Economics Introduction… Economics Definitions… Definition of Business Economics › Economics Basics
Basic Principles of Economics, Market Structures and Cost Analysis
Basic Principles of Economics:
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Economics Introduction
Economics is the social science that is concerned with the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek οἰκονομία (oikonomia, "management of a household, administration") from οἶκος (oikos, "house") + νόμος (nomos, "custom" or "law"), hence "rules of the house(hold)". Current economic models developed out of the broader field of political economy in the late 19th century, owing to a desire to use an empirical approach more akin to the physical sciences.INTRODUCTION
Economics was formerly called political economy. The term Political economy means the management of the wealth of the state. “Adam Smith, the father of modem Economics, in his book entitled 'An Enquiry into the Nature and Causes of the Wealth of Nations’ (Published in 1776) defined Economics as a study of wealth. Smith considered the acquisition of wealth as the main objective of human activity. According to him the subject matter of Economics is the study of how wealth is produced and consumed. Smith's definition is known as wealth definition.This definition was too materialistic. It gave more importance to wealth than to man for whose use wealth is produced. The emphasis on wealth was severely criticised by many others. Cailyle, Ruskin and other philosophers called it the Gospel of Mammon.
the end of human welfare. We cannot consider the desire to acquire wealth as the inspiring factor behind every human endeavor. Nor can it be expected to be the sole cause of human happiness. The emphasis has now shifted from wealth to man. Man occupies the primary place and wealth only a secondary place.
Economics is a popular, useful and significant social study. It studies economic activities of a man. Economic activities are those activities which are concerned with the efficient use of such scarce means as can satisfy the wants of the man. Human wants are unlimited, in the sense, that as soon as one want is satisfied another crops up. Most of the means satisfying these wants are limited, because their supply is less than demand. These means have many alternative uses. Because of scarcity of means and their diverse uses, there emerges a problem of choice. Everybody has to make a choice with regard to the use of his scarce means so that he may get maximum satisfaction from them. In short, Economics is the study of those activities of human beings which are concerned with the satisfaction of unlimited wants by utilizing limited resources.
Economics is not concerned with lifeless matter as is the case with natural sciences like Physics and Chemistry.
Several definitions of Economics have been given. For the sake of convenience let us classify the various definitions into four groups:
1. Science of wealth
2. Science of material well-being
3. Science of choice making and
4. Science of dynamic growth and development
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Economics Definitions
Economics is the branch of social science that studies the production, exchange, distribution, and consumption of goods and services.1. "Economics is an enquiry into the nature and causes of wealth of nations."- Adam Smith.
2. Economics is the science which treats of wealth. "-J.B. Say.
In the above definition wealth becomes the main focus of the study of Economics. The definition of Economics, as science of wealth, had some merits. The important ones are:
(i) It highlighted an important problem faced by each and every nation of the world, namely creation of wealth.
(ii) Since the problems of poverty, unemployment etc. can be solved to a greater extent when wealth is produced and is distributed equitably; it goes to the credit of Adam Smith and his followers to have addressed to the problems of economic growth and increase in the production of wealth.
The study of Economics as a 'Science of Wealth' has been criticized on several grounds. The main criticisms leveled against this definition are;
(i) Adam Smith and other classical economists concentrated only on material wealth. They totally ignored creation of immaterial wealth like services of doctors, chartered accountants etc.
(ii) The advocates of Economics as 'science of wealth' concentrated too much on the production of wealth and ignored social welfare. This makes their definition incomplete and inadequate.
3. "Economics is a study of mankind in the ordinary business of life. It examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of well-being. Thus, it is on the one side a study of wealth and on the other and more important side a part of the study of the man", Alfred Marshall
4. Robbins gave a more scientific definition of Economics. His definition is as follows: "Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses".
The definition deals with the following four aspects:
(i) Economics is a science: Economics studies economic human behaviour scientifically. It studies how humans try to optimise (maximize or minimize) certain objective under given constraints. For example, it studies how consumers, with given income and prices of the commodities, try to maximize their satisfaction.
(ii) Unlimited ends: Ends refer to wants. Human wants are unlimited. When one want is satisfied, other wants crop up. If man's wants were limited, then there would be no economic problem.
(iii) Scarce means: Means refer to resources. Since resources (natural productive resources, man-made capital goods, consumer goods, money and time etc.) are limited economic problem arises. If the resources were unlimited, people would be able to satisfy all their wants and there would be no problem.
(iv)Alternative uses: Not only resources are scarce, they have alternative uses. For example, coal can be used as a fuel for the production of industrial goods, it can be used for running trains, it can also be used for domestic cooking purposes and for so many purposes. Similarly, financial resources can be used for many purposes. The man or society has, therefore, to choose the uses for which resources would be used. If there was only a single use of the resource then the economic problem would not arise.
5. "Economics is the body of knowledge which relates to wealth "-Prof. Walker.
6. ''Economics investigates the nature of wealth and the laws of production and its distribution, "-J.S. Mill
7. "The subject treated by political economics is not happiness, but wealth"-Prof. Senior
8. "Economics is the study of how men and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time and distribute them for consumption now and in the future amongst various people and groups of society". Paul A. Samuelson
The above definition is very comprehensive because it does not restrict to material well-being or money measure as a limiting factor. But it considers economic growth over time.
These definitions have, thus, made wealth as the subject matter and central point of economics. To them, only and only important thing was wealth.
Nature or Meaning of Wealth: The term 'wealth' in these definitions is used to signify those material goods which are scarce. Material goods are those goods which can be seen and touched, for example, cloth, furniture, book, gold, silver, etc. Non-material goods or services are those which cannot be seen or touched, for example, the services of a professor, lawyer, doctor, dancer, clerk, peon etc. are not considered as wealth and so remain outside the scope of the study of economics.
There is no one universally accepted answer to the question "What is economics?" Browsing the web, we will find various answers to the question:
• The Economist's Dictionary of Economics defines economics as "The study of the production, distribution and consumption of wealth in human society
• "Economics is the study of how individuals and groups make decisions with limited resources as to best satisfy their wants, needs, and desires".
• Economics is a social science that studies how society chooses to allocate its scarce resources, which have alternative uses, to provide goods and services for present and future consumption.
• "Economics is the social science that examines how people choose to use limited or scarce resources in attempting to satisfy their unlimited wants."
Scarce and Limited resources: below mentioned are the scarce resources, which are to be utilised carefully and to get maximum benefit and those are.
1. Land: Land is that factor of production which is freely available from nature. In it, not only on the surface of soil is included, but also all other free gifts of the nature below the surface and above the surface are included; for example, forests, minerals, fertility of soil, water, etc. According to Marshall, "Land means the material and the forces which nature gives freely for man's aid, in land and water, in air, light and heat." Land is also called a natural resource.
2. Labour (skilled): Labour is a human factor of production. In it all those mental and physical activities of man are included which are performed in order to earn money. The services of a carpenter, black-smith, weaver, teacher, lawyer and doctor, etc., are called as labour according to economics.
3. Capital: Capital is that man-made factor of production which is used for more production. Factors like machines, tools, raw materials, buildings, railways, factories, etc., are called capital. The saving of a man when invested to earn will also be called capital.
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Definition of Business Economics
In simple words, business economics is the discipline which helps a business manager in decision making for acheiving the desired results. In other words, it deals with the application of economic theory to business management.According to Spencer and Siegelman, Business economics is "the integration of economic theory with business practise for the purpose of facilitating decision-making and forward planning by management".
According to Mc Nair and Meriam, "Business economics deals with the use of economic modes of thought to analyse business situation".
From the above said definitions, we can safely say that business economics makes in depth study of the following objectives:
• Explanation of nature and form of economic analysis
• Identification of the business areas where economic analysis can be applied
• Spell out the relationship between Managerial Economics and other disciplines outline the methodology of managerial economics.
CHARACTERISTICS OF BUSINESS ECONOMICS
The following characteristics of business economics will indicate its nature:1. Micro economics: Managerial economics is micro economic in character. This is so because it studies the problems of an individual business unit. It does not study the problems of the entire economy.
2. Normative science: Managerial economics is a normative science. It is concerned with what management should do under particular circumstances. It determines the goals of the enterprise. Then it develops the ways to achieve these goals.
3. Pragmatic: Managerial economics is pragmatic. It concentrates on making economic theory more application oriented. It tries to solve the managerial problems in their day-today functioning.
4. Prescriptive: Managerial economics is prescriptive rather than descriptive. It prescribes solutions to various business problems.
5. Uses macro economics: Marco economics is also useful to business economics. Macro-economics provides an intelligent understanding of the environment in which the business operates. Managerial economics takes the help of macro-economics to understand the external conditions such as business cycle, national income, economic policies of Government etc.
6. Uses theory of firm: Managerial economics largely uses the body of economic concepts and principles towards solving the business problems. Managerial economics is a special branch of economics to bridge the gap between economic theory and managerial
practice.
7. Management oriented: The main aim of managerial economics is to help the management in taking correct decisions and preparing plans and policies for future. Managerial economics analyses the problems and give solutions just as
doctor tries to give relief to the patient.
8. Multi disciplinary: Managerial economics makes use of most modern tools of mathematics, statistics and operation research. In decision making and planning principles such accounting, finance, marketing, production and personnel etc.
9. Art and science.- Managerial economics is both a science and an art. As a science, it establishes relationship between cause and effect by collecting, classifying and analyzing the facts on the basis of certain principles. It points out to the objectives and also shows the way to attain the said objectives.
OBJECTIVES OF BUSINESS ECONOMICS
Managerial economics provides such tools necessary for business decisions. Managerial economics answers the five fundamental problems of decision making. These problem are : (a) what should be the product mix (b) which is the least cost production technique and input mix (c) what should be the level of output and price of the product (d) how to take investment decisions (e) how much should be the selling cost.In order to solve the problems of decision- making, data are to be collected and analysed in the light of business objectives. Business economics supplies such data to the business economist. As pointed out by Joel Dean "The purpose of managerial economics is to show how economic analysis can be used in formulating business policies"
The basic objective of managerial economics is to analyse economic problems of business and suggest solutions and help the managers in decision-making. The objectives of business economics are outlined as below:
1. To integrate economic theory with business practice.
2. To apply economic concepts: and principles to solve business problems.
3. To employ the most modern instruments and tools to solve business problems.
4. To allocate the scarce resources in the optimal manner.
5. To make overall development of a firm.
6. To help achieve other objectives of a firm like attaining industry leadership, expansion of the market share etc.
7. To minimise risk and uncertainty
8. To help in demand and sales forecasting.
9. To help in operation of firm by helping in planning, organising, controlling etc.
10. To help in formulating business policies.
11. To help in profit maximisation.
Business economics is useful because: (i) It provides tools and techniques for managerial decisions, (ii) It gives answers to the basic problems of
business management, (iii) It supplies data for analysis and forecasting, (iv) It provides tools for demand forecasting and profit planning, (v) It guides the managerial economist.
Thus, Business economics offers a number of benefits to business managers. It is also useful to individuals, society and government.
SCOPE OF MANAGERIAL OR BUSINESS ECONOMICS
Managerial economics is a developing science which generates the countless problems to determine its scope in a clear-cut way. From the following fields, we can examine the scope of business economics.1. Demand analysis and forecasting. The foremost aspect regarding scope is demand analysis and forecasting. A business firm is an economic unit which transforms productive resources into saleable goods. Since all output is meant to be sold, accurate estimates of demand help a firm in minimising its costs of production and storage. A firm must decide its total output before preparing its production schedule and deciding on the
resources to be employed. Demand forecasts serves as a guide to the management for maintaining its market share in competition with its rivals, thereby securing its profit.
2. Cost and production analysis. A firm's profitability depends much on its costs of production. A wise manager would prepare cost estimates of a range of output, identify the factors causing variations in costs and choose the cost-minimising output level, taking also into consideration the degree of uncertainty in production and cost calculations. Production process are under the charge of engineers but the business manager works to carry out the production function analysis in order to avoid wastages of materials and time. Sound pricing policies depend much on cost control. The main topics discussed under cost and production analysis are: Cost concepts, cost-output relationships, Economies and Dis-economies of scale and cost control.
3. Pricing decisions, policies and practices. Another task before a business manager is the pricing of a product. Since a firm's income and profit depend mainly on the price decision, the pricing policies and all such decisions are to be taken after careful analysis of the nature of the market in which the firm operates. The important topics covered in this field of study are : Market Structure Analysis, Pricing Practices and Price Forecasting.
4. Profit management. Each and every business firms are tended for earning profit, it is profit which provides the chief measure of success of a firm in the long period. Economists tells us that profits are the reward for uncertainity bearing and risk taking. A successful business manager is one who can form more or less correct estimates of costs and revenues at different levels of output. The more successful a manager is in reducing uncertainity, the higher are the profits earned by him. It is therefore, profit-planning and profit measurement constitute the most challenging area of business economics.
5. Capital management. Still another most challenging problem for a modern business manager is of planning capital investment. Investments are made in the plant and machinery and buildings which are very high. Therefore, capital management requires top- level decisions. It means capital management i.e., planning and control of capital expenditure. It deals with Cost of capital, Rate of Return and Selection of projects.
6. Inventory management: A firm should always keep an ideal quantity of stock. If the stock is too much, the capital is unnecessarily locked up in inventories At the same time if the level of inventory is low, production will be interrupted due to non-availability of materials. Hence, a firm always prefers to have an optimum quantity of stock. Therefore,managerial economics will use some methods such as ABC analysis, inventory models with a view to minimising the inventory cost.
7. Linear programming and theory of games : Linear programming and theory of games have came to be regarded as part of managerial economics recently.
8. Environmental issues: There are certain issues of macroeconomics which also form a part of managerial economics. These issues relate to general business, social and political environment in which a business enterprise operates. 9. Business cycles: Business cycles affect business decisions. They refer to regular fluctuations in economic activities in the country. The different phases of business cycle are depression, recovery, prosperity, boom and recession.
Thus, managerial economics comprises both micro and macro-economic theories. The subject matter of managerial economics consists of all those economic concepts, theories and tools of analysis which can be used to analyse the business environment and to find out solution to practical business problems.
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Macro Economics
The study of economics is classified as a social science. Because economics deals with human problems. An overview of the elements that constitute in the study of economics, that is human wants, needs, scarcity, resources, goods and services, economic choice, and the laws of supply and demand. The entire subjects economics is the one most closely associate with everyday lifeEconomics is sub divided into two branches called as macroeconomics and microeconomics.
MACRO ECONOMICS
Definition- In the words of Boulding, "Macro economic theory is that part of economics which studies the overall averages and aggregates of the system."
- According to Shapiro, "Macroeconomics deals with the functioning of the economy as a whole."
- In the words of Ackley Gardner, "Macroeconomics concerns with such variables as the aggregate volume of the output of an economy, with the extent to which its resources are employed, with the size of national income and with the general price level"
Macroeconomics, on the other hand, is the field of economics that studies the behaviour of the economy as a whole and not just on specific companies, but entire industries and economies. This looks at economy-wide phenomena such as Gross National Product (GDP) and how it is affected by changes in unemployment, national income, rate of growth, and price levels.
For example, macroeconomics would look at how an increase/decrease in net exports would affect a nation's capital account or how GDP would be affected by unemployment rate. It perceives the overall dimensions of economy. It looks at the total size, shape and functioning of the economy as a whole. Rather than working individual parts.
[Eg: talks about the whole forest, but not about the individual tree]
Importance:-
1. Its knowledge is indispensable for policy makers.
2. It is very useful to the planners for preparing economic plans for the country development.
3. It explains the relationship between the price levels of goods, income of the people and output (production).
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Micro Economics
Definition
Watson says, "Microeconomics is the theory of the small, of the behaviour of the consumers, producers and markets.'- In the words of Shapiro, "Microeconomics deals with small parts of the economy.
- According to Ieftwitch, ^Microeconomics is concerned with the economic activities of economic units as consumers, resource owners and business firms."
- According to Boulding, "Microeconomics is the study of particular firm, particular household, individual price, wage, income, industry and particular commodity."
Microeconomics is the study of decisions that people and businesses make regarding the allocation of resources and prices of goods and services. This means also taking into account taxes and regulations created by governments. Microeconomics focuses on supply and demand and other forces that determine price levels for specific companies in specific industry sectors.
For example, microeconomics would look at how a specific company could maximize its production and capacity so it could lower prices and better compete in its industry.
Eg: - talks about the individual tree but not about total forest
Importance:-
1. It helps in decision making regarding utilization of resources in the organization.
2. It helps in which goods should be produced & who will produce them.
3. How should be produced and how they will be distributed.
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Managerial Economics
Managerial Economics (also called Business Economics) 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 problems of course relate to choices and allocation of resources, which are basically economic in nature and are faced by managers all the time. It is that branch of Economics, which serves as a link between abstract theory and managerial practice. It is based on economic analysis for identifying problems, organizing information and evaluating alternatives. In other words Managerial Economics involves analysis of allocation of the resources available to a firm or a unit of management among the activities of that unit. It is thus concerned with choice or selection among alternatives. Managerial Economics is by nature goal-oriented and prescriptive, and it aims at maximum achievement of objectives.Managerial Economics help managers to learn the economic principles which are relevant to decision-making in such areas as production, personnel, marketing and finance. A clear understanding of economic principles will help the manager in his activities. For example, XYZ Ltd. has limited financial, human, and physical resources. XYZ Ltd. managers seek to maximize the financial return from these limited resources. They should apply Managerial Economics to develop pricing and advertising strategies, design their organizations, and manage purchasing.
Managerial Economics applies economic theory and methods to business and administrative decision-making. Managerial Economics prescribes rules for improving managerial decisions.
Managerial Economics also helps managers to recognize how economic forces affect organizations and describes the economic consequences of managerial behaviour. It links traditional Economics with the decision sciences to develop vital tools for managerial decision making. This process is illustrated in Fig.
Managerial Economics has applications in both profit and non-profit sectors. For example, an administrator of a non-profit hospital strives to provide the best medical care possible given limited medical staff, equipment and related resources. Using the tools and concepts of Managerial Economics, the administrator can determine the optimal allocation of these limited resources. In short. Managerial Economics helps managers to arrive at a set of operating rules that aid in the efficient use of scarce human and capital resources. By following these rules, businesses, non-profit organizations and government agencies are able to meet objectives efficiently.
Thus. Managerial Economics applies the principles and methods of Economics to analyze problems faced by the management of a business or other types of organizations and helps to find solutions that advance the best interests of such organizations.
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Managerial Economics Definitions
Definitions
In the words of TJ. Webster, "Managerial economics is the synthesis of microeconomic theory and quantitative methods to find optimal solutions to managerial decision-making problems?In the words of Hirschey and Pappas, "Managerial economics applies economic theory and methods to business and administrative decision making"
According to Mansfield, "Managerial economics provides a link between economic theory and decision sciences in the analysis of managerial decision making?
Brigham and Poppas believe that managerial economics is "the application of economic theory and methodology to business administration practice."
Hague on the other hand, considers managerial economics as "a fundamental academic subject which seeks to understand and to analyse the problems of business decision-making."
According to McNair and Meriam, “Managerial economics is the use of economic modes of thought to analyse business situations.”
According to Prof. Evan J Douglas, ‘Managerial economics’ is concerned with the application of economic principles and methodologies to the decision making process within the firm or organisation under the conditions of uncertainty”. Spencer and Siegelman define it as “The integration of economic theory with business practices for the purpose of facilitating decision making and forward planning by management.”
According to Hailstones and Rothwel, “Managerial economics is the application of economic theory and analysis to practice of business firms and other institutions.” A common thread runs through all these descriptions of managerial economics which is using a framework of analysis to arrive at informed decisions to maximize the firm’s objectives, often in an environment of uncertainty. It is important to recognize that decisions taken while employing a framework of analysis are likely to be more successful than decisions that are knee jerk or gut feel decisions.
Almost any business decision can be analyzed with managerial economics techniques, but it is most commonly applied to:
1. Risk analysis - various models are used to quantify risk and asymmetric information and to employ them in decision rules to manage risk.
2. Production analysis - microeconomic techniques are used to analyze production efficiency, optimum factor allocation, costs, economies of scale and to estimate the firm's cost function.
3. Pricing analysis - microeconomic techniques are used to analyze various pricing decisions including transfer pricing, joint product pricing, price discrimination, price elasticity estimations, and choosing the optimum pricing method.
4. Capital budgeting - Investment theory is used to examine a firm's capital purchasing decisions.
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Scope of Managerial Economics
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.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
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.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.Capital Management
Large amount of money is invested in the business and that amounts should be managed efficiently.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.[ Index ▲ ]
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Application of managerial economics
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.
It should be noted that the application of managerial economics is not limited to profit-seeking business organizations. Tools of managerial economics can be applied equally well to decision problems of nonprofit organizations. While a nonprofit hospital is not like a typical firm seeking to maximize its profits, a hospital does strive to provide its patients the best medical care possible given its limited staff (doctors, nurses, and support staff), equipment, space, and other resources. The hospital administrator can use the concepts and tools of managerial economics to determine the optimal allocation of the limited resources available to the hospital. In addition to nonprofit business organizations, government agencies and other nonprofit organizations (such as cooperatives, schools, and museums) can use the techniques of managerial decision making to achieve goals in the most efficient manner.
ECONOMIC CONCEPTS USED IN MANAGERIAL ECONOMICS
Managerial economics uses a wide variety of economic concepts, tools, and techniques in the decision-making process. These concepts can be placed in three broad categories:1) The theory of the firm, which describes how businesses make a variety of decisions
2) The theory of consumer behavior, which describes decision making by consumers
3) The theory of market structure and pricing, which describes the structure and characteristics of different market forms under which business firms operate.
Role of Managerial Economics
Managerial economics, or business economics, is a division of microeconomics that focuses on applying economic theory directly to businesses. The application of economic theory through statistical methods helps businesses make decisions and determine strategy on pricing, operations, risk, investments and production. The overall role of managerial economics is to increase the efficiency of decision making in businesses to increase profit.
Pricing
Managerial economics assists businesses in determining pricing strategies and appropriate pricing levels for their products and services. Some common analysis methods are price discrimination, value-based pricing and cost-plus pricing.
Elastic vs. Inelastic Goods
Economists can determine price sensitivity of products through a price elasticity analysis. Some products, such as milk, are consider a necessity rather than a luxury and will purchase at most price points. This type of product is considered inelastic. When a business knows they are selling an inelastic good, they can make marketing and pricing decisions easier.
Operations and Production
Managerial economics uses quantitative methods to analyze production and operational efficiency through schedule optimization, economies of scale and resource analyses. Additional analysis methods include marginal cost, marginal revenue and operating leverage. Through tweaking the operations and production of a company, profits rise as costs decline.
Investments
Many managerial economic tools and analysis models are used to help make investing decisions both for corporations and savvy individual investors. These tools are use to make stock market investing decisions and decisions on capital investments for a business. For example, managerial economic theory can be used to help a company decide between purchasing, building or leasing operational equipment.
•Risk
Uncertainty exits in every business and managerial economics can help reduce risk through uncertainty model analysis and decision-theory analysis. Heavy use of statistical probability theory helps provide potential scenarios for businesses to use when making decisions.
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Relationship with other subjects
Macro Economics, Statistics, Mathematics, Accounts etc., have contributed a lot in the growth of Managerial Economics. D.C. Hague has stated, "Managerial Economics uses the logic of Economics, Mathematics and Statistics to provide effective ways of thinking about business decision problems."Economics has two main divisions: micro-economics and macro-economics. Micro-economics has been defined as that branch where the unit of study is an individual or a firm. Macro-economics, on the other hand, is aggregative in character and has the entire economy as a unit of study.
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."1. 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 microeconomic 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.
2.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.
3. 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 maximisation of profits and minimisation 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 analysing 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.
4. 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
5. 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
a) To monitor and analyse the input market,
b) To monitor market maturity, technical maturity, and competitive maturity of products being produced,
c) To have better coordination with the R & D department with respect to product and process innovation, and
d) To take decisions on production targets.
6. 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.