MODULE 1

Overview of Managerial Economics

SESSION TOPIC 1: Managerial Economics – An Overview

Learning Outcomes:

The following specific learning objectives are expected to be realized at the end of the session:

1. Know the definition of Managerial Economics

2. Discuss the scope and nature of Managerial Economics

3. Enumerate the steps in business decision making

Key Points:

Managerial Economics Macroeconomics Decision Making

Core Content:

Introduction

This module covers the discussion on the nature and scope of Managerial Economics. It also tackles the
nature of business firms and business decisions..

IN-TEXT ACTIVITY

A close interrelationship between management and economics had led to the development of managerial
economics. Economic analysis is required for various concepts such as demand, profit, cost, and
competition. In this way, managerial economics is considered as economics applied to “problems of
choice’’ or alternatives and allocation of scarce resources by the firms.

Managerial economics is a discipline that combines economic theory with managerial practice. It helps in
covering the gap between the problems of logic and the problems of policy. The subject offers powerful
tools and techniques for managerial policy making

Managerial Economics – Definition

To quote Mansfield, “Managerial economics is concerned with the application of economic concepts and
economic analysis to the problems of formulating rational managerial decisions.

Spencer and Siegelman have defined the subject as “the integration of economic theory with business
practice for the purpose of facilitating decision making and forward planning by management.”

Micro, Macro, and Managerial Economics Relationship

Microeconomics studies the actions of individual consumers and firms; managerial economics is an
applied specialty of this branch. Macroeconomics deals with the performance, structure, and behavior of

1
Econ13B/For instructional purposes only
an economy as a whole. Managerial economics applies microeconomic theories and techniques to
management decisions. It is more limited in scope as compared to microeconomics. Macroeconomists
study aggregate indicators such as GDP, unemployment rates to understand the functions of the whole
economy.

Microeconomics and managerial economics both encourage the use of quantitative methods to analyze
economic data. Businesses have finite human and financial resources; managerial economic principles
can aid management decisions in allocating these resources efficiently. Macroeconomics models and
their estimates are used by the government to assist in the development of economic policy.

Nature and Scope of Managerial Economics

The most important function in managerial economics is decision making. It involves the complete course
of selecting the most suitable action from two or more alternatives. The primary function is to make the
most profitable use of resources which are limited such as labor, capital, land etc. A manager is very
careful while taking decisions as the future is uncertain; he ensures that the best possible plans are made
in the most effective manner to achieve the desired objective which is profit maximization.

•Economic theory and economic analysis are used to solve the problems of managerial economics.

•Economics basically comprises of two main divisions namely Micro economics and Macro economics.

•Managerial economics covers both macroeconomics as well as micro- economics, as both are equally
important for decision making and business analysis.

•Macroeconomics deals with the study of entire economy. It considers all the factors such as government
policies, business cycles, national income, etc.

•Microeconomics includes the analysis of small individual units of economy such as individual firms,
individual industry, or a single individual consumer.

All the economic theories, tools, and concepts are covered under the scope of managerial economics to
analyze the business environment. The scope of managerial economics is a continual process, as it is a
developing science. Demand analysis and forecasting, profit management, and capital management are
also considered under the scope of managerial economics.

Demand Analysis and

Managerial Economics Profit Management

Capital Management

2
Econ13B/For instructional purposes only
Demand Analysis and Forecasting

Demand analysis and forecasting involves huge amount of decision making! Demand estimation is an
integral part of decision making, an assessment of future sales helps in strengthening the market position
and maximizing profit. In managerial economics, demand analysis and forecasting holds a very important
place.

Profit Management

Success of a firm depends on its primary measure and that is profit. Firms are operated to earn long-term
profit which is generally the reward for risk taking. Appropriate planning and measuring profit is the most
important and challenging area of managerial economics.

Capital Management

Capital management involves planning and controlling of expenses. There are many problems related to
capital investments which involve considerable amount of time and labor. Cost of capital and rate of
return are important factors of capital management.

Demand for Managerial Economics

The demand for this subject has increased post liberalization and globalization period primarily because
of increasing use of economic logic, concepts, tools and theories in the decision making process of large
multinationals.

Also, this can be attributed to increasing demand for professionally trained management personnel, who
can leverage limited resources available to them and maximize returns with efficiency and effectiveness.

Role in Managerial Decision Making

Managerial economics leverages economic concepts and decision science techniques to solve
managerial problems. It provides optimal solutions to managerial decision making issues.

Business Firms and Business Decisions

Business firms are a combination of manpower, financial, and physical resources which help in making
managerial decisions. Societies can be classified into two main categories - production and consumption.
Firms are the economic entities and are on the production side, whereas consumers are on the
consumption side.

The performances of firms get analyzed in the framework of an economic model. The economic model of
a firm is called the theory of the firm. Business decisions include many vital decisions like whether a firm
should undertake research and development program, should a company launch a new product, etc.

Business decisions made by the managers are very important for the success and failure of a firm.
Complexity in the business world continuously grows making the role of a manager or a decision maker of
an organisation more challenging! The impact of goods production, marketing, and technological changes
highly contribute to the complexity of the business environment.

3
Econ13B/For instructional purposes only
Steps for Decision Making

The steps for decision making like problem description, objective determination, discovering alternatives,
forecasting consequences are described below:

Define the Problem

What is the problem and how does it influence managerial objectives are the main questions. Decisions
are usually made in the firm’s planning process. Managerial decisions are at times not very well defined
and thus are sometimes source of a problem.

Determine the Objective

The goal of an organization or decision maker is very important. In practice, there may be many problems
while setting the objectives of a firm related to profit maximization and benefit cost analysis. Are the future
benefits worth the present capital? Should a firm make an investment for higher profits for over 8 to 10
years? These are the questions asked before determining the objectives of a firm.

Discover the Alternatives

For a sound decision framework, there are many questions which are needed to be answered such as:
What are the alternatives? What factors are under the decision maker’s control? What variables constrain
the choice of options? The manager needs to carefully formulate all such questions in order to weigh the
attractive alternatives.

Forecast the Consequences

Forecasting or predicting the consequences of each alternative should be considered. Conditions could
change by applying each alternative action so it is crucial to decide which alternative action to use when
outcomes are uncertain.

Make a Choice

Once all the analysis and scrutinizing is completed, the preferred course of action is selected. This step of
the process is said to occupy the lion’s share in analysis. In this step, the objectives and outcomes are
directly quantifiable. It all depends on how the decision maker puts the problem, how he formalizes the
objectives, considers the appropriate alternatives, and finds out the most preferable course of action.

Sensitivity Analysis

Sensitivity analysis helps us in determining the strong features of the optimal choice of action. It helps us
to know how the optimal decision changes, if conditions related to the solution are altered. Thus, it proves
that the optimal solution chosen should be based on the objective and well structured. Sensitivity analysis
reflects how an optimal solution is affected, if the important factors vary or are altered.

Managerial economics is competent enough for serving the purposes in decision making. It focuses on
the theory of the firm which considers profit maximization as the main objective. The theory of the firm
was developed in the nineteenth century by French and English economists. Theory of the firm
emphasizes on optimum utilization of resources, cost control, and profits in a single time period. Theory of
the firm approach, with its focus on optimization, is relevant for small farms and producers.

4
Econ13B/For instructional purposes only
Summary

The most important function in managerial economics is decision making. It involves the complete course
of selecting the most suitable action from two or more alternatives. The primary function is to make the
most profitable use of resources which are limited such as labor, capital, land etc. A manager is very
careful while taking decisions as the future is uncertain; he ensures that the best possible plans are made
in the most effective manner to achieve the desired objective which is profit maximization

Assessment/ Evaluation

Research Online Assignment/Homework

Instruction: Make a review of the present economic environment. What role does the managerial
economist play in the business decision making of the company particularly on their resource allocations
problems?

As a managerial economist, relate your findings on the operations of ;(a) a service organization; (b)
manufacturing; (c) an-agriculture-based company.

References

Refer to the references listed in the syllabus of the subject.

5
Econ13B/For instructional purposes only