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:

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.

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.

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.

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.

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 Function
Demand 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 commodity
Px = Price of the commodity
Py = Price of related goods
T = Tastes and preferences of consumer
Y = Income level
A = Advertising and promotional activities
Pp = Population (Size of the market)
Ep = Consumer’s expectations about future prices
U = Specific factors affecting demand for a commodity such as seasonal changes, taxation policy, availability of credit facilities, etc.

Law of Demand
The 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 Schedule
Demand 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 Buyer A (demand Buyer B Buyer C Buyer D (demand in Market Demand
dozen) in dozen) (demand in (demand in dozen) (dozens)
dozen) dozen)

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 Curve
Demand 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 Demand

The 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.