and to call for returns from them. The supervisory and regulatory functions of the RBI are meant for improving the standard of banking in India and for developing the banking system on sound lines.

With liberalisation and growing integration of the Indian financial sector with the international market, the supervisory and regulatory role of RBI has become critical for the maintenance of financial stability. RBI has been continuously fine-tuning its regulatory and supervisory mechanism in recent years to match international standards. Migration to new capital adequacy framework (Basel II) based on a three-pillar approach, namely, minimum capital requirements, supervisory review, and market discipline, involves implementation challenges for both RBI and banks. RBI has taken a number of initiatives to make migration to Base II smoother.

Promotional or Developmental Functions:

The RBI is expected to promote banking habit, extend banking facilities to rural and semi-urban areas, establish and promote new specialised financial agencies. The RBI has helped in the setting of the IFCI, the SFCs, the UTI, the IDBI, the Agricultural Refinance Corporation of India, etc. These institutions were established to mobilise savings and to provide finance to industry and agriculture. The RBI has developed the cooperative credit movement to encourage savings, to eliminate moneylenders from the villages and provide short-term credit to agriculture. The RBI has also taken initiative for widening financial facilities for foreign trade. It facilitates the process of industrialisation by setting up specialised institutions for industrial finance. It also undertakes steps to develop bill market in the country.

Functions of the RBI

Monetary Functions: Issue of currency, banker to Government, banker’s bank, credit control, custodian of foreign exchange.
Supervisory Functions: Licensing, branch expansion, liquidity of assets, working methods, inspection, amalgamation and reconstruction.
Developmental Functions: Promotion and mobilisation of savings, extension of banking, elimination of money lenders.

Credit Control by RBI:
As stated earlier, RBI is the controller of credit in India. Credit control means the regulation of credit by the central bank for achieving the desired objectives. It involves expansion and contraction of credit. The control over credit is necessary for preventing too much money supply in the economy and to prevent price rise.

The objectives of credit control are as follows:

to stabilise the general price level in the country;
to keep the exchange rate stable;
to promote and maintain a high level of income and employment;
to maintain a normal and steady growth rate in business activity;
to eliminate undue fluctuations in production and employment.

In order to control the volume of credit in the country, the RBI employs both general and selective methods:

ca-foundation-business-commercial-knowledge-study-material-indian-regulatory-bodies

Fig. Credit Control by RBI

1. Bank Rate – The standard rate at which the RBI is prepared to discount bills of exchange or extends advances to the commercial banks is known as the bank rate. When the RBI increases the bank rate, borrowing from banks becomes costlier and the amount of borrowings from banks is reduced. The effectiveness of bank rate is, however, limited due to certain constraints in the economy. Existence of non-banking finance institutions, large profit margins on speculative dealings, priority sector advances and increase in prices of final products to offset high interest rates are examples of these constraints.

2. Cash Reserve Ratio (CRR) – CRR refers to that portion of total deposits of a commercial bank which it has to keep with the RBI in the form of cash reserves. By raising the CRR, the RBI reduces the amount of loanable funds with commercial banks. As they can lend lesser amount, the volume of credit in the country gets reduced.

3. Statutory Liquidity Ratio (SLR) – SLR means that portion of total deposits of a commercial bank which it has to keep with itself in the form of cash reserves. An increase in the SLR has the same effect on the volume of credit as increase in the CRR.

4. Open Market Operations – These refer to the purchase and sale by the RBI of a variety of assets such as gold, government securities, foreign exchange and industrial securities from the market to increase money supply and lower interest rates. This is done to stimulate banks to give out more loans, boost private spending and increase inflation. It is called quantitative easing. If the RBI wants to reduce the volume of credit, it sells these assets. Such sale reduces money supply with banks and leads to increase in rates of interest. The open market operations of the RBI are however restricted to government securities due to underdeveloped securities market, and narrow gilt edged market.

Selective Credit Controls

Under these measures, the RBI diverts the flow of credit from speculative and unproductive activities to productive and priority areas. Under the Banking Regulation Act, 1949 the RBI is empowered to issue directives to banks, regarding their advances. These directives may relate to:

the purpose for which advances may or may not be made;
the margins to be maintained in respect of secured advances; ‘
the maximum amount of advances to any borrower;
the maximum amount upto which guarantees may be given by the bank on behalf of any firm, company, etc.; and
the rate of interest and other terms and conditions for granting advances.

The selective methods of credit control are as follows:

Margin Requirements – Commercial banks have to keep a margin between the amount of loan granted and the market value of the security against which the loan is granted. For example, they may be asked to grant loans upto 80 per cent of the security or asset. When the central bank raises margin requirements, the volume of credit is reduced. In the same manner, lowering of margin re-quirements leads to expansion of credit. Margin requirements is a selective method of credit control.
Credit Rationing – Sometimes, the Reserve Bank of India fixes a limit to the credit facilities available to commercial banks. The available credit is rationed among them according to the purpose of credit. This method of credit control is used in exceptional situations of monetary stringency. Moreover, credit rationing cannot be used for the expansion of credit in the economy.
Moral Suasion – Under this method, the central bank requests and persuades the commercial banks not to grant credit for speculative and non-essential activities. It is an informal and non-statutory method. But commercial banks honour the authority of the central bank. The central bank may also issue directives to commercial banks to refrain from certain types of lending. For example, the RBI asked banks to refrain from lending against food grains to check hoarding.
Publicity – The central bank issues reports and review statements of assets and liabilities. These publications keep commercial banks aware of conditions in the money market, public finance, trade and industry in the country. They adjust their credit activities accordingly.

Role of RBI in Economic Development

In a developing country like India, the central bank has to play a vital role. The developing coun¬tries generally do not have well organised money market and capital market. Therefore, the central bank is expected to develop the banking system and financial system of the country. In addition to the traditional functions, the RBI contributes towards the Indian economy in the following ways:

Development of Banking System – The RBI takes steps to develop a sound banking system in the country. Over the years, an integrated commercial banking structure has been developed under the supervision and control of the RBI. Regulation and control by the RBI creates public confidence in the banking system.
Development of Financial Institutions – The RBI has played an active role in the establishment of specialised institutions for agriculture, industry, small scale sector and foreign trade.
Development of Backward Areas – The RBI has encouraged banks to set up branches in backward regions so that financial facilities could be made available to people in these areas and to priority sectors. Social banking made rapid progress in India after the nationalisation of major banks in 1969.
Economic Stability – The RBI has used its monetary and credit policy to regulate inflationary pressures in the economy. The bank has controlled the volume of credit for this purpose. According to the Planning Commission, “the central bank has to take a direct and active role in creating or helping to create the machinery needed for financing development activities all over the country, and in ensuring that the finance available flows in the intended directions”.
Economic Growth – The RBI ensures adequate money supply for meeting the growing needs of different sectors of the economy.
Proper Interest Rate Structure – The RBI has helped in establishing a suitable interest rate structure so as to direct investment in the economy. A policy of low interest rate has been adopted for encouraging investment.
Miscellaneous – The RBI provides training and research facilities. It provides special facilities to priority sectors. It also guides the efforts of planners by its economic policies.

Insurance Regulatory and Development Authority (IRDA)

IRDA is a statutory and apex body that supervises and regulates insurance industry in India. It was established under the IRDA Act on December 16, 2014. It is managed by a chairman, five whole time members and four part time members all appointed by the Government of India.

OBJECTIVES:

to promote the interests and rights of policy holders
to promote and ensure the growth of insurance industry
to ensure speedy settlement of genuine claims and to prevent frauds and malpractices, and
to bring transparency and orderly conduct of financial markets dealing with insurance.

FUNCTIONS:

to issue, register and regulate insurance companies
to protect the interests of policyholders
to provide licence to insurance intermediaries such as agents and brokers who met the qualifications and code of conduct specified by it
to promote and regulate the professional organizations related with insurance business so as to promote efficiency in the insurance sector
to regulate and supervise the rates of insurance premium and terms of insurance covers
to specify the conditions and manners according to which the insurance companies and other intermediaries have to make their financial reports
to regulate the investment of policyholders funds by insurance companies, and
to ensure the maintenance of solvency margin (Company’s ability to payment claims) by insurance companies.

Competition Commission of India (CCI)

Government of India constituted the CCI under the Competition Act, 2002

Duties, Powers and Functions of the Commission

Duties of Commission
Under Section 18, Competition Commission has been charged with the following duties:

to eliminate practices having adverse effect on competition,
to promote and sustain competition,
to protect the interests of consumers, and
to ensure freedom of trade carried by other participants in markets in India.

Powers and Functions of Commission
With a view to perform the duties enumerated under section 18, the Commission has been charged with certain obligations and conferred with certain powers. These obligations and powers are as follows:

1. Inquiry into Certain Agreements (Section 19) – The Commission may inquire into any alleged contravention of the provisions contained in section 3(1) or 4(1) either on its own motion or on:

receipt of a complaint from any person, consumer or their association or trade association; or
a reference made to it by the Central Government or a State Government or a statutory authority [Section 19(1)].

2. Inquiry whether an Enterprise Enjoys Dominant Position – The Commission shall, while inquiring whether an enterprise enjoys a dominant position or not under Section 4, have due regard to all or any of the following factors, namely:

market share of the enterprise;
size and resources of the enterprise;
size and importance of the competitors;
economic power of the enterprise including commercial advantages over competitors;
vertical integration of the enterprises or sale or service network of such enterprises;
dependence of consumers on the enterprise;
monopoly or dominant position whether acquired as a result of any statute or by virtue of being a Government company or a public sector undertaking or otherwise;
entry barriers including barriers such as regulatory barriers, financial risk, high capital cost of entry, marketing entry barriers, technical entry barriers, economies of scale, high cost of substitutable goods or service for consumers;
countervailing buying power;
market structure and size of market;
social obligations and social costs;
relative advantage by way of contribution to the economic development by the enterprise enjoying a dominant position having or likely to have appreciable adverse effect on compe-tition;
any other factor which the Commission may consider relevant for the inquiry [Section 19(4)].

3. Inquiry into Combination by Commission (Section 20) – Inquiry into acquisition, control and combination. The Commission may, upon its own knowledge or information relating to acquisition referred to in Section 5(a) or acquiring of control or merger or amalgamation referred to in Section 5(6) or merger or amalgamation referred to in Section 5(c), inquire into whether such a combination has caused or is likely to cause an appreciable adverse effect on competition in India.

The Commission shall not initiate any inquiry under this sub-section after the expiry of one year from the date on which such combination has taken effect [Section 20(1)].

The Commission shall, on receipt of a notice or upon receipt of a reference under Section 6(2), in¬quire whether a combination referred to in that notice or reference has caused or is likely to cause an appreciable adverse effect on competition in India [Section 20(2)].

Factors having effect on combination. For the purposes of determining whether a combination would have the effect of or is likely to have an appreciable adverse effect on competition in the relevant market, the Commission shall have due regard to all or any of the following factors, namely:

actual and potential level of competition through imports in the market;
extent of barriers to entry to the market;
level of combination in the market;
degree of countervailing power in the market;
likelihood that the combination would result in the parties to the combination being able to significantly and sustainably increase prices or profit margins;
extent of effective competition likely to sustain in a market;
extent to which substitutes are available or are likely to be available in the market;
market share, in the relevant market, of the persons or enterprise in a combination, individ-ually and as a combination;
likelihood that the combination would result in the removal of a vigorous and effective com-petitor or competitors in market;
nature and extent of vertical integration in the market;
possibility of a failing business;
nature and extent of innovation;
relative advantage by way of contribution to the economic development, by way of combi-nation having or likely to have appreciable adverse effect on competition;
whether the benefits of the combination outweigh the adverse impact of the combination, if any [Section 20(4)].

4. Power to Grant Interim Relief (Section 33) – Section 33 empowers the Commission to grant interim relief by way of temporary injunctions.

Where during an inquiry before the Commission, it is proved to the satisfaction of the Commission, by affidavit or otherwise, that an act in contravention of Section 3(1), or Section 4(1) or Section 5 has been committed and continues to be committed or that such act is about to be committed, the

Commission may grant a temporary injunction restraining any party from carrying on such act until the conclusion of such inquiry or until further orders, without giving notice to the opposite party, where it deems it necessary [Section 33(1)].

5. Power to Award Compensation (Section 34) – Without prejudice to any other provisions contained in this Act, any person may make an application to the Commission for an order for the recovery of compensation from any enterprise for any loss or damage shown to have been suffered, by such person as a result of any contravention of the provisions of Chapter II (Sections 3 to 6), having been committed by such enterprise [Section 34(1)].

The Commission may, after an inquiry made into the allegations mentioned in the application made under sub-section (1), pass an order directing the enterprise to make payment to the applicant, of the amount determined by it as realisable from the enterprise as compensation for the loss or damage caused to the applicant as a result of any contravention of the provisions of Chapter II having been committed by such enterprise [Section 34(2)].

Orders by Commission after Inquiry into Agreements or Abuse of Dominant Position (Section 27)

Orders by Commission. Where after inquiry the Commission finds that any agreement or action of an enterprise in a dominant position, is in contravention of Section 3 or Section 4, it may pass all or any of the following orders, namely:

direct any enterprise or association of enterprises or person or association of persons, involved . in such agreement, or abuse of dominant position, to discontinue and not to re-enter such
agreement or discontinue such abuse of dominant position;
impose such penalty, as it may deem fit which shall be not more than 10 per cent of the average of the turnover for the three preceding financial years upon each of such person or enterprises which are parties to such agreements or abuse. However, where any agreement referred to in Section 3 (Le., any anti-competitive agreement) has been entered into by any cartel, the Commission shall impose upon each producer, seller, distributor, trader or service provider included in that cartel, a penalty equivalent to three times of the amount of profits made out of such agreement by the cartel or ten per cent of the average of the turnover of the cartel for the last preceding three financial years, whichever is higher;
award compensation to parties in accordance with the provisions contained in Section 34;
direct that the agreements shall stand modified to the extent and in the manner as may be specified in the order by the Commission;
direct the enterprises concerned to abide by such other orders as the Commission may pass and comply with the
directions, including payment of costs, if any;
recommend to the Central Government for the division of an enterprise enjoying dominant position;
pass such other order as it may deem fit.

Division of Enterprise Enjoying Dominant Position (Section 28)

The Central Government, on recommendation by the Commission under Section 27(f), may, in writing, direct division of an enterprise enjoying dominant position to ensure that such enterprise does not abuse its dominant position [Section 28(1)]. This order may provide for all or any of the following matters, namely:

the transfer or vesting of property, rights, liabilities or obligations;
the adjustment of contracts either by discharge or reduction of any liability or obligation or otherwise;
the creation, allotment, surrender or cancellation of any shares, stocks or securities;
the payment of compensation to any person who suffered any loss due to dominant position of the enterprise;
the formation or winding up of an enterprise or the amendment of the memorandum of association or articles of association or any other instruments regulating the business of any enterprise;
the extent to which, and the circumstances in which, provisions of the order affecting an enterprise may be altered by the enterprise and the registration thereof;
any other matter which may be necessary to give effect to the division of the enterprise [Section 28(2)].

CA Foundation Business & Commercial Knowledge Study Material Chapter 6 Common Business Terminologies – Test Questions

January 6, 2023

CA Foundation Business & Commercial Knowledge Study Material Chapter 6 Common Business Terminologies – Test Questions

1. A stock that provides regular dividends even during economic downturn is called
(a) Listed
(b) Crow Stock
(c) Income Stock
(d) Defensive Stock

2. Carrying forward a transaction from one settlement period to the next is known as
(a) Basket Trading
(b) Margin Trading
(c) Badla
(d) Option deal

3. Call is the opposite of
(a) Equity
(b) Bid
(c) Ask/offer
(d) Equity

4. A speculator who buys securities in anticipation of increase in prices is called
(a) Stag
(b) Bull
(c) Bear
(d) None of them

5. A bear market means
(a) A market wherein share prices are falling consistently
(b) A market wherein share prices are rising consistently
(c) A market wherein share prices are stable
(d) None of the above

6. Simultaneous purchase and sale of the same stock in two different markets is known as
(a) Basket trading
(b) Badla
(c) Arbitrage
(d) Margin Trading

7. Buying or selling all 30 scrips of sensex in pro-portion of their current weights in the sensex in one go is called
(a) Basket trading
(b) Arbitrage
(c) Badla
(d) Margin Trading

8. The relationship between the price of a share and the sensex is measurably
(a) Alfa
(b) Beta
(c) Book value
(d) Annuity

9. Combination of two or more firms into one firm is called
(a) Consolidation
(b) Yield
(c) Option
(d) None of the above

10. An option to buy a particular share at a specified price within a specified future period is known as
(a) Put option
(b) Bid
(c) Offer
(d) Case option

11. The value of a share printed on the share certificate is called
(a) Face value
(b) Market Value
(c) Future value
(d) Current value

12. Sensex is made up of how many scrips
(a) 50
(b) 30
(c) 40
(d) 20

13. Nifty consists of how many scrips
(a) 20
(b) 30
(c) 40
(d) 50

14. When a company makes first issue of shares to the general public it is called
(a) ADR
(b) GDR
(c) CD
(d) IPO

15. A textile firm enters into cement manufacturing business. It is an example of:
(a) Consolidation
(b) Diversification
(c) Liquidation
(d) Turnaround

16. The strategy used to minimize the risk and maxi-mize the return on an investment is called
(a) Hedge
(b) Index
(c) Bid
(d) Offer

17. The statistical measure of changes in prices on a stock exchange is:
(a) Dividend
(b) Index
(c) Beta
(d) Bid

18. A security whose price is derived from one or more underlying assets is a
(a) Blue Chip
(b) Derivative
(c) Hedge
(d) Index

19. Piecemeal sale of the assets of a division of the company is called
(a) Modernization
(b) Diversification

20. Total share holding of an investor is known as his/her
(a) Mutual Fund
(b) Holding Period
(c) Pastfolio
(d) Limit order

21. Dividing a share with a face value of Rs. 100 each into 10 shares with a face value of Rs. 10 each is an example of
(a) Sheet selling
(b) Liquidation
(c) Diversification
(d) Stock split

22. Paid form of non-personal promotional of ideas, goods and services by an identified sponsor is called :
(a) Adventuring
(b) Sales promotion
(c) Personal Selling
(d) None of the above

23. The process of comparing the products and services with those of best in the industry to improve quality and performance is known as
(a) Advertising
(b) After-sale-Device
(c) Benchmarking
(d) None of the above

24. Commitment of customers to a particular brand is called
(a) Brand Equity
(b) Brand recognition
(c) Brand loyalty
(d) Benchmarking

25. A combination of several firms working together to build or buy something is known as:
(a) Business Modal
(b) Business Portfolio
(c) Combination
(d) Consortium

26. The values, beliefs and traditions shared by the members of a company is called
(a) Corporate culture
(b) Consortium
(c) Cross selling
(d) None of the above

27. Giving unique identity to a product to differentiate it from rival products means
(a) Direct marketing
(b) Differentiation
(c) Diversification
(d) None of the above

28. It is the process of eliciting support for a company and its activities from its employees. Name it
(a) Internal Marketing
(b) Direct Marketing
(c) Internet Marketing
(d) None of the above

29. A company created jointly by two or more companies for mutual advantage is called
(a) Consolidation
(b) Merger
(c) Joint Venture
(d) None of the above

30. Dividing the total market into several groups on the basis of consumer characteristics is known as:
(a) Market segmentation
(b) Market Development
(c) Market Research
(d) None of the above.

31. Offering existing products or their new version to a new customer group is called
(a) Market entity
(b) Market Positioning
(c) Market Development
(d) None of the above

32. Selecting the most attractive market segment for a particular product or product line is known as
(a) Market Positioning
(b) Market Entry
(c) Target Marketing
(d) None of the above

33. It is the exploitation of small market segments, name it
(a) Direct Marketing
(b) Niche Marketing
(c) Mass Marketing
(d) None of the above

34. A product’s customer benefit that no other product can claim is known as
(a) Opportunity
(b) Publicity
(c) Unique Selling Proposition
(d) None of the above.

35. The rate at which the Reserve Bank of India lends, money to commercial banks for long period is called
(a) Repo Rate
(b) Goring Rate
(c) Bank Rate
(d) None of the above

36. The money deposit made by the buyer to the seller of real estate during negotiation stage is known as
(a) Earnest Money Deposit
(b) Fixed Deposit
(c) Current Deposit
(d) None of the above

37. The document issued by a bank on behalf of the importer promise to pay money for imported goods is called
(a) Letter of credit
(b) Debt Card
(c) Bank Draft
(d) None of the above

38. The rate of interest offered by the Reserve Bank of India on deposit of surplus funds by commercial banks is known as
(a) Bank Rate
(b) Repo Rate
(c) Reverse Repo rate
(d) None of the above

39. Jan Dhan Account is an example of
(a) Current Account
(b) Fixed Deposit Account
(c) Zero Balance Account
(d) None of the above

40. The rate of interest at which banks borrow money for short periods from the Reserve Bank of India is called.
(a) Bank Rate
(b) Repo Rate
(c) Reserve Repo Rate
(d) None of the above

41. Profits, people and planet together constitute a company’s
(a) Vision
(b) Mission
(c) Triple Bottom Line
(d) None of the above

42. Integration of national economies into a world economy is called:
(a) Globalisation
(b) Privatization
(c) Liberalization
(d) None of the above

43. Molasses in sugar industry is an example of
(a) Joint product
(b) Unique product
(c) Byproduct
(d) None of the above

44. Sale of public enterprises to private sector is called
(a) Globalisation
(b) Privatization
(c) Liberalization
(d) None of the above

45. Financial recovery of a loss making company is known as
(a) Turn around
(b) Privatization
(c) Liberalization
(d) None of the above

46. The roadmap of a company future is
(a) Mission
(b) Vision
(c) Business Module
(d) None of the above

47. The statement that defines what a company is and what it does is called
(a) Mission
(b) Vision
(c) Business Module
(d) None of the above

48. Activities involved in physical involvement of goods from the factory to market etc. is called
(a) Logistics
(b) Merger
(c) Mission
(d) None of the above

CA Foundation Business & Commercial Knowledge Study Material – Other Business Terminology

January 6, 2023

CA Foundation Business & Commercial Knowledge Study Material – Other Business Terminology

Other Business Terminology

Acquisition: Takeover of one firm by another.
Administration: The process of determining and executing the policies and programmes of an organisation.
Allowance: A fixed sum allowed by an employer to an employee e.g. house rent allowance.
Bankruptcy: A situation when a firm’s assets are insufficient to pay its liabilities.
Bottom line: Net profits.
Business environment: All forces and factors external to the firm but influence its working and performance.
Business facilitators: The individuals, organisations/institutions and arrangement that ease the setting up, operating and exit of business firms.
By products: Products recovered from material discarded in a main process e.g. molasses in sugar industry.
Corporate: A business entity distinct from its members e.g. a company.
Corporate governance: The system that ensures that a company’s operations are conducted in an ethical manner and as per the law. It consists of board of directors, independent audit and financial reporting.
Drawings: Cash or goods taken by the owner of the firm for personal/family use.
Electronic commerce: Commercial transactions conduced over the Internet.
Electronic filing: Fifing documents online e.g. fifing tax returns online.
Franchise: The license given by one company to another to use the former name and sell its product/ service in a specified territory in exchange for payment of fee.
Globalisation: The process of removing barriers to flow of goods, services, labour, capital and technology from one country to another leading to the emergence of a global economy.
Goodwill: Money Value of a company’s reputation.
Infrastructure: The basic facilities necessary for the operation of a society and business firms. It consists of buildings, roads, railways, posts, power supply, etc.
Joint sector: Business enterprises owned jointly by Government and private sector.
Joint products: Two or more products separated in the same processing operation which usually require further processing. For example, gasoline, lubricant, paraffin and kerosene are joint products, all produced from crude oil.
Liberalisation: Systematic removal of restrictions on private business operations.
Logistics: Movement of supplies to the production facilities (inbound logistics) and movement of products from centres of production to markets (outbound logistics).
Merger: Combination of two or more independent firms into a single firm.
Mission Statement: A statement that defines the business scope (who we are and what we do) of an organisation.
Multinational: A company which has business operations in a country otherwise the country of its incorporation.
Patent: An exclusive legal right to the inventor for use of the invention.
Pestle: Political (P), Economic (E), Social (S), Technological (T), Legal (L) and Ecological (E) Environment.
Privatisation: Selling of public enterprises to public sector.
Private sector: All business enterprises owned and controlled by private persons.
Public sector: All enterprises owned and controlled by the Government.
Proprietorship: A business owned and controlled by an individual. Also known as sole proprietorship. Retained earnings: Undistributed profits of a company.
Return: Rate of earning on an investment.
Risk: Possibility of loss on an investment.
Secondary sector: Manufacturing and construction industries.
Subsidiary: A company owned and controlled by another company.
Sustainable development: Development that can be sustained over generations or development
without compromising ecology or environment.
Term insurance: Insurance for a specific time period with no defrayal to the insured person and which become null on its expiry.
Triple bottom line: Profit, people and planet i.e. simultaneous development of economy, society and ecology.
Turnaround: Financial recovery of a loss making firm.
Vision: The roadmap of a company’s future.
Whole life insurance: An insurance policy the sum of which is payable after the death of the insured to his nominee.

Tag: CA Foundation Study Material

CA Foundation Business Economics Study Material Chapter 2 Theory of Demand and Supply – Demand Forecasting

Demand Forecasting

Demand Distinctions

Methods of Demand Forecasting

CA Foundation Business Economics Study Material Chapter 2 Theory of Demand and Supply – Elasticity of Demand

Elasticity of Demand

Price Elasticity of Demand

Measurement of price elasticity of demand

Determinants of price elasticity of demand

Income Elasticity of Demand

Cross elasticity of demand

Advertisement or Promotional Elasticity of Demand

CA Foundation Business Economics Study Material Chapter 2 Theory of Demand and Supply – Law of Demand

The Law of Demand

Exceptions to the Law of Demand

Expansion and Contraction of Demand

Increase and Decrease in demand (changes in demand OR shift in demand curve)

CA Foundation Business Economics Study Material Chapter 1 Nature and Scope of Business Economics – Basic Problems of an Economy and Role of Price Mechanism

Basic Problems of an Economy

CAPITALIST ECONOMY

SOCIALIST ECONOMY

MIXED ECONOMY

CA Foundation Business Economics Study Material – Nature and Scope of Business Economics

Nature of Business Economics

Scope of Business Economics

CA Foundation Business Economics Study Material Chapter 1 Nature and Scope of Business Economics – Introduction

Meaning of Business Economics

CA Foundation Business & Commercial Knowledge Study Material Chapter 5 Organizations Facilitating Business – Test Questions

CA Foundation Business & Commercial Knowledge Study Material Chapter 5 Organizations Facilitating Business – Indian Development Banks

Industrial Finance Corporation of India (IFCI)

Industrial Development Bank of India (Now IDBI Ltd.)

Small Industries Development Bank of India (SIDBI)

Export-Import (EXIM) Bank of India

National Bank for Agriculture and Rural Development (NABARD)

CA Foundation Business & Commercial Knowledge Study Material Chapter 5 Organizations Facilitating Business – Indian Regulatory bodies

Securities and Exchange Board of India (SEBI)

Reserve Bank of India (RBI)

Insurance Regulatory and Development Authority (IRDA)

Competition Commission of India (CCI)

CA Foundation Business & Commercial Knowledge Study Material Chapter 6 Common Business Terminologies – Test Questions

CA Foundation Business & Commercial Knowledge Study Material – Other Business Terminology