Unit-I Introduction to Managerial Economics

Introduction of Managerial Economics

Economics is “the study of the behaviour of human beings in producing, distributing
and consuming material goods and services in a world of scarce resources”.

Management is the discipline of organizing and allocating a firm’s scarce resources to

achieve its desired objectives.

These two definitions clearly point to the relationship between economics and
managerial decision making.

Meaning of Managerial Economics

Managerial Economics is a field of study that uses micro economics to help businesses
solve problems and make decisions. It’s a decision making technique that helps firms
improve their efficiency and effectiveness.

Managerial economics is a stream of management studies that emphasizes primarily on

solving business problems and decision-making by applying the theories and principles
of microeconomics and macroeconomics.

Definition of Managerial Economics:

Milton H. Spencer and Lonis Siegelman define Managerial Economics as “the
integration of economic theory with business practice for the purpose of facilitating
decision making and forward planning by management.”

In the words of Me Nair and Meriam, “Managerial Economics consists of the use of
economic modes of thought to analyse business situations.”
 Nature/Features/characteristics of managerial economics:

Nature of managerial economics is explained below:

1. Art and Science: Managerial economics is both a science and an art. As a science,
it establishes relationship between cause and effect by collecting, classifying and
analyzing the facts on the basis of certain principles. It points out to the objectives
and also shows the way to attain the said objectives.

2. Microeconomics: Managers typically deal with the problems relevant to a single

entity rather than the economy as a whole. It is therefore considered an integral part of
microeconomics.

3. Uses of Macro Economics: Managerial economics takes the help of macro-

economics to understand the overall economy and its impact on an organisation ,and to
make informed business decisions.4. Multidisciplinary: Managerial economics makes
use of most modern tools of mathematics, statistics and operation research. In decision
making and planning principles such as accounting, finance, marketing, production and
personnel etc.

5. Prescriptive or Normative Discipline:

Managerial economics is prescriptive because it tells managers what goals to pursue

and how to achieve them in specific situations. It prescribes solutions to various
business problems.

*"Prescriptive" means giving exact rules, directions, or instructions about how to do

something. "Normative" means relating to or dealing with norms, and can also mean
pertaining to giving directives or rules.
6. Management Oriented: This serves as an instrument in managers’ hands to deal effectively
with business-related problems and uncertainties. This also allows for setting priorities,
formulating policies, and making successful decisions.

7. Pragmatic: Managerial economics is pragmatic. It concentrates on making

economic theory more application oriented. It tries to solve the managerial problems in
their day-today functioning.

Scope/Importance of Managerial Economics:

1. Demand Analysis and Forecasting

2. Cost and Production Analysis

3. Pricing Decisions, Policies, and Practices

3. Pricing Decisions, Policies, and Practices

4. Capital Management

5. Profit Management

1. Demand Analysis and Forecasting: A firm relies on converting inputs into outputs
and generates revenue from them. A clear and accurate estimation of demand ensures a
continuous efficiency of the firm. Several external factors like price, income, affect the
demand that need to be analyzed.

Upon analyzing these factors affecting the demand for a product, managers can decide
on the production. After estimating the current demands, manager’s move ahead to
predict future demands for the product. This is referred to as demand forecasting.

2. Cost and Production Analysis: Cost Analysis is yet another function of Managerial
economics. A company makes a profit in two ways: by increasing the demand or by
reducing the cost. The determinants of assessing costs, the connection between cost and
yield, the gauge of cost and benefit are indispensable to a firm.

3. Pricing Decisions, Policies, and Practices: Among the 4Ps of marketing, Price
finds an important place. For any firm, Pricing is a very important aspect of Managerial
Economics as a firm's revenue earnings largely depend on its pricing policy. However,
it is a bit challenging as other players are competing in the same price segment.

4. Capital Management: Every asset a business owns is known as its

capital. Capital management thus becomes an important practice. Planning and control
of capital expenditures is a basic executive function. It involves the Equi-marginal
principle. The prime objective is to ensure the sustainable use of capital. This means
that funds should be kept at a bay when the managerial returns are less than in other
uses.

The main topics dealt with during capital management are Cost of Capital, Rate of
Return, and Selection of Projects.

5. Profit Management: A business firm is an organization designed with an intention

to make profits and profits reflect the success of a company. After all the analyses, it all
rolls down to profits. To maximize profits a firm needs to manage certain things like
pricing, cost aspects, resource allocation, and long-run decisions. The important aspects
are measurement of profit, profit policies, and techniques of profit planning like break-
even analysis, cost-volume-profit analysis, etc.

Relationship between Managerial economics and other subjects:

Managerial economic is not something which is related to economics only, but there are
other areas also to which managerial economic is related. Other related subjects of
managerial economics are:

 Economics and Managerial Economics

 Mathematics and Managerial Economics
 Statistics and Managerial Economics
 Operation Research and Managerial Economics
 Management and Managerial Economics
 Accounting and Managerial Economics
 Computers and Managerial Economics
Economic and Managerial Economics: Economics contributes a great deal towards
the performance of managerial duties and responsibilities. Managers with working
knowledge of economics can perform their function more efficiently than those
without it.

Mathematics and Managerial Economics: Businessmen deal primarily with concepts

that are essentially quantitative in nature e.g. demand, price, cost, wages etc. The use
of mathematical logic in the analysis of economic variable provides not only clarity of
concepts but also a logical and systematical framework.

Statistics and Managerial Economics: The statistical tools for e.g. theory of
probability, forecasting techniques, and regression analysis help the decision makers in
predicting the future course of economic events and probable outcome of their business
decision.
Operation Research and Managerial Economics: It’s an inter-disciplinary solution
finding techniques. It combines economics, mathematics, and statistics to build
models for solving specific business problems. Linear programming and goal
programming are two widely used Operational Research in business decision making. It
has influenced Managerial Economics through its new concepts and model for dealing
with risks.

Management Theory and Managerial Economics: As the definition of management

says that it’s an art of getting things done through others. But now a day we can define
management as doing right things, at the right time, with the help of right people so that
organizational goals can be achieved. Managerial economics has also been influenced
by the developments in the management theory. The central concept in the theory of
firm in micro economic is the maximization of profits. Managerial economics should
take note of changes concepts of managerial principles, concepts, and changing view of
enterprises goals.

Accounting and Managerial Economics: Under Accounting an accountant maintains

different accounting in systematic manner which will help the manager to take fruitful
decisions for the benefit of business organisation

Hence, concepts, methods and policies of accounting are also used under managerial
economics for solving problems of managers.

Computers and Managerial Economics: Computer helps a lot in decision making.

Through computers data, it is easy to take decisions. There are so many sites which
help us in giving knowledge of various things, and in a way helps us in updating our
knowledge.

Conclusions: Managerial Economics is closely related to various subjects i.e.

Economics, mathematics, statistics, and accountings. Computers etc. a trained
managerial economist integrates concepts and methods from all these subjects bringing
them to bear on business problem of a firm. In practical, all these subjects are getting
closed to Managerial Economics and there appears to be trends towards their
integration.

Managerial Economics Usefulness to Engineers:

A part from benefitting the business managers, managerial economics has advanced to
benefit the engineers as well. Economics is a beneficial subject for every decision-
maker and engineers to make crucial decisions in their careers.

Managerial Economics Usefulness to Engineers:

• To enhance the decision-making efficiency in business in order to increase profit.

• To study economics at the macro-level to analyze the significance of the subject in

an organization and the functioning of an organization.

• It examines the way the changing environment brings in profit for the organization
in the perfect way.

• It helps in making good decisions when it comes to choosing an alternative that

could reduce cost.

• It plays a crucial role of to help in making investment decisions for the individual
investors as well as for the corporations.

• It helps the business companies in deciding the strategies of pricing as well as

deciding the correct pricing levels to be given to their services and products.

• It helps in the decision-making related to internal working of a company like price

changes, plans of investment, and types of services to be given, inputs utilized and so
on.

However, it is important to note that engineers at the testing, developing and designing
levels do not have anything to do with managerial economics. For other engineers,
having a good knowledge of managerial economics would greatly help in valuing the
subject.

Engineering yielding too much cost in building something is not good engineering. In
order to become good engineer who has good knowledge about the ways to manage
cost and prices while providing engineering solutions, one must have a stronghold in
managerial economics.

Fundamental Concepts of managerial economics:

1. Scarcity Concept
2. Marginalism Concept
3. Equi-Marginalism utility Concept
4. Opportunity Cost concept
5. Discounting Principle concept
6. Time Perspective Concept
7. Risk and Uncertainty Concept
8. Profit concept
1. Scarcity Concept
This concept refers to the basic economic problem, the gap between limited i.e., scarce
resources and limitless wants. This situation requires people to make decisions about
how to allocate resources efficiently, in order to satisfy basic needs and as many
additional wants as possible.
2. Marginalism Concept:
A marginal benefit is the additional satisfaction or utility that a person receives from
consuming an additional unit of a good or service. Persons marginal benefit is the
maximum amount he is willing to pay to consume that additional unit of a good or
service. In a normal situation, the marginal benefit decreases as consumption increases.
3. EQUI-MARGINAL UTILITY PRINCIPLES
The law of equi-marginal utility explains the behaviour of a consumer when he
consumes more than one commodity. The law also called “law of substitution or law of
maximum satisfaction. It explains how an input to be allocated to produce various
products to obtain maximum profit.
4. THE CONCEPT OF OPPORTUNITY COST
In Managerial Economics, the opportunity cost concept is useful in decision involving
a choice between different alternative courses of action.
Resources are scarce; we cannot produce all the commodities. For the production of
one commodity, we have to forego the production of another commodity.
When you choose a particular alternative, the next best alternative must be given up.
For example, if you choose to watch cricket highlights in T.V., you must give up an
extra hour study.
Thus the “opportunity cost” is the cost of something in terms of an opportunity forgone.
In other words, the opportunity cost of an action is the value of next best alternative
forgone.
5. Discounting Principle:

Discounting principles explains 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. as it can
yield some interest during one year by investing.

6. 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.

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.

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.

7. Risk and Uncertainty concept

Management deals with decisions which have long term bearing, and since future
conditions are not perfectly predictable, there is always a sense of risk and uncertainty
about the outcome of such decision.

8. Profit Concept

Profit plays an important role in a free enterprise economy. It provides the resources for
expansion and encourages entrepreneurs to increase production.