Unit-I Nature and scope of Managerial Economics Sub: AE304

Definition, Meaning, Characteristics of managerial economics – Nature and scope

of managerial economics – Importance of managerial economics – Basic economic
tools in managerial economics – managerial economist role and responsibility.

Meaning of Managerial Economics:

Managerial economics generally refers to the integration of economic theory with
business practice. Economics provides tools managerial economics applies these tools to
the management of business. In simple terms, managerial economics means the
application of economic theory to the problem of management. Managerial economics
may be viewed as economics applied to problem solving at the level of the firm.

Definition:
According to Spencer and Siegelman:
 “The integration of economic theory with business practice for the purpose of facilitating
decision-making and forward planning by management”

According to Mc Gutgan and Moyer:

 “Managerial economics is the application of economic theory and methodology to
decision-making problems faced by both public and private institutions”
 
Characteristics of Managerial Economics:
1. Microeconomics
Managerial economics in character as it is concerned with smaller units of the economy.
It studies the problems and principles of an individual business firm or an individual
industry. It assists the management in forecasting and evaluating the trends of market.
2. Normative economics
Managerial economics belongs to normative economics. It is concerned with what
management should do under particular circumstances. It determines the goals of the
enterprise and then develops the ways to achieve these goals. It deals with future
planning, policy making, decision making and making full utilization if available
resources of enterprise.
3. Pragmatic
Managerial economics is pragmatic. It tries to solve the managerial problems in their day
to day functioning and avoids difficult issues of economic theory.
4. Uses theory of firm

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Managerial Economics uses economic concepts and principles which are known as the
theory of firm or economics of the firm. Thus, its scope is narrower than that of Pure
Economic theory.
5. Takes the Help of Macro Economics
Managerial Economics takes the help of Macro-economics also because it needs an
understanding of the circumstances and environment in which an individual firm or an
industry has to work. Issues of Macro-economics whose knowledge is necessary for the
successful management of a firm or an industry are : Business cycles, Taxation policies,
Industrial Policy of the government, Price and distribution policies, Wage policies and
anti- monopoly policies etc.
6. Aims at helping the management
Managerial economics aims at helping the management in taking correct decisions and
preparing plans and policies for future.
7. Prescriptive rather than descriptive
Managerial economics is a normative and applied discipline. It suggests the application
of economic principles with regard to policy formulation, decision making and future
planning. It not only describes the goals of an organization but also prescribes the means
of achieving these goals.
8. A scientific art
Managerial economics is called as scientific art because it helps the management in the
best and efficient utilization of scares economic resources. It assists the management in
finding out the most feasible alternative. Managerial economics facilitates good and
result orientated decisions under conditions of uncertainty.

Nature of Managerial Economics:

The practical use of economic principles in managerial economics is used to solve the
future planning and problems of management. So it is considered to be an ideal
combination of art and science. 
So To know the nature of managerial economics, it is important to know whether it is
science or art or both.

1. Managerial Economic is a Science: We know that science is systematic body of

knowledge and proved. On the other hand M.E is also science because the Principles and
theory of Managerial Economics is proved. Which is applicable for all level of
Organization and theory of demand, theory of price, theory of profit, theory of capital is
also proved, So we can say that managerial economic is science.

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2. Managerial economic is an art: Managerial economics is an art because an art is
application of skills can used for the purpose of getting some relevant information and
the other, In M.E theory is implement in Practice way in M.E managerial skills is
implemented. So ME is an art.
3. M.E for administrations of Organization: Managerial economic for
administration of organization because administration give the relevant data. They find
out the problem and solve the problem immediately in organisation and the admin
decide the target on the basis of price, Quality of the products, Demand of product.
Administration forecast the demand according to the situation of present demand of
the market.  
4. M.E is helpful in optimum resources allocation: In the organization are limited
resources and this resources can used in several places at a time by the tools and
techniques of managerial economic. The resources will used to get optimum output. In
the organisations our ultimate objective to earn profit so the limited resources used in
such a way to get maximum profit because, resources are limited. Our resources in
human and non-human resources. Human resources that means labor,  employees, and
Non-human resources that means land, building, machine, raw materials Etc. 
5. Managerial economic has component of micro economic: Managerial economics
has component of Micro economics.a. It is related with the internal factors of
organization. Internal factor of the organisations are demand of the products,
purchasing the raw materials, How to use the resource to get maximum profits. These
are related with micro component of M.E.
6. Managerial economic has components of macro economic: Managerial economic
has a component of macro economic which is related with the out side of the
organisation or a external factor of the organisation. External factor of the organisation
are competition market, nature of business, Government rules and regulations,
industrial law, Industrial Policies, Taxes these are the External factor of the
organisation and these types of problems solved by the managerial economics.
7. Managerial economic is dynamic in nature: Managerial economics is dynamic in
nature that means managerial economics is used all space of the organisation and all
except of the organisation. By the tools and technique of managerial economic to give
the relevant information and to solve the problem of the organisations So, Managerial
economic is dynamic in nature.  

Scope of Managerial Economics

1. Demand Analysis and Forecasting.
2. Cost and Production Analysis.

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 3. Pricing Decisions, Policies and Practices.
4. Profit Management.
5. Capital Management.
The study of these segments of business economics constitutes its subject matter as well
as scope. Recently, managerial economists have started making increased use of
Operational Research methods.

1. Demand Analysis and Forecasting:

The foremost aspect regarding its scope is in demand analysis and forecasting. A business
firm is an economic unit which transforms productive resources into saleable goods.
Since all output is meant to be sold, accurate estimates of demand help a firm in
minimizing its costs of production and storage.
A firm must decide its total output before preparing its production schedule and deciding
on the resources to be employed. Demand forecasts serves as a guide to the management
for maintaining its market share in competition with its rivals, thereby securing its profit.
Thus, demand analysis facilitates the identification of the various factors affecting the
demand for a firm’s product. This, in turn helps the firm in manipulating the demand for
its output.
In fact, demand forecasts are the starting point for a firm’s planning and decision-making.
This deals with the basic tools of demand analysis i.e.; Demand Determinants, Demand
Distinctions and Demand Forecasting etc.

2. Cost and Production Analysis:

A firm’s profitability depends much on its costs of production. A wise manager would
prepare cost estimates of a range of output, identify the factors causing variations in costs
and choose the cost-minimising 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 works to carry out the production function
analysis in order to avoid wastages of materials and time. Sound pricing policies depend
much on cost control.

3. Pricing Decisions, Policies and Practices:

Another task before a business manager is the pricing of a product. Since a firm’s income
and profit depend mainly on the price decision, the pricing policies and all such decisions
are to be taken after careful analysis of the nature of the market in which the firm
operates. The important topics covered in this field of study are: Market Structure
Analysis, Pricing Practices and Price Forecasting.

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4. Profit Management:
Each and every business firms are tended for earning profit; it is profit which provides
the chief measure of success of a firm in the long period. Economists tell 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 at different levels
of output. The more successful a manager is in reducing uncertainty, the higher are the
profits earned by him. It is therefore, profit-planning and profit measurement that
constitutes the most challenging area of business economics.

5. Capital Management:
Still another most challenging problem for a modern business manager is of planning
capital investment. Investments are made in the plant and machinery and buildings which
are very high. Therefore, capital management requires top-level decisions. It means
capital management i.e., planning and control of capital expenditure. It deals with Cost of
capital, Rate of Return and Selection of projects.

Importance of Managerial Economics

 
Business and industrial enterprise aims at earning maximum proceeds. A good decision
requires fair knowledge of the aspects of economic theory and tools of economic
analysis, which are directly involved in the process of decision making. Since managerial
economics is concerned with such aspects and tools of analysis, it is pertinent to the
decision making process.
Spencer and Siegelman have described the importance of managerial economics in a
business and industrial enterprise as follows:
1. Accommodating traditional theoretical concepts to the actual business behavior
and conditions
Managerial economics amalgamates tools, techniques, models and theories of traditional
economics with actual business practices and with the environment in which firm has to
operate. According to Edwin Mansfield, “ Managerial Economics attempts to bridge the
gap between purely analytical problems that intrigue many economic theories and the
problems of policies that management must face.”
2. Estimating economic relationships
Managerial economics estimates economic relationships between different business
factors such as income, elasticity of demand, cost volume, profit analysis etc.
3. Predicting relevant economic quantities
Managerial economics assist the management in predicting various economic such as
cost, profit, demand, capital, production, price etc. As a business manager has to function
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in an environment of uncertainty, it is imperative to anticipate the future working
environment in terms of the said quantities.
4. Understanding significant external forces
The management has to identify all the important factors that influence a firm. These
factors can broadly be divided into two categories. Managerial economics plays an
important role by assisting management in understanding these factors.
External factors
A firm cannot exercise any control over these factors. The plans, policies and
programmes of the firm should be formulated in the light of these factors. Significant
external factors impinging on the decision making process of a firm are economic
system of the country, business cycles, fluctuations in national income and national
production, industrial policy of the government, trade and fiscal policy of the
government, taxation policy, licensing policy, trends in foreign trade o the country,
general industrial relation in the country and so on.
Internal factors
These factors fall under the control of a firm. These factors are associated with
business operation, knowledge of these factors aids the management in making sound
business decisions.
5. Basis of business policies
Managerial economics is the founding principle of business policies. Business policies
are prepared based on studies and findings of managerial economics, which cautions the
management against potential upheavals in national as well as international economy.
Thus, managerial economics is helpful to the management in its decision making process.

Tools Used in Managerial Economics

1. Opportunity Cost Principle:
This principle is of immense use in decision-making. It can be stated as; the cost involved
in any decision consists of the sacrifices of alternatives required by that decision. If there
are no sacrifices there are no costs.
The opportunity costs are measured by the sacrifices in terms of goods and services
involved in the decision. The opportunity cost of the funds employed in one’s own
business is the amount of interest income which could be earned had that been employed
in other ventures.
The opportunity cost of using a machine to produce one product is measured as the
income which could have been obtained by renting it out to somebody else. If a machine
has only one use, its opportunity cost is zero. In the same way, the opportunity cost of the
time which an entrepreneur devotes to his business is the salary he could earn by working

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with some other firm of which he has knowledge. Thus, opportunity costs are the only
relevant principle for decision making.

2. Incremental Principle:
The economists make a use of the incremental principle in the theories of consumption,
production pricing and distribution. In price-determination, this principle states that a
firm would maximize its profits if it equates its marginal costs to its marginal revenue. In
this way, this principle guides a business manager that he should expand his business in
each direction only so long as the incremental benefit to his firm is more than the
incremental costs.
The moment the incremental benefit (marginal revenue) is equated to the incremental
cost (marginal cost); it is the point where the activity has to be limited. This principle
focuses on the changes in prices, products, procedures, investments or whatever may be
at stake in a business decision.

3. Principle of Time Perspective:

Another principle that is the principle of time perspective is useful in decision-making in
output, prices, advertising and expansion of business. Economists distinguish between the
short run and the long run in discussing the determination of price in a given market
because in the long run a firm must cover its full cost.
On the contrary, in the short-run it can afford to ignore some of its (fixed) costs. Modern
economists have started making use of an “intermediate run” between the short run and
the long run in order to explain pricing and output behaviour under what is called
oligopoly.

4. Discounting Principle:
Generally people consider a rupee tomorrow to be worth less than a rupee today. This is
also implied by the common saying that a bird in hand is worth two in the bush. Anybody
will prefer Rs. 100 today to Rs. 100 next year.
There are two main reasons for this:
(1) The future is uncertain and it is preferable to get Rs.100 today rather than a year after;
(2) Even if one is sure to receive Rs. 100 next year, one would do well to receive Rs. 100
now and invest it for a year and earn a rate of interest on Rs. 100 for one year.
What is the present worth (PW) of Rs. 100 obtainable after one year?
The principle of economics used in the calculations given above is called the discounting
principle. It can be explained as “If a decision affects costs and revenues at future dates, it
is necessary to discount those costs and revenues to obtain the present values of both
before a valid comparison of alternatives can be made”.

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5. The Equi-Marginal Principle:
This principle states that an input should be allocated in such a way that the value added
by the last unit of the input is the same in all its uses. This generalized law is known as
the equi-marginal principle.

The role of economics in management:

1. Study of economic pattern at macro-level and analysis its significance to the
organization and its functioning
2. Examine how the changing environment is profitable to ones organization in the best
possible way
3. Helps is making sound decision by choosing the best available alternative in  case of
choices.
4. Many managerial economic tools and analysis models are used to help make investing
decisions both for corporations and savvy individual investors. These tools are used to
make stock market investing decisions and decisions on capital investments for a
business.
5. Assists businesses in determining pricing strategies and appropriate pricing levels for
their products and services. Some common analysis methods are price discrimination,
value-based pricing and cost-plus pricing
6. Assists the management in the decisions pertaining to internal functioning of a firm
such as changes in price, investment plans, type of goods /services to be produced,
inputs to be used, etc…
7. Analyse changes in macroeconomic indicators such as national income, population,
business cycles, and their possible effect on the firm’s functioning.
8. The most significant function of a managerial economist is to conduct a detailed
research on industrial market.
9. He also provides management with economic information such as tax rates,
competitor’s price and product, etc. They give their valuable advice to government
authorities as well.
10. Uncertainty exits in every business and managerial economics can help reduce risk
through uncertainty model analysis and decision-theory analysis. Heavy use of
statistical probability theory helps provide potential scenarios for businesses to use
when making decisions.

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Responsibilities of Managerial Economist

1. To make a reasonable profit on capital employed:

He must have a strong conviction that profits are essential and his main obligation is to
assist the management in earning reasonable profits on capital employed in the firm.

2. He must make successful forecasts by making in depth study of the internal and
external factors:
This will have influence over the profitability or the working of the firm. He must aim at
lessening if not fully eliminating the risks involved in uncertainties. He has a major
responsibility to alert management at the earliest possible time in case he discovers any
error in his forecast, so that the management can make necessary changes and
adjustments in the policies and programmes of the firm.

3. He must inform the management of all the economic trends:

A managerial economist should keep himself in touch with the latest developments of
national economy and business environment so that he can keep the management
informed with these developments and expected trends of the economy.

4. He must establish and maintain contacts with individuals and data sources:
(i) To establish and maintain contacts:
A managerial economist should establish and maintain contacts with individuals
and data sources in order to collect relevant and valuable information in the field.
(ii) To develop personal relations: To collect information he should develop
personal relations with those having specialized knowledge of the field.
(iii) To join professional associations and should take active part in their
activities:
The success of this lies in how quickly he gathers additional information in the
best interest of the firm.

5. He must earn full status in the business and only then he can be helpful to the
management in good and successful decision-making:
For this:
(i) He must receive continuous support for himself and his professional ideas by
performing his function effectively.
(ii) He should express his ideas in simple and understandable language with the minimum
use of technical words, while communicating with his management executives.
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