U18MBT7000-ENGINEERING

ECONOMICS & FINANCIAL

MANAGEMENT

Dr.S.Kaliappan /AP - III

Department of Electrical & Electronics Engineering
CH1: ECONOMICS, COST &
PRICING CONCEPTS
CONTENTS
 Economic Theories
 Demand Analysis

 Demand Forecasting

 Different types of Cost

 Cost Curves

 Breakeven Point and its Limitations

 Profit-Volume Ratios

 Pricing Methods
ECONOMICS:

 For example consider one family, each one of the family members have
different kind of wish list in his mind.

 So, the head of the family (Father/Mother) finds out the prices of that
different things, decides upon the thing which suits most for all of
his/her family member and spend his money in such a way that he/she
gets maximum happiness/variety and at the same time saves as much
as possible.
ECONOMICS:

 Economics explains, how to utilise our limited resources in the

most satisfying manner.

 So, we are applying the principles of economics in our day to day

life directly/indirectly.

Another E.g.
 A person goes to Market to purchase vegetables.
ECONOMICS-DEFINITION:

 Economics is a science of Production, exchange and consumption

in economic systems. It shows how source resources can be used
to increase the human wealth and welfare.

Locke Anderson, Ann Putallaz and William Shepherd , Economics, Prentice Hall Inc., 1983
ECONOMICS-DEFINITION:

 Economics as the study of how society decides what, how and for
whom to produce.

David Begg,Stanely Fischer amd Rudiger Dornbusch, Economics, McGraw Hill, England,
1987
ECONOMICS-DEFINITION:

 Economics as the study of how societies use scarce resources to

produce valuable commodities and distribute them among
different people.

Paul A. Samuelson and William Nordhaus, Economics, McGraw Hill, England, 1995
ECONOMIC ACTIVITIES:
Requirement
(Needs)

Put Effort to
Satisfied after
afford that
afford that Need
requirement

Earn Money
ECONOMIC ACTIVITIES:
 A person wants Food, Clothes, House and Entertainment (to feel refreshed
after a day’s hectic work)  He needs Money to satisfy these needs  He
works hard to earn it

 In other words, there are different types of organisation in society

involves different kinds of activities such as farming, trading, banking,
etc.,  These activities carried out for the purpose of earning money 
To buy necessary goods which satisfy our needs.
DEMAND ANALYSIS
DEMAND-DEFINITION:
 Every want (Needs) supported by the willingness and ability to buy.

 In other words, if person wants a car and cannot able to pay for it means,
there is no demand for the car from his/her point of view.

 A product or service is said to have demand when the following three

conditions are met:
 Desire on the part of the buyer to buy

 Willingness to pay for it.

 Ability to pay the specified price for it.

DEMAND-TYPES:
 PRICE DEMAND: The quantity of a particular product or service
demanded at given price.

 INCOME DEMAND: The quantity of a particular product or service

demanded at a given level of income of a consumer or household

 CROSS DEMAND: The quantity demanded for a particular product or

service, given the price of a related good. The related good may be
complementary or substitute.

 For E.g., Tyres & Tubes  Complementary  One cannot go without

others. Tea & Coffee  Substitute  Take one and you have to leave other.
DEMAND FORECASTING
 Demand forecasting is a field of predictive analytics which tries to understand
and predict customer demand to optimize supply decisions by corporate supply
chain and business management.

 The process in which historical sales data is used to develop an estimate of an

expected forecast of customer demand.

 It is used to make an advanced arrangements of raw materials, equipment's,

labors, etc.,

 A forecast helps a firm to access the probable demand for its products and plan
its production accordingly.
DEMAND FORECASTING-TYPES
 SHORT TERM FORECASTING:
 Analysis carried out for a period of One Month to One Year.

 This period depends on the nature of business.

 If the demand fluctuates one month to another, forecasting may be

done only for a short period
 E.g.,
Cool Drinks, Sweater, etc.,
DEMAND FORECASTING-TYPES
 LONG TERM FORECASTING:
 Analysis carried out for a period of 5, 10 or even 20 years (Long
Term).
 This period depends on the nature of business. But for beyond 12
months the future is assumed as uncertain
 E.g.,
Ship Building, Petroleum Refinery, Paper Making, Power Generation, etc.,
DEMAND FORECASTING-METHODS
 Survey of Buyer’s Intentions or Opinion Survey

 Collective Opinion or Sales Force Polling

 Trend Projections

 Economic Indicators
OPINION SURVEY
 Most direct method of making forecasting for short-term, in which the customers
are asked what they are thinking to buy in near future.

 This method is useful when large quantities are sold to industrial producers.

DRAWBACKS:
 The entire burden of forecasting is shifted to the customer which is not wise and risky.

 Customers may exaggerate their requirements.

 Customers may be uncertain about they intend to purchase from a particular firm.
COLLECTIVE OPINION:
 Salesmen are asked to estimate sales in their respective territories.

 Salesmen are the person who are closest to the customer.

 So that this forecast give a close idea of customer reaction to the products.

 The individual salesmen estimates are added to get the total sales estimates.

 This sales estimates is checked several times to avoid undue imaginations and
also examined in the light of factors like expected change in the design, change in
prices, etc.,
COLLECTIVE OPINION:
ADVANTAGES:
 Simple and doesn’t requires any statistical techniques

 It is very much useful in the case of new products.

DISADVANTAGES:
 Suitable for Short-Term Forecasting

 As the salesmen have no idea about the economic changes means, the estimate
by them are not so correct.
TREND PROJECTIONS:
 A well established firm has considerable data's on sales.
 These data's are arranged in a chronical order called as “Time Series”.
 These Time Series are analysed by the method named as “Project the Trend”.
 In this method the trend line is projected by some statistical method, generally by least square
method.
 A real challenge for the forecaster comes when there is a turning point, that is when
management will change or revise its sales or production.
 The four important factors generally responsible for the turning point is,

(i) Trend (ii) Seasonal Variation

(iii) Cyclical Fluctuations (iv) Irregular or Random Forces.

ECONOMIC INDICATORS:
 In this forecasting method certain economic indicators are used which generally
published by “Central Statistical Organisation” under the national income estimates.
Some of this indicators are;
 Personal Income for the demand of Consumer’s Goods
 Agricultural Income for the demand of agricultural inputs, implements, etc.,
 Construction Contracts sanctioned for demand of building materials

 Registration of Automobiles for the demand of accessories, petrol, etc.,

LIMITATIONS:

 Appropriate Economic Indicator is difficult to find out

 For new products, no past data are available.
COST TYPES
DIFFERENT TYPES OF COSTS:
 In production, research, retail, and accounting, a cost is the value of money that has
been used up to produce something or spend to obtain something.
 The different types of Costs are:
 Actual Cost

 Opportunity Cost

 Incremental Cost

 Sunk Cost

 Fixed Cost

 Variable Cost

 Marginal Costing
ACTUAL COST:
 Absolute Cost or Outlay Cost

 Actual expenditure incurred for acquiring or producing a good or service.

 These costs are generally recorded in the account’s books.

E.g.,
 Actual Wages Paid
 Cost of Material Purchased
 Interest Paid
OPPURTUNITY COST:
 Opportunity cost is the cost which is not actually incurred.

 Opportunity cost is the forgone benefit that would have been derived by an
option not chosen.
 The loss of other alternatives when one alternative is chosen.

 E.g.,
 A commuter takes the train to work instead of driving. It takes 70 minutes on the train,
while driving takes 40 minutes. The opportunity cost is an hour (30mins + 30 mins) spent
elsewhere each day.

 A student spends three hours and Rs. 500 at the movies the night before an exam. The
opportunity cost is time spent studying and that money to spend on something else.
INCREMENTAL COST:
 Differential Cost.

 The additional cost incurred due to a change in nature of business activities.

 Incremental cost comes into picture only when there is a change in the exiting
plant.
 Incremental cost is the total cost incurred due to an additional unit of
product being produced.

E.g.,
 Adding a new machine, Replacing a machine by a better one, addition of a new product
line.
SUNK COST:
 A sunk cost refers to money that has already been spent and which cannot be
recovered.
 It is not affected or altered by a change in the level or nature of business
activity.
 Incremental cost will be the acquisition cost (Price of the machine, packaging,
transport, installation), service and maintenance cost.
 But the sunk cost is operating and space occupancy cost for the machine
which is not altered for if we expand the plant or shrink the plant.
FIXED COST:
 Constant Cost.

 Independent of volume of production or level of activity.

 Fixed cost will be incurred even when production is zero  No Activity

 It is important to note that, the fixed cost is not affected by the volume of
production, but the fixed cost charged per unit depends on the volume of
production.
 If more quantity produced means, fixed cost per unit will be minimum.

E.g.,

Barbeque Nation, Rent, Birthday Cake

VARIABLE COST:
 The total cost value will vary proportionally to the level of activity or changes
in the volume of production.
 Variable cost will be incurred only when there is production or when activity
is being carried out.
 The total variable cost is varying proportional to the volume of production.

E.g.,

Material Cost, Labour Cost, Birthday Treat

MARGINAL COST:
 Marginal cost is, the change in the total cost that arises when the quantity
produced is incremented by one unit

E.g.,

If the total cost of producing two unit is Rs. 100, and additionally another
one unit is added for production. On this case the total cost increased from Rs. 100
to Rs. 140, then the marginal cost of the third unit is Rs. 40.
COST CURVE:
ELEMENTS OF COST:
 The cost of the product manufactured must be calculated in order to get an
exact idea of the profit that can be made.
 Number of expenditures are incurred during the manufacture of a product.

 No item of expenditure should be left, while calculating the total cost of the
product.
 Hence the total cost is divided into different headings known as “Elements of
Cost”
ELEMENTS OF COST:
Direct Material Cost
Material Cost
Indirect Material
Cost

Direct Labour Cost

Labour Cost
Elements of Indirect Labour
Cost Cost

Factory Expenses

Administrative
Expenses
Expenses
Selling Expenses

Distribution
Expenses
BREAKEVEN ANALYSIS:
BREAKEVEN ANALYSIS:
 It is an analysis done to determine the point of activity at which the total cost

will be equal to the total revenue.

 This point is named as “Breakeven Point” and at this point the volume of

output has no profit / no loss.

 This breakeven analysis is done algebraically or graphically.

 BREAKEVEN POINT:
 The breakeven point is the level of production at which the costs of production
equal the revenues for a product.
 There is no net loss or gain.

 Any activity beyond this point will be profitable one and activity below the
point will be Losable one.
BREAKEVEN CHART (BEC):
 A Breakeven Chart is a chart that shows the sales volume level at which total costs
equal sales.
 Losses will be incurred below this point, and profits will be earned above this
point.
 The chart plots revenue (sales), fixed cost and variable cost on the vertical axis,
and volume on the horizontal axis.
 In break even chart, the fixed cost line will be parallel to the output which indicates
that the fixed costs are independent of output.
 Total cost is the addition of fixed and variable cost. Therefore it starts from the
fixed cost line and moves upwards proportional to output.
BREAKEVEN CHART (BEC):
 BREAKEVEN CHART (BEC):
 The total sales (Revenue) line will start from the origin and moves upwards.

 At a particular point, total cost line intersects the total sales line  That point is
named as “Breakeven Point”
 At this point, the total cost equals to the total sales (i.e) the production cost is equal
to the selling price. So that at this point there is no profit and no loss.
 Sales beyond this point will be profitable one and vice versa.

 The chart is useful for portraying the ability of a business to earn a profit with its
existing cost structure.
 BREAKEVEN CHART TERMINOLOGIES:
ANGLE OF INCIDENCE:
 Angle between total cost line and total sales line at the breakeven point.

 It will give the profitability position of the product.

 Greater the angle greater the profitability and vice versa.

MARGIN OF SAFETY:
 Distance between the actual sales and break even sales on the break even chart.

 Greater the margin, safer the firm from business losses, market variations and
production differences will not affect the profitability.
 BREAKEVEN CHART LIMITATIONS:
 Breakeven chart is built on the fundamental assumption that fixed costs are fixed at
all levels of activity.
 But at higher level of activity, due to the impacts of semi fixed costs, fixed cost line
will turnout to be a curve.
 Similarly, total cost line will be a curve after a certain level.

 At higher level of sales, the total sales revenue will begin to diminish due to
additional or extra advertisement, extra discounts, etc.,
 Therefore, the total sales line will intersect the total cost line at more than one point.
All these points are called breakeven points.
 CONTRIBUTION:
 Contribution is the difference between Sales and Marginal or Variable Cost.

 It is also equal to the total of Fixed Cost and Profit.

 Contribution is not a Profit. Greater the Contribution, greater the Profit.

Contribution=Sales (S) – Variable Cost (V) = Fixed Cost (F) + Profit (P)

C = S-V = F+P

C≠P
PROFIT-VOLUME RATIO or
RELATIONSHIP:
 P/V RATIO:
 It is the ratio of contribution to sales.

 With the help of P/V ratio, BEP can be calculated without a break even chart.

At BEP,

Profit, P = 0

Therefore at BEP,

C=F

Now,

P/V = C/S
 P/V RATIO:
At BEP,

Substituting and Cross Multiplying, we get,

 P/V ratio is used for,

 Profit Planning

 Determination of optimum production mix and sales mix

 For performance evaluation

 Determination of different alternatives where there are number of limiting factors or key factors.
PRICE
 PRICE FIXATION:
 Price is the amount of money for which a product or service can be exchanged.

 It is important to fix the price of the product or service. Because the buyer doesn’t
buy a physical product alone.
 He also acquires certain services and want-satisfying benefits (Free Home
Delivery, Warranty, Guarantee, Packaging, etc.,) along with the product.
 Thus, a seller usually prices a combination of the physical product plus other
services and benefits.
 Therefore Price may be defined as the amount of money which is needed to acquire
in exchange some combined assortment of a product and its accompanying
services.
 PRICE FIXATION-GENERAL GUIDELINES:
 Find the Prime Cost (Direct Expenses) and Overhead Cost (Indirect Expenses) to
fix the total cost of the product.
 Compare the cost of your product with those of the competitors.

 An eye should always be kept on the market. If orders are difficult to get, the
chances are that the price will have to drop a bit and vice versa.
 If the cost of your raw materials and labor increases, look into your competitor
and then increase the price if chances available.
 Charge higher prices when demand is high (Seasonal Product) and vice versa.
 PRICING POLICIES:
 Pricing Policies constitute the general framework (guidelines) within which
pricing decisions are made.
 A firm doesn’t follow the single pricing policy rather it needs a bundle of pricing
policies.
 These pricing policies not only for the Firm and its pricing objectives but it is
suitable for overall marketing situations.
 Pricing policy should aim at promoting long term welfare of the enterprise and
maximizing profits for the entire operations over the long-run.
 PRICING POLICIES-GENERAL CONSIDERATIONS:
 Competitive Situation:

 Goal of Profit and Sales:

 Long Range Welfare of the Firm:

 Flexibility:

 Government Policy:

 Overall Goals of Business:

 Price Sensitivity:

 Routinisation of Pricing:
 PRICING POLICIES-GENERAL CONSIDERATIONS:
 Competitive Situation:

 Goal of Profit and Sales:

 Long Range Welfare of the Firm:

 Flexibility:

 Government Policy:

 Overall Goals of Business:

 Price Sensitivity:

 Routinisation of Pricing:
PRICING METHODS:
THANK YOU….!