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Managerial Economics

Managerial Economics can be defined as amalgamation of economic theory with


business practices so as to ease decision-making and future planning by management
Managerial Economics assists the managers of a firm in a rational solution of obstacles faced
in the firms activities. It makes use of economic theory and concepts. It helps in formulating
logical managerial decisions. The key of Managerial Economics is the micro-economic
theory of the firm. It lessens the gap between economics in theory and economics in practice.
Managerial Economics is a science dealing with effective use of scarce resources. It guides
the managers in taking decisions relating to the firms customers, competitors, suppliers as
well as relating to the internal functioning of a firm. It makes use of statistical and analytical
tools to assess economic theories in solving practical business problems.
tudy of Managerial Economics helps in enhancement of analytical skills, assists in rational
configuration as well as solution of problems. !hile microeconomics is the study of
decisions made regarding the allocation of resources and prices of goods and services,
macroeconomics is the field of economics that studies the behavior of the economy as a
whole "i.e. entire industries and economies#. Managerial Economics applies micro-economic
tools to make business decisions. It deals with a firm.
The use of Managerial Economics is not limited to profit-making firms and organi$ations.
%ut it can also be used to help in decision-making process of non-profit organi$ations
"hospitals, educational institutions, etc#. It enables optimum utili$ation of scarce resources in
such organi$ations as well as helps in achieving the goals in most efficient manner.
Managerial Economics is of great help in price analysis, production analysis, capital
budgeting, risk analysis and determination of demand.
Managerial economics uses both Economic theory as well as Econometrics for rational
managerial decision making. Econometrics is defined as use of statistical tools for assessing
economic theories by empirically measuring relationship between economic variables. It
uses factual data for solution of economic problems. Managerial Economics is associated
with the economic theory which constitutes &Theory of 'irm(. Theory of firm states that the
primary aim of the firm is to ma)imi$e wealth. *ecision making in managerial economics
generally involves establishment of firms ob+ectives, identification of problems involved in
achievement of those ob+ectives, development of various alternative solutions, selection of
best alternative and finally implementation of the decision.
The following figure tells the primary ways in which Managerial Economics correlates to
managerial decision-making.
Scope of Managerial Economics


To answer these ,uestions, a firm makes use of managerial economics Managerial
Economics deals with allocating the scarce resources in a manner that minimi$es the cost.
-s we have already discussed, Managerial Economics is different from microeconomics
and macro-economics. Managerial Economics has a more narrow scope - it is actually
solving managerial issues using micro-economics. !herever there are scarce resources,
managerial economics ensures that managers make effective and efficient decisions
concerning customers, suppliers, competitors as well as within an organi$ation. The fact of
scarcity of resources gives rise to three fundamental ,uestions-
a. !hat to produce.
b. /ow to produce.
c. 'or whom to produce.
principles.
The first ,uestion relates to what goods and services should be produced and in what
amount/quantities. The managers use demand theory for deciding this. The demand
theory e)amines consumer behaviour with respect to the kind of purchases they would like
to make currently and in future0 the factors influencing purchase and consumption of a
specific good or service0 the impact of change in these factors on the demand of that
specific good or service0 and the goods or services which consumers might not purchase
and consume in future. In order to decide the amount of goods and services to be produced,
the managers use methods of demand forecasting.
The second ,uestion relates to how to produce goods and services. The firm has now to
choose among different alternative techni,ues of production. It has to make decision
regarding purchase of raw materials, capital e,uipments, manpower, etc. The managers can
use various managerial economics tools such as production and cost analysis "for hiring
and ac,uiring of inputs#, pro+ect appraisal methods" for long term investment decisions#,etc
for making these crucial decisions.
The third ,uestion is regarding who should consume and claim the goods and
services produced by the firm. The firm, for instance, must decide which is its niche
market-domestic or foreign. It must segment the market. It must conduct a thorough
analysis of market structure and thus take price and output decisions depending upon the
type of market.
Managerial economics helps in decision-making as it involves logical thinking. Moreover,
by studying simple models, managers can deal with more comple) and practical situations.
-lso, a general approach is implemented. Managerial Economics take a wider picture of
firm, i.e., it deals with ,uestions such as what is a firm, what are the firms ob+ectives, and
what forces push the firm towards profit and away from profit. In short, managerial
economics emphasi$es upon the firm, the decisions relating to individual firms and the
environment in which the firm operates. It deals with key issues such as what conditions
favour entry and e)it of firms in market, why are people paid well in some +obs and not so
well in other +obs, etc. Managerial Economics is a great rational and analytical tool.
Managerial Economics is not only applicable to profit-making business organi$ations, but
also to non- profit organi$ations such as hospitals, schools, government agencies, etc.
Nature of Managerial Economics


Managers study managerial economics because it gives them insight to reign the functioning
of the organi$ation. If manager uses the principles applicable to economic behaviour in a
reasonably, then it will result in smooth functioning of the organisation.
Managerial Economics is a Science
Managerial Economics is an essential scholastic field. It can be compared to science in a
sense that it fulfils the criteria of being a science in following sense1
cience is a ystematic body of 2nowledge. It is based on the methodical observation.
Managerial economics is also a science of making decisions with regard to scarce resources
with alternative applications. It is a body of knowledge that determines or observes the
internal and e)ternal environment for decision making.
In science any conclusion is arrived at after continuous e)perimentation. In
Managerial economics also policies are made after persistent testing and trailing. Though
economic environment consists of human variable, which is unpredictable, thus the policies
made are not rigid. Managerial economist takes decisions by utili$ing his valuable past
e)perience and observations.
cience principles are universally applicable. imilarly policies of Managerial
economics are also universally applicable partially if not fully. The policies need to be
changed from time to time depending on the situation and attitude of individuals to those
particular situations. 3olicies are applicable universally but modifications are re,uired
periodically.
Managerial Economics requires Art
Managerial economist is re,uired to have an art of utilising his capability, knowledge and
understanding to achieve the organi$ational ob+ective. Managerial economist should have an
art to put in practice his theoretical knowledge regarding elements of economic environment.
Managerial Economics for administration of organization
Managerial economics helps the management in decision making. These decisions are based
on the economic rationale and are valid in the e)isting economic environment.
Managerial economics is helpful in optimum resource allocation
The resources are scarce with alternative uses. Managers need to use these limited resources
optimally. Each resource has several uses. It is manager who decides with his knowledge of
economics that which one is the preeminent use of the resource.
Managerial Economics has components of micro economics
Managers study and manage the internal environment of the organi$ation and work for the
profitable and long-term functioning of the organi$ation. This aspect refers to the micro
economics study. The managerial economics deals with the problems faced by the individual
organi$ation such as main ob+ective of the organi$ation, demand for its product, price and
output determination of the organi$ation, available substitute and complimentary goods,
supply of inputs and raw material, target or prospective consumers of its products etc.
Managerial Economics has components of macro economics
4one of the organi$ation works in isolation. They are affected by the e)ternal environment
of the economy in which it operates such as government policies, general price level, income
and employment levels in the economy, stage of business cycle in which economy is
operating, e)change rate, balance of payment, general e)penditure, saving and investment
patterns of the consumers, market conditions etc. These aspects are related to macro
economics.
Managerial Economics is dynamic in nature
Managerial Economics deals with human-beings "i.e. human resource, consumers, producers
etc.#. The nature and attitude differs from person to person. Thus to cope up with dynamism
and vitality managerial economics also changes itself over a period of time.
Principles of Managerial Economics


Economic principles assist in rational reasoning and defined thinking. They develop logical
ability and strength of a manager. ome important principles of managerial economics are1
1. Marginal and Incremental Principle
This principle states that a decision is said to be rational and sound if given the firms
ob+ective of profit ma)imi$ation, it leads to increase in profit, which is in either of two
scenarios-
If total revenue increases more than total cost.
If total revenue declines less than total cost.
Marginal analysis implies +udging the impact of a unit change in one variable on the other.
Marginal generally refers to small changes. Marginal revenue is change in total revenue per
unit change in output sold. Marginal cost refers to change in total costs per unit change in
output produced "!hile incremental cost refers to change in total costs due to change in total
output#. The decision of a firm to change the price would depend upon the resulting
impact5change in marginal revenue and marginal cost. If the marginal revenue is greater than
the marginal cost, then the firm should bring about the change in price.
Incremental analysis differs from marginal analysis only in that it analysis the change in the
firm6s performance for a given managerial decision, whereas marginal analysis often is
generated by a change in outputs or inputs. Incremental analysis is generali$ation of
marginal concept. It refers to changes in cost and revenue due to a policy change. 'or
e)ample - adding a new business, buying new inputs, processing products, etc. 7hange in
output due to change in process, product or investment is considered as incremental change.
Incremental principle states that a decision is profitable if revenue increases more than costs0
if costs reduce more than revenues0 if increase in some revenues is more than decrease in
others0 and if decrease in some costs is greater than increase in others.
2. Equi-marginal Principle
Marginal 8tility is the utility derived from the additional unit of a commodity consumed.
The laws of e,ui-marginal utility states that a consumer will reach the stage of e,uilibrium
when the marginal utilities of various commodities he consumes are e,ual. -ccording to the
modern economists, this law has been formulated in form of law of proportional marginal
utility. It states that the consumer will spend his money-income on different goods in such a
way that the marginal utility of each good is proportional to its price, i.e.,
M! / P! " My / Py " M# / P#
!here, M8 represents marginal utility and 3 is the price of good.
imilarly, a producer who wants to ma)imi$e profit "or reach e,uilibrium# will use the
techni,ue of production which satisfies the following condition1
M$P% / M&% " M$P' / M&' " M$P( / M&(
!here, M93 is marginal revenue product of inputs and M7 represents marginal cost.
Thus, a manger can make rational decision by allocating5hiring resources in a manner which
e,uali$es the ratio of marginal returns and marginal costs of various use of resources in a
specific use.
. !pportunity "ost Principle
%y opportunity cost of a decision is meant the sacrifice of alternatives re,uired by that
decision. If there are no sacrifices, there is no cost. -ccording to :pportunity cost principle,
a firm can hire a factor of production if and only if that factor earns a reward in that
occupation5+ob e,ual or greater than its opportunity cost. :pportunity cost is the minimum
price that would be necessary to retain a factor-service in its given use. It is also defined as
the cost of sacrificed alternatives. 'or instance, a person chooses to forgo his present
lucrative +ob which offers him 9s.;<<<< per month, and organi$es his own business. The
opportunity lost "earning 9s. ;<,<<<# will be the opportunity cost of running his own
business.
#. $ime Perspecti%e Principle
-ccording to this principle, a manger5decision maker should give due emphasis, both to
short-term and long-term impact of his decisions, giving apt significance to the different
time periods before reaching any decision. hort-run refers to a time period in which some
factors are fi)ed while others are variable. The production can be increased by increasing the
,uantity of variable factors. !hile long-run is a time period in which all factors of
production can become variable. Entry and e)it of seller firms can take place easily. 'rom
consumers point of view, short-run refers to a period in which they respond to the changes in
price, given the taste and preferences of the consumers, while long-run is a time period in
which the consumers have enough time to respond to price changes by varying their tastes
and preferences.
&. 'iscounting Principle
-ccording to this principle, if a decision affects costs and revenues in long-run, all those
costs and revenues must be discounted to present values before valid comparison of
alternatives is possible. This is essential because a rupee worth of money at a future date is
not worth a rupee today. Money actually has time value. *iscounting can be defined as a
process used to transform future dollars into an e,uivalent number of present dollars. 'or
instance, => invested today at ><? interest is e,uivalent to =>.>< ne)t year.
)* " P*+,%-r.
t
!here, '@ is the future value "time at some future time#, 3@ is the present value "value at t<,
r is the discount "interest# rate, and t is the time between the future value and present value.
Managerial Economics and Micro Economics


Managerial Economics is basically a blend of Economics and Management. Two branches
of economics i.e. micro economics and macro economics are the ma+or contributors to
managerial economics.
Micro Economics is the study of the behaviour of individual consumers and firms whereas
microeconomics is the study of economy as a whole.
Managerial Economics and Micro Economics
-ll the firms operating in the market have to take under consideration the constituent of the
economic environment for its proper functioning. This economic environment is nothing
but the Micro economics elements.
Micro Economics is a broader concept as compare to Managerial Economics/ Micro
Economics forms the foundation of managerial economics. -lmost all the concepts of
Managerial Economics are the perceptions of Micro Economics concepts.
Managerial economics can be perceived as an applied Micro Economics. *emand -nalysis
and 'orecasting, Theory of 3rice, Theory of 9evenue and 7ost, Theory of upply and
3roduction are ma+or bare bones of Micro Economics that underpins the Managerial
Economics. Managerial Economics applies the theories of Micro Economics to resolve the
issues of the organi$ation and for decision making.
-ll Managers want to carry out their function of decision making with ma)imum efficiency.
Their business planning can be effectively planned and performed with comprehensive
knowledge and understanding of micro economic concept and its applications. :ptimum
decision making to achieve the ob+ective of the organisation i.e. for profit ma)imi$ing or for
cost minimi$ing, is possible with proper compliance of micro economic know how,
regardless of the technological constraints and given market conditions. Micro Economic
-nalysis is important as it is applied to day to day dilemma and concerns.
The reliance of Managerial Economics on Micro Economics is made clearer in the points
below1
If a manager wants to increase the price of the product due to increase in cost of
production, he will analy$e the price elasticity of demand for that product so that price rise is
not followed by substantial fall in the demand of the product. It is the application of demand
analysis to the real world situation.
'or fi)ing the price of the products managers applies the pricing theories, cost
and revenue theories of micro economics.
*ecisions regarding production and supply of the product in the market,
knowledge of availability of fi)ed and variable factors of production, state of technology to
be used and availability of raw-material are essential. This can be determined with the
knowledge of theory of production.
*etermination of price and output is possible with the ac,uaintance of market
structures and approaches pertinent for determination of price and output in the given market
setup.
Managerial economics utili$es statistical methods such as game theory, linear
programming etc for application of Economic Theory in *ecision making.
:ne of the responsibilities of Manager is to workout budgets for different
departments of the organi$ation which is learned from 7apital %udgeting and 7apital
9ationing.
7ost and benefit analysis helps the manager in decision making.
tudy of welfare economics helps Manager in taking care of social
responsibilities of the organi$ation.
Microeconomics is the study that deals with partial e,uilibrium analysis which
is useful for the manager in deciding e,uilibrium for his organi$ation.
Managerial Economics also uses tools of Mathematical Economics and
econometrics such as regression analysis, correlation analysis etc.
Theory of firm, an important element of microeconomics, is one of the most
significant element of Managerial Economics.
$ole of a Managerial Economist


- managerial economist helps the management by using his analytical skills and highly
developed techni,ues in solving comple) issues of successful decision-making and future
advanced planning.
The role of managerial economist can be summari$ed as follows1
>. /e studies the economic patterns at macro-level and analysis its significance to the
specific firm he is working in.
A. /e has to consistently e)amine the probabilities of transforming an ever-changing
economic environment into profitable business avenues.
B. /e assists the business planning process of a firm.
C. /e also carries cost-benefit analysis.
;. /e assists the management in the decisions pertaining to internal functioning of a firm
such as changes in price, investment plans, type of goods 5services to be produced, inputs to
be used, techni,ues of production to be employed, e)pansion5 contraction of firm, allocation
of capital, location of new plants, ,uantity of output to be produced, replacement of plant
e,uipment, sales forecasting, inventory forecasting, etc.
D. In addition, a managerial economist has to analy$e changes in macro- economic
indicators such as national income, population, business cycles, and their possible effect on
the firms functioning.
E. /e is also involved in advicing the management on public relations, foreign e)change,
and trade. /e guides the firm on the likely impact of changes in monetary and fiscal policy
on the firms functioning.
F. /e also makes an economic analysis of the firms in competition. /e has to collect
economic data and e)amine all crucial information about the environment in which the firm
operates.
G. The most significant function of a managerial economist is to conduct a detailed
research on industrial market.
><. In order to perform all these roles, a managerial economist has to conduct an elaborate
statistical analysis.
>>. /e must be vigilant and must have ability to cope up with the pressures.
>A. /e also provides management with economic information such as ta) rates,
competitors price and product, etc. They give their valuable advice to government
authorities as well.
>B. -t times, a managerial economist has to prepare speeches for top management.