Managerial Economics generally refers to the integration
of economic theory with business practice while economics provides the tools
which explain various concepts such as Demand, Supply, Price, and Competition
etc. Managerial Economics applies these tools to the management of business. In
this sense, Managerial Economics is also understood to refer to business
economics or applied economics.
Managerial Economics lies on the border line of
management and economics. It is a hybrid of two disciplines and it is primarily
an applied branch of knowledge. Management deals with principles which help in
decision making under uncertainty and improve effectiveness of an organisation.
Economics on the other hand provides a set of propositions for optimum
allocation of scarce resources to achieve the desired objectives.
Spencer Singleman : “Managerial
Economics deals with integration of economic theory with business practice for
the purpose of facilitating decision making and forward planning by
Hague : “Managerial Economics is
concerned with using logic of economics, mathematics and statistics to provide
effective ways of thinking about business decision problems.”
Joel Dean : “The purpose of Managerial
Economics is to show how economic analysis can be used in formulating business
Mansfield : “Managerial Economics
attempts to bridge the gap between the purely analytical problems that intrigue
many economic theories and the problems of policies that the management must
Mc Nair and Meriam: “Managerial
economics consists of the use of economic modes of thought to analyse business ”
OF MANAGERIAL ECONOMICS
The scope of Managerial Economics is so wide that
it embraces almost all the problems and areas of the manager and the firm. It
deals with demand analysis and forecasting, production function, cost analysis,
inventory management advertising price system, resource allocation, capital
budgeting etc. While an in-depth treatment is given to these aspects in the
relevant chapters, a cursory treatment of these aspects has been attempted
here, merely to explain the scope of the subject.
1. Demand Analysis and Forecasting
It analyses carefully and systematically the various
types of demand which enable the manager to arrive at a reasonable estimate of
demand for products of his company. He takes into account such concepts as
income elasticity and cross elasticity. When demand is estimated, the manager
does not stop at the stage of assessing the current demand but estimates future
demand as well. This is what is meant by demand forecasting. For example, if
the manufacturer of umbrellas experienced a fall in the demand the last season
because of incorrect size (the size of his product being smaller than the one
in demand) and also less choice of colours in the product, then this season, he
needs to make sure that his inventory can cater to the changing needs of the
2. Production Function
We know that resources are scarce and also have
alternative uses. Inputs play a vital role in the economics of production. The
factors of production, otherwise called inputs, may be combined in a particular
way to yield the maximum output. Alternatively, when the price of inputs shoot
up, a firm is forced to work out a combination of inputs so as to ensure that
this combination becomes a least cost combination. In this way, the production
function is pressed into service by managerial economics. If the price of
petrol shoots up considerably, then the firm needs to include diesel cars for the
regular-pickup service for its employees. Also in recent times it is economical
and also the need of the hour to hire one IT professional that can develop and
run the tailor-made software replacing the work of hoards of accountancy
professionals. Softwares like MAGIC and SAP are developed to cater to the needs
particular to a firm.
3. Cost Analysis
Cost analysis is one of the important areas studied by
managerial economics. For instance, determinants of cost, methods of estimating
costs, the relationship between cost and output, the forecast of cost and
profit-these are very vital to a firm. Managerial Economics touches these
aspects of cost-analysis, an effective knowledge and application of which is
cornerstone for the success of a firm. Only inclusion of all costs in the
analysis will lead to the correct understanding of the profit standing of the firm.
4. Inventory Management
An inventory refers to stock of raw materials which a
firm keeps. Now the problem is, how much of the inventory is an ideal stock. If
it is high, capital is unproductively tied up, which might, if the stock of
inventory is reduced, be used for other productive purposes. On the other hand,
if level of inventory is low, production will be hampered. Therefore,
managerial economics will use such methods as ABC analysis, a simple simulation
exercise and some mathematical models with a view to minimize the inventory
cost. It also goes deeper into such aspects as the need for inventory control;
it classifies inventories and discusses the costs of carrying them.Seven more
general questions that must be faced in all economies, whether they are
capitalist, socialist or communist or mixed are explained below.
Q1. What commodities are being produced and in what
This question arises directly out of the scarcity of
resources. It concerns the allocation of scarce resources among alternative
uses (a shorter phrase, resource allocation, will often be used). The question
‘What determines the allocation of resources or resource allocation?’ have
occupied economists since the earliest days of the subject. In free – market economies,
most decisions concerning the allocation of resources are made through the
price system. The study of how this system works is the major topic in the
THEORY OF PRICE.
Q2. By what methods are these commodities produced?
This question arises because there is almost always more
than one technically possible way in which goods and services can be produced.
Agricultural goods, for example, can be produced by farming a small quantity of
land very intensively, using large quantities of fertilizer, labour and machinery,
or farming a large quantity of land extensively, using only small quantities of
fertilizer, labour and machinery. Both methods can be used to produce the same
quantity of some good; one method is frugal with land but uses larger quantities
of other resources, whereas the other method uses large quantities of land but
is frugal in its use of other resources. The same is true of manufactured
goods; it is usually possible to produce the same output by several different
techniques, ranging from the ones using a large quantity of labour and only a
few simple machines to the ones using a large quantity of highly automated
machines rather than another, and the consequences of these choices about
production methods, are topics in the THEORY OF PRODUCTION.
Q3. How is society’s output of goods and services divided
among its members?
Why can some individuals and groups consume a large share
of the national output while other individuals and groups can consume only a
small share? The superficial answer is because the former earn large incomes
while the latter earn small incomes. But this only pushes the question one
stage back. Why do some individuals and groups earn large incomes while others
earn only small incomes? Economists wish to know why any particular division
occurs in a free – market society and what forces, including government
intervention, can cause it to change. It concerns with the problem of
inequality of wealth and income of the people. Such questions have been of
great concern to economists since the beginning of the subject. These questions
are the subject of the THEORY OF DISTRIBUTION. When they speak of the division
of the national product among any set of groups in the society, economists
speak of THE DISTRIBUTION OF INCOME.
Q4. How efficient is the society’s production and
This question quite naturally arises out of question 1, 2
and 3. Having asked what quantities of goods are produced, how they are
produced and to whom they are distributed, it is natural to go on to ask
whether the production and distribution decisions are efficient. The concept of
efficiency is quite distinct from the concept of justice. The latter is a
normative concept, and a just distribution of the national product would be one
that our value judgements told us was a good or a desirable distribution.
Efficiency and inefficiency are positive concepts. Production is said to be
inefficient if it would be possible to produce more of at least one commodity
without simultaneously producing less of any other – by merely reallocating
resources. The commodities that are produced are said to be inefficiently
distributed if it would be possible to redistribute them among the individuals
in the society and make at least one person better off without simultaneously
making anyone worse off. Questions about the efficiency of production and
allocation belong to the branch of economic theory called WELFARE ECONOMICS.
For instance, in the wake of computerisation, in a bank, let’s say at a point
of time, the bank needs to retrench on five employees. Instead of dismissing
them without any notice, (remember they have served your firm for many years!),
as the ‘agent’ of the bank, you can give them Voluntary Retirement (pre-matured
retirement) option that goes either with a pension or offering a lumpsum amount
at one go. In today’s parlance, in many public sector undertakings, like SAIL,
NTPC (National Thermal Power Corporation) or in private sector like Bajaj Auto,
it is termed as a ‘Golden Hand-shake’.
Questions 1 to 4 are related to the allocation of
resources and the distribution of income and are intimately connected, in a
market economy, to the way in which the price system works. They are sometimes
grouped under the general heading of MICRO ECONOMICS.
Q5. Are the country’s resources being fully utilised, or are some of them lying idle?
We have already noted that the existing resources
of any county are not sufficient to satisfy even the most pressing needs of all
the individual consumers. Surely if resources are so scarce that there are not
enough of them to produce all of those commodities which are urgently required,
there can be no question of leaving idle any of the resources that are
available. Yet one of the most disturbing characteristics of free – market
economies is that such waste sometimes occurs. When this happens the resources
are said to be involuntarily unemployed (or, more simply, unemployed).
Unemployed workers would like to have jobs, the factories in which they could
work are available, the managers and owners would like to be able to operate
their factories, raw materials are available in abundance, and the goods that
could be produced by these resources are urgently required by individuals in
the community. Yet, for some reason, nothing happens : the workers stay
unemployed, the factories lie idle and the raw materials remain unused. The
cost of such periods of unemployment is felt both in terms of the goods and
services that could have been produced by the idle resources, and in terms of
the effects on people who are unable to find work for prolonged periods of
Why do markets experience such periods of involuntary
unemployment which are unwanted by virtually everyone in the society, and can
such unemployment be prevented from occurring in the future?
These questions have long concerned economists, and have
been studied under the heading TRADE CYCLE THEORY. Their study was given
renewed significance by the Great Depression of the 1930s. In the USA and the
United Kingdom, for example, this unemployment was never less than one worker
in ten, and it rose to a maximum of approximately one worker in four. This
meant that, during the worst part of the depression, one quarter of these countries’
resources were lying involuntarily idle. A great advance was made in the study
of these phenomena with the publication in 1936 of the General Theory of
Employment, Interest and Money, by J. M. Keynes. This book, and the whole
branch of economic theory that grew out of it, has greatly widened the scope of
economic theory and greatly added to our knowledge of the problems of
unemployed resources. This branch of economics is called MACRO ECONOMICS.
Q6. Is the purchasing power of money and savings constant, or is it being eroded because of inflation?
The world’s economies have often experienced periods of
prolonged and rapid changes in price levels. Over the long swing of history,
price levels have sometimes risen and sometimes fallen. In recent decades,
however, the course of prices has almost always been upward. The 1970s, 1980s
and 1990s saw a period of accelerating inflation in Europe, the United States
and in most of the world, more particularly in the less developed countries.
Inflation reduces the purchasing power of money and
savings. Rising prices especially adversely affects salaried people who have
fixed incomes, for example if the price of vegetables rises, housewives are
surely to ask for higher allowance from their salaried husbands but hoteliers
will be quite unaffected since they will increase the menu-rates. It is closely
related to the amount of money in the economy. Money is the invention of human
beings, not of nature, and the amount in existence can be controlled by them.
Economists ask many questions about the causes and consequences of changes in
the quantity of money and the effects of such changes on the price level. They
also ask about other causes of inflation.
Q7. Is the economy’s capacity to produce goods and services growing from year to year or is it remaining static?
Why the capacity to produce grows rapidly in some
economies, slowly in others, and not at all in yet others is a critical problem
which has exercised the minds of some of the best economists since the time of
Adam Smith. Although a certain amount is now known in this field, a great deal
remains to be discovered. Problems of this type are topics in the THEORY OF
ECONOMIC GROWTH. Is the economic growth maximum? Can the economic growth be
higher then the present level of growth? These are few questions which are
answered by economists in the best possible way.
Managerial economics is such a stream of study that
engulfs economic theory as well as principles of management. It is thus an
applied branch of knowledge, very useful to today’s emerging and competitive
world of management. It touches upon all the problems of a manager and a firm,
right from the inceptional stages of production to the high-end approach of
widening the base of market reach. Decision–making under conditions of
uncertainty and risk and forward planning are its prime areas.
This branch of economics looks at the economic problem
from micro to Its analysis starts from the grass-root level to the universality
of the problem and helps in decision making in the face of an economic problem
and universally to all types of economies. The approach is scientific,
statistical, analytical and deductive. This is a boon to all managers in the
Managerial Economics is a conglomeration of two streams –
management and Comment.
Managerial Economics has been defined by various Write
down the definitions.
What is the nature and subject matter of Managerial
What is an economic problem? Or what is the root cause of
any economic problem
Highlight the major economic problems faced by any
economy in this world.
Explain the term resource
What is the significance of Managerial Economics?
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