Unit 1

Managerial Economics: Concept, Scope and Other Details

“Managerial economics is concerned with the application of economic

principles and methodologies to the decision-making process within the firm
or organization. It seeks to establish rules and principles to facilitate the
attainment of the desired economic goals of management”-Douglas.
The subject matter of economics comprises a number of concepts and
theories. The application of these concepts and theories in the process of
business decision making is known as managerial economics. In other words,
managerial economics undertakes the study of different economic tools that
are used in business decision making.

Some of the popular definitions of managerial economics are given

as follows:
According to Mansfield, “Managerial economics is concerned with the
application of economic concepts and economics to the problems of
formulating rational decision making.”

In the words of Spencer, “Managerial economics is the integration of

economic theory with business practice for the purpose of facilitating decision
making and forward planning by management”

According to Douglas, “Managerial economics is concerned with the

application of economic principles and methodologies to the decision-making
process within the firm or organization. It seeks to establish rules and
principles to facilitate the attainment of the desired economic goals of
management”.

As per Haynes, Mote, and Paul, “Managerial Economics refers to those

aspects of economics and its tools of analysis most relevant to the firm’s
business decisions-making process. By definition, therefore, its scope does not
extend to macroeconomic theory and the economics of public policy an
understanding of which is also essential for the manager.”

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From the aforementioned definitions, it can be concluded that managerial
economics serves as a link between the two disciplines, namely management
and economics. The management discipline is concerned with a number of
principles that help in business decision making and improving the
effectiveness of business organizations.

On the other hand, economics is related to an optimum allocation of limited

resources for attaining the set objectives of a business organization.
Therefore, it can be said that managerial economics is a special discipline of
economics that can be applied in business decision making of organizations.

The decision-making process of an organization involves selecting the best

course of action from the available alternatives. Therefore, an organization
should have a clear understanding of business environment so that it can
take appropriate business decisions.

Figure-1 shows the application of economics in business decision-

making:

Thus, managerial economics deals with the analysis of economic theories and
laws to take decisions based on rational thinking.

Scope of Managerial Economics:

The two branches of economics, which are macroeconomics and
microeconomics. These two branches can be directly or indirectly applied to

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the business decision making of an organization depending on the purpose of
analysis.

Thus, managerial economics undertakes both macroeconomics and

microeconomics theories. In general sense, managerial economics involves the
application of different economic tools, theories, and methodologies for
analyzing business problems and decision making.

These business problems can be related to demand and supply prospects of

an organization, level of production, pricing, market structure, and extent of
competition. The areas of business problems to which economic tools and
theories can be directly applied are classified into two categories, which are
microeconomics applied to operational or internal issues and macroeconomics
applied to environmental or external issues.

Application of Microeconomics:
In business decisions making, microeconomics can be applied to deal with
operational issues, which are internal to an organization. These issues are
under the control of management and can be solved by taking appropriate
decisions.

Basically, an organization has to deal with internal issues related to type of

business and product, size of organization, technology to be used, price
determination, investment decisions, and management of inventory.
Microeconomics strives to solve these issues, which are generally faced by
business organizations.

The operational issues can be solved by using the following

microeconomic theories:
i. Demand Theory:
Refers to a theory that is applied to understand the buying behavior of
consumers. This theory helps managers to determine the factors that affect
the buying decisions of consumers and their needs and requirements.

In addition, the demand theory helps managers to answer the

following questions:
a. Why does a consumer stop consuming certain products?

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b. How does a customer react with changes in factors, such as price, tastes
and preferences, and level of income?

Thus, the demand theory is helpful in deciding the type of product to be

produced, determining the level of production, and making pricing decisions
in the present market conditions.

ii. Production Theory:

Refers to the theory that explains the relationship between input and output.
The mainly deals with the Tissues related to production. It explains the
changes in the cost of a product or service and the effect on the total output
with change in a particular factor (input) while keeping the other factors at
constant.

Apart from this, the production theory deals with maximization of output
(when the resources ar. limited) and determination of optimum size of output.
Therefore it helps managers to decide the size of an organization, labor and
capital to be employed, and total output.

iii. Price Theory:

Involves determining the price of a product or services under different
market price theory is concerned with the analysis of market structure and
determination of price. It also enables manage to determine the conditions
that are conducive and profitable for price discrimination as well as how
advertising would help in increasing the sales of an organization. Therefore,
the price theory and market analysis helps in finalizing the pricing policies of
an organization.

iv. Profit Theory:

Helps organizations to measure the return on capital and total profit. It is a
well-known fact that the main objective of any organization is to earn profit.
However, an organization does not always earn the same amount of profit
every time due to uncertain business conditions with respect to changes in
product demand, prices of input, and competition level. There is always a
condition of risk even when an organization has employed the best technique
for production. Therefore, managing profit of an organization helps in
minimizing the risk factor and predicting the actual profit for future.

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v. Capital Theory:
Enables managers to make capital and investment decisions, which
determine the success of an organisation. As we know, capital is a scarce
resource of an organization; therefore, it should be allocated efficiently.
Generally, managers, while managing capital, face issues related to the
selection of investment project and efficient allocation of capital. These issue
are dealt with the help of the capital theory. The capital theory helps
managers in investment decision making, selecting appropriate projects, and
capital budgeting.

Application of Macroeconomics:
The macroeconomic theory deals with issues related to the general business
environment in which an organization operates. The environmental issues
can be associated with the economic, political, and social environment of a
country.

The economic environment of a country comprises the following

factors:
a. The type of economic system of the country

b. The pattern of national income, employment, saving, and investment of the

country

c. The functioning of the financial sector of the country

d. The structure and nature of foreign trade in the country

e. The trends of labor supply and capital market strength of the country

f. The economic policies of government

g. The value system of society, property rights, customs, and habits

h. The political system of the country

i. The functioning of private and public sectors

j. The impact of globalization on the country

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Thus it is not possible for an individual organization to deal with all these
factors that constitute the economic environment of a country. However, all
organizations of a country together stimulate its economic environment. All
these factors have a great impact on the functioning of individual
organizations. Therefore, organizations, while decision making, should take
into consideration the economic, political, and social factors that constitute
the economic environment of a country.

Importance of Managerial Economics:

The main objective of any business organization is to earn maximum profit.
For achieving this objective, an organization needs to ensure the effectiveness
of its decision making process. Decision-making is defined as a process of
selecting the best course of action among the available alternatives, so that
the set business objectives can be achieved.

A comprehensive decision requires a perfect knowledge of various economic

theories, concepts, and tools that are directly included in the business
decision making. Managerial economics enables manager’s in effective
business decision making as it analyzes a business problem rationally and
with different perspectives.

It helps an organization in the following ways:

a. Helps in taking decisions related to type of product, investment, pricing,
and level of production

b. Enables managers to select production techniques and best course of action

c. Comprises various economic concepts, such as demand theory, production

theory, and capital theory, which helps in studying and analyzing different
business problems

d. Helps organization in making future decisions with respect to economic

variables, such as price, demand, supply, and cost

e. Applies different economic theories and tools to the real world business
environment

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f. Enables organizations to determine and analyze factors that affect business
decisions

g. Helps in formulating business policies

h. Helps in assessing relationship between different economic variables, such

as demand, supply, income, employment, and profit

Managerial Economics in Other Disciplines:

Managerial economics undertakes the study of economic analysis for solving
different business problems However, there are other disciplines that help in
economic analysis for business decision making.

Thus, managerial economics also involves the study of certain other

disciplines. Some of the important disciplines associated with managerial
economics include mathematics, statistics, operations research, and
management theory and accounting. These disciplines help organizations in
economic analysis to a greater extent.

Let us discuss these disciplines as follows:

i. Mathematics:
Refers to one of the most crucial disciplines of business decisions making.
Organizations generally deal with the concepts that are quantitative in
nature, such as demand, price, cost, and interest rates. These concepts are
also called economic variables, which w related directly or indirectly with
each other.

An application of mathematical tools in these concepts not only provides

clarity, but also helps in designing a logical framework to measure
relationship between different economic variables. Apart from this,
mathematical tools are also used to deal with issues related to sales
optimization profit maximization, and cost minimization.

ii. Statistics:
Provides an important aid in business decision-making. An organization uses
various statistical tools to collect and analyze business data as well as to
check the validity of the data before it is applied to business analysis. Some of

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the commonly used statistical tools are forecasting techniques and regression
analysis.

These tools help managers in determining economic events that may take
place in future. In addition, these tools enable managers to project probable
results of their business decisions. Thus, the scope of managerial economics
also involves the study of different statistical tools.

iii. Operational Research:

Represents a close relationship with managerial economics. Operational
research is basically concerned with building models for solving various
business problems. It makes use of different economic concepts mathematical
techniques, and statistical tools. The most commonly used operational
research technique for solving business problems is linear programming.

iv. Management theory and accounting:

Refers to the most important disciplines that help in business decision
making. These two disciplines are closely associated with managerial
economics. Management theories help in determining the behavior of an
organization while it is striving to achieve certain predetermined goals and
objectives.

Therefore, managers must have proper knowledge of management theories.

On the other hand, accounting helps an organization to know its functioning
and performance. It also enables an organization to determine whether it
requires any course of action for improvement. Thus accounting information
serves as a primary source of data for business decision making.

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