MODULE 1 : BASIC CONCEPTS AND

PRINCIPLES OBJECTIVES:
1. Introduce key economics and assumptions of economics
2. Know the basic difference bet. Microeconomics and macroeconomics
3. Analyze how decisions are made about what, how and for whom to produce. 4. Discuss the scope
of managerial economics and its relationship with various other disciplines and functional areas

SESSION 1

Economics is defined as the social science that deals with the production, distribution, and consumption
of goods and services. Evolved in the 19th century, the economic studies have become one of the most
significant studies of modern days. From a small shop to a country, Economics plays a crucial role in the
efficient running of both. No business can flourish without applying the principles of economics. The
study of economics is extensive and varied. The nature and scope of economics depend upon the
interaction of economic agents and how economies work. Let’s analyze the nature and scope of
economics deeply.

Nature of Economics:
The nature of economics deals with the question that whether economics falls into the category of
science or arts. Various economists have given their arguments in favour of science while others have
their reservations for arts.

Economics as a Science

To consider anything as a science, first, we should know what science is all about? Science deals with
systematic studies that signify the cause and effect relationship. In science, facts and figures are
collected and are analyzed systematically to arrive at any certain conclusion. For these attributes,
economics can be considered as a science. However, economics is treated as a social science because of
the following features:

▪ It involves a systematic collection of facts and figures.

▪ Like in science, it is based on the formulation of theories and laws.

▪ It deals with the cause and effect relationship.

These points validate that the nature of economics is correlated with science. Just as in science, various
economic theories are also based on logical reasoning.
Economics as an Art

It is said that “knowledge is science, action is art.” Economic theories are used to solve various economic
problems in society. Thus, it can be inferred that besides being a social science, economics is also an art.

Activity ___

Make your own definition of economics based on your understanding

Basic Assumptions:
Economic assumptions are assumptions that a company makes about the general market environment.
Specifically, the environment it plans to operate in during the period of its financial plan. Companies
make economic assumptions regarding the upcoming state of the economy, i.e., the marketplace.
Businesses try to predict what the business environment will be like and how it will affect their ability to
generate profits.

Economists also make economic assumptions when they build economic models. Sometimes they make
economic assumptions regarding levels of competition or marketing. They may also make assumptions
about substitute goods.

Many economic models assume that the players in the marketplace have perfect information regarding
their choices. Others may even assume that we can measure subjective human values quantitatively.

In this context, the word ‘marketplace‘ refers to ‘market‘ in its abstract sense.

Without economic assumptions, economists would not be able to produce quantitative economic
models with meaningful conclusions.

Economic Assumptions

Company executives, economists, and statisticians frequently make economic

assumptions. Economic assumptions – two definitions

Below are two definitions of the term; one from a company’s and the other from an economist’s point of
view:
Company’s viewpoint
This definition, from BusinessEnglish.com, explains economic assumptions from a company’s

viewpoint: “The set of assumptions that a firm will make about the upcoming economic situation.”

Economist’s viewpoint

This definition, which Mike Moffatt writes in ThoughtCo.com, explains the meaning of the term from an
economist’s viewpoint:

“A basic assumption of economics begins with the combination of unlimited wants and limited
resources.”

“All of economics, including microeconomics and macroeconomics, comes back to this basic assumption
that we have limited resources to satisfy our preferences and unlimited wants.”

Economic assumptions
Scarcity

Scarcity or paucity refers to limitation. Raw materials, components, goods, and other supplies are
limited. However, we exist in an environment with unlimited human wants.

This is one of economics’ fundamental problems, i.e., having limitless human wants in a market where
resources that are not limitless.

Trade-off

If our wants are limitless but scarcity exists, we cannot satisfy all our wants. Therefore, we must make
choices. When we chose one thing, we are subsequently trading it for something else. In other words,
every choice has a cost, i.e., a trade-off. When we chose something, we also wonder what we will have
to give up. We call this determining what the opportunity cost is.

In other words, first, we ask ourselves: “If I choose this, what will I have to give up?” Then, we can
determine whether we are better off with our choice.

Self-interest

Our goal is to make a choice that maximizes our satisfaction. In other words, we all act in our own self
interest

Rational Behavior

Rational behavior refers to a decision-making process that is based on making choices that result in the
optimal level of benefit or utility for an individual. The assumption of rational behavior implies that
people would rather take actions that benefit them versus actions that are neutral or harm them. Most
classical economic theories are based on the assumption that all individuals taking part in an activity are
behaving rationally.
Ceteris Paribus

Ceteris paribus, literally "holding other things constant," is a Latin phrase that is commonly translated
into English as "all else being equal." A dominant assumption in mainstream economic thinking, it acts
as a shorthand indication of the effect of one economic variable on another, provided all other variables
remain the same.

Costs and benefits

We all make decisions by comparing the cost and benefits of things. Whenever we make a choice, we
compare the choice’s marginal costs against its marginal benefits. In other words, we perform a cost
benefit analysis or benefit-cost analysis. This analysis is a type of economic analysis.

Scope of Economics:
Economists use different economic theories to solve various economic problems in society. Its
applicability is very vast. From a small organization to a multinational firm, economic laws come into
play. The scope of economics can be understood under two subheads: Microeconomics and
Macroeconomics. Let’s discuss these in detail:

Microeconomics

Microeconomics examines individual economic activity, industries, and their interaction. It has the
following characteristics:
▪ Elasticity: It determines the ratio of change in the proportion of one variable to another variable. For
example-the income elasticity of demand, the price elasticity of demand, the price elasticity of
supply, etc.
▪ Theory of Production: It involves an efficient conversion of input into output. For example- packaging,
shipping, storing, and manufacturing.
▪ Cost of Production: With the help of this theory, the object price is evaluated by the price of resources.
▪ Monopoly: Under this theory, the dominance of a single entity is studied in a particular field. ▪
Oligopoly: It corresponds to the dominance of small entities in a market.

Macroeconomics

It is the study of an economy as a whole. It explains broad aggregates and their interactions “top down.”
Macroeconomics has the following characteristics:

▪ Growth: It studies the factors which explain economic growth such as the increase in output per
capita of a country over a long period of time.
▪ Business Cycle: This theory emerged after the Great Depression of the 1930s. It advocates the
involvement of the central bank and the government to formulate monetary and fiscal policies to
monitor the output over the business cycle.
▪ Unemployment: It is measured by the unemployment rate. It is caused by various factors like rising in
wages, a shortfall in vacancies, and more.
▪ Inflation and Deflation: Inflation corresponds to an increase in the price of a commodity, while
deflation corresponds to a decrease in the price of a commodity. These indicators are valuable to
evaluate the status of the economy of a country.

Positive And Normative Economics:

Positive Economics
Positive economics is a stream of economics that focuses on the description, quantification, and
explanation of economic developments, expectations, and associated phenomena. It relies on objective
data analysis, relevant facts, and associated figures. It attempts to establish any cause-and-effect
relationships or behavioral associations which can help ascertain and test the development of economics
theories.

Positive economics is objective and fact-based where the statements are precise, descriptive, and clearly
measurable. These statements can be measured against tangible evidence or historical instances. There
are no instances of approval-disapproval in positive economics.

Here's an example of a positive economic statement: "Government-provided healthcare increases public

expenditures." This statement is fact-based and has no value judgment attached to it. Its validity can be
proven (or disproven) by studying healthcare spending where governments provide healthcare.

Normative Economics
Normative economics focuses on the ideological, opinion-oriented, prescriptive, value judgments, and
"what should be" statements aimed toward economic development, investment projects, and scenarios.
Its goal is to summarize people's desirability (or the lack thereof) to various economic developments,
situations, and programs by asking or quoting what should happen or what ought to be.

Normative economics is subjective and value-based, originating from personal perspectives, feelings, or
opinions involved in the decision-making process. Normative economics statements are rigid and
prescriptive in nature. Thy often sound political or authoritarian, which is why this economic branch is
also called "what should be" or "what ought to be" economics.

An example of a normative economic statement is: "The government should provide basic healthcare to
all citizens." As you can deduce from this statement, it is value-based, rooted in personal perspective,
and satisfies the requirement of what "should" be.
Activity 1:
Normative Economics
- The transactions regarding the purchase for the COVID-19 vaccines must be transparently
stated to the public.
Positive Economics
- The Department of Health stated that the budget for COVID-19 vaccines is sufficient and will
not cause shortage for every citizen.

Basic Economic Problem

• The fundamental economic problem is the issue of scarcity and how best to produce and distribute
these scare resources.
• Scarcity means there is a finite supply of goods and raw materials.
• Finite resources mean they are limited and can run out.
• Unlimited wants mean that there is no end to the quantity of goods and services people would like
to consume.
• Because of unlimited wants – People would like to consume more than it is possible to produce
(scarcity)

Therefore because of scarcity, economics is concerned with:

• What to produce?
• How to produce?
• For whom?
Activity No. 2

SESSION 2

Managerial economics is a discipline which deals with the application of economic theory to
business management. It deals with the use of economic concepts and principles of business
decision making. Formerly it was known as “Business Economics” but the term has now been
discarded in favor of Managerial Economics.

Managerial Economics may be defined as the study of economic theories, logic and
methodology which are generally applied to seek solution to the practical problems of business.
Managerial Economics is thus constituted of that part of economic knowledge or economic
theories which is used as a tool of analyzing business problems for rational business decisions.
Managerial Economics is often called as Business Economics or Economic for Firms.

Definition of Managerial Economics:

“Managerial Economics is economics applied in decision making. It is a special branch of

economics bridging the gap between abstract theory and managerial practice.” — Haynes,
Mote and Paul.

“Business Economics consists of the use of economic modes of thought to analyse business
situations.” McNair and Meriam

“Business Economics (Managerial Economics) is the integration of economic theory with

business practice for the purpose of facilitating decision making and forward planning by
management.” — Spencer and Seegelman.
“Managerial economics is concerned with application of economic concepts and economic
analysis to the problems of formulating rational managerial decision.” — Mansfield

Nature of Managerial Economics:

• The primary function of management executive in a business organisation is decision

making and forward planning.
• Decision making and forward planning go hand in hand with each other. Decision making
means the process of selecting one action from two or more alternative courses of
action. Forward planning means establishing plans for the future to carry out the
decision so taken.
• The problem of choice arises because resources at the disposal of a business unit (land,
labor, capital, and managerial capacity) are limited and the firm has to make the most
profitable use of these resources.
• The decision making function is that of the business executive, he takes the decision which
will ensure the most efficient means of attaining a desired objective, say profit
maximization. After taking the decision about the particular output, pricing, capital, raw
materials and power etc., are prepared. Forward planning and decision-making thus go
on at the same time.
• A business manager’s task is made difficult by the uncertainty which surrounds business
decision-making. Nobody can predict the future course of business conditions. He
prepares the best possible plans for the future depending on past experience and future
outlook and yet he has to go on revising his plans in the light of new experience to
minimize the failure. Managers are thus engaged in a continuous process of decision
making through an uncertain future and the overall problem confronting them is one of
adjusting to uncertainty.
• In fulfilling the function of decision-making in an uncertainty framework, economic theory
can be, pressed into service with considerable advantage as it deals with a number of
concepts and principles which can be used to solve or at least throw some light upon the
problems of business management. E.g are profit, demand, cost, pricing, production,
competition, business cycles, national income etc. The way economic analysis can be
used towards solving business problems, constitutes the subject-matter of Managerial
Economics.
• Thus in brief we can say that Managerial Economics is both a science and an art.
Scope of Managerial Economics:

The scope of managerial economics is not yet clearly laid out because it is a developing science.
Even then the following fields may be said to generally fall under Managerial Economics:

1. Demand Analysis and Forecasting

2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management

These divisions of business economics constitute its subject matter.

Recently, managerial economists have started making increased use of Operation Research
methods like Linear programming, inventory models, Games theory, queuing up theory etc.,
have also come to be regarded as part of Managerial Economics.

1. Demand Analysis and Forecasting: A business firm is an economic organisation which is

engaged in transforming productive resources into goods that are to be sold in the
market. A major part of managerial decision making depends on accurate estimates of
demand. A forecast of future sales serves as a guide to management for preparing
production schedules and employing resources. It will help management to maintain or
strengthen its market position and profit base. Demand analysis also identifies a number
of other factors influencing the demand for a product. Demand analysis and forecasting
occupies a strategic place in Managerial Economics.
2. Cost and production analysis: A firm’s profitability depends much on its cost of
production. A wise manager would prepare cost estimates of a range of output, identify
the factors causing are cause variations in cost estimates and choose the cost-minimizing
output level, taking also into consideration the degree of uncertainty in production and
cost calculations. Production processes are under the charge of engineers but the
business manager is supposed to carry out the production function analysis in order to
avoid wastage’s of materials and time. Sound pricing practices depend much on cost
control. The main topics discussed under cost and production analysis are: Cost
concepts, cost-output relationships, Economies and Diseconomies of scale and cost
control.
3. Pricing decisions, policies and practices: Pricing is a very important area of Managerial
Economics. In fact, price is the genesis of the revenue of a firm ad as such the success of
a business firm largely depends on the correctness of the price decisions taken by it. The
important aspects dealt with this area are: Price determination in various market forms,
pricing methods, differential pricing, product-line pricing and price forecasting.
4. Profit management: Business firms are generally organized for earning profit and in the
long period, it is profit which provides the chief measure of success of a firm. Economics
tells us that profits are the reward for uncertainty bearing and risk taking. A successful
 business manager is one who can form more or less correct estimates of costs and
revenues likely to accrue to the firm at different levels of output. The more successful a
manager is in reducing uncertainty, the higher are the profits earned by him. In fact,
profit-planning and profit measurement constitute the most challenging area of
Managerial Economics.
5. Capital management: The problems relating to firm’s capital investments are perhaps the
most complex and troublesome. Capital management implies planning and control of
capital expenditure because it involves a large sum and moreover the problems in
disposing the capital assets off are so complex that they require considerable time and
labor. The main topics dealt with under capital management are cost of capital, rate of
return and selection of projects.

Conclusion: The various aspects outlined above represent the major uncertainties which a
business firm has to reckon with, viz., demand uncertainty, cost uncertainty, price uncertainty,
profit uncertainty, and capital uncertainty. We can, therefore, conclude that the subject-matter
of Managerial Economics consists of applying economic principles and concepts towards
adjusting with various uncertainties faced by a business firm.

REFERENCES:

Geetika, Ghosh and Choudgury (2018) “Managerial Economics”, 3rd Edition, McGraw Hill
Educaation (India) Private Limited,444/I, Sri Ekambara Naicker Estate, Alapakkam, Porur,
Chennai – 600 116

Basic Economic Problem, https://www.economicshelp.org/blog/glossary/basic-economic

problem/