Investment Function and Capital Expenditure from Managerial Economics

We already have discussed about consumption function. Now, we will study about investment chapter. “Investment” is known as capital expenditure i.e. the expenditure on purchasing physical assets, machinery, equipments etc.

Types of Investment:

a) Gross and Net Investment: Gross is total value of productive assets created during a given period i.e. one year. It tells us the resources mobilized by the economy, depreciation is part of gross investment, when we deduct amount of depreciation from gross investment, and we get net investment. Net investment creates new productive capacity and employment opportunity.

b) Private Investment Public Investment: Investments made by private companies and corporate come under private investment. Investment made by Government and departmental undertakings is called public investment.

c) Induced and Autonomous Investment: Autonomous investment is the investment which is income in elastic. According to this, even if the income is zero, there is some amount of investment done by the Government. It does not depend on the change in National Income.

Induced Investment

In this figure, income is shown on X-axis and investment is shown on Y-axis. You can see that even when the income is zero, some amount of investment is made.

Induced investment increases with increase in income and decreases with the decrease in income.

When income increases, the demand and consumption will increase

In this figure, income is shown on X-axis and investment is shown on Y-axis. You can see when income increases the demand and consumption will increase and so the investment to increase the production and supply and vice versa.

Total Investment

In this figure, income is shown on X-axis and investment is shown on Y-axis. We can see the total investment in the above figure.

Total Investment = Autonomous + Induced Investment

Determinant of Consumption and Factors of Consumption Function

There are two groups of determinant of consumption factors that affect consumption function.

1. Subjective or internal factors: These are related to psychological characteristics of human wants. These factors change more in long run rather than short run. These factors are,

a. Precaution motive – Every individual has a strong feeling to prepare for unseen emergencies like sickness, accident, unemployment etc. So they build up reserves for such emergencies.

b. Foresight motive – Every man has future needs. They need to save for old age, educational needs of children, marriages of daughters etc.

c. Motive for independence – Most of use have a strong desire to be independent financially. So we tend to save by sacrificing present consumption.

d. Standard of living – We always want to improve the standard of living for which we reduce the consumption and save for future.

e. Status Motive – People feel socially upgraded if they are financially strong. More wealth means higher status or pride.

2. Objective or External factors:

a. Distribution of income – This is an important factor of propensity to consume. The more inequality in income distribution, the lower will be the propensity to consume. Equal distribution of income increases the propensity to consume. Poor people have higher MPC, as their basic or primary needs are not satisfied. So, increase in income tends to increase MPC, whereas rich people have lower MPC.

b. Expectations – Every consumer has certain calculations about their future changes. This may be regarding the price, income or employment. When they expect price increase in the future, they tend to consume immediately, or if they expect unemployment in future, they tend to consume less and save more.

c. Windfall gains or losses – When the consumers get huge profit, they tend to consume more as income increases. However, loss will make them consume less due to decrease in income.

d. Fiscal policies – Fiscal policy is related to tax structure and government expenditure. When the taxes are decreased the disposable income with people with increase and so will the consumption and vice versa.

e. Stock of wealth – If any individual has enough stock of wealth in the form of bonds, fixed deposits etc., he tends to consume more from his current income. But if the stock of wealth is low, the individual will spend less and tend to save more.

These are the some example of determinant of consumption factors that affect consumption function. We already have discussed about basic concepts of Macro Economics. Now, you will know about consumption factors.

Basic Concepts of Macro Economics for Business

There are some basic concepts of macro economics which are important in business management:

Stocks and Flows:

Stock is always measured at a given point of time and flow is measured over a given period of time. Macro flow variables are National Income and output, consumption, investment etc. Both stock and flow are expressed in many units. Stock may be expressed as just rupee but flows are expressed as rupees per month, rupees per year or in any time unit. The distinction between the stock and flow can be cleared with an example. Total money supply is stock but change in money supply is flow.

Capital and Investment:

Capital is always measured at a point of time, while investment is the change in the capital stock over a period of time. Many times investment and capital formation are used synonymously.

Ex-post and Ex-ante:

These are Latin phrases, which means before hand and afterwards. Ex-ante means anything planned and intended. For example, Ex-ante saving is an amount that the people intend to save out of their income. Ex-post is realized saving, investment etc. For example, Ex-post saving is the amount that the people actually save in that period.

Ex-ante means planned and desired whereas Ex-post means actual or realized.

Equilibrium:

Equilibrium is defined in economics as the position of rest or a state of balance or a state where there is no change required in a period of time. Equilibrium is absence of disequilibrium. Economics deals with variables, whose value change over a period of time.

This concept of equilibrium is used in managerial economics also. Therefore, you, as management students, must understand this concept. Let us take an example of demand and supply analysis. This point where demand and supply intersect each other is the point where price settles down. This is the equilibrium price. Whenever there is a change in demand and supply forces, this equilibrium is disturbed. But this equilibrium is restored again by interplay of demand and supply factors. There are two types of equilibriums, partial and general equilibriums. The above example is for partial equilibrium; where, it is assumed that everything in the economy is constant. General equilibrium means equilibrium in all the market and sectors. It assumes that everything depends upon everything. It emphasizes on the interdependence between different markets and sectors of economy.

Analysis of Cost Benefit and About Cost Benefits

Cost Benefit analysis is done for the public investment projects. This is used to judge the desirability of public investment of any public products or investment. In this, we don’t analyze the money cost and money benefit; but real cost and real benefit. Here it is concerned with social benefit and social cost. Cost benefit analysis is done for the public products to analysis the social benefits from the public investments. Let us take up an example of construction of a subway.

In the above figure, on the X axis we measure the number of journeys made per week and on Y axis cost per journey. DD shows the demand curve for the journey on that route.

If OP1 is the cost per journey, two wheelers are ready to pay OD as price. So, the consumer surplus is P1AD. This is the situation before the construction of a subway. Now, when a public investment on subway is decided, then the cost benefit analysis is done to see whether this particular investment is beneficial to the society. After the construction of the subway the price of the cost per journey will come to OP2 and the number of journeys will increase to OQ2 which shows that the consumer surplus will increase after the construction of the subway. Before the construction of subway consumer surplus is P1AD and after the subway it will be P2CD. This shows that there is increase in consumer surplus that will be P1ACP2.

There are two parts of the increase in consumer surplus P2 CAP1

P2BAP – increase surplus is due to decrease in the price of cost per journey.

ABC – the increase in consumer surplus due to the increase in number of journeys on that route.

The cost saving segment is the main component to the consumer surplus.

Equilibrium under Perfect Competition of Market

There is a demand curve under perfect competition:

Equilibrium under perfect competition

This is a horizontal demand of curve. So, the price is given and the firm has to decide the output to be produced according to their cost condition at that price.

Equilibrium Condition or the optimal output level:

The firm which wants to maximize its profit and minimize the loss should produce a output where MR=MC. This condition is applied to all the firms regardless of whether it has the control to set the price or not. But where the firm has no power to decide, the price MR is the going market price (P=MR).

Revenue and cost concept tells that TR-TC is total profit. Similarly, MR-MC is the marginal profit. When both reach at this point that is MR=MC. This formula shows that the firm can make no more profit and therefore should stop there. This is called output level.

We can show the equilibrium condition under perfect competition as:

Equilibrium Condition under Perfect Competition

After this condition there are short run equilibrium with loss and long run equilibrium. The short run equilibrium with loss brings a condition of shut down point. In short run, the firm may continue its production to recover losses in long run.

We assume that all the firms have identical cost condition in the industry. In the short run, the firm will keep on producing even when it is incurring loss. But in the long run, the firm, which is not even getting normal profit, will shut down.

The existing firms will return to normal profits from super profits. So, in long run, under perfect competition the firm incurs normal profit. There are no super normal profit and no huge loss.

This concept brings an understanding about market and competition of market. This curve is applied in all competition of market.

Cost and Importance of Cost Analysis in Market

Cost is important aspect in business decision. There are different types of cost:

Opportunity cost: It is the most important and useful concept of economic analysis. Opportunity cost is known as the amount that is foregone in choosing an activity over the next best alternative.

Explicit and Implicit cost: Explicit costs are involved in actual payment to the other parties. Implicit costs are known as the value of foregone opportunities. It is not involve in an actual payment. Implicit costs are also important as the explicit costs. Sometimes implicit costs are neglected.

Sunk, incremental cost and marginal cost – Sunk costs are known as fixed costs. It is known as irrelevant costs also in daily decision making. Incremental cost is known as total additional cost of implementing managerial decision. Managerial costs are known as total cost which is associated with one unit change in output.

Incremental cost is the most important cost in real world’s business. It is applicable in real business world.

Direct and Indirect cost: Direct costs are known as the direct attribute to production of a particular product. On the other hands, indirect costs are those costs which are incurred on stationary, electricity bills, administrative expenses etc. These can’t be separated accurately or easily into individual units of production.

Fixed and Variable cost: Fixed costs incurred when output is zero. It doesn’t vary with changes in output. Variable costs change with change in output. It increases when out is increased. It decreases when out put is decreased.

Short Run Period:

It is a time of period when a fixed cost and some variable costs are fixed. In this period fixed cost can not be changed but variable cost can be increased or decreased.

Long Run Period:

It is a long period to change all the factors of production which means there are no fixed factors. All the factors are known as variable factors. In this time, business decisions are made, except on the level of technology.

Cost Output and Relationship:

Short run cost curve is divided into total fixed cost and total variable cost. So, we can indicate it as:

TC = TFC+TVC
TC = Total Cost
TFC = Total Fixed Cost
TVC = Total Variable Cost

TVC is known as the total variable cost which changes directly with the change in output. It refers cost of labour, raw material, power etc.

We can show it in a figure:

Total Fixed Cost Curve

There is another diagram which will show the curve of Total Variable Cost:

Total Variable Cost Curve

We can show the diagram to put all the curves also:

The TC, TVC and TFC Curves

At last, we can say that costs are very important in decision making because though all the units are sold in the same price but the cost of production of these units are not same. Marginal cost and incremental cost are relevant in decision making whereas sunk cost are irrelevant.

Analysis and Schedule of Law of Supply for Market

There is an inter-relation between a commodity price and supply. Any changes in prices cause the result of extension or contraction of supply. If price increases, there is extension of supply. If price decreases, there is contraction of supply. There is a law of supply which shows the relationship between price and quantity of a particular product supply. Demand and supply are depended on price. If the price matches to quantity demand and quantity supply that means it is equilibrium price. That quantity which is bought and sold at the equilibrium price is called equilibrium quantity. There are basic concepts of supply, law of supply and equilibrium detail.

Supply Analysis:

Supply is related to various quantities of goods, which a seller has wish and able to sell at a different price in a given market at a particular time, other things remaining constant. So, supply is related to amount or quantities which are not coming to market for sale and not the stock in a go-down.

The supply schedule: It shows the schedule of goods and services at different prices. There is an example of supply schedule for Rice.

Now, we can draw a supply schedule curve on the basis of Supply schedule of Rice. Here X-axis shows quantity supply and Y-axis show price. Here, price increases as supply of quantity increases.

Supply Curve

Law of Supply:

It shows the relationship between price and quantity supplied of a particular product. It is known as positive relation when price increases the quantity supply, supply will also increase. We can assume price changes if other things are constant as:

Law of Supply

Shift in Supply:

Supply curve changes in quantity supply if there is any factor other than price. It happens when, the supply curve shifts entirely right or left.

Shift in Supply Curve to right

Shift in Supply Curve to Left

Factors affecting supply:

There are many factors which affect supply like – change in the cost of production, state of technology, political uncertainty and natural factors.

So, all these are law of supply and demand which describes the equilibrium of demand and supply. There are price factors, quantity factors and many other factors which affect all these circles.

What is the financial leverage? State the uses of financial leverage

Financial leverage as opposed to operating leverage relates to the financing activities of a firm and measures the effect of EBIT on EPS of the company. A company’s sources of funds fall under tow categories – those which carry a fixed financial charge – debentures, bonds and preference share and those which don’t carry any fixed charge – equity shares. Debentures and bonds carry a fixed rate of interest and have to be paid off irrespective of the firm’s revenues. Though dividends are not contractual obligations, dividend on preference shares is a fixed charge and should be paid off before equity shareholders are paid any. The equity holders are entitled to only the residual income of the firm after all prior obligations are met.

Financial leverage refers to the mix of debt and equity in the capital structure of the firm. This results from the presence of fixed financial charges in the company’s income stream. Such expenses have nothing to do with the firm’s performance and earnings and should be paid off regardless of the amount of EBIT. It is the firm’s ability to use fixed financial charges to increase the effects of changes in EBIT on the EPS. It is the use of funds obtained at fixed costs to increase the returns to shareholders. A company earning more by the use of assets funded by fixed sources is said to be having a favorable or positive leverage. Unfavorable leverage occurs when the firm is not earning sufficiently to cover the cost of funds. Financial leverage is also referred to do as “trading equity”.

Use of financial leverage studying DFL of various levels makes financial decision-making on the use of fixed sources of funds for funding activities easy. One can assess the impact of changes in EBIT in EPS.

Like operating leverage, the risks are high at high degrees of financial leverage. High financial costs are associated with high DFL. An increase in financial costs implies higher level in financial costs implies higher level of EBIT to meet the necessary financial commitments. A firm not capable of honoring its financial commitments may be forced to go into liquidation by the lenders of funds. The existence of the firm is shaky under these circumstances. On the one hand trading on equity improves considerably by the use of borrowed funds and on the other hand, the firm has to constantly work towards higher EBIT to stay alive in the business. All these factors should be considered while formulating the firm’s mix of sources of funds. One main goal of financial planning is devise a capital structure in order to provide a high return to equity holders. But at the same time this should not be done with heavy debt financing which drives the company on to the brink of winding up.

0% Brokerage in Real Estate Sectors and Adviser Model to Grow Property Business

First time in India by Property on Wheel (POW) there is an option to buy a property on the 0% Brokerage. There is an introduction of the company which provides 0% brokerage services in the real estate sector. It offers different portfolio for the sellers If a seller who is repeat customer of the company. Repeat customer means, a person who is selling or renting his property again and again through the company channel. Then his profile is added in its record and his identification is his mobile number. If next time he wants to do some business through the company channel and he is calling from the same mobile number then he will be a repeat customer for the company.

The company charged some breakage from the seller because it has some overheads like – Managers Salaries, Petrol expenses, backend call center overheads etc.

Program for the Local Brokers:

Local Brokers plays an important role in real estate sector. There are many brokers in real estate who works in a particular area and he is the only person who has the knowledge about a particular area. You can say he has the advance information about the property. A broker can tie-up with this company to follow these terms and conditions:

• Tie up with the local brokers.
• Part of Property on Wheel.
• Convert his vehicle into POW and provide the kit and install the vehicle tracking system.
• Integrate his mobile number with the company system send or receive the requirements through SMS.
• Minimum overheads and Maximum output.
• Local Broker can also deal or generate leads outside the local market (outstation).
• Pay a minimum amount to join the company as an adviser or broker.

After the Tie up with the Property on Wheel (POW) now he can generate leads and provide information across the India. It means his business is extended.

Adviser Model:

The Adviser is a 100% pure part time or full time property business. The cost of this model is just Rs. 6999+Taxes and he has to provide at least 50-100 references of his friends or relatives. The backend call center of the company will contact to that references. The company charges Rs. 20 per reference on credit basis, credit means it would be adjust this amount in his payout.

It is a unique program with 0% brokerage for buyers. It means if you are sending someone to buy, the company does not charge anything from buyer either for rent or buy or any short of investment in properties and free property visits instantly with the help of property on wheels on competitive rates.

How Adviser Work:

When any individual join the program then the company installed GPS software in his mobile. Now he can take photo of the property, provide property related information and send it through his mobile. That property will be added in his account and will also update his account.

There is another model for adviser that is referral model (MLM). This is basically a chain business network in which you have to make pair below your network.

How Adviser Earn:

Adviser can earn from the both ways first one is generate the leads and send it to the company. If deal is completed successfully then adviser will get 20% breakage amount. This is being described in below figure—

The Second one is Referral program (MLM) the adviser can earn unlimited revenue from this model by making the pairs below his network. He will earn Rs. 1000 per pair.

Company Details:

The company is based in India in the real estate sector. It is trusted company and India’s 1st real estate retail chain. It provides services for buyers on 0% brokerage. It is PropertySensex. It has given its services for many major clients like – TATA AIG Life Insurance, Max Life Insurance, Bharti AXA Life Insurance, Religare, Aviva, Subhiksha, Spencer Retail, Vishal Mega Mart, Wall mart etc. on 0% brokerages in commercial property, commercial space, lease space, office space, rent space, show room space and residential flats across India.

Marginal Costing and Break-even Analysis

Do you know that “marginal costing” is the gift of British? OK, with the chapter of we will deal about the marginal costing and break-even analysis.

Objectives:

Meaning of Marginal Cost and Marginal Costing

Concept of Contribution

Break-even Point and Margin of Safety

Break-even Charts

Applications and Limitations of marginal costing

About the definition of Marginal Costing ICMA London has defined as, “The ascertainment of marginal costs and of the effect of profit of changes in volume or type of output by differentiating between fixed costs and variable costs.”

In another word ICMA London define about marginal costs, “the amount at any given volume of output by which the aggregate costs are changed if the volume of output is increased or decreased by one unit.”

Formula of Marginal costs:

Marginal cost = prime cost + total variable overheads

Or

Marginal cost = total variable cost.

Concept of Contribution:

Contribution called when selling price and marginal cost (variable cost) difference comes together.

Formula can be:

Contribution = selling price – variable (marginal) cost
Or Contribution = fixed cost + profit (or-loss)
Or Contribution – fixed cost = profit (or loss)

Thus,

Sales = Variable cost + fixed cost + profit (or – loss)
Sales = Variable cost = fixed cost + profit (or – loss)

In this chapter we have to read about P/V (Profit Volume) ratio also so here is P/V ratio calculation:

P/V = contribution/sales = S/C

Or = [Fixed Costs + Profit/sales] = [F+P/S]

Or = [Sales-Variable Cost/Sales] = [S-V/S]

Now, we will discuss about the Break-even Point:

Break-even Point is the representation position of that volume of sales or production which has no profit no loss. It means total sales are just equal to total cost.

The formula of the calculation of Break-even point is:

Break-even Point (units) = Total fixed costs/Contribution per unit [F/C per unit]

Break-even Sales = Total Fixed Costs x selling price per unit / contribution per unit
[F/C*S]

Fixed Cost/P/V Ratio [F/P/V]

Break-even chart shows the graphical representation of cost and revenue of inter-relation at different volumes of output.

About the advantages of Break-even chart no doubt that it helps to determine the selling price to give a desired volume of profit.

It shows costs and profits and different volumes of productions. But along with there are limitation of break-even chart also. About it people says that it always not shows true chart.

At last we can analysis about break-even and can say that it is the level of operations which is the position of cost and revenue equilibrium.

I think now, it is enough for marginal cost and break-even analysis from financial books. I will elaborate it more deeply with the further discussion where I will put some more examples also from finance and accounting books.