Unit - 1

Introduction to Managerial
Economics
 Content
• Introduction
• Meaning and Definitions of Managerial Economics
• Characteristics of Managerial Economics
• Nature of Managerial Economics
• Types of Managerial Economics
• Principles of Managerial Economics
Introduction of Managerial Economics
• Managerial economics is a stream of management studies which
emphasises solving business problems and decision-making by
applying the theories and principles of microeconomics and
macroeconomics. It is a specialised stream dealing with the
organisation’s internal issues by using various economic theories.
• Managerial economics, used synonymously with business
economics. It is a branch of economics that deals with the
application of microeconomic analysis to decision-making
techniques of businesses and management units. It acts as the via
media between economic theory and pragmatic economics.
Managerial economics bridges the gap between "theory and
practice". businesses and management units
Definitions of Managerial Economics
According to Spencer and Siegelman,“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”.
•  Managerial economics studies the application of the principles,
techniques and concepts of economics to managerial problems of
business and industrial enterprises. The term is used interchangeably
with micro economics, macro economics, monetary economics.
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.
Nature of Managerial Economics
• To know more about managerial economics, we must know about its various
characteristics. Let us read about the nature of this concept in the following
points:
• Art and Science: Managerial economics requires a lot of logical
thinking and creative skills for decision making or problem-solving. It is
also considered to be a stream of science by some economist claiming
that it involves the application of different economic principles,
techniques and methods, to solve business problems.
• Micro Economics: In managerial economics, managers generally deal
with the problems related to a particular organisation instead of the
whole economy. Therefore it is considered to be a part of
microeconomics.
• Uses Macro Economics: A business functions in an external
environment, i.e. it serves the market, which is a part of the economy
as a whole.
• Therefore, it is essential for managers to analyse the different factors of
macroeconomics such as market conditions, economic reforms,
• Multi-disciplinary: It uses many tools and principles belonging to
various disciplines such as accounting, finance, statistics,
mathematics, production, operation research, human resource, 
marketing, etc.
• Prescriptive / Normative Discipline: It aims at goal achievement
and deals with practical situations or problems by implementing
corrective measures.
• Management Oriented: It acts as a tool in the hands of managers
to deal with business-related problems and uncertainties
appropriately. It also provides for goal establishment, policy
formulation and effective decision making.
• Pragmatic: It is a practical and logical approach towards the day to
day business problems.
Types of Managerial Economics
• All managers take the concept of managerial economics
differently. Some may be more focused on customer’s
satisfaction while others may prioritize efficient production.
• The various approach to managerial economics can be seen in
detail below:
Liberal Managerialism: A market is a democratic place where people
are liberal to make their choices and decisions. The organisation
and the managers have to function according to the customer’s 
demand and market trend; else it may lead to business failures.
Normative Managerialism: The normative view of managerial
economics states that administrative decisions are based on real-life
experiences and practices. They have a practical approach to
demand analysis, forecasting, cost management, product design and
promotion, recruitment, etc.
Radical Managerialism: Managers must have a revolutionary
attitude towards business problems, i.e. they must make decisions
to change the present situation or condition. They focus more on
the customer’s requirement and satisfaction rather than only profit
maximisation.
 Objective of the firm
Profit maximisation
• Usually, in economics, we assume firms are
concerned with maximizing profit. Higher profit
means:
• Higher dividends for shareholders.
• More profit can be used to finance research and
development.
• Higher profit makes the firm less vulnerable to
takeover.
• Higher profit enables higher salaries for workers
Economic objectives of firms
The main objectives of firms are:
1.Profit maximization
2.Sales maximization (Baumol’s)
3.Increased market share/market dominance
4.Social/environmental concerns
5.Profit satisficing
6.Co-operatives
• Sometimes there is an overlap of objectives. For example,
seeking to increase market share, may lead to lower profits in
the short-term, but enable profit maximization in the long run.
Business Objectives
 SVC Week - 2
Alternative Objectives of Firms
• Baumol’s Sales or Revenue Maximization
• Williamson’s Managerial Utility Functions
• Cyert-March Satisficing Behaviour
• Rothschild’s model of Long-run Survival and Market
share goals
• Entry prevention and Risk avoidance model
• Maximization of value of the firm
Alternative aims of firms
However, in the real world, firms may pursue other objectives apart from profit
maximization.
1. Satisficing Behaviour (Cyert-March)
• In many firms, there is a separation of ownership and control. Those who own the
company (shareholders) often do not get involved in the day to day running of the
company.
• This is a problem because although the owners may want to maximize profits, the
managers have much less incentive to maximize profits because they do not get
the same rewards, (share dividends)
• Therefore managers may create a minimum level of profit to keep the
shareholders happy, but then maximize other objectives, such as enjoying work,
getting on with other workers. (e.g. not sacking them) This is the problem of
separation between owners and managers.
• This ‘principal-agent‘ problem can be overcome, to some extent, by giving
managers share options and performance related pay although in some industries
it is difficult to measure performance.
2. Sales maximization (Prof. Baumol)
• Firms often seek to increase their market share – even if
it means less profit. This could occur for various reasons:
• Increased market share increases monopoly power and
may enable the firm to put up prices and make more
profit in the long run.
• Managers prefer to work for bigger companies as it leads
to greater prestige and higher salaries.
• Increasing market share may force rivals out of business.
E.g. the growth of supermarkets have lead to the demise
of many local shops. Some firms may actually engage in
predatory pricing which involves making a loss to force a
rival out of business.
3. Growth maximization
• This is similar to sales maximization and may involve
mergers and takeovers. With this objective, the firm may
be willing to make lower levels of profit in order to
increase in size and gain more market share. More
market share increases its monopoly power and ability
to be a price setter.
4. Long run profit maximization (Rothschild)
• In some cases, firms may sacrifice profits in the short
term to increase profits in the long run. For example, by
investing heavily in new capacity, firms may make a loss
in the short run but enable higher profits in the future.
5. Social/environmental concerns
• A firm may incur extra expense to choose products which don’t
harm the environment or products not tested on animals.
Alternatively, firms may be concerned about local community /
charitable concerns.
• Some firms may adopt social/environmental concerns as part of
their branding. This can ultimately help profitability as the brand
becomes more attractive to consumers.
• Some firms may adopt social/environmental concerns on principal
alone – even if it does little to improve sales/brand image.
6. Co-operatives
• Co-operatives may have completely different objectives to a
typical PLC. A co-operative is run to maximize the welfare of all
stakeholders – especially workers. Any profit the co-operative
makes will be shared amongst all members.
 Decision Making
Meaning and Definitions of Decision Making:
• One of the most important functions of a manager is to take
decisions in the organization. Success or failure of an
organization mainly depends upon the quality of decision that the
managers take at all levels. Each managerial decision, whether it
is concerned with planning, organizing, staffing or directing is
concerned with the process of decision-making.
• A decision is a course of action which is consciously chosen from
among a set of alternatives to achieve a desired result. It means
decision comes in picture when various alternatives are present.
Hence, in organization an execute forms a conclusion by
developing various course of actions in a given situation.
Definition of Decision Making
• According to D. E. McFarland, “A decision is an act of
choice – wherein an executive forms a conclusion about
what must not be done in a given situation. A decision
represents a course of behavior chosen from a number of
possible alternatives”.
• According to Haynes and Massie, “a decision is a course of
action which is consciously chosen for achieving a desired
result”.
• According to R. A. Killian, “A decision in its simplest form
is a selection of alternatives”.
Characteristics of Decision-Making
1. Goal-Oriented:
Decision-making is a goal-oriented process. Decisions are usually made to
achieve some purpose or goal. 
2. Alternatives:
A decision should be viewed as ‘a point reached in a stream of action’. It is
characterized by two activities – search and choice. The manager
searches for opportunities, to arrive at decisions and for alter­native
solutions, so that action may take place. Choice leads to decision.
3. Analytical-Intellectual:
Decision-making is not a purely intellectual pro­cess. It has both the
inductive and deductive logic; it contains conscious and unconscious
aspects. Part of it can be learned, but part of it depends upon the personal
characteristics of the decision maker. 
4. Dynamic Process:
Decision-making is characterized as a process, rather than as, one static
entity. It is a process of using inputs effectively in the solution of selected
problems and the creation of outputs that have utility. Moreover, it is a
process concerned with ‘identifying worthwhile things to do’ in a dynamic
setting.
5. Pervasive Function:
Decision-making permeates all management and covers every part of an
enterprise. In fact, whatever a manager does, he does through decision-
making only; the end products of a manager’s work are decisions and
actions.
6. Continuous Activity:
The life of a manager is a perpetual choice making activity. He decides
things on a continual and regular basis. It is not a one shot deal.
7. Commitment of Time, Effort and Money:
Decision-making implies commitment of time, effort and money. The
commitment may be for short term or long-term depending on the type of
decision (e.g., strategic, tactical or operating). Once a decision is made, the
organisation moves in a specific direction, in order to achieve the goals.
8. Human and Social Process:
Decision-making is a human and social process involving intellectual abilities,
intuition and judgment. The human as well as social imparts of a decision are
usually taken into ac­count while making the choice from several alternatives.
9. Integral Part of Planning:
As Koontz indicated, ‘decision making is the core of planning’. Both are
intellectual processes, demanding discretion and judgment. Both aim at
achieving goals. Both are situational in nature. Both involve choice among
alternative courses of action. Both are based on forecasts and assumptions
about future risk and uncertainty.
Types of Decision-Making
The decisions taken by managers at various points
of time may be classified thus:

1. Personal and Organizational Decisions:

2. Individual and Group Decisions:
3. Programmed and Non-Programmed Decisions:
4. Strategic, Administrative and Routine Decisions:
Assumptions of Decision Making
The decision-making process, described in based on certain
assumptions:
i. Decision-Making is a Goal-
Oriented Process
ii. All Choices are Known
iii. Order of Preference
iv. Maximum Advantage
Factors Involved in Decision-Making
There are two kinds of factors to be considered in decision-making in favor of any
alternative. These may be classified as:
(i) Tangible and
(ii) Intangible Factors.
i. Tangible factors:
Among the tangible factors relevant to decision-making the important ones are:
(a) Sales; (b) Cost;(c) Purchases; (d) Production;
(e) Inventory; (f) Financial; (g) Personnel and (h) Logistics.
ii. Intangible Factors:
Among the intangible factors which may influence decision-making in favor of any
alternative, the important ones are the effects of any particular decision:
(a) Prestige of the enterprise,
(b) Consumer behaviour,
(c) Employee morale; and so on.
  Techniques and Methods of
Decision-Making

(1)Marginal Analysis

(2) Co-Effectiveness Analysis

(3) Operations Research

(4) Linear Programming

 Process and Steps in Decision-Making
• According to Stanley Vance decision-making
consists of the following six steps:
1. Perception (Awareness).
2. Conception (Outset).
3. Investigation (Study).
4. Deliberation (Planned).
5. Selection (Collection).
6. Promulgation (deceleration)
Elements of Decision-Making
• The following are the five important elements of
decision-making:
(1) Concept of good decision.
(2) Environment of decision.
(3) Psychological elements in decision.
(4) Timing of decision.
(5) Communication of decision.
Approaches to Decision-Making
The approaches to decision-making are
discussed below:
1. Centralized and Decentralized Approach  
2.Group and Individual Approach
3.Participatory and Non-Participatory
Approach
4.Democratic and Consensus Approach
Principles of Managerial Economics
• The great macroeconomist N. Gregory Mankiw has given ten principles to explain
the significance of managerial economics in business operations. These principles
are classified as follows:
Principles of How People Make Decisions
To understand how the decision making takes place in real life, let us go through
the following principles:
• People Face Trade-offs
• To make decisions, people have to make choices where they have to select among the
various options available.
• Opportunity Cost
• Every decision involves an opportunity cost which the cost of those options which we let go
while selecting the most appropriate one.
• Rational People Think at the Margin
• People usually think about the margin or the profit they will earn before investing their
money or resources at a particular project or person.
• People Respond to Incentives
• Decision making highly depends upon the incentives associated with a product, service or
activity. Negative incentives discourage people, whereas positive incentives motivate them.
Principles of How People Interact
Communication and market affect business operations. To justify the
statement, let us see the following related principles:
• Trade Can Make Everyone Better off
• This principle says that trade is a medium of exchange among people. Everyone gets
a chance to offer those products or services which they are good at making. And
purchase those products or services too, which others are good at manufacturing.
• Markets Are Usually A Good Way to Organize Economic Activity
• Markets mostly act as a medium of interaction among the consumers and the
producers. The consumers express their needs and requirement (demands) whereas
the producers decide whether to produce goods or services required or not.
• Governments Can Sometimes Improve Market Outcomes
• Government intervenes business operations at the time of unfavourable market
conditions or for the welfare of society. One such example is when the government
decides minimum wages for labour welfare.
Principles of How Economy Works As A Whole
The following principle explains the role of the economy in the functioning of an
organization:
A Country’s Standard of Living Depends on Its Ability to Produce Goods and
Services
• For the growth of the economy of a country, the organisations must be efficient enough to
produce goods and services. It ultimately meets the consumer’s demand and improves GDP
to raise the country’s standard of living.
Prices Rise When the Government Prints Too Much Money
• If there are surplus money available with people, their spending capacity increases,
ultimately leading to a rise in demand. When the producers are unable to meet the
consumer’s demand, inflation takes place.
Society Faces a Short-Run Tradeoff Between Inflation and Unemployment
• To reduce unemployment, the government brings in various economic policies into action.
These policies aim at boosting the economy in the short run. Such practices lead to
inflation.
Scope of Managerial Economics
• Managerial economics is widely applied in organizations to deal with different
business issues. Both the micro and macroeconomics equally impact the
business and its functioning.
Micro-Economics Applied to Operational Issues
To resolve the organisation’s internal issues arising in business operations, the various theories or
principles of microeconomics applied are as follows:
• Theory of Demand: The demand theory emphasises on the consumer’s behaviour towards a product
or service. It takes into consideration the needs, wants, preferences and requirement of the
consumers to enhance the production process.
• Theory of Production and Production Decisions: This theory is majorly concerned with the volume of
production, process, capital and labour required, cost involved, etc. It aims at maximising the output to
meet the customer’s demand.
• Pricing Theory and Analysis of Market Structure: It focuses on the price determination of a product
keeping in mind the competitors, market conditions, cost of production, maximising sales volume, etc.
• Profit Analysis and Management: The organisations work for a profit. Therefore they always aim at
profit maximisation. It depends upon the market demand, cost of input, competition level, etc.
• Theory of Capital and Investment Decisions: Capital is the most critical factor of business. This theory
prevails the proper allocation of the organisation’s capital and making investments in profitable
projects or venture to improve organisational efficiency.
Macro-Economics Applied to Business Environment
Any organisation is much affected by the environment it operates in. The business
environment can be classified as follows:
• Economic Environment: The economic conditions of a country, GDP, economic
policies, etc. indirectly impacts the business and its operations.
• Social Environment: The society in which the organisation functions also affects it
like employment conditions, trade unions, consumer cooperatives, etc.
• Political Environment: The political structure of a country, whether authoritarian
or democratic; political stability; and attitude towards the private sector,
influence organizational growth and development.
Managerial economics provides an essential tool for determining the business
goals and targets, the actual position of the organization, and what the
management should do fill the gap between the two.
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
behaviour 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.