MEANING SCPOE AND METHODS OF MANAGERIAL ECONOMICS

DEFINITION

Managerial Economics generally refers to the integration of economic theory with

business practice. While economics provides the tools which explain the various
concepts such as demand, supply, price, competition etc. Managerial economics
applies these tools to the management of business In this sense, Managerial
Economics is also understood to refer to Business Economics or Applied
Economics.

“Since the early 1950s, confronted with the growing variability and
unpredictability of the business environment , business managers have become
increasingly concerned with finding rational and foresightful ways of adjusting to
and exploiting environmental change. (Ansoff) We may therefore ,say that the
business world attracted the attention of academicians from 1950 onwards and o
gave rise to a separate treatment of business problems. As a result Managerial
Economics came into being.

MEANING

In its simplest terms Managerial Economics means the application of economic

theory to the problems of management. Spencer and Siegelman defined
managerial economics as “ The Integration Of Economic Theory With Business
Practice For The Purpose Of Facilitating Decision Making And Forward
Planning By Management.

It has two stages .

Stage One: Is the integration of economic theory with business practice.

Stage Two: Is the application of stage one for decision making and forward
planning.

Example:

Price is the interaction of supply and demand. When supply is short of demand,
the price goes up. A shrewd businessman will always study the economic
situation and apply them to his business. In other words, if supply is short he gets
a higher price. Alternatively if the demand is less then he can cut down his
production.
The problem of decision making has two aspects .

The problem of decision making has two aspects

1. The first one concerns with optimal allocation of scarce b resources which can
be put to alternative uses

Example

The Manager with a fixed amount of money at his disposal for the purpose of
advertisement has to chose the most effective media.

2. The second one concerns uncertainty . as the course of events cannot be

predicted, we say the course of events in future is uncertain. This is what
is meant by uncertainty. Every businessman will have to take this fact of
uncertainty into account.; and it is this uncertainty which makes decision
making function or process very difficult.

Example

Footwear Industry: Shoes may became outdated because fashions change very rapidly
Dressmaking Industry : As fashion changes very often, the manager of a dress making
industry will have to keep abreast of changing fashions.

The Problem of forward planning

When a manager has to plan for the future he has to make an accurate forecast
of the position of raw materials, the prices of factors of production, the market
prices of his products , the demand for then ,etc.

SCOPE OF MANAGERIAL ECONOMICS

The scope of Managerial economics is so wide that it embraces almost all the
problems and areas of the manager and the firm. It deals with:

Demand Analysis and Forecasting

It analyses carefully and systematically the various types of which enable the
manager to arrive at a reasonable estimate of demand for products of his
company. He takes into account such concepts as income elasticity and cross
elasticity. When demand is estimated , the manager does not stop at that stage.
Production Function

Inputs play a vital role in the economics of production . The factors of production
otherwise, called inputs , may be combined in a particular way to yield the
maximum output. Alternatively when the prices of inputs shoot up, a firm is forced
to work out a combination of inputs so as to ensure that this combination
becomes the least cost combination. In this way the production is pressed into
service by managerial economics.

Cost Analysis

Cost analysis is yet another function of managerial economics. For instance, the
determinants of costs , the methods of estimating the costs , the relationship
between cost and output , the forecast and profit--- these are vital to a firm.
Managerial economics touches these aspects of cost analysis , an effective
knowledge and application of which is cornerstone for the success of a firm.

Inventory Management

An inventory refers to the stock of raw materials which a firm keeps. Now the
problem is how much of inventory is ideal stock. If it is high capital is
unproductively tied up , which might if the inventory is reduced be used for more
productive purposes. On the other hand, if the level of inventory is low,
production will be hampered. Therefore managerial economics will use methods
such as ABC analysis, a simple simulation exercise and also a mathematical
model with a view to minimizing the inventory cost . It also goes deeper into such
aspect as the need for inventory control it classifies inventories and discusses
costs of carrying them.

Advertising

The problem of costs, the method of determining the total advertising costs and
budgets, the measuring the economic effects of advertising—these are the
problems of the manager.

Price System

The central function of a firm is not only production but pricing as well. While the
cost of production has to be taken into account, when pricing a commodity, a
complete knowledge of the price system is also essential to the determination of
the price . For instance, an understanding of how a product has to be priced
under kinds of competition fort different markets is essential to the pricing of
those commodities. A understanding of pricing of a product under conditions of
oligopoly is also essential. Pricing is actually by considerations of cost plus
pricing and policies of public enterprises. Finally there is such a thing as price
leadership and non-price competition.. It is evident from these facts that the price
system touches upon several aspects of managerial economics and aides to
guide the manager to take valid and profitable decisions.

Resource Allocation

Scarce obviously have alternative uses. How best can these scarce resources be
allocated to competing needs? The aim of course is to achieve optimization. For
this purpose some advanced tools, such as linear programming , etc. are used
to arrive at the best course of action for a specified time. . Generally speaking
two kinds of problems are of utmost importance and concern to the manager.
First, how he arrive at an optimum combination of inputs in order to get maximum
output? Secondly when the price of inputs increases, what type of substitution
should he resort to ? Or, alternatively, what type of combination of inputs should
he work out in order to ensure the least cost combination.

Capital Budgeting

This is another area which calls for a thorough understanding on the part of a
manager if he is to arrive at meaningful decisions. Capital is scarce and its cost
is something. Now the problem is how to arrive at the cost of capital; how to
ensure that capital becomes rational; how to face up budget problems; how to
arrive at investment decisions under conditions of uncertainty; how to effect a
cost benefit analysis, etc. These areas cannot be ignored by a manager.

It is obvious from the foregoing discussions, that managerial economics is

applied economics. It makes of tools which have been developed not omly by
economics but by other disciplines as well. The subject matter of managerial
economics covers two important areas, namely, decision making and forward
planning. These two areas are essential to every stage of planning, production,
marketing, etc. Managerial Economics therefore, plays a vital role in successful
business operations of a firm.

CONCEPTS OF MANAGERIAL ECONOMICS

Managerial Economics has certain terms like any other discipline . These terms
are called concepts which are described below:

Demand

In ordinary sense of the term, DEMAND means to ask for a particular thing.
Sometimes it also means asking for a thing authoritatively. In managerial
economics demand means requirement. The starting point is desire to possess a
particular thing. This desire must be backed by the ability to pay. This ability to
pay must be backed by willingness to pay. In managerial economics, demand
means a desire to have a commodity, ability to pay the price for the commodity
and willingness to pay the price for the commodity.

Supply

By supply we mean the availability of any commodity. But mere availability does
not constitute supply from the point of view of a managerial economist. The
supply of any commodity should not mean it is freely available. For example, air
is freely available but nobody pays any price for it.

Putting these two together, Demand constitutes the requirement. Supply

denotes the total the commodity available in the market for sale. Demand means
the consumers requirement, supply means the producers’ production.

Price

Demand means the requirement of a commodity at a certain price. Supply means

the availability of a commodity at a certain price. Hence the meeting point of
demand and supply is the price. This means the demand (preparedness of a
consumer to pay a certain price) and supply (preparedness of the seller to part
with the commodity at a certain price) should be same. In this sense, price is the
meeting point of demand and supply.

Sometimes, supply being constant, demand may go up. The price goes up. On
the other hand, if demand is constant and supply increases , the seller would like
to cut down the price.

The interaction of demand and supply of a commodity determines price.

Competition

When supply exceeds demand sellers compete among themselves to sell the
commodities at a lower price. This is what is meant by competition.

Economic theory explains competition in terms of:

Perfect Competition: is a situation where; products are homogenous, price is

same in all parts of the market, there is no consumer ignorance, etc.

Imperfect Competition: is a situation where for each product there are several brands.

For example tooth paste we have several brands such as Colgate, Close Up etc.
Each pert of the market may have a different price depending upon the supply
and demand factors.
Production

Production always refers to the supply side of a commodity. This means that the
sum of all the units produced constitutes the supply of a given commodity. But
the term production has its own significance. Whenever a commodity has to be
produces it requires the factors of production. The factors of production are
LAND, LABOUR Capital and Organization. These four factors are essentially
required to produce any commodity. These factors of production are also called
inputs. These inputs are combined I varying proportions. The combination which
yields maximum output with least cost is called Optimum combination.

Production is also governed by the rate of output. In the initial stages when the
output is low , the cost per unit of production will be high. As production
increases the cost of production tends to fall up to a certain level.

Distribution

Whatever is produced to be sold out. The selling part refers to marketing How to
market the goods that are produced? This is where distribution enters. The
distribution takes place in the following way. From the factory the goods that are
produced go to the authorized agents or wholesalers. This means of the factory
the goods are distributed got distributed to the wholesalers. This is the first stage
in the distribution. Each wholesaler will be having some retailers under him. From
wholesalers go down, the goods further get distributed to the retailer. This the
second stage of distribution. From retailers the goods reach the consumers. This
is the final stage.