Micro and Macro Economics
Qs. Explain the Macro and Micro analysis in Economics
OR
Distinguish between Micro and Macro Economics and show their inter-dependence
OR
Define Micro Economics and discuss its importance and limitations
Economics
Allocations of scar resources in order to get maximum satisfaction is called economics.
Economics is further divide into two parts.
1. Micro Economics
2. Macro Economics
Micro deals with individual single or particular consumer, producer, firm, industry or
Market.
While Macro deals with as whole like National income, employment level etc.
Micro Economics is called Price Theory and Macro Economics is called Income theory.
Price theory explains the composition or allocation of total production.
Qs. Income theory explain the level of total production and why the level of total
production and why the level rises and falls.
Micro Economics
In economics micro means single, individual or particular. Micro Economics means deals with single, Individual or particular consumer produce or Market etc. In conducting economics analysis, micro economics approach is on micro basis, generally an assumption of full employment in the economy as whole is made.
Importance of Micro Economics
Micro Economics has both theoritical and practical importance. From the theoritical point of view it explain the function of a free intense economics it tells as how consumer and producer take the decision for million of goods and services to consume and produce. It tells us how goods and services distributed among them. It explain the determination of the relative prices of various goods and services. For Practical importance micro economics
helps in the formulation of economics policies calculated to promote efficiency in production and welfare of the masses.
In professor Lerner’s words
Micro Economics theory facilities the understanding of what would be a hopelessly complicated consfussion of billions of facts by constructing simplified model of behaviours.
Limitation of Micro Economics
Micro Economics has same limitations.
A. It cannot give an idea of the functioning of the economy as whole.
B. It assume fall employment which is rare phenomena, it is therefore, an unrealistic
assumption.
Macro Economics Or the Theory of Income and Employment
Macro Economics deals as whole such as National Income employment, saving investment, total consumption, price level.
Macro Economics deals also with how an economy group. It determines the chief economic development and the various stages and process of economics growth. Study of macro economics is very important to get proper view of an economy.
Limitation of Macro Analysis
If has limitation of its own:
A. Individual is ignored altogether.
B. The Macro analysis over looks individuals difference for instance the price level may be
stable but the prices of food grains may have gone up.
C. While speaking of the aggregate it is also essential to remember the nature compound and
structure of the components.
Need for Integrating Macro and Micro Economics
Micro and Macro Economics can’t give adequate way to analysis the working of the economics system. So if we wish to get solutions of our main economics solution we should have to integrate the two approaches. We apply proper Integration of the Micro and Macro approaches because there are few macro problems which have no micro elements involved and few micro problems that are without macro aspects.
Conclusion
Thus if proves that subject matter of economics includes price theory (or micro economics), income and employment theory (macro economics) and growth theory.
Simply we can say economics is a study of economics system under which men work and live.
Showing posts with label Karachi Board. Show all posts
Showing posts with label Karachi Board. Show all posts
National Income, Economics, B.com Part 1 Sindh,Karachi Board
National Income
Qs. Define National Income.
OR
Distinguish Between Following
1. Gross national Income and Net National Income.
2. National Income at Market Price and National Income at factor cost.
3. Net National Income at factors cost and Net Domestic Income at factor cost.
4. Personal Income at factor cost.
5. Personal Income and Dispossible Income.
National Income
According the can economist Colin Clark
The national income for any period consists of the money value of the goods and services becoming available for consumption during that period.
According to Pigou.
National Income is that part of the objective income of the community including income derived from abroad which can be measured in money.
Thus,
National Income is the aggregate factor income (i.e. earnings of labour and property) which aries from the current production of goods and services by the nation’s economy.
The concept of national income has three interpretations:
1. Reciept Total
2. An expectiture Total
3. A Total Value of Production over the course of one year.
The various concepts of national income are given below.
A. Gross National Product (GNP)
B. Net National Product (NNP)
C. Personal Income (PI)
D. Dispossible Income
E. National Income at factor Cost
Gross National Product (GNP)
According to Camsell
GNP is defined as the total value of all final goods and services produced in a country in one year.
We can say that GNP represents the total market value of all final goods and services produced by factors of production located with in nation’s border during a year.
Problem in Measuring (GNP)
In calculating GNP wefare some problems.
1. Stress on final output
The value of only those good are added in GNP which are in their final stage of production and are available for consumption for e.g.
Table made of wood is the final product while w and is primary good.
2. Value added method.
In order to avoid pitfall of double or multiple counting is to calculate only the added value of a particular commodity at its every stage of production. (Suppose the price of your note book is 20Rs, but this include the cost of paper, printing and sending GNP will be same in both case but if we include again the cost of paper and sending etc it will double.
3. Non-Productive Transactions are excluded from GNP
We should excluded non-productive transaction like a student got money from his father.
4. Other Transactions
There are few other transaction which are not included in GNP. for example A person working in their own house holds without any payment through the market.
Using the expenditure approach the main components of GNP are as under.
i. Consumption Expenditure. (C)
All goods and services bought by house holds are grouped together consumption.
ii. Gross Private Investment. (I)
This includes investment expenditure by firms or sole properties on capital goods.
iii. Government Expenditure. (G)
Government Expenditure on durable and non-durable goods and services is include.
iv. Net exports
Differnce between export and import (X-M)
Mathematically GNP Can be Defined as
GNP = C + I + G + (X-M)
B. Net National Product (NNP)
Net National product or national income at market prices is the net market money value of all the final goods and services produced in a country during a year GNP at market price depreciation = NNP at market price
Mathematically
NNP = C + G + (Net I) + (X-M)
OR
NNP = GNP – Depreciation
Depreciation means value of goods dective years by year Defortion of the machinary is named as depreciation.
C.National Income at Factor Cost
National Income (NI) or National Income at factor cost is the aggregate earnings of the four factor of production (Land, Labour, Capital and Organization) which arise from the current production of goods and services by nation’s economy.
The major component of NI are
1. Compensation of employees (wages, salaries, commission etc)
2. Proprietors income
3. Net income from rentals and royalities.
4. Net interest (excess of interest payments of domestic bussiness system over its interest reciept and net interest reieved from abroad)
D. Personal Income (PI)
Personal income is the sum total of all incomes actually recieved by all individuals or house holds during a year. IF consists of wages, salaries, Interest and rent etc by all household.
Mathematically,
PI = NI – (corporate profits, social security, tax corporate taxes) + transfer payment.
Transfer Payment, A payment for which no productive service is made like old age pension, social security payment etc.
E. Dispossible Personal Income (DPI)
DPI is the amount whihc is left will the individuals after paying the taxes to a government.i.e.
DPI = Personal Income – Personal Taxes
OR
DPI = Consumption + Saving.
Qs. What are the different methods of measuring National Income or Gross National Product (GNP)? Point out the difficulties facing the measurements of GNP?
Method of Measuring National Income
Production of goods and services give rise to income and income gives rise to demand for goods and services. Demand gives rise to expenditure and expenditure give rise to further production of goods. Thus there is a certain flow of product income and expenditure.
National Income cane be measured by three ways.
1. Product Method (value added method)
2. Income Method
3. Expenditure Method
1. Product Method (Value Added Method)
Product method is also called value added method or national income at market price method. Which is measure in two ways.
i. Final Product approach.
ii. Value added approach
i. Final Product Approach
If represents the flow of production or value of all final goods over a one year with in the country.
ii. Value Added Approach
Under this method the economy is divide into different sectors such as Agriculture, manufacturing, commerce, transport, banking etc. So the GNP is measured by adding net value at each stage.
Precautions
The precautions to be avoided are
1. Exluding non market goods and services like father teaching his sons.
2. Depreciation allowances to be set. Depreciation is substracted from GNP.
3. Deduction of indirect taxes, Govt Charges, which is on commodity for sale.
2. Income Method
It measures the total payments made to house holds in the production of final goods and services during a year. GNP is the sum of following types of income.
i. Rental Income earned by individuals for the use of their real effects such as land, building, royalties recieved from copyrights etc.
ii. Wages include income of employees.
iii. Net Interest get from bussiness.
iv. Profit get by the firm.
v. Depreciation is a cost of production.
vi. Indirect bussiness taxes.
Precautions
We do not include the such thing whihc have no meanings like father giving his son money for education but we include a labour wages in GNP.
3. Expenditure Method
In this method GNP is measured as total spending on final goods and services produced within a country during a year. The spendings are
i. Consumption Expenditure (C)
The households spend their income on consumer durables such as Car, furniture.
ii. Non-Durable Goods
Such as foods, clothing and services.
iii. Investment (I)
iv. Government Expenditure (G)
Net Export (X-M)
So GNP is
GNP = G + I + G + (X-M)
Precautions
1. Final expenditure only include not intermediate expenditure.
2. Property Income recieved from abroad should be included in GNP.
Difficulties in the Measurement of National Income
These difficulties are,
1. Non-Availibility of statistical material For some services it is difficult to know the exact amount recieved like tutors, income services given in spare time. These are difficult to find out so not include in GNP.
2. The Danger of Double countings The cost of the commodity is likely to counted twice or multiple of it is not taken carefully.
3. Difficulty in assessing the depreciation allowance, accidential damages, repair and replacement charges. If need higher level of Judgement to asses depreciation allowance.
4. Non-Market Service Like tution centre, exclude from GNP.
5. Housing
Rent of House —-> Include from GNP
Purchase of House —-> Exclude from GNP
6. Transper earning exclude from GNP like relief allowance, pensions.
7. Self Consumed Production Like we use other or friends goods.
8. Income from foreign firms (foreign firms invest in the country)
Problems of Measurement Under-Developed Countries
The national income under developed coutries like Pakistan cannot be measured accuratly due to.
i. Self Consumed bartered consumption Some transaction which is not include money like exchange of goods. (Agriculture) are not add in National Income.
ii. No systematic acounts maintained.
iii. No occupational Classification
iv. Unreliable data.
Qs. Define Circular flow of income in a two sector economy. What factors influence the size of National Income.
Circular Flow of Income In a Two Sector Economy
We suppose that there are only two sectors in the economy.
A. House Hold
B. Bussiness Sector
i. The bussiess sector hire the factors of production owned by the household sectors and it is the sole producer of goods and services in the economy.
ii. House hold sector are buyer and purchase from bussiness sector.
iii. Bussiness Sectors sells entire output to house hold sector.
iv. There are no saving and investment in the economy.
v. House hold earn income from bussiness sector.
vi. Bussiness sector earn income from house hold sector.
vii. The economy is closed economy means no international trade.
viii. No inter-action of Government.
Determinants of National Income
There are many factor which influence the size of national income.
1. The stock of factors of Production
GNP depends on quantity and quantity of the country’s stock of production. The factors of production are land, labour capital and organization.
2. labour
Size of national income depends on quantity and quantity of labour in the country.
3. Capital
Its very important that how much capital is on for a firm if firm is large and capital is less than GNP is decline.
4. State of Technical Knowledge
Its technology and technical workers are good, than national income increase.
5. Political Stability
GNP increase if a country have political stability.
Qs What are the main causes of inequalities of income? Suggest measures to reduce inequality?
OR
What are the main causes of inequality of income in a modern society? Discuss role of taxation policy in reducing this inequality?
Inequality of Income Distribution
A country much have to ensure that its income evenly distributed not only increase. Inequality of income is main feature of capitalist economics. The socialist countries like communist china have established system whos aim is to reduce inequalities of incomes.
Causes of Inequality
Causes of inequality of income are
1. Inheritance
Some person born with a silver spoon and they got lots of money and property after death of their parents. While some are born in poor family and they got burden of payback of his parents after death so this system of inheritance causes inequality.
2. System of Private Property
Under this system a person is free to earn, free to save and free to own property. First a men earns and acquires property and then his property starts earnings (Rent from house)
3. Difference in Natural Qualities
Some peoples are giffed than other so they do work hardered efficiently than other and makes the inequality.
4. Difference In Acquired Talents
A child may born intelligent but if he is not lucky enough to recieve proper education then his ability remain undeveloped.
5. Family Influence
Here in Pakistan and India family contacts make a lot of difference to what people earn. Unskilled person got a good job from the contacts of relative, friends and other.
6. Luck and Opportunity
Some people luckily got good chance and they avail it.
Measures To Reduce Inequality
In order to reduce inequality of income we have some suggestions.
1. Fixing Minimum Wages
Fixing minimum wages will level up the incomes from below.
2. Social Security
By giving social security person get large benefits whose income low. These are free education, free medical, pension, insurance etc.
3. Equality of Opportunity
Some thing may be to done to eliminate the family influence in the matter of choice of profession (example Govt give scholarship)
4. Steeply Gradded Income Tax
By including taxes way may prevent some extent from rich persons. These taxes are super taxes, excess profit tax, capital gain tax.
5. High Taxes on luxuries
Govt may put high taxes on luxuries of life which poor person can be afford.
6. Sleep Death Duty, Succession Taxes and Estates Duty
Government should have to impose taxes on generation to switching of estate.
Conclusion
We can reduce inequality but cannot remove.
Qs. Define National Income.
OR
Distinguish Between Following
1. Gross national Income and Net National Income.
2. National Income at Market Price and National Income at factor cost.
3. Net National Income at factors cost and Net Domestic Income at factor cost.
4. Personal Income at factor cost.
5. Personal Income and Dispossible Income.
National Income
According the can economist Colin Clark
The national income for any period consists of the money value of the goods and services becoming available for consumption during that period.
According to Pigou.
National Income is that part of the objective income of the community including income derived from abroad which can be measured in money.
Thus,
National Income is the aggregate factor income (i.e. earnings of labour and property) which aries from the current production of goods and services by the nation’s economy.
The concept of national income has three interpretations:
1. Reciept Total
2. An expectiture Total
3. A Total Value of Production over the course of one year.
The various concepts of national income are given below.
A. Gross National Product (GNP)
B. Net National Product (NNP)
C. Personal Income (PI)
D. Dispossible Income
E. National Income at factor Cost
Gross National Product (GNP)
According to Camsell
GNP is defined as the total value of all final goods and services produced in a country in one year.
We can say that GNP represents the total market value of all final goods and services produced by factors of production located with in nation’s border during a year.
Problem in Measuring (GNP)
In calculating GNP wefare some problems.
1. Stress on final output
The value of only those good are added in GNP which are in their final stage of production and are available for consumption for e.g.
Table made of wood is the final product while w and is primary good.
2. Value added method.
In order to avoid pitfall of double or multiple counting is to calculate only the added value of a particular commodity at its every stage of production. (Suppose the price of your note book is 20Rs, but this include the cost of paper, printing and sending GNP will be same in both case but if we include again the cost of paper and sending etc it will double.
3. Non-Productive Transactions are excluded from GNP
We should excluded non-productive transaction like a student got money from his father.
4. Other Transactions
There are few other transaction which are not included in GNP. for example A person working in their own house holds without any payment through the market.
Using the expenditure approach the main components of GNP are as under.
i. Consumption Expenditure. (C)
All goods and services bought by house holds are grouped together consumption.
ii. Gross Private Investment. (I)
This includes investment expenditure by firms or sole properties on capital goods.
iii. Government Expenditure. (G)
Government Expenditure on durable and non-durable goods and services is include.
iv. Net exports
Differnce between export and import (X-M)
Mathematically GNP Can be Defined as
GNP = C + I + G + (X-M)
B. Net National Product (NNP)
Net National product or national income at market prices is the net market money value of all the final goods and services produced in a country during a year GNP at market price depreciation = NNP at market price
Mathematically
NNP = C + G + (Net I) + (X-M)
OR
NNP = GNP – Depreciation
Depreciation means value of goods dective years by year Defortion of the machinary is named as depreciation.
C.National Income at Factor Cost
National Income (NI) or National Income at factor cost is the aggregate earnings of the four factor of production (Land, Labour, Capital and Organization) which arise from the current production of goods and services by nation’s economy.
The major component of NI are
1. Compensation of employees (wages, salaries, commission etc)
2. Proprietors income
3. Net income from rentals and royalities.
4. Net interest (excess of interest payments of domestic bussiness system over its interest reciept and net interest reieved from abroad)
D. Personal Income (PI)
Personal income is the sum total of all incomes actually recieved by all individuals or house holds during a year. IF consists of wages, salaries, Interest and rent etc by all household.
Mathematically,
PI = NI – (corporate profits, social security, tax corporate taxes) + transfer payment.
Transfer Payment, A payment for which no productive service is made like old age pension, social security payment etc.
E. Dispossible Personal Income (DPI)
DPI is the amount whihc is left will the individuals after paying the taxes to a government.i.e.
DPI = Personal Income – Personal Taxes
OR
DPI = Consumption + Saving.
Qs. What are the different methods of measuring National Income or Gross National Product (GNP)? Point out the difficulties facing the measurements of GNP?
Method of Measuring National Income
Production of goods and services give rise to income and income gives rise to demand for goods and services. Demand gives rise to expenditure and expenditure give rise to further production of goods. Thus there is a certain flow of product income and expenditure.
National Income cane be measured by three ways.
1. Product Method (value added method)
2. Income Method
3. Expenditure Method
1. Product Method (Value Added Method)
Product method is also called value added method or national income at market price method. Which is measure in two ways.
i. Final Product approach.
ii. Value added approach
i. Final Product Approach
If represents the flow of production or value of all final goods over a one year with in the country.
ii. Value Added Approach
Under this method the economy is divide into different sectors such as Agriculture, manufacturing, commerce, transport, banking etc. So the GNP is measured by adding net value at each stage.
Precautions
The precautions to be avoided are
1. Exluding non market goods and services like father teaching his sons.
2. Depreciation allowances to be set. Depreciation is substracted from GNP.
3. Deduction of indirect taxes, Govt Charges, which is on commodity for sale.
2. Income Method
It measures the total payments made to house holds in the production of final goods and services during a year. GNP is the sum of following types of income.
i. Rental Income earned by individuals for the use of their real effects such as land, building, royalties recieved from copyrights etc.
ii. Wages include income of employees.
iii. Net Interest get from bussiness.
iv. Profit get by the firm.
v. Depreciation is a cost of production.
vi. Indirect bussiness taxes.
Precautions
We do not include the such thing whihc have no meanings like father giving his son money for education but we include a labour wages in GNP.
3. Expenditure Method
In this method GNP is measured as total spending on final goods and services produced within a country during a year. The spendings are
i. Consumption Expenditure (C)
The households spend their income on consumer durables such as Car, furniture.
ii. Non-Durable Goods
Such as foods, clothing and services.
iii. Investment (I)
iv. Government Expenditure (G)
Net Export (X-M)
So GNP is
GNP = G + I + G + (X-M)
Precautions
1. Final expenditure only include not intermediate expenditure.
2. Property Income recieved from abroad should be included in GNP.
Difficulties in the Measurement of National Income
These difficulties are,
1. Non-Availibility of statistical material For some services it is difficult to know the exact amount recieved like tutors, income services given in spare time. These are difficult to find out so not include in GNP.
2. The Danger of Double countings The cost of the commodity is likely to counted twice or multiple of it is not taken carefully.
3. Difficulty in assessing the depreciation allowance, accidential damages, repair and replacement charges. If need higher level of Judgement to asses depreciation allowance.
4. Non-Market Service Like tution centre, exclude from GNP.
5. Housing
Rent of House —-> Include from GNP
Purchase of House —-> Exclude from GNP
6. Transper earning exclude from GNP like relief allowance, pensions.
7. Self Consumed Production Like we use other or friends goods.
8. Income from foreign firms (foreign firms invest in the country)
Problems of Measurement Under-Developed Countries
The national income under developed coutries like Pakistan cannot be measured accuratly due to.
i. Self Consumed bartered consumption Some transaction which is not include money like exchange of goods. (Agriculture) are not add in National Income.
ii. No systematic acounts maintained.
iii. No occupational Classification
iv. Unreliable data.
Qs. Define Circular flow of income in a two sector economy. What factors influence the size of National Income.
Circular Flow of Income In a Two Sector Economy
We suppose that there are only two sectors in the economy.
A. House Hold
B. Bussiness Sector
i. The bussiess sector hire the factors of production owned by the household sectors and it is the sole producer of goods and services in the economy.
ii. House hold sector are buyer and purchase from bussiness sector.
iii. Bussiness Sectors sells entire output to house hold sector.
iv. There are no saving and investment in the economy.
v. House hold earn income from bussiness sector.
vi. Bussiness sector earn income from house hold sector.
vii. The economy is closed economy means no international trade.
viii. No inter-action of Government.
Determinants of National Income
There are many factor which influence the size of national income.
1. The stock of factors of Production
GNP depends on quantity and quantity of the country’s stock of production. The factors of production are land, labour capital and organization.
2. labour
Size of national income depends on quantity and quantity of labour in the country.
3. Capital
Its very important that how much capital is on for a firm if firm is large and capital is less than GNP is decline.
4. State of Technical Knowledge
Its technology and technical workers are good, than national income increase.
5. Political Stability
GNP increase if a country have political stability.
Qs What are the main causes of inequalities of income? Suggest measures to reduce inequality?
OR
What are the main causes of inequality of income in a modern society? Discuss role of taxation policy in reducing this inequality?
Inequality of Income Distribution
A country much have to ensure that its income evenly distributed not only increase. Inequality of income is main feature of capitalist economics. The socialist countries like communist china have established system whos aim is to reduce inequalities of incomes.
Causes of Inequality
Causes of inequality of income are
1. Inheritance
Some person born with a silver spoon and they got lots of money and property after death of their parents. While some are born in poor family and they got burden of payback of his parents after death so this system of inheritance causes inequality.
2. System of Private Property
Under this system a person is free to earn, free to save and free to own property. First a men earns and acquires property and then his property starts earnings (Rent from house)
3. Difference in Natural Qualities
Some peoples are giffed than other so they do work hardered efficiently than other and makes the inequality.
4. Difference In Acquired Talents
A child may born intelligent but if he is not lucky enough to recieve proper education then his ability remain undeveloped.
5. Family Influence
Here in Pakistan and India family contacts make a lot of difference to what people earn. Unskilled person got a good job from the contacts of relative, friends and other.
6. Luck and Opportunity
Some people luckily got good chance and they avail it.
Measures To Reduce Inequality
In order to reduce inequality of income we have some suggestions.
1. Fixing Minimum Wages
Fixing minimum wages will level up the incomes from below.
2. Social Security
By giving social security person get large benefits whose income low. These are free education, free medical, pension, insurance etc.
3. Equality of Opportunity
Some thing may be to done to eliminate the family influence in the matter of choice of profession (example Govt give scholarship)
4. Steeply Gradded Income Tax
By including taxes way may prevent some extent from rich persons. These taxes are super taxes, excess profit tax, capital gain tax.
5. High Taxes on luxuries
Govt may put high taxes on luxuries of life which poor person can be afford.
6. Sleep Death Duty, Succession Taxes and Estates Duty
Government should have to impose taxes on generation to switching of estate.
Conclusion
We can reduce inequality but cannot remove.
Consumption Function and the Multiplier ,Economics B.com Part 1 Sindh,Karachi Board
Qs. What is Consumption function? How is it determined?
OR
Explain the term “Propersity to consume” Bring out the functional between Consumption and Income.
OR
Distinguish between average propersity to consume and marginal propersity to consume and show that A. MPC < 1 B. MPC declines as income rises and C. Propersity to consumeis generally stable.
In the Keynession System, employement depends on effective demand which in the form of consumption demand and investment demand. If demand increase for consumption of commodity the investment increase and so employment level increase. A high propersity to consume is favourable to employment.
Meaning
Consumption function is also called propersity to consume. Consumption means amount spent on consumption at a given level of income. Consumption function or propersity to consume means the whole of schedule showing consumption expenditure at various level of income.
Factors Influence Consumption
These factors are
1. The real income of the individual.
2. His Past savings.
3. Rate of interest.
Income play a major role in order to influence consumption function. Past saving are very small and for specific purpose like contributions to social security (Pension etc). Rate of interest incourage some people save more to earn a higher rate of interest.
Average and Marginal Propersity to Consumer
The r/s between income and consumption is measured by the average and marginal propersity to consume.
APC = C / Y [Where C --> Consumption and Y --> Income]
APC is the ratio of consumption and income where
MPC = /\ C / /\Y
MPC is the rate of change in consumption to the change in income.
The normal r/s between income and consumption is such that income rises, consumption also rises, but by less than the rise in come.
Qs. Examine the meaning, working and importance of the multiplier in keynession theory of income and employment
OR
What is “Marginal Propersity to Consume”? Show how multiplier depends on the magnitude of the MPC.
MPC shows r/s between a given rise in investing and the resulting change in income. Suppose we invest 100Rs, so we expect more than that as additional income. We spend some amount from additional income and save the rest income. Additional spending depends on their MPC. Now we suppose MPC is 3/4. Then they will spend 75 Rs and save 25 Rs. If the MPC is stable the series of consecutive expenditure becomes.
/\(income) Y = 100 + 100 x (3/4) + 100 x (3/4)2 + 100 x (3/4)3
=> /\Y = 100 [1 + (3/4) + (3/4)2 + (3/4)3 + ......]
We see that an initial primary investment of 100 Rs gives rise to an icrease of 40 Rs in the National Income. The investment Multiplier measures the r/s between an increase in income caused by a primary increase in investment
Investment Multiplier = /\Y / /\I
In our case,
Multiplier = 400/100 = 4
Multiplier is given by the following formula
Multiplier = I / I – MPC
If MPC = 4/5 than Multiplier is 5
If MPC = 9/10 than Multiplier is 10 But
If MPC = 1 than Multiplier is infinite this shows a little increase of investment will load automatically a full employment.
If MPC = 0 than Multiplier = 1 shows increase in investment is equal to increase in total income.
Limitation of the Multiplier Concept
The factors which tends to reduce multiplying effect are called “Leakage”. The various limitation of multiplier are
1. MPC Not Constant
MPC is assumed constant in keyness concept of multiplier so that mps will necassarily be constant. Keyness ignor the possibility of leakager. In dynamic economy MPC or MPS never be constant.
2. Debit Concellation
If people use a part of new increment in income to repay their add debts instead of spending on further consumption.
3. Purchase of Old Stock and Securities
If new income is spent on buying on buying old stock, shares and securities, consumption will be less and multiplies in respect will be low.
4. Net Imports
If import is greater than export than if means outflow of funds to foreign coutries.
5. Price Inflation
If the price of goods increase mpc will automatically increase.
Instead of all above problem, Multiplier have very importance in economics and for economics policy. Its play a vital role as an instrument of income.
Qs. Distinguish between autonomous and introduced investment on what factors investment depend?
OR
What is meant by “Investment”? and what do you understand by introduce to invest. Discuss the factors which govern the inducement to invest in a capitalist economy.
In the keynessian system employment depends upon effective demand. Effective demand should be constitute of investment and consumption. Investment mean addition to stock of capital to the nation’s like building of new factories, new machines etc.
Autonomous and Induced Investment
Autonomous Investment is done by Govt. for promoting peoples welfares as under plan developed. Induced investment is made by the people as a result of change in income level or consumption.
Concept of Marginal Efficiency of Capital (MEC)
It has very importance in macro economics. When ever an enterprise makes a certain investment in his business, he first looks into the marginal efficiency of capital. What return he is going to certain from the given investment.
MEC is the expected rate of profit of a new capital asset.
Lets suppose, we invest 10,000 Rs on purchase of new machine. The net return of this machine is expected to Rs. 1000 per annum, The MEC will be
1000/10000 x 100 = 10%
Show the ratio of expected annual return.
Factors On Which Investment Depends.
Investment depends on
1. MEC
2. Rate of Interest
1. MEC
The MEC is the expected annual rate of return on an additional unit of a capital good.
According to Keynels
The MEC is the rate of discount which makes the present value of the prospective field from the Capital asset equal to its supply price.
MEC is -vely shoped.
2. Rate of Interest
As the investment increases the rate of interest also increase so MEC decline.
Factors Effecting MEC
MEC is influenced by shortrun as well as long run factors. These are
A. Short Run Factors
i. Demand for the Product.
ii. Liquid Assets.
iii. Sudden changes in income.
iv. Current rate of investment.
B. Long Run Factors
i. Rate of Growth of Population
ii. Technological Development
iii. Rate of Taxes.
Qs. What is “Effective Demand”? How it influence the determination of level of employment and income in an economy? Discuss
OR
Explain the Keynessian Theory of Income and Employment.
According to Keynessian employment is a function of income, the greater the level of national income the volume of employment keeping other factors constant in short run.
i.e. Capital, Technology, Quality of Labour are constant.
So in the absence of changes in these constant the total output of goods and services cannot be expanded without increasing employment. The level of both income and employment depends on the Aggregate Demand and Aggregate Supply. The intersection of Aggregate Demand curve and Aggregate supply curve shows equilibirium level of income and employment.
Keynessian emphasise on Aggregate Demand (AD) which is depends upon the total expenditure of the consumer on consumption goods and of enterprise on investment goods. Consumption depends upon the size of the consumer income and propersity to consume investment demand is determind by the MPC and the rate of interest. It depends upon fixture expectations of enterprise regarding the future yields from the goods.
Investment Demand = Distance between C and C + I
C + I —> Aggregate Demands
E —> Shows the Equilibirium level of income and employment
OY —> level of income at Equilibirium point E.
Equilibirium Not Necassary at Full Employment
It is clear that this equilibirium E between AS and AD may not be achieved at full employment and income. The equilibirium will established at full employment income only when investment demand is suffeciently large to fill the saving gap between the income and consumption correspondence to full employment.
Qs. When Aggregate Demand equals Aggregate Supply or Saving equals investment equilibirium level of national income is determined? Prove.
OR
Equilibirium level of national income is determined by the intersaction of savings and investment schedules. Discuss
Equilibirium level of income and employment is established at that level at which AD = AS. It has also been seen that AD = AS when the investment spending is equal to then amount savings.
If Income Investment < Saving
It means AD would not be sufficient to take the AS of output of the market so bringing reduction in output income and employment at level in which investment spending.
If Given Level of Income Intended Investment < Intended Savings
The enterprise will not be able to sell the entire output at given prices. So they intend to reduce output so the level of income and employment will reduced.
Qs. According to Keyness, Saving-Investment Equality is a basic condition of equilibirium. Discuss
OR
Are Saving and investment in an economy always equal? If not how can this condition be brought about
OR
What do you mean by Saving and Investment?
Investment
According to Keyness Theory,
Investment means not addition to the stock of capital goods like machinary, equipment, factories etc.
It also include Inventories that why term Investment is different from Capital.
Saving
Saving means that amount which a man saves out of income after his expenditure so, saving means the income which is not consumed.
Saving and Investment Equality
A controversial question always in mind that is Saving and Investment are equal? According to Keyness
No, but it only possible when they reach in equlibirium position.
According to Keyness
The national Income is derived from the production and Scale of A. Consumer’s good and B. Investment goods.
i.e. Income = Consumption + Investment
=> Y = C + I …… i
Another look at income is
Income = Consumption + Saving
Y = C + S …… ii
So,
By comparing these two eq. we get
C + S = C + I
=> SC saving > I (investment)
Are Savings and Investment Always Equal
According to Keyness Economics,
They must be always equal But we got that is not happen always.
By realizing all of there we get realised or actual saving and investment always equal but intended or expected savings and investment may differ. But it also equal at equilibirium level of income.
OR
Explain the term “Propersity to consume” Bring out the functional between Consumption and Income.
OR
Distinguish between average propersity to consume and marginal propersity to consume and show that A. MPC < 1 B. MPC declines as income rises and C. Propersity to consumeis generally stable.
In the Keynession System, employement depends on effective demand which in the form of consumption demand and investment demand. If demand increase for consumption of commodity the investment increase and so employment level increase. A high propersity to consume is favourable to employment.
Meaning
Consumption function is also called propersity to consume. Consumption means amount spent on consumption at a given level of income. Consumption function or propersity to consume means the whole of schedule showing consumption expenditure at various level of income.
Factors Influence Consumption
These factors are
1. The real income of the individual.
2. His Past savings.
3. Rate of interest.
Income play a major role in order to influence consumption function. Past saving are very small and for specific purpose like contributions to social security (Pension etc). Rate of interest incourage some people save more to earn a higher rate of interest.
Average and Marginal Propersity to Consumer
The r/s between income and consumption is measured by the average and marginal propersity to consume.
APC = C / Y [Where C --> Consumption and Y --> Income]
APC is the ratio of consumption and income where
MPC = /\ C / /\Y
MPC is the rate of change in consumption to the change in income.
The normal r/s between income and consumption is such that income rises, consumption also rises, but by less than the rise in come.
Qs. Examine the meaning, working and importance of the multiplier in keynession theory of income and employment
OR
What is “Marginal Propersity to Consume”? Show how multiplier depends on the magnitude of the MPC.
MPC shows r/s between a given rise in investing and the resulting change in income. Suppose we invest 100Rs, so we expect more than that as additional income. We spend some amount from additional income and save the rest income. Additional spending depends on their MPC. Now we suppose MPC is 3/4. Then they will spend 75 Rs and save 25 Rs. If the MPC is stable the series of consecutive expenditure becomes.
/\(income) Y = 100 + 100 x (3/4) + 100 x (3/4)2 + 100 x (3/4)3
=> /\Y = 100 [1 + (3/4) + (3/4)2 + (3/4)3 + ......]
We see that an initial primary investment of 100 Rs gives rise to an icrease of 40 Rs in the National Income. The investment Multiplier measures the r/s between an increase in income caused by a primary increase in investment
Investment Multiplier = /\Y / /\I
In our case,
Multiplier = 400/100 = 4
Multiplier is given by the following formula
Multiplier = I / I – MPC
If MPC = 4/5 than Multiplier is 5
If MPC = 9/10 than Multiplier is 10 But
If MPC = 1 than Multiplier is infinite this shows a little increase of investment will load automatically a full employment.
If MPC = 0 than Multiplier = 1 shows increase in investment is equal to increase in total income.
Limitation of the Multiplier Concept
The factors which tends to reduce multiplying effect are called “Leakage”. The various limitation of multiplier are
1. MPC Not Constant
MPC is assumed constant in keyness concept of multiplier so that mps will necassarily be constant. Keyness ignor the possibility of leakager. In dynamic economy MPC or MPS never be constant.
2. Debit Concellation
If people use a part of new increment in income to repay their add debts instead of spending on further consumption.
3. Purchase of Old Stock and Securities
If new income is spent on buying on buying old stock, shares and securities, consumption will be less and multiplies in respect will be low.
4. Net Imports
If import is greater than export than if means outflow of funds to foreign coutries.
5. Price Inflation
If the price of goods increase mpc will automatically increase.
Instead of all above problem, Multiplier have very importance in economics and for economics policy. Its play a vital role as an instrument of income.
Qs. Distinguish between autonomous and introduced investment on what factors investment depend?
OR
What is meant by “Investment”? and what do you understand by introduce to invest. Discuss the factors which govern the inducement to invest in a capitalist economy.
In the keynessian system employment depends upon effective demand. Effective demand should be constitute of investment and consumption. Investment mean addition to stock of capital to the nation’s like building of new factories, new machines etc.
Autonomous and Induced Investment
Autonomous Investment is done by Govt. for promoting peoples welfares as under plan developed. Induced investment is made by the people as a result of change in income level or consumption.
Concept of Marginal Efficiency of Capital (MEC)
It has very importance in macro economics. When ever an enterprise makes a certain investment in his business, he first looks into the marginal efficiency of capital. What return he is going to certain from the given investment.
MEC is the expected rate of profit of a new capital asset.
Lets suppose, we invest 10,000 Rs on purchase of new machine. The net return of this machine is expected to Rs. 1000 per annum, The MEC will be
1000/10000 x 100 = 10%
Show the ratio of expected annual return.
Factors On Which Investment Depends.
Investment depends on
1. MEC
2. Rate of Interest
1. MEC
The MEC is the expected annual rate of return on an additional unit of a capital good.
According to Keynels
The MEC is the rate of discount which makes the present value of the prospective field from the Capital asset equal to its supply price.
MEC is -vely shoped.
2. Rate of Interest
As the investment increases the rate of interest also increase so MEC decline.
Factors Effecting MEC
MEC is influenced by shortrun as well as long run factors. These are
A. Short Run Factors
i. Demand for the Product.
ii. Liquid Assets.
iii. Sudden changes in income.
iv. Current rate of investment.
B. Long Run Factors
i. Rate of Growth of Population
ii. Technological Development
iii. Rate of Taxes.
Qs. What is “Effective Demand”? How it influence the determination of level of employment and income in an economy? Discuss
OR
Explain the Keynessian Theory of Income and Employment.
According to Keynessian employment is a function of income, the greater the level of national income the volume of employment keeping other factors constant in short run.
i.e. Capital, Technology, Quality of Labour are constant.
So in the absence of changes in these constant the total output of goods and services cannot be expanded without increasing employment. The level of both income and employment depends on the Aggregate Demand and Aggregate Supply. The intersection of Aggregate Demand curve and Aggregate supply curve shows equilibirium level of income and employment.
Keynessian emphasise on Aggregate Demand (AD) which is depends upon the total expenditure of the consumer on consumption goods and of enterprise on investment goods. Consumption depends upon the size of the consumer income and propersity to consume investment demand is determind by the MPC and the rate of interest. It depends upon fixture expectations of enterprise regarding the future yields from the goods.
Investment Demand = Distance between C and C + I
C + I —> Aggregate Demands
E —> Shows the Equilibirium level of income and employment
OY —> level of income at Equilibirium point E.
Equilibirium Not Necassary at Full Employment
It is clear that this equilibirium E between AS and AD may not be achieved at full employment and income. The equilibirium will established at full employment income only when investment demand is suffeciently large to fill the saving gap between the income and consumption correspondence to full employment.
Qs. When Aggregate Demand equals Aggregate Supply or Saving equals investment equilibirium level of national income is determined? Prove.
OR
Equilibirium level of national income is determined by the intersaction of savings and investment schedules. Discuss
Equilibirium level of income and employment is established at that level at which AD = AS. It has also been seen that AD = AS when the investment spending is equal to then amount savings.
If Income Investment < Saving
It means AD would not be sufficient to take the AS of output of the market so bringing reduction in output income and employment at level in which investment spending.
If Given Level of Income Intended Investment < Intended Savings
The enterprise will not be able to sell the entire output at given prices. So they intend to reduce output so the level of income and employment will reduced.
Qs. According to Keyness, Saving-Investment Equality is a basic condition of equilibirium. Discuss
OR
Are Saving and investment in an economy always equal? If not how can this condition be brought about
OR
What do you mean by Saving and Investment?
Investment
According to Keyness Theory,
Investment means not addition to the stock of capital goods like machinary, equipment, factories etc.
It also include Inventories that why term Investment is different from Capital.
Saving
Saving means that amount which a man saves out of income after his expenditure so, saving means the income which is not consumed.
Saving and Investment Equality
A controversial question always in mind that is Saving and Investment are equal? According to Keyness
No, but it only possible when they reach in equlibirium position.
According to Keyness
The national Income is derived from the production and Scale of A. Consumer’s good and B. Investment goods.
i.e. Income = Consumption + Investment
=> Y = C + I …… i
Another look at income is
Income = Consumption + Saving
Y = C + S …… ii
So,
By comparing these two eq. we get
C + S = C + I
=> SC saving > I (investment)
Are Savings and Investment Always Equal
According to Keyness Economics,
They must be always equal But we got that is not happen always.
By realizing all of there we get realised or actual saving and investment always equal but intended or expected savings and investment may differ. But it also equal at equilibirium level of income.
Islamic Economic System ,Economics B.com Part 1 Sindh,Karachi Board
Islamic Economic System
Capitalism, Communism and Mixed Economics system has purely a materialistic approach in which human social life has no importance. But in Islamic System
The followers of Islam are required to lead a material life in such way that it becomes a source of happiness and respect of others in this world for making secure himself for next world.
Islamic Economic System consist of institutions, organizations and the social values by which natural, human and man made resources are used to produce, exchange, elistribute and consume wealth?goods and services under the guiding principles of Islam to achieve “FALAH” in this world and also other it.
Salient Features of Islamic System
Main characteristics of Economic System of Islam are.
1. The Concept of Private Property
2. Consumption of wealth
3. Production of wealth
4. Distribution of wealth
5. The concept of Zakat
6. Interest free Economy
7. Economic Growth
8. Responsibilities of the Government.
1. The Concept of Private Property
Basic Principles in Islam for Consumption or Investment of private property are
Concept of “HALAL” and “HARAM” for earning or in production and consumption of wealth.
A property cannot be used against public interest.
Show much as you have something.
Real/money Capital cannot be used for gain.
Payment of Zakat is compulsory.
2. Consumption of Wealth
In Islamic System uses of luxuries are not allowed because it against the concept of “TAQWA” should have distinguish between “HALAL” and “HARAM”.”BUKHAL” and “ISRAF” are to be avoided.
3. Production of Wealth
Price mechanism plays a key role in carrying out the production process in an Islamic Society. As Price system results in the expectations of workers and consumers the Govt. Interferences with the price mechanism to over come the problem. These things are not allowed in Islamic System.
Production of drugs, gambling, lotery, music, dance etc.
Lending and borrowing on interest
Black marketing, Smuggling etc.
4. Distribution of Wealth
Islamic Economics System favour fair (not equal) distribution of wealth in the sence that it should not be confined to any particular section of the society. For fair distribution of wealth Islam gives following steps
“BUKHAL” and “ISRAF” are to be avoided.
Payment of Zakat
Interest not allowed
Monopoly of Private firm not allowed
Earning from Black Market.
5. The Concept of Zakat
Zakat is a major source of revenue the government in an Islamic state. It levy on all goods and money or on wealth if have to pay yearly on the month of RAJAB or RAMADAN.
6. Interest free Economy
The whole financial system the bank structure in particular is run on the basis “SHARAKAT” and “MUZARABAT” in Islamic state. Therefore, Islamic economics is an interest free economy.
7. Responsibility of the Government
Responsibility of the Islamic Government are
1. Should Check un islamic activity like gambling, smuggling, black marketing etc.
2. Should secure poor people by giving them necassity of life i.e. food, clothing, health etc.
3. Should provide equal employment opportunity.
4. Social and Economic Security is required to guaranteed by the Govt.
Conclusion
An Islamic Setup provides a graceful economic and social life. it distribute the wealth in all family.
Qs. Explain the importance of Zakat in the process of Distribution of wealth in Islamic State?
The Concept of Zakat
Zakat has two meanings in Arabic
i. That which purifies
ii. That which causes growth.
i. That Which Purifies
This indicates that Zakat purifies the human soul by keeping a person away from illegal source of earning, eliminating the love for materialism and overcoming the sense of pride for being wealthy.
ii. That Which Causes Growth
This means that ALLAH protected the wealth from which Zakat had been paid and in the way the peace of mind of the person who pay Zakat.
In economics technically Zakat defined as
Zakat is a “transfer payment” which Sahib-e-Nisab muslim pay to poor given rate in the month of RAJAB.
Assessment of Zakat
1. Sahib-e-Nisab Muslim
A muslim who owns and keeps his/her possession at least 7 1/2 total gold of 52 1/2 total silver or cash money to the equivalents value is considered a Sahib-e-Nisab Muslim.
2. Exposed and Unexposed Wealth
Zakat is paid from two types wealth i.e. exposed (e.g. Bussiness, Salary, and goods) and Unexposed (e.g. gold, silver, cash money etc)
3. The Rate of Zakat
If paid on atleast 7 1/2 total golds or 52 1/2 total silver or the equivalents value of cash, goods, salary etc.
i. The rate of Zakat is 2 1/2 of total value of (cash, goods, salary, building etc)
ii. The rate of Zakat is 10% for the Agricultural Produce of land.
Beneficiares of Zakat
Beneficiares of Zakat are
1. The Poor. Those people who are below than Sahib-e-Nisab.
2. The Needy. They are the people who are unable to earn their living e.g. handicapped disabled, unemployees person.
3.The Converts. Those who convert to Islam have right to get Zakat.
4. The Debtors. Those who heavily indebbed can get zakat to repay their Zakat.
5. Mujahideen. Zakat can also be given to Mujahideen.
It is clear that Zakat is a source of financial assistance to the poor and needy to become economically independent.
Economic Significance / Importance of Zakat
1. Fair Distribution of Wealth
Islam does not permit that the wealth is distributed in few hands. Therefore people have to pay 2 1/2 % Zakat to poor.
2. Elimination of Class Conflict
Zakat makes the poor obliged and thus the problem of class conflict does not arise at all.
3. Economic Stability
Zakat promotes the velocity of Calculation of money due to which aggregate demand for goods and services increases. This determines the lives of investment, income and employment on stable footing. Hence an Islamic economy is always stable.
4. Social Security
Zakat fund not only covers the poor and the disabled but it also provides social security to the unemployed who may later on prove to be valuable assets of the nation.
5. Discouragement of Anti-Social Activities
Zakat which is paid from (rizq-e-halal) stop muslims from anti social activities like smuggling etc.
6. Social Welfare
Hospitals, schools, and handicrafts for the poor can be constructed by making use of the zakat fund.
7. Self Reliance
Zakat enables peoples to take care of each others needs.
8. Control of Crimes
The Major causes of crimes particularly the poverty of people. This can be overcome by paying Zakat regularly. Zakat decrease the crime rate.
Qs. In what respect Islamic Economic System is superior to Capitalism and Socialism. Discuss?
OR
Discuss the basic principles of Islamic Economic System and and compare it with Capitalism?
Comparison of Islamic Economic System with other Economic System
Islamic Economic System possesses the character of both capitalism and socialism and it is free from their evils. Following are the comparison of Islamic state with others.
1. Distinguishing Characteristics
Capitalist says “Economic Freedom” to producers and Consumers.
Communism says Economic Equality achieved through state ownership of the means of production.
The distinguish characteristics of an Islamic System is “Economic and Social Justice” so that every body gets his / her due.
2. The Concept of Private Property
In a Capitalist system unlimited liberty and right of ownership for private property is given which has resulted in the capitalist exploitation of workers. Islam allows the right of private ownership and freedom of enterprise in limited capitalism but not leave the property for the long period.
3. Consumption of Wealth
In Capitalism any thing can be consumed while a communist society only consumer goods and services which are allowed to be produced in the country. In Islamic Country only “HALAL” are allowed to be produced and consumed “HARAM” goods and services are not allowed to be produced and consumed.
4. Production of Wealth
Capitalism motive is only profit they produced goods for only profit. In communist society central plan authority made decision what to produce and how much to produce. But in Islamic System only have to produce “HALAL” goods and “HARAM” goods like alcohol drink, drug etc are not allowed.
5. Distribution of Wealth
In Capitalism concentration of wealth is goes on few hand due to unlimited right of ownership and free competition. In communism system dicta for ship is created due to concept of private property. In Islamic System, Due to “ZAKAT” and “SADQAT” automatically wealth transfer to poor from rich.
6. The Role of Interest
The interest made brings equal between saving and investment to promote, capital formation in a capitalist society. In communism, interest does not pay any role for saving and investment. In the Islamic system interest based economic activities are strictly banned. Hence interest is not a source of capital formation in an Islamic.
Conclusion
We conclude that Capitalist and communist are materialistic in nature and they only looking for to satisfy the material wants of the people. But Islamic economic system provides a fine blend of materialism and spiritualism.
Capitalism, Communism and Mixed Economics system has purely a materialistic approach in which human social life has no importance. But in Islamic System
The followers of Islam are required to lead a material life in such way that it becomes a source of happiness and respect of others in this world for making secure himself for next world.
Islamic Economic System consist of institutions, organizations and the social values by which natural, human and man made resources are used to produce, exchange, elistribute and consume wealth?goods and services under the guiding principles of Islam to achieve “FALAH” in this world and also other it.
Salient Features of Islamic System
Main characteristics of Economic System of Islam are.
1. The Concept of Private Property
2. Consumption of wealth
3. Production of wealth
4. Distribution of wealth
5. The concept of Zakat
6. Interest free Economy
7. Economic Growth
8. Responsibilities of the Government.
1. The Concept of Private Property
Basic Principles in Islam for Consumption or Investment of private property are
Concept of “HALAL” and “HARAM” for earning or in production and consumption of wealth.
A property cannot be used against public interest.
Show much as you have something.
Real/money Capital cannot be used for gain.
Payment of Zakat is compulsory.
2. Consumption of Wealth
In Islamic System uses of luxuries are not allowed because it against the concept of “TAQWA” should have distinguish between “HALAL” and “HARAM”.”BUKHAL” and “ISRAF” are to be avoided.
3. Production of Wealth
Price mechanism plays a key role in carrying out the production process in an Islamic Society. As Price system results in the expectations of workers and consumers the Govt. Interferences with the price mechanism to over come the problem. These things are not allowed in Islamic System.
Production of drugs, gambling, lotery, music, dance etc.
Lending and borrowing on interest
Black marketing, Smuggling etc.
4. Distribution of Wealth
Islamic Economics System favour fair (not equal) distribution of wealth in the sence that it should not be confined to any particular section of the society. For fair distribution of wealth Islam gives following steps
“BUKHAL” and “ISRAF” are to be avoided.
Payment of Zakat
Interest not allowed
Monopoly of Private firm not allowed
Earning from Black Market.
5. The Concept of Zakat
Zakat is a major source of revenue the government in an Islamic state. It levy on all goods and money or on wealth if have to pay yearly on the month of RAJAB or RAMADAN.
6. Interest free Economy
The whole financial system the bank structure in particular is run on the basis “SHARAKAT” and “MUZARABAT” in Islamic state. Therefore, Islamic economics is an interest free economy.
7. Responsibility of the Government
Responsibility of the Islamic Government are
1. Should Check un islamic activity like gambling, smuggling, black marketing etc.
2. Should secure poor people by giving them necassity of life i.e. food, clothing, health etc.
3. Should provide equal employment opportunity.
4. Social and Economic Security is required to guaranteed by the Govt.
Conclusion
An Islamic Setup provides a graceful economic and social life. it distribute the wealth in all family.
Qs. Explain the importance of Zakat in the process of Distribution of wealth in Islamic State?
The Concept of Zakat
Zakat has two meanings in Arabic
i. That which purifies
ii. That which causes growth.
i. That Which Purifies
This indicates that Zakat purifies the human soul by keeping a person away from illegal source of earning, eliminating the love for materialism and overcoming the sense of pride for being wealthy.
ii. That Which Causes Growth
This means that ALLAH protected the wealth from which Zakat had been paid and in the way the peace of mind of the person who pay Zakat.
In economics technically Zakat defined as
Zakat is a “transfer payment” which Sahib-e-Nisab muslim pay to poor given rate in the month of RAJAB.
Assessment of Zakat
1. Sahib-e-Nisab Muslim
A muslim who owns and keeps his/her possession at least 7 1/2 total gold of 52 1/2 total silver or cash money to the equivalents value is considered a Sahib-e-Nisab Muslim.
2. Exposed and Unexposed Wealth
Zakat is paid from two types wealth i.e. exposed (e.g. Bussiness, Salary, and goods) and Unexposed (e.g. gold, silver, cash money etc)
3. The Rate of Zakat
If paid on atleast 7 1/2 total golds or 52 1/2 total silver or the equivalents value of cash, goods, salary etc.
i. The rate of Zakat is 2 1/2 of total value of (cash, goods, salary, building etc)
ii. The rate of Zakat is 10% for the Agricultural Produce of land.
Beneficiares of Zakat
Beneficiares of Zakat are
1. The Poor. Those people who are below than Sahib-e-Nisab.
2. The Needy. They are the people who are unable to earn their living e.g. handicapped disabled, unemployees person.
3.The Converts. Those who convert to Islam have right to get Zakat.
4. The Debtors. Those who heavily indebbed can get zakat to repay their Zakat.
5. Mujahideen. Zakat can also be given to Mujahideen.
It is clear that Zakat is a source of financial assistance to the poor and needy to become economically independent.
Economic Significance / Importance of Zakat
1. Fair Distribution of Wealth
Islam does not permit that the wealth is distributed in few hands. Therefore people have to pay 2 1/2 % Zakat to poor.
2. Elimination of Class Conflict
Zakat makes the poor obliged and thus the problem of class conflict does not arise at all.
3. Economic Stability
Zakat promotes the velocity of Calculation of money due to which aggregate demand for goods and services increases. This determines the lives of investment, income and employment on stable footing. Hence an Islamic economy is always stable.
4. Social Security
Zakat fund not only covers the poor and the disabled but it also provides social security to the unemployed who may later on prove to be valuable assets of the nation.
5. Discouragement of Anti-Social Activities
Zakat which is paid from (rizq-e-halal) stop muslims from anti social activities like smuggling etc.
6. Social Welfare
Hospitals, schools, and handicrafts for the poor can be constructed by making use of the zakat fund.
7. Self Reliance
Zakat enables peoples to take care of each others needs.
8. Control of Crimes
The Major causes of crimes particularly the poverty of people. This can be overcome by paying Zakat regularly. Zakat decrease the crime rate.
Qs. In what respect Islamic Economic System is superior to Capitalism and Socialism. Discuss?
OR
Discuss the basic principles of Islamic Economic System and and compare it with Capitalism?
Comparison of Islamic Economic System with other Economic System
Islamic Economic System possesses the character of both capitalism and socialism and it is free from their evils. Following are the comparison of Islamic state with others.
1. Distinguishing Characteristics
Capitalist says “Economic Freedom” to producers and Consumers.
Communism says Economic Equality achieved through state ownership of the means of production.
The distinguish characteristics of an Islamic System is “Economic and Social Justice” so that every body gets his / her due.
2. The Concept of Private Property
In a Capitalist system unlimited liberty and right of ownership for private property is given which has resulted in the capitalist exploitation of workers. Islam allows the right of private ownership and freedom of enterprise in limited capitalism but not leave the property for the long period.
3. Consumption of Wealth
In Capitalism any thing can be consumed while a communist society only consumer goods and services which are allowed to be produced in the country. In Islamic Country only “HALAL” are allowed to be produced and consumed “HARAM” goods and services are not allowed to be produced and consumed.
4. Production of Wealth
Capitalism motive is only profit they produced goods for only profit. In communist society central plan authority made decision what to produce and how much to produce. But in Islamic System only have to produce “HALAL” goods and “HARAM” goods like alcohol drink, drug etc are not allowed.
5. Distribution of Wealth
In Capitalism concentration of wealth is goes on few hand due to unlimited right of ownership and free competition. In communism system dicta for ship is created due to concept of private property. In Islamic System, Due to “ZAKAT” and “SADQAT” automatically wealth transfer to poor from rich.
6. The Role of Interest
The interest made brings equal between saving and investment to promote, capital formation in a capitalist society. In communism, interest does not pay any role for saving and investment. In the Islamic system interest based economic activities are strictly banned. Hence interest is not a source of capital formation in an Islamic.
Conclusion
We conclude that Capitalist and communist are materialistic in nature and they only looking for to satisfy the material wants of the people. But Islamic economic system provides a fine blend of materialism and spiritualism.
The Components of Inventory B.com Part 1 Sindh,Karachi Board
The Components of Inventory
Categories of Inventory
You have already seen that inventory for a merchandising business consists of the goods available for resale to customers. However, retailers are not the only businesses that maintain inventory. Manufacturers also have inventories related to the goods they produce. Goods completed and awaiting sale are termed “finished goods” inventory. A manufacturer may also have “work in process” inventory consisting of goods being manufactured but not yet completed. And, a third category of inventory is “raw material,” consisting of goods to be used in the manufacture of products. Inventories are typically classified as current assets on the balance sheet. A substantial portion of the managerial accounting chapters of this book deal with issues relating to accounting for costs of manufactured inventory. For now, we will focus on general principles of inventory accounting that are applicable to most all enterprises.
Determining Which Goods to Include in Inventory
Recall from the merchandising chapter the discussion of freight charges. In that chapter, F.O.B. terms were introduced, and the focus was on which party would bear the cost of freight. But, F.O.B. terms also determine when goods are (or are not) included in inventory. Technically, goods in transit belong to the party holding legal ownership. Ownership depends on the F.O.B. terms. Goods sold F.O.B. destination do not belong to the purchaser until they arrive at their final destination. Goods sold F.O.B. shipping point become property of the purchaser once shipped by the seller. Therefore, when determining the amount of inventory owned at year end, goods in transit must be considered in light of the F.O.B. terms. In the case of F.O.B. shipping point, for instance, a buyer would need to include as inventory the goods that are being transported but not yet received. The diagram at right is meant to show who includes goods in transit, with ownership shifting at the F.O.B. point noted with a “flag.” Another problem area pertains to goods on consignment.
Consigned goods describe products that are in the custody of one party, but belong to another. Thus, the party holding physical possession is not the legal owner. The person with physical possession is known as the consignee. The consignee is responsible for taking care of the goods and trying sell them to an end customer. In essence, the consignee is acting as a sales agent. The consignor is the party holding legal ownership/title to the consigned goods in inventory. Because consigned goods belong to the consignor, they should be included in the inventory of the consignor — not the consignee!
Consignments arise when the owner desires to place inventory in the hands of a sales agent, but the sales agent does not want to pay for those goods unless the agent is able to sell them to an end customer. For example, auto parts manufacturers may produce many types of parts that are very specialized and expensive, such as braking systems. A retail auto parts store may not be able to afford to stock every variety. In addition, there is the real risk of ending up with numerous obsolete units. But, the manufacturer desperately needs these units in the retail channel — when brakes fail, customers will go to the source that can provide an immediate solution. As a result, the manufacturer may consign the units to auto parts retailers. Conceptually, it is fairly simple to understand the accounting for consigned goods. Practically, they pose a recordkeeping challenge. When examining a company’s inventory on hand, special care must be taken to identify both goods consigned out to others (which are to be included in inventory) and goods consigned in (which are not to be included in inventory). Obviously, if the consignee does sell the consigned goods to an end user, the consignee would keep a portion of the sales price, and remit the balance to the consignor. All of this activity requires a good accounting system to be able to identify which units are consigned, track their movement, and know when they are actually sold or returned.
Categories of Inventory
You have already seen that inventory for a merchandising business consists of the goods available for resale to customers. However, retailers are not the only businesses that maintain inventory. Manufacturers also have inventories related to the goods they produce. Goods completed and awaiting sale are termed “finished goods” inventory. A manufacturer may also have “work in process” inventory consisting of goods being manufactured but not yet completed. And, a third category of inventory is “raw material,” consisting of goods to be used in the manufacture of products. Inventories are typically classified as current assets on the balance sheet. A substantial portion of the managerial accounting chapters of this book deal with issues relating to accounting for costs of manufactured inventory. For now, we will focus on general principles of inventory accounting that are applicable to most all enterprises.
Determining Which Goods to Include in Inventory
Recall from the merchandising chapter the discussion of freight charges. In that chapter, F.O.B. terms were introduced, and the focus was on which party would bear the cost of freight. But, F.O.B. terms also determine when goods are (or are not) included in inventory. Technically, goods in transit belong to the party holding legal ownership. Ownership depends on the F.O.B. terms. Goods sold F.O.B. destination do not belong to the purchaser until they arrive at their final destination. Goods sold F.O.B. shipping point become property of the purchaser once shipped by the seller. Therefore, when determining the amount of inventory owned at year end, goods in transit must be considered in light of the F.O.B. terms. In the case of F.O.B. shipping point, for instance, a buyer would need to include as inventory the goods that are being transported but not yet received. The diagram at right is meant to show who includes goods in transit, with ownership shifting at the F.O.B. point noted with a “flag.” Another problem area pertains to goods on consignment.
Consigned goods describe products that are in the custody of one party, but belong to another. Thus, the party holding physical possession is not the legal owner. The person with physical possession is known as the consignee. The consignee is responsible for taking care of the goods and trying sell them to an end customer. In essence, the consignee is acting as a sales agent. The consignor is the party holding legal ownership/title to the consigned goods in inventory. Because consigned goods belong to the consignor, they should be included in the inventory of the consignor — not the consignee!
Consignments arise when the owner desires to place inventory in the hands of a sales agent, but the sales agent does not want to pay for those goods unless the agent is able to sell them to an end customer. For example, auto parts manufacturers may produce many types of parts that are very specialized and expensive, such as braking systems. A retail auto parts store may not be able to afford to stock every variety. In addition, there is the real risk of ending up with numerous obsolete units. But, the manufacturer desperately needs these units in the retail channel — when brakes fail, customers will go to the source that can provide an immediate solution. As a result, the manufacturer may consign the units to auto parts retailers. Conceptually, it is fairly simple to understand the accounting for consigned goods. Practically, they pose a recordkeeping challenge. When examining a company’s inventory on hand, special care must be taken to identify both goods consigned out to others (which are to be included in inventory) and goods consigned in (which are not to be included in inventory). Obviously, if the consignee does sell the consigned goods to an end user, the consignee would keep a portion of the sales price, and remit the balance to the consignor. All of this activity requires a good accounting system to be able to identify which units are consigned, track their movement, and know when they are actually sold or returned.
INVENTORY AND ITS IMPORTANCE TO INCOME MEASUREMENT Accounting B.com Part 1 Sindh,Karachi Board
INVENTORY AND ITS IMPORTANCE TO INCOME MEASUREMENT
Even a casual observer of the stock markets will note that stock values often move significantly on information about a company’s earnings. Now, you may be wondering why a discussion of inventory would begin with this observation. The reason is that inventory measurement bears directly on the determination of income! Recall from earlier chapters this formulation:
Notice that the goods available for sale are “allocated” to ending inventory and cost of goods sold. In the graphic, the units of inventory appear as physical units. But, in a company’s accounting records, this flow must be translated into units of money. After all, the balance sheet expresses inventory in money, not units. And, cost of goods sold on the income statement is also expressed in money:
This means that allocating $1 less of the total cost of goods available for sale into ending inventory will necessarily result in placing $1 more into cost of goods sold (and vice versa). Further, as cost of goods sold is increased or decreased, there is an opposite effect on gross profit. Remember, sales minus cost of goods sold equals gross profit. As you can see, a critical factor in determining income is the allocation of the cost of goods available for sale between ending inventory and cost of goods sold:
DETERMINING THE COST OF ENDING INVENTORY
In earlier chapters, the dollar amount for inventory was simply given. Not much attention was given to the specific details about how that cost was determined. To delve deeper into this subject, let’s begin by considering a general rule: Inventory should include all costs that are “ordinary and necessary” to put the goods “in place” and “in condition” for their resale. This means that inventory cost would include the invoice price, freight-in, and similar items relating to the general rule. Conversely, “carrying costs” like interest charges (if money was borrowed to buy the inventory), storage costs, and insurance on goods held awaiting sale would not be included in inventory accounts; instead those costs would be expensed as incurred. Likewise, freight-out and sales commissions would be expensed as a selling cost rather than being included with inventory.
COSTING METHODS
Once the unit cost of inventory is determined via the preceding rules of logic, specific costing methods must be adopted. In other words, each unit of inventory will not have the exact same cost, and an assumption must be implemented to maintain a systematic approach to assigning costs to units on hand (and to units sold).
To solidify this point, consider a simple example: Mueller Hardware has a storage barrel full of nails. The barrel was restocked three times with 100 pounds of nails being added at each restocking. The first batch cost Mueller $100, the second batch cost Mueller $110, and the third batch cost Mueller $120. Further, the barrel was never allowed to empty completely and customers have picked all around in the barrel as they bought nails from Mueller (and new nails were just dumped in on top of the remaining pile at each restocking). So, its hard to say exactly which nails are “physically” still in the barrel. As you might expect, some of the nails are probably from the first purchase, some from the second purchase, and some from the final purchase. Of course, they all look about the same. At the end of the accounting period, Mueller weighs the barrel and decides that 140 pounds of nails are on hand (from the 300 pounds available).
The accounting question you must consider is: what is the cost of the ending inventory? Remember, this is not a trivial question, as it will bear directly on the determination of income! To deal with this very common accounting question, a company must adopt an inventory costing method (and that method must be applied consistently from year to year). The methods from which to choose are varied, generally consisting of one of the following:
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
Weighted-average
Each of these methods entail certain cost-flow assumptions. Importantly, the assumptions bear no relation to the physical flow of goods; they are merely used to assign costs to inventory units. (Note: FIFO and LIFO are pronounced with a long “i” and long “o” vowel sound). Another method that will be discussed shortly is the specific identification method; as its name suggests, it does not depend on a cost flow assumption.
FIRST-IN, FIRST-OUT CALCULATIONS
With first-in, first-out, the oldest cost (i.e., the first in) is matched against revenue and assigned to cost of goods sold. Conversely, the most recent purchases are assigned to units in ending inventory. For Mueller’s nails the FIFO calculations would look like this:
LAST-IN, FIRST-OUT CALCULATIONS
Last-in, first-out is just the reverse of FIFO; recent costs are assigned to goods sold while the oldest costs remain in inventory:
WEIGHTED AVERAGE CALCULATIONS
The weighted-average method relies on average unit cost to calculate cost of units sold and ending inventory. Average cost is determined by dividing total cost of goods available for sale by total units available for sale. Mueller Hardware paid $330 for 300 pounds of nails, producing an average cost of $1.10 per pound ($330/300). The ending inventory consisted of 140 pounds, or $154. The cost of goods sold was $176 (160 pounds X $1.10):
PRELIMINARY RECAP AND COMPARISON
The preceding discussion is summarized by the following comparative illustrations. Examine each, noting how the cost of beginning inventory and purchases flow to ending inventory and cost of goods sold. As you examine this drawing, you need to know that accountants usually adopt one of these cost flow assumptions to track inventory costs within the accounting system. The actual physical flow of the inventory may or may not bear a resemblance to the adopted cost flow assumption.
DETAILED ILLUSTRATION
Having been introduced to the basics of FIFO, LIFO, and weighted-average, it is now time to look at a more comprehensive illustration. In this illustration, there will also be some beginning inventory that is carried over from the preceding year. Assume that Gonzales Chemical Company had a beginning inventory balance that consisted of 4,000 units with a cost of $12 per unit. Purchases and sales are shown at right. The schedule suggests that Gonzales should have 5,000 units on hand at the end of the year. Assume that Gonzales conducted a physical count of inventory and confirmed that 5,000 units were actually on hand. Based on the information in the schedule, we know that Gonzales will report sales of $304,000. This amount is the result of selling 7,000 units at $22 ($154,000) and 6,000 units at $25 ($150,000). The dollar amount of sales will be reported in the income statement, along with cost of goods sold and gross profit. How much is cost of goods sold and gross profit? The answer will depend on the cost flow assumption adopted by Gonzales.
FIFO
If Gonzales uses FIFO, ending inventory and cost of goods sold calculations are as follows, producing the financial statements at right: Beginning inventory
4,000 X $12 = $48,000 + Net purchases ($232,000 total)
6,000 X $16 = $96,000
8,000 X $17 = $136,000
=
Cost of goods available for sale ($280,000 total)
4,000 X $12 = $48,000
6,000 X $16 = $96,000
8,000 X $17 = $136,000
= Ending inventory ($85,000)
5,000 X $17 = $85,000 + Cost of goods sold ($195,000 total)
4,000 X $12 = $48,000
6,000 X $16 = $96,000
3,000 X $17 = $51,000
LIFO
If Gonzales uses LIFO, ending inventory and cost of goods sold calculations are as follows, producing the financial statements at right:
Beginning Inventory
4,000 X $12 = $48,000 + Net purchases ($232,000 total)
6,000 X $16 = $96,000
8,000 X $17 = $136,000
=
Cost of goods available for sale ($280,000 total)
4,000 X $12 = $48,000
6,000 X $16 = $96,000
8,000 X $17 = $136,000
=
Ending inventory ($64,000)
4,000 X $12 = $48,000
1,000 X $16 = $16,000 + Cost of goods sold ($216,000 total)
8,000 X $17 = $136,000
5,000 X $16 = $80,000
WEIGHTED AVERAGE
If the company uses the weighted-average method, ending inventory and cost of goods sold calculations are as follows, producing the financial statements at right: Cost of goods available for sale $280,000
Divided by units (4,000 + 6,000 + 8,000) 18,000
Average unit cost (note: do not round) $15.5555 per unit
Ending inventory (5,000 units @ $15.5555) $77,778
Cost of goods sold (13,000 units @ $15.5555) $202,222
Even a casual observer of the stock markets will note that stock values often move significantly on information about a company’s earnings. Now, you may be wondering why a discussion of inventory would begin with this observation. The reason is that inventory measurement bears directly on the determination of income! Recall from earlier chapters this formulation:
Notice that the goods available for sale are “allocated” to ending inventory and cost of goods sold. In the graphic, the units of inventory appear as physical units. But, in a company’s accounting records, this flow must be translated into units of money. After all, the balance sheet expresses inventory in money, not units. And, cost of goods sold on the income statement is also expressed in money:
This means that allocating $1 less of the total cost of goods available for sale into ending inventory will necessarily result in placing $1 more into cost of goods sold (and vice versa). Further, as cost of goods sold is increased or decreased, there is an opposite effect on gross profit. Remember, sales minus cost of goods sold equals gross profit. As you can see, a critical factor in determining income is the allocation of the cost of goods available for sale between ending inventory and cost of goods sold:
DETERMINING THE COST OF ENDING INVENTORY
In earlier chapters, the dollar amount for inventory was simply given. Not much attention was given to the specific details about how that cost was determined. To delve deeper into this subject, let’s begin by considering a general rule: Inventory should include all costs that are “ordinary and necessary” to put the goods “in place” and “in condition” for their resale. This means that inventory cost would include the invoice price, freight-in, and similar items relating to the general rule. Conversely, “carrying costs” like interest charges (if money was borrowed to buy the inventory), storage costs, and insurance on goods held awaiting sale would not be included in inventory accounts; instead those costs would be expensed as incurred. Likewise, freight-out and sales commissions would be expensed as a selling cost rather than being included with inventory.
COSTING METHODS
Once the unit cost of inventory is determined via the preceding rules of logic, specific costing methods must be adopted. In other words, each unit of inventory will not have the exact same cost, and an assumption must be implemented to maintain a systematic approach to assigning costs to units on hand (and to units sold).
To solidify this point, consider a simple example: Mueller Hardware has a storage barrel full of nails. The barrel was restocked three times with 100 pounds of nails being added at each restocking. The first batch cost Mueller $100, the second batch cost Mueller $110, and the third batch cost Mueller $120. Further, the barrel was never allowed to empty completely and customers have picked all around in the barrel as they bought nails from Mueller (and new nails were just dumped in on top of the remaining pile at each restocking). So, its hard to say exactly which nails are “physically” still in the barrel. As you might expect, some of the nails are probably from the first purchase, some from the second purchase, and some from the final purchase. Of course, they all look about the same. At the end of the accounting period, Mueller weighs the barrel and decides that 140 pounds of nails are on hand (from the 300 pounds available).
The accounting question you must consider is: what is the cost of the ending inventory? Remember, this is not a trivial question, as it will bear directly on the determination of income! To deal with this very common accounting question, a company must adopt an inventory costing method (and that method must be applied consistently from year to year). The methods from which to choose are varied, generally consisting of one of the following:
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
Weighted-average
Each of these methods entail certain cost-flow assumptions. Importantly, the assumptions bear no relation to the physical flow of goods; they are merely used to assign costs to inventory units. (Note: FIFO and LIFO are pronounced with a long “i” and long “o” vowel sound). Another method that will be discussed shortly is the specific identification method; as its name suggests, it does not depend on a cost flow assumption.
FIRST-IN, FIRST-OUT CALCULATIONS
With first-in, first-out, the oldest cost (i.e., the first in) is matched against revenue and assigned to cost of goods sold. Conversely, the most recent purchases are assigned to units in ending inventory. For Mueller’s nails the FIFO calculations would look like this:
LAST-IN, FIRST-OUT CALCULATIONS
Last-in, first-out is just the reverse of FIFO; recent costs are assigned to goods sold while the oldest costs remain in inventory:
WEIGHTED AVERAGE CALCULATIONS
The weighted-average method relies on average unit cost to calculate cost of units sold and ending inventory. Average cost is determined by dividing total cost of goods available for sale by total units available for sale. Mueller Hardware paid $330 for 300 pounds of nails, producing an average cost of $1.10 per pound ($330/300). The ending inventory consisted of 140 pounds, or $154. The cost of goods sold was $176 (160 pounds X $1.10):
PRELIMINARY RECAP AND COMPARISON
The preceding discussion is summarized by the following comparative illustrations. Examine each, noting how the cost of beginning inventory and purchases flow to ending inventory and cost of goods sold. As you examine this drawing, you need to know that accountants usually adopt one of these cost flow assumptions to track inventory costs within the accounting system. The actual physical flow of the inventory may or may not bear a resemblance to the adopted cost flow assumption.
DETAILED ILLUSTRATION
Having been introduced to the basics of FIFO, LIFO, and weighted-average, it is now time to look at a more comprehensive illustration. In this illustration, there will also be some beginning inventory that is carried over from the preceding year. Assume that Gonzales Chemical Company had a beginning inventory balance that consisted of 4,000 units with a cost of $12 per unit. Purchases and sales are shown at right. The schedule suggests that Gonzales should have 5,000 units on hand at the end of the year. Assume that Gonzales conducted a physical count of inventory and confirmed that 5,000 units were actually on hand. Based on the information in the schedule, we know that Gonzales will report sales of $304,000. This amount is the result of selling 7,000 units at $22 ($154,000) and 6,000 units at $25 ($150,000). The dollar amount of sales will be reported in the income statement, along with cost of goods sold and gross profit. How much is cost of goods sold and gross profit? The answer will depend on the cost flow assumption adopted by Gonzales.
FIFO
If Gonzales uses FIFO, ending inventory and cost of goods sold calculations are as follows, producing the financial statements at right: Beginning inventory
4,000 X $12 = $48,000 + Net purchases ($232,000 total)
6,000 X $16 = $96,000
8,000 X $17 = $136,000
=
Cost of goods available for sale ($280,000 total)
4,000 X $12 = $48,000
6,000 X $16 = $96,000
8,000 X $17 = $136,000
= Ending inventory ($85,000)
5,000 X $17 = $85,000 + Cost of goods sold ($195,000 total)
4,000 X $12 = $48,000
6,000 X $16 = $96,000
3,000 X $17 = $51,000
LIFO
If Gonzales uses LIFO, ending inventory and cost of goods sold calculations are as follows, producing the financial statements at right:
Beginning Inventory
4,000 X $12 = $48,000 + Net purchases ($232,000 total)
6,000 X $16 = $96,000
8,000 X $17 = $136,000
=
Cost of goods available for sale ($280,000 total)
4,000 X $12 = $48,000
6,000 X $16 = $96,000
8,000 X $17 = $136,000
=
Ending inventory ($64,000)
4,000 X $12 = $48,000
1,000 X $16 = $16,000 + Cost of goods sold ($216,000 total)
8,000 X $17 = $136,000
5,000 X $16 = $80,000
WEIGHTED AVERAGE
If the company uses the weighted-average method, ending inventory and cost of goods sold calculations are as follows, producing the financial statements at right: Cost of goods available for sale $280,000
Divided by units (4,000 + 6,000 + 8,000) 18,000
Average unit cost (note: do not round) $15.5555 per unit
Ending inventory (5,000 units @ $15.5555) $77,778
Cost of goods sold (13,000 units @ $15.5555) $202,222
COMPARING INVENTORY METHODS Accounting B.com Part I Sindh,Karachi Board
COMPARING INVENTORY METHODS
The following table reveals that the amount of gross profit and ending inventory numbers appear quite different, depending on the inventory method selected:
The results above are consistent with the general rule that LIFO results in the lowest income (assuming rising prices, as was evident in the Gonzales example), FIFO the highest, and weighted average an amount in between. Because LIFO tends to depress profits, you may wonder why a company would select this option; the answer is sometimes driven by income tax considerations. Lower income produces a lower tax bill, thus companies will tend to prefer the LIFO choice. Usually, financial accounting methods do not have to conform to methods chosen for tax purposes. However, in the USA, LIFO “conformity rules” generally require that LIFO be used for financial reporting if it is used for tax purposes. Accounting theorists may argue that financial statement presentations are enhanced by LIFO because it matches recently incurred costs with the recently generated revenues. Others maintain that FIFO is better because recent costs are reported in inventory on the balance sheet. Whichever side of this debate you find yourself, it is important to note that the inventory method in use must be clearly communicated in the financial statements and related notes. Companies that use LIFO will frequently augment their reports with supplement data about what inventory would be if FIFO were instead used. No matter which method is selected, consistency in method of application should be maintained. This does not mean that changes cannot occur; however, changes should only be made if financial accounting is improved.
SPECIFIC IDENTIFICATION
As was noted earlier, another inventory method is specific identification. This method requires a business to identify each unit of merchandise with the unit’s cost and retain that identification until the inventory is sold. Once a specific inventory item is sold, the cost of the unit is assigned to cost of goods sold. Specific identification requires tedious record keeping and is typically only used for inventories of uniquely identifiable goods that have a fairly high per-unit cost (e.g., automobiles, fine jewelry, and so forth).
PERPETUAL INVENTORY SYSTEMS
All of the preceding illustrations were based on the periodic inventory system. In other words, the ending inventory was counted and costs were assigned only at the end of the period. A more robust system is the perpetual system. With a perpetual system, a running count of goods on hand is maintained at all times. Modern information systems facilitate detailed perpetual cost tracking for those goods.
PERPETUAL FIFO
The following table reveals the application of the perpetual inventory system for Gonzales — using a FIFO approach:
Two points come to mind when examining this table. First, there is considerable detail in tracking inventory using a perpetual approach; thank goodness for computers. Second, careful study is needed to discern exactly what is occurring on each date. For example, look at April 17 and note that 3,000 units remain after selling 7,000 units. This is determined by looking at the preceding balance data on March 5 (consisting of 10,000 total units (4,000 + 6,000)), and removing 7,000 units as follows: all of the 4,000 unit layer, and 3,000 of the 6,000 unit layer. Remember, this is the FIFO application, so the layers are peeled away based on the chronological order of their creation. In essence, each purchase and sale transaction impacts the residual composition of the layers associated with the item of inventory. Realize that this type of data must be captured and maintained for each item of inventory if the perpetual system is to be utilized; a task that was virtually impossible before cost effective computer solutions became commonplace. Today, the method is quite common, as it provides better “real-time” data needed to run a successful business. JOURNAL ENTRIES: The table above provides information needed to record purchase and sale information. Specifically, Inventory is debited as purchases occur and credited as sales occur. Following are the entries:
3-5-XX Inventory
96,000
Accounts Payable
96,000
Purchased $96,000 of inventory on account (6,000 X $16)
4-17-XX Accounts Receivable
154,000
Sales
154,000
Sold merchandise on account (7,000 X $22)
4-17-XX Cost of Goods Sold 96,000
Inventory
96,000
To record the cost of merchandise sold ((4,000 X $12) + (3,000 X $16))
9-7-XX Inventory
136,000
Accounts Payable
136,000
Purchased $136,000 of inventory on account (8,000 X $17)
11-11-XX Accounts Receivable
150,000
Sales
150,000
Sold merchandise on account (6,000 X $25)
11-11-XX Cost of Goods Sold
99,000
Inventory
99,000
To record the cost of merchandise sold ((3,000 X $16) + (3,000 X $17))
Let’s see how these entries impact certain ledger accounts and the resulting financial statements:
If you are very perceptive, you will note that this is the same thing that resulted under the periodic FIFO approach introduced earlier. So, another general observation is in order: The FIFO method will produce the same financial statement results no matter whether it is applied on a periodic or perpetual basis. This occurs because the beginning inventory and early purchases are peeled away and charged to cost of goods sold — whether the associated calculations are done “as you go” (perpetual) or “at the end of the period” (periodic).
PERPETUAL LIFO
LIFO can also be applied on a perpetual basis. This time, the results will not be the same as the periodic LIFO approach (because the “last-in” layers are constantly being peeled away, rather than waiting until the end of the period). The following table reveals the application of a perpetual LIFO approach. Study it carefully, this time noting that sales transactions result in a peeling away of the most recent purchase layers. The journal entries are not repeated here for the LIFO approach. Do note, however, that the accounts would be the same (as with FIFO); only the amounts would change.
MOVING AVERAGE
The average method can also be applied on a perpetual basis, earning it the name “moving average” approach. This technique is considerably more involved, as a new average unit cost must be computed with each purchase transaction. For the last time, we will look at the Gonzales Chemical Company data:
The resulting financial data using the moving-average approach are:
As with the periodic system, observe that the perpetual system produced the lowest gross profit via LIFO, the highest with FIFO, and the moving-average fell in between.
LOWER OF COST OR MARKET ADJUSTMENTS
Although every attempt is made to prepare and present financial data that are free from bias, accountants do employ a degree of conservatism. Conservatism dictates that accountants avoid overstatement of assets and income. Conversely, liabilities would tend to be presented at higher amounts in the face of uncertainty. This is not a hardened rule, just a general principle of measurement. In the case of inventory, a company may find itself holding inventory that has an uncertain future; meaning the company does not know if or when it will sell. Obsolescence, over supply, defects, major price declines, and similar problems can contribute to uncertainty about the “realization” (conversion to cash) for inventory items. Therefore, accountants evaluate inventory and employ “lower of cost or market” considerations.” This simply means that if inventory is carried on the accounting records at greater than its market value, a write-down from the recorded cost to the lower market value would be made. In essence, the Inventory account would be credited, and a Loss for Decline in Market Value would be the offsetting debit. This debit would be reported in the income statement as a charge against (reduction in) income.
MEASURING MARKET VALUE
Market values are very subjective. In the case of inventory, applicable accounting rules define “market” as the replacement cost (not sales price!) of the goods. In other words, what would it cost for the company to acquire or reproduce the inventory? However, the lower-of-cost-or-market rule can become slightly more complex because the accounting rules further specify that market not exceed a ceiling amount known as “net realizable value” (NRV = selling price minus completion and disposal costs). The reason is this: occasionally “replacement cost” for an inventory item could be very high (e.g., a supply of slide rules at an office supply store) even though there is virtually no market for the item and it is unlikely to produce much net value when it is sold. Therefore, “market” for purposes of the lower of cost or market test should not exceed the net realizable value. Additionally, the rules stipulate that “market” should not be less than a floor amount, which is the net realizable value less a normal profit margin. What we have then, is the following decision process:
Step 1: Determine Market — replacement cost, not to exceed the ceiling nor be less than the floor.
Step 2: Report inventory at the lower of its cost or market (as determined in step 1). To illustrate, consider the following four different inventory items, and note that the “cost” is shaded in light yellow and the appropriate “market value” is shaded in tan (step 1). The reported value is in the final row, and corresponds to the lower of cost or market:
APPLICATION OF THE LOWER-OF-COST-OR-MARKET RULE
Despite the apparent focus on detail, it is noteworthy that the lower of cost or market adjustments can be made for each item in inventory, or for the aggregate of all the inventory. In the latter case, the good offsets the bad, and a write-down is only needed if the overall market is less than the overall cost. In any event, once a write-down is deemed necessary, the loss should be recognized in income and inventory should be reduced. Once reduced, the Inventory account becomes the new basis for valuation and reporting purposes going forward. Write-ups of previous write-downs (e.g., if slide rules were to once again become hot selling items and experience a recovery in value) would not be permitted under GAAP.
NVENTORY ESTIMATION TECHNIQUES Accounting B.com Part I Sindh,Karachi Board
NVENTORY ESTIMATION TECHNIQUES
Whether a company uses a periodic or perpetual inventory system, a physical count of goods on hand should occur from time to time. The quantities determined via the physical count are presumed to be correct, and any differences between the physical count and amounts reflected in the accounting records should be matched with an adjustment to the accounting records. Sometimes, however, a physical count may not be possible or is not cost effective. Then, estimation methods are employed.
GROSS PROFIT METHOD
One such estimation technique is the gross profit method. This method might be used to estimate inventory on hand for purposes of preparing monthly or quarterly financial statements, and certainly would come into play if a fire or other catastrophe destroyed the inventory. Such estimates are often used by insurance companies to establish the amount that has been lost by an insured party. Very simply, a company’s historical normal gross profit rate (i.e., gross profit as a percentage of sales) would be used to estimate the amount of gross profit and cost of sales. Once these data are known, it is relatively simple to project the lost inventory. For example, assume that Tiki’s inventory was destroyed by fire. Sales for the year, prior to the date of the fire were $1,000,000, and Tiki usually sells goods at a 40% gross profit rate. Therefore, Tiki can readily estimate that cost of goods sold was $600,000. Tiki’s beginning of year inventory was $500,000, and $800,000 in purchases had occurred prior to the date of the fire. The inventory destroyed by fire can be estimated via the gross profit method, as shown.
RETAIL METHOD
A method that is widely used by merchandising firms to value or estimate ending inventory is the retail method. This method would only work where a category of inventory sold at retail has a consistent mark-up. The cost-to-retail percentage is multiplied times ending inventory at retail. Ending inventory at retail can be determined by a physical count of goods on hand, at their retail value. Or, sales might be subtracted from goods available for sale at retail. This option is shown in the following example. To illustrate, Crock Buster, a specialty cookware store, sells pots that cost $7.50 for $10 — yielding a cost to retail percentage of 75%. The beginning inventory totaled $200,000 (at cost), purchases were $300,000 (at cost), and sales totaled $460,000 (at retail). The calculations suggest an ending inventory that has a cost of $155,000. In reviewing these calculations, note that the only “givens” are circled in yellow. These three data points are manipulated by the cost to retail percentage to solve for several unknowns. Be careful to note the percentage factor is divided within the red arrows and multiplied within the blue.
Whether a company uses a periodic or perpetual inventory system, a physical count of goods on hand should occur from time to time. The quantities determined via the physical count are presumed to be correct, and any differences between the physical count and amounts reflected in the accounting records should be matched with an adjustment to the accounting records. Sometimes, however, a physical count may not be possible or is not cost effective. Then, estimation methods are employed.
GROSS PROFIT METHOD
One such estimation technique is the gross profit method. This method might be used to estimate inventory on hand for purposes of preparing monthly or quarterly financial statements, and certainly would come into play if a fire or other catastrophe destroyed the inventory. Such estimates are often used by insurance companies to establish the amount that has been lost by an insured party. Very simply, a company’s historical normal gross profit rate (i.e., gross profit as a percentage of sales) would be used to estimate the amount of gross profit and cost of sales. Once these data are known, it is relatively simple to project the lost inventory. For example, assume that Tiki’s inventory was destroyed by fire. Sales for the year, prior to the date of the fire were $1,000,000, and Tiki usually sells goods at a 40% gross profit rate. Therefore, Tiki can readily estimate that cost of goods sold was $600,000. Tiki’s beginning of year inventory was $500,000, and $800,000 in purchases had occurred prior to the date of the fire. The inventory destroyed by fire can be estimated via the gross profit method, as shown.
RETAIL METHOD
A method that is widely used by merchandising firms to value or estimate ending inventory is the retail method. This method would only work where a category of inventory sold at retail has a consistent mark-up. The cost-to-retail percentage is multiplied times ending inventory at retail. Ending inventory at retail can be determined by a physical count of goods on hand, at their retail value. Or, sales might be subtracted from goods available for sale at retail. This option is shown in the following example. To illustrate, Crock Buster, a specialty cookware store, sells pots that cost $7.50 for $10 — yielding a cost to retail percentage of 75%. The beginning inventory totaled $200,000 (at cost), purchases were $300,000 (at cost), and sales totaled $460,000 (at retail). The calculations suggest an ending inventory that has a cost of $155,000. In reviewing these calculations, note that the only “givens” are circled in yellow. These three data points are manipulated by the cost to retail percentage to solve for several unknowns. Be careful to note the percentage factor is divided within the red arrows and multiplied within the blue.