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Managerial Economics

Unit I Definition of Economics: The word economics has come from ancient Greek word Oikonomia- management of household administration. It means that economics is that knowledge which is concerned with the management of wants by household. Later on this definition changed and different definitions were given by many experts. The important four basic definitions for the economics are: 1.Science of wealth 2.Science of Material welfare 3.Science that Deals with Scarcity 4.Science of Economic Growth - Adam Smith - Alfred Marshall - Lionel Robbins - Paul A. Samuelson

Adam Smith (Economics as a Science of Wealth): Economic laws and practices have been in operation ever since human life came in existence. Adam Smith is regarded as the father of economics, who first time organised and presented economic thought in a systematic way in his book An Enquiry into the Nature and Causes of the Wealth of Nations. This book was first published in the year 1776. This gave raise to whole new science known as economics. This is how Adam Smith is known as the father of economics. Adam Smith defined economics as a science which studies the nature and causes of the wealth of nations for Adam Smith wealth was to be-all and end-all of economic activity. Goods have value in use (Utility) and value in exchange (Price). He defined wealth as all those goods which command value in exchange. Thus economics seeks to explain and analyses the generation and distribution of wealth. This definition came in for sharp criticism for its narrow vision, and hence, since has largely been abandoned. Shortcomings of Smith: a)Ignored man and behaviour b)Meaning of wealth was restricted to material goods, services are not included. Alfred Marshall-(Economics as a Science of Material Welfare): Removing the shortcomings of Adam Smith, he shifted emphasis from wealth to welfare of man. The great economist considered economics as a means or an instrument to better the conditions of human life. He defines economics, Political economy or economics is a study of mankind in the ordinary business of life, and 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 wellbeing. How a man earn income and how he spend it. Thus economics is the study of man which are related to acquisition and enjoyment of wealth.It is on the one side a study of wealth and on the other and more important side a part of the study of man. For Marshall Wealth was only one of the ways to achieve economic welfare.

The important features of this definition is 1Economics is a study of the ordinary business of life 2Economics is a social science 3Economics studies only the material requirements of well-being. Shortcomings: a) But Marhall forgot to talk about scarcity of resources, b) Also his theory was not scientific. Material Welfare can not be quantified. c) Economics is not a social science but a human science. Lionel Robbins-(Economics as a Science of Allocation of Resources) Lionel Robbins is famous economist in 1932 out of his famous book, The nature and significance of Economic Science, and introduced the, Scarcity definition of economics. The scarcity definition of economics has been pounded by Lionel Robbins. His definition deals with scarcity. He defines economics as, Economics is the science which studies human behaviour as relationship between ends (wants) and scarce means (resources) which have alternative uses. So he discussed human behaviour concerned with the utilization of scarce (limited) resources to achieve unlimited ends (results). Features of Robbins definitions: 1Economics is a positive science, it states the facts as they are 2Economics studies human behaviour relating to decision making regarding the use of resources 3Human wants are unlimited 4The available means are limited. But these are capable of alternative uses. Shortcomings: a)Robbins definition was considered narrow, it covers only valuation but in economics there are other things too, like capital, labour income etc. b)It excludes the concept purpose which is the basis of any human action. Prof. Paul. A. Samuelson (Economics as Science of Growth): Finally Professor Paul A Samuelson gave a most satisfactory definition of economics. He added to the utility of Robbins definition. He defines economics as follows, Economics is the study of how man 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 future among various people and groups of society. 1The definition focus on both scarcity and growth. 2It is also known as the growth definition of economics.

He remarked-logically, there is no fundamental about the traditional boundaries of economics science. It is not possible to formulate restrict definition of economics. We accept definition of economics if it is related with a) Human activities, b) Activities related with wealth getting and using- more specifically, production, distribution, consumption etc. Thus it is concerned with activities which can be quantified. c) Scarcity d) Human Welfare- maximization of social welfare

Conclusion: Therefore economics is a science which studies human behaviour in relation to optimizing allocation of available resources to achieve the given end (result or target). Economics is about: a)Choices & Decision- You have taken decision to study Engineering. You have other options too but you go for your choice. Why you opted for Engineering? This answer will be given by economics. Since you have to use your scarce resources (time and money) which are limited. b)Human action- Purposeful behaviour (why you selected Engg?)Here you will have some purpose of doing engineering like getting good job, better lifestyle etc c)Scarcity- Most fundamental in economics is scarcity. If any thing is scarce it is subject to economics. d)Tradeoff- In economics you trade off between different resources by choosing one resource and giving up other resource or increasing consumption of one necessary thing and decreasing the use of other unimportant resource to reach the optimum level of combination for best satisfaction. e)Marginal Analysis- We use marginal analysis to make choices and decision. Objective is to get maximum result from each additional unit of resources. Important Concepts of Economics: Some Important concepts of Economics are: 1.Goods 2.Wealth, Capital and Income 3.Money 4.Value and Price 5.Equilibrium 6.Consumption and Wants 7.Slope or Rate of Change 1. Goods: The human wants are the starting point of all economic activity. There are two things with which he can satisfy these wants goods and services. Goods mean the commodities that we use, and services refer to the work that a person may do. Services are not something tangible or concrete. Generally goods refer to those material and non-material objects which satisfy

human wants. But in economics, the term is used in a narrow sense. For our purpose the goods includes only those material objects which possess the following characteristics. (i) These can be transferred from one person to another and (ii) These can be exchanged for one another. The most important classification of goods is as Free goods and Economic goods. Free goods are those that exist in plenty that you can with out any payment. E.g. Air, Water, sunshine, etc Economic goods are those goods which are scare and exist in limit quantity, man can have it by paying for the goods. E.g. T.V., Washing machine, mobile phone etc., It can be further classified into: (i) Consumer goods and (ii) Producer goods (also known as Capital goods). (i) Consumer goods: are those goods which directly satisfy human wants, e.g. food, cloths, house etc. It can be classified into (a) Durable goods (b) Single-use goods (a) Durable goods: The goods that can be consumed a number of times without any damages to its utility and its life time is more e.g. furniture, shoes, t.v, etc (b) Single-use (Non Durable) goods: The goods have limited life and it gets destroyed as soon as they are consumed e.g. food, cold drinks, vegetables, fruits etc. (ii) Producer goods (Capital goods): these goods that help in further production and may durable goods like machines, tools, etc and single use goods like raw materials, coal, fuel, etc. 2. Wealth, Capital and Income: Wealth is the stock of all those objects-material or immaterial which possess the following characteristics, (i) it must have utility (ii) it must be scarce (iii) it must be transferable (iv) it must be external to human being All the economic goods possess the above characteristics; a stock of such goods will be called wealth. Some immaterial objects like goodwill also form part of wealth. These are known as immaterial wealth. Wealth can be classified into four as follows: i)Personal Wealth- like buildings, ornaments, cloths etc ii)Social wealth- like roads, bridges, public hospitals, etc iii)National wealth- mines, forests, rivers, etc iv)International wealth- like international sea- routes, air-routes etc. Capital: It is the part of wealth which is used in the process of production like tools, machinery, raw materials, etc., it would be seen that all capital is wealth but all wealth is not capital. Income: The earnings received by various factors of production- land, labour, capital and organisation- according to a time schedule are called income. It is obtained by producing goods, performing services or by services or by investing. 3. Money: Money is anything that is generally acceptable as a medium of exchange and acts as a measure of value. It is accepted in payment of goods and services. It is given and received without reference to the standing of the person who offers it as payment. It is classified as (i) Cash money- it includes currency notes and coins

(ii) Bank money- it consists of cheques, drafts, bills of exchange, etc. 4. Value and Price: The term value is used to express the utility or usefulness of a commodity or services; the term price is used to explain the units of money required to purchase the commodity. 5. Equilibrium: The word Equilibrium has been borrowed from Physics. It is very frequently used in modern economic analysis. Equilibrium means a state of balance. When forces acting in opposite direction are exactly equal, the object on which they are acting is said to be in a state of equilibrium. It also refers to a state when a situation is ideal or optimum or when complete adjustment has been made to changes in an economic situation, there is no incentive for any more change, so that no advantage can be obtained by making a change. For e.g. A consumer is said to be in an equilibrium position when he is deriving maximum satisfaction. A producer or a firm is said to be in equilibrium when it is making a maximum profit or incurring a minimum loss, here there will be no inducement to change. 6. Consumption and Wants: Consumption means the using up of goods and services in such a manner that the wants of members of the community are satisfied, thus it may be defined as any economic activity directed to satisfy human and his wants. If any goods are destroyed by unforeseen accidents like earthquake, flood, wars etc it is not consumption as there is no economic purpose is served. It is divided as Consumption of goods- there is always a time gap between production and consumption and Consumption of services- services are consumed the moment they are produced. Wants means a wish or a desire. Which plays a vital role in the economic life are those which have an urge to effort and which find their satisfaction through that effort. Wants differ in their intensity, it can be conveniently classified into three categories as (a) Necessaries (b) Comfort (c) Luxuries. 7. Slope or Rate of Change: The concept of slope or rate of change is essential to gain an understanding of many economic principles. The slope, of a line or curve is defined as the rise / run or Y / X, where delta () refers to a change in The slope of a line is a rate of change.

Basic Economic Problem: From the study of the essential processes of an economy, it would appear that some fundamental problems arise whatever the type of economy. An economy exists because of two basic facts, 1.Human wants for goods and services are unlimited 2.Productive resources with which to produce goods and services are scare. Wants are unlimited and resources are limited, the economy has to decide how to use its scarce resources to give the maximum possible satisfaction to the members of the society. In doing so,

an economy has to solve some basic problems called central problems of an economy, which are: 1.WHAT to Produce 2.HOW to Produce 3.FOR WHOM to Produce What ever the type of economy or economic system, these problems has to be solved some how. These are the basic and fundamental for all economies. 1. WHAT to Produce: The problem what to produce can be dived into two related questions. a. Which goods are to be produced and which not? b. What quantities those goods, which the economy has decided to produce, are to be produced? If productive resources were unlimited we could produce as many numbers of goods as we like. If the resources are in fact scarce relative to human wants, an economy must choose among different alternative collections of goods and services that it should produce. E.g. If it is desired to produce more wheat and less cotton, land use will have to get diverted for cultivation of cotton to wheat. 2. HOW to Produce: 1The problem how to produce means which combination of resources is to be used for the production of goods and which technology is to be made use of in production. 2Once the society has decide what goods and services are to be produced and in what quantities, it must then decide how these goods shall be produced. There are various alternative methods of producing a good and the economy has to choose among them. It is always possible to employ alternative techniques of production to produce a commodity, e.g. labour can more generally, be substituted by machines, and viceversa. 3A choice would have to be made say between labour- intensive techniques and capitalintensive techniques of production. 4E.g. Bricks and cement can be carried by labour to the upper floors of a building under construction. Alternatively elevators and lifts can do the job; we have to make the choice. 3. FOR WHOM to Produce: 1 For whom to produce it means how the national product is to be distributed among the members of the society, who should get how much of the total amount of goods and services produced in the economy. 2 The third problem of sharing of the national product, Distribution of the national product depends on the distribution of national income. Those people who have larger incomes would have larger capacity to buy goods and hence will get greater share of goods and services. Those, who have low incomes would have less purchasing power to buy things. The more equal is the distribution of income, the more equal will be the distribution of the national product.

The question arises how is the national income to be distributed, that is, how is it to be determined as to who should get how much of the national income? Should the people get equal incomes and hence equal shares from the national product, or whether the distribution f national income should be done on the basis of the Marxian principle from each according to his ability, to each according to his needs or should the distribution of national income be in accordance with the contribution made to the total production, that is, should everybody get income exactly equal to what he produces? The main difficulty in the question of distribution of national product or income is how to reconcile the equity and justice aspect of distribution with the incentive aspect. From the point of view of equity distribution of national product or income n the basis f equality seems to be the best that the problem is that equality in the distribution of national product or income may adversely affect the incentive to produce more. If this incentive is destroyed or greatly diminished as a result of promoting equality, the total national output available for sharing may be so much smaller that the living standards of all may go down. The Micro Economics and Macro Economics: Economic analysis is of two types (a) Micro economic analysis and (b) Macro economic analysis 1. Micro economics: According to E. Boulding, Micro economics is the study of particular firm, particular household, individual price, wage, income, industry, and particular commodity. In the words of Leftwitch, Micro economics is concerned with the economic activities of such economic units as consumers, resource owners and business firms. 1Micro is a Greek word means small 2Micro economic theory studies the behaviour of individual decision-making units such as consumers resource owners, business firms, individual households, wages of workers, etc 3It studies the flow of economic resources or factors of production from the resource owners to business firms and the flow of goods and services from the business firms to households. It studies the composition of such flows and how the prices of goods and services in the flow are determined. 4In this analysis economists pick up a small unit and observe the details of its operation. 5It provides analytical tools for the study of the behaviour of market mechanism. 6It is also called as Price theory and 7It is also called as Partial Equilibrium analysis. Importance of Micro economics: 1Micro economics occupies a very important place in the study of economic theory. 2It has both theoretical and practical importance. 3It explains the functioning of a free enterprise economy 4It tells how millions of consumers and producers in an economy take decisions about the allocation of productive resources among millions of goods and services. 5It explains how through market mechanism goods and services produced in the community are distributed 6It explains the determination of the relative prices of the various products and productive services.

7It helps in the formulation of economic policies calculated to promote efficiency in production and the welfare of the masses. Limitations: 1It cannot give an idea of the functioning of the economy as a whole. An individual industry may be flourishing, where as the economy as a whole may be languishing 2It assumes full employment which is a rare phenomenon, at any rate in the capitalist world. Therefore it is an unrealistic assumption 2. Macro economics: According to E. Boulding Macro economics deals not with individual quantities as such but with aggregates of these quantities, not with individual income but with national income not with individual prices but with price levels, not with individual outputs but with national output. According to Gardner Ackely, Macro economics 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. 1Macro economics is the obverse of microeconomics. 2It is the study of economic system as a whole. 3It studies not one economic unit like a firm or an industry but the whole economic system 4Therefore it deals with totals or aggregates national income output and employment, total consumption, saving and investment and the genera level of prices. 5It is also called as Income theory and 6It is also called as aggregative economics. Importance: 1It helps in understanding the functioning of a complicated economic system 2It gives a birds eye view of the economic world 3For the formulation of useful economic policies for the nation macro economics is of the utmost significance. 4It is far more fruitful to regulate aggregate employment and national income and to work out a national wage policy 5It occupies most important place in economic theory in its pursuit of the solution of urgent economic problems. Limitations: 1Individual is ignored altogether. It is individual welfare which is the main aim of economics. 2It overlooks individual differences. Say the general price level may be stable, but the price of food grains may have gone spelling ruin to the poor.

Difference between Micro economics and Macro economics:

The main differences between micro economics and macro economics are the following: S.n Micro economics Macro economics o 1. Difference in the degree It studies the individual units of It deals with aggregates like of aggregation: the economy like a firm, a national income and aggregate particular commodity. savings. It studies the problem of the economy as a whole 2. Difference in objectives It is to study of principles, It studies the problems, policies problems and policies concerning and principles relating full the optimum allocation of employment of resources and resources growth of resources.

3.

Difference matter

of

subject It deals with the determination of It is full employment, national price, consumers equilibrium, income, general price-level, distribution and welfare, etc. trade cycles, economic growth, etc. Micro economics laws establish relationship between the causes and effects of economics phenomena and it is formulated by taking some assumptions. Macro economics elements are categorized into aggregate units like aggregate demand, aggregate supply, total consumption, total investment, etc. It analysis how full employment can be achieved. It deals with equilibrium between the forces demand and supply of whole economy.

4.

Method of study

5. 6.

Different assumptions

It analysis how production and factors of production are allocated among different uses. Difference of the forces of It studies the equilibrium equilibrium between the forces of individual demand and supply or market demand and supply.

Nature of Economics: Economics as Science: Science is a systemized body of knowledge about a particular branch of the universe which contains theories and principles, which are based on cause and effect relationship and are universal in nature. Similarly economics is a science, since it is a systemized body of knowledge about economic activities. As science is based on facts, economics is also based on facts which are examined by economists. As science it uses theories, principles and mathematical tools. Like science it also go through collection of data, observations of the information, examining these information, explaining and finally verifying them. Economics as an Arts: According to JM Keynes, an arts is a system of rules for attainment of given ends. It implies that art is practical. An art is also defined as collection or body of rules for the execution of external work. Applying this definition we can also say that economics is an

art. Branches like Consumption, Production and Public Finance provide practical guidance to solve economic problems. A science teaches us to know while an arts teaches us to do, in other words a science is theoretical and an arts is practical. Applying this definition, economics is an art. Since branches like production, consumption provides practical guidance to solve economics problems. In words of Samuelson Economics is the oldest of the arts, the newest of science indeed queen of all social science. Economics as Positive (Descriptive) Science: Positive science is a systemized knowledge concerning what is. It describes things the way they are, that is why they are called descriptive science. Classical economist proposed economics should be concerned only with what it is. They should not pass moral judgments. If they will do, ethical issues will be involved and this will lead to disagreement of economists theory and finally no growth of economics. Moral judgments many times may be wrong in practical situation. Economics as a Normative Science: Normative science is a body of systemized knowledge relating to the criteria of what ought to be. Challenging the view of classical school, Alferd Marshall put the argument that economics is a normative science, since it has norms (welfare). It deals with what ought to be. Economists must tell what should be done and what should be avoided. It is realistic and human in nature. Economics as Social Science: Economics is a social science which suggests that modes of promotion of economic welfare with limited means. It can be a great service to mankind. It can help person to get maximum welfare from limited resources.

Significance of Economics:
Economics is useful not only to individual but also to business firms, society and nation as a whole. Economics provides tools which can be used for solving various household, business and nations problem. Knowledge of economics is useful in almost all sphere of life. Our day starts with application of economics policies and ends by it directly or indirectly. It helps businessmen in his various decisions making with regard to price, cost, and production etc. Similarly for policy maker it helps in formulating appropriate policies for economy. Importance for Individuals- On individual level the use of economical tools is vital. Since an individual has a limited source of income and the desire and requirements of his family are unlimited. A housewife faces a difficult task to manage her family in a fixed income. Thus an individual has to use economic tools to get optimum out put from his/ her limited source. He/ she have to regularly tradeoff between options available and maximization of satisfaction with given source of income. Theory of opportunity cost & marginal utility are frequently used by an individual. Importance for a Businessmen- For any firm it is not possible to run business without using economic theories and principles. Managerial economics is an important tool for any business establishment while making any decision. Some of the important tools of economics used by managers are- law of demand, law of production, law of consumer behaviour, elasticity of demand and supply, theory of firm and many popular other principles and policies. Some time

they have to use macroeconomics too to understand external environments and government policies which are very important for their business. Importance for Nation- Macroeconomics has a significant role in the growth of any nation. Government uses different macro economical policies and theories for effective use of various resources for economic growth of the nation and for raising standard of living of people. Problem like employment, national income, inflation and growth of economy in total are solved by suitable macroeconomics tools. Fiscal, monetary, Industrial, Exim policies are governed by economic theories and these policies are used for the development of nation as whole.

Managerial Economics:
In reality decision making is not so easy because the economic world is very complex and most economic decisions have to be taken under the condition of imperfect knowledge, risk and uncertainties. Therefore taking an appropriate decision or making an appropriate choice in a extremely complex situation is very difficult task. In their endeavour to study the complex decision making process, economists have developed a large kit of analytical tools and techniques with the support of mathematics and statistics. They have developed a large corpus of economic theories with a fairly high predictive power. Analytical tools, techniques, theories and laws are used in business decision making and are dealt in separate branch known as managerial economics. Therefore :Managerial economics is a discipline which deals with the application of economic theory to business management. It deals with the use of economic concepts and principles of business decision making. Formerly it was known as Business Economics but the term has now been discarded in favour of Managerial Economics. Managerial Economics may be defined as the study of economic theories, logic and methodology which are generally applied to seek solution to the practical problems of business. Managerial Economics is thus constituted of that part of economic knowledge or economic theories which is used as a tool of analysing business problems for rational business decisions. Managerial Economics is often called as Business Economics or Economic for Firms. Managerial Economics is concerned with application of economic concept, theories to the problems of formulating rational decision making. It is an integration of economic theories and business practices for the purpose of facilitating decision making and forward planning by management. It is concerned with the application of economic principles and methodologies to the decision making process with in the firm or organization.

Definition of Managerial Economics: Managerial Economics is economics applied in decision making. It is a special branch of economics bridging the gap between abstract theory and managerial practice. Haynes, Mote and Paul. Business Economics consists of the use of economic modes of thought to analyse business situations. McNair and Meriam Business Economics (Managerial Economics) is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management. Spencer and Seegelman. Managerial economics is concerned with application of economic concepts and economic analysis to the problems of formulating rational managerial decision. Mansfield

Nature and Scope of Managerial Economics:


The primary function of management executive in a business organisation is decision making and forward planning. Decision making and forward planning go hand in hand with each other. Decision making means the process of selecting one action from two or more alternative courses of action. Forward planning means establishing plans for the future to carry out the decision so taken. The problem of choice arises because resources at the disposal of a business unit (land, labour, capital, and managerial capacity) are limited and the firm has to make the most profitable use of these resources. The decision making function is that of the business executive, he takes the decision which will ensure the most efficient means of attaining a desired objective, say profit maximisation. After taking the decision about the particular output, pricing, capital, rawmaterials and power etc., are prepared. Forward planning and decision-making thus go on at the same time. A business managers task is made difficult by the uncertainty which surrounds business decision-making. Nobody can predict the future course of business conditions. He prepares the best possible plans for the future depending on past experience and future outlook and yet he has to go on revising his plans in the light of new experience to minimise the failure. Managers are thus engaged in a continuous process of decision-making through an uncertain future and the overall problem confronting them is one of adjusting to uncertainty. In fulfilling the function of decision-making in an uncertainty framework, economic theory can be, pressed into service with considerable advantage as it deals with a number of concepts and principles which can be used to solve or at least throw some light upon the problems of business management e.g. to profit, demand, cost, pricing, production, competition, business cycles, national income etc. The way economic analysis can be used towards solving business problems, constitutes the subject-matter of Managerial Economics. There are a number of issues relevant to businesses that are based on economic thinking or analysis. Examples of questions that managerial economics attempts to answer are: What determines whether an aspiring business firm should enter a particular industry or simply start producing a new product or service? Should a firm continue to be in business in an industry in which it is currently engaged or cut its losses and exit the industry? Why do some

professions pay handsome salaries, whereas some others pay barely enough to survive? How can the business best motivate the employees of a firm? The issues relevant to managerial economics can be further focused by expanding on the first two of the preceding questions. Let us consider the first question in which a firm (or a would-be firm) is considering entering an industry. For example, what led Frederick W. Smith the founder of Federal Express, to start his overnight mail service? A service of this nature did not exist in any significant form in the United States, and people seemed to be doing just fine without overnight mail service provided by a private corporation. One can also consider why there are now so many overnight mail carriers such as United Parcel Service and Airborne Express. The second example pertains to the exit from an industry, specifically, the airline industry in the United States. Pan Am, a pioneer in public air transportation, is no longer in operation, while some airlines such as TWA (Trans World Airlines) are on the verge of exiting the airlines industry. Why, then, have many airlines that operate on international routes fallen on hard times, while small regional airlines seem to be doing just fine? Managerial economics provides answers to these questions. In order to answer pertinent questions, managerial economics applies economic theories, tools, and techniques to administrative and business decision-making. The first step in the decision-making process is to collect relevant economic data carefully and to organize the economic information contained in data collected in such a way as to establish a clear basis for managerial decisions. The goals of the particular business organization must then be clearly spelled out. Based on these stated goals, suitable managerial objectives are formulated. The issue of central concern in the decision-making process is that the desired objectives be reached in the best possible manner. The term "best" in the decision-making context primarily refers to achieving the goals in the most efficient manner, with the minimum use of available resources implying there be no waste of resources. Managerial economics helps the manager to make good decisions by providing information on waste associated with a proposed decision.

Chief Characteristics of Managerial Economics:


1It is Micro in Nature- It is an extension of Microeconomics, where we discuss about an individual firm. 2Use Market theory-It largely uses theory of private firm and general market. 3Goal Oriented- Managerial Economics is used in decision making to reach a particular goal. 4Science & Arts- Analysis and experiments are done then it is applied and practiced. 5Normative Science- Decision is taken for what it ought to be. 6Pragmatic Approach- It is a practical subject, manager does not follow 100 % theory and principles of managerial economics always, rather it incorporates the practical complications prevailing at that point of time. Since in economic theory some assumptions are always there and it is not necessary that these assumptions are always applicable. 7Use Some Theory of Macroeconomics- The Manager should be aware about the macro

level information too e.g. rate of inflation, growth of economy, government policies in relation to that particular product or industry, since these factors affect individual firm. Therefore use of macroeconomics by a decision maker in managerial economics is a common practice.

Scope of Managerial Economics:


The name managerial economics suggest that it includes that part of economics that is essential for a manager of a firm to run his business in most profitable and smooth way. Running business means making decision by choosing best among the available alternatives. The scope extends itself to all those areas of business where economic consideration for decision making is essential. Since the area of business is a continuously growing, the scope of managerial economics is not yet clearly laid out. Even then the following fields may be said to generally fall under Managerial Economics: 1.Demand Analysis and Forecasting 2.Cost and Production Analysis 3.Pricing Decisions, Policies and Practices 4.Profit Management 5.Capital Management 6.Sales Promotion and Marketing Strategies These divisions of business economics constitute its subject matter. Recently, managerial economists have started making increased use of Operation Research methods like Linear programming, inventory models, Games theory, queuing up theory etc., have also come to be regarded as part of Managerial Economics.

1.Demand Analysis and Forecasting: A business firm is an economic organisation which is engaged in transforming productive resources into goods that are to be sold in the market. A major part of managerial decision making depends on accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production schedules and employing resources. It will help management to maintain or strengthen its market position and profit base. Demand analysis also identifies a number of other factors influencing the demand for a product. Demand analysis and forecasting occupies a strategic place in Managerial Economics. 2.Cost and production analysis: A firms profitability depends much on its cost of production. A wise manager would prepare cost estimates of a range of output, identify the factors causing are cause variations in cost estimates and choose the cost-minimising output level, taking also into consideration the degree of uncertainty in production and cost calculations. Production processes are under the charge of engineers but the business manager is supposed to carry out the production function analysis in order to avoid

wastages of materials and time. Sound pricing practices depend much on cost control. The main topics discussed under cost and production analysis are: Cost concepts, costoutput relationships, Economics and Diseconomies of scale and cost control. 3.Pricing decisions, policies and practices: Pricing is a very important area of Managerial Economics. In fact, price is the genesis of the revenue of a firm ad as such the success of a business firm largely depends on the correctness of the price decisions taken by it. The important aspects dealt with this area are: Price determination in various market forms, pricing methods, differential pricing, product-line pricing and price forecasting. 4.Profit management: Business firms are generally organized for earning profit and in the long period, it is profit which provides the chief measure of success of a firm. Economics tells us that profits are the reward for uncertainty bearing and risk taking. A successful business manager is one who can form more or less correct estimates of costs and revenues likely to accrue to the firm at different levels of output. The more successful a manager is in reducing uncertainty, the higher are the profits earned by him. In fact, profit-planning and profit measurement constitute the most challenging area of Managerial Economics. How to manage the profit by taking suitable decision in a recessionary market by taking proper action at right time is a challenging task for any business manager. 5.Capital management: The problems relating to firms capital investments are perhaps the most complex and troublesome. Capital management implies planning and control of capital expenditure because it involves a large sum and moreover the problems in disposing the capital assets off are so complex that they require considerable time and labour. The main topics dealt with under capital management are cost of capital, rate of return and selection of projects. 6.Sales Promotion and Marketing Strategy: In a free and competitive market where there is a cut throat competition, the role of marketing and sales people is vital for the growth of any company. The team work of sales people play a major role in the business development of the organization. Decision maker has to be updated about the marketing strategy and planning of the competitors. They have to adopt a sales and marketing strategy, which is suitable to nature of the product and market situation. Conclusion: The various aspects outlined above represent the major uncertainties which a business firm has to reckon with, viz., demand uncertainty, cost uncertainty, price uncertainty, profit uncertainty, and capital uncertainty. We can, therefore, conclude that the subject-matter of Managerial Economics consists of applying economic principles and concepts towards adjusting with various uncertainties faced by a business firm.

Basic Economical Tools Used By Managerial Economists:


Tools of managerial economics can be used to achieve virtually all the goals of a business organization in an efficient manner. The following are the frequently used economical tools by Business Managers. 1.Principle of Scarcity: Economics is the study of how scarce resources are used to satisfy human wants which are unlimited. The fundamental problem is to economies the use of resources to satisfy as many wants as possible. It is the scarcity or short supply of resources which dictates us to make a choice between alternatives. 2.Opportunity Cost principle: The cost involved in any decision consists of the sacrifices of alternative required by that decision. If there is no alternative, so no sacrifices, there are no opportunity costs. In taking managerial decision, Opportunity cost is quite relevant. 3.Marginalism: Manager has to take into consideration the additional return by making additional investment. Economists use term marginal for all such additional magnitute of output. A manager can expand production to a level where marginal revenue is at least equal to marginal cost. 4.Discounting Principal: Managerial economists use this principle to find out the current value of future output or future flow of funds. Since the value of money (Purchasing power of money) decreases with the growth of period, the value of money received in future has to be discounted to know its current value, so that it can be compared with the fund invested at that time. If the cash inflow is more than outflow by a required margin only then decision will be taken in favour of that project. 5.Equi-Marginal Principle: It says that an input should be allocated in such a way that the value added by the last unit of input is the same in all its uses. This generalized law is known as equi-marginal principle. Let us take an example of a firm having workers active in three duties- production of bottled milk, butter & cheese. The firm must allocate these workers in such a way that the productivity of last worker (marginal) should be same in all duties. Like is a marginal worker is adds worth of Rs.100/- of bottled milk then marginal worker employed on butter and cheese should also earns worth of Rs.100/- by adding output. The additional out put worth of Rs.100/produced by marginal worker is called Value of Marginal Product (VMP). VMP of activities a, &c be should be same i.e. VMPa=VMPb=AMPc.

Specific Function of Managerial Economists:


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. Mark Hirschey and James L. Pappas cite the example of a nonprofit hospital. 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. While managerial economics is helpful in making optimal decisions, one should be aware that it only describes the predictable economic consequences of a managerial decision. For example, tools of managerial economics can explain the effects of imposing automobile import quotas on the availability of domestic cars, prices charged for automobiles, and the extent of competition in the auto industry. Analysis of managerial economics will reveal that fewer cars will be available, prices of automobiles will increase, and the extent of competition will be reduced. Managerial economics does not address, however, whether imposing automobile import quotas is good government policy. This latter question encompasses broader political considerations involving what economists call value judgments. Some of the important functions of Managerial Economists are as follows: Sales Forecasting Market Research Analysis of competitive firms Pricing Decision Evaluation of Capital and Projects Security and Investment Analysis Production and Inventory control Environmental Forecasting Social Responsibility of Corporate Corporate policies related with corporate structure ( merger, acquisition, joint venture, takeover etc.)

Science Technology and Managerial Economics:


Science: Science is a systemized body of knowledge pertaining to a particular field of enquiry. Main features of science area)Systemised body of knowledge b)Scientific method of observation c)Test of validity d)Universal application Engineering: Engineering involves application of scientific knowledge for the betterment of quality of life. According to Engineers council for Professional Development Engineering is the profession in which knowledge of mathematics and natural sciences, gained by study, experience & practices are applied with judgment to develop ways to utilize economically, material and forces for the benefit of mankind. Engineers facilitates in economic development in two waysa)Mechanisation of production process b)Development of Infrastructure Technology: Technology refers to the body of knowledge, skills and procedures for preparing,

using and doing useful things. Role of Science and Technology in Economic Development: a)Utilisation of Natural Resources- full utilization of Natural resources or wealth of any country was only possible with the development of science and technology. b)Increased efficiency- With low input to produce high output is not feasible without the use of technology. c)Factor Substitution- depending on availability of factors, engineers can substitute one factor from another by using technology. Sea water can be converted into drinking water by use of technology. d)Overcoming Scarcity- Growing rice in desert is possible with help of technology. Similiarly eliminating wastage and increasing production with low raw material or input is only possible with the help of science and technology. e)Self Reliance- with the use of science and technology any country can reach to the goal of self reliance , like India reach to the self reliance after independence in agriculture products with the introduction of Green Revolution where we used scientific method of agriculture instead of using the tradition method of farming. WHY DO ENGINEERS NEED TO LEARN ABOUT ECONOMICS? Ages ago, the most significant barriers to engineers were technological. The things that engineers wanted to do, they simply did not yet know how to do, or hadn't yet developed the tools to do. There are certainly many more challenges like this which face present-day engineers. However, we have reached the point in engineering where it is no longer possible, in most cases, simply to design and build things for the sake simply of designing and building them. Natural resources (from which we must build things) are becoming scarcer and more expensive. We are much more aware of negative side-effects of engineering innovations (such as air pollution from automobiles) than ever before. For these reasons, engineers are tasked more and more to place their project ideas within the larger framework of the environment within a specific planet, country, or region. Engineers must ask themselves if a particular project will offer some net benefit to the people who will be affected by the project, after considering its inherent benefits, plus any negative side-effects (externalities), plus the cost of consuming natural resources, both in the price that must be paid for them and the realization that once they are used for that project, they will no longer be available for any other project(s). Simply put, engineers must decide if the benefits of a project exceed its costs, and must make this comparison in a unified framework. The framework within which to make this comparison is the field of engineering economics, which strives to answer exactly these questions, and perhaps more. The Accreditation Board for Engineering and Technology (ABET) states that engineering "is the profession in which a knowledge of the mathematical and natural sciences gained by study, experience, and practice is applied with judgment to develop ways to utilize, economically, the materials and forces of nature for the benefit of mankind". It should be clear from this discussion that consideration of economic factors is as important as regard for the physical laws and science that determine what can be accomplished with engineering. Physical Environment : Engineers produce products and services depending on physical laws (e.g. Ohm's law; Newton's law).

Physical efficiency takes the form: system output(s) Physical (efficiency ) = ------------------system input(s) Economic Environment : Much less of a quantitative nature is known about economic environments -- this is due to economics being involved with the actions of people, and the structure of organizations. Satisfaction of the physical and economic environments is linked through production and construction processes. Engineers need to manipulate systems to achieve a balance in attributes in both the physical and economic environments, and within the bounds of limited resources. Following are some examples where engineering economy plays a crucial role: 1Choosing the best design for a high-efficiency gas furnace 2Selecting the most suitable robot for a welding operation on an automotive assembly line 3Making a recommendation about whether jet airplanes for an overnight delivery service should be purchased or leased 4Considering the choice between reusable and disposable bottles for high-demand beverages With items 1 and 2 in particular, note that coursework in engineering should provide sufficient means to determine a good design for a furnace, or a suitable robot for an assembly line, but it is the economic evaluation that allows the further definition of a best design or the most suitable robot. In item 1 of the list above, what is meant by "high-efficiency"? There are two kinds of efficiency that engineers must be concerned with. The first is physical efficiency, which takes the form: System output(s) Economic (efficiency) = ----------------System input(s) For the furnace, the system outputs might be measured in units of heat energy, and the inputs in units of electrical energy, and if these units are consistent, then physical efficiency is measured as a ratio between zero and one. Certain laws of physics (e.g., conservation of energy) dictate that the output from a system can never exceed the input to a system, if these are measured in consistent units. All a particular system can do is change from one form of energy (e.g. electrical) to another (e.g., heat). There are losses incurred along the way, due to electrical resistance, friction, etc., which always yield efficiencies less than one. In an automobile, for example, 10-15% of the energy supplied by the fuel might be consumed simply overcoming the internal friction of the engine. A perfectly efficient system would be the theoretically impossible Perpetual Motion Machine! The other form of efficiency of interest to engineers is economic efficiency, which takes the form: System worth Economic (efficiency) = ----------------System cost You might have heard economic efficiency referred to as "benefit-cost ratio". Both terms of this ratio are assumed to be of monetary units, such as dollars. In contrast to physical

efficiency, economic efficiency can exceed unity, and in fact should, if a project is to be deemed economically feasible. The most difficult part of determining economic efficiency is accounting for all the factors which might be considered benefits or costs of a particular project, and converting these benefits or costs into a monetary equivalent. Consider for example a transportation construction project which promises to reduce everyone's travel time to work. How do we place a value on that travel time savings? This is one of the fundamental questions of engineering economics. In the final evaluation of most ventures, economic efficiency takes precedence over physical efficiency because projects cannot be approved, regardless of their physical efficiency, if there is no conceived demand for them amongst the public, if they are economically infeasible, or if they do not constitute the "wisest" use of those resources which they require. There are numerous examples of engineering systems that have physical design but little economic worth (i.e it may simply be too expensive!!). Consider a proposal to purify all of the water used by a large city by boiling it and collecting it again through condensation. This type of experiment is done in junior physical science labs every day, but at the scale required by a large city, is simply too costly.