MBA I

UNIT I

Managerial Economics

Dr. Alfred Marshall, one of the greatest economists of the nineteenth century, writes
“Economics is a study of man’s actions in the ordinary business of life: it enquires how he gets
his income and how he uses it”.

Prof. Lionel Robbins defined Economics as “the science, which studies human behaviour as a
relationship between ends and scarce means which have alternative uses”. With this, the focus
of economics shifted from ‘wealth’ to human behaviour.

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.

Prof. Evan J Douglas defines Managerial Economics as “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”

Nature Of Managerial Economics:

1. Managerial economics is concerned with the analysis of
finding optimal solutions to decision making problems of
businesses/ firms (micro economic in nature).
2. Managerial economics is a practical subject therefore it
is pragmatic.
3. Managerial economics describes, what is the observed
economic phenomenon (positive economics) and prescribes what
ought to be (normative economics)
4. Managerial economics is based on strong economic
concepts. (conceptual in nature)
5. Managerial economics analyses the problems of the firms in
the perspective of the economy as a whole ( macro in nature)
6. It helps to find optimal solution to the business problems
(problem solving)

Managerial economics has a very important role to play by

helping managements in successful decision making and forward
planning. To discharge his role successfully, a manager must recognize
his responsibilities and obligations. There is a growing realization that
the managers contribute significantly to the profitable growth of the
firms.
SCOPE OF MANAGERIAL ECONOMICS:
The main focus in managerial economics is to find an optimal solution to a given managerial
problems. The problem may relate to production, reduction or control of costs, determination
of price of a given product or service, make or buy decisions, inventory decisions, capital
The following aspects may be said to generally fall under Managerial Economics.

Characteristics of Managerial Economics

Prof. D .M .Mithani has mentioned the following broad salient features of Managerial
Economics as a specialized discipline:
• It involves an application of Economic theory – especially, micro economic analysis to
practical problem solving in real business life. It is essentially applied micro economics.

• It is a science as well as art facilitating better managerial discipline. It explores and enhances
economic mindfulness and awareness of business problems and managerial decisions.

• It is concerned with firm‘s behaviour in optimum allocation of resources. It provides tools to

help in identifying the best course among the alternatives and competing activities in any
productive sector whether private or public.
Relationship of Managerial Economics with Other Disciplines
By its nature, managerial economics borrows heavily from several other disciplines. The nature
and scope of managerial economics can also be understood well by studying its relationship
with other disciplines. Managerial economics draws heavily from the following disciplines:

Economics and Econometrics – As stated earlier that managerial economics is an application of

economic theory into business practices / management. Managerial economics uses both
micro and macro economics-their concepts, theories, tools and techniques.
In managerial economics, we also use various types of models such as schematic models
(diagrams) analog models (flow charts) and mathematical models and stochastic models. The
roots of most of these models lie in economic logic. Economics also tells us the art of
constructing models. Empirically estimated functions, which are being used in managerial
economics are basically econometric estimates.
Mathematics and Statistics – Mathematical tools are widely used in model building for
exploring the relationship between related economic variables. Most of the decision models are
constructed in terms of mathematical symbols. Geometry, trignometry and algebra are
different branches of mathematics and they provide various tools & concepts such as
logarithms, exponentials, vectors, determinants, matrix algebra, and calculus, differentials and
integral.
Similarly, statistical tools are a great aid in business decision-making. Statistical tools such as
theory of probability, forecasting techniques, index numbers and regression analysis are used in
predicting the future course of economic events and probable outcome of business decisions.
Statistical techniques are used in collecting, processing & analyzing business data, and in testing
the validity of economic laws.

Operational Research (OR) – OR is used for solving the problems of allocation, transportation,
inventory building, waiting line etc.
Linear programming and goal programming models are very useful for managerial decisions.
These are widely used OR techniques. In fact, OR is an inter-disciplinary solution finding
technique. It combines economics, mathematics and statistics to build models for solving
specific problems and to find a quantitative solution there by.

Accountancy – It provides business data support for decision-making. The data on costs,
revenues, inventories, receivables and profits is provided by the accountancy. Cost accounting,
ratio analysis, break-even analysis are the subject matters of accountancy and they are of great
help to managers in decision-making.

Psychology and Organisation Behaviour (OB)–In fact, managerial economics analyses the
individual behaviour of a buyer and seller [microeconomic units]. Psychology is helpful in
understanding the behavioural aspects like attitude and motivation of individual decision
making unit.

Psychological Economics-a new discipline of recent origin analyses the buyer‘s behaviour useful
for marketing management.
Behavioural models of firms have also been developed based on organization psychology and
micro economics to explain the economic behaviour of a firm.

Management Theory – Management theories bring out the behaviour of the firm in its efforts
to achieve some predetermined objectives. With change in environment and circumstances,
both the objectives of firm and managerial behaviour change. Therefore sufficient knowledge
of management theory is essential to the decision-makers. The basic knowledge of the
principles of personnel, marketing, financial and production management is required for
accomplishing the task.

Opportunity Cost Concept-

According to Adam Smith, ―Pains and sacrifices of labour are real cost of production‖
Opportunity cost is not the actual expenditure but it is the revenue earned by employing that
good or service in some other alternative uses. Opportunity cost is the cost of producing any
commodity in the next best alternative cost.

For example the inputs which are used to manufacture a car may also be used in the
productions of military equipment. A farmer who is producing paddy can also produce sugar
cane with the same factors. Therefore, the opportunity cost of one quintal of paddy is the
amount of sugarcane given up. Main points of opportunity cost are:

1. The opportunity cost of any commodity is only the next best alternative forgone.

2. The next best alternative commodity that could be produced with the same value of the
factors, which are more or less the same.
3. It helps in determining relative prices of factor inputs at different places.

4. It helps in determining the remuneration to services.

5. It helps the manager to decide what he should produce in the factory

Incremental Principle- Incremental principle states that a decision is profitable if revenue

increases more than costs; if costs reduce more than revenues; if increase in some revenues is
more than decrease in others; and if decrease in some costs is greater than increase in others.
The incremental concept is closely related to the marginal costs and marginal revenues of
economic theory.
Incremental concept involves two important activities which are as follows:

 Estimating the impact of decision alternatives on costs and revenues.

 Emphasising the changes in total cost and total cost and total revenue resulting from changes
in prices, products, procedures, investments or whatever may be at stake in the decision. The
two basic components of incremental reasoning are as follows:

 Incremental cost: Incremental cost may be defined as the change in total cost resulting from a
particular decision.

 Incremental revenue: Incremental revenue means the change in total revenue resulting from
a particular decision.

THE CONCEPT OF TIME PERSPECTIVE -The time perspective concept states that the decision
maker must give due consideration both to the short run and long run effects of his decisions.
He must give due emphasis to the various time periods. It was Alfred Marshall who introduced
time element in economic theory. Marshall explained four market forms based on time in
economic theory
i. e., i. Very Short Period
ii. Short Period
iii. Long Period
iv. Very long Period or Secular Period

1. Very Short Period: Very short period refers to the type of competitive market in which
the supply of commodities cannot be changed at all. So in a very short period, the
market supply is perfectly inelastic. The price of the commodity depends on the demand
for the product alone.

2. Short Period: Short period refers to that period in which supply can be adjusted to a
limited extent by varying the variable factors alone. the market supply is relatively
elastic.
3. Long Period: Long period is the time period during which the supply conditions are
fully able to meet the new demand conditions. In the long run, all (both fixed as well as
variable) factors are variable. the market supply is perfectly elastic.
4. Very long Period or Secular Period: The very long run is a situation where technology
and factors beyond the control of a firm can change significantly.

THE DISCOUNTING PRINCIPLES-

• Discounting principles talks about the comparison of money value between present
and future time
A rupee to be received tomorrow is worth less than a rupee today
• Whenever we make comparison between present and the future values of money, we
always discount future value to make it comparable with the present value.
• Example: Suppose there is a choice between receiving a gift of Rs. 1000/- today and
Rs.1000/- next year, naturally everyone would prefer Rs.1000/- today
• Even though if there is a certainty of receiving Rs.1000/- next year, we choose to get
Rs.1000/- today, as it can yield some interest during one year by investing. Explaining
the discounting principle is to ask how much money today would be equivalent to
Rs.100000 a year from now.

LAW OF EQUI-MARGINAL UTILITY PRINCIPLES The idea of equi-marginal principles was

first mentioned by H.H. Gossen. Hence it is called as Gossen’s Second Law. Alfred
Marshall made it as law. The law of equi-marginal utility explains the behavior of a
consumer when he consumes more than one commodity.
The law also called “law of substitution or law of maximum satisfaction.

DEFINITION: “If a person has a thing which can be put to several uses, he will distribute
it among these uses in such a way that it has the same marginal utility in all”.
CONCEPTS OF MICRO AND MACRO ECONOMICS:
‘Economics’ is defined as the study of how the humans work together to convert limited
resources into goods and services to satisfy their wants (unlimited) and how they distribute the
same among themselves. Economics has been divided into two broad parts i.e. Micro
Economics and Macro Economics. Here, in the given article we’ve broken down the concept
and all the important differences between micro economics and macro economics, in tabular
form, have a look.
MICROECONOMICS
The term ‘micro’ means small. The study of an individual consumer or a firm is called
microeconomics (also called the Theory of Firm). Micro means ‘one millionth’.
Microeconomics deals with behavior and problems of single individual and of micro
organization. Managerial economics has its roots in microeconomics and it deals with the micro
or individual enterprises. It is concerned with the application of the concepts such as price
theory, Law of Demand and theories of market structure and so on.
MACROECONOMICS
The term ‘macro’ means large. The study of ‘aggregate or total level of economic activity in a
country is called macroeconomics. It studies the flow of economics resources or factors of
production (such as land, labour, capital, organisation and technology) from the resource
owner to the business firms and then from the business firms to the households. It deals with
total aggregates, for instance, total national income total employment, output and total
investment. It studies the interrelations among various aggregates and examines their nature
and behaviour, their determination and causes of fluctuations in the. It deals with the price
level in general, instead of studying the prices of individual commodities. It is concerned with
the level of employment in the economy. It discusses aggregate consumption, aggregate
investment, price level, and payment, theories of employment, and so on.
Though macroeconomics provides the necessary framework in term of government policies
etc., for the firm to act upon dealing with analysis of business conditions, it has less direct
relevance in the study of theory of firm.