Managerial Economics can be defined as amalgamation of economic theory with business

practices so as to ease decision-making and future planning by management. Managerial

Economics assists the managers of a firm in a rational solution of obstacles faced in the firm’s
activities. It makes use of economic theory and concepts. It helps in formulating logical
managerial decisions. The key of Managerial Economics is the micro-economic theory of the
firm. It lessens the gap between economics in theory and economics in practice. Managerial
Economics is a science dealing with effective use of scarce resources. It guides the managers in
taking decisions relating to the firm’s customers, competitors, suppliers as well as relating to the
internal functioning of a firm. It makes use of statistical and analytical tools to assess economic
theories in solving practical business problems.

Study of Managerial Economics helps in enhancement of analytical skills, assists in rational

configuration as well as solution of problems. While microeconomics is the study of decisions
made regarding the allocation of resources and prices of goods and services, macroeconomics is
the field of economics that studies the behavior of the economy as a whole (i.e. entire industries
and economies). Managerial Economics applies micro-economic tools to make business
decisions. It deals with a firm.

The use of Managerial Economics is not limited to profit-making firms and organizations. But it
can also be used to help in decision-making process of non-profit organizations (hospitals,
educational institutions, etc). It enables optimum utilization of scarce resources in such
organizations as well as helps in achieving the goals in most efficient manner. Managerial
Economics is of great help in price analysis, production analysis, capital budgeting, risk analysis
and determination of demand.

Managerial economics uses both Economic theory as well as Econometrics for rational

managerial decision making. Econometrics is defined as use of statistical tools for assessing
economic theories by empirically measuring relationship between economic variables. It uses
factual data for solution of economic problems. Managerial Economics is associated with the
economic theory which constitutes “Theory of Firm”. Theory of firm states that the primary aim
of the firm is to maximize wealth. Decision making in managerial economics generally involves
establishment of firm’s objectives, identification of problems involved in achievement of those
objectives, development of various alternative solutions, selection of best alternative and finally
implementation of the decision.

The following figure tells the primary ways in which Managerial Economics correlates to
managerial decision-making.
Managerial Economics deals with allocating the scarce resources in a manner that minimizes the
cost. As we have already discussed, Managerial Economics is different from microeconomics
and macro-economics. Managerial Economics has a more narrow scope - it is actually solving
managerial issues using micro-economics. Wherever there are scarce resources, managerial
economics ensures that managers make effective and efficient decisions concerning customers,
suppliers, competitors as well as within an organization. The fact of scarcity of resources gives
rise to three fundamental questions-

What to produce?

How to produce?

For whom to produce?

To answer these questions, a firm makes use of managerial economics principles.

The first question relates to what goods and services should be produced and in what
amount/quantities. The managers use demand theory for deciding this. The demand theory
examines consumer behaviour with respect to the kind of purchases they would like to make
currently and in future; the factors influencing purchase and consumption of a specific good or
service; the impact of change in these factors on the demand of that specific good or service; and
the goods or services which consumers might not purchase and consume in future. In order to
decide the amount of goods and services to be produced, the managers use methods of demand
forecasting.
The second question relates to how to produce goods and services. The firm has now to choose
among different alternative techniques of production. It has to make decision regarding purchase
of raw materials, capital equipments, manpower, etc. The managers can use various managerial
economics tools such as production and cost analysis (for hiring and acquiring of inputs), project
appraisal methods( for long term investment decisions),etc for making these crucial decisions.

The third question is regarding who should consume and claim the goods and services produced
by the firm. The firm, for instance, must decide which is it’s niche market-domestic or foreign?
It must segment the market. It must conduct a thorough analysis of market structure and thus
take price and output decisions depending upon the type of market.

Managerial economics helps in decision-making as it involves logical thinking. Moreover, by

studying simple models, managers can deal with more complex and practical situations. Also, a
general approach is implemented. Managerial Economics take a wider picture of firm, i.e., it
deals with questions such as what is a firm, what are the firm’s objectives, and what forces push
the firm towards profit and away from profit. In short, managerial economics emphasizes upon
the firm, the decisions relating to individual firms and the environment in which the firm
operates. It deals with key issues such as what conditions favour entry and exit of firms in
market, why are people paid well in some jobs and not so well in other jobs, etc. Managerial
Economics is a great rational and analytical tool.

Managerial Economics is not only applicable to profit-making business organizations, but also to
non- profit organizations such as hospitals, schools, government agencies, etc.

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.

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 macro economics

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 macro economics.

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.

Managerial Economics and Micro Economics

Managerial Economics is basically a blend of Economics and Management. Two branches of

economics i.e. micro economics and macro economics 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.

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.
Principles of Managerial Economics

Economic principles assist in rational reasoning and defined thinking. They develop logical
ability and strength of a manager. Some important principles of managerial economics are:

Marginal and Incremental Principle

This principle states that a decision is said to be rational and sound if given the firm’s objective
of profit maximization, it leads to increase in profit, which is in either of two scenarios-

If total revenue increases more than total cost.

If total revenue declines less than total cost.

Marginal analysis implies judging the impact of a unit change in one variable on the other.
Marginal generally refers to small changes. Marginal revenue is change in total revenue per unit
change in output sold. Marginal cost refers to change in total costs per unit change in output
produced (While incremental cost refers to change in total costs due to change in total output).
The decision of a firm to change the price would depend upon the resulting impact/change in
marginal revenue and marginal cost. If the marginal revenue is greater than the marginal cost,
then the firm should bring about the change in price.

Incremental analysis differs from marginal analysis only in that it analysis the change in the
firm's performance for a given managerial decision, whereas marginal analysis often is generated
by a change in outputs or inputs. Incremental analysis is generalization of marginal concept. It
refers to changes in cost and revenue due to a policy change. For example - adding a new
business, buying new inputs, processing products, etc. Change in output due to change in
process, product or investment is considered as incremental change. Incremental principle states
that a decision is profitable if revenue increases more than costs; if costs reduce more than
revenues; if increase in some revenues is more than decrease in others; and if decrease in some
costs is greater than increase in others.

Equi-marginal Principle

Marginal Utility is the utility derived from the additional unit of a commodity consumed. The
laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when the
marginal utilities of various commodities he consumes are equal. According to the modern
economists, this law has been formulated in form of law of proportional marginal utility. It states
that the consumer will spend his money-income on different goods in such a way that the
marginal utility of each good is proportional to its price, i.e.,

MUx / Px = MUy / Py = MUz / Pz

Where, MU represents marginal utility and P is the price of good.

Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the technique
of production which satisfies the following condition:

MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3

Where, MRP is marginal revenue product of inputs and MC represents marginal cost.

Thus, a manger can make rational decision by allocating/hiring resources in a manner which
equalizes the ratio of marginal returns and marginal costs of various use of resources in a specific
use.

Opportunity Cost Principle

By opportunity cost of a decision is meant the sacrifice of alternatives required by that decision.
If there are no sacrifices, there is no cost. According to Opportunity cost principle, a firm can
hire a factor of production if and only if that factor earns a reward in that occupation/job equal or
greater than it’s opportunity cost. Opportunity cost is the minimum price that would be necessary
to retain a factor-service in it’s given use. It is also defined as the cost of sacrificed alternatives.
For instance, a person chooses to forgo his present lucrative job which offers him Rs.50000 per
month, and organizes his own business. The opportunity lost (earning Rs. 50,000) will be the
opportunity cost of running his own business.

Time Perspective Principle

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.

Discounting Principle

According to this principle, if a decision affects costs and revenues in long-run, all those costs
and revenues must be discounted to present values before valid comparison of alternatives is
possible. This is essential because a rupee worth of money at a future date is not worth a rupee
today. Money actually has time value. Discounting can be defined as a process used to transform
future dollars into an equivalent number of present dollars. For instance, $1 invested today at
10% interest is equivalent to $1.10 next year.

FV = PV*(1+r)t
Where, FV is the future value (time at some future time), PV is the present value (value at t0, r is
the discount (interest) rate, and t is the time between the future value and present value.

Role of a Managerial Economist

A managerial economist helps the management by using his analytical skills and highly
developed techniques in solving complex issues of successful decision-making and future
advanced planning.

The role of managerial economist can be summarized as follows:

He studies the economic patterns at macro-level and analysis it’s significance to the specific firm
he is working in.

He has to consistently examine the probabilities of transforming an ever-changing economic

environment into profitable business avenues.

He assists the business planning process of a firm.

He also carries cost-benefit analysis.

He 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,
techniques of production to be employed, expansion/ contraction of firm, allocation of capital,
location of new plants, quantity of output to be produced, replacement of plant equipment, sales
forecasting, inventory forecasting, etc.

In addition, a managerial economist has to analyze changes in macro- economic indicators such
as national income, population, business cycles, and their possible effect on the firm’s
functioning.

He is also involved in advicing the management on public relations, foreign exchange, and trade.
He guides the firm on the likely impact of changes in monetary and fiscal policy on the firm’s
functioning.

He also makes an economic analysis of the firms in competition. He has to collect economic data
and examine all crucial information about the environment in which the firm operates.

The most significant function of a managerial economist is to conduct a detailed research on

industrial market.

In order to perform all these roles, a managerial economist has to conduct an elaborate statistical
analysis.

He must be vigilant and must have ability to cope up with the pressures.
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.

At times, a managerial economist has to prepare speeches for top management.