Business Economics – Notes Chapter 1


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 management.”

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 policies.”

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 face.”

Mc Nair and Meriam: “Managerial economics consists of the use of economic modes of thought to analyse business


 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 consumer.


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 quantities?

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 distribution?

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 time.

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 world.

Self-Assessment Questions-

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 Economics?

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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