Discuss the nature and scope of managerial economics?

Managerial Economics : Definition, Nature, Scope

Managerial economics is a discipline which deals with the application of economic
theory to business management. It deals with the use of economic concepts and
principles of business decision making. Formerly it was known as “Business
Economics” but the term has now been discarded in favour of Managerial Economics.
Managerial Economics may be defined as the study of economic theories, logic and
methodology which are generally applied to seek solution to the practical problems of
business. Managerial Economics is thus constituted of that part of economic knowledge
or economic theories which is used as a tool of analysing business problems for rational
business decisions. Managerial Economics is often called as Business Economics or
Economic for Firms.

Definition of Managerial Economics:

“Managerial Economics is economics applied in decision making. It is a special branch
of economics bridging the gap between abstract theory and managerial practice.” –
Haynes, Mote and Paul.
“Business Economics consists of the use of economic modes of thought to analyse
business situations.” - McNair and Meriam
“Business Economics (Managerial Economics) is the integration of economic theory
with business practice for the purpose of facilitating decision making and forward
planning by management.” - Spencerand Seegelman.
“Managerial economics is concerned with application of economic concepts and
economic analysis to the problems of formulating rational managerial decision.” –
Mansfield

Nature of Managerial Economics:

 The primary function of management executive in a business organisation is

decision making and forward planning.
 Decision making and forward planning go hand in hand with each other. Decision
making means the process of selecting one action from two or more alternative courses
of action. Forward planning means establishing plans for the future to carry out the
decision so taken.
 The problem of choice arises because resources at the disposal of a business
unit (land, labour, capital, and managerial capacity) are limited and the firm has to make
the most profitable use of these resources.
 The decision making function is that of the business executive, he takes the
decision which will ensure the most efficient means of attaining a desired objective, say
profit maximisation. After taking the decision about the particular output, pricing, capital,
raw-materials and power etc., are prepared. Forward planning and decision-making
thus go on at the same time.
 A business manager’s task is made difficult by the uncertainty which surrounds
business decision-making. Nobody can predict the future course of business conditions.
 He prepares the best possible plans for the future depending on past experience and
future outlook and yet he has to go on revising his plans in the light of new experience
to minimise the failure. Managers are thus engaged in a continuous process of decision-
making through an uncertain future and the overall problem confronting them is one of
adjusting to uncertainty.
 In fulfilling the function of decision-making in an uncertainty framework,
economic theory can be, pressed into service with considerable advantage as it deals
with a number of concepts and principles which can be used to solve or at least throw
some light upon the problems of business management. E.g are profit, demand, cost,
pricing, production, competition, business cycles, national income etc. The way
economic analysis can be used towards solving business problems, constitutes the
subject-matter of Managerial Economics.
 Thus in brief we can say that Managerial Economics is both a science and an art.
Scope of Managerial Economics:
The scope of managerial economics is not yet clearly laid out because it is a
developing science. Even then the following fields may be said to generally fall
under Managerial Economics:
1. Demand Analysis and Forecasting
2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
These divisions of business economics constitute its subject matter.
Recently, managerial economists have started making increased use of Operation
Research methods like Linear programming, inventory models, Games theory, queuing
up theory etc., have also come to be regarded as part of Managerial Economics.
1.Demand Analysis and Forecasting: A business firm is an economic organisation
which is engaged in transforming productive resources into goods that are to be sold in
the market. A major part of managerial decision making depends on accurate estimates
of demand. A forecast of future sales serves as a guide to management for preparing
production schedules and employing resources. It will help management to maintain or
strengthen its market position and profit base. Demand analysis also identifies a
number of other factors influencing the demand for a product. Demand analysis and
forecasting occupies a strategic place in Managerial Economics.
2.Cost and production analysis: A firm’s profitability depends much on its cost of
production. A wise manager would prepare cost estimates of a range of output, identify
the factors causing are cause variations in cost estimates and choose the cost-
minimising output level, taking also into consideration the degree of uncertainty in
production and cost calculations. Production processes are under the charge of
engineers but the business manager is supposed to carry out the production function
analysis in order to avoid wastages of materials and time. Sound pricing practices
depend much on cost control. The main topics discussed under cost and production
analysis are: Cost concepts, cost-output relationships, Economics and Diseconomies of
scale and cost control.
3.Pricing decisions, policies and practices: Pricing is a very important area of
Managerial Economics. In fact, price is the genesis of the revenue of a firm ad as such
 the success of a business firm largely depends on the correctness of the price decisions
taken by it. The important aspects dealt with this area are: Price determination in
various market forms, pricing methods, differential pricing, product-line pricing and price
forecasting.
4.Profit management: Business firms are generally organized for earning profit and in
the long period, it is profit which provides the chief measure of success of a firm.
Economics tells us that profits are the reward for uncertainty bearing and risk taking. A
successful business manager is one who can form more or less correct estimates of
costs and revenues likely to accrue to the firm at different levels of output. The more
successful a manager is in reducing uncertainty, the higher are the profits earned by
him. In fact, profit-planning and profit measurement constitute the most challenging area
of Managerial Economics.
5.Capital management: The problems relating to firm’s capital investments are perhaps
the most complex and troublesome. Capital management implies planning and control
of capital expenditure because it involves a large sum and moreover the problems in
disposing the capital assets off are so complex that they require considerable time and
labour. The main topics dealt with under capital management are cost of capital, rate of
return and selection of projects.

Conclusion: The various aspects outlined above represent the major uncertainties
which a business firm has to reckon with, viz., demand uncertainty, cost uncertainty,
price uncertainty, profit uncertainty, and capital uncertainty. We can, therefore, conclude
that the subject-matter of Managerial Economics consists of applying economic
principles and concepts towards adjusting with various uncertainties faced by a
business firm.

Business decision making

Business decision making is essentially a process of selecting the best out of alternative
opportunities open to the firm. The steps below put managers analytical ability to test
and determine the appropriateness and validity of decisions in the modern business
world. Following are the various steps in decision making process:
1. Establish objectives
2. Specify the decision problem
3. Identify the alternatives
4. Evaluate alternatives
5. Select the best alternatives
6. Implement the decision
7. Monitor the performance
Modern business conditions are changing so fast and becoming so competitive and
complex that personal business sense, intuition and experience alone are not sufficient
to make appropriate business decisions. It is in this area of decision making that
economic theories and tools of economic analysis contribute a great deal.
It is difficult to precisely define economics since it's a broad discipline. An easy way to
understand economics is to define it as a branch of social sciences that studies the production,
consumption and distribution of wealth along with human welfare. Microeconomics and
managerial economics are the sub-divisions of economics along with others such as
macroeconomics, behavioral economics, development economics, environmental economics or
financial economics. There are some fundamental differences between these two subdivisions.

Definitions

Microeconomics is the study of a single or an individual unit of an economy. It focuses on

determining the market prices through demand and supply where the deciding units are
consumers and firms. Therefore, it pays attention to individuals' income and output. Resource
allocation is also an important element of microeconomics, which entails availing resources in an
efficient way so it fulfills the requirements of an economy. On the other hand, managerial
economics applies the economic theories and analytical tools to provide choices for a firm. It
deals with different methodologies and principles for businesses to allocate scarce resources for
decision-making.

Outcomes

The two branches can be differentiated on the basis of results produced by each. As mentioned,
microeconomics involves both firms and consumers, therefore it has a broader scope. The effects
of microeconomics are on an individual's behavior, which can be either producer or consumer,
but managerial economics narrows it down to businesses only. The outcomes produced by
managerial economics influence the decision-making of firms.

Positive and Normative Economics

Positive economics explains facts in the exact manner in which they are, and what they will be. It
is objective in nature, while normative economics provides value judgment and expresses an
opinion on what it ought to be. Microeconomics consists of both since they are both a part of its
scope. Managerial economics, however, is normative because it provides judgment on the
outcomes of a firm. It analyzes the future position of a firm so it does not contain any factual
content. The effects of a firm's decisions are discussed, explaining what a firm should do to
achieve its objectives.

Macroeconomics

Macroeconomics deals with economy as a whole, combining all the units. Microeconomics is the
study of an individual's behavior that does not have a grain of macroeconomics. On the other
hand, managerial economics applies microeconomics in a significant way and considers
macroeconomic theories as well while analyzing results. Therefore, it is a combination of both
microeconomics and macroeconomics; for instance, it applies demand, supply or cost through
microeconomics and also takes into account national income or inflation under macroeconomics
11 different types of pricing

1) Premium pricing

It is a type of pricing which involves establishing a price higher than your

competitors to achieve a premium positioning. You can use this kind of pricing
when your product or service presents some unique features or core
advantages, or when the company has a unique competitive
advantage compared to its rivals. For example, Audi and Mercedes are
premium brands of cars because they are far above the rest in their product
design as well as in their marketing communications.

2) Penetration pricing

It is a commonly used pricing method amongst the various types of pricing is

designed to capture market share by entering the market with a low price as
compared to the competition. The penetration pricing strategy is used in order
to attract more customers and to make the customer switch from current
brands existing in the market. The main target group is price sensitive
customers. Once a market share is captured, the prices are increased by the
company. However, this is a sensitive strategy to apply as the market might
be penetrated by yet another new entrant. Or the margins are so low that the
company does not survive. And finally, this strategy never creates long
term brand loyalty in the mind of customers. This strategy is used mainly to
increase brand awareness and start with a small market share.

3) Economy pricing

This type of pricing takes a very low cost approach. Just the bare minimum to
keep prices low and attract a specific segment of the market that is highly
price sensitive. Examples of companies focusing on this type of pricing
include Walmart, Lidl and Aldi.

4) Skimming price

Skimming is a type of pricing used by companies that have a

significant competitive advantage and which can gain maximum revenue
advantage before other competitors begin offering similar products or
substitutes. It can be the case for innovative electronics entering the
marketing before the products are copied by close competitors or Chinese
manufacturers.

After being copied, the product loses its premium value and hence the price
has to be dropped immediately. Thus, to get maximum margins from their
products, innovative companies keep launching new variants so that
customers are always in the discovery phase and paying the required
premium.

5) Psychological pricing

It is a type of pricing which can be translated into a small incentive that can
make a huge impact psychologically on customers. Customers are more
willing to buy the necessary products at $4,99 than products costing $5. The
difference in price is actually completely irrelevant. However, it makes a great
difference in the mind of the customers. This strategy can frequently be seen
in the supermarkets and small shops.

6) Neutral strategy

This type of pricing focuses on keeping the price at the same level for all four
periods of the product lifecycl. However, with this type of strategy, there is
no opportunity to make higher profits and at the same time, it doesn’t allow for
increasing the market share. Also, when the product declines in turnover,
keeping the same price effects the margins thereby causing an early demise.
This pricing is used very rarely.

7) Captive product pricing

It is a type of pricing which focuses on captive products accompanying

the core products. For example, the ink for a printer is a captive product where
the core product is the printer. When employing this strategy companies
usually put a higher price on the captive products resulting in increased
revenue margins, than on the core product.
8) Optional product pricing

It can be frequently observed in the case of airline companies. For example,

the basic product of KLM Airlines is offering or providing seats in the airplane
for different flights. However, once the customers start purchasing these
seats, they are offered optional features along with the seats. Examples may
be extra seat space, more drinks etc. Because of this optional product, there
is more revenue generated from the main product. Customers are willing to
spend for the optional product as well.

9) Bundling price

Ever hear of the offer of 1 + 1 free? In the supermarket, when two different
products are combined together such as a razor and the lotion for shaving,
and they are offered as a deal, then we get to experience the bundling type of
pricing first hand. This strategy is mainly used to get rid of excess stocks.

10) Promotional pricing strategy

It is just like Bundling price. But here, the products are bundled so as to make
the customer use the bundled product for the first time. This type of pricing
focuses on buying one, and getting a new type of product for free.
Promotional pricing can also serve as a way to move old stock as well as to
increase brand awareness.

11) Geographical pricing

It involves variations of prices depending on the location where the product

and service is being sold and is mostly influenced by the changes in the
currencies as well as inflation. An example of geographic pricing can also be
the sales of heavy machinery, which are sold after considering the
transportation cost of different locations. Click here to read more
on geographical pricing strategy.

Depending on the goals and objectives of your company, and the strategies
decided by your company, you can use any of the 11 types of pricing
mentioned above. One can identify what strategy should be applied by
analyzing the market and also the product/service lifecycle they are present
in.