Chapter One
Introduction to Managerial Economics
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 and Other Disciplines
Managerial economics has its relationship with other disciplines for propounding its theories
and concepts for managerial decision-making.
Essentially, it is a branch of economics.
Managerial economics is closely related to certain subjects like statistics, mathematics,
accounting and operations research.
Managerial economics helps in estimating the product demand, planning of production
schedule, deciding the input combinations, estimation of cost of production, achieving
economies of scale and increasing the returns to scale. It also includes determining price of
the product, analyzing market structure to determine the price of the product for profit
maximization, which helps them to control and plan capital in an effective manner.
Successful mangers make good decisions, and one of their most useful tools is the
methodology of managerial economics.
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.
We can conclude that managerial economics consists of applying economic principles and
concepts towards adjusting with various uncertainties faced by a business firm.
Circular Flow of Economic Activity
The individuals own or control resources, which are necessary inputs for the firms in the
production process.
These resources (factors of production) are classified into four types.
Land: It includes all natural resources on the earth and below the earth. Non-renewable
resources such as oil, coal etc once used will never be replaced. It will not be available for our
children. Renewable resources can be used and replaced and is not depleted with use.
Labour: is the work force of an economy. The value of the worker is called as human capital.
Capital: It is classified as working capital and fixed capital (not transformed into final products)
Entrepreneurship: It refers to the individuals who organize production and take risks. All these
resources are allocated in an effective manner to achieve the objectives of consumers (to
maximize satisfaction), workers (to maximize wages), firms (to maximize the output and profit)
and government (to maximize the welfare of the society).
The fundamental economic activities between households and firms are shown in the diagram.
The circular flows of economic activities are explained in a clockwise and counterclockwise
flow of goods and services.
The four sectors namely households, business, government and the rest of the world can also be
considered to see the flow of economic activities.
The circular flow of activity is a chain in which production creates income, income generates
spending and spending in turn induces production.
The major four sectors of the economy are engaged in three economic activities of production,
consumption and exchange of goods and services.
These sectors are as follows:
Households: Households fulfill their needs and wants through purchase of goods and services
from the firms. They are owners and suppliers of factors of production and in turn, they receive
income in the form of rent, wages and interest.
Firms: Firms employ the input factors to produce various goods and services and make
payments to the households.
Government: The government purchases goods and services from firms and factors of
production from households by making payments.
Foreign sector: Households, firms and government of India purchase goods and services
(import) from abroad and make payments. On the other hand, all these sectors sell goods and
services to various countries (export) and in turn receive payments from abroad
Nature of the Firm
A firm is an association of individuals who have organized themselves for turning inputs into
output.
The firm organizes the factors of production to produce goods and services to fulfill the needs of
the households.
Each firm lays down its own objectives which is fundamental to the existence of a firm.
The major objectives of the firm are:
To achieve the Organizational Goal
To maximize the Output
To maximize the Sales
To maximize the Profit of the Organization
To maximize the Customer and Stakeholders Satisfaction
To maximize Shareholder’s Return on Investment
To maximize the Growth of the Organization
Firms are established to earn profit, to keep the shareholders happy.
To increase their market share, they try to maximize their sales.
In the present business world firms try to produce goods and services without harming the
environment. Firms are not always able to operate at a profit. They may be facing the operating
loss also. Economists believe that firms maximize their long run rather than their short run profit.
Therefore, managers have to make enough profit to satisfy the demands of their shareholders and
to maximize their wealth through the company.