UNIT-11

FIRM & INDUSTRY:-

FIRM:- A firm is the which owns, controls and manages the plant or plants. The term used from
the financial and administrative angle. In other words, the ownership of all the assets and
activities lies with the firm. The entire profits or loss occur and account of various activities is
attributed to firm.

INDUSRIES: Industry is generally defined as a group of firms producing the same or slightly
different products for the same market or using raw material. Thus all the firms producing
similar products are engaged in providing similar service can be categorized into one industry.

Eg:- Automobile industry. 1. Pharmaceutical Industry etc.

Productions:- production is an activity that transforms input into o/p or conversion of

resources into commodities. The transforming process of i/p’s into o/p’s can be change in
firm , change in place and change in time. With the help of these transformations usability of
the product is increased.

Therefore protectionists of producing, storing and distribution of goods and services.

It is the act of converting or transforming input into l/p and is technically carried out
by a firm. A firm is business unit which under take the activities of transforming input into
output.

Def:- “Production is the organized activity of transforming resources into finished

products in the form of goods & services.

-Parkinson.

Production functions:- the inputs for any product are land , labour, capital ,
technology and organization. The production function mathematically can be expressed as.

Q= f( Ld, Lb, C, O, T )
Where Q= quantity of production.

F= function that is the relation b/w i/p’s & o/p’s

Ld= land, Lb= Labour, C= Capital

O= Organization, T= Technology

Importance:
1. When inputs are specified in physical units, production function helps to estimate the level
of production.
2. It becomes is equates when different combinations of inputs yield the same level of output.
3. It indicates the manner in which the firm can substitute on input for another
without altering the total output.
4. When price is taken into consideration, the production function helps to select the
least combination of inputs for the desired output.
5. It considers two types’ input-output relationships namely ‘law of variable
proportions’ and ‘law of returns to scale’. Law of variable propositions explains the
pattern of output in the short-run as the units of variable inputs are increased to
increase the output. On the other hand law of returns to scale explains the pattern
of output in the long run as all the units of inputs are increased.
6. The production function explains the maximum quantity of output, which can be
produced, from any chosen quantities of various inputs or the minimum quantities
of various inputs that are required to produce a given quantity of output.
Production function can be fitted the particular firm or industry or for the economy as
whole. Production function will change with an improvement in technology.
Assumptions:

Production function has the following assumptions.

1. The production function is related to a particular period of time.
2. There is no change InTechnology.
3. The producer is using the best techniques available.
4. The factors of production are divisible.
5. . Production function can be fitted
to a short run or a long run
Cobb-Douglas production function:
Production function of the linear homogenous type is invested by Juntwicksell and
first tested by C. W. Cobb and P.Dougles in 1928. This famous statistical production
function is known as Cobb-Douglas production function. Originally the function is
 applied on the empirical study of the American manufacturing industry. Cabb –
Douglas production function takes the following mathematical for
P= (bLa C1-a)
Where P=output
C=Capital
L=Labour
a, i-a =Elasticity of production

The formula function estimated for the USA by Cobb-Douglas is

P= (1.01L0.75 C0.25)

Assumptions:

It has the following assumptions

1. The function assumes that output is the function of two factors viz. capital and
labour.
2. It is a linear homogenous production function of the first-degree
3. The function assumes that the logarithm of the total output of
the economy is a linear function of the logarithms of the
labour force and capital stock.
4. There are constant returns to scale
5. All inputs are homogenous
6. There is perfect competition
7. There is no change InTechnology
Production function with one variable input:

Production function with one variable proportions’ . this law is also called the law of
diminishing marginal returns. This law can be stated as follows: As the proportion of one factor
in a combination factors is increased, after will diminish. This law explains. when there is a
change in the proportion of factors or inputs used . how the total o/p is effected

This law states that other things remain constant when one variable input is changed
keeping other constant or fined. The o/p will increase. More than proportionately that of the
rate of increase in inputs, in the beginning period then after some time the o/p may increase in
the same proportion and finally if will less proportionately increase.
Labour variable Total production Average products Marginal Products
input (units) (AP)
(TP) (MP)

0 0 0 0

1 5 5 5 Stage-I

2 12 6 7

3 18 6 6

4 20 5 2 Stage –II

5 20 4 0

6 18 3 -2
State-III
7 14 2 -4

In the above table the total product is increasing at an increasing rate. Moreover, the
product and marginal product also increase. This stage is called stage-I. This stage is also called
the stage of increasing returns.

After reaching the second unit of labour the marginal product starts decreasing the
total product increasing but at a very slow rate. This stage is called stage-II. This stage is also
called of decreasing returns.

When the total product decreases, average product also decreases. Therefore marginal
product becomes negative. This stage is called stage-III. This stage is also called the stage of
negative returns.
24
21
18
15
TP
12
9 AP
6
MP
3
0
-3 0 1 2 3 4 5 6 7
-6

From the above diagram, variable input labour is on x-axis, on y-axis the total product,
average product and marginal product is measured. The total product curve moves upward
and then moves downward. The total product slopes downwards after a certain point.
Marginal product increases and then it decreases and finally it starts destining.

In a nut shell the law of variable proportions states that the contribution mode to the
total o/p by the additional unit of labour will be negative.

Production function with two variables(i/p’s):

 A production function with two variable inputs can be represented by a family of
isoquants or isoproduct curves or production indifference curves.

‘ISO” refers to equal, ‘quant’ refers to quantity. An isoquant may be defined as a curve
which shows, the different combinations of the two inputs producing the same level of
output. Graphically, the isoquant can be drawn conveniently for two factors of production.

Assumptions:-

1. Two factors can be substituted for each other.

2. No changes in technology.

Features of Isoquant:-

1. An isoquant is a negatively sloped curve.

2. A higher isoquant represents large output.
3. No two isoquant curve intersect each other.
4. Isoquants are convex to the origin.
Eg:- The concept of isoquant can be easily understood by the table given below.

Combination Capital (Units) Labour(units) TP

A 1 15 10,000

B 2 10 10,000

C 3 6 10,000

D 4 3 10,000

From the above table A shows 1 unit of capital and 15 units of labour which produces a given
quantity of 10,000 units of o/p. The combination represents B, C, & D i.e. 2 units of capital, 10
units of labour, 3 units of labour will all produce the same 10,000 units of o/p. All these
combinations can be plotted on the graph. By joining all these points the curve known as
Isoquant curve is obtained.
ISOCOST:- Isocost refers to the cost curve which will show the various combinations of two
inputs. Which can be purchased with as given amount of total money.

300 Rs

O x

From the figure it can be seen that of the level of production changes, the total cost will
change and automatically, the isocost curve moves upward.

Law of Returns to Scale:-

Statement:- Other things being equal if the quantities of all variable inputs is increased. Initially
the output will increase at an increasing rate than the rate of increasing inputs and after
sometime the output may increase in the same proportion of the input and finally, the rate of
increase in the output will be less than the rate of increasing inputs.

Assumption:-

1. All factors are variable.

2. No changes in production technique.
According to this law there are three stages.

1. Law of increasing returns

2. Law of constant returns
3. law of deceasing returns

1. Law of Increasing Returns:- This law states that the volume of output keeps on
increasing with every increase in the input. Where a given increase in inputs leads to a
more than proportionate in the output. The law of increasing returns to scale is said to
be operate. We can introduce division of labour and other technological means to
increase production. Hence the total product increases at increasing rate.

Proportionate increase in Output

> 1
Proportionate increase in Input
1 11

2. Law of constant returns to scale:- When the scope for division of labour gets restricted,
the rate of increase in the total output remains constant. The law of constant returns to
scale is said to operate. This law states that the rate of increase or decrease in volumes
of output is same to that rate of increase/decrease in inputs.
3. Law of decreasing returns to scale:- Where the proportionate increase in the input does
not lead to equivalent increase in output, the output increases at a decreasing rate, the
law of decreasing returns to scale is said to be operate. This results in higher average
cost per unit.
These laws can be illustrated with an example of agricultural land. Take one acre of land. If
you till the land well with adequate bags of fertilizers and sow good quality seeds, the
volume of output increases.

The following table illustrates further

 Factors Total products Marginal products

Land/Capital Labour (or)

Returns in units

1 2 4 4

2 4 10 6

3 6 18 8

4 8 28 10

5 10 38 10

6 12 48 10

7 14 56 8

8 16 62 6

R C R D

output

I R

O Input x
Internals & External economies of scale:-

Meaning of economies of scale:- As a result of the large scale production the production
costs is low, that is known as economies of scale.

Definition:- As long as the output is increased in the long run the cost of the production
will be at minimum level is known as economies of scale. Economies of scale are divided in to 2
parts.

1. Internal economies
2. External economies

1. Internal economies:- Internal economies are those benefits or advantages enjoyed by

an individual firm if it increases its size and output. Internal economies are enjoyed by
the individual firm itself when its output increases.
Types of Internal economies:-

1. Labour economies:- A large firm can attract specialist or efficient labour and due
to increase in specialization, the efficiency and productivity will increase leading
to decrease in the labour cost per unit of output.
Eg; Small firm Big farm

Output produced by 1000 units 3000 units

workers

Salary paid for a worker 10000 20000

Cost per units 10 6.67

In the above example in case of a Big firm the labour cost per unit Rs6.70ps per
unit compared to Rs10 in case of small firm which is lowest.

2. Technical economies:- A large firm can adapt and implement new and latest technology
which helps in reduction in cost of manufacturing process. Whereas the small firm may
not have the capability to implement the latest technology. A large firm can make use
more and more mechinary. A large firm can manage the production activities in
continuous series without any loss of time thereby saving in time and transportation
cost.
3. Managerial Economics:- The managerial cost per unit will decrease due to mass scale
production. His salary remains the same weather the o/p is high or low. Moreover the
large firm can recruit the skilled professional by paying him a good salary. But in small
firm it may not have that much capacity pay high salary.
 4. Marketing Economics:- A large firm can raise their financial requirement on bulk scale.
Therefore they get a discount. Similarly the advertisement cost will reduce because a
large firm produces a variety of different types of products. Moreover a large firm can
employ sales professional to market their product effectively
5. Financial Economics:- A large firm can raise their financial requirement easily from
different sources than a small one. A large firm can raise their capital easily from the
capital market. Because the investor has more confidence in law firm than small firm.
6. Risk Bearing Economics:-The large firm can minimize the business risk because it
produces a variety of products. The loss in one product line can be balanced by the
profit in other product line.

2. External Economics:-

External Economics are those benefits which are enjoyed by all the firms in an industry
irrespective of their size and output. External Economics are shared by all the firms in the
industry.

Types of External Economics:-

1. Economics of Localization:- When all the firms are situated at one place all the firms will be
enjoying the benefits of skilled labour infra-structure facilities and cheap transport.
Thereby reducing the manufacturing cost.
2. Economics of information:- All the firms in an industry can have a common research and
development center through with the research work can be undertaken jointly. They can
also have the information related to market and technology.
3. Growth of subsidiary Industry:- The production process can be divided into different
components. Each component can be manufactured by specialized subsidiary firm at low
cost.
4. Economics of B: product:- The waste materials released by a particular firm can be used as
an input by the other firms to manufacture a b product.
Diseconomies of scale:-

When a large firm increase its size and o/p beyond a certain limit the firm will be suffering
from disadvantages that is the cost of production will start increasing etc. That is known as
diseconomies of scale.

Reasons for Diseconomies of scale:-

1. Coordination becomes difficult:- Because of large size the management may face a
critical problem of coordination. There is a more chance of wrong decision. Decisions
are taken in a hurry leading to inefficiency and increase in the cost of production.
 2. Difficulties in managing:- Because of large scale unit it becomes difficult for the top
management to control the whole organization and more over it will be difficult for the
management to check each and every department of large scale business.
3. Delay in decision making:- There will be delay in decision making because the
management has to consult each and every department.
4. Increase in risks:- Increase in the size and o/p of the firm leads to increase in production
and increase in production leads to increased investment and therefore risk also
increase.
5. Difficulties in obtaining finance:- There will be difficulties for large firm to further
expand because it may face difficulties in raising the huge capital.
6. Marking is diseconomical:- Due to increased competition in the day-to-day market
sellers are forced heavily to spend on advertising publicity. Therefore the advertisement
expenditure.

Cost Analysis

The managerial economist is concerned with making managerial decisions. Different

business proposals are evaluated in terms of their costs & revenues. Cost analysis deals with
the possible variations in the concept of cost & its relationship with output both in short run &
long run.

Nature And Concept of cost:

Cost refers to the expenditure increased to produce a particular product. All costs involved a
sacrifice of some kind or other to acquire some benefit.

The cost of product normally includes the cost of raw material, cost of labour and other
expanses.

This cost is known as total coat (TC). This is compound with total revenue (TR) realized in
the sales of the production the differences b/w total revenue & total cost is called profit.

P = TR-
TC

An understanding of the meaning various costs. The costs concept is essential for clear
business thinking.

The following are the possible variations in the concept of cost.

1. Fixed cost and total fixed cost:- Fixed cost refers to that cost which does not change with
level of o/p. That means fixed cost remains constant at any level of output. Even if the o/p is nil
the fixed cost remains unchanged.
Eg:- Salary, taxes, Rut, insurance. Adding all the components of fixed cost, we get total fixed
cost.

2. Variable cost and total variable cost:- Variable cost refers to those cost which fluctuate
directly with the level of output. The means if the output increases the variable cost also will
increase. If the o/p increases the variable cost also will increase. If the o/p is zero, variable cost
will be zero.

Eg:- Power, Raw material etc.,

If we add all the components of variable cost we get total variable cost.

3. Opportunity Cost:- Opportunity cost refers to sacrificing the next best alternative in order to
attain that alternative. This is nothing but the revenue that is last in not utilizing the best
alternative.

4. Explicit (or) Out-of-pocket cost:-

Explicit cost refers to the expenses incurred in purchase or using the inputs that is used in the
production process. These require current cash payments.

5. Implicit (or) Book cost (or) Imputed cost:-

 Implicit costs are those cost which are not actually paid by the firm but it arises when the
organizer supplies his own factors as production or input by himself. They are recorded in the
books of accounts but don’t require any current cash payments.

For example the organizer may use his own building for his business for which no rent is paid.

6. Incremental costs and sunk costs:-

Incremental costs refer to the change in total cost due to change in the level of business
activity.

Eg: Adding new equipment. Adding a new product etc. Suck cost refers to those cost which is
not affected by change in level of business activity. Those cost remains same at all levels of
business activity.

Eg:- Preliminary expenses.

7. Abandonment costs and shutdown costs:- If the product is stopped temporarily the expenses
incurred on plant & machinery during the stoppage period is called shutdown cost.

The cost of the incurred due to discontinuance of activities on plant and machinery
permanently is called abandonment cost.

1. Short run and long run costs

2. past costs and future costs
3. Direct and indirect costs
4. urgent and postponed costs
5. Replacement cost and Historical costs.
Cost and output relationship:-

The cost of production depends upon several factors, such as labour cost, material cost,
technological cost etc, the relationship also.

The cost output relationship facilities many managerial decisions such as

1. Formation of optimum size

2. Expenses control
3. Profit analysis
4. Pricing decision
5. Promotional decisions.
Cost in short run:-
 Costs in the short run are classified into fixed cost and variable cost. The fixed cost may be
as certain in the terms of total fixed cost and average fixed cost per unit. The variable cost san
be determined in terms of total variable cost and average variable cost per unit.

Monthly FE VE TE AFE AVE ATC MC

units

0 100 0 100 ---- ---- --- ---

1 100 30 130 100 30 130 30

2 100 54 154 50 27 77 24

3 100 72 172 33.33 24 57.3 18

4 100 96 196 25 24 49 24

5 100 150 250 20 30 50 54

6 100 216 316 16.67 36 52.67 66

7 100 320 420 14.29 45.71 60.00 104

The following diagram explains the behavior of costs in the short run.

Let us take o/p on axis and cost on y-axis.

Conclusion:- From the above diagram it can be noticed that as the o/p goes on increasing,
average fixed cost curve will continue to decrease. The average variable cost curve is a ‘U’
shaped curve denoting that AVC curve tends fall in the beginning when the o/p is increasing.
But after a particular level of o/p it gradually increases. Average variable cost. The ATC is a ‘U’
shaped curve marginal cost curve is also rises sharply. The rising marginal cost curve will pass
through AVE and ATC.

Marginal cost and Average cost:-

Marginal cost is less than average cost when the average cost is falling. The following is the
diagram. When the average cost is rising, the marginal is more than the average cost.

When average cost is constant, then the marginal cost is also constant.

Costs in long run:

Long run refers to that period of time over which all factors are variable. The firm has move
time at its disposal to make any change in the production depending on its requirements. It can
plan & organize every strategy to reduce its cost of production or maximize the value of
production. It has no constraints in terms of resources. It has no fixed costs. All costs are
variable hence the long run costs refer to the costs of producing different levels of output by
changing the scale of production.

A long run is also expressed as a series of short run. Short run average cost curve is associated
with short run. The long run is associated with the series of short run average curves. The long
run average cost curve(LAC) is flat ‘U’ shaped curve enveloping a series of short run average
cost curves. It is tangential to all the short run average cost curves. The points tangency
represents minimum average cost in the long run. The long run and short average costs are
equal to each other only at a particular point of tangency. The following diagram explains the
behaviour of costs in the long run.

Conclusion:- From the above diagram it is clear that the firm is producing an output of OX 1
units on a plant of SAC. It wants to produce OX2 units of output then it come on SAC1 by over
utilization of SAC1 or by acquiring a bigger size plant of SAC2 & operating on it. It will be less
costly to operate on SAC2. It wants to produces OX 3 units of output it can operate on the bigger
size plant SAC3 at least cost. X3A3 is the least cost at the output of OX3 units & the firm attains
optimum level of out put in the long run at OX3 level.

Break Even Analysis:-

 The main purpose of any business is to maximize the profit & to minimize the cost. BEA is
refers to breakeven point. Breakeven point means it is a point where there is no profit or there
is no loss. The breakeven point (BEP) will be explained through the following diagram.

Break even Analysis:- The break even analysis refers to that tool or important method which
explains the relationship b/w cost revenue and profit at the different levels of o/p or sales.

Break Even point:- Breakeven point is located at the point where total sales curve or total
revenue curve (or) total cost curve. The BEP is also called no profit or no loss region. Total
revenue is equal to total cost.

Break even chart:- The graphical representation of cost revenue relationship to the volume of
o/p is called BEC.

Assumptions:
1. All costs are classified into two – fixed and variable.
2. Fixed costs remain constant at all levels of output.
3. Variable costs vary proportionally with the volume of output.
4. Selling price per unit remains constant in spite of competition or change in the
Volume of production.
5. There will be no change in operating efficiency.
6. There will be no change in the general price level.
7. Volume of production is the only factor affecting the cost.
8. Volume of sales and volume of production are equal. Hence there is no unsold
stock.
9. There is only one product or in the case of multiple
products. Sales mix remains constant.
Merits:
1. Information provided by the Break Even Chart can be understood
 more easily than those contained in the profit and Loss Account
and the cost statement.
2. Break Even Chart discloses the relationship between cost,
volume and profit. It reveals how changes in profit. So, it helps
management indecision-making.
3. It is very useful for forecasting costs and profits long term planning and growth
4. The chart discloses profits at various levels of production.
5. It serves as a useful tool for cost control.
6. It can also be used to study the comparative plant efficiencies of the industry.
7. Analytical Break-even chart present the different elements, in the
costs – direct material, direct labour, fixed and variable overheads.
Demerits:
1. Break-even chart presents only cost volume profits. It ignores other
considerations such as capital amount, marketing aspects and effect
of government policy etc., which are necessary in decision-making.
2. It is assumed that sales, total cost and fixed cost can be represented
as straight lines. In actual practice, this may not be so.
3. It assumes that profit is a function of output. This is not always
true. The firm may increase the profit without increasing its
output.
4. A major drawback of BEC is its inability to handle production and sale of
multiple products.
5. It is difficult to handle selling costs such as advertisement and sale promotion
in BEC.
6. It ignores economics of scale in production.
7. Fixed costs do not remain constant in the long run.
8. Semi-variable costs are completely ignored.
9. It assumes production is equal to sale. It is not always true because generally
there may be opening stock.
10. When production increases variable cost per unit may not remain
constant but may reduce on account of bulk buyingetc.
11. The assumption of static nature of business and economic activities is a well-
known defect of BEC.

1. Fixed cost
2. Variable cost
3. Contribution
4. Angle of incidence
 5. Margin of safety
6. Profit volume ratio
7. Break-Even-Point

1. Fixed cost: Expenses that do not vary with the volume of production are
known as fixed expenses. Eg. Manager’s salary, rent and taxes, insurance
etc. It should be noted that fixed changes are fixed only within a certain
range of plant capacity. The concept of fixed overhead is most useful in
formulating a price fixing policy. Fixed cost per unit is not fixed.
2. Variable Cost: Expenses that vary almost in direct proportion to the
volume of production of sales are called variable expenses. Eg. Electric
power and fuel, packing materials consumable stores. It should be noted
that variable cost per unit is fixed.
3. Contribution: Contribution is the difference between sales and variable
costs and it contributed towards fixed costs and profit. It helps in sales
and pricing policies and measuring the profitability of different proposals.
Contribution is a sure test to decide whether a product is worthwhile to
be continued among different products.
4. Margin of safety: Margin of safety is the excess of sales over the break
even sales. It can be expressed in absolute sales amount or in percentage.
It indicates the extent to which the sales can be reduced without
resulting in loss. A large margin of safety indicates the soundness of the
business. The formula for the
5. Angle of incidence:
This is the angle between sales line and total cost line at the Break-even
point. It indicates the profit earning capacity of the concern. Large angle of incidence
indicates a high rate of profit; a small angle indicates a low rate of earnings. To
improve this angle, contribution should be increased either by raising the selling price
and/or by reducing variable cost. It also indicates as to what extent the output and
sales price can be changed to attain a desired amount of profit.
1. Profit Volume Ratio
is usually called P. V. ratio. It is one of the most useful ratios for studying the
profitability of business. The ratio of contribution to sales is the P/V ratio. It may be
expressed in percentage. Therefore, every organization tries to improve the P. V. ratio
of each product by reducing the variable cost per unit or by increasing the selling price
per unit. The concept of P. V. ratio helps in determining break even-point, a desired
amount of profit etc. P/V RATIO =CONTRIBUTION/SALES*100
Break – Even- Point :If we divide the term into three words, then it does not require further
explanation. Break-divide Even-equal Point-place or position

Break Even Point refers to the point where total cost is equal to total revenue.
It is a point of no profit, no loss. This is also a minimum point of no profit, no loss. This
is also a minimum point of production where total costs are recovered. If sales go up
beyond the Break Even Point, organization makes a
profit. If they come down, a loss is incurred

Marginal costing Formulae:-

1. Contribution = sales – variable cost

= fixed cost + profit
= P/V ratio x sales
100
2. BEP sales = fixed cost x 100
P/v ratio
= sales – margin of safety
= fixed cost
Unit contributions
3. Margin of safety = sales – BEP sales
= profit x 100
P/V ratio
= sales x margin of safety ratio
4.Sales when desired profit given = fixed cost + desired profit
P/V ratio
5. P/V ratio = contribution x 100
Sales
= Fixed cost x 100
BEP sales
= profit x 100
Margin of safety
= Changes in profit x 100
Changes in sales

PROB:- U are the given the information about 2 companies in 2000

Particulars Company A Company-B

Sales 50 00 000 50 00 000

F.E 12 00 000 17 00 000

V.E 35 00 000 30 00 000

You are required to calculate, p/v ratio, BEP, margin of safety.

Sol:-

Company-A

Sales = 50, 00, 000

F.E = 12, 00, 000

V.E = 35, 00, 000

Profit = (5000000 – 1200000 – 3500000) = 3,00,000

P/V = S - V x 100 = 1500000 x 100 = 30%

S 5000000

BEP = Fixed cost = 1200000 x 100 = 40,00000

P/v ratio 30

Margin of sales = S – BEP sales

= 5000000 – 4000000 = 1000000/-

Company-B

Sales = 5000000

F.E = 1700 000

V.E = 3000000

Profit = 3,00,000

P/V ratio = 2000000 x 100=40%

 5000000

BEP = FE = 1700000x 100 = 4250000 =1700000x 100 = 4250000

P/V ratio 40

Margin of sales = S – BEP sales

= 50 00 000 – 4250000

= 750000

Prob:- A company prepares a budget to produce 3 lakh units, with fixed cost as Rs. 15 lakhs and
average variable cost of Rs.10 each. The selling price is to yield 20% profit on cost. You are
required to calculate (a) p/v ratio (b) BEP.

Sol:- Given information:

Sales = 3, 00,000 units

Variable cost per units = 10/-

Fixed cost = 1500,000

Profit = 20% of cost

Total variable cost = 300000 x 10/-

= 30,00,000/-

Total cost = fixed cost + variable cost

= 3000000 + 1500000

= 4500000

But profit = 20% on cost

Profit = 45,00,000 x 20/100 =900000

Sales = F.E + V.E+P

= 1500000 + 3000000 +900000

 = 5400000

Contribution = S - V = 5400000 – 3000000

= 2400000

P/V ratio = C x 100 = 2400000 x 100 = 44.44%

S 5400000

BEP sales = Fixed cost = 1500000 x 100

p/v ratio 44.44

=3375000
Prob:-
The P/V ratio of a company is 40% and the margin of safety is 30%. U ‘r’ required to workout
the BEP and net profit if the slaves value Rs. 14000.
Sol:- Given information,
P/V ratio=40%
Margin of safety = 30%
Sales= 1400/-
Margin of safety = sales x margin of safetyratio
= 14000 x 30 = 4200/-
100
Margin of safety = profit
P/V ratio

Profit = 4200 x 40 = 1680/-

100

BEP sales = sales – margin of safety

= 14000 – 4200 = 9800/-

Prob:- Sales axe Rs. 110000/- producing a profit of Rs. 4000/- in period 1. Sales are Rs.150000/-
producing a Rs. 12000/- in period2. Determine BEP and fixed expenses and margin of safety for
two periods.
Sol:- Given period1 Period2
Sales 110000/- 150000/-
Profit 4000/- 12000/-
P/V ratio = ∆P x 100 = 12000 – 4000 x 100
∆S 110000 – 150000

= 8000 x 100 = 20%

40000

Contribution for period I = sales x p/V ratio

= 110000 x 20
100
= 22,000/-
But C = f + p
f = C – P = 22000 – 4000 = 18,000

Contribution for period I = sales x P/V ratio

= 150000 x 20
100
= 30,000/-
But C = f + p
f = C – P = 30000 – 12000 = 18,000/-

BEp sales = f
P/V ratio

=18000 = 90,000/-
20
100

Margin of safety(I) = sales – BEP sales

= 150000 – 90000

= 60,000/-

PROB:- From the following information you can calculate BEP p/v ratio and margin of safety.
And also calculate sales when expected profit is 50,000/-.
Sales : 100000
 Fixed cost : 30,000
V.E: 60,000
Sol:- Contribution = sales – VE
= 100000 – V.E = 40000/-
Profit = contribution – F.E
= 40,000 – 30,000 = 10,000/-

P/V ratio = C/S x 100 = 40000 x 100 = 40%

10,000

BEP sales = FE = 30,000

P/V ratio 40
100

= 300000 = 75000/-
4
Margin of safety = sales – BEP sales
= 100000 – 7500
= 25,000/-
Sales when profit = 50,000/- = f + Expected profit
P/V ratio

= 30000 + 50000
40
100

= 8000000
40
= 200000/-

Prob:- The P/V ratio of a company is 50% and margin of safety is 25%. U ‘r’ required to workout
the BEP and net profit if the sales are 50,000/-
Sol:- P/V ratio = 50%
Margin of safety = 25%
Sales = 50,000/-
Margin of safety = sales x margin of safety ratio
=50000 x 25/100
=12,500/-
Margin of safety = sales – BEP sales
12,500 = 50,000 – BEP sales

BEP sales = 37,500/-

Margin of safety = Profit
P/V ratio

Profit = margin of safety x p/v ratio

= 12,500 x 50
100
= 6250/-

Prob:- A company prepare a budget to produce 400000 units with FE as rupees 1400000 avg.
V.E of Rs.15 each the selling price is to yield 25% profit on cost your required to calculate p/v
ratio and BEP.
Sol:- Sales = 4,00,000 units

f C = 1400000

variable cost for each = 15/-

profit = 25% of cost

Total variable cost = sales of units x variable cost for each

= 400000 x 15

= 60,00,000.

Total cost =fixed cost + V.C

= 14,00,000 + 60,00,000

= 74,00,000

But profit = 25% of cost

 = 7400000 x 25
100

= 18,50,000/-

Sales= fixed cost + VC + profit

= 92,50,000/-

Contribution = S – V
= 92,50,000 – 60,00,000

=32,50,000

P/V ratio = S – V x 100

S
= 92,50,000 – 60,00,000 x 100
92,50,000
= 35.135%

BEP sales = fixed cost

P/V ratio

= 1400000 x 100
35.15

= 3984615/-

Prob:- Sales are Rs.100000/- producing a profit of 10000/- in period1. Sales are Rs.200000/-
producing a profit of 50000/- in period 2. Determine BEP and fE. And also calculate sales when
expected profit Rs.90,000/-
Sol:-
Sales I = 100000 Profit I = 10000/-
II = 200000 II = 50000/-

P/V ratio = ∆P = 40000 x 100

∆S 100000

Contribution for period I = sales x P/V ratio

 = 100000 x 40 = 40,000/-
100

f = C – P = 40,000 – 10,000 = 30,000/-

contribution for period II = 200000 x 40 = 80,000/-

100

f = C – P = 40,000 – 10,000 = 30,000/-

BEP sales = f = 30,000 = 3,00,000/-

P/V ratio 40
100

Sales when profit = 90,000/- = fC + desired profit

P/V ratio
= 30,000 + 90,000
40
100

=1,20,00000
40

= 3,00,000/-

Advantages of BEA:-

The following are the advantages of BEA.

1) BEA is useful to assertive the profit on a particular level of sales (or) a given
capacity of production.
2) It is useful to calculate sales required to earn a particular desired level of profit.
3) It is useful to compare the product lines sales area, methods of sale for individual
company.
4) It is useful to compare the efficiency of the different firms.
5) It is useful to decide whether add or drop decisions.
6) It is useful to decide to make or buy decision for a given component or spare
part.
 7) It is a valuable tool to decide what production mix will give optimum sales.
8) It is useful to assess the impact of changes in fixed cost, variable cost (or) selling
price on BEP & profits during a given period.
Prob:- VC during the year 40000/- sales 80000/- FC 20,000/- what will be the sales value to
obtain 30,000/- profit.

Sol:- P/V ratio = S – V x 100 = 40000 x 100 = 50%

S 80000

Sales when desired profit = fC + desired profit

P/V ratio

= 20,000 + 30,000

50

100

=50,000 x 100

50 = 1,00,000/-

Prob:- A bus can carry a maximum of 36000 passengers per annum at fair of Rs.400/- the
variable cost per passenger is Rs.150/-. The F.C is Rs.25,00,000/- per year. Find BEP, in terms of
passengers and also in terms of collection.

Sol:- Given information,

Selling price = 400/-

VC per unit = 150

P/V ratio = 400 – 150 x 100= 62.5%

400

BEP = FC = 2500 000 x 100

P/V 62.5

= 40,00,000/-

Input units = 40,00,000 = 10,000 passengers

400
BEP in units = f C = 25,00,000 = 10,000 passengers

Unit contribution 250

Prob:- Srikanth enterprises deals in the supply of hardware parts of computer. The following
data is available for two successive periods.

Particulars period I period II

Sales 50,000 1,20,000

FC 10,000 10,000

VC 30,000 80,000

Calculate BEP and margin of safety & P/V ratio.

Sol:- Period I

Sales 50,000

Profit = (50,000 – 10,000 – 30,000) = 10,000/-

P/v = S – V x 100 = 20000 x 100 = 40%

S 50,000

BEP = FC = 10000 = 25,000

P/V 40

100

Margin of safety = S – BEP = 25,000/-

Period II

Profit = (1,20,000 – 10,000 – 80000) = 30,000/-

P/v = S – V x 100 = 40000 x 100 = 33.33 %

 S 120,000

BEP = FC = 10000 = 30,000/-

P/V 33.33

100

Marginal of safety = SALES – BEP

= 90,000/-

PROB:-

A firm has a FC of Rs.10000/- selling price per unit Rs. 5/- and VC per unit 3/- calculate BEP
and BEP in units. Also determine the margin of safety that actual production is 8000 units.

SOL:- selling price = 5/-

Variable cost per unit = Rs.3/-

I.C = Rs. 10,000/-

P/V ratio = S – V x 100 = 40%

BEP = 10000 x 100 = 25,000/-

40

In units = 25000 = 5000 units

BEP in units = FC = 10000 = 5000 units

Unit contribution

Sales when production is 8000 units = 8000 x 5

 = 40,000/-

VC when production is 8000 units = 8000 x 3

= 24000/-

P/V ratio = 40,000 – 24,000 x 100 = 40%

40,000

BEP sales = 10,000 x 100 = 25,000/-

40

Margin safety when production is 8000 = 15,000/-

Problem :

ABC wishes to known its (a) BEP of production (b) margin of safety during july to December
from the following information

Particulars January - june July – December

Sales 2,00,000 2,50,000

Net profit 20,000 30,000

(1) P/V ratio = change in profit x 100

Change in sales

= 30000 – 20,000 x 100

50,000

= 20%

Contribution for 1 year = sales x P/V ratio

= 4,50,000 x 20

100

= 90,000/-
 C=f+P

90000 = f + 50,000

F = 40,000/-

BEP = f = 40000 x 100 = 200000 per year

P/V 20

BEP per 6 months = 100000{(200000 x 6 )}

12

Therefore, Margin of safety for July to Dec = 6 months sales – 6 months BEP sales.

= 250000 – 100000

= 150000/-

Prob:- From the following data calculate the BEP selling price per unit Rs.50/- Direct material
cost per unit Rs. 15/- Direct labour per unit Rs. 5/- total fixed over heads Rs. 60,000/-.

SOL:- Total V.E = DM + DL

= 15 + 5 = 20/-

Therefore Contribution = S – V = 50 – 20 = 30/-

P/V ratio = C x 100 = 30 x 100 = 60%

S 50

BEP = f = 60,000 x 100

P/V ratio 60

= 1,00,000/-
 2 Marks Questions and Answers

1) Define production function and write formula for production function?

a) Production function is defined as a technical relationship between a given set of inputs and
the possible output from it. it is a function that defines the maximum amount of output that
can be produced with a given set of output

Q=f(L1,L2,C,O,T) (LAND, LABOUR, CAPITAL ,ORGANIZATION ,TECHNOLOGY)

2) Meaning of Isoquant?

a) Isoquant refers to the curve throughout which equal quantity is obtained from several
combinationof inputs underlying it.

3) Meaning of Isocost?
a) Isocost refers to that cost curve which represents the combination of inputs that will cost
the firm the same amount of money .
4) Explain cobb –douglas production function?
a) Cobb and douglas formulated a production function,in the contest of USA,which revealed
constant returns to scale.there were no economies or diseconomies resulting from large
scale production.according to cobb and douglas

P=bLaC1-a

P=total output

L=the index of employment of labour in manufacturing

a,a-1 are the elasticities of production

5) MRTS.

a) Marginal rate of technical substitution refers to the rate at which one input factor is
substituted with the other to attain a given level of output

MRTS = Change in one input,say,capital

. Change in another input, say, labour

6) Define cost?

a) Cost is defined as the sacrifice made to acquire some benefit. Cost is the expenditure
incurred to produce a particular product or service

7) Explain about BEA point?

A) Break even analysis refers to analysis of the breakeven point. The BEP is defined as no profit
or no loss point. In another words, it points out how much minimum is to be produced to see
the profits.BEP= (TR=TC)

8) What is the meaning of laws of returns?

a) Laws of returns to scale, refers to the returns enjoyed by the firm as a result of change in all
the inputs. There are three returns

a) Laws of increasing returns to scale

b) Laws of constant returns to scale

c) Laws of decreasing returns to scale

9) Explain about internal economies of scale?

a) Internal economies refer to the economies in production costs which accrue to the firm
alone when it expands its output. The internal economies occur as a result of increase in the
scale of production.

10) Explain about external economies of scale?

a) External economies refer to all the firms in the industry, because of growth of the industry as
a whole or because of growth of ancillary industries. External economies benefit all the firms in
the industry as the industry expands

11) Explain explicit cost and implicit cost?

a) Explicit costs are those expenses that involve cash payments. These are the actual or
business costs that appear in the books of accounts. These costs include payment of wages and
salaries

Implicit costs are the costs of the factor units that are owned by the employer himself. These
costs are not actually incurred but would have been incurred in the absence of employment of
self – owned factors.

12) Explain out of pocket cost and book cost?

a) Out-of pocket costs also known as explicit costs are those costs that involve current cash
payment. Book costs also called implicit costs do not require current cash payments. But the
book costs are taken into account in determining the level dividend payable during a period.

13) Explain fixed cost and variable cost

a) Fixed cost is that cost which remains constant for a certain level to output. It is not affected
by the changes in the volume of production. But fixed cost per unit decrease, when the
production is increased. Fixed cost includes salaries, Rent, Administrative expenses
depreciations etc.

Variable is that which varies directly with the variation is output. An increase in total output
results in an increase in total variable costs and decrease in total output results in a
proportionate decline in the total variables costs. The variable cost per unit will be constant. Ex:
Raw materials, labour, direct expenses, etc.

14) write formulas of breakeven point ?

Fixed Expenses
1. Break Even point (Units) =
Contributi on per unit
Fixed expenses
2. Break Even point (In Rupees) = X sales
Contributi on
15) what is diseconomies of scale?

a) Internal and external diseconomies are the limits to large-scale production. It is possible that
expansion of a firm’s output may lead to rise in costs and thus result diseconomies instead of
economies.

16) what are the merits of BEA

A) Information provided by the Break Even Chart can be understood more easily then those
contained in the profit and Loss Account and the cost statement.
 1. Break Even Chart discloses the relationship between cost, volume and profit. It reveals
how changes in profit. So, it helps management in decision-making.

17) What are demerits of BEA

A)Break-even chart presents only cost volume profits. It ignores other considerations such as
capital amount, marketing aspects and effect of government policy etc., which are necessary in
decision making.

1. It is assumed that sales, total cost and fixed cost can be represented as straight lines. In
actual practice, this may not be so.
2. It assumes that profit is a function of output. This is not always true. The firm may
increase the profit without increasing its output.
18) what is the meaning of contribution ?

a) Contribution is the difference between sales and variable costs and it contributed towards
fixed costs and profit.

Contribution = Sales – Variable cost

Contribution = Fixed Cost + Profit.

19) What is margine of safety ?

a) Margin of safety is the excess of sales over the break even sales. It can be expressed in
absolute sales amount or in percentage. The formula for the margin of safety is

Profit
Present sales – Break even sales or
P. V. ratio

20) What is angle of incidence?

a) This is the angle between sales line and total cost line at the Break-even point. It indicates
the profit earning capacity of the concern.

QUESTION BANK

1. Break Even Analysis (Theory and simple problems)

2. Write a short note on law of variable proportion.
3. Briefly explain economics and diseconomies of scale.
4. Write short notes on production function. Explain nature in short run and long run.
5. Define cost. Explain is concepts and behaviour (short run and long run).
6. Write a short note on:( for 5M or 2M)
 a. MRTS
b. Isocosts
c. Isoquants
d. Least cost combination
e. Law of returns to scale
f. Cobb- Dougles production.

MODULE-II

S.No Question CO B Marks

L
1 A) Explain Production Function with one variable input. 2 2 6
B) Complete the following table. Show all calculations. 6
Labour (Units) TP(Units) AP(Units) MP(Units)
0 0 ? ?
1 ? ? 20
2 ? ? 26
3 66 ? ?
4 ? 19 ?
5 ? ? 4
A) What is Isoquant ? Explain its properties. 2 2 6
6

2 B) The different combinations of Labour and Capital for the firm to produce 50
units of output given in the following table. Assume the cost of Labour is
Rs.5/Unit and Cost of Capital is Rs.6/Unit. Which combination is best to produce
50 Units?
Labour (Units) Capital (Units) Output(Units)
60 400 50
70 320 50
80 260 50
90 218 50
100 200 50
 110 195 50
120 192 50
130 190 50
3 A) Explain Cobb- Douglas Production Function. 2 2 6
B) Explain Laws of returns to scale. 6
A) Write short notes on FC, AFC, VC, AVC, TC and AC. 2 1& 6
4 B) Compute TFC, TVC, AFC, AVC and AC for a firm with the 2 6
following data at all output levels.
Output(Units) TC(Rupees)
0 60
1 100
2 120
3 150
4 200
5 280
5 Describe various types of internal and external economies of scale. 2 2 12
6 A) From the following information find out a)BEP in Units b)P/V Ratio c) BEP 2 1 6
in value d)Number of units to be sold to achieve a target profit of Rs.1,20,000
e)Profit at sale of 8000 units.
B) The information about Raj & Co. is given below.
P/V Ratio is 20%,TFC is Rs.36,000
Selling Price/ Unit is Rs.150 6
Compute a) Contribution/Unit b) Variable Cost/Unit c) BEP in Units &
Rupees.
7 A) If actual sales are 10,000 units, Selling price is Rs. 20/Unit, Variable Cost 2 2 6
is Rs. 10/Unit and Fixed Cost is Rs.80, 000, Find out a) BEP in units and
value b) Profit c) What should be the sales required for earning a profit of
RS.60,000.
B) From the following information given below, Compute Margin of Safety
in units and value. Fixed Cost is Rs.1800 and Units produced during the
year are 1,000.
Particulars Cost/Unit (Rupees)
Raw Materials 10 6
Wages 10
Transportation 5
Fuel 5
Selling Price 40
8 Explain the concept of Break Even Analysis with its assumptions and limitations. 2 2 12

Write short notes on a) Semi Variable Cost b) Opportunity Cost 2 3 12

9 c)Break Even Chart d) Dis Economies of Scale
10 Write short notes on a) Isocost b)Isoquant c)MRTS 2 2 12