MANAGERIAL ECONOMICS

Introduction to Economics

Economics is a study of human activity both at individual and national level. The economists of
early age treated economics merely as the science of wealth. The reason for this is clear. Every
one of us in involved in efforts aimed at earning money and spending this money to satisfy our
wants such as food, Clothing, shelter, and others. Such activities of earning and spending money
are called
Economic activities. It was only during the eighteenth century that dam Smith, the !ather of
Economics, defined economics as the study of nature and uses of national wealth".
#r. lfred $arshall, one of the greatest economists of the nineteenth century, writes Economics is
a study of man"s actions in the ordinary business of life% it en&uires how he gets his income and
how he uses it. Thus, it is one side, a study of wealth' and on the other, and more important side' it
is the study of man. s $arshall observed, the chief aim of economics is to promote (human
welfare", but not wealth. The definition given by C )igou endorses the opinion of $arshall. )igou
defines Economics as the study of economic welfare that can be brought directly and indirectly,
into relationship with the measuring rod of money.
)rof. *ionel +obbins defined Economics as the science, which studies human behaviour as a
relationship between ends and scarce means which have alternative uses. ,ith this, the focus of
economics shifted from (wealth" to human behaviour".
*ord -eynes defined economics as (the study of the administration of scarce means and the
determinants of employments and income.
Microeconomics:
The study of an individual consumer or a firm is called microeconomics .also called the Theory of
!irm/. $icro means (one millionth". $icroeconomics deals with behavior and problems of single
individual and of micro organi0ation. $anagerial economics has its roots in microeconomics and it
deals with the micro or individual enterprises. It is concerned with the application of the concepts
such as price theory, *aw of #emand and theories of mar1et structure and so on.
Macroeconomics:
The study of (aggregate" or total level of economics activity in a country is called macroeconomics.
It studies the flow of economics resources or factors of production .such as land, labor, capital,
organi0ation and technology/ from the resource owner to the business firms and then from the
business firms to the households. It deals with total aggregates, for instance, total national income
total employment, output and total investment. It studies the interrelations among various
aggregates and e2amines their nature and behaviour, their determination and causes of
fluctuations in the. It deals with the price level in general, instead of studying the prices of individual
commodities. It is concerned with the level of employment in the economy. It discusses aggregate
consumption, aggregate investment, price level, and payment, theories of employment, and so on.
Though macroeconomics provides the necessary framewor1 in term of government policies etc.,
for the firm to act upon dealing with analysis of business conditions, it has less direct relevance in
the study of theory of firm.
Management
$anagement is the science and art of getting things done through people in formally organi0ed
groups. It is necessary that every organi0ation be well managed to enable it to achieve its desired
goals. $anagement includes a number of functions% )lanning, organi0ing, staffing, directing, and
controlling. The manager while directing the efforts of his staff communicates to them the goals,
ob3ectives, policies, and procedures' coordinates their efforts' motivates them to sustain their
enthusiasm' and leads them to achieve the corporate goals.
. Managerial Economics
Introduction
$anagerial Economics as a sub3ect gained popularity in 4S after the publication of the boo1
$anagerial Economics by 5oel #ean in 6786.
$anagerial Economics refers to the firm"s decision ma1ing process. It could be also interpreted as
Economics of $anagement or Economics of $anagement. $anagerial Economics is also called
as Industrial Economics or 9usiness Economics.
s 5oel #ean observes managerial economics shows how economic analysis can be used in
formulating polices.
Concept of Managerial Economics
The discipline of managerial economics deals with aspects of economics and tools of analysis,
which are employed by business enterprises for decision:ma1ing. 9usiness and industrial
enterprises have to underta1e varied decisions that entail managerial issues and decisions.
#ecision:ma1ing can be delineated as a process where a particular course of action is chosen from
a number of alternatives. This demands an unclouded perception of the technical and
environmental conditions, which are integral to decision ma1ing. The decision ma1er must possess
a thorough 1nowledge of aspects of economic theory and its tools of analysis. The basic concepts
of decision:ma1ing theory have been culled from microeconomic theory and have been furnished
with new tools of analysis. Statistical methods, for e2ample, are pivotal in estimating current and
future demand for products. The methods of operations research and programming proffer
scientific criteria for ma2imi0ing profit, minimi0ing cost and determining a viable combination of
products.
#ecision:ma1ing theory and game theory, which recogni0e the conditions of uncertainty and
imperfect 1nowledge under which business managers operate, have contributed to systematic
methods of assessing investment opportunities.
lmost any business decision can be analy0ed with managerial economics techni&ues. ;owever,
the most fre&uent applications of these techni&ues are as follows%
< Risk analysis: =arious models are used to &uantify ris1 and asymmetric information and to
employ them in decision rules to manage ris1.
< Production analysis: $icroeconomic techni&ues are used to analy0e production efficiency,
optimum factor allocation, costs and economies of scale. They are also utili0ed to estimate the
firm>s cost function.
< Pricing analysis: $icroeconomic techni&ues are employed to e2amine various pricing decisions.
This involves transfer pricing, 3oint product pricing, price discrimination, price elasticity estimations
and choice of the optimal pricing method.
< Capital udgeting: Investment theory is used to scrutini0e a firm>s capital purchasing decisions
MEANING OF MANAGERIAL ECONOMICS
$anagerial economics, used synonymously with business economics, is a branch of economics
that deals with the application of microeconomic analysis to decision:ma1ing techni&ues of
businesses and management units. It acts as the via media between economic theory and
pragmatic economics. $anagerial economics bridges the gap between >theoria> and >pracis>. The
tenets of managerial economics have been derived from &uantitative techni&ues such as
regression analysis, correlation and *agrangian calculus .linear/. n omniscient and unifying theme
found in managerial economics is the attempt to achieve optimal results from business decisions,
while ta1ing into account the firm>s ob3ectives, constraints imposed by scarcity and so on.
paradigm of such optmisation is the use of operations research and programming.
$anagerial economics is thereby a study of application of managerial s1ills in economics. It helps
in anticipating, determining and resolving potential problems or obstacles. These problems may
pertain to costs, prices, forecasting future mar1et, human resource management, profits and so on.
!E"INI#IONS O" MANAGERIAL ECONOMICS
McGutgan and Moyer: $anagerial economics is the application of economic theory and
methodology to decision:ma1ing problems faced by both public and private institutions.
McNair and Meriam: $anagerial economics consists of the use of economic modes of thought
to analyse business situations.
Spencer and Siegelman: $anagerial economics is the integration of economic theory with
business practice for the purpose of facilitating decision:ma1ing and forward planning by
management.
$aynes% Mote and Paul: $anagerial economics refers to those aspects of economics and its
tools of analysis most relevant to the firm"s decision:ma1ing process. 9y definition, therefore, its
scope does not e2tend to macroeconomic theory and the economics of public policy, an
understanding of which is also essential for the manager.
$anagerial economics studies the application of the principles, techni&ues and concepts of
economics to managerial problems of business and industrial enterprises. The term is used
interchangeably with business economics, microeconomics, economics of enterprise, applied
economics, managerial analysis and so on. $anagerial economics lies at the 3unction of economics
and business management and traverses the hiatus between the two disciplines.
C$ARAC#ERIS#ICS O" MANAGERIAL ECONOMICS
&' Microeconomics: It studies the problems and principles of an individual business firm or an
individual industry. It aids the management in forecasting and evaluating the trends of the mar1et.
(' Normati)e economics: It is concerned with varied corrective measures that a management
underta1es under various circumstances. It deals with goal determination, goal development and
achievement of these goals. !uture planning, policy:ma1ing, decision:ma1ing and optimal
utilisation of available resources, come under the banner of managerial economics.
*' Pragmatic: $anagerial economics is pragmatic. In pure micro:economic theory, analysis is
performed, based on certain e2ceptions, which are far from reality. ;owever, in managerial
economics, managerial issues are resolved daily and difficult issues of economic theory are 1ept at
bay.
+' ,ses t-eory o. .irm: $anagerial economics employs economic concepts and principles, which
are 1nown as the theory of !irm or >Economics of the !irm>. Thus, its scope is narrower than that of
pure economic theory.
/' #akes t-e -elp o. macroeconomics: $anagerial economics incorporates certain aspects of
macroeconomic theory. These are essential to comprehending the circumstances and
environments that envelop the wor1ing conditions of an individual firm or an industry. -nowledge of
macroeconomic issues such as business cycles, ta2ation policies, industrial policy of the
government, price and distribution policies, wage policies and antimonopoly policies and so on, is
integral to the successful functioning of a business enterprise
0' Aims at -elping t-e management: $anagerial economics aims at supporting the management
in ta1ing corrective decisions and charting plans and policies for future.
1' A scienti.ic art: Science is a system of rules and principles engendered for attaining given ends.
Scientific methods have been credited as the optimal path to achieving one>s goals. $anagerial
economics has been is also called a scientific art because it helps the management in the best and
efficient utilisation of scarce economic resources. It considers production costs, demand, price,
profit, ris1 etc. It assists the management in singling out the most feasible alternative. $anagerial
economics facilitates good and result oriented decisions under conditions of uncertainty.
2' Prescripti)e rat-er t-an descripti)e: $anagerial economics is a normative and applied
discipline. It suggests the application of economic principles with regard to policy formulation,
decision:ma1ing and future planning. It not only describes the goals of an organi0ation but also
prescribes the means of achieving these goals.
Nature o. Managerial Economics
$anagerial economics is, perhaps, the youngest of all the social sciences. Since it originates from
Economics, it has the basis features of economics, such as assuming that other things remaining
the same .or the *atin e&uivalent ceteris paribus/. This assumption is made to simplify the
comple2ity of the managerial phenomenon under study in a dynamic business environment so
many things are changing simultaneously. This set a limitation that we cannot really hold other
things remaining the same. In such a case, the observations made out of such a study will have a
limited purpose or value. $anagerial economics also has inherited this problem from economics.
!urther, it is assumed that the firm or the buyer acts in a rational manner .which normally does not
happen/. The buyer is carried away by the advertisements, brand loyalties, incentives and so on,
and, therefore, the innate behaviour of the consumer will be rational is not a realistic assumption.
4nfortunately, there are no other alternatives to understand the sub3ect other than by ma1ing such
assumptions. This is because the behaviour of a firm or a consumer is a comple2 phenomenon.
The other features of managerial economics are e2plained as below%
(a) Close to microeconomics% $anagerial economics is concerned with finding the solutions
for different managerial problems of a particular firm. Thus, it is more close to
microeconomics.
(b) Operates against the backdrop of macroeconomics% The macroeconomics conditions
of the economy are also seen as limiting factors for the firm to operate. In other words, the
managerial economist has to be aware of the limits set by the macroeconomics conditions
such as government industrial policy, inflation and so on.
(c) Normative statements% normative statement usually includes or implies the words
(ought" or (should". They reflect people"s moral attitudes and are e2pressions of what a
team of people ought to do. !or instance, it deals with statements such as (?overnment of
India should open up the economy. Such statement are based on value 3udgments and
e2press views of what is (good" or (bad", (right" or ( wrong". @ne problem with normative
statements is that they cannot to verify by loo1ing at the facts, because they mostly deal
with the future. #isagreements about such statements are usually settled by voting on
them.
(d) Prescriptive actions% )rescriptive action is goal oriented. ?iven a problem and the
ob3ectives of the firm, it suggests the course of action from the available alternatives for
optimal solution. If does not merely mention the concept, it also e2plains whether the
concept can be applied in a given conte2t on not. !or instance, the fact that variable costs
are marginal costs can be used to 3udge the feasibility of an e2port order.
(e) Applied in nature% ($odels" are built to reflect the real life comple2 business situations
and these models are of immense help to managers for decision:ma1ing. The different
areas where models are e2tensively used include inventory control, optimi0ation, pro3ect
management etc. In managerial economics, we also employ case study methods to
conceptuali0e the problem, identify that alternative and determine the best course of
action.
(f) Offers scope to evaluate each alternative% $anagerial economics provides an
opportunity to evaluate each alternative in terms of its costs and revenue. The managerial
economist can decide which is the better alternative to ma2imi0e the profits for the firm.
(g) Interdisciplinary% The contents, tools and techni&ues of managerial economics are drawn
from different sub3ects such as economics, management, mathematics, statistics,
accountancy, psychology, organi0ational behavior, sociology and etc.
(h) Assumptions and limitations% Every concept and theory of managerial economics is
based on certain assumption and as such their validity is not universal. ,here there is
change in assumptions, the theory may not hold good at all.