Managerial Economics

Module 1:
Introduction to managerial economics
Meaning and defnition economics- economic theory and managerial
economics-nature and scope of managerial economics-relationship
to other branches of learning-usefulness of managerial economics
Defnition and scope of managerial economics:
Managera economcs s economcs apped n decson-makng. It s that
branch of economcs whch nks abstract theory wth managera practce.
Economcs s a scence concerned wth the probem of aocatng scarce
resources wth competng ends. Managera economcs may aso be taken as
economcs apped to probems of choce of aternatves and aocaton of
scarce resources by the rms. Managera economcs s goa orented and
ams at maxmum achevement of ob|ectves.
Managera economcs emerged ony n the eary part of 1950s. Managera
economcs generay refers to the ntegraton of economc theory wth
busness practce. Economcs provdes the toos whch expan the varous
aspects such as demand, suppy, prce, competton etc. Economc prncpes
by themseves do not oher ready-made soutons appcabe n the changng
busness word. After the Second Word War and partcuary after 1950, wth
the expanson of busness a over the word, the busness manager was
faced wth many probems due to changng busness envronment. The prme
functon of a management executve n a busness organzaton s decson-
makng and forward pannng.
The decsons and forward pannng s for the future, whch s uncertan. In
the rea word, the busness manager rarey has compete nformaton as to
future saes, costs, prots, capta etc.
Hence decsons are made and pans formuated on the bass of past data,
current nformaton and the estmates about future predcted as best as
possbe. As pans are mpemented over tme, therefore, pans may have to
be revsed and dherent courses of acton adopted. Managers are thus
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engaged n a contnuous process of decson-makng through an uncertan
future and the overa probem confrontng them s one of ad|ustng to
uncertanty.
In fung the functon of decson-makng n an uncertanty frame-work,
economc theory can be pressed nto servce wth consderabe advantage.
Economc theory deas wth a number of concepts and prncpes reatng to
prot, demand, c0st, prcng etc. Whch aded by aed dscpnes ke
accountng, statstcs and mathematcs can be used to sove the probems of
busness management.
Defnition of managerial economics:
Accordng to Mcnar and Meram," Managera economcs s the use of
economc modes of thoughts to anayse busness stuaton".
Accordng to Prof. Watson," Prce theory n the servce of busness executves,
s known as managera economcs".
Prof. D.C.Haque denes managera economcs as," a fundamentay an
academc sub|ect whch seeks to understand and to anayse the probems of
busness decson-takng".
Accordng to W.W.Haynes, managera economcs s the study of the
aocaton of resources avaabe to a rm or other unt of management
among the actvtes of that unt".
Spencer has dened managera economcs as," managera economcs s the
ntegraton of economc theory wth busness practce for the purpose of
factatng decson-makng and forward -pannng by the management."
"Managera economcs s concerned wth busness emcency". Prof. Sma.
"Managera economcs s the appcaton of economc theory and
methodoogy to busness admnstraton and practce". Brgham and Pappas.
Dougas has dened managera economcs as," managera economcs s
concerned wth the appcaton of economc prncpes and methodooges to
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the decson makng process wth the rm or organzaton under condtons of
uncertanty. It seeks to estabsh rues and prncpes to factate the
attanment of the desred economc goas reate to costs, revenues and
prots and are mportant wthn both the busness and the non-busness
nsttutons".
It s cear from the above dentons; dherent economsts try to pro|ect the
sub|ect matter of managera economcs dherenty. However, ther vew-
ponts have the foowng features n common:
1. Managera economcs s concerned wth decson makng of economc
nature. It deas wth dentfyng dherent choces and aocatng mted
resources.
2. Managera economcs s goa orented, t ams at maxmum achevement
of ob|ectves and how decsons shoud be made by the manager to acheve
the foa.
3. Managera economcs s pragmatc as t deas wth matters accordng to
ther practca sgncance.
4. Managera economcs appes quanttatve technques to busness. Whe
measurement wthout theory can ony ead to fauty concusons. Precson
theory wthout measurement cannot be operatonay usefu.
Managera economcs s pragmatc and reastc n nature. It s apped to
sove probems faced by the busness rms. These probems are reated to
choce and aocaton of resources whch are economc n character. It shoud
be remembered that decson-makng n busness s nuenced not ony by
economc factors, but, aso by many other factors such as,
1. Human
2. Behavora
3. Technoogca and
4. Envronmenta
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Scope of managerial economics:
Snce managera economcs s a newy formed dscpne, no unform pattern
s adopted and dherent authors treat the sub|ect n dherent ways. However,
the foowng topcs have been regarded as the scope of the sub|ect,
managera economcs:
I. Whether managera economcs s normatve or postve economcs
II. Area of study
III. Prots- the centra concept of managera economcs
IV. Optmzaton
V. Reatonshp of managera economcs wth other dscpnes.
I. Managerial economics- Is it positive or normative:
Postve economcs s descrptve n character. It descrbes economc
actvtes as they are. Accordng to Prof. Lone Robbns economcs s a
postve scence and he beeved that economst, shoud be neutra
between ends and he cannot pronounce on the vadty o utmate
|udgments of vaue.
Whe normatve economcs passes |udgments of vaue. Managera
economcs draws from descrptve economcs and tres to pass |udgments of
vaue n the context of the rm. Managera economcs s many normatve n
nature.
II. rea of study:
Broady speakng, managera economcs deas wth the foowng topcs:
1. Demand anayss and forecastng
2. Cost and producton anayss
3. Prcng decsons, poces and practces
4. Prot management
5. Capta management
6. Lnear programmng and theory of games.
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1. Demand analysis and forecasting:
Accurate estmaton of demand by anayzng the forces actng on demand of
the product produced by the rm forms the vta ssue n takng ehectve
decsons at the rm eve. Demand anayss attempts at ndng out the
forces of determnng saes. Ths has two man managera purposes.
1. Forecastng saes and 2. Manpuatng demand.
The demand anayss covers the topcs ke demand determnants, demand
dstnctons and demand forecastng.
!. "ost and production analysis:
In decson-makng, cost estmates are very essenta. Producton pannng,
prot pannng etc depends upon sound prcng practces and accurate cost
anayss. Producton anayss deas wth physca terms of the product, whe
cost anayss deas wth the monetary terms. Cost anayss s concerned wth
cost concepts, cost-output reatons, economes of scae, producton functon
and cost contro.
#. $ricing decisions% policies and practices:
Prcng forms the core of managera economcs. The success or faure of a
rm many depends on accurate prce decsons to ehectvey compete n the
market. The mportant aspects of the study under ths are prce
determnaton under dherent market condtons, prcng methods and poce
product ne prcng and prce forecastng.
&. $roft management:
A busness enterprses are prot makng nsttutons. The success or faure
of a rm s measured ony n terms of prot t has made and the percentage
of dvdend t has decared. Hence, prot management, prot poces and
technques. Prot pannng ke break-even anayss s studed under ths
category.
'. "apital management:
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Capta management s the most troubesome probem for the management
of busness nvovng hgh-eve decsons. Capta management deas wth
pannng and contro of capta expendture. Cost of capta, rate of return
and seecton of pro|ect etc.
(. )inear programming and theory of games:
Lnear programmng and theory of games have come to be regarded as part
of managera economcs, as there s a trend towards ntegraton of
managera economcs and operatons research.
III. $roft: *he central concept in managerial economics:
Generay, prots are the prmary measure of the success of any busness. It
s the acd test of the economc strength of the rm. Economc theory makes
a fundamenta assumpton that maxmzng prot s the basc am of every
rm. Ths assumpton s by and arge true, though n modern socety ths
may not aways hod good. Modern rms pursue mutpe ob|ectves such as
wefare, obgatons to socety and consumers etc. However, prot
maxmzaton receves top prorty, f not soe ob|ectve. Consequenty, prot
maxmzaton contnues to be the ob|ectve of the rm and the study of rm
n managera economcs has centered on the concept of prot.
The maxmzaton of prots s the man ob|ectve of any rm and the survva
of the rm depends on the prots t earns. Prots are the man ndcator of a
rms success. It s the ndex of busness emcency. Further, the concept of
prot maxmzaton s very much usefu n seectng the aternatves n
makng a decson at the rm-eve.
I+. ,ptimi-ation:
Another mportant concept used n managera economcs s optmzaton.
Ths ams at optmzng a gven ob|ectve. The am of near programmng s
to ad the process of optmzaton and choce. It ohers numerca soutons to
the probem of makng of optmum choces. Ths pont of optmzaton
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emerges when they are constrants optmzaton s basc to managera
economcs n decson-makng.
+. .elationship of managerial economics /ith other disciplines:
Managera economcs s cosey reated to other sub|ects ke mcro economc
theory, macro economc theory, mathematcs, statstcs, accountng and
operatons research. Managera economcs," as usng the ogc of
economcs, mathematcs and statstcs to provde ehectve ways of thnkng
about busness decson probems".
Managerial economics and micro economics:
Managera economcs s many mcro economc n character, makng use of
many of the concepts and toos provded by mcro-economc theory. The
concept of eastcty of demand, margna cost, market structures, the theory
of the rm and the theory of prcng of mcro-economcs are fuy made use of
by managera economcs. Hence the study of mcro economcs s essenta
for the better understandng of managera economcs. A mcro economc
theores whch can be apped n busness are made use of n managera
economcs.
Managerial economics and macro economics:
Macro economcs s concerned wth aggregates and macro economcs
concepts are used n managera economcs n the area of forecastng genera
busness condtons. The theory of the rm, prcng poces etc have to be
vewed n the broad frame work of the economc system and t s essenta
that the busness executves shoud have some knowedge of the entre
economc system. Macro economc concepts ke natona ncome, soca
accountng, managera emcency of capta, mutper, busness cyces, sca
poces etc have to be studed n managera economcs for forecastng the
busness condtons.
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Both mcro and macro economcs are cosey reated to managera
economcs. Managera economcs draws from mcro and macro economcs,
so that t can appy these prncpes to sove the day-to-day probems faced
by busnessmen.
Managerial economics and mathematics:
Managera economcs s becomng ncreasngy mathematca n character.
Busnessmen dea wth varous concepts whch are measurabe. The use of
mathematca ogc provdes carty of concepts. It aso gves a systematc
frame-work wthn whch quanttatve reatonshp maybe anayzed.
Mathematcs, therefore, s of great hep to managera economcs. The ma|or
probem confrontng busnessmen s to mnmze cost or maxmze prot or
optmze saes. To nd out the souton for the overa probems,
mathematca concepts and technques are wdey used. Mathematca
technques ke near programmng, games theory etc hep managera
economsts to sove many of ther probems.
Managerial economics and statistics:
Statstcs s a scence concerned wth coecton, casscaton, tabuaton and
anayss of data for some speced purpose. Managera economcs and
statstcs are cosey reated as busnessmen dea many wth concepts that
are quantabe for exampe: demand, prce, cost of operaton etc.
Statstcs s usefu to managera economcs n many ways:
a. Managera economcs requres marshang of quanttatve data to nd out
functona reatonshp nvoved n decson-makng. Ths s done wth the
hep of statstcs.
b. Statstca methods are used for emprca testng n managera economcs.
c. The busness executves have to work and take decsons n an uncertanty
frame-work. The theory of probabty evoved by statstcs heps managera
economsts for takng a ogca decson.
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Thus statstca methods provdes sound base for decson-makng and hep
the busnessmen to acheve the ob|ectve wthout much dmcuty. Statstca
toos are extensvey used n the souton of managera probems.
Managera economsts make use of varous statstca technques ke the
theory of probabty, co-reaton technques, regresson anayss etc. n
varous busness stuatons.
Managerial economics and accounting:
Accountng s concerned wth recordng the nanca operatons of a busness
rm. Accountng nformaton s one of the prmary sources of data requred
for managera economsts for the decson-makng purpose. The nformaton
t contans can be used by the managera economst to throw some ght on
the future course of acton.
Managerial economics and operations research:
Operatons research s the," appcaton of mathematca technques n
sovng busness probems". It deas wth mode budng that s constructon
of theoretca-modes that hep the decson-makng process. Though the
roots of operatons research e n mtary studes, t s now argey used n
busness admnstraton, pannng and contro. Lnear programmng and
aed concepts of operatons research are used n managera economcs.
0undamental concept of managerial economics:
Economc theores, concepts, and anaytca toos are of great hep to a
busnessman n arrvng at better decsons n actua busness fe. The
foowng economc concepts are fundamenta to economc concepts are
fundamenta to busness anayss and decson-makng
1. Opportunty cost prncpe
2. Incrementa cost and revenue prncpe
3. Tme perspectve
4. Equ-margna prncpe
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1. ,pportunity "ost:
Decsons mpy makng a choce from the varous aternatves. The
opportunty cost of a decson s the sacrce of the next best aternatve
course of acton avaabe. A decson s cost free f t nvoves no sacrce.
Ths can be best understood wth the hep of a few ustratons:
1. The opportunty cost of the funds empoyed n ones own busness s the
nterest that coud be earned on those funds had they been empoyed n
other ventures.
2. The opportunty cost of the tme an entrepreneur devotes to hs own
busness s the saary he coud earn by seekng empoyment esewhere.
3. The opportunty cost of usng a machne to produce one product s the
earnngs foregone whch woud have been possbe from other products.
4. The opportunty cost of hodng Rs. 500 as cash n hand for one year s the
10% rate of nterest, whch woud have been earned had the money been
kept as xed depost n a bank.
Thus, t shoud be cear that opportunty costs requre ascertanment of
sacrces, f a decson nvoves no sacrces, the opportunty cost s n. For
decson-makng, opportunty costs are the ony reevant costs.
!. Incremental cost and revenue principle:
Incrementa concept s cosey reated to the margna costs and margna
revenues. Incrementa concept nvoves estmatng the mpact of decson
aternatves on costs and revenues, emphaszng the changes n tota cost
and tota revenue resutng from changes n prces products, procedures,
nvestments or whatever may be at stake n the decson.
The two basc components of ncrementa reasonng are: ncrementa cost
and ncrementa revenue. Incrementa cost may be dened as the change n
tota cost resutng from a partcuar decson. Incrementa revenue s the
change n tota revenue resutng from a partcuar decson. For exampe: f a
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rm decdes to go for computerzaton of market nformaton, the addtona
revenue t earns w be termed ncrementa revenue and the extra cost of
settng up computer factes w be termed ncrementa cost. Thus when the
ncrementa revenue exceeds ncrementa cost resutng from a partcuar
decson t s regarded protabe. Ths certany heps n arrvng at a better
decson by comparng ncrementa costs and revenues of aternatve
decsons.
#. *ime perspective:
In the ed of prcng tme has a cruca roe to pay. The credt goes to
Marsha for takng cognzance of tme eement n the theory of vaue. He
studed the market on the bass of tme namey very short perod, short
perod, ong perod etc. In managera economcs, the anayss and decsons
are cassed nto short and ong perod. That s why short and ong perod.
That s why short and ong run tme perods are wdey known and popuary
used n managera economcs. Margna economsts are concerned wth
short-run and ong-run ehects of decsons on revenues and costs. The
cruca probem n decson-makng s to mantan the rght baance between
the short and ong run busness perspectves. In other words, the managera
shoud take a ong-range vew of ehects on costs and revenues rather than
merey a short-sghted vew. A decson may be made on the bass of short-
run consderatons, but may, as tme passes, have ong-run repercussons
that make t more or ess protabe than at rst seemed. In the utmate
anayss, a proper baance between the short-term consderatons and ong-
term mpcatons s nuenced by the senstvty of the customers.
&. *he e1ui-marginal principle:
An mportant proposton of economcs s that an nput shoud be aocated n
such a way that the vaue added by the ast unt s the same n a uses. Ths
proposton s popuary known as the equ-margna prncpe. Let us consder
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a case n whch the rm s nvoved n four actvtes vz actvty, actvty b,
actvty c, actvty d. A these actvtes requre the servces of abour. The
rm can ncrease any one of the actvtes by empoyng more abour, but
ony at the cost of other actvtes. In ths case, the rm aocates abour for
each of the actvty n such a manner that the vaue of the margna product
s equa n a actvtes.
VMP = VMP = VMP = VMP
Where L ndcates abour and a, b, c, d, represent the actvtes, that s, the
vaue of the margna product of abour empoyed n a s equa to the vaue of
the margna product of the abour empoyed n b, and so on.
If the rm funds that the vaue of the margna product s greater n one
actvty than another, the rm must reaze the fact that an optmum has not
been acheved.
Importance2 usefulness of managerial economics:
1. Managera enabes the use of economc ogc and prncpes to ad
management decson-makng. Managers are decson-makers and
economcs shoud be reevant to gve practca gudance n arrvng at rght
decsons. Every manager has to take mportant decsons about usng hs
mted resources ke and, capta, abour, nance etc. to get the maxmum
returns, therefore, managera economcs, concentrates on those practca
aspects of mcro-economcs whch hep n decson-makng.
2. Managera economcs focuses on the most protabe use of scarce
resources rather than on the achevement of equbrum prces and
quanttes as pure theory of economcs does. Vewed ths way t s more
practca and pragmatc than mcro economcs. Managera economcs
equpped wth theoretca background provdes an answer to practca
probems faced by a busness rm.
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3. Managera economcs has ntroduced dynamsm n the word of decson-
makng and busness envronment. In a free market economy, success n
busness depends upon how qucky busness antcpates and responds to the
changng nature of the market pace. Busness managers, forever, face a
need to adapt to changes n the busness envronment. The busness word
has to be dynamc to face the changng trends n demand. Ths dynamsm
pervades decson-makng and necesstates the ntegraton of managera
economcs nto the busness envronment.
4. Managera economcs has gven rse to the emergence of a new approach
n decson-makng known as corporate strategy. Busness Corporatons work
wth a gven set of corporate goas and ob|ectves aganst the background of
a set of assumptons about the companys economc, compettve, reguatory,
factor-suppy, technoogca and nternatona envronment. Strategc
pannng s a three-fod probem vz a portfoo probem, an nvestment
probem and a strategy seecton probem and a strategy seecton probem.
The portfoo probem pertans to whch busness shoud the company adopt.
The nvestment probem pertans to the eve of nvestment to be made by
each busness. The strategy seecton probem pertans to the specc
nanca, marketng and producton strateges to be foowed by each
busness rm. Thus the ntegraton of managera economcs n decson-
makng has gven rse to corporate economcs.
5. Managera economcs sharpens the busness acumen. An abty to
anayse probems ogcay and ceary heps to make good decsons.
Managera economcs provdes necessary toos to the management n ts
decson-makng process.
6. Managera economcs has emerged as a speca branch of knowedge
aed to economcs to enrch the decson makers at varous eves of rms
operatons. Concepts n the area of demand, costs, saes etc hep to appy
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theores to the souton of probems n day-to-day busness actvty.
Managera economcs wth the knowedge of operatons research provdes
the professona managers wth the requred toos and modes to sove
probems n a more scentc way.
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