Chapter 1 Meaning, Scope & Methods of Managerial Economics

Chapter 1

Meaning, Scope & Methods of Managerial Economics

Managerial Economics

Objectives:• After studying the chapter, you should understand:

1. The subject matter of Managerial Economics

2. The analytical approach used in Managerial Economics

What is Economics

• Economics is usually defined as a social science concerned with analyzing and describing the production, distribution and consumption of wealth.

Robbin’s Definition : More recently. An English economist Lionel Robbins defines Economics as “ the science which describes human behavior as a relationship between (given ) ends and scarce means which have alternative uses”

Definition of Managerial Economics

• Douglas - “Managerial economics is .. the application of economic principles and methodologies to the decision-making process within the firm or organization.”

• Pappas & Hirschey - “Managerial economics applies economic theory and methods to business and administrative decision-making.”

• 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.”

Meaning of Managerial Economics• Managerial Economics: Managerial economics

is essentially applied economics in the field of business management. It is economics of business or managerial decisions. It pertains to all economic aspects of managerial decision making.

• It is an evolutionary science, it is a journey with continuing understanding and application of economic Knowledge, theories, models, concepts and categories in dealing with emerging business or managerial situations and problems in a dynamic economy.

Types Of Business Decision

• Price and Output Decision• Demand Estimation• Choice of a Technique of Production• Advertising Decision• Long-run Production Decision• Investment Decision

Nature of Managerial Decision

Decision Making Problem requires a choice among alternative courses of action so as to achieve the objective.

Lets understand this with the help of a example:Consider Maruti Udyog Limited which

manufacturers cars. Suppose it identifies 2 possible course of action also called as strategies to meet the growing demand of its product.


First Strategy is to plan for its internal expansion of productive capacity.

Second Strategy is to take over the premier Auto Limited and use its capacity to increase output to meet growing demand of its product.

Objective of the firm is to maximize profits to be earned from the expansion of output.

Let S1 stand for strategy one and S2 stand for Strategy 2.


The objective function for the above decision making problem can be stated as maximise profits (S1, S2)

To choose from the 2 alternative strategies, the following decision rule can be made:

Choose strategy S1 if profits from S1 › profits from S2.

Choose Strategy S2 if profits from S2 › profits from S1

Managerial Decision Making Process

The 5 steps in the decision making processEstablishing Objective

Defining the Problem

Identifying Possible Alternative Course of Action

Evaluating Alternative Course of Action and

Choosing the Best

Implementing and Monitoring the Decision

Considering Legal and Social Constraints

Considering Financial, Technological,

Infrastructural and Input Constraints

Managerial Economics: An Integration of Economics, Decision Science and Business

Management

Managerial Economics: An Integration of Economics, Decision Science and Business Management

Managerial Economics bridges the gap between traditional economic theory and real business practices for the purpose of facilitating decision making and forward planning by management.

Economic Theory

Business Management

Managerial Economics

Characteristics of Managerial Economics

1. Micro Economics:- Managerial economics is micro economics in character as it is concerned with smaller units of the economy. It studies the problems and principles of an individual business firm or and individual industry.. It assist the management in forecasting and evaluating the trends in the market.


2. Normative Economics :- Managerial economics belongs to normative economics. It is concerned with what management should do under particular circumstances. It determines the goals of the enterprise and then develops the ways to achieve these goals. It deals with the future planning, policy-making, decision- making and making full utilization of the available resources of the enterprises.


3. Pragmatic :- Managerial economics is pragmatic. It tries to solve the managerial problems in their day-to-day functioning and avoids difficult issues of economic theory.

4. Uses Theory of firm :- Managerial economics uses economic concepts and principles which are know as the theory of firm or economics of the firm. Thus, its scope is narrower than that of Pure Economic Theory.


5. Takes help of Macro Economics :- Managerial economics takes help of macro economics also because it needs an understanding of the circumstances and environment the individual firm or industry has to work. Issues of macro economics whose knowledge is necessary for the successful management of a firm or an industry are : Business Cycles, Taxation Policies, Industrial Policy, Price and Distribution Policies, Wage Policies and Anti-Monopoly Policies etc.


6. Aims at helping the Management :-Managerial economics aims at helping the management in taking correct decisions and preparing plans and policies in the future.

Scope of Managerial Economics

The scope of managerial economics includes the following subjects :

a) Theory of Demandb) Theory of Productionc) Theory of Exchange or Price Theoryd) Theory of Profite) Theory of Capital and Investment f) Environmental Issues

Scope of Managerial Economicsa) Theory of Demand :According to Spencer and Siegelman “A

business firm is an economic organization which transforms productivity sources into goods that are to be sold in the market “

i) Demand Analysis: helps the management in identifying factors that influence the demand for the products of a firm. For eg an estimation of future sales is essential before preparing production schedule and employing productive resources. Thus demand analysis and forecasting is essential for business planning.


ii) Demand Theory : is a study of behaviour of consumers. It answers questions such as why do the consumer buy a particular commodity ? How much they purchase a commodity ? What is the effect of income, habit and taste on the demand of a commodity ? What are the factors influencing the demand of a commodity ? Why and when do consumers stop to consume a commodity .

Scope of Managerial Economicsb) Theory of Production : Production and cost analysis is

important for smooth functioning of production process and project planning.

Production theory helps in determining the size of firm and the level of production.

It explains how average and marginal costs change with the change in production

Under what conditions do costs increase or decrease?How does total production increase when input of one of the

factors of production is increased keeping other factors constant ?


How can one factor of production substitute another when all the factors are increased simultaneously ?

How can optimum production be obtained ?


c) Theory of Exchange or Price Theory : It explains how the prices are determined under

different markets ?How and to what extent advertisement can be helpful

in increasing sales of a firm in market. Pricing is an important area of managerial economics.

Pricing policy affects the demand for the product. It also includes pricing methods, pricing policies, differential pricing, product line pricing and price forecasting .

Scope of Managerial Economicsd) Theory of Profit: Profit maximization is the aim of

every firm. Profits is the difference between total revenue and total cost. Because of the following factors profits are always uncertain :

i) Demand of the product ii) Prices of the factors of production iii) Nature and degree of competition in the market iv) Price behaviour under changing conditions. Hence Profit Planning and Profit Management are

necessary for improving profit earning efficiency of the firm.


e) Theory of Capital and Investment :This theory explains the following issues :i) Selection of most suitable investment

project ii) Most efficient allocation of capitaliii) Assessing the efficiency of capitaliv) Minimizing the possibility of under

capitalization or Over- capitalization.

Scope of Managerial Economicsf) Environmental Issues : Certain issues of macro-economics also

form a part managerial economics. These relate to social and political environment in which a business and industrial firm has to operate .This is governed by factors:

i) The type of economic system of the country ii) Business cycles, industrial policy of the countryiii) Trade, fiscal and taxation policiesiv) Price and labour policy v) General trends in economy with regards to the production,

employment, income, prices, savings and investment etc.


vi) General trends in the foreign trade of the country

vii) How develop is the banking sectorviii) Social structure and political systemAs the management of a firm cannot have any

control over these factors, it should adjust the plans, policies and programmes of the firm according to these factors to offset their adverse effect on the firm.

Significance of Managerial Economics

Spencer and Siegelman have described the importance of Managerial economics and industrial enterprise as follows:

1. Reconciling Traditional Theoretical Concepts to the Actual Business Behaviour and Conditions : Managerial economics reconciles the tools, Techniques, models and theories of traditional economics with actual business practices and with the environment in which a firm has to operate.


2.Estimating Economic Relationships: Managerial economics estimates economic relationship between different business factors such as income, elasticity of demand and cost volume of profit analysis etc.

3. Predicting Relevant economic Quantities :Its helps the management in predicting various

economic quantities such as cost, profit, demand, capital, production, price etc.


4. Understanding Internal and External Forces

5. Basis of Business policies: Managerial economics is the foundation of business policies. Business policies are prepared on the basis of studies and findings of managerial economics which warns the management against all the turning points in national as well as international economy .

Managerial Economics : Normative or Positive

Normative Economics : Basically prescribes what it out to be.

Positive Economics : explains the economic phenomenon as : What is, what was and what will be.

“Managerial Economics is a blending of pure or positive science with applied or normative science.”

Relationship with other Disciplines

Economics has to aspects : Positive and Normative Economics

Normative Economics : Basically prescribes what it out to be.

Positive Economics : explains the economic phenomenon as : What is, what was and what will be.

“Managerial Economics is a blending of pure or positive science with applied or normative science.”

Economic and Managerial Economic Theory

The relationship between the two theory is like that of engineering science to Physics or of Medicine to Biology. Both deal with problems of scarcity and resource allocation.

The 3 contribution of Economic theory to Managerial economics are:

1. It helps Managerial Economic by building Analytical models which helps in analyzing the structure of Managerial problems

2. It contributes a set of Analytical Methods which helps to enhance the analytical abilities of a business analyst.

3. It helps to clarify Concepts used in business analysis which helps the managers to avoid conceptual pitfalls.

Management Theory and Accounting

Accounting refers to the recording of transactions of the firm in certain books.

Profit Maximization is a major objective of any firm.

In order to make correct managerial decisions, it requires proper knowledge of cost and revenue information. So it is necessary for a managerial economist to be able to interpret and use accounting data.

Managerial Economics and Mathematics

Mathematical concepts and tools are widely used in economic logic to solve problem related to how firm should minimize costs, how to maximize profits, or how to optimize sales.

Mathematical symbols are most convenient to handle and understand various concepts like incremental cost, elasticity of demand etc

Managerial Economics and Statistics

• Managerial Economics needs tools of Statistics in more than one way:

1.Business man can correctly forecast the demand of the product.

2. Impact on variations such as taste, fashion, and changes in income on demand

3.It provides a sure base for decision making

Managerial Economics and Operational Research

Operational Research is concerned with the complex problems arising out of the management of men, machines, materials and money.

Role and Responsibilities of a Managerial Economist

• Demand Estimation and Forecasting• Preparation of business/sales forecast• Analysis of the market survey• Analyzing the issues and problems of the concerned industry.• Assisting the business planning process of the firm• Discovering new and possible fields of business• Advising on pricing, investment and capital budgeting policies• Evaluation of capital budgets• Building micro and macro economic models• Directing economic research activity• Briefing the management on current domestic and global economic issues

and emerging challenges.

Usefulness of Managerial Economics

1. Managerial Economics enables the use of economics logic and principles to aid management decision making

2. It focuses on the most profitable use scarce resources rather than the achievement of equilibrium prices and quantities as pure theory of economics does.

3. It has introduced dynamism in the world of decision making and business environment.

4. It has given rise to emergence of a new approach in decision making Known as Corporate strategy

5. Managerial economics sharpens the business aceum

Question Bank

Q1. Define Managerial economics . How does it differs from traditional economics .

Q2. Discussion the Importance of Managerial Economics with special reference to decision- making .

Q3. Explain the role and responsibilities of a Managerial economist.

Q4. What is the scope of Managerial Economics.

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Chapter 1 Meaning, Scope & Methods of Managerial Economics