INTRODUCTION TO MANAGERIAL ECONOMICS

Meaning & Nature & Scope of ME: -

 Managerial economics is the economics applied in decision-making.

 It is the branch of economics which serves as a link between abstract theory and
managerial practice.

 It is based on economic analysis for identifying problems, organizing information

and evaluating alternatives.

 Economics as a science concerned with the problem of allocation of scarce

resources among competing ends.
&
 ME -- involves in analysis of allocation of the resources available to the
firm or a unit of management among the activities of that unit.
 It is, thus, concerned with the choice or selection among
alternatives.
 ME – is by nature goal-oriented and prescriptive and aims at
maximum achievement of objectives.

Definition: -

“Managerial economics…is the integration of economic theory with business

practice for the purpose of facilitating decision-making and forward planning by
management.”

---- Spencer and Siegel man.

“Managerial economics is the application of economic theory and

methodology to business administration practice.”

---- Brigham and Pappas.

Nature of ME: -

The nature of the economic theory considered relevant for managerial

decision-making.

 Macro-economic conditions: -

The decisions of the firm are made almost always within the
broad framework of economic environment within which the firm operates, known as
macro-economic conditions.

With regard to these conditions, we may stress three points: -

a) The economy in which the business operates is predominantly a free enterprise

using prices and market.

b) The present-day economy if the one undergoing rapid technological and economic
changes.

c) The intervention of government in economic affairs has increased in recent times

and there is no likelihood that this intervention will step in future.

 Limits within which a business management must operate.

 It can ignore neither the working of the market, nor the pace of economic
change, nor the activities of government in the economic sphere.

 The management which keeps itself well and continuously informed of

changes in the economic system is called Progressive Management.

 Micro-economic conditions: -

The micro-economic analysis deals with the problems of an

individual firm, industry, consumer, etc.

In case of ME, micro-economics helps in studying what is going

on within the firm; how best to use the available scarce resources between various
activities of the firm; how to be technically as well as economically efficient; etc.

Some of the popular micro-economic concepts are – elasticity of

demand, MC, the long-run economies and diseconomies of scale, opportunity cost,
present value, and market structures.
 Positive vs. Normative Approach: -

Whether one is using any one among the above, one can take
recourse to positive or normative approach or both.

Positive approach Normative approach

concerns with ---- what is, was, or
will be
The statement ‘a government deficit will
reduce unemployment and cause an
increase in prices’ is a hypothesis in
positive economics,
Concerns with what ought to be.
The statement ‘in setting policy,
unemployment ought to matter more than
inflation’ is a hypothesis in normative
approach.

Positive economics (both micro & macro) Normative micro-economic, is concerned

is of two types: (i) descriptive, and (ii) with problems like what the objectives and
theory. policies of business ought to be and how to
go about them.
As pointed out earlier, ME is concerned with analysis which is prescriptive or normative
in nature.

 Integration of Economic theory and Business Practice: -

a) With the help of the theory one can understand the actual business behaviour.
This does not mean that in economics there is always a theoretical
construct present – for every business behaviour.

Economists have developed a theory of firm which fundamentally centres on

the assumption of Profit maximization and the assumption that the firms act
rationally in pursuit of their objectives.

Rationally ---- is usually taken as implying that the firm has perfect knowledge
of all relevant variables when making decisions.

But the theory may be criticized from many standpoints:

1. It is not that a firm always aims at profit maximization

(because it may aim at sales maximization or maintenance
of firms market share.

2. The firms generally have imperfect knowledge of the

things which matter for their decision-making. Actually
firms take decisions under conditions of uncertainty.
 b) ME attempts to estimate and predict the economic quantities and relations.
Since the business manager has to operate within the
environment of uncertainty, economic quantities have to be
predicted and economic relationships to be estimated for decision-
making and forward planning.

c) Decision-making and forward planning is done with the help of estimated

economic quantities and relationships.
Economic forecasting suggests the various outcomes with their
respective probabilities for the managers to choose from.

d) The managers cannot ignore the environment within which they operate.
They must consider both external and internal factors of his
business environment.

To summarize….

 ME is micro-economic in character, where the unit of study is a firm.

 ME is concerned with normative micro-economics.
 ME concentrates on making economic theory more application-oriented.
 ME takes the help of macro-economics also as to understand the external
conditions which are relevant to the business.
 ME is influenced by – human and behavioural considerations,
technological and environmental factors.

Chief characteristics of ME: -

1. Micro-economic in character – as it only concentrates only on the study of the

firm and not on the working of the economy.
2. Takes the help of macro-economics to understand and adjust to the environment
in which the firm operates.
3. It is normative rather than positive in character.
4. It is both conceptual and metrical.
5. The contents of ME are based mainly on the ‘theory of firm’.
6. Knowledge of ME helps in making wise choices.

Significance of ME: -

1. It enables the manager to achieve optimal solution by providing a number of tools

and techniques.
2. ME provides most of the concepts that are needed for the analysis of business
problems.
3. ME helps in making decision – product mix, production techniques, input mix,
output level, price of the product, investment decisions, advertisement etc.
Scope of ME: -

ME has a close connection with economic theory (micro-economics as

well as macro-economics), operations research, statistics, mathematics and the
theory of decision-making.

ME also draws together and relates ideas from various functional areas of
management like production, marketing, finance and accounting, project
management, etc.

A professional managerial economist has to integrate concepts and

methods from all these disciples and functional areas in order to understand and
analyses practical managerial problems.

In so far as managerial economics is concerned, the following aspects constitute its

subject-matter:

i.) Objectives of the Business firm,

ii.) Demand analysis and forecasting,
iii.) Production and cost,
iv.) Competition,
v.) Pricing and output,
vi.) Profit,
vii.) Investment and capital budgeting, and
viii.) Product Policy, Sales Promotion and Market Strategy.

1. ME and Traditional Economics:

In general the relation between managerial economics and the economic
theory is very much like the relation of engineering to physics and of medicine to
biology.

 Both deal with identical problems – ie. problems of scarcity and resource
allocation.
 Since the labour and the capital resources are very limited in, it
must find the best way in which to utilize them for achieving the
set goals.

 Economists mainly concentrate on the study of types of markets,

 Managerial economists are concerned more with problems like
the impacts of market or technological changes on competitive
position of the firm and the likely reactions of their own actions in
the market.

 The two main contributions of economics to managerial economics are:

  To help in understanding the market conditions and the general
economic environment within the firm operates.
 To provide a philosophy for understanding and analyzing
resource-allocation problems.

The business efficiency is the result of technical and economic efficiency.

o Technical efficiency requires that production is carried out to the
best of technological specifications,
While
o Economic efficiency requires that the firm maximizes its goal (of
profit, sales etc.) by producing maximum output at minimum
cost.)

 It has generally been found that though businesses survive

and grow inspite of technical inefficiency, but they cannot
survive long without economic efficiency.
 ME is concerned with both kinds of efficiencies
 It takes the help of economic analysis for achieving
both technical and economic efficiency in business
operations.

2. ME and Operations research

 Both are concerned with taking effective decisions.

o Given the firms objectives, both are concerned with what is the
best way of achieving them.

 ME is fundamental academic subject which seeks to understand and to

analyze the problems of business decision-taking,
while
o Operations Research is an activity carried out by functional
specialists within the firm to help the manager to do his job of
solving decision problems.

 This explains the close relationship between the both.

 OR is useful where the solution to one smallish problem can, when

found, be applied to a whole range of similar small problems.

 OR is often both expensive and a slow process because it aims at

reaching accurate rather than rapid solutions.

o ME helps managers to get the results quickly and cheaply.

 o ME provides the managers with the tools he needs to carry out
this ‘instant’ Operations research.

3. ME and Mathematics:
 Mathematics – derivations, expositions of economic analysis.
o ME is closely related to managerial economics.

 Mathematics widens the sweep of analysis of ME

 The main branches of mathematics which are generally used by a

managerial economist are geometry and calculus,
While
o The main mathematical concepts used are the logarithms and
exponentials, vector and determinants, input-output tables,
Operations research, etc.

4. ME and Statistics
 Statistics is widely used by Managerial economists.

 ME aims at quantifying the past economic activity as well as to predict

its future course.

 This is needed for a correct judgment and decision-making.

 The most useful aspect of statistics is that it can deal with uncertainty
conditions which the firm is generally found to face.

 ME heavily depend upon the theory of probability to take care of such

problems in decision-making.

5. ME and the Theory of Decision-making

 The theory of decision making is relatively a new subject that has
significance for ME.

o Much of economic theory is based on the assumption is a

single goal – profit maximization or consumer utility
maximization.

o And also rest on the assumption of certainty or perfect

knowledge.

o The theory of decision making often replaces the notion of a

single optimum solution with the view of finding solutions that
balance conflicting objectives.
 o It probes motivation, the relation of rewards and aspiration
levels, and patterns of influence and authority.

 Economic theory and theory of decision making appear to be in

conflict, each based on a different set of assumptions.

o Which theory shall we choose?

 While economic analysis is useful in the achievement of better

decision and economic theory is easy to apply in simply, slow moving
situations with clear-cut objectives, it is much less capable to handle
complex problems with multiple goals and high degrees of uncertainty
and where quick decisions are necessary.

 In brief, ME helps business executives understand how the managerial

process combines and synthesizes ideas and methods from the various
functional fields like sales mgt, production mgt, etc.

 Thus, ME offers opportunity to integrate ideas from the various

specialized functions and disciplines into an overall point of view – the
perspective of a good manager.

Role of Managerial Economist in Business: -

a) Specific decision (as mentioned above)

b) General Tasks (External & Internal)