Factor Pricing1

8/9/2019 Factor Pricing1

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Factor Pricing

Presented by:-1. Priti Uikey(860)

2. Pranali Thote(858)

3.Varshrani lakade(823)


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Introduction of topic

Theory of factor pricing.

Rent

Wages & interest

Capital Budgeting


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Theory of factor pricing

The Theory of Factor Pricing is concerned with theevaluation of the services of the factors of production.

It deals with the determination of the share prices of four

factors of production, e.g. land, labor, capital andenterprise.


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A B CC D E

CapitalLabourLand

Commodities

Factor-inputs

Relation between product theory &

factor-input


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Price determination in factor

market

The Basic principle of price mechanism is Theprice of factor service is determined by itsdemand & supply.

Demand for factor service:

Demand for factors is a Derived Demand

Derived Demand: factorservice is demandednot for its own sake but due to demand forgood that it produce.

Ex: increased demand for s/w solutions resultsin increased demand for s/w engineers.


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Marginal productMarginal product can measured both in

Physical unit& in term ofrevenuegenerated for the firm.

Marginal Physical Productivity:(MPP)

Addition to total product (in physical unit)

due to use of additional unit of variablefactor.

MPPN= TPPN-TPPN-1

MPPN = TPP

F Where F stand for factor service


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Marginal Revenue productivity(MRP)

Addition to the revenue product of firm due to useof additional unit of variable factor.

MRPN = TRP

F where TRP= TPP X P

MRPN=MPPN X P .

In perfect competition p= MR

Therefore , In perfect competitive market,

MRPN=MPPN X MR


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Marginal Revenue curve

0

Y

X

ARP

MRP

Output

Quantity of variable inputs


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factor demandElasticity of Demand for Factors

If factor price form small portion of total cost so itsdemand will be inelastic and vice versa

Depends upon the elasticity of demand for commodity.

If factor is easily substitutable then demand will be elastic

Supply of Factors of ProductionThe supply of factors of production is a complicated

topic but still it can be said that the higher the price ofa factor of production, other things remaining the

same, the greater will be its supply and vice versa.


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Rent:Rental incomeEconomic rentTheory of rent

1.Ricardian theory of rent2.Modern theory of rent


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Rental Income


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The income earned per unit of land or capital.

Depending Factors:vThe level of demand for factor MRP which depend

on MPP & demand for good it produces i.eGoods MR.

vThe elasticity of demand for the good:

Demand is less elastic for product whose

production the factor is used higher would berental income ,& vice versa.

vThe elasticity of supply of factor:

As supply of factor is less elastic ,

1.More factor owner can gain from high demand.

2.economical level is also become high.

vThe total factor supply by other factor owner:

As the level of economic rent is higher ,each unit offactor can earn from any given level demand.


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Economic Rent

Economic rent is nothing but producers surplus. Surplus = Actual income profit or min.

income

Total return obtained by selling the product of plot

of land is more than total cost of cultivation, theowner of land earn surplus income is in nature ofeconomic rent.


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Continue.

Economic rents 3 forms:

1.Differential rent:

Difference in quality of different land.

Surplus of fertile land is more than less fertile land.

Scarcity rent:

Supply of factor is less then its demand.

Situational Rent:

Plot of land possess advantage over other.


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Ricardian Theory of rent It was Propounded by David Ricardo

It believes that rent accrues to superior plot ofland that possess some Differentialadvantages like fertility or situation overother land .

The surplus is define as economic rent. Economic rent arises under extensive &

intensive cultivation. In extensive cultivation ,rent arise due to

differences in fertility of different plot of land. In intensive cultivation, rent arise due to

difference in productivity of different doses oflabour & capital .


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Modern theory of rent Factor inputs whose supply is not perfectly elastic earn

surplus income. Surplus = Actual earning Transfer earning

Actual earning of factor service :Determined by its Market demand & Market

Supply.Market price = price where demand and

supply is equal.This Market price represents actual earning.Transfer earning of factor service:The price which is necessary to be paid to

retain given unit of factor in certain industry.Define by minimum supply price of factor input.


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Continue.

Type of factor inputs: Specific :Less Use in alternative occupation, supply is

limited.Low opportunity cost(transfer earning) but

high market priceEx: actors, cricketersNon specific:

Commonly used in any occupations.Low opportunity cost & low market price.Ex: delivery boys.


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Economic rent & elasticity of supply Perfectly elastic supply:

ss

E

dd

Q

p

o

Quantity of factor input

Price

offactori n

put

Actual Earning=Transfer earning

Actual earning= OQEP

Transfer earning= OQEP


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Perfectly Inelastic supply:

E

dd

Q

p

o


Price

offactori n

put

Actual Earning=economic rent

Actual earning= OQEP

Transfer earning= 0

ss


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elastic supply:

E

dd

Q

p

o


Price

offactori n

put

Transfer earning

ssEconomic

rent

Economic rent=OQEP-OQET=PET


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Wage & Interest

Presented by:

Pranali thote(858)


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WAGES

DEFINITION The payment made for the services of labour

is called wages.TYPES OF WAGES

Nominal Wage The amount of money paid tolabour as a reward for his service is callednominal wage.

Real Wage The amount of goods and

services the labourer can get with his moneywage is called the real wage.


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Real wage depends upon the followingfactors :-

The amt of money wage multiplied by thepurchasing power of money.

The amt of extra facilities given by the employer.

The conditions of services.e.g. length of working period, regularity irregularity

of employment, agreeableness or disagreeablenessof the environment.

The possibility of extra earnings.


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Wage DifferentialsWage rates differ as between different

occupations, countries and times.

Different occupations arise due to followingfactors:-

Agreeableness or disagreeableness of thejob

The cost of training

The regularity of employment

Differences in ability

Opportunities for spectacular earnings

Relative social prestige


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Wage differentials as between different countries

arise due to immobility of labour. Wages differentials as between different times are

caused by the differences in the demand andsupply conditions.


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Wage Theories

Different theories of wage determination have beenproposed from time to time.

Some theories like Subsistence theory, Standard ofliving theory, Wages fund theory, Marginal

productivity theory. But modern economists prefer the demand and

supply mechanism.


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Demand & Supply Theory

Demand For Labour the schedule of units of

labour that firms would be willing to employ at allconceivable prices during a given time period.

Depends upon Following Factors:

Derived demand :- Demand for labour is derived

from the demand for the commodity which ithelps to produce.

Productivity of Labour :- A firm demands labourbecause it contributes to production.

Degree of substitutability :- how far capital is agood substitute for labour & the relative prices.


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Supply Of Labour - the schedule of units of labourthat workers would be willing to offer at eachconceivable price.

Depends upon Following Factors:

Economic Factors:- Labour is natural human instinct, hence work is a

sacrifice of leisure. Wage is an inducement thatmakes labour undergo this sacrifice.

Non-economic Factors:- Inertia may develop on account of certain non-

monetary advantages of some occupations. Size of population and its composition.


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E

Wage

-Ra

te

W

D

S

0 Q X

Y

Units of labour

S D


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interestDEFINITION Interest is the price which a borrower has to pay

for the use of capital.TYPES OF INTERESTqGross Interest

The total amount of money paid by aborrower to the lender for the use of

capital is called gross interest. Gross interest contains elements other

than the price, like Payment for riskand Payment for effort andinconvenience.

q

qN t I t t


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qNet Interest Compensation are deducted from the gross

interest, and the balance left out is known as

net interest. Interest Rate Differentials:Interest rates vary from market to market &

types of loans.

Responsible Factors For Multiplicity of rates:

The money market is not homogenous.

According to the period of the loan.

According to the nature of the security.

Because of differences in demand andsupply conditions.


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Capital budgeting

Present by: Varashrani lakade(823)


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Capital Budgeting

a process of conceiving, generating, evaluating &

selecting the most profitable projects for investingthe funds available to the firms.

It plays a vital role in assisting most business firmsto achieve their various goals, e.g. Profitability

growth, stability ,risk reduction, social goals etc.


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Concept of Capital Budgeting

Capital Budgeting consists of the entire process ofplanning expenditure whose returns are expected toextend beyond one year.

Proposals for capital assets or capital outlays are groupedin the following categories:

Replacements. Expansion: additional capacity in existing product lines.

Expansion: new product lines. Modernization of investments. Diversification of product lines & markets for producing a

new product. Strategic investment proposals. Rent or buy decision, viz., whether to hire machines or buy

them for the purpose of production. Important outlays, such as cost of training programmers &

revenue generation projects.


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Need of Capital Budgeting

for the future development of the business, visualized inadvance.

Big economics of plant size may make it desirable to

build capacity in anticipation of growth of demand.

There is usually a long gestation period between thetime the project is planned & the time the plant goesinto operation.

Sources of capital also usually require several months ofadvance planning.


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Nature of Capital Budgeting Problem

The Capital Budgeting problem consists broadly of threequestions as follows:

1.

2.How much money will be needed for expenditures in thecoming period?

3.How much money will be available?

4.How should the available money be doled out tocandidate projects?

The first question is that ofdemand for capital.

The second question relates to that ofsupply of capital.

The third question is that ofCapital rationing.


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Demand for Capital

capital budgeting relates to need or demand for capital.

It arises from the demand for goods & services thatcapital can produce.

It refers to the amount which a firm would like to invest,given the cost of capital & the return on investment.

It depends on its productivity & its cost.

objective of capital expenditures is to make profits.

Thus, this problem involves :

1.Anticipated needs:

Built-up for smallest operating unit of organization.

Built-up as an integral part of annual budgets or generaldevelopment plans for a longer period.


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Demand for Capital(Cont.)

2. Prospective Profitability: The crucial element in

estimating the demand for capital is the prospectiveyield or the rate of return.

Principles are:

Source of Productivity: Direct sources are Cost savings& Sales expansion.

Individual Project earnings:

Future Profits:

Appropriate Alternative:

Economic Life of an asset:

Discounting:

Average amount outlay:

a.


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Supply of Capital

This problem has two parts:

A. How much can be raised internally from depreciationplus retained earnings?

B. How much will be obtained by outside financing?

i.e.

Sources of Capital & Cost of Capital

1.Internal Sources

2.External Sources

Sources of Capital


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Internal Sources

Internal source of capital is firms own saving.Internal savings are generated in two ways

-by depreciation charges & -by retained earnings.

The main task in regard to raising internal fundsare:

To forecast how much cash will be generatedinternally.

to decide how much cash to pay out individends.

deciding the amount for long-term investment.


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External SourcesThe external source of capital supply is Capital market. ways of raising funds from the capital market are-

a)Sales of bonds: The firms may borrow funds directly fromthe capital market by selling some kind of bonds. e.g.mortgage & debenture bonds.

b)

c)Issuing new shares of common stock(or equity shares): a

company can raise finance by issuing new commonstocks depends, among other things, on liking ordisliking of old stockholders.

d)

e)Preferred stocks: preferred stockholders get preferences

over common or equity stockholders in the payment ofdividend.

f)

g)Convertible securities, direct loans, etc:

a)


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Cost of Capital ratio of prospective earnings per share to the selling price

for new share.

Capital is a scarce & productive commodity.

Every scarce & useful commodity has a price, capital hasa price too, termed as cost of capital.

It may be explicit or implicit.

explicit cost of capital is the interest paid on it.

implicit cost is the expected return from the second bestuse of money capital.


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Capital Rationing

Capital Rationing is central in the planning and control ofcapital expenditures, since demand for funds normallyexceeds supply.

Capital Rationing arises when the firm sets an absolutelimit on the size of its capital budget in any one yearand this limit is less than the level of investment thatwould be undertaken.


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Capital Budgeting: Risk & Uncertainty Concept of Certainty: the decision-maker has perfect

knowledge of the environment & the result of whateverdecision he might take.

Concept of Risk: the storage of knowledge in which eachalternative leads to a set of outcomes, each outcomeoccurring with a probability that is known to the decisionmaker.

Risk is the chance that the actual outcome may differfrom the expected outcome.

Concept of Uncertainty: It is a state in which one or morealternatives result in a set of possible specific outcomes

whose probabilities are either not known or not meaningful. It is subjective phenomenon.

E.g. 1.Life of new plant & future maintenance areunpredictable.

2.Technological changes are highly unpredictable.


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