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Break-even analysis is a technique widely used by production management and management accountants. It is based on categorising production costs between those which are "variable" (costs that change when the production output changes) and those that are "fixed" (costs not directly related to the volume of production). Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss (the "break-even point").
In the diagram above, the line OA represents the variation of income at varying levels of production activity ("output"). OB represents the total fixed costs in the business. As output increases, variable costs are incurred, meaning that total costs (fixed + variable)
also increase. At low levels of output, Costs are greater than Income. At the point of intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made. Fixed Costs Fixed costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. In the long term fixed costs can alter perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or through the growth in overheads required to support a larger, more complex business. Examples of fixed costs: - Rent and rate - Depreciation
- Research and development - Marketing costs (non- revenue related) - Administration costs Variable Costs Variable costs are those costs which vary directly with the level of output. They represent payment output-related inputs such as raw materials, direct labour, fuel and revenuerelated costs such as commission. A distinction is often made between "Direct" variable costs and "Indirect" variable costs. Direct variable costs are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre. Raw materials and the wages those working on the production line are good examples. Indirect variable costs cannot be directly attributable to production but they do vary with output. These include depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs. Semi-Variable Costs
Whilst the distinction between fixed and variable costs is a convenient way of categorising business costs, in reality there are some costs which are fixed in nature but which increase when output reaches certain levels. These are largely related to the overall "scale" and/or complexity of the business. For example, when a business has relatively low levels of output or sales, it may not require costs associated with functions such as human resource management or a fully-resourced finance department. However, as the scale of the business grows (e.g. output, number people employed, number and complexity of transactions) then more resources are required. If production rises suddenly then some short-term increase in warehousing and/or transport may be required. In these circumstances, we say that part of the cost is variable and part fixed. The analysis of a breakeven chart considers whether a venture runs at a profit or a loss. Sales above the breakeven point indicates that continued and profitable growth. The principle of break-even theory is that during the early stages of a business venture, total costs, both fixed and variable, exceed sales. As output increases, sales begin to rise faster than costs and, eventually, they become equal (breakeven point). If sales continue to rise and exceed total costs, the business achieves profitability. The tool assumes that all the goods which are produced will be sold and that costs, namely the price, will remain constant. Likewise, it also relies on the capacity in terms of output to remain unchanged. Breakeven charts are universally applied to simply and graphically illustrate and forecast a company's projected revenue, and to calculate the time for profitability to be reached. It is used by financial and marketing strategists to predict the effect that changes in price will have on the percentage change in sales over time.
NATIONAL INCOME
Definition National Income is defined as, the total net value of all goods and services produced within a nation over a specified period of time, representing the sum of wages, profits, rents, interest, and pension payments to residents of the nation.
C - Private consumption Inv - Gross investment G - Government spending eX-i - Exports Imports
Whereas nominal GDP refers to the total amount of money spent on GDP, real GDP refers to an effort to correct this number for the effects of inflation in order to estimate the sum of the actual quantity of goods and services making up GDP. The former is sometimes called "money GDP," while the latter is termed "constant-price" or "inflation-corrected" GDP -or "GDP in base-year prices"
Determination of GNP
GNP can be determined in three ways, all of which should in principle give the same result. They are - the Output or Value-Added approach, the income approach, and the expenditure approach. The most direct of the three is the Output approach, which sums the outputs of every class of enterprise to arrive at the total. The income approach works on the principle that the incomes of the productive factors must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things.
2: Expenditure Approach
In economies, most things produced are produced for sale, and sold. Therefore, measuring the total expenditure of money used to buy things is a way of measuring production. This is known as the expenditure method of calculating GDP. Note that if you knit yourself a sweater, it is production but does not get counted as GDP because it is never sold. Sweater-knitting is a small part of the economy, but if one counts some major activities such as child-rearing (generally unpaid) as production, GDP ceases to be an accurate indicator of production. Similarly, if there is a long term shift from non-market provision of services (for example cooking, cleaning, child rearing, do-it yourself repairs) to market provision of services, then this trend toward increased market provision of services may mask a dramatic decrease in actual domestic production, resulting in overly optimistic and inflated reported GDP.
3: Income Approach
This method measures GDP by adding incomes that firms pay households for the factors of production they hire- wages for labor, interest for capital, rent for land and profits for entrepreneurship. Two adjustments must be made to get GDP: 1. Indirect taxes minus subsidies are added to get from factor cost to market prices. 2. Depreciation (or capital consumption) is added to get from net domestic product to gross domestic product. National Income = Wages + Interest Income + Rental Income + Profit
income... hence we compare the average income which is the total income divided by the total population... the average income is called as per capita income, per capita income is measured as national income/total population of the country
The
Figure 11.1 above shows, how production income and expenditure are mutually related.
Economic activity is directly related to these three stages. Based on this, three methods are used for calculating national income. They are: Production method Income method Expenditure method
You can calculate national income by following any one of these methods. Considering the nature and requirements of the economy one or more methods are used for calculating national income. Let us examine these methods separately. Production Method This method is based on the total production of a country during a year. First of all production units are classified into primary, secondary and tertiary sectors. Then we identify the various units that come under these sectors. We estimate the goods and services produced in each of these sectors. The sum total of products produced in these three sectors is the total output of the nation. The next step is to find out the value of these products in terms of money. The money sent by Indian citizens working abroad is also added to this. Now we get the gross national income. GNI = Money value of total goods and services + Income from abroad. This method helps us to find out contributions of various sectors to national income.
Income Method
Factors of production together produce output and income. The income received by the factors of production during a year can be obtained by adding rent to land, wages to labour, interest to capital and profit to organizations. This will be equal to the income of the nation. In other words, total income is equal to the reward given to various factors of production. By adding the money sent by the Indian citizens from abroad to the income of the various factors of production, we get the gross national income. GNI = Rent + Wage + Interest + Profit + Income from abroad. This method will help us to know the contributions made by different agents like landlords, laborers, capitalists and organizers national income.
Expenditure Method
National income can also be calculated by adding up the expenditure incurred for goods and services. Government as well as private individuals spend money for consumption and
production purposes. The sum total of expenditure incurred in a country during a year will be equal to national income. GNI = Individual Expenditure + Government Expenditure. This method will help us to identify the expenditure incurred by different agents. Any one of the above methods can be used for calculating national income. Production method = Income method = Expenditure method. Net National Product (NNP): It is the agreegate market value of final goods and services produced in a country in a year after deducting depreciation charges provided for the replacement of worn out capital assets. It should be noted that, in the competitive of the net national product depreciation charges should be deducted from the gross national product. This is necessary, because, in the process of production some capital assets are used up a part of final goods services produced has to be set apart as depreciation charges to the replacement of warm-out capital assets.
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Some people get their incomes from many other sources It is very difficult to compute their income from different sources and in this way the exact figure of NI is mislead. No-cooperation of the people: In most of under-developed countries, people do not cooperate with data collecting staff. Non-marketed goods and services: In estimating the national income, only those goods and services are included for which the payment is made the unpaid or non-marketed goods and services are excluded such as production for self consumption, help or volunteer etc Under-ground economy: In under-developed countries, about 30% of the economy is under-ground the officially declared incomes are less than the actual incomes.
Other Limitations,
Price Changes A higher nominal GNP of a nation may not mean that the standard of living is better. If the prices increase at a high rate, the real GNP may even fall. Voluntary Services GNP figures do not include the contribution of the voluntary agencies which raise the general welfare, e.g. the Tung Wah group of hospitals. In this respect, the GNP figures underestimate the level of welfare. The voluntary work of housewives is also neglected by the GNP figures. It again under-estimates our welfare or standard of living.
Leisure It is also a source of welfare and raises our standard of living, e.g. the welfare enjoyed with a Chinese New Year Holiday. However, the monetary value is difficult to calculate. Illegal Activities Drug trafficking and illegal gambling are activities omitted in the value of GNP. It is difficult to determine its effect on the welfare of an economy. Undesirable Effects of Production
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GNP figures had not considered the effects of pollution, traffic congestion on the economy. They have lowered our standard of living. Problem of Comparison Output Composition Nations with the same GNP may have different living standard because their output composition may be different. In general, a higher level of consumer goods & services in the GNP indicates a higher current level of living standard. Distribution of Income & Wealth If income is obtained by a small rate of people in a nation, the general living standard is still low compared with a nation having a more evenly distributed income or GNP. Population Size A large population has a lower living standard even if its GNP is the same as that of a small population. The per capita GNP is more useful to compare the 2 nations. National Defense If a nation has spent a lot of resources in the production of weapons and so on, its living standard may not be improved. Time Technology will be improved over time. This may not be shown in GNP figures because there may be small changes in cost and price only. Besides, durable goods provide welfare to us over a period of time ( usually more than 1 year ). This cannot be shown by GNP figures within a year.
Significance of NI It seeks to measure the level of production in the country in one year. We can know whether the economy is growing, stagnant or declining by comparing it with the previous years . National income shows contributions by various sectors of economy. Living standard and economic welfare of the people can be compared with other countries.
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But it is not proper to differentiate between economic and non-economic welfare on the basis of money. Pigou also accepts it. According to him, non-economic welfare can be improved upon in two ways. First, by the income-earning method. Longer hours of working and unfavourable conditions will affect economic welfare, adversely. Second, by the income spending method. In economic welfare it is assumed that expenditures incurred on different consumption goods provide the same amount of satisfaction, but in actuality it is not so, because when the utility of purchased goods starts diminishing the non-economic welfare declines which results in reducing the total welfare. But Pigou is of the view that it is not possible to calculate such effects, because non-economic welfare cannot be measured in terms of money. The economist should, therefore, proceed with the assumption that the effect of economic causes on economic welfare applies also to total welfare. Hence, Pigou arrives at the conclusion that the increase in economic welfare results in the increase of total welfare 'and vice versa. But it is not possible always, because the causes tl1at lead to an increase in economic welfare may also reduce the non-economic welfare. The increase in total welfare may, therefore, be Jess than anticipated. For instance, with the increase in income, both the economic, welfare and total welfare increase and vice versa. But economic welfare depends not only on the amount of income but also on the methods of earning and spending it. When the workers earn more by working in factories but reside in slums and vitiated atmosphere, the total welfare cannot be said to have increased, even though the economic welfare might have increased. Similarly, as a result of increase in their expenditure proportionately to, income, the total welfare cannot be presumed to have increased, if they spend their increased income, on harmful commodities like wine, cigarettes etc. Hence, economic welfare is not an indicator of total welfare.
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II. Change in the composition of national income and economic welfare III. Changes in the distribution of national income and economic welfare. (i) The change in the size of national income and economic welfare: There is direct relationship between size of national income and economic welfare. The changes in the size of national income and economic welfare may be positive or negative. The positive change in the national income increases its volume, as a result people consume more of goods and services, which. leads in increase in the economic welfare. Whereas the negative change in national income results in reduction of its volume; People get lesser goods and services for consumption which leads to decrease in economic welfare. But this relationship depends on a number of factors. Is the change)n national income real or monetary? If the change in national income were due to change in prices, it would be difficult to measure the real change in economic welfare. For example, when the National income increase as a result of increase in prices, the increase in economic welfare is not possible because it is probable that the output of goods and services may not have increased. It is more likely that the economic welfare would decline as a result of increase in prices, It is only the real increase in national income that increases economic welfare. Second, it depends on the manner in which the increase in national income comes about. The economic welfare cannot be said to have increased, if the increase in. national income is due to exploitation of labour, e.g. to increase in production by workers working for longer hours, by paying them lesser wages than the. minimum. Thus, forcing them to put their women and children to work, by not providing then with facilities of transport to and from the factories and of residence, and their residing in slums. Third, national income cannot be a reliable index of economic welfare, if per capita income is not borne in mind. It is possible that with the increase in national income, the population may increase at the same pace and thus the per capita income may not increase at all. In such a situation, the increase in national income will not result in in-crease in
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economic welfare. But from this, it should not be concluded that the increase in per capita income results in increase in economic welfare and vice versa. It is possible that as a result of increase in national income, the per capita income might have risen. But if the national income has increased due to the production of capital goods and there is shortage of consumption goods on account of decrease in their output the economic welfare will not increase even if the national income and per capita income rise. This is because the economic welfare of people depends not on capital goods but on consumption goods used by them. Similarly, when during war time the national income and the per capita income rise sharply; the economic welfare does not increase because during war days the entire production capacity of the country is engaged in producing War material and there is shortage of consumption goods. As a result, the standard of living of the people falls and the economic welfare decreases. Often, even with the increase in national income and per capita income the economic welfare decreases. This is the case when as a result of the increase in national income, income of the richer sections of the society increases and the poor do not gain at all from it. In other words, the rich become richer and the poor become poorer. Thus when the economic welfare of the rich increases, that of the poor decreases. Because the poor are more than the rich!, the total economic welfare decreases. Last, the influence of increase in national income on economic welfare depends also on the method of spending adopted by the people. If with the, increase in income, people spend on such necessities and facilities, as milk, ghee, eggs, fans, etc., which increase efficiency, the economic welfare will increase. But on the contrary, the expenditure on drinking, gambling etc. will result {n decreasing the economic welfare. As a matter of fact, the increase or decrease in economic welfare as a result of increase in national income depends on changes in the tastes of people. If the change in fashions and tastes takes place in the direction of the consumption of better goods, the economic welfare increases, otherwise the consumption of better goods, decreases. It is clear from the above analysis that though the national income and economic welfare are closely inter-related, yet it cannot be said with certainty that the, economic welfare would increase with the increase in national income and per capita income. The increase or decrease in economic welfare as a result of increase in national in come depends on a number of factors such as
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the rate of growth of population, the methods. of earning income the conditions working; the method of spending, the fashions and tastes, etc. (ii) Changes in the composition of national income and economic welfare: composition of national income refers to the kind of the goods and services produced in the country. Change in the composition of national income may sometimes increase economic welfare and may at another time decrease it.
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But it is not essential that the equal distribution of national income , would lead to increase ,in economic welfare. On the contrary, there is a greater possibility of the economic welfare decreasing if the policy towards the rich is not rational. Heavy taxation and progressive taxes at high rates affect adversely the productive capacity, investment and capital formation, thereby decreasing the national income. Similarly, when through the efforts of the Government the income of the poor increases but if they spend that income on bad goods like drinking, gambling etc. or if their population increases, the economic welfare will decrease. But both these situations are not real and only express the fears, because the government. while imposing different kinds of progressive taxes on the rich, keeps particularly in view that taxation should not affect the production and investment adversely. On the other hand, when the income of a poor man increases he tries to pro vide better education to his children and to improve his standard of living. Thus we arrive at the conclusion that as a result of the increase in national income, the economic welfare will increase provided that the income of the poor increases instead of decreasing and they improve their standard of living and that the income of the rich decreases in such ,a way that their productive capacity, investment and capital accumulation do not decline.
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overcrowded. There is loss in time. Accidents occur daily which cripple or kill people. Environment becomes polluted. There are the problems of water, power, housing, transportation, etc. Crimes spread. Life becomes complex and the quality of life deteriorates. Consequently, social welfare is reduced; but all these stresses and strains of city life are not included in the national income estimates. Strangely, the efforts made by governments to remedy the ills of the city Life are included in the GNP because they involve public expenditure. On the other hand, in places where there is no congestion, people enjoy fresh air and the beauty of nature, the quality of life tends to increase. But this is not reflecte in GNP.
Non-market Transactions,
Some of the non-market transactions increase, welfare but they are not included in national income estimates. The services of housewives within the home and community activities such as religious functions, affect the welfare of the people but they are excluded from the estimates of GNP because no market transaction is involved in providing these services.
Externalities
Similarly, there are externalities which tend to increase or decrease welfare but they are not included in GNP estimates. "An externality is a cost or benefit conferred upon second or third parties. as a result of acts of individual production and consumption." But the cost or benefit of an externality cannot be measured in money terms because it is not included in market activities. "An example of an external benefit is the pleasure one man derives from his neighbours fine garden: An example of an external cost is environmental pollution caused by industrial plants." The former tends to increase welfare and the latter tends to reduce it. Since externalities are "untraded interdependencies", they are excluded from national. Income estimates.
Nature of Production
GNP estimates do not reflect the capacity of different goods to provide different levels of satisfaction to the community. The same amount of money spent on a nuclear bomb or on building a dam across a river adds equally to the national income. But they provide
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different levels, of satisfaction to the community. A bomb does' not increase welfare while a dam increases welfare.
Standard of Living
National income estimates also do not reflect standard of living of the community which determines its welfare. If more national expenditure is incurred on the production of arms and ammunitions and on capital goods and less on producing consumption goods, this difference is not reflected in GNP estimates. But the reduction in the production of consumption goods tends to decrease the welfare of the people, while the increase in the expenditure on armaments and capital good does not increase welfare. Keeping the above limitations in view, GNP cannot be used as a measure of welfare. However, a few economists have tried to broaden the definition of GNP so as to make it a measure of economic welfare. A pioneering attempt toward this direction has been made
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by Professors Nordhaus and Tobin in 1972. They have constructed a 'Measure of 'Economic Welfare' which they call MEW. Professor Samuelson calls it 'Net Economic Welfare', or NEW. According to Nordhaus arid Tobin, in MEW they have tried 'w measure all consumption that leads to human welfare. To estimate the value of MEW, they deduct from consumption certain items which do not contribute to welfare and add other items that contribute to welfare but are excluded from GNP estimates. The deductions which they make are of three types: (1) Those public and private expenditures that do not yield utility directly. They call them "regrettable necessities", such as government expenditures on national defence, police force, road maintenance, and sanitation services, and expenses by consumers on commuting (i.e., travelling regularly by train, scooter, car or bus between one's residence and place of work). (2) All consumer expenditures on durable household goods such as washing machines, cars, TV sets, etc. which yield utility over their lifetime. (3) Estimated costs arising from "negative externalities" which are dis-amenities arising from urbanisation" congestion and pollution. All these reduce human welfare.
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Having made these deductions, Nordhaus and Tobin add three items to consumption: They are: (1) the value of non-market activities; (2) the estimates of the value of the services of durable consumer goods actually consumed by the owners- both households and government; and (3) the estimates of the value of leisure. In estimating MEW, Nordhaus and Tobin devote more attention to the valuation leisure. For this they adopt two approaches: the opportunity cost approach and the intrinsic-value approach. The first approach is based on the principle that when a person chooses to enjoy more leisure, it is always at the cost of foregoing more income. An hour's leisure means an hour's wages foregone, They estimated that the value of leisure measured by the opportunity cost approach has been steadily rising over the years because of the steady rise in the real wage rate per hour over the years. The intrinsic-value approach measures the value of leisure in terms of the actual enjoyment (utility) provided by, say, an hour's leisure. By using such valuation devices, Nordhaus and Tobin estimated that the figure of MEW in the United States for 1965 was dollars 1200 billion which was twice the' GNP, for the same year. Their estimate of the growth of per capita MEW for the period 1929.65 averaged 1.1 per cent a year, as against 1.7 per cent a year for pet I pita GNP for the same period. The estimates reveal that there was mark able increase in economic welfare. At the same time, the regrettable necessities had also been growing rapidly. From the above discussion, it should not be .inferred that MEW is :ant to replace GNP It is at best an attempt to supplement GNP order to include non-market activities in the latter for relating it to economic welfare.
Limitations of National Income as a measure of National Welfare: National Income estimate considers only those transactions which are carried through money. It does not take into A/c the portion of output especially the farm output. If the portion of output kept for self consumption is also brought to the market, the national Income will increase, though the total output in the country has not really increased. So, increase in income does not result in increase in economic welfare.
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The N.I. at current prices cannot be a proper indicator of the economic welfare of the community. This is because if the prices changes, the N.I. also charges. But the actual production of the economy does not change. So, if the income alone increases without an increase in production, economic welfare cannot increase. The per capita Income is a better index that the N.I. to measure economic welfare of a country. The per capita Income also is not a foolproof index of economic welfare. This is because, if the growth of population in the country is at a higher rate than the increase it the real national income of the country, the per capita income and the economic welfare of the people will decrease.
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Reference
http://tutor2u.net/business/production/break_even.htm http://www.lmcuk.com/management-tool/breakeven-chart
http://www.scribd.com/doc/18446513/Lecture-21
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