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Cost Control Cost Reduction

It aims at achieving the pre-determined

cost targets and ends when the targets are
It aims at achieving a reduction in unit cost of
goods manufactured or services rendered without
impairing their suitability for the use intended.
It entails target setting, ascertaining the
actual performance and comparing it
with the targets, investigating the
variances and taking remedial measures.
It does not recognise any condition as permanent
and believe that, by waste reduction, expense
reduction and increased production cost
reduction objective can be achieved.
It does not challenges norms or standards
established for the purpose.
It assumes existence of concealed potential
savings and challenges the norm.
It is a preventive function. It is a corrective function.
Cost control is operated through setting
standards of targets and comparing
performance therewith

Cost reduction is a continuous process of critical
cost examination, analysis and challenge of
standards. Each aspect of business viz.,
products, process, procedures, methods,
organization, personnel, etc. is critically
examined and reviewed with a view of
improving efficiency and effectiveness and
reducing the costs. standards which are the basis
of control are constantly challenged for
Decision Making
Types of Business Decision having economic Content:
1. Production Decisions:
2. Inventory Decisions:
3. Cost Decisions:
4. Marketing Decisions:
5. Investment Decisions:
6. Personnel Decisions

Decision Making Process:
Setting Objectives
Defining the problem
Identifying Causal Factors
Finding Alternative Solutions
Gathering Information
Evaluating Alternatives
Implementing and Monitoring the Results
Prof. Joel Dean says that Use of Economic analysis in formulating policies is
known as Managerial Economics.
According to Hail Stones and Rathanel: Managerial Economics is the application
of Economic theory and analysis to practice by business firms.

Managerial Economics fills up the gap between abstract economic theories and its
practical applicability. It integrates economic principles with business management.
Hence Business Economics refers to the application of economic theories and
concepts to find solutions to business and managerial problems.

Role of Managerial Economist
To identify various business problems their causes, consequences and suggest the
remedial measures:
To provide a quantitative base for decision making and forward planning:
To act as an economic adviser to the firm:
To have a complete information about the environmental factors:
To quickly respond to the changes:

Responsibilities of a Managerial Economist
Reasonable profit, Business forecasting, To have contact with the data sources,
Technological development, Government policies, Finance, Location, Objectives, To
undertake Research Activities .
Dynamic Theory of Profit:
propounded by an American economist, J. B. Clark, according to whom, profit is a result
of change. According to him, five changes are constantly taking place in society, which
give rise to profit. They are:- (a) Changes in the size of the population (b) Changes in the
supply of capital (c) Changes in production techniques (d) changes in the forms of
industrial organization and (e) Changes in human wants. For example: if the demand for a
commodity increases due to increase in population or increase in income of the people,
the price of the commodity will rise and if the cost of production remaining the same,
profits would accrue to the entrepreneurs producing the commodity. On the other hand,
cost of production, may go down as a result of the adoption of a new technique of
production, or as a result of cheapening of the raw material, and if price remains constant
or doesnt fall to the same extent, the profit would emerge.

The Risk theory of Profit:
This theory was formulated by F. B. Hawley in 1907. It was supported by Marshall.
According to him, profit is the reward for risk taking in business. According to the Risk
Theory, the entrepreneur earns profits because he undertakes risks. The manufacturer
produces goods with a view to selling them. If the goods are not sold there is loss. No
entrepreneur will incur this risk unless there is a prospect of corresponding gain. Profit is
the reward of taking such risks. The reward is a necessary inducement without which
entrepreneurs will not work. Hence higher the risk, the greater is the possibility of profit.

Uncertainty-bearing theory of Profit:
An American economist F. H. knight, is the main profounder of this theory, according to
whom, profit is the reward for uncertainty bearing. The main function of entrepreneur is to
act in anticipation of future events. He produces goods in anticipation of demand and
purchases goods in anticipation of resale. Entrepreneurs have to undertake the work of
production under conditions of uncertainty, as nobody guarantees the sale of output in the

Wage theory of Profit:
This theory was propounded by the American economist Prof. Taussig. It was supported by
another economist Prof. Davenport. According to this theory, profit is also a type of wage
which is given to the entrepreneur for the services rendered by him. In the words of Taussig:
Profit is the wage of the entrepreneur which accrues to him on account of his special
ability. This theory finds a perfect similarity between labour and Organization. Just as
labour receives wages for his services, in the same manner entrepreneurship gets profit for
the role played by him in the production process. The only difference between them is
labour renders physical services and entrepreneurship renders intellectual work in
production. Hence entrepreneur is not different from labour. Hence Prof. Taussig referred
profit as A type of wage accruing to entrepreneurship

Innovation Theory of Profit:
This theory was advocated by Prof. Joseph. A. Schumpeter. An innovation can be of any
shape, say, introduction of a new product, introduction of a new production technique or
a new machine or a new plant, a change in the internal organizational set-up of the firm,
use of a new source of raw material or a new form of energy, change in the quality of the
product or in the methods of salesmanship etc.,

According to Schumpeter, profit is the cause and effect of innovation. As a result of
innovation, the cost of production reduces, which creates a gap between the existing
price and the cost of production. Whenever any new innovation is introduced, it calls for
a new combination of factors or reallocation of resources.

It is worth noting here, that profits caused by a particular innovation, is only temporary
and tend to be competed away as others imitate and also adopt that. When an
entrepreneur introduces a new innovation, he is first in a monopoly position, for the new
innovation is confined to him only. He therefore makes large profits. When after
sometime others also adopt it in order to get a share, profits will disappear.

Limiting factors of Profit
Threat of Competition, Birth of substitutes, Heavy Taxation, Increased Wages, Increasing
the cost of inputs, Ceiling on Profits.