MANAGERIAL ECONOMICS Managerial economics (sometimes referred to as business economics) is a branch of economics that applies microeconomic analysis to decision

methods of businesses or other management units. As such, it bridges economic theory and economics in practice. It draws heavily from quantitative techniques such as regression analysis and correlation, Lagr angian calculus (linear). If there is a unifying theme that runs through most of managerial economics it is the attempt to optimize business decisions given the firm s ob!ectives and given constraints imposed by scarcity, for e"ample through the use of operations research and programming. Almost any business decision can be analyzed with managerial economics techniques, but it is most commonly applied to#

Risk analysis $ various models are used to quantify ris% and asymmetric information and to employ them in decision rules to manage ris%. 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. Pricing analysis $ microeconomic techniques are used to analyze various pricing decisions including transfer pricing, !oint product pricing, price discrimination, price elasticity estimations, and choosing the optimum pricing method. Capital budgeting $ Investment theory is used to e"amine a firm s capital purchasing decisions.

At universities, the sub!ect is taught primarily to advanced undergraduates and graduate business schools. It is approached as an integration sub!ect. &hat is, it integrates many concepts from a wide variety of courses. In many countries it is possible to read for a degree in 'usiness (conomics which often covers managerial economics, financial economics, game theory, business forecasting and industrial economics.
MANAGERIAL ECONOMICS Managerial Economics can be de ined as amalgamation o economic t!eory "it! business practices so as to ease decision#making and uture planning by management . )anagerial (conomics assists the managers of a firm in a rational solution of obstacles faced in the firm*s activities. It ma%es use of economic theory and concepts. It helps in formulating logical managerial decisions. &he %ey of )anagerial (conomics is the micro$economic theory of the firm. It lessens the gap between economics in theory and economics in practice. )anagerial (conomics is a science dealing with effective use of scarce resources. It guides the managers in ta%ing decisions relating to the firm*s customers, competitors, suppliers as well as relating to the internal functioning of a firm. It ma%es use of statistical and analytical tools to assess economic theories in solving practical business problems. +tudy of )anagerial (conomics helps in enhancement of analytical s%ills, assists in rational configuration as well as solution of problems. ,hile microeconomics is the study of decisions made regarding the allocation of resources and prices of goods and services, macroeconomics is the field of economics that studies the behavior of the economy as a whole (i.e. entire industries and economies). )anagerial (conomics applies micro$economic tools to ma%e business decisions. It deals with a firm.

&he use of )anagerial (conomics is not limited to profit$ma%ing firms and organizations. 'ut it can also be used to help in decision$ma%ing process of non$profit organizations (hospitals, educational institutions, etc). It enables optimum utilization of scarce resources in such organizations as well as helps in achieving the goals in most efficient manner. )anagerial (conomics is of great help in price analysis, production analysis, capital budgeting, ris% analysis and determination of demand. )anagerial economics uses both Economic t!eory as well as Econometrics for rational managerial decision ma%ing. (conometrics is defined as use of statistical tools for assessing economic theories by empirically measuring relationship between economic variables. It uses factual data for solution of economic problems. )anagerial (conomics is associated with the economic theory which constitutes -&heory of .irm/. &heory of firm states that the primary aim of the firm is to ma"imize wealth. 0ecision ma%ing in managerial economics generally involves establishment of firm*s ob!ectives, identification of problems involved in achievement of those ob!ectives, development of various alternative solutions, selection of best alternative and finally implementation of the decision. &he following figure tells the primary ways in which )anagerial (conomics correlates to managerial decision$ma%ing.

Scope o Managerial Economics

)anagerial (conomics deals with allocating the scarce resources in a manner that minimizes the cost. As we have already discussed, )anagerial (conomics is different from microeconomics and macro$economics. )anagerial (conomics has a more narro" scope $ it is actually solving managerial issues using micro$economics. ,herever there are scarce resources, managerial economics ensures that managers ma%e effective and efficient decisions concerning customers, suppliers, competitors as well as within an organization. &he fact of scarcity of resources gives rise to three fundamental questions$ a. ,hat to produce1 b. 2ow to produce1 c. .or whom to produce1 &o answer these questions, a firm ma%es use of managerial economics principles. &he first question relates to "!at goods and ser$ices s!ould be produced and in "!at amount%&uantities. &he managers use demand theory for deciding this. &he demand theory e"amines consumer behaviour with respect to the %ind of purchases they would li%e to ma%e currently and in future3 the factors influencing purchase and consumption of a specific good or service3 the impact of change in these factors on the demand of that specific good or service3 and the goods or services which consumers might not purchase and consume in future. In order to

decide the amount of goods and services to be produced, the managers use methods of demand forecasting. &he second question relates to !o" to produce goods and ser$ices . &he firm has now to choose among different alternative techniques of production. It has to ma%e decision regarding purchase of raw materials, capital equipments, manpower, etc. &he managers can use various managerial economics tools such as production and cost analysis (for hiring and acquiring of inputs), pro!ect appraisal methods( for long term investment decisions),etc for ma%ing these crucial decisions. &he third question is regarding "!o s!ould consume and claim t!e goods and ser$ices produced by the firm. &he firm, for instance, must decide which is it*s niche mar%et$ domestic or foreign1 It must segment the mar%et. It must conduct a thorough analysis of mar%et structure and thus ta%e price and output decisions depending upon the type of mar%et. )anagerial economics helps in decision$ma%ing as it involves logical thin%ing. )oreover, by studying simple models, managers can deal with more comple" and practical situations. Also, a general approach is implemented. )anagerial (conomics ta%e a wider picture of firm, i.e., it deals with questions such as what is a firm, what are the firm*s ob!ectives, and what forces push the firm towards profit and away from profit. In short, managerial economics emphasizes upon the firm, the decisions relating to individual firms and the environment in which the firm operates. It deals with %ey issues such as what conditions favour entry and e"it of firms in mar%et, why are people paid well in some !obs and not so well in other !obs, etc. )anagerial (conomics is a great rational and analytical tool. )anagerial (conomics is not only applicable to profit$ma%ing business organizations, but also to non$ profit organizations such as hospitals, schools, government agencies, etc.

Principles o Managerial Economics

Economic principles assist in rational reasoning and de ined t!inking' (!ey de$elop logical ability and strengt! o a manager' Some important principles o managerial economics are)

1. Marginal and Incremental Principle

(!is principle states t!at a decision is said to be rational and sound i gi$en t!e irm*s ob+ecti$e o pro it ma,imi-ation. it leads to increase in pro it. "!ic! is in eit!er o t"o scenarios# I total re$enue increases more t!an total cost' I total re$enue declines less t!an total cost' )arginal analysis implies !udging the impact of a unit change in one variable on the other. )arginal generally refers to small changes. )arginal revenue is change in total revenue per unit change in output sold. )arginal cost refers to change in total costs per unit change in output produced (,hile incremental cost refers to change in total costs due to change in total output).&he decision of a firm to change the price would depend upon the resulting impact4change in marginal revenue and marginal cost. If the marginal revenue is greater than the marginal cost, then the firm should bring about the change in price. Incremental analysis differs from marginal analysis only in that it analysis the change in the firm s performance for a given managerial decision, whereas marginal analysis often is generated by a change in outputs or inputs. Incremental analysis is generalization of marginal concept. It refers to changes in cost and revenue due to a policy change. .or e"ample $ adding a new business, buying new inputs, processing products, etc. 5hange in output due to change in process, product or investment is considered as incremental change. Incremental principle states that a decision is profitable if revenue increases more than costs3 if costs reduce more than revenues3 if increase in some revenues is more than decrease in others3 and if decrease in some costs is greater than increase in others.

2. Equi-marginal Principle
)arginal 6tility is the utility derived from the additional unit of a commodity consumed. &he laws of equi$ marginal utility states that a consumer will reach the stage of equilibrium when the marginal utilities of various commodities he consumes are equal. According to the modern economists, this law has been formulated in form of law of proportional marginal utility. It states that the consumer will spend his money$income on different goods in such a way that the marginal utility of each good is proportional to its price, i.e.,

M/, % P, 0 M/y % Py 0 M/- % P,here, )6 represents marginal utility and 7 is the price of good. +imilarly, a producer who wants to ma"imize profit (or reach equilibrium) will use the technique of production which satisfies the following condition# MRP1 % MC1 0 MRP2 % MC2 0 MRP3 % MC3 ,here, )87 is marginal revenue product of inputs and )5 represents marginal cost. &hus, a manger can ma%e rational decision by allocating4hiring resources in a manner which equalizes the ratio of marginal returns and marginal costs of various use of resources in a specific use.

3. Opportunity Cost Principle

'y opportunity cost of a decision is meant the sacri ice o alternati$es required by that decision. If there are no sacrifices, there is no cost. According to 9pportunity cost principle, a firm can hire a factor of production if and only if that factor earns a reward in that occupation4!ob equal or greater than it*s opportunity cost. 9pportunity cost is the minimum price that would be necessary to retain a factor$service in it*s given use. It is also defined as the cost of sacrificed alternatives. .or instance, a person chooses to forgo his present lucrative !ob which offers him 8s.:;;;; per month, and organizes his own business. &he opportunity lost (earning 8s. :;,;;;) will be the opportunity cost of running his own business.

4. Time Perspecti e Principle

According to this principle, a manger4decision ma%er should give due emphasis, both to short$term and long$ term impact of his decisions, giving apt significance to the different time periods before reaching any decision. +hort$run refers to a time period in which some factors are fi"ed while others are variable. &he production can be increased by increasing the quantity of variable factors. ,hile long$run is a time period in which all factors of production can become variable. (ntry and e"it of seller firms can ta%e place easily. .rom consumers point of view, short$run refers to a period in which they respond to the changes in price, given the taste and preferences of the consumers, while long$run is a time period in which the consumers have enough time to respond to price changes by varying their tastes and preferences.

!. "iscounting Principle
According to this principle, if a decision affects costs and revenues in long$run, all those costs and revenues must be discounted to present values before valid comparison of alternatives is possible. &his is essential because a rupee worth of money at a future date is not worth a rupee today. )oney actually has time value. 0iscounting can be defined as a process used to transform future dollars into an equivalent number of present dollars. .or instance, <= invested today at =;> interest is equivalent to <=.=; ne"t year. 45 0 P56718r9t :!ere. 45 is t!e uture $alue 7time at some uture time9. P5 is t!e present $alue 7$alue at t;. r is t!e discount 7interest9 rate. and t is t!e time bet"een t!e uture $alue and present $alue'

Role o a Managerial Economist

A managerial economist helps the management by using his analytical s%ills and highly developed techniques in solving comple" issues of successful decision$ma%ing and future advanced planning. &he role o managerial economist can be summarized as follows# 1' <e studies t!e economic patterns at macro#le$el and analysis it*s signi icance to t!e speci ic irm !e is "orking in' 2' <e !as to consistently e,amine t!e probabilities o trans orming an e$er#c!anging economic en$ironment into pro itable business a$enues' 3' <e assists t!e business planning process o a irm' =' <e also carries cost#bene it analysis' >' <e assists t!e management in t!e decisions pertaining to internal unctioning o a irm suc! as c!anges in price. in$estment plans. type o goods %ser$ices to be produced. inputs to be used. tec!ni&ues o production to be employed. e,pansion% contraction o irm. allocation o capital. location o ne" plants. &uantity o output to be produced. replacement o plant e&uipment. sales orecasting. in$entory orecasting. etc' ?' In addition. a managerial economist !as to analy-e c!anges in macro# economic indicators suc! as national income. population. business cycles. and t!eir possible e ect on t!e irm*s unctioning'

@' <e is also in$ol$ed in ad$icing t!e management on public relations. oreign e,c!ange. and trade' <e guides t!e irm on t!e likely impact o c!anges in monetary and iscal policy on t!e irm*s unctioning' A' <e also makes an economic analysis o t!e irms in competition' <e !as to collect economic data and e,amine all crucial in ormation about t!e en$ironment in "!ic! t!e irm operates' B' (!e most signi icant unction o a managerial economist is to conduct a detailed researc! on industrial market' 1;' In order to per orm all t!ese roles. a managerial economist !as to conduct an elaborate statistical analysis' 11' <e must be $igilant and must !a$e ability to cope up "it! t!e pressures' 12' <e also pro$ides management "it! economic in ormation suc! as ta, rates. competitor*s price and product. etc' (!ey gi$e t!eir $aluable ad$ice to go$ernment aut!orities as "ell' 13' At times. a managerial economist !as to prepare speec!es or top management'

Consumer Cemand # Cemand Cur$e. Cemand 4unction D La" o Cemand

#$at is "emand%
0emand for a commodity refers to the quantity of the commodity that people are willing to purchase at a specific price per unit of time, other factors (such as price of related goods, income, tastes and preferences, advertising, etc) being constant. 0emand includes the desire to buy the commodity accompanied by the willingness to buy it and sufficient purchasing power to purchase it. .or instance$(veryone might have willingness to buy -)ercedes$+ class/ but only a few have the ability to pay for it. &hus, everyone cannot be said to have a demand for the car -)ercedes$s 5lass/. 0emand may arise from individuals, household and mar%et. ,hen goods are demanded by individuals (for instance$clothes, shoes), it is called as individual demand. ?oods demanded by household constitute household demand (for instance$demand for house, washing machine). 0emand for a commodity by all individuals4households in the mar%et in total constitute mar%et demand.

"emand &unction
0emand function is a mathematical function showing relationship between the quantity demanded of a commodity and the factors influencing demand. 0" @ f (7", 7y, &, A, A, 7p, (p, 6) In the above equation, 0" @ Buantity demanded of a commodity 7" @ 7rice of the commodity 7y @ 7rice of related goods & @ &astes and preferences of consumer A @ Income level A @ Advertising and promotional activities 7p @ 7opulation (+ize of the mar%et) (p @ 5onsumer*s e"pectations about future prices 6 @ +pecific factors affecting demand for a commodity such as seasonal changes, ta"ation policy, availability of credit facilities, etc.

'a( o) "emand
&he law of demand states that there is an inverse relationship between quantity demanded of a commodity and it*s price, other factors being constant. In other words, higher the price, lower the demand and vice versa, other things remaining constant.

"emand *c$edule
Cemand sc!edule is a tabular representation of the quantity demanded of a commodity at various prices. .or instance, there are four buyers of apples in the mar%et, namely A, ', 5 and 0. 0emand schedule for apples PRICE 7Rs' per Euyer do-en9 7demand do-en9 A Euyer in 7demand do-en9 E Euyer in 7demand do-en9 C Euyer C 7demand in Market Cemand in do-en9 7do-ens9

1;

1=

2>

11

12

1;

3@

13

1=

12

=>

&he demand by 'uyers A, ', 5 and 0 are individual demands. &otal demand by the four buyers is mar%et demand. &herefore, the total mar%et demand is derived by summing up the quantity demanded of a commodity by all buyers at each price.

"emand Cur e
Cemand cur$e is a diagrammatic representation o demand sc!edule . It is a graphical representation of price$ quantity relationship. Individual demand curve shows the highest price which an individual is willing to pay for different quantities of the commodity. ,hile, each point on the mar%et demand curve depicts the ma"imum quantity of the commodity which all consumers ta%en together would be willing to buy at each level of price, under given demand conditions.

0emand curve has a negative slope, i.e, it slopes downwards from left to right depicting that with increase in price, quantity demanded falls and vice versa. &he reasons for a downward sloping demand curve can be e"plained as follows$ 1' Income effect$ :it! t!e all in price o a commodity. t!e purc!asing po"er o consumer increases' (!us. !e can buy same &uantity o commodity "it! less money or !e can purc!ase greater &uantities o same commodity "it! same money' Similarly. i t!e price o a commodity rises. it is e&ui$alent to decrease in income o t!e consumer as no" !e !as to spend more or buying t!e same &uantity as be ore' (!is c!ange in purc!asing po"er due to price c!ange is kno"n as income e ect' 2' +ubstitution effect$ :!en price o a commodity alls. it becomes relati$ely c!eaper compared to ot!er commodities "!ose price !a$e not c!anged' (!us. t!e consumer tend to consume more o t!e commodity "!ose price !as allen. i'e. t!ey tend to substitute t!at commodity or ot!er commodities "!ic! !a$e not become relati$ely dear' 3' Law of diminishing marginal utility$ It is t!e basic cause o t!e la" o demand' (!e la" o diminis!ing marginal utility states t!at as an indi$idual consumes more and more units o a commodity. t!e utility deri$ed rom it goes on decreasing' So as to get ma,imum satis action. an indi$idual purc!ases in suc! a manner t!at t!e marginal utility o t!e commodity is e&ual to t!e price o t!e commodity' :!en t!e price o commodity alls. a rational consumer purc!ases more so as to e&uate t!e marginal utility and t!e price le$el' (!us. i a consumer "ants to purc!ase larger &uantities. t!en t!e price must be lo"ered' (!is is "!at t!e la" o demand also states'

E+ceptions to 'a( o) "emand

&he instances where law of demand is not applicable are as follows$

1.

(!ere are certain goods "!ic! are purc!ased mainly or t!eir snob appeal. suc! as. diamonds. air conditioners. lu,ury cars. anti&ue paintings. etc' (!ese goods are used as status symbols to display one*s "ealt!' (!e more e,pensi$e t!ese goods become. more $aluable "ill be t!ey as status symbols and more "ill be t!ere demand' (!us. suc! goods are purc!ased more at !ig!er price and are purc!ased less at lo"er prices' Suc! goods are called as conspicuous goods' (!e la" o demand is also not applicable in case o giffen goods' Gi en goods are t!ose in erior goods. "!ose income e ect is stronger t!an substitution e ect' (!ese are consumed by poor !ouse!olds as a

2.

necessity' 4or instance. potatoes. animal at oil. lo" &uality rice. etc' An increase in price o suc! good increases its demand and a decrease in price o suc! good decreases its demand' 3' (!e la" o demand does not apply in case o e,pectations o c!ange in price o t!e commodity. i'e. in case o speculation' Consumers tend to purc!ase less or tend to postpone t!e purc!ase i t!ey e,pect a all in price o commodity in uture' Similarly. t!ey tend to purc!ase more at !ig! price e,pecting t!e prices to increase in uture'

,ature O) Managerial Economics

)anagerial (conomics and 'usiness economics are the two terms, which, at times have been used interchangeably. 9f late, however, the term )anagerial (conomics has become more popular and seems to displace progressively the term 'usiness (conomics. &he prime function of a management e"ecutive in a business organization is decision$ma%ing and forward planning. 0ecision$ma%ing means the process of selecting one action from two or more alternative courses of action whereas forward planning means establishing plans for the future. &he question of choice arises because resources such as capital, land, labour and management are limited and can be employed in alternative uses. &he decision$ma%ing function thus becomes one of ma%ing choices or decisions that will provide the most efficient means of attaining a desired end, say, profit ma"imization. 9nce decision is made about the particular goal to be achieved, plans as to production, pricing, capital, raw materials, labour, etc., are prepared. .orward planning thus goes hand in hand with decision$ma%ing. A significant characteristic of the conditions, in which business organizations wor% and ta%e decisions, is uncertainty. And this fact of uncertainty not only ma%es the function of decision$ ma%ing and forward planning complicated but adds a different dimension to it. If %nowledge 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 %nown so that in their light, plans may have to be revised, and a different course of action adopted. )anagers are thus engaged in a continuous process of decision$ma%ing through an uncertain future and the overall problem confronting them is one of ad!usting to uncertainty. In fulfilling the function of decision$ma%ing in an uncertainty framewor%, economic theory can be pressed into service with considerable advantage. (conomic theory deals with a number of concepts and principles relating, for e"ample, to profit, demand, cost, pricing production, competition, business cycles, national income, etc., which aided by allied disciplines li%e Accounting. +tatistics and )athematics can be used to solve or at least throw some light upon the problems of business management. &he way economic analysis can be used towards solving business problems. 5onstitutes the sub!ect$matte of )anagerial (conomics.

"e)inition O) Managerial Economics

According to )cCair and )eriam, )anagerial (conomics consists of the use of economic modes of thought to analyse business situation +pencer and +iegelman have defined )anagerial (conomics as -the integration of economic theory with business practice for the purpose of facilitating decision$ma%ing and forward planning by management/. ,e may, therefore define )anagerial (conomics as the discipline which deals with the application of economic theory to business management. )anagerial (conomics thus lies on the borderline between economics

and business management and serves as abridge between economics and business management and serves as a bridge between the two disciplines.+ee 5hart=

5hart = D (conomics, 'usiness )anagement and )anagerial (conomics.

-spects o) -pplication O) Economics

&he application of economics to business management or the integration of economic theory with business practice, as +pencer and +iegelman have put it, has the following aspects#

1'

Reconciling traditional t!eoretical concepts o economics in relation to t!e actual business be!a$ior and conditions' In economic t!eory. t!e tec!ni&ue o analysis is one o model building "!ereby certain assumptions are made and on t!at basis. conclusions as to t!e be!a$ior o t!e irms are dro"n' (!e assumptions. !o"e$er. make t!e t!eory o t!e irm unrealistic since it ails to pro$ide a satis actory e,planation o t!at "!at t!e irms actually do' <ence t!e need to reconcile t!e t!eoretical principles based on simpli ied assumptions "it! actual business practice and de$elops appropriate e,tensions and re ormulation o economic t!eory. i necessary'

2'

Estimating economic relations!ips. $i-'. measurement o $arious types o elasticities o demand suc! as price elasticity. income elasticity. cross#elasticity. promotional elasticity. cost#output relations!ips. etc' t!e estimates o t!ese economic relation#s!ips are to be used or purposes o orecasting'

3'

Predicting rele$ant economic &uantities. eg'. pro it. demand. production. costs. pricing. capital. etc'. in numerical terms toget!er "it! t!eir probabilities' As t!e business manager !as to "ork in an en$ironment o uncertainty. uture is to be predicted so t!at in t!e lig!t o t!e predicted estimates. decision#making and or"ard planning may be possible'

='

/sing economic &uantities in decision#making and

or"ard planning. t!at is.

ormulating business policies and. on t!at basis. establis!ing business plans or t!e uture pertaining to pro it. prices. costs. capital. etc' (!e nature o economic orecasting is suc! t!at it indicates t!e degree o probability o $arious possible outcomes. i'e' losses or gains as a result o ollo"ing eac! one o t!e strategies a$ailable' <ence. be ore a business manager t!ere e,ists a &uanti ied picture indicating t!e number o courses open. t!eir possible outcomes and t!e &uanti ied probability o eac! outcome' Feeping t!is picture in $ie". !e decides about t!e strategy to be c!osen'

5.

/nderstanding signi icant e,ternal orces constituting t!e en$ironment in "!ic! t!e business is operating and to "!ic! it must ad+ust. e'g'. business cycles. luctuations in national income and go$ernment policies pertaining to public inance. iscal policy and ta,ation. international economics and oreign trade. monetary economics. labour relations. anti#monopoly measures. industrial licensing. price controls. etc' (!e business manager !as to appraise t!e rele$ance and impact o t!ese e,ternal orces in relation to t!e particular business unit and its business policies'

C$ie) C$aracteristics O) Managerial Economics

It would be useful to point out certain chief characteristics of )anagerial (conomics, inasmuch it*s they throw further light on the nature of the sub!ect matter and help in a clearer understanding thereof.

1' 2'

Managerial Economics micro#economic in c!aracter' Managerial Economics largely uses t!at body o economic concepts and principles. "!ic! is kno"n as G(!eory o t!e irm* or GEconomics o t!e irm*' In addition. it also seeks to apply Pro it (!eory. "!ic! orms part o Cistribution (!eories in Economics'

3'

Managerial Economics is pragmatic' It a$oids di icult abstract issues o economic t!eory but in$ol$es complications ignored in economic t!eory to ace t!e o$erall situation in "!ic! decisions are made' Economic t!eory appropriately ignores t!e $ariety o backgrounds and training ound in indi$idual irms but Managerial Economics considers t!e particular en$ironment o decision#making'

='

Managerial Economics belongs to normati$e economics rat!er t!an positi$e economics 7also sometimes kno"n as descripti$e economics9' In ot!er "ords. it is prescripti$e rat!er t!an descripti$e' (!e main body o economic t!eory con ines itsel to descripti$e !ypot!esis. attempting to generali-e about t!e relations among di erent $ariables "it!out +udgment about "!at is desirable or undesirable' 4or instance. t!e la" o demand states t!at as price increases' Cemand goes do"n or $ice#$ersa but t!is statement does not tell "!et!er t!e outcome is good or bad' Managerial Economics. !o"e$er. is concerned "it! "!at decisions oug!t to be made and !ence in$ol$es $alue +udgments'

Production

and

Supply

7roduction analysis is narrower in scope than cost analysis. 7roduction analysis frequently proceeds in physical terms while cost analysis proceeds in monetary terms. 7roduction analysis mainly deals with different production functions and their managerial uses.

+upply analysis deals with various aspects of supply of a commodity. 5ertain important aspects of supply analysis are supply schedule, curves and function, law of supply and its limitations. (lasticity of supply and .actors influencing supply. Pricing Cecisions. Policies and Practices

7ricing is a very important area of )anagerial (conomics. 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 pries decisions ta%en by it. &he important aspects alt with under this area is# 7rice 0etermination in various )ar%et .orms, 7ricing methods, 0ifferential 7ricing, 7roduct$line 7ricing and 7rice .orecasting. Pro it Management

'usiness firms are generally organized for the purpose of ma%ing profits and, in long run, profits provide the chief measure of success. In this connection, an important point worth considering is the element of uncertainty e"iting about profits because of variations in costs and revenues which, in turn, are caused by torso both internal and e"ternal to the firm. If %nowledge about the future were fact, profit analysis would have been a very easy tas%. 2owever, in a world of certainty, e"pectations are not always realized so that profit planning and measurement constitute the difficult are of )anagerial (conomics. &he important acts covered under this area are# Cature and )easurement of 7rofit. 7rofit iciest and &echniques of 7rofit 7lanning li%e 'rea%$(ven Analysis. Capital Management

9f the various types and classes of business problems, the most comple" and able some for the business manager are li%ely to be those relating to the firm*s investments. 8elatively large sums are involved, and the problems are so comple" that their disposal not only requires considerable time and labour but is a term for top$level decision. 'riefly, capital management implies planning and trolls of capital e"penditure. &he main topics dealt with are# 5ost of 5apital. 8ate return and +election of 7ro!ect.

&he various aspects outlined above represent the ma!or uncertainties which a ness firm has to rec%on with, viz., demand uncertainty, cost uncertainty, price certainty, profit uncertainty, and capital uncertainty. ,e can, therefore, conclude the sub!ect$matter of )anagerial (conomic consists of applying economic cripples and concepts towards ad!usting with various uncertainties faced by a ness firm.

Managerial Economics -nd Ot$er *u./ects

Aet another useful method of throwing light upon the nature and scope of managerial (conomics is to e"amine is relationship with other sub!ects. In this connection, (conomics, statistics, )athematics and Accounting deserve special mention. Managerial Economics and Economics

)anagerial (conomics has been described as economics applied to decision$ ma%ing. It may be viewed as a special branch of economics bridging the gulf between pure economic theory and managerial practice.

(conomics has two main divisions# microeconomics and macroeconomics. )icroeconomics has been defined as that branch where the unit of study is an individual or a firm. )acroeconomics, on the other hand, is aggregate in character and has the entire economy as a unit of study.

)icroeconomics, also %nown as price theory (or )arshallian economics.) Is the main source of concepts and analytical tools for managerial economics. &o illustrate various micro$economic concepts such as elasticity of demand, marginal cost, the short and the long runs, various mar%et forms, etc. are all of great significance to managerial economics. &he chief contribution of macro$

economics is in the area of forecasting. &he modern theory of income and employment has direct implications for forecasting general business conditions. As the prospects of an individual firm often depend greatly on general business conditions, individual firm forecasts depend on general business forecasts.

A survey in the 6.E. has shown that business economists have found the following economic concepts quite useful and of frequent application#

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Price elasticity o demand Income elasticity o demand Opportunity cost (!e multiplier Propensity to consume Marginal re$enue product Speculati$e moti$e Production unction Ealanced gro"t! Li&uidity pre erence'

'usiness economics have also found the following main areas of economiFcs as useful in their wor%

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Cemand t!eory (!eory o t!e irm#price. output and in$estment decisions Eusiness inancing Public inance and iscal policy Money and banking National income and social accounting (!eory o international trade Economics o de$eloping countries' Economics and Accounting

Managerial

)anagerial (conomics is also closely related to accounting, which is concerned with recording the financial operations of a business firm. Indeed, accounting information is one of the principal sources of data required by a managerial economist for his decision$ma%ing purpose. .or instance, the profit and loss statement of a firm tells how well the firm has done and the information it contains can be used by managerial economist to throw significant light on the future course of action$whether it should improve or close down. 9f course, accounting data call for careful interpretation. 8ecasting and ad!ustment before they can be used safely and effectively.

It is in this conte"t that the growing lin% between management accounting and managerial economics deserves special mention. &he main tas% of management accounting is now seen as

being to provide the sort of data which managers need if they are to apply the ideas of managerial economics to solve business problems correctly3 the accounting data are also to be provided in a form so as to fit easily into the concepts and analysis of managerial economics.

0ses O) Managerial Economics

)anagerial economics accomplishes several ob!ectives. .irst, it presents those aspects of traditional economics, which are relevant for business decision ma%ing it real life. .or the purpose, it culls from economic theory the concepts, principles and techniques of analysis which have a bearing on the decision ma%ing process. &hese are, if necessary, adapted or modified with a view to enable the manager ta%e better decisions. &hus, managerial economics accomplishes the ob!ective of building suitable tool %it from traditional economics.

+econdly, it also incorporates useful ideas from other disciplines such a psychology, sociology, etc., if they are found relevant for decision ma%ing. In face managerial economics ta%es the aid of other academic disciplines having a bearing upon the business decisions of a manager in view of the carious e"plicit and implicit constraints sub!ect to which resource allocation is to be optimized.

&hirdly, managerial economics helps in reaching a variety of business decisions. 7i9 7ii9 :!at :!at products inputs and and ser$ices s!ould be s!ould producedH be usedH

production

tec!ni&ues

7iii9 <o" muc! output s!ould be produced and at "!at prices it s!ould be soldH 7i$9 7$9 :!at <o" are t!e s!ould best t!e si-es and locations capital o be ne" plantsH allocatedH

a$ailable

.ourthly, managerial economics ma%es a manager a more competent model guilder. &hus he can capture the essential relationships which characterize a situation while leaving out the cluttering details and peripheral relationships.

.ifthly, at the level of the firm, where for various functional areas functional specialists or functional departments e"ist, e.g., finance, mar%eting, personal production, etc., managerial economics serves as an integrating agent by co$coordinating the different areas and bringing to bear on the decisions of each department or specialist the implications pertaining to other functional areas. It thus enables business decision$ ma%ing not in watertight compartments but in an integrated perspective, the significance of which lies in the fact that the functional departments or specialists often en!oy considerable autonomy and achieve conflicting coals.

.inally, managerial economics ta%es cognizance of the interaction between the firm and society and accomplishes the %ey role of business as an agent in the attainment of social and economic welfare. It has come to be realized that business part from its obligations to shareholders has

certain social obligations. )anagerial economics focuses attention on these social obligations as constraints sub!ect to which business decisions are to be ta%en. In so doing, it serves as an instrument in rehiring the economic welfare of the society through socially oriented business decisions.

Managerial Economist 1ole -nd 1esponsi.ilities

A managerial economist can play a very important role by assisting the )anagement in using the increasingly specialized s%ills and sophisticated techniques which are required to solve the difficult problems of successful decision$ma%ing and forward planning. &hat is why, in business concerns, his importance is being growingly recognized. In advanced countries li%e the 6.+.A., large companies employ one or more economists. In our country too, big industrial houses have come to recognize the need for managerial economists, and there are frequent advertisements for such positions. &atas, 05) and 2industan Lever employ economists. Indian 7etrochemicals 5orporation Ltd., a ?overnment of India underta%ing, also %eeps an economist. Let us e"amine in specific terms how a managerial economist can contribute to decision$ma%ing in business. In this connection, two important questions need be considered#

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:!at role does !e play in business. t!at is. "!at particular management problems lend t!emsel$es to solution t!roug! economic analysisH <o" can t!e managerial economist best ser$e management. t!at is. "!at are t!e responsibilities o a success ul managerial economistH

1ole O) Managerial Economist

9ne of the principal ob!ectives of any management in its decision$ma%ing process is to determine the %ey factors which will influence the business over the period ahead. In general, these factors can be divided into two$category (i) e"ternal and (ii) internal. &he e"ternal factors lie outside the control management because they are e"ternal to the firm and are said to constitute business environment. &he internal factors he within the scope and operations of a firm and hence within the control of management, and they are %nown as business operations.

&o illustrate, a business firm is free to ta%e decisions about what to invest, where to invest, how much labour to employ and what to pay for it, how to price its products and so on but all these decisions are ta%en within the framewor% of a particular business environment and the firm*s degree of freedom depends on such factors as the government*s economic policy, the actions of its competitors and the li%e. En$ironmental Studies

An analysis and forecast of e"ternal factors constituting general business conditions, e.g., prices, national income and output, volume of trade, etc., are of great significance since every business from is affected by them. 5ertain important relevant questions in this connection are as follows#

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:!at is t!e outlook or t!e national economyH :!at are t!e most important local. regional or "orld"ide economic trendsH :!at p!ase o immediately a!eadH t!e business cycle lies

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:!at about population s!i ts and t!e resultant ups and do"ns in regional purc!asing po"erH :!at are t!e demands prospects in ne" as "ell as establis!ed marketsH :ill c!anges in social be!a$ior and as!ions tend to e,pand or limit t!e sales o a company*s products. or possibly make t!e products obsoleteH

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:!ere are t!e market and customer opportunities likely to e,pand or contract most rapidlyH :ill o$erseas markets e,pand or contract. and !o" "ill ne" oreign go$ernment legislation*s a ect operation o t!e o$erseas plantsH :ill t!e a$ailability and cost o credit tend to increase or decrease buyingH Are money or credit conditions a!ead likely to be easy or tig!tH :!at t!e prices o ra" materials and inis!ed products are likely to beH Is competition likely to increase or decreaseH :!at are t!e main components o t!e i$e#year planH :!at are t!e areas "!ere outlays !a$e been increasedH :!at are t!e segments. "!ic! !a$e su ered a cut in t!eir outlayH

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:!at is t!e outlook regarding go$ernment*s economic policies and regulationsH :!at about c!anges in de ense e,penditure. ta, rates. tari s and import restrictionsH :ill Reser$e Eank*s decisions stimulate or depress industrial production and consumer spendingH <o" "ill t!ese decisions a ect t!e company*s cost. credit. sales and pro itsH

8easonably accurate answers to these and similar questions can...

(nable management*s to chal% out more wisely the scope and direction of their own business plans and to determine the timing of their specific actions. And it is these questions which present some of the areas where a managerial economist can ma%e effective contribution.

&he managerial economist has not only to study the economic trends at the macro$level but must also interpret their relevance to the particular industry4firm where he wor%s. 2e has to digest the ever$growing economic literature and advise top management by means of short, business$li%e practical notes.

In a mi"ed economy li%e India, the managerial economist pragmatically interprets the intentions of controls and evaluates their impact. 2e acts as a bridge between the government and the

industry, translating the government*s intentions and transmitting the reactions of the industry. In fact, government policies charge out of the performance of industry, the e"pectations of the people and political e"pediency. Eusiness Operations

A managerial economist can also be helpful to the management in ma%ing decisions relating to the internal operations of a firm in respect of such problems as price, rate of operations, investment, e"pansion or contraction. 5ertain relevant questions in this conte"t would be as follows#

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:!at "ill be a reasonable sales and pro it budget or t!e ne,t yearH :!at "ill be t!e most appropriate production Sc!edules and in$entory policies or t!e ne,t si, mont!sH :!at c!anges in "age and price policies s!ould be made no"H <o" muc! cas! "ill be a$ailable ne,t mont! and !o" s!ould it be in$estedH 4unctions

Speci ic

A further idea of the role managerial economists can play, can be had from the following specific functions performed by them as revealed by a survey pertaining to 'ritain conducted by E.G.,. Ale"ander and Ale"ander ?. Eemp#

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Sales orecasting Industrial market researc!' Economic analysis o competing companies' Pricing problems o industry' Capital pro+ects' Production programs' Security%in$estment analysis and orecasts' Ad$ice on trade and public relations' Ad$ice on primary commodities' Ad$ice on oreign e,c!ange' Economic analysis o agriculture' Analysis o underde$eloped economics' En$ironmental orecasting'

&he managerial economist has to gather economic data, analyze all pertinent information about the business environment and prepare position papers on issues facing the firm and the industry. In the case of industries prone to rapid technological advances, he may have to ma%e a continuous assessment of the impact of changing technology. 2e may have to evaluate the capital budget in the light of short and long$range financial, profit and mar%et potentialities. Hery often, he may have to prepare speeches for the corporate e"ecutives.

It is thus clear that in practice managerial economists perform many and varied functions. 2owever, of these, mar%eting functions, i.e., sales forecasting and industrial mar%et research, has been the most important. .or this purpose, they may compile statistical records of the sales performance of their own business and those relating to their rivals, carry our analysis of these records and report on trends in demand, their mar%et shares, and the relative efficiency of their retail outlets. &hus while carrying out their functions3 they may have to underta%e detailed statistical analysis. &here are, of course, differences in the relative importance of the various functions performed from firm to firm and in the degree of sophistication of the methods used in carrying them out. 'ut there is no doubt that the !ob of a managerial economist requires alertness and the ability to wor% under pressure. Economic Intelligence

'esides these functions involving sophisticated analysis, managerial economist may also provide general intelligence service supplying management with economic information of general interest such as competitors prices and products, ta" rates, tariff rates, etc. In fact, a good deal of published material is already available and it would be useful for a firm to have someone who understands it. &he managerial economist can do the !ob with competence. Participating in Public Cebates

)ay well$%nown business economists participate in public debates. &heir advice and views are being sought by the government and society ali%e. &heir practical e"perience in business and industry ads stature to their views. &heir public recognition enhances their stature in the organization itself. Indian Conte,t

In the Indian conte"t, a managerial economist is e"pected to perform the following functions#

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Macro# orecasting or demand and supply' Production planning at macro and micro le$els' Capacity planning and product#mi, determination' Economics o $arious productions lines' Economic easibility o ne" production lines%processes and pro+ects' Assistance in preparation o o$erall de$elopment plans' Preparation o periodical economic reports bearing on $arious matters suc! as t!e company*s product#lines. uture gro"t! opportunities. market pricing situation. general business. and $arious national%international actors a ecting industry and business'

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Preparing brie s. speec!es. articles and papers or top management or $arious C!ambers. Committees. Seminars. Con erences. etc' Feeping management in ormed o $arious national and international de$elopments on economic%industrial matters'

,ith the adoption of the Cew (conomic 7olicy, the macro$economic (nvironment is changing fast at a pace that has been rarely witnessed before. And these changes have tremendous implications for business. &he managerial economist has to play a much more significant role. 2e has to constantly gauge the possibilities of translating the rapidly changing economic scenario into viable business opportunities. As India marches towards globalization, he will have to interpret the global economic events and find out how his firm can avail itself of the carious e"port opportunities or of establishing plants abroad either wholly owned or in association with local partners.

1esponsi.ilities O) Managerial Economist

2aving e"amined the significant opportunities before a managerial economist to contribute to managerial decision$ma%ing, let us ne"t e"amine how he can best serve the management. .or this, he must thoroughly recognize his responsibilities and obligations.

A managerial economist can serve management best only if he always %eeps in mind the main ob!ective of his business, viz., to ma%e a profit on its invested capital. 2is academic training and the critical comments from people outside the business may lead a managerial economist to adopt an apologetic or defensive attitude towards profits. 9nce management notices this, his effectiveness is almost sure to be lost. In fact, he cannot e"pect to succeed in serving management unless he has a strong personal conviction that profits are essential and that his chief obligation is to help enhance the ability of the firm to ma%e profits.

)ost management decisions necessarily concern the future, which is rather uncertain. It is, therefore, absolutely essential that a managerial economist recognizes his responsibility to ma%e successful forecasts. 'y ma%ing best possible forecasts and through constant efforts to improve upon them, he should aim at minimizing, if not completely eliminating, the ris%s involved in uncertainties, so that the management can follow a more orderly course of business planning. At times, he will have to reassure the management that an important trend will continue3 in other cases, he may have to point out the probabilities of a turning point in some activity of importance to management. In any case, he must be willing to ma%e considered but fairly positive statements about impending economic developments, based upon the best possible information and analysis and sta%e his reputation upon his !udgment. Cothing will build management confidence in a managerial economist more quic%ly and thoroughly than a record of successful forecasts, well documented in advance and modestly evaluated when the actual results become available.

A few corollaries to the above proposition need also be emphasized here.

.irst, he has a ma!or responsibility to alert Imanagement at the earliest possible moment in case he discovers an error in his forecast. 'y promptly drawing attention to changes in forecasting conditions, he will not only assist management in ma%ing appropriate ad!ustment in policies and programs but will also be able to strengthen his own position as a member of the management team by %eeping his fingers on the economic pulse of the business.

+econdly, he must establish and maintain many contacts with individuals and data sources, which would not be immediately available to the other members of the management. ("tensive familiarity with reference sources and material is essential, but it is still more important that he %nows individuals who are specialists in particular fields having a bearing on his wor%. .or this purpose, he should !oin professional associations and ta%e active part in them. In fact, one of the best means of determining the caliber of a managerial economist is to evaluate his ability to obtain information quic%ly by personal contacts rather than by lengthy research from either readily available or obscure reference sources. ,ithin any business, there may be a wealth of %nowledge and e"perience but the managerial economist would be really useful if he can supplement the e"isting %now$how with additional information and in the quic%est possible manner.

Again, if a managerial economist is to be really helpful to the management in successful decision$ ma%ing and forward planning, he must be able to earn full status on the business team. 2e should be ready and even offer himself to ta%e up special assignments, be that in study teams, committees or special pro!ects. .or, a managerial economist can only function effectively in an atmosphere where his success or failure can be traced not only to his basic ability, training and e"perience, but also to his personality and capacity to win continuing support for himself and his professional ideas. 9f course, he should be able to e"press himself clearly and simply and must always try to minimize the use of technical terminology in communicating with his management e"ecutives. .or, it is well %nown that hat management does not understand, it will almost automatically re!ect. .urther, while intellectually he must be in tune with industry*s thin%ing the wider national perspective should not be absents from his advice to top management.

2uestion 3an4
1' 2' 3' =' Ce ine managerial economics "it! de inition <o" does managerial economics di er rom economicsH :rite a s!ort note on managerial economist' E,plain t!e scope o managerial economics'