Month: December 2020

Management Notes

Henry Fayol’s 14 Principles of Management

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Henri Fayol, a French mining engineer and management theorist, is renowned for his development of the 14 Principles of Management. These principles form a significant part of his administrative theory, which aimed to establish a comprehensive framework for effective management in organizations. In his 1916 book General and Industrial Management, Fayol argued that managerial practices are universal and can be applied to all types of organizations.

Fayol’s principles provide a foundation for modern management, emphasizing the role of planning, organizing, leading, and controlling within an organization.

  1. Division of Work

The principle of division of work emphasizes specialization and efficiency. Fayol argued that by dividing tasks into smaller, more manageable units, workers can develop expertise in a specific area, leading to increased productivity and better performance. Specialization allows employees to perform tasks more efficiently, reducing time and effort, while also improving accuracy and skill development.

For example, in a manufacturing environment, workers who specialize in specific production processes, such as assembly or quality control, can complete their tasks more effectively than generalists who perform a variety of roles.

  1. Authority and Responsibility

According to Fayol, authority and responsibility go hand in hand. Authority is the right to give orders and expect obedience, while responsibility refers to being accountable for fulfilling assigned duties. Fayol argued that managers must have the authority to issue commands but must also bear the responsibility for ensuring that their directives are carried out effectively.

Effective management requires a balance between authority and accountability to maintain discipline and achieve organizational goals.

  1. Discipline

Discipline is essential for the smooth functioning of an organization. Fayol believed that discipline involves obedience, respect for authority, and adherence to established rules and regulations. Clear and fair policies, consistent enforcement, and mutual respect between employees and management help maintain discipline.

Organizations with strong disciplinary systems tend to have more engaged employees and efficient operations.

  1. Unity of Command

The principle of unity of command states that each employee should report to only one superior. Fayol argued that if an employee receives orders from multiple sources, it leads to confusion, conflict, and inefficiency. This principle ensures that communication is clear and that employees understand their specific responsibilities.

By maintaining a clear chain of command, organizations can avoid contradictory instructions and reduce the likelihood of misunderstandings.

  1. Unity of Direction

Unity of direction emphasizes that all members of the organization should be aligned toward the same objectives, with a common plan for achieving them. This principle ensures that everyone in the organization works together toward shared goals, avoiding fragmentation and inefficiency.

For example, in a marketing department, all team members should work toward increasing brand awareness, rather than pursuing individual or conflicting objectives.

  1. Subordination of Individual Interests to General Interest

Fayol believed that the interests of the organization should take precedence over the interests of individual employees. While individual goals and aspirations are important, the collective success of the organization must be prioritized. Fayol stressed that managers must align individual interests with organizational goals to ensure that personal ambitions do not interfere with the company’s success.

This principle fosters a sense of collective responsibility and encourages employees to work for the greater good of the organization.

  1. Remuneration

Remuneration refers to fair compensation for employees’ efforts. Fayol argued that wages should be equitable and based on factors such as skill, effort, responsibility, and performance. Fair remuneration serves as a motivator for employees and contributes to job satisfaction and organizational loyalty.

Fayol also believed in offering both financial and non-financial rewards to motivate employees.

  1. Centralization

Centralization refers to the degree to which decision-making authority is concentrated at the top levels of management. Fayol recognized that the optimal level of centralization varies depending on the organization’s size, nature, and circumstances. In highly centralized organizations, top management retains most decision-making authority, while decentralized organizations delegate authority to lower-level managers.

The key is to strike the right balance between centralization and decentralization to ensure that decisions are made efficiently while maintaining overall organizational control.

  1. Scalar Chain

The scalar chain refers to the hierarchy or chain of command within an organization. Fayol argued that a well-defined hierarchy ensures that authority flows from the top levels of management to the bottom, and that communication follows a clear path. This structure provides a framework for decision-making and accountability.

Fayol also advocated for “gangplank” communication, allowing for direct communication between employees at the same level to avoid delays caused by following the scalar chain rigidly.

  1. Order

Order refers to the organization and arrangement of resources, including people and materials, in the workplace. Fayol believed that every resource should have a specific place and function, ensuring that everything is in its proper position. This principle promotes efficiency by reducing confusion and delays in operations.

In a well-ordered organization, the right person is in the right job, and materials are placed where they are easily accessible when needed.

  1. Equity

Equity involves treating employees fairly and with respect. Fayol believed that fairness should govern all managerial actions, as employees are more motivated and loyal when they feel valued and respected. Equity encourages a harmonious workplace, where employees are treated justly in terms of pay, opportunities, and recognition.

Managers must strive to create an atmosphere of kindness and justice, ensuring that all employees are treated equally regardless of rank or position.

  1. Stability of Tenure of Personnel

Fayol emphasized the importance of retaining employees for a stable workforce. High employee turnover can be disruptive and costly for organizations, as it requires time and resources to train new workers. By promoting stability in the workforce, organizations can benefit from employees’ accumulated skills and experience.

Long-term employment contributes to improved productivity, as employees become more proficient in their roles over time.

  1. Initiative

Fayol believed that managers should encourage employees to take initiative and contribute their ideas to the organization. When employees are allowed to express their creativity and take initiative, they feel more engaged and motivated. This principle fosters innovation, as employees are more likely to suggest improvements to processes and products.

Managers should create an environment where employees feel empowered to propose new ideas and take ownership of their work.

  1. Esprit de Corps

Esprit de corps refers to promoting team spirit and unity within the organization. Fayol argued that a strong sense of camaraderie and mutual respect among employees leads to higher morale and greater productivity. Managers should focus on building a sense of community within teams and fostering a positive work culture.

By encouraging teamwork and open communication, managers can create a cohesive and motivated workforce that works together toward shared goals.

Management Notes

Key differences between Management and Administration

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Management refers to the process of planning, organizing, leading, and controlling resources—such as people, finances, and materials—to achieve specific goals efficiently and effectively. It involves setting objectives, developing strategies, coordinating tasks, and making informed decisions to guide an organization or group toward success. Management also entails motivating employees, resolving conflicts, and ensuring that resources are used optimally. It plays a critical role in both day-to-day operations and long-term strategic planning, aiming to balance productivity with innovation and adaptability in a constantly changing environment.

Characteristics of Management:

  1. Goal-Oriented Process

Management is primarily a goal-oriented activity. It is focused on achieving specific organizational objectives, whether they are financial, operational, or related to employee welfare. Managers set clear, measurable goals and work systematically to achieve them. Without defined goals, management lacks direction and purpose. The entire process of planning, organizing, leading, and controlling revolves around achieving these objectives efficiently and effectively.

  1. Pervasive Function

Management is a universal function present in every type of organization—business, government, education, and non-profit institutions. Regardless of the size or nature of the organization, management is necessary to ensure that resources are used efficiently and objectives are met. It exists at all levels of the organization, from top-level strategic decision-making to operational management at the ground level. This pervasive nature makes management a critical function in every organization, regardless of industry or purpose.

  1. Multidimensional

Management is multidimensional in nature, involving the management of work, people, and operations. First, it includes managing the work or tasks that need to be accomplished. Second, it involves managing people, which requires interpersonal skills, communication, and leadership to guide and motivate employees. Lastly, it covers managing operations, which includes processes, technology, and the physical resources required to produce goods or services. These dimensions are interconnected and require managers to be versatile and skilled in multiple areas.

  1. Continuous Process

Management is not a one-time activity but an ongoing process. Managers continuously plan, execute, and evaluate strategies and operations to ensure that the organization stays on course to achieve its goals. As internal and external environments change, managers need to revisit and adjust their plans to accommodate new challenges and opportunities. This dynamic nature makes management a continuous process, requiring ongoing attention and adaptation.

  1. Dynamic Function

Management is dynamic because it must adapt to the ever-changing business environment. Economic conditions, technological advancements, customer preferences, and legal requirements are always evolving. As a result, management practices need to be flexible and adaptable to respond effectively to these changes. A static management approach would fail in a competitive and volatile environment, so managers must continuously innovate and adjust strategies to stay relevant and successful.

  1. Group Activity

Management is inherently a group activity. It involves coordinating and guiding people to work together towards a common goal. Effective management ensures that the collective efforts of individuals are aligned with organizational objectives. This requires fostering collaboration, communication, and teamwork among employees, as well as aligning individual goals with the organization’s mission. Management also ensures that the roles and responsibilities of each team member are clearly defined to avoid confusion and promote accountability.

  1. Intangible Force

Although management produces tangible results, the process itself is intangible. It cannot be physically seen, but its presence is felt through the smooth operation of the organization. The quality of management is reflected in organizational success, employee morale, and the achievement of objectives. A well-managed organization will have a positive work environment, efficient operations, and satisfied stakeholders, even though management as a process remains unseen.

  1. Decision-Making Process

Management heavily relies on decision-making. Managers are constantly required to make decisions, whether they are related to resource allocation, employee management, strategy implementation, or customer relations. Effective decision-making involves analyzing data, assessing risks, weighing alternatives, and choosing the best course of action. Decisions impact every aspect of the organization, making it crucial for managers to be skilled in making informed and timely decisions that contribute to organizational success.

  1. Interdisciplinary Nature

Management draws knowledge and concepts from various disciplines such as economics, psychology, sociology, finance, and information technology. A manager needs to be familiar with these fields to handle the diverse range of challenges faced by modern organizations. For example, understanding human behavior helps in managing employees, while knowledge of finance is essential for resource allocation and budgeting. This interdisciplinary nature makes management a broad and versatile field that incorporates multiple areas of expertise.

Administration

Administration refers to the process of formulating policies, setting objectives, and overseeing the overall governance of an organization or institution. It involves high-level decision-making, focusing on strategic planning, resource allocation, and the establishment of guidelines to ensure smooth functioning. Unlike management, which deals with the execution of plans, administration is concerned with defining the framework within which management operates. Administrators are responsible for setting organizational goals, maintaining control over operations, and ensuring that the organization adheres to legal, ethical, and policy-based standards while achieving long-term objectives.

Characteristics of Administration:

  1. Policy-Making Function

Administration primarily deals with the formulation of policies and plans for the organization. Administrators set the overall direction by deciding the goals and guidelines that govern how the organization will operate. These policies provide a framework for the management team to execute day-to-day tasks. Thus, the core function of administration is to establish a long-term vision and develop the rules and procedures to achieve it.

  1. Top-Level Activity

Administration is a top-level activity, typically carried out by the highest-ranking executives or board of directors. This level of responsibility involves overseeing the entire organization and making decisions that affect its overall direction. While management focuses on operational tasks, administration focuses on strategic planning and ensuring that the organization moves in the right direction to meet its goals.

  1. Strategic in Nature

Administration is strategic, focusing on the long-term growth, development, and sustainability of the organization. It involves decisions related to overall organizational policies, resource allocation, and the external environment. Administrators consider factors like market trends, governmental policies, and economic conditions to set a strategic course for the future. This strategic nature distinguishes administration from management, which is more tactical and operational.

  1. Goal Setting

One of the core responsibilities of administration is to set the organization’s objectives. Administrators determine what the organization aims to achieve in the long run, such as financial goals, market expansion, or social impact. Once these goals are established, they guide the organization’s operations and serve as benchmarks for success. The clear definition of goals ensures that all activities align with the overall mission of the organization.

  1. Coordination of Resources

Administration involves the coordination of all resources—human, financial, and material—to achieve organizational objectives. Administrators ensure that resources are allocated efficiently across departments and projects to meet strategic goals. This requires balancing priorities, managing budgets, and ensuring that the right resources are available at the right time.

  1. Decision-Making

A critical characteristic of administration is decision-making, particularly at the strategic level. Administrators make high-level decisions that shape the future of the organization, such as mergers, acquisitions, new market entry, or changes in organizational structure. These decisions are based on an analysis of internal capabilities and external factors like competition and regulatory requirements. Effective decision-making in administration ensures the long-term success of the organization.

  1. Bureaucratic Framework

Administration typically operates within a bureaucratic framework, meaning it is characterized by formal rules, hierarchies, and structured procedures. This framework ensures that policies are implemented consistently throughout the organization. A clear chain of command and defined roles make it easier to enforce policies, maintain accountability, and ensure that administrative functions are carried out systematically.

  1. Control and Regulation

Administration is responsible for maintaining control over organizational processes by ensuring adherence to policies and standards. It sets up monitoring and evaluation systems to assess performance, ensure compliance, and implement corrective measures when necessary. The control function of administration ensures that all departments and activities align with the organization’s strategic goals and regulatory requirements.

  1. Interdisciplinary Approach

Like management, administration draws from various disciplines such as economics, law, political science, and sociology. This interdisciplinary approach is necessary because administrators deal with complex and diverse issues that require knowledge from multiple fields. For instance, understanding legal frameworks helps administrators comply with regulatory policies, while knowledge of economics aids in budgeting and resource allocation.

Key differences between Management and Administration

Basis of Comparison Management Administration
Focus Execution Policy-making
Nature Doing Thinking
Scope Operational Strategic
Decision-making Middle & lower levels Top-level
Objective Profit maximization Welfare
Function Active Passive
Control Internal (employees) External (owners)
Approach Result-oriented Process-oriented
Authority Limited Broad
Discipline Practical Theoretical
Skills Technical Conceptual
Influence Direct Indirect
Responsibility Middle/lower level Top level
Flexibility More Less
Focus Area Business activities Organizational goals
Management Notes

Management as a Science, as an Art and as a Profession

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Management is a multidimensional field that incorporates principles from both science and art, while also evolving into a recognized profession. This classification reflects its systematic, creative, and increasingly specialized nature.

Management as a Science:

Science is characterized by systematic knowledge, organized principles, and a cause-and-effect relationship. It involves the use of logical, rational approaches to problem-solving and decision-making. For management to be considered a science, it must meet certain criteria: it should be based on universally accepted principles, derived from empirical evidence, and capable of being tested under various conditions.

  1. Systematic Body of Knowledge

Management, as a science, is built on a systematic body of knowledge that includes established theories, models, and principles. These principles guide managers in decision-making and organizational operations. Concepts such as Frederick Taylor’s scientific management, Henry Fayol’s administrative theory, and Max Weber’s bureaucratic management reflect the application of scientific principles to manage people, resources, and processes efficiently. These principles have been tested in various organizations and situations, yielding predictable outcomes, much like scientific experiments.

  1. Universal Principles

Management is based on universally accepted principles such as division of labor, authority and responsibility, and unity of command. These principles, when applied correctly, tend to produce similar results regardless of the industry or geographical location. For instance, the principle of specialization (division of labor) has been shown to improve productivity in factories, service industries, and even in high-level corporate settings.

  1. Empirical and Evidence-Based

Like science, management relies on observation and experimentation. Management theories are derived from real-world experiences and research. For example, scientific management evolved from studies on productivity in the industrial era. Similarly, the contingency theory of management arose from empirical studies showing that no one-size-fits-all approach works for every organization. Managers rely on data and analytics to make informed decisions, indicating that management has a strong scientific foundation.

Limitations as a Science

While management has many scientific aspects, it is not a pure science like physics or chemistry, where outcomes are certain. In management, human behavior is unpredictable, and organizations operate in dynamic environments. Therefore, while management uses scientific methods, the presence of variables such as emotions, culture, and leadership styles can lead to different outcomes, reducing its precision compared to the natural sciences.

Management as an Art:

Art is the expression of creativity, intuition, and subjective judgment. It focuses on achieving desired results through personal skills, insights, and expertise. Management, as an art, requires a creative and personalized approach to dealing with people and situations. Successful managers often rely on their experience, judgment, and intuition to navigate complex environments.

  1. Personal Skills and Creativity

Management, as an art, requires personal expertise, creativity, and innovation. Managers must adapt general principles to specific situations, crafting strategies tailored to their organization’s unique needs. This is where creativity comes into play. For instance, while the principle of motivation may be universal, how a manager motivates a sales team versus a research team may differ significantly. Leadership styles, communication techniques, and conflict resolution strategies all require an element of art in their execution. Effective managers blend the science of management with personal style, emotional intelligence, and people skills.

  1. Judgement and Intuition

In art, individuals apply their judgment and intuition, which cannot be replicated or standardized. Similarly, managers often rely on their gut feeling or intuition when making decisions, especially when facing uncertainty. For example, when a manager decides to enter a new market or hire a particular candidate, scientific principles might guide their thinking, but ultimately, the decision may hinge on the manager’s personal judgment or intuition.

  1. Flexibility and Adaptation

Management is not a rigid practice. Managers must be flexible and adaptive, tailoring their approach to fit the changing dynamics of the business environment. In art, creativity lies in interpreting and expressing in varied ways. Likewise, in management, a successful manager must innovate and adapt strategies to suit the specific context, whether it’s handling a crisis, managing a diverse workforce, or steering through market disruptions.

Limitations as an Art:

The artistry in management comes from personal experience and innate skills, but it also means that results may vary greatly. Not every manager will apply the same principles with the same level of success. Hence, management as an art lacks the replicability and consistency of a science. Furthermore, reliance on intuition and creativity alone can sometimes lead to unsystematic or inconsistent decisions.

Management as a Profession:

Profession is defined by specialized knowledge, formal education, a code of ethics, and social recognition. As management has developed over time, it has increasingly taken on the characteristics of a profession.

  1. Specialized Knowledge

Management has become a formal discipline with its own body of knowledge, methods, and tools. This knowledge is imparted through formal education and specialized training programs, such as MBA (Master of Business Administration) degrees, which aim to develop managerial skills in areas like finance, marketing, human resources, and operations.

  1. Formal Training and Qualification

Management is now recognized as a field that requires formal training and education. Business schools, universities, and professional associations offer programs designed to equip aspiring managers with the skills needed to succeed. The rise of certifications like Project Management Professional (PMP) or Chartered Manager (CMgr) demonstrates the growing demand for professional qualifications in management.

  1. Code of Ethics

Many professional management bodies, such as the American Management Association (AMA) or the Institute of Management Consultants (IMC), require their members to adhere to a code of ethics. Ethical behavior is increasingly becoming a cornerstone of managerial practice. Managers are expected to demonstrate responsibility, fairness, and transparency in their decision-making, ensuring accountability to both their organization and society.

  1. Social Recognition

Over time, management has gained recognition as a profession with an important social role. Managers play a critical part in shaping organizations, economies, and even societal progress. The demand for skilled and ethical managers in every sector underscores management’s professional status.

Limitations as a Profession:

While management has many characteristics of a profession, it is still evolving. Unlike professions such as medicine or law, there is no strict licensing requirement for managers. Although formal education is highly valued, it is not mandatory, and many successful managers thrive based on experience and innate skills rather than formal qualifications. Additionally, management lacks a single unified professional body that governs all aspects of the field.

University of Mumbai BMS Notes

Meaning and Definitions of Administration

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The Administration is a set of procedures for administering Management in a company. It consists of a number of steps and ways in order to build efficient programs, policies, and systems within an organization that will be followed to manage operations.

The fundamental role of the Administration is to lay the framework for the Organization. This framework is used by the Management to build plans and execute orders. Administration represents the top level of management professionals in a company. Usually, these are the business owners or the CEO of a company.

Simply put, management can be understood as the skill of getting the work done from others. It is not exactly same as administration, which alludes to a process of effectively administering the entire organization. The most important point that differs management from the administration is that the former is concerned with directing or guiding the operations of the organization, whereas the latter stresses on laying down the policies and establishing the objectives of the organization.

Broadly speaking, management takes into account the directing and controlling functions of the organization, whereas administration is related to planning and organizing function.

With the passage of time, the distinction between these two terms is getting blurred, as management includes planning, policy formulation, and implementation as well, thus covering the functions of administration. In this article, you will find all the substantial differences between management and administration.

The administration is a systematic process of administering the management of a business organization, an educational institution like school or college, government office or any nonprofit organization. The main function of administration is the formation of plans, policies, and procedures, setting up of goals and objectives, enforcing rules and regulations, etc.

Administration lays down the fundamental framework of an organization, within which the management of the organization functions.

The nature of administration is bureaucratic. It is a broader term as it involves forecasting, planning, organizing and decision-making functions at the highest level of the enterprise. Administration represents the top layer of the management hierarchy of the organization. These top-level authorities are the either owners or business partners who invest their capital in starting the business. They get their returns in the form of profits or as a dividend.

Constituents of Administration are:

  • Formations of all company policies.
  • Framing the plan of actions for various objectives of a company.
  • Setting the goals for all departments in the Organization.
  • Enforcing the rules and regulations within the Organization.
University of Mumbai BMS Notes

Capital Market, Money Market

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The capital market encompasses the trade in both stocks and bonds. These are long-term assets bought by financial institutions, professional brokers, and individual investors.

The capital market is where stocks and bonds are traded. Its movements from hour to hour are constantly monitored and analyzed for clues to the health of the economy at large, the status of every industry in it, and the consensus for the short-term future.

The overriding goal of the companies institutions that enter into the capital markets is to raise money for their long-term purposes, which usually come down to expanding their businesses and increasing their revenues. They do this by issuing stock shares and by selling corporate bonds.

Money Market

The money market is the trade in short-term debt. It is a constant flow of cash between governments, corporations, banks, and financial institutions, borrowing and lending for a term as short as overnight and no longer than a year.

The money market is a good place for individuals, banks, other companies, and governments to park cash for a short period of time, usually one year or less. It exists so that businesses and governments that need cash to operate can get it quickly at a reasonable cost, and so that businesses that have more cash than they need can put it to use.

 Capital market

 Money market
 Liquidity  Capital market securities are considered liquid because of stock exchange but compared to money market instruments these are less liquid.  Money market securities enjoy higher degree of liquidity.
 Investment outlays  The investment in capital market does not require huge financial investment  The money market instruments are quite expensive so huge financial investment is required.
 Participants  Thee participants of capital market are financial institutions, banks, public and private companies, foreign and ordinary retail investors from public.  Thee participants of money market are banks, private and public companies but foreign and ordinary retail investors do not participate in money market.
 Safety  The instruments of the capital market are riskier.  The instruments in the money market are safe and less risky due to short duration.
 Instruments  The instruments dealt in this market are bonds, debentures, equity shares and stock.  The instruments dealt in the market are bills of exchange, treasury bills, banker’s acceptance, etc

University of Mumbai BMS Notes

Organized Market, Unorganized Market

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The organised sector of the money market con­sists of the Reserve Bank of India, commercial banks, companies lending money, financial inter­mediaries such as the Life Insurance, Credit and Investments Corporation of India, Unit Trust of India, Land Mortgage Banks, Cooperative Banks, Insurance Companies etc. and call loan brokers, and stock brokers.

The unorganised sector of the money market is largely made up of indigenous bankers, money lenders, traders, commission agents etc., some of whom combine money lending with trade and other activities.

Generally speaking, these two sec­tors of the Indian money market — those institu­tions which come directly or indirectly under the broad regulations of the Reserve Bank constitute the organised sector, while the others which fall completely outside the purview of the central bank­ing regulations, make up the unorganised sector.

The organised sector is mainly composed of the commercial banks, cooperative banks and dis­count houses, acceptance houses and land mort­gage banks. The unorganised sector is largely outside the control of the Central Bank and is characterised by lack of uniformity in their business dealings. In India, the indigenous bankers and money lend­ers, traders, are important segment of unorgan­ised money market.

Features of the Indian money market:

First, a major characteristic of the Indian money market is that the seasonality of demand for credit broadly follows the course of the agricultural sea­sons. The implication is that during the busy sea­son the commercial banks have to borrow from the RBI, while the level of such borrowings declines during the slack season. This provides a very use­ful lever to the RBI in controlling the volume of credit.

Secondly, Indian money market consists of organised and unorganised sectors. As already pointed out, the organised sector is composed of the RBI, Commercial banks, Co-operative banks, Land mortgage banks. Considering the continen­tal character of the country, the banking develop­ment is most inadequate for the needs of trade and industry largely because of the hoarding habit of the people.

Thirdly, with a view to strengthening the or­ganised money market in India, new institutions have been established and consolidated to either lend on long-term basis or regulate credit in a pre­scribed manner. The new institutions which have come up after independence are IFC (1948), NIDC (1954), ICIC (1955), SFC (1951), NSIC (1955), UTI (1964) and the IDBI (1964).

Fourthly, the Indian money market is domi­nated by the unorganised sector. The only link that exists between the organised and unorganised sec­tors is through commercial banks. Indigenous bank­ers carry on their activities through the media of these commercial banks.

In rural areas, they do so through cooperative credit societies. However, a number of credit socie­ties are under the control of money lenders. It seems that a growing number of spurious cooperative so­cieties have been organised solely to enable these money lenders to take advantage of the concessions they offer.

Fifthly, unorganised market has of late been strengthened with the addition of unaccounted or black money. A conservative estimate places this amount at between Rs. 2,500 and Rs. 10,000 crores. As a result of the income velocity of money, con­siderable savings will be accruing in the unaccounted income sector. These sectors seek out­lets which again escape from the tax net and thus enlarge the un-accounted sector. Unaccounted money is used in smuggling of goods, drugs, and precious metals and in real estates. These high re­turn activities are invariably financed by the black money.

The impact of unaccounted money on the money market is very significant. With its growth in the country a number of mushroom indigenous bankers have sprang up, who are quite different from the traditional bankers and it reported that they lend money at very high rate of interest.

The indigenous money market has itself become a law­less market. The unaccounted money as part of the unorganised money market is invested in property, smuggling, trade and real estate. This fact has fur­ther limited the effectiveness of monetary policy.

Sixthly, there is no direct link between the un­organised and organised money markets. It is es­sential to establish a link between the two markets.

The above figure shows the unorganised money market with the growth of unaccounted money.

Seventhly, the bill market system is yet to de­velop fully. The bill market is one of the important sub-markets of the money market. The bill market or discount market refers to the market where short dated bills are bought and sold. The treasury bills are the most important instrument used in the bill market. The Bill Market scheme was introduced in 1952 and in 1970 but is only partially successful.

Lastly, a well-developed money market will have close links with the leading money markets of the world and will be sensitive to the develop­ments in these foreign markets. But the Indian money market is an insular one with little contract with foreign markets.

Partly due to the exchange control restrictions on capital movements there is no movement of funds between the Indian money market and the foreign market. The Indian money market does not attract any foreign funds.

Money market is the place or mechanism where short-term instruments that mature within a year are traded. Money market meets the work­ing capital requirements of industry, trade and commerce. Long-term requirements of industries are not met by money market instruments.

The cen­tral bank occupies a pivotal position in money market. It is regarded as ‘presiding deity’ of money markets. Its function is not only that of a watch dog of the monetary system but also of a promo­tional and development banker.

On the other hand, capital market is a market in which lenders or investors provide long-term funds in exchange for financial assets offered by borrowers and holders. The primary purpose of capital market is to direct the flow of savings into the long-term investments. The distinction between the money market and capital market is based on the difference in the period of the financial assets.

Though the terms money market and capital market are used interchangeably, they differ in a number of ways. Money market primarily exists as a means of liquidity adjustment. But a capital market’s main function is to serve as a link between long-term in­vestors and long-term borrowers.

Secondly, money market and capital market instruments also differ in terms of risk. Money market instruments generally carry low credit risk and low market risk. Capital market instruments include bonds, debentures, equity shares and pref­erence shares.

Thirdly, money market is dominated by one set of financial institutions commercial banks and the central bank. But in the capital market, no sin­gle institution dominates the market.

However, there is no fundamental difference between capital market and money market regard­ing transferring of resources. There is no close nexus in money and capital markets.

Commercial banks are active in money mar­ket while non-banking financial institutions and public financial institutions are active in capital market. There is a considerable degree of overlap in the function of different financial institutions.

University of Mumbai BMS Notes

Primary Market and Secondary Market

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Primary Market

primary market, securities are created for the first time for investors to purchase. New securities are issued in this market through a stock exchange, enabling the government as well as companies to raise capital.

For a transaction taking place in this market, there are three entities involved. It would include a company, investors, and an underwriter. A company issues security in a primary market as an initial public offering (IPO), and the sale price of such new issue is determined by a concerned underwriter, which may or may not be a financial institution. An underwriter also facilitates and monitors the new issue offering. Investors purchase the newly issued securities in the primary market. Such a market is regulated by the Securities and Exchange Board of India (SEBI).

The entity which issues securities may be looking to expand its operations, fund other business targets or increase its physical presence among others. Primary market example of securities issued includes notes, bills, government bonds or corporate bonds as well as stocks of companies.

Functions of Primary Market

  • New issue offer

The primary market organises offer of a new issue which had not been traded on any other exchange earlier. Due to this reason, it is also called a New Issue Market. Organising new issue offers involves a detailed assessment of project viability, among other factors. The financial arrangements for the purpose include considerations of promoters’ equity, liquidity ratio, debt-equity ratio and requirement of foreign exchange.

  • Underwriting services

Underwriting is an essential aspect while offering a new issue. An underwriter’s role in a primary marketplace includes purchasing unsold shares if it cannot manage to sell the required number of shares to the public. A financial institution may act as an underwriter, earning a commission on underwriting.

Investors rely on underwriters for determining whether undertaking the risk would be worth its returns. It may so thus happen that an underwriter ends up buying all the IPO issue, and subsequently selling it to investors.

  • Distribution of new issue

A new issue is also distributed in a primary marketing sphere. Such distribution is initiated with a new prospectus issue. It invites the public at large to buy a new issue and provides detailed information on the company, issue, and involved underwriters.

Types of Primary Market Issuance

After the issuance of securities, investors can purchase such securities in various ways. There are 5 types of primary market issues.

  • Public issue

Public issue is the most common method of issuing securities of a company to the public at large. It is mainly done via Initial Public Offering (IPO) resulting in companies raising funds from the capital market. These securities are listed in the stock exchanges for trading.

A privately held company converts into a publicly-traded company when its shares are offered to the public initially through IPO. Such public offer allows a company to raise funds for expansion of business, improving infrastructure, and repay its debts, among others. Trading in an open market also increases a company’s liquidity and provides a scope for issuance of more shares in raising further capital for business.

The Securities and Exchange Board of India is the regulatory body that monitors IPO. As per its guidelines, a requisite due enquiry is conducted for a company’s authenticity, and the company is required to mention its necessary details in the prospectus for a public issue.

  • Private placement

When a company offers its securities to a small group of investors, it is called private placement. Such securities may be bonds, stocks or other securities, and the investors can be both individual and institutional.

Private placements are easier to issue than initial public offerings as the regulatory stipulations are significantly less. It also incurs reduced cost and time, and the company can remain private. Such issuance is suitable for start-ups or companies which are in their early stages. The company may place this issuance to an investment bank or a hedge fund or place before ultra-high net worth individuals (HNIs) to raise capital.

  • Preferential issue

A preferential issue is one of the quickest methods available to companies for raising capital. Both listed and unlisted companies can issue shares or convertible securities to a select group of investors. However, the preferential issue is neither a public issue nor a rights issue. The shareholders in possession of preference shares stand to receive the dividend before the ordinary shareholders are paid.

  • Qualified institutional placement

Qualified institutional placement is another kind of private placement where a listed company issues securities in the form of equity shares or partly or wholly convertible debentures apart from such warrants convertible to equity shares and purchased by a Qualified Institutional Buyer (QIB).

QIBs are primarily such investors who have the requisite financial knowledge and expertise to invest in the capital market. Some QIBs are:

  • Foreign Institutional Investors registered with the Securities and Exchange Board of India.
  • Foreign Venture Capital Investors.
  • Alternate Investment Funds.
  • Mutual Funds.
  • Public Financial Institutions.
  • Insurers.
  • Scheduled Commercial Banks.
  • Pension Funds.

Issuance of qualified institutional placement is simpler than preferential allotment as the former does not attract standard procedural regulations like submitting pre-issue filings to SEBI. The process thus becomes much easier and less time-consuming.

  • Rights and bonus issues

Another issuance in the primary market is rights and bonus issue, in which the company issues securities to existing investors by offering them to purchase more securities at a predetermined price (in case of rights issue) or avail allotment of additional free shares (in case of bonus issue).

For rights issues, investors retain the choice of buying stocks at discounted prices within a stipulated period. Rights issue enhances control of existing shareholders of the company, and also there are no costs involved in the issuance of these kinds of shares. For bonus issues, stocks are issued by a company as a gift to its existing shareholders. However, the issuance of bonus shares does not infuse fresh capital.

Secondary Market

The term “secondary market” is also used to refer to the market for any used goods or assets, or an alternative use for an existing product or asset where the customer base is the second market (for example, corn has been traditionally used primarily for food production and feedstock, but a “second” or “third” market has developed for use in ethanol production).

A secondary market is a platform wherein the shares of companies are traded among investors. It means that investors can freely buy and sell shares without the intervention of the issuing company. In these transactions among investors, the issuing company does not participate in income generation, and share valuation is rather based on its performance in the market. Income in this market is thus generated via the sale of the shares from one investor to another.

In the secondary market, securities are sold by and transferred from one investor or speculator to another. It is therefore important that the secondary market be highly liquid (originally, the only way to create this liquidity was for investors and speculators to meet at a fixed place regularly; this is how stock exchanges originated, see History of the Stock Exchange). As a general rule, the greater the number of investors that participate in a given marketplace, and the greater the centralization of that marketplace, the more liquid the market.

Fundamentally, secondary markets mesh the investor’s preference for liquidity (i.e., the investor’s desire not to tie up his or her money for a long period of time, in case the investor needs it to deal with unforeseen circumstances) with the capital user’s preference to be able to use the capital for an extended period of time.

Accurate share price allocates scarce capital more efficiently when new projects are financed through a new primary market offering, but accuracy may also matter in the secondary market because:

1) Price accuracy can reduce the agency costs of management, and make hostile takeover a less risky proposition and thus move capital into the hands of better managers

2) Accurate share price aids the efficient allocation of debt finance whether debt offerings or institutional borrowing.

Functions of Secondary Market

  • A stock exchange provides a platform to investors to enter into a trading transaction of bonds, shares, debentures and such other financial instruments.
  • Transactions can be entered into at any time, and the market allows for active trading so that there can be immediate purchase or selling with little variation in price among different transactions. Also, there is continuity in trading, which increases the liquidity of assets that are traded in this market.
  • Investors find a proper platform, such as an organised exchange to liquidate the holdings. The securities that they hold can be sold in various stock exchanges.
  • A secondary market acts as a medium of determining the pricing of assets in a transaction consistent with the demand and supply. The information about transactions price is within the public domain that enables investors to decide accordingly.
  • It is indicative of a nation’s economy as well, and also serves as a link between savings and investment. As in, savings are mobilised via investments by way of securities.

Different Instruments in the Secondary Market 

The instruments traded in a secondary market consist of fixed income instruments, variable income instruments, and hybrid instruments.

  • Fixed income instruments

Fixed income instruments are primarily debt instruments ensuring a regular form of payment such as interests, and the principal is repaid on maturity. Examples of fixed income securities are debentures, bonds, and preference shares.

Debentures are unsecured debt instruments, i.e., not secured by collateral. Returns generated from debentures are thus dependent on the issuer’s credibility.

As for bonds, they are essentially a contract between two parties, whereby a government or company issues these financial instruments. As investors buy these bonds, it allows the issuing entity to secure a large amount of funds this way. Investors are paid interests at fixed intervals, and the principal is repaid on maturity.

Individuals owning preference shares in a company receive dividends before payment to equity shareholders. If a company faces bankruptcy, preference shareholders have the right to be paid before other shareholders.

  • Variable income instruments

Investment in variable income instruments generates an effective rate of return to the investor, and various market factors determine the quantum of such return. These securities expose investors to higher risks as well as higher rewards. Examples of variable income instruments are equity and derivatives.

Equity shares are instruments that allow a company to raise finance. Also, investors holding equity shares have a claim over net profits of a company along with its assets if it goes into liquidation.

As for derivatives, they are a contractual obligation between two different parties involving pay-off for stipulated performance.

  • Hybrid instruments

Two or more different financial instruments are combined to form hybrid instruments. Convertible debentures serve as an example of hybrid instruments.

Types of Secondary Market

Secondary markets are primarily of two types – Stock exchanges and over-the-counter markets.

  • Stock exchange

Stock exchanges are centralised platforms where securities trading take place, sans any contact between the buyer and the seller. National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are examples of such platforms.

Transactions in stock exchanges are subjected to stringent regulations in securities trading. A stock exchange itself acts as a guarantor, and the counterparty risk is almost non-existent. Such a safety net is obtained via a higher transaction cost being levied on investments in the form of commission and exchange fees.

  • Over-the-counter (OTC) market

Over-the-counter markets are decentralised, comprising participants engaging in trading among themselves. OTC markets retain higher counterparty risks in the absence of regulatory oversight, with the parties directly dealing with each other. Foreign exchange market (FOREX) is an example of an over-the-counter market.

In an OTC market, there exists tremendous competition in acquiring higher volume. Due to this factor, the securities’ price differs from one seller to another.

Apart from the stock exchange and OTC market, other types of secondary market include auction market and dealer market.

The former is essentially a platform for buyers and sellers to arrive at an understanding of the rate at which the securities are to be traded. The information related to pricing is put out in the public domain, including the bidding price of the offer.

Dealer market is another type of secondary market in which various dealers indicate prices of specific securities for a transaction. Foreign exchange trade and bonds are traded primarily in a dealer market.

Management Notes

Determinants and Law of Supply

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Supply refers to the quantity of a good or service that producers are willing and able to offer for sale in the market at various prices over a specific period of time. It is a fundamental concept in economics that reflects the relationship between price and the quantity supplied. Generally, supply increases with rising prices because higher prices provide greater incentives for producers to produce more, while supply decreases when prices fall.

Determinants of Supply:

Supply is influenced by several factors, known as the determinants of supply. These factors determine the quantity of goods or services that producers are willing to offer in the market at various price levels. Understanding these determinants is crucial for analyzing market dynamics and predicting changes in supply.

1. Price of the Good

The price of a good is the most significant determinant of supply. As prices increase, producers are incentivized to supply more of the good to maximize profits, and vice versa. This direct relationship between price and supply is the basis of the law of supply.

2. Cost of Production

The cost of production, including raw materials, labor, and overheads, directly affects supply. Lower production costs enable producers to supply more at the same price, while higher costs reduce supply. For example, a decrease in the price of raw materials allows firms to produce goods more economically, increasing supply.

3. Technology

Advancements in technology enhance production efficiency and reduce costs, leading to an increase in supply. Technological innovations enable faster and higher-quality production, often at lower costs. For instance, automation in manufacturing industries has significantly boosted supply.

4. Government Policies

Policies such as taxes, subsidies, and regulations impact supply.

    • Taxes increase production costs, reducing supply.
    • Subsidies lower costs, encouraging producers to supply more.

Regulations, such as environmental laws or safety standards, may restrict supply by imposing additional compliance costs.

5. Prices of Related Goods

If producers can switch between products, the prices of related goods affect supply. For example, if the price of corn rises, farmers might allocate more resources to grow corn instead of wheat, reducing the supply of wheat.

6. Number of Producers

An increase in the number of producers in a market typically increases overall supply. Conversely, if firms exit the market due to losses or other factors, supply decreases.

7. Expectations of Future Prices

If producers expect prices to rise in the future, they may withhold current supply, reducing it temporarily. Conversely, if prices are expected to fall, producers may increase supply to sell before the price drops.

8. Natural and External Factors

Events like natural disasters, climate conditions, and global crises can disrupt production and affect supply. For example, droughts reduce the supply of agricultural products, while favorable weather conditions boost it.

Law of Supply:

Law of Supply is a fundamental principle in economics that describes the relationship between the price of a good or service and the quantity supplied, assuming all other factors remain constant (ceteris paribus). It states that as the price of a good increases, the quantity supplied also increases, and conversely, as the price decreases, the quantity supplied decreases. This positive correlation arises because higher prices provide greater incentives for producers to increase production to maximize profits.

Key Assumptions of the Law of Supply

  • Ceteris Paribus Condition

Other factors affecting supply, such as technology, production costs, or government policies, remain constant.

  • Rational Behavior of Producers

Producers aim to maximize their profits by supplying more at higher prices.

  • No Change in Market Conditions

Market conditions like consumer preferences, competition, or input prices are stable.

Explanation with Example

Suppose the price of oranges increases from $2 to $4 per kilogram:

  • At $2 per kilogram, farmers supply 500 kilograms.
  • When the price rises to $4 per kilogram, farmers supply 1,000 kilograms.

This increase in supply reflects producers’ willingness to produce more at higher prices due to higher profit margins.

Graphical Representation

The supply curve, typically upward-sloping, illustrates the law of supply.

  • X-axis: Quantity supplied
  • Y-axis: Price of the good

The curve shows that as price increases, quantity supplied rises, demonstrating a direct relationship.

Exceptions to the Law of Supply

  • Perishable Goods

Producers may sell all their stock, irrespective of price, to avoid spoilage.

  • Future Expectations

If producers expect prices to rise, they might withhold supply temporarily.

  • Fixed Supply Situations

In cases like antiques or natural resources, the supply cannot increase regardless of price.

  • Market Constraints

Producers may face resource or capacity limits, preventing them from increasing supply.

Importance of the Law of Supply:

  • Pricing Decisions

Helps businesses determine pricing strategies based on supply responsiveness.

  • Market Equilibrium

Works with the law of demand to establish equilibrium price and quantity in the market.

  • Policy Formulation

Guides governments in crafting policies like subsidies or price controls.

University of Mumbai BMS Notes

Price and output determination under Duopoly

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If an industry is composed of only two giant firms, each selling identical products and having half of the total market, there is every likelihood of collusion between the two firms. The firms may agree on a price, or divide the market, or assign quota, or merge themselves into one unit and form a monopoly or try to differentiate their products or accept the price fixed by the leader firm, etc., etc.

In case the duopolists producing perfect substitute engage in price competition, the firm having lower costs, better goodwill and clientele will drive the rival firm out of the market and then establish a monopoly.

If the products of the duopolists are differentiate, each firm will have a close watch on the actions of its rival firms. The firms manufacturing good quality products with lesser cost will earn abnormal profits. Each firm will fix the price of the commodity and expand output in accordance with the demand of the commodity in the market.

Duopoly Models:

There are four main duopoly models which explain the price and quantity determinations in duopoly. These models are:

(i) Classical Model of Cournot and Edge Worth.

(ii) Hotellings Spatial Equilibrium Model.

(iii) Stackelberg’s Model.

(iv) Modern Game Theory Model.

(i) Cournot and Edgeworth Model:

Cournot approach is based, on the assumptions that rivals output remains the same and one duopolists plans to change in his output. Edgeworth model assumes that rival’s price of the good to remain unchanged as one duopolists plans a change in his price of the good.

(ii) Stackberg’s Approach:

It is based on the assumptions that one of the duopolists is a ‘Leader’ and the other is the follower.

(iii) Hotelling Spatial Equilibrium Model:

In this model, the products of the duopolists are differentiate in the eyes of the buyers by virtue of the location of the duopolists.

(iv) Game Theory Approach:

Whenever there are two or a few firms competing in an industry for profit, each firm can and dose react to the price, quantity, quality and product changes which other firm undertakes. The duopolists or oligopoly have a reaction function. As firms under duopoly are independent, they, therefore, employ strategies. The competing firm also make plans to contract and makes decisions about output and price of the good keeping in view the strategy of its rivals. The plans made by these firm, are known as game strategies. The game theory model describes the firms, interaction model. It is the analytical framework in which two or more firms compete for economics profits that depend on the strategy that the others employ.

All games theory models have at least three common elements:

(a) Players: Players in the game theory are the firms.

(b) Strategies: Strategies are the plans, the possible choices of the firms for production of output, prices of goods, changes in the quality of the product

(c) Pay offs (economic profit): These are the profits or losses realized by the firm.

University of Mumbai BMS Notes

Price and output determination under Oligopoly

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A diversity of specific market situations works against the development of a single, generalized explanation of how an oligopoly determines price and output.

Pure monopoly, monopolistic competition and perfect competition, all refer to rather clear-cut market arrangements; oligopoly docs not.

“Oligopoly is an industry structure characterized by a small number of firms producing all or most of the output of some good that may or may not be differentiated”.

Price and Output Determination Under Oligopoly

  • Cournot’s Model
  • Stackelberg Model
  • Bertrand Model
  • Edgeworth Model
  • Collusive Oligopoly

Cournot’s Model

As per Cournot’s model, each duopolist thinks that regardless of his actions and the effect upon the market of the product the other will go on producing the same commodity.

Cournot model says if the output of a firm is two- thirds of the competitive output and the price is two–third, this is most profitable i.e., monopoly price.

Stackelberg Model

The producer under a duopoly structure integrates the decision level of his rival. It then integrates in its own profit function and thereby maximizes profit. Thus, Leader-follower relation emerges.

Bertrand Model

According to this model, producers try to set lower the price until the price is equal to the cost of production.

Edgeworth Model

Each duopolist thinks that his rival will continue to charge the same price as he is just doing irrespective of what price he decided to set. No determinate equilibrium will exist under duopoly.

Collusive Oligopoly

According to this model, firms form a cartel. Firms jointly fix the price and output with a view to maximizing joint profit. For example, OPEC countries form a cartel.

Explanation of Price and Output Determination Under Oligopoly

We cannot explain the pricing and output decisions under duopoly a single theory. It will not be satisfactory. The reasons are:

(i) The number of firms may vary which is dominating the market. Sometimes there may be only two or three firms that dominate the entire market (Tight oligopoly). At another time there are 7 to 10 firms that capture 80% of the market (loose oligopoly).

(ii) The goods produced may or may not be standardized under oligopoly.

(iii) Sometimes the firms under oligopoly cooperate with each other in the fixing of price and output of goods. At another time, they choose to act independently.

(iv) Sometimes barriers to entry are very strong in oligopoly and at another time, they are quite loose.

(v) Sometimes A firm under oligopoly cannot certainly predict with the reaction of the rival firms if any changes occur in the prices and output of its goods. Considering the wide range of diversity of market situations, a number of models have been developed which explain the behavior of the oligopolistic firms.

  • Price Determination in Non-Collusive Oligopoly:

In this case, each firm follows an independent price and output policy on the basis of its judgment about the reactions of his rivals. If the firms are producing homogeneous products, price war may occur. Each firm has to fix the price at the competitive level. On the contrary, in case of differentiated oligopoly, due to product differentiation, each firm has some monopoly control over the market and therefore charge near monopoly price.

Thus, the actual price may fall between the two limits:

(i) The Upper Limit of Monopoly Price and,

(ii) The Linear limit of Competitive Price.

Practically, there is every possibility to determine the exact price within these limits. However, there may be the following possibilities:

(i) There may be complete price instability in the market which results in price war.

(ii) The price may settle down at intermediate level due to the working of the market forces.

(iii) The firm may accept the prevailing price and adjust itself according to prevailing price.

So long as the firm earns adequate profits at the prevailing price, it may not try to change it. Any effort to change it may create uncertainties in the market. A firm will stick to that price to avoid uncertainties. Thus, the price tends to be rigid where oligopolist takes independent action.

  • Equilibrium under Collusion:

The modern economists are of the view that independent price determination cannot exist for long in oligopoly. It leads to uncertainty and insecurity and to overcome them there is a tendency among oligopolists to act collectively by tacit collusion. In addition, the firms can gain the economics of production. All the firms in oligopoly tend to enlarge their size and lower their costs of production per unit and capture maximum share of the market.

Collusive oligopoly is a situation in which firms in a particular industry decide to join together as a single unit for the purpose of maximising their joint profits and to negotiate among themselves so as to share the market.

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