Managerial economics

MANAGERIAL ECONOMICS
UNIT-1
Definition, Nature, Scope
Managerial economics is a discipline which deals with the application of economic
theory to business management. It deals with the use of economic concepts and principles of
business decision making. Formerly it was known as “Business Economics” but the term has
now been discarded in favour of Managerial Economics.
Managerial Economics may be defined as the study of economic theories, logic and
methodology which are generally applied to seek solution to the practical problems of business.
Managerial Economics is thus constituted of that part of economic knowledge or economic
theories which is used as a tool of analysing business problems for rational business decisions.
Managerial Economics is often called as Business Economics or Economic for Firms.
Definition of Managerial Economics:
“Managerial Economics is economics applied in decision making. It is a special branch of
economics bridging the gap between abstract theory and managerial practice.” – Haynes,
Mote and Paul.
“Business Economics consists of the use of economic modes of thought to analyse business
situations.” - McNair and Meriam
“Business Economics (Managerial Economics) is the integration of economic theory with
business practice for the purpose of facilitating decision making and forward planning by
management.” - Spencerand Seegelman.
“Managerial economics is concerned with application of economic concepts and economic
analysis to the problems of formulating rational managerial decision.” – Mansfield
Nature of Managerial Economics:
1. Managerial economics is concerned with the analysis of finding optimal solutions to
decision making problems of businesses/ firms (micro economic in nature).
2. Managerial economics is a practical subject therefore it is pragmatic.
3. Managerial economics describes, what is the observed economic phenomenon (positive
economics) and prescribes what ought to be (normative economics)
4. Managerial economics is based on strong economic concepts. (conceptual in nature)
5. Managerial economics analyses the problems of the firms in the perspective of the
economy as a whole ( macro in nature)
6. It helps to find optimal solution to the business problems (problem solving)
7. It is an art and science.
o The primary function of management executive in a business organisation is decision making
and forward planning.
o Decision making and forward planning go hand in hand with each other. Decision making
means the process of selecting one action from two or more alternative courses of action.
Forward planning means establishing plans for the future to carry out the decision so taken.
o The problem of choice arises because resources at the disposal of a business unit (land, labour,
capital, and managerial capacity) are limited and the firm has to make the most profitable use
of these resources.
o The decision making function is that of the business executive, he takes the decision which will
ensure the most efficient means of attaining a desired objective, say profit maximisation.
After taking the decision about the particular output, pricing, capital, raw-materials and
power etc., are prepared. Forward planning and decision-making thus go on at the same time.

o A business manager’s task is made difficult by the uncertainty which surrounds business
decision-making. Nobody can predict the future course of business conditions. He prepares
the best possible plans for the future depending on past experience and future outlook and yet
he has to go on revising his plans in the light of new experience to minimise the failure.
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.
o In fulfilling the function of decision-making in an uncertainty framework, economic theory can
be, pressed into service with considerable advantage as it deals with a number of concepts
and principles which can be used to solve or at least throw some light upon the problems of
business management. E.g are profit, demand, cost, pricing, production, competition,
business cycles, national income etc. The way economic analysis can be used towards solving
business problems, constitutes the subject-matter of Managerial Economics.
o Thus in brief we can say that Managerial Economics is both a science and an art.
Scope of Managerial Economics:
The scope of managerial economics is not yet clearly laid out because it is a developing
science. Even then the following fields may be said to generally fall under
Managerial Economics:
1. Demand Analysis and Forecasting
2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
These divisions of business economics constitute its subject matter.
Recently, managerial economists have started making increased use of Operation Research
methods like Linear programming, inventory models, Games theory, queuing up theory etc.,
have also come to be regarded as part of Managerial Economics.
1.Demand Analysis and Forecasting: A business firm is an economic organisation which is
engaged in transforming productive resources into goods that are to be sold in the market. A
major part of managerial decision making depends on accurate estimates of demand. A forecast
of future sales serves as a guide to management for preparing production schedules and
employing resources. It will help management to maintain or strengthen its market position and
profit base. Demand analysis also identifies a number of other factors influencing the demand for
a product. Demand analysis and forecasting occupies a strategic place in Managerial Economics.
2.Cost and production analysis: A firm’s profitability depends much on its cost of production. A
wise manager would prepare cost estimates of a range of output, identify the factors causing are
cause variations in cost estimates and choose the cost-minimising output level, taking also into
consideration the degree of uncertainty in production and cost calculations. Production
processes are under the charge of engineers but the business manager is supposed to carry out the
production function analysis in order to avoid wastages of materials and time. Sound pricing
practices depend much on cost control. The main topics discussed under cost and production
analysis are: Cost concepts, cost-output relationships, Economics and Diseconomies of scale and
cost control.
3.Pricing decisions, policies and practices: Pricing is a very important area of Managerial
Economics. In fact, price is the genesis of the revenue of a firm ad as such the success of a
business firm largely depends on the correctness of the price decisions taken by it. The important
aspects dealt with this area are: Price determination in various market forms, pricing methods,
differential pricing, product-line pricing and price forecasting.
4.Profit management: Business firms are generally organized for earning profit and in the long
period, it is profit which provides the chief measure of success of a firm. Economics tells us that

profits are the reward for uncertainty bearing and risk taking. A successful business manager is
one who can form more or less correct estimates of costs and revenues likely to accrue to the
firm at different levels of output. The more successful a manager is in reducing uncertainty, the
higher are the profits earned by him. In fact, profit-planning and profit measurement constitute
the most challenging area of Managerial Economics.
5.Capital management: The problems relating to firm’s capital investments are perhaps the most
complex and troublesome. Capital management implies planning and control of capital
expenditure because it involves a large sum and moreover the problems in disposing the capital
assets off are so complex that they require considerable time and labour. The main topics dealt
with under capital management are cost of capital, rate of return and selection of projects.
Conclusion: The various aspects outlined above represent the major uncertainties which a
business firm has to reckon with, viz., demand uncertainty, cost uncertainty, price uncertainty,
profit uncertainty, and capital uncertainty. We can, therefore, conclude that the subject-matter of
Managerial Economics consists of applying economic principles and concepts towards adjusting
with various uncertainties faced by a business firm.
Objectives of Managerial Economics
Managerial economics is a method to analyze goods or services and make business
decisions.Managerial economics is a method to analyze goods or services and
make businessdecisions from the analysis. This form of studying can help identifythemes and
trends that could be the cause and effect of good and bad businessdecisions. Managerial
economics is usually applied to assist in making decisionson risk management, manufacturing,
pricing and investment. It has been used in profit and not-for-profit organizations.
Implement Analytical Tools-
An objective of managerial economics is to implement devices that will measure and
analyze a broad scale of a company’s financial goals. These devices can be as simple as
manually recording production processes to making cost-effective suggestions to developing a
top-scale database program that will help identify obstacles and potential growth areas.
Analyze Business Goals
Managerial economics helps to assess business goals and stratagem on acontinuous
basis--weekly, monthly and quarterly, for example. Using managerialeconomics helps to
scrutinize the hazards of business choices and evaluatemarketing techniques and procedures.
Make New Business or Product Decisions
The process of managerial economics also allows for deciding if an investment ina
new business or product venture is financially sound. After assembling thenecessary data,
decision makers are able to develop a strategy and plan for production, quantity, pricing,
marketing and handling. Understanding the risksand cost beforehand will allow the company a
better opportunity to reach itsobjectives and make a profit.
Applications of ManagerialEconomics
Managerial economics is an economic tool kit for business leaders and managers. The following
theories, techniques, and approaches are used by business managers to optimize firm profits and
market share.
1. Theory of the firm
2. Demand theory
3. Production and cost analysis
4. Capital budgeting

5. Game theory
1. The Theory of Firm Managerial economics builds on the theory of the firm. The theory of
the firm is a microeconomic approach to business analysis of inputs, production methods,
output, and prices. • Focuses on profit maximization, demand and price, production and
factor utilization, and cost minimization. • Emphasizes the optimization of quantity,
price, costs and profits in a single time period for a single kind of product produced in a
single facility. • With its focus on optimization, remains relevant for small farms, small
natural resource producers, or small factories serving local markets • Not useful for mid
to large size businesses with multiple products, production facilities, and markets.
2. Demand Theory Demand theory refers to the amount of product that a buyer is willing
and able to buy at a specified price. • Business managers are responsible for forecasting
and estimating the demand for a product within the marketplace and producing the
product in appropriate volume. • Customers who once demanded a single, easily-
produced product are increasingly demanding a combination of physical units and
bundles of associated support services and quality attributes. • Managerial economics
offers tools to create a demand forecast that represents the quantity of both units and
support services demanded as a function of price.
3. Production & Cost Analysis • Production and cost analysis refers to the microeconomic
techniques used to analyse production efficiency, optimum factor allocation, economies
of scale, and cost function. • Production and cost analysis incorporates the expenses
associated with raw materials, components, subassemblies, communications,
transportation, and customer support services. Business managers work to add more
value to the products that their companies produce. • Business managers often face
transfer pricing problems as they determine product price points.
4. Capital Budgeting • Capital budgeting refers to the branch of managerial economics that
is concerned with investment decisions and capital purchasing decisions. • Capital
budgeting is the analytical process of determining the optimal investment of scarce
capital so as to realize the greatest profit from that investment. • Capital budgeting ranks
proposed investments in order of their potential profitability.
There are two main criteria for selecting potential business investments:
 Business managers, engaged in capital budgeting, generally have a minimum desired
rate of return specified as the cut-off point to determine whether or not a project
should be accepted or rejected.
 Business managers, engaged in capital budgeting, generally experience constraint
from top management regarding the total amount of potential investment.
a. The postponability method- when business managers purchase new equipment and
replacements based on their level of urgency. Investments are not made if they can be
postponed until a later point.
b. The payback method- The payback method is used to measure the worth of an investment
project. • The payback method focuses primarily on profitable near-future earnings rather
than long-term profits with uncertain profits. Prepared by: Jay H. Shah, Department of
Technology Management, CSPIT, CHARUSAT 10 Business managers, engaged in
capital budgeting, take hold of stockholders' funds and work to maximize their earning
potential through four main strategies:
c. Financial statement method- Based on the accounting information and book values. •
Business managers hope that the figures they generate will eventually match the accounts
after the project is completed. Discounted cash flow technique4) • The discounted cash
flow technique recognizes that the use of money has a cost. • Money spent or received
today has a different value than money spent or received in the future Business managers,

engaged in capital budgeting, take hold of stockholders' funds and work to maximize
their earning potential through four main strategies:
5. Game Theory Game theory is a decision-making tool for business managers. Game
theory refers to a mathematical method for analysing a conflict. • The opposing interests
in the game are called players. The alternative is not between two decisions to be made
but between two or more strategies to be used against the opposing interest. The value of
the game is called the average gain. Each player supports a strategy that maximizes his or
her average gain. • Game theory allows capital budgeters to consider all possible
forecasts for proposed investment projects. • Game theory is potentially limited by the
inputs used in analysis, and is limited by the facts utilized in the game. Incorrect or
misleading information will result in inaccurate analysis of the potential gains of a
project.
6. Morden Development In Managerial Economics • Managerial economics is, in many
ways, geared to the business managers and decision-making needs of traditional firms. •
Corporations are increasingly part of global net- works of product research and design,
production, and distribution. • Firms are moving from linear, centralized, hierarchical
structures to decentralized, cooperative, and team-based structures. • Customer support
services are increasingly critical to winning market segments or shares and serves to
differentiate one competitor from another. • These customer support services factor into
the expense and profit forecasts made by business managers
Conclusion:
Managerial Economics, which applies economic theory and methods to business
and administrative decision-making and managerial problems, is a vital tool for
effective economic forecasting and profit optimization. “Management without
economics has no roots.” & “Economics without management bears no fruits.”

Managerial economics

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