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Meaning ,Nature and Scope of Managerial Economics

DFINITIONS OF ECONOMICS AND

MANAGERIAL ECONOMICS

ECONOMICS: Economics is a social science . Its basic function is to study how people – individual house holds, firms and nations maximizing their gains from their limited resources and opportunities.

In economic terminology it is called as “maximizing behaviour” or more approximately “optimizing behaviour”.

Optimization means selecting best out of available resources with the objective of maximizing gains from given resources.

What is Economics?Human wants are unlimitedResources available to satisfy these wants are scarce /

limitedPeople want to maximize their gains Economic agents / society have some economic problems

because of scarcity of resourcesThey need to choose scarce resources among alternatives

(scarce resources) based on choice and valuation of alternatives

Economics is thus a social science, which studies human behaviour

in relation to optimizing allocation of available resources to

achieve the given goals.

Eg :Individual household behaviour, firm, industry and nation.

• Economics is also a study of choice-making behaviour of the people.

Prof. Samuelson remarks economics as “the oldest of arts and newest

of science, indeed the queen of the social science.

Economic theory & methods

Business management

decision problems

Managerial economics

Optimal solutions to

business problems

DEFINITIONS OF MANAGERIAL ECONOMICS

• It is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management- Spencer and Seigleman

7

He defines that managerial economics is

concerned with the application of economic

concepts and economic tools to the problems of

formulating rational decision making

- Mansfield

Scope of Managerial Economics

Economics has two major branches

1. Micro Economics2. Macro Economics

-The term Micro means small and Macro means big.-Both are applied to business directly or indirectly. -Managerial economics comprises both micro and macro economic theories. -The parts of micro and macro economics that constitute managerial economics depend on the purpose of analysis.

Types of Economic Analysis

i. Micro and macroii. Positive and normativeiii. Short and long runiv. Partial and general equilibrium

i. Micro and macroMicroeconomics-(meaning “small”)-look at

smaller picture of the economy and is the study of the behaviour of small economic units.

Macroeconomics-(meaning “large”)-is that branch of economic analysis that deals with the study of aggregates

ii. Positive and normativePositive statements are factual by nature; normative

statements involve some degree of value judgment, and cannot be verified by empirical study or logic.

Positive economics establishes a relationship between cause and effect. It is “what is” in economic matters

E.g. The distribution of income in India is unequal.

Normative economics is concerned with questions involving value judgments. It is “what ought to be” in economic matters.

E.g. The distribution of income in India should be equal.

iii. Short and long run

Short run is a time period not enough for consumers and producers to adjust completely to any new situation.

Long run is a “planning horizon” in which consumers and producers can adjust to any new situation.

iv. Partial and general equilibriumEquilibrilium is a state of balance that can occur

in a model

Partial equilibrium analysis studies the internal outcome of any policy action in a single market only.- Ceteris Paribus

General equilibrium analysis explains economic phenomena in an economy as a whole.

What is Microeconomics?Study of economic phenomena at micro level i.e.

individual and firm level.

When it establishes cause and effect relationship between two or more economic events at micro level and provide basis of analysis it is positive science .

When it gives value judgment on ‘what is good’ and ‘what is bad’ for society it is a normative science.

Micro-economics applied to internal issues :

Operational issues are of internal nature. Internal

issues include all those problems which arise

within the business organization and fall within

purview and control of the management .

Some of the basic internal issues are :What to produce

How much to produce

Choice of technology i.e. choosing of the factor –combination

Choice of price i.e. how to price the commodity

How to promote sales

How to face the price competition

How to decide on new investments

How to manage capital and profit

How to manage inventory i.e. stock of both finished goods and

raw material

Macro-economics deals with external issues :

The type of economic system in the country

General trends in National Income, employment,

prices, savings and investments

Government’s economic policies i.e., industrial,

monetary, price and foreign etc.

DECISION SCIENCESROLE OF MANAGERSIs essentially an economic one.

-decision making is the main job of management.

E.g.: Role of a financial manager-

To mobilize resources from various resources so as to minimize the cost of funds & deploy these resources so as to maximize the return on investment

Kinds of Economic DecisionsWHAT TO PRODUCE ?

HOW TO PRODUCE ?

FOR WHOM TO PRODUCE ?

ARE RESOURCES USED ECONOMICALLY?

ARE RESOURCES FULLY EMPLOYED?

IS THE ECONOMY GROWING? Increased labor force,

increased capital formation and technological progress.

DECISION MAKING AREASBusiness decision making is influenced not only by economic

considerations, but also by human behavioral, technological and

environmental factors due to growing public awareness

“Decision making and processing information are two important

tasks of managers”

In order to make good decisions managers must be able to

obtain, process and use information.

Basic Assumptions in Economic Analysis

Ceteris Paribus is a Latin phrase, literally translated in

English means “with other things (being) the same”

or “ all other things being equal.”

• Rationality implies that consumers and producers

measure and compare the costs and benefits of a decision

before going ahead.

Economic principles relevant to managerial decisionsi. Concept of Scarcity

ii. Concept of Opportunity Cost

iii. Concept of Marginality

iv. Discounting Principle:

v. Production Possibility Curve(PPC) or Production Possibility Frontier (PPF) or Transformation curve

Economic principles relevant to managerial decisions contd… i)Concept of Scarcity : Human wants are

unlimited, but human capacity to satisfy such wants is limited.Hence decision has to be made regarding the ends to be pursued and the goods to be used for achievement of such ends.

Resources Demands for Resources

Economic principles relevant to managerial decisions contd…ii)Concept of Opportunity Cost:Managerial Economist has to make choices in all

aspects of business by sacrificing some of the alternatives, since resources are scarce and wants are unlimited.

It is the benefit forgone from the next best alternative that is not selected(sacrificed)

Eg. Reliance or Tata Indicom in cellular services.

Economic principles relevant to managerial decisions contd…iii) Concept of Marginality:

The concept of marginality deals with a unit increase in cost or revenue or utility.

Change in Total Cost

Marginal cost =

Change in Total Output

Economic principles relevant to managerial decisions contd…iv) Discounting Principle:

-It refers to time value of money

- Businesses need to bother about discounting because most business decisions relate to outflow and inflow of money and resources that take place at different points of time.

Economic principles relevant to managerial decisions contd…v) Production Possibility Curve(PPC) or Production Possibility

Frontier (PPF) or Transformation curve

- Production Possibility Curve is a graph that shows the different combinations of quantities of two goods that can be produced (or consumed) in an economy, subject to limited availability of resources.

-The PPC depicts the trade off between any two items produced (or consumed), in a two goods framework. If we want to have more of one good, we must have less of the other good, due to limited availability of resources, i.e. there must be an opportunity cost involved in having more of one good.

Food

Clothing

p

q

Fp

Fq

Cp Cq

N

M

PPC for an Individual

0

The decrease in the units of food is the opportunity cost of producing more clothing. Where M is not attainable and N is not desirable.

Production Possibility Curve(PPC) contd... Three specific assumptions to illustrate the PPF for a

society are:1)The economy is operating at full employment.2)Factors of production are fixed in supply; can however

be reallocated among different uses.4)Technology remains the same.

Food

Clothing

p

q

Fp

Fq

Cp Cq

Productively insufficient area

PPC for the Society

0

Infeasible Area