Managerial Economics

B.Com 1st Year Hons.

Chapter - 1st Nature & Scope of Managerial Economics

Managerial Economics (Meaning)

Managerial economics is the study of how scarce resources are directed most efficiently to achieve managerial
goals. It is a valuable tool for analyzing business situations to take better decisions.

Definition

Managerial economics studies the application of the principles, techniques and concepts of economics to managerial
problems of business and industrial enterprises.

According to Spencer and Siegel man:

“The integration of economic theory with business practice for the purpose of facilitating decision-making and
forward planning by management”.

According to McGutgan and Moyer:

“Managerial economics is the application of economic theory and methodology to decision-making problems faced
by both public and private institutions”.

According to Prof. Evan J Douglas:

“Managerial Economics is concerned with the application of economic principles and methodologies to the decision
making process within the firm or organization under the conditions of uncertainty”

Characteristics

 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 (future planning)

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 (sensibly and realistically)

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.

 Use of Macro Economics

Managerial Economics takes the help of Macro-economic 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

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 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.

Nature

 Managerial Economic is a Science: M.E is a science because the Principles and theory of Managerial Economics
is proved. Which is applicable for all level of Organization and theory of demand, theory of price, theory of
profit, theory of capital is also proved.

 Managerial economic is an art: Managerial economics is an art because an art is application of skills can used for
the purpose of getting some relevant information and the other, In M.E theory is implement in Practice way in
M.E managerial skills is implemented.

 M.E for administrations of Organization: Managerial economic for administration of organization because
administration give the relevant data. They find out the problem and solve the problem immediately in
organisation and the admin decide the target on the basis of price, Quality of the products, Demand of product.
Administration forecast the demand according to the situation of present demand of the market.

 M.E is helpful in optimum resources allocation: In the organization are limited resources and this resources can
used in several places at a time by the tools and techniques of managerial economic. The resources will used to
get optimum output. In the organisations our ultimate objective to earn profit so the limited resources used in
such a way to get maximum profit because, resources are limited

 Managerial economic has component of micro economic: Managerial economics has component of Micro
economics as It is related with the internal factors of organization. Internal factor of the organisations are
demand and supply of the products, market structure etc.

 Managerial economic has components of macro economic: Managerial economic has a component of macro
economic which is related with the outside of the organisation or a external factor of the organisation. External
factor of the organisation are competition market, nature of business, Government rules and regulations,
industrial law, Industrial Policies, Taxes these are the External factor of the organisation and these types of
problems solved by the managerial economics.

 Managerial economic is dynamic in nature: Managerial economics is dynamic in nature that means managerial
economics is used all space of the organisation and all except of the organisation. By the tools and technique of
managerial economic to give the relevant information and to solve the problem of the organisations So,
Managerial economic is dynamic in nature.

Scope

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1. Demand analysis and 3. Pricing decisions, policies and 5. Capital management.
forecasting. practice.
6. Analysis of business
2. Cost and production analysis. 4. Profit management. environment.

1. Demand analysis:

A business firm is an economic organization which is engaged in transforming productive resources into goods that
are to be sold in the market. A major part of managerial decision-making depends on accurate estimates of demand.
A forecast of future sales serves as a guide to management for preparing production schedules and employing
resources. It will help management to maintain or strengthen its market position and profit-base. Demand analysis
also identifies a number of other factors influencing the demand for a product. Demand analysis and forecasting
occupies a strategic place in Managerial Economics.

2. Cost analysis:

Cost estimates are most useful for management decisions. The different factors that cause variations in cost
estimates should be given due consideration for planning purposes. If one is able to measure cost it is very important
for more sound profit planning, cost control and often for sound pricing practices.

3. Pricing practices and policies:

As price gives income to the firm, it constitutes as the most important field of Managerial Economics. The success of
a business firm depends very much on the correctness of the price decisions taken by it. The various aspects that are
dealt under it cover the price determination in various market forms, pricing policies, pricing method, differential
pricing, productive pricing and price forecasting.

4. Profit management:

The main purpose of a business firm is to earn the maximum profit. There is always an element of uncertainty about
profits because of variation in costs and revenues. If knowledge about the future were perfect, profit analysis would
have been very easy task. But in this world of uncertainty expectations are not always realized. Hence profit planning
and its measurement constitute the most difficult area of Managerial Economics.

Under profit management we study nature and management of profit, profit policies and techniques of profit
planning like Break Even Analysis.

5. Capital management:

The problems relating to firm’s capital investments are perhaps the most complex and troublesome. Capital
management implies planning and control of capital expenditure because it involves a large sum and moreover the
problems in disposing the capital assets of arc so complex that they require considerable time and labour.

The main topics dealt with under capital management arc cost of capital, rate of return and selection of projects.

6. Analysis of business environment:

The environmental factors influence the working and performance of a business undertaking. Therefore, the
managers will have to consider the environmental factors in the process of decision-making. Decisions taken in
isolation of environmental factors would prove harmful to the firm. Therefore, the management must be fully aware
of economic environment, particularly those economic factors which constitute the business climate.

Certain macro-economic theories such as income and employment theory, monetary theory etc. help in analyzing
business climate.

Analysis of monetary policy, fiscal policy, industrial policy, foreign trade policy and other direct controls also help in
forecasting business climate.

Therefore, macro- economic theory and government policies arc also included in the scope of managerial economics.

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Techniques

Managerial economics uses a wide variety of economic concepts, tools, and techniques in the decision-making
process. These concepts can be placed in three broad categories:

1. The theory of the firm: A firm can be considered a combination of people, physical and financial resources,
and a variety of information. Firms exist because they perform useful functions in society by producing and
distributing goods and services. In the process of accomplishing this, they use society's scarce resources,
provide employment, and pay taxes.
 The theory of the firm is the microeconomic concept that states the overall nature of companies is to
maximize profits meaning to create as much of a gap between revenue and costs.
 The theory has been debated as to whether a company's goal is to maximize profits in the short-term or
long-term.
 Solely focusing on profit maximization comes with a level of risk in regards to public perception and a loss of
goodwill between the company, consumers, investors, and the public.

2. Theory of consumer behavior: In Economics describes how consumers allocate incomes among different
goods and services to maximize their utility. Here consumer behavior is best understood in three distinct
steps - consumer preferences, budget constraints, and consumer choices.

3. Profit Maximization Theory: A process that companies undergo to determine the best output and price
levels in order to maximize its return. The company will usually adjust influential factors such as production
costs, sale prices, and output levels as a way of reaching its profit goal.

Micro, Macro, and Managerial Economics Relationship

Microeconomics studies the actions of individual consumers and firms; managerial economics is an applied specialty
of this branch. Macroeconomics deals with the performance, structure, and behavior of an economy as a whole.
Managerial economics applies microeconomic theories and techniques to management decisions. It is more limited
in scope as compared to microeconomics. Macroeconomists study aggregate indicators such as GDP, unemployment
rates to understand the functions of the whole economy.

Microeconomics and managerial economics both encourage the use of quantitative methods to analyze economic
data. Businesses have finite human and financial resources; managerial economic principles can aid management
decisions in allocating these resources efficiently. Macroeconomics models and their estimates are used by the
government to assist in the development of economic policy.

Chapter – 3rd Demand Forecasting

Different types & objectives of demand forecasting

Demand forecasting

Accurate demand forecasting is essential for a firm to enable it to produce the required quantities at the right time
and to arrange well in advance for the various factors of production. Forecasting helps the firm to assess the
probable demand for its products and plan its production accordingly.

Demand Forecasting refers to an estimate of future demand for the product. It is an objective assessment of the
future course of demand. It is essential to distinguish between forecast of demand and forecast of sales. Sales
forecast is important for estimating revenue, cash requirements and expenses. Demand forecast relates to
production inventory control, timing, reliability of forecast etc.

Objectives and Types of Demand Forecasting

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Based on the time span and planning requirements of business firms, demand forecasting can be classified into
short-term demand forecasting and long-term demand forecasting.

The demand forecasting can be divided into two parts :

1. Short-term Forecasting:
(a) To help in preparing suitable sales and production policies.
(b) To help in ensuring a regular supply of raw materials.
(c) To reduce the cost of purchase and avoid unnecessary purchase.
(d) To ensure best utilization of machines.
(e) To make arrangements for skilled and unskilled workers so that suitable labour force may be maintained.
(f) To help in the determination of a suitable price policy
(g) To determine financial requirements.
(h) To determine separate sales targets for all the sales territories.
(i) To eliminate the problem of under or over production.

2. Long-term Forecasting
(a) To plan long-term production
(b) To plan plant capacity.
(c) To estimate the requirements of workers for long period and make arrangements.
(d) To determine an appropriate dividend policy.
(e) To help the proper capital budgeting.
(f) To plan long-term financial requirements.
(g) To forecast the future problems of material supplies and energy crisis.

Factors affecting demand forecasting

For making a good forecast, it is essential to consider the various factors governing demand forecasting. These
factors are summarized as follows:
1. Prevailing business conditions: While preparing demand forecast it becomes necessary to study the general
economic conditions very carefully. These include the price level changes, change in national income, per capita
income, consumption pattern, savings and investment habits, employment etc.

2. Conditions within the industry: Every business enterprise is only a unit of a particular industry. Sales of that
business enterprise are only a part of the total sales of that industry. Therefore, while preparing demand forecasts
for a particular business enterprise, it becomes necessary to study the changes in the demand of the whole industry,
number of units within the industry, design and quality of product, price policy, competition within the industry etc.

3. Conditions within the firm: Internal factors of the firm also affect the demand forecast. These factors include
plant capacity of the firm, quality of the product, price of the product, advertising and distribution policies,
production policies, financial policies etc.

4. Factors affecting export trade: If a firm is engaged in export trade also it should consider the factors affecting the
export trade. These factors include import and export control, terms and conditions of export, exam policy, export
conditions, export finance etc.

5. Market behaviour: While preparing demand forecast, it is required to consider the market behaviour which brings
about changes in demand.

6. Sociological conditions: Sociological factors have their own impact on demand forecast of the company. These
conditions relate to size of population, density, change in age groups, size of family, family life cycle, level of
education, family income, social awareness etc.

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7. Psychological conditions: While estimating the demand for the product, it becomes necessary to take into
consideration such factors as changes in consumer tastes, habits, fashions, likes and dislikes, attitudes, perception,
life styles, cultural and religious bents etc.

8. Competitive conditions: The competitive conditions within the industry may change. Competitors may enter into
market or go out of market. A demand forecast prepared without considering the activities of competitors may not
be correct.

Chapter – 2nd Demand

What is Demand?
Demand is an economic principle referring to a consumer's desire to purchase goods and services and willingness to
pay a price for a specific good or service. Holding all other factors constant, an increase in the price of a good or
service will decrease the quantity demanded, and vice versa.
Market demand is the total quantity demanded across all consumers in a market for a given good. Aggregate
demand is the total demand for all goods and services in an economy. Multiple stocking strategies are often required
to handle demand.

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KEY TAKEAWAYS
Demand refers to consumers' desire to purchase goods and services at given prices.

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Demand can mean either market demand for a specific good or aggregate demand for the total of all goods in an
economy. Demand, along with supply, determines the actual prices of goods and the volume of goods that changes
hands in a market.

Understanding Demand
Businesses often spend a considerable amount of money to determine the amount of demand the public has for
their products and services. How much of their goods will they actually be able to sell at any given price? Incorrect
estimations either result in money left on the table if demand is underestimated or losses if demand is
overestimated. Demand is what helps fuel the economy, and without it, businesses would not produce anything.

Demand is closely related to supply. While consumers try to pay the lowest prices they can for goods and services,
suppliers try to maximize profits. If suppliers charge too much, the quantity demanded drops and suppliers do not
sell enough product to earn sufficient profits. If suppliers charge too little, the quantity demanded increases but
lower prices may not cover suppliers’ costs or allow for profits. Some factors affecting demand include the appeal of
a good or service, the availability of competing goods, the availability of financing, and the perceived availability of a
good or service.

Supply and Demand Curves

Supply and demand factors are unique for a given product or service. These factors are often summed up in demand
and supply profiles plotted as slopes on a graph. On such a graph, the vertical axis denotes the price, while the
horizontal axis denotes the quantity demanded or supplied. A demand curve slopes downward, from left to right. As
prices increase, consumers demand less of a good or service. A supply curve slopes upward. As prices increase,
suppliers provide more of a good or service.

Market Equilibrium
The point where supply and demand curves intersect represents the market clearing or market equilibrium price. An
increase in demand shifts the demand curve to the right. The curves intersect at a higher price and consumers pay
more for the product. Equilibrium prices typically remain in a state of flux for most goods and services because
factors affecting supply and demand are always changing. Free, competitive markets tend to push prices toward
market equilibrium.

Market Demand vs. Aggregate Demand

The market for each good in an economy faces a different set of circumstances, which vary in type and degree. In
macroeconomics, we can also look at aggregate demand in an economy. Aggregate demand refers to the total
demand by all consumers for all good and services in an economy across all the markets for individual goods.
Because aggregate includes all goods in an economy, it is not sensitive to competition or substitution between
different goods or changes in consumer preferences between various goods in the same way that demand in
individual good markets can be.

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