Nature and scope of managerial economics

Definition:- according to McNair and Merriam, Managerial economics

consists of the use of economic mode of thought to analyze business
situation.

According to Spencer and Siegel man managerial economics is the

integration of economic theory with business practice for the purpose
of facilitating decision-making and forward planning by management.”
We may therefore, define “managerial economic as the discipline,
which deals with the application of economic theory to business
management.”

Decision-making and forward planning:-

The prime function of a management executive in a business

organization is decision making and forward planning. Decision-making
means the process of selecting one action from two or more alternative
course of action whereas forward planning means establishing plans for
the future. The question of choice arises because resources, such as
capital, land, labor and management are limited and can be employed
in alternative uses. The decision-making function thus become one of
making choices or decisions that will provide the most efficient means
of attaining a desired end , say, a profit maximization. Once a decision is
made about the particular goal to be achieved, plan as to production
thus goes hand in hand with decision-making.

A significant characteristic of the conditions in which business

organizations work and take decisions is uncertainty and this fact of
uncertainty not only makes the function of decision-making and
forward planning complicated but adds a different dimension to it.

Aspect of applications:-

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1)Reconciling traditional, theoretical concepts of economic in relation to
the actual business behavior and conditions. In economic theory, the
technique of analysis is one of model building whereby certain
assumptions are made and on that basis, conclusions as to the
behavior of the firms are draw take an example, an assumption usually
made is that firms at maximizing profit and on that basis, the theory of
the firm suggests how much the firm will produce and at what price it
would sell. In practice, however, firms do not always aim at maximum
profit and to that extent the theory of the firm fails to provide a
satisfactory explanation of the firm’s actual behavior.
2)Estimating economic relationships viz. measurement of various types of
elasticity of demand such as price elasticity, income elasticity, and
promotional cost-output relationship. The estimates of these economic
relationships to be used for purpose of forecasting.
3)Predicting relevant economic quantities e.g. Profit, productions, costs,
précising capital etc. in numerical terms together with their
probabilities. As the business manager has to work in an environment
of uncertainty future is to be predicted so that in the light of the
predicted estimates decision making and forward planning may be
possible.
4)Using economic quantities in decision-making and forward planning
that is formulating business policies and on that basis, establishing
business plans for the future pertaining to profit, price, cost, capital
etc.
5)Understanding significant external forces constituting the environment
in which the business is operating and to which it must adjust e.g.
business cycles, fluctuations in national income and government
policies pertaining to public finance, fiscal policy and taxation,
industrial licensing, monetary economic, labour relation, price control
etc.

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 Scope of managerial economics:-

1)Demand analysis and forecasting: - A business firm is an economic

organism which transforms productive resources into good that are to
be sold in a market. A major part of managerial decision-making
depends on accurate estimates of demand. Before production
schedules can be prepared and resources employed, a forecast of
future sale is essential demand analysis helps identity the various
factors influencing the demand for a firm’s product and thus provide
guidelines to manipulating demand. The chief topics covered are
demand determination, demand distinctions and demand forecasting.
2) Cost analysis:- A study of economic costs, combined with the data
drawn from the firm’s accounting record, can yield significant cost
estimates that are useful for management decisions. ‘The factor
causing variation in costs must be recognized and allowed for it
management is to arrive at cost estimate which are significant for in
classification, cost-output relationship, cost control and cost reduction.
3)Production and supply analysis:- Production analysis frequently
proceeds in physical terms while cost analysis proceeds in monetary
terms. P.A mainly deals with different production functions and their
managerial uses.
Supply analysis deals with various aspects of supply of a common
certain important aspects of supply analysis are- supply schedule,
curves and functions, law of supply and its limitation.
4)Pricing – decision, policies and practices :- Pricing is a very important
area of managerial economics. In fact, price is the genesis of the
revenue of a firm and as such the success of a business firm large
depends on the correctness of the price decisions taken by it.

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 The important aspect deals under this are Post-Determination in
various market forms, pricing method, differential pricing, price
forecasting.
5)Profit Management :- Business firms are generally organized for the
purpose of making profits and in the long run, profit provide the chief
measure of success. It the knowledge about the future were perfect,
profit analysis would have been a very easy task. The important
aspects covered under these areas are Nature and measurement of
profit, profit policies and technique of profit planning like Break-even
analysis.
6)Capital management:- The most complex and troublesome for the
business manager are likely to be those relating to the firm’s capital
investment capital management implies planning and control of capital
expenditure the main topics deal with are cost of capital, Rate of
return and selection of projects.
Basic economic tools in managerial economics
The most significant contributions of economics to managerial
economic lie in certain principles, which are basic to the entire amount
of managerial economic. The basic principle may be identified as:-
1)Opportunity cost principle:- By opportunity cost of a decision is meant
the sacrifice of alternative required by that decision. This can be best
understood with the help of a few illustrations.
A) The opportunity cost of the fund employed in one’s own business is
the interest that could he earned on those fund had they been
employed in other ventures.
B) The opportunity cost of using a machine to produce one product is
the earning forgone which would have been possible from other
product.
C) If a machine can produce either X or Y the opportunity cost of
producing a given quantity of X is, therefore, the quantity of Y which

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 it would have produce. If that machine can produce 10 units of X or
20units of Y, the opportunity cost of 1X is 2Y.
D) Suppose we have no information about quantities produced, but
have information about their prices. In this case, the opportunity
cost can be computed in term of the ratio of their respective prices,
say Px/Py.
For decision making opportunity cost is the only relevant
cost. The opportunity cost principle may be stated under the cost
involved in any decision consist of the sacrifices of alternative
required by that decision. If there are no sacrifices, there is no cost.
2)Incremental principle:- incremental concept is closely related to the
marginal cost and marginal revenues, for of economic theory. In actual
business situation, it often become difficult to apply the concept of
marginal which has to be replaced by incremental, for in real world
business, one is concerned with not ‘unit change’ but ‘chunk change.’
Incremental concept in values estimating the impact of decision
alternatives on costs and revenues, emphasizing the change in total
cost and total revenue resulting from change in prices, product,
procedure, investment or whatever may be at stake in the decision.
The two basic component of incremental reasoning are incremental
cost and incremental revenue incremental cost may be defined as the
change in total cost resulting from a particular decision. For instance, if
a firm decides to go for computerization of market information, the
additional revenue it earns will be termed incremental revenue and
the extra cost of setting of computer facilities will term incremental
cost the incremental principle may be stated as under.
“A decision” is obviously a profitable one if:-
A) It increases revenue more than cost.
B) It decreases some cost to a greater extent than it increases other.
C) It reduces cost more than revenues.
D) It increases some revenues more than it decreases other.
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3)Principle of time perspective:- the principle of time perspective may be
stated as under “ A decision should take into account bath the shout-
run and long-run effect on revenues and cost and maintain the eight
balance between the long run and short-run perspectives.
4)Discounting principle:- one of the fundamental ideas in economics is
that a rupee tomorrow is worth less than rupee today. A simple
example would make this paint clear-suppose a person is offered a
choice to make a gift of Rs. 100 today or Rs. 100 next year. Naturally,
he wills choice the Rs.100 today. This is true for two reason- first, the
future is uncertain and there may be uncertainty in getting Rs.100 if
the present opportunity is not availed of secondly, even if he is sure to
receive the gift in future, today Rs.100 can be invested so as to earn
interest, say, at 8% so that one year after the Rs.100 of today will
become Rs.108 whereas if he does not accept Rs.100 today he will get
Rs.100 only one year. Naturally, he would prefer the first alternative
because he is likely to gain by Rs.8 in future.