MANAGERIAL ECONOMICS

THE NATURE AND

SIGNIFICANCE OF
MANAGERIAL ECONOMICS
Economics
Economics is a social science. Its basic function is to
study how people – individuals, households, firms
and nations, maximize their gains from their limited
resources which have alternative uses, to produce
goods and services for present and future
consumption.
Social science
Limited resources
Alternative uses
Economics
It concerned with the allocation of scare means in
such a manner that consumer can maximize their
satisfaction, producers can maximize their profit
and society can maximize its social welfare.
Economic system is the way in which a society
decides the three fundamental questions:
What to produce?
How to produce?
For whom to produce?
Economics as a study of wealth
Adam smith defined economics, as the study of the
nature and causes of the generation of wealth of a
nation.

He argued that the larger amount of wealth and the

betterment of the whole society could be achieved by
an efficient allocation of resources through the
market mechanism.
Economics as a study of welfare
According to Alfred Marshall- Economics is a
study of man’s actions in the ordinary course of
life. It enquires how he gets his income and how
he spends it.
Economics as a study of allocation of scarce
resources
According to Robbins- Economics is the science
which studies human behavior as a relationship
b/w ends and scarce means which have
alternative uses.
Growth-Paul A. Samuelson: how man and society
choose, with or without use of money, to employ
scare resource which have alternative uses to
produce and distribute them for consumption for
present and future.
Macro economics is the study of economy as a whole.
That examines the economic behavior of aggregates-income
, general price level and the national output.
Micro Economics studies the economics behavior of
individual decision making units of an economy.
Cont..
 Firm
A unit of management operating under a trade name in conducting a
business activity.
 Industry
A set or collection of all the business firms producing a similar product.
E.g., automobile, electronics, food stuffs and so on.
Economic Growth
It refers to generation of more output from the application of given
resources under a state of technology.
 Economic development
It implies enhancement of capacity to pro-duce more thro-ugh resource and
technology development.
 Equilibrium
A condition of perfect balance in the opposing forces.
 What is Managerial Economics?
 Managerial economics is essentially applied economics in the field of
business management. It is the economics of business or managerial
decisions. It pertains to all economic aspects of managerial decision
making.
 Managerial economics may be defined as the integration of economic
theory with business practice for the purpose of facilitating decision
making and forward planning by management.
 It will be useful to understand the meaning of two wards-decision
making and forward planning
 Decision making-selecting one out of a set of two or more
alternatives.
 Forward planning- planning for the future.
 Management has to make decision and forward plan on the basis of
past statistical data, present information and future anticipation. It
helps management in making right decision and planning for future
in a atmosphere of uncertainty.
 Application of micro economics concept
 Normative approach
 Goal oriented
 Conceptual and metrical
 Pragmatic Economics
 Prescriptive rather than descriptive
 Aims at helping the management
Micro V/S Macro Economics
Managerial Economics Relevance in Business Decisions:
“As link between traditional Economics and the decision
making science”

• Business Planning
• Cost control
• Price determination
• Business Prediction
• Profit planning & Control
• Inventory management
• Manages capital
Functions: Role and Responsibilities of a Managerial
Economist
A managerial economist in a business firm may carry on a wide range of
duties, such as:
• Demand estimation and forecasting.
• Preparation of business/sales forecasts.
• Analysis of the market survey to determine the nature and extent of
competition.
• Analysing the issues and problems of the concerned industry.
• Assisting the business planning process of the firm.
• Discovering new and possible fields of business endeavour and its
cost-benefit analysis as well as feasibility studies.
• Advising on pricing, investment and capital budgeting policies.
• Evaluation of capital budgets.
• Building micro and macro economic models
• Directing economic research activity.
• Briefing the management on current domestic and global
economic issues and emerging challenges.
• Interpretation, analysis and reporting of current economic
matters, upcoming developments in business, government and
foreign or global sectors.
 Scope of Managerial Economics
Following are the core topics of managerial economics:
 Demand Function and Estimation, Demand Elasticity,
Demand Forecasting
 Production Function and Laws
 Cost Analysis
 Pricing and Output Determination in different market
structures such as perfect competition, monopoly, oligopoly
and monopolistic competition
 Pricing Policies and Practices in Real Business/risk &
uncertainty
 Profit Planning and Management
 Capital Budgeting and Management
 Government and Business
 Fundamental concepts associated with bus.
economics
 Applying the economic principles for solving his practical problems, the business
economist has to use additional skills and tools to make up the gap b/w economics theory
and bus practice.

1. Opportunity cost principle and decision rule: It is related to the alternative uses of
scarce resources(every choice has an opportunity cost). The scarcity and the alternative uses
of the resources give rise to the concept of opportunity cost. It is the forgone benefits that
would have been derived by an option not chosen.
 The opportunity cost of anything is the next best alternative that could be produced instead
by the same factors and same cost.
 It can be applied to all other kinds of resources involved in business decisions, especially
where there are at least two alternative options involving costs and benefits.

 Decision rule: Actual earning > opportunity cost.

Cont…
2. Incremental principle and decision rule : It is applied to business decisions which
involve bulk production and a large increase in total cost and total revenue. Such an
increase in total cost and total revenue is called incremental cost and incremental
revenue related to output.
It involves estimating the impact of taking production decision alternatives on cost
and revenue. A decision is accepted when(IR.> IC)

3. Principle of time perspective: The decision maker must give due consideration to
time element in his decision making. “ a decision by the firm should take into
account of both short-run and long-run effects on revenues and cost & maintain the
right balance between the long and short run.
It refers to the duration of time period extending from the relevant past and
foreseeable future taken in view while taking a business decision. Relevant past
refers to the period of past experience and trends which are relevant for business
decisions with short & long run implications.
 Cont…
4. Discounting principle: This principle talks about comparison of the money value b/w
present and future time. Implies affects on cost & revenue at future dates, it is necessary
to discount those cost & revenue to PV before a valid comparison of alternative is
possible. This principle said that “sooner the better” & today rupee is having more
worth than tomorrows rupee. (PV=FV/(1+i)t or FV=PV(1+i)t

5. Equi-marginal principle: States that a utility maximizing consumer distributes his

consumption expenditure b/w various goods and services ( allocation of resource) in
such a way so that result will be equal in term of utility. According to it a utility
maximizing a consumer should spend his limited income on different commodities in
such a way that the lat rupee spent on each commodity yield him equal MU in order to
get maximum satisfaction.
In business allocation Of resources b/w their alternative uses with a view to maximizing
profit in case a firm carries out more than one business activity.
This principle suggest that available resources should be allocated b/w the alternative
options that the marginal productivity gains from various activities are equalized.
Cont….
6. Contribution Analysis: The contribution of a business decision refers to the
difference b/w the incremental revenue and incremental cost associated with that
particular decision(IR-IC)
It is a useful technique for taking various decisions- acceptance/ rejection,
introduce new plant, make/ buy a product.

7. Marginal Principle: Marginal refers to the change in total qty or value due to a
one unit change in its determinant and implies judging the impact of a unit
change in one variable to other. It can be use in cost analysis, pricing analysis and
consumption analysis.
It has significance where maximization or minimization problem is involved-
maximization of a consumer utility, maximization of a firm’s profit and
minimization of cost etc.
Business decision must be carried out so long as its(MR> MC)
Cont…
8. Risk and uncertainty:
 Managerial decisions are actions of today which bear fruits in future which is
unforeseen.
 Future is uncertain and involves risk.
 The uncertainty due to unpredictable changes in the business cycle, structure of the
economy and government policies.
 The managerial economists have tried to take account of uncertainty with the help of
subjective probability.
 The probabilistic treatment of uncertainty requires formulation of definite subjective
expectations about the cost, revenue and the environment.
9. Principle of scarcity: scarcity refers to the basic economic problem, the gap b/w limited
resources and unlimited wants.
 According to the scarcity principle, the price for a scarce good should rise until an
equilibrium is reached b/w supply and demand. This is used by the marketer, by
creating the scarcity of goods in the market, then consumer become ready to pay
more amount, until and unless he get the product.
Production Possibility Curve
Increasing Opportunity Cost
Constant Opportunity Cost
Decreasing Opportunity Cost
Assumption
 Only two goods X (consumer goods) and Y (capital goods) are produced in different
proportions in the economy.
 The same resources can be used to produce either or both of the two goods and can be

shifted freely between them .

 The supplies of factors are fixed. But they can be re-allocated for the production of the
two goods within limits.
 The production techniques are given and constant.
 The economy’s resources are fully employed and technically efficient.
 The time period is short.
Objective of a firm
 Profit maximization
 Maximization of sales revenue.
 Maximization of firm growth rate
 Maximization of manager’s utility function.
 Entry prevention and risk avoidance
 Long run survival of the firm
 Satisfaction to customer / employees/goodwill
 Projecting a favorable public image.
 To Decision Making
A sound/scientific analysis of business situation and
problem is the key to right/appropriate decision-making.
Knowledge and application of economic principles, theories,
dogmas and modelling is of great help in the decision-
making process, as such, managerial economics is essentially
an applied science with which a manager/businessman
should be familiar in his own interest of right-course of
decision-making.