Managerial Economics Module - 1

1 MANAGERIAL ECONOMICS
INTRODUCTION TO MANAGERIAL ECONOMICS

Managerial economics, as the name itself implies, is an offshoot of two distinct disciplines:
Economics and Management. In other words, it is necessary to understand what these disciplines
are, at least in brief, to understand the nature and scope of managerial economics
ECONOMICS - INTRODUCTION
In the meaning of economics, the term ‘Economics’ owes its origin to the Greek word
‘Oikonomia’, which can be divided into two parts: oikos means home and nomos means
management. Thus, in earlier times, economics was referred to as home management where the
head of a family managed the needs of family members from his limited income.
Till the 19th century, Economics was known as ‘Political Economy.’ The book named ‘An
Inquiry into the Nature and Causes of the Wealth of Nations’ (1776) usually abbreviated as
‘The Wealth of Nations’, by Adam Smith is considered as the first modern work of Economics.
Economics Definition
Defining economics has always been a controversial issue since time immemorial. Definition of
economics by different economists have different viewpoints. Some economists had a viewpoint
that economics deals with problems, such as inflation and unemployment while others believed
that economics is a study of money,
Therefore, a simple definition of economics is defined by taking four definition
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SIVA KRISHNA.G | Assistant Professor
Wealth Definition of Economics
This is a classical definition of economics by Adam Smith, who is also considered as the father
of modern economics.
“Economics is the study of the nature and causes of nations’ wealth or simply as the study of
wealth.” Adam Smith
Key Features of Wealth economics definition
1. The main objective of Economics is to gain maximum wealth as possible
2. The core of economic activity: are production, distribution and consumption.
3. It deals with the causes of the creation of wealth in an economy.
4. The term ‘wealth’ used in this definition referred to material wealth.
Welfare Definition of Economics
It is a neo-classical definition of economics by Alfred Marshall.
“It is the study of mankind in the ordinary business of life. It enquires how he gets his income and
how he uses it. In one view, it is a study of wealth and on other hand it is part of study of man.”-
Alfred Marshall
Key features of Welfare economics definition
1. It defines Economics as the study of activities related to a human being and their material
welfare.
2. Marshall clarified that Economics is related to incomes of individuals and its uses for
creating material welfare.
3. Collectively incomes of a group of individuals form the wealth of a nation and ultimate
goal is to increase welfare of individual by their routine activities.
Scarcity Definition of Economics
It is a pre-Keynesian definition of economics by Robbins in his book ‘Essays on the Nature and
Significance of the Economic Science’ (1932).
“Economics is a science which studies human behaviour as a relationship between ends and
scarce means which have alternative uses.” Lionel Charles Robbins
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Key features of Scarcity economics definition
1. It recognized that Economics is a science deal with the economic behaviours of a human
being.
2. It also focuses on optimum utilisation of scarce resources.
3. It provides three basic features of human existence, which are unlimited wants, limited
resources, and alternative uses of limited resources
4. There is a need for efficient use of scarce resources, and the primary objective of
Economics is to ensure efficiency in the use of resources with a purpose to satisfy human
wants.
Growth Definition of Economics
This is the modern perspective definition of economics by Samuelson. He provided the growth-
oriented definition of economics.
“Economics is the study of how man and society choose with or without the use of money to employ
the scarce productive resources, which have alternative uses, to produce various commodities over
time and distributing them for consumption, how or in the future among various person or groups
in society.” Paul Samuelson
Key features of Growth economics definition
1. It deals with the allocation of scarce resource to be used in productive purposes.
2. The selection of the most efficient use of the resources from alternative ways.
3. The growth of economies will depend upon the consumption and production in the
economy.
4. This definition also points towards Economics as a study of an economic system.
Economics have different definition of economics by different economists and social thinkers
with different objectives and contexts. All these definitions are correct and none can be taken as
universally acceptable.
The definition deals with the following four aspects:
(i) Economics is a science: Economics studies economic human behaviour scientifically. It

studies how humans try to optimise (maximize or minimize) certain objective under given
constraints. For example, it studies how consumers, with given income and prices of the
commodities, try to maximize their satisfaction.
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(ii) Unlimited ends: Ends refer to wants. Human wants are unlimited. When one want is
satisfied, other wants crop up. If man's wants were limited, then there would be no
economic problem.
(iii) Scarce means: Means refer to resources. Since resources (natural productive resources,
man-made capital goods, consumer goods, money and time etc.) are limited economic
problem arises. If the resources were unlimited, people would be able to satisfy all their
wants and there would be no problem.
(iv) Alternative uses: Not only resources are scarce, they have alternative uses. For example,
coal can be used as a fuel for the production of industrial goods, it can be used for running
trains, it can also be used for domestic cooking purposes and for so many purposes.
Similarly, financial resources can be used for many purposes. The man or society has,
therefore, to choose the uses for which resources would be used. If there was only a single
use of the resource then the economic problem would not arise.
Scarce and Limited resources: below mentioned are the scarce resources, which are to be utilised
carefully and to get maximum benefit and those are.
1. Land: Land is that factor of production which is freely available from nature. In it, not only on
the surface of soil is included, but also all other free gifts of the nature below the surface and above
the surface are included; for example, forests, minerals, fertility of soil, water, etc. According to
Marshall, "Land means the material and the forces which nature gives freely for man's aid, in land
and water, in air, light and heat." Land is also called a natural resource.
2. Labour [skilled]: Labour is a human factor of production. In it all those mental and physical
activities of man are included which are performed in order to earn money. The services of a
carpenter, black-smith, weaver, teacher, lawyer and doctor, etc., are called as labour according to
economics.
3. Capital: Capital is that man-made factor of production which is used for more production.
Factors like machines, tools, raw materials, buildings, railways, factories, etc., are called capital.
The saving of a man when invested to earn will also be called capital.
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Classification of economics:
For the purpose of study and teaching Pro.Rangnar Frish has classified economics into two broad
categories. These are: Micro-economics and Macro-economics. These two words have been
derived from Greek words ‘Micro’ and ‘Macro’, which means small and large respectively.
Macro Economics
The study of economics is classified as a social science. Because economics deals with human
problems. An overview of the elements that constitute in the study of economics that is human
wants, needs, scarcity, resources, goods and services, economic choice and the laws of supply and
demand. The entire subjects economics is the one most closely associate with everyday life
Economics is sub divided into two branches called as macroeconomics and microeconomics.
MACRO ECONOMICS
Definition
- In the words of Boulding, "Macro economic theory is that part of economics which studies the
overall averages and aggregates of the system."
- According to Shapiro, "Macroeconomics deals with the functioning of the economy as a whole."
- In the words of Ackley Gardner, "Macroeconomics concerns with such variables as the aggregate
volume of the output of an economy, with the extent to which its resources are employed, with the
size of national income and with the general price level"
Macroeconomics, on the other hand, is the field of economics that studies the behaviour of the
economy as a whole and not just on specific companies, but entire industries and economies. This
looks at economy-wide phenomena such as Gross National Product (GDP) and how it is affected
by changes in unemployment, national income, rate of growth, and price levels.
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For example, macroeconomics would look at how an increase/decrease in net exports would affect
a nation's capital account or how GDP would be affected by unemployment rate. It perceives the
overall dimensions of economy. It looks at the total size, shape and functioning of the economy as
a whole. Rather than working individual parts.
{Eg: talks about the whole forest, but not about the individual tree}
Importance:-
1. Its knowledge is indispensable for policy makers.
2. It is very useful to the planners for preparing economic plans for the country development.
3. It explains the relationship between the price levels of goods, income of the people and
output (production).
MICRO ECONOMICS
Definition
Watson says, "Microeconomics is the theory of the small, of the behaviour of the consumers,
producers and markets.'
- In the words of Shapiro, "Microeconomics deals with small parts of the economy.
- According to Ieftwitch, ^Microeconomics is concerned with the economic activities of economic

units as consumers, resource owners and business firms."
- According to Boulding, "Microeconomics is the study of particular firm, particular household,

individual price, wage, income, industry and particular commodity."
Microeconomics is the study of decisions that people and businesses make regarding the allocation
of resources and prices of goods and services. This means also taking into account taxes and
regulations created by governments. Microeconomics focuses on supply and demand and other
forces that determine price levels for specific companies in specific industry sectors.
For example, microeconomics would look at how a specific company could maximize its
production and capacity so it could lower prices and better compete in its industry.
Eg: - talks about the individual tree but not about total forest
Importance:-
1. It helps in decision making regarding utilization of resources in the organization.
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2. It helps in which goods should be produced & who will produce them.
3. How should be produced and how they will be distributed.
MANAGEMENT
Management is the science and art of getting things done through people in formally organized
groups. It is necessary that every organization be well managed to enable it to achieve its desired
goals. Management includes a number of functions: Planning, organizing, staffing, directing, and
controlling. The manager while directing the efforts of his staff communicates to them the goals,
objectives, policies, and procedures; coordinates their efforts; motivates them to sustain their
enthusiasm; and leads them to achieve the corporate goals.
MANAGERIAL ECONOMICS
Managerial Economics (also called Business Economics) a subject first introduced by Joel Dean
in 1951, is essentially concerned with the economic decisions of business managers. It is a branch
of Economics that applies microeconomic analysis to specific business decisions (i.e. Economics
applied in business decision-making). Managerial Economics may be viewed as Economics
applied to problem solving at the level of the firm. The problems of course relate to choices and
allocation of resources, which are basically economic in nature and are faced by managers all the
time. It is that branch of Economics, which serves as a link between abstract theory and managerial
practice. It is based on economic analysis for identifying problems, organizing information and
evaluating alternatives. In other words Managerial Economics involves analysis of allocation of
the resources available to a firm or a unit of management among the activities of that unit. It is
thus concerned with choice or selection among alternatives. Managerial Economics is by nature
goal-oriented and prescriptive, and it aims at maximum achievement of objectives.
Managerial Economics help managers to learn the economic principles which are relevant to
decision-making in such areas as production, personnel, marketing and finance. A clear
understanding of economic principles will help the manager in his activities. For example, XYZ
Ltd. has limited financial, human, and physical resources. XYZ Ltd. managers seek to maximize
the financial return from these limited resources. They should apply Managerial Economics to
develop pricing and advertising strategies, design their organizations, and manage purchasing.
Managerial Economics applies economic theory and methods to business and administrative
decision-making. Managerial Economics prescribes rules for improving managerial decisions.
Managerial Economics also helps managers to recognize how economic forces affect organizations
and describes the economic consequences of managerial behaviour. It links traditional Economics
with the decision sciences to develop vital tools for managerial decision making. This process is
illustrated in Fig.
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The role of Managerial Economics in managerial decision-making.
Managerial Economics has applications in both profit and non-profit sectors. For example, an
administrator of a non-profit hospital strives to provide the best medical care possible given limited
medical staff, equipment and related resources. Using the tools and concepts of Managerial
Economics, the administrator can determine the optimal allocation of these limited resources. In
short. Managerial Economics helps managers to arrive at a set of operating rules that aid in the
efficient use of scarce human and capital resources. By following these rules, businesses, non-
profit organizations and government agencies are able to meet objectives efficiently.
Thus. Managerial Economics applies the principles and methods of Economics to analyze
problems faced by the management of a business or other types of organizations and helps to find
solutions that advance the best interests of such organizations.
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Managerial Economics Definitions
Definitions
In the words of TJ. Webster, "Managerial economics is the synthesis of microeconomic theory
and quantitative methods to find optimal solutions to managerial decision-making problems?
In the words of Hirschey and Pappas, "Managerial economics applies economic theory and
methods to business and administrative decision making"
According to Mansfield, "Managerial economics provides a link between economic theory and
decision sciences in the analysis of managerial decision making?
Brigham and Poppas believe that managerial economics is "the application of economic theory
and methodology to business administration practice."
Hague on the other hand, considers managerial economics as "a fundamental academic subject
which seeks to understand and to analyse the problems of business decision-making."
According to McNair and Meriam, “Managerial economics is the use of economic modes of
thought to analyse business situations.”
According to Prof. Evan J Douglas, ‘Managerial economics’ is concerned with the application of
economic principles and methodologies to the decision making process within the firm or
organisation under the conditions of uncertainty”. Spencer and Siegelman define it as “The
integration of economic theory with business practices for the purpose of facilitating decision
making and forward planning by management.”
According to Hailstones and Rothwel, “Managerial economics is the application of economic

theory and analysis to practice of business firms and other institutions.” A common thread runs
through all these descriptions of managerial economics which is using a framework of analysis to
arrive at informed decisions to maximize the firm’s objectives, often in an environment of
uncertainty. It is important to recognize that decisions taken while employing a framework of
analysis are likely to be more successful than decisions that are knee jerk or gut feel decisions.
Almost any business decision can be analyzed with managerial economics techniques, but it is
most commonly applied to:
1. Risk analysis - various models are used to quantify risk and asymmetric information
and to employ them in decision rules to manage risk.
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2. Production analysis - microeconomic techniques are used to analyze production

efficiency, optimum factor allocation, costs, and economies of scale and to estimate the
firm's cost function.
3. Pricing analysis - microeconomic techniques are used to analyze various pricing
decisions including transfer pricing, joint product pricing, price discrimination, price
elasticity estimations, and choosing the optimum pricing method.
4. Capital budgeting - Investment theory is used to examine a firm's capital purchasing
decisions.
Nature of Managerial Economics

Managers study managerial economics because it gives them insight to reign the functioning of
the organization. If manager uses the principles applicable to economic behaviour in a reasonably,
then it will result in smooth functioning of the organisation.
Managerial Economics is a Science: Managerial Economics is an essential scholastic field. It can

be compared to science in a sense that it fulfils the criteria of being a science in following sense:
 Science is a Systematic body of Knowledge. It is based on the methodical observation.

Managerial economics is also a science of making decisions with regard to scarce resources
with alternative applications. It is a body of knowledge that determines or observes the
internal and external environment for decision making.
 In science any conclusion is arrived at after continuous experimentation. In
Managerial economics also policies are made after persistent testing and trailing. Though
economic environment consists of human variable, which is unpredictable, thus the policies
made are not rigid. Managerial economist takes decisions by utilizing his valuable past
experience and observations.
 Science principles are universally applicable. Similarly policies of Managerial
economics are also universally applicable partially if not fully. The policies need to be
changed from time to time depending on the situation and attitude of individuals to those
particular situations. Policies are applicable universally but modifications are required
periodically.
Managerial Economics requires Art: Managerial economist is required to have an art of

utilising his capability, knowledge and understanding to achieve the organizational objective.
Managerial economist should have an art to put in practice his theoretical knowledge regarding
elements of economic environment.
Managerial Economics for administration of organization: Managerial economics helps the

management in decision making. These decisions are based on the economic rationale and are
valid in the existing economic environment.
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Managerial economics is helpful in optimum resource allocation: The resources are scarce with
alternative uses. Managers need to use these limited resources optimally. Each resource has several
uses. It is manager who decides with his knowledge of economics that which one is the preeminent
use of the resource.
Managerial Economics has components of micro economics: Managers study and manage the
internal environment of the organization and work for the profitable and long-term functioning of
the organization. This aspect refers to the micro economics study. The managerial economics deals
with the problems faced by the individual organization such as main objective of the organization,
demand for its product, price and output determination of the organization, available substitute and
complimentary goods, supply of inputs and raw material, target or prospective consumers of its
products etc.
Managerial Economics has components of macroeconomics: None of the organization works

in isolation. They are affected by the external environment of the economy in which it operates
such as government policies, general price level, income and employment levels in the economy,
stage of business cycle in which economy is operating, exchange rate, balance of payment, general
expenditure, saving and investment patterns of the consumers, market conditions etc. These
aspects are related to macroeconomics.
Managerial Economics is dynamic in nature: Managerial Economics deals with human-beings

(i.e. human resource, consumers, producers etc.). The nature and attitude differs from person to
person. Thus to cope up with dynamism and vitality managerial economics also changes itself over
a period of time.
Scope of Managerial Economics

Demand analysis and forecasting: When a business manager decides to venture into a business,
the very first thing he needs to find out is the nature and amount of demand for the product, both
at present and in the future. A firm's performance and profitability depends upon accurate estimates
of demand. The firm will prepare its production schedule on the basis of demand forecast. Demand
analysis helps to identify the factors influencing the demand for a firm's product and thus helps a
manager in business planning. Demand analysis and forecasting thus help him in the choice of the
product and in planning output levels. The main topics covered under demand analysis and
forecasting are the concepts of demand, demand determinants, law of demand, its assumptions,
elasticity of demand (price, income and cross elasticity), demand forecasting, etc.
Cost and production analysis
• Estimation of the cost in production.

• Recognizing the factors, which are causing cost to firm.
• Suggests cost should be reduced for making good profits.
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• Production analysis deals with, Minimum cost should be spend on raw materials
and maximum production should be obtained
Pricing decisions, policies and practices
 Once a particular quantity of output is ready for sale, the firm has to fix its price given the
conditions in the market. Pricing is a very important aspect of Managerial Economics as a
firm's revenue earnings largely depend on its pricing policy. A correct pricing policy makes
a firm successful, while incorrect pricing may lead to its elimination. The topics covered
under this area are: price determination in various market forms such as perfect market,
monopoly, oligopoly, etc., pricing methods such as differential pricing and product-line
pricing, and price forecasting.
Profit management
 Business firms are established with the objective of making profits and it is thus the chief
measure of success. For maximizing profits the firm needs to take care of pricing, cost
aspects and long-range decisions, i.e., it has to evaluate its investment decisions and carry
out the best policy of capital budgeting for the firm under a given set of conditions. If we
know the future, profit analysis would be an easy task. However, in a world of uncertainty
our expectations are not always realized, so that profit planning and measurement
constitute a difficult area of Managerial Economics. The important aspects covered under
this area are: nature and measurement of profit, profit policies, and techniques of profit
planning like break-even analysis, cost-volume-profit analysis, etc.
Capital Management
 Large amount of money is invested in the business and that amounts should be managed
efficiently.
Competition
 Study of markets is one of the important aspects of the work of a managerial economist. A
manager should have clear knowledge of different markets existing in the environment.
The environment is not constant and goes on changing. Thus, the manager should know
clearly about perfect and imperfect markets so as to introduce the product in such markets
where he can increase the sales revenue. The main aspects are perfect market, monopoly
market, monopolistic market, oligopoly market, and price fixation under different market
conditions.
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Managerial Economics and Micro Economics

Managerial Economics is basically a blend of Economics and Management. Two branches of
economics i.e. micro economics and macroeconomics are the major contributors to managerial
economics.
Micro Economics is the study of the behaviour of individual consumers and firms whereas
microeconomics is the study of economy as a whole.
Managerial Economics and Micro Economics
 All the firms operating in the market have to take under consideration the constituent of
the economic environment for its proper functioning. This economic environment is
nothing but the Micro economics elements.
 Micro Economics is a broader concept as compare to Managerial Economics. Micro
Economics forms the foundation of managerial economics. Almost all the concepts of
Managerial Economics are the perceptions of Micro Economics concepts.
 Managerial economics can be perceived as an applied Micro Economics. Demand Analysis
and Forecasting, Theory of Price, Theory of Revenue and Cost, Theory of Supply and
Production are major bare bones of Micro Economics that underpins the Managerial
Economics. Managerial Economics applies the theories of Micro Economics to resolve the
issues of the organization and for decision making.
 All Managers want to carry out their function of decision making with maximum
efficiency. Their business planning can be effectively planned and performed with
comprehensive knowledge and understanding of micro economic concept and its
applications. Optimum decision making to achieve the objective of the organisation i.e. for
profit maximizing or for cost minimizing, is possible with proper compliance of micro
economic know how, regardless of the technological constraints and given market
conditions. Micro Economic Analysis is important as it is applied to day to day dilemma
and concerns.
The reliance of Managerial Economics on Micro Economics is made clearer in the points
below:
 If a manager wants to increase the price of the product due to increase in cost of production,
he will analyze the price elasticity of demand for that product so that price rise is not
followed by substantial fall in the demand of the product. It is the application of demand
analysis to the real world situation.
 For fixing the price of the products managers applies the pricing theories, cost and revenue
theories of micro economics.
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 Decisions regarding production and supply of the product in the market, knowledge of
availability of fixed and variable factors of production, state of technology to be used and
availability of raw-material are essential. This can be determined with the knowledge of
theory of production.
 Determination of price and output is possible with the acquaintance of market structures
and approaches pertinent for determination of price and output in the given market setup.
 Managerial economics utilizes statistical methods such as game theory, linear
programming etc for application of Economic Theory in Decision making.
 One of the responsibilities of Manager is to workout budgets for different departments of
the organization which is learned from Capital Budgeting and Capital Rationing.
 Cost and benefit analysis helps the manager in decision making.
 Study of welfare economics helps Manager in taking care of social responsibilities of the
organization.
 Microeconomics is the study that deals with partial equilibrium analysis which is useful
for the manager in deciding equilibrium for his organization.
 Managerial Economics also uses tools of Mathematical Economics and econometrics such
as regression analysis, correlation analysis etc.
 Theory of firm, an important element of microeconomics, is one of the most significant
element of Managerial Economics.
Application of M E
The application of managerial economics is these examples. Tools of managerial economics can
be used to achieve all the goals of a business organization in an efficient manner. Typical
managerial decision making may involve one of the following issues:
1.Deciding the price of a product and the quantity of the commodity to be produced.
2.Deciding whether to manufacture a product or to buy from another manufacturer.
3.Choosing the production technique to be employed in the production of a given product.
4.Deciding on the level of inventory a firm will maintain of a product or raw material.
5.Deciding on the advertising media and the intensity of the advertising campaign
6.Making employment and training decisions.
7.Making decisions regarding further business investment.
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It should be noted that the application of managerial economics is not limited to profit-seeking
business organizations. Tools of managerial economics can be applied equally well to decision
problems of nonprofit organizations. While a nonprofit hospital is not like a typical firm seeking
to maximize its profits, a hospital does strive to provide its patients the best medical care possible
given its limited staff (doctors, nurses, and support staff), equipment, space, and other resources.
The hospital administrator can use the concepts and tools of managerial economics to determine
the optimal allocation of the limited resources available to the hospital. In addition to nonprofit
business organizations, government agencies and other nonprofit organizations (such as
cooperatives, schools, and museums) can use the techniques of managerial decision making to
achieve goals in the most efficient manner.
ECONOMIC CONCEPTS USED IN MANAGERIAL ECONOMICS
Managerial economics uses a wide variety of economic concepts, tools, and techniques in the
decision-making process. These concepts can be placed in three broad categories:
1) The theory of the firm, which describes how businesses make a variety of decisions
2) The theory of consumer behavior, which describes decision making by consumers
3) The theory of market structure and pricing, which describes the structure and
characteristics of different market forms under which business firms operate.
Relationship with other subjects

Macro Economics, Statistics, Mathematics, Accounts etc., have contributed a lot in the growth of
Managerial Economics. D.C. Hague has stated, "Managerial Economics uses the logic of
Economics, Mathematics and Statistics to provide effective ways of thinking about business
decision problems."
Economics has two main divisions: micro-economics and macro-economics. Micro-economics has
been defined as that branch where the unit of study is an individual or a firm. Macro-economics,
on the other hand, is aggregative in character and has the entire economy as a unit of study.
1. Managerial Economics and Traditional Economics: Managerial Economics has been

described as economics applied to decision-making. It may be viewed as a special branch of
economics bridging the gulf between pure economic theory and managerial practice. The relation
between Managerial Economics and Economics is as close as is Engineering to Physics and
Medicines to Biology.
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Traditional Economics has two main divisions: microeconomics and macroeconomics.

Microeconomics; also known as price theory, is the main source of concepts and analytical tools
for managerial economics. To illustrate, various microeconomic concepts such as elasticity of
demand, marginal cost, the short and long runs, opportunity cost, various market forms, etc., are
all of great significance to managerial economics. The chief contribution of macroeconomics is in
the area of forecasting. The modern theory of income, employment, trade cycles, etc. has
implications for forecasting general business conditions. As the prospects of an individual firm
often depend greedy on general business conditions, individual firm forecasts depend on general
business forecasts.
2. Managerial Economics and Accounting: Managerial economics and accounting are closely
interrelated. Accounting can be defined as the recording of financial operations of a business firm.
A business manager needs a lot of accounting information data for logical analysis in decision-
making and policy formulation at the level of firm. The accounting data and information has to be
presented in a methodological manner worthy of analysis and interpretation for decision-making
and future planning. This is why a new branch of accounting known as 'management accounting'
has developed to help correct managerial decision-making. The main task of management
accounting is to provide the sort of data which managers need to solve some business problems
accurately.
3. Managerial Economics and Operational Research: Operational Research is closely related

to managerial economics. Operational research is the application of mathematical techniques to
solving business problems. It provides all the data required for business decisions and forward
planning. Techniques such as linear programming, game theory, etc. are due to the works of
operational research, linear programming is extensively used in decision-making. Managerial
economics is concerned with efficient use of scarce resources. Operational research is also
concerned with efficient use of scarce resources. There is close affinity between managerial
economics and operational research. Managerial economics gives special emphasis to the
problems involving maximisation of profits and minimisation of costs, while operational research
focuses attention on the concept of optimisation. Managerial economics has made much use of
optimisation concept but initially started with marginal analysis taken from economics. Managerial
economics uses the logic of Economics, Mathematics and Statistics for undertaking effective
decisions, while operational research techniques based on these ways of thinking are being used
to solve decision-making problems in business. Again, both operational research and managerial
economics are concerned with taking effective decisions.
Operational research is a tool in the hands of managerial economics to solve day-to-day business
problems. Managerial economics is an academic subject which aims at understanding and
analysing problems and decision-making by a firm. Thus, operational research is a functional
activity pursued by specialists within the firm. Though it is expensive and a slow process, it helps
managers make accurate solutions by means of providing necessary data.
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4. Managerial Economics and Marketing: Managerial Economics helps marketing in two ways.
First, as a basic discipline, providing tools and concepts of analysis and second, as an integrating
area, providing its judgement on the optimum sales volume under the given cost function of a firm,
market structure, and the objective function to be optimized. How much to sell under given
circumstances is answered by an economist and how to sell the desired amount of output is the
domain of the marketing manager. Sometimes, selling more than what is desired may harm the
interest of the firm. It has, however, the sanction neither of Economics nor of marketing principles
as both stresses on the protection of long run interests of the firm.
Economics is of a great help to marketing in the sphere of pricing. Of the three basic aspects of
pricing viz. value theory, price theory, and pricing techniques, the first two are the exclusive
domain of Economics, while the third one forms part of both Managerial Economics and
marketing. In the case of pricing techniques, there are varying practices in different organizations.
In many pricing is handled by the accounts staff such as chartered accountants and company
secretaries. There are several areas of marketing which are totally or heavily dependent on
economic theory. These are:
1. Theory of the Firm

2. Concepts of goals and goal formulation
3. Market structures
4. Pricing
5. Managerial Economics and Production Management: Production is defined as the creation
of utility by transforming input into output. It usually refers to manufacturing activity and the term
operations are used to denote a wider meaning, encompassing all economic activity which creates
economic utility. Operations personnel have four basic responsibilities to fulfill while producing a
firm's products or services:
1. Supply of quantities,
2. Maintenance of time-bound deliveries,
3. Fulfillment of quality requirement, and
4. Economizing production operations.
For this, the personnel have to deal with a number of inter-related areas including production
planning, production control, quality control, methods analysis, materials handling, plant layout,
inventory control, work management, and wage incentives. A knowledge of Economics would
help operations personnel not only to economize their production operations but also help them
a. To monitor and analyse the input market,

b. To monitor market maturity, technical maturity, and competitive maturity of
products being produced,
c. To have better coordination with the R & D department with respect to product
and process innovation, and take decisions on production targets.
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6. Managerial Economics and Personnel Management: A human resource manager has to

concern himself with two types of problems: (i) an effective utilization of human resources in
terms of costs and productivity and (ii) improvement in the terms and conditions of employment
as an adjunct to employee satisfaction. Manpower planning, at the micro level, is another important
function of an HRD manager wherein a firm ensures that it has the right number and the right kind
of people, at the right places, at the right time, doing work for which they are economically most
useful.
Managerial economics can help personnel management by analysing the economic and financial
aspects of personnel problems both in relation to the economic welfare of the firm and to the
prevailing environment of the economy as a whole. It explains the economic implications of
policies and strategies and judges their consistency with respect to organizational objectives as
well as internal and external constraints. It can provide a safety range for wage negotiations with
trade unions. Business forecasting could provide information for devising employment norms of
the sales force.
Role of Managerial Economics in Decision Making:

Business firms are a combination of manpower, financial, and physical resources which help in
making managerial decisions. Societies can be classified into two main categories − production
and consumption. Firms are the economic entities and are on the production side, whereas
consumers are on the consumption side.
The performances of firms get analyzed in the framework of an economic model. The economic
model of a firm is called the theory of the firm. Business decisions include many vital decisions
like whether a firm should undertake research and development program, should a company launch
a new product, etc.
Business decisions made by the managers are very important for the success and failure of a firm.
Complexity in the business world continuously grows making the role of a manager or a decision
maker of an organisation more challenging! The impact of goods production, marketing, and
technological changes highly contribute to the complexity of the business environment.
Steps for Decision-Making
The steps for decision making like problem description, objective determination, discovering
alternatives, forecasting consequences are described below:
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Business Decision Making Steps
Define the Problem
What is the problem and how does it influence managerial objectives are the main questions.
Decisions are usually made in the firm’s planning process. Managerial decisions are at times not
very well defined and thus are sometimes source of a problem.
Determine the Objective
The goal of an organization or decision maker is very important. In practice, there may be many
problems while setting the objectives of a firm related to profit maximization and benefit cost
analysis. Are the future benefits worth the present capital? Should a firm make an investment for
higher profits for over 8 to 10 years? These are the questions asked before determining the
objectives of a firm.
Discover the Alternatives
For a sound decision framework, there are many questions which are needed to be answered such
as − what are the alternatives? What factors are under the decision maker’s control? What variables
constrain the choice of options? The manager needs to carefully formulate all such questions in
order to weigh the attractive alternatives.
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Forecast the Consequences
Forecasting or predicting the consequences of each alternative should be considered. Conditions

could change by applying each alternative action so it is crucial to decide which alternative action
to use when outcomes are uncertain.
Make a Choice
Once all the analysis and scrutinizing is completed, the preferred course of action is selected. This
step of the process is said to occupy the lion’s share in analysis. In this step, the objectives and
outcomes are directly quantifiable. It all depends on how the decision maker puts the problem,
how he formalizes the objectives, considers the appropriate alternatives, and finds out the most
preferable course of action.
Sensitivity Analysis
Sensitivity analysis helps us in determining the strong features of the optimal choice of action. It
helps us to know how the optimal decision changes, if conditions related to the solution are altered.
Thus, it proves that the optimal solution chosen should be based on the objective and well
structured. Sensitivity analysis reflects how an optimal solution is affected, if the important factors
vary or are altered.
Managerial economics is competent enough for serving the purposes in decision making. It focuses
on the theory of the firm which considers profit maximization as the main objective. The theory
of the firm was developed in the nineteenth century by French and English economists. Theory of
the firm emphasizes on optimum utilization of resources, cost control, and profits in a single time
period. Theory of the firm approach, with its focus on optimization, is relevant for small farms and
producers.
Meaning of Managerial Economist
Managerial economist is a person who manages business efficiently using various economic
theories and methodologies. He supports the management team in better decision making through
his analytical skills and specialized techniques.
A Managerial Economist is also termed as an economic advisor or business economist. He is

responsible for analyzing various internal and external environmental forces that influence the
functioning of business organizations. Managerial economist makes several successful business
forecasts and updates the management team regarding the economic trends from time to time.
Managerial Economist always remains in touch with all the latest economic developments and
environmental changes for informing the management. He has an efficient role in earning
reasonable profits on invested capital as it supplies all relevant information which helps in making
proper plans and strategies. Managerial economist has three important roles in every business
organization: Demand analysis and forecasting, capital management and profit management.
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Role and Responsibilities of Managerial Economist
Studies Business Environment: The managerial economist is responsible for analyzing the
environment in which business operates. Proper study of all external factors that affect the
functioning of organization is must for proper functioning. He studies various factors like growth
of national income, competition level, price trends, phase of the business cycle and economy and
updates the management regarding it from time to time.
Analyses Operations Of Business: He analyses the internal operation of business and helps
management in making better decisions in regard to internal workings. Managerial economist
through his analytical and forecasting skills provides advice to managers for formulating policies
regarding internal operations of the business.
Demand Forecasting And Estimation: Proper estimation and forecasting of future trends helps
the business in achieving desired profitability and growth. Managerial economist through proper
study of all internal and external forces makes successful forecasting of future uncertainties or
trends.
Production Planning: Managerial economist is responsible for scheduling all production

activities of business. He evaluates the capital budgets of organizations and accordingly helps in
deciding timing and locating of various actions.
Economic Intelligence: He provides economic intelligence services by communicating all

economic information to management. Managerial economist keeps management always updated
of all prevailing economic trends so that they can confidently talk in seminars and conferences.
Performing Investment Analysis: A managerial economist analyzes various investment

avenues and chooses the most appropriate one. He studies and discovers new possible fields of
business for earning better returns.
Focuses on Earning Reasonable Profit: He assists management in earning a reasonable rate of

profit on capital employed in the business. Managerial economist monitors activities of
organizations to check whether all operations are running efficiently as per the plans and policies.
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Maintaining Better Relations: A managerial economist maintains better relations with all
internal and external individuals connected with the business. It is his duty to develop a peaceful
and cooperative environment within the organization and aims to reduce any opposition taking
place.
BASIC ECONOMIC PRINCIPLES
Economic theory offers a variety of concepts which can be of considerable assistance to the
managers in decision-making practices. These tools are helpful for managers in solving business-
related problems. These are thus taken as guides in making decisions. The following arc the basic
economic tools for decision-making:
1. Opportunity cost principle

2. Incremental concept /principle
3. Principle of time perspective
4. Discounting principle
5. Equi-marginal principle.
Opportunity cost principle
Opportunity cost principle is related and applied to scarce resource. When there are alternative
uses of scarce resource, one should know which best alternative is and which is not. We should
know what gain by best alternative is and what loss by left alternative is.
“Devenport” An American Economist explains the concept of opportunity cost with reference to
an example. Suppose a girl had two kinds of fruits- one pear and one peach, and if a bad boy is
after her to seize the fruits, then the best way for the girl is to drop one fruit and run with the other,
so that, she can at least save one fruit, at the cost of the other. When the girl so drops by the way -
side one fruit and runs with the other, then the opportunity cost of the fruit she saves is the foregone
alternative of the fruit she lost. This is the opportunity cost theory.
The concept of opportunity cost plays an important role in managerial decisions. This concept
helps in selecting the best possible alternative from among various alternatives available to solve
a particular problem. This concept helps in the best allocation of available resources.
The opportunity cost of any action is simply the next best alternative to that action - or put more
simply, "What you would have done if you didn't make the choice that you did".
The income or benefit foregone as the result of carrying out a particular decision, when resources
are limited or when mutually exclusive projects are involved.
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Definitions
— In the words of Left witch, "Opportunity cost of a particular product is the value of the foregone
alternative products that resources used in its production, could have produced."
Opportunity cost is not what you choose when you make a choice —it is what you did not choose
in making a choice. Opportunity cost is the value of the forgone alternative — what you gave up
when you got something.
Example 1: If a person is having cash in hand Rs. 100000/-, he may think of two alternatives to
increase cash.
Option 1: Investing in bank. We will get returns amount 10000/-
Option2: Investing in business. We get returns amount 17000/-
Generally we chose the option 2 because we will get more returns than the option 1. Here the
option 1 is the opportunity cost, that what we have not chosen.
Example 2: I have a number of alternatives of how to spend my Friday night: I can go to the
movies; I can stay home and watch the baseball game on TV, or go out for coffee with friends. If
I choose to go to the movies, my opportunity cost of that action is what I would have chosen if I
had not gone to the movies - either watching the baseball game or going out for coffee with friends.
Note that an opportunity cost only considers the next best alternative to an action, not the entire
set of alternatives.
The opportunity cost of a decision is based on what must be given up (the next best alternative) as
a result of the decision. Any decision that involves a choice between two or more options has an
opportunity cost.
Incremental concept /principle
The main objective of this principle is maximization of profits. Or In other words to raise the
profits in the business
General rule: By increasing in the production, the total cost of the product raises and
simultaneously profit also rises.
Practicality in the business:
How much we extra we should produce to get the best profits and how much extra cost is incurring
for the extra production.
It is related to the marginal cost and marginal revenue concepts in economic theory. Incremental
concept involves estimating the impact of decision alternatives on costs and revenues, emphasizing
the changes in total cost and total revenue resulting from changes in prices, products, procedures,
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investments or whatever else may be at stake in the decisions. The two basic components of
incremental reasoning are:
1. Incremental cost
2. Incremental revenue.
Incremental cost may be defined as the change in total cost resulting from a particular decision.
Incremental revenue is the change in total revenue resulting from a particular decision.
The incremental principle may be stated as follows: A decision is a profitable one if—
a) it increases revenue more than cost

b) it decreases some costs to a greater extent than it increases others
c) it increases some revenues more than it decreases others and
d) it reduces cost more than revenues.
Suppose a firm gets an order that brings additional revenue of Rs 3,000. The cost of production
from this order is:
Rs:
Labour 800
Material 1300
Overheads 1000
Selling and administration 700

expences
Full cost 3800
At a glance, the order appears to be unprofitable. But suppose the firm has some idle capacity that
can be utilised to produce output for new order. There may be more efficient use of existing labour
and no additional selling and administration expenses to be incurred. Then the incremental cost to
accept the order will be:
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Rs:
Labour 600
Material 1000
Overheads 800
Total Incremental cost 2400
Incremental reasoning shows that the firm would earn a net profit of Rs 600 (Rs 3,000 – 2,400),
though initially it appeared to result in a loss of Rs 800. The order should be accepted.
A simple situation in everyday life provides an example of incremental analysis. Consider a worker
leaving work to travel home. Groceries are required and can be purchased at slightly higher prices
at a store on the way from the work place to the home, or at lower prices by driving to a store 3
miles (4.82 km) from home. The worker decides to purchase the groceries on the way home since
no incremental travel costs are involved, and the incremental difference in grocery prices will be
less than the value the worker places on the time and other costs required to drive to the more
distant store.
Principle of time perspective
Principle: “a decision by the firm should take into account of both short-run and long-run effects
on revenues and cost & maintain the right balance between the long run and short run.
According to this principle, a manger/decision maker should give due emphasis, both to short-term
and long-term impact of his decisions, giving apt significance to the different time periods before
reaching any decision. Short-run refers to a time period in which some factors are fixed while
others are variable. The production can be increased by increasing the quantity of variable factors.
While long-run is a time period in which all factors of production can become variable. Entry and
exit of seller firms can take place easily. From consumers point of view, short-run refers to a period
in which they respond to the changes in price, given the taste and preferences of the consumers,
while long-run is a time period in which the consumers have enough time to respond to price
changes by varying their tastes and preferences.
Eg: ABC is a firm engaged in continuous production of X commodities (long run). In the
production process, it is having daily an ideal time (free time) for few hours. In that ideal time,
firm can take an order for manufacturing other similar goods instead of wasting time. By
manufacturing goods in the ideal time firm does not incur any extra fixed cost like (salaries, wages
and rent and) because it is constant. So the fixed cost is absent in the production which is done in
the ideal time. Generally in production of goods, fixed and variable cost (raw material & labour)
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is present. However, here the production made in the ideal time, fixed cost is absent. This shows
the cost is reduced in production that is made in the ideal time. Investment made in the business
can also be recovered very quickly and in short time.
For example,
Suppose there is a firm with a temporary idle capacity. An order for 5000 units comes to
management’s attention. The customer is willing to pay Rs 4/- unit or Rs.20000/- for the whole lot
but not more. The short run incremental cost (ignoring the fixed cost) is only Rs.3/-. Therefore the
contribution to overhead and profit is Rs.1/- per unit (Rs.5000/- for the lot) Analysis: From the
above example the following long run repercussion of the order is to be taken into account:
If the management commits itself with too much of business at lower price or with a small
contribution it will not have sufficient capacity to take up business with higher contribution.
If the other customers come to know about this low price, they may demand a similar low price.
Such customers may complain of being treated unfairly and feel discriminated against.
In the above example it is therefore important to give due consideration to the time perspectives.
“A decision should take into account both the short run and long run effects on revenues and costs
and maintain the right balance between long run and short run perspective”.
Here the principle of time perspective applies, where maintains right balance between long
run and short-run markets.
Discounting principle
This principle talks about comparison of the money value between present and future time.
Eg: suppose 1) 100/- is gifted to a particular person today.
2) 100/- will be given as gift to same particular person after one year.
Normally a person chooses first offer only. Why because “today rupee is having more worth than
tomorrows rupee”
Business application:
Example 1:
In the business, everybody prefers to do cash sale only rather than the credit sale and
even they are ready to give cash discount for cash sale. The reason is we will get a rupee today and
today’s rupee is more valuable than the tomorrow’s rupee. But In credit sale we will get rupee
tomorrow or in the future time and nobody give the discount for credit sale.
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Example 2:
We commonly see bank and postal departments adverting that they will give 12% interest for every
year on bank deposits what we have invested with them. With this 12% interest for one year, if we
want to get 1-lakh rupees after one year, how much we should deposit at present? This question is
answered by discounting principle.
In the future if we want to earn 100000/- how much we should invest at present. Example in the
bank (100/- @ 12% interest rate of one year)
The equi-marginal principle
This is one of the widely used concepts in managerial economics. This principle is also known the
principle of maximum satisfaction. According to this principle, an input should be allocated in
such a manner that the value added by the last unit of input is same in all uses. In this way. this
principle provides a base for maximum exploitation of all the inputs of a firm so as to maximise
the profitability.
The equi-marginal principle can be applied in different areas of management. It is used in

budgeting. The objective is to allocate resources where they are most productive. It can be used
for eliminating waste in useless activities. It can be applied in any discussion of budgeting. The
management can accept investments with high rates of return so as to ensure optimum allocation
of capital resources. The equi-marginal principle can also be applied in multiple product pricing.
A multi-product firm will reach equilibrium when the marginal revenue obtained from a product
is equal to that of another product or products. The equi-marginal principle may also be applied in
allocating research expenditures.1
Rule:
This principle suggests that available resources (inputs) should be so allocated between the
alternative options that the marginal productivity gains (MP) from the various activities are
qualized.
Definitions
In the words of Ferguson, "Law of equi-marginal utility states that to maximise utility, consumers
way allocate their limited incomes among goods and services in such a way that the marginal
utilities per dollar (rupee) of expenditure on the last unit of each good purchased will be equal"
According to Marshall, "if a person has a thing which he can put to several uses, he will distribute
it among these uses in such a way that it has the same marginal utility in all"
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Lipsey is of the view that, "The consumer maximising his utility wilt so allocate expenditure
between commodities that the utility derived from the last unit of money spent on each is equal"
Example: students allocating limited available days for existing subjects during examinations for
getting best percentage. 14 days to go for examinations and having 7 subjects. Students may not
always allot 2 days for each subject, they may allot more days for hard subject and less days for
easy subject to maintain good percentage
Example:
Equi-marginal principle is applied in the allocation of the resource in the way of production.
Example a farmer is having different four agricultural farms like
1. Paddy
2. Mangoes
3. Sugar cane
4. Corns.
The above four agricultural farms are in the total 80 acres, each farm in the 20 acres, all together
80 acres. The farmer is having limited 80 employees with him for employing in the four farms for
production. In general, 80 employees are divided and employed for four farms evenly as each farm
will be allotted with 20 employees. However, in reality there is no need to allot 20 employees for
each farm, because mango farm need less number of employees, whereas paddy farm needs more
number of employees. Sugarcane and corn farms require average number of employees. Like
shown below
Farms Labour employees

Paddy 30
Mangoes 20
Sugarcane 15
Corns 15
Total 80
The above table reveals the allocation of the resources (labour) available with a farmer according
to the production nature and requirement.
*****
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1 MANAGERIAL ECONOMICS

INTRODUCTION TO MANAGERIAL ECONOMICS

Therefore, a simple definition of economics is defined by taking four definition

Wealth Definition of Economics

Key Features of Wealth economics definition

1. The main objective of Economics is to gain maximum wealth as possible

2. The core of economic activity: are production, distribution and consumption.

3. It deals with the causes of the creation of wealth in an economy.

4. The term ‘wealth’ used in this definition referred to material wealth.

Welfare Definition of Economics

It is a neo-classical definition of economics by Alfred Marshall.

Key features of Welfare economics definition

Scarcity Definition of Economics

Key features of Scarcity economics definition

2. It also focuses on optimum utilisation of scarce resources.

Growth Definition of Economics

Key features of Growth economics definition

1. It deals with the allocation of scarce resource to be used in productive purposes.

4. This definition also points towards Economics as a study of an economic system.

The definition deals with the following four aspects:

(i) Economics is a science: Economics studies economic human behaviour scientifically. It

1. Its knowledge is indispensable for policy makers.

- According to Ieftwitch, ^Microeconomics is concerned with the economic activities of economic

- According to Boulding, "Microeconomics is the study of particular firm, particular household,

1. It helps in decision making regarding utilization of resources in the organization.

3. How should be produced and how they will be distributed.

The role of Managerial Economics in managerial decision-making.

Managerial Economics Definitions

According to Hailstones and Rothwel, “Managerial economics is the application of economic

2. Production analysis - microeconomic techniques are used to analyze production

Nature of Managerial Economics

Managerial Economics is a Science: Managerial Economics is an essential scholastic field. It can

 Science is a Systematic body of Knowledge. It is based on the methodical observation.

Managerial Economics requires Art: Managerial economist is required to have an art of

Managerial Economics for administration of organization: Managerial economics helps the

Managerial Economics has components of macroeconomics: None of the organization works

Managerial Economics is dynamic in nature: Managerial Economics deals with human-beings

Scope of Managerial Economics

Cost and production analysis

• Estimation of the cost in production.

Pricing decisions, policies and practices

Managerial Economics and Micro Economics

ECONOMIC CONCEPTS USED IN MANAGERIAL ECONOMICS

Relationship with other subjects

1. Managerial Economics and Traditional Economics: Managerial Economics has been

Traditional Economics has two main divisions: microeconomics and macroeconomics.

3. Managerial Economics and Operational Research: Operational Research is closely related

1. Theory of the Firm

a. To monitor and analyse the input market,

6. Managerial Economics and Personnel Management: A human resource manager has to

Role of Managerial Economics in Decision Making:

Steps for Decision-Making

Business Decision Making Steps

Define the Problem

Determine the Objective

Discover the Alternatives

Forecast the Consequences

Forecasting or predicting the consequences of each alternative should be considered. Conditions