Unit 1- Meaning And Importance Of Managerial Economics

Meaning

Managerial economics is a science that deals with the application of various economic theories,
principles, concepts and techniques to business management in order to solve business and
management problems. It deals with the practical application of economic theory and
methodology to decision-making problems faced by private, public and non-profit making
organizations.

The same idea has been expressed by Spencer and Seigelman in the following words. “Managerial
Economics is the integration of economic theory with business practice for the purpose of facilitating
decision making and forward planning by the management”.According to Mc Nair and Meriam,
“Managerial economics is the use of economic modes of thought to analyze business situation”.
Brighman and Pappas define managerial economics as,” the application of economic theory and
methodology to business administration practice”.Joel dean is of the opinion that use of economic
analysis in formulating business and management policies is known as managerial economics.

Features of managerial Economics

1. It is a new discipline and of recent origin

2. It is a highly specialized and separate branch by itself.
3. It is basically a branch of microeconomics and as such it studies the problems of only
one firm in detail.

1. It is mainly a normative science and as such it is a goal oriented and prescriptive science.
2. It is more realistic, pragmatic and highlights on practical application of various economic

The theories to solve business and management problems.

 It is a science of decision-making. It concentrates on decision-making process, decision-

models and decision variables and their relationships.
 It is both conceptual and metrical and it helps the decision-maker by providing
measurement of various economic variables and their interrelationships.
 It uses various macro economic concepts like national income, inflation, deflation, trade
cycles etc to understand and adjust its policies to the environment in which the firm
operates.
 It also gives importance to the study of non-economic variables having implications of
economic performance of the firm. For example, impact of technology, environmental
forces, socio-political and cultural factors etc.
 It uses the services of many other sister sciences like mathematics, statistics, engineering,
accounting, operation research and psychology etc to find solutions to business and
management problems.

SCOPE OF MANAGERIAL ECONOMICS

The term “scope” indicates the area of study, boundaries, subject matter and width of a
subject. The following topics are covered in this subject.

1. OBJECTIVES OF A FIRM
2. DEMAND ANALYSIS AND FORECASTING

3. PRODUCTION AND COST ANALYSIS

4. PRICING DECISIONS, POLICIES AND PRACTICES

5. PROFIT MANAGEMENT

6. CAPITAL MANAGEMENT

7. LINEAR PROGRAMMING AND THE THEORY OF GAMES

The term linear means that the relationships handled are the same as those represented by
straight lines and programming implies systematic planning or decision-making. It implies
maximization or minimization of a linear function of variables subject to a constraint of linear
inequalities. It offers actual numerical solution to the problems of making optimum choices.
It involves either maximization of profits or minimization of costs. The theory of games
basically attempts to explain what is the rational course of action for an individual firm or an
entrepreneur who is confronted with the a situation where in the outcome depends not only
on his own actions, but also on the actions of others who are also confronted with the same
problem of selecting a rational course of action. Both these techniques are extensively used in
business economics to solve various business and managerial problems.

8. MARKET STRUCTURE AND CONDITIONS

9. STRATEGIC PLANNING

It provides a framework on which long term decisions can be made which have an impact on
the behavior of the firm. The perspective of strategic planning is global. In fact, the
integration of business economics and strategic planning has given rise to a new area of study
called corporate economics.

10. OTHER AREAS

1. Macroeconomic management of the country relating to economic system, national

income, trade cycles Savings and investments and its impact on the working of a firm.
2. Knowledge and information about various government policies like monetary, fiscal,
physical, industrial, labor, foreign trade, foreign capital and technology, MNCs etc
and their impact on the working of a firm.
3. Impact of international changes, role of international financial and trade institutions in
formulating domestic polices of a firm.

Importance of the study of Managerial Economics

The following points indicate the significance of the study of this subject in its right perspective.

1. It gives guidance for identification of key variables in decision-making process.

2. It helps the business executives to understand the various intricacies of business and
managerial problems and to take right decision at the right time.
 3. It provides the necessary conceptual, technical skills, toolbox of analysis and techniques of
thinking and other such most modern tools and instruments like elasticity of demand and
supply, cost and revenue, income and expenditure, profit and volume of production etc to
solve various business problems.
4. It is both a science and an art. In the context of globalization, privatization, liberalization and
marketization and a highly competitive dynamic economy, it helps in identifying various
business and managerial problems, their causes and consequence, and suggests various
policies and programs to overcome them.
5. It helps the business executives to become much more responsive, realistic and competent
to face the ever changing challenges in the modern business world.
6. It helps in the optimum use of scarce resources of a firm to maximize its profits.
7. It also helps in achieving other objectives a firm like attaining industry leadership, market
share expansion and social responsibilities etc.
8. It helps a firm in forecasting the most important economic variables like demand, supply,
cost, revenue, price, sales and profit etc and formulate sound business polices
9. It also helps in understanding the various external factors and forces which affect the
decision-making of a firm.

Thus, it has become a highly useful and practical discipline in recent years to analyze and
find solutions to various kinds of problems in a systematic and rational manner.

Knowledge of decision making and forward planning

Managerial Economist is a specialist and an expert in analyzing and finding answers to business and
managerial problems. A Managerial Economist has to perform several functions in an organization.
Among them, decision-making and forward planning are described as the two major functions and
all other functions are derived from these two basic functions.

1. Decision-making

The word ‘decision’ suggests a deliberate choice made out of several possible alternative courses
of action after carefully considering them. Decision-making is essentially a process of selecting the
best out of many alternative opportunities or courses of action that are open to a management.

2. Forward planning

The term ‘planning’ implies a consciously directed activity with certain predetermined goals and
means to carry them out. It is a deliberate activity. It is a programmed action. Basically planning is
concerned with tackling future situations in a systematic manner.

Forward planning implies planning in advance for the future. It is associated with deciding the
future course of action of a firm. It is prepared on the basis of past and current experience of a firm.

Summary

Managerial economics is a new and a highly specialized branch of economics. It brings together
economic theory and business practice. It assists in applying various economic theories and
principles to find solutions to business and management problems.
It is applied economics and makes an attempt to explain how various economic concepts are
usefully employed in business management. It is a practical subject. It opens up the mind of a
managerial economist to the complex and highly challenging business world. The features of
managerial economics throw light on the nature of the emerging subject and the scope gives
information about the wide coverage of the subject. The concepts of decision- making and
forward planning are the two basic functions of a managerial economist. In a way the entire
subject matter of managerial economics is to be understood in the background of these two
functions

Objectives Of Firms

Economists over a period of time have developed various theories and models to explain different
kinds of goals of modern firms. Broadly speaking they can be dived in to three groups. They are as
follows-

1. The profit maximization model.

2. Managerial theories or models
3. Behavioral theories or models.

Let us study some of the important theories under each category.

Profit Maximization Model

Main propositions of the profit-maximization model.

The model is based on the assumption that each firm seeks to maximize its profit given certain
technical and market constraints. The following are the main propositions of the model.

1. A firm is a producing unit and as such it converts various inputs into outputs of higher value
under a given technique of production.
2. The basic objective of each firm is to earn maximum profit.
3. A firm operates under a given market condition.
4. A firm will select that alternative course of action which helps to maximize consistent profits
5. A firm makes an attempt to change its prices, input and output quantity to maximize its
profit.

Criticisms

1. Ambiguous term. The term profit maximization is ambiguous in nature. There is no clear cut
explanation whether a firm has to maximize its net profit, total profit or the rate of profit in a
business unit. Again maximum amount of profit cannot be precisely defined in quantitative terms.

2. Always it may not be possible. Profit maximization, no doubt is the basic objective of a firm. But
in the context of highly competitive business environment, always it may not be possible for a firm
to achieve this objective. Other objectives like sales maximization, market share expansion, market
leadership building its own image, name, fame and reputation, spending more time with members
of the family, enjoying leisure, developing better and cordial relationship with employees and
customers etc. also has assumed greater significance in recent years.

3. Separation of ownership and management. In many cases, to-day we come across the business
units are organized on partnership or joint stock company or cooperative basis. In case of many large
organizations, ownership and management is clearly separated and they are run and managed by
salaried managers who have their own self interests and as such always profit maximization may not
become possible.

4. Difficulty in getting relevant information and data. In spite of revolution in the field of
information technology, always it may not be possible to get adequate and relevant information to
take right decisions in a highly fluctuating business scenario. Hence, profits may not be maximized.

5. Conflict in inter-departmental goals. A firm has several departments and sections headed by
experts in their own fields. Each one of them will have its own independent goals and many a times
there is possibility of clashes between the interests of different departments and as such always
profits may not be maximized.

6. Changes in business environment. In the context of highly competitive and changing business
environment and changes in consumers’ tastes and requirements, a firm may not be able to cope up
with the expectations and adjust its policies and as such profits may not be maximized.

7. Growth of oligopolistic firms. In the context of globalization, growth of oligopoly firms has
become so common through mergers, amalgamations and takeovers. Leading firms dominate the
market and the small firms have to follow the policies of the leading firms. Hence, in many cases,
there are limited chances for making maximum profits.

8. Significance of other managerial gains. Salaried managers have limited freedom in decision
making process. Some of them are unable to forecast the right type of changes and meet the market
challenges. They are more worried about their salaries, promotions, perquisites, security of jobs, and
other types of benefits. They may lack strong motivations to make higher profits as profits would go
to the organization. They may be contented with only satisfactory level of profits rather than
maximum profits.

9. Emphasis on non-profit goals. Many organizations give more stress on non-profit goals. From the
point of view of today’s business environment, productivity, efficiency, better management,
customer satisfaction, durability of products, higher quality of products and services etc have gained
importance to cope with business competition. Hence, emphasis has been shifted from profit
maximization to other practical aspects.

10. Aversion to reduction in power. In case of several small business units, the owners do not want
to share their powers with many new partners and hence, they try to keep maximum powers in their
hands. In such cases, keeping more power becomes more important than profit maximization.

11. Official restrictions over profits of public utilities. Public utilities or public corporations are
legally prohibited to make huge profits in many developing countries like India.

Thus, it is clear that a firm cannot maximize its profits always. There are many constraints in the
background of multiple objectives. Each one of the objectives has its own merits and demerits and a
firm has to strike a balance between all kinds of objectives. However, today it is the view of many
experts that in spite of several alternative objectives, a firm has to make adequate profits. For
undertaking any kind of welfare or other activities to promote the welfare of either consumers or
workers, a firm should have sufficient revenue. Other wise all other objectives would remain only on
paper and can never be implemented. Non-profit goals serve as supplementary or complementary
ones to the primary objective of profit maximization Thus, the traditional objective of profit
maximization has relevance even today of course with some modifications.

Economist Theory Of Firm

According to Economist theory of firm, a firm is a producing unit. It transforms or converts all kinds
of inputs in to outputs. The basic function a firm is to produce those goods and services which are
demanded by consumers in the market. It produces various kinds of goods and services and supplies
them in the market for the satisfaction of different groups of people either directly or indirectly. A
firm is a business unit and it is organized on commercial principles. In the process of production and
sale of different goods and services, it aims at making profits.

According to this theory, a traditional firm is a group with a particular organizational and
management structure having command over its own property rights. It is a legal entity on the
basis of ownership and contractual relationship organized for production and sale of goods and
services. In olden days a firm was called by various names like shops, firms, enterprise, production
and business concerns etc. But today, it is organized on various forms like a sole trader, partnership
concern, Joint Stock Company, cooperative society etc.