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The Definition and Scope of Managerial Economics

Objectives: After studying the chapter, you should understand:

1. The subject matter of Managerial Economics

2. The analytical approach or concepts used in Managerial Economics

What is managerial economics?


Managerial economics is .. the application of economic principles and methodologies to the decisionmaking process within the firm or organization.
economic theory and methods administrative decision-making. to business and

Pappas & Hirschey - Managerial economics applies

Salvatore - Managerial economics refers to the application

of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively.


It involves an application of managerial economic theory.
It is a science as well as art. It is concerned with firms behaviour in optimal allocation

of resources.


The application of managerial economics is, by no means,

limited . Tools of managerial economics can be used to achieve virtually all the goals of a business organization in an efficient manner. Typical managerial decision making may involve one of the following issues:

Various decisions are

Deciding the price of a product and the quantity of the

commodity to be produced Deciding whether to manufacture a product or to buy from another manufacturer Choosing the production technique to be employed in the production of a given product Deciding on the level of inventory a firm will maintain of a product or raw material Deciding on the advertising media and the intensity of the advertising campaign Making employment and training decisions Making decisions regarding further business investment and the mode of financing the investment


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, which describes how businesses make a variety of decisions; (2) The theory of consumer behavior, which describes decision making by consumers; and (3) The theory of market structure and pricing, which describes the structure and characteristics of different market forms under which business firms operate.


The theory of the firm is an useful way to begin the study of

managerial economics. The theory provides a broad framework within which issues relevant to managerial decisions are analyzed. 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. The behavior of firms is usually analyzed in the context of an economic model, an idealized version of a real-world firm. The basic economic model of a business enterprise is called the theory of the firm.


Consumers play an important role in the economy since they

spend most of their incomes on goods and services produced by firms. In other words, they consume what firms produce. Thus, studying the theory of consumer behavior is quite important. Economists have an optimization model for consumers, similar to that applied to firms or producers. While firms are assumed to be maximizing profits, consumers are assumed to be maximizing their utility or satisfaction. Of course, more goods and services will, in general, provide greater utility to a consumer.


As mentioned earlier, firms' profit maximizing output

decisions take into account the market structure under which they are operating. There are four kinds of market organizations: Perfect competition, Monopolistic competition, oligopoly, And Monopoly.

It is a market form in which there is large no. of seller and

large no. buyer dealing with identical product.

Conditions need to be satisfied before a market structure is

considered perfectly competitive are:

existence of many buyers and sellers. homogeneity of the product sold in the industry. Perfect knowledge about market perfect mobility of resources or factors of production. Free entry and exit Example..FMCG products.

A market structure comprising many firms competing with

differentiated product . The sellers under monopolistic competition differentiate their product; unlike under perfect competition, the products are not considered identical. Free entry and exit Selling cost. ExampleApparel retail stores in india. pantaloon, life style, fashion bazaar

Oligopoly means there is few seller in market and large no. of

buyer. Competition among the few producer. Probably the most important characteristic of an oligopolistic market structure is the interdependence of firms in the industry. If an oligopolistic firm changes its price or output, it has perceptible effects on the sales and profits of its competitors in the industry. Thus, an oligopolistic market always considers the reactions of its rivals in formulating its pricing or output decisions. Example.. Tyre producer in India..MRF,CEAT,Apollo,TVS, JK, Continental

Monopoly can be considered as the polar opposite of perfect competition.
It is a market form in which there is only one seller and large no. buyer. There are many factors that give rise to a monopoly. Like high cost of

product/service in production, govt. rules

A monopoly may arise due to declining cost of production for a particular

product. Example.. Fevi quick

Example.. Monopoly due to rules. Indian railway (govt.rules)


Managerial decisions both in the short run and in the long run

are partly shaped by the market structure relevant to the firm. The following economic concept are fundamental to business analysis and decision making. And it includes Opportunity cost Optimisation techniques Incremental principle Time perspective and Discounting principle.

EXPLANATION: OPPORTUNITY COST:-The cost of sacrificing something else(y) from the use of a given resources when a decision is made in favour of one thing (x). OPTIMISATION TECHNIQUE: EQUI MARGINAL PRINCIPLE:-The equi marginal principle is fundamental in economics analysis. It is very significant in determining optimal condition in resource allocation. INCREMENTAL PRINCIPLE:-The incremental concept refers to the change in total , e.g., incremental cost may be defined as the change in total cost due to a specific decision. similarly incremental revenue is the change in total revenue caused by a decision. TIME PERSPECTIVE:-Time is an important factor in business decision making. A timely decision is always effective and rewarding, if appropriate. In business decisions , in relation to time period , there are short term and long term perspective. o SHORT TERM PERSPECTIVE:-Short term time perspectives are based on the short-run analysis of the business data and performance. o LONG TERM PERSPECTIVE :-In long run the perception is towards growth development and expansion.

DISCOUNTING PRINCIPLE:- A present gain is value

more then 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: V=A/(1+i) where ,V=present value, A=annuity or returns expected during a year , I =current rate of interest.


Four major differences are listed here:

1) Managerial economics is an interdisciplinary study combining microeconomics, operational research, managerial accounting and psychology. Microeconomics is a disciplinary study. 2) Managerial economics applies available economic reasoning to get practical solution whereas microeconomics searches for new reasoning to get theoretical solution.

Therefore managerial economics is for practitioners while microeconomics is for theorists. 3) Assumptions of the study in managerial economics are more realistic. Managerial economics, coping with realistic problem, places more realistic assumptions to get more precise solution. Microeconomics assumes simpler situations to make theoretical points easy and clear. 4) The element of the study of managerial economics is narrower. Managerial economics deals with each transaction while microeconomics deals with a firm as an organization.