MANAGERIAL ECONOMICS

Managerial economics (sometimes referred to as business economics) is a branch

of economics that appliesmicroeconomic analysis to decision methods of businesses or

other management units. As such, it bridges economic theory and economics in practice. It

draws heavily from quantitative techniques such as regression

analysis andcorrelation, Lagrangian calculus (linear). If there is a unifying theme that runs

through most of managerial economics it is the attempt to optimize business decisions

given the firm's objectives and given constraints imposed by scarcity, for example through

the use of operations research and programming.

Almost any business decision can be analyzed with managerial economics techniques, but

it is most commonly applied to:

Risk analysis - various models are used to quantify risk and

asymmetric information and to employ them in decision rules to manage risk.

Production analysis - microeconomic techniques are used to analyze production

efficiency, optimum factor allocation, costs, economies of scale and to estimate the

firm's cost function.

Pricing analysis - microeconomic techniques are used to analyze various pricing

decisions including transfer pricing,joint product pricing, price discrimination, price

elasticity estimations, and choosing the optimum pricing method.

Capital budgeting - Investment theory is used to examine a firm's capital

purchasing decisions.

At universities, the subject is taught primarily to advanced undergraduates and graduate

business schools. It is approached as an integration subject. That is, it integrates many

concepts from a wide variety of prerequisite courses. In many countries it is possible to

read for a degree in Business Economics which often covers managerial

economics,financial economics, game theory, business forecasting and industrial

economics.

MANAGERIAL ECONOMICS

Managerial Economics can be defined as amalgamation of economic theory with business practices so as to ease decision-making and future planning by management. Managerial Economics assists the managers of a firm in a rational solution of obstacles faced in the firm’s activities. It makes use of economic theory and concepts. It helps in formulating logical managerial decisions. The key of Managerial Economics is the micro-economic theory of the firm. It lessens the gap between economics in theory and economics in practice. Managerial Economics is a science dealing with effective use of scarce resources. It guides the managers in taking decisions relating to the firm’s customers, competitors, suppliers as well as relating to the internal functioning of a firm. It makes use of statistical and analytical tools to assess economic theories in solving practical business problems.

Study of Managerial Economics helps in enhancement of analytical skills, assists in rational configuration as well as solution of problems. While microeconomics is the study of decisions made regarding the allocation of resources and prices of goods and services, macroeconomics is the field of economics that studies the behavior of the economy as a whole (i.e. entire industries and economies). Managerial Economics applies micro-economic tools to make business decisions. It deals with a firm.

The use of Managerial Economics is not limited to profit-making firms and organizations. But it can also be used to help in decision-making process of non-profit organizations (hospitals, educational institutions, etc). It enables optimum utilization of scarce resources in such organizations as well as

helps in achieving the goals in most efficient manner. Managerial Economics is of great help in price analysis, production analysis, capital budgeting, risk analysis and determination of demand.

Managerial economics uses both Economic theory as well as Econometrics for rational managerial decision making. Econometrics is defined as use of statistical tools for assessing economic theories by empirically measuring relationship between economic variables. It uses factual data for solution of economic problems. Managerial Economics is associated with the economic theory which constitutes “Theory of Firm”. Theory of firm states that the primary aim of the firm is to maximize wealth. Decision making in managerial economics generally involves establishment of firm’s objectives, identification of problems involved in achievement of those objectives, development of various alternative solutions, selection of best alternative and finally implementation of the decision.

The following figure tells the primary ways in which Managerial Economics correlates to managerial decision-making.

Scope of Managerial Economics

Managerial Economics deals with allocating the scarce resources in a manner that minimizes the cost. As we have already discussed, Managerial Economics is different from microeconomics and macro-economics. Managerial Economics has a more narrow scope - it is actually solving managerial issues using micro-economics. Wherever there are scarce resources, managerial economics ensures that managers make effective and efficient decisions concerning customers, suppliers, competitors as well as within an organization. The fact of scarcity of resources gives rise to three fundamental questions-

a. What to produce?b. How to produce?c. For whom to produce?

To answer these questions, a firm makes use of managerial economics principles.

The first question relates to what goods and services should be produced and in what amount/quantities. The managers use demand theory for deciding this. The demand theory examines consumer behaviour with respect to the kind of purchases they would like to make currently and in future; the factors influencing purchase and consumption of a specific good or service; the impact of change in these factors on the demand of that specific good or service; and the goods or services which consumers might not purchase and consume in future. In order to decide the amount of goods and services to be produced, the managers use methods of demand forecasting.

The second question relates to how to produce goods and services. The firm has now to choose among different alternative techniques of production. It has to make decision regarding purchase of raw materials, capital equipments, manpower, etc. The managers can use various managerial

economics tools such as production and cost analysis (for hiring and acquiring of inputs), project appraisal methods( for long term investment decisions),etc for making these crucial decisions.

The third question is regarding who should consume and claim the goods and services produced by the firm. The firm, for instance, must decide which is it’s niche market-domestic or foreign? It must segment the market. It must conduct a thorough analysis of market structure and thus take price and output decisions depending upon the type of market.

Managerial economics helps in decision-making as it involves logical thinking. Moreover, by studying simple models, managers can deal with more complex and practical situations. Also, a general approach is implemented. Managerial Economics take a wider picture of firm, i.e., it deals with questions such as what is a firm, what are the firm’s objectives, and what forces push the firm towards profit and away from profit. In short, managerial economics emphasizes upon the firm, the decisions relating to individual firms and the environment in which the firm operates. It deals with key issues such as what conditions favour entry and exit of firms in market, why are people paid well in some jobs and not so well in other jobs, etc. Managerial Economics is a great rational and analytical tool.

Managerial Economics is not only applicable to profit-making business organizations, but also to non- profit organizations such as hospitals, schools, government agencies, etc.

Principles of Managerial Economics

Economic principles assist in rational reasoning and defined thinking. They develop logical ability and strength of a manager. Some important principles of managerial economics are:

1. Marginal and Incremental Principle

This principle states that a decision is said to be rational and sound if given the firm’s objective of profit maximization, it leads to increase in profit, which is in either of two scenarios-

If total revenue increases more than total cost. If total revenue declines less than total cost.

Marginal analysis implies judging the impact of a unit change in one variable on the other. Marginal generally refers to small changes. Marginal revenue is change in total revenue per unit change in output sold. Marginal cost refers to change in total costs per unit change in output produced (While incremental cost refers to change in total costs due to change in total output).The decision of a firm to change the price would depend upon the resulting impact/change in marginal revenue and marginal cost. If the marginal revenue is greater than the marginal cost, then the firm should bring about the change in price.

Incremental analysis differs from marginal analysis only in that it analysis the change in the firm's performance for a given managerial decision, whereas marginal analysis often is generated by a change in outputs or inputs. Incremental analysis is generalization of marginal concept. It refers to changes in cost and revenue due to a policy change. For example - adding a new business, buying new inputs, processing products, etc. Change in output due to change in process, product or investment is considered as incremental change. Incremental principle states that a decision is profitable if revenue increases more than costs; if costs reduce more than revenues; if increase in some revenues is more than decrease in others; and if decrease in some costs is greater than increase in others.

2. Equi-marginal Principle

Marginal Utility is the utility derived from the additional unit of a commodity consumed. The laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when the marginal utilities of various commodities he consumes are equal. According to the modern economists, this law has been formulated in form of law of proportional marginal utility. It states that the consumer will spend his money-income on different goods in such a way that the marginal utility of each good is proportional to its price, i.e.,

MUx / Px = MUy / Py = MUz / Pz

Where, MU represents marginal utility and P is the price of good.

Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the technique of production which satisfies the following condition:

MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3

Where, MRP is marginal revenue product of inputs and MC represents marginal cost.

Thus, a manger can make rational decision by allocating/hiring resources in a manner which equalizes the ratio of marginal returns and marginal costs of various use of resources in a specific use.

3. Opportunity Cost Principle

By opportunity cost of a decision is meant the sacrifice of alternatives required by that decision. If there are no sacrifices, there is no cost. According to Opportunity cost principle, a firm can hire a factor of production if and only if that factor earns a reward in that occupation/job equal or greater than it’s opportunity cost. Opportunity cost is the minimum price that would be necessary to retain a factor-service in it’s given use. It is also defined as the cost of sacrificed alternatives. For instance, a person chooses to forgo his present lucrative job which offers him Rs.50000 per month, and organizes his own business. The opportunity lost (earning Rs. 50,000) will be the opportunity cost of running his own business.

4. Time Perspective Principle

According to this principle, a manger/decision maker should give due emphasis, both to short-term and long-term impact of his decisions, giving apt significance to the different time periods before reaching any decision. Short-run refers to a time period in which some factors are fixed while others are variable. The production can be increased by increasing the quantity of variable factors. While long-run is a time period in which all factors of production can become variable. Entry and exit of seller firms can take place easily. From consumers point of view, short-run refers to a period in which they respond to the changes in price, given the taste and preferences of the consumers, while long-run is a time period in which the consumers have enough time to respond to price changes by varying their tastes and preferences.

5. Discounting Principle

According to this principle, if a decision affects costs and revenues in long-run, all those costs and revenues must be discounted to present values before valid comparison of alternatives is possible. This is essential because a rupee worth of money at a future date is not worth a rupee today. Money actually has time value. Discounting can be defined as a process used to transform future dollars into an equivalent number of present dollars. For instance, $1 invested today at 10% interest is equivalent to $1.10 next year.

FV = PV*(1+r)t

Where, FV is the future value (time at some future time), PV is the present value (value at t0, r is the discount (interest) rate, and t is the time between the future value and present value.

Role of a Managerial Economist

A managerial economist helps the management by using his analytical skills and highly developed techniques in solving complex issues of successful decision-making and future advanced planning.

The role of managerial economist can be summarized as follows:

1. He studies the economic patterns at macro-level and analysis it’s significance to the specific firm he is working in.

2. He has to consistently examine the probabilities of transforming an ever-changing economic environment into profitable business avenues.

3. He assists the business planning process of a firm.4. He also carries cost-benefit analysis.5. He assists the management in the decisions pertaining to internal functioning of a firm such as changes

in price, investment plans, type of goods /services to be produced, inputs to be used, techniques of production to be employed, expansion/ contraction of firm, allocation of capital, location of new plants, quantity of output to be produced, replacement of plant equipment, sales forecasting, inventory forecasting, etc.

6. In addition, a managerial economist has to analyze changes in macro- economic indicators such as national income, population, business cycles, and their possible effect on the firm’s functioning.

7. He is also involved in advicing the management on public relations, foreign exchange, and trade. He guides the firm on the likely impact of changes in monetary and fiscal policy on the firm’s functioning.

8. He also makes an economic analysis of the firms in competition. He has to collect economic data and examine all crucial information about the environment in which the firm operates.

9. The most significant function of a managerial economist is to conduct a detailed research on industrial market.

10. In order to perform all these roles, a managerial economist has to conduct an elaborate statistical analysis.

11. He must be vigilant and must have ability to cope up with the pressures.12. He also provides management with economic information such as tax rates, competitor’s price and

product, etc. They give their valuable advice to government authorities as well.13. At times, a managerial economist has to prepare speeches for top management.

Consumer Demand - Demand Curve, Demand Function & Law of Demand

What is Demand?Demand for a commodity refers to the quantity of the commodity that people are willing to purchase at a specific price per unit of time, other factors (such as price of related goods, income, tastes and preferences, advertising, etc) being constant. Demand includes the desire to buy the commodity accompanied by the willingness to buy it and sufficient purchasing power to purchase it. For instance-Everyone might have willingness to buy “Mercedes-S class” but only a few have the ability to pay for it. Thus, everyone cannot be said to have a demand for the car “Mercedes-s Class”.

Demand may arise from individuals, household and market. When goods are demanded by individuals (for instance-clothes, shoes), it is called as individual demand. Goods demanded by household constitute household demand (for instance-demand for house, washing machine). Demand for a commodity by all individuals/households in the market in total constitute market demand.

Demand FunctionDemand function is a mathematical function showing relationship between the quantity demanded of a commodity and the factors influencing demand.

Dx = f (Px, Py, T, Y, A, Pp, Ep, U)In the above equation,Dx = Quantity demanded of a commodityPx = Price of the commodityPy = Price of related goodsT = Tastes and preferences of consumerY = Income levelA = Advertising and promotional activitiesPp = Population (Size of the market)Ep = Consumer’s expectations about future pricesU = Specific factors affecting demand for a commodity such as seasonal changes, taxation policy, availability of credit facilities, etc.

Law of DemandThe law of demand states that there is an inverse relationship between quantity demanded of a commodity and it’s price, other factors being constant. In other words, higher the price, lower the demand and vice versa, other things remaining constant.

Demand ScheduleDemand schedule is a tabular representation of the quantity demanded of a commodity at various prices. For instance, there are four buyers of apples in the market, namely A, B, C and D.

Demand schedule for apples

PRICE (Rs. per dozen)

Buyer A (demand in dozen)

Buyer B (demand in dozen)

Buyer C (demand in dozen)

Buyer D (demand in dozen)

Market Demand (dozens)

10 1 0 3 0 4

9 3 1 6 4 14

8 7 2 9 7 25

7 11 4 12 10 37

6 13 6 14 12 45

The demand by Buyers A, B, C and D are individual demands. Total demand by the four buyers is market demand. Therefore, the total market demand is derived by summing up the quantity demanded of a commodity by all buyers at each price.

Demand CurveDemand curve is a diagrammatic representation of demand schedule. It is a graphical representation of price- quantity relationship. Individual demand curve shows the highest price which an individual is willing to pay for different quantities of the commodity. While, each point on the market demand curve depicts the maximum quantity of the commodity which all consumers taken together would be willing to

buy at each level of price, under given demand conditions.

Demand curve has a negative slope, i.e, it slopes downwards from left to right depicting that with increase in price, quantity demanded falls and vice versa. The reasons for a downward sloping demand curve can be explained as follows-

1. Income effect- With the fall in price of a commodity, the purchasing power of consumer increases. Thus, he can buy same quantity of commodity with less money or he can purchase greater quantities of same commodity with same money. Similarly, if the price of a commodity rises, it is equivalent to decrease in income of the consumer as now he has to spend more for buying the same quantity as before. This change in purchasing power due to price change is known as income effect.

2. Substitution effect- When price of a commodity falls, it becomes relatively cheaper compared to other commodities whose price have not changed. Thus, the consumer tend to consume more of the commodity whose price has fallen, i.e, they tend to substitute that commodity for other commodities which have not become relatively dear.

3. Law of diminishing marginal utility- It is the basic cause of the law of demand. The law of diminishing marginal utility states that as an individual consumes more and more units of a commodity, the utility derived from it goes on decreasing. So as to get maximum satisfaction, an individual purchases in such a manner that the marginal utility of the commodity is equal to the price of the commodity. When the price of commodity falls, a rational consumer purchases more so as to equate the marginal utility and the price level. Thus, if a consumer wants to purchase larger quantities, then the price must be lowered. This is what the law of demand also states.

Exceptions to Law of DemandThe instances where law of demand is not applicable are as follows-

1. There are certain goods which are purchased mainly for their snob appeal, such as, diamonds, air conditioners, luxury cars, antique paintings, etc. These goods are used as status symbols to display one’s wealth. The more expensive these goods become, more valuable will be they as status symbols and more will be there demand. Thus, such goods are purchased more at higher price and are purchased less at lower prices. Such goods are called as conspicuous goods.

2. The law of demand is also not applicable in case of giffen goods. Giffen goods are those inferior goods, whose income effect is stronger than substitution effect. These are consumed by poor households as a necessity. For instance, potatoes, animal fat oil, low quality rice, etc. An increase in price of such good increases its demand and a decrease in price of such good decreases its demand.

3. The law of demand does not apply in case of expectations of change in price of the commodity, i.e, in case ofspeculation. Consumers tend to purchase less or tend to postpone the purchase if they expect a fall in price of commodity in future. Similarly, they tend to purchase more at high price expecting the prices to increase in future.

Nature Of Managerial Economics

Managerial Economics and Business economics are the two terms, which, at times have been used

interchangeably. Of late, however, the term Managerial Economics has become more popular and

seems to displace progressively the term Business Economics.

The prime function of a management executive in a business organization is decision-making and

forward planning. Decision-making means the process of selecting one action from two or more

alternative courses of action whereas forward planning means establishing plans for the future. The

question of choice arises because resources such as capital, land, labour and management are

limited and can be employed in alternative uses. The decision-making function thus becomes one

of making choices or decisions that will provide the most efficient means of attaining a desired end,

say, profit maximization. Once decision is made about the particular goal to be achieved, plans as

to production, pricing, capital, raw materials, labour, etc., are prepared. Forward planning thus goes

hand in hand with decision-making.

A significant characteristic of the conditions, in which business organizations work and take

decisions, is uncertainty. And this fact of uncertainty not only makes the function of decision-making

and forward planning complicated but adds a different dimension to it. If knowledge of the future

were perfect, plans could be formulated without error and hence without any need for subsequent

revision. In the real world, however, the business manager rarely has complete information and the

estimates about future predicted as best as possible. As plans are implemented over time, more

facts become known so that in their light, plans may have to be revised, and a different course of

action adopted. Managers are thus engaged in a continuous process of decision-making through an

uncertain future and the overall problem confronting them is one of adjusting to uncertainty.

In fulfilling the function of decision-making in an uncertainty framework, economic theory can be

pressed into service with considerable advantage. Economic theory deals with a number of

concepts and principles relating, for example, to profit, demand, cost, pricing production,

competition, business cycles, national income, etc., which aided by allied disciplines like

Accounting. Statistics and Mathematics can be used to solve or at least throw some light upon the

problems of business management. The way economic analysis can be used towards solving

business problems. Constitutes the subject-matte of Managerial Economics.Definition Of Managerial Economics

According to McNair and Meriam, Managerial Economics consists of the use of economic modes of

thought to analyse business situation Spencer and Siegelman have defined Managerial Economics

as “the integration of economic theory with business practice for the purpose of facilitating decision-

making and forward planning by management”. We may, therefore define Managerial Economics as

the discipline which deals with the application of economic theory to business management.

Managerial Economics thus lies on the borderline between economics and business management

and serves as abridge between economics and business management and serves as a bridge

between the two disciplines.See Chart1

Chart 1 – Economics, Business Management and Managerial Economics.

Aspects of Application Of Economics

The application of economics to business management or the integration of economic theory with

business practice, as Spencer and Siegelman have put it, has the following aspects:

1. Reconciling traditional theoretical concepts of economics in relation to the actual

business behavior and conditions. In economic theory, the technique of analysis is one of

model building whereby certain assumptions are made and on that basis, conclusions as

to the behavior of the firms are drown. The assumptions, however, make the theory of the

firm unrealistic since it fails to provide a satisfactory explanation of that what the firms

actually do. Hence the need to reconcile the theoretical principles based on simplified

assumptions with actual business practice and develops appropriate extensions and

reformulation of economic theory, if necessary.

2. Estimating economic relationships, viz., measurement of various types of elasticities

of demand such as price elasticity, income elasticity, cross-elasticity, promotional

elasticity, cost-output relationships, etc. the estimates of these economic relation-ships

are to be used for purposes of forecasting.

3. Predicting relevant economic quantities, eg., profit, demand, production, costs,

pricing, capital, etc., in numerical terms together with their probabilities. As the business

manager has to work in an environment of uncertainty, future is to be predicted so that in

the light of the predicted estimates, decision-making and forward planning may be

possible.

4. Using economic quantities in decision-making and forward planning, that is,

formulating business policies and, on that basis, establishing business plans for the

future pertaining to profit, prices, costs, capital, etc. The nature of economic forecasting

is such that it indicates the degree of probability of various possible outcomes, i.e. losses

or gains as a result of following each one of the strategies available. Hence, before a

business manager there exists a quantified picture indicating the number o courses open,

their possible outcomes and the quantified probability of each outcome. Keeping this

picture in view, he decides about the strategy to be chosen.

5. Understanding significant external forces constituting the environment in which the

business is operating and to which it must adjust, e.g., business cycles, fluctuations in

national income and government policies pertaining to public finance, fiscal policy and

taxation, international economics and foreign trade, monetary economics, labour

relations, anti-monopoly measures, industrial licensing, price controls, etc. The business

manager has to appraise the relevance and impact of these external forces in relation to

the particular business unit and its business policies.

Chief Characteristics Of Managerial Economics

It would be useful to point out certain chief characteristics of Managerial Economics, inasmuch it’s

they throw further light on the nature of the subject matter and help in a clearer understanding

thereof.

1. Managerial Economics micro-economic in character.

2. Managerial Economics largely uses that body of economic concepts and principles,

which is known as ‘Theory of the firm’ or ‘Economics of the firm’. In addition, it also seeks

to apply Profit Theory, which forms part of Distribution Theories in Economics.

3. Managerial Economics is pragmatic. It avoids difficult abstract issues of economic

theory but involves complications ignored in economic theory to face the overall situation

in which decisions are made. Economic theory appropriately ignores the variety of

backgrounds and training found in individual firms but Managerial Economics considers

the particular environment of decision-making.

4. Managerial Economics belongs to normative economics rather than positive

economics (also sometimes known as descriptive economics). In other words, it is

prescriptive rather than descriptive. The main body of economic theory confines itself to

descriptive hypothesis, attempting to generalize about the relations among different

variables without judgment about what is desirable or undesirable. For instance, the law

of demand states that as price increases. Demand goes down or vice-versa but this

statement does not tell whether the outcome is good or bad. Managerial Economics,

however, is concerned with what decisions ought to be made and hence involves value

judgments.

Production and Supply

Production analysis is narrower in scope than cost analysis. Production analysis frequently

proceeds in physical terms while cost analysis proceeds in monetary terms. Production analysis

mainly deals with different production functions and their managerial uses.

Supply analysis deals with various aspects of supply of a commodity. Certain important aspects of

supply analysis are supply schedule, curves and function, law of supply and its limitations. Elasticity

of supply and Factors influencing supply.

Pricing Decisions, Policies and Practices

Pricing is a very important area of Managerial Economics. In fact, price is the ness of the revenue of

a firm and as such the success of a business firm largely depends on the correctness of the pries

decisions taken by it. The important aspects alt with under this area is: Price Determination in

various Market Forms, Pricing methods, Differential Pricing, Product-line Pricing and Price

Forecasting.

Profit Management

Business firms are generally organized for the purpose of making profits and, in long run, profits

provide the chief measure of success. In this connection, an important point worth considering is

the element of uncertainty exiting about profits because of variations in costs and revenues which,

in turn, are caused by torso both internal and external to the firm. If knowledge about the future

were fact, profit analysis would have been a very easy task. However, in a world of certainty,

expectations are not always realized so that profit planning and measurement constitute the difficult

are of Managerial Economics. The important acts covered under this area are: Nature and

Measurement of Profit. Profit iciest and Techniques of Profit Planning like Break-Even Analysis.

Capital Management

Of the various types and classes of business problems, the most complex and able some for the

business manager are likely to be those relating to the firm’s investments. Relatively large sums are

involved, and the problems are so complex that their disposal not only requires considerable time

and labour but is a term for top-level decision. Briefly, capital management implies planning and

trolls of capital expenditure. The main topics dealt with are: Cost of Capital. Rate return and

Selection of Project.

The various aspects outlined above represent the major uncertainties which a ness firm has to

reckon with, viz., demand uncertainty, cost uncertainty, price certainty, profit uncertainty, and capital

uncertainty. We can, therefore, conclude the subject-matter of Managerial Economic consists of

applying economic cripples and concepts towards adjusting with various uncertainties faced by a

ness firm.

Managerial Economics And Other Subjects

Yet another useful method of throwing light upon the nature and scope of managerial Economics is

to examine is relationship with other subjects. In this connection, Economics, statistics,

Mathematics and Accounting deserve special mention.

Managerial Economics and Economics

Managerial Economics has been described as economics applied to decision- making. It may be

viewed as a special branch of economics bridging the gulf between pure economic theory and

managerial practice.

Economics has two main divisions: microeconomics and macroeconomics. Microeconomics has

been defined as that branch where the unit of study is an individual or a firm. Macroeconomics, on

the other hand, is aggregate in character and has the entire economy as a unit of study.

Microeconomics, also known as price theory (or Marshallian economics.) Is the main source of

concepts and analytical tools for managerial economics. To illustrate various micro-economic

concepts such as elasticity of demand, marginal cost, the short and the long runs, various market

forms, etc. are all of great significance to managerial economics. The chief contribution of macro-

economics is in the area of forecasting. The modern theory of income and employment has direct

implications for forecasting general business conditions. As the prospects of an individual firm often

depend greatly on general business conditions, individual firm forecasts depend on general

business forecasts.

A survey in the U.K. has shown that business economists have found the following economic

concepts quite useful and of frequent application:

1. Price elasticity of demand

2. Income elasticity of demand

3. Opportunity cost

4. The multiplier

5. Propensity to consume

6. Marginal revenue product

7. Speculative motive

8. Production function

9. Balanced growth

10. Liquidity preference.

Business economics have also found the following main areas of economi9cs as useful in their

work

1. Demand theory

2. Theory of the firm-price, output and investment decisions

3. Business financing

4. Public finance and fiscal policy

5. Money and banking

6. National income and social accounting

7. Theory of international trade

8. Economics of developing countries.

Managerial Economics and Accounting

Managerial Economics is also closely related to accounting, which is concerned with recording the

financial operations of a business firm. Indeed, accounting information is one of the principal

sources of data required by a managerial economist for his decision-making purpose. For instance,

the profit and loss statement of a firm tells how well the firm has done and the information it

contains can be used by managerial economist to throw significant light on the future course of

action-whether it should improve or close down. Of course, accounting data call for careful

interpretation. Recasting and adjustment before they can be used safely and effectively.

It is in this context that the growing link between management accounting and managerial

economics deserves special mention. The main task of management accounting is now seen as

being to provide the sort of data which managers need if they are to apply the ideas of managerial

economics to solve business problems correctly; the accounting data are also to be provided in a

form so as to fit easily into the concepts and analysis of managerial economics.

Uses Of Managerial Economics

Managerial economics accomplishes several objectives. First, it presents those aspects of

traditional economics, which are relevant for business decision making it real life. For the purpose, it

culls from economic theory the concepts, principles and techniques of analysis which have a

bearing on the decision making process. These are, if necessary, adapted or modified with a view

to enable the manager take better decisions. Thus, managerial economics accomplishes the

objective of building suitable tool kit from traditional economics.

Secondly, it also incorporates useful ideas from other disciplines such a psychology, sociology, etc.,

if they are found relevant for decision making. In face managerial economics takes the aid of other

academic disciplines having a bearing upon the business decisions of a manager in view of the

carious explicit and implicit constraints subject to which resource allocation is to be optimized.

Thirdly, managerial economics helps in reaching a variety of business decisions.

(i) What products and services should be produced?

(ii) What inputs and production techniques should be used?

(iii) How much output should be produced and at what prices it should be sold?

(iv) What are the best sizes and locations of new plants?

(v) How should the available capital be allocated?

Fourthly, managerial economics makes a manager a more competent model guilder. Thus he can

capture the essential relationships which characterize a situation while leaving out the cluttering

details and peripheral relationships.

Fifthly, at the level of the firm, where for various functional areas functional specialists or functional

departments exist, e.g., finance, marketing, personal production, etc., managerial economics serves

as an integrating agent by co-coordinating the different areas and bringing to bear on the decisions

of each department or specialist the implications pertaining to other functional areas. It thus enables

business decision- making not in watertight compartments but in an integrated perspective, the

significance of which lies in the fact that the functional departments or specialists often enjoy

considerable autonomy and achieve conflicting coals.

Finally, managerial economics takes cognizance of the interaction between the firm and society and

accomplishes the key role of business as an agent in the attainment of social and economic

welfare. It has come to be realized that business part from its obligations to shareholders has

certain social obligations. Managerial economics focuses attention on these social obligations as

constraints subject to which business decisions are to be taken. In so doing, it serves as an

instrument in rehiring the economic welfare of the society through socially oriented business

decisions.

Managerial Economist Role And Responsibilities

A managerial economist can play a very important role by assisting the Management in using the

increasingly specialized skills and sophisticated techniques which are required to solve the difficult

problems of successful decision-making and forward planning. That is why, in business concerns,

his importance is being growingly recognized. In advanced countries like the U.S.A., large

companies employ one or more economists. In our country too, big industrial houses have come to

recognize the need for managerial economists, and there are frequent advertisements for such

positions. Tatas, DCM and Hindustan Lever employ economists. Indian Petrochemicals Corporation

Ltd., a Government of India undertaking, also keeps an economist.

Let us examine in specific terms how a managerial economist can contribute to decision-making in

business. In this connection, two important questions need be considered:

1. What role does he play in business, that is, what particular management problems

lend themselves to solution through economic analysis?

2. How can the managerial economist best serve management, that is, what are the

responsibilities of a successful managerial economist?

Role Of Managerial Economist

One of the principal objectives of any management in its decision-making process is to determine

the key factors which will influence the business over the period ahead. In general, these factors

can be divided into two-category (i) external and (ii) internal. The external factors lie outside the

control management because they are external to the firm and are said to constitute business

environment. The internal factors he within the scope and operations of a firm and hence within the

control of management, and they are known as business operations.

To illustrate, a business firm is free to take decisions about what to invest, where to invest, how

much labour to employ and what to pay for it, how to price its products and so on but all these

decisions are taken within the framework of a particular business environment and the firm’s degree

of freedom depends on such factors as the government’s economic policy, the actions of its

competitors and the like.

Environmental Studies

An analysis and forecast of external factors constituting general business conditions, e.g., prices,

national income and output, volume of trade, etc., are of great significance since every business

from is affected by them. Certain important relevant questions in this connection are as follows:

1. What is the outlook for the national economy? What are the most important local,

regional or worldwide economic trends? What phase of the business cycle lies

immediately ahead?

2. What about population shifts and the resultant ups and downs in regional purchasing

power?

3. What are the demands prospects in new as well as established markets? Will

changes in social behavior and fashions tend to expand or limit the sales of a company’s

products, or possibly make the products obsolete?

4. Where are the market and customer opportunities likely to expand or contract most

rapidly?

5. Will overseas markets expand or contract, and how will new foreign government

legislation’s affect operation of the overseas plants?

6. Will the availability and cost of credit tend to increase or decrease buying? Are

money or credit conditions ahead likely to be easy or tight?

7. What the prices of raw materials and finished products are likely to be?

8. Is competition likely to increase or decrease?

9. What are the main components of the five-year plan? What are the areas where

outlays have been increased? What are the segments, which have suffered a cut in their

outlay?

10. What is the outlook regarding government’s economic policies and regulations?

11. What about changes in defense expenditure, tax rates, tariffs and import restrictions?

12. Will Reserve Bank’s decisions stimulate or depress industrial production and

consumer spending? How will these decisions affect the company’s cost, credit, sales

and profits?

Reasonably accurate answers to these and similar questions can...

Enable management’s to chalk out more wisely the scope and direction of their own business plans

and to determine the timing of their specific actions. And it is these questions which present some

of the areas where a managerial economist can make effective contribution.

The managerial economist has not only to study the economic trends at the macro-level but must

also interpret their relevance to the particular industry/firm where he works. He has to digest the

ever-growing economic literature and advise top management by means of short, business-like

practical notes.

In a mixed economy like India, the managerial economist pragmatically interprets the intentions of

controls and evaluates their impact. He acts as a bridge between the government and the industry,

translating the government’s intentions and transmitting the reactions of the industry. In fact,

government policies charge out of the performance of industry, the expectations of the people and

political expediency.

Business Operations

A managerial economist can also be helpful to the management in making decisions relating to the

internal operations of a firm in respect of such problems as price, rate of operations, investment,

expansion or contraction. Certain relevant questions in this context would be as follows:

1. What will be a reasonable sales and profit budget for the next year?

2. What will be the most appropriate production Schedules and inventory policies for

the next six months?

3. What changes in wage and price policies should be made now?

4. How much cash will be available next month and how should it be invested?

Specific Functions

A further idea of the role managerial economists can play, can be had from the following specific

functions performed by them as revealed by a survey pertaining to Britain conducted by K.J.W.

Alexander and Alexander G. Kemp:

1. Sales forecasting

2. Industrial market research.

3. Economic analysis of competing companies.

4. Pricing problems of industry.

5. Capital projects.

6. Production programs.

7. Security/investment analysis and forecasts.

8. Advice on trade and public relations.

9. Advice on primary commodities.

10. Advice on foreign exchange.

11. Economic analysis of agriculture.

12. Analysis of underdeveloped economics.

13. Environmental forecasting.

The managerial economist has to gather economic data, analyze all pertinent information about the

business environment and prepare position papers on issues facing the firm and the industry. In the

case of industries prone to rapid technological advances, he may have to make a continuous

assessment of the impact of changing technology. He may have to evaluate the capital budget in

the light of short and long-range financial, profit and market potentialities. Very often, he may have

to prepare speeches for the corporate executives.

It is thus clear that in practice managerial economists perform many and varied functions. However,

of these, marketing functions, i.e., sales forecasting and industrial market research, has been the

most important. For this purpose, they may compile statistical records of the sales performance of

their own business and those relating to their rivals, carry our analysis of these records and report

on trends in demand, their market shares, and the relative efficiency of their retail outlets. Thus

while carrying out their functions; they may have to undertake detailed statistical analysis. There

are, of course, differences in the relative importance of the various functions performed from firm to

firm and in the degree of sophistication of the methods used in carrying them out. But there is no

doubt that the job of a managerial economist requires alertness and the ability to work under

pressure.

Economic Intelligence

Besides these functions involving sophisticated analysis, managerial economist may also provide

general intelligence service supplying management with economic information of general interest

such as competitors prices and products, tax rates, tariff rates, etc. In fact, a good deal of published

material is already available and it would be useful for a firm to have someone who understands it.

The managerial economist can do the job with competence.

Participating in Public Debates

May well-known business economists participate in public debates. Their advice and views are

being sought by the government and society alike. Their practical experience in business and

industry ads stature to their views. Their public recognition enhances their stature in the

organization itself.

Indian Context

In the Indian context, a managerial economist is expected to perform the following functions:

1. Macro-forecasting for demand and supply.

2. Production planning at macro and micro levels.

3. Capacity planning and product-mix determination.

4. Economics of various productions lines.

5. Economic feasibility of new production lines/processes and projects.

6. Assistance in preparation of overall development plans.

7. Preparation of periodical economic reports bearing on various matters such as the

company’s product-lines, future growth opportunities, market pricing situation, general

business, and various national/international factors affecting industry and business.

8. Preparing briefs, speeches, articles and papers for top management for various

Chambers, Committees, Seminars, Conferences, etc.

9. Keeping management informed o various national and international developments on

economic/industrial matters.

With the adoption of the New Economic Policy, the macro-economic Environment is changing fast

at a pace that has been rarely witnessed before. And these

changes have tremendous implications for business. The managerial economist has to play a much

more significant role. He has to constantly gauge the possibilities of translating the rapidly changing

economic scenario into viable business opportunities. As India marches towards globalization, he

will have to interpret the global economic events and find out how his firm can avail itself of the

carious export opportunities or of establishing plants abroad either wholly owned or in association

with local partners.

Responsibilities Of Managerial Economist

Having examined the significant opportunities before a managerial economist to contribute to

managerial decision-making, let us next examine how he can best serve the management. For this,

he must thoroughly recognize his responsibilities and obligations.

A managerial economist can serve management best only if he always keeps in mind the main

objective of his business, viz., to make a profit on its invested capital. His academic training and the

critical comments from people outside the business may lead a managerial economist to adopt an

apologetic or defensive attitude towards profits. Once management notices this, his effectiveness is

almost sure to be lost. In fact, he cannot expect to succeed in serving management unless he has a

strong personal conviction that profits are essential and that his chief obligation is to help enhance

the ability of the firm to make profits.

Most management decisions necessarily concern the future, which is rather uncertain. It is,

therefore, absolutely essential that a managerial economist recognizes his responsibility to make

successful forecasts. By making best possible forecasts and through constant efforts to improve

upon them, he should aim at minimizing, if not completely eliminating, the risks involved in

uncertainties, so that the management can follow a more orderly course of business planning. At

times, he will have to reassure the management that an important trend will continue; in other

cases, he may have to point out the probabilities of a turning point in some activity of importance to

management. In any case, he must be willing to make considered but fairly positive statements

about impending economic developments, based upon the best possible information and analysis

and stake his reputation upon his judgment. Nothing will build management confidence in a

managerial economist more quickly and thoroughly than a record of successful forecasts, well

documented in advance and modestly evaluated when the actual results become available.

A few corollaries to the above proposition need also be emphasized here.

First, he has a major responsibility to alert ‘management at the earliest possible moment in case he

discovers an error in his forecast. By promptly drawing attention to changes in forecasting

conditions, he will not only assist management in making appropriate adjustment in policies and

programs but will also be able to strengthen his own position as a member of the management

team by keeping his fingers on the economic pulse of the business.

Secondly, he must establish and maintain many contacts with individuals and data sources, which

would not be immediately available to the other members of the management. Extensive familiarity

with reference sources and material is essential, but it is still more important that he knows

individuals who are specialists in particular fields having a bearing on his work. For this purpose, he

should join professional associations and take active part in them. In fact, one of the best means of

determining the caliber of a managerial economist is to evaluate his ability to obtain information

quickly by personal contacts rather than by lengthy research from either readily available or obscure

reference sources. Within any business, there may be a wealth of knowledge and experience but

the managerial economist would be really useful if he can supplement the existing know-how with

additional information and in the quickest possible manner.

Again, if a managerial economist is to be really helpful to the management in successful decision-

making and forward planning, he must be able to earn full status on the business team. He should

be ready and even offer himself to take up special assignments, be that in study teams, committees

or special projects. For, a managerial economist can only function effectively in an atmosphere

where his success or failure can be traced not only to his basic ability, training and experience, but

also to his personality and capacity to win continuing support for himself and his professional ideas.

Of course, he should be able to express himself clearly and simply and must always try to minimize

the use of technical terminology in communicating with his management executives. For, it is well

known that hat management does not understand, it will almost automatically reject. Further, while

intellectually he must be in tune with industry’s thinking the wider national perspective should not be

absents from his advice to top management.

Question Bank

1. Define managerial economics with definition

2. How does managerial economics differ from economics?

3. Write a short note on managerial economist.

4. Explain the scope of managerial economics.