Meaning:

The science of Managerial Economics has emerged only recently. With

the growing variability and unpredictability of the business
environment, business managers have become increasingly concerned
with finding rational and ways of adjusting to an exploiting
environmental change.

The problems of the business world attracted the attentions of the

academicians from 1950 onwards. Managerial economics as a subject
gained popularity in the USA after the publication of the book
“Managerial Economics” by Joel Dean in 1951.

Definition:
Managerial economists have defined managerial economics
in a variety of ways:
According to E.F. Brigham and J. L. Pappar, Managerial Economics is
“the application of economic theory and methodology to business
administration practice.”

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To Christopher Savage and John R. Small: “Managerial Economics is

concerned with business efficiency”.
D.C. Hague describes Managerial Economics as “a fundamental
academic subject which seeks to understand and analyse the problems
of business decision making.”
The above definitions emphasise the interrelationship of economic
theory with business decision making and forward planning.
Economic Theory and Managerial Theory:
Economic Theory is a system of inter-relationships. 

Managerial theory provides necessary conceptional tools which can be

of considerable help to the manager in taking scientific decisions. The
managerial theory provides the maximum help to a business manager
in his decision making and business planning.
Nature of Managerial Economics:
Managerial economics is a science applied to decision making. It
bridges the gap between abstract theory and managerial practice. It
concentrates more on the method of reasoning. In short, managerial
economics is “Economics applied in decision making”.

Decision Making:
Managerial economics is supposed to enrich the conceptual and
technical skill of a manager. It is concerned with economic behaviour
of the firm. It concentrates on the decision process, decision model
and decision variables at the firm level. It is the application of
economic analysis to evaluate business decisions.

The primary function of a manager in business organisation is

decision making and forward planning under uncertain business
conditions. Some of the important management decisions are
production decision, inventory decision, cost decision, marketing
decision, financial decision, personnel decision and miscellaneous
decisions. One of the hallmarks of a good executive is the ability to
take quick decision. He must have the clarity of goals, use all the
information he can get, weigh pros and cons and make fast decisions.

The decisions are taken to achieve certain objectives. Objectives are

the motivating factors in taking decision. Several acts are performed to
attain the objectives quantitative techniques are also used in decision
making. But it may be noted that acts and quantitative techniques
alone will not produce desirable results. It is important to remember
that other variables such as human and behavioral considerations,
technological forces and environmental factors influence the choices
and decisions made by managers.

Scope of Marginal Economics:

Managerial Economics is a developing subject. The scope of
managerial economics refers to its area of study. Managerial
economics has its roots in economic theory. The empirical nature of
managerial economics makes its scope wider. Managerial economics
provides management with strategic planning tools that can be used to
get a clear perspective of the way the business world works and what
can be done to maintain profitability in an ever changing environment.

Managerial economics refers to those aspects of economic theory and

application which are directly relevant to the practice of management
and the decision making process within the enterprise. Its scope does
not extend to macro-economic theory and the economics of public
policy which will also be of interest to the manager. While considering
the scope of managerial economics we have to understand whether it
is positive economics or normative economics.

Positive versus Normative Economics:

Most of the managerial economists are of the opinion that managerial
economics is fundamentally normative and prescriptive in nature. It is
concerned with what decisions ought to be made.

The application of managerial economics is inseparable from

consideration of values or norms, for it is always concerned with the
achievement of objectives or the optimization of goals. In
managerial economics, we are interested in what should
happen rather than what does happen. Instead of explaining
what a firm is doing, we explain what it should do to make
its decision effective.

Positive Economics:
A positive science is concerned with ‘what is’. Robbins regards
economics as a pure science of what is, which is not concerned with
moral or ethical questions. Economics is neutral between ends. The
economist has no right to pass judgment on the wisdom or folly of the
ends itself.

He is simply concerned with the problem of resources in relation to

the ends desired. The manufacture and sale of cigarettes and wine may
be injurious to health and therefore morally unjustifiable, but the
economist has no right to pass judgment on these since both satisfy
human wants and involve economic activity.
Normative Economics:
Normative economics is concerned with describing what should be the
things. It is, therefore, also called prescriptive economics. What price
for a product should be fixed, what wage should be paid, how income
should be distributed and so on, fall within the purview of normative
economics?

It should be noted that normative economics involves value

judgments. Almost all the leading managerial economists are of the
opinion that managerial economics is fundamentally normative and
prescriptive in nature.

It refers mostly to what ought to be and cannot be neutral about the

ends. The application of managerial economics is inseparable from
consideration of values, or norms for it is always concerned with the
achievement of objectives or the optimisation of goals.

In managerial economics, we are interested in what should happen

rather than what does happen. Instead of explaining what a firm is
doing, we explain what it should do to make its decision effective.
Managerial economists are generally preoccupied with the optimum
allocation of scarce resources among competing ends with a view to
obtaining the maximum benefit according to predetermined criteria.

To achieve these objectives they do not assume ceteris paribus, but try
to introduce policies. The very important aspect of managerial
economics is that it tries to find out the cause and effect relationship
by factual study and logical reasoning. The scope of managerial
economics is so wide that it embraces almost all the problems and
areas of the manager and the firm.

Subject Matter of Marginal Economics:

(i) Demand Analysis and Forecasting:
A firm is an economic organisation which transforms inputs into
output that is to be sold in a market. Accurate estimation of demand,
by analysing the forces acting on demand of the product produced by
the firm, forms the vital issue in taking effective decision at the firm
level.

A major part of managerial decision making depends on accurate

estimates of demand. When demand is estimated, the manager does
not stop at the stage of assessing the current demand but estimates
future demand as well. This is what is meant by demand forecasting.

This forecast can also serve as a guide to management for maintaining

or strengthening market position and enlarging profit. Demand
analysis helps in identifying the various factors influencing the
demand for a firm’s product and thus provides guidelines to manipu-
late demand. The main topics covered are: Demand Determinants,
Demand Distinctions and Demand Forecasting.

(ii) Cost and Production Analysis:

Cost analysis is yet another function of managerial economics. In
decision making, cost estimates are very essential. The factors causing
variation in costs must be recognised and allowed for if management
is to arrive at cost estimates which are significant for planning
purposes.
The determinants of estimating costs, the relationship between cost
and output, the forecast of cost and profit are very vital to a firm. An
element of cost uncertainty exists because all the factors determining
costs are not always known or controllable. Managerial economics
touches these aspects of cost analysis as an effective knowledge and
the application of which is corner stone for the success of a firm.

Production analysis frequently proceeds in physical terms. Inputs play

a vital role in the economics of production. The factors of production
otherwise called inputs, may be combined in a particular way to yield
the maximum output.

Alternatively, when the price of inputs shoots up, a firm is forced to

work out a combination of inputs so as to ensure that this combination
becomes the least cost combination. The main topics covered under
cost and production analysis are production function, least cost
combination of factor inputs, factor productiveness, returns to scale,
cost concepts and classification, cost-output relationship and linear
programming.

(iii) Inventory Management:

An inventory refers to a stock of raw materials which a firm keeps.
Now the problem is how much of the inventory is the ideal stock. If it
is high, capital is unproductively tied up. If the level of inventory is
low, production will be affected.

Therefore, managerial economics will use such methods as Economic

Order Quantity (EOQ) approach, ABC analysis with a view to
minimising the inventory cost. It also goes deeper into such aspects as
motives of holding inventory, cost of holding inventory, inventory
control, and main methods of inventory control and management.

(iv) Advertising:
To produce a commodity is one thing and to market it is another. Yet
the message about the product should reach the consumer before he
thinks of buying it. Therefore, advertising forms an integral part of
decision making and forward planning. Expenditure on advertising
and related types of promotional activities is called selling costs by
economists.

There are different methods for setting advertising budget: Percentage

of Sales Approach, All You can Afford Approach, Competitive Parity
Approach, Objective and Task Approach and Return on Investment
Approach.

(v) Pricing Decision, Policies and Practices:

Pricing is very important area of managerial economics. The control
functions of an enterprise are not only productions but pricing as well.
When pricing a commodity, the cost of production has to be taken into
account. Business decisions are greatly influenced by pervading
market structure and the structure of markets that has been evolved
by the nature of competition existing in the market.

Pricing is actually guided by consideration of cost plan pricing and the

policies of public enterprises. The knowledge of the pricing of a
product under conditions of oligopoly is also essential. The price
system guides the manager to take valid and profitable decision.
(vi) Profit Management:
A business firm is an organisation designed to make profits. Profits are
acid test of the individual firm’s performance. In appraising a
company, we must first understand how profit arises. The concept of
profit maximisation is very useful in selecting the alternatives in
making a decision at the firm level.

Profit forecasting is an essential function of any management. It

relates to projection of future earnings and involves the analysis of
actual and expected behaviour of firms, the sales volume, prices and
competitor’s strategies, etc. The main aspects covered under this area
are the nature and measurement of profit, and profit policies of special
significance to managerial decision making.

Managerial economics tries to find out the cause and effect

relationship by factual study and logical reasoning. For example, the
statement that profits are at a maximum when marginal revenue is
equal to marginal cost, a substantial part of economic analysis of this
deductive proposition attempts to reach specific conclusions about
what should be done.

The logic of linear programming is deduction of mathematical form. In

fine, managerial economics is a branch of normative economics that
draws from descriptive economics and from well established deductive
patterns of logic.

(vii) Capital Management:

Planning and control of capital expenditures is the basic executive
function. The managerial problem of planning and control of capital is
examined from an economic stand point. The capital budgeting
process takes different forms in different industries.

It involves the equi-marginal principle. The objective is to assure the

most profitable use of funds, which means that funds must not be
applied when the managerial returns are less than in other uses. The
main topics dealt with are: Cost of Capital, Rate of Return and
Selection of Projects.

Thus we see that a firm has uncertainties to rock on with. Therefore,

we can conclude that the subject matter of managerial economics
consists of applying economic principles and concepts towards
adjusting with these uncertainties of the firm.

In recent years, there is a trend towards integration of managerial

economics and Operation Research. Hence, techniques such as linear
Programming, Inventory Models, Waiting Line Models, Bidding
Models, Theory of Games, etc. have also come to be regarded as part of
managerial economics.

Managerial Economics and Economics:

Managerial Economics has been described as economics applied to
decision making. It may be studied as a special branch of economics,
bridging the gap between pure economic theory and managerial
practice. Economics has two main branches—micro-economics and
macro-economics.

Micro-economics:
‘Micro’ means small. It studies the behaviour of the individual units
and small groups of such units. It is a study of particular firms,
particular households, individual prices, wages, incomes, individual
industries and particular commodities. Thus micro-economics gives a
microscopic view of the economy.

The micro-economic analysis may be undertaken at three

levels:
(i) The equalisation of individual consumers and produces;

(ii) The equalization of the single market;

(iii) The simultaneous equilibrium of all markets. The problems of

scarcity and optimal or ideal allocation of resources are the central
problem in micro-economics.

The roots of managerial economics spring from micro-economic

theory. In price theory, demand concepts, elasticity of demand,
marginal cost marginal revenue, the short and long runs and theories
of market structure are sources of the elements of micro-economics
which managerial economics draws upon. It also makes use of well
known models in price theory such as the model for monopoly price,
the kinked demand theory and the model of price discrimination.

Macro-economics:
‘Macro’ means large. It deals with the behaviour of the large
aggregates in the economy. The large aggregates are total saving, total
consumption, total income, total employment, general price level,
wage level, cost structure, etc. Thus macro-economics is aggregative
economics.

It examines the interrelations among the various aggregates, and

causes of fluctuations in them. Problems of determination of total
income, total employment and general price level are the central
problems in macro-economics.

Macro-economies is also related to managerial economics. The

environment, in which a business operates, fluctuations in national
income, changes in fiscal and monetary measures and variations in the
level of business activity have relevance to business decisions. The
understanding of the overall operation of the economic system is very
useful to the managerial economist in the formulation of his policies.

The chief contribution of macro-economics is in the area of

forecasting. The post-Keynesian aggregative theory has direct
implications for forecasting general business conditions. Since the
prospects of an individual firm often depend greatly on business in
general, for-casts of an individual firm depend on general business
forecasts, which make use of models derived from theory. The most
widely used model in modern forecasting is the gross national product
model.

Role of Managerial Economics in Business

Development:
Decision making is an integral part of today’s business management.
Making a decision is one of the most difficult tasks faced by a
professional manager. A manager has to take several decisions in the
management of business. The life of a manager is filled with making
decisions alter decisions.

Decision making is a process and a decision is the product of such a

process. Managerial decisions are based on the flow of information.
Decision making is both a managerial function and an organisational
process. Managerial function is exercised through decision making.

The purpose of decision making as well as planning is to direct human

behaviour and effort towards a future goal or objective. It is
organisational in that many decisions transcend the individual
manager and become the product of groups, teams, committees, etc.

Once the decision is taken it is implemented within the minimum time

and cost. A study of the principles of business decisions will enable
managers to understand business problems in a better perspective and
increase their ability to solve business problems facing them in the
management of business.

Executives make many types of decisions connected with the business

such as production, inventory, cost, marketing, pricing, investment
and personnel. In the long-run, application of principles of business
decisions will result in successful outcomes. A good decision is one
that is based on logic, considers all available data and possible
alternatives and applies the quantitative approach.

Organisational decisions are those which the executive makes in his

personal capacity as a manager. They include the adoption of the
strategies, the framing of objectives and the approval of plans. These
decisions can be delegated to the organisational members so that
decisions could be implemented with their support. These decisions
aim at achieving the best interests of the organisation. The basic
decisions are those which are more important, they involve long-range
commitment and heavy expenditure of funds.

A high degree of importance is attached to them. A serious mistake

will endanger the company s existence. The selection of a location,
selection of a product line, and decision relating to manage the
business are all basic decisions. They are considered basic because
they affect the whole organisation.

Some of the important types of business decisions are given

below:
(i) Production Decisions:
Production is an economic activity which supplies goods and services
for sale in a market to satisfy consumer wants thereby profit
maximisation is made possible. The business executive has to make
the rational allocation of available resources at his disposal. He may
face problems relating to best combination of the factors to gain
maximum profit or how to use different machine hours for maximum
production advantage, etc.

(ii) Inventory Decision:

Inventory refers to the quantity of goods, raw material or other
resources that are idle at any given point of time held by the firm. The
decision to hold inventories to meet demand is quite important for a
firm and in certain situation the level of inventories serves as a guide
to plan production and is therefore, a strategic management variable.
Large inventory of raw materials, intermediate goods and finished
goods means blocking of capital.

(iii) Cost Decisions:

The competitive ability of the firm depends upon the ability to produce
the commodity at the minimum cost. Hence, cost structure, reduction
of cost and cost control has come to occupy important places in
business decisions. In the absence of cost control, profits would come
down due to increasing cost.

Business decisions about the future require the businessmen to choose

among alternatives, and to do this, it is necessary to know the costs
involved. Cost information about the resources is very essential for
business decision making.

(iv) Marketing Decisions:

Within market planning, the marketing executive must make decisions
on target market, market positioning, product development, pricing
channels of distribution, physical distribution, communication and
promotion. A businessman has to take mainly two different but
interrelated decisions in marketing.

They are the sales decision and purchase decision. Sales decision is
concerned with how much to produce and sell for maximising profit.
The purchase decision is concerned with the objective of acquiring
these resources at the lowest possible prices so as to maximise profit.
Here the executive’s basic skill lies in influencing the level, timing, and
composition of demand for a product, service, organisation, place,
person or idea.

(v) Investment Decision:

The problems of risks and imperfect foresight are very crucial for the
investment decision. In real business situation, there is seldom an
investment which does not involve uncertainties. Investment decision
covers issues like the decisions regarding the amount of money for
capital investment, the source of financing this investment, allocation
of this investment among different projects over time. These decisions
are of immense significance for ensuring the growth of an enterprise
on sound lines. Hence, decisions on investment are to be taken with
utmost caution and care by the executive.

(vi) Personnel Decision:

An organisation requires the services of a large number of personnel.
These personnel occupy various positions. Each position of the
organisation has certain specific contributions to achieve organi-
sational objectives. Personnel decisions cover the areas of manpower
planning, recruitment, selection, training and development,
performance appraisal, promotion, transfer, etc. Business executives
should take personnel decisions as an essential element.

Role and Responsibility of a Managerial Economist:

With the advent of managerial revolution and transition from the
owner- manager to the professional executive, the managerial
economists have occupied an important place in modern business. In
real practice, firms do not behave in a deterministic world.

They strive to attain a multiplicity of objectives. Economic theory

makes a fundamental assumption of maximising profits as the basic
objective of every firm. The application of pure economic theory
seldom leads us to direct executive decisions.

Present business problems are either too obvious in their solution or

purely speculative and they need a special form of insight. A
managerial economist with his sound knowledge of theory and
analytical tools can find out solution to the business problems. In
advanced countries, big firms employ managerial economists to assist
the management.

Organisationally, a managerial economist is placed nearer to the policy

maker simple because his main role is to improve the quality of policy
making as it affects short term operation and long range planning. He
has a significant role to play in assisting the management of a firm in
decision making and forward planning by using specialised skills and
techniques.

The factors which influence the business over a period may lie within
the firm or outside the firm.

These factors can be divided into two categories:

(i) External and

(ii) internal.
The external factors lie outside the control of the firm and these
factors constitute ‘Business Environment’. The internal factors lie
within the scope and operation of a firm and they are known as
‘Business Operations’.

1. External Factors:
The prime duty of a managerial economist is to make extensive study
of the business environment and external factors affecting the firm’s
interest, viz., the level and growth of national income, influence of
global economy on domestic economy, trade cycle, volume of trade
and nature of financial markets, etc. They are of great significance
since every business firm is affected by them.

These factors have to be thoroughly analysed by the

managerial economist and answers to the following
questions have also to be found out:
(i) What are the current trends in the local, regional, national and
international economies? What phase of trade cycle is going to occur
in the near future?

(ii) What about the change in the size of population and the resultant
change in regional purchasing power?

(iii) Is competition likely to increase or decrease with reference to the

products produced by the firm?

(iv) Are fashions, tastes and preferences undergoing any change and
have they affected the demand for the product?
(v) What about the availability of credit in the money and capital
markets?

(vi) Is there any change in the credit policy of the government?

(vii) What are the strategies of five year plan? Is there any special
emphasis for industrial promotion?

(viii) What will be the outlook of the government regarding its

commercial and economic policies?

(ix) Will the international market expand or contract and what are the
provisions given by the trade organisations?

(x) What are the regulatory and promotional policies of the central
bank of a country?

Answer to these and similar questions will throw more light on the
perspective business and these questions present some of the areas
where a managerial economist can make effective contributions
through scientific decision making. He infuses objectivity, broad
perspective and concept of alternatives into decision making process.

His focus on long term trends helps maximise profits and ensures the
ultimate success of the firm. The role of the managerial economist is
not to take decisions but to analyse, conclude and recommend. His
basic role is to provide quantitative base for decision making. He
should concentrate on the economic aspects of problems. He should
have a rare intuitive ability of perception.
2. Internal Factors:
The managerial economist can help the management in making
decision regarding the internal operations of a firm in respect of such
problems as cost structure, forecasting of demand, price, investment,
etc.

Some of the important relevant questions in this connection

are as follows:
(i) What should be the production schedule for the coming year?

(ii) What should be the profit budget for the coming year?

(iii) What type of technology should be adopted in the specific process

and specify it?

(iv) What strategies have to be adopted for sales promotion, inventory

control and utilisation of manpower?

(v) What are the factors influencing the input cost?

(vi) How different input components can be combined to minimise the

cost of production?

Apart from the above studies, the managerial economist has to

perform certain specific functions. He helps to co-ordinate practices
relating to production, investment, price, sales and inventory sched-
ules of the firm. Forecasting is the fundamental activity which
consumes most of the time of the managerial economist.
The sales forecast acts as a link between the external uncontrollable
factors and the internal controllable factors and are intimately related
to general economic activity. The managerial economist is usually
assigned the task of preparing short term general economic and
specific market forecasts to provide a framework for the development
of sales and profit. He has to help the firm to plan product
improvement, new product policy, and pricing and sales promotion
strategy.

The managerial economist often needs focused studies of specific

problems and opportunities. He should indulge in market survey, a
product preference test, an advertising effectiveness study and
marketing research. Marketing research is undertaken to understand a
marketing problem better.

The managerial economist has to undertake an economic analysis of

competing firms. He should also undertake investment appraisal,
project evaluation and feasibility study. It is the duty of the managerial
economist to provide necessary intelligence.

To conclude, a managerial economist has a very important role to play.

He should be held in the confidence of the management. A managerial
economist can serve the management best only if he always keeps in
mind the main objective of his firm, which is to make a profit.

Responsibilities of a Managerial Economist:

We have analysed the nature, scope and methods of managerial
economics. We shall now proceed to discuss the last part of our
investigation the responsibilities of a managerial economist. As
mentioned above, the managerial economist has an important role to
play.

The managerial economist can play a very important role by assisting

management in using the increasingly specialised skills and sophisti-
cated techniques which are required to solve the different problems of
successful decision making and forward planning.

The functions of a managerial economist can be broadly defined as the

study and interpretation of economic data in the light of the problems
of the management. The managerial economist should be in a position
to spare more time and thought on problems of an economic nature
than the firm’s administration. His job may involve a number of
routine duties closely tied in with the firm’s day to day activities.

The managerial economist is employed primarily as a general adviser.

The advisory service refers to the opportunities open to the managerial
economist because of the growing role of government in business life.
He is responsible for the working of the whole business concern.

The most important obligations of a managerial economist is that his

objective must coincide with that of the business. Traditionally, the
basic objective of business has been defined in terms of profit
maximisation.
As a managerial economist, he must do something more than routine
management to earn profit. He cannot expect to succeed in serving
management unless he has a strong conviction which helps him in
enhancing the ability of the firm.

The other most important responsibility of a managerial economist is

to try to make as accurate forecast as possible. The managerial
economist has to forecast not only the various components of the
external business picture, but he has also to forecast the various
phases of company’s activity, that is the internal picture of the
company.

The managerial economist should recognise his responsibilities to

make successful forecast. By making the best possible forecasts, the
management can follow a more closely course of business planning.
Yet another responsibility of the managerial economist is to bring
about a synthesis of policies pertaining to production, investment,
inventories, price and cost. Production is an organised activity of
transforming inputs into output.

The process of production adds to the values or creation of utilities.

The money expenses incurred in the process of production constitute
the cost of production. Cost of production provides the floor, to
pricing. It provides a basis for managerial decision.

There are several areas which have attracted the attention of the
managerial economist, such as maximising profit, reducing stocks,
forecasting sales, etc. If the inventory level is very low, it hampers
production. A managerial economist’s first responsibility, therefore, is
to reduce his stocks, for a great deal of capital is unprofitably- ably tied
up in the inventory.

The managerial economist’s contribution will be adequate only when

he is a member of full status in the business team. The managerial
economist should make use of his experience and facts in deciding the
nature of action.

He should be ready to undertake special assignments with full

seriousness. The managerial economist can put even the most
sophisticated ideas in simple language and avoid hard technical terms.
It is also the managerial economist’s responsibility to alert the
management at the earliest possible moment in case he discovers an
error in his forecast. By this way, he can assist the management in
adopting appropriate adjustment in policies and programmes.

He must be alert to new developments both economic and political in

order to appraise their possible effects on business. The managerial
economist should establish and maintain many contacts and data
sources which would not be immediately available to the other
members of management. For this purpose, he should join
professional and trade associations and take an active part in them.

To conclude, a managerial economist should enlarge the area of

certainty. To discharge his role successfully, he must recognise his
responsibilities and obligations. No one can deny that the managerial
economist contributes significantly to the profitable growth of the firm
through his realistic attitude.