LECTURE NOTES 1

MANAGERIAL ECONOMICS (EC 403)

INTRODUCTION
Managerial Economics
Definitions
1. a study of those economic theories, logic and methodology which are generally applied to seek solutions to the practical problems
of business. Managerial economics is thus constituted of that part of economic knowledge or economic theories which is used as a
tool of analysing business problems for rational business decision.
2. “Managerial economics is concerned with application of economic concepts and economic analysis to the problems of formulating
rational managerial decision.” Mansfield, E (ed.) Managerial Economics and Operations Research (1966).
3. Is concerned with the application of economic principles and methodologies to the decision making process within the firm or
organization. It seeks to establish rules and principles to facilitate the attainment of the desired economic goals of management.
These economic goals of management relate to costs, revenues and profits and are important within both the business and the
noon business institution (Evan, J Douglas)
4. Is concerned with finding optimal solutions to decision making.
Managerial economics is often called Business Economics or Economics for firms.
The scope of managerial economics
It includes a part of microeconomic theory including the theory of demand, theory of production, theory of price determination, theory of
profit and capital budgeting, and a part of macroeconomic theory including theory of national income, theories of economic growth and
fluctuations, international trade and the study of state policies and their repercussions on the private business activities constitute by
and large, the scope of managerial economics. The other most important disciplines on which economic analysis draws heavily are
mathematics and statistics, management theory and accounting.
There are three main contributions of economic theory to business economics:
(1) Economic theories can contribute to the management science through building analytical models that help in recognizing the
structure of the managerial problem, eliminating the minor details that might obstruct decision making, and in concentrating on the
main issue.
(2) Economic theory contributes to the business analysis “a set of analytical methods” which may not be directly applied to specific
business problems but they do enhance the analytical capabilities of the business analyst.
(3) Economic theories offer clarity to the various concepts used in business analysis that enables the managers to avoid conceptual
pitfalls.
Models
A model is any representation of reality or a simplified representation of reality. It may be in graphical, physical or mathematical terms.
Or
Deliberately simplified pictures of the real world; any representation (physical or abstract) of a real thing, event or circumstances.
Types of models
1. Scale- these are miniaturised versions of the real thing, e.g. airplane, buildings, ships, automobiles, where the model is visually
similar to the piece of reality it represents.
2. Symbolic- these are models that represent reality in numeric, algebraic or graphic form. The models use words and other symbols
to represent reality and include descriptive speech (usually simplifies or abstracts from reality e.g. the statement “A horse is a 4
legged animal with a long brushy tail”. The statement gives a general idea of what a horse is without mentioning the complexities
involved in the physical or psychological makeup of a horse or the differences between a thoroughbred and a Percheron) or writing
, diagrams and mathematical expressions. Diagrams represent reality by means of lines, shading and other features, and they
abstract from finer details.
3. Mathematical- model tries to show the workings of the real world by means of mathematical symbols, equations and formula e.g.
y  a  bx . Mathematical and symbolic models are the more usual models that have wider applicability.
4. Simulation - simulation is the process of experimenting or using a model and noting the results that occur. The simulation models
represent the behaviour of a real system, e.g. flight simulator used in the training of pilots. The models are used where there is no
suitable mathematical model, where the mathematical model is too complex, or where it is not possible to experiment upon a
working system without causing serious disruption as in the case of training of pilots.
5. Heuristic- these are models that use a set of intuitive rules which managers hope will produce at least a workable solution, and a
better solution than methods currently being used. For example a delivery van driver may be instructed to plan the day’s deliveries
using the following rule “After each call deliver to the nearest customer whom you have not yet visited.” The driver has no way of
knowing whether the route gives optimum time and disturbances, and any improvements can come only through testing other
heuristic approaches.
6. Iconic-these are visual models of the real object(s) they represent. They may be larger or smaller than reality. E.g. a model steam
engine is much smaller than the real thing whilst the coloured plastic models of molecular structures are much larger. Both of these
are iconic models and so are pictures, maps and diagrams although these latter are in different form to the reality they represent.
7. Analogue- these use one set of physical movements or properties to represent another set. In other words, although taking a form
physically different from that which they represent, have other features in common and thus inferences can be drawn by reference
too the model rather than the real situation. Examples are road maps depicting highways and features of an actual geographic
area; animals used for medical testing instead of humans; wind tunnels that act as an artificial climatic environment.
Models may be further classified into normative and descriptive. Normative models are concerned with finding the best, optimum or
ideal solution to the problem. Many mathematical models fall into this classification. Descriptive models describe the behaviour of a
system without attempting to find the best solution to any problem e.g. the simulation model.
The test of a good model is its ability to generate testable predictions and the success of those predictions. However complex looking a
model is and however many variations it contains it still involves considerable simplification of reality and any results or predictions
obtained from the model must therefore be used with caution and judgement.

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Why models are used
(a) Useful for teaching individuals about the operation of complex systems (pedagogical function). This allows us to deal with the
central issues of the problem without the need the added complexity of relatively minor influences e.g. student learning about
the interrelationships of an economic system in a basic macroeconomics course. By using a simple model of 4 or 5 equations.
(b) As an explanatory device since they are a vehicle for relating separate objects and events in a logical fashion. Models may aid
the researcher in discovering relationships that exist between and among variables e.g. high correlation is found the
researcher seeks to know why and test this relationship with future observations . Models are used when the actual testing in
real environment is impossible or too expensive or too dangerous.
(c) Predictive purposes- past relationships between objects and events can be expected to hold true for future events. Thus if we
have found that two events are causally related, such as low winter temperatures and high electricity consumption we may
predict increased consumption in the next cold season.
Economic models and procedure for testing them.
Economic models are widely used in Economics including managerial economics. Managerial economics uses symbolic models,
mathematical models and graphs. The process of building and testing an economic model is as follows:
1. Establish a set of definitions and a set of assumptions about the entity to be modeled.
2. Theoretical analysis or logical deduction whereby the logical implications of the assumptions are followed through and
identified.
3. Predictions are tested against data on the actual behaviour of the entity being modeled.
4. If predictions are not supported by data, the model is amended or discarded.
5. If predictions are borne by data, the model is valid, at least for the time being.

Models deliberately leave out a host of assumed minor influences to permit economists to focus on what they think is important.
Role of Business in society
1. Suppliers of capital, labour and other resources have all received substantial returns for their contributions.
2. Consumers have benefited from both quantity and quality of goods and services available for consumption.
3. Taxes on the business profits of firms as well as on payments made to suppliers of labour, materials, capital and other inputs
have provided the revenues for govt to increase its service to society.
4. Business firms are expected to operate in a manner that would maximize some index of social well-being. However,
government, to avoid excessive exploitation of consumers where there are monopolies e.g. utilities there is direct regulation
(must earn a fair return for shareholders)- antitrust legislation to avoid collusion by producers – labour laws to avoid unfair
labour practices. – where there are negative externalities e.g. pollution, firms must internalize social costs (through pollution
control).
Role of the State in the Economy
Govt intervention in the market economy is in part to respond to problems created by both positive and negative externalities in
production, marketing and consumption.
Fiscal Intervention- Govt makes frequent use of both grant and tax policies. A tax policy is a system of penalties designed to limit
undesirable performance e.g. fines for truckers exceeding a certain weight limits. Govt responds to positive externalities by providing
subsidies to private business firms. These can take the form of direct payments, special tax treatments, govt provided low cost
financing. Special tax treatments include investment tax credits, depletion allowances, local govt tax allowances for locating in certain
areas. If society wishes to limit the harmful consequences of pollution, for example, either subsidies for pollution reduction or taxes on
pollution levels can provide effective incentives. A system of pollution tax penalties is assertion of society’s right to a clean environment.
Granting of patents and operating subsidies for example are two frequently used methods by which govt recognizes positive
externalities and provides compensation to reward activities that provide such externalities.

Regulation – Rationale for regulation (i) efficiency B>C (ii) Equity or fairness- to deliberately benefit the poor. Market may have failed
e.g. goods may be efficiently produced by a natural monopoly. (iii) Firms may have market power to limit output and raise prices. (iv)
limit concentration of economic and political power.
The regulation of operating rights is one method of providing firms with an incentive to promote service “in the public interest” e.g.
control of TV and radio broadcasting rights, state regulatory bodies that govern state chartering of banks (they must meet needs of
service areas). Patent rights are a govt grant of exclusive right to produce, use or sell an invention or innovation for a limited period of
time. Idea of patent right is to achieve benefits of R and D.

Operating Controls or standards - designed to limit undesirable behaviour by compelling certain actions while prohibiting others e.g.
controls over environmental pollution (automobile emissions) safety standards, firms handling food products, drugs and other
substances that could harm consumers, industrial work conditions. Possibilities of evasion of controls are considerable-checking on
prices of thousands of household/ food items is a mammoth task and besides ‘new products’ are developed. There is also deliberate
deterioration of quality. Price controls may not be operated against exports (manufacturers may charge high export prices- they may
reduce supplies to the home market in favour of exports). Antitrust laws- these are laws designed to promote competition and prevent
monopoly.
BUSINESS OBJECTIVES
(1) Profit maximization. This is the traditional view. Role of profits (i) Resource Allocation- abnormal profits serve as a valuable
signal that firm or industry output should be increased. Below normal profits provide signal for contraction and exit. (ii)Reward
for innovation- abnormal profits constitute an important reward for innovation and efficiency. (below normal profits constitute a
penalty for stagnation and inefficiency.} Profits thus provide an incentive for innovation and productive efficiency and in
resource allocation. , The traditional view (of profit maximization) has come under attack because of the following reasons:
(a) Divorce of ownership from control- firms are owned and by shareholders and controlled and operated by professional
managers. Firms do not always operate in the interests of their owners. According to the behavioral model, people
have objectives but organizations cannot. According to the Managerialist model managers and shareholders have
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 different and conflicting objectives. It has never been empirically proved that shareholders are more concerned with
profitability than anything else. Profitability is not the sole criterion by which shareholders appraise the performance of
a company. Profit is not synonymous with cash.
(b) Difficulties of pursuing profit maximization- the uncertainties which the firm faces often dictate that short run profit
maximizing behaviour be subordinated to the more important objective of long run survival of the company. Concern
is more often with market share and diversification. This is more often more important than short run profit
maximizing. Goodwill is often a long run objective. The theory is often ambiguous whether it is short run or long run
profit being maximized.
(c) Problems concerning the measurement of profit. Traditionally profitability has been regarded as the main measure of
business efficiency but it is not necessarily a good measure of the efficiency since profits may be the result of
imperfections in the market which have resulted in monopolistic exploitation. Profits may be overstated by
accountants. Profits are recorded at a particular time yet the business is going on. Systems of valuation of assets
vary from firm to firm (FIFO and LIFO
(d) Firms do not have the necessary knowledge and apriori data to equalize MR and MC. It is argued businessmen
themselves are not aware of this objective. Other objectives are sales maximization, a target rate of return, a target
market share, preventing price competition etc.
(e) Reasonable profit target-The profit maximization in a technical sense (making MC=MR) is beset with serious
computational and data problems. Most goods and services are produced in large quantities- bulks and batches. Only
few goods like ships, planes, turbines are countable in units. Why would a fir m seek reasonable profits? – Preventing
entry of competitors- preventing entry of competitors- restraining trade union demands- maintaining customer
goodwill- projecting a favourble public image.
Other objectives of business firms
(2) Sales Revenue Maximization (Baumol ,1959)
(3) Maximization of firm’s growth rate (Morris ,1963)
(4) Maximization of managerial utility (Williamson,1963) managers seek to maximize their own utility function subject a minimum
level of profit (prestige, power status, job security, professional excellence, discretionary profits for pet projects)
(5) Satisfying behaviour (Satisficing behaviour) – managers work under constraints and instead have to achieve satisfactory
profits.
(6) Long run survival and market share goals.
(7) Entry prevention (and risk avoidance) – especially in the case of limit pricing.
Managerial economics
Managerial economics deals with the application of the economic concepts,theories,tools and methodologies to solve practical
problems in a business. It helps the manager in decision making and acts as a link between practice and theory".[1] It is sometimes
referred to as business economics and is a branch of economics that applies microeconomic analysis to decision methods of
businesses or other management units.
As such, it bridges economic theory and economics in practice.[2] It draws heavily from quantitative techniques such as regression
analysis, correlation and calculus.[3] If there is a unifying theme that runs through most of managerial economics, it is the attempt
to optimize business decisions given the firm's objectives and given constraints imposed by scarcity, for example through the use
of operations research, mathematical programming, game theory for strategic decisions,[4] and other computational methods[5]
Scope[edit]
Managerial economics to a certain degree is prescriptive in nature as it suggests course of action to a managerial problem. Problems
can be related to various departments in a firm like production, accounts, sales, etc.
(a) Operational issues
Demand decision
Production decision
Theory of exchange or price theory
All human economic activity
(b) Environmental issues
Nature and trend of domestic business/ international environment
nature and impact of social costs and government policy

Managerial economics applies economic theory and methods to business and administrative decision making. Managerial economics
prescribes rules for improving managerial decisions. Managerial economics also helps managers recognize how economic forces affect
organizations and describes the economic consequences of managerial behavior. It links traditional economics with the decision
sciences to develop vital tools for managerial decision making. This process is illustrated in Figure 1.1. Managerial economics identifies
ways to efficiently achieve goals. For example, suppose a small business seeks rapid growth to reach a size that permits efficient use
of national media advertising. Managerial economics can be used to identify pricing and production strategies to help meet this short-
run objective quickly and effectively.
Key Points in These Definitions
If you analyze these definitions you may reach the following key points:
1.    It is application/integration of principles and methodologies of economics
2.    on business issues
3.    to make choices
4.    for the attainment of desired economic goals, and
5.    future policies/planning
6.    under the current condition of uncertainty.
Scope of Managerial Economics:
 
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The scope of managerial economics includes following subjects:
(i) Theory of Demand
(ii) Theory of Production
(iii) Theory of Exchange or Price Theory
(iv) Theory of Profit
(v) Theory of Capital and Investment
 
Importance of Managerial Economics:
 Business and industrial enterprises aim at earning maximum proceeds. In order to achieve this objective, a managerial executive has
to take recourse in decision making, which is the process of selecting a specified course of action from a number of alternatives. A
sound decision requires fair knowledge of the aspects of economic theory and the tools of economic analysis, which are directly
involved in the process of decision-making. Since managerial economics is concerned with such aspects and tools of analysis, it is
pertinent to the decision making process.
 Spencer and Siegelman have described the importance of managerial economics in a business and industrial enterprise as follows:
 (i) Accommodating traditional theoretical concepts to the actual business behavior and conditions:Managerial economics
amalgamates tools, techniques, models and theories of traditional economics with actual business practices and with the environment
in which a firm has to operate. According to Edwin Mansfield, “Managerial Economics attempts to bridge the gap between purely
analytical problems that intrigue many economic theories and the problems of policies that management must face”. 
(ii) Estimating economic relationships: Managerial economics estimates economic relationships between different business factors
such as income, elasticity of demand, cost volume, profit analysis etc. 
(iii) Predicting relevant economic quantities: Managerial economics assists the management in predicting various economic
quantities such as cost, profit, demand,
capital, production, price etc. As a business manager has to function in an environment of uncertainty, it is imperative to anticipate the
future working environment in terms of the said quantities. 
(iv) Understanding significant external forces: The management has to identify all the important factors that influence a firm. These
factors can broadly be divided into two categories. Managerial economics plays an important role by assisting management in
understanding these factors.
 
(a) External factors: A firm cannot exercise any control over these factors. The plans, policies and programs of the firm should be
formulated in the light of these factors. Significant external factors impinging on the decision making process of a firm are economic
system of the country, business cycles, fluctuations in national income and national production, industrial policy of the government,
trade and fiscal policy of the government, taxation policy, licensing policy, trends in foreign trade of the country, general industrial
relation in the country and so on. 
(b) Internal factors: These factors fall under the control of a firm. These factors are associated with business operation. Knowledge of
these factors aids the management in making sound business decisions. 
(v) Basis of business policies: Managerial economics is the founding principle of business policies. Business policies are prepared
based on studies and findings of managerial economics, which cautions the management against potential upheavals in national as
well as international economy. Thus, managerial economics is helpful to the management in its decision-making process.
Characteristics of Managerial Economics: 
(i) It studies the problems and principles of an individual business firm or an individual industry. It aids the management in forecasting
and evaluating the trends of the market. 
(ii) It is concerned with varied corrective measures that a management undertakes under various circumstances. It deals with goal
determination, goal development and achievement of these goals. Future planning, policy making, decision making and optimal
utilization of available resources, come under the banner of managerial economics. 
(iii)  Managerial economics is pragmatic. In pure microeconomic theory, analysis is performed, based on certain exceptions, which are
far from reality. However, in managerial economics, managerial issues are resolved daily and difficult issues of economic theory are
kept at bay. 
(iv) Managerial economics employs economic concepts and principles, which are known as the theory of Firm or 'Economics of the
Firm'. Thus, its scope is narrower than that of pure economic theory. 
(v) Managerial economics incorporates certain aspects of macroeconomic theory. These are essential to comprehending the
circumstances and environments that envelop the working conditions of an individual firm or an industry. Knowledge of macroeconomic
issues such as business cycles, taxation policies, industrial policy of the government, price and distribution policies, wage policies and
antimonopoly policies and so on, is integral to the successful functioning of a business enterprise.
(vi) Managerial economics aims at supporting the management in taking corrective decisions and charting plans and policies for future.
(vii) Science is a system of rules and principles engendered for attaining given ends. Scientific methods have been credited as the
optimal path to achieving one's goals. Managerial economics has been is also called a scientific art because it helps the management
in the best and efficient utilization of scarce economic resources. It considers production costs, demand, price, profit, risk etc. It assists
the management in singling out the most feasible alternative. Managerial economics facilitates good and result oriented decisions
under conditions of uncertainty.
(viii) Managerial economics is a normative and applied discipline. It suggests the application of economic principles with regard to policy
formulation, decision-making and future planning. It not only describes the goals of an organization but also prescribes the means of
achieving these goals.
Managerial Economics

Managerial Economics can be defined as amalgamation of economic theory with business practices so as to ease decision-making and
future planning by management. Managerial Economics assists the managers of a firm in a rational solution of obstacles faced in the
firm’s activities. It makes use of economic theory and concepts. It helps in formulating logical managerial decisions. The key of
Managerial Economics is the micro-economic theory of the firm. It lessens the gap between economics in theory and economics in
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practice. Managerial Economics is a science dealing with effective use of scarce resources. It guides the managers in taking decisions
relating to the firm’s customers, competitors, suppliers as well as relating to the internal functioning of a firm. It makes use of statistical
and analytical tools to assess economic theories in solving practical business problems.
Study of Managerial Economics helps in enhancement of analytical skills, assists in rational configuration as well as solution of
problems. While microeconomics is the study of decisions made regarding the allocation of resources and prices of goods and services,
macroeconomics is the field of economics that studies the behavior of the economy as a whole (i.e. entire industries and economies).
Managerial Economics applies micro-economic tools to make business decisions. It deals with a firm.
The use of Managerial Economics is not limited to profit-making firms and organizations. But it can also be used to help in decision-
making process of non-profit organizations (hospitals, educational institutions, etc). It enables optimum utilization of scarce resources in
such organizations as well as helps in achieving the goals in most efficient manner. Managerial Economics is of great help in price
analysis, production analysis, capital budgeting, risk analysis and determination of demand.
Managerial economics uses both Economic theory as well as Econometrics for rational managerial decision making. Econometrics is
defined as use of statistical tools for assessing economic theories by empirically measuring relationship between economic variables. It
uses factual data for solution of economic problems. Managerial Economics is associated with the economic theory which constitutes
“Theory of Firm”. Theory of firm states that the primary aim of the firm is to maximize wealth. Decision making in managerial economics
generally involves establishment of firm’s objectives, identification of problems involved in achievement of those objectives,
development of various alternative solutions, selection of best alternative and finally implementation of the decision.
The following figure tells the primary ways in which Managerial Economics correlates to managerial decision-making.
Nature and Scope of Managerial Economics
The most important function in managerial economics is decision-making. It involves the complete course of selecting the most suitable
action from two or more alternatives. The primary function is to make the most profitable use of resources which are limited such as
labor, capital, land etc. A manager is very careful while taking decisions as the future is uncertain; he ensures that the best possible
plans are made in the most effective manner to achieve the desired objective which is profit maximization.
Economic theory and economic analysis are used to solve the problems of managerial economics.
Economics basically comprises of two main divisions namely Micro economics and Macro economics.
Managerial economics covers both macroeconomics as well as microeconomics, as both are equally important for decision making and
business analysis.
Macroeconomics deals with the study of entire economy. It considers all the factors such as government policies, business cycles,
national income, etc.
Microeconomics includes the analysis of small individual units of economy such as individual firms, individual industry, or a single
individual consumer.
All the economic theories, tools, and concepts are covered under the scope of managerial economics to analyze the business
environment. The scope of managerial economics is a continual process, as it is a developing science. Demand analysis and
forecasting, profit management, and capital management are also considered under the scope of managerial economics.
Characteristics of Managerial Economics
 
Microeconomics
Managerial economics in character as it is concerned with smaller units of the economy. It studies the problems and principles of an
individual business firm or an individual industry. It assists the management in forecasting and evaluating the trends of market.
Normative economics
Managerial economics belongs to normative economics. It is concerned with what management should do under particular
circumstances. It determines the goals of the enterprise and then develops the ways to achieve these goals. It deals with future
planning, policy making, decision making and making full utilization if available resources of enterprise.
Pragmatic
Managerial economics is pragmatic. It tries to solve the managerial problems in their day to day functioning and avoids difficult issues of
economic theory.
Uses theory of firm
Managerial Economics uses economic concepts and principles which are known as the theory of firm or economics of the firm. Thus, its
scope is narrower than that of Pure Economic theory.
Takes the Help of Macro Economics
Managerial Economics takes the help of Macro-economics also because it needs an understanding of the circumstances and
environment in which an individual firm or an industry has to work. Issues of Macro-economics whose knowledge is necessary for the
successful management of a firm or an industry are : Business cycles, Taxation policies, Industrial Policy of the government, Price and
distribution policies, Wage policies and anti- monopoly policies etc.
Aims at helping the management
Managerial economics aims at helping the management in taking correct decisions and preparing plans and policies for future.
Prescriptive rather than descriptive
Managerial economics is a normative and applied discipline. It suggests the application of economic principles with regard to policy
formulation, decision making and future planning. It not only describes the goals of an organization but also prescribes the means of
achieving these goals.
A scientific art
Managerial economics is called as scientific art because it helps the management in the best and efficient utilization of scares economic
resources. It assists the management in finding out the most feasible alternative. Managerial economics facilitates good and result
orientated decisions under conditions of uncertainty.
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.

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There are certain chief characteristics of managerial economics, which can help to understand the nature of the subject matter and help
in a clear understanding of the following terms:
Managerial economics is micro-economic in character. This is because the unit of study is a firm and its problems. Managerial
economics does not deal with the entire economy as a unit of study.
Managerial economics largely uses that body of economic concepts and principles, which is known as Theory of the Firm or Economics
of the Firm. In addition, it also seeks to apply profit theory, which forms part of distribution theories in economics.
Managerial economics is concrete and realistic. I avoids difficult abstract issues of economic theory. But it also involves complications
ignored in economic theory in order to face the overall situation in which decisions are made. Economic theory ignores the variety of
backgrounds and training found in individual firms. Conversely, managerial economics is concerned more with the particular
environment that influences decision-making.
Managerial economics belongs to normative economics rather than positive economics. Normative economy is the branch of
economics in which judgments about the desirability of various policies are made. Positive economics describes how the economy
behaves and predicts how it might change. In other words, managerial economics is prescriptive rather than descriptive. It remains
confined to descriptive hypothesis.
Managerial economics also simplifies the relations among different variables without judging what is desirable or undesirable. For
instance, the law of demand states that as price increases, demand goes down or vice-versa but this statement does not imply if the
result is desirable or not. Managerial economics, however, is concerned with what decisions ought to be made and hence involves
value judgments. This further has two aspects: first, it tells what aims and objectives a firm should pursue; and secondly, how best to
achieve these aims in particular situations. Managerial economics, therefore, has been described as normative microeconomics of the
firm.
Macroeconomics is also useful to managerial economics since it provides an intelligent understanding of the business environment.
This understanding enables a business executive to adjust with the external forces that are beyond the management’s control but
which play a crucial role in the well being of the firm. The important forces are: business cycles, national income accounting, and
economic policies of the government like those relating to taxation foreign trade, anti-monopoly measures and labour relations.
Importance of Managerial Economics
 
Business and industrial enterprise aims at earning maximum proceeds. A good decision requires fair knowledge of the aspects of
economic theory and tools of economic analysis, which are directly involved in the process of decision making. Since managerial
economics is concerned with such aspects and tools of analysis, it is pertinent to the decision making process.
Spencer and Siegelman have described the importance of managerial economics in a business and industrial enterprise as follows:
Accommodating traditional theoretical concepts to the actual business behavior and conditions
Managerial economics amalgamates tools, techniques, models and theories of traditional economics with actual business practices and
with the environment in which firm has to operate. According to Edwin Mansfield, “ Managerial Economics attempts to bridge the gap
between purely analytical problems that intrigue many economic theories and the problems of policies that management must face.”
Estimating economic relationships
Managerial economics estimates economic relationships between different business factors such as income, elasticity of demand, cost
volume, profit analysis etc.
Predicting relevant economic quantities
Managerial economics assist the management in predicting various economic such as cost, profit, demand, capital, production, price
etc. As a business manager has to function in an environment of uncertainty, it is imperative to anticipate the future working
environment in terms of the said quantities.
Understanding significant external forces
The management has to identify all the important factors that influence a firm. These factors can broadly be divided into two categories.
Managerial economics plays an important role by assisting management in understanding these factors.
External factors
A firm cannot exercise any control over these factors. The plans, policies and programmes of the firm should be formulated in the light
of these factors. Significant external factors impinging on the decision making process of a firm are economic system of the country,
business cycles, fluctuations in national income and national production, industrial policy of the government, trade and fiscal policy of
the government, taxation policy, licensing policy, trends in foreign trade o the country, general industrial relation in the country and so
on.
Internal factors
These factors fall under the control of a firm. These factors are associated with business operation, knowledge of these factors aids the
management in making sound business decisions.
Basis of business policies
Managerial economics is the founding principle of business policies. Business policies are prepared based on studies and findings of
managerial economics, which cautions the management against potential upheavals in national as well as international economy.
Thus, managerial economics is helpful to the management in its decision making process.