Introduction Managerial Economics and Business economics are the two terms, which, at times have been used

interchangeably. Of late, however, the term Managerial Economics has become more popular and seems to displace progressively the term Business Economics. The discovery of managerial economics as a separate course in management studies has been attributed to three major factors: i) The growing complexity of business decision-making processes, because of changing market conditions and the globalization of business transactions. ii) The increasing use of economic logic, concepts, theories, and tools of economic analysis in business decision-making processes. iii) Rapid increase in demand for professionally trained managerial manpower.

It should be noted that the recent complexities associated with business decisions has increased the need for application of economic concepts, theories and tools of economic analysis in business decisions. The reason of making appropriate business decision requires clear understanding of existing market conditions, market fundamentals and the business environment in general. Business decision-making processes require intensive and extensive analysis of the market conditions in the product, input and financial markets. Economic theories, logic and tools of analysis have been developed for the analysis and prediction of market behaviors. The application of economic concepts, theories, logic, and analytical tools in the assessment and prediction of market conditions and business environment has proved to be a significant help to business decision makers all over the world.

Definition of Managerial Economics Managerial economics has been generally defined as the study of economic theories, logic and tools of economic analysis, used in the process of business decision making. It involves the understanding and use of economic theories and techniques of economic analysis in analyzing and solving business problems, evaluate business options and opportunities with a view of arriving to appropriate business decision.


M H Spencer and L Seigelman. Evan J Douglas. Managerial Economics thus lies on the borderline between economics and business management and serves as a bridge between economics and business management. or other types of organizations and to help find solutions that advance the best interests of such organizations”3..). Inc. Economic principles contribute significantly towards the performance of managerial duties as well as responsibilities. 11. 3. Managerial Economics and Operations Research.1. Managers with some working knowledge of economics can perform their functions more effectively and efficiently than those without such knowledge. Taking appropriate business decisions requires a good understanding of the technical and environmental conditions under which business decisions are taken.J. (Prentice-Hall. 2 . Norton and Co. N. 1...J. 1986).Spencer and Siegelman have defined Managerial Economics as "The integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management"1.3. 2.W. 1969). Managerial Economics. (New York: W. R Davis and S Chang. 4.. It seeks to establish rules and principles to facilitate the attainment of the desired economic goals of management”2. 1966). Principles of managerial Economics (Prentice-Hall. 1987). N. Douglas also defined “Managerial Economics is concerned with the application of economic principles and methodologies to the decision making-process within the firm or organization. (Irwin Illinois. therefore define Managerial Economics as the discipline which deals with the application of economic theory to business management. ch. 1. Ch. Davis and Chang defined as “Managerial economics applies the principles and methods of economics to analyse problems faced by management of a business. Application of economic theories and logic to explain and analyze these technical conditions and business environment can contribute significantly to the rational decision-making process. E Mansfield (ed. Mansfield defines “Managerial Economics is concerned with the application of economic concepts and economics to the problems of formulating rational decision making”4 We may. Managerial Economics: Analysis and Strategy.

etc. The business manager has to appraise the relevance and impact of these external forces in relation to the particular business unit and its business policies. e.g. The estimates of these economic relationships are to be used for purposes of forecasting. costs. anti-monopoly measures. etc. profit. e. cross-elasticity.g. capital.. formulating business policies and. as Spencer and Siegelman have put it.Applications of Economics to Managerial Economics The application of economics to managerial economics or the integration of economic theory with business practice. iv) Understanding significant external forces constituting the environment in which the business is operating and to which it must adjust. decision making and forward planning may be possible. international economics and foreign trade. on that basis. 3 . that is. in numerical terms together with their probabilities. promotional elasticity. fiscal policy and taxation. demand. monetary economics. prices. before a business manager there exists a quantified picture indicating the number o courses open. price controls. capital. industrial licensing.. costs. future is to be predicted so that in the light of the predicted estimates. he decides about the strategy to be chosen. Hence. cost-output relationships. labour relations. viz. has the following aspects:i) Estimating economic relationships.e. ii) Predicting relevant economic quantities. measurement of various types of elasticities of demand such as price elasticity. pricing. business cycles.. Keeping this picture in view. etc. i. establishing business plans for the future pertaining to profit. their possible outcomes and the quantified probability of each outcome. As the business manager has to work in an environment of uncertainty. losses or gains as a result of following each one of the strategies available. income elasticity. etc. fluctuations in national income and government policies pertaining to public finance. iii) Using economic quantities in decision making and forward planning. production. The nature of economic forecasting is such that it indicates the degree of probability of various possible outcomes.

.The application of economics concepts and theories in combination with quantitative methods is illustrated in figure below. Figure for Applications of Economics to Managerial Economics Managerial Decision Areas • • • • • • • Assessment of Invisible Funds Selecting Business Area Choice of Product Determining Optimum Output Determining Price of the Product Determining Input-Combination and Product and technology Sales Promotion Application of Economic Concepts and Theories in Decision-Making Use of Quantitative Methods • Mathematical Tools • Statistical Tools • Econometrics Managerial Economics Application of Economics Concepts. Theories and Analytical Tools to find Optimum Solution to Business Problems 4 .

It avoids difficult abstract issues of economic theory but involves complications ignored in economic theory to face the overall situation in which decisions are made. iv) Managerial Economics belongs to normative economics rather than positive economics (also sometimes known as Descriptive Economics). which is known as 'Theory of the firm' or 'Economics of the firm'. The main body of economic theory confines itself to descriptive hypothesis. May 1966. Managerial Economics. however. the law of demand states that as price increases. 2. i) Managerial Economics is micro-economic in character. In other words. Importance of Managerial Economics There are three major contributions of economic theory to business economics which have been enumerated by Baumol5 as follows: i) Building of analytical models that help to recognize the structure of managerial Problems. which forms part of Distribution Theories in Economics. No. 5. In addition. attempting to generalize about the relations among different variables without judgment about what is desirable or undesirable. For instance. Economic theory appropriately ignores the variety of backgrounds and training found in individual firms but Managerial Economics considers the particular environment of decision making. eliminate the minor details that can obstruct decision making. 5 . is concerned with what decisions ought to be made and hence involves value judgments. Vol. it is prescriptive rather than descriptive. Demand goes down or vice-versa but this statement does not tell whether the outcome is good or bad.Characteristics of Managerial Economics It would be useful to point out certain chief characteristics of Managerial Economics as much as they throw further light on the nature of the subject matter and help in a clearer understanding thereof. it also seeks to apply Profit Theory. ‘What Can Economic Theory contribute to Managerial Economics. iii) Managerial Economics is pragmatic. and help to concentrate on the main problem area.’ In AER. 51. W J Baumol. ii) Managerial Economics largely uses that body of economic concepts and principles.

a business firm plans to launch a new product for which close substitutes are available in the market. the manager would need to investigate and analyse the following thoroughly: (a) Production related issues. It is in fact. (New York: W.. intuition and business acumen of the manager need to be supplemented with quantitative analysis of business data on market conditions and business environment. 1966). one method of deciding whether or not this product should be launched is to obtain the services of a business consultant. sociopolitical and technological environment. enabling the managers avoids conceptual pitfalls..ii) Making available a set of analytical methods for business analyses thereby. Also in Herbert A Simon. developing and analyzing possible course of action Fourth Phase: Selecting a particular course of action from available alternatives. The other method would be for the decision-maker or manager to decide. Economic Analysis and Business Decisions Business decision-making basically involves the selection of best out of alternative opportunities open to the business organization. In doing this.W. Note that second phase and third phase are the most crucial in business decision-making. Decision making processes6 involve four main phases.). Inc. ‘ The Decision-Making Process’ in Mansfield (ed. and. Second Phase: Collection and analysis of information on economic. 6. enhancing the analytical capabilities of the business analyst. Norton and Co. They put the manager’s analytical ability to test and help in determining the appropriateness and validity of decisions in the modern business environment. in this area of decision-making that economic theories and tools of economic analysis make the greatest contribution in business. Personal intelligence. Third Phase: Inventing. iii) Clarification of the various concepts used in business analysis. 6 . including: First Phase: Determining and defining the objective to be achieved. Managerial Economics and Operations research. (b) Sales prospects and problems. If for instance. experience.

and. 7 . and. For example. it can help in ascertaining the relevant variables and specifying the relevant data. it provides consistency to business analysis and helps in arriving at right conclusions. supply. price. it can give clear understanding of the various necessary economic concepts. (b) The industrial business trends. and the like that are used in business analysis. (c) Supply position of inputs required for the production process. (b) Cost of production associated with each production technique. (f) Market structure and the degree of competition. The application of economic theories in solving business problems helps in facilitating decisionmaking in the following ways: First. as well as their respective market shares. (e) Production costs of the competitive products. (e) Pricing strategies of the prospective competitors. (g) The supply position of complementary goods. Second. (f) Availability of foreign exchange. the manager will be required to collect and analyse Information or data on: (a) Available production techniques. (c) Major existing and potential competitors. cost. the manager will be required to collect and analyse data on: (a) General market trends. (d) Input prices. if inputs are to be imported. Regarding the sales prospects and problems. including demand. (d) Prices of the competing products. Third. petrol and electricity.With regards to production. in deciding what variables need to be considered in estimating the demand for two different sources of energy.

(f) How to face price competition. However. (c) Choice of technology (choosing the factor combination). These problems include all those problems which arise within the business organization and fall within the control of management. making a satisfactory profit is not always guaranteed due to business 8 . and to find solutions to practical business problems. (d) Choice of price (product pricing). Some of the basic internal issues include: (a) Choice of business and the nature of product (what to produce). which explains the consumer behavior in terms of decisions on whether or not to buy a commodity and the quantity to be purchased. The theory of production or theory of the firm explains the relationship between inputs and output. (h) How to manage profit and capital. the scope of managerial economics extends to those economic concepts. Generally. Operational problems are of internal nature. (g) How to decide on new investments.and macro-economic theories. iv) Profit analysis and profit management. Price theory explains how prices are determined under different market conditions. theories. ii) Theory of Production and production decisions. and tools of analysis used in analyzing the business environment. In broad terms. and. managerial economics is applied economics. (i) How to manage inventory.Scope of Managerial Economics Managerial economics comprises both micro. iii) Analysis of Market structure and Pricing theory. ii) Environment or external issues. The areas of business issues to which economic theories can be directly applied are divided into two broad categories: i) Operational or internal issues and. The microeconomic theories dealing with most of these internal issues include: i) The theory of demand. (b) Choice of size of the firm (how much to produce). (e) How to promote sales. Profit making is the most common business objective.

such as trade unions. v) Theory of capital and investment decisions. and political atmosphere of the country in which the business is situated. consumers’ cooperatives. Environmental issues are issues related to the general business environment. In macroeconomic terms. Managerial economics is particularly concerned with those economic factors that form the business climate. Capital is the foundation of any business. income. economic growth. These are issues related to the overall economic. vi) Government’s economic policies. iv) Magnitude of and trends in foreign trade. and so on. in calculating the pure return on capital and pure profit. Macroeconomics applied to Business Environment. and producer unions. savings and investment. assessing the efficiency of capital. managerial economics focus on business cycles. prices. x) The political environment. vii) Social organizations. The factors constituting economic environment of a country include: i) The existing economic system in the country. Some of the important issues related to capital include: choice of investment project. v) Trends in labour and capital markets. ii) General trends in production. and for future profit planning. and content and logic of some relevant government activities and policies which form the business environment. in making allowances for the risk premium. employment.uncertainties. the most efficient allocation of capital. and. Profit theory guides firms in the measurement and management of profits. as well as the determinant of the firm’s success level. 9 . ix) The degree of openness of the economy. social. It efficient allocation and management is one of the most important tasks of the managers. iii) Structure of the financial institutions.

By implication. be denied the fact that there is a gap between economic theory and practice. Through economic models. when there are economies of scale. is the ceteris paribus assumptions (that is all other things being constant or equal). It is a general belief that assumptions of economic models are unrealistic in most cases. Managerial Economics. economists create a simplified world with its restrictive boundaries from which they derive their conclusions. Abstract economic theories cannot be simply applied to real life situations.. Though economic theories are. “The big gap between the problems of logic that intrigue economic theorists and the problems of policy that plague practical management needs to be bridged in order to give executive access to the practical contributions that economic thinking can make to top management polices”. 1977). ‘ Microeconomic Theory’ in Perspective in Economics-Economists Looks at Their Field of Study by AA Brown. 8. (New Delhi: Prentice Hall of India. ‘Microeconomic theory facilitates the understanding of what would be a complicated confusion of billions of facts by constructing simplified models of behaviour that are sufficiently similar to the actual phenomenon to be of help in understanding them’7.8 The gap arises from the fact that there exists a gap between the abstract world of economic models and the real world.). and when inputs are tripled. It is a general knowledge that there exists a gap between theory and practice in the world of economic thinking and behaviour. It suffices to say that although economic theories do not directly offer custom-made solutions to business problems. In the words of Keynes. 10 . This however. It cannot. output will be more or less doubled. in their abstract form however. 36. does not mean that economic models and theories do not serve useful purposes. This assumption has been alleged to be the most unrealistic assumption. output would be more or less tripled. vii. E Neuberger. or method of blind manipulation. A P Lerner. “The objective [economic) analysis is to provide a machine. (NY: McGraw-Hill). no doubt. This theoretical conclusion may not hold in practice. they provide a framework for logical economic thinking and analysis. The most common assumption of the economic models. 7. it seems theoretically sound that when inputs are doubled. Although economic models are said to be an extraction from the real world. the closeness of this extraction depends on how realistic the assumptions of the model are. and M Pakmastier (eds. nevertheless. hypothetical in nature. a theory which appears logically sound might not be directly applicable in practice. Take for instance. as you may recall. they do look divorced from reality. Joel Dean..Gap between Theory and Practice and the Role of Managerial Economics. Economic theories are highly simplistic because they are propounded on the basis of economic models based on simplifying assumptions.

The General Theory of Employment Interest and Money. and tools of analysis used in the analysis of business environment. 1936).. Managerial economics can bridge the gap between economic theory and real world business decisions. (Harcourt Brace. but to provide ourselves with an organized and orderly method of thinking out particular problem……”. theories. Economic analysis presents the business decision makers with a road map. business decisions may likely be irrational and arbitrary.9 In the opinion of Boulding. 14. iii) Processing and analyzing the facts. Irrationality is highly counter-productive. 297. iv) Drawing the relevant conclusions. ii) Collecting the relevant data and related facts. the objective of economic analysis is to present the ‘map’ of reality rather than a perfect picture of it. The managerial economic logic and tools of analysis guide business decision makers in: i) Identifying their problems in the achieving their goals. K E Boulding. and does not take them to their destinations. v) Determining and evaluating the alternative means of achieving the goal and. and to find solutions to practical business problems.which will furnish an infallible answer. 10. Managerial Economics comprises both micro-and macro-economic theories. 11 . it guides them to their destinations.10 The need for such a framework arises because the real economic world is too complex to permit consideration of every bit of economic facts that influence economic decisions. Conclusion This unit has been able to expose what managerial economics is all about and why it is necessary to have it for effective business decisions. Its scope extends to those economic concepts. vi) Taking appropriate decision. 9. Without the application of economic logic and tools of analysis. J M Keynes. 1948). New York. (New York: Harper and Bros. Economic Analysis.

12 .Summary To put some light to the understanding and appreciation of managerial economics as a tool of business analysis. where we learned that the scope of managerial economics extends to some economic concepts and tools used in analyzing the business environment in order to seek for solutions to practical business problems. iii) Managerial Economics and the gap between theory and practice. the unit focused on the following issues: i) Economic analysis and business decisions. ii) Scope of Managerial Economics. where it was pointed out that business decision-making basically involves the selection of best out of alternative opportunities open to the business enterprise. Managerial economics can bridge this gap through logic and tools of analysis that guide business decision makers. where it was pointed out that there exists a gap between theory and practice in the world of economic thinking and behaviour.

13 . (2002) Managerial Economics. 1936). (New York: Harper and Bros.J. N. (New Delhi: Prentice Hall of India. Inc. Managerial Economics: Analysis and Strategy.. D.J.).. (Prentice-Hall. Managerial Economics. • • Joel Dean. J M Keynes..References • Dwivedi. 1966). sixth edition (New Delhi: Vikas Publishing House Ltd).. M H Spencer and L Seigelman. N. • • • R Davis and S Chang. Managerial Economics. 1948).W. 1969). The General Theory of Employment Interest and Money. Norton and Co. 1987). 1977). • Evan J Douglas. Principles of managerial Economics (Prentice-Hall. (Harcourt Brace.. 1986). N. New York. E Mansfield (ed. (Irwin Illinois. • K E Boulding. (New York: W. Managerial Economics and Operations Research. Economic Analysis.