Nature and Scope of

Managerial Economics
Mr. Deepak Kulkarni
 What’s Economics
Artha – Money/Income

Shasthra – Body of Knowledge

Economics – Body of knowledge which deals

with the management of money
 Managerial Economics
According to Milton H Spencer and Louis
Siegelman “Managerial Economics is the
integration of economic theory with
business practice for the purpose of
facilitating decision making and forward
planning by the management.
Economic Theory Business
and Methodology Management
Decision Problems

Business Economics
Application of Economics
to solve business
problems

Optimal solutions to
business problems
 Nature of Managerial
Economics
 Micro in nature- concerned with the study
of the problems of the firm.

Pragmatic in nature- aims at solutions to

problems considering the environment in
which the business operates.
 Prescriptive in nature rather than
descriptive- aims at prescribing solutions to
business problems rather than describing
theories.

Uses Macro-Economics too – enables an

executive to understand the business
environment nd adjust with the
uncontrollable external factors
Scope of Managerial Economics
1) Demand Analysis and Forecasting:
- Forecasting future sales of products
and services.
- Identify demand determinants
- guidelines to manipulate demand
2) Cost Analysis:
- Discovering and measuring them for
effective profit planning and cost control
- covers cost-output relationships,
economies and diseconomies of scale,
cost control and cost reduction
3) Production and Supply Analysis:
- deals with planning production and its
managerial uses
- supply analysis deals with various
aspects of supply of a commodity
- maximize firm’s revenue through proper
planning of production and supply.
4) Pricing decisions, policies and practices:
- correct pricing decisions form the
backbone of success of the firm
- covers price determination in various
market conditions, pricing methods and
price forecasting.
5) Profit Management:
- high level of uncertainty in variation of
costs caused by sudden change in the
internal and external factors
- ME helps in estimating considerably
such uncertainties by manipulating costs
- covers break even analysis,
measurement of profit, profit policies and
techniques etc
6) Capital Management:
- most complex decisions of business
often revolve around planning and
allocation of capital
- decisions irreversible in nature
- ME helps in planning and control of
capital expenditure.
- covers cost of capital, rate of return and
selection of projects
 Fundamental Concepts
1) Opportunity Cost Principle:
The interest or the income that could have been
earned had the money been employed on other
ventures instead of the current venture.
- Represents the income foregone/sacrificed as a
result of investing in the current venture.
Example: Bank FD@ 7.25% Vs Child’s marriage
2) The Concept of incremental reasoning:
Incremental/marginal=one extra unit
Two components
1. Incremental cost- change in total cost
resulting from a particular decision
2. Incremental revenue- change in total revenue
resulting from a particular decision
Statement of the Principle:
A decision is a profitable decision if,
(i)It increases revenue more than costs
(ii)Decreases some costs to a greater extent
than it increases other costs
(iii) Increases some revenues more than it
decreases others
(iv)Reduces costs more than revenues
Illustration:
Estimated Revenue from a new order is Rs
5000
Estimated costs on execution(in Rs)
Labour 1500
Materials 2000
Overhead 1800
S&D 700
Full Cost 6000
Loss on execution 5000 – 6000= 1000
Change in circumstance
1.Existence of idle capacity
2.Incremental Overhead
New Estimated costs(in Rs)
Labour 1000
Materials 2000
Overhead 500
Incremental cost 3500
Incremental Profit= 5000-3500= Rs. 1500

Depends upon existence of idle capacity

3) Principle of time perspective:
Statement of the Principle
A managerial decision should take into
account both the short run and long run
effects on revenues and costs and
maintain the right balance between long
run and short run perspectives.
A decision may be made based on short run
considerations/gains but it may boomerang
in the long run.

Ex. Reduction in price to gain customers in the

short run may affect the image of the firm in
the long run when it increases prices owing
to an increase in costs in the future.
4) The Discounting Principle:
Statement of the principle
Any decision which affects costs and revenues at
future dates should discount those costs and revenues
to present values before comparing the alternatives.
Thumb rule: A rupee received today is more worth than
if it is received tomorrow.
---- Uncertainty of receipts in future
---- Inflation/Price Rise
Formula: V= Rs.100/(1+i)n
Assume a cash flow of rent of Rs.500 every year on an asset let out
for rent
Bank Interest rate: 10% p.a
NPV= 500/(1+0.10) + 500/(1+0.10)2
= 500/1.10+500/1.21
= 454.5+413.2
= Rs. 867.70 /-
Ex: Calculate the NPV with the given
information
a. Year end cash flow: Rs. 1000
b. Rate of interest: 5% p.a
c. Tenure: 4 years
Answer,
V= Rs.100/(1+i)n
NPV= 1000/1.05+1000/(1.05)2
+1000/(1.05)3+1000/(1.05)4
= 952.381+907.0295+863.8376+822.7025
= 3545.951
NPV.xls
5) The concept of Contribution:
The concept explains about contribution of unit of output to
the overheads and profit.
- Helps in determining the best product mix when scarce
resources are involved
- Fresh order Vs Shut down Vs Continue with existing
product
- Unit contribution is the per unit difference between
incremental revenue and incremental cost
Illustration:
A rather confused product manager approaches
you with a problem. With only a few scarce
resources at his disposal he needs to choose
which product to manufacture given that the firm
has the capacity to produce 1000 units of the
selected product. With your knowledge advise
the product manager
Solution:

Contribution.xls

Best pick : Produce 1000 units of product 4

Managerial Economics and
Economics - Differences
 Concept of risk and return
Risk:
The element of uncertainty about the occurrence
of a desired event in future.

Return:
The profit which the entrepreneur gets for his
function of bearing risk and uncertainty.
Circular Flow of Money