BUSINESS ECONOMICS

Business economics is deemed to apply economic theory and principles to business

decision-making. It is concerned with the use of economic analysis for the
formulation and solution of business problems.

Managerial economics is a relatively new discipline, emerging from the work of

economists in the early 20th century who recognised that businesses faced unique
decision-making problems that could not be addressed using traditional economic
theories. Over time, managerial economics has developed into a distinct field of
study with its knowledge and analysis methods.

While there is no single definition of managerial economics, it can be broadly

described as applying microeconomic analysis to business decision-making.
Managerial economists use economic theory and principles to analyse business
situations and make decisions about pricing, production, investment, and other
strategic issues.

L. Pappas and E. F. Brigham wrote a managerial economics book entitled

“Managerial Economics: An Introduction”. They define managerial economics as
“the application of economic analysis to decision-making within an organisation”,
emphasising that it should aid managers’ decisions to increase organisational
efficiency and profitability.
Managerial economics, in simpler terms, is the application of economic principles
and methods to business decision-making. It is concerned with how managers use
economic concepts and tools to make sound business decisions.

Managerial economics bridges the gap between the theory of economics and
managerial practice. It draws upon microeconomic theory to recommend how to
operate a business most efficiently. It also applies microeconomic analysis to
specific managerial decisions, such as pricing, product mix, capital budgeting, etc.

According to Mc Nair and Meriam, “Business economic consists of the use of

economic modes of thought to analyse business situations.”
Siegel man has defined managerial economic (or business economic) as “the
integration of economic theory with business practice for the purpose of facilitating
decision-making and forward planning by management.”

NATURE OF MANAGERIAL ECONOMICS

 Managerial economics is, perhaps, the youngest of all the social sciences. Since it
originates from Economics, it has the basis features of economics, such as
assuming that other things remaining the same. The other features of managerial
economics are explained as below:
(a) Close to microeconomics: Managerial economics is concerned with finding the
solutions for different managerial problems of a particular firm. Thus, it is more
close to microeconomics.
(b) Operates against the backdrop of macroeconomics: The macroeconomics
conditions of the economy are also seen as limiting factors for the firm to operate.
In other words, the managerial economist has to be aware of the limits set by the
macroeconomics conditions such as government industrial policy, inflation and so
on.
(c) Normative statements: A normative statement usually includes or implies the
words ‘ought’ or ‘should’. They reflect people’s moral attitudes and are
expressions of what a team of people ought to do. For instance, it deals with
statements such as ‘Government of India should open up the economy. Such
statement are based on value judgments and express views of what is ‘good’ or
‘bad’, ‘right’ or ‘ wrong’. One problem with normative statements is that they
cannot to verify by looking at the facts, because they mostly deal with the future.
Disagreements about such statements are usually settled by voting on them.
(d) Prescriptive actions: Prescriptive action is goal oriented. Given a problem and
the objectives of the firm, it suggests the course of action from the available
alternatives for optimal solution. If does not merely mention the concept, it also
explains whether the concept can be applied in a given context on not. For
instance, the fact that variable costs are marginal costs can be used to judge the
feasibility of an export order.
(e) Applied in nature: ‘Models’ are built to reflect the real life complex business
situations and these models are of immense help to managers for decision-making.
The different areas where models are extensively used include inventory control,
optimization, project management etc. In managerial economics, we also employ
case study methods to conceptualize the problem, identify that alternative and
determine the best course of action.
(f) Offers scope to evaluate each alternative: Managerial economics provides an
opportunity to evaluate each alternative in terms of its costs and revenue. The
managerial economist can decide which is the better alternative to maximize the
profits for the firm.
(g) Interdisciplinary: The contents, tools and techniques of managerial economics
are drawn from different subjects such as economics, management, mathematics,
statistics, accountancy, psychology, organizational behavior, sociology and etc.
(h) Assumptions and limitations: Every concept and theory of managerial
economics is based on certain assumption and as such their validity is not
universal. Where there is change in assumptions, the theory may not hold good at
all.
Scope of Managerial Economics:
The scope of managerial economics refers to its area of study. Managerial
economics refers to its area of study. Managerial economics, Provides management
with a strategic planning tool that can be used to get a clear perspective of the way
the business world works and what can be done to maintain profitability in an ever-
changing environment.
Managerial economics is primarily concerned with the application of economic
principles and theories to five types of resource decisions made by all types of
business organizations.
a. The selection of product or service to be produced.
b. The choice of production methods and resource combinations.
c. The determination of the best price and quantity combination
d. Promotional strategy and activities.
e. The selection of the location from which to produce and sell goods or service to
consumer.
The production department, marketing and sales department and the finance
department usually handle these five types of decisions.
The scope of managerial economics covers two areas of decision making
a. Operational or Internal issues
b. Environmental or External issues
 a. Operational issues: Operational issues refer to those, which wise within the
business organization and they are under the control of the management. Those
are:
Demand Analysis and Forecasting: Unless and until knowing the demand for a
product how can we think of producing that product. Therefore demand analysis is
something which is necessary for the production function to happen. Demand
analysis helps in analyzing the various types of demand which enables the manager
to arrive at reasonable estimates of demand for product of his company. Managers
not only assess the current demand but he has to take into account the future
demand also.
• Production Function: Conversion of inputs into outputs is known as production
function. With limited resources we have to make the alternative use of this limited
resource. Factor of production called as inputs is combined in a particular way to
get the maximum output. When the price of input rises the firm is forced to work
out a combination of inputs to ensure the least cost combination.
• Cost analysis: Cost analysis is helpful in understanding the cost of a particular
product. It takes into account all the costs incurred while producing a particular
product. Under cost analysis we will take into account determinants of costs,
method of estimating costs, the relationship between cost and output, the forecast
of the cost, profit, these terms are very vital to any firm or business.
• Inventory Management: What do you mean by the term inventory? Well the
actual meaning of the term inventory is stock. It refers to stock of raw materials
which a firm keeps. Now here the question arises how much of the inventory is
ideal stock. Both the high inventory and low inventory is not good for the firm.
Managerial economics will use such methods as ABC Analysis, simple simulation
exercises, and some mathematical models, to minimize inventory cost. It also helps
in inventory controlling.
• Advertising: Advertising is a promotional activity. In advertising while the copy,
illustrations, etc., are the responsibility of those who get it ready for the press, the
problem of cost, the methods of determining the total advertisement costs and
budget, the measuring of the economic effects of advertising are the problems of
the manager. There’s a vast difference between producing a product and marketing
it. It is through advertising only that the message about the product should reach
the consumer before he thinks to buy it. Advertising forms the integral part of
decision making and forward planning.
• Pricing system: Here pricing refers to the pricing of a product. As you all know
that pricing system as a concept was developed by economics and it is widely used
in managerial economics. Pricing is also one of the central functions of an
enterprise. While pricing commodity the cost of production has to be taken into
account, but a complete knowledge of the price system is quite essential to
determine the price. It is also important to understand how product has to be priced
under different kinds of competition, for different markets. Pricing equals cost plus
pricing and the policies of the enterprise. Now it is clear that the price system
touches the several aspects of managerial economics and helps managers to take
valid and profitable decisions.
• Resource allocation: Resources are allocated according to the needs only to
achieve the level of optimization. As we all know that we have scarce resources,
and unlimited needs. We have to make the alternate use of the available resources.
15 For the allocation of the resources various advanced tools such as linear
programming are used to arrive at the best course of action.
(b) An environmental issue in managerial economics refers to the general
business environment in which the firm operates. They refer to general economic,
social and political atmosphere within which the firm operates. A study of
economic environment should include:
a. The type of economic system in the country.
b. The general trends in production, employment, income, prices, saving and
investment.
c. Trends in the working of financial institutions like banks, financial corporations,
insurance companies
d. Magnitude and trends in foreign trade;
e. Trends in labour and capital markets;
f. Government’s economic policies viz. industrial policy monetary policy, fiscal
policy, price policy etc.
The social environment refers to social structure as well as social organization like
trade unions, consumer’s co-operative etc. The Political environment refers to the
nature of state activity, chiefly states’ attitude towards private business, political
stability etc. The environmental issues highlight the social objective of a firm i.e.;
the firm owes a responsibility to the society. Private gains of the firm alone cannot
be the goal. The environmental or external issues relate managerial economics to
macro economic theory while operational issues relate the scope to micro
economic theory. The scope of managerial economics is ever widening with the
dynamic role of big firms in a society.
MANAGERIAL ECONOMICS RELATIONSHIP WITH OTHER
SUBJECTS
Many new subjects have evolved in recent years due to the interaction among basic
disciplines. While there are many such new subjects in natural and social sciences,
managerial economics can be taken as the best example of such a phenomenon
among social sciences. Hence it is necessary to trace its roots and relation ship with
other disciplines.
Economic and Managerial Economics: Economics contributes a great deal
towards the performance of managerial duties and responsibilities. Just as the
biology contributes to the medical profession and physics to engineering,
economics contributes to the managerial profession. All other qualifications being
same, managers with working knowledge of economics can perform their function
more efficiently than those without it. What is the Basic Function of the Managers
of the Business? As you all know that the basic function of the manager of the firm
is to achieve the organizational objectives to the maximum possible extent with the
limited resources placed at their disposal. Economics contributes a lot to the
managerial economics.
Mathematics and Managerial Economics: Mathematics in Managerial Economics
has an important role to play. Businessmen deal primarily with concepts that are
essentially quantitative in nature e.g. demand, price, cost, wages etc. The use of
mathematical logic in the analysis of economic variable provides not only clarity
of concepts but also a logical and systematical framework.
Mathematics is closely related to Managerial Economics, certain mathematical
tools such as logarithm and exponential, vectors, determinants and matrix algebra
and calculus etc.
Statistics and Managerial Economics: Statistical tools are a great aid in business
decision making. Statistical techniques are used in collecting processing and
analyzing business data, testing and validity of economics laws with the real
economic phenomenon before they are applied to business analysis. The statistical
tools for e.g. theory of probability, forecasting techniques, and regression analysis
help the decision makers in predicting the future course of economic events and
probable outcome of their business decision. Statistics is important to managerial
economics in several ways. Managerial Economics calls for marshalling of
quantitative data and reaching useful measures of appropriate relationship involves
in decision making. Let me explain it through an example: In order to base its price
decision on demand and cost consideration, a firm should have statistically derived
or calculated demand and cost function.
Operation Research and Managerial Economics: It’s an inter-disciplinary
solution finding techniques. It combines economics, mathematics, and statistics to
build models for solving specific business problems. Linear programming and goal
programming are two widely used Operational Research in business decision
making. It has influenced Managerial Economics through its new concepts and
model for dealing with risks. Though economic theory has always recognized these
factors to decision making in the real world, the frame work for taking them into
account in the context of actual problem has been operationalized. The significant
relationship between Managerial Economics and Operational Research can be
highlighted with reference to certain important problems of Managerial Economics
which are solved with the help of Operational Research techniques, like allocation
problem, competitive problem, waiting line problem, and inventory problem.
Management Theory and Managerial Economics: As the definition of
management says that it’s an art of getting things done through others. Bet now a
day we can define management as doing right things, at the right time, with the
help of right people so that organizational goals can be achieved. Management
theory helps a lot in making decisions. ME has also been influenced by the
developments in the management theory. The central concept in the theory of firm
in micro economic is the maximization of profits. ME should take note of changes
concepts of managerial principles, concepts, and changing view of enterprises
goals.
Accounting and Managerial Economics: There exits a very close link between
Managerial Economics and the concepts and practices of accounting. Accounting
data and statement constitute the language of business. Gone are the days when
accounting was treated as just bookkeeping. Now it’s far more behind
bookkeeping. Cost and revenue information and their classification are influenced
considerably by the accounting profession. The focus of accounting within the
enterprise is fast changing from the concept of bookkeeping to that of managerial
decision making.
Computers and Managerial Economics: You all know that today’s age is known
as computer age. Every one of us is totally dependent on computers. These
computers have affected each one of us in every field. Managers also have to
depend on computers for decision making. Computer helps a lot in decision
making. Through computers data which are presented in such a nice manner that
it’s really very easy to take decisions. There are so many sites which help us in
giving knowledge of various things, and in a way helps us in updating our
knowledge.
Psychology and Managerial Economics: Consumer psychology is the basis on
which managerial economist acts upon. How the customers react to a given change
in price or supply and its consequential effect on demand / profits is the main focus
of study in managerial economics. We assume that the behavior of the consumer is
always rational which in reality is not so. Psychology contributes towards
understanding the behavioral implications, attitude and motivations of each of the
micro economics variables such as consumer, supplier investor worker or an
employee.
Conclusions: Managerial Economics is closely related to various subjects i.e.
Economics, mathematics, statistics, and accountings. Computers etc. a trained
managerial economist integrates concepts and methods from all these subjects
bringing them to bear on business problem of a firm. In particular all these subjects
are getting closed to Managerial Economics and there appears to be trends towards
their integration.

BASIC ECONOMIC TOOLS IN ME:

Managerial Economics is both conceptual and metrical. Before the substantive
decision problems which fall within the purview of managerial economics are
discussed, it is useful to identify and understand some of the basic concepts
underlying the subject. Economic theory provides a number of concepts and
analytical tools which can be of considerable and immense help to a manager in
taking many decisions and business planning. This is not to say that economics has
all the solutions. In fact, actual problem solving in business has found that there
exists a wide disparity between economic theory of the firm and actual observed
practice. Therefore, it would be useful to examine the basic tools of managerial
economics and the nature and extent of gap between the economic theory of the
firm and the managerial theory of the firm.
The contribution of economics to managerial economics lies in certain principles
which are basic to managerial economics. There are six basic principles of
managerial economics. They are:
1. Incremental principle
2. Time perspective principle.
3. Opportunity cost principle.
4. Equi-marginalism principle.
5. Discounting principle
6. Marginalism principle
7. Concept of scarcity
8. Production possibility curve
9.
1. Incremental principle: The incremental concept is probably the most
important concept in economics and is certainly the most frequently used in
Managerial Economics. Incremental concept is closely related to the
marginal cost and marginal revenues of economic theory. The two major
concepts in this analysis are incremental cost and incremental revenue.
Incremental cost denotes change in total cost, whereas incremental revenue
means change in total revenue resulting from a decision of the firm.
The incremental principle may be stated as follows:
A decision is clearly a profitable one if
(i) It increases revenue more than costs.
(ii) It decreases some cost to a greater extent than it increases others.
(iii) It increases some revenues more than it decreases others.
(iv) It reduces costs more than revenues.
2. Concept of Time Perspective: The time perspective concept states that the
decision maker must give due consideration both to the short run and long
run effects of his decisions. He must give due emphasis to the various time
periods. It was Marshall who introduced time element in economic theory.

The economic concepts of the long run and the short run have become part
of everyday language. Managerial economists are also concerned with the
short run and long run effects of decisions on revenues as well as costs. The
main problem in decision making is to establish the right balance between
long run and short run. In the short period, the firm can change its output
without changing its size. In the long period, the firm can change its output
 by changing its size. In the short period, the output of the industry is fixed
because the firms cannot change their size of operation and they can vary
only variable factors. In the long period, the output of the industry is likely
to be more because the firms have enough time to increase their sizes and
also use both variable and fixed factors.
3. The Opportunity Cost Concept: Opportunity cost principle is related and
applied to scarce resource. When there are alternative uses of scarce
resource, one should know which best alternative is and which is not. We
should know what gain by best alternative is and what loss by left
alternative is.

The concept of opportunity cost plays an important role in managerial

decisions. This concept helps in selecting the best possible alternative from
among various alternatives available to solve a particular problem. This
concept helps in the best allocation of available resources. The opportunity
cost of any action is simply the next best alternative to that action - or put
more simply, "What you would have done if you didn't make the choice that
you did". The income or benefit foregone as the result of carrying out a
particular decision, when resources are limited or when mutually exclusive
projects are involved. Opportunity cost is not what you choose when you
make a choice —it is what you did not choose in making a choice.
Opportunity cost is the value of the forgone alternative — what you gave up
when you got something.
Example 1: If a person is having cash in hand Rs. 100000/-, he may think of
two alternatives to increase cash.
Option 1: Investing in bank. We will get returns amount 10000/-
Option2: Investing in business. We get returns amount 17000/- Generally we
chose the option 2 because we will get more returns than the option 1. Here
the option 1 is the opportunity cost, that what we have not chosen. The
opportunity cost of a decision is based on what must be given up (the next
best alternative) as a result of the decision. Any decision that involves a
choice between two or more options has an opportunity cost.

In managerial decision making, the concept of opportunity cost occupies an

important place. The economic significance of opportunity cost is as
follows: 1. It helps in determining relative prices of different goods.
2. It helps in determining normal remuneration to a factor of production.
 3. It helps in proper allocation of factor resources.

4. Equi-Marginal Concept: One of the widest known principles of economics

is the equi-marginal principle. The principle states that an input should be
allocated so that value added by the last unit is the same in all cases. This
generalisation is popularly called the equi-marginal.

Let us assume a case in which the firm has 100 unit of labour at its disposal.
And the firm is involved in five activities viz., А, В, C, D and E. The firm
can increase any one of these activities by employing more labour but only
at the cost i.e., sacrifice of other activities. An optimum allocation cannot be
achieved if the value of the marginal product is greater in one activity than
in another. It would be, therefore, profitable to shift labour from low
marginal value activity to high marginal value activity, thus increasing the
total value of all products taken together.
If, for example, the value of the marginal product of labour in activity A is
Rs. 50 while that in activity В is Rs. 70 then it is possible and profitable to
shift labour from activity A to activity B. The optimum is reached when the
values of the marginal product is equal to all activities.
This can be expressed symbolically as follows:
VMPLA = VMPLB = VMPLC = VMPLD = VMPLE
Where VMP = Value of Marginal Product. L = Labour ABCDE = Activities
i.e., the value of the marginal product of labour employed in A is equal to
the value of the marginal product of the labour employed in В and so on.
The equimarginal principle is an extremely practical notion. It is behind any
rational budgetary procedure.
The principle is also applied in investment decisions and allocation of
research expenditures. For a consumer, this concept implies that money may
be allocated over various commodities such that marginal utility derived
from the use of each commodity is the same. Similarly, for a producer this
concept implies that resources be allocated in such a manner that the
marginal product of the inputs is the same in all uses.

5. Discounting Concept: This concept is an extension of the concept of time

perspective. Since future is unknown and incalculable, there is lot of risk
and uncertainty in future. Everyone knows that a rupee today is worth more
than a rupee will be two years from now. This appears similar to the saying
that “a bird in hand is more worth than two in the bush.” This judgment is
made not on account of the uncertainty surrounding the future or the risk of
inflation. It is simply that in the intervening period a sum of money can earn
a return which is ruled out if the same sum is available only at the end of the
period. In technical parlance, it is said that the present value of one rupee
available at the end of two years is the present value of one rupee available
today. The mathematical technique for adjusting for the time value of money
and computing present value is called ‘discounting’. This principle talks
about comparison of the money value between present and future time.
Eg: suppose 1) 100/- is gifted to a particular person today.
2) 100/- will be given as gift to same particular person after one year.
Normally a person chooses first offer only. Why because “today rupee is
having more worth than tomorrows rupee” Example In the business,
everybody prefers to do cash sale only rather than the credit sale and even
they are ready to give cash discount for cash sale. The reason is we will get
a rupee today and today’s rupee is more valuable than the tomorrow’s rupee.
But In credit sale we will get rupee tomorrow or in the future time and
nobody give the discount for credit sale.

6.MARGINALISAM PRINCIPLE : Marginalism generally includes the

study of marginal theories and relationships within economics. The key
focus of marginalism is how much extra use is gained from incremental
increases in the quantity of goods created, sold, etc. and how these measures
relate to consumer choice and demand. Marginalism covers such topics as
marginal utility, marginal gain, marginal rates of substitution, and
opportunity costs, within the context of consumers making rational choices
in a market with known prices. These areas can all be thought of as popular
schools of thought surrounding financial and economic incentives. Marginal
cost is the cost which incurred to produce the next or one more unit.
Marginal Revenue is the benefit which gets by producing one more or next
unit. Cost will be less and benefit will be more.

7. CONCEPT OF SCARCITY Human wants are unlimited, but human

capacity to satisfy such wants is limited. Scarcity refers to the basic
economic problem, the gap between limited – that is, scarce – resources and
theoretically limitless wants. This situation requires people to make
decisions about how to allocate resources efficiently, in order to satisfy basic
needs and as many additional wants at possible. Any resource that has a
non-zero cost to consume is scarce to some degree, but what matters in
practice is relative scarcity. Scarcity is also referred to as "paucity."
8. PRODUCTION POSSIBILITY CURVE The production possibility
frontier (PPF) is a curve depicting all maximum output possibilities for two
goods, given a set of inputs consisting of resources and other factors. The
PPF assumes that all inputs are used efficiently. Factors such as labor,
capital and technology, among others, will affect the resources available,
which will dictate where the production possibility frontier lies. The PPF is
also known as the production possibility curve or the transformation curve.