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Absorption

Overview

Absorption in economics is the total demand for all types of marketed goods and services by all economic agents living in a given economy, in spite of the source of the goods and services. Absorption can also mean the total expenditure of goods and services for investment, consumption purposes and by use of the government. It’s using output whereby it includes imports but excludes exports. As such, absorption contrasts production because production excludes imports and includes exports. Since absorption is equal to the total number of all goods and services produced domestically, alongside all imports, it’s therefore right to say that it equals the national income less the balance of trade.

Absorption approach to depression looks at the effects of absorption on different forms of expenditure, and highlights that devaluation is only able to improve the balance of payment on current account if and when production expands relative to absorption.

Absorption Costing

Absorption costing is a costing system whereby all normal costs regardless of whether they are fixed or variable costs are charged to cost units produced. Absorption costing has its own advantages and disadvantages.

Advantages of absorption costing

- It appreciates the importance of fixed costs in production
- Absorption costing is the most preferred method for use when preparing financial accounts
- The costing technique is accepted and recognized by Inland Revenue since stock is never underrated.
- When everything else remains constant i.e. production, but the sales ebb and flow, absorption costing will not indicate any fluctuation in net profit
- Different from marginal costing whereby fixed can change to variable costs, absorption costing is cost to the stock value hence can alter stock evaluation.

Disadvantages of Absorption Costing:

- Since absorption costing puts emphasis on total costs (i.e. fixed and variable costs), it isn’t quite useful for the management to rely on it for decision making, planning as well as control
- Since the management would put emphasis on the total cost, the cost volume profit will be ignored. At such a point, the management will be required to use its own intuition to make a practical decision.

Example of Absorption

When aid is extended to a particular economy, it’s expected that by all means it will go toward reducing the current account balance which in this case is the absorbed aid. It can also go to increase reserve accumulation or capital outflows. Research indicates that short-term absorption is quite low, with a lot of aid going out through the capital account. What is more, spending of aid, which is defined more in terms of the expansion of a government fiscal expenditure due to aid, is considerably higher compared to aid absorption meaning that aid will methodically lead to an inoculation of domestic liquidity in the economies receiving aid. This example can help shed more light on the weak link normally put between growth and aid hence there is need for a better coordination between concerned monetary and fiscal authorities while responding to aid for absorption to be effective.

Tags: Economics, government, Income, liquidity, market, revenue

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