Managerial Economics Lecture Notes

Topic 1 - Introduction to Managerial Economics: Definition, Nature and

Scope, Relationship with other areas in Economics, Production Management,
Marketing, Finance and Personnel, Operations research, Role of managerial
economist

Managerial Economics (also called Business Economics) is a subject first introduced by

Joel Dean in 1951, is essentially concerned with the economic decisions of business managers. It
is a branch of Economics that applies microeconomic analysis to specific business decisions (i.e.
Economics applied in business decision-making). Managerial Economics may be viewed as
Economics applied to problem solving at the level of the firm.
The application of managerial economics is these examples. Tools of managerial
economics can be used to achieve all the goals of a business organization in an efficient manner.
Typical managerial decision making may involve one of the following issues:

1. Deciding the price of a product and the quantity of the commodity to be produced.
2. Deciding whether to manufacture a product or to buy from another manufacturer.
3. Choosing the production technique to be employed in the production of a given product.
4. Deciding on the level of inventory a firm will maintain of a product or raw material.
5. Deciding on the advertising media and the intensity of the advertising campaign
6. Making employment and training decisions.
7. Making decisions regarding further business investment.

What is economics, management, managerial economics, manager and managerial economist?

Economics is the study of human being in producing, distributing and consuming
material goods and services in a world of scarce resources.
Economics is the science of making decisions in the presence of scarce resources.
Resources are simply anything used to produce a good or service or more generally to
achieve a goal. Scarcity implies that by making one choice you give up another.
Management is the science of organizing and allocating of firms scarce resources to
achieve its desired objectives.
Managerial economics use analysis to make business decisions involving the best use or
allocation of an organization’s scarce resources.
Managerial economics is a study of how to direct scarce resources in the way that most
efficiently achieves a managerial goal.
Managerial economics helps managers recognize how economic forces affect
 organizations and describe economic consequences of managerial behavior. It also links
economic concepts and quantitative methods to develop vital tools for management
decision making.
Managerial economics deals with the application of the economic concepts, theories,
tools, and methodologies to solve practical problems in a business.
Manager is a person who directs resources to achieve a stated goal. This definition
includes individuals who a) direct the efforts of others, including those who delegate
tasks within an organization such as a firm b) purchase inputs to be used in the
production of goods and services such as the output of a firm c) in charge of making
other decisions, such as product price quality.
Qualities of an effective manager
a. identify goals and constraints
b. recognize the nature and importance of profits
c. understand incentives
d. understand markets
e. recognize the time value of money
f. use marginal analysis

Role of managerial economist

  Managerial economist's main role is to improve the quality of policy making as it
affects short term operation and long range planning. He has a significant role to play in
assisting the management of a firm in decision making and forward planning by
using specialized skills and techniques.

What is the scope of Managerial Economics?                                    

A. Demand analysis and forecasting

When a business manager decides to venture into a business, the very first thing
he needs to find out is the nature and amount of demand for the product, both at present
and in the future. A firm's performance and profitability depends upon accurate estimates
of demand. The firm will prepare its production schedule on the basis of demand forecast.
Demand analysis helps to identify the factors influencing the demand for a firm's product
and thus helps a manager in business planning. Demand analysis and forecasting thus
help him in the choice of the product and in planning output levels. The main topics
covered under demand analysis and forecasting are the concepts of demand, demand
determinants, law of demand, its assumptions, elasticity of demand (price, income and
cross elasticity), demand forecasting, etc.
 B. Cost and production analysis

 Estimation of the cost in production.

 Recognizing the factors, which are causing cost to firm.
 Suggests cost should be reduced for making good profits.
 Production analysis deals with,   Minimum cost should be spend on raw
materials and maximum production should be obtained

C. Pricing decisions, policies and practices

Once a particular quantity of output is ready for sale, the firm has to fix its price
given the conditions in the market. Pricing is a very important aspect of Managerial
Economics as a firm's revenue earnings largely depend on its pricing policy. A correct
pricing policy makes a firm successful, while incorrect pricing may lead to its
elimination. The topics covered under this area are: price determination in various market
forms such as perfect market, monopoly, oligopoly, etc., pricing methods such as
differential pricing and product-line pricing, and price forecasting.

D. Profit management

Business firms are established with the objective of making profits and it is thus
the chief measure of success. For maximizing profits the firm needs to take care of
pricing, cost aspects and long-range decisions, i.e., it has to evaluate its investment
decisions and carry out the best policy of capital budgeting for the firm under a given
set of conditions. If we know the future, profit analysis would be an easy task. However,
in a world of uncertainty our expectations are not always realized, so that profit
planning and measurement constitute a difficult area of Managerial Economics. The
important aspects covered under this area are: nature and measurement of profit, profit
policies, and techniques of profit planning like break-even analysis, cost-volume-profit
analysis, etc.

E. Capital Management

             Large amount of money is invested in the business and that amounts should be
managed efficiently.

F. Competition

Study of markets is one of the important aspects of the work of a managerial

economist. A manager should have clear knowledge of different markets existing in
the environment. The environment is not constant and goes on changing. Thus, the
manager should know clearly about perfect and imperfect markets so as to introduce the
product in such markets where he can increase the sales revenue. The main aspects are
 perfect market, monopoly market, monopolistic market, oligopoly market, and price
fixation under different market conditions.

Managerial economics and traditional economics relationship

Another useful method throwing light upon the nature and scope of managerial
economics is to examine its relationship with other subjects. In this connection, Economics,
Statistics, Mathematics and Accounting deserve special mention. Prof. D.C. Hague
has described managerial Economics  uas using the logic of Economics, Mathematics and
Statistics to provide effective ways of thinking about business decision problems."

a. Managerial Economics and Traditional Economics: Managerial Economics has been

described as economics applied to decision-making. It may be viewed as a special branch of
economics bridging the gulf between pure economic theory and managerial practice. The
relation between Managerial Economics and Economics is as close as is Engineering to
Physics and Medicines to Biology.

Traditional Economics has two main divisions: microeconomics and macroeconomics.

Microeconomics; also known as price theory, is the main source of concepts and analytical
tools for managerial economics. To illustrate, various microeconomics concepts such as
elasticity of demand, marginal cost, the short and long runs, opportunity cost, various market
forms, etc., are all of great significance to managerial economics. The chief contribution of
macroeconomics is in the area of forecasting. The modern theory of income, employment,
trade cycles, etc. has implications for forecasting general business conditions. As the
prospects of an individual firm often depend greedy on general business conditions,
individual firm forecasts depend on general business forecasts.

b. Managerial Economics and Accounting: Managerial economics and accounting are

closely interrelated. Accounting can be defined as the recording of financial operations of a
business firm. A business manager needs a lot of accounting information data for logical
analysis in decision-making and policy formulation at the level of firm. The accounting data
and information has to be presented in a methodological manner worthy of analysis and
interpretation for decision-making and future planning. This is why a new branch of
accounting known as 'management accounting' has developed to help correct managerial
decision-making. The main task of management accounting is to provide the sort of data
which managers need to solve some business problems accurately.
 
c. Managerial Economics and Operational Research: Operational Research is closely
related to managerial economics. Operational research is the application of mathematical
techniques to solving business problems. It provides all the data required for business
decisions and forward planning. Techniques such as linear programming, game theory, etc.
are due to the works of operational research, linear programming is extensively used in
decision-making. Managerial economics is concerned with efficient use of scarce resources.
Operational research is also concerned with efficient use of scarce resources. There is close
affinity between managerial economics and operational research. Managerial economics
gives special emphasis to the problems involving maximization of profits and minimization
of costs, while operational research focuses attention on the concept of optimisation.
Managerial economics has made much use of optimisation concept but initially started with
marginal analysis taken from economics. Managerial economics uses the logic of Economics,
Mathematics and Statistics for undertaking effective decisions, while operational research
techniques based on these ways of thinking are being used to solve decision-making
problems in business. Again, both operational research and managerial economics are
concerned with taking effective decisions.

Operational research is a tool in the hands of managerial economics to solve day-to-day

business problems. Managerial economics is an academic subject which aims at
understanding and analyzing problems and decision-making by a firm. Thus, operational
research is a functional activity pursued by specialists within the firm. Though it is expensive
and a slow process, it helps managers make accurate solutions by means of providing
necessary data.

d. Managerial Economics and Marketing: Managerial Economics helps marketing in two

ways. First, as a basic discipline, providing tools and concepts of analysis and second, as an
integrating area, providing its judgement on the optimum sales volume under the given cost
function of a firm, market structure, and the objective function to be optimized. How much to
sell under given circumstances is answered by an economist and how to sell the desired
amount of output is the domain of the marketing manager. Sometimes, selling more than
what is desired may harm the interest of the firm. It has, however, the sanction neither of
Economics nor of marketing principles as both stresses on the protection of long run interests
of the firm.

Economics is of a great help to marketing in the sphere of pricing. Of the three basic aspects
of pricing viz. value theory, price theory, and pricing techniques, the first two are the
exclusive domain of Economics, while the third one forms part of both Managerial
Economics and marketing. In the case of pricing techniques, there are varying practices in
different organizations. In many pricing is handled by the accounts staff such as chartered
accountants and company secretaries. There are several areas of marketing which are totally
or heavily dependent on economic theory. These are:

1. Theory of the Firm

2. Concepts of goals and goal formulation

3. Market structures

4. Pricing

e. Managerial Economics and Production Management: Production is defined as the

creation of utility by transforming input into output. It usually refers to manufacturing
activity and the term operations are used to denote a wider meaning, encompassing all
economic activity which creates economic utility. Operations personnel have four basic
responsibilities to fulfill while producing a firm's products or services: [Raymond R. Mayor,
1975 p. 3]

1.  Supply of quantities,

2. Maintenance of time-bound deliveries,

3. Fulfillment of quality requirement, and

4.  Economizing production operations.

For this, the personnel have to deal with a number of inter-related areas including
production planning, production control, quality control, methods analysis, materials
handling, plant layout, inventory control, work management, and wage incentives. A
knowledge of Economics would help operations personnel not only to economize their
production operations but also help them:

1. To monitor and analyse the input market,

2. To monitor market maturity, technical maturity, and competitive maturity of

products being produced,

3. To have better coordination with the R & D department with respect to product and
process innovation, and

4. To take decisions on production targets.

f. Managerial Economics and Personnel Management: A human resource manager has to

concern himself with two types of problems: (i) an effective utilization of human resources in
terms of costs and productivity and (ii) improvement in the terms and conditions of
employment as an adjunct to employee satisfaction. Manpower planning, at the micro level,
is another important function of an HRD manager wherein a firm ensures that it has the right
number and the right kind of people, at the right places, at the right time, doing work for
which they are economically most useful.

Managerial economics can help personnel management by analysing the economic and
financial aspects of personnel problems both in relation to the economic welfare of the firm
and to the prevailing environment of the economy as a whole. It explains the economic
implications of policies and strategies and judges their consistency with respect to
organizational objectives as well as internal and external constraints. It can provide a safety
range for wage negotiations with trade unions. Business forecasting could provide
information for devising employment norms of the sales force.