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ANNAMALAI UNIVERSITY

DIRECTORATE OF DISTANCE EDUCATION

M.Sc. PLANT AND MACHINERY VALUATION

First Year

MANAGEMENT SCIENCE

LESSONS : 1 – 20

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FIRST YEAR

MANAGEMENT SCIENCE

Editorial Board

Members

Dr. C. Antony Jeyashekar

Dean

Faculty of Engineering and Technology Annamalai University

Annamalainagar

Dr. G. Ganesan

HOD of Manufacturing Engineering

Faculty of Engineering & Technology Annamalai University

Annamalainagar

Dr. A. Prabaghar

Associate Professor and Wing Head

Engineering Wing - DDE Annamalai University

Annamalainagar

Internals

Mr. N. Muthukumar

Assistant Professor

Manufacturing Engineering Engineering wing - DDE

Annamalai University Annamalainagar

Mr. L. Arunkumar

Assistant Professor

Manufacturing Engineering Engineering Wing - DDE


Lesson Writer

Mr. M. Anand

Assistant Professor

Civil and Structural Engineering Engineering wing - DDE


i


FIRST YEAR

MANAGEMENT SCIENCE

SYLLABUS

Micro – Economics

Consumption: Indifference curve- consumer’s surplus- elasticity.

Production: input-output analysis- short- run and long- run production

function-isoquant curves-least cost combination-return to scale.

Price mechanism: Law of demand & its conditions, exceptions and

limitations of law of demand; law of supply - equilibrium price –

importance of time element.

Pricing of products under different market conditions: perfect,

monopoly and monopolistic competition.

Factor pricing :Factors of production and payments thereof:-

Finance: Interest- term loan – working capital – cash flow & liquidity.

Organizations and Profit

Functions of entrepreneur – value addition - Theories of profit

Macro – Economics

Money- Functions and role of money

Inflation and Deflation: Types of inflation- causes – effects – inflationary

gap – control of inflation – monetary, fiscal and direct measures – deflation

– cause – effects – deflationary gap – measures to control deflation – deficit

financing.

Foreign exchange variation – and its influence

National Income/National Wealth: Circular flow of income- concepts of

GNP & NP- per capital income and consumption- components of national

income-income expenditure and output methods of computing national

income.

Components of Economy: Primary sector – secondary sector – tertiary

sector in urban economy – Parasitic components in urban economy.

ii


FIRST YEAR

MANAGEMENT SCIENCE

CONTENT

Lesson No.

Title Page No.

1 Theory of Consumption 1

2 Production Function 7

3 The Price Mechanism – I 24

4 The Price Mechanism – II 44

5 Pricing Under Different Market Condition 48

6 Factor Pricing 56

7 Finance Function 63

8 Theories of Interest and Profit 69

9 Money 78

10 Components of Economy 82

11 National Income 87

12 Inflation and Deflation 95

13 Organizational Behaviour 102

14 Motivation and Personality 128

15 Leader and Leadership Quality 148

16 Principles of Scientific Management 160

17 Cost, Depreciation and Valuation 169

18 Job Evaluation, Wages and Incentives 183

19 Plant Location 198

20 Motion and Time Study 222

LESSON - 1

THEORY OF CONSUMPTION

1.1 INTRODUCTION

This lesson introduces the economic behaviour of the consumers when they

attempt to consume goods and services

1.2 OBJECTIVES

To understand how consumers choose what quantity of any good or service

in the event of price and income change

1.3 CONTENT

1.3.1 Utility theory

1.3.2. Indifference Curve analysis

1.3.3 Consumer Surplus

Theory of consumer behaviour

Utility Theory

Theory of

Consumer

Behaviour

Indifference

Curve

Analysis

1.3.1 UTILITY THEORY

The analysis of consumer behaviour in economics is concerned with:

How consumers choose what quantity of any good to purchase

Why consumers’ demand for a good generally fall down as its price goes up

How consumers change their spending pattern if their income rises or falls

One theoretical way of explaining this is the concept of utility.

Utility is the satisfaction that a consumer obtains from the consumption of

commodities

For any commodity, the marginal utility that a consumer gets from the

consumption of an extra unit of the commodity will tell, as the consumption

increases. This is the law of diminishing marginal utility

Consumer equilibrium is reached, at a given income level by spending on

goods so as to maximize total utility from all the goods purchased.

Suppose that a household buys two commodities, X and Y.

Let the marginal utility of a unit of X be MUx and the marginal utility of a unit

of Y be MUY.

Let the price per unit of X (in pence) be PX and the price per unit of Y be PY.

The household will attain a utility-maximising equilibrium where the marginal

utility from the last Rupee spent is the same for X and Y.

i.e. where: Y

X

X

X

P

P

P

MU

2

Cross multiplying gives:

Y

X

Y

X

P

PX

MU

MU

This is true of any pair of commodities bought by the household.

Indifference curve analysis

INDIFFERENCE

CURVE ANALYSIS

Consumer equilibrium

where indifference

curve touches

Budget line

Price effect

Substitution effect

Income effect

Budget Line

A budget line on a graph that shows the maximum combination of:

Two products, X and Y or

One product X and ‘all other goods’

that consumers can afford to buy with a given income at current prices for the

goods.

Quantity of product 'X'

Qu

an

tity

of

pro

du

ct

'Y'

Budget line

Quantity of product 'X'

Qu

an

tity

of

all o

ther

go

od

s

Budget line

1.3.2. Indifference Curve Analysis

An indifference curve is a line on a graph that shows the combinations of:

Two products, X and Y or

One product X and ‘all other goods’ which, if purchased, will give consumers

the same total satisfaction or utility.

3

With a given income or budget for spending on goods, consumers will

maximize their total satisfaction or utility by purchasing quantities of X and Y, or

quantities of X and ‘all other goods’ which lie on an indifference curve as far from

the origin as possible. This will be an indifference curve that touches the budget

line at a tangent. (See diagram below).

Combination of product X and all other goods that

maximizes consumer utility with a given budge rot

income

Utility-maximising

combination

I

Quantity of X

consumed

Quantity of all

other goods

consumed

As consumers’ income increases the budget line will move further from the

origin, and an indifference curve that touches the new budget line at a tangent will

also be further from the origin, providing greater maximum total satisfaction for

consumers.

Price effect

A price change given the same total consumer money income, will alter

consumers’ real income.

A price will mean that consumers can afford to buy less

A price reduction will make consumers able to buy more The slope of the

budget line will change.

Income effect and substitution effect of a price change

A

Quantity of X

Quantity of Y

B1 B

A

B

I2

I1

H

J

K

In the diagram above, an increase in the price of X will alter the consumer’s

budget line from BB to BB1. They can afford less of X with their income.

The new utility-maximising combination of X and Y changes from point J on

indifference curve I2 to point H on indifference curve I1. The higher price of X

4

means that consumers will now buy less. There are two reasons for the shift from J

to H.

Substitution effect

Product Y is now cheaper than before, compared with the price of X.

consumers will therefore buy more of Y. This is illustrated in the diagram by

drawing a line AA parallel to the new budget line BB1, that touches the ‘old’

indifference curve I2 at a tangent.

Given the change in relative prices, if consumers had enough income, they

would now prefer to combine purchase of X and Y at point K rather than at point J.

This is the so-called substitution effect of the price change.

Income effect

But consumers don’t have more income to afford to buy the combination of X

and Y at point J. The rise in the price of X means that they will buy the

combination at point H. The fall in their real income means that they will demand H

rather than K.

This difference is the so-called income effect of the price change. This analysis

can be used to show how consumer demand for most products will fall as the price

of the product goes up.

Exceptions, where demand rises if price rises, are:

‘Giffen goods’

Goods bought for ostentation

1.3.3 CONSUMER SURPLUS

The negative slope of the demand curve (or inverse relationship between price

and quantity demanded) is illustrated in Figure Linear and non-linear demand

relationships gives rise to a concept that has often been influenced in guiding

economic policy known as consumer surplus. This is defined as follows:

A consumer’s surplus is the excess of the price which a person would be

willing to pay rather than go without the good, over that which he actually does

pay.

In other words, the gap between the total utility of a good and its total market

value is called consumer surplus. The surplus arise because we “receive more than

we pay for”: such bonus is rooted in the law of diminishing marginal utility.

It is easy to observe how this consumer surplus arise. We pay the same price

for each egg or glass of water. Thus we pay for each unit what the last unit is

worth. But by our fundamental law of diminishing marginal utility, the earlier

units are worth more to us than the last. Thus, we enjoy a surplus on each of

these earlier units. When trade stops benefiting us the stops giving further

surplus, we stop buying.

This is also sometimes referred to as consumer’s rent. The magnitude of

consumer surplus can be approximated by the area under the demand curve,

5

which represents the additional aggregate payment consumers would pay in excess

of the amounts actually paid for a good at the going price. For example, area p’p’’B

if the product was sold at price p” in Figure Linear and non -linear demand

relationships.

OI Q

Price

(P)

D’D

A

B

D’D

P’

’

P’

Movement along the

demand curve

caused by changes in

‘own’ price of product

Quantity demanded (per time period) Figure: Linear and non-linear relationships

One way of appreciating the meaning of this concept is to imagine that goods

are sold on an open auction basis so that each potential consumer is able to bid the

price that he or she is willing to pay – individual. If the good is being sold by a

discriminating monopolist, the objective would be to ensure that no consumer

surplus remains. In other words, everyone will have paid a price that just equals

the valuation they have each placed on the good. Consider the value (i.e. price) you

would place on a drink of water, if you had been in the desert for a week relative to

that which someone else in a more ‘comfortable’ situation would place on it!

The concept of consumer surplus is useful in making many decisions about

public goods—it has been employed in decisions about airports, roads, dams,

subways, and parks.

1.4 REVISION POINTS

1. How consumers change their spending pattern if their income rises or falls

2. An indifference curve is a line on a graph that shows the combinations of

two products, X and Y

1.5 INTEXT QUESTIONS

1. What is meant by utility theory?

2. What is meant by indifference analysis?

1.6 SUMMARY

One way of appreciating the meaning of this concept is to imagine that goods

are sold on an open auction basis so that each potential consumer is able to bid the

price that he or she is willing to pay – individual. If the good is being sold by a

discriminating monopolist, the objective would be to ensure that no consumer

surplus remains.

6

1.7 TERMINAL EXCERCISE

1. What is meant by income effect

2. What is price effect

1.8 SUPPLEMENTARY MATERIALS

1. Managerial economics-M.L Trivedi

2. Managerial economics-RL Gupta

3. Indian economy-R.KAvarni & M. Grija

1.9 ASSIGNMENTS

1. Define the concepts: Marginal Utility, Consumer equilibrium, consumer

surplus, indifference curve – Price Effect, Income effect

2. What are the uses of the concept Consumer surplus

1.10 REFERENCE BOOKS

1. C.N. Vakil & H.N Pathak, Introduction of Economy Voro & Co. Publishers

Pvt. Ltd. (2008,) New Delhi.

2. K.P.M Sundaram, Elementary Economics S. Chand and co. (2009) Delhi.

1.11 LEARNING ACTIVITIES

1. Discuss the concept consumer surplus

Differentiate Linear and Non Linear Relationship

1.12 KEYWORDS

Marginal utility, Indifferences, consumer supplies.

7

LESSON - 2

PRODUCTION FUNCTION

2.1 INTRODUCTION

This particular division of Economics deals with how various factors like land,

labour, capital and technology can optimally be combined for their efficient

utilization in order to maximise the output or minimize cost of production

2.2 OBJECTIVES

Production function is the Relationship between various factors of

production in realising output useful in understanding lest cost combination

of factors involved in production

To understand productions process in the long and short run.

2.3 CONTENTS

2.3.1 Production and Cost Analysis

2.3.2 Production Function

2.3.3 Least-cost Combination of Inputs

2.3.4 The Analysis of Production Costs

2.3.5 Production decisions in the short run and long run

2.3.6 Diminishing returns in production

2.3.7 Economies and diseconomies of scale

2.3.7.1 Internal economies of scale

2.3.7.2 External economies of scale

2.3.7.3 Internal diseconomies of scale

2.3.7.4 External diseconomies of scale

2.3.1 Production and Cost Analysis

Costs of production useful in understanding of what happens to cost of

production as production increases unit by unit.

Short run

Long run

Isoquants

Least cost combination

returns to scale

In order to maximize profits, a firm endeavours to increase its revenue and

lower its cost. To this end, managers try to produce optimum levels of output, use

the least-combination factors of production, increase factor productivities, and

improve organizational efficiency. If there is no cost, the firm will always benefit

from an expansion of its production. If cost is prohibitive, the firm may not find it

profitable to produce at all. In other situations, the level of production will be

governed by cost of production, among other factors.

Cost of production provides the floor to pricing. It provides a basis for

managerial decisions with respect to the price the firm must quote to its prospective

customers, in deciding whether to accept a particular order or not, whether to

8

abandon an old or establish a new product line, whether or not to increase the

volume of specific outputs, to use idle capacity or rent facilities to outsiders, and

whether to make a particular product or buy it. There are no straight and simple

rules for such decisions and it is necessary to study production and cost analysis

thoroughly to arrive at these decisions. The costs which firms incur are payments

to various factors of production and hence they indicate incomes of these factors

also. An understanding of cost thus helps to understand the distribution of factor

incomes as well.

Production and cost analysis is concerned with the supply side of the market.

Production analysis is done in physical terms while cost analysis is discussed in

monetary terms. The former relates physical output to physical units of factors of

production, and studies the least cost combination of factor inputs, factor

productivities, and return to scale. The latter deals with various types of costs and

their role in decision making, determinants of costs both in the short and long-run,

and the determination of cost functions and their uses in decision making. This

chapter, discusses the production function and related concepts first, and then

goes on to cost analysis.

2.3.2 Production Function

A production function expresses the technological or engineering relationship

between the output of a commodity and its inputs. Traditional economic theory

speaks of four factors of production, viz., land, labour, capital and organization or

management. Technology also contributes to output growth and it is now regarded

as an additional determinant of output. Thus, the output of an industry is a

positive function of the quantities of land, labour and capital, the quality of

management, and the level of technology that is employed in its production.

Symbolically, it can be denoted as follows:

x = f(Ld, L, K, M, T)

f1, f2, f3, f4, f5 > 0

where x = output of commodity X

Ld = land employed in the production of X

L = labour employed in the production of X

K = capital employed in the production of X

M = management employed in the production of X

T = technology employed in the production of X

f = unspecified function

f1 = partial derivative of f with respect to the i th independent variable.

Function above describes a general production function. In a specific situation,

one or the other of these various factor inputs may not be important and the

relative importance of a factor of production varies from one type of product to

9

another. Land is perhaps the most important input factor in the case of an

agricultural product while it is of minor importance in the case of a manufacturing

product. Production of wheat, for example, can be increased through the use of

more and better quality of fertilizers, more and timely irrigation, etc., but beyond a

point increase in land becomes necessary for a further increase in its production. In

contrast to this, the production of steel, for example, can be increased significantly

without any increase in the land occupied by the steel industry. Besides, more land

may not even be available near a steel factory and occupying land at any other

place may not be convenient and profitable. Furthermore, the investment in land is

a significant part of the total cost of wheat production while it is an insignificant

component of the total cost of steel. Similarly, the role of management and

technology may be more crucial in the case of an industrial product than in the

case of an agricultural product. For these reasons, researchers often modify

function above to suit their specific objectives.

For a good exposition of production decision problems, it is convenient to work

with two input factors for an output. If labour and capital are the only two inputs,

the production function (3-1) reduces to

x = f(L,K)

Function has three variables: output of commodity X (x), units of l Labour (L)

and units of capital (K). For a given value of x, there will be alternative

combinations of L and K. These combinations of L and K will vary with variations in

x. generally speaking, both labour and capital are necessary for the production of a

commodity and they are substitutes to each other. Thus for any given level of

output, an entrepreneur will need to hire both labour and capital but he would

have an option to employ any one combination of these factors out of several

possible combinations. The alternative combinations of factors for a given output

level will be such that if the use of one factor input is increased that of another will

decrease and vice versa. To illustrate this, consider the hypothetical example of an

entrepreneur engaged in making shoes. In order to make shoes, he needs at least

one cobbler, and some capital, which consists of leather, thread, sewing tools,

machines, etc. For making a given number of shoes, he would have alternative

combinations of labour (cobbler) and capital, for labour and capital are substitutes

to a certain extent. For example, a cobbler having the minimum tools would hardly

be able to complete one pair of shoes in a day while another cobbler of the same

efficiency having a sewing machine and other useful tools could perhaps make two

pairs of shoes in a single day. The alternative combinations of labour and capital for

making different numbers of shoes per day are illustrated in Table.

Table: Input-Output Relationships

X = 2 X = 5 X = 9 X = 12 X = 14

L K L K L K L K L K

1 20 2 20 3 20 4 20 5 20

10

X = 2 X = 5 X = 9 X = 12 X = 14

2 12 3 14 4 13 5 15 6 17

3 8 4 10 5 10 6 12 7 15

4 6 5 7 6 8 7 10 8 13

5 4 6 5 7 6 8 8 9 11

6 3 7 4 8 5 9 7 10 10

An isoquant by definition is the locus of all those combinations of labour and

capital which yield the same output. In our example, the entrepreneur could

employ 1 cobbler and 20 units of capital, 2 cobblers and 12 units of capital, 3

cobblers and 8 units of capital,…., or 6 cobblers and 3 units of capital to

manufacture 2 pairs of shoes. If he aims at producing 5 pairs of shoes, the

alternative input combinations open to him are 2 cobblers and 20 units of capital, 3

cobblers and 14 units of capital, and so on. If we plot these alternative input

combinations for a given output and assume a continuous variation in the possible

combinations of labour and capital, we can draw a curve called isoquant for the

given units of output. The isoquants for various output levels of Table are shown in

Figure Isoquants.

The family of isoquants or iso-product curves makes up all the possible

combinations of labour and capital that can be employed to produce different

outputs of a commodity. Thus, they are geometric representation of a production

function. The isoquant in Figure represent the production function in our

hypothetical shoe industry.

25

20

15

10

5

5 10 15 20

X=14

X=12

X=9

X=5

X=2

UNITS OF LABOUR (L)

UN

ITS

OF

CA

PIT

AL

(K

)

Figure Isoquants

The shape of these isoquants is such that

a) they are falling,

b) the higher the isoquant is, the higher the output it represents,

c) they do not intersect each other, and

11

d) they are convex from below.

An isoquant is falling, for it can neither be rising nor constant. A rising

isoquant implies that output does not increase with increase in labour and capital,

which is obviously not true. A horizontal or vertical isoquant means that output

does not respond to variations in one of the input factors, others remaining

constant. This is also not true because usually output increases with an increase in

any one factor of production, others remaining the same. For similar reasons, a

higher isoquant represents a higher level of output.

An isoquant never intersects another isoquant, for if they did it would mean

that with the same units of labour and capital, two different levels of output can be

produced, which is absurd. The isoquants are convex from below because

substitution of labour for capital becomes more and more difficult as more of labour

is substituted for capital. In our hypothetical example, the isoquant x = 2, for

example, is convex from below because when labour is increased from 1 unit to 2

units, capital use is reduced from 20 units to 12 units, a fall of 8 units, a fall of 4

units, and so on. The rate of substitution, which was 1 unit of labour = 8 units of

capital, changed to 1 unit of labour = 4 units of capital. This is because of

increasing difficulties in substitution. If labour and capital were perfect substitutes,

isoquants would have been falling straight lines as in Figure Isoquants when

Factors are Perfect Substitutes.]Figure Isoquants when Factors are Perfect

Substitutes

On the other hand, if one factor of production could not be substituted for

another at all, isoquants would be rectangular as in Figure Isoquants when Factors

are Perfect Non-substitutes.

25

5 10 15 20

UNITS OF LABOUR (L)

UN

ITS

OF

CA

PT

IAL

(K

)

X1 X2 X3

20

15

10

5

Figure: Isoquants when Factors are Perfect Non-substitutes

12

Since labour and capital are not perfect substitutes and their substitutability

becomes more and more difficult as one factor is substituted for another isoquants

are convex from below.

20

15

10

5

25

5 10 15 20

UNITS OF LABOUR (L)

UN

ITS

OF

CA

PT

IAL

(K

)

X2

X1

In addition to the above properties of isoquants, it may be noted that they do not touch either the

labour or the capital-axis. This is because, as stated above, both labour and capital are necessary for

the production of any commodity.

2.3.3 Least-cost Combination of Inputs

The production function indicates the alternative combination of various

factors of production which can produce a given output. Of these, an entrepreneur

would like to choose that combination of input factors, which costs him the least.

To explain how he can determine the least cost combination for a given output, we

need the prices of the factors of production. Let the price of labour (P L) be Rs.9 per

unit and the price of capital (PK) Rs.6 per unit. Assume that any amount of labour

and capital can be bought at these respective fixed prices. Let our entrepreneur

make nine pairs of shoes. The alternative combinations of labour and capital open

to him are as given in the columns headed by x = 9 in Table Input-Output

Relationships and isoquant x = 9 Figure Isoquants. Let us now determine his least

cost combination.

There are two ways to determine the least cost combination of inputs for a

given output. One way is to find the cost of each input combination and choose the

one which has the least cost. The cost of an input combination is found by

multiplying the price of each input by its quantity and then summing it over all

inputs. In our example, there are six alternative combinations of labour and capital

to produce nine pairs of shoes. The cost of each of these combinations will be as

follows:

13

Combination 5 represents the least cost for producing 9 pair of shoes. The

least total cost of producing various other quantities can be determined in a similar

way.

Combination Inputs Units

Costs (Rs.) L K

1 3 20 3 × 9 + 20 × 6 = 147

2 4 13 4 × 9 + 13 × 6 = 114

3 5 10 5 × 9 + 10 × 6 = 105

4 6 8 6 × 9 + 8 × 6 = 102

5 7 6 7 × 9 + 6 × 6 = 99

6 8 5 8 × 9 + 5 × 6 = 102

A more general way to determine the least cost combination is geometrical in

nature. We first draw iso-cost lines as follows. With a given sum of money C and

only two factors of production, labour and capital, the quantities of labour and

capital one can purchase are given by

C = LPL +KPK

If a shoe-maker has Rs.99 at PL = Rs.9, PK = Rs.6, he can buy 11 units of

labour with no capital, 16.5 units of capital with no labour, 7 units of labour and 6

units of capital, and so on. The various combinations of labour and capital that he

could buy with Rs.99 are represented by the line C = 99 in Figure Iso-cost Lines.

20

15

10

5

25

5 10 15 20

UNITS OF LABOUR (L)

UN

ITS

OF

CA

PT

IAL

(K

)

C = 147

C = 120

C = 99

C = 69

14

Figure Iso-cost Lines

Line C = 99 is an iso-cost line. It is the locus of all those combinations of

labour and capital which could be bought for Rs.99. similar isoquant lines can be

drawn for different sums of money. Figure Iso-cost Lines gives a few iso-cost lines.

It may be noted that all these iso-cost lines are parallel, for factor prices are the

same in all cases.

In order to determine the least cost input combination or the maximum output

for a given cost, we superimpose the isoquant map on the iso-cost map as shown in

Figure Least-Cost Input Combination.

It is seen that the maximum output that can be obtained with an outlay of

Rs.99 is 9 pairs of shoes, where the iso-cost line C = 99 is tangent to the isoquant x

= 9 at point C. Rs.99 is the least cost of producing 9 pairs of shoes, and the least

combination of inputs for this output is 7 units of labour and 6 units of capital. Any

other input combination on isoquant x = 9 will have a cost higher than Rs.99. For

example, input combinations at points C1 and C2 would cost Rs.105 and Rs.102,

respectively. Similarly, the least-cost input combinations for output levels 2, 5, 12

and 14 are given by points A, B, D and E, respectively in Figure Least-Cost Input

Combination. Thus, the line ABCDE represents the least cost combinations of

inputs for different levels of output. It denotes the expansion path and is called the

scale line.

2.3.4 The Analysis of Production Costs

In this part we examine the internal operations of business by analyzing the

nature of costs of production and the impact costs have on business decision -

making. Some of the questions which managers face are as follows:

Whether to increase or reduce production at the margin as bottlenecks are

reached?

Whether to increase production using more labour?

Whether or not to increase the overall scale of production by expanding to a

new plant size?

Just as consumers, given limited incomes, make decisions about what goods

to buy and in what quantity, so managers must make decisions about how much to

produce (the size of output) and how to produce; in terms of the combination of

inputs (i.e., labour, raw materials, capital equipment and so on), again with limited

resources. These decisions will depend heavily on the relevant costs of production.

In this lesson, the following concepts are covered:

The production function.

Variable costs versus fixed costs.

Production decisions in the short run and long run.

Diminishing returns in production.

Maximizing profit and the production decision.

Economies and diseconomies of scale.

15

In managerial decision-making, an understanding of the firm’s costs of

production and how they change as output is increased or reduced is essential. Of

course, behind increases and reductions in costs of production lie considerable

changes in the internal workings of the firm. Hence the good manager constantly

keeps in mind the impact of output decisions on the so-called ‘stakeholders’ in the

firm: employees, shareholders, suppliers, customers, etc. Other management

subjects such as corporate strategy and organizational behaviour deal with the

internal decision-making process within firms and the effect this has an outcomes.

In contrast, economists are more concerned with the nature of the relationship

between the firm and its market – the competitive environment – and more

specifically the relationship between output, price and costs of production, which in

turn affects the employment of factors of production. We therefore start this lesson

by considering the relationship between inputs and outputs as described by the

production function.

The production function and costs of production

Firms are essentially involved in adding value by converting inputs into

outputs. Firms employ labour, purchase materials and components, and invest in

land, buildings, plant and equipment with a view to maximizing the amount of

output that can be derived from these inputs. These inputs can be combined in

different ways (e.g. labour intensive versus capital intensive production) and we

might expect the decision as to the precise combination used to be related directly

to the costs of different forms of production. In this discussion we adopt the

position that managers are interested in minimizing the cost of producing any given

output, though we acknowledge that in practice there may be constraints (e.g.

union manning agreements) which prevent the kind of smooth adjustment process

as set out in the following discussion. Throughout most of the discussion in this

lesson it is assumed that the firm is not wasting resources, that is to say, it is

assumed that it is minimizing its cost of production at any given output.

The production function is a mathematical expression which relates the

quantity of all inputs to the quantity of outputs assuming that managers employ all

inputs efficiently.

In general terms the production function for any firm may be expressed as

follows:

This expression is a shorthand notation to show that the quantity (Q) of output

produced is determined by (or a function (F) of) a range of inputs (I1 to In). The

inputs or factors of production I1 to In are classified by economists under the

general headings of labour, land and capital though the production function can

equally relate output to different types of labour, capital, etc.

It may not always be obvious to managers what the precise technical

relationship is between their firms’ inputs and outputs. However, it must be the

Q = F(I1, I2, I3…….In)

16

case that there is a relationship and economists have derived a number of general

mathematical forms to describe typical relationships.

Variable costs Versus Fixed costs

In the production process some costs are fixed in the sense that they do not

vary as output changes. For example, the lease rent on an office and the capital

cost of a computer (including interest charges) are examples of costs which once

incurred usually remain the same as output rises – the fixed factors of production.

In contrast, those costs which do not change with output are known as the variable

costs. If more goods or services are produced, more inputs are employed and

variable costs increase. The kind of inputs involved are raw materials, components,

energy, telephone usage and, often, staffing levels – the variable factors of

production.

It is useful to analyze the way in which fixed costs and variable costs behave

as the level of production changes. Such analysis allows us to identify whether or

not resources are being used most efficiently. If total fixed costs and total variable

costs are averaged over the various levels of output, we can derive values for

average fixed costs (AFC) and average variable costs (AVC). Combining the AFC and

the AVC gives average total costs (ATC). These costs are illustrated in Figure-the

costs of production. The key points to note about the nature of these costs are the

following:

Average fixed costs: As the fixed costs are distributed across more and more

output, the average fixed costs decline continuously until at very large output levels

they are negligible.

Average variable costs: Average variable costs may fall initially but after a

certain level of output they begin to rise. This occurs because of what economists

term the law of diminishing returns, mentioned in lesson and discussed more fully

below. It is, of course, possible for average variable costs to rise continuously as

output expands (as in Figure - the costs of production), while in some businesses

there may be a large output range over which they are constant.

Average total costs: Average total costs, being the combination of AFC and

AVC, tend to decline initially and then rise after a certain level of output is reached.

Average total cost is often referred to by accountants as the unit cost. It is also

often referred to as average cost.

The extent to which a firm can alter its factors of production is dependent

upon the time period concerned. In general, the longer the time period the more

scope a firm has to vary its inputs. The importance of the time dimension in

production decisions gives rise to the concepts of the short run and long run.

17

Q

Output (Q)

Minimum ATC

Production

costs

AVCATC

Total fixed costs

AFC

Figure: The costs of production

2.3.5 Production decisions in the short run and long run

The short run is the time period during which the amount of at least one input

is fixed in supply (e.g. the amount of capital equipment installed or in some

organizations the number of personnel employed) but the other inputs can be

altered. In essence, the short run is the operating period of the firm where the

management has already made a technical decision about the production

process: for example, in a bank so many cashiers are employed using a given

number of automatic teller machines in a particular branch. To expand the

volume (output) of service it may be possible to employ more staff relatively

quickly, but to expand the floor area of the branch and to incorporate more

capital equipment will usually take much more time and planning.

The long run, therefore, represents a sufficient length of time for management

to be able to vary all inputs into the production process. This is also known as

the planning horizon of the firm in contrast to the current operating period. For

example, in order to meet a growing demand from customers the bank’s

management may decide over the next five years to purchase a much larger

building capable of housing many more cash machines and employing a much

larger number of staff. The bank will therefore over this period have moved

from one scale of operation to another which in turn will give rise to different

set of cost relationships.

18

It is important to appreciate that the terms short run and long run should not

be interpreted too rigidly. They are defined according to the extent to which the firm

is able to alter its inputs and this will vary from business to business. For example,

in large-scale manufacturing plants with high set-up costs, it is obviously difficult

to expand production quickly beyond the capacity of the plant, though it may be

possible to achieve this over a longer time period through more investment. The

length of time in the case of nuclear power generation is many years, while, by

contrast, in service-orientated businesses the planning period may be relatively

short. It may be quicker to buy and install a new microcomputer than to train new

staff.

2.3.6 Diminishing Returns in Production

Assuming that the firm is using its existing resources efficiently, the extent to

which output can be increased is dependent upon the extent to which inputs can be

varied. In the short run, as more and more variable inputs are applied to the fixed

factors of production, we tend to find that at first average (unit) costs fall but eventually

they begin to rise because diminishing returns set in. Economists refer to this trend

as the law of diminishing returns. It is easy to think of cases where this will occur in

manufacturing. For example, if the Maruthi motor company faces a sudden surge in

demand for its Alto range of cars and attempts to meet this extra demand by simply

employing more workers on a given assembly line, a point will be reached when

manning exceed the optimal level and unit costs rise. Therefore, if the company

believes that the increase in demand is permanent, it would be better to begin planning

an increase in capacity. Diminishing returns also apply in the service sector. For

instance, imagine a retail store attempting to serve more and more customers by

simply employing additional sales assistants but without extra cash registers – long

queues would be a reflection of diminishing returns in this case.

Minimum

ATC

Average

total cost

ATC

Marginal cost

MC

Production

costs

Output (Q)

The output at which average costs

are at their lowest is known as the

technically optimum output, and is

output q1, in Figure-costs of production.

At this point the factors of production are

being combined so as to minimize unit

costs.

The change in total costs of

production as output is changed is

referred to as the marginal cost. Marginal

cost is correctly defined as the additional

cost incurred of

producing one more unit of output, though in practice it is often applied in general

terms of any appropriate increment in production, e.g. the addition to total

electricity generating costs of bringing into service the marginal power station.

19

Marginal costs in the short run will only depend on changes in variable costs

because fixed costs are unaltered. In the long run marginal costs reflect changes in

the total costs of production since all inputs are variable. Hence, when discussing

changes in output we need to distinguish the impact on marginal costs in the short

run and long run. Figure Marginal cost and output illustrates a typical relationship

between short-run marginal cost and output (the nature of the long-run marginal

cost is addressed later in a discussion of economies and diseconomies of scale).

Figure: Marginal cost and output

At the margin, as output is increased the additional costs of production will

tend to fall at first but rise as diminishing returns set in, as illustrated in Figure

Marginal cost and output. There is an important relationship between marginal and

average total costs as shown in this figure. As long as the marginal cost (MC) is less

than the average total cost (ATC) of production, then the latter must be falling.

Once marginal cost exceeds average total cost the latter will be rising. If you have

difficulty understanding this relationship think about the effect on the average

score of a sports team when the last player scores more or less than the average

scored by the previous players.

In Figure Marginal cost and output, the marginal cost curve fell and then rose.

However, empirical studies of firms suggest that sometimes marginal costs do not

vary greatly with the level of output but instead are broadly constant over a certain

range of output.

The flatness of the marginal

cost curve between outputs of q1

and q2 in Figure Constant

marginal costs means that

average variable costs remain

constant until around capacity

output is reached. Only variable

costs have a bearing on marginal

costs because fixed costs are

fixed. Often, of course, marginal

costs will start to rise before

absolute full capacity working is

reached as management tries to

squeeze out further output.

O

Marginal cost of

production

Falling

marginal

cost

Constant marginal cost

Capacity

limit

q1

q2

Output

Figure: Constant marginal costs

2.3.7 Economies and Diseconomies of Scale

In the long run, management decisions will be concerned with how production

costs change as the size of the business alters. Opening up new factories, offices

and shops is associated with a change in the scale of output. There are broadly

three possibilities as follows which may arise:

Constant returns to scale. This arises when the volume of output increases in

the same proportion to the volume of inputs.

20

Increasing returns to scale. This arises where the volume of output rises more

quickly than the volume of inputs.

Decreasing returns to scale. This arises where the volume of output rises less

quickly than the volume of inputs.

These three possibilities are associated with constant cost, decreasing cost and

increasing cost production in the long run respectively. For example, increasing

returns to scale should result in decreasing costs (whether or not costs do in fact

fall also depends on input prices).

The existence of increasing and decreasing returns to scale is explained by the

presence of both internal and external economies and diseconomies of scale in

production.

2.3.7.1 Internal economies of scale

Internal economies of scale arise in industries such as chemicals, oil

extraction, High street banking, etc., where there must be a large output to

minimize long-run average costs. Economies stem from the more effective use of

available resources resulting in higher productivity and lower costs. A number of

internal economies of scale can be readily identified in relation to the following:

Labour. Better use may be made of specialized labour and managerial skills in

large firms and there may be economies in firms can often attract and fully

utilize better quality staff. In addition, a superior division of labour may be

achievable, which is likely to lead to the development of expertise on the part of

staff and a consequent growth in overall productivity.

Investment. There is likely to be a minimum level of investment which is viable

in many businesses – a firm cannot buy half of a computer even though it may

only require that much computing capacity! Investment economies of scale are

likely to be more evident in large – rather than small-scale enterprises.

Procurement. Large firms have muscle and are more likely to be able to gain

cost savings through bulk purchasing. This is particularly evident in grocery

retailing, for example in the United Kingdom where the market is dominated by

a small number of supermarket chains, namely Tesco, Sainsburym Gate-way,

ASDA and Argyle (Safeway and Presto) which are able to exercise considerable

bargaining power over grocery producers. A firm which purchase all or most of

a supplier’s output will be able to exert considerable monopsony (i.e. dominant

buyer) power and drive down price.

Research and development. In industries such as aerospace and

pharmaceuticals the pursuit of competitive advantage requires heavy

investment in R&D. To be viable, the cost must be spread over the very large

output which only large-scale enterprises can hope to achieve.

Capital. Large firms can often raise loan finance more easily and cheaply than

smaller businesses since they usually offer greater security to lenders. Also,

many larger firms are publicly quoted and hence have access to the equity

market.

21

Diversification. Many large firms spread risk by operating in a number of

different markets. For example, ICI supplies paints, fertilizers, pharmaceuticals

and so on. A collapse of one market should not, therefore, jeopardize the whole

company.

Promotion. Large firms are likely to be able to make more effective use of

advertising, specialist sales forces and distribution channel.

By-products. In large enterprises such as oil companies, the opportunity exists

to produce a wide range of by-products in quantities which are commercially

exploitable.

2.3.7.2 External economies of scale

Internal economies of scale relate to the operations and decisions made by the

individual firm. They are therefore directly under the control of the firm’s

management. In contrast, external economies arise at the industry level and are

generally associated with growth over time in the industry. Three main types of

external economies may arise relating to the following:

Labour force. Where firms in an industry group together there is often a large

and skilled labour force in the locality which all firms can utilize.

Suppliers. As an industry grows, it is often the case that specialized ancillary

firms become concentrated in the locality, supplying components, transport,

consultancy services, etc. For example, with the development of the financial

services industry in London, it is not surprising that there is also a

concentration of accountancy and legal advisory services (as well as wine

bars!).

Social infrastructure. A concentration of industry in a particular area will also

lead to the development of educational and training facilities, roads, rail

networks and a greater availability of housing for workers, all of which may

help to reduce industry’s costs. Indeed industry and government often

cooperate to ensure that these facilities are developed in areas of business

expansion, e.g. through new town developments and regional expansion

schemes.

2.3.7.3 Internal diseconomies of scale

A growing firm is likely to benefit from economies of scale which are internal to

its operations. However, as growth continues a point may be reached where certain

internal diseconomies of scale arise. These result in rising long-run marginal and

unit costs. Once this occurs the firm needs to consider whether or not further

expansion is desirable. Such diseconomies may relate to the following:

Management. The larger a firm’s operations become, the more complex the

managerial structure often needs to be. There is a danger that management will

become bureaucratic and unresponsive. This leads to ‘organizational slack’ and

the internal decision-making process slows down as staff becomes alienated.

The firm may also become less responsive to changes in the external market.

How often do we hear the criticism that a firm has ‘too many layers of

management’ resulting from inadequately managed growth?

22

Labour. It is a well-known fact that industrial disputes are more likely to occur

in large rather than small companies. This arises because, as the labour force

grows, the gap between ‘management’ and ‘the workers’ grows and

consequently loyalty to the firm falls. At the same time unionization increases

and this can bring with it more rigid wage-bargaining processes leading to

friction between management and workforce. Costs may rise because of lowered

productivity and the need for greater managerial supervision. Absenteeism and

slacking in work also tend to be more prevalent in large firms.

Other inputs. As the firm grows its demand for inputs increases. If the supply

of these inputs is limited then their unit cost will rise as the firm’s output

expands. This applies not only to materials and components but to certain

skilled labour requirements.

2.7.3.4 External diseconomies of scale

Sometimes costs rise as the whole industry expands in a particular area.

Growth can put pressure on the price of housing and transport and this may

ultimately feed through to higher wage demands and increased distribution costs.

There may also be additional costs associated with congestion and other

environmental hazards.

PRODUCTION COSTS IN THE LONG RUN

As firms expand production over the long run and move to different scales of

operation, if internal and external economies of scale exist unit costs will fall as the

volume of output increases. This represents increasing returns to scale or decreasing

cost production as defined above. Presumably, however, unit costs will not always

decline (otherwise they would eventually approach zero) and hence we would expect

them eventually to level out. The firm is then said to operate under constant cost

production. It is conceivable that at some very large output internal and external

diseconomies of scale might cause unit costs to rise, leading to increasing c ost

production. These three possibilities – increasing, constant and decreasing returns to

scale are illustrated in Figure The long-run average cost curve.

Constant returns to scale

Increasing

returns to

scale

Decreasing

returns to

scale

Constant cost

production

Decreasing

cost

production

Increasing

cost

production

Oq1 q2 Output expansion

over the long run

Average (i.e.per

unit cost of

production

Figure: The long-run average cost curve

The art of good management is to

capture the benefits of internal and

external economies and, of course, to avoid

the onset of internal and external

diseconomies. Ideally, firms will want to

operate at the level of output which

corresponds to minimum units costs over

the long run or what is sometimes termed

the minimum efficient scale (MES). This

represents the technical optimum scale of

production for the firm. In Figure The long-

run average cost curve an output of at least

q1 must be achieved to minimize long-run

average costs and hence this is the MES.

23

As there is constant cost production between outputs q1 and q2 there is no

single optimum scale – instead, any of the outputs in this range represents a

technical optimum. However, if the long-run average cost curve were U-shaped

there would be one scale of output, at the bottom of the U, which represented the

technical optimum. Achieving MES gives a firm a strong competitive advantage in

the market place over higher-cost producers.

Clearly, management must strive to avoid long-run average costs rising. As

one of the major diseconomies of large-scale production is managerial breakdown,

firms have tended to establish sub-units, separate operating companies and so on

to avoid this.

2.4 REVISION POINTS

A production function expresses the technological of engineering relationship

between the output of a commodity and its inputs. Through the lesson we know

about the production cost analysis and production decision in the short run and

long run

2.5 INTEXT QUESTION

1. what is production and cost analysis

2. what is production function

2.6 SUMMARY

Sometimes costs rise as the whole industry expands in a particular area.

Growth can put pressure on the price of housing and transport and this may

ultimately feed through to higher wage demands and increased distribution costs.

There may also be additional costs associated with congestion and other

environmental hazards.

2.7 TERMINAL EXERCISE

1. Define the concepts:

2. Production Function, Iso-quant, Iso-cost line, least cost combination,

increasing returns, Decreasing Returns, Constant Returns.

3. Variable cost, Fixed Cost, Average Cost, Marginal Cost



2. Financial management, S.N Maheswari

2.9 ASSIGNMENTS

1. Write an essay on Internal and External Economies of scale.

2. Explain the relationship between Marginal and Average Cost. Explain with

the diagram

2.10 SUGGESTED READINGS / REFERENCE BOOKS


2. Indian economy-R.K.Avarni & M. Grija


1. Discuss the relationship between marginal cost and average cost

2.12 KEYWORDS

ISO – quant, ISO – cost, Marginal COM, average cost, fixed cost, economics

to sale.

24

LESSON - 3

THE PRICE MECHANISM - I

3.1 INTRODUCTION

This lesson deals with how the prices of goods and services are determined in

the varying demand for supply of goods and services

Demand & its determinants exceptions and limitation

Law of demand

Law of supply

Elasticity

3.2 OBJECTIVES

To understand the law of demand and supply

To identify the determinants of demand

To distinguish between and change and shift in demand

To know the concept of Elasticity in demand supply

To understand the significance of price, income on demand

To know the role of consumer, government and firms in determining the

price

3.3 CONTENTS

3.3.1 The Analysis of Consumer Demand 3.3.2 The law of demand

3.3.3 The determinants of demand 3.3.4 The classification of products 3.3.5 Concepts of elasticity

3.3.6 Income elasticity of demand 3.3.7 The relationship between price elasticity and sales revenue

3.3.8 Marginal revenue

3.3.1 The Analysis of Consumer Demand

A firm is unlikely to make adequate profits, and hence remain in business for

very long, unless it has a reasonable knowledge of the demand conditions facing it

in the market place. Complete ignorance of these conditions means that it will have

not clear basis – other than guesswork – for deciding how much to produce, what

quantity it can expect to sell, and at what price. By contrast, the successful firm

plans effectively how to allocate its resources so that it can respond positively to

any changes in the demand for its products. For example, it will hold sufficient

finished stocks and maintain an adequate stream of work in progress to meet

expected surges in demand.

In this lesson we develop a number of economic concepts which are useful to

an understanding of consumer behaviour. The key aim is to identify the forces that

determine the demand for a firm’s product and to show how management can

proceed to measure the magnitude and impact of these forces. Therefore, much of

what is presented in this chapter provides a foundation for various aspects of

business management. For example, if management can estimate the importance of

25

factors such as price, advertising or the rate of interest in determining the quantity

demanded, then this will help in a planning useful marketing strategy. At the same

time, if it is possible to predict (albeit with some margin of error) the volume of sales

that can be expected when one or more of these factors is altered, this will have

important implications for the firm’s overall financial and business strategies.

Some of the factors affecting the demand for a firm’s product are under the

direct control of management (such as the advertising spend) while other factors

that influence demand are external. External factors include consumers’ incomes,

the prices charged by competitors, demographic trends and changes in the weather.

As they lie outside the firm they may be described as ‘uncontrollable’ conditions of

demand. Business planning should nevertheless incorporate some estimate of how

these forces might change in the future and what the ultimate impact of possible

changes will be on sales. We shall focus on the measurement and determination of

demand, linking the concepts introduced in this chapter to the determination of

revenues received from sales and to the overall structure of the industry in

question. This provides a useful introduction to the more detailed analysis of

market structure and the nature of competition.

Much of what is presented in this lesson represents a simple and practical

approach to understanding demand, based on a theoretical foundation developed

by various economists over many years. various models of consumer behaviour

have been put forward by economists insights into the decision-making process of

consumers. However, they all draw on the (common sense) observation that

consumers, when spending their hard-earned money, attempt to increase their

utility (i.e. overall satisfaction from their limited budgets). In other words, it is

(realistically) assumed that all consumers are rational in that they desire to

maximize their own well-being.

In this lesson the following central concepts are discussed:

The market demand curve.

Consumer surplus.

The determinants of demand.

The classification of products.

Concepts of elasticity.

The relationship between price elasticity and sales revenue.

When economists discuss the ‘demand’ for a product, they mean the effective

demand, that is, the amount consumers are willing to buy at a given price and over a

given period of time. Demand, in the economists’ sense, does not mean the wants,

desires or needs of people since these may not be backed up by the ability to pay (you

may want a Jaguar motor car but, unless you actually go out and buy one your desire

will have no bearing on the demand for Jaguar cars!). Mangers refer to demand in the

same way, hence readers should have no difficulty with this treatment.

26

At any given time and for any good or service it is possible to perceive of a

consumer’s demand curve.

A Consumer’s demand curve relates the amount the consumer is willing to buy

to each conceivable price for the product.

Clearly, we would expect the consumer to be willing to buy more of something

the lower its price. From the notion of a relationship between an individual

consumer’s demand for a product and its price we can derive the total demand of

all consumers in the market – the latter in turn gives rise to the notion of an

aggregate or market demand curve for a product.

The market demand curve is derived by summing the individual demand curve

of consumers horizontally.

A market demand curve is shown in Figure Derivation of the market demand

curve. DADA represents the demand for the product by Kumar at various price levels

while DEDE represents the corresponding demand by Kavitha. Summing

horizontally it will be seen that, for example, at price P1, a total quantity of Q(A + E) is

demanded, which is equal to the sum of the individual quantities demanded,

QA and QE, at that price.

3.3.2 THE LAW OF DEMAND

Product demand curves, both individual and market, show the relationship

between different possible prices of the good in question and the quantity of the

good which we expect to sell.

In general there is a central law of demand, which states that there is an

inverse relationship between the price of a good.

Price (P)

O

Quantity Demanded (Q)

(a)

Price (P)

O


(b)

Price (P)


(c)

DA

DA

QA Q1

D1

D1

Q(A+1)

D(A+1)

At any Kumar’s Kavitha’s Market

Price demand demand demand + =

Figure on Derivation of the market demand curve and the quantity demand assuming

all other factors that might influence demand are held constant

Thus, if price increases, it is normally the case that less will be bought (and

vice versa). In other words, a rational consumer prefers to pay less rather than

more for something. In this respect we think it is safe to assume that most

27

consumers are rational! Economists are sometimes criticized for assuming

‘consumer rationality’, but at least in terms of the way in which it is presented here,

it does not seem to be an outlandish assumption about consumer behaviour.

It is important to be aware of the significance of the expression assuming all

other factors that might influence demand are held constant’. Economic activity is

complex and usually more than one thing is changing at any given time. For

example, at the time a firm is changing the price of a product household incomes

may also be increasing, advertising expenditure may be rising, consumers may be

revising their attitude to the product and so forth. In order to study the relationship

that exists between price and demand, it is necessary to ‘freeze’ the picture. We can

then later study how behaviour changes as we introduce other factors which might

impact on demand, step by step. The assumption of all other factors held constants’

is therefore, merely a convenient framework to begin the study of what we accept is

a much more complex relationships in practice. The assumption is often

abbreviated and stated in its Latin form as ceteris paribus. Also, by initially

examining how demand changes only in relation to changes in price we are able to

illustrate the demand relationship in a simple, two-dimensional, diagram.

We stated above that if price increases, demand normally falls (and vice versa).

The word ‘normally’ is very important and later we shall examine cases where the

law of demand may not apply. For the moment, however, we shall assume that the

demand curve is downward sloping from left to right, with price measured on the

vertical axis and quantity demanded on the horizontal axis as shown by the line DD

in Figure Linear and non-linear demand relationships. Note that if price is

continuously increased, a point must eventually be reached where nothing will be

demanded, point ‘P’ in Figure Linear and non -linear demand relationships.

Likewise, management will eventually discover that the only way it can sell more is

to give the good away (i.e. charge a zero price – point q’ in the figure)! The line DD in

Figure Linear and non-linear demand relationships is referred to, generally, as a

demand ‘curve’, despite the fact that in this diagram it is shown as a straight line.

Economists frequently use linear demand curves as approximations for true

relationships between price and demand which may in fact be non-linear (such as

D’D’ in Figure Linear and non-linear demand relationships). This is purely for

convenience and illustration in text books, though over small sections of the curve

a linear representation will often provide a close enough approximation to predict

actual demand in many practical applications.

3.3.3 The Determinants of Demand

As we have stated above, the study of consumer behaviour generally shows

that as the price of a product falls, consumers will choose to buy more of it, Ceteris

paribus. However, a change in the price of the good itself is only one determinant of

the total quantity of the good demanded. A listing of the most important factors

which affect demand might include the following:

The ‘own price’ of the good itself (Po).

The price of substitute goods (Ps).

The price of complementary goods (Pc).

28

The level of advertising expenditure on the product in question, as well as

on complementary and substitute products (A).

The level and distribution of consumer’s disposable incomes ( Y ), i.e.

income after state direct taxes and benefits.

Changes in consumers’ tastes and preferences (T).

The cost and availability of credit (C).

Consumer’s expectations concerning future price rises and availability of

the product (E).

Changes in population, if we are examining the total market demand (POP).

In relation to particular products some of these factors may be more important

as determinants of demand than others. The factors other than ‘own price’ which

affect demand may generally be described as representing the conditions of demand

(i.e. the ‘environment’ within which consumers decide how much to purchase at

any given price). We can summarize these conditions in a demand function, which

in shorthand notation express the quantity demanded of a product (Qd) over a given

time period, as:

Thus, the demand curve (either DD or D’D’) in Figure Linear and non -linear

demand relationships shows the quantities of the good in question that will be

bought (Qd) at different prices (Po) with all other factors in the demand function held

constant. Clearly, as Po changes, there will be a movement along the demand curve,

say from A to B (in the case of a price rise) or B to A (in the case of price fall).

However, if any of the other factors in the demand function should change, then

there will be a shift in the demand curve as illustrated in Figure Shifts in the

demand curve. This highlights, the fact that, as the conditions of demand change

(except for PO, the ‘own price’), there will be a new price-quantity relationship

established. For example, a population boom is likely to mean that at any given

price, PO*, more will be demanded over time, shown by the increase from Q1 to Q2

in Figure Shifts in the demand curve.

OI Q1 Q2

Q

D

D1

D

D1

P*

o

Price (P)

Shifts in the demand curve

caused by changes in the

determinants of demand,

other than own price

Qd = POPE,C,T,,YA,,P,P,P dcsof

29

Quantity demanded (per time period)

Figure: Shifts in the demand curve

The distinction between a movement along a product’s demand curve and a

shift in the curve is useful because it helps to identify the causes and nature of

changes in demand.

When the own price changes, the outcome is a movement along the demand

curve and when any other determinant of demand changes, there will be a shift of

the demand curve (either to the left, showing a fall in the quantity demanded, or to

the right, showing a rise, depending on the nature of the change).

Some examples of shifts in demand curves are presented in Figure Changes in

conditions of demand.

3.3.4 The Classification of Products

There are two distinct reasons why more of a good is usually demanded as its

price falls (and vice versa). These are referred to as the ‘income effect’ and the

‘substitution effect’ as follows:

The income effect. As its own price falls, consumers are in effect better off

and hence able to buy more of the good. The fall in price has raised their

effective purchasing power, while the opposite applies in the case of a price

rise. The change in price is equivalent, in effect, to a change in income (though

actual income is unchanged).

The substitution effect. As the price of a product falls, it becomes relatively

cheaper than alternatives. Hence, there is a natural tendency for consumers

to switch towards the product in question, substituting more of it for other

goods. The opposite outcome occurs of course, where there is a rise in the

price of the product.

The substitution effect on demand of a price change will always be opposite in

direction to the price change (assuming rational behaviour on the part of

consumers) or zero if no substitutes exist at al. The income effect, however, can

either increase or reduce demand depending not only on the direction of the income

change but on the nature of the good or service. The direction of the income effect

allows us to classify the nature of products under the following particular headings:

Normal products. Goods and services may be classified as ‘normal products’

if the quantity demanded rises as income rise and falls as incomes fall. Here,

as throughout the rest of the chapter, income refers to a change in real

purchasing power rather than simply a nominal change which may be

neutralized by a proportionate price change. For example, family cars would

be classified as ‘normal’ since as household incomes rise (in real terms), the

demand for such cars also generally rises. Note that the key factor is the link

between demand and income – we would still expect an inverse relationship

between price and quantity demanded.

Inferior products. Certain products are classified as ‘inferior’ because the

demand for them falls as incomes rise (and vice versa). For example, as

household incomes rise, there may be a tendency to switch from buying

30

cheaper, lower quality meats to buying Grade A beef. The switch from inferior

to superior products is common as real incomes rise over time. For most

inferior goods, however, there is still likely to be an overall increase in demand

as their price falls. This is because the positive substitution effect (i.e. a switch

towards the relatively inexpensive product) more than offsets the negative

income effect on demand.

Giffen Products. A special case of the inferior product arises when as price

rises, more of the good in question is bought – resulting in an upward sloping

demand curve, contrary to the normal law of demand. Such products are

classified as Giffen products, named after a nineteenth-century English

economist who studied the response to changes in the price of potatoes in

Ireland. Giffen found that as the price of potatoes rose, the Irish at that time

bought more since they could not afford to buy as much of the more expensive

foodstuffs such as meat. This response to a price change is still found today in

many developing countries – as the price of rice rises, people are forced to buy

less meat and fish in order to be able to continue buying sufficient quantities

of rice to stay alive – hence the vicious circle of famine and malnutrition found

common in many parts of Africa

31

O Q

P

D1

D2

D1

D2

(a) A rise in the price of a

substitute good shifts the

demand curve rightwards

O Q

P

D1

D2

D1

D2

(b) A rise in the price of a

complementary good

shifts the demand curve

leftwards

O Q

P

D1

D2

D1

D2

(c) A rise in advertising

expenditure on the good is

likely to shift the demand

curve rightwards

O Q

P

D1

D2

D1

D2

(d) A fall in consumers

incomes shifts the

demand curve leftwards

O Q

P

D1

D2

D1

D2

(e) A rise in the cost of

credit is likely to shift the

demand curve leftwards

O Q

P

D1

D2

D1

D2

(f) A more optimistic

outlook is likely to shift

the demand curve

rightwards

Figure: Changes in the conditions of demand (demand curves DD refer to good in question)

32

In the case of Giffen products, the income effect of a price change is so large

that it swamps the substitution effect, leading to an overall rise (fall) in demand for

the product as its price rises (declines).

Veblen products. It has also been suggested that ‘luxury type’ products also

display perverse price-demand relationships, though for different reasons to

that of the Giffen products case. These are sometimes referred to as Veblen

products, after the American economist, Thorstein Veblen (1857-1929), who

explored the phenomenon. For example, as the price of a piece of jewellery

rises, the demand for it may also rise as consumer attach a ‘snob’ value to

owning and displaying expensive items. Equally, all the price falls there is the

possibility that the product could lose its up-market image – ‘everyone can

afford it, so why bother to buy it’! This situation reflects a change in tastes,

determined by the perception of the product in relation to its price. The

existence of a positive veblen effect is, of course, very advantageous to the

producers concerned since it enables them to charge premium prices for their

products.

3.3.5 Concepts of elasticity

The discussion so far has been concerned with the broad direction of

relationships between price changes, changes in other possible determinants of

demand and the quantity demanded. However, in addition to understanding the

nature of demand, it would of course be very useful if management were able to

estimate the extent to which demand is likely to respond to a price change. Gauging

this responsiveness is referred to by economists as the measurement of price

elasticity. In addition, since, as we have seem, demand is affected by many factors,

we can calculate elasticity (i.e. responsiveness of quantity demanded) wi th respect

to a wide range of variables other than price, notably the price of other goods and

income. Thus we can define the following:

Price elasticity of demand

This measure the responsiveness of quantity demanded of a product to

changes in its ‘own price’. For example, if the price of alcohol increases, what

happens to the quantity of alcohol demanded?

Cross elasticity of demand

This measure the responsiveness of quantity demanded to changes in the

prices of other goods (both complements and substitutes). For example, if the price

of one brand of coffee rises, what happens to the demand for another coffee brand?

Or, if the price of petrol falls, what happens to the demand for cars?

Income elasticity of demand

This measures the responsiveness of demand to change in the real income of

consumers. For example, if real income are rising, on average, by £100 per month,

what will happen to the demand for housing?

Elasticities

33

Price elasticity ofdemand

Income elasti city of

demand

Cross elasticity of

demand

Income elasticity of

demand

ELASTICITIES

How much demand changes in responseto changes in ……..

How much supply changes in response

to changes in ……..

Price of the good

Household

income

Price of another

good

Price of the good

In general terms, a coefficient of elasticity can be calculated for each of the

above categories using the following general formula:

We will now examine each of these three elasticity concepts in more detail.


Based on the general formula, the (own) price elasticity of demand for a

product may be defined as:

Where a product has a downward sloping demand curve (the usual case), the

value of the price elasticity of demand will always be negative – since when price

rises demand falls and when price falls demand rises. Conventionally, however, the

negative sign is omitted when the value of elasticity is stated and we follow the

convention in the following discussion.

Two different types of price elasticity (Ed) can be calculated as follows:

Arc elasticity of demand, and

Point elasticity of demand.

Arc elasticity of demand

Coefficient of elasticity = ariablerelevant v in the change Percentage

demandedquantity in change Percentage

Ed = product theof price in the change Percentage


34

With reference to Figure Arc elasticity of demand, arc elasticity measures the

responsiveness of demand between two points on the demand curve such as X and

Y, whereas, as the name suggests, point elasticity is concerned with the elasticity at

only one given point of the curve. Since managers are usually concerned with

estimating the effect on demand of, say, a 5% rise in price, the price change causes

a movement along a section of the demand curve and hence the arc elasticity

formula is the one that is often used for practical purposes.

Using the notation shown in Figure arc elasticity of demand we can calculate

arc elasticity as:

O Q

P

Y

X

Q1 Q2½ (Q1 + Q2)

½ (P1 + P2)

P1

P2

Arc elasticity is measured at

midpoint between X and Y; i.e.,

at 1/2 (Q1+Q2) and ½ (P1+P2)

Quantity Demanded

It is important to appreciate the reason why arc elasticity is expressed on the

basis of the average quantity, ½ (Q2 + Q1), and average price, ½ (P2 + P1). When

there is an appreciable price change, the value of elasticity calculated on the basis

of X as the starting point will differ from that calculated on the basis of Y as the

starting point – we end up with two different values for the sensitivity of demand to

price changes which will not be very useful in business decisions. Using the

midpoint, however, ensures that price elasticity is the same regardless of the

direction of movement on the demand curve and, since it is based on the average

price and average quantity, it will be closer to the true estimate of elasticity over the

price range than that based on either of the two extreme points.

Point elasticity of demand

It should be intuitively clear from Figure Arc elasticity that as X and Y come

closer together, the arc shrinks in size and the two values for elasticities calculated

Arc Ed = )(2/1/)(

)(2/1/)QQ(

1212

1212

PPPP

QQ

= )(

)(

)(

)(

12

12

12

12

QQ

PPX

PP

QQ

35

at X and Y separately will get closer to each other. If the distance is negligible, the

arc will end up as a single point and the arc elasticity calculation can be replaced

by that for point elasticity.

While point elasticity is expressed here in relation to Q1 and P1 it will be

appreciated that since the difference between Q1 and Q2 and P1and P2 will be

infinitesimally small, it no longer matters whether we use the ini tial or final price

and quantity values. In business, of course, management is unlikely to be

interested in ‘infinitesimally’ small changes in price since it is impractical to

introduce, say, a 0.0001% change in the retail price of most products.

The term ‘elastic’ and ‘inelastic’ are often used to describe different degrees of

elasticity. In general (and ignoring the negative sign):

Products with a price elasticity of demand of less than 1are said to have a

relatively inelastic demand with respect to price – they are said to be price

inelastic.

Products with a price elasticity of demand greater than 1 are said to have a

relatively elastic demand – they are said to be price elastic.

Products with a price elasticity of demand equal to 1 are said to have a unit

elasticity of demand.

Irrespective of the precise method of calculation, the value of the resulting

price elasticity of demand will vary depending upon the nature of the demand for

the good in question. In Figure Degrees of elasticity of demand the fol lowing three

extreme price elasticities are illustrated (a, b and c) together with a representation

(d) of the elasticities along a down-ward sloping demand curve.

Perfectly inelastic demand: When the demand for a product is entirely

unresponsive to any change in price, the demand curve will be a vertical line as

shown in Figure Perfectly inelastic demand with Ed equal to zero at every point.

This is referred to as a perfectly inelastic demand.

Perfectly elastic demand: Where the demand curve is horizontal, any

quantity of the product can be sold at a certain price, P1, as in Figure Perfectly

elastic demand. Demand is said to be perfectly elastic with a value of infinity at this

price. Any increase in the price, no matter how small, will result in none of the

product being sold. If the price is reduced, even marginally, demand (theoretically)

becomes infinite.

Unit elasticity of demand: A further special case arises when the shape of

the demand curve is a rectangular hyperbola as in Figure Unit elasticity of demand.

At any point on it the value of elasticity is equal to unity.

Point Ed = 112

112

/)(

/)(

PPP

QQQ

= 1

1

12

12

)(

)(

Q

PX

PP

QQ

36

O Q

P

O Q

P

O Q

P

O Q

P

Ed = 0P1 Ed = (-) x

(a) Perfectly inelastic demand (b) Perfectly elastic demand

Ed = (-) 1 at

all points

(c) Unit elasticity of demand (d) Range of elasticity

Ed = (-) x

Ed = (-) 1

Ed = 0

The three cases above are, in practice, rarely found and should be treated as

theoretical benchmarks for an analysis of actual price elasticities. Small stre tches

of a demand curve though may closely equate to one or other of these extremes.

Figure Range of elasticity shows a situation where the value of elasticity varies

between zero and infinity along its length with a value of 1 at the midpoint. It is

important to appreciate that (excluding the cases of vertical and horizontal demand

curves) even where a product has a linear demand curve, its elasticity changes as

price is altered. This follows because the original price and quantity figures, which

enter into the elasticity calculation (see above). This means that price elasticity

must be recalculated for every price change. If the price elasticity was, say, 0.6

when the price was last increased by 5%, even if in the meantime none of the

conditions of demand have altered – i.e. the demand curve has not shifted (which in

itself is most unlikely) – a further 5% increase in price is likely to be associated with

a price elasticity above 0.6.

Given that the price elasticity of demand is a numerical measure of the

responsiveness of quantity demanded to changes in price, there is obviously a

relationship between the value of the elasticity and the total sales revenue received

by the firm. This has important implications for pricing strategy and we shall return

37

to it later in this chapter. First, we introduce the other elasticity of demand

measures noted earlier, namely cross-price and income elasticity.

Cross-price elasticity of demand

Cross-price elasticity of demand (sometimes simply referred to as ‘cross-

elasticity’) indicates the responsiveness of the demand for one product to changes

in the prices of other goods or services. The concept has most relevance where there

are obvious substitute or complementary commodities and it is, therefore, of key

importance to businesses which face major competition or whose sales vary directly

with the sales of other goods, e.g. mortgages and mortgage protection insurance.

If A is the good or service we are interested in and B is the other product

whose price is altering. We can calculate the value of the cross-price elasticity of

demand for A with respect to B as:

In the case of substitutes, the resulting figure will be positive since a fall in the

price of a substitute will lead to more sales of the substitute and hence a fall in the

demand for the other product being considered. In the case of complementary

products, the resultant value will be negative. If the demands for the two goods

appear to be unrelated then, of course, the cross-price elasticities between them

can be expected to be negligible or zero.

The terminology regarding the degree of cross-price elasticity (ignoring the

sign) is the same as for price elasticity namely:

1 = unit cross-price elasticity.

Less than 1 = inelastic cross-price elasticity.

Greater than 1 = elastic cross-price elasticity.

3.3.6 Income elasticity of demand

As noted earlier, demand is also likely to be responsiveness to factors other

than ‘own price’ or the price of complements and substitutes. One important factor

is real income (i.e. nominal income adjusted for inflation). Empirical studies usually

define nominal income in terms of either household disposable income (i.e. house -

hold income after income tax, and other direct taxes, plus welfare state payments

have been incorporated) or gross national income. Income elasticity of demand is

defined as:

The value of the income elasticity will usually be positive, suggesting that more

is bought as real income rises, though for certain products it may be negative as we

Income Ed = income realin change Percentage


Cross-price Ed = b of price in the change Percentage

demandedA ofquantity in change Percentage

38

saw earlier, albeit in a slightly different context. The actual values of income

elasticities can be used to classify products into the following two broad categories:

Inferior goods: These are goods of which consumers buy less when real

incomes rise. The value of income elasticity is, therefore, negative. Examples might

be potatoes, Lada cars, cheap package holidays, etc.

Normal goods: These are the most common goods with demand generally

rising as real income rises. They can themselves be further subdivided into two

categories:

Necessities: These are goods and services which exhibit a positive income

elasticity of demand, though the value will tend to be less than 1. Articles such as

basic foodstuffs and ordinary day-to-day clothing fall into this category. Consumers

will purchase a certain amount of these goods at very low levels of income, but they

will tend for any given percentage increase in real income to increase their spending

on the goods by a smaller proportion.

Luxuries: At very low income levels, nothing will be spent on these but, once a

certain threshold level is reached, the proportionate rise in demand for luxury

goods is greater than the proportionate rise in real income, e.g. foreign holidays,

eating out and video recorders.

From the above classification it is obvious that it will pay firms which want to

expand output to concentrate on selling products with high income elasticities

when living standards are rising. With greater purchasing power, people will tend to

buy disproportionately more luxury-type goods. On the other hand, firms producing

goods with low income elasticities will tend to face a more stable market for their

products and will be less affected in times of economic downturn. The food retailing

industry is usually an example of this.

3.3.7 The relationship between price elasticity and sales revenue

In addition to income elasticity, a firm’s fortunes will also be affected by price

elasticity as demand, and hence the firm’s revenue, changes as a result of price

changes. The total receipts or total revenue (TR) earned by a business from sales is

calculated by multiplying the total output sold (Q) by the average unit price (P), i.e.

TR = P X Q. The resulting value of total revenue is illustrated by the shared area in

Figure Demand and total revenue with price at P1 and quantity demanded equal to

Q1. Where there is unit elasticity of demand, as the price is varied the total revenue

earned from sales remains unchanged. For example, a 1% fall in price will bring

about a 1% rise in sales, leaving total revenue unaltered. However, as we indicated

earlier, unit elasticity is an extreme case and unlikely to be found over more than

modest stretches of a demand curve. It will usually be the case that the value of

elasticity will vary along the demand curve, as shown earlier in Figure. As price

changes by a certain proportion, the quantity demanded usually changes by a

greater or lesser proportion.

39

Price (P) D

D

QQ1O

P1

Total

revenue

P1xQ1

Quantity demanded

Figure: Demand and total revenue

In general, we can derive the following rules:

With a price inelastic demand:

An increase in price causes a reduction in quantity demanded, but total

revenue increases;

A fall in price causes an increase in quantity demanded, but total revenue

earned declines.

With a price elastic demand:

An increase in price causes such a large fall in sales that total revenue falls;

A reduction in price causes such a large increase in the quantity demanded

that the total revenue rises.

Hence, it is clear that accurate estimates of price elasticity are vital to

business decision-making. Putting this way, ignorance of the market response to

price changes is likely to be a recipe for disaster!

The link between total revenue and price elasticity results from the fact that,

faced with a downward sloping demand curve for a product, management must

lower price if they want to sell more (other factors held constant). But if extra sales

compensate for the lower unit price then total revenue will not decline. Similarly,

management might raise the price of a product to raise revenues, but the resulting

collapse of demand may actually cause total revenue to contract. In other words,

the precise responsiveness of demand to a price change determines the effect of a

price change on revenue received. This introduces another important concept which

40

will be used throughout much of the remainder of this book, namely marginal

revenue.

3.3.8 Marginal Revenue

Marginal revenue is defined as the change in total revenue as a firm sells one

more or one less unit of its output. The size of a ‘unit’ will vary from firm to firm –

for example, the smallest unit of water which is charged to domestic users is likely

to be much more than a single litre, while the car dealer may be concerned with the

sale of a single car. To be mathematically correct, marginal revenue is the increase

in total revenue resulting from an infinitesimally small change in quantity sold. But

it can be approximated by looking at the change in total revenue resulting from a

small, quantifiable, change in output.

In the figure on the relationship between elasticity, total revenue, marginal

revenue (MR) and the demand curve (D). The demand curve is also the average

revenue (AR) curve because it shows the price at which each unit is sold. Provided

that when units are sold they are all sold at the same price, price and average

revenue must be identical.

The key points to note are as follows:

The marginal revenue curve declines at twice the rate of the demand (average

revenue) curve. Hence, the marginal revenue curve cuts the horizontal axis at a

point mid-way between the origin and point C in the Figure Elasticity, marginal

revenue and total revenue. A proof of this mathematical relationship is given at the

end of the chapter.

When total revenue is increasing, marginal revenue is positive. This results

from the fact that demand is elastic between points A and B on the demand curve

DD in Figure about Elasticity, marginal revenue and total revenue.

Total revenue is maximized when marginal revenue is zero which occurs when

the price elasticity is unitary. Therefore, further attempts to increase total revenue

by lowering price below P* will fall since sales volume will not increase sufficiently

to compensate for the price fall.

41

O C

Price (P)

Quantity demanded*

Elastic

demand

Ed = (-) 1

D (AR)

Q

P*

a

MR

B

D

Inelastic

demand

O Q

Quantity demanded

Q*

Total Revenue

Maximum

P* x Q*

Elastic

Demand

Inelastic

Demand

Figure: Elasticity, marginal revenue and total revenue

Marginal revenue is concerned with changes in total revenue resulting from

small changes in sales. Since many business decisions hang on whether to increase

or reduce sales, t concept of marginal revenue is central to much of the discussion

relating to business decision-making in subsequent chapters. It is important,

therefore, that the reader should not proceed further until the concept is fully

understood.

Summary of points on elasticity


Formula

pricein change %

demandedquantity in change %

42

Values (ignoring sign)

Demand

0 is perfectly price inelastic. Price does not affect demand (e.g. a vertical straight line demand curve).

0 to 1 is price inelastic. A price cut causes a fall in revenue.

1 has unit price elasticity. Price changes do not influence revenue.

1 to infinity

is price elastic. A price cut leads to a rise in revenue.

infinity Is perfectly price elastic. A small rise in price reduces demand to zero (eg. A horizontal straight line demand curve).

Uses

Estimating effect on revenue of changing price

Predicting change in volume sold if price changes

For government, judging the effect on indirect tax revenue of change in tax

on a good

Determinants

Necessity or luxury (a necessity will have low price elasticity of demand)

Proportion of income spent on the good (low proportion => low elasticity)

Proximity of substitutes (many substitutes => high price elasticity)

Time period under consideration (elasticity increases with time period)

Income elasticity of demand

Formula

incomein change %

demandin change %

Values

Demand

>1 is income elastic. This is a normal good, for which demand will

grow at a greater rate than the level of income.

0 to 1 is income inelastic. This is a normal good but demand will rise at less than the rate of income.

0 has nil income elasticity. Demand will not change with income

<0 has negative income elasticity. This is an inferior good, for which demand fails as income rises.

Uses

Planning output capacity during times of changing national income

Spotting growth markets and products

Planning social provisions (e.g. roads; leisure facilities)

Determinants

Quality of the product in relation to substitutes

43

Time period under consideration (expensive tastes need time to develop)

Whether household or market is being considered (more likely to find

inferior goods at household level)

Cross elasticity of demand

This measures the responsiveness of demand for one good to changes in the

price of another.

Formula

B good of pricein change %

demandedA good ofquantity in change %

Values/determinants

> 0 for substitutes: a fall in the price of one reduces the amount demanded of

the other.

< 0 for complements: a fall in the price of one raises demand for the other.

If the cross elasticity is zero, A and B are neither substitutes nor complements.

The cross elasticity of demand for A relative to B is thus determined by the

degree to which A and B are substitutes or complements.

Elasticity of supply

Formula

pricein change %

suppliedquantity in change %

Values

Supply

0 is perfectly price inelastic: Price does not affect supply, e.g.

antiques, vintage wines (applies if supply curve is vertical).

0 to 1 is price inelastic. Price changes cause smaller proportionate changes in supply.

1 has unit price elasticity. Supply varies proportionately with price

(applies where straight supply curve passes through origin).

1 to Infinity is price elastic. A price change causes larger proportionate change

in supply.

Infinity is perfectly price elastic. Producers will supply any amount at a

given price but none at a slightly lower price (applies if supply curve is horizontal).

Determinants

Time period

The range of alternatives open to the producer

The cost of attracting more factors of production (e.g. labour, capital) or

the saving from making factors redundant

Availability of excess stocks

The extent of excess capacity in the industry

Markets for agricultural products are an example for perfectly inelastic supply

in the short term (because crops taken time to grow). If demand is inelastic, then

44

fluctuations in supply (e.g. due to crop failure of a bumper harvest) can lead to

sharp fluctuations in price.

3.4 REVISON POINTS

1. Price mechanism about the analysis of consumer demand and also explain

the law of demand, concepts of elasticity of demand, the concepts

2. Explain the Relationship between Price Elasticity and Sales Revenue


1. Define marginal revenue

2. Define price elasticity of demand

3.6 SUMMARY

We have seen a number of economic concepts which are useful to understand

consumer behaviour. The key aim is to identify the forces that determine the

demand for a firm’s product and to show how management can proceed to measure

the magnitude and impact of these forces. Therefore, much of what is presented in

this lesson provides a foundation for various aspects of business management.

Management can estimate the importance of factors such as price, advertising or

the rate of interest in determining the quantity demanded, for that will help in a

planning useful marketing strategy.


1. Explain the concept of elasticity of demand

2. What is demand

3. What is elasticity of demand

4. What is law of demand

3.8 SUPPLIMENTARY MATERIALS

1. Managerial economics – R. Cauvry & Grija



3.9 ASSIGNMENTS

1. Explain Nature and type of different Elasticity of Demand with suitable

diagram.

2. List out the determinants of demand



2. Indian economy-R.KAvarni & M. Grija


1. Define the Concepts: Law of Demand, Price elasticity of Demand, Income

electricity of Demand, Causes elasticity of Demand.

2. Write short notes on: Individual demand, Market Demand, Determinants of

Demand, Change and shift in demand.

3.12 KEY WORDS

Demand, Elasticity of demand interior good, giffen good, veblan good

46

LESSON - 4

THE PRICE MECHANISM - II

4.1 INTRODUCTION

This lesson deals with how the prices of goods and services are determined in

the varying demand for supply of goods and services

4.2 OBJECTIVES

To understand the law of demand and supply

To identify the determinants of demand

To distinguish between and change and shift in demand

To know the concept of Elasticity in demand supply

To understand the significance of price, income on demand

To know the role of consumer, government and firms in determining the

price

4.3 CONTENTS

4.3.1 Demand

4.3.2 Supply

4.3.3 Equilibrium price

The Price Mechanism

4.3.1 Demand

The demand curve (price plotted against quantity) represents estimates of the

quantities of a good that would be demanded per time period at different price

levels.

Demand is influenced by price. Demand is higher at lower prices, and so the

demand curve slopes downwards from left to right.

Demand Price controls Supply

The market

Equilibrium price THE PRICE

MECHANISM Functions of the

price

mechanism

Firms Government Consumers

47

Explanation: the consumer seeks maximum satisfaction from limited income.

Other things being equal, a fall in price of a good increases the satisfaction per

penny spent on it above that available from other goods. The consumer will

increase demand for the cheaper good and cut demand for the other goods.

Changes in the price of the good are reflected by a movement along the

demand curve: a different quantity is demanded at the new prices.

A shift in the demand curve results from changes in the following other factors

influencing demand.

The price and availability of substitutes (eg tea and coffee)

The price and availability of complements (eg CD players and CDs)

The size of household income and, in some cases, the cost and availability of

finance or credit, eg with owner-occupied housing and spending on credit cards

Tastes, fashions, attitudes towards a good

Consumer expectations about future market conditions (eg expected price rises

or supply shortages)

The distribution of income among the population

Shift to the right in demand

Price

Shift to the left in demand

D1

D0

Price

D1

D0

The quantity demanded at any

given price is now higher than

before – eg. Because the price of a

substitute has risen


given price is now higher than

before – eg. Because the price of a



given price is now less than before

– eg. Because the price of a


4.3.2 SUPPLY

The supply curve (again, price plotted against quantity) represents estimates of

the quantities of a good that firms in the industry will want to supply to the market

per time period at different price levels.

Firms will want to supply more at higher prices, and so supply curve slopes

upwards from left to right. A change in price is reflected by a movement along the

supply curve.

48

Shift to the right in demand

Price

Shift to the left in demand

S1

S0

Price

A shift in the supply curve results from changes in the following other factors

The marginal costs of producing the good. (A market supply curve represents

the marginal costs of production for the industry as a whole)

The prices and costs of making other goods that firms could switch to making

instead

Supply conditions – eg weather conditions in the case of agricultural goods;

quota restrictions when a government imposes production limits

4.3.3 Equilibrium Price

Consumer surplus

Producer surplus

C

B

Demand

SupplyPrice

QuantityO

P

A

Q

In a free and stable market, the forces of demand and supply will interact so

that an equilibrium (‘market clearing’) price and quantity will be reached. This is

where:

The quantity demanded equals the quantity that firms want to supply (Q in

the diagram above), and so

All production output is purchased by consumers at the market price (P), and

there are no market pressures for a change in price or quantity

Firms now want to supply more of

the good at any given price –

eg because marginal costs of

producing the good have

fallen.

Firms now want to supply less of

the good at any given price –

eg because marginal costs of

producing the good have

fallen.

Quantity Quantity

49

Different consumers will be prepared to pay different prices. The demand curve

shows consumers’ overall ‘marginal willingness to pay’ for additional quantities of

the product.

What consumers have to pay is shown by area OPBQ is above

Area OABQ shows what they would be willing to pay

The difference – area PAB – is called consumer surplus

4.4 REVISION POINTS

1. Determinants of demand

2. Concept of elasticity in demand supply

4.5 INTEXT QUESTION

1. Define equilibrium price

2. Define consumer surplus

4.6 SUMMARY

In nutshell this part of the lesson introduced how the prices of goods and

services are determined using the basic factors ‘demand and supply’ of goods and

services. The law of demand introduces the relationship between price and

quantity demanded. Demand for a good tend to alter from time to time. If the

alteration in demand is due to ‘price’ it is ‘change in demand’. If the demand

change due to the reasons other than ‘price’ it is shift in demand. The concept

‘elasticity of demand’ is a measure to know the extent of change in demand and

supply with respect price, income and prices of related goods. The nature and

degree of responsiveness vary with respect to nature of good in question

4.7 TERMINAL EXCERSISE

1. what is supply

2. what is meant by price




3. Indian economy-R.K.Avarni & M. Grija

4.9 ASSIGNMENTS

1. How Prices are determined in a Market? Use diagram to explain.

2. Explain in detail about the price mechanism with flow chart.


1. C.N. Vakil & H.N. Pathak. Introduction of economy Voro & Co. Publishers

Pvt. Ltd. (2008), New Delhi.


1. Define the concepts: Marginal Utility, Consumer equilibrium, consumer

surplus, indifference curve – Price Effect, Income effect

4.12 KEYWORDS

Equilibrium Price surplus, indifference curve , Price Effect, Income effect

51

LESSON - 5

PRICING UNDER DIFFERENT MARKET CONDITION

5.1 INTRODUCTION

This part of Economics introduces the Nature of the mechanism of exchange of

goods and services through price determination in a market. Under perfect

competition and monopoly models have proved useful for predicting behaviour in

the market. We understand about the monopolistic competition

5.2 OBJECTIVES

To understand the different market structure that are existing on the basis of

Nature of goods and services

Number of buyers and sellers

Regulatory mechanisms laid by the government

5.3 CONTENTS

5.3.1 The firm maximizing profits

5.3.2 Perfect competition

5.3.3 Monopoly

5.3.4 Monopolistic Competition

Perfect competition & monopoly

Market structures

Perfect

competition

MARKET

STRUCTURES

The firm:

Maximising profits

Imperfect

Competition

MonopolyMonopolistic

competition

5.3.1 The firm Maximizing Profits

For the firm in perfect competition or monopolistic competition, for the

oligopolistic and the monopolist, the profit-maximising condition is the same.

Marginal cost (MC) = Marginal revenue (MR)

You need to understand each model of market structure – perfect

competition, monopolistic competition, and monopoly. Pay attention to

the significance of the number of firms, the nature of the product and the

ease of entry and exit in the industry.

52

Diminishing returns in the short term can be assumed for all markets: the AC

curve is U-shaped.

QuantityQ1 Qm Q2

MR

MC

Co

st

From position Q1 in the diagram above, the firm will expand output to Qm

since the extra revenue it gets from selling the additional units of output exceeds

the extra cost it incurs in producing and selling the additional units.

Higher levels of output are not attractive because the firm will make a loss on

the additional units (MC > MR), reducing overall profits.

In the short term:

A loss-making firm might stay in the market, hoping that in the longer term,

prices will go up or costs will fall

A firm might earn supernormal profits (defined in the last section of Chapter 7

above), even in a competitive market

A firm might succeed in eliminating or reducing competition, or might be

protected from competition, by barriers to entry

Barriers to entry determine the number of sellers in a market, and include the

following:

Patents and copyrights

Government legislation creating/protecting a monopoly

A natural monopoly (economies of scale)

The high costs of getting established in the market (entry costs)

In the short run, the threat of price cuts and a price war (predatory pricing)

Firms will try to earn supernormal profits if they can. However, competition

erodes supernormal profits, and firms may have to be satisfied, when equilibrium is

reached in the long run, with just normal profits.

Equilibrium changes when circumstances change – eg a shift in market

demand or supply.

A firm is in equilibrium when it is maximizing its profits, and can’t make

bigger profits by altering the price and output level for its product or service

An industry is in equilibrium when the following apply

53

Supply and demand are equal at a certain price and output level

There are no firms trying to get into the market

There are no firms trying to get out of the market

5.3.2 PERFECT COMPETITION

Perfect competition refers to a situation in which all firms in the market are

price takers, because they do not have the ability to influence the market price, and

must accept the ruling market price for their product.

The perfect competition model provides: a benchmark against which to

measure the efficiency of other market structures.

Assumptions of perfect competition are as follows.

A large number of buyers and sellers

Producers and consumers acting rationally and possessing the same

information

Homogeneous product

Free entry of firms into and exit out of the market

No transport costs or information-gathering costs

A firm’s demand curve (= price = average revenue or AR curve) differs

according to the type of market the firm is in.

A perfectly competitive firm must accept the ruling market price, and can only

sell its output at that price (AR = MR). This contrast with a price -making firm,

which faces a downward sloping demand curve

QO

AR = MR

Revenue

per unit

AR

Revenue

per unit

O QMRA B

Demand curve and

MR curve of a firm in

perfect competition

AR and MR curves for

price making firm

If MR > MC in the short, run, firms earn supernormal profits and, under

conditions of perfectly competition, prices will be bid down as new firms enter the

industry and market output rises.

In the long run under perfect competition, normal profits only are earned when

MC = MR, since AC = AR. MC = MR = AR = AC.

To illustrate the position of a price-making firm in an exam answer, a

straight line demand curve can usually be drawn, for simplicity. The MR

curve can then be drawn as a straight line too, cutting the x axis (output

axis) half-way between the origin of the graph and the point where the AR

curve cuts the x axis.

54

Perfect competition: long-run equilibrium

QuantityO

AC

OQuantity of a firm

(Smaller scale)

Qf

The market The firm

Market

demandMarket

supplyS

D

P

Qm

PMR= AR

Imperfect competition refers to a situation (such as monopolistic competition,

oligopoly or monopoly – each considered below) in which one or more firms are

price makers, and can have some choice in deciding the price at which they will sell

their product.

5.3.3 Monopoly

Assumptions of pure monopoly are as follows.

One firm is the sole producer of a good with no close substitutes.

Barriers to entry exist

P

QMR

AR

Quantity

MC

Monopoly Equilibrium

The monopolist’s demand (AR) curve is the industry demand curve.

Where profits are maximized (MC = MR), usually AR > AC and therefore

supernormal profits are earned.

Profits are maximized at output level Q below where AC is minimized

(allocative inefficiency).

Supernormal profits can encourage a firm to become inefficient and wasteful of

resources. This is called X-inefficiency.

55

Possible points in favour of pure monopoly are as follows.

Economies of scale can be achieved

Monopolists can afford to pay for research and development out of

supernormal profits

Monopoly may be more stable than perfect competition

5.3.4 Monopolistic Competition

Product differentiation distinguishes a perfectly competitive market from a

monopolistically competitive market. For instance how producers of pen

differentiate each Varity they make, from the existing ones that are selling in the

market at time.

Detergents, toilet soaps, tooth brushes, beverages and pens we use are the

examples for the goods that are the examples of differentiated products, thought

they are meant for similar use.

Even though there are many firms in a monopolistically competitive market,

the demand curve faced by any one firms slopes downward because each product is

slightly different from all other products, each firm is like a mini monopoly—the

only producer of that specific product. The downward slope reflects the

differentiated nature of the products: the products are not perfect substitutes

(identical goods) as in the case of perfect competition.

Thus, the firm in monopolistic competition is a price maker. As the price of

“X” brand beverage is increased, when other things remains the same, consumers

switch to other beverages and the quantity demanded of “X” brand falls, but not to

zero.

The perfect competition and monopoly models have proved useful for

predicting behaviour in markets in which there are very large numbers of suppliers

or one supplier respectively. Many markets today, however, do not accord with

either of these extremes. Perfect competition assumes homogenous products, but

even where there is a large number of suppliers to a market there is often some

brand “loyalty” so that suppliers are not complete price takes, e.g. in the retail

sector or personal services such as hairdressing.

Monopolistic competition refers to markets in which there are a large number

of firms competing, supplying products which consumers believe are close but not

complete substitutes. Therefore, it is a market in which firms compete through

slight product differentiation, and management has discretion in pricing, trading off

price against quantity sold. The demand curve faced by each firm will be more

price elastic because of the existence of considerable competition. It is assumed

that there is relatively free entry into and exit from the industry and that entry and

exit are regulated by the level of profit earned.

Assumptions of monopolistic competition are as follows.

Relatively large numbers of firms

56

producing essentially similar (‘homogeneous’) products (goods that are meant

for similar use)

Freedom of entry and exit in the long run

Although, in the short term, firms in monopolistic competition may earn

supernormal profits (like a monopolist), in the longer term, the entry of firms and

increase in supply will erode these.

short-run equilibrium

Price

and

costs

MC

AT

C

MR AR

OUTPUT

P1

C1

Q1

MCATC

ARMR

OUTPIT

Price

and

costs

Long run equilibrium

P2=

c

Q2

X

The diagram on short-run equilibrium illustrates the cost and revenue curves

for a typical firm in monopolistic competition. Assuming a goal of profit

maximization, the output q1 is sold (where MR=MC) at price p1 (note that the price

is greater than the marginal cost). By comparing the average revenue cure (AR) and

the short-run average cost curve (ATC) we can see that the firm is earning a pure

profit. This profit is AR-ATC per unit (i.e. P1-C1),which gives a total pure profit.

The profit can be expected to attract new suppliers into the market. The effect

of this is to reduce the demand for the output of the existing firms in the industry

and to increase the price sensitivity of their products. The market demand is

shared out amongst a large number of suppliers competing keenly on price.

Assuming no impediments to the competitive prices, new entry will continue until

all of the pure profit is competed away. The effect is shown in the diagram long run

equilibrium. The demand curve (AR) has shifted inwards and become more elastic

until it is tangential at the profit-maximising output to the long-run average cost

curve. At output q2 and price p2 average revenue equals average cost (AR = ATC)

and now only normal profit is earned. Only if a firm could either convince

consumers that its product was superior – and hence worth paying more for - or

obtain a cost advantage over rivals, would pure profits continue to be earned.

Monopolistic competition model suggests, therefore, that where there is a large

number of suppliers with each supplying a similar product the following will occur.

Competition will lower prices and profits as in a perfect competitive market.

However the price will remain higher and the output lower than under perfect

competition. The firm in a perfectly competitive market sets its price equal to

the marginal cost. In imperfect competition price is set above marginal cost.

57

Production occurs at less than optimum scale. In the diagram on long run

equilibrium it is clear that production, even in the long run, occurs at an

output below that at which average cost in minimized (point X)

Imperfect competition is associated with brand differentiation. This means

more expenditure on advertising and packaging which raises costs.

Firms in monopolistic competition will try to avoid competition on price, in

order to preserve their position as a price maker.

Non-price competition of various forms may be practiced.

Product differentiation (eg design differences)

Branding

Advertising and sales promotion

Creating ‘add-on’ services

Market structure in nut shell

Market structure Perfect competition Monopolistic competition

Monopoly

Number of firms Many Many One

Number of buyers Many Many Many

Markets with just one or few very powerful buyers are subject to slightly different conditions

Demand conditions Identical substitutes

Very close substitutes

No substitutes

Perfectly elastic demand curve MR = AR

Down ward-sloping demand curve

MR < AR

Price/non-price

competition Competition on price

Non-price

competition No competition

Profit-maximising equilibrium where

MC = MR = AC = AR MC = MR MC = MR

Earn super normal profits?

1. short term

2. slightly longer term

Might do

No

Often will

Not usually

usually

usually

5.4 REVISON POINTS

Pricing under different market condition we know the perfect competition , how

to the firm maximizing the profits and perfect competition


1. Explain the perfect competition

2. Explain the assumptions of monopolistic competition

5.6 SUMMARY

Market is a mechanism where goods and services are exchanged for price. The

nature of market varies with nature of goods and services that are traded, and

number of buyers and sellers and the regulatory mechanism laid by the

government from time to time. Market is broadly classified into Perfect and

58

imperfect market. Perfect market is an ideal situation but not a practical reality.

The market structure in which we get goods and services every day are imperfectly

competitive. Market is a mechanism where goods and services are exchanged for

price. The nature of market varies with nature of goods and services that are

traded, and number of buyers and sellers and the regulatory mechanism laid by the

government from time to time. Market is broadly classified into Perfect and

imperfect market. Perfect market is an ideal situation but not a practical reality.

The market structure in which we get goods and services every day are imperfectly

competitive.


1. What is perfect competition?

2. What is monopoly?




3. Indian economy-R. Kavarni & M. Grija

5.9 ASSIGNMENTS

1. Write an essay on long run equilibrium in perfect competition.

2. Distinguish between Perfect Competition for Monopoly.

3. Explain short &long run equilibrium in monopolistic competition.


1. C.N. Vakil & H.N Pathak. Introduction of Economy Voro & Co. Publishers


5.11 LEARNING ACTITIES

1. Write short notes on: Assumption of (a) Perfect competition; (b) monopoly.

2. Short Questions: (1) Assumption of Monopolistic competition.

5.12 KEYWORDS

Market Equilibrium, equilibrium price, perfect competition, imperfect

competition. Product differentiation.

59

LESSON - 6

FACTOR PRICING

6.1 INTRODUCTION

Factors of production are fundamental for determining the output that is

generated in total. Factors of production and their pricing and Factor pricing under

perfect and imperfect competition

6.2 OBJECTIVES

To understand the distinction between

Product and factor pricing under different market conditions

6.3 CONTENT

6.3.1 Differences between Factor Pricing and Product Pricing

6.3.2 Factor Prices under Perfect Competition

6.3.3 Demand for Factor Service

6.3.4 Supply of Factor Services

6.3.5 Factor Pricing Under Imperfect Competition

6.3.1 Differences between Factor Pricing and Product Pricing

Though, like product pricing, factor pricing is based on the forces of demand and

supply, yet there are fundamental differences between the two which make factor

pricing as a distinct theory: (i) There are differences in the nature of demand for a

product and a factor. The demand for a product is direct demand based on its

marginal utility. While the demand for a factor is derived demand – derived from the

demand for the product it helps to produce. (ii) The supply of a product depends on its

money cost, of production, while the supply of a factor depends on its opportunity cost,

the minimum earning which it can earn in the next best alternative use. (iii) The

pricing of some of the factors like labour and entrepreneur are influenced by social and

human factor, whereas product pricing is influenced little by these factors. Despite

these apparent differences, “the theory of product prices and the theory of factor prices

are parts of one whole”. As pointed out by Watson: “The costs of firms depend on factor

prices as well as on technology. The demands of consumers depend on their tastes and

on their incomes which they receive from the sale of their factors, i.e. their productive

services. Consumer demands, in turn, along with technology, determine the marginal

productivities of factors.

6.3.2 Factor Prices under Perfect Competition

The price of factor of production, like the price of a product, is determined by

demand and supply. Though the conditions of demand and supply for different factors

are different, yet certain common principles have been laid down by economists.

Assumptions

The analysis of factor pricing under perfect competition is based on the

following assumptions.

1. There is perfect competition in the product market and the factor market.

60

2. The number of buyers and sellers of factor services is large.

3. All units of a factor are homogeneous.

4. Factors of production are perfectly mobile.

5. There is perfect substitutability between factors and their units.

6. All factor-units are divisible.

7. Buyers and sellers of factor services have complete knowledge about market

conditions.

8. Buyers and sellers of factor services have complete freedom to enter and

leave the market.

9. The law of variable proportions operates.

6.3.3 Demand for Factor Service

The demand for a factor service is derived demand which is derived from the

demand for the product that it helps to produce. If the demand for the product is

high, the demand for the factor service will also be high, and vice versa. In fact, the

demand for a factor services depends not only on the demand for its products but

on its elasticity of demand. The more elastic the demand for the product is, the

greater will be the elasticity of demand of factor service used in its production. On

the contrary, the less the elasticity of demand for the product is, the lower will be

the elasticity of demand for its related factor service.

Demand Schedule for a Factor Service

(1)

Units of Factor

(2)

Total Output

(3)

Marginal Physical

Product (MPP)

(4)

(Rs) Price Per Unit

of Output

(5)

(VMP) Value of Marginal Product

(3 x 4)

(6)

Total Revenue (2

x 4)

(7)

(MRP) Marginal Revenue Product

1 10 10 5 50 50 50

2 25 15 5 75 125 75

3 37 12 5 60 185 60

4 45 8 5 40 225 40

5 50 5 5 25 250 25

6 53 3 5 15 265 15

7 53 0 5 0 265 0

6.3.4 Supply of Factor Services

The supply of a factor service means the number of units which a resource

owner sells at a particular price. There is a direct relationship between price and

the supply of a factor service. This is in the short-run when the supply of

productive service is not perfectly elastic. More of it will be supplied at a higher

price and less at a lower price.

However, the elasticity of supply of a factor service will be determined by the

relative importance of the firm as a buyer of the productive service. Under a

perfectly competitive factor market there are many buyers of a productive service so

that a single firm purchases only a small portion of the total factor service and in

no way influences its market price. It takes the price of the factor service as given

61

and employs as many units as it needs at that price. Thus the supply of a factor

service to the firm is perfectly elastic in the long-run at the given market price. As a

result the average factor cost (AFC) and the marginal factor cost (MFC) of the

productive service to the firm are equal to the price of the factor service, AFC = MFC

= Price of the Factor Service. This is explained in Table.

Table

Units of Factor Service

(1)

Price of Factor

(2)

Total Cost

(3)

Average Factor Cost

(4)

Marginal Factor Cost

(5)

1 Rs. 5 5 5 -

2 Rs. 5 10 5 5

3 Rs. 5 15 5 5

4 Rs. 5 20 5 5

Determination of Factor Price. Given the demand and supply conditions of the

factor service as enumerated above the firm will continue to employ more units of a

particular factor service so long as the additional revenue obtained from an

additional unit of the factor service (MRP) exceeds the extra cost of employing it

(MFC). It will be earning maximum profits at the point at which the marginal

revenue product equals the marginal factor cost. If the firm employs less than this,

MRP would be higher than MFC and it would be to its advantage to hire more units

of the factor service because they would add to revenue more than costs. In case

the firm decides to hire beyond the point of equality of MRP and MFC, it would be a

loser because costs would rise more than revenue. Thus in a perfectly competitive

factor market the firm will be in equilibrium when MRP MFC which implies two

conditions: first, MRP must equal MFC, and second, the MRP curve must cut the

MFC curve from above at the equilibrium point.

O

PE

AFC = MFC

VMP = MRP

Q

Reve

nu

e c

ost

R

Figure: Units of Factor Service

The pricing of a factor service as stated above can be explained

diagrammatically. In Figure VMP = MRP is the demand curve and AFC = MFC is the

62

supply curve of the factor service. Since the price of the factor service is given and

constant at OP for the firm, the MRP curve cuts the MFC curve at E from above.

This is the equilibrium point for the firm at which it employs OQ units of the factor

service. The MRP curve also cuts the MFC curve at R. But this cannot be the

equilibrium point because MRP cuts MFC from below. It is not the point of

maximum profit for the firm because MRP is higher than MFC beyond this point R.

Thus E is the point of equilibrium in a perfectly competitive factor market when

MRP = VMP = MFC = AFC = Price.

6.3.5 Factor Pricing Under Imperfect Competition

Factor pricing under imperfect competition or monopoly is studied under three

categories: (a) when the factor market is perfectly competitive and the product

market is imperfectly competitive or monopolistic, (b) when there is monopsony in

the factor market and perfect competition in the product market, and (c) when

there is monopsony in the factor market and monopoly in the product market. We

discuss these variants of factor pricing under imperfect competition.

(A) Factor Market Perfectly Competitive and Product Market Imperfectly Competitive or

Monopolistic

In a perfectly competitive factor market, the price of the factor service is given

for the firm and does not affect the volume of its purchases. The supply curve or

the cost curve is horizontal to the X-axis (AFC = MFC). But because there is

imperfect or monopoly in the product market, the MRP curve will lie below the VMP

(value of marginal product) curve. Since we know that under imperfect competition

or monopoly in the product market marginal revenue is less than price (AR) of the

product, therefore the marginal revenue product will be less than the value of

marginal product. Symbolically, MRP<VMP since MR<P (under imperfect

competition both AR and MR curves slopes downward).

E1

AFC / MFC

Q1

VM

P,

MR

P c

ost

Q

E

A

VMP

MRP

Figure-A: Units of Factor Service

63

The firm will be in equilibrium where MRP equals MFC, the price of the factor

under perfect competition. This is shown in Figure-A Units of Factor Service by

point E where the firm employs OQ units is QE which is less than QA the value of

its marginal product. Thus the factor services gets less than the value of its

marginal product by EA amount. Moreover, when the firm equates MRP with MFC it

employs less units of the factor service because of imperfect competition in the

product market than what it would have had there been perfect competition. Thus

it employs OQ units of the factor, as compared with OQ1 units (where VMP = MFC)

that a competitive product seller would employ consequently. Under imperfectly

competitive product market, the demand for the factor will be less by Q1Q.

(B) Monopoly in the Factor Market and Perfect Competition in the Product Market

A monopolist firm is a single buyer of a particular factor in the market. Since

the firm is the market for the factor in this case, the supply of factor service to the

monopolist is identified to its supply to the market. Thus the supply curve to the

firm (AFC) is positively sloping from left to right upward. The firm can employ more

units of the factor service by offering a higher price per unit. The MFC curve to this

AFC curve will also be sloping upward and will be above the AFC curve throughout

its length. This is illustrated in the Table B. Columns (1) and (2) show the supply of

the factor units at various prices. Column (3) shows the total cost of employing

each unit of the factor service [column (1) X (2)]. Column (4) shows the average

factor cost which is found out by dividing column (3) by column (1). The result is

that column (4) equals column (1), i.e. AFC = Price. Column (5) shows the marginal

factor cost which is the addition made unit of the factor service. It is the difference

between successive total costs shown in column (3). Thus the table reveals that

MFC > AFC = Price.

Since we are assuming perfect competition in the product market, the value of

the marginal product will be equal to the marginal revenue product (VMP = MRP).

The firm can sell any amount without affecting the price of the product and the

value of the marginal product (VMP) therefore coincides with the marginal revenue

product (MRP), as shown in Figure-B.

Table B

(1)

Units of Factor

(2)

Price of Factor Service

(3)

Total Cost

(4)

AFC

(5)

MFC

(1) Rs. 10 10 10 -

(2) 11 22 11 12

(3) 12 36 12 14

(4) 13 52 13 16

64

Q

A

E

B

AFC

ARP

MRP

(VMP)

RE

VE

NU

E C

OS

T

Figure-B: Units of Factor Service

(C) Monopsony in the Factor Market and Monopoly in the Product Market

When there is monopsony in the factor market and monopoly in the product

market, the MRP < VMP and the MFC > AFC. This implies that the MRP curve will

lie below the VMP curve and MFC curve will lie above the AFC curve, as shown in

Figure C. As usual, the firm is in equilibrium at point E where the MRP curve cuts

the MFC curve from above and equals it. The firm employs OQ units of the factor

service at QP price which is less than QE the marginal revenue product of the

factor.

A

MFC

AFC

VMP

MRP

P

E

O Q

VM

P, M

RP

, C

ost

Units of Factor Service

Figure C

Thus due to its monopolistic position in the factor market, the firm exploits the

factor units used to the extent of PE (QE-QP). On the other hand, due to its

monopolistic position in the product market, the MRP of the factor is less than its

VMP and the firm exploits the factor units employed further to the extent of EA

65

amount. We may conclude that in the case of monopsony in the factor market and

monopoly in the product market, the factor used in production by the firm is

doubly exploited: first, due to the excess of MRP over the price of the factor, and

second, due to the excess of the VMP over the marginal revenue product of the

factor.

6.4 REVISION POINTS

1. Price under perfect competition, supply of factor services, important

competition.

2. Monopoly in product market.


1. What is meant by factor pricing?

2. What is meant by supply price?

6.6 SUMMARY

Wage is the payment made to the worker for the contribution made in the

production. In simple terms what is the marginal contribution of one more

labourer in the production is the basis for determining wages and on the other side

how labour market is responding to the changes in the wages.


1. What is meant by factor pricing under important competition?

2. Short type: (a) Demand for Factor Services. (b) Supply of factor services.


1. Managerial Economics - M.L. Trivedi.

2. Managerial Economics - R.L. Gupta.

3. Indian Economy - R.K. Avarni & M. Grija.

6.9 ASSIGNMENTS

1. Explain how factor prices are determined when factor market in perfectly

competitive to product Market is imperfect.



Pvt. Ltd (2008), New Delhi.


1. Explain the factor pricing and product pricing

2. Discuss about demand and supply

6.12 KEYWORDS

Factor Services, Factor Pricing, Product Pricing, Demand and Supply.

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LESSON - 7

FINANCE FUNCTION

7.1 INTRODUCTION

All business decisions have financial implication. A single decision may

financially affect different departments of an organisation. Financial management

may be described as making decisions on financial matters, implementing the

decisions and review of the implementation. It is the process of managing the

finance function

7.2 OBJECTIVES

To understand the nature of financial requirements for a business

To know the sources of finance

To understand the flow of funds

7.3 CONTENTS

7.3.1 Functions

7.3.2 Working capital

7.3.3 Term loans

7.3.4 Cash flow statement

7.3.5 Liquidity

7.3.1 Functions of a Financial Manager (Management)

Some of the major functions of a financial manager are as follows:

1. Estimating the Amount of Capital Required

2. Determining Capital Structure

3. Choice of Sources of Funds

4. Procurement of Funds

5. Utilisation of Funds

6. Disposal of Profits or Surplus

7. Management of Cash

8. Financial Control.

Finance is the lifeblood of business concern, because it is interlinked with all

activities performed by the business concern. In a human body, if blood circulation

is not proper, body function will stop. Similarly, if the finance not being properly

arranged, the business system will stop. Arrangement of the required finance to

each department of business concern is highly a complex one and it needs careful

decision. Quantum of finance may be depending upon the nature and situation of

the business concern. But, the requirement of the finance may be broadly classified

into two parts: Long-term Financial Requirements or Fixed Capital Requirement

Financial requirement of the business differs from firm to firm and the nature of the

requirements on the basis of terms or period of financial requirement, it may be

long term and short-term financial requirements.

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Long-term financial requirement means the finance needed to acquire land

and building for business concern, purchase of plant and machinery and other

fixed expenditure. Long- term financial requirement is also called as fixed capital

requirements. Fixed capital is the capital, which is used to purchase the fixed

assets of the firms such as land and building, furniture and fittings, plant and

machinery, etc. Hence, it is also called a capital expenditure.

Short-term Financial Requirements or Working Capital Requirement Apart

from the capital expenditure of the firms, the firms should need certain expenditure

like procurement of raw materials, payment of wages, day-to-day expenditures, etc.

This kind of expenditure is to meet with the help of short-term financial

requirements which will meet the operational expenditure of the firms. Short-term

financial requirements are popularly known as working capital.

7.3.2 Working Capital

Capital required for a business can he classified under two main categories. They are:

a. Fixed capital

Capital required for purchase of fixed assets like land, building, plant,

machinery, office equipment and furniture is called fixed capital. These assets are

purchased for constant use in production. They are not intended for re -sale. These

fixed assets are used on a permanent basis for producing goods and services.

Hence, fixed capital requirements are financed by means of share capital and long

term borrowings. The amount of fixed capital required will depend upon the size of

the organisation and the nature of business.

b. Working capital

Capital required for purchase of raw materials and for meeting the clay-to—

day expenditure on salaries, wages, rent, advertising etc is called working capital.

In simple words, working capital refers to that part of a firm’s capital which is

required for financing short-term operations or current assets such as stock,

debtors, cash etc.

Concept of working capital: There are two concepts of working capital. They are:

a. Gross working capital

In a broad sense, the working capital refers to the gross working capital. This

represents amount of funds invested in current assets, Under the gross concept,

working capital is equal to total current assets. Current assets are those assets

which can he converted into cash within an accounting year (or operating cycle) It

includes I. Cash in hand and at hank 2. Sundry debtors less provision 3. Bills

receivables 4. Closing stock 5. Short-term investments 6. [‘repaid expenses, 7.

Accrued incomes.

b. Net working capital

In a narrow sense, working capital refers to net working capital. Networking

capital is the excess of current assets over current liabilities. Current liabilities are

those claims which are expected to mature for payment with in an accounting year.

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It includes 1 .Sundry creditors 2. Bills payable 3. Outstanding expenses 4. Bank

overdraft 5.Dividend payable, 6.Provision for taxation.

Net working capital may be positive or negative. When the current assets

exceed current liabilities, the working capital is positive. On the other hand, when

the current liabilities exceeds current assets, the working capital is negative.

Both gross working capital and net working capital concepts are important

aspects of working capital. The gross working capital is suitable to company form of

organisation where there is divorce between ownership and management and

control. But the net working capital concept may be suitable for sole proprietorship

or partnership firm. Of the two, net working capital concept is widely accepted.

7.3.3 Term Loans

An understanding of the several essential elements of a term loan is necessary

in order to appreciate fully the important and unique position that such loans have

come to occupy in the business credit market of the United States. The basic

elements that define a term loan are: (1) credit extended to a business concern; (2)

a direct relationship between borrower and lender; (3) provision at time of making

the loan that some part of the principal is repayable after the passage of one year.1

'While particular types of collateral security, repayment provisions, uses of funds by

borrowers or loan agreements may be associated with term loans, none of these are

essential characteristics

Term Loans Are a Form of Business Credit

The fact that term loans are credits extended to business concerns serves to

differentiate them from many other types of loans, also having terms of more than

one year, that are made by commercial banks, insurance companies and other

financial institutions. The salient factor is that the term lender usually appraises

the probabilities of financial success of a business enterprise in judging the

likelihood of repayment of the loan at maturity. Thus the definition of term loans

excludes consumer loans, where attention is focused on the moral and financial

worth of an individual—who is not necessarily an entrepreneur. Also excluded are

loans to individuals se-cured by mortgages on residential property. In making loans

of this type the lender customarily looks to the value of the pledged In contrast,

even where term loans to businesses are collaterally secured by real estate or other

property, the lender generally looks mainly (or exclusively) to the earning power of

the business rather than to the value of pledged property to protect himself against

loss. The collateral security given by a business concern is usually of a specialized

type that cannot be liquidated by the lender to realize any certain amount in case of

default.

7.3.4 Cash Flow Statement

Cash flow statement is a statement which shows the sources of cash inflow

and uses of cash out-flow of the business concern during a particular period of

time. It is the statement, which involves only short-term financial position of the

business concern. Cash flow statement provides a summary of operating,

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investment and financing cash flows and reconciles them with changes in its cash

and cash equivalents such as marketable securities. Institute of Chartered

Accountants of India issued the Accounting Standard (AS-3) related to the

preparation of cash flow statement in 1998

Cash plays a very important role in the economic life of a business. A firm

needs cash to make payment to its suppliers, to incur day-to-day expenses and to

pay salaries, wages, interest and dividends etc. In fact, what blood is to a human

body , cash is to a business enterprise. Thus, it is very essential for a business to

maintain an adequate balance of cash. For example, a concern operates profitably

but it does not have sufficient cash balance to pay dividends, what message does it

convey to the shareholders and public in general. Thus, management of cash is

very essential. There should be focus on movement of cash and its equivalents.

Cash means, cash in hand and demand deposits with the bank. Cash equivalent

consists of bank overdraft, cash credit, short term deposits and marketable

securities. Cash Flow Statement deals with flow of cash which includes cash

equivalents as well as cash. This statement is an additional information to the

users of Financial Statements. The statement shows the incoming and outgoing of

cash. The statement assesses the capability of the enterprise to generate cash and

utilize it. Thus a Cash-Flow statement may be defined as a summary of receipts

and disbursements of cash for a particular period of time. It also explains reasons

for the changes in cash position of the firm. Cash flows are cash inflows and

outflows. Transactions which increase the cash position of the entity are called as

inflows of cash and those which decrease the cash position as outflows of cash.

Cash flow Statement traces the various sources which bring in cash such as cash

from operating activities, sale of current and fixed assets, issue of share capital and

debentures etc. and applications which cause outflow of cash such as loss from

operations, purchase of current and fixed assets, redemption of debentures,

preference shares and other long-term debt for cash. In short, a cash flow

statement shows the cash receipts and disbursements during a certain period.

Objectives of cash flow statement

The statement of cash flow serves a number of objectives which are as follows :

Cash flow statement aims at highlighting the cash generated from operating

activities.

Cash flow statement helps in planning the repayment of loan Schedule and

replacement of fixed assets, etc.

Cash is the centre of all financial decisions. It is used as the basis for the projection

of future investing and financing plans of the enterprise.

Cash flow statement helps to ascertain the liquid position of the firm in a better

manner . Banks and financial institutions mostly prefer cash flow statement to

analyse liquidity of the borrowing firm.

Cash flow Statement helps in efficient and effective management of cash.

The management generally looks into cash flow statements to understand the

internally generated cash which is best utilised for payment of dividends

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7.3.5 Liquidity

Liquidity is the ability of a company to meet the short term obligations. It is

the ability of the company to convert its assets into cash. Short term, generally,

signifies obligations which mature within one accounting year. Short term also

reflects the operating cycle: buying, manufacturing, selling, and collecting. A

company that cannot pay its creditors on time and continue not to honour its

obligations to the suppliers of credit, services, and goods can be declared a sick

company or bankrupt company. Inability to meet the short term liabilities may

affect the company’s operations and in many cases it may affect its reputation too.

Lack of cash or liquid assets on hand may force a company to miss the incentives

given by the suppliers of credit, services, and goods. Loss of such incentives may

result in higher cost of goods which in turn affect the profitability of the business.

So there is always a need for the company to maintain certain degree of liquidity.

However, there is no standard norm for liquidity. It depends on the nature of the

business, scale of operations, location of the business and many other factors.

Every stakeholder has interest in the liquidity position of a company. Supplier of

goods will check the liquidity of the company before selling goods on credit.

Employees are also have interest in the liquidity to know whether the company can

meet its employees’ related obligations: salary, pension, provident fun d etc.

Shareholders are interested in understanding the liquidity due to its huge impact

on the profitability. Shareholders may not like high liquidity as profitability and

liquidity are inversely related. However, shareholders are also aware that non -

liquidity will deprive the company from getting incentives from the suppliers,

creditors, and bankers. Liquidity and Business Decisions One can understand the

liquidity position by analyzing the financial statements of a company. Following

financial items are required to understood to understand the liquidity position of a

company:

Current Assets

Current Liabilities

Liquidity position of a company can examined through financing decisions or

investment decisions. A company can finance its investment by different

combination of current and long term sources. In other words, a company can

invest the money, raised through short term source or long term sources, in the

current assets or non-current assts. Some of the relevant business strategies are as

follows:

Financing the current assets by current sources

Financing the current assets by the long term sources

Financing non-current assets by the short term sources

Financing non-current assets by long term sources One can get an idea about

the above mentioned decisions by seeing the balance sheet or determining the

working capital of a company. Liquidity and Working Capital Financial Accounting

Short Term Liquidity

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As mentioned in the previous section, working capital helps in understanding

the liquidity position of a company. It also shows the financ ing or investment

decisions of a company. Working capital is the excess of current assets over the

current liabilities. So working capital of a company can take one of the following

directions:

Positive working capital: When current assets are more than the current

liabilities

Negative working capital: When the current liabilities are more than the

current assets

Zero working capital: when the current assets are equal to the current

liabilities

Conventionally, it is accepted that higher the positive working capital, better is

the liquidity position. The rationale of this position is that the it is easier to sell off

the current assets and make the payment towards the current liabilities.

7.4 REISION POINTS

1. Concept of working capital.

2. Long term and short term finance functions.


1. What are the type of transactions that result in flow of funds?

2. Discuss the term liquidity.

7.6 SUMMARY

1. Various factors determining the finance functions how to generate and

manage long term and short term funds. The flow of funds during operation

and end of the year. Liquidity position of the firm.


1. How to ascertain liquid position of firm.

2. What are the ways of calculating repayment of loans.


1. Financial Management Theory, Problems and Solution Dr. Ramachandran /

Dr. Srinivasan, Shriram Publications.

7.9 ASSIGNMENTS

1. Functions of working capital.

2. What are the long term funds?


1. Financial Management, I.M. Pandey.

2. Financial Management, S.N. Maheswari.


1. List out the functions of finance manager.

7.12 KEY WORDS

Term funds, sources of funds, flow of funds, liquidity.

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LESSON - 8

THEORIES OF INTEREST AND PROFIT

8.1 INTRODUCTION

'Interest' is one form of payment made for using someone's money for our

purpose. It can be understood as opportunity cost of the money that someone

forego for our use. Banks charge and pay interest simply applying the above

principle. Interest rate as a concept is very important in determining many vital

factors in any economy

'Profit' is the buzz word for any business house. The extent and the dimension

of profit of a business house may determine the nature of competition in that

industry, it is the reward for the entrepreneurs to run the business

8.2 OBJECTIVES

To understand various theories on profit

To know some of the functions of an entrepreneur

To distinguish between various types of interest To introduce various

theories on interest

8.3 CONTENTS

8.3.1 Interest

8.3.2 The Classical Theory of Interest

8.3.3 Keynes Liquidity Preference Theory of Interest

8.3.4 Profits

8.3.5 Functions of an entrepreneur

8.3.1 INTEREST

In common parlance interest is a payment made by a borrower to the lender

for the money borrowed and is expressed as a rate per cent per year.

In economics, interest has been defined in a variety of ways. Commonly,

interest is regarded as the payment for the use or service of capital. If retained by

the owner, it can be used by him for further production and the additional product

he gets through the employment of his capital includes interest. For if he had lent

his capital to someone else, he would have received interest in returns. As Carver

said “interest is the income which goes to the owner of capital”.

In Mill’s words: “Interest is the remuneration for more abstinence”. According

to the classical economists, it is only by postponing consumption that capital can

be created. Since to abstain from consumption is disagreeable and painful, the

lender is paid a reward in the form of interest. When people abstain from

consumption they save and thus interest becomes the reward for saving. Saving,

however, does not involve any sacrifice or abstinence on the part of the rich. To

avoid this fallacy, Marshall substituted the word ‘waiting’ for abstinence and

interest is then the reward for waiting to him.

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Keynes regarded interest as a purely monetary phenomenon, payment for the

use of money. It is the reward for parting with the liquidity of money. In Keynes

words, “The possession of actual money lulls our disquietude; and the premium

which we require to make us part with money is the measure of the degree or our

disquietude”. Interest is thus a premium which is offered to wealth-holders to

induce them to part with their cash.

Gross and Pure Interest

Pure or Net Interest: It is the payment for the use of capital or money only.

This is interest in the true economic sense. It is normally the same during a period

of time even in different markets.

Reward for Risk-Taking: The lender exposes himself to risk when he lends

money. Gross interest includes the reward for risk-taking. The greater the risk

element, the higher is the rate of gross interest. Unsecured loans are more risky

than secured ones and they carry a high premium rate.

Reward for Inconvenience: When a lender loans money he foregoes its use

for the duration of the loan. His money is locked up and cannot be used for more

profitable purposes. Or, if he needs this amount for his personal use, he will have

to undergo the inconvenience of arranging it from some other source. In fixing the

rate of interest the lender includes in it the reward for such inconveniences.

Reward for Management: The lender has to incur expenditure in keeping

proper accounts of the borrowers. He buys account books and even maintains staff.

He has to remind the borrowers and sometimes has to file a suit for the recovery of

loans. The payment that the lender receives from the borrower also includes the

expenses for management.

Pure interest is what remains with the lender after deducting the reward for

risk-taking, management and inconvenience from gross interest.

8.3.2 The Classical Theory Of Interest

According to the classical theory, rate of interest is determined by the supply

and demand of capital. The supply of capital is governed by the time preference and

the demand for capital by the expected productivity of capital. Both time preference

and productivity of capital depend upon waiting or saving. The theory is, therefore,

also known as the supply and demand theory of waiting or saving.

Demand Side: The demand for capital consists of the demand for productive

and consumptive purpose. Ignoring the latter, capital is demanded by the investors

because it is productive. But the productivity of capital is subject to the law of

variable proportions. Additional units of capital are not as productive as the earlier

units. A stage comes when the employment of an additional unit of capital in the

business is jut worthwhile and no more. The demand for capital is inversely related

to the rate of interest, and the demand schedule for capital slopes downward from

left to right. There are, however, certain other factors which govern the demand for

capital, such as the growth of population, technical progress, process of

rationalization, the standard of living of the community, etc.

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Supply Side: The supply of capital depends upon savings, rather upon the

will to save and the power to save of the community. Some people save irrespective

of the rate of interest. They would continue to save even if the rate of interest were

zero. There are others who save because the current rate of interest is just enough

to induce them to save.

Determination: Assuming the level of income to be given, the rate of interest

is determined by the interaction of the demand curve and the supply curve of

capital. This is shown in figure below. D and S curves intersect at E which is the

equilibrium point when OQ quantity of capital is demanded and supplied at OR

rate of interest. If at any time the rate of interest rises above OR to OR1 the demand

for investment funds will fall and the supply of funds will increase. Since the supply

of capital is more than the demand (R1s>R1d) the rate of interest will come down to

the equilibrium level OR. The opposite will be the case if the rate of interest falls to

OR2. The demand for capital is greater than the supply (R1d1>R2s1) and rate of

interest will rise to OR. The ultimate situation is one of equality between saving and

investment brought about by the equilibrium or the natural rate of interest. If at

any time savings are more than OQ, the rate of interest would fall below OR

because the demand for capital remains the same. (Imagine a supply curve below

the S curve in the figure, D curve being the same). At the lower rate of interest,

people will save less but the demand for the investible funds will increase which will

tend to raise the rate of interest to the equilibrium level OR.

O Q

E

d s

S

Y

X

QUANTITY OF CAPITAL

R1

R

R2

Ds1

d1RA

TE O

F IN

TER

ES

T

8.3.3 Keynes Liquidity Preference Theory of Interest

Keynes defines the rate of interest as the reward of not hoarding but the

reward for parting with liquidity for the specified period. It “is not the ‘price’ which

brings into equilibrium the demand for resources to invest with the readiness to

abstain from consumption. It is the ‘price’ which equilibrates the desire to hold

wealth in the form of cash with the available quantity of cash”. In other words, the

rate of interest in the Keynesian sense is determined by the demand for and the

supply of money. This theory is, therefore, characterized as the monetary theory of

interest, as distinct from the real theory of the classical.

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Supply of Money: Of the two determinants of the rate of interest, the supply

of money refers to the total quantity of money in the country for all purposes at any

time. Though the supply of money is a function of the rate of interest to a degree,

yet it is considered to be fixed by the monetary authorities (the supply curve of

money is taken as perfectly inelastic).

Demand for Money: For the second determinant the demand for money,

Keynes coined a new term “liquidity preference” by which his theory of interest is

commonly known. Liquidity preference is the desire to hold cash. The money is

cash “lulls our disquietude” and the rate of interest which is demanded in exchange

for it is a “measure of the degree of our disquietude”. The rate of interest, in Keynes

words, is the “premium which has to be offered to induce people to hold the wealth

in some form other than hoarded money”. The higher the liquidity preference, the

higher will be rate of interest that will have to be paid to the holders of cash to

induce them to part with their liquid assets.

According to Keynes there are three motives behind the desire of the people to

hold liquid cash: (1) the transactions motive, (2) the precautionary motive, and (3)

the speculative motive.

Transactions Motive: The transaction motive relates to “the need of cash for

the current transactions of personal and business exchanges”. It is further divided

into the income and business motives. The income motive is meant “to bridge the

interval between the receipt of income and its disbursement”, and similarly, the

business motive as “the interval between the time of incurring business costs and

that of the receipt of the sale proceeds”. If the time between the incurring of

expenditure and receipt of income is small, less cash will be held by the people for

current transactions, and vice versa.

Precautionary Motive: The Precautionary motive relates to “the desire to

provide for contingencies requiring sudden expenditures and for unforeseen

opportunities of advantageous purchases”. Both individuals and businessmen keep

cash in reserve to meet unexpected needs. Individuals hold some cash to provide

for illness, accidents, unemployment and other unforeseen contingencies. Similarly

businessmen keep cash in reserve to tide over unfavourable conditions or to gain

from unexpected deals.

Keynes holds that the transactions and precautionary motives are relatively

interest-inelastic, but are highly income-elastic. The amount of money held under

these two motives (M1) is a function (L1) of the level of income (Y) and is expressed

as M1 = L1 (Y).

Speculative Motive: Money held under the speculative motive is for “securing

profit from knowing better than the market what the future will bring forth”.

Individuals and businessmen having funds, after keeping enough for the

transactions and precautionary motives, like to gain by investing in bonds at the

opportune moments. The amount of money held under the speculative motive

depends on the rate of interest.

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8.3.4 Profits

In ordinary sense, profit is the surplus of income over expenses of production

according to a businessman. It is the amount left with him after he has made

payments for all factor services used by him in the process of production. But he

may not have been careful in calculating all such expenses of production in the

economic sense. Therefore, economists regard businessman’s profit as gross profit

as distinct from pure or net profit because it includes the following constituents.

1.Rent on Land: The businessmen may have used his own land for erecting

the factory so that he may be saved of the botheration of paying rent to some other

landlord. This rent is included in his profit. This is implicit or imputed rent which is

not part of his profit. Had he hired land from some other person, he would have

paid its rent. In calculating net profit, implicit rent should be deducted from gross

profit.

2. Interest on Capital: Similarly, he may have used his own capital in his

business in order to avoid the inconvenience of borrowing from some other person.

The implicit interest is again included in his gross profit. If he had borrowed the

same amount of capital for investment in his business, he would have paid interest

on it. This interest should, therefore, be subtracted from his gross profit to arrive at

net profit.

3. Wages of Management: The businessman may have been busy in

organizing, coordinating and managing the entire business himself. Btu he may

have been contented with income received after meeting all expenses of production.

If he had not performed the work of management himself he would have employed a

manager to whom he would have paid wages. This his gross profit includes implicit

wages which are required to be deducted for calculating net profit. In all joint stock

companies, profits are received by shareholders, the managers and managing

directors are all salaried persons whose salaries are included in the expenses of the

firms.

4. Depreciation Charges: During the process of production machinery and

plants depreciate and become obsolete. Expenses incurred on their repairs and

replacements are a part of the cost of production.

5. Insurance Charges

6. Net Profit

a) Reward for Uncertainty Bearing.

b) Reward for Coordination.

c) Rent of Ability.

d) Reward of Innovation.

e) Monopoly Gains.

f) Windfalls.

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The Dynamic Theory

Prof. J.B. Clark propounded his dynamic theory of profit in 1900. To him,

profit is the difference between the price and the cost of production of the

commodity. But profit is the result of dynamic change. In a dynamic state, “five

generic changes are going on, every one of which reacts on the structure of society”.

They are:

1. Population is increasing.

2. Capital is increasing.

3. Methods of production are improving.

4. The forms of industrial establishment are changing, the less efficient

shops, etc., are passing from the field, and the most efficient are surviving.

5. The wants of consumers are multiplying.

In the static state, competition tends to eliminate these five kinds of changes

so that each factor receives what it produces. The selling price and the cost of

production are equal and there are no profits. What entrepreneurs receive are

simply wages of management.

Profits are the result exclusively of five dynamic changes, i.e., changes in

population, capital, techniques of production, forms of business organization and in

the wants of people.

The Innovation Theory

Prof. Schumpeter attributes profits to dynamic changes resulting from an

innovation.

Schumpeter assigns the role of an innovator not to the capitalist but to the

entrepreneur. The entrepreneur is not a man of ordinary managerial ability, but

one who introduces something entirely new. He does not provide funds but directs

their use. To perform his economic function, he requires two things: first, the

existence of technical knowledge in order to produce new products: and second, the

power of disposal over the factors of production in the form of credit. He gets credit

from the banks and uses his ability to un tap the existing technical knowledge. This

brings about an innovation which disturbs the circular-flow of production in the

economy and leads to the emergence of profits. Thus the role of the entrepreneur is

quite distinct from that of the capitalist.

Profits therefore, accrue to the entrepreneur as a reward for innovating and

not as a reward for risk-taking. According to Schumpeter, an innovation may

consist of:

1. the introduction of a new product;

2. the introduction of a new method of production;

3. the opening up of new market;

4. the discovery of a new source of raw materials; and

5. the reorganization of the industry.

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When any one of these innovation is introduced by an entrepreneur, it tends to

reduce the cost of production of the commodity below its selling price. Profits

emerge.

The Risk Theory

The risk theory of profit is associated with F.B. Hawley who regards risk-taking

as the main function of the entrepreneur. Profit is the residual income which the

entrepreneur receives because he assumes risks. The entrepreneur exposes his

business to risk, and receives in turn a reward in the form of profit because the

task of risk-taking is irksome. Profit is ‘an excess of payment above the actuarial

value of the risk’. No entrepreneur will be willing to undertake risks if he gets only

the normal return. Therefore, the reward for risk-taking must be higher than the

actual value of the risk.

According to Hawley, the entrepreneur can avoid certain risks for a fixed

payment to the insurance company. But he cannot get rid of all risks by means of

insurance, for if he is able to do so, he would cease to be an entrepreneur and

would earn only wages of management and no profit.

But all persons are incapable of undertaking risks, so risks act as a deterrent

to the supply of entrepreneurs. Those who remain in business are able to earn an

excess of payment above the actuarial value of the risk.

The Uncertainty-Bearing Theory

Prof. Frank H. Knight regards profit as the reward of bearing non-insurable

risks and uncertainties. He distinguishes between insurable and non-insurable

risks. Certain risks are measurable in as much as the probability of their

occurrence can be statistically calculated. The risk of fire, theft of merchandise and

of death by accident are insurable. There are certain unique risks which are

incalculable. The probability of their occurrence cannot be statistically computed

because of the presence of uncertainty in them.

Profit is thus the difference between ex ante and ex post returns. In a

competitive economy if entrepreneurs compete cautiously and do not raise the

prices of factor services to the value of their marginal product, they will earn

positive profit.

Uncertainty-bearing is the most important function in a dynamic state. It is

the entrepreneur who either delegates this function among different personnel or

assumes them himself. The expectation of profit is, in a way, the supply price of

entrepreneurial uncertainty-bearing. In a competitive economy where there is no

risk, every entrepreneur will have a minimum supply price. If his reward fall below

it, entrepreneurial services will not be supplied. But the presence of uncertainty

tends to raise the minimum supply price which is actually a ‘risk premium’ which

the entrepreneur expects to be paid. This is profit.

“Only unpredictable changes give rise to profit. Changes in population and

capital being predictable do not occasion imperfect competition or profit. Thus

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profit is due to non-insurable risks and uncertainties generated by dynamic

change.

8.3.5 Functions of an Entrepreneur

i) Identifying Entrepreneurial Opportunity: There are many opportunities in

the world of business. These are based on human needs like food, fashion,

education, etc., which are constantly changing. These opportunities are not realised

by common man, but an entrepreneur senses the opportunities faster than others

do. An entrepreneur therefore, has to be creative and innovative.

ii) Turning Ideas into Action: An entrepreneur should be capable of turning

his ideas into reality. He collects information regarding the ideas, products,

practices to suit the demand in the market. Further steps are taken to achieve the

goals in the light of the information collected.

iii) Feasibility Study: The entrepreneur conducts studies to assess the

market feasibility of the proposed product or services. He anticipates problems and

assesses quantity, quality, cost and sources of inputs required to run the enterprise

by preparing a ‘project report’.

iv) Resourcing: The entrepreneur needs various resources in terms of money,

machine, material, and men to running the enterprise successfully. An essential

function of an entrepreneur is to ensure the availability of all these resources.

v) Setting up of the Enterprise: For setting up an enterprise the

entrepreneur may need to fulfil some legal formalities. He also tries to find out a

suitable location, design the premises, install machinery and do many other things.

vi) Managing the Enterprise: He has to manage men, material, finance and

organise production of goods and services. He has to market each product and

service, after ensuring appropriate returns (profits) of the investment. Only a

properly managed organisation yields desired results.

vii) Growth and Development: Once the enterprise achieves its desired

results, the entrepreneur has to explore another higher goal for its proper growth

and development. The entrepreneur is not satisfied only with achieving a set goal

but constantly strives for achieving excellence.

8.4 REVISION POINTS

1. Gross and pure interest, preference theory of interest, theories of interest

2. Various profit theories, rent on land, interest on capital, wages of

management, depreciation charges


1. Define gross and pure interest

2. Define is profit

3. List out depreciation charges

8.6 SUMMARY

Rate of interest in the Keynesian sense is ‘price’ which equilibrates the desire

to hold wealth in the form of cash with the available quantity of cash. For Keynes

80

there are three motives that drive people to hold liquid cash. 1. Transaction motive

2. Precautionary motive 3. Speculative motive. Profit can accrue in the following

forms; rent, interest on Capital, wages, Depreciation. Profit is the dynamic changes

resulting from an innovation of many types. For Professor F.B. Hawley, profit is an

excess of payment above the actuarial value of the risk. But for professor Frank H.

Knight profit is the reward of bearing non-insurable risks and uncertainties.


1. Write short notes on classical theory of interest.

2. What is dynamic theory.


1. Managerial Economics, M.L. Trivedi.

2. Managerial Economics, R.L. Gupta.

3. Indian Economy, R.K. Avarni & M. Grija.

8.9 ASSIGNMENTS

1. Keyers liquidity preference theory of interest.

2. Write short notes on: (a) Hawley’s Risk Theory of Profit; (b) Knige’s

uncertaining bearing theory.


1. C.N.Vakil & H.N Pathak. Introduction of Economy Voro & Co. Publishers



1. Write short notes on (a) Classical theory and interest.

2. What are the different types of innovation?

3. Explain Keynes Liquidity Preference Theory of Interest.

8.12 KEYWORDS

Grass Interest, Pure Interest, Liquidity Preference, Transaction Motives,

Precauring Motive, Speculative Motive. Invention, Risk Bearing, Uncertaining

Bearing.

81

LESSON - 9

MONEY

9.1 INTRODUCTION

Money as a medium of exchange completes transaction of goods and services

among various parties. After introduction of money the 'barter' system hardly

exists. It paved way for various other forms of money

9.2 OBJECTIVES

To know history of various forms of money from the genesis till date

To understand various functions of Money

To know the relationship between money supply and GDP

9.3 CONTENTS

9.3.1 The Origin of money

9.3.2 Money supply

9.3.3 Demand for money

9.3.4 Relationship between money supply and GDP

9.3.1 Introduction – The Origins

The origins of money are lost in antiquity; most primitive tribes known today

make some use of it. The ability of money to free people from the cumbersome

necessity of barter must have led to its early use as soon as some generally

acceptable commodity appeared.

Metallic money

All sorts of commodities have been used as money at one time or another, but

gold and silver proved to have great advantages. They were precious because their

supply was relatively limited, and they were in constant demand by the rich for

ornament and decoration. Thus they tended to have a high and stable price.

Before the invention of coins it was necessary to carry the metals in bulk.

For the reasons of abuse of metallic money other forms of money came into

existence.

Paper Money

When it first came into being, paper money was a promise to pay on demand

so much gold, the promise being made first by goldsmiths and later by banks.

Banks, too, became known for their vaults (safes) where the precious gold was

stored and protected. As long as the institutions were known to be reliable their

pieces of paper would be a “as good as gold”. Such paper money was backed by

precious metal and was convertible on demand into this metal.

The history of nineteenth and early twentieth century banking on both sides of

the Atlantic is full of examples of banks ruined by “panics,” sudden runs on their gold

reserves. Central banks were a natural outcome of this sort of banking system.

Fiat Currencies

As time went on, note issue by private banks became less common and central

banks took control of the currency. Central banks in turn became governmental

institutions. In time only central banks were permitted to issue notes. Originally

the central banks issued currency that was fully convertible into gold.

82

During the period between World War I, II almost all the countries of the world

abandoned the gold standard; their currencies were no longer convertible into gold.

Money that is not convertible by law into anything valuable depends upon its

acceptability for its value. Money that is declared by government order or fiat, to be

legal tender for settlement of all debts is called a fiat money. Today almost all

currency is fiat money.

Functions of Money: Money is what money does. Anything that performs

the functions of money is money. There are three function of money.

Medium of exchange: It is the first and foremost function. It is usable in

buying and selling goods and services. As a medium of exchange, money allows

society to escape the complications of barter and thereby to reap the benefits of

geographic and human specialisation

Standard of value: Society finds it convenient to use the monetary unit as a

yardstick for measuring the relative worth of heterogeneous goods and resources.

Just as we measure distance in miles or kilometres, we gauge the value of goods

and services in terms Rupees. This has distinct advantages. With a money system,

we need not state the price of each product in terms of all other products for which

it might possibly be exchanged; we need not state the price of cows in terms of

grains, cloths, barrels of oil etc., This use of money as a common denominator

means that the price of each product need be stated only in monetary unit. Money

is also used as standard of value for transactions involving future payments. Debt

obligations of all kinds are measured in terms of money.

Store of Value: Because money is the most liquid of all assets, it is a very

convenient form in which to store wealth. Most methods of holding money do not

yield monetary returns such as one gets by storing wealth in the form of real assets

(property) or paper assets (stocks, bonds, and so forth). However, money does have

the advantage of being immediately usable by a firm or a household in meeting any

and all financial obligations.

There is distinction between money and income. What we earn is not money.

Money is used only to pay the income. We need money because it serves as a

common item in which the prices of all goods and services can be set.

9.3.2 Money Supply

It is currency and chequeable deposits with the banks. This is the narrow

definition of money and denoted by M1 in our monetary statistics. There is also a

broad definition of money. Broad money includes, in addition to M1, fixed or time

deposits with banks, which are not usually available for spending until the end of

the term, but, nevertheless, can be converted into saving or chequeable deposits in

no time, with some loss of interest. Broad money, there more is defined as

currency + all bank deposits and is denoted by M3 in our monetary statistics.

When we talk of money supply, we usually refer to M3.

9.3.3 Demand for Money

An individual’s wealth can be held, broadly, in two forms

(a) Interest bearing assets

83

(b) Non-interest bearing assets or, money

The interest bearing assets are bonds. So when we are asking why do we

demand money, we are, essentially, asking as to why would anyone like to demand

money which either yields no interest (Currency) or which yields very low interest

(chequeable deposits) when this money can be held as interest bearing bonds?

When we are talking about demand for money we are referring to real money

demand. In other words we are saying that if the price level doubled over night,

then the amount of money people would want to hold would also double. Thus the

demand for money is proportional to the level of prices. Real money demand, then,

is quantity of money demand divided by the price level.

First we demand money to buy goods and services. This is called the

transaction demand for money. This is the primary motive. The demand for money

to transact in goods and services is the positive function of income (GDP). Higher

the income greater will be the need to buy goods and services and hither will be the

transaction demand for money. But is also a negative function of interest rates. If

interest rate rises, we are foregoing a higher return by holding money. So the

temptation to hold less at any point of time. For example, instead of drawing

money for the whole month I may draw money weekly and let the balance money

earn interest in the meantime.

The second reason for holding money is precautionary. Individuals and firms

hold money with a precautionary motive for unforeseen contingencies. It will also

depend on how much interest we are foregoing on this money held. Thus

precautionary demand for money is also a positive function of income and a

negative function of interest rates.

The speculative demand for money, thus, arise because people think that by

holding a certain stock of money, they can make capital gains or avoid capital

losses. There is an inverse relationship between bond prices and interest rate.

Speculative demand for money is also a positive function of income to the extent

that the more income you have the more you can afford to speculate. We can

conclude then, the demand for money is an increasing function of income and

decreasing function of interest rate.

9.3.4 Relationship between Money Supply and GDP

GDP is the total production goods and services in the economy and money

refers to a stock of liquid assets, which can be exchanged for goods and services. A

given stock of money flows through the economy a number of times (called velocity

of circulation) each time resulting in a new transaction, and the value of the GDP is

nothing but the sum total of all these transactions over a period of time. GDP

therefore depends on the stock of money multiplied by the speed with which the

money changes hands. If the number of times money changes hands, or the

velocity of circulation, is assumed to be stable, then there is a close relationship

between the stock of money and GDP. As the stock of money increases, more goods

and services will be exchanged and the GDP will rise. However, there is a catch. If

the economy is already operating close to full capacity, and the money supply

continues to grow they have a situation where the money supply is rising but the

84

supply of goods and services, which can be exchanged for this money, is not rising

correspondingly. There is more money chasing few goods and services. As a result

prices will increase more than the increase in real output and the policy maker may

have to carefully, weigh the trade-offs, considering the fact that price stability is one

of the paramount objectives of macroeconomic policy

On the other hand, if the GDP is below the capacity of the economy to

produce, an increase in the money stock can plan a simulative role in the economy

by increasing real output with little rise in prices.

9.4 REVISION POINTS

1. Metallic money, Paper money

2. Money supply relationship between money supply and gap

9.5 INTEXT QUESTION

1. Distinguish between GNP and GDP.

2. Write Short notes on (i) Money supply; (ii) Demand for Money

9.6 SUMMARY

The different forms of money are Metallic Money, paper Money, Fiat

Currencies. Money functions as Medium of exchange, standard of value and Store

of value. M1, M2, M3 are the usual notations to denote various ways of money

supply. Demand for money is proportional to the level of prices. Demand for

money is for two purposes; transaction demand and speculative demand.


1. What is money?

2. What is money supply?

9.8 ASSIGNMENTS

1. Explain the relationship between Money supply and GDP.

Write Short notes on: (i) Money supply; (ii) Demand for Money.






1. C.N. Vakil & H.N Pathak, ‘Introduction of Economy Voro & Co. Publishers


9.11 LEARNING ACTIVITES

1. Discuss the relationship between money supply and GDP.

2. Discuss about the national income and GDP.

9.12 KEYWORDS

Metallic money, Paper Money, Fiat Currencies, Demand and Supply.

85

LESSON - 10

COMPONENTS OF ECONOMY

10.1 INTRODUCTION

The functioning and strength of any economy is explained by the strengths of

the various sectors of that economy. The nature of growth of any economy is

explained by how effectively the sectors interact with each other

10.2 OBJECTIVES

To understand the sectoral contribution of various sectors for the

development of a country

To understand the nature and problems of urbanisation and its impact on

economy

10.3 CONTENT

10.3.1 Sectors

10.3.2 Trends in change in growth of economic development

10.3.3 Urbanisation

10.3.1 Sectors

Primary Sector

When the economic activity depends mainly on exploitation of natural

resources then that activity comes under the primary sector. Agriculture and

agriculture related activities are the primary sectors of economy.

Secondary Sector

When the main activity involves manufacturing then it is the secondary sector.

All industrial production where physical goods are produced come under the

secondary sector.

Tertiary Sector

When the activity involves providing intangible goods like services then this is

part of the tertiary sector. Financial services, management consultancy, telephony

and IT are good examples of service sector.

10.3.2 Trends in Change in the growth of Sectoral contribution to Economic Development

Structural transformations in modern economic growth include the shift away

from agriculture to non-agricultural activities (Primary to secondary) and from

industry to services sectors (Secondary to Tertiary). A change in the scale of

productive units, and a related shift from personal enterprises to impersonal

organisation of economic firms, with a corresponding change in the occupational

status of labour experienced.

The share of the agricultural sector in total product declined in all developed

countries except Australia.

Sector Country year Percent share

in total product

Agriculture Great Britain 1841 22

86

1955 5

France 1872 42

1962 9

USA 1879 49

1948 9

Japan 1878 63

1962 14

On the other hand share of the industrial sector rose to more than 50 per cent

by the end of the long period for the following countries

SECTOR Country Per cent share

in total product

MANUFACTURING

GREAT BRITAIN 56

FRANCE 52

USA 42

JAPAN 49

GERMANY 52

SWEDEN 55

USSR 58

NORWAY 53

The rapidity of structural transformation in modern economic growth can also

be illustrated by the changes in the distribution of labour force among the three

major sectors. For example, By end of the long periods of growth, the share of

labour force attached to the agricultural sector was 5 per cent in Great Britain -

lowest among the world countries.

Consequently the share of labour force attached to the industrial sector ranged

between 50 per cent among the developed countries.

The intersectoral shifts were accompanied by growth in the scale of firms and

changes in the type of organisation within sectors such as manufacturing or trade,

from small incorporated forms to the large corporate units with the rapid shifts in

industrial structure and rapid change in technology.

There were also rapid shifts in allocation of product among types and sizes of

producing firms and consequently in the allocation of labour force. There was high

inter-industry, inter-status, and inter-occupational mobility of the labour force

among employees from blue-to white-collar jobs, from less to more skilled

occupations and from small to large enterprises.

10.3.3 Urbanisation

Modern economic growth has been characterised by the movement of an

increasing proportion of the population in developed countries from rural areas to

urban areas is known as urbanisation. This urbanisation is largely a product of

industrialisation.

87

1. Urbanisation affected the level and structure of consumer expenditure in

developed countries in three ways

2. Urbanisation lead to an increasing division of labour, growing specialisation,

and the shift of many activities from non-market oriented pursuits within the

family or the village to specialised market-oriented firms

3. Urbanisation made the satisfaction of an increasing number of wants more

costly. Urban life became costlier because of congestion and overcrowding.

This created difficulties of housing, sanitation, water, intra-city and city

transportation and similar basic amenities in the cities.

The demonstration effect of the city life lead to imitation of consumption

patterns by the large immigrants, which lead to increased consumer expenditure.

Problems in Urban areas/Cities: parasitic Components

Cities have always placed demands on their sites and their hinterlands. In

order to extend their usable territory, urban developers often reshaped natural

landscapes, levelling hills, filling valleys and wetlands, and creating huge areas of

made land.

On this new land, they constructed a built environment of paved streets,

malls, houses, factories, office buildings, and churches. In the process they altered

urban biological ecosystems for their own purposes, killing off animal populations,

eliminating native species of flora and fauna, and introducing new and foreign

species.

Thus urbanites, constructed a built environment that replaced the natural

environment and created a local micro-climate, with different temperature gradients

and rainfall and wind patterns than those of the surrounding countryside.

City populations require food, water, fuel, and construction materials, while

urban industries need natural materials for production purposes. In order to fulfill

these needs, urbanites increasingly had to reach far beyond their boundaries.

In the twentieth century, as urban population increased, the demand for food

drove the rise of large factory farms. The subject of the flow of food and other such

commodities into 19th century cities and its subsequent marketing, however, still has

to find its historian. Cities also require fresh water supplies in order to exist --

engineers, acting at the behest of urban elites and politicians, built waterworks, thrust

water intake pipes ever further into neighbouring lakes, dug wells deeper and deeper

into the earth looking for groundwater, and dammed and diverted rivers and streams

to obtain water supplies for domestic and industrial uses and for fire-fighting.

In the process of obtaining water from distant locales, cities often transformed

them, making deserts where there had been fertile agricultural areas. The

acquisition of protected water shed areas and the building of reservoirs often

resulted in the flooding of many towns and farms.

City entrepreneurs and industrialists were actively involved in the

commodification of natural systems, putting them to use for purposes of urban

consumption. The exploitation of water power from rivers and streams for instance,

88

provided power for manufacturing cities, also sharply altered river dynamics,

destroying fish populations and depriving downstream users of adequate and

unpolluted supplies.

For materials to build and to heat the city, loggers stripped millions of acres of

forests, quarrymen tore granite and other stone from the earth, and miners dug

coal to provide fuel for commercial, industrial and domestic uses.

Urbanites had to seek locations to dispose of the wastes produced. by their

construction, manufacturing and consumption. They were, seeking an "ultimate

sink" for the wastes, but often ended up polluting downstream locales. Initially,

they placed wastes on sites within the city, polluting the air, land, and water with

industrial and domestic effluents and modifying and even destroying natural

biological systems. In the post-Civil War period, as cities grew larger, they disposed

of their wastes by transporting them to more distant locations.

Cities constructed sewerage systems for domestic wastes. They usually

discharged the sewage into neighbouring waterways, often polluting the water

supply of downstream cities. In order to avoid epidemics of waterborne disease

such as typhoid and cholera, downstream cities sought new sources of supply or

used technological fixes, such as water filtration or chlorination, but the choices

were not simple. Industrial wastes also added to stream and lake pollution, and

urban rivers often became little more than open sewers.

The suburban out-migration, which had begun with commuter trains and

streetcars accelerated because of the availability and convenience of the

automobile, now increased to a torrent, putting major strains on the formerly rural

and undeveloped metropolitan fringes. To a great extent, suburban layouts, ignored

environmental considerations, making little provision for open space, producing

endless rows of resource-consuming and pesticide-and fertilizer-dependent lawns,

contaminating groundwater through leaking septic tanks, and absorbing excessive

amounts of fresh water and energy.

The growth of the edge or outer city since the 1970s, reflected a continued

preference on the part of Americans for space-intensive single-family houses

surrounded by lawns, for private automobiles over public transit, and for Greenfield

development. Without greater land use planning and environmental protection,

urban areas will, as it has in the past, continue to damage and to stress the natural

environment.

10.4 REVISION POINTS

1. Trends in change in the growth of sectoral contribution to economic

development, urbanisation

10.5. INTEXT QUESTIONS

1. What is meant by economy

2. What is primary sector

89

10.6 SUMMARY

Various economic activities of an economy is broadly known as Primary,

Secondary and Tertiary Sectors. Over the past, some of the country specific

sectoral contribution in total product of that country portray the nature of

economic activity. This give rise to various policy direction for a country in the form

of planning. Urbanisation pose lot of problems to its dwellers in managing the

environment. The issues are solid waste generation, Air Pollution, Water pollution

and shrinking sources of potable water. Transport and traffic management is a day

to day issue and also a long term issue. If the status-quo continue the stress and

damage to natural environment is inevitable.


1. Write short notes on structure transformation.

2. Define secondary sector.





10.9 ASSIGNMENTS

1. Explain Urbanisation and problems in urban areas.

2. Differentiate various sectors.


1. C.N. Vakil & H.N Pathak, Introduction of Economy Voro & Co. Publishers



1. Discuss what are the problems involved in urban areas.

2. Discuss modern trends for economic contribution.

10.12 KEYWORDS

Primary, Secondary, Tertiary Sectors, Nature Environment, Built Environment

Demand.

90

LESSON - 11

NATIONAL INCOME

11.1 INTRODUCTION

As a concept it is different from Private income. Private budget (income

expenditure statement) adjusts expenditure according to income. Whereas public

budget decides the expenditure first and augments income for the expenditure.

National income is one of the indicator of Economic Growth of an Economy

11.2 OBJECTIVES

To introduce different methods of estimation of National Income

To know the concept of circular flow of income.

To know the relationship between money supply and GDP

11.3 CONTENTS

11.3.1 National Income

11.3.2 Gross National Product

11.3.3 Gross Domestic Product

11.3.4 Economic Units and Circular Flow of Income

11.3.5 National Income Measurement

11.3.1 NATIONAL INCOME

National Income – income of the nation during a period of time – provides a

comprehensive measure of the economic activities of a nation. Its annual

magnitude divided by the nation’s population, called the per capita income, is

used as a measure of the standard of living of the people in the nation, and the

distinction between rich, middle income and poor countries is based on the

magnitude of the per capita income.

The growth rate of an economy is also measured by the rate at which its real

national income is growing. Knowledge of the national income and its movements

over time is of significance to a business organization also, as this provides a

measure of the nation’s ability to buy goods and services, and, thus, business sales

are dependent on its magnitude.

Income Concepts

There are several versions of national income, though, strictly speaking, only

one of them is referred to as the national income. These include:

Gross National Product (GNP)

Net National Product (NNP)

These measures define both at the market price as well as at the factor cost.

Thus, we have the GNP at market price (GNPM), NNP at the market price (NNPM),

NNP at the factor cost (NNPF).

91

11.3.2 Gross National Product

The GNP at market price stands for the monetary value of all goods and

services that are

(a) Currently produced.

(b) Sold through the official market.

(c) Not resold or used in further production during the measurement period.

(d) Produced by nationally owned resources (factors of production).

(e) Valued at market prices

A brief rationale and explanation of these factors follows

GNP is expressed in terms of money (rupees in India) because the goods and

services are non-additive in physical quantities due to differences in the units of

measurements (tonnes of wheat, metres of cloth, number of cars, number of

haircuts etc) and the per unit values (one car is not equal to one haircut or even

one scooter). It is said that ‘you cannot add apples and oranges’. By using the

prices, the GNP is constructed. Quantities of various goods are multiplied by their

respective prices, and then the various money magnitudes are added to give GNP.

Income is a flow concept and so the GNP includes only those items that are

produced during the period of time for which the GNP stands. Thus, the GNP in

1991 includes the production of all goods and services between January 1, 1991

through December 31, 1991 only. The changes in inventories during the pe riod are

treated as positive or negative purchases by the producer for the purpose of

reconciling the production measure with the end-use expenditure measure.

The GNP accounts only for goods that are traded through the official market.

This is a limitation of the measure but it is resorted to internationally owing to the

difficulties in measuring non-marketed or not officially marketed production. Thus,

it ignores the ‘do it yourself’ activities (which are not paid for) as well as the

un/under reported productions. For example, the household work, including

babysitting, white washing of own house, and tutoring of own children and other do

it yourself activities are excluded, while payments to maid-servants, washermen,

paid babysitters, private tuitions and so on are included in the GNP. Also, activities

like painting, drawing, photography, etc, which are carried out for self-consumption

(or even for sale but not in the current year), are left out of the GNP. Similarly,

unreported productions (though a part of market transactions but not a part of

official transactions) triggered by the desire to avoid excise duties or for other

reasons, are not included in the GNP. These give rise to what is called as the black

(parallel) economy.

Raw materials and intermediate goods (i.e., goods resold or used for further

production during the measurement period) are not included in the GNP, so as to

avoid double counting of production. Thus, wheat used in making bread, leather

used in making shoes and tyres used in cars are excluded because these are

contained in the values of bread, shoes and cars, respectively.

92

The GNP belongs to the nation, and thus, it must be produced by its owned

factors of production only. Since some factors of production like labour,

entrepreneur, and capital are globally mobile and we do have multinationals

operating in many countries, a part of this GNP is produced abroad and a part of

foreign GNP is produced under a nation’s territory. Thus, if an Indian resident

professor takes up a four-month’s Visiting Professorship in a University in the

United States, his income in there will be a part of India’s GNP and similarly the

profit that a foreign owned firm (say Citibank) makes in India is not a part of India’s

GNP. Thus, for GNP, the location of production is immaterial.

11.3.3 Gross Domestic Product

The GDP refers to the value of the goods and services produced within the

nation’s geographical territory, irrespective of the ownership of the resources.

GDPF = GNPF – NIA

From the point of the employment generation at home, GDP is more relevant

than GNP, and hence, the former often receives greater attention than the latter.

Corresponding to GNP and GDP, there are NNP and NDP. The difference

between the gross and the net is the capital consumption, called depreciation (D).

Thus,

NNPF = GNPF – D

NDPF = GDPF – D

It is the NNPF which is referred to as the national income. This is because

depreciation is really the consumed part of the fixed capital in the production

process and it is difficult to measure it accurately (what we have is the accounting

and not the economic depreciation).

11.3.4 Economic Units and Circular flow of Income

On the basis of the economic units, the nation could be studied through five

sectors: (a) households, (b) firms, (c) financial institutions (capital market), (d) the

government and (e) the rest of the world. These five sectors interact, produce and

circulate the income.

All the factors of production are assumed to be owned by households.

Households supply these factors to firms (governmental, private and joint), who

produce all the GNP. The firms pay factors’ rewards (rent, wage, interest and profit)

to households, corporate tax to the government and for imports to the rest of the

world, and maintain the balance as savings with financial institutions. The firms, in

turn, receive payments for supplying consumption goods to households and to the

government.

93

Circular Flow of Income

They also receive subsidies from the government for their exports to rest of the

world, and raise funds for the investments from financial institutions. The

government receives corporate tax from firms and personal tax from households

and advances subsidies to firms and transfer payments to households, besides

paying firms for their expenditure on goods and services. Its savings (lack of

savings) go to (come from) financial institutions. Financial institutions receive

savings from all the three sectors (households, firms and government) and pay for

all the investment goods to firms. Households receive payments for all owned

14

Financial

institutions

Government

Households Firms

Rest of the World

15 16

10

6 [Rents + wages +

interest +

profi t]

Pvt. Consumption

Investments

13 Govt. Savings (-

ve)

GNP FOP

1 5

11 Per savings

8 9 7

12

3

2 4

94

factors of production from firms and transfer payments from the government. It

pays firms for consumption goods, personal tax to the government and puts its

savings in financial institutions. This process continues period after period and this

is how income is produced and circulated among the various sectors of the

economy.

The circular flow of income shows leakages (withdrawals) from the national

income, which does not form a part of the expenditure on national product. These

are savings (S), taxes (T), and imports (M). Also, it indicates injections (additions)

into expenditure on national product, which do not come from national income.

These are investment (I), government expenditure (G) and exports (X). These

injections and leakages are related. Saving finances investment, partly or fully, as

do taxes finance government expenditure, Also, some of the expenditure on imports

provides foreigners with the means to purchase our exports.

Although the leakages may eventually finance the injections, they do not cause

them. There is no reason for S = I, T = G, and M = X, but the total planned leakages

must equal the total planned injections for the equilibrium to hold:

S + T + M = I + G + X

11.3.5 National Income Measurement

National income could be measured in three different ways:

Production or value added approach

Income approach

Expenditure approach

And if done correctly, the following equation must hold:

Production = Income = Expenditure

This is because the three approaches are circular in nature. It begins at

production, through recruitments of factors of production, generating and going as

incomes to factors of production, who expend it on production. A brief discussion of

these approaches follows.

Production Approach

Under this approach, the GDP at the factor cost, is measured as the sum of

the values of the flows of value added from various production centres or of the

production of final goods and services. Thus, the GDP at the factor cost is given by

GDPF = P1Q1 + P2Q2 + ……… + PnQn

=

n

i

iiQP1

Where Pi = price of final good i

Qi = output of final good i

n = number of goods and services produced in the economy.

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Incidentally, note that equation assumes that all productions can be valued in

money terms.

The production sectors are conveniently classified into (a) primary, (b)

secondary and (c) tertiary. The primary sector includes agricul ture, forestry and

fishing, and mining and quarrying. The secondary sector consists of

manufacturing, electricity, gas and water supply, and construction. The tertiary

sector consists of all items under services. The contribution of each of these sectors

and their sub-sectors to the GDP at the factor cost (at current prices) during 1950-

51, 1980-81, 1990-991 and 2000-01 is reported in Table.

A distinction is also made between the agriculture, industry and services

sectors. The first sector includes items 1 and 2 of the table, the second, items 3, 4,

5 and 6 and items 7 through 12 go in the third sector.

Table: Gross Domestic Product at Factor Cost by Economic Activity (at Current Prices)

(% share)

Sector 1950-51 1980-81 1990-91 2000-01

Primary 56.5 39.6 33.5 27.3

1. Agriculture 52.2 34.7 28.3 22.7

2. Forestry and fishing 3.6 3.4 2.7 2.2

3. Mining and quarrying 0.7 1.5 2.5 2.4

Secondary 14.5 24.4 26.9 24.5

4. Manufacturing 11.5 17.7 18.7 15.8

5. Electricity, gas and water supply 0.2 1.7 2.2 2.6

6. Construction 2.8 5.0 6.0 6.1

Tertiary (Services) 29.0 36.0 39.7 48.2

7. Trade, hotels and restaurants 6.5 12.0 13.0 13.8

8. Transport, storage and communication 3.5 4.7 7.1 7.3

9. Banking and insurance 0.8 2.8 4.4 6.2

10. Real estate, dwellings & business services 9.2 6.0 3.7 6.3

11. Public administration and defence 3.0 4.7 5.7 6.6

12. Other services 6.0 5.8 5.8 8.0

GDP at factor cost (Rs. Crore) 8979 1,22,427 4,77,814 18,95,843

Source: National Accounts Statistics, CSO, various issues

A careful examination of the data in Table would reveal that in the last

50 years, the share of both the secondary and tertiary sectors in GDP has increased

substantially at the cost of that of the primary sector. Further, the role of the

tertiary sector has grown at the fastest rate. This is a sign of prosperity, provided of

course, the requirements for wage-goods are met reasonably well.

Income Approach

Under the cost or income approach, the national income equals the sum of the

costs of production of goods and services, which equals the earnings that

households receive for their factors of production. These include the wages and

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salaries received for the supply of labour (W); rents for land, buildings, equipments,

and the like (R); interest for borrowed capital (I); and profit for entrepreneurship (P).

Thus, the NDP at the factor cost is given by

NDPF = W + R + I + P

Transfer payments/receipts, such as unemployment benefits and pensions are

not included in income. Since there are self-employed people in all countries, and

they rarely classify their incomes into the above four components, the functionally

distributed national income data contains a mixed income category. Further, a

significant proportion of the Indian people are self-employed and accordingly, the

mixed income category is a dominant component here. The Indian data on income

by factors’ share (functional distribution of income) for the selected few years are

given in table. Some columns in this table are blank as comparable data is not

available. The data reveals that labour commands the maximum share in NDP

(above 40 per cent) and that its share has increased over time. The labour share is

over whelming in all countries.

Table NDP at Factor Cost by Factor Incomes (at Current Prices)

(% share)

Sector 1960-61 1984-85 1980-81 1990-91 1993-94

1. Compensation of employees 33.7 42.2 36.8 38.4 37.4

2. Operating surplus 2.1. Rent 2.2. Interest 2.3. Profit and dividend

5.2 3.2 6.7

3.5 8.6 6.0

7.7 11.5 12.9

3. Mixed income 51.2 39.7 55.5 50.1 49.7

4. NDP at factor cost (Rs. Crore) 1,10,340.0 4,25,619.0 6,51,322.0

5. Property income (Rs. Crore) 5.1. Rent 5.2. Interest

9,920.0 24.0 76.0

49,673.0 21.4 78.6

76,179.0 22.0 78.0

Note: Rent paid by an industry for land, structures, machinery, equipment, etc. is treated as a factor payment. Except for residential buildings, no imputation for rent for using own buildings, machinery and equipment is made.

Source: National Accounts Statistics, CSO, various issues.

Expenditure Approach

Under this method, national income is measured as the sum of all final

expenditure. Final expenditure consists of expenditure on private consumption (C),

gross investment – both private and public (I), expenditure on government (federal,

state and local) consumption (G), foreigners’ expenditure on our exports of goods

and services (X), net of our expenditure on imports of goods and services from

abroad (M). Therefore, GDP at the market price could be measured as

GDPM = C + I + G + X – M

It must be noted that what is not consumed is saving. Further, while saving

equals investment in the world as a whole, the same is not necessarily true for a

country. This is so because some countries save more and some less than they

need to invest. The balance between the supply of savings and demand for

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investments is met by financial flows between economies, the net of which is given

by the difference between imports and exports of goods and services. Thus, saving =

income – private consumption – government consumption = investments + exports –

income.

11.4 REVISON POINTS

1. National income measurement.

2. Factor cost by economic activity.

3. Gross national product, gross domestic product, net national product.


1. What is meant by income measurement?

2. What is national income?

11.6 SUMMARY

Demand for money is proportional to the level of prices. Demand for money is

for two purposes; transaction demand and speculative demand. Circular flow of

income is about how economic units like households, firms, financial institutions

and Government interact in circulation of income.


1. Distinguish between GNP and GDP.

2. Production approach.

3. Income approach.

4. Expenditure approach.





11.9 ASSIGNMENTS

1. Explain in detail about three different ways of National Income

measurements.




11.11 LEARNING ACTIVITES

1. Discuss about the national income and GDP.

11.12 KEYWORDS

GNP, NNP, GDP, national income, income measurement.

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LESSON - 12

INFLATION AND DEFLATION

12.1 INTRODUCTION

Inflation is an everyday phenomenon impacting everyone in the economy. This

lesson details on what is the implications of it in every sector of the economy

Deflation is a phenomenon not very common to every country. It spread worse

impact than inflation in an economy if experienced.

12.2 OBJECTIVES

To familiarise various types of inflation

To explain various causes of inflation

To understand various measures to control inflation

To understand the impact of deflation

To study various policy options to combat deflation

12.3 CONTENT

12.3.1 Inflation

12.3.2 Deflation

12.3.1 Inflation

Inflation refers to a continuous rise in general price level. In India, we

estimate inflation based on the movement in wholesale price index (WPI) which is

reported every week with a two week lag. Consumer price index (CPI) is used to

arrive at cost of living changes and for the calculation of dearness allowance or cost

of living allowance. In many other countries inflation is derived from movements in

Consumer price Index (CPI)

Causes of Inflation: It can be caused by

1. Demand factors referred to as “Demand Pull” inflation can be caused by an

increase in any of the components of aggregate demand i.e., consumer

demand (C), Investment Demand (I) Government Demand (G) or, net

foreigner’s demand or some combination of the above. It is however increase

in Government demand which is the primary cause of demand pull inflation.

When the demand increases the extent of price increase depends on the

supply situation. At one extreme, let us assume that there is massive excess

capacity all around the economy and the suppliers in the economy can meet

the excess demand for goods and services without resorting to increase in

prices, then we may not see any rise in prices consequent to an increase in

demand. At the other extreme, let us assume that the economy is operating

at its full capacity and there is no scope for increasing production. In that

case, the entire increase in demand will be dissipated by way of a rise in

prices. In real life, however, we neither encounter economy wide massive

excess capacity not do we come across a situation where output cannot be

increased at all. In real life, as demand increases, price and output both

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increase; when the economy is closer to capacity output, price ruse is steeper

and, vice versa, when there is some excess capacity in the economy.

2. Cost-push is driven by an increase in costs, independently of demand. The

Logic underlying this phenomenon is as follows. Conceptually, the

contribution that a factor of production, say labour, markets to the revenue of

a firm is the additional output that the firm gets by employing that labour

times the price of the output. The wage that they labour gets, therefore, is

supposed to reflect this. Now if, because of union pressures, wages are

pushed up without any increase in the worker’s contribution to the output,

per unit cost of production goes up at each level of output. If firms fact a rise

in costs, they will respond partly by raising prises and passing the cost on to

their consumers and partly by cutting back on production. Note that unlike

demand-pull inflation where both prices and output go up, cost-push inflation

results in a rise in prices and fall in output. We have taken the example of

labour costs here, but costs could also go up because of an increase in

material costs, import costs, due to increase in oil prices, strong bargaining

power of producers etc. in short any increase in costs or money gain greater

than productivity will result in increase in process.

Inflation can also be expectation driven. If people expect inflation to be say 5%

then based on this expectation, people will revise prices and actually take the

inflation to 5%. Expectations are formed based on post inflation rates. Policy

change, under the circumstances, lies in finding ways to douse the expectations.

Policy credibility is key to this. Otherwise, expected inflation may drive actual

inflation.

Kinds of inflation

An examination of the time series data across countries would suggest that all

countries have experienced some, though varying degrees of inflation over time. By

the degree of inflation and the trend in the inflation rate, five kinds of inflation are

distinguished.

(a) Hyperinflation/Runaway inflation

(b)High inflation

(c)Galloping inflation

(d)Low inflation

(e)Crawling inflation

Hyperinflation: Phenomenon where the rate of inflation is around 1000

percent per year (=22 percent per month, compounded) it has happened in a few

countries in the past monthly) and more. This appears to be too high an inflation

rate to prevail anywhere but it has happened in a few countries in past

Country Year of start Rate of inflation

Germany January 1922 322 percent per month

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Hungary August 1945 19800 percent per month

Brazil 1980 – 1990s 1009-2938 percent per year

High Inflation: Inflation at the high two digit rate to the top of the three digit

rate per year. Such inflation was witnessed in the Russian federation and in Nigeria

during 1990s

Galloping inflation: is the inflation where the inflation and high inflation

countries, and would surely be found in some countries at least for few years. Most

countries in the world experienced fairly high inflation during 1974 through 1982.

Low inflation: Refers to the inflation whose rate falls within one digit to the

low two digits per year. This is the most common kind of inflation and it has been

experienced by most countries in the last 50 years or so.

Crawling inflation: The one which is low and which moves up and down

slowly. This is the common form currently.

STABILISATION POLICY: INFLATION MANAGAMENT

Stabilising the price level so as to avoid secular stagnation and secular

inflation is the prime objective of any Government. The main instruments of

stabilisation policy are:

(a) Monetary policy

(b) Fiscal policy

(c)Direct controls

Instruments of Monetary Policy

The instruments of monetary policy are of two types: first, quantitative, general

or Indirect; and second qualitative, selective or direct. They affect the level of

aggregate demand through the supply of money, cost of money and availability of

credit.

Bank Rate Policy: The bank rate is the minimum lending rate of the central

bank at which it rediscounts first class bills of exchange and government securities

held by the commercial banks. When the central bank finds that inflationary

pressures have started emerging within the economy, it raises the bank rate.

Borrowing from the central bank becomes costly and commercial banks borrow less

from it. The commercial banks, in turn, raise their lending rates to the business

community and borrowers borrow less from the commercial banks. There is

contraction of credit and prices are checked from rising further.

Open Market Operations: Open market operations refer to the sale and

purchase of securities in the money market by the central bank. When prices are

rising and there is need to control them, the central bank sell securities. The

reserves of commercial banks are reduced and they are not in a position to lend

more to the business community. Further investment is discouraged and the rise in

prices is checked.

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Changes in Reserve Ratios: Every bank is required by law to keep a certain

percentage of its total deposits in the form of a reserve fund in its vaults and also a

certain percentage with the central bank. When prices are rising, the central bank

raises the reserve ratio. Banks are required to keep more with the central bank.

Their reserves are reduced and they lend less. The volume of investment, output

and employment are adversely affected.

Selective Credit Controls: Selective credit controls are used to influence

specific types of credit for particular purposes. They usually take the form of

changing margin requirements to control speculative activities within the economy.

When there is brisk speculative activity in the economy or in particular sectors in

certain commodities, and prices start rising, the central bank rises the margin

requirement on them. The result is that the borrowers are giving l ess money in

loans against specified securities.

FISCAL POLICY

Fiscal policy is a powerful instrument of stabilisation. “By fiscal policy we refer

to the government actions affecting its receipts and expenditures which we

ordinarily take as measured by the government’s net receipts, its surplus or deficit”.

The government may offset undesirable variations in private consumption an

investment by anti-cyclical variations of public expenditures and taxes.

Instruments of Fiscal Policy

Fiscal policy through variations in government expenditure and taxation

profoundly affects national income, employment, output and prices. An increase in

public expenditure during depression adds to the aggregate demand for goods and

services and leads to a large increase in income via the multiplier process; while a

reduction in taxes has the effect of raising disposable income thereby increasing

consumption and investment expenditures of the people. On the other hand, a

reduction of public expenditure during inflation reduces aggregate demand,

national income, employment, output and prices; while an increase in taxes tends

to reduce disposable income and thereby reduces consumption and investment

expenditures. Thus the government can control deflationary and inflationary

pressures in the economy by a judicious combination of expenditure and taxation

programmes. We discuss below the various instruments of fiscal policy.

Direct Controls

The aim of direct controls is to ensure proper allocation of scarce resources for

the purpose of price stabilization. They are meant to affect strategic points of the

economy. They affect particular consumers and producers. Such controls are in the

form of licensing, rationing, price, and wage controls, export duties, exchange

controls, quotas, authorization, anti-hoarding control, monopoly control, etc. They

are more effective in overcoming bottlenecks and shortages arising from inflationary

pressures. Their success, however, presupposes the existence of an efficient and

honest administration. Otherwise, they lead to black marketing, corruption, long

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queues, speculation, etc. Therefore, they should be resorted to only in emergencies

like war, crop failures and hyper-inflation.

12.3.2 Deflation

From the beginning of the present century, many countries have been facing

the opposite threat—deflation. It must be impressed that deflation is really worse

than inflation. Recessions generally occur when there is a widespread drop in

spending often following an adverse supply shock or the bursting of an economic

bubble. Governments usually respond to recessions by adopting expansionary

macroeconomic policies, such as increasing money supply, increasing government

spending and decreasing taxation.

This is explained through the costs of deflation—some of which are highlighted

below.

a) Deflation causes real wage to rise, which tends to raise unemployment and

reduce profit, which in turn, triggers investment fall and thereby a fall in

aggregate demand and income and increase in unemployment.

b) Deflation leads to an increase in real interest rate, which tends to raise the

cost of debt and thereby discourages investment, causing income to fall and

unemployment to rise.

c) Deflation causes the expected price fall, which, in turn, causes consumption

and investment to fall and aggregate supply to rise. The latter two events

reinforce each other to cause price to fall further.

d) Deflation tends to redistribute income in favour of creditors and fixed income

groups (like pensioners, widows and salary earners to some extent) whose

marginal propensity to consume is relatively lower, it tends to lower

consumption, aggregate demand and real income.

The factors given above are obviously very harmful to any economy and

therefore all governments, including the United States, are currently trying their

best to overcome the deflationary threat. Interest rates have been reduced

considerably throughout the world in the last three or four years and currently the

federal fund rate in the United States stands at a 45 years low of 1 percent

FISCAL POLICIES TO OVERCOME DEFLATION

Budget Deficit – Fiscal Policy during Depression: Deficit budgeting is an

important method of overcoming depression. When government expenditures

exceed receipts, larger amounts are put into the stream of national income than

they are withdrawn. The deficit represents the net expenditure of the government

which increase national income by the multiplier times the increase in net

expenditure.

Compensatory Fiscal Policy

The compensatory fiscal policy aims at continuously compensating the

economy against chronic tendencies towards inflation and deflation by

manipulating public expenditures and taxes. It, therefore, necessitates the adoption

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of fiscal measures over the long-run rather than once-for-all measures at a point of

time. When there are deflationary tendencies in the economy, the government

should increase its expenditures through deficit budgeting and reduction in taxes.

This is essential to compensate for the lack in private investment and to raise

effective demand, employment, output, and income within the economy.

Discretionary Action: Discretionary fiscal policy requires deliberate changes

in the budget by such actions as changing tax rates or government expenditures or

both. It may generally take three forms:

i) changing taxes with expenditures constant,

ii) changing expenditures with taxes constant, and

iii) variations in both expenditures and taxes simultaneously. The first method

is more effective in controlling inflation by raising tax rates and keeping

government expenditure unchanged. The second method is more useful in

controlling deflationary tendencies.

Public Expenditures

We have seen above that all variants of fiscal policy involve public

expenditures. It is therefore, instructive to study the nature and problems of public

expenditures as a stabilizing instrument. Public expenditures are of two types:

(i) compensatory spending, and (ii) pump priming.

Compensatory Spending: is resorted to for the purpose of compensating the

decline in private investment. Any shrinkage in private investment expenditures is

offset by public expenditures on public works and relief measures. Public works are

“durable goods, primarily fixed structures, produced by the government”. They

include roads, airports, railroads, post offices, canals, dams, sewage system, school

and hospital and other buildings, flood and erosion control, parks, etc. Relief

measures are the social security payments like relief payments, subsidies,

unemployment insurance, pensions, etc. When private investment shows signs of

decline and there is a likelihood of recession, the government should immediately

take up public works programme and increase its expenditure on relief measures.

Pump Priming: is one of the variants of public expenditure. the basic idea is

that public spending may be used in modest and temporary does to “prime to

pump” of economic activity which will sooner or later operate on its own motive

power and bring the economy to the path of steady economic growth without

further public spending. It signifies that a certain volume of public spending will

serve at start up the economic machine, which thereafter will reach satisfactory

level of output on its own power.


1. Trends in change in the growth of sectoral contribution to economic

development.


1. What is meant by economy?

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2. What is primary sector?

12.6 SUMMARY

Deflation is just opposite of inflation. Deflation causes expected price fall

results in fall in investment and hence in consumption, resulting in aggregate

supply to rise. These events reinforce each other to cause further fall in price level.

Fall in price level is very harmful to the economy and therefore to government.

Compensatory Fiscal Policy and increase in Public Expenditure are the policy

options adopted worldwide.


1. Write short notes on structure transformation

2. Define: Fiscal Policy

3. Define: Budget Deficit.





12.9 ASSIGNMENTS

1. Write an essay of Instructions of Fiscal Policy.

2. List out various Fiscal Policy measures to overcome deflection.


1. C.N. Vakil & H.N Pathak.; ‘Introduction of Economy Voro & Co. Publishers



2. Discuss what are the problems involved in urban areas.

3. Explain the role of monetary policy in controlling inflow.

12.12 KEYWORDS

Cost-Push, Fiscal Poling, Monetary Policy Compensatory Spending, Pump

Primary.

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LESSON - 13

ORGANIZATIONAL BEHAVIOUR

13.1. INTRODUCTION

Organizational behaviour is a study of human behaviour, attitudes, and

performance in organizations. It divulges the various aspects of motivation, leader

behaviour, power, interpersonal relations and communication, group structure and

problems, learning, attitudes, perception, change process, conflict, job design and

work stress etc. The study involves interaction among the formal structure, the

tasks to be undertaken, the technology employed and the method of carrying out

work, the behaviour of people, the process to management and the external

environment in which an organisation is functioning.

13.2 OBJECTIVES

To understand the meaning and importance of organizational behaviour

To explain the historical development of organizational behaviour

To examine organisation as a social system and

To analyse the environmental and other factors influencing organizational

behaviour.

13.3 CONTENTS

13.3.1. Definition and meaning

13.3.2. Basic approaches of Organizational Behaviour

13.3.3. Importance of Organizational Behaviour

13.3.4. Fundamental concepts of Organizational Behaviour

13.3.5. Role of behavioural science

13.3.6. Constraints of organizational behaviour and managerial performance

13.3.7. Understanding Individual

13.3.1 Definition and Meaning of Organizational Behaviour

Organizational behaviour is the study of the behaviour of people within an

organizational setting. It involves the understanding, prediction and control of

human behaviour and the factors which influence the performance of people as

members of an organisation. The study of it is to utilize it as a tool for human

benefit. It can broadly be applied to the behaviour of people in all types of

organizations, such as those of business, government, and service organizations.

According to Keith Davis, organizational behaviour is the study and application

of knowledge about how people act within organizations. It relates to other system

elements such as structure, technology and the external social environment.

In the words of Stephen P. Robbins, organizational behaviour is the study of

the impact that individuals, groups, and structure have on behaviour, within

organizations, for the purpose of applying such knowledge toward improving the

effectiveness of an organization.

Organizational behaviour is a field of study. This means that it is a distinct

area of expertise with a common body of knowledge. What does it study? It studies

three determinants of behaviour in organizations: individuals, groups, and

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structure. Organizational behaviour is an applied study. It applies the knowledge

gained about individuals, groups, and the effect of structure on their behaviour in

order to make organizations work more effectively.

13.3.2 Basic Approaches of Organizational Behaviour

The study of organizational behaviour mainly tries to integrate four basic

elements viz. people, structure, technology, and the environment, therefore, it rests

on an interdisciplinary foundation of fund -concepts about the nature of people and

organizations. Thus the basic approaches and dimensions in which the subject can

be understood are as follows:

1. Interdisciplinary Approach: The study of organization behaviour cannot be

undertaken in terms of a single discipline atone. It is necessary that the approach is

interdisciplinary, and through behavioural sciences. It brings together social sciences

and other disciplines that contribute to its study. It appropriates from these disciplines

ideas that will improve the relations between people and organizations. The interest of

various social sciences in people is sometimes expressed by the general term

"behavioural science" which represents the systematized body of knowledge pertaining

to why and how people behave as they do.

2. Human Resource Approach: The human resource approach is

developmental. It is concerned with the growth and development of people toward

higher levels of competency, creativity and fulfillment, because people are the

central resource any organisation and in any society. This, approach can be very

easily understood by comparing it with the traditional management approach where

the manager decides to do something and then gets it done through people

according to his directives and under his strict control and supervision without

taking his workers into confidence just to satisfy his whims. The human resource

approach, on the other hand, is developmental and facilitative. It help people grow

each developing self-control responsibilities and other in them so as to create a

climate where all can contribute to the orgnisation to the limits of their improved

abilities. It will get satisfaction by making fuller use of their capabilities. It is similar

McGregor's theory.

This approach is also known as the supportive approach because in this approach

manager’s role changes. He does not control the employees get the work done, he rather

supports them to grow according to the abilities. Supportive managers provide a good

organizational climate in which people can grow and be productive.

3. Contingency Approach: Traditional management relied on principles to

provide a "one best-way" of managing. There was a correct way to organise, to

delegate, and divide work regardless of the type of organisation or situation

involved. Management principles were considered universal. As the field of study of

organizational behaviour developed the concept of universality gained support.

Behavioural ideas, it was thought, can apply to any type of situation; for example

an employee-oriented leadership should consistently be better than a task oriented

leadership, whatever the circumstances

http://fundc.ir.c-nu'.-/

107

The widely accepted view now is that there are only a few across the board-

concepts that apply to all situations, it has been found are much more complex

than first perceived, and different variables require different behavioural

approaches. The result is the contingency approach to organizational behaviour,

which holds that different situations require different behavioural practices for

effectiveness.

It is presumed that there is no one best way. Each situation must be analysed

carefully to determine the significant variables that exist in order to establish the

kinds of practices that will be more effective. The strength of the contingency

approach is that it encourages analysis of each situation prior to action, while

discouraging habitual practices based on universal assumptions about people in

organizations.

4. Productivity Approach: Most organizations now-a-days try to be

productive, so it is productivity that governs organizational behaviour. Productivity

is a ratio that compares units of output with units of input. If more can be

produced from the same amount of input, productivity is improved or alternately if

lesser input can produce the same output, productivity has increased. The idea of

productivity does not imply that one should produce more, rather, it is a measure

of how efficiently one produces whatever output is desired. Consequently, better

productivity is a valuable measure of how well resources are used by the society. It

means that as a lesser quantity is consumed to produce each unit of output, there

is minimum waste and better management of resource.

Productivity is often measured in terms of economic input and output, but

human and social input and output also are important. For example, it better

organizational behaviour can improve job satisfaction a human output or benefit

occurs. In the same manner, when employee development programmes lead to a by-

product viz. better citizens in a community, a valuable social output results.

Organizational decisions typically involve human, social and/or economic issues,

and productivity is usually a significant part of these decisions.

5. System Approach: While classical theorists paid too much attention to the

structure of organisation, the human resource experts people paid attention solely

to the feelings and attitudes of the workers. What was missing in understanding

management was the simultaneous examination of the structural as well as the

human aspects of the organisation. The system theory people argue that an

organisation is a purposeful system with several sub-systems which are, closely

interconnected. Any action that is taken to solve the problems of one sub-system

will have its repercussions on other sub-systems as well, since all the parts of the

organisation are closely interconnected.

The supporters of this approach identified five sub systems: (1) the production

sub-system which attends to all the production tasks of the organisation (2) the

maintenance sub-system which offers stability and predictability via the proper

selection of employees, the inspection of incoming raw materials, and the like (3)

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the boundary sub-system & interactions with the external environment are carried

out to monitor changes that take place in the economic, social, technological,

market and other significant environments lacing the organisation. (4) The adaptive

sub-system which deals with the concerns of long-range planning and innovations;

and (5) the managerial sub-system which cuts across all of the functions mentioned

above.

Thus the systems approach envisions the organisation as a purposeful system

with its five sub-systems which should operate in unison because of their

interconnection in achieving the goals of the organisation. The systems theorists,

primary among them, Katz and Kahn (1966), describe organisation as "open to

external environment" receiving certain "inputs" from the environment such as

human resources, raw materials and other necessary ingredients to run the

organisation, engaging in operations that transform the inputs into the final

product; the process known as "throughputs", and finally turning out the 'outputs"

in its final form to be sent back to the environment The organisation, since open to

the environment, also receives "feedback" from the environment and takes

corrective action as necessary and it can be applied especially to the social system

of the organisation.

13.3.3 Importance of Organisational Behaviour

People: The success and failure of an organisation mainly depends upon the

type of people with which it is working people make up the internal social system of

the organisation. They consist of individual employees who are expected to perform

the tasks allotted to them, the groups (may be small or large) who work as teams

and have the -responsibility for getting the job done. Besides, these groups or be

unofficial, informal groups and more official, formal ones. Groups are dynamic.

They form, change, and disband. The human organisation today is not the same as

it was yesterday, or the day before. People are the living, thinking, feeling beings

who work in the organisation to achieve their objectives. Organizations exist to

serve people, rather than people existing to serve organizations.

Structure: Structure refers to the formal or official relationships of people in

the organisation. Different jobs are required to accomplish all of an organisation

activities. There are managers and employees, accountants and assemblers. These

people have to be related income structural way so that their work can effectively be

co-ordinated. These relationships create complex problems of co-operation,

negotiation, and decision- making. The structure of the organisation has to fit with

several other factors such as the technology, size and the environment facing the

organisation in order for the system to be effective. Hence, managers have to deal

with and manage the structural aspects of the organisation as wel1.

Technology: Technology is the mechanism by which the end product or

service of the organisation is produced. It provides the resource with which people

work and affects the tasks that they perform. People cannot perform or accomplish

much with their bare hands, so they build buildings, design machines, create work

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procedures and assemble resources. The technology used has a significant

influence on working relationships. An assembly line is not the same as a research

laboratory; and a steel mill does not have the same working conditions as a

hospital. The great advantage of technology is that it allows people to do more and

better work, but it also restricts people in various ways. It has costs as well as

benefits. Thus, managing technology is an important component of effective and

efficient performance.

Environment: No single organisation exists alone and isolated. Rather all

organizations operate within an external environment. It is part of a larger system

that contains many other elements such as government, the family, and other

organizations. All of these mutually influence each other in a complex system that

creates a context for a group of people. Individual organizations, such as a factory

or a school, cannot escape being influenced by this external environment. It

influences the attitudes of people, affects working conditions, and provides

competition for resources and power. It must be considered in the study of human

behaviour in organizations and more particularly in the work context.

13.3.4. Fundamental Concepts of Organizational Behaviour

In order to understand the object of organizational behaviour comprehensively,

it is needed to thoroughly study the fundamental concepts revolving around the

nature of people and organisation. A summary of these ideas follows in the

following paragraphs.

The nature of people

With regard to people, there are four basic concepts: individual differences, a

whole person concept, motivated behaviour and the value of the person. Koith

Davis analyses the assumptions about the nature of people as under;

a) Individual Differences: All individuals in the universe are different from

each other. This is a fact even supported by science. The idea of individual

differences comes basically from psychology. Individual differences mean that

management can get the greatest motivation among employees by treating them

differently. If it were not for individual differences, some standard across-the-board

way of dealing with employees could be adopted, and minimum judgement would

be required hereafter. Individual differences require that a manager's approach to

employee should be individual, not statistical. This belief that each person is

different from all others is typically called the law of Individual differences.

b) Whole Person Concept: Although some organisations may wish they could

employ only a person's skill or brain they actually employ a whole person, rather

than certain characteristics. Different human traits may be separately studied, but

in the final analysis they are part of one system making up a whole person. Skill

does not exist apart from background or knowledge. Home life is not totally

separable from work life, and emotional conditions are separate from physical

conditions. People function as a total human being.

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If the management practises organizational behaviour of various techniques, it

implies that, it is trying to develop a better employee but also it wants to develop

better person in terms of growth and of fulfilment. Jobs in organizations shape

people somewhat as people perform them, so management needs to be concerned

about its effect on the whole person. Employees belong to many organ izations other

than their employees, and they play many roles inside and outside the firm. If the

whole person can be improved then benefits will extend beyond the firm into the

larger society in which each employee lives.

c) Motivated Behaviour: An important determinant of individual behaviour

and performance in an organisation is motivation. From psychology it can be

learned that normal behaviour of Individuals has causes closes may relate to a

person's needs and/or the consequences that result from acts. In the case of needs,

people are motivated not by what we think they ought to have but by what they

themselves want. To an outside observer a person's needs may be realistic, but they

are still controlling. This fact leaves management with basic ways to motivate

people. It can show them how certain actions will increase their need fulfilment, or

it can threaten decreased need fulfilment if they follow an undesirable course of

action. Clearly a path toward increased need fulfilment is the better approach.

Motivation is an essential stimulant through which the operations of an

organisation can be accomplished. No matter how much modern technology and

equipment an organisation has, these things cannot be put use until they are

released and guided by people who have been effectively motivated towards the

expected ends.

d) Value of the person: This concept is of a different order from the other

three because it is more an ethical philosophy than a scientific conclusion. If

mainly asserts that people are to be treated differently from factors of production

because they are of a higher order in the universe. It recognises that because

people are of a higher order, they want to be treated with respect and dignity. Every

job, irrespective of its natures the people who do it to proper respect and

recognition of their unique aspirations and abilities. The concept of human dignity

rejects the old idea of treating, employees simply as economic tools. Since

organizational behaviour always involves people, ethical philosophy is involved in

one way or another in each action. Human decisions cannot be made apart from

values.

The Nature of Organizations

Organizations are the outcome of interactions among people. So with two

organizations, the two key concepts are that they are social entities and that they

are formed on the basis of give and take principle. The nature of organisation

embodies two basic assumptions as quoted by Davis, relating to

1. Social systems: It can be learned from sociology that organizations are the

social systems in which individuals and groups fill their roles, and perform the

activities therein. These roles and activities are governed by social laws as well as

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psychological laws. Just as people have psychological needs they also have the

social roles and status. Then behaviour is influenced by their group as well as their

individual drives and motives. In fact two types of social systems exist side by side

in organizations. One is the formal social system and the other is the informal

social system

The existence of a social system implies that the organizational environment is

one of dynamic change, rather than a static set of relations, parts of the system are

interrelated, interdependent and subject to influence by any other. The idea of a

social system provides a framework for analysing organizational behaviour. It helps

make organizational behaviour problems understandable and manageable and

finally to achieve the organizational goals effectively.

2. Mutual benefit: Mutual benefit is represented by the statement

organizations need people, and people also need organizations any organisation

irrespective of its nature and type has human purpose. They are formed and

maintained on the basis of some mutuality of interest among their participants.

People see organizations as a means to help them reach their goals, while

organizations need people to help reach organizational objectives. If give and take

between organisation and employees working therein is lacking, it makes no sense

to try to assemble a group and develop co-operation. It also provides a

superordinate goal that integrates the efforts of individuals and groups. The result

is that they are encouraged to attack organizational problems rather than each

other. Indeed, this mutuality of interests provides a superordinate goal and forms a

basis for mutual cooperation. The same can be seen in the following

Mutual interest provides a superordinate goal for employees and the

organisation.

Holistic organizational behaviour

When the six fundamental concepts of organizational behaviour are considered

together, they provide a holistic concept of the subject. Holistic organizational

behaviour interprets people-organisation relationships in terms of the whole

person, whole group, whole organisation, and whole social system. It takes an

across - the-board view of people in organizations in an effect to understand as

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many as possible of the factors that influence their behaviour. Issues are analysed

in terms of the total situation affecting them rather than in terms of an isolated

event of problem.

Historical origins

As quoted by Keith Davis in his book "Human Behaviour at work" that

although human relations have existed since the beginning of time, the art and

science of trying to deal with them in complex organisation is a relatively recent

origin. In the early days people worked hard alone or in such small groups that

their work relationships were easily understood and handled. It has been popular

to assume that under these conditions people worked in a Utopia of happiness and

fulfilment, but this assumption is largely a nostalgic reinterpretation of history.

Actual conditions were brutal and back breaking. People worked from morning till

evening under intolerable conditions of disease, filth, danger, and scarcity of

resources. They had to work this way to survive, and very little effort was devoted to

their job satisfaction.

Then came the industrial revolution. In the beginning, the conditions of people

did not improve, but at least the seed was planted for potential, improvement.

Industry expanded the supply of goods and knowledge that eventually gave workers

increased wages, shorter hours, and more work satisfaction. In this new industrial

environment Robert Owen, a Welsh factory owner, about the year 1800, was one of

the first to emphasize human needs of employees. He refused to employ young

children. He brought his workers cleanliness and temperance and improved their

working conditions. This could hardly be called modern organizational behaviour,

but it was a beginning. He was called "the real father" of personnel administration

by an early writer.

Andrew Ure incorporated human factor into his philosophy of manufactures in

1835. He recognised the mechanical and commercial parts of manufacturing but he

also added a third factor, which was the human factor. He provided workers with

hot tea, medical treatment, "a fan apparatus" for ventilation, and sickness

payments. The ideas of Owen and Ure were accepted slowly or not at all, and they

often, deteriorated into a paternalistic do- good approach rather than a genuine

recognition of the importance of people at work.

Scientific management movement

It was in the latter part of the nineteenth century when the human element in

organizations attracted marked attention. It was awakened by Frederick. W. Taylor

in the United States. He is often called "the father of scientific management", an d

the changes he brought to management paved the way for later development of

organizational behaviour. Prior to this workers were considered as slaves to be

purchased and sold in the market and very little attention was paid to them as

human beings. Taylor's main concern was with the efficiency of both workers and

management. He believed that his methods of scientific management would lead to

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improved management-labour relations, and contribute to improved industrial

efficiency and prosperity

Taylor adopted an instrumental view of human behaviour together with the

application of standard procedures of work. Workers were regarded as rational,

economic beings motivated directly by monetary incentives linked to the level of

work output. Workers were viewed as isolated individuals and more as units of

production to be handled almost in the same way as machines. Hence, scientific

management is often referred to as a machine theory model. This movement

overlooked the significance of interpersonal behaviour in work settings.

The contributions made by Taylor continue to evoke much criticism and

comment by many management experts. As M. Rose argues Taylor's diagnosis of

the industrial situation was based on the single theme inefficiency. Among his

criticisms are that Taylor selected the best workers for his experiments and

assumed that workers who were not good at one particular task would be best at

some other task. There is, however, not certainty of this practice. Taylor regarded

workers from an engineering view point and as machines, but one best way of

performing a task is not always the best method for every worker. Rose also argues

that the concept of a fair day's pay for a fair day's work is not purely a technical

matter. It is also a notion of social equity and not in keeping with a scientific

approach.

The Hawthorne studies

It was in the 1920s and 1930s that stand out as a landmark in the history of

human behaviour at work when the Hawthorne studies' were conducted at Western

Electric company in America by Elton Mayo and R.J. Roethlisberger at Harvard

University. They gave an academic stature to the study of human behaviour at

work. The result of these studies was the concept that an organisation is a social

system and the worker is indeed the most important element in it. Their

experiments showed that the worker is not a simple tool but a complex personality

interacting in a group situation that often is difficult to understand.

There were four main phases to the Hawthorne experiments.

a) The Illumination Experiments: The original investigation was conducted

on the lines of the classical approach and was concerned, in typical scientific

management style, with effect of the intensity of lighting upon the workers

productivity. The workers were divided into two groups, one is an experimental

group and the other a control group. The net result of these tests were inclusive as

production in experimental group varied with no apparent relationship to the level

of lighting, but actually increased when conditions were made much worse.

Production also increased in the control group although the lighting remained

unchanged. The level of action was influenced, clearly by factors other than

changes in physical conditions of work. This prompted a series of other experiments

' investigating factors of worker productivity.

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b) The Relay Assembly Test Room: In the relay assembly test room the work

was boring and repetitive. It involved assembling telephone relays of putting

together a number of small parts. A control room was setup for the purpose, in

which measurement could be taken of humidity, illumination and other physical

factors. Six women workers were transferred from their normal departments to a

separate area. This group of six was segregated from others and also insulated from

the traditional practices of management. The experiment was divided into 13

periods during which the workers were subjected to a series of planned and led

changes to their conditions of work, such as reducing of work, rest pauses and

provision of refreshments. The general environmental conditions of the test room

were similar to those of the normal assembly line. During the experiment the

observer adopted a friendly manner, consulting with the workers, listening to their

complaints and keeping them informed of the experiment, following all but one of

the changes there was continuous increase in the level of production. The

researchers formed the conclusion that (1) better and more sympathetic

supervision, (2) closer and more informed interpersonal relation among the group,

(3) greater autonomy of the group as well as its members, and (4) a sense of

belonging promoted in them.

c) Mass interviewing programme: Another significant phase of the

experiments was the interviewing programme. The test room studies showed that

the type of supervision influenced morale. So the problem was how to improve

supervision? Why not get the frank opinions of the workers themselves on this

issue?

Accordingly, the programme was taken up of interviewing them. It had two

phases. In the first phase from September 1928 to the middle of 1929 it was the

direct type interview i.e. they were asked a few specific questions, to which the

answers were supposed to reveal their attitudes. It was found in course of these

interviews that the workers wanted to speak about many other things than those

embodied in the pre-determined questionnaires. So second phase of the interview

programme was launched in the later part of 1929. It was the depth or non

directive interview, in which the interviewer instead of asking the worker set

questions, encouraged him to talk freely on topics of his own choice. The average

length of the depth interview was one and a half hours, compared to only 30

minutes in the earlier straight interview. By 1931 over 20,000 employees were

interviewed separately many of them twice, informally and in confidence, with the

onset of the Depression, however, this programme was suspended.

The main conclusions arrived at experiments were that the supervisors should

be trained in such a way that they do not behave with the workers as their bosses.

Instead they should be kind and sympathetic to them. They should be trained more

to listen to talk, to be more result oriented, more concerned with the workers and

more skilled in handling social personal situations.

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d). Bank Wiring Group Observation: The earlier investigations had revealed

that informal groups among workers could influence to a great extent the behaviour

of their individual members. An important trend in such behaviour was restriction

of output. So the experimenters wanted to ascertain how a group could put

pressure on an individual member for lowering production in a high-incentive

system. Accordingly, the Bank wiring Group was set up and its behaviour was

studied for seven months from November 1931 to May 1932.

The group chosen for study comprised 14 men operators who assembled

switches for central office switchboard equipment. It was noted that the men

formed their own informal organisation with sub-groups or cliques, and with

natural leaders emerging with the consent of the members. The group developed its

own pattern of informal social relations and 'norms' of what constituted proper'

behaviour. Despite a financial incentive scheme where the workers could receive

more money for more produce, the group decided on a level of output well below the

level they were capable of producing. Group pressures on individual workers were

stronger than financial incentives offered by management. The group believed that

if they increased their output management would raise the standard level of rates.

The new emphasis on people at work was a result of trends that had been

developing over a long period of time. It helped bring human values into balance

with other values at work. But unfortunately, the term human relations' gradually

lost favour, although it continues to be used especially at the operating level

because of its appropriateness. An example is the statement. 'The supervisor is

effective with human relations. As the field became more mature and research-

based, the new term that arose to describe it was Organizational behaviour".

13.3.5. Role of Behavioural Science

The behavioural science offers several ideas to management as to how human

factor should be properly emphasised to achieve organizational objectives. Human

factor is not merely an instrument in the organisation but the very core of

organizational existence. An organisation is a conscious interaction of two or more

persons. This suggests that since organisation is the interaction of persons, they

should be given adequate importance in managing the organisation. This becomes

more important specially because of the changing dimensions of human behaviour,

changing from money-motivated behaviour to multi-motivated behaviour. The

changing behavioural pattern suggests that organizational structure and process

should be based on human characteristics. From this point of view managers must

understand the behavioural pattern of the people. Behavioural science provides this

opportunity by analysing human behaviour for understanding and prescribing

means for shaping human behaviour a particular direction.

Understanding Human Behaviour

Behavioural science provides a way for understanding human behaviour in the

organisation. For shaping human behaviour in definite direction for achieving

certain predetermined objectives, managers must know how the people in the

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organisation behave. Behavioural science paves the way for understanding human

behaviour in all the directions in which beings interact. Thus human behaviour can

be understood at the dual level, interpersonal level, group level and intergroup

level.

1. Individual Level: The behaviour of human beings as social men is first

issue in behavioural science. It offers for analysing why and an individual behaves

in a particular way. As will be seen later, human behaviour is a complex

phenomenon and is affected by a large number of factors - psychological, social,

and cultural, and others. Behavioural Science integrates these factors to provide

simplicity in understanding human behaviour.

2. Interpersonal Level: Human behaviour can be understood at the level of

interpersonal interaction. Such interpersonal interaction is normally in paired

relationship which represents man's most natural attempt at socialisation. When

one focuses on the influence of one's peer and its effect in working relationship, or

examines the two-person subordinate relationship, it is obvious that the two-person

relationship is inevitable in the organisation. Behavioural Sci ence contributes

means for understanding these interpersonal relationships in the organisation.

Analysis of reciprocal relationship, role analysis, and transactional analysis are

some of the common methods which provide such understanding.

3. Group Level: Though people interpret anything at their individual level,

they are often modified by group pressures which thus becomes a force in shaping

human behaviour. Thus individuals should be studied in group also. Research in

group dynamics has contributed vitally to the behavioural science and shows how a

group behaves in its norms, cohesion, goals, procedures, communication pattern,

leadership, and membership. These research results are furthering managerial

knowledge understanding group behaviour which is very important for

organizational morale and productivity.

4. Intergroup Level: The organisation is made up of many groups that develop

a complex of relationship to build its processes and substance. Understanding the

effect of group relationships is important for managers in today's organisation. Inter

group relationship may be in the form of co-operation or competition. The co-

operative relationships help the organisation in achieving its objectives. Behavioural

science provides means to understand and achieve co-operative group relationships

through interaction, rotation of members among groups, avoidance of win -lose

situation, and focus on total group objectives.

Controlling and Directing Behaviour

After understanding the mechanism of human behaviour, managers are

required to control and direct the behaviour so that it conforms to standards

required for achieving organizational objectives. Thus managers are required to

control and direct the behaviour at all levels of individual interaction. For this

purpose, behavioural science helps managers in many areas: use of power and

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sanction, leadership, communication, and building organisation climate conducive

for better interaction.

1. Use of Power and Sanction: Organizational behaviour can be controlled

and directed by the use of power and sanction which are formally prescribed by the

organisation. Power is referred to as capacity of an individual to take certain action

and may be utilised in many ways. The use of power is related with sanction in the

organisation. However, more use of power and sanction in the organisation is not

enough for directing human behaviour. Moreover, these can be used in several

ways and not all ways are equally effective. Behavioural science explains how

various means of power and sanction can be utilised so that both organizational

and individual objectives are achieved simultaneously.

2. Leadership: Another method of bringing human behaviour in tune with

organizational requirement is leadership. Today, the difference between a

successful and failing organisation lies in the quality of leadership of its managerial

personnel. Behavioural science brings new insights and understanding to the

practice and theory of leadership. It identifies various leadership styles available to

a manager and analyses which style is more appropriate in a given situation. Thus

managers can adopt styles keeping in view the various dimensions of organizations,

individuals, and situations.

3. Communication: Communication is the building blocks of an organisation.

It is communication through which people come in contact with others. People in

the organisation, particularly, at higher level spend considerable time in

communication. To achieve organizational effectiveness, the communication must

be effective. The communication process and how it works in interpersonal

dynamics has been evaluated by behavioural science. The factors that affect

communication have been analysed so as to make it more effective.

4. Organizational Climate: Organizational climate refers to the total

organizational situations affecting human behaviour. Organizational climate takes a

systems perspective and affects human behaviour. Behavioural science suggests

the approach to create organizational climate, in totality rather than merely

improving the physiological conditions organising employee satisfaction by

changing isolate work process. Satisfactory working conditions, adequate

compensation, and the necessary equipments for the job are viewed as only small

part of the requirements for sound motivational climate. Other greater importance

are the creation of an atmosphere of effective supervision, the opportunity for the

realisation of personal goals, congenial relations with others at the work and a

sense of accomplishment. Thus, behavioural science has discovered a new

approach of managing people in the organisation.

5. Organizational Adaptation: Organizations as dynamic entities are

characterised by pervasive change. In this age of environmental variability, real job

of a manager is to provide continuity in organizations because organizations have to

adapt themselves to the environmental changes making suitable internal

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arrangements. However, such organizational arrangements are mostly resisted by

the internal people. Thus, managers have to face dual problems, identifying need

for change and then implementing the changes without adversely affecting the need

satisfaction organizational people. Behavioural science has the ongoing process as

its goal. It is also the essence of managing change. Management of change is seen

as a self- perpetrating ever-evolving phenomenon.

13.3.6. Constraints or limitations of organizational behaviour and managerial performance

In the words of Keith Davis, organizational behaviour primarily emphasizes

only on the human side of organizations and the kinds of benefits that attention to

it can bring. Further he says organizational behaviour will not absolutely abolish

conflict and frustration among the employees in the organisation but it can only

reduce them. It is a way to improve the whole not an absolute answer to problems.

Furthermore, it is part of cloth of an organisation. We can discuss organizational

behaviour as a separate subject, but to apply it we must tie it back to whole reality.

Improved organizational behaviour will not solve unemployment. It will not make

up for our own deficiencies. It cannot substitute for poor planning, input

organisms, or inadequate controls. It is only one of many factors operating within a

larger social system.

The major constraints of organizational behaviour can be discuss under.

Behavioural Bias: People who lack system understanding may develop a

behavioural bias, which gives them a narrow view point that emphasizes satisfying

employee experiences while overlooking the broader system of the organisation in

relation to all its public. This condition is often called as 'tunnel vision' because

view points are narrow, as if people were working through a tunnel. They see only

the view at the other end of the tunnel while missing the broader landscape.

It should be evident that concern for employees can be so greatly overdone

that the original purpose of joining people together productive organizational

outputs for society - is lost. Sound organizational behaviour should help achieve

organizational purposes, not replace them. The person who ignores the needs of

people as consumers of organizational outputs while championing employees needs

is misapplying the ideas of organizational behaviour. It is also true that the person

who pushes production outputs without regard for employee needs is misapplying

organisation behaviour. Sound organizational behaviour recognises a social system

in which many types of human needs are served in many ways.

Behavioural bias can be so misapplied that it harms employees as well as the

organisation. Some people, inspire of their good intentions, so overwhelm others

with care that they are reduced to dependent and unproductive - indignity. They

become content not fulfilled. They find excuses for failure, rather than taking

responsibility for progress. As happened with scientific management years ago

concern for people can be misapplied by over eager partisans until it becomes

harmful.

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Thus, employees as well as managers can handicap a fellow employee through

unrestricted concern and care.

The law of diminishing returns: Over emphasis on organizational behaviour

practice may produce negative results as indicated by the law of diminishing

returns. It is a limiting factor in organizational behaviour the same way that it is in

economics. In economics the law of diminishing returns refers to a declining

amount of extra outputs when more of a desirable input is added to an economic

situation. After a certain point, the output from each unit of added input tends to

become smaller. The added output eventually may reach zero and even decline

when more units of input are added.

The law of diminishing returns in organizational behaviour works in a similar

way. It states that at some point increases of a desirable practice produce declining

returns, eventually zero returns, and then negative returns as more increases are

added. The concept implies that for any situation there is an optimum amount of a

desirable practice such as participation. When that point is exceeded, the re is a

decline in returns. In other words, the fact that a practice is desirable does not

mean that more of it is more desirable. More of a good thing is not necessarily good.

Diminishing returns may not apply to every human situation, but the idea

applies so widely that it is of general use. Furthermore, the exact point at which an

application becomes excessive will vary with the circumstances but an excess can

be reached with nearly any practice.

Generally one question may be raised saying that why does the law of

diminishing returns exist? Essentially, it is a system concept. It applies because of

the complex system relationships of many variables in a situation. The facts state

that when an excess of one variable develops, although that variable is desi rable, it

tends to restrict the operating benefit of other variables so substantially that net

effectiveness declines. For example too much security may lead to less employee

initiative and growth. This relationship shows that organizational effectiveness is

achieved not by maximizing one human variable but by working all system

variables together in a balanced way.

Employee autonomy as an example. Employee autonomy is a higher - order

need that is frequently emphasized. Some observers speak autonomy as an ideal,

implying that, if employees could have complete autonomy, then the ideal state

would be achieved, but this kind of reasoning ignores the law of diminishing

returns. As shown in figures effectiveness tends to decline when too much

autonomy occurs. On reason probably is that, excess autonomy prevents

coordination toward central goals. Different units of the organisation cannot work

together, the labour of employees is wasted.

At the end of the continuum, the lack of autonomy also is ineffective. When

autonomy declines below an appropriate level, the organisation fails to develop and

use the talents of employees. The result is that effectiveness declines with both

excessive use and miserly use of autonomy. Most success is gained in the broad

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middle ground of use. This relationship produces a humpback curve for autonomy

when it is chatted with effectiveness.

The law of diminishing returns serves as a warning that although increases in

desirable practices can be beneficial, an excess of any of them will be

counterproductive. Moderation is required. People observed with building only

autonomy or creating maximum. Employee security will not be contributing to

organizational success. There can be too much of a good thing just as there can be

too little of it.

Other problems: One problem that has plagued organizational behaviour has

been the tending for business firms to have short time horizons for the expected

pay off from behavioural programmes. This search for a 'quick fix' sometimes leads

managers to embrace the newest fad to address the symptoms while neglecting

underlying problems or to fragment their efforts within the firm. The emergence of

organizational development programmes that focus on system wide change and the

creation of long-term strategic plans for the management of human resources have

helped bring about more realistic expectations concerning employees as a

productive asset.

Another challenge that confronts organizational behaviour is to see whether

the ideas that have been developed and tested during periods of organizational

growth and economic plenty will endure with equal success under new conditions.

Specifically, the environment in the future may be marked by some shrinking

demand, scare resources, and more intense competition. When organizations

stagnate, decline, or have their survival threatened, there is evidence that stress

and conflict increase. Will the same motivational models be useful in these

situations? Are different leadership styles called for? Will the trend toward

participative processes be reversed? Since no easy answers to these and many

other questions exist, it is clear that there is still tremendous room for further

development of organizational behaviour.

Manipulation of people: A significant concern about organizational behaviour

is that its knowledge and techniques can be used to manipulate people as well as to

help them develop their potential. People who lack respect for the basic dignity of

human being could learn organizational behaviour ideas and use them for selfish

ends. They could use what they know about motivation or communication to

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manipulate people without regard for human welfare. People who lack ethical

values could use people in unethical ways.

The philosophy of organizational behaviour is supportive and oriented toward

human resources. It seeks to improve the human environment and help people to

grow forward their human potential. However, the knowledge and technique of this

subject may be used for negative as well as positive consequences. This possi bility

of true of knowledge in most any field, so it is no special limitation of organizational

behaviour. Nevertheless, we must be cautions that what is known about people is

not used to manipulate them. The possibility of manipulation means that people i n

power in organizations need to be people of high ethical and moral integrity who

will not misuse their power. Without ethical leadership, the new knowledge that is

learned about people becomes a dangerous instrument for possible misuse. Ethical

leadership will recognise such guides as the following as quoted by Wayne F.

Cascio.

a) Social responsibility, Responsibility to others arises whenever people have

power in an organisation.

b) Open communication: The organisation shall operate as a two-way open

system with open receipt of inputs from people and open disclosure of its

operations to them.

c) Cost-benefit analysis: In addition to economic costs and benefits human and

social costs and benefits of an activity shall be considered in determining

whether to proceed with it.

What is the difference between genuine motivation and manipulation of

people? Basically the conditions of use need to be examined. If people understand

what is happening and have substantial freedom to make their own choices, they

are not being manipulated. But if they are being covertly directed and/or lack free

choices, they are being manipulated. This is true whether the manipulator is a

social scientist, another employee or a manager.

As the general population learns more about organizational behaviour, it will

be more difficult to manipulate them, but the possibility is ways there. That is why

society needs ethical leaders. But ethical leader cannot succeed unless there also

are ethical followers.

13.3.7. Understanding Individual

This heading divulges with understanding individual behaviour in an

organization. It explains the nature of human being as an individual, as an

employee in the organization. The human beings may have several similarities as

well as differences among them. These similarities and differences will have impact

on the behaviour of employees in the organization. The personality of employees

and the determinants of personality which will have an impact on an individual

behaviour are also dealt in this unit. Learning is a process wherein environment

plays a major role. People act as they perceive. Different people perceive things

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differently. Values play an important role in the study of organizational behaviour

as they lay the foundation to understand perception, attitudes, and personality.

In any human activity, nothing of any consequence happens until an

individual wants to act. The success or failure of any organization depends not only

on the organizational functions - production, finance, marketing and also on the

quality of human character. What individual can accomplish depends to a great

extent on how much and why one wants to act. The individual's will to work is

different from his capacity to work. Management can buy employee's time, his

physical efforts but not his enthusiasm, initiative or loyalty. One of the serious

problems in organizations is to get maximum efforts and contribution of

individuals.

The Individual

The Individual is a person with distinct character and personality traits or

behavioural patterns. Every person has his own individuality, which means that the

individuals who form the groups have individual differences. Obviously, any group

is characterised by individual differences. An individual moves from childhood,

through adolescence, to adulthood; and accordingly his personality attains the

necessary change and maturity. The more the maturity the more the adjustability.

The individual starts his development from the very moment of birth. The

biological factor, sociological factors, historical factors, genetic factors, cultural and

environmental factors as well as heredity substantially influence the developmental

processes of perception, learning and motivation. It ultimately develops a

personality of his own, i.e. any individual has a personality of his own.

The individual develops into adolescence through infancy and childhood.

Freud pointed to the possibility of identifying the basis for adult personality

patterns in the problems of early childhood. Many other thinkers have also

provided identical view of the behaviour of individual in the early norms of test

performance at each age in developing mental abil ity. Regarding individual

development Kolasa's remark seems to be relevant: "Up to age two the child is

immersed in problems of his sensor motor operations. Preconception thought,

where concrete things are recognised a standing for real ones, develops before age

four though classification of these concepts takes place up until age seven. Even at

this age however, the child is tied to concrete states (though in greater number) and

not until approximately age 11 is there a move to abstract thought and use of logic

and hypotheses. While the stages may be too rigidly defined, Piaget’s research does

show the changing nature of the individual and his ability proceed in the world.

Thus, the individual in the process of change to reach his real self as a long line of

transition. Again dogmatic positions may be faced by the individual at certain ages

during the period of maturity.

The basic input for human behaviour is sensation of information. Hence,

development of individual necessitates development of sensational also. Cognitive

process is another critical function in individual behaviour for which the variables

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like perception, learning, abilities), concept formation, problem solving, language,

etc. are important. Any individual has to develop these qualities in him for an

important cognitive process to take place in him. These qualities, in some

magnitude, are prevalent in every individual. The greater the development of them

the greater would be the cognitive process.

Management and human factor

The functions of management are planning, organizing, motivating, and

controlling. These functions that comprise the management process-a step-by-step

way of doing something-are relevant regardless of the type of organization or level of

management with which one is concerned. As Harold Koontz and Cyril O'Donnell

have said: "Acting in their managerial capacity, presidents, department heads,

foremen, supervisors, college deans, bishops, and heads of governmental agencies

all do the same thing. As managers they are all engaged in part in getting things

done with and through people. As a manager, each must, at one time or another

carry out all duties. The Planning involves setting goals and objectives for the

organization and developing "work maps" showing how these goals and objectives

are to be accomplished. Once plans have been made, organizing becomes

meaningful. This involves bringing together resources-people, capital and

equipment in the most effective way to accomplish the goals. Organizing, therefore,

involves an integration of resources.

Motivating plays a large part in determining the level of performance of

employees, which, in turn, influences how effectively the organizational goals will be

met. Motivating is sometimes included as part of directing, along with

communicating and leading.

William James of Harvard in his study found that hourly employees could

maintain their jobs (that is, not be fired) by working at approximately 20 to 30 per

cent of their ability. His study also showed that employees work at close to 80 to 90

percent of their ability if highly motivated. Both the minimum level at which

employees might work and yet keep their jobs and the level at which they could be

expected to perform with proper motivation. This shows us that if motivation is low,

employees' performance will suffer as much as if ability were low. For this reason,

motivating is an extremely important function of management.

Another function of management is controlling. This involves feedback of

results and follow-up to compare accomplishments with plan and to makes

appropriate adjustments where outcomes have deviated from expectations.

Even though these management functions are stated separately, and as

presented seem to have a specific sequence, one must remember that they are

interrelated. While these functions are interrelated at any one time one or more

may be of primary importance.

Skills of a manager

The three areas of skill necessary for carrying out the process of management

as specified by Paul Hersey and Kenneth H. Blanchard. They are Technical skill,

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Human skill and conceptual skill. Technical skill -ability to use knowledge,

methods, techniques and equipment necessary for the performance of specific tasks

acquired from experience, education, and training.

Human skill-ability and judgement in working with and through people,

including an understanding of motivation and an application of effective leadership.

Conceptual skill-ability to understand the complexities of the overall

organization and where one's own operation fits into the organization. This

knowledge permits one to act according to the objectives of the total organization

rather than only on the basis of the goals and needs of one's own immediate group.

The appropriate mix of these skills varies as an individual advances in

management from supervisory to top-management positions. To be effective less

technical skill tends to be needed as one advances from lower to higher levels in the

organization but more conceptual skill is necessary. Supervisor at l ower levels need

considerable technical skill because they are often required to train and develop

technicians and other employees in sections. At the other extreme, executives in a

business organization need to know how to perform all the specific tasks at the

operational level. However, they should be able to see how all these functions are

interrelated in accomplishing the goals of the total organization.

While the amount of technical and conceptual skills needed at these different

levels of management varies, the common denominator that appears to be crucial at

all levels is human skill.

Importance of human skills

The human skills were considered unimportant in the past, but they are of

primary importance today. For example, one of the great entrepreneurs John D.

Rockefeller, stated: "I will pay more for the ability to deal with people than any other

ability under the sun". These words of Rockefeller are often echoed. According to a

report by the American Management Association, an overwhelming majority of the

two hundred managers who participated in a survey agreed that the most

important single skill of an executive is ability to get along with people. In this

survey, management rated this ability more vital than intelligence, decisiveness',

knowledge or job skills, management skills necessary at various levels of an

organization.

Nature of man

Human Nature: The term "human nature" refers to the characteristics of

mankind which generally enable us to distinguish humans from animals, from

inanimate objects, and from social abstractions such as society or organization.

The descriptions of human nature, however, vary enormously. Human nature

can be the set of motives, mental and emotional capacities, and psychic

mechanisms common to human being. More broadly speaking, it is a set of human

needs, drives, predispositions, tendencies, propensities, and actual behaviours.

Human nature can be conceptualized in a negative way in the absence of

socialization. This sociological and psychological perspective treats human nature

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as a source of systematic variance in behaviour. Man's nature can be described in

terms of: Levels; Dialectic; Norms; Innateness; and learning:

(i) Levels: Here mankind is assumed to have a biological nature, a social nature,

and a creative nature (Murphy, 1958).

(ii) Dialectic: Man is seen as having more separate natures, which behave as a

result of their dialectical interaction.

(iii) Norms: With a metaphysical philosophy one can make lists of behaviours

required of humans if they are give evidence of being human.

(iv) Learning: A less restrictive approach to that of the sociobiologisls allows pan-

human learned behaviour to be called part of human nature. Thus a learned

behaviour, is a characteristic of human nature. Human nature is a measure of

central tendency among human not necessarily observable in a given human

being.

(v) Innateness: In this sociobiological approach almost every individual has a set

of genetically determined characteristics which do not diffe rentiate that

individual from others.

Definition

The Greek philosophers described human nature as a rational principle

governing humans in an almost law-like manner. Man is driven to be rational

because the universe is rational. This law- boundedness characteristic of human

nature carried over into the medieval view although the content of the law changed,

mankind was driven not to be rational but to seek out perfect good.

Humans were viewed as purposeful creatures who use reasons to carry out the

dictates of their will. A focus on the passions and emotions emerged, which led to

two opposing views. Mantaigne characterized "human as inconsistent, irresolute,

and untamable". These thinkers could-not envisage any kind of malleability in

human nature which would make humans manageable or teachable in any complex

way. A second view however, stressed the plasticity of man's nature, and believe

that essentially, man's nature could be moulded.

Adoption and selection theories of organizations are based on assumptions

that humans are controlled by their environments, while strategic choice theories

focus on the role of voluntarism.

If human nature is the result of, or caused by, or emerging from something

external to humankind, then it can be called law bound. This means that human

characteristic can be explained, predicted, accounted for, controlled by reference to

metaphysical, biological, historical, cultural, social, or environmental forces.

Alternatively, if human nature is the result of something internal to humankind

then it can be called self bound. In this view human nature emerges out of human

purposiveness or sense making rather than in response to external law.

Similarities and differences among individuals

Individuals differ in personal characteristics and these differences create

difference in work performance and behaviour of individuals at work place.

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Individuals differ in physical build up, appearance, intelligence attitudes,

personality, interests, motives, skills, training education, job knowledge and skills.

Such differences have their important impact in industry as they affect, the job

behaviour of the people. The behaviour of any individual responds to any particular

situation depending upon what he brings into the situation, in terms of abilities,

education, skills, trainings, desires, interests, habits and understanding.

Psychology assist in studying the difference of one individual with another. People

differing their physical characteristics, intelligence, intellectual attitude, interests,

temperament and in character. Human nature is greatly influenced by the

environment, acquired habits, traits and characteristics. The management can

change the behaviour of persons by changing the work environment and by

educating and by training them. Certainly there are differences between

individuals. Placed in similar situations all people do not act alike. However, there

are certain fundamental similarities underlying the behaviour of all individuals that

can be identified and then modified to individual differences.

Individual difference can be assessed in terms of differences in individual

characteristics. Most prominent among them can be (1) Physical characteristics. (2)

Personality traits, (3) Perception, (4) Attitudes, (5) Emotions, and (6) Memory. The

other characteristics are interests, motivation, behaviour and approaches especially

frustration, role behaviour, the overall personality, and so on. The prominent, ones

are described here.

1. Physical Characteristics: are weight, arm span, vital capacity, strength of

the grip, visual acuity, auditory acuity, fatiguability, appearance and countenance,

facial expressions and gestures, etc. Evaluation of such differences in the physical

characteristics is important so the individual performance generally depends on

such characteristics.

2 Personality: Traits are also known as temperamental or emotional qualities

of a person, can be the essential characteristics of the behavioural pattern of the

individual. These traits are: dominant, cheerful, cowardly, dishonest, timid, honest,

moody, etc. Many such personality traits or characteristics are found in great

magnitude in some persons: especially characteristics like aggressiveness,

persistence, sociability, dominance, helpfulness, orderliness etc. are very dominant

in certain individuals. Some psychologists are of the opinion that personality traits

are different, from emotional traits, character traits of personal traits.

Characteristics like spirituality, honesty, truthfulness, integrity, etc. are character

traits; while emotional maturity, cheerfulness, aggressiveness, neuroticism,

pessimism, etc. are emotional or temperamental traits. Personal traits are specific

and typical ways of an individual's behaviour such as co-operative attitude,

submissiveness, humbleness, meekness, dominance, optimism, etc. Though these

traits can be inborn, they can be achieved through experiences and learning, too.

3. Perception: Differences in perception also substantially differentiate

individuals. There are no two opinions that people differ in their perception ability.

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What we see is based on the way the brain organises the nervous impulses which

come from the eye. The difference in perception is characterised by difference in

what we see, hear and understand, which is brought about by how the figures are

framed in the process of seeing, hearing and understanding. In this context, it can

be observed that what we perceive depends not only on our power of seeing or

hearing but also the frame of reference in which it is seen or heard. If a person is

exposed to different situations or if different people are exposed to one situation,

their perception is bound to differ. It shows that the perception ability differs from

person to person and from situation to situation. At the same time the manager's

performance efficiency depends on his perception ability. The greater the perception

ability the greater would be the managerial efficiency.

4. Attitude: Attitude is another very important concept in individual

differences on the one hand and, in psychology and organizational behaviour on the

other. It is very often used as an important variable to determine individual

differences.

5. Emotions: Individual differences can be judged in terms of emotional

differences also. Emotion is a complex state involving conscious feeling,

physiological changes, and an evaluation of a given situation as having significance

of some kind for the individual. Many emotions are accompanied by action

tendencies toward approach or withdrawal. For example, if somebody, who is

closely associated with us, behaves in an unexpected and opposite direction from

what we desired of him, then we would be provoked to have a strong feeling of

anger, which is our emotion, in fact, every individual has certain 'wired in'

resources for emotional behaviour that tend to develop in a pattern of emotional

development which, as a matter of fact, can be universal. However, learning

influences the emotional pattern considerably, which cannot be ignored.

6. Memory: Memory is the ability to retain and recall what is conceived. It is

the faculty for keeping things in one's mind. Memory therefore, is an essential

faculty of individuals, which is closely associated with perception and learning.

Though it can be an inborn quality considerable amount of memory power can be

achieved through recollection also. Individuals differ in their memory power which

is the ability to remember things after some interval. Though it is an essential

faculty, under certain circumstances ability to forget is also a blessing.

Interests, behaviours and approaches, motivation, and such other factors also

differ considerably from individual to individual. Accordingly, individual behaviour

may also differ.

Model of human being

The self, or human nature, interacts with world through "connectedness" this

is the continuity between internal psycostructure and external objects. To

understand the behaviour of people which is a very complex thing, there is need to

examine the structural integrative and field properties of a human system. Let us

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make an attempt to broaden our perspective of man's nature by analysing and

understanding the major models of a human being.

Psychoanalytic Model of a Man: It is based on the pioneer work of Sigmund

Freud. The underlying principle of this model is based on the clinical analysis. This

model is complied and outlines three sets of concepts (id, ego and super ego) and

their interaction. The behaviour is the result of interaction of three key sub-systems

within the personality, 'id' 'ego' and superego’. The 'id' contains the innate drive of

man such as hunger, thirst and aggression. These innate drives are constructive,

primitive and sexual in nature which provides the basic energy of life. The ' id'

operates as pleasure seeking principle and is concerned with immediate pleasure. It

is there selfish and unconcerned with reality or moral considerations. The second

sub-system the 'ego' develops to mediate between the demands of the ‘id’ and the

realities of life. The initial concept of 'ego' was that it is meet the 'id' demands. But

‘ego’ in fact is the central control of personality and operates in terms of reality. The

third key system the ‘superego’ which contemplates moral values of society, it is the

conscience which is concerned bad, right or wrong. Superego is the additional inner

control coming into central operation to cope with the uninhibited desire of the 'id'.

Anxiety

Anxiety is both a painful experience and a warning of impending danger and

hence forces the individuals to do something to adjust with the situation. Ego can

cope with anxiety by rational measures. Freud distinguished three types of anxiety

(a) Reality anxiety (b) Neurotic anxiety (c) Moral anxiety. The reality anxiety stems

from threats in external environment. The neurotic anxiety arises when 'id' is

threatened to break ego control and the resulting behaviour will lead to

punishment. The moral anxiety when individual contemplates doing something.

Another point of importance in psychoanalytic model of man is the psychosexual

development. Freud said psychosexual development as a succession stages

characterised to achieve libidinal pleasure. Following stages of psychoanalytic

formulation.

Oral stage: This occurs during the first year of life when libidinal pleasure is

achieved primarily through stimulation of the lips and mouth

Anal Stage: It involves the second and third year of life in which the libidinal

pleasure is associated with defecation.

Phallic Stage: The stage of “Phallic” is between 3 and 5 years ago when the

child seeks pleasure through self manipulation of the genitals.

Latency Stage: The stage of "Latency" is between 6 and 12 years ago when

sexual pleasure recedes in importance and the child is busy in developing various

skills.

Genital Stage: The final stage is the genital stage in which real pleasure

comes from heterosexual relations. Thus psychoanalytic man is dominated by

instinctual biological drives an unconscious motives.

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Behaviouristic Model of Man: The concept of behaviour stems from the early

work of John Watson. He emphasised that through the objective observation of

behaviour and stimulus conditions, the psychologists learn to predict and control

man's behaviour. The behaviourists make a distinction between respondent and

apparent behaviours. The respondent responses include simple reflexes and

emotional responses which are elicited by appropriate stimuli even prior to

learning. The term apparent is brought in because in such responses the individual

operates upon or modifies the environment. Crucial to both respondent and

apparent condition is reinforcement which refers to the strengthening of the new

responses by presentation of suitable stimulus.

Reinforcement may be negative as well as positive. Reinforcement is effective

because it reduces the level of tension created by biological drives like hunger and

other physiological needs (primary drive) and psychological needs like social drives,

self- esteem, social approval (secondary needs) etc. learned condi tioning. Similarly

generalisation is the tendency for a response developed by a conditioned stimulus

to become associated with other stimulus. Similarly discrimination occurs when the

individual learns to distinguish between similar stimuli and respond to one and not

to another. According to this model complex processes such as perceiving, forming

concepts, solving problems, taking decisions etc. are based on the core idea of

discrimination operation.

Humanistic Model of Man: Humanistic model attributes great importance to

human learning but emphasises reflection, reasoning and creative imagination

rather than conditioning. Much of human behaviour is influenced by past

experience. The human being is self aware, future oriented and capable of resisting

environmental influences. The idea of self is somewhat synonymous with the of ego.

The humanistic model emphasises the concept of uniqueness of individuals,

recognition actualisation.


1. Understanding individual.

2. Management and human factor.

3. Organisational behaviour.


1. What is meant by organisational behaviour?

2. Define nature of man.

13.6 SUMMARY

In this lesson characteristics of organisational behaviour are discussed. The

facts of Hawthorne experiments and its impact on employee performance. It shows

how the study of OB and other disciplines have emerged.


1. What are the characterisations of OB?

2. Examine the salient features of Hawthorne experiments.

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3. Briefly explain the factors influencing OB.

4. Analyse individual behaviour and nature of man.


1. https://en.wikipedia.org/wiki/organizational_behavior

2. https://study.com/academy/lesson/what-is-organizational-behavior-

definition-and-history-of -the-field.html

13.9. ASSIGNMENTS

1. Identify two ethical dilemmas that you have faced during the past year? How

did you resolve them?

2. “The best way to review OB is through a contingency approach”, Build an

argument to support this statement.

13.10. SUGGESTED READINGS / REFERENCE BOOKS

1. Luthans Fred “International organizational behaviour” McGraw Hill

Publication co. Ltd., New Delhi 1988.

2. Aswathappa K. “Organisational Behaviour” H PH Bombay

3. Davis Keith and Newstrom, W. John “Human Behaviour at work” McGraw

Hill Book co., International edition.

4. Hersey, Paul and Blachard Ken “Management of Organisational Behaviours-

utilizing Human Resources” prentice hall of India ltd.,


1. Discuss about individual and nature of man

13.12 KEY WORDS

Social System, Human Behaviour, Leadership, Organisational Climate,

Personality Traits, Perception, Anxiety.

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LESSON - 14

MOTIVATION AND PERSONALITY

14.1. INTRODUCTION

Motivation describes the forces acting on or within a individual that cause the

individual to behave in a specific and goal directed manner. Motivation is the most

important concept in understanding the behaviour of the individual. Every

organisation has people with-outstanding abilities who perform better than the

others. Why do some people perform well while others do not? We try to answer the

questions by understanding the meaning of the motivation.

People in the organisation have dignity, self-respect, values, sentiments and

aspirations apart from the economic status. Because of these the efficiency of the

enterprise is related not only to the efficiency of the sophisticated machines

installed but also importantly upon the satisfaction and desire of people to put their

mind and heart into the work.

14.2 OBJECTIVES

To understand the importance of the concepts motivation and personality

To discuss various theories of motivation

To know various personality attributes

14.3 CONTENT

14.3.1. Meaning

14.3.2. Theories of Motivation

14.3.3. Personality

14.3.1. MEANING

Motivation encompasses numerous complex aspects of human behaviour to

which contribution has been made by Sociologists, Social Anthropologists,

Psychologists and the business executives.

The term motivation was generated from the Latin word 'movere' which means

'to move'. People who are 'motivated' exert greater efforts to perform than those who

are not motivated. However, this definition is relative. Berelson and Steiner (1964)

defined 'A motive is an inner statement energies, activities or moves, and that

directs or channels behaviour towards goals'. Sanford and Wrightsman (1970)

described that a motive is a restless-ness, a lakh, a yen, a force, once in the group

of motive, the organism does something. It most generally does something to reduce

restlessness, to remedy the lakh, to alleviate the yen, to mitigate the force; a more

descriptive and less substantive definition would say that motivation is the

willingness to do. Willingness to do is conditioned by the need for satisfaction.

"Motivation refers to the way in which urges, drives, desires, aspirations, strivings

or needs, direct, control or explain the behaviour of human beings" (DALTON).

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The definition of motivation includes the following:

The urges, drives, desires, aspirations, strivings or needs of a human being

influence human behaviour,

The factors to influence human behaviour are Psychological sociological,

economical or managerial.

The efficiency of such behaviour - this may be tested by the resultant action.

Whether this behaviour has directed, controlled or implemented the desired action.

If the individual feels motivated, his behaviour will result in the performance of

desired action. Volumes have been written on human motivation, the two

outstanding works of Abraham Maslow and Frederick Herzberg may be considered.

To be the pillar posts on this subject Professor A.H. Maslow wrote motivation and

personality and Professor Frederick Herzberg, Bermard Mausener and Barbara

Block Synderman wrote books on motivation to work. The word 'motive' has been

interpreted the many words like 'desires', 'counts', 'wishes', 'aims', 'goals', 'needs',

drives' and 'incentives'.

Motivation process

The motivation process is depicted in the following figures:

Figure – I

Figure – II

Motivation of people depends on their motives. Motives are defined more often

as needs, wants, drives or impulses within the individual. Motives are generally

directed towards goals. These goals may be conscious or sub conscious.

An unsatisfied need creates tension which stimulates drives within individual.

The drives generate a search behaviour to find a particular goal that, if attained,

will satisfy need and lead to reduction of tension, Motivated employees are in a

state of tension. In order to relieve this tension, they engage in activity. The greater

the tension, the more activity will be needed to bring about relief. When individuals

work hard at some activity, we can conclude that they are driven by a desire to

achieve some goals that they perceive as having value to them.

It is, however, underivable that motives are directed to the attainment of goal

which in turn determine the behaviour of the human beings. This behaviour

ultimately leads to goal directed activity' such as preparing food and goal activity

such as eating food (Hersey & Kenneth). The motivation process is built on the

foundation of unsatisfied need. Although infrequently viewed as self-serving

desires, human beings behave in a way that they perceive to be best in their se lf

interest. Ever, consciously or unconsciously asks, himself, what is in kit form of

engaging in any form of behaviour. The principle that individuals are motivated by

their self interest underlies almost every economic theory and is contained,

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explicitly or implicitly in all theories of motivation. Whether it is called self serving

behaviour, need satisfaction or whatever, the underlying concept is the same:

individuals act so as to maximise their own self interest. Thus, self interest is the

ultimate motivating process.

In systems sense motivation consists of three interacting and independent

elements, motives, behaviour and goals.

Behaviour

All behaviour is a series of activities. Behaviour is generally motivated by a

desire to achieve a goal. At any moment individuals may indulge in multifarious

activities like working, talking, eating and the like. They switch over from one

activity to another activity quickly. In order to predict and control the behaviour

managers must understand the motives people.

Motives (needs)

The terms motives, needs and drives are used interchangeably Motives are

action-oriented and provide thrust toward goals accomplishment. Needs are created

whenever there is a physiological or psychological imbalance. For example, the

needs for food and water are translated into the hunger and thirst drives, and the

need for friends becomes a drive for affiliation.

Goals

Motives are directed towards goals. Motives generally create a state of

disequilibrium, physiological or psychological imbalance within the individual.

Attaining a goal will tend to restore physiological or psychological balance. Goals

are the ends which provide satisfaction human wants.

Types of needs - primary needs (Motives)

Psychologists classified needs into different categories. A simple classification

is primary needs and secondary needs. The primary needs include physiological

needs. Physiological needs are food, shelter, clothing, water, air etc. These needs

arise from the basic physiology of life and are important to survival and

preservation. Therefore, these needs universal in people but the intensity of these

needs may vary from person to person. These physiological needs are conditioned

by social, pu.1et.1ces and are physiologically based. The primary motives include

hunger, thirst, sleep and material concern.

General Motives

General Motives are those which lie between the primary and secondary

motives. The motives of competence, curiosity, manipulation, activity and affection

can be included in this category. An understanding if these motives is important to

the study of human behaviour. They are relevant to organizational behaviour than

the primary motives.

The competence motive

Robert White (1959) built his tie of motivation around competence. He believes

that people strive to have control over their competence. This motive is mostly

http://pu.1et.1ces/

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exhibited at the age of nine by venturing out into the world on their own by

crossing the road by themselves, ride a bicycle, play basket ball etc. These needs

are manifested by the drive for competence, or mastery over the environment.

This motive has interesting implications for job design in an organization.

People may be motivated by the challenging job of trying to master the job or to

become competent in the job.

The curiosity manipulation and activity motives

Although these drives often get the small child into trouble, curiosity

manipulation and activity, if carried forward to adulthood can be very beneficial to

the organisation. If the employees are stifled from expressing curiosity,

manipulation and activity motives the organisation will eventually suffer.

The affection motive

Affection Motive is associated with both primary and secondary motives.

Affection motive is associated with love and affiliation. Affection deserves special

attention because of its growing importance to the world where we suffer from

interpersonal, inter-individual and national conflict where quality of life and human

rights are becoming increasingly important to modern society.

Secondary motives

The Secondary drives are undoubtedly critical to the study of the human

behaviour. As a human society develops economically and becomes more complex,

the primary drives and to a lesser degree, the general drives give way to the learned

secondary drives in motivating behaviour. Secondary needs vary among people

much more than primary needs. This exists even as opposites in two different

persons. One person has a need for self assertion and is aggressive with people. A

second person on the other hand may be submissive and to yield to others

aggressions. Needs also change according to the situation. Secondary needs

produce a variety of motives in each person. For example, the behaviour-

absenteeism can result from lack of interest in the job conflict with a co-worker or

for a variety of other reasons.

Characteristics of secondary needs

Secondary needs are often hidden, so that a person cannot recognize them.

This fact alone makes motivation difficult. Since secondary needs are so vague,

dissatisfied workers often say their dissatisfaction is caused by something easier to

identify, such as low wages. In summary, secondary needs are strongly conditioned

by experience. They vary in type and intensity among people. They are subject to

change within an individual work in groups rather than alone. They are often

hidden from conscious recognition. They are vague feelings instead of specific

physical needs and influence behaviour.

Although human needs have been classified as Primary and secondary needs,

in an individual person, they are inseparable. The state of the physical body affects

the mind and the state of mind can affect the physical body. Everyone must be

treated as a whole person.

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Need for power, need for achievement and need for affiliation are some of the

important secondary motives. They are commonly referred to as n Pow, n Ach and n Aff.

The power motive

McClelland has also done research on N. power. His latest work discusses the

two faces of power. McClelland (1976) differentiates between personal power and

institutional or social power. McClelland describes the institutional power manager

exercises power in the interests and the welfare of the organisation. Institutional

power managers are said to be very effective since they are wil ling to somewhat

sacrifice their own interests for the organisation's overall well being.

Clayton P. Alderfer (1911) explained the power need as the need to manipulate

others or the drive for superiority over others. Any one in a responsible position in

business, government, unions, education or the military may exhibit a considerable

need for power. Power motive has significant implications for organizational

leadership and for the informal, political aspects of organization, power has

emerged as the one of the most important dynamics in the study of organizational

behaviour

The achievement motive

David Mc Clelland (1961) used the Thematic Apperception Test (TAT) which

proved to be very effective tool in researching achievement. One picture in the TAT

shows a young man ploughing a field, the sun is about to sink in the west. The

person supposed to take the test is suppose to tell a story about what he or she

sees in the picture. The story will project a person's major motives. For example,

the test taker may say that will the picture is sorry the sun is going down because

he still has more land to plough and he wants to get the crops planted before it

rains. Such response indicates high achievement. A low achiever might say that.

the man in happy the sun is finally going down so that he can go to the house relax

and have a cool drink.

Individuals high in N. Ach exhibit certain characteristics and can easily be

spotted in organization. High N. Ach individuals like to work on jobs which are

fairly challenging. Too little challenge will bore them, since there is no opportunity

to satisfy their urge to achieve. High N. Ach individuals will not try to work on jobs

that are so challenging that successful task accomplishment becomes doubtful.

High N. Ach individuals hence seek jobs that are so challenging that successful

task accomplishment becomes doubtful. High N. Ach individuals hence seek jobs

that are moderately challenging. The achievement motive can be expressed as a

desire to perform interims of a standard of excellence or to be successful in

competitive situations. The specific characteristics of a high achiever can be

summarised as follows.

The affiliation motive

Affiliation plays a very complex but vital role in human behaviour. Individuals

high in N. Affiliation (N.Aff) like to interact with colleagues in the organisation. They

have a strong desire for approval and reassurance from others and they are willing

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to conform to the norms of groups to which they belong. In effect, they have needs

to develop affinity and warm relationships with people in the work system. They

usually like to work with others in a friendly atmosphere.

Sometimes affiliation is equated with social motives and or group dynamics.

When we go back to the Hawthorne studies conducted many years ago, the

importance of affiliation motive in the behaviour of organizational participants is

very clear. Employees have a very intense need to belong to and be accepted by the

group. This affiliation motive is an important part of the group dynamics. People

high in N. Affiliations are said to perform better in their jobs when they are given

supportive feedback. Co-operative work norms where pressure for increased output

comes from friends also increase outputs. Thus friendly managers and supervisors

can influence individuals high in N. Affiliation and motivate them to work harder.

The security motive

Security is a very intense motive. Security motive appears to be very much

simpler. Humans have learned security motive to protect themselves from the

contingencies of life and actively try to avoid situations which would prevent them

from satisfying their primary, general and secondary motives. The simple conscious

security motive is typically taken care of by insurance policies, personal savings

plans, and other fringe benefits at the place of employment. On the other hand the

more complex, unconscious security motive is not so easily fulfilled but may have a

greater and more intense impact on human behaviour.

The status motive

Status or prestige is more relevant along with security in today's dynamic

society. The modern affluent person is often painted as a status seeker and is

accused of being concerned with material symbols of status like the right clothes,

the right car, or the latest personal computer than the more basic, human oriented

values in life. Status can be simply defined as the relative ranking that a person

holds in a group, organization or society. Everyone has status, but it may be high

or low depending on how the relative positions are ranked. Sociologist Talcott

Parson, identified the membership in a family, personal qualities, achievements and

authority and power possession are the sources of status.

14.3.2. THEORIES OF MOTIVATION

Theories of motivation can be categorized broadly under content or need theories,

cognitive or process theories. Maslow, Alderfer, Murray. McClelland are some of the

people who have made significant contribution to the content theories which basically look

at the motives or needs in individuals that influence behaviour.

The content theories of work motivation

The content theories of motivation which are basically concerned with the need

patterns of the individuals are given below.

The content theories of work motivation attempt to determine what is that

motivates people at work. The contents theorists are concerned with identifying the

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needs/drives that people have and how these needs/drives prioritised. At first,

money was felt to be the only incentive (scientific management) and then a little

later it was felt that incentives include working conditions, security and perhaps a

democratic style of supervision (human relations).

Recently the content of motivation has been deemed to be the so called 'higher-

level' needs or motives, such as esteem and self actualization (Maslow),

responsibility, recognition, achievement and advancement (Herzberg) and growth

and personal development (Alderfer) A thorough understanding of work motivation

leads to specific application techniques.

Maslow’s hierarchy of needs

Abraham Maslow (1954, 1968) need hierarchy theory is probably the most

widely known theory of individual needs and motivation. Abraham Maslow

recognizes that needs have a certain priority. As the more basic needs are satisfied,

a person seeks to fulfil the higher-level needs. If one's basic needs are not met, they

claim priority, and efforts to satisfy the higher-level needs must be postponed. A

need hierarchy of five levels of AH Maslow has gained wide attention. He has

synthesised these problems and postulated a need hierarchy, while suggesting that

a need if fulfilled easily will not be motivation. The five levels include

1. Physiological needs

2. Safety and Security needs

3. Belonging and Social needs

4. Esteem and status needs

5. Self actualization and fulfilment needs

The important point about need levels is that they usually have a definite

sequence of domination. Second-level needs do not dominate until first-level needs

are reasonably satisfied. Third level needs do not dominate until first and second

level needs have been reasonably achieved and so on. as illustrated in the Figure -3.

Maslow’s Hierarchy of needs

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Lower order needs

People must labour to satisfy their physiological needs. These needs comprise

food, clothing, shelter, sex, etc. When these are satisfied to some degree, it becomes

their wish to satisfy other needs.

The need that next tends to dominate is for safety and status. Having satisfied

their basic physiological needs today, people wants on assurance that these needs

will be met tomorrow and thereafter. Because of individual differences, people need

different amounts of security. These needs are also called as economic needs.

Higher order needs

Third level needs are belonging and social involvement. Some people say that

these needs are met mostly off the job. However, one third-to one-half of an

employee's working hours are spent at work. People work in a social environment,

and some of their social needs must be met there as well as away from work.

Emotional needs for affection, love, warmth and friendship are satisfied by

being in the company of friends, relatives, or other groups such as work groups,

play groups and voluntary groups.

The needs at fourth level include those for esteem and status. We need to feel

made ourselves that we are worthy, to feel also that others think we are worthy,

(status) and to believe that they likewise are worthy. The ease of self worth and ego

can be satisfied with respect, recognition, esteem, appreciation and applause from

others. The fifth level need is that for self actualization, which means becoming all

one is capable of becoming. This need is less apparent than others because many

people in the developing countries are busy wi th first, second level needs and the

people in the developed nations are busy with third and fourth level needs. Though

self actualization dominates few people, it influences nearly all people. They choose

occupations that they like and they get certain satisfaction from accomplishing

their tasks.

Hierarchy of needs - an interpretation

Maslow suggested that there are five Levels of needs arranged in hierarchical

fashion. Maslow further suggested that all satisfied need is not a motivator. He

contended that on unsatisfied need motivates a person.

Lower needs are primarily satisfied through economic rewards. People earn

money as a medium of exchange to purchase satisfaction for physiological and

security needs. Their higher order needs are primarily satisfied through

psychological and social rewards. These higher needs require different ways of

thinking about people. Managers have felt sometime that wages i.e. money solves

everything.

The five-way classification of needs is somewhat artificial, because individual

difference causes many expectations to it. In a real situation all needs are

interacting together within a whole person. They try to overlap and combine.

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However, the five way classification does give managers useful insights into which

needs are likely to dominate a person in a specific situation.

The concept of hierarchical needs may be helpful to the management to design

a motivational model which includes the level of priorities attached by the worker

for the fulfilment of his needs. Individuals will certainly like to fulfil the first

category needs before switching to the second category needs. Every individual

would like to fulfil the needs falling in the first two categories. The remaining needs,

highly situational, are influenced by the society, culture and individual's own

characteristics.

What the need hierarchy model essentially says is that gratified needs are not

as strongly motivating as unmet needs. That is employees are more enthusiastically

motivated by what they are seeking than by what they already have. In other terms,

people work for food alone when they have no food i.e., satisfied need is not a

motivator or an unsatisfied need is a motivator. Managers who understand the

need pattern of their people can provide the types of work environment that will

satisfy their needs at work. Managers can motivate employees by giving appropriate

organizational support which will gratify individuals needs. Maslow's theory helps

managers in understanding the needs of individuals and motivate them.

Herzberg's two-factor theory of motivation

Herzberg developed a specific content theory of the work motivation which is

an extension of Maslow's need theory. Herzberg's research concluded that job

satisfiers are related to job content and that job dissatisfies are related to job

context. Herzberg titled satisfiers as motivators, and the dissatisfies as hygiene

factors. Hence, it is known as the Herzberg's two factor theory of motivation.

Hygiene factors

Company policies and administration, supervision, working conditions, inter

personal relations, money, status and security may be thought of as maintenance

factors. These are not an intrinsic part of the job, but they are related to the

condition under which a job is performed. Herzberg found that Hygiene factors

produced no growth in worker output capacity.

Motivators

Satisfying factors that involve feelings of achievement, professional growth and

recognition that one can experience in a job of less challenge and scope are referred

to as motivators, Herzberg used this term because these factors seem capable of

having a positive effect on job satisfaction.

Herzberg's (1966) theory is closely related to the Maslow's need hierarchy. The

hygiene factors are similar to the Maslow's lower order needs (see Fig. 3). The

hygiene factors are preventive and environmental in nature. These hygiene factors

prevent dissatisfaction, but they do not lead to satisfaction.

The hygiene factors do not motivate but they prevent the development of

dissatisfaction. Motivators will motivate on the job. Maslow's higher order needs

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and motivators are approximately the same. According to Herzberg an individual

may be motivated with a challenging job content. Herzberg's two factor theory has

thrown light on the content of work motivation. Management are often perplexed

because they are paying high wages and salaries, giving excellent fringe benefit

package and provide best working conditions, but their employees are not still

motivated. Most of the management concentrate on hygiene factors. Whenever they

face the problem of morale, they give higher pay, more fringe benefits and better

working conditions. Herzberg's theory offers an explanation by stating that

management are concentrating on hygiene factors rather than on motivators.

Herzberg identified certain characteristics with job satisfaction and others to job

dissatisfaction. Intrinsic factors such as achievement, recognition and the work

itself, responsibility and advancement seem to be related to job dissatisfaction. On

the other hand when they were dissatisfied, they cite extrinsic motivators, such as

company policy and administration, supervision, inter personal relations, and

working conditions.

According to Herzberg, the factors leading to job satisfaction are separate and

distinct from those that lead to job dissatisfaction. Therefore, managers who seek to

eliminate these factors that can create job dissatisfaction can remove

dissatisfaction but not necessary motivation. When the Hygiene factors are

adequate, people will not be dissatisfied. If we want to motivate people, Herzberg,

suggests using achievement recognition, the work itself, responsibility and growth.

These are the characteristics that people find intrinsically rewarding. Herzberg was

the first to say that the hygiene factors are absolutely necessary to maintain the

human resources of an organisation. According to Herzberg's theory only a

challenging job which has the opportunities for achievement, recognition,

responsibility, advancement and growth will motivate personnel. The theory has

been criticized for the following weaknesses.

1. Herzberg's theory over simplified the work motivation.

2. The Reliability of the methodology is questioned.

3. A person may dislike part of his or her job, yet still think the job is acceptable.

4. The motivation - hygiene theory ignores situational variable.

5. Herzberg assumes that there is a relationship between satisfaction and

productivity. But the research methodology he used looked only at satisfaction

but not productivity.

Inspire of the limitations Herzberg contributed substantially to the study of

work on motivation. Herzberg also drew attention to the importance of job content

in work motivation which has been neglected or totally overlooked. The job design

technique of job enrichment is-also one of Herzberg's contributions. Overall,

Herzberg also failed to give a Comprehensive theory of work motivation. It also

partially describes the complex nature of motivational process of people in the

organisation.

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14.3.3. PERSONALITY

Behaviour always involves a complex interaction of the individual and the

situation. When are some people quiet and passive, while others are loud and

aggressive? or certain personality types better adopted to certain Job types? What

do we know from theories of personality that can be help us to explain and predict

the behaviour of individuals in organizations? This section, to answer such

questions.

What is personality?

When we talk of personality, we do not mean that a person has charm,

attitude toward life. When psychologist talk of personality, the dynamic concept

describing the growth and development of a fair psychological system rather than

looking at part of the person, personality looks at some aggregate whole that is

greater than the parts. A human personality is determined by four very closely

interconnected aspects.

1. Moral qualities which are the social aspect of the personality.

2. Temperament which is the biological basis of the personality

3. Individual characteristics of the psychic process; sensations, perceptions,

attention, thinking, memory, emotion, etc.,

4. Schooling - the persons knowledge and skills.

The term personality' is derived from the Latin word 'per sonnare" as to speak

through". The Latin term was used to denote the actors used to wear in ancient

Rome and Greece. Personality totally referred to how people influence others

through their appearances (actions). But for an academician personality external

appearance and behaviour, (ii) the inner awareness of permanent organizing force

and (iii) the particular organization of measurable traits, both inner and outer.

Thus, a thoroughly complete definition of personality becomes a jigsaw puzzle

because human being operates as a whole, not as a series of distinct parts. Though

psychologist scientists unanimously agree to the importance of personality, able to

come out with an unanimous definition. Personality has various views by many

people in different ways as found below

Personality is a broad, amorphous designation relating to all approaches of

persons to others and themselves. To most its and students of behaviour, this term

refers to the study of the characteristic traits of the individual, relationships

between these ' the way in which a person adjusts to other people and situations.

Personality is a pattern of stable states and characteristics of a person, that

influence his or her behaviour towards goal achievement. Each person has unique

ways of projecting these states.

Personality is a very diverse and complex psychological concept. The word

'personality' may mean something like outstanding, invigorating interpersonal

abilities.

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We must also recognize and explain the fact that development results in man

by acquiring a distinctiveness or uniqueness which gives him identity which

enables him and us to recognize him as apart from others. These distinguishing

characteristics are summarized by the term personality.

The most frequently used definition of personality was by GORDON ALLPORT

more than fifty years ago. He said personality is "the dynamic organisation within

the individual of those psycho physical system that determines his unique

adjustments to his environments. Hence, personality is the sum total of ways in

which an individual reacts and interacts with others. A person's moral qualities are

the most important traits of personality, that dominates over all its other traits and

determines his behaviour. These qualities largely depend on the persons outlook,

his views and conceptions of the surrounding world and natural and social

phenomena. So personality is a combination of body and mind. Personality is

neither exclusively mental nor exclusively physical but it is a function of mind and

body in unity. It is an universal phenomena found in individual

Personality Attributes

Four personality attributes have been identified that appear to have more

direct relevance for explaining and predicting behaviour in organizations. These are

1. Locus of control

2. Authoritarianism

3. Machiavellianism

4. Risk propensity

1. Locus of Control: Some people believe that they are masters of their own

fate. Other people see themselves as pawns of fate, believing that what happens to

them in their lives is due to luck or chance. Locus of control is internal; these

people believe they control their destiny. Those who see their life controlled by

outsiders are externals. The employees who rate high in externality are less

satisfied with their jobs. More alienated from the work setting and less involved in

their jobs are internals. A manager might also expect of find that externals blame a

poor performance: evaluation on their boss's prejudice their own other events

outside their control. Internals would probably explain the same evaluation in

terms of their own actions

(2). Authoritarianism: It is the belief that there should be status and power

differences among people in organizations. The extremely high authoritarian

personality is intellectually rigid in judging of others. They are differential to those

above and exploitative of those below, distrustful and resistant to change.

Possessing a high authoritarian demands sensitivity to the feelings of others, tact

and the ability to adapt to complex and changing situations. On the other hand,

where jobs are highly structured and success depends on close conformity to rules

and regulations, the high authoritarian employee should perform quite well.

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(3) Machiavellianism: It is named after NICCOLO MACHIVELLI who wrote in The

16th century on how to gain and manipulate power. An individual executing strong

Machiavellian tendencies is pragmatic, maintains distance and believes that ends

can justify means. Do high machs make good employees? That answer depends on

the type of job and whether you consider ethical implications in evaluating

performance. In jobs that quite bargaining skills (such as labour negotiator) or

where there are rewards for winning (as in commission sales) high machs may be

productive. The ends cannot justify the means or there are no ability standards of

performance, our ability to predict a high machs perform will severally be reduced.

(4) Risk Propensity: People differ in their willingness to take chances.

Individuals with a high risk propensities make more rapid decisions and less

information in making their choice than low risk propensity individuals. Managers

might use this information to align employee risk tasking propensity with specific

job demands.

Stages of Personality Development: Personality development as by Floyed L.

Ruch is concerned with "the process by which the child gradually acquires patterns

of overt behaviour, thinking, problem-solving and, above all, the motives, emotions,

conflicts and the ways of coping up conflicts that will go to make up his adult

personality". The development approach, though a form of personality theory, is

different from personality theories which will be discussed separately.

Personality in modern times is consisting of both elements-physiological which

interact to result in desirable action by an individual. 'Hence, it is needless to argue

heredity versus environment or motivation versus learning. In fact, all these

variables, heredity, environment, or motivation and learning- contribute to the

development of human personality. A personality variable usually processes three

characteristics; (i) ability over time, (ii) generality across situation and (iii) interim]

variability in either frequency of occurrence or intensity.

The stages of personality development may be identified as follows.

(1) Psycho-analytical or Freudian stage

(2) Social learning or Neo-Freudian stage

(3) Cognitive stage.

Psycho-analytical or Freudian Stage: Psycho-analytical theory propounded

by Sigmund Freud in 1932 concentrates largely on five identifiable stages of

psycho-sexual development through which a child passes. These stages are (i) Oral,

(ii) anal, (iii) phallic or Oedipus, (iv) latency and (v) genital. These stages are

explained earlier.

Though these stages did lead to the acquisition of particular motives such as

sexuality, hostility, dependency, etc. they have not been accepted by modern

psychologists on two grounds: (i) improper use of terminology and (ii) stretching the

stages to the degree of illogical ends. Regarding choice of words Mischel makes the

following observations:

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"Without having at hand a suitable set of learning concepts and terms for

personality development, Freud relied on his own preference for a 'body language',

he preferred to say 'oral' rather than 'dependent', 'anal' rather than 'compulsive',

'genital' rather than 'mature'.

The other shortcoming in his philosophy was his over-emphasis or sex which

overshadowed the underlying concepts which he intended to project.

Neo-freudian Stage: Julian Rotter in 1954 and Albert Bandura in 1962 laid

greater emphasis on social learning theory to acquire motive values, expectancies

and behaviours through social reward and punishment. Erik Erikson in 1962 also

highlighted the need for social rather than sexual adaptation of an individual.

Erik Erikson has identified eight psycho-social stages of development. They are

stages, (1) Mouth and senses (2) Eliminative organs and musculature, (3)

Locomotion and genitals, (4) Latency develop during birth to sixth year of age. The

remaining stages (5) Puberty and adolescence (6) Early adulthood (7) Young and

middle adulthood and (8) Mature adulthood develop later.

Erikson thought it strongly that psycho-social crisis occurs within each of the

above stages; to have a normal fulfilling personality, it is necessary that each crisis

should be resolved optimally. Most vulnerable crisis is associated with the stage of

adolescence which provides a point of criticality to re-integrate the past with future

goals. However, from organizational behaviour point of view, it is the young and

middle adult stage which is most important. Most organizational participants are

found in this stage which are seen struggling between "generatively" and

"stagnation". Young and middle-aged adults may overcome their crisis by being

productive to organization which will ultimately result in the development of their

healthiest personalities. It enjoins on the organizations to take benefit of this

productivity drive implemented by the adults.

Cognitive Stage: The cognitive stage of personality development breaks

further apart from the Freud's psycho-analytical theory. The most Representative

work on cognitive theory is of Swiss psychologist Jean Piaget. Unlike Freud, Piaget

was convinced that it was conscious and not the instinctive unconscious was the

most important variable in the development of individual's personality. He is also

accredited as the forerunner in the development of child psychology. Earlier

psychologists did not consider child as their subject, of research. He felt that

learning consists of an important accompaniment of development which cannot

crystallise unless the child has the necessary cognitive structure to assimilate new

information. This was a new challenge to the behaviourists. He identified four major

stages of cognitive (intellectual) development: They are (1) Sensorimotor (0-2 years)

(2) Pre-operational (2-7 years), (3) Concrete operational (7-11), (4) Formal

operational (11 and above years).

In the earliest stage, "Children acquire knowledge or cognition about their

surroundings through simple, sensorimotor manipulations". During this stage

when the child is of few months, he repeats acts which bring him reward or some

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interesting outcome. After reaching the age of about two years, he starts solving

simple problems. He also realises that there are objects in the world separate from

themselves which they can affect or control to get the desired results. It is the stage

when shift takes place from sensorimotor to conceptual or operational level. During

the per-operational stage children begin to use symbols and language in their

thought process so as to develop a class or category.

He enters the concrete stage of cognitive development. It is at this age that he

understands concepts such as conservation which may best explained by the

following example given by Fred Luthans:

“Water is first poured into two identical containers. Children in either pre-

operational stages will readily acknowledge that the two containers contain equal

amount of water. Then the water in one of the flat containers is poured into a tall

container in front of the child. When asked which container has more water,

children in the pre-operational stage will generally say tall container, but children

who are in the concrete stage will say that there is the same amount of water in

both the flat and tall containers".

The above example shows that only on reaching the concrete stage of

development the children may understand concepts such as conservation.

Piaget's empirical researches have revealed that certain social and political

attitudes depend on the stage of cognitive development. These results are of

immense relevance to the study of organizational behaviour.

The formal operational stage is reached by the mature and intelligent adults

who function in an organization. At this stage, there is no need for the

manipulation of objects. They have the needed capacity and skills to analyse,

reason, imagine and evaluate events.

It may, however, be stated that the four stages of cognitive development cannot

be equated with the personality stages in the same manner as Freud's psycho-

sexual stages. Both theories contribute partially to understanding human

personality.

Chris Argyris continuum from immaturity to maturity

Chris Argyris feels that the personality instead of passing through precise

stages develops along a continuum "from immaturity as an infant to maturity as an

adult".

He has identified seven characteristics in the immaturity- maturity continuum

in the following table.

Immaturity-Maturity Continuum

Immaturity Characteristics Maturity Characteristics

Positivity Activity

Dependence Independence

Few ways of behaving Diverse behaviour

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Immaturity Characteristics Maturity Characteristics

Shallow interests Deep interests

Short-time perspective Long-term perspective

Subordinate position Superordinate position

Lack of self-awareness Self-awareness and control

He explains further the scope and the conditions under which his concept operates:

1. The seven dimensions represent only one aspect of the total personality. Much

also depends upon individual's perception, self-concept and adaptation and

adjustment.

2. The seven dimensions continually change in degree from the infant to the

adult end of the continuum.

3. The model, being only a construct, cannot predict specific behaviour. However,

it does provide a method of describing and measuring the growth of any

individual in the culture.

4. The seven dimensions are based upon latent characteristics the personality

which may be quite different from the observable behaviour.

He has made an assumption that the personality of a man in organization is

towards the mature end of the continuum. This will warrant a formal organization

to ensure activity for passivity, independence for dependence, long for short

perspective, superordinate to subordinate position and self- awareness and control,

to lack of awareness and perhaps external control.

Argyris feels that generally reverse happens with the result that the mature

organizational participant" becomes frustrated which results in conflict with the

organisation. In the light of this fact he rightly visualises incongruity the mature

man and the organization.

Probably Argyris has wrongly made a supposition that all organizational men

are mature. There are many persons even in private or governmental organizations

who, inspite of all aberrations in their personality, continue to function in the

organization. Their age and years of service have not bestowed any maturity and

commitment on them. This concept will vary if the basic assumption proves wrong

in the light of living examples in public and private enterprises in India and

elsewhere.

Personality Determinants

There has been an argument in personality research that whether an

individual's personality is the result of heredity or environment. Is the personality

predetermined at heredity in or is the result of individuals interacts with its

environment. However, personality appears to be a result of both influences. An

adult personality is generally considered to be made up of both hereditary and

environmental factors moderated by situational condition.

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People are enormously complex; their abilities and interests and attitudes are

diverse. The drama of life unfolds in fantastically broad patterns from nursing

infant to the lonely senile adult; from the teens to the stable fifties; from the

idealistic to realistic; from tragedy of comedy; from the birth to death. The journey

of an individual through life can take infinite number of paths. But the question

arises I are the determinants of individual personality? We often notice personality

characteristics such as extroversion, assertiveness and warmth etc. greatly

contribute to success of an individual in his jobs. Most hires on job, however, are

not a tributable to a person's amount of intelligence alone but also to certain

personality characteristics. We frequently hear such comments as, "He is very

intelligent but lazy", "He is mediocre but hard-working" etc. The most pertinent and

relevant question is how personality originates and develops? The major

determinants personality of an individual can be studied under three broad -

headings-biological, environmental and situational.

Biological factors

Biological factors may be studied under three heads-the heredity, the brain the

physical stature.

1. Heredity: The relative effects of heredity comprises an extremely lament in

personality theory. Certain characteristics, primarily physical in nature, are

inherited from one's parents, transmitted by genes in the chromosomes contributed

by each parent. Research on animals has showed that both physical and

psychological characteristics can be transmitted through heredity. But research on

human beings is inadequate to support this viewpoint. However, psychologists and

geneticists have accepted to the fact that heredity plays an important role in one's

personality. The importance of heredity varies from one personality trait to another.

For instance, heredity is generally more important determining a person's

temperament than values and ideals.

2. Brain: Another biological factor that determines personality is the role of

brain of an individual. Though some promising inroads are made by researchers,

the psychologists are unable to prove empirically the contribution of human brain

in influencing personality. Preliminary results from the Electrical Stimulation of the

Brain (ESB) research gives indication that better understanding of human

personality and behaviour might come from the study of the brain.

3. Physical Features: Perhaps the most outstanding factor that contributes to

personality i.e. the physical stature of an individual. An individual's external

appearance is proved to be having a tremendous effect on his personality. For

instance, the fact, that a person is short or tall, fat or skinny, handsome or ugly,

black or fair will undoubtedly influence the person's effect on others and in turn,

will affect the self-concept. According to Paul H. Mussen a child's physical

characteristics may be related to his approach to the social environment, to the

expectancies of others, and to their reactions to him. These in turn may have

impacts on personality development. Similarly, a rapidly maturing girl or boy will be

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exposed to different physical and social situations and activities than will a slowly

maturing boy or girl. Psychologists contend that the different rates of maturation

will also influence the individual's personality.

II. Environmental

Among the factors that exert pressures on our personality formation of the

culture in which we are raised, our early conditioning, the norms among our family,

friends and social groups and other influences that we experience. The environment

that we are exposed to plays a critical role in shaping a personality. Culture

established the norms, attitudes and values that are passed along from one

generation to the next and create consistencies over time. Heredity sets the

parameters or outer limits, but an individual’s full potential will be determined by

how well she adjust to the demands and requirements of environment.

III Situational

The situation influences the effects of heredity and environment on

personality. An individual personality changes in different situations. The different

demands of different situations call for different aspects of one's personality. Thus

situation will influence an individual personality.

Personality Traits: These are enduring characteristics that describe in

individuals behaviour. Popular characteristics include shy, aggressive, -

submissive, lazy, ambitions, loyal and timid.

16 Primary traits

1. Reserved Outgoing

2. Less intelligent More intelligent

3. Affected by feelings Emotionally stable

4. Submissive Dominant

5. Serious Happy go lucky

6. Expedient Conscientious

7. Timid Venturesome

8. Tough-minded Sensitive

9. Trusting Suspicious

10. Practical Imaginative

11. Forthright Shrewd

2. Self assured Apprehensive

13. Conservative Experimenting

14. Group dependent Self-sufficient

15. Uncontrolled Controlled

16. Relaxed Tense

Stages in personality development: The various stages of personality from

birth to maturity can be divided into following ten stages. Every individual passes

through these stages. They are:

(i). Stage of Dependence: Every individual starts his life completely

dependent on others. A few individual never weaned out from this dependence and

always lean on parents or friends or on someone.

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(ii) Stage of Comfort and Eating: In this stage the chief interest is the

physical comfort and food. A few grow-up with a feeling that comfort is the most

important thing in life.

(iii) Stage of Impulsiveness: The parents praise the child when he takes his

first step, in the process of learning for walking by himself. But when he tries to

walk by himself on the street, his parents scold him. The child is unable to make

out the difference between the two activities and is in a stage of impulsiveness. He

is not able to understand the change from praise to punishment for walking. The

child acts first and thinks next, many adults who have outgrown childhood are

possessing the impulsiveness.

(iv) Show off Stage: Show off stage is normal in childhood. But some adults to

maintain this stage and feel proud in showing off.

(v) Stage of Low Boiling Point: Some do not like being interrupted and go

through life with low boiling point losing temper on trifle incidents.

(vi) Stage of Stubbornness: Every child is too small and weak to win by his

own strength, but he could be stubborn and thus corner his parents. If his parents

handle him wrongly during this stage, it may become a permanent habit and he

goes through the life with this habit.

(vii) Stage of Inferiority and Gullibility: Some never grow out of their school

stage of feeling inferior and being gullible. They lack confidence in themselves and

consult fortune teller or allow superstitious to make their decision.

(viii) Gang Stage: There are certain groups of individuals who form a gang.

They want to be the chief while others remain aloof. Some like to continue still in

the childhood gang stage


1. The curiosity manipulation and activity motives

2. Affiliation motive

3. Stages of personality developments


1. Define motivation

2. Define personality

14.6 SUMMARY

Motivation in said as an inner state that activates behaviours towards goal.

The famous theories on human motivation are discussed in the organizational and

social context. Personality is composed of several characteristics which are

comparatively permanent and influence human behaviour.

14.7. TERMINAL EXERCISE

1. Explain various theories of motivation

2. State the various personality attributes and explain its significance in OB

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1. www.managementstudyguide.com/what _is_motivation.htm

14.9. ASSIGNMENTS

1. Why do people sometimes falsify records to achieve goals?

2. Why might an employee with a low level of motivation be a top performer?

14.10. SUGGESTED READINGS / REFERENCE BOOKS

1. Luthans Fred “International organizational behaviour” McGraw Hill

Publication co. Ltd., New Delhi 1988.

2. Aswathappa K. “Organisational Behaviour” H PH Bombay

3. Davis Keith and Newstrom, W. John “Human Behaviour at work” McGraw

Hill Book co., International edition.

4. Hersey, Paul and Blachard Ken “Management of Organisational

Behaviours- utilizing Human Resources” prentice hall of India ltd.,


1. Write an essay on biological factor

2. list out personality attributes

14.12 KEY WORDS

Needs, Motives, Traits, Personality, Motivation Theory.

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LESSON - 15

LEADER AND LEADERSHIP QUALITIES

15.1. INTRODUCTION

The role of the supervisor and his relationship with the worker are vital for an

effective functioning of any organization. Supervisors are a very important part of

management and this is because wider range of managerial responsibility falls on

the shoulders of the supervisors. The function and qualities of a supervisor is

linked with attitude, morale job satisfaction, industrial disputes and ultimately

production. The concept of leadership and the role of a leader or supervisor has

been changed, due to the growth of new social values. So Maier (1970) has

remarked “The supervisors become the pivotal around which many things revolve.

The type of personal contact which he builds can obviously make and break

morale”.

The supervisor of a fabricating plant remarked that his headaches were not

with the problem of production, but with the problem of supervision. Bass (1960)

has defined leadership as the observed effort of one member of change another,

member’s behaviour by altering the motivation of the other members or by

changing their habits.

Leadership is accomplishing something through other people what wouldn’t

have happened if you weren’t there. Today, leaders are being able to mobilise ideas

and values that energise other people.

15.2 OBJECTIVES

To understand the nature of supervision and its impact on employee

behaviour and productivity.

To define the meaning of leader and to analyse the desirable qualities of

leader.

15.3 CONTENTS

15.3.1 Qualities of a Successful Supervisor

15.3.2 Functions of a supervisor

15.3.3 Types of Supervisors

15.3.4 Selection of Supervisors

15.3.5 Types of Leadership

15.3.6 Michigan Studies on Leadership

15.3.7 Situational Leadership Theory

15.3.8 What makes Leadership Effective?

15.3.9 Training and Methods

According to Maier, the effectiveness of a leader is determined by whether

there is any change in the observed behaviour of the followers. This change is

induced by changing motivation and by initiating structure into the work situation.

The part played by leadership today in industrial relations is gaining importance

with increasing recognition. Blum and Naylor (1968) have said “Just as society

looks for a leader to define its purpose and lead it forward, so both management

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and labour have been concerned in the selection and development of men who can

successfully attack the many perplexing problems that confront them”. Many

studies have shown that the supervisor who mostly determines the employee -

employer relationship is the centre and the crux around which the vari ed problems

of industrial psychology more.

15.3.1. Qualities of a Successful Supervisor

The congenial relationship between the employee and the employer mainly

depends upon the supervisor. It is absolutely essential for the supervisor to possess

certain qualities and characteristics in order to be successful in his role of

supervision. An employer has to maintain close contact with the workers. The main

problem is to lead, to guide and above all direct them. The employee -employer

relationship is not an unilateral affair but one of bilateral relationship. The problem

of maintaining sound interaction between the leader and the group has great

importance not merely in industry but in every field of activity.

It is rather difficult to give various criteria of successful leader. This is because

there is a variety of ways of defining the success of a leader. However, one

important criterion of determining good leadership is to find out, how far his

subordinates follow his order without question.

According to the behavioural approach the best way is to study what leaders

do, rather than in terms of what leaders are. So in this approach emphasis is

placed more upon the leader's behaviour rather than with the leader's traits.

Regarding leadership characteristics research findings show that the qualities of a

successful supervisor is behavioural or situational. In other words, it is related to

the interactions of the leader and the group. In short, a supervisor is not born, but

made. So the good qualities of a supervisor depend primarily upon the

environment. Further, it depends upon the situation at hand. Regarding the

personality factors, there is a wide variation in the qualities of a successful

leader/supervisor. For instance, a leader who is successful in an autocratic group

may not be so, in a democratic group.

In the words of Puckey, a leader must be able, to coordinate besides should

have the power to reflect the progress of the group. According to Dr. May Smith

(1952) a leader should have intelligence, insight and imagination, good judgement,

a sense of humour, a sense of justice and above all, a well balanced personality.

In fact, the overall personality of an individual is largely responsible for

determining leadership. In India, for example, besides other factors, the overall

personality of Mahatma Gandhi, Pandit Jawaharlal Nehru, Netaji Subhash

Chandra Bose, Shri Jaya Prakash Narayan, Mrs. Indira Gandhi and others, has

attracted many followers. And all of them are glittering examples of leaders who

possessed a great attraction for the people.

Some of the important qualities essential for a successful leader have been

mentioned by the Industrial Conference Board such as the ability to learn, to

analyse and gather new information, industriousness, resourcefulness and persis-

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tency in attacking work problems, willingness to accept any criticism, emotional

stability and a sense of humour, the ability to inspire confidence, respect for other's

capacity for decision and ability to express oneself orally and so on.

According to Craig and Charters the necessary characteristics of a successful

leader are personal interest in employees, self-confidence, forcefulness, ability to

command and respect, ability to praise and blame effectively and so on.

Gibb (1922) has chalked out a list of seven aspects of leadership behaviour.

And they include performing professional and technical speciality, knowing

subordinates as well as showing consideration for them, getting channels of

communications open, accepting personal responsibility and setting an example,

initiating and directing action, training men as a team and making decisions.

A good leader possesses eleven qualities in the opinion of Kretch and

Crutchfield (1948), According to them, a good leader is a planner, an executive, a

gatekeeper, a mediator, an expert, a law maker, a father figure and so on. In the

words of Blum and Naylor (1968) a successful leader is a person "whose men

respect him, whose men follow his orders without question, whose men like him,

whose work group has high morale and who looks out for his men". In brief, the

leader should act as an ideal or an examples for the follower. Further he must be

capable of fulfilling the needs of the followers and by doing so he could win over the

confidence of his people.

15.3.2. Functions of a Supervisor

The foreman or supervisor today is something like a statesman according to

Tiffin. In other words, the foreman is both a commander and a helper to his

workers. In short, his personality and behaviour towards the workers determines to

a great extent the rate of production. By tracing the history of the supervisor, one

can note that a supervisor was all powerful. In fact, he was the monarch of all

hierarchies. He was rather interested in hiring and in firing the workers. The

supervisor was always considered right, while the workers were always considered

to be wrong. The supervisor in the past had to do a lot of work. For instance, he

was in charge of wage, rate of work, controlling the quality of work, method of work,

training the workers, maintenance of machinery, problems of discipline etc. All

these being his main functions, he was called a "jack of all trades but a master of

none". At that time, no consideration was given to the executive ability of the

supervisors. This was perhaps because, it was not needed at that period.

But in the modern period, drastic changes have taken place in the role of a

supervisor, especially with the development of scientific management and the

growth of new social values. Of late, the supervisor has become democratic and he

is no more a dictator. In the modern industrial development, the foreman's

responsibility has increased considerably. He is the representative of the

management to the workers. Further his role and position become very important,

since the average workers come into direct contact with him. Many of the old

functions of the supervisor have been changed and taken away such as the living of

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the workers, maintaining discipline, lay off and strikes. And these functions have

been taken over by the personnel department. Similarly the Job evaluation

department has taken up task of fixing the rate of payment. Quality control is given

to a specialised technical department. Time and motion (movement) analysts

department are in charge of the rate or method of work. Maintenance and repair

work come under the custody of maintenance and repair department while training

programme is put under the control of tuning departments.

Although many of these duties have been taken from him, still the supervisor

has several other important duties. For example, the supervisor has to know a little

of law matters. The factories acts, wages acts, and contracts are handled by him.

Quick decisions are to be taken on account of the urgency of the matter. Disputes

are increasing as a result of the formation of several kinds of labour unions. In the

olden days, the supervisor was viewed always as right and the worker was found

always as wrong. But today, due to change in the status of the employees, both

groups are partly wrong and partly right. The supervisor has to tackle both the boss

and the worker. Sometimes in a critical situation, he has to handle several

conflicting orders with high degree of social skill. The technique of dealing will the

employees today has changed from an autocratic way to democratic one.

Understanding has become more important and suppose the supervisor is not

careful in all his dealings and transactions, he may breed hostility and

discontentment among the workers. In short supervisor is the pivotal around which

many problems revolve.

According to Brown (1958), "The supervisor is the conductor of an orchestra

rather than, a one-man band and he realises that his job is to coordinate and

creating willingness to work among employees".

On the psychological aspects, the supervisor-cum-employer has a terrific role

to play while dealing with employees. The employer works as a father-figure and the

employees depend upon him for emotional security, self-realisation and release of

tensions. So the supervisor should have the ability to take the workers into

confidence. At any stage, there should not be any type of sudden change, without

the knowledge of the workers. The employee must be in a position to predict, what

is expected of him. And as such the actions of his supervisors will be predictable.

Mild and consistent discipline by the employer must be encouraged instead of strict

and rigid discipline. It has been observed that leaders of several organisations who

are in the habit of showing their disapproval and dislike towards their employees in

the public, have been proved to be worst leaders. These leaders fail to understand

that each person has an ego and any insult would deeply hurt the person,

particularly when such damaging remarks are made in the presence of others or in

public. So, any criticism towards the employees should be expressed in private but

praise or appreciation can be made in public.

15.3.3. Types of Supervisors

Bardford and Lippitt (1946) have classified the supervisors into four types.

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1. The hard boiled autocrat

2. The benevolent autocrat

3. The Laissez - faire supervisor

4. The democrat.

1) The Hard Boiled Autocrat

The hard boiled autocrat constantly checks production. He gives orders and

expects immediate acceptance. Mostly he is a rigid disciplinarian and he believes

that praise will spoil the workers' efficiency. He is very much status conscious. And

he does not trust the employee's initiative. Under such circumstances, the workers

criticise the leader at his back, which can be called as 'back-biting'. This kind of

behaviour makes the group to feel that he is insecure, tense, aggressive and

egocentric. But usually the Indian employees show an uncritical acceptance of

authority. According to Kakar (1971) the autocratic authority is the ideal image of

the Indian employees.

2) The Benevolent Autocrat

This is another type of leadership. A benevolent autocrat dominates all

employees. Suppose the employee fails to meet the standards, this makes him feel

hurt, angry and surprised in such a group, the employees depend upon the leader

for all decisions. Further these employees exhibit a slow regression to more

submission, dependency and inability to accept responsibility.

3) The Laissez-faire Supervisor

This type of leader often makes himself busy in paper work. And as such, he

tends to keep away from the employees. A leader of this kind has no goal and he is

indecisive. Such a group has the tendency of find out scapegoats. Further it is

unstable and it has low output. Finally, the laissez-faire group lacks direction. And

in such, a directionless group, failure and insecurity as well as frustration are

typical.

4) The Democrat

In this category the democratic supervisor shares group decisions. He spends

time for planning and he is quite decisive. He has high self-confidence and security.

He often encourages employees to function in a democratic framework as remarked

by Lippit and Bradford.

There are two major dimensions to the managerial grid, according to Blake and

Mounton (1964). That is to say, first there is concern for production and next there

is concern for people. And this two-fold categorization leads to five types of

managers.

1) The exacting task master is mainly concerned with production and least

bothered about human relations. In this type, the supervisor - subordinate

relationship is one of authority and obedience. 2) The second type is Worker -

Oriented Manager. He is highly concerned with human values and he is a

humanist. He helps the workers in their difficulties. He is not boss. And as such, he

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gently persuades the employees to follow certain principles, without forcing them.

3) The third type is passive manager. He is neither concerned with production nor

with people (workers). He simply works formally as a manager by maintaining the

status quo. He has minimum involvement with the organisation. In short, somehow

he wants to manage and retain his position. 4) The fourth type is Complete

Manager. The basis of this manager is to promote the conditions which integrate

creativity, high productivity and high morale, through concerted team action. So he

is viewed as a complete manager who relies o mutual understanding. Adequate or

proper communication between the manager and staff is encouraged by the

complete manager. In other words, this type o manager believes in the bilateral

communication but not unilateral. 5) The final type is Individual - Organisational

Centered Manager. This type of Manager importance to optimum-coordination

between the needs of the workers and the requirements of the organisation. To him

the system of work should be designed and planned in such a way that both the

employees and the management achieve the best.

15.3.4. Selection of Supervisors

Supervisors were usually selected in the past, on the basis of the production

record. But this was not a desirable system. In the words of Gray (1952) "The

supervisor may understand how to control the machine, but not how to control his

men. Much of the time of the experts in industry is spent repairing damage to

human feelings by their supervisors, who do not know how to deal with their men.

While the supervisor is the master craftsman with material he is a novice with the

personnel". In other words, the supervisor takes care of the machine elements but

leaves the human elements untouched or unnoticed. So the selection of supervisors

has to be done from the humanitarian standpoint. And for the successful

supervisor, the production record is not that much important as the right attitude

and the right practice of this attitude of the employees.

According to Blum and Naylor (1968) in the selection: "several different types

of employees, psychological tests have been successful. But in the selection of

potential executives these tests have not been to any great help till now. A job

analysis of the qualities of a supervisor are quite essential for the selection of a

supervisor. So long as this has not been done, it is rather difficult to select a

supervisor. On the basis of tests and interviews supervisors may be selected.

However, the right method of selecting them has not yet bee i developed.

According to Kretch and Crutchfield (1948), the supervisor should know how

to behave and how to deal with the workers. Further, he should know how to apply

his potentiality in the right direction. In the word of Blun and Naylor (1998) by and

large, psychologists can effectively describe a person's characteristics, such as his

intelligence level, ambition level, maturity level, interests and abilities with the help

of psychological tests. Further by using these variables and their probable inter-

relations as his psychologists can provide descriptive evidence that will enable the

management to decide whether it wants such a person, for a specific executive

position. Suppose the criterion is known, the psychologist? Can do the matching!

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But with regard to many executive positions, the trouble either the criterion, is

usually not clearly defined to perhaps the criterion varies from company to

company.

To sum up the successful qualities of a leader or supervisor can use developed

through proper training. In short, supervisors are made and they are not born. And

the qualities of a supervisor are situational and behavioural, suppose training is

given at all levels, a lot of inefficiency can be avoided. With the realisation of this

fact, the need for training all types of administrators has been well recognised and

put into practice.

15.3.5. Types of Leadership

“Leadership is the ability to persuade others to seek defined objectives

enthusiastically.”

Leadership can be classified into three categories or levels as given below, for

the purpose of management.

1. The big boss or the Top management.

2. The boss or the Middle management.

3. The Foreman and supervisors or Front line management.

The above mentioned three types of leaders function at different levels and

they have different duties and responsibilities. However, all the three categories are

concerned with the problem of how to deal with the employees and lead them. So, it

is essential to always keep contact with people. Thus, an effective and successful

leader is one who always tries to keep close contact with the workers or the

employees. According to Slum and Naylor (1968) that leadership is not an one way

affair. But it involves interaction of the leader and the group. From this stand point,

the first-line supervisor is considered as the leader or the supervisor for all practical

purposes. This is because he is the only person with whom the workers come into

immediate and direct contact for all practical purposes.

According to Barnard (1938) the job of an executive is responsible for devising

a system of communication, which will allow the organisation to function smoothly.

An executive should show a strong willingness to cooperate with people since he is

always concerned with securing services from individuals. In the words of Slum and

Naylor (1968) "The-executives formulate the general purposes of the organisation

and they must-indoctrinate their subordinates with these general purposes, so that

the organisation will function in a unified manner".

In an aircraft factory, Bose (1955) studied the importance of supervision on

productivity. High productivity was associated with employee centered supervision,

rather than close supervision and skill in supervising the group as a whole. In 1956

Ganguli conducted investigations on the worker perception of supervisors and an

analysis of their role in the government railway workshop at Kharagpur. The

findings were similar to those found in the western studies.

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15.3.6. Michigan Studies on Leadership

Likert, Kate, Maccoby, Kalm and Seashore have conducted studies on

leadership behaviour at the Institute for Social Research, Michigan University. The

initial study was carried out by Kate, Maccoby and Morse (1950). This classical

study illustrates the early Michigan approach to leadership. The results showed

that supervisors in charge of high producing section were found to be employee

centered while expressing their attitude. On the contrary, supervisors in charge of

low producing sections were found to be production centered in their orientation.

The study conducted by Lawshe and Nagle (1953) has suggested that the

attitude of supervisors appeared to be related to the productivity of the work group.

Lewin, Lippit and White (1939) studied the behaviour of children of 10 to 11 years

by giving them training in authoritarian, democratic and "laissez faire" leadership.

That is to say, each group was exposed to each of the three kinds of leadership. The

results showed that there was more ego involvement and "we" feeling in the

democratic atmosphere and this was not so in the authoritarian atmosphere. The

authoritarian group shared either a sense of apathy or aggression. But

aggressiveness was very low in the democratic group. Further it was noted that

some boys preferred the autocratic to the democratic order, probably because of

their home background, this interesting finding has been supported by Peaks study

(1945).

15.3.7. Situational Leadership Theory

The situational leadership model is developed by Paul Hersey and Kenneth

Blanchard which suggests that the leadership effectiveness depends upon the

situation in which leadership is exercised. In their model, the authors have

employed two dimensions of leader behaviour as were used in Ohio State University

studies. The two dimensions were task (production-oriented) and relationship

(people-oriented) The level of followers' development, or say, maturity is categorized

into four levels based on their abil ity and willingness to accept responsibility for

completing their task. Followers who are unable and unwilling are categorized as

the least mature, and those who are both able and willing are termed as the most

mature. The model suggests that the two different types of styles are used to

influence the followers of four different levels of maturity as is depicted.

The leaderships style varies across the levels of followers' maturity. A leader

needs to use a telling style of leadership with immature followers who are both

unable and unwilling to take responsibility for completing their work. Once the

followers mature to the second level, the leader needs to exercise a selling style.

Followers further matured i.e., able but unwilling, need to be led by employin g

participating style by the leader. Finally, the most mature followers who are able as

well as willing require to be led by the delegating style of leadership for the simple

reason because the followers accept responsibility entrusted upon them.

What leadership style should be employed at which maturity level of followers

is now tabulated as follows:

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Table: followers Maturity level Vis- a vis leadership style

S. No. Maturity level Recommended Leadership Style

1. Low ability, low willingness Telling (directive, low support)

2. Low ability, high willingness Selling/ coaching (directive, supportive)

3. High ability, low willingness Participating /supporting (supportive/ low direction)

4. High ability, high willingness Delegating (low direction, low support)

However, one key limitation of the situational leadership model is the absence of

central hypotheses that could be tested. It also does not have a widely accepted

research base which would make it a more valid and reliable theory of leadership.

Nonetheless, the theory has intuitive appeal and is widely used for training and

development in corporation. It has achieved considerable popularity and also

awakened many managers to the idea of situational approaches to leadership styles.

15.3.8 What Makes Leadership Effective?

Although deciding what makes leadership effective seems as if it should be a

simple decision, the theories and research reviewed earlier illustrate the complexity

of the issue. By now, you know that leadership means taking along people in the

fulfillment of certain desired goals or set objectives. Leadership does not mean

imposing willing or unwilling working under one in an office or a factory. In

practice, people are always impressed by something extraordinary and great and

are prepared to follow it if it really touches their hearts. Thus, leadership needs to

win the hearts of others to attain some desired goals. The following points will be of

great help in this regard:

1. Mental and Physical Health

A healthy mind rests in a healthy body. A leader needs to have sound health

both mental and physical to be able to bear the pulls and pressures of his role as

leader. He must also possess stamina and balanced temperament.

2. Knowledge and Intelligence

One most important requirement of a leader is to have required knowledge of

human-behaviour, psychology and professional competence. In order to evince his

convincing competency, the leader also must update himself continuously and keep

renewing himself.

3. Clear-cut and Worthy Goals

Actions without clearut directions lead nowhere. That is why there is very little

achievement inspite of a lot of movement in life. Hence, a leader needs to be very

clear in mind about what to achieve, how to achieve and then reinforce it by a

strong will-power and conviction.

4. Conviction

Swami Vivekananda said "Great convictions are the mothers of great deeds". It

is always man and women with convictions who influence others. There are millions

with opinions but very few with convictions. Leader must have courage of

conviction to impress upon his subordinates.

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5. Sense of Responsibility

A leader also must be of sense of responsibility for the task assigned to him. In

other words, a leader must discharge his responsibility thrusted upon him willingly

and cheerfully. This enjoins upon us to put our heart and soul into the work, with

single minded dedication, and devotion. This ensures our success in performing the

particular task.

6. Motivation

Effective motivation comes from within not from outside. Strictly speaking, real

motivation cannot be imposed or injected from outside. In order to inculcate

motivation from within the subordinates, a leader needs to have capacity to

appreciate others and look at things from his subordinates angle.

7. Initiative and Drive

You know that electric energy locked up in the power house is of no use unless

it is flown through the cables and manifested itself through the medium of various

gadgets so as to be beneficial. Similarly, passive goodness of leader is never helpful

unless it is action-oriented and result producing. Initiative and drive are, therefore,

the essential prerequisites of effective leadership.

Besides, some writers have identified a number of other factors that influence

leadership effectiveness. The important ones are:

1. The leader's own personality, past experience and expectations.

2. The expectations and behaviour of his superiors.

15.3.9 Training and Methods

There are mainly two types of techniques by which managers can acquire the

knowledge, skills and attitudes and make themselves competent mangers. One is

through formal training and the other is through on-the job experiences

Off- the-Job Training Method

i) Lecture: It is the simplest of all techniques. This is the best technique to

present and explain series of facts, concept and principles. The lecturer

organizes the material and gives it to a group of trainees in the form of talk.

ii) Conferences and Seminars: A conference or seminar is a meeting of several

people to discuss the subjects of common interest. Better contribution from

members can be expected as each one builds upon the ideas of other participants.

iii) Case studies: They are commonly used in managerial training on MBA

university programmes and the like. Cases are prepared on the basis of

actual business situations that happened in various organizations.

iv) Role playing: A problem situation is simulated by asking the participants to

assume the role of a particular person in the situation. The participant

interacts with other participants assuming different roles.

v) Business Games: Under this method, the trainees are divided into groups or

different teams. Each has to discuss and arrive at solutions concerning such

subject as production, pricing, research expenditure, advertising etc.,

assuming it to be the management of a simulated firm.

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vi) Vestibule Training: In vestibule training, employees are trained on the

equipment they are employed, but the training is conducted away from the

place of work. For training machine shop operator, a vestibule or separate

room is arranged for training in which all necessary equipment and machines

required in an actual machine shop, are duplicated. In pilot training, for

example, airlines use flight simulators for safety, learning efficiency and cost

savings, including savings on maintenance, pilot cost, fuel and the cost of not

having an aircraft in regular services.

vii) Sensitivity Training: The main objectives of sensitivity training are the

development of awareness of sensitivity to behavioural patterns of one self

and others.

Electronic Training

Computerized and internet-based and/or CD-ROM systems to interactively

enhance his or her knowledge or skills. Trainee start with a computer screen that

shows the applicant’s completed employment application, as well as information

about the nature of the job.

Video Conferencing

Companies use video conferencing to train employees who are geographically

separated from each other or from the trainer. This method permits people in one

location to communicate live via a combination of audio and visual equipment with

people in another city or country or with groups in several towns or cities.

Training through the Internet

Many companies use the internet and/or their proprietary intranets to deliver

computer based training. For instance, silicon graphics transferred many of its

training materials to CD-ROMs. Later silicon graphics therefore replaced the CD-

ROM system by distributing training materials via its intranet.

On-the-Job Training Method

i) Job Rotation: The transferring of executives from job-to-job and from

department-to-department in a systematic manner is called Job Rotation.

When a manager is posted to new job as part of such a programme, it is not

merely an orientation assignment. He has to assume the full responsibility

and perform all kinds of duties.

ii) Coaching: In coaching, the trainee is placed under a particular supervisor

who acts as instructor and teaches job knowledge and skills to the trainee.

He tells him what he wants to do, how it can be done and follows up while it

is being done and corrects errors.

iii) Understudy: An understudy is a person who is under training, to assume at

a future time, the full responsibility of the position currently held by his

superior.

iv) Multiple Management: Multiple management is a system in which

permanent advisory committees of managers study problems of the company

and makes recommendations to higher management. It is also called junior

board of executives system.

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1. On the job training and off the job training methods.

2. Leadership theories.

3. Training through internet.


1. What is meant by leadership?

2. Explain the types of supervision?

15.6 SUMMARY

Classification of leadership styles and qualities of a successful leader are

discussed in this lesson. Types of supervisor and its impact on employees -

Employer relations are also discussed and deliberated. Training techniques are

highlighted.


1. What are the qualities of a successful leader?

2. Explain the contribution of Michigan studies on supervision?

3. Explain the situational leadership theory of Paul Hensey and Ken

Blanchard?

4. What do you understand by "Managerial Grid" theory of Blake and Mouton?

5. Evolve a best strategy of selecting supervisors. What are the desirable traits?

6. What is meant by training?


1. https://en.mwikipedia.org/wiki/Leadership

2. https://www.mindtools.com/pages/article/newLDR_41.htm

15.9 ASSIGNMENTS

1. Examine the role of leaders to change management.

2. “Leader are by nature or nurtured” – Critically evaluate this statement.

3. Design a training programme for the First line supervisor working in

automobile Industry.

15.10. SUGGESTED READING / REFERENCE BOOKS

1. Prasad L.M. “Organisation theory and Behaviour” sultan Chand and sons

New Delhi.

2. Earnest Dale: Management theory and practice (Tokgo: McGraw Hill

Publications)

3. Gilmer, B.H.: Industrial and Organizational Psychology New York: McGraw

Hill Book Co.

4. Girishbala Mohanty: Text-book of Industrial and Organisational Psychology-

New Delhi: Oxford & IBH Publishing Co.


1. Discuss about the quality of successful supervisor

15.12 KEY WORDS

Leader, supervisor, situational leadership, managerial grid.

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LESSON - 16

PRINCIPLES OF SCIENTIFIC MANAGEMENT

16.1. INTRODUCTION

Management means many things to many people. economists regard it as a

factor of production. sociologists see it as a class or group of persons while

practitioners of management treat it as a process in simple terms, management is

what a manger does. it has been called by mary parket follet: “the art of getting

things done through people”. this definition throws light on the fact that managers

achieve organisational goals by arranging others to perform rather than performing

the tasks themselves

16.2 OBJECTIVES

To understand the nature of management.

To gain insights into the historical perspective of management.

To appraise the major contributions to the management thought.

16.3 CONTENTS

16.3.1 Management as Science.

16.3.2 Scientific Management ERA

16.3.3 Salient Features of Scientific Management.

16.3.4 Management principles

16.3.5 Private and Public Sector ownership

Management, in fact, is much more that no one single definition has been

universally accepted. Nor can anyone definition capture all the facets of

management, given its dynamic nature. That is why, it is often said that there are

as many definitions of management as there are authors in the field. However, the

definition given by James A.F. Stoner encompasses all the important facets of

management. According to him :

“Management is the process of planning, organising, lead ing and controlling

the efforts of organisation members and of using all other organisational resources

to achieve stated organisational goals”. This definition suggests:

Management is a process because all managers irrespective of their level in

the organisation, engage in certain intendedly activities in order to achieve the

desired goals:

Managers use all the resources of the organisation, both physical as well as

human :

Management aims at achieving the organisations goals.

The practice of management is as old as human civilization. In fact much of

the progress of mankind over the centuries may be attributed to the effective

management of resources. The irrigation systems, existence of public utilities, the

construction of various monuments like Taj Mahal, and the Egyptian pyramids of

the bygone era amply demonstrate the practice of management in the olden days

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also. The ancient civilisations of Mesopotamia, Greece, Rome and Indus-valley

displayed the marvellous results of good management practices. However, the study

of management in a systematic way as a distinct body of knowledge is only of recent

origin. That is why, management is often described as “oldest of the arts and

youngest of the sciences”. Thus, the practice of management is not new. It has been

practiced for thousands of years. But the science part of it ‘the systematic body of

knowledge’ is, no doubt, a phenomenon of the present century.

The traditional management practices remained quite stable through the

centuries until the birth of Industrial revolution in the mid 18th century. The

industrial revolution brought about the substitution of machine power for man

power through several scientific inventions. As a result, within a few decades, the

picture of industrial activity had undergone a metamorphic change. Man’s quest for

new ways of doing things, coupled with his ingenuity in adopting the scientific and

technological inventions in the production of various goods and services resulted in:

Mass production in anticipation of demand :

Advent of corporate form of organisation which facilitate such large scale

production.

Spectacular improvements in the transport and communication facilities ;

Increase in competition for markets :

The Establishment of the new employer - employee relationship and so on.

Industrial revolution had thus sown the seeds of modern management. The

early scientific inquiries into the practice of management began. In what follows in

this lesson, the evolution of management thought over the years is discussed in a

chronological way.

Management Levels

Though the terms ‘manager’ is used to mean anyone who gets the things done

through other people, we find the managers in any organisation with varying

authority and responsibilities. In any company the total management job requi res

many skills and talents. Obviously, therefore, the job of manager is divided and

subdivided. Such an arrangement implies different levels of management.

Front - Line Managers

This is the entry level job in the management. Managers at this level direct the

operating employees (workers). They are close to the action, for their job involves

supervising the activities of operatives. Front-Line managers are called foreman,

supervisor, inspector and so on in any organisation.

Middle Level Managers

Middle management level includes in many organisations, more than one level.

Managers who work at all the levels between the lower and top levels constitute the

middle management. Department heads, Regional managers, Zonal managers and

the like fall in this category. They report to top managers. Their principal

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responsibilities are to direct the activities of lower level managers who implement

the organisation’s policies.

Top level Managers

This level consists of a small group of executives. Board of Directors,

Chairman, Managing Director and the top functional heads and divisional

managers comprise this level. Top managers are responsible for the overall

management of the organisation. They decide the enterprise objectives, policies and

strategies to be pursued to achieve those objectives. They provide direction to the

organisational by guiding the organisation’s interactions with its environment.

16.3.1. MANAGEMENT AS A SCIENCE

It is therefore relevant to examine the exact nature of management whether it

is a science or an art. ‘Before arriving at a conclusion, let us understand the nature

of science as well as art. Any branch of knowledge to be considered as science, (like

the ones we have physics, chemistry, engineering, etc.,) should fultil the following

conditions :

The existence of a systematic body of knowledge encompassing a wide array of

principles :

The principles have to be evolved on the basis of constant enquiry and

examination ;

The principles must explain a phenomenon by establishing cause - effect

relationship;

The principles have to be amenable for verification.

Looked at from this angle, management as a discipline fulfils the above

criterion. Over the years, thanks to the contributions of man thinkers and

practitioners. management has emerged with own principles. The application of

these principles helps any practising manager to achieve the desired goals.

However, while using the principles, one should not lose sight of the variables in

the situation, since situations differ from one another. Thus, the importance of

personal judgement cannot be undermined in the application of principles. Further,

management is a dynamic subject in that it has drawn heavily from economics,

psychology, sociology, engineering and mathematics, to mention a few. It is multi-

disciplinary in nature. But a word of caution. Though management, considering its

subject matter and the practical utility, may be considered as ‘Science’ for reasons

discussed below, it cannot be viewed as an’ exact science’.

16.3.2. Scientific Management ERA

Frederick Winslow Taylor (1856-1915) should be ever remembered for his

contribution to the management movement. In an effort to address several

organisational problems. Taylor developed the body of knowledge what is now called

“Scientific management”. Taylor investigated the effective use human beings at the

shop floor level in the industrial organisation. He defined managing as the art of

“knowing exactly what you want men to do and then seeing that they do it in the

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best and cheapest way”. For the emphasis he had placed on the scientific way of

doing things, he is often called the “father of scientific management”.

16.3.3. Salient Features of Scientific Management

Taylor conducted various experiments at the work place to find out how

human beings could be made more efficient by standardising the work. These

experiments have provided the following features of scientific management.

i. Separation of planning and doing

Taylor emphasized the separation of planning from actual doing. Before

Taylor’s Scientific Management, a worker used to plan about how he had to work

and what instruments were necessary for that. This was creating lot of problems.

Taylor insisted that planning should be left to the supervisor and the worker should

concentrate on doing the work.

ii) Functional Foremanship

Separation of planning from doing resulted in the development of

supervision system. For this purpose, Taylor evolved the concept of functional

foremanship based on specialization of functions.

iii. Job analysis

According to Taylor the best way of doing a job is one which requires the least

movements. consequently less time and cost. He analysed the various jobs to find out

the best way of doing the things with the help of Time and Motion and Fatigue studies.

a) Time study involves the determination of time, a movement takes to

complete. The movement which takes minimum time is the best one. This helps in

fixing the fair work for a period.

b) Motion study involves the study of movements which are involved in doing a

job and thereby elimination the wasteful movements and performing only necessary

movements.

c) Fatigue study shows the amount and frequency of rest required in completing

the work. Thus job analysis, as given by Taylor, suggests the fair amount of a day’s

work requiring certain movements and rest periods to complete it.

iv. Standardization

Instruments and tools, period of work, amount of work, working conditions

and cost of production have to be standardized on the basis of job analysis and

various elements of costs that go into the job.

v. Scientific Selection and Training of Workers

Taylor suggested that workers should be selected on a scientific basis taking

into account their education, work experience, aptitude, physical strength, etc., A

worker should be given work for which he is physically and technically most

suitable. Apart from selection, proper emphasis should be laid on the training of

workers to make them efficient and effective.

vi. Financial Incentives

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Taylor introduced financial incentives to motivate workers to put in their maximum

efforts. he applied the concept of differential piece rate system. According to this scheme, a

worker who completes the normal work gets wages at higher rate per piece and one who does

not complete gets at lower rate. To make the differential piece rate system work, he has

suggested that wages should be based on individual performance.

vii. Economy

While applying scientific management, not only scientific and technical aspects

should considered but adequate consideration should be given to economy and

profit. For this purpose, techniques of cost estimates and control should be

adopted. The economy and profit can be achieved by making the resources more

productive as well as by eliminating the wastages.

viii. Mental Revolution

Taylor strongly suggested a change in the attitude of employees and

employees. Mutual conflict should be replaced by mutual cooperation which is

beneficial to both. Taylor argued that mental revolution is the most important

feature of scientific management because in its absence, no principle of scientific

management could be applied.

In his crusade against the unscientific methods of management which were

prevalent at that time. Taylor had to face bitter criticism from different quarters. It

is an irony that in the beginning both workers and the managements did not

understand Taylor’s preaching’s correctly. Workers had struck work in protest

against the proposed changes in the work routine and systems. The American

congress had even called Taylor for an explanation. Taylor’s philosophy, in simple,

as reiterated by him before the congress and also in his book “The principles of

Scientific Management”. rested on the following four basic principles :

the development of a true science of management, so that the best method for

performing each task could be determined :

The Scientific selection of the workers, so that each worker would be given

responsibility for the task for which he or she was best suited :

The scientific education and development of the worker: and

Intimate, friendly co-operation between management and labour.

16.3.4 Management Principles

F.W Taylor

In 1911, Frederick Winslow Taylor published his work, The principles of

Scientific Management, in which he described how the application of the scientific

method to the management of workers greatly could improve productivity.

Scientific management methods called for optimizing the way that tasks were

performed and simplifying the jobs enough so that workers could be trained to

perform their specialized sequence of motions in the one "best" way. Prior to

scientific management, work was performed by skilled craftsmen who had learned

their jobs in lengthy apprenticeships. They made their own decisions about how

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their job was to be performed. Scientific management took away much of this

autonomy and converted skilled crafts into a series of simplified jobs that could be

performed by unskilled workers who easily could be trained for the tasks.

Taylor became interested in improving worker productivity early in his career

when he observed gross inefficiencies during his contact with steel workers.

Taylor's 4 Principles of Scientific Management

After years of various experiments to determine optimal work methods, Taylor

proposed the following four principles of scientific management:

1. Replace rule-of-thumb work methods with methods based on a scientific

study of the tasks.

2. Scientifically select, train, and develop each worker rather than passively

leaving them to train themselves.

3. Cooperate with the workers to ensure that the scientifically developed

methods are being followed.

4. Divide work nearly equally between managers and workers, so that the

managers apply scientific management principles to planning the work and

the workers actually perform the tasks.

These principles were implemented in many factories, often increasing

productivity by a factor of three or more. Henry Ford applied Taylor's principles in

his automobile factories, and families even began to perform their household tasks

based on the results of time and motion studies.

Drawbacks of Scientific Management

While scientific management principles improved productivity and had a

substantial impact on industry, they also increased the monotony of work. The core

job dimensions of skill variety, task identity, task significance, autonomy, and

feedback all were missing from the picture of scientific management.

While in many cases the new ways of working were accepted by the workers, in

some cases they were not. The use of stopwatches often was a protested issue and

led to a strike at one factory where "Taylorism" was being tested. Complaints that

Taylorism was dehumanizing led to an investigation by the United States Congress.

Despite its controversy, scientific management changed the way that work was

done, and forms of it continue to be used today.

Scientific management, or Taylorism, is a management theory that analyzes

work flows to improve economic efficiency, especially labour productivity. This

management theory, developed by Frederick Winslow Taylor, was popular in the

1880s and 1890s in manufacturing industries. While the terms "scientific

management" and "Taylorism" are often treated as synonymous, an alternative view

considers Taylorism to be the first form of scientific management. Taylorism is

sometimes called the "classical perspective," meaning that it is still observed for its

influence but no longer practiced exclusively. Scientific management was best

known from 1910 to 1920, but in the 1920s, competing management theories and

methods emerged, rendering scientific management largely obsolete by the 1930s.

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However, many of the themes of scientific management are still seen in industrial

engineering and management today. Important components of scientific

management include analysis, synthesis, logic, rationality, empiricism, work ethic,

efficiency, elimination of waste, and standardized best practices . All of these

components focus on the efficiency of the worker and not on any Frederick Winslow

Taylor Frederick Winslow Taylor is considered the creator of scientific management.

specific behavioural qualities or variations among workers. Today, an example of

scientific management would be determining the amount of time it takes workers to

complete a specific task and determining ways to decrease this amount of time by

eliminating any potential waste in the workers' process. A significant part of

Taylorism was time studies. Taylor was concerned with reducing process time and

worked with factory managers on scientific time studies. At its most basic level,

time studies involve breaking down each job into component parts, timing each

element, and rearranging the parts into the most efficient method of working. By

counting and calculating, Taylor sought to transform management into a set of

calculated and written techniques.

Frank and Lillian Gilbreth

While Taylor was conducting his time studies, Frank and Lillian Gilbreth were

completing their own work in motion studies to further scientific management. The

Gilbreths made use of scientific insights to develop a study method based on the

analysis of work motions, consisting in part of filming the details of a worker's

activities while recording the time it took to complete those activities. The fil ms

helped to create a visual record of how work was completed, and emphasized areas

for improvement. Secondly, the films also served the purpose of training workers

about the best way to perform their work. This method allowed the Gilbreths to

build on the best elements of the work flows and create a standardized best

practice. Time and motion studies are used together to achieve rational and

reasonable results and find the best practice for implementing new work methods.

While Taylor's work is often associated with that of the Gilbreths, there is often a

clear philosophical divide between the two scientific management theories. Taylor

was focused on reducing process time, while the Gilbreths tried to make the overall

process more efficient by reducing the motions involved. They saw their approach

as more concerned with workers' welfare than Taylorism, in which workers were

less relevant than profit. This difference led to a personal rift between Taylor and

the Gilbreths, which, after Taylor's death, turned into a feud between the Gilbreths

and Taylor's followers. Even though scientific management was considered

background in the 1930s, it continues to make significant contributions to

management theory today. With the advancement of statistical methods used in

scientific management, quality assurance and quality control began in the 1920s

and 1930s. During the 1940s and 1950s, scientific management evolved into

operations management, operations research, and management cybernetics. In the

1980s, total quality management became widely popular, and in the 1990s "re-

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engineering" became increasingly popular. One could validly argue that Taylorism

sent the groundwork for these large and influential fields we practice today.

16.3.5. Private and public Sector ownership

Ownership of business is represented by the right of an individual or a group

of individuals to acquire legal title to assets for the purpose of controlling them and

to enjoy the gains or profits from such possession and use.

For business purpose, therefore, the chief forms of ownership organisation are:

1. Sole proprietorship

2. Partnership

3. Co-operative society

4. Joint stock company

Private sector

1. Individual Ownership

(i) Sole proprietorship

2. Group ownership

(i) Partnership

(ii) Hindu joint family firm

(iii) Company

(iv) Co-operative society

3. Public sector

1) Group ownership

i) Department

ii) Public corporation

iii) Government Company

iv) Commission


1. Effective management of social responsibilities.

2. scientific management.

3. Management aims of achieving the organisation goals.

16.5 INTEXT QUESTION

1. What is meant by management as a science?

2. List out the role of top level managers.

16.6 SUMMARY

Though management has been in practice in some form or other since time

immemorial, the development of a systematic body of knowledge dates back to the

last few decades. Industrial revolution has immensely contributed for the

development of management thought. Over the years, it has drawn heavily from

various disciplines like economics, psychology, sociology, operations research and

so on. The contributions of prominent thinkers who have created an everlasting

impact on management have been discussed in this lesson in detail. An attempt is

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made to expose the learner to the historical development of management over the

years.


1. “Management is oldest of the Arts and youngest of the Science” Discuss.

2. List out the features of scientific management


1. https://en.mwikipedia.org/wiki/Scientific_management

2. https://www.mindtools.com/pages/article/newTMM_Taylor.htm

16.9 ASSIGNMENTS

1. Analyses the contribution of F.W. Taylor and Henry Fayol Modern

Management Thought and discuss how they differ in their approach.

2. “Management is to business what the mind is to a human being”. Critically

examine this statement.

16.10 SUGGESTED READINGS/ REFERENCE BOOKS

1. Harold Koontz, Cynil O’donnell and Melitrich: Management (Tokyo: McGraw

Hill Publications)

2. James Stover: Management (New Delhi: Prentice Hall of India, 1980.

3. Drucker Peter F., 1981 Management Tasks, Responsibilities and practices

Allied publishers New Delhi.

4. Terry, George R and Franklin, Strephe G. 1988 Principles of management.

All India Traveller Book Seller Delhi.


1. Differentiate private sector and public sector ownership

2. List out management principles

16.12. KEY WORDS

Organisation Goals, Job Analysis, Standardization, Scientific Selection,

Knowledge Workers.

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LESSON - 17

COST, DEPRECIATION AND VALUATION

17.1. INTRODUCTION

Cost function plays a vital role among all the functions of an organisation to

ensure success and organisational growth in the environment of global competition.

Generally fixed assets, except land, such as Plant and Machinery, Furniture,

Buildings and Equipment have a short period of useful life. As these assets are

permanently used in the business they necessarily go down in value in course of

time. Depreciation is thus, diminution in the value of a fixed asset due to use and /

or the lapse of time.

The term depreciation is derived from the Latin words ‘do’ (meaning down) and

‘pretium’ (meaning price) in business, it is used to denote loss or value which arise

through wear and tear or some other form of material deterioration or the affluxion

of time.

17.2 OBJECTIVES

To impart an understanding about installation of Cost accounting.

To familiarise you the basic costing concepts, principles and types of cost.

To acquaint you with the different costing techniques available to exercise

cost control.

To give brief note about different methods of Depreciation.

To explain the managerial significance of Depreciation Accounting.

To know about the value and value analysis

17.3 CONTENTS

17.3.1. Cost Accounting

17.3.2. Objectives of cost Accounting

17.3.3. Essential of installing Costing System

17.3.4. Elements of cost

17.3.5. Depreciation

17.3.6. Methods of Depreciation

17.3.7. Valuation

17.3.8. Procedure of value Analysis.

17.3.1. COST ACCOUNTING

The cost control has to happen at the point of incurrence and it is necessary

that the facilities available are fully utilized to swell the volume of operations which

will automatically bring down the cost per unit. The impact of volume on Cost Per

Unit is certainly a measure of efficiency, productivity and the intensity of utilisation

of resources.

Cost Accountancy has many aspects like cost accounting, budgetary control,

cost control and cost audit. Cost accounting denotes the formal mechanism by

means of which costs are ascertained.

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Cost Accounting is classifying, recording and appropriate allocation of

expenditure for the determination of the costs of products or services, and for the

presentation of suitably arranged data for purposes of control and guidance of

management.

“It is the application of costing and cost accounting principles, methods and

techniques to the science, art and practice of cost control and the ascertainment of

profitability. It includes the presentation of information derived there from for the

purpose of managerial decision - making”

Institute of Cost and Management Accountant (ICMA), London.

The term ‘Cost Accountancy’ includes Costing and Cost accounting. Its

purposes are Cost-control and Profitability - ascertainment. It serves as an

essential tool of the management for decision-making.

Costing and Cost Accounting

It is defined as “the classifying, recording and appropriate allocation of

expenditure, for the determination of costs, the relation of these costs to sale value

and the ascertainment of profitability”. So this is a technique and processes of

ascertaining costs.

Cost Accounting

“The process of accounting for cost from the point at which expenditure is

incurred of committed to the establishment of its ultimate relationship with cost

centres and cost units. In its widest usage it embraces the preparation of statistical

data, the application of cost control methods and the ascertainment of the

profitability of the profitability of activities carried out or planned” - ICMA.

It is defined as “the application of accounting and costing principles

methods and techniques in the ascertainment of costs and the analysis of savings

and / or excesses as compared with previous experience or with standards.” So it is

a formal system of accounting for costs by means of which costs of products and

services are ascertained and controlled.

Applications of costing

The application is wide. All types of activities, manufacturing and non

manufacturing in which monetary value is involved. Wholesalers, retailers, banking

and insurance companies railways, hotels, hospitals, colleges and the like, all have

to adopt cost accounting techniques to operate efficiently.

17.3.2. OBJECTIVES OF COST ACCOUNTING

1. To ascertain the cost per unit of the different products manufactured by a

business concern.

2. To provide a correct analysis of cost both by process or operations and by

different elements of cost.

3. To disclose sources of wastage and to prepare such reports which may be

necessary to control such wastage.

4. To furnish requisite data to guide in fixing the price.

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5. To ascertain the profitability.

6. To exercise effective control of stocks.

7. To advice management on future expansion.

8. To help in the preparation of budgets.

9. To assist in taking various financial decisions such as introduction of new.

products, replacement etc.

10. To organise cost reduction programmes with the help of different department

managers.

11. To offer specialized services of cost audit in order to prevent the errors and

frauds and to facilitate prompt and reliable information of the Management.

12. To provide suitable means and information to the top management to control

and guide the operations of the business organisation.

13. To compare actual costs with the standard costs and analyse the causes of

variation.

14. To contribute necessary information to develop cost standards and to

introduce the system of budgetary control.

15. To enable the management to know where to economic on costs, how to fix

prices, how to maximize profits and so on.

16. Cost accounting provides management with cost data relating to products,

processes, jobs and different operations in order to control the costs and

maximize the earnings. It plays’ a vital role in all the business activities.

17.3.3. ESSENTIALS OF INSTALLING COSTING SYSTEM

The general considerations to be observed in installing a costing system are as

follows :

The Objective: Whether the objective of installing the costing system is

limited to a specific area, e.g. material management, or fixing selling price, or to

arrive at a certain managerial decision or the object is to install the system for

covering all the aspects of cost affecting the business. The approach to install the

system will be dependent on its objective.

The Area of Operation: Having decided the objective, the areas of operation of

the system are to be studied, by which the management can be best benefited. If

production is slack, attention will have to be paid to increase if production is good

but the sales are receding, study will be made to increase the sales and action

taken according to the results of study and analysis. Such areas, which require

immediate attention, are to be carved out on priority basis to be handled by the

cost system.

The Organisation of the Business: No system of cost installation would

succeed until the organisation structure of the business is taken into account. The

organisational part would help to determine the scope of working and improvement.

If the interest of management call for certain minor changes in the organisational

structure, to its advantage, the same may have to be done.

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The Conception & Reception of the Idea: The idea of the installation of the

cost system is to be placed before the staff and the workers in a manner that it is

well received and not objected to on flimsy grounds. The success of the system

would depend on the co-operation of the persons engaged in the enterprise, and the

co-operation will be forth coming only if the idea and plans are well conceived and

received. The benefits of introducing the system to all the sections should be well

explained.

Collection of Data & Prompt Information: The cost data works as a base for

decision making. There should be evolved a proper system for the collection of the

required cost data and information promptly. Secondly, there should be a system to

verify the correctness of the data supplied, otherwise the conclusions drawn would

be wrong and time spent in its working would go waste.

Cost Records & Cost Books: The maintenance of cost records and cost books

depends on the size and nature of the business, but the basic requirements. The

manner in which the financial accounts could be interlocked into an integral

accounting system has to be studied and worked out. Decision has to be taken if

two separate set of books-one for financial accounts and other for cost accounts-

have to be maintained and thereafter the results are to be reconciled. Proper books

and records are to be kept and maintained to meet the requirements of either of the

two situations mentioned above.

Control system for the Elements of Cost: System would have to be devised

for recording and controlling costs of materials, labour and overheads, in

accordance with costing principles and procedures.

Type and Method of Costing: The choice of method of costing would depend

on the nature of production, e.g. Job Cost method or the Process Cost method. For

cost control, standard costing along with budgetary control may have to be selected

and applied. Similarly, for decision-making, Marginal and Differential costing

techniques may be found useful. Preparations for the application of the particular

method and technique / type should be made initially.

Responsibility Accounting: Responsibility accounting is a technique of cost

control by delegating, etc., known as responsibility centres. It has to be judged

whether a particular official who had been assigned a particular function, has

implemented the same or not within the time allotted to him, or not, and thus the

responsibility has got to be fixed for failure-action on individual persons, for the

sake of control of cost. For this purpose, a system of responsibility accounting

should be evolved.

The specific considerations as distinct from general considerations to be kept

in view while installing a cost system are as follows :

Size and Nature of Business: In a business of big size, a detailed cost system

is necessary while in a small business, the system should be within the

requirements so that the expenses on the installation and its working may not out-

weigh the utility.

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The cost system is good for business engaged in manufacturing or in service -

rendering concerns but for others. Even in production enterprise like colliery where

the production costs are all direct costs, the financial accounts may be so designed

as to obviate the need of any cost system, unless otherwise called for.

Products: The nature of product determines the method of costing to be applied. If

the material content of the product is more valuable, the material cost records need be kept

in comparatively more elaborate manner so as to make material cost control effective.

Same is the position with regard to labour and overhead.

Organisation: The organisational set up for a costing system should be

modelled that the control part is exercised by the Cost Accountant, as such, the

present organisational set up of the costing department need close study to suggest

necessary changes.

Functional study: The functional divisions of an undertaking based on cost

are a) Manufacturing, b) Administration, and c) Selling & Distribution. A study of

the present working of the different departments is necessary to suggest

improvements.

17.3.4. ELEMENTS OF COST

For proper control and managerial decisions management is to be provided

with necessary data to analyse and classify costs. For this purpose the total cost is

analysed by elements of cost based on nature of expenses. The elements of cost are

further analysed into different elements as follows.

By grouping the above elements of cost, the following division of cost are

obtained;

1. Prime cost-Direct materials + Direct labour + Direct expenses

2. Works of factory cost - Prime cost + works of Factory overheads

3. Cost of production - work cost - Administration overheads.

4. Total cost or cost of sales- cost of production + selling and distribution

overheads.

The difference between the cost of sales and selling Price represents profit or

loss.

Direct Materials

It is the one which can be identified in the product and can be conveniently

measured and directly charged to the product, Ex: Timber in furniture.

Classification of direct materials

1. All raw materials like jute in the manufacture of gunny bags pig iron in

foundry and fruits in eating industry.

2. Materials specifically purchased for a specific job, process or order like glue

for book binding, starch powder for dressing yarn.

3. Parts or components purchased or produced like batteries for radio.

4. Primary packing materials like cardboard box.

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Indirect materials

In some cases, though the material is a part of the finished product yet it is

not treated as direct materials. ex: nails in furniture making. This is because it is

used in small quantities. Even certain items which do not physically become a part,

of the finished products, ex: coal, Greece etc.

Direct Labour

It includes payment made to the following groups of labour :

1. Labour engaged on the actual production of the product in carrying out an

operation or process.

2. Labour engaged in aiding the manufacture by way of supervision

maintenance, tools setting, transportation of material cost.

3. Inspectors, analysis etc, specially required for such production.

Indirect Labour

It is of general character and cannot be conveniently identified with a

particular cost unit. Indirect labour is not directly engaged in the production

operations but only to assist or help in production operations, direct or chargeable

expenses. It includes all expenditures other than direct material or direct labour

that are specifically incurred for a particular product. Such expenses is charged as

part of the - prime cost. Ex: Excise duty, Royalty.

Overheads: It may be defined as the aggregate of the cost of indirect materials,

indirect labour and such other expenses including services as cannot conveniently

be charged direct to specific cost units. Thus, overheads are all expenses other than

direct expenses. In general terms overheads comprise all expenses incurred for or

in connection with the general organisation of the whole or part of the undertaking.

The main groups into which overheads may be sub-divided are the following.

1. Manufacturing overheads.

2. Administration overheads.

3. Research and Development overheads.

Expenses excluded from costs: The total cost of a product should include

only those items of expenses which are a change against profit. Items of expenses

which are relating to capital assets, capital losses, payments by way of distribution

of profits and matters of pure finance should not form a part of the costs. ex:

Income tax, dividends etc.

Cost sheet or statement of cost: It is to show the output of a particular

accounting period along with break-up of costs. The date incorporated in cost sheet

are collected from various statements of accounts which have been written in cost

account either day-to -day or regularly records.

It is generally presented in column in the form of total cost of current period,

per unit for the period, total cost per unit etc. Cost sheet is a Memorandum

statement. Therefore, it does not form part of double entry cost accounting records.

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Advantages

1. It discloses the total cost and the cost per unit of the units produced during

the given period.

2. It enables a manufacturer to keep close watch and control over the cost of

production.

3. By providing a comparative study of the various elements of current cost with

the past results and standard costs, it is possible to find out the causes of

variations in costs and to eliminate the adverse factors and conditions which

go to increase the total cost.

4. It acts as a guide to the manufacturer and helps him in formulating a definite

useful production policy.

5. It helps in fixing up the selling price more accurately.

6. It helps the businessman to minimise the cost of production when there is a

cut throat competition.

7. It helps the businessman to submit quotations with reasonable degree of

accuracy against tenders for the supply of goods.

17.3.5 DEPRECIATION

“Depreciation represent that part of the cost a fixed asset to its owner, which is

not recoverable when the asset is finally put-out of use by him. Provision against

this loss of capital is an integral cost of conducting the business during the effective

commercial life of the asset and is not dependent upon the amount of profit cleared.

The Institute of Chartered Accountants of Australia

“Depreciation is the allocation of the entire cost of depreciable assets to the

operating expense of a series of fiscal period”.

Mr. Montgomery

“Depreciation is the process of spreading the value of a fixed asset over

accounting periods comprising its service life”.

17.3.6 METHODS OF DEPRECIATION

1. Straight - line Method

As this method is very simple and easy to understand, it is widely used. This is

otherwise as “Fixed Instalment method” or “Original Cost System”. Under this

method a fixed amount is to be charged as depreciation for each year of expected

use of the asset. The annual charge is computed by dividing the depreciable cost,

total cost minus salvage value by the estimated working life expressed in years.

Suppose an asset is purchased for Rs. 80,000 and its residual value at the end of

its tenth year of life during the course of 10 years at the rate of Rs. 7,200 per year.

It is suitable for use in connection with patents. leaseholds and machinery etc, as

depreciation is connection with patents, leaseholds and similar assets having a

definite life and it is not suitable for plant and machinery etc. as depreciation is

constant while the repairs will be heavy in later years. This method is generally

followed regarding ocean going ships etc.

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2. Service - Hours Method

This method takes into consideration the “running time” of the asset for the purpose of

calculating the amount of depreciation. For example, in the case of air-craft the estimated

useful life may be calculated in terms of “flying hours”. The formula is,

D= C – S

× Service Hours n

This method is useful 1) where obsolescence is not a primary factor 2) use of

asset can be measured in terms of time and 3) the utility of the asset is directly

related to its working time.

3. Productive Output Method

In this method it is essential to make an estimate of the units of output the

asset will produce in its lifetime. For example, in case of a truck, estimated useful

life may be in terms of kilometres operated and for a stamping machine, a certain

number of stamps. Depreciation is calculated as under.

D= C – S

× units of output n

4. Diminishing Balance Method

This method is otherwise known as Reducing Balance Method or Written Down

Value Method. This method yields its diminishing annual depreciation charges by

applying a constant rate to the written down value of the cost an asset. Here

depreciation is provided on the basis of a percentage. Though this percentage

remains the same, the actual provision drops year after year, because the

percentage is based on the diminishing value. Suppose the cost of an asset is

Rs.20,000. At the rate of 10% depreciation for the first year is Rs. 2,000. For the

next year it is Rs. 1,800

(20,000-2,000=18,000 × 10 ).

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It is clear that the depreciation is written off on the basis of the balance in the

account of the asset.

The main advantage of this method is that the decreasing depreciation charges

in the later years on a asset’s life fund to compensate the increasing cost of

maintenance and repairs as the asset grown older and thus help to make the total

cost of using the asset more or less content. Hence, this method is suitable for a

assets like plant and machinery, boiler, lorry, motor, car and buildings.

5. Sum of the years Digit Method

Depreciation rate, under this method is expressed a fractions. For getting the

fractions, one has to add the numbers representing the period of life, use the sum

thus obtained as a denominator and use as numerator, the same numbers take in

reverse order and finally multiply the net asset value by the fractions thus

produced. For example a fixed asset costing Rs. 50,000/- (Rs. 10,000/- residual

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value) with estimate useful life of 5 years the denominator of the fraction for each

would be 15 (1+2+3+4+5) years The allowable depreciation, for the first year is 5/15

of cost, for second year 4/15 of the cost and so on.

6. Double Declining Balancing Method

Under this method the depreciation is charged on the reducing balance

method but the rate of depreciation is determined by multiplying the straight line

rate by two. Here residual value is ignored. This method is often used in the U.S.A.

7. Revaluation Method

Assets such as Loose Tools, Pattern Copyrights, Models Livestock, Packing

Materials, Bottles, Jigs etc, Cannot be depreciated under Straight Line Method or

Reducing Method, as they do not depreciate uniformly. So they are revalued at the

end of each accounting year. The difference between the opening value and the

revaluated amount is treated as used cost or depreciation. This method is ideal for

special utility assets purchased for use on a specific project and whose utility at the

end of the project is problematical. If the revaluation discloses any appreciation in

the value of asset it should be treated as capital reserve.

8. Replacement Method

This system is frequently utilised in public utility companies. This system does

not record depreciation until a unit is replaced. When unit is replaced at time, the

amount equal to the cost of the new assets (less the residual value of the old asset)

is charged to depreciation.

9. Annuity Method

Earlier methods ignore interest on the capital sunk in the acquisition of the

asset. Hence, this method takes the case of the fact that the business decides

losing the original cost of the asset also loses interest (on the amount used for

buying the asset) which he would have earned had the same amount been invested

in some other form of investment. Under this system the amount of total

depreciation is determined by adding the cost of asset and interest thereon at an

expected rate. As the calculation of depreciation is difficult, a depreciation Annuity

Table has been specially constructed for this purpose. This shows the amount that

can be written down annually, as depreciation on the asset along with a certain

rate of interest on the capital sunk, in the asset. The depreciation to be written off

can be found out from the Annuity Table.

This system is an exact method of providing depreciation. It is applicable only

to leaseholds which generally involve considerable capital outlay over a specific

term of years. It is not applicable to plant and machinery as they are subject to

frequent calculations on account of additions and dismantling of them.

10. Depreciation Fund Method

The method is otherwise known as Sinking Fund Method. This system

combines both the depreciation of asset and its replacement under one

comprehensive approach of providing ready cash for purchasing new asset at the

time of replacing the old one. For this purpose the depreciation amount is set aside

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and invested in Government bonds, Securities etc. Interest on these investments is

also invested on similar investments. When the life of the asset comes to an end,

the securities are sold and a new asset is purchased with the help of the sale

proceeds. The amount that is kept aside as depreciation and invested every year is

such that the accumulated amount with compound interest, will be equal to the

cost of the asset, less residual value if any, at the time when it becomes worthless

to the business. For this purpose “Sinking Fund Table” is used which shows how

much is to be invested every year to get Re. I for some years with certain percentage

of interest. Such figure is multiplied by the value of asset.

11. Insurance Policy Method

It is similar to Depreciation Fund Method instead of making investments,

arrangements are made with an insurance company which will receive premium

annually and pay at the end of the fixed period the required amount. The premium

amount has to be paid in the beginning of each year. The annual premium is

treated as the annual depreciation. The amount is credited every year to the

Depreciation Fund Account by debiting Depreciation Account. Fund Account by

debiting Depreciation Account. On payment of the premium. Depreciation fund

Policy Account is debited. Here there is no entry for interest as no interest will be

received from the Insurance company.

12. Depletion Method

This method is most suitable for mines, quarries etc, from which a certain

quantity of output is expected to be obtained. The value of mine depends only upon

the quantity of minerals that be obtained. When the whole quantity is taken out,

the mine loses its value. Hence, one can say that the mine depreciates according to

the quantity mined. The rate of depreciation is worked out as so much per tonne. It

is obtained by simply dividing the cost of the mine by the total quantity of the

mineral expected to be available.

17.3.7. VALUATION

This is a process which is useful for managerial decision making by which

unnecessary costs are indentified and eliminated without impairing the quality and

efficiency. It is also concerned with exploring channels of performance improvement

and in endeavours to get value for a given cost by a continuous process of planned

action.

This is an effective tool of cost reduction value analysis probe into the

economic attributes of value. It improve performance, increases the value of the

product and reduces the costs by a continuous process of planned action.

Value and value analysis

Value is used in a broader sense and it has different meanings for different

persons. Ex. For Management it is the return on investment.

TYPES OF VALUE

i) Use value

There are certain characteristics of a product which make it useful for certain

purpose.

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Example

Pen for writing, it measures the quality of performance of a product. The use

value may be primary and secondary. Primary use value indicates the attributes of

a product which are essential for its performance as engine, steering wheel and axle

in a motor car without which car cannot move. Secondary use value refers to such

devices as bonnet or the mudguard or the wind screen without which motor car can

be driven but they are necessary for the protection of engine and other parts.

Esteem value: Certain properties of product do not increase its utility or

performance but they make it esteemable which would induce customers to

purchase the product. ex: Going for Palmolive soap though Lifebuoy serves the

purpose.

Cost value: The value is measured in terms of cost involved :

Exchange value: Certain characteristics of a product facilitate its exchange for

something else and what are the exchange value of that product.

Value analysis: It seeks to provide the different values required in a product or

service at the least cost without impairing its qualify, efficiency and attractiveness.

Relationship between value, function and cost

Value = Function

Cost

Value can be improved by the following ways :

a) by improving function, cost remaining constant

b) by improving cost, function remaining constant

c) by improving function and reducing cost.

17.3.8 PROCEDURE OF VALUE ANALYSIS

1. Identification and definition of the problem.

2. The feasibility of the alternatives and exploring the best method of performing

the work at the minimum cost.

3. The investment, if any, required for the alternative.

4. Percentage of the return on new investment.

5. Costs resulting indirectly out of a decision to change to alternative like costs of

items becoming obsolete, cost training etc.

6. The benefits from the alternative like reduction in costs and increased

revenue.

7. Recommendation of the final proposal for implementation after considering the

above points which will increase use value or esteem value.

Techniques of value analysis

Lawrence & Miles of the General Electric company who is known as the father

of value analysis has developed the following techniques :

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1. Work is specific

Here people at the top will be influenced by the specific proposal and it is

possible that the right manufacturing process may be developed after careful

examination. Hence, avoid generalities because they serve only to prevent changes

and protect the status quo.

2. Obtain all available costs

Information about all available costs should be obtained. The specific method

may slightly increase cost in department but may lead to reduction in other

departments resulting in overall reduction. Relevant costs for each function may be

obtained, if not available it must be calculated accurately.

3. Information from the most Authentic Source

Information on any aspect of cost, methods of manufacture, finishing packing

etc., should be obtained from the most reliable source. To get the correct

information, a questionnaire should be developed. The following things may be

taken care while collecting information.

a) Design of the product and its value.

b) Relationship of cost proportionate to the use value or esteem value.

c) Selecting the essential features alone.

d) Searching for better substitute.

e) Chances of reducing the material cost.

f) Deciding whether all labour operations are necessary.

g) Possibility of standardisation and simplification of products.

4. Evaluate function by comparison

Here comparison is made with the functions of other concerns, the cost etc.

This will lead to a number of alternatives which can be examined to see if any of

them is likely to result in a cheaper but reliable alternative.

5. Discuss with specialists and take advantage of their expertise knowledge

It is highly needed to get specialised knowledge form suitable specialist,

without such expertise knowledge status quo will be continued and opportunity of

improving value and reducing cost will be lost.

6. Use real creativity

Value analysis involves a creative appeal for finding out unnecessary costs.

The human mind is capable of developing new ideas which lead to cost reduction

and performance improvement. Creative thinking can be helpful in cost reduction

by simplifying the existing part or item to do the same function.

7. Consult your suppliers for new ideas

As your suppliers are dealing with many others who are in the same line of

business, their ideas and suggestions will be great help to you.

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8. Use Standard parts whenever possible

Standard parts are interchangeable and cheaper than specially made parts

because parts are generally made by mass production methods leading to reduced

costs. Specially made parts should be used only when it is unavoidable to do so.

9. Refine ideas till only one acceptable alternative remains,

10. Get the maximum cooperation from colleagues to other department with whom you

have to deal.

Advantages of value analysis

1. It is a powerful tool for cost reduction because its basic objective is the

identification of unnecessary costs in a product or service and efficiently

eliminating them without impairing its quality and efficiency.

2. It is scientific tool for increasing the productivity of a concern because it

aims at exploring various alternatives for efficient use of all types of resources in

employment and making available goods and services of the kind and quality most

wanted by customers, at lower and lower costs.

3. It helps to keep management abreast of the latest technology and other developments

because value analysis aims at examining new methods and techniques of doing things with a

view to reducing the cost and increasing the value of the items.

4. It ensures the fullest possible use of resources because it aims at

eliminating all unnecessary costs.

5. It induces the creative ability of the staff because it involves a creative

approach for finding out unnecessary costs.

6. It creates proper atmosphere for increased efficiency because it aims at a

continuing research for improvement in efficiency.

7. It is helpful in any drive for import substitution because i t explores new

methods and techniques of manufacturing indigenous goods which may serve the

same purpose.

8. It can be applied at the stage from initial design stage of an item right up to

the final stage of its packing and dispatch because it aims at iden tifying

unnecessary costs at all levels with a view to eliminating them systematically.


1. Causes of inflation, inflation management, demand factor.

2. Overcome deflation, discretionary action.


1. What is meant by inflation, hat is aggregate demand.

17.6 SUMMARY

To Summarize, this lesson gave a brief account of different methods and

techniques of costing. The different methods given here help to understand the

procedure of computing cost in different fields of business activities. This helps to

enhance the application of cost accounting to multifarious business and non -

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business activities and hence widen the scope of cost accounting. The various

techniques mentioned to exercise control over cost are useful. The meaning of

Depreciation and Depreciation policy, depreciation accounting and methods of

depreciation are discussed in this lesson. Conceptual ideas relating to value

analysis and procedure of value analysis are highlighted.


1. Define costing and cost Accounting.

2. Define costing and discuss briefly its object and advantages.

3. Explain the term cost unit and cost centre.

4. What is main features job costing? And state its limitations.

5. Explain the nature and uses of batch costing.

6. What are the objectives of Depreciation Accounting?

7. Explain the different methods of Depreciation.

8. What are the advantages of value analysis.

17.8 SUPPLEMENTARY MATERIAL

1. https://en.mwikipedia.org/wiki/depreciation.

17.9. ASSIGNMENTS

1. “Cost Accounting has become an essential tool of management even in non-

profit making institution” - Discuss.

2. What do you mean by depreciation? Examine the factors influencing the

amount of depreciation?

3. Discuss the different types of value analysis? Examine the procedure for

value analysis.

17.10. SUGGESTED READINGS REFERENCE BOOKS

1. Horngren, C.T. Accounting for Management Control – An introduction,

Englewood Cliff, N.O.X., Prentice Hall, 1985.

2. De Paule, F.C. Management Accounting in Prentice, London, Pitman, 1959.

3. B.S. Khanna and others: Cost Accounts, S. Chand & Sons. New Delhi. 2002.

4. N.L. Abuja and G.K. Chanda: Principles of cost Accounting.


1. Explain about fiscal policy

2. Discuss about the causes of deflation

17.12. KEY WORDS

Cost Unit, Cost Centre, Job costing, Historical Costing, Fixed cost,

Opportunity cost Straight line, Productive output, Annuity, Depreciation

Fund, Valuation, and Over heads

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LESSON -18

JOB EVALUATION, WAGE AND INCENTIVES

18.1. INTRODUCTION

Job evaluation is a practical technique, designed to enable trained and

experienced staff to judge the size of one job relative to others. Job evaluation is the

outcome of job analysis. Job analysis provides the information necessary for appraising

or evaluating a job like tasks to be performed in a job, skill, knowledge, abilities,

aptitude etc., necessary to carry out the tasks, responsibilities, authority and

accountability requirements to perform a job successfully. Job description and job

specification and employee specification are three sub-systems of job analysis. Job

description provides the information relating to minimum acceptable human qualities

like knowledge and skill necessary to perform a job. Employee specifications indicate

minimum employee qualifications like physical, educational, behavioural etc., which

represent the possession of minimum acceptable human qualities. Thus, job analysis

provides information necessary for job evaluation Employees are paid in monetary

and non-monetary forms for their work. The former is the most basic elements by

which individuals are attracted towards an organisation is the wage or salary. The

monetary compensations are primary and incentive. The primary compensation is

the wage or salary, wage is used to denote payments to hourly-rated production

workers and the salary is used to denote payment to clerical, supervisory and

managerial employees.

18.2 OBJECTIVES

To compare the duties, responsibilities and demands of a job with that of

other jobs.

To determine the hierarchy and place of various jobs in an organization.

To understand the different methods

Solving wage controversies

To distinguish among minimum wage, living and fair wage

To understand the different methods of wage payment

To analyse the types of wage incentive plans

18.3 CONTENTS

18.3.1. Job evaluation

18.3.2. Uses of job Evaluation

18.3.3. Limitations of Job Evaluation

18.3.4. Job Evaluation Methods

18.3.5. Wage and salary

18.3.6. Method of payment of wages

18.3.7. Requirements of good incentive plan

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19.3.1 Job evaluation

Job evaluation deals with money and work. It determines the relative worth or

money value of jobs. The International Labour Organisation defined job evaluation

as, “an attempt to determine and compare demands which the normal performance

of a particular job makes or normal workers, without taking into account the

individual abilities or performance of the workers concerned”.

Wendell L. French defined job evaluation as, “a process of determining the

relative worth of the various jobs within the organization so that differential wage

may be paid to jobs of different worth”.

Job evaluation is defined as, “the overall activity of involving as orderly,

systematic method as procedure of ranking, grading and weighting of jobs to

determine the value of a specific job in relations to other jobs”.

British Institute of Management (1970) defined job evaluation as “the process

of analyzing and assessing the content of jobs. In order to place them in an

acceptable rank order, which can then be used as a basis for remuneration system.

Job evaluation, therefore, is simply a technique, designed to assist in development

of new pay structure, by defining relativities between jobs on a consistent and

systematic basis.”

Thus, job evaluation may be defined as a process of determining the relative

worth of jobs ranking and grading them by comparing the duties and

responsibilities, requirements like skill, knowledge of a job with other jobs with a

view to fix compensation payable to the concerned job holder.

Procedure

Job evaluation is an aid to measure the contribution of human resource to the

job and the organization. Proper ground should be prepared to measure the

contributions of human resources and to appraise relative worth of jobs. It is very

difficult for a single man to study, review and evaluate all jobs. Hence, appointment

of a job evaluation committee consisting of technical and non-technical people is

more appropriate.

The next step in the preparation of ground work is analyzing the jobs which

are to be evaluated. Job knowledge can be obtained from the job description and

job specification records. Job knowledge can be gathered and collected through

interviews, observations, activity sampling, questionnaires, critical incidents,

dairies etc.

The next step is identification of compensable factors like knowledge in respect

of education, experience, skill etc. This ground work is more useful for systematic

job evaluation.

18.3.2. Uses of job Evaluation

Job evaluation has certain advantages over other techniques of pay fixation.

They are:

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1. It is a logical and to a certain extent an objectives method of ranking and

grading the jobs.

2. It helps to fit the newly created jobs in the existing structure.

3. Employee grievances, doubts and complaints would be at the lower level, as it

is a systematic and objective methods of wage fixation.

4. It eliminates some undesirable factors like inequalities in bargaining

capacities of employees and employers, fluctuations in market rates etc.

5. It satisfies the principles of fair wage, wage equity, uniformity in wages etc.

6. It helps to redesign the jobs for minimizing wide wage differentials.

7. It ensures employee satisfaction about wage level and wage equity.

8. It also helps to redesign the jobs by reallocating the easy and difficult tasks

equally among various jobs.

18.3.3. Limitations of Job Evaluation

Though there are certain advantages of job evaluation, it suffers from some

problems. They are:

1. Job evaluation is not exactly scientific

2. Modus operandi of most of the techniques is difficult to understand even to

the supervisors.

3. The factors taken by the programme are not exhaustive.

4. There may be wide fluctuations in compensable factors in view of changes in

technology, values and aspirations of employee etc.

5. Employees, trade union leaders, management and the programme operators

may perceive differently in selecting the compensable factors, in giving

weightages or digress etc.

6. The results of job evaluation may not exactly coincide with social evaluations,

which in turn, result in employee dissatisfaction.

7. Job evaluation is only one among several factors in determining wage level.

Sometimes other factors like government policy may dominate the job

evaluation.

8. It also helps to redesign the jobs by reallocating the easy and difficult tasks

equally among various jobs.

9. Job evaluation programme once structure may not be useful for the next time.

Despite these limitations or problems, job evaluation is the most appropriate

techniques for fixing and revising wage, as it is a system and objectives method of

wage fixation.

18.3.4. Job Evaluation Methods

Ranking Method, Grading Method, Point System, Factor-Comparison Method.

Jobs are evaluated on the basis of various techniques. These techniques are

grouped into two classes viz., conventional and non-conventional techniques.

Conventional techniques are divided into quantitative and non-quantitative

techniques. Non-quantitative techniques include ranking (simple ranking and

paired comparison) and job classification and grading method. Quantitative

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techniques include point rating and factor comparison method. Non-conventional

methods consist of (i) time-span of discretion theory, (ii) decision making,

(iii) solving compensable factor, (vi) guide line method, (vii) Urwick or profile method

and (viii) profile method.

Conventional Non-Quantitative Techniques or Methods

Conventionally, non-quantitative- simple and crude techniques were

developed. They are ranking and job classification methods.

Ranking Method

a) Simple Ranking: This is the most simplest and administratively the most

easiest technique. The evaluator compares one job with other jobs based on duties,

responsibilities and demands made by the jobs on job incumbent and the degree of

importance of the job to the organization and ranks all the jobs from the most

important to the least important. The evaluator has to appraise and rank the jobs

but not the job incumbents.

b) Ranking the key Jobs: Ranking all the jobs at a stretch under simple

ranking method is difficult. The evaluator, in order to minimize this problem, has to

identify the key or representative jobs at the first stage: rank they key jobs at the

second stage; identify and rank all other jobs at the third stage.

c) Paired Comparison: Another problem of ranking method is that each job

cannot be compared with all other jobs for the purpose of ranking. The method of

paired comparison can be adopted to minimize this problem. Under this paired

comparison method, the evaluator ranks each job in turn against all other jobs to

be appraised, so that a series of paired rankings is produced. This method is more

comprehensive, logical and reliable, compared to the simple ranking method.

d) Single Factor Ranking Method: Another problem in ranking method is

difficulty of operation of the method as ranking has to be done on the basis of

number of factors. In view of this, Goldenberg has suggested a single factor ranking

scheme. The single factor considered is the discretionary contents present in each

job related to other jobs. The single most important task to be performed in a job is

identified and compared within the other jobs. Thus, pure ranking does not cover

these refinements.

The jobs are to be priced after they are ranked. In other words, money value

should be assigned to each job. Key jobs with known monetary values will be used

as the basis to determine the money value of other jobs. Generally there is

agreement about the rates of key jobs.

Advantages

Advantages of this method include- (i) This method is the simplest, quickest

and least costly from the view point of time and money, (ii) it is also appropriate for

ranking the top managerial personnel in large organizations, and (iii) it is useful as

a first and basic step of job evaluation.

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Disadvantages

Despite the above mentioned advantages, this method suffers from the

following disadvantages- (i) This method provides no yardstick for measuring the

relative worth of one job against the other, (ii)Job requirements, job specifications

and employee specifications are not considered in evaluation. (iii) It does not

indicate the extent or degree to which one job is worthy than the other. (iv) It is not

a comprehensive and systematic technique.

Job Classification and Grading Method

Class and grade are used differently in this method. A grade is a groups of

different skills to perform. A class is a subdivision of a given occupation. For

example, Assistant Accountant, Accountant, Seminar Accountant. The jobs within

a class have fairly similar tasks to be performed, whilst the jobs within a grade may

be different as far as tasks are concerned. However, classes and grades are

designed for the similar jobs and thus receive similar pay. For example, a grade

may consist of jobs like Financial Accountants, Cost Accountants and Management

Accountants and a class may consist of Assistant Financial Accountant, Financial

Account, Senior Financial Accountant and Chief Financial Accountant.

Under this method, jobs at different levels in the organization hierarchy are

divided into various grades, with a clear cut definition of each grade. Grades are

formulated on the basis of nature of tasks. Requirements of skill, knowledge,

responsibilities and authority of various jobs. There are several steps in the

mechanism of this method. The important among them are:

1. Determine the shape and size of organizational structure i.e., tall or flat

organization, geographical or functional organization etc.

2. Preparation of job descriptions

3. Preparation of grade descriptions based on various components.

4. Establishment of a number of job grades and division of the organization into

various grades like Grade- I, Grade-II, Grade- III.

5. Discussion and negotiation with trade union representatives regarding the

number of grades, descriptions, getting their consent, finalizing the number of

grades and grade description and recording them.

6. Selection of key jobs and grading them.

7. Grading the entire jobs.

8. Classifying the jobs of each grade

9. Assigning the money value of the key grades first and then to all other grades.

Advantages

This method enjoys the following advantages:

i) It is simple and easy to understand and operate. (ii) It provides an

opportunity for a systematic organization structure. (iii) Pay grades are better and

appropriate for comparison with those of other organizations. (iv)It is more

elaborate than ranking method.

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Limitations

i) If sometimes seems to be arbitrary, though it takes the views of the

representative of the trade unions. (ii) Writing grade descriptions is not easy in this

method. However, classification and gradation represent a link in the historical

development of job evaluation between ranking and a points system.

Conventional Quantitative Techniques or Methods

There are two methods under conventional quantitative techniques, viz., points

rating and factor comparison system.

Points Rating Method: This method was introduced by Merrill R. Lott. This was

one of the earliest approaches for evaluating jobs based on quantitative values. This

method is analytical in the sense that jobs are broken into components for

purposes of comparison. This method is quantitative as each component of the job

is assigned a numerical value. Thus, characteristics of factors considered to have a

bearing on all jobs in the programme like skill, knowledge, responsibility, working

conditions etc., are selected under this method. Each factor is divided into degrees

or levels and point value is assigned to each level. The total of point values assigned

to each factor gives the total point values for each job which can be compared.

This method of job evaluation should be developed systematically and applied

methodically in order to avoid the anomalies. The important steps insteps in the

process of developing this techniques are:

1. Constituting a representative committee of members from various

departments for job evaluation.

2. selecting a sample of jobs and preparing job descriptions, job specifications

and employee specifications

3. Selecting and defining those factors which are related to all jobs and are

considered to be most critical in determining the relative degrees of difficulty

and responsibility between jobs. Eight to twelve factors are most desirable.

The following factors may be considered for this purpose.

a) Skill: education, training, judgement, analysis, mental complexity,

mental dexterity, adaptability etc.

b) Effort: Physical demand, visual, effort, concentration, mental effort,

alertness etc.,

c) Responsibility: For preventing monetary loss, machines, materials

safety policy etc.,

d) Job conditions: working conditions, hazards etc.

4. Determining the weight of each factor according to its relative importance.

Assigning the percentage value to each factor. The total percentage of all

factors is 100.

5. Defining each factor, specifying the scope and elements of each factor.

6. Determining relative value of each level within factors. Factors can be

divided into point values by arithmetic or geometric progression.

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7. Testing the mechanism. Get the total points with the help of above discussed

method for a new sample jobs and compare them with the results obtained

through other methods.

8. Appraise all the jobs and arrive at a composite numerical value for each job.

9. Price the points in order to arrive at the wage level and establish a wage

structure with the help of organisational hierarchy of jobs and salary policy.

There are no hard and fast rules regarding factors, sub-factors assigning the

weightages, deciding upon degrees and values.

This system is only a preliminary step in arriving at an equitable pay

structure. There are no scientific technique to guide in respect of assigning money

value to the points. But various factors like influence of trade unions, pay structure

in comparable industries, financial points system will help in arriving at an

equitable pay structure. The important task in this context is conversion of point

scores into monetary values be assigning a standard unit of money to each point.

money value of various scores can be attained by plotting a graph with points

ratings on the X- axis and money value on the Y- axis. Important one is showing

current salary rates on Y-axis against the score of the job concerned on X-axis.

Trend line through a scatter of points is seen. In case point score is divided among

various grades of jobs in an organisation, the pay level can be related to the grades.

The minimum and maximum pay of each grade are shown in the figures. The pay

scale of various jobs will be fixed within the minimum and maximum limits of the

pay.

This method is superior to other methods discussed so far, as this is analytical

as well as quantitative. The advantages on this method are:

Advantages

1. Almost the same pay scale can be arrived at for the same jobs because

agreement among rates on the same is very close.

2. Definitions are written in applicable terms to jobs.

3. Assigning monetary values is very easy.

4. Prejudice, bias and error of human judgement are minimized in this

technique.

5. Point score or monetary values cannot be manipulated very easily.

6. Assignment of point score or money values is consistent and accurate.

7. Once the score is assigned to a particular job it is long standing.

8. Wage differentials would be systematic and according to the content of the job

under this method.

9. Despite these merits, this technique also suffers from various disadvantages.

Disadvantages

1. It is difficult to determine factor levels and assign point values.

2. It would be somewhat difficult to explain the mechanism and operation of this

method of employees, supervisors and trade union leaders.

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3. Operation of this method involves heavy expenditure, spending of much time

and clerical work.

However, this technique is superior to the conventional non-quantitative

techniques in several respects. Another conventional quantitative technique is the

point factor or factor comparison method.

The Point Factor or Factor Comparison Method

This method is based both on the principles of points rating and principle of

ranking. This method is analytical as jobs are broken into sub-factors and

components. Under this method, first the components or sub-factors are ranked

under various factor headings. The next step is assigning the monetary values to

the components or sub-factors of each job. Thus, each job is ranked a number of

times (i.e., number of compensable components or sub-factors).

The mechanism or modus operandi of this method involves the following steps:

1. Developing job descriptions, job specifications or job requirements, covering

physical requirements, mental requirements, skill requirements, training and

experience, responsibility and authority working conditions etc.

2. Selecting a number of key jobs. This step is more critical and useful from the

point of evaluation as the other jobs are assigned monetary values based on the

fixed wage rates arrived for the key jobs on the basis for negotiations. A key job

must be clearly divisible into sub-factors and components. This step also

involves dividing the job into sub-factors and components.

3. The third step is ranking of key jobs. The sub-factors of each key job must be

given relative ranks, based on their individual contribution to the total job.

4. The fourth step involves valuing the sub-factors of each of the key job. This

step is also known as factor evaluation. Money worth of each sub-factor of

the key jobs is ascertained in order to know the total money value (or salary)

of each of the key jobs.

5. The fifth step is integrating the monetary value of sub-factors arrived through

factors evaluation with those of ranking of factors. It is to find out whether

the difference among factors as per the ranking and factor evaluation is one

and the same or not. Cross checking is provide where the money value of

each sub-factor is given in brackets.

6. The sixth step is comparing all the jobs (factor by factor) of the same grade of

level with the related key job and establishing monetary value of the sub-

factors of various jobs based on the monetary value of sub-factors or key

jobs. There are certain advantages to this technique over others.

Advantages

1. It is analytical and quantitative method

2. This method is a combination of two techniques i.e., ranking and factor

comparison

3. Since ‘modus operandi’ of this system is relatively easy to understand, it can

be operated and explained to supervisors, employees and trade union leaders.

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4. This technique is more reliable and valid, compared to other techniques, as

each job is compared with all other jobs from two respects. i.e., factor rank

order and factor comparison.

5. This technique assigns money value more or less fairly and objectively and

there is cross-checking of money value with rank order.

6. However, this technique suffers from certain disadvantages.

Disadvantages

1. It is costly and somewhat difficult to operate compared to the convention

non-quantitative techniques.

2. Factor evaluation in this method is not that such objective as that of point-

rating technique.

3. This technique does not consider all the sub-factors as the operation of the

system would be difficult is it considers all the factors.

Apart from these conventional techniques of job evaluation, there are some

developments in job evaluation techniques in recent years. These techniques will be

discussed under non-conventional techniques.

Market pricing method

In different job evaluation methods like job comparison or ranking method,

grading or job classification method, point rating method and factor comparison

method, points or factors are calculated. After calculating these points, they are to

be converted into monetary value i.e., in terms of rupees. Under the market pricing

method the points/factors are converted on the basis of market factors like demand

and supply. For example, if a particular skills demand is more than the supply

compared to other skills, that particular skill enjoys higher market price and thus

the points of that particular skill is converted at that higher market price compared

to other skills whose supply is more than the demand for the same and ultimately

are quoted at less price in the market. Thus, the jobs with greater demand are

priced at high and consequently higher salaries are fixed for them. And the jobs

with lower demand, lower market price are fixed lower salaries.

Job pricing method

As stated earlier, the points or factors arrived through the methods like

ranking/job comparison, grading/ job classification, point rating and fac tor

comparison are converted into monetary values. These points/ factors are

converted at the price which is fixed on the basis of mental ability, physique,

analytical ability, sharpness, difficulty in carrying out the job etc.

18.3.5 Wage and salary

Wage and salary are often discussed in loose sense, as they are used

interchangeably. But ILO defined the term wage as “the remuneration paid by the

employer for the services of hourly, daily, weekly and fortnightly employees”. It also

means that remuneration paid to production and maintenance or blue collar

employees.

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The term salary is defined as the remuneration paid to the clerical and

managerial personnel employed on monthly or annual basis.

This distinction between wage and salary does not seem to be vali d in these

days of human resources approach where all employees are treated as human

resources and are viewed at par. Hence, these two terms can be used

interchangeably. As such, the term wage and/or salary can be defined as the direct

remuneration paid to an employee compensating his services to an organization.

Salary is also known as basic pay.

Earnings are the total amount of remuneration received by an employee during

a given period. These include salary (pay) dearness allowance, house rent

allowance, city compensatory allowance, other allowance, overtime payments etc.

Nominal Wage

It is the wage paid or received in monetary terms. It is also known as money wage.

Real Wage

Real wage is the amount of wage arrived after discounting nominal wage by the

living cost. It represents the purchasing power of money wage.

Take home salary

It is the amount of salary left to the employee after making authorized

deductions like contribution to the provident fund, life insurance premium, income

tax and other charges.

Minimum wage

It is the amount of remuneration which could meet the “normal needs of the

average employee regarded as a human being living in a civilized society”. It is

defined as the amount or remuneration. “which may be sufficient to enable a

worker to live in reasonable comfort, having regard to all obligations to which an

average worker would ordinarily be subjected to”.

Statutory minimum wage

It is the amount of remuneration fixed according to the provisions of the

minimum wage Act, 1948.

The need-based minimum wage

It is the amount of remuneration fixed on the basis of norms accepted at the

15th session of the Indian Labour Conference held at New Delhi in July, 1957.

The conference recommended that minimum wages should ensure the

minimum human needs of industrial workers. The norms laid down by it are: (i) in

calculating the minimum wage, the standard working class family should be taken

to comprise three consumption units for one earner, the earnings of women,

children and adolescent being disregarded (ii) minimum food requirements should

be calculated on the basis of a set intake of calories as recommended by

Dr. Aykroyd for an average Indian adult of moderate activity. (iii) Clothing

requirements should be estimated on the basis of per capita consumption of 18

yards per annum which would give for the average worker’s family of four a total of

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72 yards. (iv) in respect of housing, the rent corresponding to the minimum area

provided for under Government Industrial Housing Scheme should be taken into

consideration in fixing the minimum wage, (v) fuel, lighting and other

miscellaneous, items of expenditure should constitute 20 per cent of the total

minimum wage.

The living wage

According to the committee on fair wages, the living wage is the highest

amount of remuneration and naturally it would include all amenities which a

citizen living in a modern civilized society is entitled to expect, when the economy of

the country is sufficiently advanced and the employer is able to meet the expanding

aspirations of his workers.

The fair wage

Fair wages are equal to that received by workers performing work of equal

skill, difficulty or unpleasantness.

Incentive wage

This is the amount of remuneration paid to a worker over and above the

normal wage as an incentive for employee’s contribution to the increased

production or saving in time or material.

Wage rate

It is the amount of remuneration for a unit of time excluding incentives,

overtime pay etc.

Standard wage rate

It is the amount of wage fixed for a unit of time fixed on the basis of job

evaluation standards.

Need for sound salary administration

Management has to formulate and administer the salary policies on sound

lines as (i) most of the employee’s satisfaction and work performance are based on

pay. (ii) Internal inequalities in pay are more serious to certain employees;

(iii) employees compare their pay with that of other (iv) employees react only to

gross external inequities. (v) employee comparisons of pay are uninfluenced by

levels of aspirations and pay history; and (vi) employees compare the pay of

different employees with their skill, knowledge, performance etc.,

18.3.6. Method of payment of wages

Time wages

Here payment is made on the basis of time. In this system better quality can

be expected. It is easy to understand and also assured of stable income and better

handling of machines and less wastages. But efficient people are not motivated

because there is no incentive. Here planning the output is difficult.

Piece Rate system

This system is adopted by most of the organization, where wage is based on

the performance. This used were the standard of performance is established and

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measured accurately when completed. Normally a guaranteed minimum is

incorporated under this system.

This provides incentive to the workforce, reduces supervisory burden,

minimizes cost of production enables the organization to estimate cost of

production and spreads the overhead costs over-greater number of products.

But it reflects on the health of workers and condition of machinery. Additional

expenses are to be incurred for keeping extra records. This is not applicable when

group effort is required for the completion of the job. Indirect contributions are

increased wastage, careless handling of machineries and equipments, uncertainty

about wage and decreased morale.

Balance or Debt Method

Under this method, workers are guaranteed time rate with an alternative piece

rate, if the earnings calculated on piece rate exceeds the amount which he ought to

have got, if it is calculated on time rate, he gets credit balance. If the piece rate

equals the time rate, the question of excess payment does not arise. When the piece

rate is less than the time rate worker is paid the time rate and the excess payment

is debited in his accounts. Adjustments are made periodically and balance is paid

to him. This system enables the efficient worker to earn more and also below

average worker is not penalized.

Wage Differentials

1. Occupational differentials

2. Skill differentials

3. Geographical differentials

4. Inter firm differentials

5. Inter industry differentials

6. Differential based (Male/ Female)

Occupation differentials

Occupational differentials are used to motivate young person’s to incur costs

for training themselves and to make them to shoulder higher responsibilities. These

differentials meet the satisfy needs of employees.

Skill differentials

Skilled and unskilled jobs are differentiated, manual and non-manual jobs are

also segregated.

Geographical differentials

Here workers in the same industry and the same occupation living in different

geographical areas are paid different wages. The need for such differentials arise

due to climatic conditions, cost of living, availability of manpower and other factors

peculiar to different geographical segments.

Inter firm differentials

Differences in technological advances, managerial efficiency, capacity to pay

size of the company other advantageous features of the organization are responsible

for disparities in interfirm wage rates.

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Inter industry differentials

Differential arise because of variable in the work of different industries

Differentials based on sex

These arise due to the inherent capacity difference of male and female. But the

government policy is to give equal pay for equal work but still the difference persist.

Wage differential reflects the physical and mental ability of workers differences

in productivity and labour turnover. At times wages are conditioned by competitive

environment. The level of supervisory skill required also contributes to the

existence of differentials.

Wage incentives

Wage incentive plans reward to employee for his good job-performance. Almost

all commonly employed wage incentive schemes guarantee a minimum wage plus

incentive based upon operator’s performance, if it exceeds a plan wide standard.

Normally, the wage incentive plans should depend on the standards set by work

measurement. The wage rate may be the result of mutual agreement between

employer and employee of formal/ informal evaluation of the employer, operator’s

performance depends upon estimates of standard output.

18.3.7. Requirements of good incentive plan

1. It should be simple, easy to understand and, to operate. It should involve least

clerical work.

2. It would be well planned and guarantee a minimum wage.

3. A worker should be rewarded in proportion to his efforts and achievements

reward should be promptly paid.

4. A worker should get enough and adequate incentive for his contributions.

5. The scheme should preferably be based on time- study data.

6. It should give incentive both for quantity and quality of production.

7. Standards should be fairly set

8. The scheme should be just for workers as well as the management

9. Standards and the allowed time should be altered only when there is a change

in the work method.

10. Standardization should preferably be the basis for all incentive schemes, work

methods, materials, work place, working conditions etc., and all should be

standardized.

11. Worker should be suffer his incentive for reasons beyond his control

12. No limit should be put on a worker’s incentive earnings,

13. The plan should be installed with the consent of the employees.

14. Once installed, the incentive scheme should-be rigidly maintained.

Advantages

1. It helps in the process of pr-determination of labour costs

2. It reduces absenteeism

3. It enhances creativity

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4. It increase productivity

5. It identifies inefficient workers

6. It reduces need for supervision

7. It provides relaxed environment wherein they can utilize their efficiency fully

for getting maximum emoluments.

8. The burden of proof of individual worth is vested with the employees.

9. It allows possibility of immediate financial reward for initiative and

industriousness.

Disadvantages

1. Quality may be sacrificed in order to increase quantity.

2. It may develop conflict among the workers.

3. It may increase scrap and rejects

4. Impracticable incase of new jobs

5. Affects the health of the workers

6. Feeling of insecurity, emotional strains

7. Delays beyond the control of employees such as power out inadequate in

material supply, failure in the automated system develops strain in their

relationship with managements.

8. Transfers may not be acceptable to them in view of changes in earning

capacity.


1. Different methods of job evaluation and eliminating.

2. Inequalities.

3. Difference Between Living Wage and fair wage.


1. Explain the advantages and limitations of job evaluation.

2. Explain The Different Method Of Job Evaluation With Examples

18.6 SUMMARY

Evaluating the relative worth of a job is what is known as job evaluation.

Objectives, advantages, limitations and scope of job evaluation are discussed in this

lesson. Methods of job evaluation have been explained with in incrustations.

Wage means all remuneration capable of being expressed interms of money.

Incentive is the reward of employee’s job performance. Principles of wage fixation,

concept of wage differentials, different types of incentive plans with their

advantages and disadvantages are discussed in this lesson.

18.7. TERMINAL EXERCISE

1. What are the objectives of job evaluation?

2. Describe advantages of ranking method in job evaluation

3. Discuss grading method and graphic scales method.

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1. https://en.mwikipedia.org/wiki/Job_evaluation

18.9. ASSIGNMENTS

1. Justify that the job evaluation techniques is the real factor for determining

wage & salary administration.

18.10. SUGGESTED READING / REFERENCE BOOKS

1. Sikula A.F Personnel administrations and Human resource Development

John Wiley, New York.

2. Memoria, C.B. Personnel Management Himalaya publishing house, Bombay.

3. Agarwal R.D. Dynamics of personnel management in India Tata McGraw Hill

book company, New Delhi.


1. list out the requirement of good incentive plan

2. Difference Between Wage And Salary

18.12. KEY WORDS

Job Evaluation – Factors Comparison- Point System – Checklist Method –

Graphic Scales – Critical Incident Technique.

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LESSON - 19

PLANT LOCATION

19.1. INTRODUCTION

The location of the plant can have a crucial effect on the profitability of a

project and scope for future expansion. many factors to be considered when

selecting a suitable site

The location of a plant is a major decision and is affected by many factors both

internal and external to the organizations operations. Internal factors include the

technology used, the capacity, the financial posi tion and the work force required.

External factors include the economic, political and social conditions in the various

localities.

19.2 OBJECTIVES

To understand about the various process characteristics and site selection.

To know the principles and different types of plant layout

To find out the uses of maintenance and also compare the breakdown and

preventive maintenance.

19.3 CONTENTS

19.3.1 Area selection

19.3.2 Community selection

19.3.3 Layout Introduction

19.3.4 Plant layout factors

19.3.5 Types of layout

19.3.6 Maintenance

19.3.1 AREA SELECTION

Area or territory selection calls for the information of a more general nature. In

this initial phase, management is involved in selecting region or general area in

which the plant should be located. The following are the important factors that

influence its selection.

Market

The market is a location of the buyers. It is a factor to be considered in plant

location. Depending on the product, market may be concentrated or widely

dispersed. When a market is concentrated, the market factor lend to influence the

investigator to locate close to this concentration.

For a product servicing a dispersed market the influence of the Market factor

becomes less obvious. It is possible to determine the center market, which is a

statistical device helpful in approximating that point which will provide the lowest

cost for distribution. The center of the market can be used only as a guide for plant

location. The method used to locate a market center is analogous to locatin g the

center of gravity, of a two dimensional object in mechanics.

Locating plant near the markets for this products and services is of primary

importance in a plant location decision. Particularly this factor should be

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considered if the manufacturing increases the bulk or weight of the product,

renders it more fragile or make it capable of being easily spoiled. Besides, adding

transportation costs, distance adds to transmit time and slows down delivery thus

affecting promptness of service.

If the product is relatively inexpensive and transportation costs (e.g. bricks,

cement) add substantially to the price, a location near the market is desirable. Also

if the product is custom-made, close customer contact is essential. In assembly

type industries many raw materials are gathered together from diverse locations

and assembled into single units. Such industries tend to locate near the market.

Raw materials

The location of raw material is influential in the location problem. Some

industries by the nature of their manufacturing process are forced to locate the

near raw material sources. The steel industry has traditionally located close to the

coal fields since it uses coal in large quantities. However, since new processes have

been developed for basic steel refining which eliminate the need for coal , this

change in the raw material demand could lead to a complete relocation of the steel

industry.

The raw material could be treated in three classes.

1. Pure material which are included in the manufacturing part without loss of

weight.

2. Weight losing materials, only a part of whose weight is represented in the

weight of the finished article.

3. Materials found virtually everywhere.

By assuming uniform rates per distance traveled, which is are

oversimplification, the following generalisation regarding the effect of raw material

on plant location may be made.

1. When a single raw material is used, without loss of weight, locate the plant

at the raw material source, at the market or at any point in between them.

2. When a weight losing material is demanded for the plant, then locate the

plant at the raw material source.

3. When a material found everywhere is used, locate close to market area,

since the material is available everywhere.

Ease of access to suppliers of raw materials, parts, tools, equipment, may be

important. Promptness and regularity of delivery from suppliers and minimization

of freight costs are important.

In general this factor is most likely to be important in transportation of

materials and parts represents the major portion of unit costs and these inputs are

available only in a particular region. If the raw material is bulky and if it is greatly

reduced in bulk by transferring into various products and by-products in

processing, then location near raw material sources is important. If the raw

material is perishable and processing makes it less, then also locating near raw

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material source is important. If raw material comes from a variety of locations, the

plant may be situated so as to minimize total transportation cost.

In calculating transportation costs, the fact that should be considered is that

these costs are not simply a function of distance but vary depending upon specific

routes and specific product classifications.

Transportation

The problem of transportation is an important factor in plant location. The

movement of material can consume a very high percentage of the final cost to the

customer. One plant location analysis for a specific plant done by an analyst

showed that locating the plant as little as 400 kilometres from the best location

caused loss potential projects of as much as Rs. 30 lakhs per year. This penalty

included higher cost of labour, power and fuel as well as higher transport costs.

The different transportation medium may be listed as follows.

i) Railroads - all classes of traffic,

ii) Water carriers - all classes of traffic

iii) High way vehicle - all classes of traffic.

iv) Pipe lines - Bulk liquid and gases.

v) Aircraft - Where speed is essential and where access by the surface

agencies is difficult.

vi) Pack animals - in different terrain.

vii) Belt, cable or rail conveyers of various types -short distance.

viii) Human carriers - short distance and small quantities.

ix) Electric cable - electric energy.

x) Telecommunications - information commercial negotiations.

Each of the above transportation mediums has its advantages and limitations.

In order to select the proper transportation media, the shipper should consider the

following.

i) Type and extent of material handling facilities at origin and destination.

ii) The relations cost of the various media

iii) The demand for special services, e.g. refrigeration.

Transportation cost vary with the type of route, media and the type of media

selected as well as the length of distance traveled. In general the cost of moving

material per unit distance traveled tapers off as the length of distance traveled

increase.

Adequate transportation facilities are essential for the economic operations of

a production system. The bulk of all freight shipment is made by rail. Rail transport

offers a great deal of flexibility and speed. Most firms required access to railways

which they consider to be essential carriers of their products.

For companies that produce or buy heavy and bulky commodities, water

transportation is an important factor in locating plants.

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Truck transport is also important particularly for intercity transport.

Availability of pipelines may also influence location. Use of aircraft is expanding

and so the proximity to airports be vital. Travelling expenses of management and

sales personnel should also be considered.

Labour supply and wages

Not only the labour force must be available but also they must contains skills

required in a given manufacturing process.

The history of labour relations in a prospective area for location be studied.

For obvious reasons, it is difficult to secure objective comments from area leaders

and local government officials particularly are promoting their community. The rate

of labour turnover is a good indication of the relationship between management and

labour. A high turnover rate shows up in a high labour cost and it is directly related

to productivity.

The labour force required by a particular industry is predominantly the

location problem takes on some different aspects compared but whose labour force

is predominantly male. Wage levels must also be considered. Wages and skill

available may be lower in a particular and therefore industries requiring many

unskilled workers, which wages are attractive to such regions.

Manpower is one of the most important and costly inputs in production

systems. An ample supply of labour is essential. Firms often the areas in which

there will be more than three or four times of the permanent job applicants

available than the required number. It advantageous to locate in places where there

is diversification industries and business. It is not desirable to have more than his

available work force in manufacturing. The type and level of possessed by the

labour force is important. If company requires particular skills that are not wide

spread, it may have to locate near the particulars areas where these skills are

available. Otherwise, training costs might be more and inadequate productivity

would result. In these cases, labour is desirable but not essential since all the

workers will require some training anyway. It should be noted that a firm can

relocate from a high skill/high cost to a low skill/low cost operation if sufficient

process mechanization is achieved to permit trading off the higher in machinery for

less manpower and lower wages and level of skills.

The existence of regional wage rate differentials may be important particularly

in those cases in which labour cost represents the bulk of total production cost as

in the textile industries. This factor must be considered in light of the skills

available in the area, the size of the labour force, productivity levels, etc., the extent

of unionizations, prevailing labour- management attitudes history of labour

relations turnover rates, absenteeism. etc, should also be considered.

Climate and fuel

Climate greatly influences human efficiency and behaviour. A plant whose

production process require a constant temperature of 20°C find no such situation.

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It should be located on a site that has a temperature of 20°C and standard

deviation of 5. This will call for least amount of artificial heating and cooling.

Heating engineers can compute heating costs on the basis of temperature

data. In addition to fuel costs, climate can influence selection of a territory because

of the amount of precipitation or pollution. Wind velocity and direction can also

influence plant location these become very important factors when the possibility of

radioactive fallout resulting from an attack upon a distant city is considered.

Location of other plants and warehouses

Firms always try to place new plants where they will complement sister plants

and warehouses and minimize total cost. They look market needs and supply and

demand disparities and locate where in markets have been served by long distance

travels. The location competitors plants and warehouses must also be considered,

the object being to obtain an advantage in both freight costs and the level customer

service.

19.3.2 Community selection

Once the general territory for location has been selected, it becomes necessary

to choose a community and a site. A decision must be made regarding the size of

the community in which the plant is to be locate the alternative choices can be

classified as

1) City location

2) Suburban location

3) Country location

City Vs Suburban Vs Country

The advent of the automobile has brought new mobility to the working force.

This is one of the reasons for the present day industrial rush to the country. Wide -

open spaces and freedom to expand are probably two of the biggest inducements.

The type of manufacturing process may dictate the site relation. For example,

a country location is desirable for a plant producing explosives some of the general

conditions leading to the selection of an appropriate type of community might be

listed as follows:

A) Conditions suggesting a city location

i) Large skilled labour required

ii) Process heavily dependent upon availability of city utilities

iii) Multi floor building desirable

iv) Close contact with suppliers is demanded

v) Rapid public transportation is available.

B) Conditions suggesting a suburban location

i) Semiskilled labour force required

ii) Avoidance of heavy city taxes and insurance desired

iii) Labour force residing close to the plant

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iv) Plant expansion is easier than in city

v) Community close to but not in large population center

c) Conditions suggesting a country location

i) Large site required for either present demand or expansions

ii) Lowest property taxes available desired

iii) Unskilled labour force required

iv) Low wages required to meet competition

v) Morale of working force improved by country location

vi) Manufacturing process is dangerous or objectionable

The choice of the community depends upon the region already chosen Most

community selection factors cannot be quantified and can e evaluated subjectively.

Managerial preferences

This often plays an important role in plant location decision. Many due to

community ties companies will not relocate. When firms locate the location

selection in some cases is heavily influenced by preferences of the managers who

will be transferred.

Community facilities

This involves such factors as quality of life, which in turn is a function of the

availability of such facilities as schools, churches, medical services, police and fire

protection, cultural, social and recreational opportunities, having good streets and

highways. Also important are the communication facilities and the range frequency

and reliability of transportation facilities.

Community attitudes

Community attitude is an another factor to be considered in location the plant.

The cultural, social and educational community atmosphere is being given more

attention by plant location investing a since management has recognised that these

aspects are often important to key employees.

The political climate of a community might well be investigation the tendency

of government bodies to encroach on the privilege business has caused

management to carefully study the political climate in a prospective location. The

back issues of the local newspaper a period of time can level such aspects.

These can be difficult to evaluate. Unless the industry is for so reason of an

offensive nature, most communities welcome new industries However, the

formation of anti-industrial pressure groups or a lack co-operation, interest and

enthusiasm on the part of community can result in poor relation between the

relocating firm and local government labour and the general public.

Community, government laws and taxation

State and local laws should be studied when considering various location.

Labour laws, workmen's compensation laws, etc., vary widely from one location to

another.

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Some of the aspects of industrial operation regulated by law hours of work,

minimum wages and working conditions for women employees. The respective laws

should be investigated which penalize certain types of industry in certain areas.

Waste disposal smoke reduction and nuisance regulations should be studied for the

various alternative locations.

Some industrial concerns pay excessive taxes. Taxes should considered in

selecting a site but a plant location analysis says that incentives are relatively

unimportant secondary factor of location. Given the governing factor, the tax

incentive may induce a specific local within the area defined by the basic factor. If

the location offering incentives is not within the area set by the governing factor it is

simple not considered.

Stable, honest and co-operation of government officials are important asset as

most of the local legislations affecting industry under their control. Restricting,

unreasonable local ordinary concerning building codes, zoning, pollution control

etc., can seriously inhibit operations.

Tax rates are important but must be considered in terms of service provided.

There should be some attempt to forecast these charges, future expansion of

community services and facilities is likely, taxes probably increase.

Financial Inducements

Many central and state governments offer subsidy and financial inducements

to companies to influence them to build plants in their areas. Government may

provide loans for plants for newly established plants within their regions. However,

the companies should not allow temporary inducements to overshadow the basic

merits of any location.

Profile of present Industry

The kinds and quality of industrial concerns already in the community area

also pertinent factory to be considered in plant location.

Site Selection

This is the final stage in the plant location analysis.

One thumb rule regarding the size of a site is that it be not less than five times

the actual size of the plant itself. This is considered a minimum in order to allow for

loading platform, siding, transport access, parking facilities and storage area.

Wherever possible, open land is desirable or two or more sides to allow for future

expansion.

Unfortunately, tempting offers of a fine site or attractive tax frequently

influences plant location decision. Objective data is essential to good plant location.

Researchers in plant location says, that in order to properly select a list of

general specification should be as follows.

i) Description of the building to be constructed including the sketch.

ii) Size of the plot.

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iii) Necessary railroad, highway and waterway facilities.

iv) Minimum size of water main, gas line and power line.

v) Volume of ground water to be utilized.

vi) Sewage and effluent disposal requirements.

vii) Safety area for offensive odours, noise, smoke, etc.

viii) Provisions for sprinkler pressure (ground tank or local water main)

The maps published by the Geographical Survey are useful in electing a good

plant site. These maps show the land elevations, water feature, dams, buildings,

railroads and power lines. When choosing a site the following factors should be

investigated.

Topography

The topography, soil mixture and drainage must be suited to the type of

building required and must be capable of providing with a proper foundation. If

considerable land improvement is required, low-priced land may turn to be

expensive.

Utilities

The cost, adequacy and reliability of the supply of power and water must be

evaluated.

Power

All Industries today require electric power of some sort. In addition there are

certain industrial processes that require large amount of electric power. For

example the refining of Aluminium require cheap electricity in large amounts and

for this reason Aluminium processing plants are located in areas where large

sources of inexpensive power is available.

In a situation where a large amount of steam is utilised for processing or

heating it is sometimes advisable to use this steam for power generation purpose.

The following check list may be helpful when examining the power situation in

a given area.

i) Type of service

a) Hydro - electric

b) Steam

c) Other

ii) Reliability of service - history of stoppages,

iii) Adequacy of supply - seasonal restriction.

iv) Kind

a) phase

b) cycle

c) voltage

v) Rates

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vi) Availability of off peak contracts.

vii) Fuel adjustment.

viii) Lighting allowances

ix) Discounts and penalties.

Hydro-electric power Is usually associated with cheap rates, although the

original installation of the hydro electric plant considerably more costly than that of

steam plant. Technical developments leads to constant improvement in power

generation and

Water

There are certain industrial processes which requiring large of water. Selecting

a site with a good water supply is essential in steel, paper board, paper pulp, food

and chemical processes.

Water is generally available from three sources,

(i) surface - water from lakes, streams, etc.,

(ii) ground - springs and wells and

(iii) rain water

Surface water varies greatly in its chemical analysis and microscopic and

vegetation may add taste and colour harmful to specific manufacturing processes.

Hard water can damage steam boilers, pumps and circulating systems, engines and

other water jacket equipment. The PH factor is the measure of hydrogen ion

concentration of water and it expression of its acidity or alkalinity. This factor

should be checked tress affect the manufacturing process.

The cost of the supply of power and water are sizeable and constantly

recurring costs. Accurate cost determination requires contact with the local utility

company. Use restrictions may be imposed and may be wide variations in

availability. The water supply must be sufficient to meet peak needs and

compensate for dry spells. If water is poor quality it may require chemical treatment

or purification. The cost of connecting these services to the plant must not be

overloaded. Sometimes it can be done only at high costs.

Waste disposal

This must be considered when selecting the site. The plant should it be

positioned so that prevailing winds carry any fumes from populated areas and so

that waste may be disposed of properly and at reasonable expense.

Waste disposal is getting to be more and more of a problem as industrial

concentration built up. As the radioactive materials finding industry in increasing

numbers, the problem of disposal of radioactive waste has become quite critical.

Enterprising businessman heavily industrialized area might establish profitable

business of collecting and disposing of radioactive wastes from the industries.

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Transportation facilities

Railroads and highways should be close by in order to minimize the cost of rail

lines and access roads. There must be enough through highways and railroads to

serve the community itself. Special requirements for water or air transport must be

considered. The plant itself should be easily accessible by car or preferably public

transport.

Intangible factors to consider include the dependability and character of the

available carriers, frequency of service and freight and terminal facilities. Cost and

time required to transport the finished product to market and the time required to

contact or service a customer must also be considered.

Land costs

These are generally of minor importance as they are non-recurring and make

up a relatively small proportion of the total cost of locating a new plant.

It should be emphasized that plant location analysis is a periodic task. The

world is rapidly changing and the management should not, expect a location to

remain optimal forever. Every organization should periodically reassess its

environment whether any long term changes have occurred that may make it

advantageous for the organization to alter or possibly relocate some portion of its

facilities.

19.3.3. Layout

Plant layout is the integrating phase of the design of a production system. The

basic objective of layout is to develop a production system that meets requirements

of capacity and quality in the most economical way. The specification of what to

make (drawings and specifications), how it is to be made (route sheets and

operation sheets) and how many like (forecasts, orders or contracts) become the

basis for developing integrated system of production. This integrated system must

provide for machines, workplaces and storage in the capacities required so that

feasible schedules can be determined for the various parts and products. The

system should also provide a transportation system which moves parts and

products through the system. It should provide auxiliary services for production

such as tool cribs and maintenance shops and for personnel such as medical

facilities and cafeterias.

Principles of a good layout

An optimum plant layout is one which provides maximum satisfaction to all

parties concerned; that is the employees and management as well as the stock

holders. Each of the parties involved has certain interest in obtaining a good plant

layout. Keeping these interest in mind the major principles of a good layout are:

1. provide over all simplifications

2. minimise cost of materials handling

3. provide high work-in-process turnover

4. provide effective space utilization

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5. provide for worker convenience and promote job satisfaction and safety

6. avoid unnecessary capital investment

7. stimulate effective labour utilisation

Simplify the production process

This is the broadest objective in obtaining a good layout. A good layout should

be planned to facilitate the over-all manufacturing process so that it can be carried

on in an optimum manner. More specifically, simplification may come from the

following:

a) Equipment should be arranged to provide greater utilisation. Equipment

involving high capital inventory should be located so that it can be

conveniently used on a multiple- shift basis. Material handling equipment,

like conveyors should be located so that a group of products can utilise it

conveniently.

b) A good layout will minimize production delays and reduce congestion,

production delays may be reduced or eliminated by good line balancing.

Provision of proper amount of storage space reduces congestion on the

floor.

c) Good plant layout allows for the needs of maintenance of equipment.

Equipment must be located so that routine maintenance is easy to

perform. Good layout calls for prediction of future maintenance problems.

d) Increasing output or shortening manufacturing time can be provided in an

improved layout. Increased output means greater output with the same or

less cost, saves the man hours and reduce machine hours. Manufacturing

time can be reduced by eliminating idle time and removing unnecessary

storages.

Minimizing Materials Handling

In a plant the production machines should be arranged such that the

materials pass directly from one machine to the another. Material handling is

brought to a minimum by this arrangement of machines. In many situations

manual material handling is most economical. Even in this situation reducing the

distances required for manual material handling should be considered when

planning.

Providing high work-in-process turnover

Every day material remains in the plant and adds cost to the product because

of the tied-up capital investment. In the process industries, for example, in

petroleum refineries where the product is in the liquid state, work-in-process

turnover is high and unnecessary in-process stages are reduced to a minimum.

When the product is in the solid state, it is much more likely to involve a high

capital investment in work-:in-process. Although this is primarily a production

control problem, good layout can be helpful in reducing work-in-process.

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Effective space utilisation

Making good use of space involves considering not only production and storage

areas, but also the floor area required by service departments. Stock bins spread

out on only one level, idle aisles, and unorganised storage areas are all lead to poor

space utilisation. The cost of floor space varies from one location to another location

but considerable thought have to be given for accurately calculating floor area cost.

Worker convenience and Job satisfaction

Workers want to work in a convenient environment. Providing the worker with

a place to leave his tools and with easy access to materials storage, reducing

excessive noise with sound- deadening walls, as well as considering his safety are

factors that should be examined when planning a layout. Attention to such items as

heat, ventilation, light and removal of moisture and dirt is important in promoting

worker's job satisfaction. Layout that calls for unstable stacking of materials should

be changed to correct safety hazards. The layout engineer should keep close contact

with the safety engineer in order to assure that safety has been thoroughly

considered in a given layout.

Unnecessary capital investment

Capital investment in equipment can sometimes be reduced by the proper

arrangement of machines and departments by conveniently locating a particular

piece of equipment two different parts, both requiring part-time use of a broach,

may be routed through the same broach. Thus the cost of a second machine is

avoided. During the process planning phase capital investment can be minimized

by making use of idle time on previously owned equipment. This type of problem is

primarily one of the production scheduling, but by being aware of the problem the

layout man can facilitate production scheduling by installing a good layout.

Labour utilisation

Every year so many productive man-hours are wasted because of poor layout.

Proper layout does not guarantee but certainly stimulates the effective utilisation of

man power. The following suggestions should be considered in making effective

utilisation of labour.

a) Direct labour utilisation: Improper layout can make the production;

extremely wasteful. Making it necessary for the production worker walk

great distances to obtain tools or materials can waste a number of man

hours. Good methods engineering and line balancing can minimise worker

idle time.

b) Indirect labour utilisation: Building design to provide ease of maintenance

can save many rupees per year. Proper design of ailes can result in better

utilisation of fork-lift operator.

c) Better supervision: A supervisor should theoretically be in contact with his

department at all times. An enclosed office should be provided for a

foreman with direct line authority. This is essential when a foreman finds

it necessary to discipline a subordinate.

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19.3.4. Plant Layout Factors

Every one with in an industrial organisation is concerned with plant layout in

some way and everyone within a plant is interested in its layout to some degree.

The worker is interested in the arrangement of his work station. The foreman is

interested in layout as it affects the output of his department. Middle management

is interested in layout as it affects the output and costs. Suggestions that result in

plant layout thinking may come from anyone in the organisation from the director

to the production worker.

Most plant layout decisions are stimulated by one of the following factors.

a) product-design change

b) new product

c) change in volume of demand

d) facilities becoming obsolete

e) frequent accidents

f) poor working environment

g) change in the location or concentration of markets

h) cost reduction

Product-design changes

Automobile models are radically changed frequently which usually require a

change in plant layout. A full time plant layout department is essential in an

automobile industry. In industries manufacturing a more stabilised product, plant

layout may not be a crucial problem. These concerns must solve the plant layout

problems whenever a product change comes even though it may occur infrequently.

New product

The addition of a new product as well as the dropping of an old one is a

development which results in thinking about the plant layout problem. Progressive

companies are continually on the alert for new product developments. Research

and development departments are continually providing new products for the

industrial or home consumer. As these products come to the production -planning

stage plant layout should be integrated with the planning of the production

processes.

Changes in the volume of demand

An increased demand for a product may result in the revision of a present

plant layout. It may result in the planning of a completely new plant. A decreased

demand for a product may also result in plant layout changes.

Facilities becoming obsolete

Plant layout problems are often created by the obsolescence of industrial

equipment, processes and buildings. Equipment replacement results in only minor

changes in a present layout. On the other hand, when an industrial process

becomes obsolete, changes in plant layout are usually demanded. Buildings that

become obsolete, whether because of size limitations or some other reason, may

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result in plant expansion of present building, the building of a new plant or a move

into a new building Any one of these alternatives involve considerable plant layout

work.

Frequent accidents

Hazards to safety must be foreseen while designing good plant layout Where

electric welding is a part of an industrial process, shields or screen must be

provided around the arc-welding production centers in order to prevent injury to

the eyes of personnel in surrounding areas. Aisles should be designed so as to

minimise the possibility of accidents caused by materials handling equipment.

Poor working environment

Worker complaints regarding working conditions such as noise or changes in

temperature, may be resolved by changes in plant layout. Providing the worker with

easy accessibility to materials, tools and instructions are considered in good plant

layout. A layout which considers these factors helps to establish the reputation of a

firm as a good place to work.

Change in the location or concentration of markets

Changes of market locations lead not only to plant layout problems but often

make plant location studies necessary. Often the planning of a completely new

plant is the answer to changes in market location.

Cost reduction

Cost reduction is a general term indicating management's device to reduce any

one of the numerous costs involved in operating an industry. Since the time of the

Industrial Revolution it has been one of cost vital of all the considerations in

manufacturing industries. It must continue to have top priority if productivity

curves are to continue upward.

Costs can be reduced in many ways. New materials develop which can be

substituted for expensive materials. The development of a faster production process

can reduce the inventory tied-up in work-in process inventory. Improved layout is

synonymous with improved methods. In addition, improved plant layout can result

in the reduction of cost brought by better utilisation of buildings, tools and

equipment. With automatic factory on its way, the costs of maintenance will rise

rapidly compared to the costs of production. Proper layout can facilitate

maintenance procedures and thereby achieve cost reductions.

Basic types of layout

Layout choices must closely tied to higher level decisions. Several fundamental

strategic choices must be made in layout planning.

Determining what to move

Productions consist of combining and manipulating men, materials and

machines. These elements may be combined in various ways during production

activity. The proportion in which these elements will be used depends on their

relative cost and on the production process selected before laying out a plant it is

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necessary to determine which of the elements are to be fixed and which will be

mobile during the process a production. Various alternatives are available in

determining which factor to move.

a) to move the product and worker from one workstation another workstation

b) to move the product from one workstation to and workstation, keeping

machine and worker stationary

c) to move the worker and the machine to the product which held at one

location

The decision as to which arrangement to employ depends on relative mobility

of each factor in plant and on the comparative cost each method.

The first method that is moving both product and worker from machine to

machine is not very common in modem production. It employed in some job-lot

production plants turning out custom – made products, worker moves with his

work from machine to machine usually operating a limited variety of machines.

The second method is common in the manufacture of standardised products.

Product moves through machine work stations and continuous process equipment

which are fixed to locations and attended by work Example is the flow of materials

in any automobile manufacture.

In the third arrangement the worker and the machines are brought to the

materials. Manufacturing operations producing bulky products as steam turbines,

boilers, generators, locomotives and ships.

Fabricated and assembly of smaller parts are usually carried out the first and

second arrangement. There are many instances where the machining of large

castings and other parts of the product is done portable machine tools which are

brought to the product. In most manufacturing concerns producing standard

products and custom made products employs the first two alternatives.

19.3.5 Types of Layout

This is designed for the non-repetitive, intermittent types of production where

special orders are handled. In process grouping similar processes or equipment are

grouped together. When strategy calls for focus, resources (employees and

equipment) must be organised the around process. A process layout accomplishes

this purpose by clustering in one center the resources that perform similar

functions. For example all grinding is done in a grinding department, all bills are

processed in the same area of a shop and all bills are processed in an accounts

payable section. This format is most commonly used when many different products

(customers) must be produced or served intermittently at the same work stations.

Demand levels are too low or unpredi table to allow human and capital resources to

be set aside exclusively for a particular product line or type of customer. Resources

relatively general purpose, flexible and less capital intensive. The process layout is

less vulnerable to changes in product mix or new marketing strategies. Employee

supervision can be more specialised which is important when the job con tent

requires a good deal of technical knowledge.

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PROCESS LAYOUT

Advantages of process layout

(i) Lower capital investment

Less capital is needed because production machines will utilised to greater

capacity. Machine can be kept operation most of the time. Equipment is highly

productive.

(ii) Wide flexibility in production facilities

Greater variety of jobs can be handled on a comparative small investments

because of utilisation of various types general purpose equipment. Each machine

can perform a wide range of similar kinds of operations. Moreover there is flexibility

in planning production. Jobs are scheduled for a department as a whole. So it is

possible to assign work to any available machine in the given department.

(iii) Effective supervision readily achieved

Each foreman supervises only a limited range of machine operations like

foreman over welding and grinding. Because task for each foreman is not too

diverse, he becomes highly proficient in time and with practice. He is able to direct

the setup and performance of every kind of operation done on the equipment. He

also becomes expert in maintenance and repair of equipment, inspection

requirement and planning production control of his department.

(iv) Machine failures do not seriously disrupt production schedules

Industrial machine break-downs do not hold up subsequent operations. If

there is break-down in one machine in department the work can be easily

transferred to machine in the same department.

Disadvantages of process layout

(i) More material handling

There will be no definite channels through which all the work will flow. Work

in-process, may return to the same department more than once for processing and

this makes back tracking of work making higher cost of materials handling.

(ii) Greater total floor area required

A greater proportion of the floor space is required for service activities which

result in a lower proportion of total plant area being devoted to actual production

activities. There is greater need for aisles, temporary storage at each department.

All of these need more floor space per unit of product turned out.

(iii) Higher skilled labour and difficulty in labour procurement

Workers must be skilled because they operate a number of general purpose

machines doing a variety of jobs. More highly skilled labour is required and wage

rates will be usually higher. Further there may be difficulty in procuring such

labour on short notice.

(iv) Need for more frequent inspection

Inspection is generally necessary before the work goes to the next operation in

another department. Strict departmental responsibility for quality of work turned

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out is the main reason for the need of inspection in each department. Subsequent

rejection of material by another department causes a considerable amount of

handling, confusion and rerouting to rework the faulty part.

(v) Longer processing times

Total time needed for processing production orders under process layout is

greater than that required in product layout. More time is consumed because work

necessary for loading the machines must be delivered to each department and after

processing work is to be held for inspection. More over large amount of material s

handling is necessary between departments. It is difficult to co-ordinate material

handling because personnel cannot always be made available to move when it is

released from a department. The end result is longer period of processing time.

Process layout is suitable for intermittent production. It is employed - the

same facilities are used to fabricate and assemble a wide variety of parts when part

and product designs are not stable. From historical of view process layout preceded

product layout. Any considerable growth in demand for product of any industry

gradually makes advisable aversion of layout in part or whole from process to

product. A gradual transition from process to product layout may take place as and

increases for products. Product layout is introduced first either arts of fabricating

activities or in assembly operations. The complete product layout arrangement is

finally introduced to whole production process.

PRODUCT LAYOUT

Equipment needed to fabricate or assemble the product is brought together

and setup in accordance with the required sequence operations. Material flows

through predetermined channels of operations from the receipt of raw materials to

fabrication of various component parts to final assembly, layout is designed for the

flow type of production where continuous or repetitive operations are carried on to

produce large quantities standardised product. Under product grouping all the

machines needed to produce part or sub assembly are arranged sequentially

continuous line in the order in which the successive operations product must be

performed. The part flows from machine to machine-moving a short distance at a

time until all required operations completed. This arrangement results in

processing of the product forward flow from the receipt of raw materials to

shipment of finished product. Straight line production has been adopted in

numerous continuous process industries such as sugar refineries, cement plants,

automobiles etc. In recent years many other industries have recognised the

advantages to be gained by adopting line production methods.

Advantages of product layout

1. Channelised flow of work reduces materials handling: Definite and direct

channels for the flow of materials, short distances between operations elimination

of backtracking and mechanisation of handling are features of product layout.

These reduces materials handling cost.

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2. Low cost labour and easy in procurement and training: Because of the

use of special purpose automatic or semi-automatic machine's and elaborated

tooling product layout an effectively utilise low - cost unskilled and semiskilled

labour.

3. Less inspection required: A limited amount of inspection at the end or at

some critical in the line is usually sufficient.

4. Floor area more productive: Minimum aisles. General absence of large

banks of, temporary storage and numerous inspection. There is less need for

movement of quantities to centre and temporary storage.

5. Short processing time: Intermediate activities between machine operations

such as travel, storage and inspection occurs less frequently. Therefore,

opportunities for delays will be reduced. Hence, the total time for processing

product is shortened.

6. Simplicity and easy production control: As long as changes in design of

product are held to a minimum and operations are standardised engineering and

production planning activities is largely limited to initial program necessary to

establish production. At the beginning it is necessary to prepare drawings, list of

parts, materials requirement, routing procedures and so on. This simplifies

production planning and control problem.

Disadvantages of Product Layout

1. Higher initial investment

In product layout frequently at various work centers more than sufficient

capacity will exist. This condition result in an unavoidable duplication of facilities

and increases the investment required for product layout.

2. Production line shut down will occur

If a machine fails under product layout there is a shutdown of production.

Shut down of line can also be caused by a miner shortages of material, employee

absenteeism or poor production

3. Supervision more difficult

Line is a collection of numerous kinds of machine requiring wide range of

knowledge on the part of supervisor Foreman's job involves supervision of diverse

activities because each machine requires a knowledge of various setups, kin of

operations and operating feeds. He is also responsible for the quality control of

many kinds of jobs being simultaneously processed. He must be also familiar with

maintenance requirements of his equipment.

4. Inflexibility of facility

Equipment under product layout consists of facilities designed to perform

special operations. Usually no machine unit of the line is exactly interchangeable in

capacity, kind of work performed with any other unit. This characteristic of strict

product layout results in inflexibility of facilities makes for interruption, costly

change over or makes replacement design changes are made.

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HYBRID LAYOUT

More often a positioning strategy combines elements of both product and

process focus. This is an intermediate positioning strategy which calls for a hybrid

layout. Some portions of the facility designed as a process layout and other portions

are designed as product layout. This treatment is often applied when group

technology cells, one-worker-multiple-machine stations, or flexible manufacturing

systems are introduced. These "islands of automation" represent miniature product

layouts, since all resources needed to make the family of parts are together as one

center. At the same time, not all production can be handled this way and the rest of

the facility represents a process layout. Hybrid layouts also are found when

facilities have both fabrication and assembly operations. Fabrication operations,

where components made from raw materials, tend to have a process focus. As

operations tend to have a product focus.

Another example of a hybrid layout is a retail store, merchandise may be grouped so

that customers have a fairly good of where to find desired items (a process layout). At the

same customers often are routed along fairly predetermined paths layout. The motive is to

maximise exposure to the full array of thereby stimulating sales.

FIXED POSITION LAYOUT

The fourth basic type of layout is the fixed-position layout a product is

particularly massive or bulky it does not make move it from one work station to

another as with process, product hybrid layouts. Such is the case in shipbuilding,

assembling airplanes or making huge pressure vessels, building dams or repairing

home furnaces. Workers, along with their tools and equipment, come to the product

to work on it until it is finished, or at least until much of work is completed. This

layout type minimizes the number of times that the product must be moved and

often is the only feasible solution.

19.3.6. Maintenance

Efficient use of plant and equipment is a vital factor for the industrial growth,

particularly in a developing country like ours. Plant and equipments besides being

very expensive, are in many cases imported involving valuable foreign exchange.

Further the cost of plant and equipment forms a considerable portion of the total

cost production. Thus' it is imperative to look after them as careful, possible. Plant

maintenance is of great importance as it provides a means to maintain the plant

and equipment in a high state of operating efficiency and enhance its productivity.

Generally in Indian industries the utilization of plant and equipment needs to

be considerably improved. While there may be many reasons for under utilization,

downtime due to unscheduled breakdowns and stoppages is one of the primary

causes. It is necessary to increase the working life of the existing plant and increase

the utilization. Efficient utilization of plant becomes extremely important in order

that the capital resources are available for expansion schemes rather than

replacement of equipment which in turn will help industrial development.

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Poor maintenance causes economical loses such as:

1. Increased downtime

2. Poor efficiency

3. Deterioration of equipment

4. Poor quality of product

5. Higher labour costs

6. Loss of material in, process

7. Higher production costs

8. Increased hazards etc.

Systematic maintenance procedure offers tremendous possibilities for saving

in money, materials and manpower. These savings come through

1. Reduction in downtime

2. Reduced losses of material in process

3. Increased life of the equipment

4. Reduction in overtime

5. Optimum spares inventory

6. Timely replacement of spares and machines

7. Maintenance of product quality

8. Proper running of equipment

9. Optimum operational cost of the machines

Through proper maintenance the downtime of equipment comes down

considerably. Machines are attended to before they breakdown. Spare parts are

replaced before they fail. Lubrication is done regularly and according to a timetable.

All these and many other activities keep the equipment in good running condition.

Whenever the equipment breakdown, particularly in a chemical plant the

materials in process, which are all inside the various types of equipment,

undergoing some reaction or the other get spoiled. Often these materials need to be

flushed and drained before starting the plant again. The losses due to this wastage

can be substantial if the materials being treated are expensive. Rayon plant is one

such example. If the raw materials are imported it will be still worse and hence

such losses are to be reduced, which is possible through proper maintenance.

In India the cost of plant and machinery is quite high and many sophisticated

equipments are still imported. Replacements are not easy. Capital is scarce. Hence

the installed equipment should be kept in good working order as long/as possible

and its life must be prolonged to the extent possible, proper maintenance, timely

replacement of parts, modifications to suit the conditions of operation etc., help to

enhance the life of the equipment.

Good maintenance leads to higher output through lower downtime of plant

and equipment, better quality of products through improved efficiency and l ower

unit costs through reduced breakdown expenses. Plant and equipment deteriorate

with use. If the deterioration is not checked they will not function and will become

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unserviceable. Maintenance primarily aims at keeping the plant and equipment in

efficient operating conditions, minimizing the downtime, as to ensure their

maximum availability for production.

Broadly, the objectives of a systematic maintenance scheme are, to safeguard

the investment, to keep the equipments in good working condition, to prol ong the

life of the equipment and to assure optimum availability.

TYPES OF MAINTENANCE

Maintenance practices can be broadly classified into following two types:

1. Breakdown maintenance

2. Preventive maintenance

Break-down maintenance

In the case of breakdown maintenance the equipment is generally attended

only when it breaks down. The maintenance crew will carry out the necessary

repairs, when the machine has actually broken down and is not able to function, in

order to put it back into commission. Such breakdowns may occur to any machine

at any time. There are many disadvantages in this system. Some of them are:

i) There is always an urgency to put the machine back in the working

condition and hence the machine may not get adequate maintenance.

ii) Since the type and time of breakdown is uncertain, production plans get

completely disrupted.

iii) Planning of maintenance work is not possible.

iv) Distribution of workload is difficult.

v) Results in unbalanced utilization of maintenance staff.

vi) May result in overstaffing the maintenance department.

vii) Increased overtime.

viii) Increased downtime of equipment due to non-availability of man-power.

ix) Excessive inventory of spares.

x) Waste of materials in process in continuous chemical Industries.

xi) Poor working conditions for maintenance staff.

However, breakdown maintenance system may be suitable in certain

conditions such as

i) Where plant capacity exceeds market demand.

ii) Standbys are available and quick switching over is possible

iii) Process is obsolete and more modern equipment is under consideration.

iv) May be economical for non-critical equipment where this type of

maintenance is cheaper than any other system.

Normally, breakdown maintenance system is not recommended in a general

practice since it has many disadvantages and this system of maintenance is now

being gradually replaced by more systematic type maintenance.

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Preventive maintenance

As the name itself indicates preventive maintenance is based on the old adage

"Prevention is better than cure" or "a stitch in time saves nine". Preventive

maintenance is a systematic maintenance procedure where-in the condition of the

plant is constantly watched through a systematic inspection and preventive action

is taken to reduce the incidence of breakdowns. The necessity for either major or

minor repairs is determined, to prevent unexpected interruptions to the plant and

equipment or any deterioration.

The fundamental activities of preventive maintenance are:

a) Periodical inspection of plant and equipment to discover conditions of

deterioration

b) upkeep of equipment to remove or repair such conditions while they are

still in a minor stage.

Thus the essence of the preventive maintenance is a well planned inspection

system. Proper inspection at the right time is the crux of the preventive

maintenance system. The results of inspection are used to analyze the problems of

upkeep, replacement and modification well in advance and thereby help proper

planning and assessment of the work contents of the jobs. It is of course necessary

to determine with great care what is to be inspected and when. Meticulous

recording of the facts revealed during such inspections is another important point.

Analysis of such records indicate the type of maintenance work needed,

replacements required, planning of maintenance work and inventory of spares.

Preventive maintenance renders more effective use of manpower and material and

helps to attain greater efficiency in plant operation. Planning of maintenance work

and optimum inventory of spares and components, become possible with the

introduction of this system. It will be possible to synchronize the maintenance

program so that there is least interruption to continuous operation and production.

As against breakdown maintenance where plant equipment gets the attention

only when they breakdown, preventive maintenance is a planned and systematic

procedure which takes a continuous care of the equipment, mending and repairing

as and when required to minimize breakdowns and unscheduled stoppages,

resulting in various advantages and savings.

However, certain limitations of preventive maintenance are, that during initial

stages of its introduction, it may appear to be expensive, although in the long run it

is highly beneficial. The procedure and the frequency of inspection would have to be

carefully worked out and improved over a period of time. The data for preventive

maintenance will have to be built up gradually and the system has to be refined

depending on the data collected.

The various elements of a preventive maintenance system in an industry are

as follows:

1. An inventory of all the plant and equipment that need to be maintained.

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2. Categorization of equipments to assess the relative importance and thereby

determine the equipments requiring preventive maintenance.

3. A well designed inspection system.

4. A good lubrication system.

5. Maintenance of adequate records and analysis of these records.

6. Planning of maintenance work.

7. Control of maintenance stores and spares.

8. Organization for preventive maintenance work.

PREVENTIVE VERSUS BREAK-DOWN MAINTENANCE

Quality control procedures are designed to track characteristics of quality and

to take action to maintain quality within limits. In some instances the action called

for may be equipment maintenance. The maintenance function then acts in a

supporting role to equipment operating effectively to maintain quality standards, as

well as to maintain the quantitative and cost standards of output.

There are alternate policies that may be appropriate, depending on the

situation and the relative costs. First, is routine preventive maintenance

economical, or will it be less costly to wait for breakdowns to occur and repair the

equipment? Are there guidelines that may indicate when preventive is likely to be

economical? What service level is appropriate when breakdowns do occur? How

large should maintenance crews be to balance the costs of downtime versus the

crew costs? In addition there are long range decisions regarding the possible

overhaul or replacement of a machine.


1. The location of a plant is a major decision affected by many factors both

internal and external to the organization operations”- Explain.

2. If it takes just as long to perform a preventive maintenance as it does a

repair is there an advantage to preventive maintenance.


1. List and describe plant location factors.

2. What are the steps of a plant location study?

19.6. SUMMARY

Facilities location planning entails consideration of the technology of the

process, the behaviour of potential employees, and the economic impact of the

location. Such planning obviously represents a major effort. Principles and factors

of layout are discussed. Product layout and process layout are explained in detail.

Advantages and disadvantages of this layout and the line balancing technique for

product layout are explained. Principles of materials handing and the common

materials handling equipment like conveyors cranes and trucks are discussed in

this lesson.


1. What kind of costs are associated with machine break-down?

2. What is break-down time distribution?

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1. Bugga, “Modern production management” 4 th edition, John Whieley.

2. Krishna, N.V., “Preventive maintenance”, National Productivity Council, New

Delhi.

19.9 ASSIGNMENTS

1. Briefly identify four basic types of handling equipments. Indicate example for

each.

2. How can the techniques of simulation help in evaluating alternate

maintenance practice?


1. Krajewski and Ritzman, “Operations management”, Addison Whesely.

2. Apple, J.M., “Plant layout and materials handling”, prentice Hall.

3. Moore, F. G., “Plant Layout design” John Whieley.

4. Buffa “Modern Production management”, 4th edition, John Whieley.

5. Menipaz, Ehed,: Essentials of production and operations management”

Prentice Hall.

6. Apple, J.M., “Plant layout and Materials Handling”, Ronald Press.


1. Discuss the types of situations of machine break-downs.

2. What are the principles of materials handling?

19.12 KEY WORDS

Break-down time distribution, Preventive maintenance, Preventive

maintenance cycle, Replacement, Simulation, Process inputs, Process

outputs, Process characteristics, Personal preference, Tax incentives and legal

aspects, Territory, Comments, Site, Location influence on layout, Process

layout, Product.

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LESSON - 20

MOTION AND TIME STUDY

20.1. INTRODUCTION

“Motion study is the science of eliminating wastefulness resulting from

unnecessary, ill directed and inefficient motions. The aim of motion study is to find

and perpetuate the schemes of least waste methods of labour”. An analysis of the

motions used in an industrial process with an aim to improve efficiency and

productivity. A method to establish ‘the one best way to perform a task.”

It is mainly for the following three ways:

1. To get completely rid of as many human movements as possible

2. To shorten the movements be that he cannot get rid of

3. To make the necessary movements with less tiring

20.2 OBJECTIVES

To understand the procedure and advantages of motion study.

To know the concept and steps of time study.

To aware the performance rating and allowance factors.

20.3 CONTENTS

20.3.1 Motion study

20.3.2. Tools of motion study

20.3.3. Time study

20.3.4 Performance rating

20.3.5 Rating Scales

20.3.6 Allowance factor

20.3.7 Standard time

20.3.1 Motion Study

1. The procedure of performing a task is entirely from motion studies and more

effective operations are discovered.

2. Similarly there may be certain changes in the use of materials, machines and

equipments, ultimately leading to greater motivation and improved morales.

3. Date are always secured from which a series of job specification may be –

developed.

4. Motion study exerts a salutary influence upon the general morales of an

organization, particularly when the savings made are shared with the

employees.

PROCEDURE

1). Select and Define 2) record 3) critically examine 4) Develop the best 5)

Install and 6) Maintain.

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Select and Define

It is to select the job worth studying and define the objectives to be achieved.

For this we must consider the following aspects.

i) Economic aspects ii) technical aspects iii) Human reactions

It is of no use in carrying out the study if the economic importance of the job is

small or if the job is likely to be discontinued or modified in near future.

Regarding technical aspects, one should make sure that adequate technical

knowledge is available to carry out the study.

Human reactions and employee attitudes are the most difficult to foretell since

mental and emotional reactions to investigations and changes have to be

anticipated.

It is readily accepted, if good industrial relations exist, and explained to all

concerned. Method study will be more readily accepted if started on jobs

unpleasant to workers, i.e. dirty jobs or those calling for the lifting of heavy weights.

If method study successfully removes the unpleasant features of these jobs,

reduces effort and fatigue of workers, they will naturally be less resistant to

cooperate. Method study with following objectives may be among the first to be

selected for motion study.

To reduce manufacturing cost.

To avoid bottlenecks which hold up other production operations

To reduce fatigue incurred by workers in order to increase their efficiency.

To avoid poor use of materials, labour or machine capacity that results in high

scrap and reprocessing costs.

To improve upon operations involving repetitive work using or great deal of

labour and liable to run for a long time etc.

Record

After selecting the job the next step is to record all the relevant information

and procedure pertaining to the present or existing method in detail and in the

form of a chart to obtain more clear picture about the same.

The success of an investigation depends upon the accuracy with which the

facts are portrayed because they will provide the basis of both the critical

examination and the development of the improved method. It is, therefore, essential

that the record be clear and concise. All the facts be related to the situation under

investigation obtained be, arranged for appraisal and comparison.

Critical Examination

The recorded events in sequence. The critical examination is achieved by

means of sets of detailed questions.

The primary questions to indicate the facts and the reasons underlying them.

The secondary questions to show the alternatives and consequently the means

of improvement.

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Develop the Best Method

1. Record the method proposed through the critical examination.

2. Consult all levels of management and workers for their suggestions and

objections.

3. Test the modified proposed method for its advantages

4. Prepare and put up the report on proposed method to the management for its

final approval and subsequent implementation.

The proposed method appears to be sound requires further study and

development.

New method may require experimental work to develop it. Developing new

ideas, means looking of all aspects of manufacture in order to get the best possible

return from the ideas.

The development of new method is simplified to a certain extent by extracting

and working with the key activities that are suggested by the conclusions of the

critical examination.

In fact many ideas, developed after critical questioning require little capital

outlay. This is one of the major attractions of work study. It may be necessary to

modify a procedure, to get someone else to do a job and also for reorganise the way

of issuing work etc. But it needs cooperation of there.

Install: It has two stages:

1. Preparation and 2. Implementation

Preparation: It involves three stages viz., planning, arranging and rehearsing.

For the planning aspect, one person should be made responsible for the task,

actual dates should be fixed for each stage to complete and copies of any time -table

drawn up to cover the installation should be brought into time with the dates

selected for each stage.

Arranging aspect involves,

1. checking that all the necessary plant, tools and equipment are available and

that services are laid on

2. checking the availability and continuity of all materials, supplies and services

3. selecting workers for the proposed method and imparting them the necessary

training

4. Informing everyone concerned of the plans and time-table for the installation.

Rehearsing involves trail run of the proposed method using supervisors, work

study officers and the appropriate workers.

Implementation or actual installation involves the introduction of developed

method as standard practice.

During the initial period offer installation, a close watch should be kept so that

the problems associated with the proposed method are carefully studied and

remedied if necessary.

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Installation phase is complete as the newly installed method starts working

smoothly and satisfactorily and gives encouraging results,

Maintain

Once the new method has seen installed it should be maintained in its

specified form and the workers should not be allowed to slip back into the old

method or introduce elements not allowed for unless there is very good reason for

doing so. To be maintained, a method must first be very clearly defined and

specified. Tools, layout and elements of movement must be specified beyond any

risk of misinterpretation.

Proper functioning of the installed method is ensured by periodic checks and

verifications. Purpose of checks and reviews is to find if the method being practiced

is the same or it has deviated from the authorised one.

Reason for deviation if any should be explored and the necessary changes may

be made in the procedure being practised so that it reverts to the authorized one.

Views of the workers, supervisors and other persons related with the installed

method can be of much help in exploring further improvements.

In a number of cases the conditions may change from time to time and this

may mean that some of the assumptions upon which the improved method was

built up are no longer valid. Therefore, the method should be reviewed at intervals

to make allowances, for any change may arise as a result of suggestion schemes.

20.3.2 Tools of Motion study

I. Process chart

A chart may be a diagram, a picture or a graph which gives an overall view of

the situation, say a process. It helps visualising various possibilities of alterations

or improvement. A chart representing a process may be called a process chart, A

process chart records graphically or diagrammatically in sequence, the operations

connected with a process. The chart portrays the process with the he lp of a set of

symbols and aids in better understanding and examining the process with a

purpose to improve the same.

II. Principles of Motion Study

The following principles must be borne in mind for effective motion study.

Rules of intelligent laziness: It means not to do a job in hard way if there is an

easier way like:

1. Don't do jobs by hand if machines can, do them

2. Eliminate handling

3. Use the fewest motion possible

4. Use fixed positions for small materials and tools.

Rules for keeping busy

Use two hands and, also use the feet as well as the hands if they can be used.

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Rules for Reduction

Transfer all heavy lifting to mechanical lifting devices

Use momentum where possible rather than force.

Continuous curved motions are easier and less firing that motion involving

sharp changes in direction.

Assign all work to the body member best suited for it.

Use the body to the best advantages mechanically

Eliminate working conditions that add to fatigue

On fatiguing jobs allow rest periods.

On Mononotonous jobs provide an occasional break.

Rules for placing men: Use man-power to its best advantage considering the

job to be filled and the man available. Where there are several workers doing the

same job day after day split the job into small tasks and let them specialize.

III. Motion Study Questions

Ask some questions related to the job. Some general questions are i) who,

where, why, when and how is the job is done? Is this movement necessary? can it

be eliminated? can it be shortened? can it be transferred to the machine? etc.

IV. Micromotion Study

Micromotion study way of improving jobs means taking moving picture of jobs,

then running them slowly through a prerector, by studying the pictures a trained

analyst can figure out how to improve even short-cycle jobs. After improving the

job, a moving picture of the new method is a perfect and permanent record of how

the work is done. Besides furnishing a record, movies help in the training of men

particularly new time and motion study men. They can run and return the films

and they can practice setting time standards without getting out into the factory

until they have little experience. But it is costly and also not welcomed by unions.

V. Therbling Analysis

A therbling is a small part of a job. It is much too short to time with a stop

watch. A time study man analyses jobs part by part but his parts of job would stop

at say "tightenbolt". Tighten bolt is made up of the therblings move band, get ready

to pick up wrench, grasp wrench; move hand with wrench, position wrench and so

on. No one paid much attention, to until it has a rebirth during World war II when

the government set up training programmes to show frames how to improve jobs.

Today several consulting engineering companies use it as a bread-and-butter,

technique.

20.3.3 Time Study

Time study is defined as "A searching scientific analysis of methods and

equipment used or planned in doing a place of work, development practical detail of

the best way of doing it and determination of the time required. An important part

of the concept in this definition is that time study and the job standardization of

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which it is a part are more than timing, with a watch. Taylor says. "Here statistics

as to time which a man takes to do a given piece of work do not constitute a time

study. Time study involves careful study of the time in which work ought to be

done.

BASIC STEPS IN TIME STUDY

The following eight steps constitute the time study process exclude the

selections' of the job for the worker which have to be done before the steps in the

list are taken up;

a) Obtaining and recording all the available information about the job, operator

and the surrounding conditions likely to, affect the execution of work.

b) Recording the complete description of the method, breaks down the operation

into 'elements'.

c) Examining the detailed breakdown to ensure the most effect method and

motions are being used and determining sample size.

d) Measuring with a timing device (stop-watch), and record the time taken by the

operator to perform each element the operation.

e) At the same time, assessing the effective speed of working the operator relative

to the observers concept of the rate corresponding to standard rating.

f) Extending observed time to "basic times".

g) Determining the allowances to be made over and above the basic time for the

operation.

h) Determining the "standard time" for the operation.

The stop watch

Usually, three types of stop watches are used for performing time study;

i) Flyback type, ii) Non-flyback type, and iii) the split hand stop-watch type.

However the first two types are used for a large majority of cases.

Timing elements by stop-watch

There are two principal methods of timing with the stop-watch, a) Cumulative

timing and b) Flyback timing. In cumulative method the watch runs continuously

throughout the study. It is started at the beginning of the first element of the first

cycle to be timed and is stopped after the study is completed. The purpose of this

procedure is too sure that all the time during which the job is observed is recorded

in the study.

In flyback method the stop-watch is reset to zero reading, by returning the

hands of the watch to zero, at the end of each element and the hands of the watch

are allowed to start immediately at the beginning of the next element, the time for

each element being observed directly.

In case of flyback timing, the study man reaches the clock at an exact minute

preferably at the next major division such as the hour or one of the five minute

points, and sets his stop-watch running, noting the exact time in the "time on"

space. He reaches the location where the study is to be made water running and

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allows it to do so till he is ready to start timing. At the beginning of the first element

of the first work cycle, as the hands are snapped back there is nothing in the fi rst

entry to show for the time that has elapsed. At the end of the study, the hand is

snapped back to zero on completion of the last element of the last cycle and

thereafter allowed to run continuously until he can again reach the clock and note

the time of finishing when the watch is finally stopped. The final clock time is

entered in the "time off' space on the form. The two times recorded before and after

the study are known as "check times". The clock reading at the beginning of the

study is subtracted from the clock reading at the end of the study yielding the

elapsed time, to be entered in its appropriate location.

The recorded time is obtained as the aggregate of time of all the elements, i.e.,

other activities noted in the study and ineffective time and check time are also

noted. This aggregate should ideally equal the elapsed time but in practice is found

to be different from the elapsed time. The difference may be attributed to the

cumulative loss of very small fractions of time at the return of the hand to zero and

to bad reading of missed elements. The difference observed in case of cumulative

timing is less since there is no loss due to snapback effects.

Cumulative timing has the significant advantage that even in the event of

missing element or non-recording of some occasional element it does not have any

effect on the overall time. However, cumulative timing calls for spending of more

time in determining individual element timing which can be only obtained after

performing a subtraction operation.

Distinction between Time and Motion Study

Motion study is concerned with a study of work done by the workman with

sufficient consideration of the arrangement of machines and their functioning to

insure efficient worker production, whereas time study includes a detailed analysis

of both machine time or the time taken by the machine doing its share of the work

and ‘Manual’ time or the time taken by the workman, Manual time will usually be

found to be of three general classes (i) the handling of tools used by the workman,

in connection with the job (ii) the handling of the machine by the workman and (iii)

the handling of the material that being worked upon.

20.3.4 Performance rating

Rating and allowances are the two most controversial aspects of time study.

Most time study in industry are used to determine standard times for setting

workloads and as a basis for incentive plans procedures employed have a bearing

on the earnings of the workers as well as on the productivity. Time study is not an

exact science, although much research has been and continues to be undertaken to

attempt to establish a scientific basic for it. Rating (the assessment of a worker's

rate of working) and allowances to be given for recovery from fatigue and other

purpose still largely matters of judgement and therefore of bargaining between

management and labour.

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It has, already, been said that time studies should be made as far as possible,

on a number of qualified workers; and that very fast very slow workers should be

avoided, at least while making the first few studies of an operation. Who is a

"qualified worker"? A Qualified Worker is one who is accepted as having the

necessary physical attributes, who possesses the required intelligence and

education, and who has acquired the necessary skill and knowledge to carry out

the work in hand to satisfactory standards of safety, quantity and quality.

The acquisition of skill is a complicated process. It has been observed that

among the attributes which differentiate the experienced worker from the

inexperienced are the following:

a) achieves smooth and consistent movements;

b) acquires rhythm;

c) responds more rapidly to signals;

d) anticipates difficulties and is more ready to overcome them

e) carries out the task without giving the appearance conscious attention and is

therefore more relaxed.

Rating is the assessment of the worker's rate of working relative to the

observer's concept of the rate corresponding to standard pace and standard

performance is the rate of output which qualifier workers will naturally achieve

without over-exertion as an average over the working day or shift, provided that

they know and adhere to the specified method and provided that they are motivated

to themselves to their work. This performance is denoted as 100 on the standard

rating and performance scales.

Rating of effort

The purpose of rating is to determine, from the time actually taken by the

operative being observed, the standard time which can be maintained by the

average qualified worker and which can be used as realistic basis for planning,

control and incentive schemes. What the study man is concerned within therefore

the speed with which the operative carries out the work, in relation to the study

man's concept of a normal speed.

Speed of what? Certainly not merely speed of movement, because an unskilled

operative may move extremely fast and yet take longer to perform an operation than

a skilled operative who appears to be working quite slowly. The unskilled operative

puts in a lot of unnecessary movements which the experienced operative has long

since eliminated. The only thing that counts is the effective speed of the operation.

Judgement of effective speed can only be acquired through experience and

knowledge of the operations being observed. It is very easy for an inexpe rienced

study man either to be fooled by a large number of rapid movements into believing

that an operative is working apparently slow movements are very economical of

motion. The amount of effort which has to be exerted and the difficulty encountered

by the operative is a matter for the study man to judge in the light of his experience

with the type of job. Operations involving mental activities (Judgement of finish, for

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example, in inspection of work) are most difficult to assess. Experience of the type

of work is required before satisfactory assessments can be made. Inexperienced

study men can be made to look very foolish in such cases, and moreover can be

unjust to above-average and conscientious workers.

In any job the speed of accomplishment must be related to an idea of a normal

speed for the same type of work. This is an important reason for doing a proper

method study on a job before attempting to set a time standard. It enables the

study man to gain a clear understanding of the nature of the work and often

enables him to eliminate excessive effort or judgement and so bring his rating

process nearer to a simple assessment of speed.

20.3.5 Rating Scales

There are several scales of rating in use, the most common of which are those

designated the 100-133 scale, the 60-80, the 75- 100, and the British Standard

scale which is the 0-100 scale. The newer" 0-100 scale has, however, certain

important advantages which have led to its adoption as the British Standard. In the

0- 100 scale, 0 represents zero activity and 100 the normal rate of working of the

motivated qualified worker- that is, the standard rate.

Determination of basic time

The number 100 represents standard performance. If the study man decides

that the operation he is observing is being performed with less effective speed than

his concept of standard, he will use a factor of less than 100, say 90 or 75 or

whatever he considers represents a proper assessment. If, on the other hand, he

decides that the effective rate of working is above standard, he gives it a factor

greater than 100- say, 110, 115 or 110.

It is usual practice to round off ratings to the nearest multiple of five on the

scale; that is to say, if the rate is judged to be 13% above standard, it would be put

down at 115. During the first weeks of their training, study men are unlikely to be

able to rate more closely than the nearest ten.

If the study man's ratings were always impeccable, then, however, many times

he rates and times are element the result should be that-

Observed Time * Rating = A Constant

An example, expressed numerically, might read as follows:

Cycle Observed time Rating Constant

(decimal minutes)

1. 0.20 * 100 = 20

2. 0.16 * 125 = 20

3. 0.25 * 80 = 20

and so on

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It is always a comparison with the standard rating. So, if the standard rating is

taken to be 100, then dividing the constant by the standard rating (100) will yield

the constant known as the "basic time" for the element.

Observed Time *= Rating

=Basic Time Standard Rating

For example

0.16 * -yg = 0.20 min.

Recording the rating

In general, each element of activity must be rated during its performance

before the time is recorded, without regard to previous of succeeding elements.

It is important that the rating should be made while the element is in progress and that

it should be noted before the time is taken, as otherwise there is a very great risk that

previous times and ratings for the same element will influence the assessment. Since the

rating of an element represents the assessment of the average rate of performance for that

element, the longer the element the more difficult it is for the study man to adjust his

judgment to that average. Long elements, though timed as a whole up to the break points,

should be rated every half minute.

Ratings to the nearest five is found to give sufficient accuracy in the final

result. Greater accuracy than this can be attained only after very long training and

practice.

20.3.6. Allowance Factors

The determination of allowances is the most controversial part of work study.

The fact that the calculation of allowances cannot be altogether accurate under all

circumstances is no excuse for using them as a dumping ground for any factors

that have been missed or neglected in making the time study. The difficulty

experienced in preparing a universally accepted set of precise allowances that can

be applied to every working situation is due to various reasons. The most important

among them are-

1) Factors related to the Individual

If every worker in a particular working area was to be considered individually

it might well be found that a thin, active, alert worker at the peak of physical

condition required a smaller allowance to recover from fatigue than the other

worker. Similarly, every worker has a unique learning curve which can affect the

manner in which he conducts his work. There is also some reason to believe that

there may be ethnic variations in the response to the degree of fatigue experienced

by workers, particularly when engaged on heavy manual work.

2) Factors related to the nature of work itself

Many of the tables developed for the calculation of allowances give figures

which may be acceptable for light and medium work in industry but which are

inadequate when applied to operations involving very heavy and strenuous work

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such as work beside furnaces in steel mills. Moreover every working situation has

its own particular attributes which may affect the degree of fatigue experienced by

the worker or may lead to unavoidable delay in the execution of a job. Other factors

inherent in the job can also contribute to the need for allowances, although in a

different way- for example, when protective clothing or gloves have to be worn, or

when there is constant danger or when there is a risk of spoiling or damaging the

product.

3) Factors related to the environment

Allowances in particular relaxation allowances, have to be determined with

due regard to various environmental factors such as heat, humidity, noise, dirt,

vibration, light intensity, dust, wet conditions and so on. Each of these will affect

the amount of relaxation allowances needed. Environmental factors may also be

seasonal in nature. This is particularly so for those who work in the open air, such

as workers in the construction industry or in shipyards.

Relaxation allowances

Relaxation allowance is an addition to the basic time intended to, provide the

worker with the opportunity to recover from the physiological and psychological

effects of carrying out specified work under specifi ed conditions and to allow

attention to personal needs. The amount of allowance will depend on the nature of

the job.

Relaxation allowances are calculated so as to allow the worker to recoveror

from fatigue. Fatigue may be defined as physical and/or mental weariness, real or

imagined, existing in a person and adversely affecting his ability to perform work.

The effects of fatigue can be lessened by rest pauses, during which the body

recovers from its exertion, or by slowing down the rate of working and thus

reducing the expenditure of energy.

Allowances for fatigue are normally added element by element to the basic

times, so that a work value for each element is built up separately, the element

standard times being combined to yield the standard time for the whole job or

operation. In this way it is possible to deal with any extra allowance which may be

required to compensate for severe climatic conditions, since the element may

sometimes be performed in cool weather and sometimes when it is very hot.

Allowances for climatic conditions have to be applied to the working shift or

working day rather than to the element or job, in such a way that the amount of

work which the worker is expected to produce over the day or the shift is reduced.

The standard time for the job remains the same, whether the job is performed in

summer or winter, since it is intended to be a measure of the work that the job

contains.

Relaxation allowances have two major components; fixed allowances and

variable allowances.

Fixed allowances are composed of

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1. Allowances for personal needs: This allowance provides for the necessity to

leave the workplace to attend to personal needs such as washing, going to the

lavatory and getting a drink. Common figures applied by many enterprises

range from 5 to 7%.

2. Allowances for basic fatigue: This allowance always a constant is given to

take account of the energy expended while carrying out work and to alleviate

monotony. A common figure is 4% of basic time. This is considered to be

adequate for a worker who carried out the Job while seated who is engaged on

light work in good working conditions and who is called upon to make only

normal use of hands, legs and senses.

Variable allowances are added to fixed allowances when working conditions

differ markedly from those stated above, for instance because of poor environmental

conditions that cannot be improved, added stress, and strain in performing the job

in question and so on.

Rest pauses: Relaxation allowances can be taken in the form of rest pauses.

While there is no hard and fast rule governing rest pauses, a common practice is to

allow a 10 to 15 minutes break at mid-morning and mid-afternoon often coupled

with facilities for tea, coffee or cool drinks or snacks and to permit the remainder of

the relaxation allowance to be taken at the discretion of the worker.

Rest pauses are important for the following reasons:

1. They decrease the variation in the worker's performance throughout the

day and tend to maintain the level nearer the optimum.

2. They break up the monotony of the day.

3. They give the workers the chance to recover from fatigue and to attend to

personal needs.

4. They reduce the amount of time off taken by workers during working

hours.

Contingency Allowances

A contingency allowance is a small allowance of time which may be included in

a standard time to meet legitimate and expected items of work or delays, the precise

measurement of which is uneconomical because of their infrequent or irregular

occurrence.

The allowance provides for small unavoidable delays as well as for occasional

and minor extra work and so It would be proper to split the allowance into these

components, the contingency allowance for work being allowed to attract fatigue

allowance just as any other items of work does, and the delay part of the allowance

being given with only a personal needs increment. In practice this is a distinction

which is often ignored. Contingency allowances are always small and it is usual to

express them as a percentage of the total repetitive basic minutes in the job, adding

them to the rest of the work in the job and adding a relaxation percentage to the

whole contingency allowance. Contingency allowance should not be more than 5%

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and should only be given in cases where the study man is absolutely satisfi ed that

the contingencies cannot be eliminated and that they are justified.

Policy allowances

A policy allowance is an increment, other than bonus increment, applied to

standard time (or to some constituent part of it, eg. work content) to provide a

satisfactory level of earnings for a specified level of performance under exceptional

circumstances.

Policy allowances are not a genuine part of time study and should be used

with the utmost caution and only in clearly defined circumstances. They should

always be dealt with quite separately from basic times, and if used at all, should

preferably be arranged as an addition to standard times, so as not to interfere with

the time standards set by time study.

The usual reason for making a policy allowance is to line up standard times

with the requirements of wage agreements between employers and trade unions. In

several enterprises in the United Kingdom, for example, the incentive performance

is generally set at such a level that the average qualified worker as defined, can

earn a bonus of 33.5% of his basic time rate if he achieves standard performance.

There is no need to apply a policy allowance to achieve this state of affairs; it is

simply necessary to arrange for the rate paid per standard minute of work produced

to be 133.5% of the basic time rate per minute, and in general it is better to

accommodate any special wage requirements in this way, by adjusting the rate paid

per unit of work rather than the standard time.

Special Allowances

Special allowances may be given for any activities which are not normally part

of the operation cycle but which are essential to the satisfactory performance of the

work. Such allowances may be permanent or temporary. Wherever possible, these

allowances should be determined by time study.

When time standards are used as the basis for a payment -by- results scheme,

it may be necessary to make a start-up allowance to compensate for time taken by

any work and any enforced waiting time which necessarily occurs at the start of a

shift or work period before production can begin. A shut down allowance may

similarly be given for work or waiting time occurring at the end of the day. A

cleaning allowance is of much the same character it is given when the worker has

to give attention from time to time to cleaning his machine or workplace. Tool

allowance is an allowance of time to cover the adjustment and maintenance of

tools.

A small batch allowance is required to enable a worker working on small

batches to decide what to do and how to go about it and then to work up to a

standard performance by practice and repetition. The calculation of this allowance

will depend on whether it is a one-of-a-type batch or not, on the length and batch

size or run length and on the frequency of similar work and its degree of

complexity.

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20.3.7. STANDARD TIME

It is now possible to obtain a complete picture of the standard time for a

straightforward manual job or operation, one which is considered to attract only the

two allowances which have so far been discussed in detail: contingency allowance

and relaxation allowance. The standard time for the job will be the sum of the

standard times for all the element of which it is made up, due regard being paid to

the frequencies with which the elements recur, plus the contingency allowance

(with its relaxation allowance increment). In other words- Standard time is the total

time in which a job should be completed at standard performance.


1. If it takes just as long to perform a preventive maintenance as it does a

repair is there an advantage to preventive maintenance.

2. How can the techniques of simulation help in evaluating alternate

maintenance practice?


1. Explain the procedure to be followed in a motion study.

2. What are the principles governing the motion study?

3. Distinguish between time and motion study.

20.6. SUMMARY

There is one best way of doing all jobs which involves less time, less cost and

optimum efficiency. The procedure to be followed in job movements in order to save

energy is highlighted in this lesson. Methods, objectives and procedure of time

study are also portrayed.


1. What is break-down time distribution?

2. Discuss the types of situations of machine break-downs

3. List and describe plant location factors.

4. What are the steps of a plant location study?

5. What are the principles of materials handling?

20.8 SUPPLEMENTARY MATERRIALS

1. https://en.mwikipedia.org/wiki/Time_and _motion_study

20.9 ASSIGNMENTS

1. Briefly identify four basic types of handling equipments. Indicate example for

each.

2. Explain the methods of time study.

3. What kinds of costs are associated with machine break-down?

20.10 SUGGESTED READINGS/ REFERENCE BOOKS

1. Krajewski and Ritzman, “Operations management”, Addison Whesely.

2. Buffa “Modern Production management”, 4th edition, John Whieley.

3. Menipaz, Ehed,: Essentials of production and operations management”

Prentice Hall.

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4. Bugga, “Modern production management” 4 th edition, John Whieley.

5. Krishna, N,V., “Preventive maintenance”, National Productivity council, New

Delhi.

6. Apple, J.M., “Plant layout and materials handling”, prentice Hall.

7. Moore, F. G., “Plant Layout design” John Whieley.


1. “The location of a plant is a major decision affected by many factors both

internal and external to the organization operations”-explain.

2. What do you mean by "allowances"? Give an example how it is given while

calculating standards.

20.12 KEY WORDS

Standard time – Time study – Motion economy – Allowances Ratings.

886E110

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