Managerial Economics Unit 1

Unit 1 Meaning and Importance of

Managerial Economics
Structure:
1.1 Introduction
Objectives
Case Let
1.2 Definitions
1.3 Scope of Managerial Economics
1.4 Significance of the Study of Managerial Economics
1.5 Functions of a Managerial Economist
1.6 Summary
1.7 Glossary
1.8 Terminal Questions
1.9 Answers
1.10 Case Study
Reference/E-Reference

1.1 Introduction
Economics impacts our day-to-day lives. Economics also influences the
decisions taken by managers of business firms. Any business is part of an
economy. As we know, economic conditions heavily impact business
activities and vice versa. The per capita income of the citizens will define the
purchasing power on the basis of which, the business enterprises will decide
what products to manufacture and sell. A new enterprise has to forecast the
demand for the product, which it wants to sell. The day to day product
market has to decide a viable price depending upon the interaction between
the demand and the supply. Thus, management practitioners and
academicians brought economics to their perspective and developed
‘Managerial Economics’.
Objectives:
After studying this unit, you should be able to:
 describe the relevance and context for managerial economics
 explain the salient and distinguishing features of the subject
 recognise the role of the Managerial Economist in a business firm

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 assess the scope of the subject vis-à-vis business management

 explain the decision making process
 apply the decision making process in day-to-day business

Case Let
Slowdowns and booms in the global economy affect business firms either
negatively or positively. The recent slowdown in the global and Indian
economy has forced many Indian companies to revise their revenue
outlook for the current as well as the coming fiscal year. The impact of
the global turmoil has hit export-oriented firms the hardest, but the
decline in their sales is expected to be partly offset by the depreciation of
the Rupee against the US Dollar. In spite of the difficult business
conditions, investors in Indian firms are expecting the firms’ managers to
achieve good returns on investment by taking prudent decisions.
In this turbulent condition, how can managers take decisions that lead to
better utilisation of resources? How can the firms’ performance be
sustained in the prevailing conditions of volatile macroeconomic
conditions?

1.2 Definitions
In this section, we will discuss a few definitions. Managerial economics is a
science that deals with the application of various economic theories,
principles, concepts and techniques to business management in order to
solve business and management problems. It deals with the practical
application of economic theory and methodology in decision-making
problems faced by private, public and non-profit making organisations.
The same idea has been expressed by Spencer and Siegelman, in the
following words: “Managerial economics is the integration of economic
theory with business practice for the purpose of facilitating decision making
and forward planning by the management”1. Mc Nair and Meriam say,
“Managerial economics is the use of economic modes of thought to analyse
business situation”2. Brighman and Pappas define managerial economics
as, “the application of economic theory and methodology to business

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administration practice”3. Joel Dean is of the opinion that use of economic

analysis in formulating business and management policies is known as
managerial economics4.
Features of managerial economics
The features of managerial economics are as follows:
 It is more realistic, pragmatic and highlights the practical application of
various economic theories to solve business and management
problems.
 It is a science of decision-making. It focuses on decision-making
process, decision models and decision variables and their relationships.
 It is both conceptual and metric in nature, and it assists the decision-
maker through precise and evident measurement of various economic
variables and their interrelationships.
 It uses various macroeconomic concepts like national income, inflation,
deflation, trade cycles, etc. to understand and adjust its policies to the
environment in which the firm operates.
 It also gives importance to the study of non-economic variables having
implications on economic performance of the firm. For example, impact
of technology, environmental forces, socio-political and cultural factors,
etc.
 It uses the services of many other related sciences like mathematics,
statistics, engineering, accounting, operation research and psychology
to find solutions to business and management problems.
It should be clearly remembered that managerial economics does not
provide ready-made solutions to all kinds of problems faced by a firm. It
provides only the logic and the methodology to find out the answers, but not
the answers themselves. It all depends on the manager’s ability, experience,
expertise and intelligence to use different tools of economic analysis to find
out the correct answers to business problems.

1.3 Scope of Managerial Economics

In this section we will discuss the scope of managerial economics. The
scope helps in understanding the subject, area of the study, boundaries and
width of the subject. Business economics is comparatively a new and

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upcoming subject. Consequently, there is no unanimity among different

economists with respect to the exact scope of business economics.
However, the following topics are explained in this subject:
1. Objectives of a firm
2. Demand analysis and Forecasting
3. Production and Cost Analysis
4. Pricing Decisions, Policies and Practices
5. Profit Management
6. Capital Management
7. Linear Programming and the Theory of Games
8. Market Structure and Conditions
9. Strategic Planning
10. External environment
Objectives of a firm
Historically, profit maximisation has been considered as the main objective
of a business unit. All business organisations have multiple objectives which
are multidimensional out of which some are supplementary and some are
competitive. Few others are inter-connected and few others are opposing.
There are various goals like social, economic, organisational, human, and
national. All the objectives are determined by various factors and forces
such as corporate environment, socio-economic conditions, nature of power
in the organisation and external constraints under which a firm operates.
However, in the midst of several objectives, even today, the traditional profit
maximisation objective has a very high place. All other policies and
programmes of a firm revolve round this objective.
Demand analysis and forecasting
Mostly, a firm is a producing unit. It produces different kinds of goods and
services. It has to meet the requirements of consumers in the market. The
basic problems like: what to produce; where to produce; for whom to
produce; how to produce; how much to produce and how to distribute them
in the market, are to be answered by a firm. Hence, the firm has to study in
detail about the various determinants of demand, nature, composition and
characteristics of demand, elasticity of demand, demand distinctions,
demand forecasting, etc. The production plan prepared by a firm should
include all these points.

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Production and cost analysis

Production means conversion of inputs into the final output. It may be either
in physical or in monetary terms. Physical production deals with the
production of outputs by a firm, by employing different factor inputs in proper
proportions. Always, the most basic goal of any firm is to increase the
output. Production analysis deals with production function, laws of returns,
returns to scale, economies of scale, etc. Production cost is concerned with
estimation of costs to produce a given quantity of output. Cost controls, cost
reduction, cost cutting and cost minimisation receive top most priority in
production and cost analysis. Maximisation of output with minimum cost is
the basic goal of any firm. Cost analysis deals with the study of various cost
concepts, their classification and cost-output relationship in the short run
and long run.
Pricing decisions, policies and practices
Pricing decisions means to fix the prices for all the goods and services of
any firm. This is based on the pricing policy and practices of that particular
firm. Amongst all the policies the most important policy of any firm would be
the price setting policy. The pricing decision depends on the revenue
(amount), income (level) and profits (volume) earned by a firm. Hence, we
have to study price-output determination under different market conditions,
objectives and considerations of pricing policies, pricing methods, practices,
policies, etc. We also study price forecasting, marketing channel, distribution
channel, sales promotion policies, etc.
Profit management
Basically, a firm can be a commercial or a business unit. Consequently, its
success or failure is measured in terms of the amount of profit it is able to
earn in a competitive market. The management gives top most priority to
this aspect. There are many theories in profit management, like emergence
of profit, functions of profit and its measurement, profit policies, techniques,
profit planning, profit forecasting and break even point.
Capital management
This is one of the essential areas of business unit. The success of any
business is based on proper management and adequate capital investment.
Business managers, as part of cost-benefit analysis, have to study the cost
of employing capital and the rate of return expected from each and every

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project. Under capital management, managers should assess capital

requirement, methods of capital mobilisation, capital budgeting, optimal
allocation of capital, selection of highly profitable projects, cost of capital,
return on capital, planning and control of capital expenditure, etc.
Linear programming and theory of games
The term linear means that the relationships handled can be represented by
straight lines and the term programming implies systematic planning or
decision-making. It implies maximisation or minimisation of a linear function
of variables subject to a constraint of linear inequalities. It offers actual
numerical solution to the problems of making optimum choices. It involves
either maximisation of profits or minimisation of costs.
Basically, the theory of games attempts to explain the rational course of
action for an individual firm or an entrepreneur who is confronted with a
situation, wherein the outcome depends not only on his own actions, but
also on the actions of others who are also confronted with the same problem
of selecting a rational course of action. In short, under the conditions of
conflicts and uncertainty, a firm or an individual faces problem similar to that
of the player of any game. Both these techniques are extensively used in
business economics to solve various business and managerial problems.
Market structure and conditions
The information on market structure and conditions of various markets is the
most important part of the business. The nature, extent and degree of
competition, number of sellers and buyers, etc. determine the nature of
policies to be adopted by a firm in the market.
Strategic planning
It provides long term decisions, which will have a huge impact on the
behaviour of the firm. The firm fixes up some long-term goals and objectives
and selects a different strategy to achieve them. This framework is a recent
addition to the scope of business economics with the emergence of MNCs.
The perspective of strategic planning is global. In fact, the integration of
business economics and strategic planning has given rise to a new area of
study called corporate economics.

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External environment
The external environment has a significant role in managerial economics.
Few examples of external environment impacting managerial economics are
as follows:
1. Macroeconomic management of the country relating to economic
system, national income, trade cycles, savings and investments and its
impact on the working of a firm
2. Budgetary operations of the government and its implications on the firm
3. Knowledge and information about various government policies such as
monetary, fiscal, physical, industrial, labour, foreign trade, foreign capital
and technology, MNCs, etc. as well as their impact on the working of a
firm
4. Impact of liberalisation, globalisation, privatisation and marketisation on
the operations of a firm
5. Impact of international changes, role of international financial and trade
institutions in formulating domestic polices of a firm
6. Problems of environmental degradation and pollution and its impact on
the policies of a firm
7. Improvements in the field of science and technology and its impact on a
firm, etc
8. Socio-political, cultural and other external forces and their influence of
business operations
Thus, it is clear that the scope of managerial economics is expanding with
the growth of modern business and business environment.

1.4 Significance of the Study of Managerial Economics

This section elaborates on the significance of the study of managerial
economics. Managerial economics does not give importance to the study of
theoretical economic concepts. Its main concern is to apply theories to find
solutions to day-to-day practical problems faced by a firm. The following
points indicate the significance of the study of this subject in its right
perspective:
1. It gives guidance for identification of key variables in decision-making
process.

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2. It helps the business executives to understand the various intricacies of

business and managerial problems and to take right decisions at the
right time.
3. It provides the necessary conceptual, technical skills, toolbox of analysis
and techniques of thinking and other such modern tools and instruments
like elasticity of demand and supply, cost and revenue, income and
expenditure, profit and volume of production, etc to solve various
business problems.
4. It is both a science and an art. In the context of globalisation,
privatisation, liberalisation and marketisation and a highly competitive
dynamic economy, it helps in identifying various business and
managerial problems, their causes and consequence, and suggests
various policies and programmes to overcome them.
5. It helps the business executives to become much more responsive,
realistic and competent to face the dynamic challenges in the modern
business world.
6. It helps in the optimum use of scarce resources of a firm to maximise its
profits.
7. It also helps in achieving other objectives a firm likes attaining industry
leadership, market share expansion and social responsibilities, etc.
8. It helps a firm in forecasting the most important economic variables like
demand, supply, cost, revenue, price, sales and profit, etc and formulate
sound business policies
9. It also helps in understanding the various external factors and forces
which affect the decision-making of a firm.
Thus, it has become a highly useful and practical discipline in recent years
to analyse and find solutions to various kinds of problems in a systematic
and rational manner.

1.5 Functions of a Managerial Economist

This section elaborates the functions of a managerial economist. Managerial
economist is a specialist and an expert in analysing and finding answers to
business and managerial problems. He has in-depth knowledge of the
subject. He is an authority and has total command over his subject.

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A managerial economist has to perform several functions in an organisation.

Decisions making and forward planning are described as the two major
(basic) functions and remaining functions are derived from the two basic
functions.
A detailed description of the basic functions is given below for better
understanding.
Decision-making
The word ‘decision’ suggests a deliberate choice made out of several
possible alternative courses of action after carefully considering them. The
act of making a choice that signifies a solution for an economic problem is
economic decision making. It involves making a choice amongst a set of
alternative courses of action.
Decision-making is essentially a process of selecting the best option out of
many alternative opportunities or courses of action that are open to a
manager.
The choice made by the business executives are difficult, crucial and have
far-reaching consequences. The basic aim of making a decision is to select
the best course of action which maximises the economic benefits and
minimises the use of scarce resources of a firm. Hence, each decision
involves cost-benefit analysis. A slight error or delay in decision making may
cause considerable economic and financial damage to a firm. It is for this
reason that the management experts are of the opinion that right decision-
making at the right time is the secret of a successful manager.
Forward planning
The term ‘planning’ implies a consciously directed activity with certain
predetermined goals and means to carry them out. It is a deliberate activity.
It is a programmed action. Basically, planning is concerned with tackling
future situations in a systematic manner.
Forward planning implies planning in advance. It is associated with deciding
the future course-of-action of a firm. It is prepared on the basis of past and
current experience of a firm. It is prepared in the background of uncertain
and unpredictable environment and guess work. Future events and
happenings cannot be predicted accurately. Growing firms devote a
significant share of their current output to net capital formation for bolstering

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the future economic output. A business executive must be intelligent enough

to think in advance, prepare a sound plan and take all possible
precautionary measures to meet all types of challenges of the future
business. Hence, forward planning has acquired greater significance in
business circles.

Activity 1:
Select any type of business and prepare a plan with the predetermined
goals and means to carry them out. List down any 2-3 goals.

Self Assessment Questions

Fill in the blanks:
1. Managerial economics is the integration of ________ with ____ for
solving business and management problems.
2. Managerial economics fills up the gap between _______ and _______.
3. Managerial economics is mainly a _______________ science.
4. Basic objective of a firm today is _______________________.
5. Managerial economics is basically a branch of __________ economics.
6. Two major functions of a managerial economist are ____ and ______.
True or False
1. Managerial economics includes concepts from both microeconomics
and macroeconomics.
2. Managerial economics includes some theoretical tools and techniques
which may not be applicable in the real world.
3. Managerial economics helps to take decisions that lead to an increase in
a business firm’s profits.
4. Managerial economics is not related to other functional areas of
business management.
5. Forecasting of business performance can be done by using certain tools
and techniques of managerial economics.

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1.6 Summary
Let us recapitulate the important concepts discussed in this unit:
 Managerial economics is a new and a highly specialised branch of
economics. It brings together economic theory and business practice. It
assists in applying various economic theories and principles to find
solutions to business and management problems.
 It is applied economics and makes an attempt to explain how various
economic concepts are usefully employed in business management. It is
a practical subject. It opens up the mind of a managerial economist to
the complex and highly challenging business world. The features of
managerial economics throw light on the nature of the emerging subject
and the scope gives information about the wide coverage of the subject.
The concepts of decision-making and forward planning are the two basic
functions of a managerial economist. In a way, the entire subject matter
of managerial economics is to be understood in the background of these
two functions.

1.7 Glossary
Decision: It is a deliberate choice made out of several possible alternative
courses of action after carefully considering them.
Managerial economics: Managerial economics is the integration of
economic theory with business practice for the purpose of facilitating
decision making and forward planning by the management.
Planning: It is a consciously directed activity with certain predetermined
goals and means to carry them out.

1.8 Terminal Questions

1. Define managerial economics and explain its main characteristics.
2. Discuss the scope of managerial economics.
3. Explain the importance of managerial economics.
4. Discuss the functions of a managerial economist.

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1.9 Answers

Self Assessment Questions

1. Economic theory, Business Practice
2. Economic theory Practice
3. Prescriptive
4. Profit optimisation
5. Micro
6. Decision-making Forward Planning
True or False
1. True
2. False
3. True
4. False
5. True

Terminal Questions
1. Managerial economics is a science that deals with the application of
various economic theories, principles, concepts and techniques to
business management in order to solve business and management
problems. Refer to unit 1.2.
2. The scope helps in understanding the subject, area of the study,
boundaries and width of the subject. Refer to unit 1.3.
3. The main concern of the subject is to apply theories to find solutions to
day-to-day practical problems faced by a firm. Refer to unit 1.4.
4. A managerial economist has to perform several functions in an
organisation. Decisions making and forward planning are described as
the two major (basic) functions and remaining functions are derived
from the two basic functions. Refer to unit 1.5.

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1.10 Case Study: Economics in Action

Costlier inputs, weaker rupee dim CFL bulbs

Pramugdha Mamgain
NEW DELHI: Lighting companies like Philips, Havells and Bajaj
Electricals, have increased the prices of CFL (compact fluorescent lamp)
bulbs by up to 15% due to soaring prices of key raw material – rare earth
element – after the Chinese cut its production and exports.
Phosphor, the rare earth element, prices have shot up almost six times to
$300 per kg in the last few months because its supply fell short of
demand following the Chinese government's move to protect its CFL
industry. An entry level CFL bulb, which was selling at Rs. 80 a few
weeks ago, now costs Rs. 90 in the domestic market.
"Increase in rare earth prices diluted the advantage we had earned
through economies of scale," Havells India president, Sunil Sikka said.
Weakening rupee too, has made imports costlier. Sikka said his company
has proposed to the government to remove taxes on rare earth imports to
keep prices of the energy-efficient bulbs under check. Indian companies
are paying a tax of close to 20% on imports of rare earth.
About 97% of global rare earth is produced in China. The country also
dominates the global CFL production with a share of 70%. China's move
to limit rare earth exports makes the industry's movement towards clean
energy products difficult, because there are no alternatives for phosphor,
Philips Lighting India President Nirupam Sahay said.
Rising incomes, along with falling prices and increased awareness, have
helped CFL lighting to become a Rs. 2,000 crore industry, growing 25%-
30% a year. The total lighting market in the country is pegged at Rs.
7,000 crore, still dominated by incandescent lamps, or light bulbs. Philips
Lighting has increased CFL prices by 7-10%, while Bajaj Electricals
increased them by 8-10%.
Philips Lighting's Sahay said that the cost component of phosphor in CFL
has increased to 18% from 5% till the second quarter of this year.
Companies have not revised the prices of LED, or light-emitting diode
lamps, because the cost component of rare earth in LED bulbs is low.

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Discussion Questions:
Imagine that you are a manager in one of the lighting companies.
1. How could the increase in prices of your company’s CFLs impact the
demand for your CFLs? How would you address any potential
negative impact?
2. How does the depreciating Rupee affect the cost of imported
phosphor?
3. How does taxation affect the cost of imported phosphor?
4. What strategies could you adopt to minimise the risks arising from
increase in the price of imported phosphor?
(Source: The Economic Times, Nov 24, 2011)
Hint: Use the theoretical concept and answer the questions

Reference:
 Spencer, Milton H. & Siegelman, Louis (1959), Managerial Economics,
Homewood, Illinois: Richard. D. Irwin, Inc.
 McNair, Malcolm P. & Meriam, Richard S., (1941), Problems in Business
Economics, New York & London: McGraw Hill Book Co. Inc.
 Pappas, James L., & Brigham, Eugene F., (1979), Managerial
Economics, Hinsdale: Ill Dryden Press.
 Dean Joel, (1951), Managerial Economics, Englewood Cliffs: N J,
Prentice Hall.

E-Reference:
 www.Economictimes.com – retrieved on 24th November 2011

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