Tag: Operations Management

Management Notes

Banking System in India

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In India the banks and banking have been divided in different groups. Each group has their own benefits and limitations in their operations. They have their own dedicated target market. Some are concentrated their work in rural sector while others in both rural as well as urban. Most of them are only catering in cities and major towns.

Indian Banking System: Structure

Bank is an institution that accepts deposits of money from the public.

Anybody who has account in the bank can withdraw money. Bank also lends money.

Indigenous Banking

The exact date of existence of indigenous bank is not known. But, it is certain that the old banking system has been functioning for centuries. Some people trace the presence of indigenous banks to the Vedic times of 2000-1400 BC. It has admirably fulfilled the needs of the country in the past.

However, with the coming of the British, its decline started. Despite the fast growth of modern commercial banks, however, the indigenous banks continue to hold a prominent position in the Indian money market even in the present times. It includes shroffs, seths, mahajans, chettis, etc. The indigenous bankers lend money; act as money changers and finance internal trade of India by means of hundis or internal bills of exchange.

Disvantages

(i) They are unorganized and do not have any contact with other sections of the banking world.

(ii) They combine banking with trading and commission business and thus have introduced trade risks into their banking business.

(iii) They do not distinguish between short term and long term finance and also between the purpose of finance.

(iv) They follow vernacular methods of keeping accounts. They do not give receipts in most cases and interest which they charge is out of proportion to the rate of interest charged by other banking institutions in the country.

Suggestions for Improvements

(i) The banking practices need to be upgraded.

(ii) Encouraging them to avail of certain facilities from the banking system, including the RBI.

(iii) These banks should be linked with commercial banks on the basis of certain understanding in the respect of interest charged from the borrowers, the verification of the same by the commercial banks and the passing of the concessions to the priority sectors etc.

(iv) These banks should be encouraged to become corporate bodies rather than continuing as family based enterprises.

Structure of Organized Indian Banking System

The organized banking system in India can be classified as given below:

Reserve Bank of India (RBI)

The country had no central bank prior to the establishment of the RBI. The RBI is the supreme monetary and banking authority in the country and controls the banking system in India. It is called the Reserve Bank’ as it keeps the reserves of all commercial banks.

Commercial Banks

Commercial banks mobilise savings of general public and make them available to large and small industrial and trading units mainly for working capital requirements.

Commercial banks in India are largely Indian-public sector and private sector with a few foreign banks. The public sector banks account for more than 92 percent of the entire banking business in India—occupying a dominant position in the commercial banking. The State Bank of India and its 7 associate banks along with another 19 banks are the public sector banks.

Scheduled and Non-Scheduled Banks

The scheduled banks are those which are enshrined in the second schedule of the RBI Act, 1934. These banks have a paid-up capital and reserves of an aggregate value of not less than Rs. 5 lakhs, hey have to satisfy the RBI that their affairs are carried out in the interest of their depositors.

All commercial banks (Indian and foreign), regional rural banks, and state cooperative banks are scheduled banks. Non- scheduled banks are those which are not included in the second schedule of the RBI Act, 1934. At present these are only three such banks in the country.

Regional Rural Banks

The Regional Rural Banks (RRBs) the newest form of banks, came into existence in the middle of 1970s (sponsored by individual nationalized commercial banks) with the objective of developing rural economy by providing credit and deposit facilities for agriculture and other productive activities of al kinds in rural areas.

The emphasis is on providing such facilities to small and marginal farmers, agricultural labourers, rural artisans and other small entrepreneurs in rural areas.

Other special features of these banks are

(i) Their area of operation is limited to a specified region, comprising one or more districts in any state.

(ii) Their lending rates cannot be higher than the prevailing lending rates of cooperative credit societies in any particular state.

(iii) The paid-up capital of each rural bank is Rs. 25 lakh, 50 percent of which has been contributed by the Central Government, 15 percent by State Government and 35 percent by sponsoring public sector commercial banks which are also responsible for actual setting up of the RRBs.

These banks are helped by higher-level agencies: the sponsoring banks lend them funds and advise and train their senior staff, the NABARD (National Bank for Agriculture and Rural Development) gives them short-term and medium, term loans: the RBI has kept CRR (Cash Reserve Requirements) of them at 3% and SLR (Statutory Liquidity Requirement) at 25% of their total net liabilities, whereas for other commercial banks the required minimum ratios have been varied over time.

Cooperative Banks

Cooperative banks are so-called because they are organized under the provisions of the Cooperative Credit Societies Act of the states. The major beneficiary of the Cooperative Banking is the agricultural sector in particular and the rural sector in general.

The cooperative credit institutions operating in the country are mainly of two kinds: agricultural (dominant) and non-agricultural. There are two separate cooperative agencies for the provision of agricultural credit: one for short and medium-term credit, and the other for long-term credit. The former has three tier and federal structure.

At the apex is the State Co-operative Bank (SCB) (cooperation being a state subject in India), at the intermediate (district) level are the Central Cooperative Banks (CCBs) and at the village level are Primary Agricultural Credit Societies (PACs).

Long-term agriculture credit is provided by the Land Development Banks. The funds of the RBI meant for the agriculture sector actually pass through SCBs and CCBs. Originally based in rural sector, the cooperative credit movement has now spread to urban areas also and there are many urban cooperative banks coming under SCBs.

Management Notes

Types of Securities in Banks

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Security is what the borrower puts up to guarantee payment of the loan. Moreover security means immovable & chattel or personal asset or assets to which a lender can have recourse if the borrower defaults in the loan payment. Bankers, whenever advancing loans, first ask for the security to be put for the loans requested. Different types of securities are used depending upon the nature of the advances issued by the banks. A good security must be enough to cover the risk, highly liquid, free from any encumbrance, clean in ownership and easy to handle.

There are two types of banks security.

  • Personal Security
  • Non-personal security

  1. Personal security

If any banks client himself or third party is considered as security is called personal security. without receiving the immovable & chattel assets as security, if bank can receive any client himself or any person own self on be half of that client as security is considered as personal security. Bank will consider the person or third party only for then when he has enough social dignity and goodwill or a scope of applying law against himself in future or he is engaged in renowned business, government or recognized non government organization.

  1. Non-personal security

without receiving any client himself or any person own self on be half of that client as security , if bank can receive the immovable & chattel assets as security is considered as non-personal security. There are four types of non-personal security. such as-

  • Lien
  • Pledge
  • Mortgage
  • Hypothecation

The above four categories of non-personal security are given below with detail.

(a) Lien

The right of retain foods is known as lien. The lawful right of a lender to offer the guarantee property of an account holder who neglects to meet the commitments of an advance contract. A lien exists, for instance, when an individual takes out a vehicles advance. The lien holder is the bank that allows the advance, and the lien is discharged when the credit is forked over the required funds. Another kind of lien is a repairman’s lien, which can be appended to genuine property if the property proprietor neglects to pay a foreman for administrations rendered. In the event that the account holder never pays, the property can be sold to pay the lien holder. There are two types of lien:-

  • General lien: Here, Bank has the possess of the assets have been kept as security and bank can’t transfer the possession to another until the loan amount is being paid.
  • Special lien: Here, Bank has the possess of the assets have been kept as security and bank can transfer the possession to another on conditions is called special lien.

(b) Pledge

Here the possess of assets is to bank or loan provider, but the ownership is to borrower. After payment, bank transfers the possession of security assets to borrower. When a customer takes loan against jewels he pledges the jewel to the bank.  Similarly a customer availing loan on key cash credit basis pledges the  goods to the banker by keeping them in a godown under lock and key  control of the bank. Pledged goods are to be insured and the pledgee (banker) has to take reasonable care to protect the property pledged.

3. Mortgage

It is an interest in property created as security for a loan or payment of debt and terminated on payment of the loan or debt. A mortgage is a contract that permits a loan provider partially or fully to foreclose that security when a borrower is unable to pay the loan amount. Mortgage is applicable only for immovable assets and this is why it is called immovable property mortgage. There are many types of mortgage have been described below.

  • Simple mortgage: If the loan amount isn’t paid by borrower and legal step is taken against him or lender can purchase which security assets on the opinion of borrower is called simple mortgage.
  • Fixed mortgage: The borrower gives which property in black & white or in registering to the lender and if the loan is not paid in time, then legal possession of that security is gained by lender is called fixed mortgage.
  • Conditional mortgage: If the loan amount isn’t paid in time and without fulfilling the determined conditions, the which security is not sold or transfered is called conditional mortgage.
  • Floating mortgage: The possession right of which mortgage properly is belonged to borrower and only documents are submitted to loan provider is called floating mortgage.
  • Equitable mortgage: The documents of which mortgage property is kept to bank for a specific time period and possession is belonged to borrower and after exceeding the payment period bank try to gain the legal possession is called equitable mortgage.
  • Registered equitable mortgage: The ownership documents of which mortgage property is kept to lone provider with registration for a specific time period and possession is belonged to borrower is called registered equitable mortgage.
  • Use fructuary mortgage: The possession & consumption of which mortgage property is given to loan provider as loan providing till a specific time period and after exceeding that time period the belongingness of that property is leaved to borrower is called use fructuary mortgage.
  • English mortgage: The ownership of which mortgage property is to loan provider and possession or belongingness of that property is to borrower is called English mortgage. If borrower is fail to pay the loan amount then the possession power is automatically gone to loan provider.
  1. Hypothecation

It is pledge to secure an obligation without delivery of title or possession.

At last we can say that, at the modern banking sectors a great changes has been occurred in the categories of categories of mortgage.

Management Notes

Organizational Decision Making

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Decision making can be defined as selecting between alternative courses of action. Management decision making concerns the choices faced by managers within their duties in the organization. Making decisions is an important aspect of planning. Decision making can also be classified into three categories based on the level at which they occur.

Strategic Decisions: These decisions establish the strategies and objectives of the organization. These types of decisions generally occur at the highest levels of organizational management.

Tactical Decisions: Tactical decisions concern the tactics used to accomplish the organizational objectives. Tactical decisions are primarily made by middle and front-line managers.

Operational Decisions: Operational decisions concern the methods for carrying out the organizations delivery of value to customers. Operational decisions are primarily made by middle and front-line managers.

Decisions can be categorized based on the capacity of those making the decision.

Personal Decisions: Personal decisions are those primarily affecting the individual though the decision may ultimately have an effect on the organization as a result of its effect on the individual. These types of decisions are not made within a professional capacity. These decisions are generally not delegated to others.

Organizational Decisions: An organizational decision is one that relates or affects the organization. It is generally made by a manager or employee within their official capacity. These decisions are often delegated to others.

Strategies:

Marginal Analysis

Marginal analysis helps organizations allocate resources to increase profitability and benefits and reduce costs. An example from indeed.com is if a company has the budget to hire an employee, a marginal analysis may show that hiring that person provides a net marginal benefit because the ability to produce more products outweighs the increase in labor costs.

SWOT Diagram

This tool helps a manager study a situation in four quadrants:

  • Strengths: Where does the organization excel compared to its competition? Consider the internal and external strengths.
  • Weaknesses: What could the organization improve?
  • Opportunities: How can the organization leverage its strengths to create new avenues for success.
  • Threats: Determine what obstacles prevent the organization from achieving its goals.

Decision Matrix

A decision matrix can provide clarity when dealing with different choices and variables. It is like a pros/cons list, but decision-makers can place a level of importance on each factor. According to Dashboards, to build a decision matrix:

  • List your decision alternatives as rows
  • List relevant factors as columns
  • Establish a consistent scale to assess the value of each combination of alternatives and factors
  • Determine how important each factor is in choosing a final decision and assign weights accordingly
  • Multiply your original ratings by the weighted rankings
  • Add up the factors under each decision alternative
  • The highest-scoring option wins

Pareto Analysis

The Pareto Principle helps identify changes that will be the most effective for an organization. It’s based on the principle that 20 percent of factors frequently contribute to 80 percent of the organization’s growth. For example, suppose 80 percent of an organization’s sales came from 20 percent of its customers. A business can use the Pareto Principle by identifying the characteristics of that 20 percent customer group and finding more like them. By identifying which small changes have the most significant impact, an organization can better prioritize its decisions and energies.

Steps:

Make long-term goals and use them to measure your decisions.

All too often, organizations find themselves endlessly running around in pursuit of short-term goals. Money that has been committed to a year-long project gets overrun or set off because flashy or short-term priorities arise and resources are redirected. As a result, you typically end up with an awful lot of confusion and a lack of overall progress.

To avoid this problem, nail down your high-priority, long-term goals from the outset. Then as your organization makes decisions, ask yourself whether what you’re doing aligns with those goals. This should be a constant process, returning again and again to check your organizational activity against your goals.

When you apply this method successfully, you will engage more reliably in short-term projects that support your long-term goals. Over time, this will push your organization forward.

Align your goals with your core values

Ideally, these should flow from your organization’s mission and core values. Your organization’s goals may evolve over time, but its values should be much less mutable.

Your organizational values confer a coherent sense of identity and continuity to your organization. They should be clearly understood and agreed upon by your decision-makers. As you evaluate your goals, make sure that they are aligned with your core values.

Assess (and reassess) spending

One way to evaluate your priorities as they are being realized today is to take a look at your spending. Often, you may think you’re prioritizing a particular goal or effort, while your budget tells a different story.

Make sure your organizational spending reflects your identified priorities. If not, you need to take a second look. And as with any such check-in, it’s essential to make this a regular assessment to continuously verify that you’re on track.

Understand the impacts of your decisions.

Some decisions may be discrete and routine, having neat boundaries and only significantly impacting the matter directly at hand. But more often, organizational decisions may have wide-ranging consequences, especially if they will touch on policy or processes.

As your organization considers varying possibilities, make sure to weight second and third-order effects. These consequences can provide crucial context for the decision at hand.

Remember your personnel.

Organizations tend to depend on the quality of their employees to succeed. If your decisions make it difficult for your employees to be productive in their work environment, it will damage your prospects for long-term success even if your decisions appear to advance a short-term goal.

Evaluate the effect your decisions will have on your employees’ ability to perform their jobs and factor this component into your decisions accordingly.

The most effective decision-making should lead to improved work toward your long-term goals, which should be driven by core values. You should constantly reevaluate your spending and assess likely consequences of your actions. If you follow these steps thoroughly, you will have assembled a framework for successful organizational decision-making.

Advantages of Decision Making

Increase People’s Participation

Decision making in the organisation is done by a group of peoples working in the organisation. It is not carried out by a single individual rather than by a group of people. Each people actively participates in decision making of the organisation. They are free to present their creative ideas without any boundations.

Also, none of them is individually criticized for any failure but the whole group is responsible to handle. This increases the participation level of different people in the organisation.

Gives More Information

Good decision-making process acquires enough information before taking any action. In decision making, there is a large number of peoples involved. It is undertaken by the whole group rather than by a single individual. Each person gives his perspective to handle a particular situation.

They all represent there facts and figures according to their skill. This generates enough information which can be used for better understanding of the situation. This helps managers in taking corrective decisions.

Provide More Alternatives

Companies are able to get different alternatives for a particular situation through group decision making. There are different people working as a group for proper decisions. Each person looks differently to a particular problem.

They give their own perspectives and ideas for it. This way there are different options available to choose. All the alternatives are properly analysed in light of handling situation. The best one is chosen to arrive at a better result.

Improves the Degree of Acceptance and Commitment

Companies always face the chances of conflict among its staff working in the organisation. Through group decision making each person gets equal right to share his views and ideas.

Here decisions are not imposed on the peoples but are created with their participation. It develops a sense of loyalty and belongingness among people towards the business. They easily accept the decisions taken and are committed to their roles.

Helps In Strengthening the Organisation

It helps in improving the strength of the organisation. Decision making provides a platform to each individual working in an organisation to equally represent their ideas. Everybody gets an equal right to take part in managing the organisation.

It develops a sense of cooperation and unity among individuals working there. They all come together and work towards the accomplishment of the company’s goals. This increases the overall productivity of the organisation and strengthens its overall structure.

Improves the Quality of Decisions

Decision making helps in taking quality decisions at the right time. There are different experts engaged by organisations in their decision-making group. These peoples have through knowledge and creative thinking.

They analyse each and every aspect of every alternative available to them for handling situations. Best among the different alternatives available is chosen. It enables in quality decision making which helps in easy attainment of objectives.

Limitations:

Consultation ambiguity: This can be a scenario where a group of employees all feel like they have a vote in a decision or when a manager asks for input but doesn’t consider a group’s views. It’s important for a manager to solicit feedback but to make sure that contributors understand it’s the manager’s final decision.

Avoiding discomfort: Sound management decision making requires leaders who do not confuse their need for comfort with making the best decision. Some of the most effective decisions involve a degree of discomfort for the manager.

Appearing indecisive: Sometimes, a systematic decision making process has a downside. Being too rigorous in evaluating every possible angle can draw out the process and open the risk of appearing indecisive. Keep stakeholders informed about the timeline for a decision.

Blind spots: People have particular perspectives and ways of thinking that can create blind spots, which may be important for an effective decision but cannot be readily apparent. It can be helpful to seek input from trusted colleagues to provide a different perspective.

Groupthink: This occurs when a group’s members want to minimize conflict and reach a comfortable decision at the expense of a critical evaluation of other ideas and viewpoints. It’s important to explore alternatives a group may not have considered.

Management Notes

Production Information System, Objectives, Components, Types, Benefits, Challenges, Emerging Trends

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Production Information System (PIS) is a specialized subsystem of MIS that manages and controls all manufacturing activities of an organization. It deals with production planning, scheduling, inventory control, quality control, and monitoring of production process. PIS collects real-time data from shop floor, converts it into meaningful information and supports decision-making for optimum utilization of resources. It helps in reducing wastage, minimizing production cost, and improving efficiency and product quality, thereby ensuring timely delivery and achieving overall organizational goals.

Objectives of Production Information System:

1. Production Planning

One major objective of a Production Information System is to support effective production planning. The system provides information about customer orders, production capacity, available materials, workforce, machinery, and production requirements. Managers can use this information to determine what products need to be manufactured, in what quantities, and within which time period. Production information can also be coordinated with sales, inventory, purchasing, and supply chain activities. This helps reduce planning errors and production delays. Therefore, PIS supports systematic production planning and better coordination of manufacturing resources according to organisational requirements.

2. Production Scheduling

PIS aims to improve production scheduling by helping managers determine the timing and sequence of production activities. The system considers factors such as machine availability, labour requirements, material availability, production capacity, and delivery schedules. Proper scheduling helps organisations allocate production resources efficiently and avoid unnecessary idle time. Managers can monitor schedules and make adjustments when production conditions change. Integration with inventory and order information can also improve coordination between production and other departments. Thus, PIS helps organisations develop realistic production schedules, reduce delays, and improve the utilisation of production resources.

3. Efficient Resource Utilisation

An important objective of PIS is to ensure efficient utilisation of production resources. Manufacturing requires effective use of raw materials, labour, machinery, equipment, energy, and production capacity. The system provides information about resource availability and usage, allowing managers to identify underutilisation or excessive consumption. Production data can help managers allocate resources according to production requirements. Better resource utilisation can reduce waste, idle time, and unnecessary operating costs. Therefore, PIS supports managers in achieving optimum utilisation of available production resources and improving the overall efficiency of manufacturing operations.

4. Inventory Control

PIS supports effective inventory control by providing information about raw materials, work-in-progress, and finished goods. The system can monitor stock levels, material consumption, receipts, issues, and production requirements. Managers can use this information to identify shortages, excess inventory, and replenishment requirements. Integration with purchasing and production planning can help ensure that materials are available when required. Effective inventory control can reduce production interruptions and unnecessary inventory holding. Therefore, PIS helps organisations maintain appropriate inventory levels, improve material availability, reduce wastage, and support smooth production operations.

5. Quality Management

Another objective of PIS is to support quality management throughout the production process. The system can record information related to quality inspections, defects, production standards, rejected units, and corrective actions. Managers can analyse quality information to identify recurring problems and areas requiring improvement. Monitoring quality data at different stages of production can help organisations detect problems earlier. This supports consistent production standards and reduces waste caused by defective products. Therefore, PIS contributes to quality monitoring, defect identification, process improvement, and maintenance of required production standards.

6. Reducing Production Costs

PIS aims to help organisations control and reduce production costs by providing information about materials, labour, machine usage, production time, and operational expenses. Managers can compare actual production costs with planned or standard costs and identify significant variations. Information about material wastage, machine idle time, and inefficient processes can help management take corrective measures. Better planning and resource utilisation can also reduce unnecessary expenditure. Therefore, PIS supports cost monitoring, waste reduction, efficient resource utilisation, and improved control over manufacturing expenses, contributing to more efficient production operations.

7. Monitoring Production Performance

PIS helps managers monitor production performance by providing information about production quantities, completion rates, machine utilisation, labour productivity, defects, and production delays. Managers can compare actual performance with planned targets and identify deviations. Regular reports and dashboards can provide information about the current condition of production activities. This allows managers to investigate problems and take corrective action when necessary. Performance information can also be used to evaluate the efficiency of production departments and processes. Thus, PIS supports continuous monitoring, performance evaluation, and improvement of manufacturing operations.

8. Supporting Production Decision Making

A Production Information System provides managers with relevant information for production-related decision making. Managers may need to decide production quantities, resource allocation, scheduling, inventory requirements, equipment usage, and capacity utilisation. PIS brings together information from production, inventory, sales, purchasing, and other related functions. This provides managers with a broader view of production conditions. Reports and analytical information can help compare alternatives and identify possible operational problems. Therefore, PIS supports timely and informed production decisions and helps managers coordinate manufacturing activities with organisational requirements.

9. Improving Coordination

PIS aims to improve coordination among production and other business functions. Production activities are closely connected with sales, purchasing, inventory, finance, logistics, and supply chain management. An integrated information system allows relevant departments to share updated production information. For example, sales information can support production planning, while inventory information can indicate whether required materials are available. Better information sharing reduces communication gaps and helps departments coordinate their activities. Therefore, PIS promotes integrated information flow, interdepartmental coordination, and smooth functioning of production-related business processes.

10. Reducing Production Delays

Another objective of PIS is to help identify and reduce production delays. Delays may occur because of material shortages, machine breakdowns, labour constraints, scheduling problems, or quality issues. PIS provides information about production progress, resource availability, machine status, and pending activities. Managers can use this information to identify potential bottlenecks and take corrective action. Timely information can also help coordinate materials, labour, and equipment more effectively. Therefore, PIS contributes to timely production, better workflow management, reduced bottlenecks, and improved delivery performance.

Components of Production Information System:

1. Hardware

Hardware refers to the physical equipment used to operate the Production Information System. It includes computers, servers, scanners, printers, storage devices, sensors, production terminals, and networking equipment. In modern manufacturing environments, machines and industrial devices may also be connected to the system for collecting production information. Hardware enables the collection, processing, storage, and communication of production data. Reliable hardware is important for continuous monitoring of manufacturing activities. Therefore, hardware provides the physical infrastructure required for operating the PIS and supporting production-related information processing.

2. Software

Software includes the applications and programmes used to manage production information. Production software can support production planning, scheduling, inventory management, material requirements planning, quality control, maintenance, and production reporting. It processes data collected from manufacturing activities and converts it into useful information for managers and employees. The software may also integrate with ERP, inventory, sales, and supply chain systems. Appropriate software should be reliable, user-friendly, scalable, and suitable for production requirements. Thus, software forms an important component of PIS by supporting the automation and management of production processes.

3. Production Data

Production data is the basic input of a Production Information System. It includes information about production quantities, raw materials, work-in-progress, finished goods, machine utilisation, labour hours, production schedules, defects, and production costs. Data may be collected manually or automatically through machines, sensors, scanners, and other systems. Accurate and timely production data is necessary for effective planning, monitoring, and decision making. Poor-quality data can result in incorrect production reports and planning problems. Therefore, production data provides the essential information base required for managing and controlling manufacturing activities.

4. Database

A database stores production-related information in an organised and structured manner. It may contain records of production orders, materials, machines, employees, suppliers, inventory, quality inspections, and finished products. A database management system enables authorised users to store, retrieve, update, and analyse production information efficiently. Centralised storage can improve data consistency and reduce unnecessary duplication. Production databases can also be integrated with ERP and other business systems to support information sharing. Therefore, the database provides the central storage foundation for maintaining and accessing production information.

5. Production Planning and Scheduling Module

The production planning and scheduling module supports decisions regarding what, how much, and when products should be manufactured. It uses information about customer orders, production capacity, available materials, workforce, machinery, and delivery requirements. The module can help prepare production schedules and allocate resources to different production activities. Managers can monitor planned and actual production and make adjustments when necessary. Integration with inventory and procurement systems can further improve material availability. Therefore, this component supports systematic production planning, scheduling, capacity utilisation, and coordination of manufacturing activities.

6. Inventory and Materials Management

The inventory and materials management component manages information about raw materials, components, work-in-progress, and finished products. It tracks stock levels, material receipts, issues, transfers, consumption, and replenishment requirements. The information helps production managers determine whether sufficient materials are available for scheduled production. Integration with purchasing and production planning can reduce material shortages and unnecessary inventory accumulation. Accurate inventory information also supports cost control and resource planning. Thus, this component helps ensure timely availability of materials, effective inventory control, reduced wastage, and smooth production operations.

7. Quality Management

The quality management component collects and processes information related to product and process quality. It can maintain records of quality inspections, production defects, rejected units, testing results, quality standards, and corrective actions. Managers can analyse quality information to identify recurring problems and improve production processes. Quality information may be collected at different stages of manufacturing to identify defects at an early stage. Integration with production data helps management understand the relationship between production activities and quality outcomes. Therefore, this component supports quality monitoring, defect reduction, process improvement, and maintenance of production standards.

8. People and Users

People are an essential component of the Production Information System because they operate, manage, maintain, and use the system. Users may include production managers, supervisors, production workers, inventory staff, quality personnel, planners, IT professionals, and senior managers. Different users require different types of production information according to their responsibilities. Production managers may analyse performance reports, while workers may enter production data or view work instructions. IT professionals maintain the technical system. Therefore, people provide the skills, judgement, supervision, and operational support necessary for effective use of the Production Information System.

9. Network and Communication

Network and communication infrastructure enables production information to move between machines, production departments, warehouses, offices, and other business systems. It includes local networks, internet connections, communication devices, industrial networks, and related technologies. A reliable network allows production data to be collected and shared efficiently. For example, information from production equipment can be transmitted to monitoring or management systems. Secure communication is important to protect production and business information. Therefore, network infrastructure supports real-time information sharing, system integration, remote monitoring, and coordination of production activities.

10. Procedures and Controls

Procedures and controls define how production information should be collected, processed, verified, stored, and used. Procedures may cover production data entry, material issuing, quality inspection, production reporting, equipment monitoring, and system access. Controls help ensure that information is accurate and that production activities follow established organisational requirements. Access controls can restrict sensitive information to authorised users, while backup procedures help protect important records. Clearly defined procedures also improve consistency in system usage. Therefore, this component provides a structured and controlled framework for managing production information and supporting reliable production operations.

Types of Production Information Systems:

1. Production Planning System

A Production Planning System helps organisations determine the quantity and timing of products to be manufactured. It uses information about customer demand, sales orders, available materials, production capacity, workforce, and machinery. The system helps managers prepare production plans and coordinate manufacturing activities with inventory and purchasing requirements. It can also provide information about planned and actual production. Effective production planning helps organisations avoid overproduction, material shortages, and inefficient resource utilisation. Therefore, a Production Planning System supports systematic manufacturing planning, resource allocation, capacity utilisation, and coordination of production activities.

2. Production Scheduling System

A Production Scheduling System focuses on determining the sequence and timing of production activities. It considers factors such as machine availability, workforce, materials, production capacity, and delivery deadlines. The system helps managers assign production jobs to appropriate machines and work centres and establish production timelines. Actual progress can be compared with planned schedules so that adjustments can be made when required. Effective scheduling reduces idle time, production bottlenecks, and unnecessary delays. Thus, a Production Scheduling System supports efficient workflow management, timely production, better machine utilisation, and coordination of manufacturing activities.

3. Material Requirements Planning System

A Material Requirements Planning (MRP) System helps organisations determine the materials and components required for production. It uses information about the master production schedule, bill of materials, inventory levels, and planned production requirements. The system calculates what materials are needed and when they should be available. This helps organisations coordinate purchasing and production activities and reduce the risk of material shortages. MRP can also help control excess inventory by aligning material purchases with production requirements. Therefore, a Material Requirements Planning System supports material availability, inventory control, production planning, and efficient resource utilisation.

4. Manufacturing Execution System

A Manufacturing Execution System (MES) monitors and manages production activities on the manufacturing floor. It provides information about production orders, work progress, machine utilisation, labour activities, product quality, and production performance. MES connects production planning with actual manufacturing operations and can provide near-real-time information about production status. Managers and supervisors can use this information to identify delays, quality issues, and resource problems. MES is particularly useful for monitoring detailed shop-floor activities. Therefore, a Manufacturing Execution System supports real-time production monitoring, process control, performance measurement, and operational coordination.

5. Inventory Management System

An Inventory Management System manages information about raw materials, components, work-in-progress, and finished goods. It records stock receipts, issues, transfers, consumption, and current inventory levels. The system helps production managers determine whether required materials are available and when replenishment may be necessary. Integration with purchasing and production planning can improve coordination between material availability and manufacturing requirements. Accurate inventory information can reduce stock shortages, excessive inventory, and production interruptions. Thus, an Inventory Management System supports effective stock control, material availability, warehouse management, and smooth production operations.

6. Quality Management System

A Quality Management System manages information related to product and process quality. It can record inspection results, defects, rejected products, testing information, quality standards, and corrective actions. Quality information can be collected at different stages of production to identify problems early. Managers can analyse quality records to determine recurring defects and areas requiring process improvement. The system can also help monitor compliance with established organisational quality procedures. Therefore, a Quality Management System supports quality control, defect reduction, process improvement, product consistency, and monitoring of manufacturing quality performance.

7. Maintenance Information System

A Maintenance Information System manages information related to machinery, equipment, maintenance activities, and equipment performance. It can maintain records of maintenance schedules, equipment history, breakdowns, repairs, spare parts, and maintenance costs. Managers can use the system to schedule preventive maintenance and monitor equipment conditions. Proper maintenance information helps reduce unexpected machine breakdowns and production interruptions. It can also support better planning of maintenance resources and spare parts. Therefore, a Maintenance Information System contributes to equipment reliability, preventive maintenance, reduced downtime, and improved utilisation of production machinery.

8. Computer-Integrated Manufacturing System

A Computer-Integrated Manufacturing (CIM) System integrates computer-based technologies across different manufacturing activities. It can connect product design, production planning, manufacturing operations, inventory, quality control, and other production functions. The system enables information to flow between different stages of manufacturing and supports greater automation. CIM can improve coordination between design and production activities and reduce manual information transfer. It is particularly useful in organisations with advanced and highly integrated manufacturing environments. Therefore, CIM supports manufacturing integration, automation, information sharing, production efficiency, and coordinated control of manufacturing activities.

Benefits of Production Information Systems:

1. Improved Production Planning and Scheduling

One major benefit of PIS is effective production planning and scheduling. It uses real-time data and advanced algorithms to create accurate production schedules by considering material availability, machine capacity, and labour. This ensures optimum utilization of resources and minimizes idle time. PIS enables finite capacity planning, prioritizes urgent orders, and reduces production lead time. By providing real-time visibility into shop floor activities, it helps managers to quickly adjust plans in case of machine breakdown or demand changes, ensuring timely delivery, smooth workflow, and achievement of production targets efficiently.

2. Effective Inventory Control and Cost Reduction

PIS provides excellent inventory control by maintaining optimum levels of raw materials, work-in-progress, and finished goods. It prevents overstocking and stock-outs through demand forecasting and just-in-time (JIT) techniques. The system tracks inventory movement, reduces wastage, and minimizes carrying cost and storage expenses. By integrating with purchasing and stores department, it ensures timely procurement and reduces production cost. Accurate inventory data also helps in avoiding production stoppages. Ultimately, PIS leads to significant cost reduction, improves cash flow, and enhances overall profitability through efficient material management and control.

3. Enhanced Quality Control and Operational Efficiency

PIS significantly improves quality control and overall operational efficiency. It continuously monitors the manufacturing process, collects shop floor data, and detects defects at early stages. By implementing Statistical Quality Control (SQC) tools and real-time inspection, it ensures products meet quality standards and reduces rework and rejection rates. The system standardizes production procedures, minimizes human errors, and enhances productivity. It also helps in maintaining equipment through preventive maintenance scheduling. This results in consistent product quality, higher customer satisfaction, reduced wastage, and improved efficiency across all production operations and processes.

4. Better Decision Making and Resource Utilization

PIS supports better decision-making by providing accurate, timely, and relevant information to management. It generates detailed reports on resource utilization, machine performance, labour productivity, and production costs. This data-driven approach helps managers to identify bottlenecks, analyze variances, and take corrective actions promptly. The system optimizes allocation of men, machines, and materials, ensuring maximum resource utilization and minimizing idle time. With real-time monitoring and what-if analysis, management can make strategic decisions regarding expansion, outsourcing, and capacity planning, leading to improved profitability and sustainable growth.

5. Integration and Competitive Advantage

PIS provides seamless system integration with other subsystems like ERP, Supply Chain Management, and Sales Information System. This integration ensures smooth data flow between departments, eliminates data silos, and improves coordination. It enhances communication between production, inventory, purchasing, and marketing departments, leading to faster order processing and better customer service. By improving efficiency, reducing costs, and ensuring on-time delivery, PIS creates a strong competitive advantage for the organization. It enables quick response to market changes, supports innovation, and helps the company to sustain in a highly competitive manufacturing environment.

Challenges in Production Information Systems:

1. High Implementation Cost and Complexity

One major challenge is the high implementation cost and technical complexity involved in PIS. It requires huge investment in hardware, specialized software, sensors, and infrastructure for real-time data collection. Customization as per specific manufacturing process, licensing fees, and consultancy charges further increase expenses. For small and medium enterprises, this cost is often unaffordable and leads to budget overruns. Moreover, designing, installing, and configuring PIS is technically complex and needs expert knowledge. Without proper cost-benefit analysis and financial planning, organizations may face financial strain and fail to achieve expected return on investment from the system.

2. System Integration and Compatibility Issues

Integrating PIS with existing systems like ERP, Supply Chain Management, inventory, and quality control is a critical challenge. Legacy machines and old software often have different data formats, protocols, and architectures that are not compatible with modern PIS. This creates data silos, duplication, and inconsistency in reporting. Achieving seamless system integration requires middleware, customization, and extensive testing which is time-consuming and expensive. If integration fails, it causes inaccurate scheduling, inventory mismatch, and disrupted workflow. Effective coordination between production, purchasing, and sales becomes difficult, reducing overall operational efficiency and productivity.

3. Data Accuracy, Security and Maintenance

Maintaining data accuracy and ensuring data security is a serious challenge in PIS. Shop floor data collected from sensors and manual entries may be incomplete, inconsistent, or erroneous, leading to wrong production schedules and decision-making failures. Financial and design data is highly sensitive and vulnerable to cyber-attacks, unauthorized access, and data breach. Implementing robust security measures like encryption and access controls increases complexity. Furthermore, PIS requires regular updates, preventive maintenance, and technical support. Lack of skilled IT personnel and high dependence on vendors for system maintenance creates operational risks and increases long-term costs.

4. Resistance to Change and Lack of Training

Resistance to change from employees is a major human-related challenge. Workers and supervisors accustomed to traditional manual methods fear job loss, increased monitoring, and complexity of new technology. This leads to low adoption, intentional bypassing, and errors in system usage. Additionally, lack of proper training and development and technical skills makes it difficult to operate PIS effectively. Operators fail to understand real-time dashboards, alerts, and reporting tools. Without effective change management, communication, and continuous training programs, employees remain demotivated. Management must involve users from planning stage to overcome cultural barriers and ensure successful implementation.

5. Technological Obsolescence and Scalability

Rapid technological obsolescence and lack of scalability pose continuous challenges. Manufacturing technology, automation tools, and software versions change quickly, making existing PIS outdated within few years. Upgrading hardware and software to match new innovations requires additional investment and causes production downtime. Many PIS are rigid and cannot scale up to handle increased production volume, new product lines, or multi-location operations. This limits future expansion and flexibility. Organizations must adopt flexible architecture and future-proof systems with modular design. Without regular technological upgradation and strategic planning, PIS fails to support long-term growth and competitive advantage.

Emerging Trends in Production Information Systems:

1. Artificial Intelligence in Production

Artificial Intelligence (AI) is increasingly being used in Production Information Systems to analyse production data and support managerial decisions. AI systems can identify patterns in production performance, predict equipment failures, detect quality problems, and recommend improvements. Machine learning algorithms can analyse historical and real-time data to improve production planning and forecasting. AI can also support automated inspection and process optimisation. By reducing dependence on manual analysis, organisations can respond more quickly to production problems. Therefore, the integration of AI and machine learning is making Production Information Systems more intelligent, predictive, and capable of supporting efficient manufacturing decisions.

2. Internet of Things in Manufacturing

The Internet of Things (IoT) connects machines, sensors, equipment, and other production devices to information networks. Sensors can continuously collect information about machine performance, temperature, production speed, energy consumption, and operating conditions. This information can be transferred to Production Information Systems for analysis and monitoring. Managers can therefore obtain real-time production information and identify problems quickly. IoT also supports predictive maintenance, inventory monitoring, and automated production processes. The growing use of connected devices is transforming traditional manufacturing into more connected and data-driven operations, improving visibility, efficiency, monitoring, and decision making.

3. Cloud-Based Production Systems

Cloud computing is becoming increasingly important in Production Information Systems because it allows production data and applications to be accessed through internet-based infrastructure. Organisations can store production information on cloud platforms instead of depending entirely on local servers. Cloud-based systems can provide greater accessibility, scalability, and integration between different production locations. Managers may access production reports and performance information from different locations using authorised devices. Cloud systems can also reduce some infrastructure requirements and simplify system upgrades. As a result, cloud-based Production Information Systems are supporting flexible, connected, and scalable production management.

4. Big Data Analytics

Modern production environments generate large amounts of data from machines, sensors, inventory systems, quality inspections, suppliers, and production processes. Big Data Analytics enables organisations to process and analyse this information to identify useful patterns and relationships. Production managers can use analytics to monitor performance, identify bottlenecks, forecast demand, analyse defects, and improve resource utilisation. Historical and real-time data can be combined to support more informed decisions. The increasing use of Big Data is therefore changing Production Information Systems from simple information-recording tools into analytical systems capable of supporting continuous production improvement and better operational planning.

5. Predictive Maintenance

Predictive maintenance uses production data, sensors, analytics, and machine-learning techniques to predict when equipment may require maintenance. Traditional maintenance may depend on fixed schedules or occur after equipment failure. Predictive maintenance analyses indicators such as vibration, temperature, operating time, and machine performance to identify possible equipment problems. Production managers can schedule maintenance before major breakdowns occur. This can help reduce unexpected downtime, improve equipment utilisation, and support better maintenance planning. Integration of predictive maintenance with Production Information Systems enables organisations to combine equipment data, maintenance records, and production schedules for more effective manufacturing operations.

6. Robotics and Automation

Robotics and automation are becoming important components of modern production systems. Robots can perform repetitive, precise, or hazardous activities such as assembly, material handling, packaging, welding, and inspection. Production Information Systems can collect information from automated equipment and monitor production performance. Automation can reduce manual errors, improve consistency, and increase production speed. When robotic systems are connected with information systems, managers can obtain better visibility into machine performance and production output. The integration of robotics, automation, and information systems is therefore supporting more efficient, accurate, and flexible manufacturing operations.

7. Digital Twins

A Digital Twin is a digital representation of a physical machine, production process, or manufacturing system. It uses data from real-world operations to represent and analyse the condition and behaviour of the physical system. Production managers can use digital twins to monitor performance, test changes, identify potential problems, and evaluate different production scenarios without immediately changing the actual production environment. This can support better planning and process optimisation. Integration of Digital Twin technology with Production Information Systems provides organisations with improved simulation, monitoring, prediction, and decision support for modern manufacturing operations.

8. Smart Manufacturing

Smart Manufacturing uses connected technologies, automation, analytics, and intelligent information systems to improve manufacturing processes. Machines, employees, software, sensors, and production facilities can exchange information and work together through integrated systems. Production Information Systems can collect real-time data and use it to support production planning, quality management, maintenance, and resource allocation. Smart manufacturing can provide greater visibility into production activities and enable faster responses to operational problems. The development of smart factories represents a major shift toward connected, automated, flexible, and data-driven production environments.

9. Cybersecurity in Production Systems

As production systems become increasingly connected, cybersecurity has become an important emerging area. Production Information Systems may be connected to organisational networks, cloud platforms, IoT devices, and external systems, creating potential security risks. Cyberattacks can affect production data, operational systems, and manufacturing activities. Organisations are therefore adopting stronger authentication, access controls, network monitoring, data encryption, backups, and security management practices. Cybersecurity is becoming an integral part of production system design rather than a separate activity. Strong security measures help protect production information, operational technology, system availability, and business continuity.

10. Mobile Production Information Systems

Mobile technology is increasingly being integrated with Production Information Systems to provide access to production information through smartphones, tablets, and other mobile devices. Managers and supervisors can monitor production status, inventory levels, machine performance, quality information, and work orders without remaining at a fixed workstation. Mobile systems can also support communication between production teams and enable quicker reporting of operational problems. With appropriate security controls, mobile access can improve the speed and flexibility of production management. Therefore, mobile Production Information Systems are supporting real-time access, faster communication, and more responsive manufacturing operations.

Management Notes

Networking of Computers, Client Server LAN, Wide Area Network (WAN)

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A computer network is a system in which multiple computers are connected to each other to share information and resources.

Characteristics of a Computer Network

  • Share resources from one computer to another.
  • Create files and store them in one computer, access those files from the other computer(s) connected over the network.
  • Connect a printer, scanner, or a fax machine to one computer within the network and let other computers of the network use the machines available over the network.

NODA

A node is any physical device within a network of other tools that’s able to send, receive, or forward information. A personal computer is the most common node. It’s called the computer node or internet node.

Modems, switches, hubs, bridges, servers, and printers are also nodes, as are other devices that connect over Wi-Fi or Ethernet. For example, a network connecting three computers and one printer, along with two more wireless devices, has six total nodes.

Nodes within a computer network must have some form of identification, like an IP address or MAC address, for other network devices to recognize it. A node without this information, or one that’s offline, no longer functions as a node.

In telecommunications networks, a node is either a redistribution point or a communication endpoint. The definition of a node depends on the network and protocol layer referred to. A physical network node is an electronic device that is attached to a network, and is capable of creating, receiving, or transmitting information over a communications channel. A passive distribution point such as a distribution frame or patch panel is consequently not a node.

Network nodes are the physical pieces that make up a network. They usually include any device that both receives and then communicates information. But they might receive and store the data, relay the information elsewhere, or create and send data instead.

For example, a computer node might back up files online or send an email, but it can also stream videos and download other files. A network printer can receive print requests from other devices on the network, while a scanner can send images back to the computer. A router determines which data goes to which devices that request file downloads within a system, but it can also send requests out to the public internet.

Client Server LAN

On a client/server network, every computer has a distinct role: that of either a client or a server. A server is designed to share its resources among the client computers on the network. Typically, servers are located in secured areas, such as locked closets or data centers (server rooms), because they hold an organization’s most valuable data and do not have to be accessed by operators on a continuous basis. The rest of the computers on the network function as clients.

The components of a client/server LAN.

Wide Area Network (WAN)

A wide area network (WAN) is a telecommunications network that extends over a large geographical area for the primary purpose of computer networking. Wide area networks are often established with leased telecommunication circuits.

Business, as well as education and government entities use wide area networks to relay data to staff, students, clients, buyers and suppliers from various locations across the world. In essence, this mode of telecommunication allows a business to effectively carry out its daily function regardless of location. The Internet may be considered a WAN.

Similar types of networks are personal area networks (PANs), local area networks (LANs), campus area networks (CANs), or metropolitan area networks (MANs) which are usually limited to a room, building, campus or specific metropolitan area, respectively.

Management Notes

Theory of interest

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1. Productivity Theory:

According to productivity theory, interest can be defined as a reward for availing the services of capital for the production purpose.

Labor that is having good amount of capital produces more as compared to the labor who is not assisted by good amount of capital.

For example, farmer having tractor to plough the field produces more as compared to the farmer who does not have it. Thus, interest is the payment for the productivity of capital.

However, the productivity theory is criticized on the following grounds:

  1. Focuses only on the causes for what the interest is paid, not on the determination of interest rates.
  2. Assumes that interest is paid due to the productivity of capital. In such a case, pure interest should vary as per the productivity of the capital. However, pure interest is the same in money market during the same period of time.
  3. Lays emphasis on the demand of interest, but ignores the supply side of capital.
  4. Fails to explain how the interest is paid for the loan borrowed for consumption purposes.

2. Abstinence or Waiting Theory:

The abstinence theory was propounded by Senior. According to him, interest is a reward for abstinence. When an individual saves money out of his/her income and lends it to other individual, he/she makes sacrifice. The term sacrifice implies that the individual refrains from consuming his/her whole income that he/she could spent easily. Senior advocated that abstaining from consumption is unpleasant. Therefore, the lender must be rewarded for this. Thus, as per Senior, interest can be regarded as the reward for refraining from the use of capital.

Abstinence theory was also criticized by a number of economists. According to the theory, an individual feels unpleasant when they save as it reduces his/her consumption. However, rich people do not feel unpleasant while saving because they are able to meet their requirements.

Therefore, Marshall has replaced the term abstinence with waiting and described saving in terms of waiting. He states that saving is done by transferring the present requirement to the future and the person needs to wait for meeting those requirements. However, people do not want to wait rather they are motivated to save money by providing a certain amount of interest.

3. Austrian or Agio Theory:

Austrian theory is also termed as psychological theory of interest. This theory was advocated by John Rae and Bohm Bawerk in an Austrian school. According to Austrian theory, interest came into existence because present goods are preferred over future goods. Therefore, the present goods have premium with them in the form of interest. In other words, present satisfaction is of greater concern as compared to future satisfaction.

Therefore, future satisfaction has certain type of discount if compared with present satisfaction. The interest is the discounted amount that is required to be paid for motivating people to invest or transfer their present requirements to future. For example, an individual has to make a choice between two options.

He/she can either have Rs. 500 now or the same amount after a year. In such a case, he/she would prefer to have Rs. 500 in present. However, in case, the individual has a choice of getting Rs. 500 in present and Rs. 600 after one year.

In such a case, he/she would be more inclined toward getting Rs. 600 after a year. Thus, the extra payment of Rs. 100 would compensate the sacrifice involved in delaying his/her present satisfaction. The extra payment of Rs. 100 in the given case is considered as interest.

Agio theory’ has been criticized by various economists on the following grounds:

  1. Lays too much emphasis on the supply aspect and ignores the demand aspect
  2. Does not focus on the determination of rate of interest

4. Classical or Real Theory:

Classical theory helps in the determination of rate of interest with the help of demand and supply forces. Demand refers to the demand of investment and supply refers to the supply of savings. According to this theory, rate of interest refers to the amount paid for saving.

Therefore, the rate of interest can be determined with the help of demand for saving money to be invested in the capital goods and the supply of savings. Let us understand the concept of demand of investment. Capital goods are used for the production of consumer goods and provide returns continuously for many years.

However, a certain degree of uncertainty is associated with capital goods due to their future use. In addition, operation and maintenance costs are involved in using capital goods. This makes organizations to calculate the net expected return on the marginal cost that is represented as the percentage of cost of capital good.

In case, an organization has similar type of capital goods, then the increase in one more capital good would not yield them high revenue. The increase in the rate of interest would result in the fall of demand of capital goods.

Figure-18 shows the demand for capital investment:

4.1

In Figure-18, MRP represents the marginal revenue productivity curve. When the demand of capital is OM, then the rate of interest is Or. The net rate of return becomes equal to the current rate of interest (Or) at the OM demand of capital.

In case, the rate of interest decreases to Or’, then the demand of capital increases to OM’. The net rate of return is equal to Or’ when the amount of capital demanded is OM’. The demand for capital goods increases with a decrease in the rate of interest.

On the other hand, the supply of capital increases by the amount saved by an individual and the saving is done by transferring the present requirement to the future requirement. The rate of interest would increase with the increase in the amount of saving by an individual.

The rate of interest can be determined with the help of demand of investment and supply of savings. It would be the point of equilibrium where demand and supply intersects each other or get equal.

Figure-19 shows the determination of rate of interest with the help of demand and supply curves:

4.2

In Figure-19, SS is the supply curve of saving and II is the demand curve of investment that intersect each other at Or rate of interest with quantity of saving and investment is OM. OM represents the amount that is lent, borrowed and used for investment. The rate of interest can be changed by changing the demand and supply of savings and investment.

The classical theory is criticized by Keynes due to various reasons, which are as follows:

  1. Assumes the full employment of resources, which is not true in reality. This is because if one resource is reduced from one production process, then it would be utilized for other production process. On the contrary, if resources are available in abundant, then there is no need to save them.
  2. Assumes that investment can be increased only when individuals reduce their consumption. This is because if the consumption is less, then the saving would increase, which would lead to the increase in investment. However, if the demand of capital goods decreases, then the incentive to produce capital goods would also decrease. This would result in the decrease of investment.
  3. Assumes that there is no change in the income level of an individual. Thus, according to classical theory, saving and investment become equal due to change in rate of interest. However, according to Keynes theory, savings and investment become equal because of changes occur in the income level of an individual.

5. Loanable Fund Theory:

Loanable fund theory agrees with the view that time preference plays an important role in determining the occurrence of interest. This theory is also termed as neo-classical theory of interest. According to neo-classical economists, interest is the amount paid for loanable funds. It focuses on the determination of rate of interest with the help of demand and supply of loanable funds in the credit market. Let us understand the concept of supply of loanable funds.

The supply of loanable funds depends on the following factors:

  1. Savings:

Act as one of the sources of loanable funds. The loanable funds in the form of saving are classified as ex-ante saving and Robertsonian sense. Ex-ante saving refers to the saving that an individual plans according to his/her expected income and expenditure in the starting of a year or financial year or for a month.

On the other hand, Robertsonian sense refers to the saving that is produced by taking the difference of previous period income and present period consumption. In both the types of savings, the savings are different at different rate of interest. Savings are dependent on the income level that vanes with the rate of interest. The increase in the rate of interest would result in the increase of the level of saving and vice versa.

In the context of organizations, the amount left after distributing the profit in the form of dividends is termed as the saving of an organization. The savings of an organization depends on the rate of interest prevailing in the market. Increased rate of interest would encourage organizations to increase savings instead of borrowing money from loan market.

2. Dishoarding:

Involves reduction in the money stock of an organization. Therefore, in the previous money stock, the liquidity of money is high that can be utilized in the present time as loanable funds. The higher the rate of interest, the more would be the money dishoarded and vice versa.

3. Credit by bank:

Refers to the loan provided by bank to the organizations. Banks can increase or decrease the money lend to an organization on the basis of certain criteria. The supply of loanable funds increases with the increase in the money created by banks. The supply curve is interest elastic for loanable funds. The higher the rate of interest, the more the bank would lend money and vice versa.

4. Disinvestment:

Refers to the situation when the existing capital goods of an organization are reduced or the stock of the organization is less than the previous stock. In such a condition, the fund that is used for the replacement purposes are used as loanable funds.

According to Bober, ”Disinvestment is encouraged by the somewhat by a high rate of interest on loanable funds. When the rate is high, some of the current capital may not produce a marginal revenue product to match this rate of interest. The firm may decide to let this capital run down and to put the depreciation finds in the ban market”

After determining the factors that influence the supply of loanable funds, let us study the demand for loanable funds. The demand for loanable funds depends on investment, consumption, and hoarding of income. Organizations require loanable funds to a greater extent for expanding the stock of capital goods, such as machines and buildings.

The demand for loanable funds depends on the extent to which organizations require loanable funds. Interest is the price at which the loanable funds can be bought. Organizations require loanable funds at which the net rate of return on capital goods is equal to the rate of interest.

The higher rate of interest demotivates organizations to buy capital goods or expand their stock of capital goods. Therefore, the demand of loanable funds is interest elastic for organizations; therefore, the demand curve would slope downwards.

Another major constituent of demand for loanable funds is the requirement of funds b) individuals for consumption. Generally, individuals require loanable fund when they desire to purchase something out of their budget or the consumer goods that they cannot afford from their present income. The lower the rate of interest, the higher would be the demand for loanable goods. Therefore, the demand for loanable funds is interest elastic for individuals; thus the demand curve slopes downward.

Along with organizations and individuals, there are some people who require loanable goods for hoarding purposes. Hoarding refers to the holding of some part of income by the individuals for future use. In hoarding, the supplier and buyer of loanable funds is the same person.

A person may want to hold funds when the rate of interest is low. On the contrary, he/she may use his/her funds by investing in new projects, when the rate of interest is high. Therefore, the demand of loanable funds is interest elastic for hoarding purpose; thus, the demand curve slopes downward.

Figure-20 shows the interaction between the demand and supply curve of loanable funds to reach at equilibrium position:

4.3

In Figure-20, DH represents dishoarding curve, BM is bank credit curve, S represents saving curve, and DI is disinvestment curve. LS represent the supply of loanable funds, which is produced by summing up the DH, BM, S, and DI curve. Similarly, H represents hoarding, C is consumption, and I is investment, which together form LD.

In Figure-20, LD is the demand for loanable funds. The point at which the demand and supply curve of loanable funds intersect each other is termed as equilibrium point (E). At point E, the rate of interest is OR with ON loanable funds. Therefore, OR would be the equilibrium rate of interest in the credit market.

Management Notes

Meaning of Correlation, Importance

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Correlation, in the finance and investment industries, is a statistic that measures the degree to which two securities move in relation to each other. Correlations are used in advanced portfolio management, computed as the correlation coefficient, which has a value that must fall between -1.0 and +1.0

A perfect positive correlation means that the correlation coefficient is exactly 1. This implies that as one security moves, either up or down, the other security moves in lockstep, in the same direction. A perfect negative correlation means that two assets move in opposite directions, while a zero correlation implies no relationship at all.

For example, large-cap mutual funds generally have a high positive correlation to the Standard and Poor’s (S&P) 500 Index – very close to 1. Small-cap stocks have a positive correlation to that same index, but it is not as high – generally around 0.8.

However, put option prices and their underlying stock prices will tend to have a negative correlation. As the stock price increases, the put option prices go down. This is a direct and high-magnitude negative correlation.

  • Correlation is a statistic that measures the degree to which two variables move in relation to each other.
  • In finance, the correlation can measure the movement of a stock with that of a benchmark index, such as the Beta.
  • Correlation measures association, but does not tell you if x causes y or vice versa, or if the association is caused by some third (perhaps unseen) factor.

Importance of correlation Analysis

Correlation is very important in the field of Psychology and Education as a measure of relationship between test scores and other measures of performance. With the help of correlation, it is possible to have a correct idea of the working capacity of a person. With the help of it, it is also possible to have a knowledge of the various qualities of an individual.

After finding the correlation between the two qualities or different qualities of an individual, it is also possible to provide his vocational guidance. In order to provide educational guidance to a student in selection of his subjects of study, correlation is also helpful and necessary.

Correlation Statistics and Investing

The correlation between two variables is particularly helpful when investing in the financial markets. For example, a correlation can be helpful in determining how well a mutual fund performs relative to its benchmark index, or another fund or asset class. By adding a low or negatively correlated mutual fund to an existing portfolio, the investor gains diversification benefits.

In other words, investors can use negatively-correlated assets or securities to hedge their portfolio and reduce market risk due to volatility or wild price fluctuations. Many investors hedge the price risk of a portfolio, which effectively reduces any capital gains or losses because they want the dividend income or yield from the stock or security.

Correlation statistics also allows investors to determine when the correlation between two variables changes. For example, bank stocks typically have a highly-positive correlation to interest rates since loan rates are often calculated based on market interest rates. If the stock price of a bank is falling while interest rates are rising, investors can glean that something’s askew. If the stock prices of similar banks in the sector are also rising, investors can conclude that the declining bank stock is not due to interest rates. Instead, the poorly-performing bank is likely dealing with an internal, fundamental issue.

Management Notes

Degrees of Price Discrimination

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Price discrimination means charging different prices from different customers or for different units of the same product. In the words of Joan Robinson: “The act of selling the same article, produced under single control at different prices to different buyers is known as price discrimination.” Price discrimination is possible when the monopolist sells in different markets in such a way that it is not possible to transfer any unit of the commodity from the cheap market to the dearer market.

Degrees of price discrimination

Prof. Pigou in his Economics of Welfare describes three degrees of discriminating power which a monopolist may wield. The type of discrimination discussed above is called discrimination of the third degree. We explain below discrimination of the first degree and the second degree.

Discrimination of the First Degree (1st) or Perfect Discrimination

Discrimination of the first degree occurs when a monopolist charges “a different price against all the different units of commodity in. such wise that the price exacted for each was equal to the demand price for it and no consumer’s surplus was left to the buyers.”

Joan Robinson calls it perfect discrimi­nation when the monopolist sells each unit of the product at a separate price. Such discrimination is possible only when consumers are sold the units for which they are prepared to pay the highest price and thus they are not left with any consumer’s surplus.

For perfect price discrimination, two conditions are required

(1) To keep the buyers separate from each other, and

(2) To deal with each buyer on a take-it-or-leave-it basis. When the discriminator of first degree is able to deal with his customers on the above basis, he can transfer the whole of consumers’ surplus to himself. Consider Figure 1. Where DD1 is the demand curve faced by the monopolist. Each buyer is assumed as a price-taker. Suppose the discriminating monopolist sells four units of his product at four different prices:

OQ1 unit at OP1price, Q1Q2 unit at OP2 price, Q2Q3 unit at OP3 price and Q3Q4 unit at OP4 price. The total revenue (or price) obtained by him would be OQ4 AD. This area is the maximum expenditure that the consumers are willing to incur to buy all four units of the product under the first-degree discriminator’s all-or-nothing offer. But with no price discrimination under simple monopoly, the monopolist would sell all four units at the uniform price OP4 and thus obtain the total revenue of OQ4AP4.

This area represents the total expenditure that consumers would actually pay for the four units. Thus the difference between what Quantity the consumers were willing to pay (OQ4 AD) under Fig. 1 the take-it-or-leave-it offer of the first degree discrimi­nator and what they actually pay (OQ4AP4) to the simple monopolist, is consumers’ surplus. This is equal to the area of the triangle DAP4.

Thus under the first-degree price discrimination, the entire consumers’ surplus is pocketed by the monopolist when he charges a separate price for each unit of the product. Price discrimination of the first degree is rare and is to be found in such rare products as diamonds, jewels, precious stones, etc. But a monopolist must have full knowledge of the demand curve faced by him and he should know the maximum price that the consumers are willing to pay for each unit of the product he wants to sell.

Discrimination of the Second Degree (2nd) or Multi-part Pricing

In discrimination of the second degree, the monopolist divides the consumers in different slabs or groups or blocks and charges different prices for different slabs of the same product. Since the earlier units of the product have more utility for the consumers than the later ones, the monopolist charges a higher price for the former units and reduces the price for the later units in the respective slabs.

Such discrimination is only possible if the demand of each consumer below a certain maximum price is perfectly inelastic. Electric supply companies in developed countries practice discrimination of the second degree when they charge a high rate for the first slab of kilowatts of electricity consumed. As more electricity is used, the rate falls with subsequent slabs.

Figure 2 illustrates the second degree discrimination, where DD1is the demand curve for electric­ity on the part of domestic consumers in a town. CP3 represents the cost of generating electricity, so that the electricity company charges M1P1 rate per kw. up to OM1 units. For consuming the next M1 to М2 units, the rate is lowered to M2P2. The lowest rate charged is M3P3 for M2 to M3 units. M3P3 is, however, the lowest rate which will be charged even if a con­sumer consumes more than M3 units of electricity.

If the electricity company were to charge only one rate throughout, say M3P3the total revenue would not be maximized. It would be OCP3 M3But by charg­ing different rates for different unit slabs, it gets the total revenue equal to OM3 x P1M1 + OM2 x P2M2 + OM3x P3M3 Thus the second degree discriminator would take away a part of consumers’ surplus covered by the rectangles ABEP1and BCFP2 .The shaded area in three triangles DAP1 Р1ЕР2, and P2FP3 still remains with consumers as their surplus.

The second degree price discrimination is practised by telephone companies, railways, companies supplying water, electricity and gas in developed countries where these services are available in plenty. But it is not found in developing countries like India where such services are scarce.

The differences between the first and second degree price discrimination may be noted. In the first degree discrimination, the monopolist charges a different price for each different unit of the prod­uct. But in second degree discrimination, a number of units in one slab (or group or block) are sold at the lowest price and as the slabs increase, the prices charged by the monopolist are lowered. In the case of the former the monopolist takes away the whole of consumers’ surplus. But in the latter case, the monopolist takes away only a portion of the consumers’ surplus and the other portion is left with the buyer.

Conditions under which Price Discrimination is Possible

Price discrimination is possible under following conditions:

  1. Nature of Commodity

In the first place it is said that price discrimination is possible when the nature of the commodity or service is such that there is no possibility of transference from one market to the other.

That is, the goods sold in the cheaper market cannot be resold in the dearer market; otherwise the monopolist’s purpose will be defeated.

  1. Distance of Two Markets

Price discrimination is possible when the two markets or markets are separated by large distance or tariff barriers, so that it is not possible to transfer goods from a cheaper market to dearer markets. For instance, a monopolist may sell the same product at a higher price in Bombay and lower price in Meerut.

  1. Ignorance of the Consumers

Price discrimination is possible when the consumers are ignorant about price discrimination, they are not aware that in one part of the market prices are lower than in the other part. Thus, he purchases in dearer market, than in cheaper market since he is ignorant of the prices that are prevailing in different markets.

  1. Government Regulation

Price discrimination occurs when the government rules and regulations permit. For instance, according to rules, electricity rates are fixed at higher level for industrial purposes and lower for domestic uses. Similarly, railways charge by law higher fares from first class passengers than from the second class passengers. Hence, price discrimination is possible because of legal sanction.

  1. Geographical Discrimination

Price discrimination may be possible on account of geographical situations. The monopolist may discriminate between home and foreign buyers by selling at lower price in the foreign market than in the domestic market. Geographical discrimination is possible because no unit of the commodity sold in one market can be transferred to another.

  1. Difference in Elasticity of Demand

A commodity may have different elasticity of demand in different markets. Thus, the market of a commodity can be separated on the basis of its elasticity of demand.

Hence, a monopolist can charge different prices in different markets classified on the basis of elasticity of demand, low price is charged where demand is more elastic and high price in the market with the less elastic demand or inelastic demand.

  1. Artificial Difference between Goods

A monopolist may create artificial differences by presenting the same commodity under different names and labels, one for the rich and snobbish buyers and the other for the ordinary customers. For instance, a biscuit manufacturer may wrap small quantity of the biscuits, give it separate name and charge a higher price. Thus, he may charge different price for substantially the same product. He may charge Rs. 2/- for 100 gram wrapped biscuits and Rs. 1.50 for unwrapped biscuits.

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