Nature of Managerial Economics
Managerial Economics and Business economics are the two terms, which, at times have been
used interchangeably. Of late, however, the term Managerial Economics has become more
popular and seems to displace progressively the term Business Economics.
Managerial economics
The prime function of a management executive in a business organization is decision making and
forward planning. Decision Making means the process of selecting one action from two or more
alternative courses of action whereas forward planning means establishing plans for the future.
The question of choice arises because resources such as capital, land, labour and management are
limited and can be employed in alternative uses. The decision making function thus becomes one
of making choices or decisions that will provide the most efficient means of attaining a desired
end, say, profit maximization. Once decision is made about the particular goal to be achieved,
plans as to production, pricing, capital, raw materials, labour, etc., are prepared. Forward
planning thus goes hand in hand with decision making.
A significant characteristic of the conditions, in which business organizations work and take
decisions, is uncertainty. And this fact of uncertainty not only makes the function of decision
making and forward planning complicated but adds a different dimension to it. If knowledge of
the future were perfect, plans could be formulated without error and hence without any need for
subsequent revision. In the real world, however, the business manager rarely has complete
information and the estimates about future predicted as best as possible. As plans are
implemented over time, more facts become known so that in their light, plans may have to be
revised, and a different course of action adopted. Managers are thus engaged in a continuous
process of decision making through an uncertain future and the overall problem confronting
them is one of adjusting to uncertainty.
In fulfilling the function of decision making in an uncertainty framework, economic theory can
be pressed into service with considerable advantage. Economic theory deals with a number of
concepts and principles relating, for example, to profit, demand, cost, pricing production,
competition, business cycles, national income, etc., which aided by allied disciplines like
Accounting. Statistics and Mathematics can be used to solve or at least throw some light upon
the problems of business management. The way economic analysis can be used towards solving
business problems. Constitutes the subject matter of Managerial Economics.
Definition of Manjagerial Economics
According to McNair and Meriam, “Managerial Economics consists of the use of economic
modes of thought to analyze business situation.”
Spencer and Siegelman have defined Managerial Economics as “The integration of economic
theory with business practice for the purpose of facilitating decision making and forward
planning by management.”
We may, therefore define Managerial Economics as the discipline which deals with the
application of economic theory to business management. Managerial Economics thus lies on the
borderline between economics and business management and serves as a bridge between
economics and business management.
Application of Economics to Business Management
The application of economics to business management or the integration of economic theory
with business practice, as Spencer and Siegelman have put it, has the following aspects :–
• Reconciling traditional theoretical concepts of economics in relation to the actual
business behavior and conditions. In economic theory, the technique of analysis is one
of model building whereby certain assumptions are made and on that basis, conclusions
as to the behavior of the firms are made. The assumptions, however, make the theory of
the firm unrealistic since it fails to provide a satisfactory explanation of that what the
firms actually do. Hence the need to reconcile the theoretical principles based on
simplified assumptions with actual business practice and develops appropriate
extensions and reformulation of economic theory, if necessary.
• Estimating economic relationships such as measurement of various types of elasticities
of demand such as price elasticity, income elasticity, cross-elasticity, promotional
elasticity, cost-output relationships, etc. The estimates of these economic relationships
are to be used for purposes of forecasting.
• Predicting relevant economic quantities, eg., profit, demand, production, costs, pricing,
capital, etc., in numerical terms together with their probabilities. As the business
manager has to work in an environment of uncertainty, future is to be predicted so that
in the light of the predicted estimates, decision making and forward planning may be
possible.
• Using economic quantities in decision making and forward planning, that is,
formulating business policies and, on that basis, establishing business plans for the
future pertaining to profit, prices, costs, capital, etc. The nature of economic forecasting
is such that it indicates the degree of probability of various possible outcomes, i.e.
losses or gains as a result of following each one of the strategies available. Hence,
before a business manager there exists a quantified picture indicating the number of
courses open, their possible outcomes and the quantified probability of each outcome.
Keeping this picture in view, he decides about the strategy to be chosen.
• Understanding significant external forces constituting the environment in which the
business is operating and to which it must adjust, e.g., business cycles, fluctuations in
national income and government policies pertaining to public finance, fiscal policy and
taxation, international economics and foreign trade, monetary economics, labour
relations, anti-monopoly measures, industrial licensing, price controls, etc. The
business manager has to appraise the relevance and impact of these external forces in
relation to the particular business unit and its business policies.
Characteristics of Managerial Economics
• Managerial Economics is micro-economic in character.
Managerial Economics largely uses that body of economic concepts and principles, which is
known as ‘Theory of the firm’ or ‘Economics of the firm’. In addition, it also seeks to apply Profit
Theory, which forms part of Distribution Theories in Economics.
• Managerial Economics is pragmatic. It avoids difficult abstract issues of economic theory
but involves complications ignored in economic theory to face the overall situation in
which decisions are made. Economic theory appropriately ignores the variety of
backgrounds and training found in individual firms but Managerial Economics considers
the particular environment of decision making.
• Managerial Economics belongs to normative economics rather than positive economics
(also sometimes known as Descriptive Economics). In other words, it is prescriptive
rather than descriptive. The main body of economic theory confines itself to descriptive
hypothesis, attempting to generalize about the relations among different variables without
judgment about what is desirable or undesirable. For instance, the law of demand states
that as price increases. demand goes down or vice-versa but this statement does not tell
whether the outcome is good or bad. Managerial Economics, however, is concerned with
what decisions ought to be made and hence involves value judgments.
Production and Supply
Production analysis is narrower in scope than cost analysis. Production analysis frequently
proceeds in physical terms while cost analysis proceeds in monetary terms. Production analysis
mainly deals with different production functions and their managerial uses.
Supply analysis deals with various aspects of supply of a commodity. Certain important aspects
of supply analysis are supply schedule, curves and function, law of supply and its limitations.
Elasticity of supply and Factors influencing supply.
Pricing Decisions, Policies and Practices
Pricing is a very important area of Managerial Economics. In fact, price is the ness of the
revenue of a firm and as such the success of a business firm largely depends on the correctness of
the prices decisions taken by it. The important aspects dealt with under this area are :– Price
