Introduction to Managerial Economics

Concept of Managerial Economics

1. Meaning of Managerial Economics
Managerial Economics has been a separate science from Traditional Economics since 1951.
Due to this reason, economists treat managerial economics as a young and growing science.
The contribution for introducing managerial economics as a separate science goes to
American economist Joel Dean. He published a book 'Managerial Economics' in 1951. Since
then the broad study of this subject has been started. At present time, Managerial
Economics has been one of the most popular subjects for students and business world.
Managerial economics is taken as an applied micro-economics. The theories of managerial
economics are related to the study of economic activities of a firm. Managerial economics
provides the knowledge of how a firm uses traditional economic theories into practice. In
other words, managerial economics is taken as a science which reduces the gap between
abstract economic theory and managerial practice. Managerial economics was known as
Business Economics in the beginning but nowadays it is often called as managerial
economics. Managerial economics is also known as goal oriented science because it deals
with the achievement of business objectives. Optimum allocations of limited resources, cost
minimization, price determination, determination of market share etc. are included in
managerial objectives. Managerial economics provides suggestions to the manager while
performing economic activities on the basis of various objectives. Hence, it is also known as
prescriptive science.
In order to study managerial economics broadly, the following definitions need to be
understood:

Joel Dean: Use of economic analysis in formulating policies is known as Managerial

Economics.

Spencer and Seigleman: Managerial Economics is the integration of economic theory

and business practice for the purpose of facilitating decision making and forward
planning by management.

Haynes, Mote and Paul: Managerial Economics is applied in decision making. It is a

special branch of economics bridging the gap between abstract theory and managerial
practice.

E. Mansfield: Managerial economics is concerned with the ways in which business

executives and other policy makers should make decisions.

J.L. Pappas and E.F. Brigham: Managerial Economics is the application of economic
theory and methodology to business administration practice.

Charles Stokes: Managerial Economics is a selection from the tool-box of economic

principles. It is a collection of those methods and those kinds of analysis that have direct
application to management.

D.S. Watson: Managerial Economics is the price-theory in the service of business

executive.

Reckie and Crook: To the businessman, managerial economics is the branch of

economics which can assist him in finding optimal solutions to business problems.

On the basis of above mentioned definitions, managerial economics has been a major
branch of traditional economics. Managerial economics contributes in determining business
decisions and formulating business plans. Hence it is also known as Economics of Business
Decision. The first secret of any manager being appropriate decision, managerial economics
provides the foundation of making optimum decision regarding the economic activities of
the firm. It takes help of economics, logics, mathematics, statistics etc. in making optimum

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managerial decisions. In this context, it is appropriate to quote the statement provided by

D.C. Hague. According to D.C. Hague, "Managerial Economics uses the logics of economics,
mathematics and statistics to provide effective ways of thinking about business problems."
To conclude, Managerial economics is an applied microeconomic theory that basically deals
with the choice and allocation of scarce resources of the firm.
2. Features of Managerial Economics
The major features of managerial economics are discussed below:
i.

Microeconomic in Nature
Micro economics studies and analyzes the individual economic unit. The subject matter
of managerial economics is also related to the study and analysis of economic activity of
a particular firm. That is why managerial economics is micro economic in nature. Like
micro economics, managerial economics also deals with the optimum use of limited
resources of the firm. Managerial economics studies the three issues like that of micro
economics as follows:
What to produce? (Type of good)
How to produce? (Technology)
What are the relative shares of each factor of production? (Distribution)

ii.

Normative and Prescriptive Science

Traditional economics can be studied in two forms as positive and normative. Positive
science deals with the question: what is. In other words, positive science studies the
cause and effect relationship between variables. On the other hand, normative science
deals with the question: what should be. Managerial economics provides suggestion to
the managers in achieving the goals of the firm. It provides information to the managers
about using the economic laws practically in the firm. Similarly, managerial economics
works as a guide to make short-run and long-run policies and plans of the firm
successful. Due to this reason, managerial economics is treated as normative and
prescriptive science.

iii. More Pragmatic

Most of the theories of traditional economics are abstract in nature. Managerial
economics is found to be more pragmatic rather than being dogmatic. Managerial
economics makes effort for appropriate solution to the practical problems faced by the
firm by removing complex and abstract concepts of traditional economics. It helps the
firm to reach the height of success by making appropriate policies and plans on the
basis of empirical facts and experiments. In this way managerial economics being an
applied science, it is more pragmatic as compared to traditional economics.
iv. Narrow Scope
Managerial economics studies the theory of firm under traditional economics in
elaborative form. It is basically concerned with the economic activities of the firm and
only with the theory of profit relating to distribution. That is why the scope of managerial
economics is narrow.
v.

Conceptual and Metrical

Managerial economics is both conceptual and metrical. Managerial economics provides
the concepts related to the economic activities of the firm and at the same time it uses
metrical method of calculating the values of various economic variables through
mathematics and statistics. Due to the metrical use, managerial economics helps in
forecasting various economic variables of the firm.

vi. Use of MacroEconomics

There are two branches of traditional economics - micro and macro economics. Despite
of having separate scopes of these two branches, they are interdependent to each

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other. For example, the cost of various factors of production as well as the level of
employment, consumption and investment etc. in an economy influence the pricing
decision of a firm. Since decision of price determination is micro economic in nature, its
determinants are macro economic variables. Macro economics studies trade cycle,
taxation policy, industrial policy, national income, and imports and exports policies. With
the help of these macro economic variables, firms can understand their business
environment and make effective decisions. Hence, managerial economics uses the
concept of macro economics in order to make effective business decisions.
vii. Integration of Economic Theory and Business Practice
Managerial economics helps to integrate traditional economic theories, tools and
technologies with real business. Similarly it helps to develop and expand them according
to need. In reality, managerial economics is the economics of business. The major
factors to be studied in managerial economics are maximization of profit, minimization
of cost etc. In present scenario, maximization and minimization are converted into the
single term optimization. Managerial economics helps to integrate profit and cost with
accounting concept. According to Edwin Mansfield, "Managerial Economics attempts to
bridge the gap between the purely analytical problems that intrigue many economic
theories and the problems of policies that management must face."
3. Scope/Subject Matter of Managerial Economics
Managerial economics has a narrow scope as compared to traditional economics. Managerial
economics being a new academic subject, economists have differences in their opinions
regarding its scope. The fundamental scope of managerial economics can be explained
below:
i.

Demand Analysis and Demand Forecasting

The demand for the product produced by the firm is affected by various factors. The firm
has to make a complete study about the demand for its product. For this, it has to
forecast sales by analyzing the various determinants of demand. In managerial
economics, we study demand analysis and various methods of demand forecasting.
Under demand analysis, price elasticity, income elasticity, cross elasticity, advertising
elasticity etc. are studied. Managerial economics helps in using mathematical
techniques to calculate the values of these elasticities of demand. The firm can achieve
related information regarding pricing policy, advertising policy, market expansion policy
etc. on the basis of elasticity of demand. Managerial economics helps in using
mathematical and statistical tools required for demand forecasting. Demand forecasting
helps to provide the numerical value of possible demand in the future on the basis of
past information so that effective decisions can be made at present. In order to forecast
demand, managerial economics uses different statistical and non-statistical techniques.

ii.

Cost and Production Analysis

In managerial economics we study the cost and production of a firm. The firm starts its
production process after analyzing the demand for its product. Production is defined as
the creation of utility in any good or service for the purpose of sale. Different factors of
production are employed in the process of production. Factors of production are scarce
and they can be brought into alternative uses. The firm has to produce good by using
appropriate combination of these scarce resources. Managerial economics studies the
method of employing technically and economically efficient combination of inputs in the
process of production. Payments are made to these inputs for using them by the firm.
The payments made to these inputs are the costs of the firm. It is necessary for the firm
to estimate the cost of production in order to make effective managerial decision. In
order to estimate cost of the firm, its determinants should be identified. Due to the fact
that the determinants of cost are not completely known and out of control of the firm,
they invite uncertainties in cost. Managerial economics helps to forecast economic cost
for profit planning and competitive pricing of the firm. Under cost and production

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analysis, managerial economics deals with concept and types of cost, production
function, costproduction relationship, optimal employment of inputs, law of variable
proportions, laws of returns to scale etc.
iii. Price Theory
Price theory is the heart of managerial economics. Firm should determine appropriate
price for the product to make it saleable. The revenue of the firm is the income received
by it after selling its output. The determination of price of the product depends upon the
condition of market. In perfectly competitive market situation, the firm acts as a price
taker and adjusts its production. In other words, price remains fixed in perfect
competition so that the firm has to adjust its production and sales in order to achieve
higher profit. If the firm is a monopolist, it works as a price maker. The firm inspired from
profit maximizing objective determines price on the basis of marginal cost and marginal
revenue. In oligopoly there is strong competition between firms. Price war is a
continuous phenomenon in this type of market situation. Sometimes firms compete with
each other through advertisement and other tools of sales promotion in order to attract
customers. In managerial economics we study the method of price determination
according to the nature of market structure. Similarly, pricing policies which are
successful in managerial practice are also studied under it. For example, managerial
economics helps to study price discrimination, multiple product pricing, peak-load
pricing, transfer pricing, etc.
iv. Profit Management
Profit is defined as the difference between revenue and cost of the firm. Generally the
main objective of the firm is maximization of profit but this objective is not always
achieved by the firm. Profit is the result of exhibiting the ability by an entrepreneur.
Higher the efficiency of the entrepreneur, higher will be the level of profit of the firm. On
the other hand, profit of the firm is dependent on risk and uncertainty. Risk and
uncertainties arise due to various factors like change in taste and preference of
consumers, competition observed in the market, technological change etc. An efficient
manager always attempts to minimize these risks and uncertainties as far as possible. In
this situation profit management plays a vital role. Under profit management,
managerial economics explains about profit policies, profit measurement, profit planning
etc.
v.

Capital Management
A firm has to manage capital appropriately in order to run the firm smoothly. Capital
management implies appropriate mobilization of capital expenditures. Capital
expenditure refers to the expenditure made on capital goods from which the firm
expects cash gains in the future. That is why capital expenditure should be made
efficiently by the firm. According to Edwin Mansfield, "Successful capital investment can
turn a losing firm into a winner. Foolish capital investment can sink a firm that in other
respect is well managed." Capital management is a long-term concept. Long-term
capital management includes the selection of investment project, cost of capital, rate of
return from capital etc. which are studied in managerial economics.

vi. External Problems

The scope of managerial economics is not only related to the internal problems and
solution of the firm, it is also related to the study of environmental problems. External
problems include the situation of macroeconomic variables and social as well as political
conditions. The decision process of the firm is influenced by the changes in trade cycle,
fiscal policy, international trade, monetary policy etc. The scope of managerial
economics includes these external factors so that the manager can efficiently make the
firm successful.
4. Use / Significance of Managerial Economics in Corporate Decision Making

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i.

Reconciling traditional economic theories to actual business behaviour

Most of the theories of traditional economics are abstract in nature. Managerial
economics is more pragmatic rather than being dogmatic. Managerial economics makes
effort to provide appropriate solution to the problems faced by the firms in a practical
manner by removing complex and abstract concepts of economic theories. It helps the
firm to reach the height of success by providing appropriate policies and plans on the
basis of empirical facts and experiments. Being an applied science, it is more pragmatic
than traditional economics. Managerial economics integrates traditional economic
theories with the actual business behaviour. According to Edwin Mansfield, "Managerial
economics attempts to bridge the gap between the purely analytical problems that
intrigue many economic theories and the problems of policies that management must
face."

ii.

Estimating economic relationship

It is necessary for the firm to study the internal and external factors in order to make
effective business decisions. The internal and external factors create risk and
uncertainties in the process of decision making. The firm has to implement future plans
by establishing relationship between various economic variables. For example, by
establishing economic relationship between demand and its determinants, the firm can
forecast demand correctly. Similarly decision making process of the firm can be made
effective by estimating economic relationship between cost and its determinants, profit
and its determinants and so on.

iii. Predicting economic quantities

Prediction of economic quantities implies the calculation of the values of economic
variables of the firm. With the help of various mathematical and statistical methods, the
firm can forecast various economic variables. For example, firm can make its present
decisions effective by predicting economic quantities like quantity of production, profit,
price, demand etc. For doing such forecasting activities, managerial economics plays an
important role.
iv. Helpful in understanding external factors
The importance of managerial economics lies not only in solving the problems of the firm
but it is also related to the study of environmental factors. External factors include
situation of macro economic variables and social as well as political conditions. These
determinants have deep effect on the firm's decision making process. The firm cannot
control the changes observed in environmental conditions. Various external factors like
trade cycle, fiscal policy, monetary policy, international trade etc. influence the decision
making process of the firm. Firm has to formulate plans on the basis of these external
factors. Managerial economics helps to generate effective decisions by making these
external factors favourable to the firm.
v.

Basis of business policies

Managerial economics helps the firm to establish economic relationship between
variables and forecast the values of these variables through mathematical and
statistical techniques. The firm formulates business policies on the basis of predicted
economic quantities. In this way managerial economics serves as a basis of business
policies of the firm.

5. Factors Influencing Managerial Decision

The various economic and non-economic factors influencing managerial decision are
explained below:
i.

Economic Factors

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Among various factors affecting managerial decision, economic factor is considered to

be the major factor. A manager has to make decision on the basis of two opposing forces
of demand and cost. Change in price of the product, taste and preference of the
consumers, government policies etc. affect the demand side whereas the cost of
machine, price of labour, technological change etc. affect the supply side of the firm.
ii.

Objective of the Firm

A firm without any objective is like a horse without saddle. Due to this reason, a
manager has to determine the objectives of the firm. Managerial decision changes
according to the objectives of the firm. A firm has different objectives. For example,
profit maximizing objective, sales-revenue maximizing objective, maximization of
managerial utility etc. are the major objectives of the firm. The manager has to keep
perfect harmony of economic activities with the objective of the firm.

iii. Environmental Factors

The scope of managerial economics is not only related to the internal problems and
solution of the firm, it is also related to the study of environmental problems. External
problems include the situation of macroeconomic variables and social as well as political
conditions. The decision process of the firm is influenced by the changes in trade cycle,
fiscal policy, international trade, monetary policy etc. The scope of managerial
economics includes these external factors so that the manager can efficiently make the
firm successful. Environmental factors include the following three main elements which
are discussed below:
a. Public Awareness
Various pressure groups like political parties, consumer group, trade union,
community union etc. are included in this factor. The firm has to perform its
production and sales activities by considering the opinions and approaches of these
pressure groups.
b. Social Cost
A society has to bear real cost due to the economic activity performed by the firm.
For instance, the society has to face the negative impacts of pollution emitted by the
firm in the process of production. That is why, a manager has to involve in production
process by reducing the social cost as far as it is possible. This determines the social
responsibility of the manager.
c. Human Factors
Various types of constraints are faced by the firm while producing good. Among these
different types of constraints, labour force is believed to be the major constraint. The
duty of the manager is to produce output by keeping intact with the labour union.
Managerial decisions should be made in such a way that they can increase the
welfare of human factors employed by the firm. In this way, human factors also affect
managerial decision.

Best of Luck

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