Managerial economics

Managerial Economics is the application of economic theory &

quantitative methods ( mathematics & statistics ) to the managerial
decision making process.

It is combination of two terms ‘Managerial & Economics’.

(1)Meaning of Managerial : The term managerial refers to the
functions of the management. The main functions of management
are Decision making & Forward planning.
Decision making –process of choosing from among the
alternatives to achieve firm’s established goals.
Forward planning –making the plans for future.
 (2) Meaning of Economics : Economics is the study
of the optimal use of scarce resources to satisfy
human needs & wants. It has two broad categories-
 Microeconomics and Macroeconomics

 According to Peterson and Lewis,

“Managerial Economics is an application of
that part of microeconomics which focuses attention
on those topics which are of greatest interest &
importance to managerial enterprises. These topic
include Demand, Production, Cost, Pricing, Market
Structure & Government Regulation”.
In the words of T.J.Wehster,” Managerial economics is
the synthesis of microeconomic theory & quantitative
methods to find optimal solutions to managerial decision-
making problems.”
Samuelson & Marks is of the opinion that,”
Managerial economics is the analysis of major
management decisions using the tools of economics”.
According to Spencer & Seligman,” Managerial
economics is the integration of economic theory with
business practice for the purpose of facilitating decision
making & forward planning by management”.
 The common elements are:

 (i) Managerial economics is an application of

economics, particularly of microeconomics to
managerial decision making.
 (ii) Managerial economics can be used to make
better management decisions.
 (iii) Managerial economics uses decision science
for decision making about the optimum allocation
of scarce resources to competing activities.
 (iv) Managerial economics can be applied to
government agencies & the other non-profit
organizations as well as to business.
 Management
Economic concepts Decisions Problems Decisions Sciences
Framework for decisions
•Product, Price & Output Tool & Techniques
•Make or Buy of Analysis
•Theory of consumer behaviour •Production Technique
•Theory of the Firm •Inventory Level •Numerical Analysis
•Theory of Market Structures & •Advertising Media & •Statistical Estimation
Pricing Training •Forecasting
•Investment & •Game Theory
Financing •Optimization

Managerial Economics
Use of Economic Concepts & Decision Science
Methodology to solve Managerial Decision Problems.

Optimal solutions to Managerial Decision Problems

 Application of Economic Theory

Optimal
Management Descriptive solutions to
Managerial
Decision & Specific
Economics
problems Prescriptive organizational
objectives

Decision Sciences
 The nature of managerial
economics can be
 Applied Economic
theory
 Pragmatic
 Multi-disciplinary
 Descriptive &
Prescriptive
 Applied Science
 Applied Economic theory -application of economic theory
to managerial decision making.

 Pragmatic-it suggests how economic principles are applied

to the formulation of policies and programmes.

 Multi-disciplinary -related to different disciplines like

statistics, management, operational research, mathematics,
economics and psychology
 Descriptive & Prescriptive –
as descriptive it attempts to interpret observed
phenomena and to formulate theories about
possible cause and effect relationship.
 As perspective it attempts to predict the
outcomes of specific management decisions.
 Applied Science –it is applied social
science and can be applied in two ways-
 First, given existing environment the
principles of managerial economics may
provide a framework whether managers
are efficiently allocating resources to
producer firm‟s output at least cost.
 Second, principles of managerial
economics can help managers to various
economic symbols.
Scope of Managerial Economics
 Demand Analysis &
Forecasting
 Production Function
 Cost Analysis
 Inventory
Management
 Advertising
 Price System
 Resource Allocation
 Capital Mgt.
 Profit Mgt.
 Decision Theory
under Uncertainty
 Difference between Managerial Economics
& Economics
Managerial Economics
Economics
1) It deals with the
1) It includes application of body of the
economic principles.
principles itself.
2) It is mostly micro- 2) It is both micro as
economics in character. well as macro.
3) Scope is narrow. 3) Scope is wide.
4) It modifies & enlarges 4) It gives the
the models. simplified models.
5) It introduces certain 5) It makes certain
feedbacks. assumptions.
6) It is much influenced by 6) It is less influenced
other factors. by other factors.
7) In this the social gain is 7) In this the social
secondary. gain is primary.
 Role of Managerial Economist

Specific General
Decisions Assignment

Internal Factors
External Factors •Pricing & Profit
•General Economic Policies
Conditions •Investment Decisions
•Demand for the product •Technological
•Input Cost Development
•Market Conditions •Business Planning
•Firm’s share in •Statistical Records
the Market •Supply of Economic
•Economic Policies Information
 Responsibility of a Managerial
Economist
 Better Management of resources
 Forecasting
 Additional information
 To Maximize Profit
 Conceptual as well as Practical
 Researcher
 Thinking, Discussing & Criticizing
 Taking up challenging tasks
 Essential Qualification of a
Managerial Economist
 Diplomacy
 Thorough knowledge
 Rare intuitive ability
 Creative mind
 Modest
 Conceptual & metrical
Significance of Managerial
Economics
 Utilization of Natural & Man-made
Resources
 Solving Economics Problems
 Application of Traditional Economics
 Use of Ideas from other Subjects
 Variety of Business Decisions
 An Integrating Agent
 Revenue to the government
 Social Benefits
 Advertising Media
 Other Uses
Limitation of Managerial
Economics
 Emergence of
Monopolies
 Emergence of
Oligopoly
 Exploitation of
Workers
 Social Costs
 Environmental
Pollution
 Cut-throat
Competition
IMPORTANCE OF
MANAGERIAL
DECISION MAKING
 What is Managerial Economics

Decision making refers to the choices between courses

of action or strategy. It is the process of determining
best possible solution to a given problem.

In the word of Spencer & Seligman,” Managerial

Decision-making may be defined as the
process of selecting one alternative from two
or more alternative or courses of action.”

.
Managerial decision must be made Timely.
In the words of Pappers & Hirschey,”
Managerial Decision-making is the process
of determining the best possible solution
to a given problem.”

Effective Decision-making is
the art of making the best choice from all
available alternatives.
`
Note:- In decision making, the Time of the
decision is very important.
 Process of Managerial
Decision Making
Determining the Objective

Defining the Problem

Identifying possible Solutions

Consider
Consider
Predicting the Consequences Legal
Input
&
Constraints
Selecting the best possible Solution Other
Constraints

Implement the Decision

 Importance of Decision

Making
Importance of Product Decision
 Importance of Product methods Decision
 Importance of Price & Quantities Decision
 Importance of Promotional Strategy Decision
 Importance of Locational Decision

In short
1) What products & services should be produced.
2) What input & production techniques should be used.
3) How much output should be produced & at what price it
should be sold.
4) What are optimal sizes & location of plants &
5) How should available capital allocated.
OBJECTIVES OF THE
FIRM
 Meaning of a Firm
According to Edwin
Mansfield,“Firm is a unit that produces a
good or service for sale.”
In the words to Salvatore,”A Firm
is an organization that combines & organizes
resources for the purpose of producing
goods & service for sale at profit.”

According to H.C.Peterson & W.C.

Lewis,”In order to earn profits, the firm is
an entity that organizes factors of
production to goods & services that will
meet the demands of individual consumers
Objectives of the Firm
1) Profit Maximization
2) Revenue or Sales
Maximization
3) Maximization of
Satisfaction
4) Security Profits
5) Growth
Maximization
6) Maximization OF
Managerial Utility or
Discretion
7) Satisficing Theory
8) Cyert & March‟s
Behavioural Theory
 Profit Maximization
Meaning of Profit
Profit means all income that flows to
investors.
For an Economist, The term Profit refers to
‘Pure Profit’ i.e ‘Economic Profit’

Economic Profit
It is the difference between total Revenue
& total Cost, including both explicit &
implicit costs.
=TR-TC
 Economic Profit = Total Revenue – Total Explicit Cost
= Total Revenue – Explicit Costs – Normal Profit

Accounting Profit/ Business Profit = Total Revenue – Total Explicit Cost

= Economic Profit + Normal Profit

Profit Maximization as the only objective of business firms is the main assumption of the
traditional economic theory. It also forms the basis of conventional price theory.

The basic propositions of the theory as follows:

1) The firm is a transformation unit.

2) The firm tries to attain its objective of profit maximization in a rational manner.
3) The market environment in which it operates, is given.
4) The profit-maximizing condition does not change with reference to time-perspective.
5) The primary concern of the theory of firm is to analyze changes in the prices
& quantities of input & output.
 Conditions of Profit
Maximization
In the words of Nicholson,”A profit maximizing firm chooses both its inputs
& outputs with the sole goal of achieving maximum economic profit. I.e,
the firm seeks to make the difference between its total revenues & its
total economic costs as large as possible.”

Conditions are:
1) Marginal Revenue (MR) = Marginal Costs (MC)
2) Slope of marginal revenue curve should be less than the slope of
marginal cost curve
Or
Marginal cost curve must cut marginal revenue curve from below.
According to William F. Samuelson & Stephen G. Marks,”The firm‟s profit
maximizing level of output occurs when the additional revenue from
selling an extra unit just equals the extra cost of producing it, that is,
when
MR = MC.”
 Y
A
Cost/
Revenue (1A)
B
(Rs.)
Q1 Q Q2 X
Y

Profit ( Max. Profit) (1B)

(Rs.)
P TP
Q1 Q Q2 X
Y MC
Revenue/ A (1C)
Cost (Rs.)
B E N
D
Q1 Q Q2 MR
X
OUTPUT
 (2) Sales Maximization Goal
According to this theory, once Profits reach
acceptable levels, the goal of the firms
becomes maximization of sales revenue
rather than maximization of profits.

(3) Maximization of Satisfaction

In view of Scitovosky maximization of
satisfaction is the main objective of the firm.
An entrepreneur wants to maximize satisfaction even at
the cost of profits. It is due to the fact that after
certain level of profits, the psychology of the
entrepreneur will be to give more preference to
leisure in comparison to profits. As the income of an
entrepreneur increases , he prefers leisure to efforts
to be incurred in producing output.
 (4) Secure Profits
Prof. Rothschild is of the view that the objective of the
firm is to get Secure Profits.
The firm is motivated not by profits maximization but by
the objective of security profit. It implies that a firm in
deciding its price & output policy does not aim at
maximizing its profits at a particular time or for a
particular period of time, but to have a constant flow of
profits for a long period of time.

(5) Growth Maximization

According to this theory, Rate of growth & potential of
growth are the yardsticks used to measure the success
of a firm. The manager of a firm aims at maximizing the
growth of his firm. The growth of a firm implies
increase in its size, production & Sales.
(6)Maximization of Managerial Utility or
Discretion
The theory of Managerial Utility Maximization was
developed separately by Berle- Means- Galbraith &
Williamson. It is also known as Managerial Discretion
Theory.
The theory is based on the concept that shareholders of the
firm & managers are 2 separate groups. The owners wants
Dividends & are therefore interested in profit maximization, the
managers , on the other hand, have different motives other
than profit maximization.
The expression for this: U = f ( S, M, ID )
s=additional expenditure
M=managerial emoluments
ID =discretionary investments
 (7) Satisfying Theory
It was produced by Herbert Simon. He
argued that due to imperfection of data &
uncertainty prevailing in the real world,
profit policy of the firm is not maximizing
profit satisficing.

The term „satisficing‟ means satisfactory

overall performance.
The firm is satisficing organization
rather than profit maximizing
entrepreneur.
(8) Cyert & March’s Behavioural
Theory

The behavioural theory of the firm has

been propounded by Cyert & March in
their book “ A Behavioural Theory of the
Firm.”
According to
this theory, the firm is a multi-goal,
multi-decision organizational coalition.
It consists of the various groups
associated with the firm; managers,
shareholders, workers, customers & so
on. Each group has its own goal.
 (9) Entry-Prevention & Risk-
avoidance
Another objective of the firms, suggested
by some economists, is to prevent entry of
new firms in to the industry.

The motive behind entry-prevention

may be-
Profit Maximization in long run
Securing constant market share &
Avoidance of risk caused by unpredictable
behaviour of new firms.