Guagua Community Colleges

Guagua, Pampanga

Bachelor of Science in Accountancy

Managerial Economics

Chapter 1-The Nature, Scope and Practice of Managerial Economics

MEANING OF MANAGERIAL ECONOMICS

In management studies, the terms ‘Business Economics’ and ‘Managerial Economics’ are often
synonyms. Both the terms, however, involve ‘economics’ as a basic discipline useful for certain
functional areas of business management.

Economics is the study of men as they live, behave, move and think in the ordinary business of life.
Economics in essence pertains to an understanding of life’s principal preoccupation. It is a religion of
the day-in living for the want satisfying activity. Economics, as a social science, studies human behavior
as a relationship between numerous wants and scarce means having alternative uses.

Managerial economics is essentially applied economics in the field of business management. It is the
economics of business or managerial decisions. It pertains to all economic aspects of managerial
decision making.

Managerial Economics: An Integration of Economics, Decision Science and Business Management

Managerial economics is a specialized discipline of management studies which deals with application
of economic theory and techniques to business management. Managerial economics is evolved by
establishing links on integration between economic theory and decision sciences (tools and methods
of analysis) along with business management in theory and practice — for the optimal solution to
business/managerial decision problems. This means, managerial economics pertains to the
overlapping area of economics along with the tools of decision sciences such as mathematical
economics, statistics and econometrics as applied to business management problems. The idea is
presented in a nutshell through:
THE SALIENT FEATURES AND SIGNIFICANCE OF MANAGERIAL ECONOMICS

 It involves an application of economic theory — especially, microeconomic analysis to

practical problem solving in real business life. It is essentially applied microeconomics.
 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 behavior in optimal 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.

MANAGERIAL ECONOMICS: NORMATIVE OR POSITIVE

According to economists like Professors Marshall and Pigou, the ultimate object of the study of any
science is to contribute to human welfare. According to these economists, economics should be a
normative science. It should be able to suggest policy measure to the politicians. It should be able to
prescribe guidelines for the conduct of economic activities.

According to Prof. Robbins, however, economics is a positive science. Science is, after all, a
search for truth and, therefore, economics should study the truth as it is and not as it ought to be. This
is because when we say that this ought to be like this, we presume that our point of view is correct.
When we express opinions, our own value enters into our consideration. In the study of a problem at
a given point of time, not only economic considerations but also many other considerations, such as
ethical, political, etc., must be considered. It is after weighing the relative importance of these various
factors that a policy decision is to be taken. There are, therefore, bound to be differences in respect
of policy prescription and it is, therefore, better to keep away from areas which are controversial and
study the facts as they are.

Managerial economics is a blending of pure or positive science with applied or normative

science. It is positive when it is confined to statements about causes and effects and to functional
relations of economic variables. It is normative when it involves norms and standards, mixing them
with cause-effect analysis.

Scope of Managerial Economics

The scope of business economics is usually restricted to the understanding of the business behavior
and problems of a firm at a micro level in the context of the prevailing business environment. The
methodology of business economics involves microeconomic analysis in analyzing the behavior and
problems of the business unit in particular.

• Microeconomic analysis is understanding the business environment in the economy.

Following are the main characteristic features of business economics as a specialized discipline:

• It involves on application of economics theory – especially microeconomics analysis to

practical problem solving in real business life. It is essentially applied microeconomics. It is a science
and facilitating better managerial discipline.

• It is concerned with firms between in optimal allocation of resources. It provides tools to help
identify the best source among the alternatives and competing activities in any productive sector
whether private or public.
Uses/Objectives of Managerial Economics

Managerial economics may be useful in the following respects:

 It makes problem-solving easy in business;

 It improves the quality and preciseness of decisions;
 It helps in arriving at quick and appropriate decisions.

Application Areas of Managerial Economics in Business Decision-Making

Production and
Inventory
Management

Knowledge Strategic
Management Management

Business
Economics:
Theory and
Policy Issues
Human Resource Marketing
Management
Management

Financial Management

SCIENTIFIC METHOD OF ECONOMIC ANALYSIS IN THE MANAGERIAL DECISION-MAKING

The Scientific Method

The scientific method implies an analytical approach in the study of a phenomenon. The
economist while studying man’s economic behavior and the associated problem. The man’s economic
behavior on the whole pertains to the want-satisfying activity against using the available limited on
scarce resources.

Modern economic life is dynamic and one’s behavior governed by human mind is not certain.
This keeps economics as a social science little less than perfect with permanency of the theory in its
universal application.

Managerial economists tend to rely on the scientific research method in building and
empirically testing business-oriented economic models. This scientific approach consists of the
following steps:
 • Defining the problem

• Formulation of the hypothesis

• Abstraction for the model building

• Data collection

• Testing the hypothesis

• Deduction based on data analysis

• Evaluating the test results

• Conclusion for decisions

BASIC ASSUMPTIONS IN ECONOMIC MODELS AND ANALYSIS

Economists usually construct models for analyzing economic behavior and problems in view. An
economic model is a set of assumptions about economic variables and their relationships concerning
certain aspects of economic reality.

Economic models are constructed by using logic and mathematics for deducting implications on the
basis of assumptions. In short, economists develop and use theoretical models as aides to
understanding economic complexities, with simplifying assumptions.

1. Ceteris Paribus Assumption

Ceteris paribus is a Latin phrase meaning “all other things remaining the same” or “all relevant
factors being equal or unchanged.” The term is used frequently as an axiom in the analysis of a variety
of economic phenomena. For example, in price theory the analysis of a price change is carried under
ceteris paribus assumption regarding the market behavior. It is assumed, for instance, that only
demand changes, supply and determinants of supply remaining unchanged. Thus, it is inferred that
when demand rises, supply being constant, price rises.

2. Psychological Assumptions

In economic analysis, it is basically assumed that the behavior of an economic man, whether
he is a consumer or a producer or an agent of production, is normal and that he is a rational person.
Thus, in every economic analysis, it is explicitly or tacitly assumed that decision-taking units in the
economic system such as consumers, factors or firms, behave in a rational manner. Their behavior is
treated as rational when it is confined to some specific well-defined motivation.

3. Structural Assumptions

In constructing an economic model, to study the working of a particular phenomenon or in

selling an economic dogma, certain implicit assumptions about the related structural issues involved
about the nature of physical structure, or the topography of a region, the climatic conditions, or the
biological limitations of human resources, are to be made. These are the many implied structural
assumptions in the analysis of an economic phenomenon.

4. Institutional Assumptions

Man is a socio-political animal, his behavior is influenced by the social, political and economic
institutions of the time. Thus, in analyzing his economic behavior, we have to make assumptions about
the social, political and economic institutions surrounding him. Institutional assumptions are
specifically related to the type of economic system and its political setting.

TIME PERSPECTIVE

Time is an important factor in business decision-making. A timely decision is always effective and
rewarding, if appropriate. Usually, decisions for the future actions are based on the past observations.
A foreseeable future outcome is generally the extension of the course of action and the results
obtained in the relevant past period in the business trend analysis.

In business decisions, in relation to time-period, thus, there are short-term and long-term
perspectives.

Short-term time perspectives are based on the short-run analysis of the business data and
performance. Usually, from trade cycles’ point of view, seasonal fluctuations in the business are
observed and decisions are carried to deal with the changing circumstance in the course of business
within a short period.

In long-run, the perception is towards growth, development and expansion. It is related to the
long-run business planning for progress. In this regard, external influencing factors are also
considered.

DISCOUNTING PRINCIPLE

A present gain is valued more than a future gain. Thus, in investment decision-making, discounting of
future value with the present one is very essential. The following formula is useful in this regard:

Where, V= present value,

 A = annuity or returns expected during a year,

i = current rate of interest.

To illustrate the formula, suppose A = 110 and i = 10% or 1/10, we can ascertain the present value of
Php110.00 one year after as:

In business decision-making process, thus, the discounting principle may be stated as: “If a decision
affects costs and revenues at future dates, it is necessary to discount those costs and revenues to
present values before a valid comparison of alternatives is possible.”