Williamson’s Managerial Discretionary Theory:

The theory of Managerial Utility Maximization was developed separately by Berle-Means-Galbralth

and Williamson. It is also known as Managerial Discretion Theory. The Theory is based on the
concept that shareholders or owners of the firm and managers are (two separate groups. The owners
or the shareholders want high dividends and are. therefore, interested in maximizing profits, the
managers, on the other hand, have different motives other than profit maximization. Once the
managers have achieved a level of profit that will pay satisfactory dividends to shareholders and still
ensure growth.

they are free to increase their own emoluments and also the size of their staff and expenditure on
them. In the words of Williamson, "7b the extent that the pressure from the capital market and
competition in the product market is imperfect, the manager, therefore, has discretion to pursue goals
other than profits." Further Berle and Means suggested that "The lack of corporate democracy
league's owners or shareholders with little or no power to change corporation policy."

According to Williamson, "Managerial Utility function may be expressed as follows:

U = f (S, M. ID)

It will be read: Managerial utility is a function (f) of additional expenditure on staff, managerial
emoluments and discretionary investment.

(Here, U = managerial utility; S = additional expenditure on staff; M = managerial emoluments and

ID = discretionary investment).

Managerial utility function maximizes the utility of the managers rather than profits of the firm. The
manager is expected to follow policies which maximize the following components of his utility
function.

I. Expansion of Staff: The manager will like to increase the quality and number of staff reporting to
him. This will lead to an increase in the salary of the staff. More staff are valued because they lead to
the manager getting more salary, more prestige and more security.

ii. Increase in Managerial Emoluments: Managerial Utility also depends on managerial

emoluments. It includes facilities like entertainment allowance, luxurious office, staff car, company
phone, etc. Expenditure of this nature reflects to a large extent the prestige, power and status of the
manager.

iii. Discretionary Power of Investment: Managerial utility also depends on the discretion of the
manager to undertake investment beyond those required for normal operations. The manager is in a
position to invest in advanced technology and modem plants. Such investments may or may not be
economically efficient. These investments may be undertaken for the self-satisfaction of the manager.
According to the theory, in a firm, shareholders and managers are two separate groups. The firm tries
to get maximum returns on investment and get maximum profit, whereas managers try to maximize
profit in their satisfying function.

At last, Williamson’s managerial discretion theory shows the utility function of a manager. In this
theory, the firm will try to get maximum returns or maximum profit where as manager try to
maximum utility satisfying function. They are in equilibrium when the utility has maximum amount.

Criticism
1. The model fails to describe how businesses take their price and output decisions in a highly
competitive set up.[1]
2. The relationship between better performance of managers and the increasing amounts spent
on manager’s utility by the firm is not always true.[6]
3. The model does not apply in a dynamic set up like changing demand and cost conditions
during booms and recessions.
Baumol's Theory of Sales Revenue Maximisation

Prof. Baumol, in his book 'Business behavior, Value and Growth' has propounded a theory of Sales
Maximization. Main aim of a firm is to maximize sales. By sales he meant total revenue earned by the
sale of goods. That is why this goal is also referred to as Sales Maximization Goal. According to this
theory, once profits reach acceptable levels, the goal of the firms become maximization of sales revenue
rather than maximization of profits.

In the words of Baumoul, 'The sales maximization goal says that managers of firms seek to maximize
their sales revenue subject to the constraint of earning a satisfactory profits. "

The above definition maintains that when the profits of firms reach a level considered satisfactory by the
shareholders then the efforts of the managers are directed to maximize revenue by promoting sales
instead of maximizing profit. While studying this theory. K must be kept in view that firms do not Ignore
profit altogether. They do aspire to attain a general level of profit. But once an acceptable level of profit
is obtained their goal shifts to sales maximization in place of profit maximization.

Baumol raised serious questions on the validity of profit maximization as an objective of the firm. He
stressed that in competitive markets, firms would rather aim at maximizing revenue, through
maximization of sales. According to him, sales volumes, and not profit volumes, determine market
leadership in competition. He further stressed that in large organizations, management is separate from
owners. Hence there would always be a dichotomy of managers' goals and owners' goals. Manager's
salary and other benefits are largely linked with sales volumes, rather than profits.

Baumol hypothesized that managers often attach their personal prestige to the company's revenue or
sales; therefore they would rather attempt to maximize the firm's total revenue, instead of profits.
Moreover, sales volumes are better indicator of firm's position in the market, and growing sales
strengthen the competitive spirit of the firm. Since operations of the firm are in the hands of managers,
and managers' performance is measured in terms of achieving sales targets, therefore it follows that
management is more interested in maximizing sales, with a constraint of minimum profit. Hence the
objective is not to maximize profit, but to maximize sales revenue, along with which, firms need to
maintain a minimum level of profit to keep shareholder satisfied. This minimum level of profit is
regarded as the profit constraint.

However, empirical evidence to support above arguments of Baumol is not sufficient to draw any
definite conclusion. Whatever research has been done is based on inadequate data; hence the results are
inconclusive.

Arguments in favour of Maximisation of Sales Goal

Following arguments are given in favour of maximisation of sales goal:

 i. More Realistic: Goal of maximization of sales is a more realistic goal- In fact, firms accord more
importance to the goal of sales maximization than profit maximization. It is so because success of a firm
is generally judged from its total sales. According to Ferguson and Krupps, 'Among the various
alternatives advanced, Baumoul’s thesis has great advantage — it raises the other models in the direction
of reality and plausibility while still permitting a rather general theoretical analysis."

ii. More Practical: Revenue maximization thesis of Baumol is more practical. It is so because goal of
revenue (Sales) maximization leads to more production which, in turn, leads to fall in price. As a result,
consumers' welfare is promoted. They also endorse this goal of the firms.

iii. More Availability of Loans: At the time of sanctioning loan to a firm, financial institutions mainly
consider its sales. Prospects of loans are bright for such firms as have large total sales.

iv. Strong Position in the Market: Maximum sales of a firm symbolize its strong position in the market.
Sales of a firm will be large only in that situation when consumers like its production, firm has more
competitive power and has been expanding. All these features are indicative of the progress of the firm.

v. More Advantageous to the Managers: It is more to the advantage of the managers that the firm should
aim at sates maximization. This way their credibility enhances in the market. Maximum sales is a
reflection of the competence of the managers It has a favorable effect on their wages. Firm is in a
position to offer higher wages to the employees. Consequently, employer-employee relations become
more cordial. II is the constant endeavor of the managers to maximize the sales of the firm after attaining
a given level of profit.

Value of Maximization Theory of Firm

In managerial economics, the primary objective of management is assumed to be maximization of the
firm’s value. The value can be defined as the present value of the firm’s expected future cash flows,
cash flows may for now, be equated to profits, therefore the value of the firm today, its present value,
is the value of its expected future profits, discounted back to the present at an appropriate interest
rate.
The essence of the model with which are concerned expressed as follows:

Value of the firm = PV of expected future profits.

Where PV is the abbreviation for the present value, and so forth represent the expected profits in each
year ‘t’, ‘i’ is the appropriate interest rate.
Since profits are equal to total revenue (TR) minus total cost (TC), equation (i) may be written as
Maximizing equation (ii) involves the determinants of revenues, costs and the discount rate in each
future year of some unspecified time. Revenues, costs and the discount rate are interrelated,
complicating the problem even more.

A firm’s total revenues are directly determined by the quantity of its products sold and the process
received, for managerial decision making, the important considerations relate to factors that affect
prices and quantities, and to the interrelationships between them. These factors include the choice of
products of the firm designs, manufactures and sells the advertising-strategies, it employs, the pricing
it established, the general state of the economy it encounters and the nature of the competition it
faces in the market place. In short, revenue relationship encompasses both demand and supply
considerations.

The cost relationships involved in producing a firm’s products are similarly complex. Costs require
examination of alternative production systems, technological options, input possibilities, and so on.
The prices of the factors of production play an important role in cost determination, and thus factors
supply considerations are important.

Finally, there is the relationship between the discount rate and the company’s production mix, physical
assets and financial structure. These factors affect the cost of availability of financial resources for the
firm and ultimately determine the discount rate used by investors to establish a value of the firm.

To determine the optional course of action requires that marketing, production and financial decisions
as well as decisions related to personnel, product distribution and so on be combined into a single
integrated system, one which shows how any action affects all parts of the firm. The economic model
of the firm provides a basis for this integration and the principles of economic analysis enable
to analysis the important interrelations.

Superiority of this theory

 Shareholder wealth maximization is the basic goal of any business firm because of the following
reasons:

1. Efficient allocation of resources:  It provides guideline for firm making decision of firm and
also promotes an efficient allocation of resources. Resources are generally allocated by taking into
consideration the expected return and risk associated to course of action. The market value of stock
itself reflects the risk return trade off associated to any investor in the capital market. 
2. Separation between ownership and management:  The goal of shareholder wealth
maximization is also justifiable form the view point of separation of ownership and management in a
business firm. Stockholders provides funds to operate a business firm and they appoint a team of
management to run the firm. 
3. Residual owners: Shareholders are the last to share in earnings and assists of the company.
Therefore, shareholders wealth is maximized, and then all other with prior claim that shareholder
could be satisfied. 
4. Emphasis on cash flow: Wealth maximization goal uses cash flows rather than accounting
profit as the basic input for decision making. The use of cash flow is clearer because it uniformly
means profit after tax plus non-cash outlays to all. 
5. Recognizes time value of money: It also recognizes the time value of money. All the cash flow
generated over the life of the business firms are discounted back to present value using required rate
of return and decision is based on the present value of future returns. 
6. Consideration risk: Wealth maximization objective also considers the risks associated to the
streams of future cash flows. Depending on the degree of risk, a proper required rate of return is
determined to discount back the future streams of cash flows. Greater the risk larger will be the
required rate of return and vice-versa.
The complexities involved in the fully integrated decision making analysis limit its use to major
planning decisions. The decision process involved in both fully integrated and partial optimization
problems takes place in two steps, one must apply various techniques to determine the optimal
decision.

Williamson’s Model of Managerial Discretion

The managerial theory of firm developed by Oliver E. Williamson states that managers apply discretion
in making and implementing policies to maximize their own utility rather than trying for the
maximization of profit which ultimately maximize own utility subject to minimum profit. Profit works as
a limit to the top managers’ behavior in the sense that the financial market and the shareholders
require a
minimum profit to be paid out in the form of dividends, otherwise the job security of managers is put
in danger. Hence, managers look at their self-interest while making decision on price and selling
quantity of output. Manager’s decision on price and output differs from the decisions of profit
maximizing firm.

Utility maximization of managers guided by their own self-interest is possible, like in Baumol’s sales
maximization model, only in a corporate type of business organization with the separation of ownership
and management functions. Such organizational structure permits the managers of a firm to pursue
their own self-interest, subject only to their ability to keep effective control over the firm. In
particular managers are fairly certain of keeping hold of their power (i) if profits at any time are at an
acceptable level, (ii) if the firm shows a reasonable rate of growth over time, and (iii) if sufficient
dividends are paid to keep the stockholders happy.

Williamson’s model suggests that manager’s self-interest focuses on the achievement of goals in four
particular areas, namely:

1. High salaries
2. Staff under their control
3. Discretionary investment expenditures
4. Fringe benefits (i.e., additional employee benefit: an additional benefit provided to an
employee, for example, a company car or health insurance)
This model depends on some assumptions which are:
1. Weakly competitive environment.
2. A divorce of ownership from control of firm (manager is free to perform any action)
3. A capital market imposes minimum profit constraint (manager’s work for minimum profit
imposed by a capital market).
According to Williamson, managers want ‘utility’ which is the same things as happiness or satisfaction.
Top managers and chief executive officers reveal expenditure preference that is they derive utility
expenditure on staff (S), managerial emoluments (M), and discretionary profits. The discretionary
profit is defined as the profit level higher than the level necessary for long-term survival.

The managerial utility function includes such variables as salaries, security, power, status, prestige and
professional excellence. Of these variables, only the first variable ‘salaries’ is measurable. The others
are non pecuniary. Therefore, in order to make them operational, they must be expressed in terms of
other variables with which they are related and which are measurable. This is captured by the concept
of expense preference, which is defined as the satisfaction which managers again from certain types of
expenditures. In particular, staff expenditures on well being (slack payments) and funds available for
discretionary investment gives a positive satisfaction to the managers because these expenditures are a
source of security and reflect the power, status, prestige and professional achievement of managers.

Staff expenditures, emoluments and discretionary investment expenses are measurable in

money terms and will be used as proxy-variables to replace the non-operational concepts (e.g. power,
status, prestige, professional excellence) appearing in the managerial utility function. With this
background, the utility function of the managers may be written in the form

U = f  (  S,   M,   ID)

Where S = staff expenditure, including managerial salaries; M = managerial emoluments; and I D =

discretionary investment; f(S, M, I D) is the utility function.

Managers have “expense preferences”, maximization of utility derived from (i) amount spent on staff
(S), (ii) additions to manager’s salaries and benefits in the form of “perks” (M), (iii) discretionary profit
(D) which exceed the minimum required to satisfy the shareholder’ available as a source of finance for
“pet project”.

Different definitional and behavioral relations are involved in Williamson’s model. They are introduced
below:
i) Demand of the firm: It is assumed that the firm has a known downward sloping demand curve
defined by the function.

Q  = f1(P, S, Ɛ)
P = f2(Q, S, Ɛ)

Where, Q = output, P = price, S = staff expenditure, Ɛ = (Greek letter epsilon) = the condition of the
environment or a demand-shift parameter reflecting autonomous changes in demand; f1(P, S, Ɛ) and
f2(Q, S, Ɛ) are the market demand equation for the firm’s product.

An increase in staff expenditure (S) is supposed to cause an upward shift to the demand curve and thus
allow the charging of a higher price. The same holds for any other change in the environment, which
shifts upwards the demand curve of the firm.

ii) Production cost: The total cost of production (C) is assumed to be an increasing function of output
(Q).

So, C = f3 (Q)

Where δC/δQ>0 (i.e., total cost increases with the increase in the level of output, and vice versa)
iii) Actual Profit (π): The actual profit is defined as revenue from sales (R), minus the production costs
(C), and minus the staff expenditure (S) or actual profits are the difference between total revenue
earned less the production costs (C) and expenditure on staff (S). This is symbolically expressed as:

π=R–C–S

π
iv) Reported Profit  R: This is the profit reported to the tax authorities. Reported profit ( R) is the π
difference between actual profits and supplementary or nonessential managerial expenditure as
represented by management slack. It is the actual minus the managerial emoluments (M) which are tax
deductible. So,

πR = π – M = R – C - S – M
π π
v) Minimum Profit ( 0): Minimum profit ( 0) is the amount of profits (after tax) which is required to
be paid as acceptable dividend to satisfy the owner-shareholders of the firm. If the shareholders do not
get reasonable dividends they may sell their share and thereby expose the firm to the risk of being
taken over by others, or alternatively they will vote for the dismissal of the top management. Both of
these actions by the shareholders will reduce the job security of the top managerial team. Hence,
managers must earn some minimum profits for the shareholders in the form of dividends to keep the
shareholders satisfied so as to ensure manager’s job security. To meet this objective, the reported

profits must be large enough to be equal to minimum profit ( π0) plus the tax (T) that must be paid to
the government. This is mathematically expressed as:

πR ≥ π0 + T
The tax function is of the form T = Ť + πR
t. 
Where t = marginal tax rate or unit profit tax; Ť = a lump sum tax

vi) Discretionary investment (ID): Discretionary investment is the amount left from the reported, after

subtracting the minimum profit ( π0) and the tax (T). The mathematical expression for this definitional
relationship is:

ID =  πR - π0 – T
πD): This is the amount of profit left after subtracting from the actual profit
vii) Discretionary profit (

π
( ) the minimum profit requirement (π0) and the tax (T). The mathematical expression for this
definitional relationship is:

πD = π – π0 – T
Thus, there are three types of profit concepts discussed in Williamson’s managerial utility

maximization model of the firm: actual profits ( π), reported profit (πR), and minimum profits (π0).
Discretionary profits should be carefully distinguished from discretionary investment. As explained

earlier, discretionary profits are the amount left after minimum profit ( π0) and tax (T) are deducted
π π π
from actual profits ( D =   –  0 – T5) but discretionary investment equals reported profits minus
minimum profits and tax. Thus, we have discretionary investment

πR – π0 – T
ID = 

π π
Since difference between reported profits ( R) and actual profits ( ) arise/ occur due to
management slack, discretionary profits can be stated as under

πD = ID + expenditure due to management slack. Thus, if management slack is zero

πR = π and πD = ID

Profit Maximization Objective of a Firm

Profit maximization is the most accurate description of managerial goal. The profit maximization is one
of the very important assumptions of economic theory, which always assumes that a firm aims to
maximize of profit. The attempt of an entrepreneur to maximize profit is regarded as a rational
behavior. Hence, profit maximization continues to be a central concept in managerial economics.
There are two approaches to explain the equilibrium of a firm on the context of profit maximization.
Among them one is old method of total cost and total revenue approach and another is the marginal
revenue and marginal cost approach.

Total Revenue (TR) – Total Cost (TC) Approach

Total revenue (TR) and total cost (TC) approach is the simplest method to determine the equilibrium of
a firm. To calculate the profit of a firm, we find out the difference between the  total revenue
and total cost at difference levels of output. A firm is said to be in equilibrium when the difference
between total revenue (TR) and total cost (TC) is maximum. Every rational producer will try to
maximize his profit. We can find equilibrium of a firm with the help of this approach both under
perfect and imperfect (monopoly) market competition.

i) Equilibrium of the firm under perfect competition

the firm is in equilibrium when it has no incentive to change its level of output. In perfect competition,
a firm is said to be in equilibrium when it maximizes its profits (π), which is defined as the difference
between total revenue and total cost.

π = TR – TC

Where, π = profit, TR = Total Revenue and TC = Total Cost

Given that the normal profit rate is included in the cost items of the firm, π is the profit above the
normal rate of return on capital and the remuneration for the risk bearing function of the
entrepreneur. The firm is in equilibrium when it produces the output that maximized the differences
between total receipts (Revenue) and total costs. The equilibrium of the firm can be explained with
the help of the following figure:

As shown in the figure, TR and TC are total revenue and total cost curves of a firm in a perfectly

competitive market. TR curve in a straight line through the origin, showing that the price is  constant at
all levels of output. The firm is a price taker and can sell any amount of output at the going market
price, with its TR increasing proportionately with its sales. The slope of TR curve is the MR. It
is constant and equal to the prevailing market price. Since all units are sold at the same price.

The slope of TC curves reflects ‘U’ shape of the AC curve i.e. law of variable proportions. The firm
maximizes its profit at the output ‘OX’, where the distance between TR and TC is the greatest. At the
lower (OX1) and higher levels (OX2) than OX, the firm has losses. The TR-TC approach awkward to use
when firms are combined together in the study of the industry.

ii) Equilibrium of the Firm under Imperfect Competition (Monopoly)  

Under imperfect competition, AR and MR of a firm are two different things. This is because under
imperfect competition, a firm is a price-maker. It can sell more by lowering the price of its output. In
the figure, AR and MR curves of a firm fall downward from left to right. According to this approach, for
a firm to be equilibrium or maximization of profit, marginal revenue should be equal to marginal cost
and the marginal cost curve should cut the marginal revenue curve from below.
It is shown in the figure, at the beginning, total cost is higher than total revenue. There is no profit. At
points P and Q, total revenue is equal to total cost. So, there is neither profit nor loss and is called the
break-even point. After OA output, total revenue is higher than total cost, so profit begins to show. At
OB output, the difference between total revenue and total cost is maximum. The firm is in equilibrium
and earns maximum profit, TR - TC (EB - NB) = EN is profit. Point Q is again the break-even point.
Beyond OC output, total cost exceeds total revenue and the firm incurs losses. In case of perfect
competition, the TR become the straight line.

Marginal Revenue (MR) - Marginal Cost (MC) Approach

Marginal revenue and marginal cost approach is another method to know the equilibrium of a firm. The
modern economist Mrs. Joan Robinson propounded this approach. According to this approach, for a firm
to be equilibrium or maximization of profit, marginal revenue (MR) should be equal to marginal cost
(MC) and the marginal cost curve should - cut the marginal revenue curve from below. It will be
profitable for a firm to increase its production when MR exceeds MC.

i) Equilibrium of the firm under perfect competition

The equilibrium of a firm in the perfect competition can also be shown through the help of marginal
revenue (MR) and marginal cost (MC) approach. For fulfilling the condition of maximum profit, marginal
cost (MC) must be less than marginal revenue (MR). A firm is said to be in equilibrium when marginal
cost (MC) must be equal to the marginal revenue (MR) or MC curve must intersect MR curve from
below. It is shown in the figure:
In the figure, AR and MR are the same and AR=MR is a straight line. It is assumed that MC falls at first
and then starts rising. MC curve cuts MR curve at E point from below and it is equal to MR. The profit
maximizing output is OQ where firm fulfills two basic conditions of equilibrium.

ii) Equilibrium of a firm under imperfect competition (Monopoly)

Under imperfect competition, AR and MR of a firm are two different things. This is because under
imperfect competition, a firm is a price-maker. It can sell more by lowering the price of its output. In
the figure, AR and MR curves of a firm fall downward from left to right. According to this approach, for
a firm to be equilibrium or maximization of profit, marginal revenue should be equal to marginal cost
and marginal cost curve should cut the marginal revenue curve from below.

In this figure, at point E both the conditions of equilibrium have been fulfilled. Hence, E is the point of
equilibrium. The firm gets equilibrium at OM output where marginal revenue is equal to marginal cost.
The OM quality of output is sold at price OP price. Before OM output, the increase in output add more
to revenue than to cost but after OM output, the increase in output adds more to cost than revenue.
Profit is the total revenue OMQP minus total cost OMNR. Hence, the firm earns the abnormal profit
equal to RNQP.
Criticisms/ Demerits of Profit Maximization Theory  The objective has been criticized by some
economists saying there may have other objectives in a firm such as sales maximization, welfare or
satisfactions etc. this objective is criticized on the following grounds.

1. Profit maximization criterion is vague and ambiguous. Profit may be long-term, after tax or
before tax. It is not clear.
2. In this objective, total profit earned during the life of assets and timing of their realization is
ignored. Hence, equal value for earning realized on different periods is not realistic. It ignores the time
value of money.
3. This objective is concerned only with the size of profit and gives no weight to the degree of
uncertainty of future profits. Two businesses with varying degree of risk and producing same size of
profit is considered similar under profit maximization criterion. Thus, the risk element is ignored,
which is one of the most important dimensions of financial management.
4. This objective is incomplete because it ignores the appreciation in the value of securities or
firm. Investors and owners of the businessmen are benefited not only by the earning of profit, but also
due to the appreciation in the stock price.

Factors Influencing Managerial Decisions

Managerial decision-making is the process of selecting a particular course of action from among a
number of alternatives. Since the factors of production are limited and can be put to alternative uses.
The objective of a firm is to achieve optimal result from use of available resources. If there were no
alternatives, there would be no scarcity, and no choice as well as no decisions, so that the problem of
choice arises.
The choice is the most important role of management. Hence, best choice should be made whether the
knowledge of future prospect, decision could be made and plans could be formulated without errors.
However in many cases, there may not complete knowledge. New decisions have to be made and old
plans may have to be repeated as new courses of action are adopted in order to obtain desired
objectives. The following factors influence the managerial decision-making.

1. Objectives of a firm: Efficient or optimal decision-making requires a goal or objective be

established. That is a management decision can only be evaluated against the goal that the firm is
attempting to achieve. Traditionally, economists have assumed the objective of the firm is to maximize
profit. That is, it is assumed that managers consistently make decisions in order to maximize profit.
That should be clear either in current year or in next year.
2. Economic factors: According to traditional concept a firm tries to maximize its profit. Many
economists have challenged this concept; the firm may have other objectives such as sales
maximization. Although it cannot be cleared that the preference for profitability is high. So that
manager should consider if the set course of action is profitable or not, can be done with least cost or
not. Demand forecasting, pricing condition, cost estimation will have to made for the purpose. It must
consider the size of and direction of future changes in prices, demand, general level of economic
activity, possible strikes, changes in fission, which affects the demand on the one side and on the
supply side. Cost of machine, cost of borrowing, cost of renting space to store would be studied.
3. Technological Factors: There is significant role of technology in decision making in the
economic theory. Technology also influences the business decisions. The manager must consider the
factor such as assessment and emerging new technological alternatives, the technological moves of
competitors and emerging new technological and process in their planning and available resource
allocation. The technological alternatives suitable to the situation should be taken as good for short
run marketing or production decision. But the consideration of technological factor cannot be
a basis for business decision with reaching at final decision, economic factor should also be considered
well.
4. Human and behavioral factors: The economic consideration is important in decision-making.
Although managers may not always give top most priority to economic consideration. It should be taken
into account the factors such as the impact of decision on employee’s morale (determination) as in
case of cutting of extra benefits of motivation. The small entrepreneurs may not be agreed to expand
or diversify despite green signals ahead because they feel that expansion may strain their quiet life or
may threaten their control over management. Manager must always consider constrain imposed upon
him by forces at work within his own firm such as individual and collective interests and pressures
within the firm. Hence, the manager should base his final decision on both economic logic as well as
human and personal thinking.
5. Environmental factors: The firm’s managers should be fully aware of the economic, social and
political conditions curtailing the country while making business decisions. The environment existing in
and out of the firm should be considered. The political and social consequences as to decision can’t be
overlooked. The importance of environmental factors is growing each day due to the following causes.
1. Public awareness: The awareness of the impact of firm’s decision on society is
growing. Many pressure groups like political parties, consumer’s forum, trade unions and other exist
these days. The pressure groups watch secondly the nature and consequences of a decision whether
decisions are harmful to their interest and they will protest the decision.
2. Social costs: The decision of firm has social through their productive activities like
pollution, congestion, development of slums and others. Hence, the manager may have to take into
account the environmental factors while making decisions. It should be considered carefully while
making decisions of all the factors. But economic factors still play a dominant role in decision making
because the firms are commercial in nature.
The managers cannot ignore the environment within which they operate. They must understand and
adjust to the external factors, such as government intervention in business, taxation, business cycle
fluctuation etc. Modern business has to keep itself well informed of changes in its environment and
adjust its decisions accordingly from time to time.

Uses/Significance of Managerial Economics in Business

Decision Making
Management is concerned with decision-making. Decision-making needs a balance between
simplification of analysis to be manageable and complications for handling a variety of factors
and objectives. Managerial economics accomplished several objectives. Moreover, it also needs
common sense and good judgment. Managerial economics helps the decision-making process in the
following ways:
1. Managerial economics presents those aspects of traditional economics, which are relevant for
business decision-making in real life. It culls from economic theory the concepts, principles and
techniques of analysis, which have a bearing on the decision-making process. These are, if necessary,
adopted or modified with a view to enable the manager take better decisions.
Thus, managerial economics accomplished the objective of building a suitable took kit from traditional
economics.
2. Managerial economics also incorporates useful ideas from other disciplines such as psychology,
sociology, etc; if they are found relevant for decision-making. In fact, managerial economics takes the
aid of other academic disciplines having a bearing upon the business decisions of a manager in view of
the various explicit and implicit constraints subject to which resource allocation is to be optimized.
3. Managerial economics helps in reaching a variety of business decisions in a complicated
environment such as what products and services should be produced? What inputs and production
techniques should be used? How much output should be produced and at what prices it should be sold?
What are the best sizes and locations of new plants? When should equipment be replaced? And how
should the available capital be allocated?
4. Managerial economics makes a manager a more competent model builder. Thus, he can capture
the essential relationship, which characterizes a situation while leaving out the cluttering details and
peripheral relationships.
5. At the level of the firm, where for various functional areas, functional specialists or functional
departments exist, such as finance, marketing, personal, production, etc. Managerial economics serves
as an integrating agent by coordinating the different areas and bringing to bear on the  decisions of
each department or specialist the implications pertaining to other functional areas. It thus, enables
business decision-making not in watertight compartments but in an integrated perspective, the
significance of which lies in the fact that the functional departments or specialists often
enjoy considerable autonomy and achieve conflicting goals.
6. Managerial economics takes cognizance of the interaction between the firm and society and
accomplishes the key role of business as an agent in the attainment of social and economic welfare. It
has come to be raised that business, apart from its obligations to shareholders, has certain social
obligations. Managerial economics focuses attention on those social obligations as
constraints subject to which business decisions are to be taken. It serves as an instrument in furthering
the economic welfare of the society through socially oriented business decisions.
7. Managerial economics is helpful in making decisions such as the following: What should be the
product-mix? Which is the production technique and the input-mix that is least costly? What should be
the level of output and price for the product? How to take investment  decisions? How much should the
firm advertise and how to allocate an advertisement fund between different media? It has to concede
that good decisions require ability to analyze problems logically and clearly.
In summary, the usefulness of managerial economics lies in borrowing and adopting the took-kit from
economic theory, incorporating relevant ideas from other disciplines to achieve better
business decisions, serving a catalytic agent in the course of decision-making by different functional
departments at the firm’s level and finally accomplishing a social purpose through orienting
business decisions towards social obligations.

H. A. Simon opines that firms aim at satisfying rather than

maximizing
H. A. Simon opines that firms aim at satisfying rather than maximizing
H.A. Simon has propounded this model in 1955, he argued that the real business world is full of
uncertainty, accurate and adequate data are not readily available where data are available managers
have little time and ability to process data and managers work under a number of constraint. Under
such conditions it is not possible for the firms to act in terms
of rationality postulated under profit maximization hypothesis. Nor do the firms seek to maximize
sales, growth or anything else. Instead they seek to achieve a ‘satisfactory profit’, a ‘satisfactory
growth’, and so on.

This behavior of firms is termed as satisfaction behavior of firms is that a firm is a coalition of different
groups connected with the various activities of the firm e.g. shareholders, managers, workers, input
supplier, customers, bankers, tax authorities and so on. All if these groups have some kinds of
expectations often conflicting from the firm, and the firm seeks to satisfy all of the in one way or
another.

Simon said that a firm has normally an aspiration level. An aspiration level is the level of achievement,
which the firm hopes for in a particular field. For example, if a firm hopes to increase sales in the
present year by 10%, it is his aspiration level about sales. The aspiration level of profit will depend on
past experience and in fixing in future uncertainties will be taken into account. If it is easily attend,
the aspiration level will be raised. If it proves difficult to attain, it will be revised downwards. When
the actual performance of a firm falls short of an aspiration level, ‘search activity’ will be started so
that remedial action can be taken to achieve the aspiration level by better
performance. Search activity is the search for new alternatives of action.

But there is limit to search activities because of the cost to be incurred in obtaining information.
Hence, all alternatives will not be explored. A satisfactory alternative course of action will be
selected. Since the firm limits search activity due to involvement of costs, it does not maximize profit.
Hence, the firms aim at ‘satisfying’, rather than ‘maximizing’. If the aspiration level is nearer to
profit, the result that can be obtained under the assumption of satisfying is similar to the result under
the assumption of profit maximization.

The aspiration level of the firm means the demarcation between the satisfactory and unsatisfactory
results.
 

Criticisms of Simon’s Satisficing Theory

This theory has the following weakness as:

1. The main weakness of the satisficing theory of Simon is that he has not specified the ‘target’
level of profits which a firm aspires to reach. Unless that is known, it is not possible to point output the
precise areas of conflict between the objectives of profit maximizing and satisficing.
2. As commended by Boumol and Quant, it is constrained maximization with only constraints and
no maximization.
3. Simon does not clarify a satisfactory level of performance based on a certain level of rate of
profits. According to Simon, there may be many satisfactory levels depending upon the groups that
cooperate in the firm. It is difficult for the firm to choose such a profit rate that satisfies all groups
function within the firm. Thus, the operational value of Simon’s model is limited.

Modern Oligopolistic firms typically seek to maximize their

sales subject to minimum profit constraints
Modern Oligopolistic firms typically seek to maximize their sales subject to minimum
profit constraints.
Boumol’s theory of sales maximization is an alternative theory of firm’s behavior. The basic premise of
this theory is that sales maximization, rather than profit maximization, is the plausible goal of the firm.
As pointed by him, there is no reason to believe that all firms seek to maximize their profits. Business
firms pursue a number of incompatible objectives and
it is not easy to single out one as the most common objective pursued by the firms. His observation
shows that more managers seek to maximize sales revenue rather than profits. He argues that in
modern business management is separated from ownership, and managers enjoy the discretion to
pursue goals other than profit maximization. According to Boumol, Business managers pursue the goal
of sales maximization for the following reasons:

1. Financial institutions consider sales an index of performance of the firm and willing to finance
to the firm with growing sales.
2. Profit figures are available only annually, sales figures can be obtained easily and more
frequently to assess the performance of the management. Maximization of sales is more satisfying for
the managers than the maximization of profits which go to the pockets to the shareholders.
3. Salaries and slack earnings of the top managers linked more closely to sales than to profit.
4. The routine personal problems are more easily handled with growing sales. Higher payments
may be offered to employees of sales figures indicate better performance. Profits are generally known
after a year.
5. If profit maximization is the goal and it rises in one period to an unusually high level, this
becomes the standard profit target for the shareholders which managers find very difficult to maintain
in the long-run.
6. Sales growing more than proportionately to market expansion indicate growing market share
and a greater competitive strength and bargaining power of a firm in a collective oligopoly.
Under sales maximizing objective output is greater and price lower than under the objective of profit
maximization. Hence, Boumol has described two types of equilibrium under sales maximization
objective which are:
1. Without profit constraint to sales maximization, & 
2. There is profit constraint to sales maximization

 
In the figure, total profit curve (TP) measures the vertical distance between the total revenue and that
cost at various levels of output. At first, total profit rises and after a profit falls downwards.

If the firm is a profit maximize, it would produce the level of output OA. However, in Boumol’s model
the firm is sales maximize, but it must also earn a minimum level of profit acceptable level of profit is
OM, the firm will produce the level of output OB which maximizes its sales revenue the firm earns
profit BE, which is less than the maximum attainable profit AH. At this point, output OB total revenue
is BR1. The figure shows that sales or total revenue maximizing output OB is larger than profit
maximizing output OA.

The firm aims at sales maximization subject to a profit constraint as Boumol contended. If OM is the
minimum total profit, which firm wants, then ML is the minimum profit line. This minimum profit line
ML cuts TP curve at point E. There, the firm produces and sells OB output.

At output OB, the firm will have total revenue equal to BR1, which has less maximum possible total
revenue of CR2. It should be noted that the firm can earn minimum profit ON even by producing ON
output. But total revenue at output OH is much less than at output OB. In summary, two types of
equilibrium appear to be possible. One in which the constraint provides no effective barrier to sales
maximization. The firm is assumed to be able to pursue an independent price policy that is to set its
price so as to achieve its goal of sales maximization (given the profit constraint) without being
concerned about the reactions of competitors.

A profit maximizer produces the output OB defined by the equilibrium

Given that the marginal cost is always positive, it is obvious that at the level OB, the marginal revenue
is also positive. That is TR is still increasing at OB, since its slope is still positive. In other words, the
maximum of TR curve occurs to the right of the level of output at which profit is maximized.

The sales maximize sells at a price lower than profit maximize. The price at any level of output is the
slope of the line through the origin to the relevant point of the total revenue curve (corresponding to
the particular level of output).

Criticisms of this Model This model is not also free from certain weakness as below:

1. As pointed by Boumol, sales maximize will in general produce and advertise more than a profit
maximize, which is invalid. Hawkins comments that a sales-maximizer may choose a higher, lower or
identical output and a higher, lower or advertising budget. It depends on the responsiveness of demand
to advertising rather than price cuts.
2. In case of multi-products, Baumol has argued that revenue and profit maximization yield the
same results. But Williamson has shown that sales maximization yields different results from profit
maximization.
3. This model fails to explain observed market situations in which price are kept for considerable
time periods in the range of inelastic demand.
4. This model ignores the interdependence of the price of oligopolistic firms.
5. It ignores not only actual competition, but also the threat of potential competition from rival
oligopolistic firms.
6. This model does not show how equilibrium in an industry in which all firms are sales
maximizers, will be attained. Baumol does not establish the relationship between the firms and
industry.

Relationship of Managerial Economics with Traditional

Economics
The relationship between managerial economics and economic theory is very much like the relation of
engineering to physics and of medicines to biology. It is in fact the relation of an applied field to its
more fundamental and conceptual counterpart. Economics provides certain basic concepts and
analytical tools, which are applied suitably to a business situation.

The relationship between managerial economics and traditional economics is facilitated by considering
the structure of traditional study. The traditional fields of economic study about
theory, Micro economics focuses on individual consumers firms and industries. Macro economics focuses
on aggregations of economics units, especially national economics. The traditional
field: agricultural economics, comparative economic system, economic development, economic
history, industrial organization, international trade, labor economics, money and banking, public
economics, urban and regional economics. The emphasis on normative economics focuses on
prescriptive statements that are established rules on the specified field. Positive economics focuses on
description that describes that manner in which economics forces operate without attempting to state
how they should operate. The focus of each field of study is sufficiently well defined to warrant the
breakdown suggested.

Since each area of economics has some bearing on managerial decision making, managerial economics
draws from them all. In practice, some are more relevant to the business firm that others and hence to
managerial economics. Both micro economics and macro economics are important in managerial
economics but the micro economic theory of the firm is especially significant. The theory of firm is the
single most important element in managerial economics. However, because the individual firm is
influenced by the general economy, that is domain of macro economics. Managerial economics is
certainly on normative theory. We want to establish decision rules that will help managers attain the
goals of their firm, agency or organization; this is the essence of the word normative. If managers are
to establish valid decision rules, however, they must thoroughly know the environment in which they
operate for this reason positive or descriptive economics is important.

Scope of Managerial Economics

The scope of managerial economics means the fields of study which managerial economics cover.
Hence, scope of managerial economics includes the subject matter of managerial economics and
relationship of managerial economics with other subjects also fall under the scope of managerial
economics.

Managerial economics has a close connection with economic theory, operations research, statistics,
mathematics and the theory of decision making. Managerial economics also draws together and relates
ideas from various functional areas of management such as production, marketing, finance and
accounting, project management, etc. Managerial economics is concerned; the following aspects
constitute its subject matter.

1. Demand analysis and forecasting: Demand analysis theory can be a source of many useful

insights for business decision-making. The fundamental objective of demand theory is to identify and
analyze the basic determinants of consumer needs of wants. An understanding of the forces behind
demand is a powerful tool for managers. Such knowledge provides the background needed to make
pricing decisions, forecast sales and formulate marketing strategies. A forecast of future sales is
essential before making production schedules of employing resources. The forecast helps the manager
in keeping of strengthening the market and increasing profits. Demand analysis and forecasting both
are very much essential for business planning and take an important place in managerial economics.
Under this topic are: determinants of demand, types of demand, elasticity of demand, various
statistical and non-statistical methods of demand forecasting. 
2. Cost and production analysis: The cost estimates are helpful for managerial economics. The
cost estimate is essential for planning aims. The factors determining costs are not always known or
controllable which gives rise to cost uncertainty. It is required to find out the economics costs and
measure them for profit planning cost control and sound pricing practices. The factors of production
are scarce (limited) and have alternative uses. The factors of productions may be allocated in a
particular way to get maximum output. Due to this, production analysis is also importance in
managerial economics. The major topics of study under cost and production analysis are: concepts of
cost and classification, production function, least-cost combination of inputs, factor of productivity
returns to scale, etc.
3. Pricing decisions and techniques:  Pricing decisions take up an important place in managerial
economics because the main objective of a firm is the maximization of profits that depends on suitable
pricing decisions. So price is the source of the revenue, the success of a firm depends on the
correctness of the pricing decisions. The main topics included under it are: Price determination under
different market structure, pricing objectives, pricing methods, price discrimination, price of joint
products.
4. Profit and capital management: Profit provides the index of success of a business firm. So the
business firms are organized for making profits. Profits analysis is difficult since the knowledge about
uncertainty future but uncertainty expectations are not always realized which makes the profit
planning and measurement difficult that is covered by managerial economics. The important aspects
covered under the topics are nature theories and measurement of profit, profit policies and techniques
of profit planning. There is one of difficult problems of a business manager is relating to firm’s capital
investments, are numerous. Hence, capital management is required, which in turn, needs considerable
time and labor. Capital management means planning and control of capital expenditures. The main
aspects covered are: Cost of capital, types of investment decisions, and evaluation of selections of
projects.
5. Objective of business firm: A firm should fix its objective at the initiation of the business. The
objective may be many ranging from profit maximization to sales maximization to utility maximization
to satisfying. It is assumed that manager consistently makes decisions in order to maximize profit.
Though a firm may have only one objective at a time. The objective should guide a firm in decisions
regarding its prices and outputs.
Traditionally, managerial economics drew heavily upon economic analysis for its decision-making
process. But lately, the development of mathematical and statistical techniques for analyzing
situations faced by managerial economists has also prompted their use in the decision-making process.
Managerial economics is also concentrated on integration of managerial economics and operation
research. Hence, many mathematical, statistical as well as other techniques are also regarded as a
part of a managerial economics.

The Cyert and March Theory of Firm

The behavioral theory of firm was developed by Cyert and March focuses on the decision making
process of the large multi product firm under uncertainty in an imperfect market. They deal with the
large corporate managerial business in which ownership is separated. Their theory originated from the
concern about the organizational problem with the internal structure of such firms
creates and from the need to investigate the effect on the decision making process in these large
organization. The internal organizational actors may well explain the difference in the reactions of
firms to the same external stimuli, that to the same changes in their economic environment.

The assumptions underlying the behavioral theories about the complex nature of the firm introduces an
element of realism into the theory of the firm. The firm is not treated as a single-goal, single decision
unit, as in the traditional theory, but as a multi goal, multi decision organization coalition. The firm is
as a coalition of different groups which are connected with its activity; in various ways, managers,
workers, shareholders, customers, suppliers, bankers, tax inspectors and so on. Each group has its own
set of goals or demands.

The behavioral theory recognizes explicitly that there exists a basic dichotomy in the firm, there are
individual members of the coalition firm and there is the organization coalition known as ‘the firm’.
The consequence of the dichotomy is a conflict of goals; individuals may have different goals to those
of the organization firm.

Cyert and March argue that the goals of the firm depend on the demand of the members of the
coalition, while the demand of these members are determined by various factors such as aspiration of
the members, their success in the past in occupying their demands, the expectations,
the achievements of other groups in the same or other firms, the information available to them. The
demands of the various groups of the coalition firm change continuously over time. Given the resources
of the firm in any one period, not all demands, which confront the top management can be satisfied.
Hence, there is a regular bargaining process between the various members of the coalition firm and
inevitable conflict.

The top management has several tasks; to get the goals of the firm which are often in conflict with the
demands of the various groups, to resolve the conflict between the various groups, to reconcile as far
as possible the conflict in goals of the firm and of its individual groups.

The goals of the firm are set by the top management, which the main five goals of the firm are:

1. Production Goal: The production goal originates from the production department. The main
goal of the production manager is the smooth running of the production process. Production should be
distributed evenly over time, irrespective of possible seasonal fluctuations of demand, so as to avoid
excess capacity and lay off of workers at some periods and over working the plant and resorting to
rush recruitment of workers at other times with the consequence of higher, costs due to excess
capacity and dismissal payments or too frequent breakdowns of machinery and waste of raw materials
in period of rush production.
2. Inventory Goal: The inventory goal originates mainly from the inventory department if such a
department exists, or from the sales and production department. The sales department wants an
adequate stock of output for the customers, while the production department needs adequate stocks
of raw materials and other items necessary for a smooth flow of the output process.
3. Sales Goal: The sales goal and the share of the market goal originate from the sales
department. The same department will also normally set the ‘sales strategy’ that is decided on
the advertising campaigns, the market research programs, and so on.
4. Profit Goal: The profit goals is set by the management so as to satisfy the demand of share
holders and the expectations of bankers and other finance institutions; and also to create funds with
which they can accomplish their own goals and projects, or satisfy the other goals of the firm.
5. Share of the market goal:  While making decisions, the firms are guided by these goals. All
goals must be satisfied but there is an implicit order of priority among them. The conflict among
different goals may crop up.
The number of goals of the firm may be increased, but the decision making process becomes increasing
complex. The efficiency of decision making decreases as the number of goals increases. The law of
diminishing returns holds for managerial work as for all other types of labor.

The goals of the firm are ultimately decided by the top management through continuous bargaining
between the groups of the coalition. In the process of goal formation the top management attempts to
satisfy as many as possible of the demands with which the various members of the coalitions confront
it. The goals of the firm such as the goals of the individual members or particular groups of the
coalition take the form of aspiration levels rather than strict maximizing constraints.

The firm in the behavioral theories seeks to satisfy, i.e., to attain a ‘satisfactory’ overall performance
as defined by the set aspiration goals, rather than maximize profits, sales or other magnitudes. The
firm is as satisfying organization rather than a maximizing entrepreneur. The top management,
responsible for the coordination of the activities of the various members of the firm, wishes to attain a
‘satisfactory’ level of production, to attain a share of the market, to earn a ‘satisfactory’ level of
profit, to divert a ‘satisfactory’ percentage of their total receipts to research and development or to
advertising, to acquire a ‘satisfactory’ public image and so on. But it is not clear in
the behavioral theories what is a satisfactory and what an unsatisfactory attainment is.

They argue that satisfying behavior is rational given the limitations, internal and external with in which
the operation of the firm is confined. They take by the form of aspiration levels, and whether attained,
the performance of the firm is considered as satisfactory. The goals do not normally take the form of
maximization of the relevant magnitudes. The firm is not a maximizing but rather a satisfying
organization.

Conflicting Goals
 The aspiration levels of the individuals within the firm which determine these goals change over time
as a result of organizational learning. Thus, these goals are regarded as the product of a bargaining
learning process in the organization coalition. But it is not essential that the different goals may be
resolved amicably. There may be conflicts among these goals.

The conflicting interest can be reconciled by the distribution of side payments’ to members of the
coalition. Side payments may be in cash or kind, the latter being mostly in the form of policy side
payments. But the actual among of total side payments is not fixed for the coalition but depends upon
the demand of members and on the form of the coalition. Demands of coalition members equal actual
side payments only in the long-run. But the behavioral theory focuses on the short-run relation
between side payments and demands and on the imperfections in factor markets.

In the short-run, new demands are being constantly made and the goals of the organization are
continually adapted, to a greater or lesser extent, to take account of these demands. The demands of
the members of the organizational coalition need not be mutually consistent. But all demands are not
made simultaneously and the organization can remain viable by attending to demands in sequence. A
problem will arise when the organization is not able to accommodate the demands of its members even
sequentially, because it lacks the resources to do so.

Besides, side payments, the conflicting goals of the organization are resolved by subjecting them to a
constant review. This is because, aspiration levels’ of coalition members change with experience. In
fact, the aspiration levels change with the process of satisfying. Each person in the organization has a
satisfying level for each of his goals.

Criticisms of this theory The Cyert and March theory of the firm has been severely criticized on the
following grounds:

1. The behavioral theory relates to a duopoly firm and fails as the theory of market structures. It
does not explain the interdependence and interaction of firms, nor the way in which the
interrelationship of firms leads to equilibrium of output and price at the industry level. Thus, the
conditions for the attainment of a stable equilibrium in the industry are not determined.
2. The theory does not consider either the conditions of entry the effects on the behavior of
existing firms of a threat of potential entry by firms.
3. The behavioral theory explains the short-run behavior of firms and ignores their long-run
behavior. It cannot explain the dynamic aspects of inventions and innovations which are related to the
long-run.
4. The behavior theory is based on the simulations approach which is a predictive technique. It
simply products the behavior of the firm but does not explain it.

Characteristics/ Features of Managerial Economics

Different authorities on the subject matter of managerial economics have given differently. However,
the following characteristics seem to these viewpoints as:

1. Micro economic character: Managerial economics is micro economic in character because it is

a unit of study i.e. firm. It only deals the problems of firms but not deal with the entire economy as a
unit of study. However, it takes the help of macroeconomic to understand and adjust to the
environment in which the firm operates.
2. Choice and Allocation: Managerial economics is concerned with decision-making of economic
nature. This implies that managerial economics deals with identification of economic choices and
allocation of scarce resources.
3. Goal oriented: Managerial economics is goal-oriented and prescriptive. It deals with how
decisions should be formulated by managers to achieve the organizational goals.
4. Conceptual and Metrical: Managerial economics is both ‘Conceptual and Metrical’. An
intelligent application of quantitative techniques to business presupposes considered judgment and
hard and careful thinking about the nature of the particular problem to be solved. Managerial
economics provides necessary conceptual tools to achieve this. Moreover, it helps the decision-maker
by providing measurement of various economic entities and their relationships. This metrical dimension
of managerial economics is complementary to its conceptual framework.
5. Pragmatic: Managerial economics is pragmatic. It is concerned with those analytical tools,
which are useful in improving decision-making. Economic theory appropriately ignores the variety of
backgrounds and training found in individual firms but managerial economics considers the particular
environment of decision making.
6. Normative: Managerial economics belongs to normative economics rather than positive
economics. In other words, it is prescriptive rather than descriptive. The main body of economic theory
confines itself to descriptive hypothesis, attempting to generalize about the relations among different
variables without judgment about what is desirable or undesirable. Managerial economics firstly tells
what aims and objectives a firm should pursue and secondly, it tells how best to  achieve these aims in
particular situations.
7. Multi-disciplinary: Managerial economics is related with different disciplines such as Statistics,
Mathematics, Management, Operational Research, Psychology etc.
Similarly, managerial economics provides a link between traditional economics and the decision
sciences for managerial decision-making.

Managerial economics is an application of economic theories and tools of decision

science in solving business problems.

Forward planning and decision making are the two important functions of a business executive. It may
be defined as a process of selecting a particular – course of action from among number of alternative
courses of action. There would be no scarcity, no price of action and of course no economics whether
there is any limitation of resources. But factors of production are limited and can be put in
alternative uses. Hence, questions of choice arise. Decision-making involves making choice or making
decision for attaining desired goal. The rationale of good decision-making lies in its capacity to build
high result from scare resources. Forward planning means established plans for the future plans for
various things are made like production, pricing, capital, raw material, labor, wage etc.

Managerial decisions are made where the outcomes associated with each possible course of action are
known with certainty. All major managerial decisions are made under conditions of uncertainty. The
manager must select a course of action from the observed alternatives. Decision making of forward
planning is difficult due to uncertainty. The manager may unknown of future sales, costs, profits,
capital situations etc. So, that the decisions should be made on the basis of past data and current
information as well as future is predicted as accurately as possible.

The managers should confront uncertainty and the main problem is arranging uncertainty, which drives
to risk and is the chances, which expected result might not occur, or there is a chance of loss. The
uncertainty area are numerous such as market demand, production cost, pricing, environmental
factors, financing and profits which influence revenue, production, use of allocation of resources,
spending outlays, profit and create problems in raising capital, pricing, etc.

Due to these, decisions will have to be made in conditions of uncertainty and must formulate plans for
the future. In this condition, managerial economics is of considerable help. Economic theory deals with
demand, pricing cost, production, composition, profit etc. these concept aided by accounting,
statistics, and mathematics help to solve business problems. The economic analysis can be used
towards solving business problems constitutes the subject matter of management economics.

Meaning of Managerial Economics

Managerial economics is an application of economic theory and method to practice the managerial
decision-making or solving business problems. It uses the tools and techniques of economic analysis to
solve managerial problems or to achieve the firm’s desired objectives. So that managerial economics is
very important to entrepreneurs in decision making and forward planning of a business.
Managerial economics is economics applied in decision making. It is a branch of economics that serves
as a link between abstract theory and managerial practice. It is based on economic analysis for
identifying problems, organizing information and evaluating alternatives.

Managerial economics is by nature goal oriented and prescriptive and aims at maximum achievement of
objectives. Many economists and thinkers have given various definitions of managerial economics in
their words. According to Prof. Pappas and Brigham, “Managerial economics is designed to provide a
rigorous treatment of those aspects of economic theory and analysis that are most useful for
managerial decision analysis.” They more added that, “Managerial economics is the application of
economic theory and methodology to business administration practice. More specifically, managerial
economic analysis and solve the managerial problems.”

In the words of Prof. D.C. Hague, “Managerial economics is a fundamental academic subject which

seeks to understand and to analyze the problems of business decision making.” This definition states
that it should be finalized the business problem for decision-making. Prof. Savage and Small defined as,
“Managerial economics is concerned with business efficiency, the function of managerial economists
being the efficient direction of business organization to make a productive enterprises out of material
and human resources.” In the words of Hynes, “Managerial economics is the study of allocation of
resources available to a firm among the activities of that unit.” Managerial economics is the integration
of economic theory with business practice for the purpose of facilitating decision-making and forward
planning by management.

Most of the definitions of managerial economics is related to decision making are more acceptable.
Managerial economics is the science of decision making which provides a link between
two disciplines that are economics and business management.

In short, the use of economic theory and methods to analyze and improve the managerial decision-
making process combines the study of theory and practice to gain a useful and practical perspective.
From both economics and decision sciences, managerial economics provides an integrative and
comprehensive framework for solving managerial decision.

Managerial economics links traditional economics with the decision sciences to develop important tools
for managerial decision-making. Although managerial economics is comparatively a new subject in the
early part of 1950s, it was known as business economics in the beginning. The term of managerial
economics gradually has become popular and displaced the business economics.

It is closely related to traditional economics that is based on the theories and principles such as
demand analysis, production analysis, price theories and practice, theory of profit and market
structure which are the subject matter of micro economic theory. But there is little bit differences
between managerial economics and traditional economics theory because managerial economics seeks
the help of other disciplines such as accounting, management, statistics, mathematics to get optimal
solutions to the decision problems.

The difference between managerial economics and traditional economics can be summarized as
follows:

Managerial Economics Traditional Economics

Managerial economics concerns with

Traditional economics deals with
the application of economic principles to the
the body to the principles itself.
problems of the firm.
But traditional economics
Managerial economics is only microeconomics in
consists of both micro and
character. It studies the problems of a firm but it does
macroeconomics. It studies
not concern with the individual unit. It does not also
the individual unit and the
study the macroeconomic phenomenon.
economy as a whole.
Only the theory of profit is studied in managerial
In traditional economics, the
economics. Because it is concerned primarily with
microeconomics is a branch
entrepreneurial decision and value theory.
under which are studied all the
Managerial economics adopts, modifies and theories of factor pricing such as
reformulates economic models to suit the specific rent, wages, interest and profit.
conditions and serves the specific problem solving
Economic theory hypothesizes
process and it also modifies and enlarges it.
economic relationships and
Managerial economics introduces certain feedback builds economic models and it
such as objectives of the firm, multi-product nature of also give the simplified model.
manufacture, behavioral constraints, environmental
Economic theory makes certain
aspects, legal constraints, constraints on resources
assumptions, thus, embodying a
availability etc. It attempts to solve the real life,
combination of certain
complex business problems with the aid of tool
complexities assumed away in
subjects, e.g., mathematics, statistics, econometrics,
economic theory.
accounting, operation research and so on.

The Process of Collective Bargaining as a Mechanism for the

Settlement of Labour Disputes
Process of collective Bargaining involves the following steps:
Step – I Pre-negotiation Phase: This is the stage before starting collective bargaining. At his stage, the
management wants to estimate the power and capacity of labour unions. At this stage, all the relevant
data information and figures are collected so that the stage may be prepared for negotiation. 
Step – II Selection of Negotiators: At this stage, both the management and labour unions select their
representatives who will take part in negotiations from their side. Only such persons are selected as
negotiations that are fully acquainted with the problems on which negotiations are going to be held.

Step – III Strategy of Bargaining: Management should decide the basis strategies and policies that will
be followed at the time of bargaining with employees. Everything must be made clear before goings to
the bargaining table. In addition to this, the management should get due powers to enter
into agreements with workers. Similarly, labour unions should also determine the strategies on
the basis of which they will take part in negotiation.

Step – IV Tactics of Bargaining: The technique of collective bargaining depends upon the principle of
“Give and Take”. Both the parties try to get more than they sacrifice. All the aspects of contracts are
discussed in details. After this, the decisions are revolved and reviewed. The services of government
mediators can also be used if required.

Step – V Contract: Fifth stage of the process of collective bargaining is to enter into a collective
agreement. Such agreements are made for a certain time. These agreements give full details of
security of job, grievance handling procedure, promotion policy, rules regarding lay off, rules regarding
retrenchment, hours of work, rules regarding leaves, incentive schemes, security and health,
managerial liability etc.

Step – VI Implementation of the Contract: The last stage of the process of collective bargaining is the
implementation of the agreements entered into between management and labour unions. Both the
parties should honour these agreements and implement them whole-heartily.

Function and Importance of Effective Leadership

Functions of Effective Leadership 
In every organization, there is a manger to carryout different activities in order to achieve the
predetermined goals. Leadership functions of a manager are closely related with managerial functions.
As a managerial leader, he has to set a group goal, make plans, motivate subordinates and supervise
performance. 

Related Topic:
- Leadership Concept and Nature of Leadership

Besides these functions, the important part of a managerial leader is an influencing power to make the
work done as he totally depends on his subordinates. So, the managerial leadership is based on
influence, not on power and authority. But, he has to perform several other functions. The more
important of these functions are given below: 
1. Develop Team Work 

One of the primary functions of the leader is to develop his work group as a team. It is his
responsibility to create a congenial work environment keeping in view the competence, needs and
potential ability of the subordinates. 

2. Determine the Goal of Organization 

A managerial leader should determine the goal of an organization. For the achievement of
organizational goal, he must inform followers about the plan, policies and goals of an organization, so
that the subordinates can act collectively in the process of achieving the predetermined goal of an
organization. 

3. Act as a Representative of the Work Group 

The leader of work group is expected to act as a link between the workers group and top management.
The leader has to communicate the problems and grievances of his subordinates to the top
management whenever necessary. He should represent subordinates to top management and vice versa
for effective and efficient work at organization to achieve its goal. 

4. Provide Guidance 
When the subordinates face problem in connection with their performance at work, the leader has to
guide and advice the subordinates to solve their problems. The problems may be technical or
emotional in nature. So, a manager must be pioneer to his subordinates. 

5. Time Management 

The function of leaders includes not only ensuring the quality and efficiency of work performed by the
team but also checking that the different stages of works are completed on time. So, the managerial
leader has to manage the time for effective supervision of the work done by the subordinates on time. 

6. Coordination 

A manager cannot do all the activities by himself. Hence, he needs coordination from all the
subordinates. For that, he tries his best to get coordination for the achievement of organization goal. 

7. Good Human Relations 

A managerial leader must make a good relationship among the employees. He must be loyal to the
staffs and able to solve the problems. He must be well informed regarding human problems and act
accordingly. 

8. Proper Use of Power 

While exercising power in relation to his subordinates, the leader must be careful and use his power in
different way according to the environment and situation. It may be necessary to use reward power,
coercive / expert power, formal or informal power depending on what will stimulate positive response
from the subordinates. 

9. Secure Effectiveness of Group Effort 

To get the optimum contribution towards the achievement of objectives, the leader must follow
reward system to improve the efficiency of workers. Beside, a managerial leader should have to
delegate authority, invite participation of employees in decision making, and communicate necessary
information to employees so that it will ensure effectiveness of group effort to achieve the objectives
of the organization. 
10. Use of Managerial Skills 

A managerial leader faces different problems while conducting managerial activities. To solve the
problem, he must have different knowledge like technical, analytical, administrative, human relation
and conflict management etc. A good managerial leader must have managerial skill to make the work
done through the subordinates.

Importance of Leadership
Importance of leadership can be understood by the following functions which a leader generally
performs. 

1. Representative of Subordinates 

Leader is a link between the work group and the top management. As being the representative of
subordinates, he carries the voice of the subordinates to top management. 

2. Guides and Inspires 

An effective leader guides and inspires or motivates his group members to work willingly for achieving
the goals. He makes every effort to direct and channelize all energies of his followers to the goal-
oriented behavior. He creates enthusiasm for higher performance among his followers. 

3. Appropriate Counselor 

Employees often suffer from emotional disequilibrium in organization. Leader can render advice and
can try to remove barriers, real or imaginary and instill confidence in the employees. Leadership
creates a cooperative and wholesome attitude among employees for successful work accomplishment. 

4. Creates Vision and Initiative 

It has been rightly said, where there is no vision, people perish. Leaders give vision to their followers
which, in turn, create initiative and enthusiasm among them. The followers use this vision and
initiative to take up challenging tasks. 

5. Leader Develops Team Spirit 

Leader inculcates a sense of collectivism in the employees and forces them to work as a team.
Individuals within the group may possess varied interests and multiple goals. A leader has to reconcile
their conflicting goals and restore equilibrium. 

6. Creates Work Environment 

Effective leaders can create work environment in which group members can work with pleasure. For
this, a leader creates and maintains interpersonal relations of trust and confidence among the group
members.

7. Leader Manages Time 

Unsatisfactory human performance in organization can be primarily attributed to utilization of time. A

good leader manages his time well by proper planning based on information and facts, and by arriving
at decisions at an appropriate moment. He visualizes problems before his subordinates turn into
emergencies. 
8. Resolves Conflicts 

Leaders play a crucial role in resolving the conflicts arising in the group. He does it by harmonizing the
diverse intense interests of group members and the organization. 

9. Leader Strives for Effectiveness 

A leader throws him to fill the gap between him and his subordinates with a concrete effort to bring
order out of the chaos and confusion and improve organizational effectiveness. He provides an
adequate reward structure to improve the performance of employees. He delegates authority
whenever needed and invites participation from the employees to achieve better results. He tries to
infuse strong will to do into the group, as to secure the best contribution of human energy. He provides
imagination, foresight, enthusiasm and initiative to group members and forces them to have an identity
of interests, outlook and action. 

10. Ensures Survival and Success of Enterprise 

Quality of leadership goes a long way in the success and survival of an enterprise. Without effective
leadership, many well-established enterprises have miserably failed.

Trait Theory of Leadership

Leader and non-leaders are different because of certain traits. The trait approach or theory seeks to
determine 'what makes a successful leader' for the leader's own personal characteristics. From the very
beginning, people have emphasized that a particular individual was successful leader because of his
certain qualities or characteristics. This leadership approach was so popular between 1930s and 1950s.
In other words, different leaders contain different traits at the different level i.e. there are no
universal traits which are applicable to all the leaders. According to this theory, leadership is largely a
function of certain traits or qualities. This states that there are certain unique traits or qualities
essential for a successful leader. Any person who wants to be a successful leader must possess those
traits. 

Related Topic:
Personality Traits and its Characteristics

A successful leader should possess following traits: 

a) Social Qualities 
A successful leader has social skills. He/she understands people and knows their strength and
weakness. A leader should have self-confidence, ability to inspire, initiative, knowledge of human
nature, human relation and human attitude. 

b) Intellectual Qualities 

Higher level of intellectual qualities is required for the quality leadership. Leaders generally have high
level of intelligence. Intelligence means ability to think scientifically, analyze accurately and interpret
clearly and precisely the situation. 

c) Emotional Stability 

A leader should have high level of emotional stability. He should be free from different biases. In other
words, a successful leader is always emotionally stable. He should not be bias and have full control on
his anger and fears (i.e. too soft at heart) as both these extremes are bad. 

d) Moral Qualities 

Leader should be fair at work. He should have strong will power, normal courage, sense of purpose,
objectivity, achievement drive and integrity. 

e) Physical Traits 

Physical traits of a man are determined by heredity factors. In other words, physical traits and rate of
maturation determine the personality formation which is an important factor in determining leadership
success. Physical traits include height, weight, physique, health, appearance, vitality, endurance,
enthusiasm, forcefulness etc. 

f) Some Other Traits 

This theory also emphasizes that these traits need not necessarily be inborn but may be acquired
through education, training and practice. Some other important traits of leadership are:

 Major Traits of a Leadership

Personal drive Generally high level

 Personal integrity Honest in dealing with followers

Cognitive ability Ability to make decisions

Flexibility Capability to adapt in changing environment

Self-confidence Confidence in ownself

Business Knowledge Job-relevant knowledge

Personal warmth Warmth in relationship

Desire to lead Intense desire to lead

Implications of the Theory 

 The theory emphasizes that a leader requires some traits and qualities to be effective.
 Many of these qualities may be developed in individuals through training and development
programs.

Limitation of Trait Theory 

 It fails to take into account influence of other factors on leadership. 
 There are no definite tests for the measurement of these traits. It is not clear how high score a
person must achieve to achieve an effective trait.
 Various studies prove that the trait theory cannot be used in all situations.
 There is no universal list of traits of successful leaders. Different authors have different lists of
traits. 
 This theory does not offer any guidance for developing these qualities.

MANAGERIAL ECONOMICS

Managerial Economics refers to the firm’s decision making process. It could be also interpreted

as “Economics of Management” or “ Industrial economics “ or “Business economics”.

Nature of managerial Economics:

1. Close to microeconomics :

Managerial economics is concerned with finding the solutions for different managerial

problems of a particular firm. Thus, it is more close to microeconomics.

2. 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.

3. Normative statements:

• A normative statement usually includes or implies the words ‘ought’ or ‘should’. They

reflect people’s moral attitudes and are expressions of what a team of people ought to

do

• . Such statement are based on value judgments and express views of what is ‘good’ or

‘bad’, ‘right’ or ‘ wrong’.

• One problem with normative statements is that they cannot to verify by looking at the

facts, because they mostly deal with the future. Disagreements about such statements

are usually settled by voting on them.

4. Prescriptive actions:

• Prescriptive action is goal oriented.

• Given a problem and the objectives of the firm, it suggests the course of action from the

available alternatives for optimal solution.

• It also explains whether the concept can be applied in a given context on not. For

instance, the fact that variable costs are marginal costs can be used to judge the

feasibility of an export order.

5. Applied in nature:

• ‘Models’ are built to reflect the real life complex business situations and these models

are of immense help to managers for decision-making.

• The different areas where models are extensively used include inventory control,

optimization, project management etc.

• In managerial economics, we also employ case study methods to conceptualize the

problem, identify that alternative and determine the best course of action.

6. Offers scope to evaluate each alternative:

• Managerial 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 maximize the

profits for the firm.

7. Interdisciplinary:

• The contents, tools and techniques of managerial economics are drawn from different

subjects such as economics, management, mathematics, statistics, accountancy,

psychology, organizational behavior, sociology and etc.

Scope of Managerial Economics:

Managerial economics refers to its area of study. Managerial economics, Provides management

with a strategic planning tool that can be used to get a clear perspective of the way the business

world works and what can be done to maintain profitability in an ever-changing environment.

. Managerial economics is primarily concerned with the application of economic principles and

theories to five types of resource decisions made by all types of business organizations.

a. The selection of product or service to be produced.

b. The choice of production methods and resource combinations.

c. The determination of the best price and quantity combination

d. Promotional strategy and activities.

e. The selection of the location from which to produce and sell goods or service to

consumer

The scope of managerial economics covers two areas of decision making

• Operational or Internal issues

• Environmental or External issues

A. OPERATIONAL ISSUES:

Operational issues refer to those, which are within the business organization and they are

under the control of the management. Those are:

1. Theory of demand and Demand Forecasting

2. Pricing and Competitive strategy

3. Production cost analysis

4. Resource allocation

5. Profit analysis
6. Capital or Investment analysis

7. Strategic planning

1. Demand Analyses and Forecasting:

➢ Demand analysis also highlights for factors, which influence the demand for a product.

This helps to manipulate demand. Thus demand analysis studies not only the price

elasticity but also income elasticity, cross elasticity as well as the influence of advertising

expenditure with the advent of computers.

➢ Demand forecasting has become an increasingly important function of managerial

economics. A firm can survive only if it is able to the demand for its product at the right

time, within the right quantity. Understanding the basic concepts of demand is essential

for demand forecasting

2. Pricing and competitive strategy:

➢ Pricing decisions have been always within the preview of managerial economics. Price

theory helps to explain how prices are determined under different types of market

conditions.

➢ Competitions analysis includes the anticipation of the response of competitions the

firm’s pricing, advertising and marketing strategies. Product line pricing and price

forecasting occupy an important place here.

3. Production and cost analysis:

➢ Production analysis is in physical terms.

➢ While the cost analysis is in monetary terms cost concepts and classifications, cost-output

relationships, economies and diseconomies of scale and production functions are

some of the points constituting cost and production analysis.

4. Resource Allocation:

➢ Managerial Economics is the traditional economic theory that is concerned with the

problem of optimum allocation of scarce resources.

➢ Marginal analysis is applied to the problem of determining the level of output, which

maximizes profit.
➢ In this respect linear programming techniques has been used to solve optimization

problems. In fact lines programming is one of the most practical and powerful

managerial decision making tools currently available.

5. Profit analysis:

➢ Profit making is the major goal of firms. There are several constraints here an account of

competition from other products, changing input prices and changing business

environment hence in spite of careful planning, there is always certain risk involved.

➢ Managerial economics deals with techniques of averting of minimizing risks. Profit theory

guides in the measurement and management of profit, in calculating the pure return on

capital, besides future profit planning.

6. Capital or investment analyses:

➢ Capital is the foundation of business. Lack of capital may result in small size of

operations. Availability of capital from various sources like equity capital, institutional

finance etc. may help to undertake large-scale operations.

➢ Hence efficient allocation and management of capital is one of the most important tasks

of the managers.

➢ The major issues related to capital analysis are:

1.The choice of investment project

2.Evaluation of the efficiency of capital

3.Most efficient allocation of capital.

Knowledge of capital theory can help very much in taking investment decisions. This involves,

capital budgeting, feasibility studies, analysis of cost of capital etc.

7. Strategic planning:

➢ Strategic planning provides a long-term goals and objectives and selects the strategies

to achieve the same. . The perspective of strategic planning is global.

➢ strategic planning has given rise to be new area of study called corporate economics.

B. Environmental or External Issues:

. They refer to general economic, social and political atmosphere within which the firm operates.
A study of economic environment should include:

The type of economic system in the country.

a. The general trends in production, employment, income, prices, saving and investment.

b. Trends in the working of financial institutions like banks, financial corporations, insurance

companies

c. Magnitude and trends in foreign trade;

d. Trends in labour and capital markets;

e. Government’s economic policies viz. industrial policy monetary policy, fiscal policy, price

policy etc.

➢ The social environment refers to social structure as well as social organization like trade

unions, consumer’s co-operative etc.

➢ The Political environment refers to the nature of state activity, chiefly states’ attitude

towards private business, political stability etc.

➢ The environmental issues highlight the social objective of a firm i.e.; the firm owes a

responsibility to the society. Private gains of the firm alone cannot be the goal.

Demand forecasting:-
 refers to the predictionor estimation of a future situation under given constraints.
 Stuff Forecasting is the process of estimation in unknown situations and
Prediction.
 Demand forecasting is the activity of estimating the quantity of a product
orservice that consumers will purchase.
 Forecasting customer demand for products and services is a proactive process
of determining what products are needed where, when, and in what quantities.
Consequently, demand forecasting is a customer–focused activity.
 Demand forecasting is also the foundation of a company’s entire logistics
process. It supports other planning activities such as capacity planning, inventory
planning, and even overall business planning.

  
Types of forecasting:-
there are following types of forecasting which are below:-

1.short term forecasting:

 Short-term( 1 day to 3 months), managers are interested in forecasts for
disaggregated demand( for specific product, for specific geography, etc)
 Little time to react to errors in demand forecast, so the forecasts need to be as
accurate as possible.
 Time series analysis is often used.
 In absence of historical data managers use judgment methods.
eg., clothes. Strategic decisions. Extending or reducing the limits of resources.

2. medium term forecasting:

 Time horizon for medium-term( 3 months to 24 months).
 Relates to aggregate planning(sales & operations planning).
 Medium term forecast is used to build up seasonal inventory.
 Both time-series and causal methods are used.

3. long term forecasting:

 Time horizon exceeding two years.
 Long term forecasts are used for process selection, capacity planning & location
decisions.
 Judgment models & causal models are used.
eg., petroleum, paper, shipping. Tactical decisions. Within the limits of resources
already available.

Forecasting could be done in the following ways:-

1) Active and Passive.

2) Total Market and Market Segmentation.
3) Company Forecast and Industry Forecast.
4) Short Term and Long Term Forecasting.

Purpose of Demand Forecasting:-

1.Better planning and allocation of resources.

2. Appropriate production scheduling.
3. Inventory control.
4. Determining appropriate pricing policies.
5. Setting s les targets and establishing controls and Incentives.
6. Planning a new unit or expanding existing one.
7. Planning long term financial requirements.
8. Planning Human Resource Development strategies.

Objective of demand forecasting:-

1. Helping for continuous production

2. Regular supply of commodities
3. Formulation of price policy
4. Arrangement of finance
5. Labor requirement.

IMPORTANCE OF DEMAND FORECASTING:-

 Planning and scheduling production
 Budgeting of costs and sales revenue
 Controlling inventories
 Making policies for long term investment
 Helps in achieving targets of the firm

Methods of demand forecasting:

A. Qualitative Methods (Survey Methods):
1. Survey method:
Survey methods constitute another important forecasting tool, especially for short-term
projections.
The consumers are directly approached and are asked to give their opinions about the
particular product. The questionnaire must be carefully prepared bearing in mind the
qualities of a good questionnaire. It must be simple and interesting so as to evoke
consumers’ response.
Consumers’ Survey may acquire three forms:
a) Complete Enumeration Survey
b) Sample Survey
c) End-Use Method.
a) Complete Enumeration Survey:
Complete Enumeration Survey covers all the consumers. It resembles the Census Data
Collection which considers the entire population. In this case all the consumers are
covered and information is obtained from all regarding the prospective demand for the
product under consideration.in this methode consumer opinions are concerned.
We can obtain complete information by contacting every possible present, past or would
be consumers of the product. No doubt it is not very easy to carry out the survey on
such a large scale. Even the collected information will be difficult and too tedious to be
analyzed. The reliability on such consumers’ information may be questionable, if the
opinions are not authentic.
b) Sample Survey:
In case of the sample survey method, few consumers are selected to represent the
entire population of the consumers of the commodity consumed. The total demand for
the product in the market is then projected on the basis of the opinion collected from the
sample. The most important advantage of this method is that it is less expensive and
less tedious compared to the method of complete enumeration. The sample chosen
should not be too small or too large. This method if applied carefully will yield reliable
results especially in case of new brands and new products.
c) End –Use Method:
A given product may have different end uses. For example: milk may have different end
uses such as milk powder, chocolates, sweet -meats like ‘barfi’ etc. Therefore the end
users of milk are identified. A survey is planned of the end users and the estimated
demands from all segments of end users are added. This method of demand
forecasting is easy to manage if the number of end-users is limited. In this method the
investigator expects the end- users to provide correct information well in advance of
their respective production schedules.

 Delphi Method:
This is a variant of the opinion poll or survey method.
Here we invite different experts and take their opinion and they finally try to find an
average of their ideas. We again intimate the experts about the average opinion, and
give them an opportunity to revise their forecast. Delphi is useful when you want to have
an overall subjective assessment about complex business environment. All the experts
are distant and they dont know each other, therefore each one tries to give the best
possible estimate.

 Nominal Group Technique:

It is similar to Delphi, but here we ask experts to sit together and explain their
perspective to others so that others can also give their opinion. People frame their
estimates individually, but thereafter they give justification for their opinion.
 opinion poll method :
Here we collect information about the issue from people using opinion poll. We may
take interview, we may collect data using questionnaire, or we may organise meeting /
conference to find opinion of people. Variants of opinion poll are : focus group
discussion – which is used in marketing to know about consumer opinions.
 Expert opinion method
 PANEL OF EXPERTS IN SAME FIELD WITH EXPERIENCE & WORKING
KNOWLEDGE.
 COMBINES INPUT FROM KEY INFORMATION SOURCES.
 EXCHANGE OF IDEAS AND CLAIMS.
 FINAL DECISION IS BASED ON MAJORITY OR CONSENSUS, REACHED
FROM EXPERT’S FORECASTS
B. Quantitative Methods (Statistical Methods):-

1. Time Series Analysis (Trend Projection):

Time Series Analysis is used to estimate future demand. The Time Series Method is
based on obtaining the historical data regarding the demand for the product.
The Time Series forecasting models are based on historical observations of the values
of the variable that is being forecast.
 The time series relating to sales represent the past pattern of effective demand
for a particular product. Such data can be presented either in a tabular form or
graphically for further analysis. The most popular method of analysis of the time series
is to project the trend of the time series.a trend line can be fitted through a series either
visually or by means of statistical techniques. The analyst chooses a plausible algebraic
relation (linear, quadratic, logarithmic, etc.) between sales and the independent
variable, time. The trend line is then projected into the future by extrapolation.
 Its Popular because: simple, inexpensive, time series data often exhibit a
persistent growth trend.
 Its Disadvantage: this technique yields acceptable results so long as the time
series shows a persistent tendency to move in the same direction. Whenever a turning
point occurs, however, the trend projection breaks down.

2. Moving Averages:
 Moving averages method can be used when the forecast period is either odd or
even.
 ]The method of Moving Average is useful when the market demand is assumed
to remain fairly steady over time. The Moving Average for ‘n’ months is found by simply
summing up the demand during the past ‘n’ months and then dividing this total by ‘n’.
Moving Average = Demand in the previous ‘n’ months/ n.
 moving average method. Here we take moving average of either 3 days or 5 days or 7 days and
try to forecast using this moving average. We may also use smoothing to remove exceptional
fluctuations Moving average is a case where data can be used to forecast on the basis of past
trend
 Example of moving average : Period data 3 year moving average 2001 300 2002 400 400 2003
500 434 2004 400 500 2005 600 600 2006 800 700 2007 700

3. Exponential Smoothing:
Here we use the past data to smooth the data. Here we use the past data to predict the
future.
In this technique more recent data are given more weight age. This is based on the
argument that the more recent the observations, the more its impacton future and
therefore is given relatively more weight than the earlier observations.
4. Index Numbers:
The Index Numbers offer a device to measure changes in a group of related variables
over a period of time. In case of index numbers we select a Base Year which is given
the value of 100 and then express all subsequent changes as a movement of this
number. The most commonly used is the Laspeyres’ Price Index.

5. Regression Analysis:
This Statistical method is undertaken to measure the relationship between two variables
where correlation appears to exist. For example: we can establish a relationship
between the age of the air condition machine and the annual repairs expenses.
However this is purely based on the availability of statistical data irrespective of the
actual causes of damage for which the repair expenses have to be incurred.

6. Econometric Models:
 The Econometric Models used in forecasting takes the form of an equation or system of
equation which seems best to express the most probable interrelationship between a set of
economic.
 The Econometric Models can be quantitatively and qualitatively formulated.
 One of the first steps in the construction of an Econometric Model is to determine all or
most of the factors influencing the series to be forecast. Then the influence of these factors is
reflected in the form of an equation. These models are generally used by econometricians. One
of the major limitations of Econometric Model approach is the assumption that the relationships
established in the past will continue to prevail in the future. The Econometric Models have failed
in many cases but this does not imply that we should abandon them. Being analytical in nature
and process oriented in approach they throw more light on problems of a theoretical and
statistical nature provided the statistical data are reliable.

7. Input-Output Analysis:
 The Input-Output Analysis provides perhaps the most complete examination of all the
complex inter-relationships within an economic system.
 The Input-Output forecasting is based on a set of tables that explain the inter-relationship
among the various components of the economy.
 The Input-Output Analysis shows how an increase or decrease in the demand for cars will
lead to increase in production of steel, glass, tyres etc. The increase in demand for these
materials will have second line effect. The Input-Output Analysis helps us to understand the
inter-industry relationships to provide information about the total impact on all industries as a
result of the original increase in demand forecast.
There is no unique method for forecasting the demand for any product

Casual method:
 Causal forecasting model show the cause for demand and its relation to other
variables. Usually, regression is used for modeling the cause-and-effect behavior.
Examples: Soft drink can be related to the average summer temperature.
Rainfall can give us an estimate of crop and in turn an estimate of the estimate of the
demand for consumer durables in the rural areas.