Managerial economics, as the name it implies, is an offshoot of two distinct disciplines:
economics and management.
Spencer and Siegelmen define managerial economics as “the integration of economic theory
with business practice for the purpose of facilitating decision making and forward planning”.
Birgham and pappasbelive that managerial economics is “the application of economic
theory and methodology to business administration practice”.
Michel R Baye defines managerial economics as “the study of how to direct scarce resources
in a way that most efficiently achieves managerial goal”
INTRODUCTION TO ECONOMICS:
Economics is a study of human activity both at individual and national level. The economists
of earlier age treated economics merely as the” Science of Wealth”
Earning money and spending this money to satisfy our wants such as food, clothing, shelter
Such activities of earning and spending money are called „economic‟ activity.
ADAM SMITH was the father of economics.
DEFINITIONS OF ECONOMICS:
1. According to Adam Smith, “The study of nature of national wealth”.
2. Dr. Alfred Marshall, ”Economics is a study of man‟s actions in the ordinary business of
life; it enquires how he get his income and how he uses it.”
3. A.C.Pigou, “the study of economic welfare that can be brought directly and indirectly, into
relationship with the measuring rod of money”.
4. Prof. Lionel Robbins, “The science which studies human behavior as a relationship
between ends and scarce means which have alternative uses”.
Salient features of economics according to Prof. Robbins,
1. Unlimited Wants: we have unlimited no.of wants or ends and it is difficult to satisfy
2. Scarce Resources: we have limited or scarce resources. The resource are said to be
scarce when they are limited in supply with relation to total demand.
3. Alternative Uses: scarce resources can be put to alternative uses. In other words, a
particular commodity or a good can be put to different alternative uses.
4. Choice: of the above alternatives, which one I do choose? How do I behave in
satisfying my unlimited wants with the scarce resources?
The study of an individual consumer or firm is called micro economics. Also called ‘the
theory of firm’.Micro economics deals with the problems of single individual or single
problem. Managerial economics has its roots in micro economics.
The study of aggregate or total level of economic activity in a country is called macro
economics. it studies the flow of economic resources or factors of production. The important
tools of macro economics include national income analysis, balance of payments, theories of
employment, and so on.
Macro economics provides the necessary framework in term of government
policies etc., for the firm to act upon dealing with analysis of business conditions.
Factors for production:- Land
Management:-Management is the science and art of getting things done through people in
formally organized groups.
Functions of management are planning, organizing, staffing, directing and controlling.
Manager:A manager gets things done through people in an organization.
Resources: men, material, machines, money and technology.
A manager is responsible for achieving the targeted results. The manager‟s task is to
maximize the profits of the firm and minimizes the costs.
He has to take such decisions: Planning the production, fixing the selling price,
adding a particular product or dropping it from the product line.
NATURE OF MANAGERIAL ECONOMICS:
Managerial Economics Perhaps, the youngest of all social sciences. It has the basic features
1. close to micro economics:
Managerial economics considered with finding the solutions for different managerial
problems of a particular firm. Thus it is more close to micro economics.
2. Operates against the backdrop of macro economics:
The macro economic conditions of the economy are also seen as limiting factor for the firm
to operate. In otherwords the managerial economist has to be aware of the limits set by macro
economic conditions in such as govt. industrial policy, inflation, and so on.
3. Normative statements:
A normative statement usually implies or include the words „ought‟ or „should‟. They reflect
people moral attitudes and are expressions of what a team of people ought to do.
4.Prescriptive actions: (goal oriented).
Prescriptive actions are goal oriented. Given a problem and objectives of the firm, it suggests
the course of action from the available alternatives for optimal solution.
5.Applied in nature:(help to managers for decision making).
„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.
6. Offers scope to evaluate each alternative: managerial economics provides an opportunity
to evaluate each alternative in terms of its cost and revenues. The managerial economist can
decide which is the better alternative to maximum the profits for the firm.
The contents, tools of managerial economics drawn from different subjects such as
economics, management, statistics, accountancy, psychology, organizational behaviour,
8. Assumptions and limitations:
The concept and theory of managerial economics is based on certain assumptions and such as
their validity is not universal. Where there is change in assumptions, the theory may not hold
SCOPE OF MANAGERIAL ECONOMICS:The main focus in managerial economics is to find an optimal solution to give a managerial
problem. The problem may relate to production, reduction or control of costs, make or buy
decisions, inventory decisions, capital management or profit planning, investment decisions
or human resource management.
Managerial economist makes uses of the concepts, tools and techniques of economics
and other related disciplines to find an optimum solution to a given managerial problem.
Land , labour, capital and organisation are four major contributors of factors of production
.rent,wages,interest, and profit are return to the factors of production.these factors are used
for the people howmuch rawmateirial required for producing the products.
Reduction of cost:
By using this managerial economics we will reduce the manufacturing cost as well as other
costs of the products.
Homuch inventory is required for the organisation and how we always maintain demand
equal to suply it also shows by managerial economoics.
By using managerial economics the business people will estimate howmuch investment is
required for smooth running of the organisation.
Depending on the manufacturing cost we should code the price by considering some amount
Make and buy decisions:
This M.E useful to the people for howmuch rawmaterial they need for their organisation and
howmuch they have s output for reaching the demand.
Long term decisions need a careful analysis expected returns ,risk,and uncertainity.
how much time required for completion of project or particular work.
THE MAIN AREAS OF MANAGERIAL ECONOMICS:
1. Demand decisions:
The analysis and forecasting of demand for a given product and service is the first task of
managerial economist. The impact of changes in price, income levels and prices of alternative
products or services assessed and accordingly the demand decisions are taken to maximize
2. Input-output decisions:
How much raw material we required for getting the desired output. The cots of inputs in
relation to output studied to optimize the profits. it is necessary for the manager to know the
relationship between the cost and output both in short run and long run to position his
products in the competitive environment.
3. Price-output decisions:
How to code the price for the products we will take the decision by using managerial
If our product is new one in the market we should code
a) Equal to competitors
b) Less than competitors
c) Differentiate price
If our product familiar in the market we should consider manufacturing or operational cost.
4. Profit-related decisions:
It is necessary to any businessman has to know about whether his firm runs in a profitable
way or not. for knowing the firm‟s profitability position the business man or manager take the
help of some techniques they are break even analysis, ratio analysis.
5. Investment decisions:
By using managerial economics the business people will estimate howmuch investment is
required for smooth running of the organisation. Investment decisions are also called capital
budgeting decisions. These decisions are irreversible.
6. Economic forecating and forward planning:
Economic forecating leads to forward planning. It is necessary to forecast the trends in the
economy to plan for the future in terms of investments, profits, products, products, and
markets.this will minimise the risk and uncertainity about the future.
LINKAGES WITH OTHER DISCIPLINES:Economics:
M.E is the offshoot of economics and hence the concepts of managerial economics are
basically economic concepts. Economics and managerial economics, both are concerned with
the problems of scarcity and resource allocation. Economics provides the managerial
An understanding of general economic environment within which the firm operates.
A framework to solve the resource allocation problems.
Decision making is the main focus in operation research and managerial economics.
Operational research focuses on solving the managerial problems. O.R is a tool for finding
the solution for managerial problem. For solving the managerial problems some O.R models
are extensively used they are linear programming, queuing, optimization techniques and
Managerial economist is concerned with estimating and predicting the relevant economic
factors for decision making and forward planning. Extensively used mathematic techniques
are algbra, exponentials, vectors, and soon.
Statistics deals with different techniques useful to analyze the cause and effect relationship in
a given variable or phenomenon. It helps manager to deal with the situations of risk and
uncertainty through its techniques such as correlation, regression, time series, probability and
The accountant provides accounting information relating to costs, revenues, profit/loses etc.
the main objective of the accounting function is to record, classify and interpret the given
accounting data. The managerial economist depends upon the accounting data for decision
making and forward planning.
Consumer psychology is basis on which managerial economist acts upon. Psychology
contributes towords understanding the behavioural implications, attitudes, motivations of
each micro economic variables such as consumer, supplier/seller, investor, worker/ an
Organization behaviour study and develop behaviour models of the firm i.e how to maintain
relations with managers, peers and with workers.
MANAGERIAL ECONOMICS DECISION MAKING PROCESS:
Business decision making is essentially a process of selecting the best out of alternative
opportunities open to the firm. The steps below put managers analytical ability to test and
determine the appropriateness and validity of decisions in the modern business world.
Following are the various steps in decision making process:
Specify the decision problem
Identify the alternatives
Select the best alternatives
Implement the decision
Monitor the performance
Modern business conditions are changing so fast and becoming so competitive and complex
that personal business sense, intuition and experience alone are not sufficient to make
appropriate business decisions. It is in this area of decision making that economic theories
and tools of economic analysis contribute a great deal.
BASIC ECONOMIC TOOLS IN MANAGERIAL ECONOMICS FOR DECISION
Economic theory offers a variety of concepts and analytical tools which can be of
considerable assistance to the managers in his decision making practice. These tools are
helpful for managers in solving their business related problems. These tools are taken as
guide in making decision.
Following are the basic economic tools for decision making:
Principle of the time perspective
1) Opportunity cost principle:
Opportunity cost refers to „costs of next best alternative foregone‟. We have scarce resources
and all these have alternative uses. By the opportunity cost of a decision is meant the sacrifice
of alternatives required by that decision.
a) The opportunity cost of the funds employed in one‟s own business is the interest that could
be earned on those funds if they have been employed in other ventures.
b) The opportunity cost of using a machine to produce one product is the earnings forgone
which would have been possible from other products.
c) The opportunity cost of holding Rs. 1000as cash in hand for one year is the 10% rate of
interest, which would have been earned had the money been kept as fixed deposit in bank.
Its clear now that opportunity cost requires ascertainment of sacrifices. If a decision involves
no sacrifices, its opportunity cost is nil. For decision making opportunity costs are the only
2) Incremental principle:
Incremental costs are the „added coats of a change in the level or nature of activity‟. It is also
called differential cost. It is related to the marginal cost and marginal revenues, for economic
theory. Incremental concept involves estimating the impact of decision alternatives on costs
and revenue, emphasizing the changes in total cost and total revenue resulting from changes
in prices, products, procedures, investments or whatever may be at stake in the decisions.
The two basic components of incremental reasoning are
1. Incremental cost
2. Incremental Revenue
The incremental principle may be stated as under:
“A decision is obviously a profitable one if –
it increases revenue more than costs
it decreases some costs to a greater extent than it increases others
it increases some revenues more than it decreases others and
it reduces cost more than revenues”
3) Principle of Time Perspective
Managerial economists are also concerned with the short run and the long run effects of
decisions on revenues as well as costs. The very important problem in decision making is to
maintain the right balance between the long run and short run considerations.
Suppose there is a firm with a temporary idle capacity. An order for 5000 units comes to
management‟s attention. The customer is willing to pay Rs 4/- unit or Rs.20000/- for the
whole lot but not more. The short run incremental cost(ignoring the fixed cost) is only Rs.3/-.
There fore the contribution to overhead and profit is Rs.1/- per unit (Rs.5000/- for the lot)
From the above example the following long run repercussion of the order is to be taken into
1) If the management commits itself with too much of business at lower price or with a small
contribution it will not have sufficient capacity to take up business with higher contribution.
2) If the other customers come to know about this low price, they may demand a similar low
price. Such customers may complain of being treated unfairly and feel discriminated against.
In the above example it is therefore important to give due consideration to the time
perspectives. “a decision should take into account both the short run and long run effects on
revenues and costs and maintain the right balance between long run and short run
4) Discounting Principle:
One of the fundamental ideas in Economics is that a rupee tomorrow is worth less than a
rupee today. Suppose a person is offered a choice to make between a gift of Rs.100/- today or
Rs.100/- next year. Naturally he will chose Rs.100/- today. This is true for two reasonsi) The future is uncertain and there may be uncertainty in getting Rs. 100/- if the present
opportunity is not availed of
ii) Even if he is sure to receive the gift in future, today‟s Rs.100/- can be invested so as to
earn interest say as 8% so that one year after Rs.100/- will become 108
5) Equi – marginal Principle:
This principle deals with the allocation of an available resource among the alternative
activities. According to this principle, an input should be so allocated that the value added by
the last unit is the same in all cases. This generalization is called the equi-marginal principle.