Panr I: INTRODUCTION

CHAPTER
and Scope of
1
-Sture
rr{fiana geri al E c on omi c s

I .l lntroduction
Emergelce of managerial economics as a separate course
of management "i,rdies can
be attributed to at least three factors: (a) growing complexity
of business decision-
making process due to changing market" condi'tions'ano
(D) consequent upon, the increasing use of
tuslnlss Lnvironment,
economic togl., co;.ept-s, theories and
tools of economic analysis in the process of business
decision-making, and (c) rapid
increase in.demand for professionally trained managerial
glance at how these factors have contributeJ
*unpo*..."L!t us have a
to trre creation of .managerial
economics, as a separate branch of study.
It is a widely-accepted fact that business decision-making process
has become
increasingly complicated due to ever growing complexities
in the business world.
There was a time when busine.ss.unitslshopi fr*r,
factories, mills, etc.) were set
up, owned and m.anaged by individuals or business families.
top business families like Tatas, Birlas, Singhanias,
f" f"ai", there were 22
Ambanis and piemjis, etc. Big
industries were few and scale of businesf
managerial skills acquired through traditional "p.rjti""-
*.; ;iil;j;t sma1. The
family training-anJ-.if.ri.n.. *.r.
sufficient to manage small and iredium r.ut. uuiin.sses.
Although J large part of
private business is still run on a small scale
and managed in the iraditional style of
business management, the industrial business
*o.fa frur changed drastically in size,
nature and content._ The growing complexity of
the business
to the growth of large scale industries, grora,th of a largeriorld .u, il. attributed
,u.Lay-oi industries,
diversification of industrial products, and diversification of business
""iarsion corporations,
activities of corporate firms, growth of multinational
and mergers and
takeovers, especially after thJ second world
war. These factors have contributed a
great deal to the recent increase in inter-firm,
inter-indust y *J ini..nutlonut rivalry
competition, risk and uncertainty. Business decision-making
in this [ifi'or business
environment is a very complex.affa,l.Pr family
iraining a;d ..p..i*i, rs no longer
sufficient to meet the manigerial challenges.
The. growing complexity of business decision-making
has inevitably increased the
application of economic concepts, theories and tools
of eionomic this area.
The reason is that making appropriate business decision """rv'rr.'i,
-an
understanding of market conditions,
..qui.., a clear
the nature and degree of .od:;ition, market
fundamentals and the business environment. This
requires an intensive and extensive
analysis of the market conditions in the product
*uiket, input market ano nnan"ial
2 PArt /: INTRODUCTION

on the other hand, economic theories, logic and tools of analysis have
been
market.
aevetopJ to a.ralyre and-predict market behaviour. The application of economic
prediclion of
con.#r, theories. logic aid analytical tools in the assessment andof
market conditions and business environment has proved to be geat-he-lp in
business decision-making. The contribution of economics
to business decision-
economic theories and
mating-tras come to ue-wioety recognized..consequently,
crystallized
analytical tools, which *" *iO.iy ur.Jin business deiision-makinq Yt.
-r.p".ate
managerial economics or
irto u branch of management studies, called
business economics'
Letusbeginourstudyofmanagerialeconomicsbyleaming
(D What economics is
and
1i;; eUout managerial decision-making problems'
(iii)Howeco,omicscontributestobusinessdecision.making?

1.2 What ls Economics?

and analytical tools
Managerial economics essentially constitutes of economic theories
It is useful to know
that #e widely applieci to business decision-making. _therefore
,rnii, Economics is a social scienie. Its basic tunction is to study
"';;;;;;;t^. their
to*"p."pr.-irJiuiauut., households, firms and nations-madmize this is called
gains from
their limited resources and opportunities. In economic terminolory,
Optimizing
maximizing behaviour o., ,obi. appropriatelY, optimizing behaviour'
the obiective- of
behaviour is, selecting thi best iit it ouoilobl, options with
thus a social science, which
maxriiring gains fromlh, grurn r"rour"rr.Economicsls to
behaviour ii relation to optimizing allocation of availab.le
resources
studies hul^i" their
how households allocate
achiiue the given ends. For example, economics itudies
services they consume so
fimiteJ ,.roi..". (income) between the various goods and.
how with
ttrat ihey are able to 1;ru*irnir. their total satisfaction. It
analyzes households
limited income decide 'rrtut-to consume' and'how much to consume' with the aim
of maximizing total utilitY'
consider the case of firms, the producers of goods and services'
Economics
of the commodity to produce'
studies how producers-the firms-make the choicJ
or market segment to cater
itre production technology, location of the firm, market
i", firi.. of the product, ihe amount to spend on advertizing (if necessary) and the
strategy for facing competition, etc'
men and
At macro level, economics studies how nations allocate their resources,
material, between .o*p"iing needs of the society so that economic.wery:
^ir."' 3^|q:
il:#l* il;;i*il"i. Lono'"i.''*dies .how -s:l:Ti::1 TT:'i::,
p:::*
o"ir.v, exrend]ture policy' p"t-t,!:li? l?::t^ tariff
::
il;ot"';"t"i.t-r"-"1";
monetary ;;il;," ;;i;il;-;;ii.v, ?"19iq" traae (export-import policv)'
policy, etc. - Bnd, the effects of these policies'
Note
- ; ilT", '*.rrt *, there is no final answer toqr*.. this euestion
t:..11'pffl:-s:::t5t::li,'l::;i$i*"}"il'**:tri:*
::,HJ. "
ffiT',lll'""""*" ";.;
,r,. p^, two and
"
centuries
Tr.h iT]:..1T-ir,:*:1,'::*,::,T _*,
Economics has been-denned dinercntrv at differcnt
:?iil:"tr: Ll?ilffi":';i";.ff;,il",f i."a??i; p,..r,.ry.
-r -^^-^-:^- --ho*< lraaqrrer 'economics is tstilll
rstul an
il::':?t'i:"ffi:'X'"rf;.":'ii""" ,,i""4- i'Jiiir'i"*:j::*:::::: llllllr ?i:?T;;"'"""'ics
(Schurtz)'
icience'
:;:::ffiJ;':fl".:l"irfr,i."i ;;-.i;"";.;;'.'G'ono'nr.' is st,r a voung
 NATURE AND SCOPE OF MANAGERIAL
ECONqMICS 3
Economics is obviouslv.a study of the
choice-making behaviour of the people.
In
reality' however, choice-maling i. ur
is very complex and most economic oecisions
*t riffi
iJ it toot , because the economic worrd
trave to be taken under the condition
imperfect knowledge, risk and.unc".t"irt of
making an appropriate choice in an extrem.iv.orpro
il.#r.,
taking an appropriate decision or
tn tn1i1 ri.*--:ti"";;-virf airncutt tast.
to study the complex i..irioir-.nuting process, economists have
developed1nd.eavou1.
a large l<rt of anilvticat tooti and *"iiii*rwith
the aid of mathematics and
staristi:::rl rr1v1 ae.ve]on.o r*e!1il;;;';'",
predictive power. Analyticil tools
nomic theories with a fairly high
". aid tech;;qr;;, ,rono*r" lcnus and theories constitute
the body of economiis.

1.3 What ls Managertat Economlcs?

The subject matter of economic science
consists of the rogic, toors and techniques
analyzing economic ohenomena as weil of
as, ewruating
techniques and ecoiomic theories..rn" ,ptimization
""i"ir'ir-ritions, in
"pprr."rr*;i;;#;J{"i.n..
decision-making is all pervasive. fvfo.e
specincaffy,
business
Mentgerlel Oeclllon Aruss economic laws and tools of economic
. analysis are
Asses$nentot tnvestible Funds - now applied g."" deal in tt. p.o..r,
. Selectlng 4 oiburinrs
. Cholce ol Eusrness
product
Araa
{ecision-making. This has led, ui rn"ntion"J earlier,
. Determining Optimum Outout to..ft: emergence of a separate branch of study
. Determining pice of the procluct called managerial economics. ffre appiication
: !:fSE g[%{if,, t- @ m o i n a,ti ii i n d rech n o! q y of
economic concepts and theories in ctmbination
with quantitative methods is illustrateO in
fig. t.t.
Managerial economics can be broadly delined
as^the study of economic theories, loeicLnd bols
alybsis tlat arg rrri inTni prorrs o7
!.:::::*,:
Dustness decision-making. Economic thiories and
techniques- of economii analysis are
ipplied to
ana.lyze business problems, evaluate"business
Application of Economii Concepts, options and opportunities with a view to
Theories and Analyticat ativing at
Tools to find Optimum Sotution io er.in"rr;riobt;;:r"* an appropriate business decision. Manageiial
economics is thus constituted of that
Dart of
Fig. 1.1 Application of Economics to economic knowledge, logic, theories and
anatyticat
Manageriol Decision_Making tools that are used for rational business
aecision-
making.
Let us look at some definitions ofmanagerial
o*nuints\1 economics offered by a few eminent economists.
Maaagerlal "Managerial economics is concerned with
Economtcs the problems of formulatin! the application of economic concepts ..nd
economics to
."if"ia decision making,,2.
"Managerial economics ...-is the integration
of ..ino,ni. theory with business
purpose of facilitating decision
making and ro.**a pi*ning or^;(t{:!i#
uy management.,3.
and Seigelman
Notes -Spencer
- 2. Mansfield, E. (ed.), Managerial Economics and Operations
Research,
p. 11. (.W.W. Norton and Co., Inc., New york, 1966).,
3. Spencer, M.H., and Scigelman, L., Managerial Economics, (Irwin Illinois.
1969), p. l
 4' Part I INTRoDUCTIoN

"Managerial economics is concemed with the application of economic principles and methodologies
to the decision-making process within the firm or organization. It seek to establish rules and
principles to facilitate. the attainment of the desired economic goals of management'/.

-Douglas
'lManagerial economics applies the principles and methods of economics to anal1.'ze problems faced
by management ofa business, or other [pes oforganizations and to help find solutions that advance
the best interests of such organizations"s and Chang
-hrns
These definitions of managerial economics together reveal the qature of the
discipline even though they do not provide its perfect definition.

1.4 Why do Managers Need to Know Economics?

Economics contributes a great deal towards the performance of managerial duties and
tesponsibilities. Just as biology contributes to the medical profession and physics to
. rgineering, economics contributes to the malagerial profession. Ati other
professional qualifications being the same, managers with a working knowledge of
economics can perform their functions more efficiently than those without it. The
basic function of the managers of a business firm is to achieve the objective of the
firm to the maximum possible extent with the limited resoulces placed at their
disposal. The emphasis here is on the maximization of the objective and limitedness
-- of the resources. Had the resources been unlimited, the problem of economizing on
never arisen. But resources at the
gre by all means limited. Therefore,
-sis;p$H:g.E
\{h'\ o ? h=(*-
i .e\ I I
\eir use.

- tr.98r s$ \o
\o
o\
\nomics. Let us now see how
ii siS.F e,EF,H (: os .b0 \ion-making. As mentioned
6[-trd*81,
.,8.o, BE O tr-- !? -q)
v) J the stu$t of logic, tools and
.,Ts EEtr c)ul! (,
!l \s .o
ources to achieve the given
\ $ ! E.u'g (:=
q)xo-
.f,6

0) .e
E r). 3-.
ql
o z'
o riques that managers need to

i'3"'=s i 3 cx
aE A
ar o
tr
efore, a working knowledge
atial for managers. ln other
I
,,.:E ; s s I sS I
o
o

,.-- -'+ g
---_:-:
A.Y.iQ
A;>.r
E>t
1rO-E
E
6
-.' re a number of decisions in
o)
LA=
E rru gQ
o.
r decisions are taken under

=
'.9 aT
q
O
U.3
ebo
!a
JJ
AO\
\o
' due to Uggqrlqb behaviour
a v o.= lergence of competlio-rs with
*9 e 'E E
Hvt
.=-'o rtionaf Fictors impacting the
6J
B'6
UC rs well as social and political
:., :r:.::5 .3 E {=
u >dern business world adds
--: '--.i ::F E B.=
s> ,egree of uncertainty and risk
,o 3-E
A<
icted with a high degree of
l. h uy b Frii3 ES to predict the future course
sciudlbfn - .:E
do
rs
of lirarc d F \s
!ro
srages of its grrr[- A \-() l{)
mfinished scitu'@E t s..S N.J., l9E7), p. l.
c-Hall, N.J., l9t6), p. 3.
 NATURE AND SCOPE OF MANAGERIAL
ECONOMICS 5

*,J,::,tt"TJ[ffi ,,]:,#J::,,.,:T.d:]ffi ;:mffi.[.?ll*.,;"liJ

formulate a business strategy in. conformity *iit,
the goals ;i[-i"r.
rational business decision -iequires a clear understariding Taking a
environmental conditions related to the business issues
;f A. technical and
for which decisions are taken.
Application of economic theories to explain and analyze
the technical conditions and
the business environment contribut.r a go;d deai
to .utionuiJ.;ision-making.
Economic theories have, therefore, gained u uo. of application in the analysis
range.
of practical problems of businei. with the groiving ;;,npi";it-
environment, the usefulness. of economic theory of business
as a tool of analysis and its
contribution to the process of decision-making ha,
b..n *ide1y i..osrir.a.
Baumol6 has pointed out three main contributions
business ecomomics.
of economic theory to
Firsl, 'one of the most important things which the economic
contribute to the management science' is bullding [theories] can
analytical models, *rrirt help to
recognize the structure of managerial problems,
eliminate the minor Jetails Lhat might
obstruct decision-making, and [erp to concentrate
on the main issue.
secondly, economic theory contributes to the business analysis .a
set of analytical
methods', which may not be applied dir^eclly to specific
uurinls, p.oli.rr, but they
do enhance the anarytical capabilities of the business
analyst.
Thirdly, economic theories offer clarity to the various
concepts used in business
analysis, which enables the managers to avoid conceptual
pitfalls.

I .5 Appllcatlon of Economrcs to Business Decisrons: An Example

we have discussed above in general terms, of course how
.- - economics
to business decision-making. In this iection, we show this
contribute can
application in
some hypothetical business issues.
Business decision-making is.essentially a process
of selecting the best out of
altemative opportunities open to the firm. th. pio..r.
of decision-muf.irg;.orr"pi.J,
. four main phases:
! (i) determining and defining the objective to be achieved;
(ii) collections and- analysis of business related data and
other information regarding
economic, social, political and.technological environment
necessity and occasion for decision; -J-for.ru"ing the

(iii)inventing developing and analyzing possible courses of

action; and
(iv) selecting a particular course of action, from the available altematives.
This process of decision-making is, however, not as
simple as it appears to be.
steps (ii) and (iii) are crucial in business decision-making.
Thlse ,t"p, f,*
managers,

Note
- 6' Baumol' w'J''what can Economic Theory contribute to
Managerial Economics, in AER, vol. 51, No.2, May
1961.
7' see also Simon, Herbert A. "The Decision-Making process"
in Mansfield (ed.), op. cit.
6 Part 1: INTRODUCTION

analytical ability to test and determine the appropriateness and validity of decisions in
the modem business world. Modem business conditions are changing so fast and
becoming so competitive and complex that personal business sense, intuition and
experience alone may not prove sufficient to make appropriate business decisions.
Personal intelligence, experience, intuition and business acumen of the decision-
makers need to be supplemented with quantitative analysis of business data on market
conditions and business environment. It is in this area of decision-making that
economic theories and tools of economic analysis contribute a great deal.
For instance, suppose a firm plans to launch a new product for which close
substitutes are available in the market. One method of deciding whether or not to
launch the product is to obtain the services of business consultants or to seek expert
opinion. If the matter has to be decided by the managers of the firm themselves, the
two areas which they will need to investigate and analyze thoroughly are:
(i) production related issues, and
(ii) sales prospects and problems.
In regard to production related issues, managers will be required to collect and
analyze data on:
(a) available techniques of production,
(D) cost of production associated with each production technique,
(c) supply position of inputs required to produce the planned commodity,
(d) price structure of inputs,
(e) cost structure of competitive products, and
(/) availability of foreign exchange if inputs are to be imported.
In order to assess the sales prospects, managers are required to collect and
analyze data on:
(a) market size, general market trends and demand prospects for the product,
(b) trends in the industry to which the planned product belongs,
(c) major existing and potential competitors and their respective market shares,
@ prices of the competing products,
(e) pricing strategy of the prospective competitors,
( / ) market structure and degree of competition, and

(S) supply position of complementary goods.

analysis of input and output markets that the application of
It is in this kind of
economic theories and tools of economic analysis helps significantly in the process
of decision-making.
Economic theories state the functional relationship between two or more economic
variables, under certain given conditions. Application of relevant economic theories to
the problems of business facilitates decision-making in at least tlree ways.
 NATURE AND SCOPE OF MANAGERIAL ECONOMICS 7

First, it gives a clear understanding of various economic concepts (e.g., cost,

price, demand, etc.) used in business analysis. For example, the concept of 'cost'
includes 'total', 'average', 'marginal', ofixed', 'variable', oactual', and 'opportunity'.
Economics clarifies which cost concepts are relevant and in what context
Second, it helps in ascertaining the relevant variables and speciffing the relevant
data. For example, it helps in deciding what variables need'to be ionsidered in
estimating the demand for two different sources of energy-petrol and electricity.
Third, economic theories state the general relationship between two or more
economic variables and also events. Application of the relevant economic theory
provides consistency to business analysis and helps in arriving at right conclusions.
Thus, application of economic theories to the problems of business not only guides,
assists and streamlines the process of decision-making but also contributei i good
deal to the validity of the decisions.

1.6 The Scope of Managerlal Economlcs

Economics has two major branches: (i) Microeconomics, and (ii) Macroeconomics.
Both micro and macro-economics are applied to business analysis and decision-
making--directly or indirectly. Managerial economics comprises, therefore, both
micro and macro economic theories. The parts of microeconomics and
macroeconomics that constitute managerial economics depend on the purpose of
analysis.
In general, the scope of managerial economics comprises all those economic
concepts, theories and tools of analysis which can be used to analyze issues related
, to demand prospects, production and cost, market structure, Ievel of competition and
general business environment and to find solutions to practical business problems. In
other words, managerial economics is economics applied to the analysiJ of business
problems and decision-making. Broadly speaking, it is apptied economics.
The areas of business issues to which economic theories can be directly applied
may be broadly divided into trvo categories: (a) microeconomics applied to operational
or intemal issues, and (6) macroeconomics applied to environmentai or extemal issues.

Operational issues are of internal nature. Intemal issues include all those problems
-!..6.1
Mlcro' which arise within the business organization and fall within the purview and control
of the management. Some of the bisic internal issues are: (i) choice of business and
i::ilf itj the nature of product, i.e., what to produce; (ir) choice of size of the firm, i.e., how
d#;t;rrt much
lssues to produce; (iir) choice of technology, i.e., choosing the factor-combination;
(iv) choice of price, i.e., how to price the commodlty; (v) how to promote sales;
(vi) how to face price competition; (vii) how to decide on new investments;
(viii) how to manage profit and capital; (lx) how to manage an inventory i.e., stock
of both finished goods and raw materials. These problems may also figure in forward
planning. Microeconomics deals with such questions confronted by managers of
business enterprises. The following microeconomic theories deal with most o1these
questions.
Thcorvof Demand theory deals with consumers' behaviour. It answers such questions as: How
Demand do the consumers
decide whether or not to buy a commodity? How do they decide
8 Part 1: INTRODUCTION

on the quantity of a commodity to ,be purchased? When do they stop consuming a

commodity? How do the consumers behave when price of the commodity, their
income and tastes and fashions, etc., change? At what level of demand, does changing
price become inconsequential in terms of total revenue? The knowledge of demand
theory can, therefore, be helpful in making the choice of commodities, finding the
optimum level of production and in determining the price of the product.
Theory of Production theory explains the relationship between inputs and output. It also explains
.-,P::!:.::::: under what conditions costs increase or decrease; how total output behaves when
- Proouctron
-zno
oJii"i,l units of one factor (input) are increased keeping other factors constant, or when all
factors are simultaneously increased; how can output be maximized from a given
quantity of resources; and how can the optimum size of output be determined?
Production theory thus, helps in determining the size of the firm, size of the total
output and the amount of capital and labour to be employed, given the objective of
the firm.
of
Anatysts Price theory explains how price is determined under different kinds of market
conditions; when price discrimination is desirable, feasible and profitable; and to what
,rrrr!li{rl};
piiiti" ririr] extent advertising can be helpful in expanding sales in a competitive market. Thus,
price theory can be helpful in determining the price policy of the firm. Price and
production theories together, in fact, help in determining the optimum size of the firm.
Profit Anatysts Profit making is the most common objective of all business undertakings. But making
.. and Proflt a satisfactory profit is not always guaranteed because a firm has to carry out its
Manasement
activities under conditions of uncertainty with regard to (i) demand for the product,
(ii) input prices in the factor market, (iii) nature and degree of competition in the
product market, and (iv) price behaviour under changing conditions in the product
market, etc. Therefore, an element of risk is always there even if the most efficient
techniques are used for predicting the future and even if business activities are
meticulously planned. The firms are, therefore, supposed to safeguard their interest and
avert or minimize the possibilities of risk. Profit theory guides firms in the
measurement and management of profit, in making allowances for the risk premium,
in calculating the pure retum on capital and pure profit and also for future profit
planning.
The.orv or. Capital like all other inputs, is a scarce and expensive factor. Capital is the foundation
i:.1:::'-!:
ln
ve5 tm Ien
of business. Its efficient allocation and management is one of the most important
o..jiirri tasks of the managers and a determinant of the success level of the firm. The major
issues related to capital are (i) choice of investment project, (ii) assessing the
efficiency of capital, and (iil) most efficient allocation of capital. Knowledge of capital
theory can contribute a great deal in investment-decision making, choice of projects,
maintaining the capital, capital budgeting, etc.

1.6.2 Environmental issues pertain to the general business environment in which a business
Macro- operates. They are related to the overall economic, social and political atmosphere of
economics the country. The factors which constitute economic environment of a country include
Applied to
Busi n ess
the follorving:
tnvironm en t (i) the q.'pe of economic system in the country,
(li) general trends in national income, employment, prices, saving and investnenL etc.,
 NATURE AND SCOPE OF MANAGERIAL ECONOMICS 9

(iii) of and trends in the working of financial institutions, e.g., banks,

structure
financial corporations, insurance companies, etc.,
(iv) magnitucie of and trends in foreign trade,
(v) trend in labour supply and strength of the capital market,
(vi) govemment's economic policies, e.g., industrial policy, monetary, fiscal, price
and foreign trade,
(vii) social factors like value system of the society, property rights, customs and
habits,
(viil) socio-economic organizations like trade unions, consumers' associations,
consumer cooperatives and producers' unions,
(ix) political environmenr, which is constituted of such factors as political system-
democratic, authoritarian, socialist, or otherwise, State's attitude towards private
business, size and working of the public sector and political stabiliry and
(x) the degree of globalization of the economy and the influence of MNCs on the
domestic markets.
It is far beyond the powers of a single business firm, howsoever large it may be,
to determine and guide the course of economic, social and political factors of the
nation. However, all the firms together or giant business houses can jointly influence
the economic and political environment of the country8 For the business community
in general, however, the economic, social and political factors are to be treated as
business parameters.
The environmental factors have a far-reaching bearing upon the functioning and
performance of the firms. Therefore, business decision-makers have to take into
account the present and future economic, political and social conditions in the country
and give due consideration to the environmental factors in the process of Cecision-
making. This is essential because business decisions taken in isolation of
environmental factors may not only prove infructuous, but may also lead to heavy
losses as has happened in case of establishing SEZ in Nandigram and Tata's small care
project in Singur district of West Bengal. Consider also, for example, the following
kinds of business decisions-
o a decision to set up a new alcohol manufacturing unit or to expand the existing
ones ignoring the impending prohibition-a political factor-would be suicidal
for the firm;
o a decision to expand the business beyond the paid-up capital permissible under
Monopolies and Restrictive Trade Practices Act (MRTP Act) amounts to inviting
legal shackles;
r a decision to employ a highly sophisticated, labour-saving technology ignoring
the prevalence of mass open unemployment-an economic factor-may prove
to be self-defeating;

Note
8. Forexample, Federation of Indian Chambersc,- ,:,.,*erce and Industries (FICCI) has been influencing the govemment's
- r, r -;r investment, customs, oil prices, monetary
economic policies, especially in regard to (interesl rate) policy and
taxation policy.
10 Parl.4: INTRODUCTION

o a decision to expand the business on a large

scale, in a society having a low
per capita income and hence a low purchasing power stagnant over
a long
period may lead to wastage of resourtes
The managers of business firms are, therefore, supposed to be fully aware
of the
economic, social and political conditions_-prevailing^in the count.y *frif.
taking
decisions on business issues of wider implications.
Managerial economics is, however, concerned with only the economic
environment, and in particular with those economic factors which form the
business
climate. The study of political and social factors falls out of the purview
oimanageriat
economics. It should, however, be bome in mind that economic, social
and political
behaviour of the.people are interdependent and interactive. ror'exampfi
growtn of
monopolistic tendencies in the industrial sector of India led to the enactnlnt
of the
Monopolies and Restrictive Trade Practices Act (1961), wrrictr resiii.t,
proliferation of large business houses. Similarly, varioui inauitriat
tt.
poticy iesotutions
formulated until 1990 in the light.of the socio-political ideology o? ttJg*.--.nt
restricted the scope a_nd area of private business and had restrai'ned
the eifansion or
private business in India. Some of the major areas in which politics 'irrflu"n...
economic affairs the country are concentration of economic power, growth of
monopoly, state of^of
technology, existence mass poverty and unemploy..it, foreign
-of
trade, taxation policy, labour relations, distribution sysiem of essentiai goojs, etc.
In this book, we will concentrate on only some basic aspects of macroeconomics,
including meaning and measurement of national income and its determination;
theories
of business cycles, economic growth, and economic factors; content anJ'logic
of
some relevant state policies which form the business environment.
The.major macroeconomic or environmental issues that figure in business
decision-
""ffi: making, particularly with regard to forward planning and formulation
of the future
strategy, may be described under the following threi categories.
l. Issues Related to Macroeconomic Trends in the Economy. Macroeconomic
trends are indicated by the trends in macro variables, e.g., the general
trend in the
economic activities of the country, the level of GDR investmeit climate,
trends in
national output (measured by GNP or GDP) and employment, as well
as price trends.
These factors not only determine prospects of private business, but also greatly
-the
influence the functioning of individual firms. Therefore, a firm planning to set up a
new unit or expand its existing size would like to ask itself
'whai is the leneral trend
in the economy? What would be the consumption level and pattem oittr.
society?
Will it be profitable to expand the business?'Answers to these-questions and the
like
are sought through macroeconomic studies.
2' Issues Related to Foreign Trade. Most countries have trade and
financial relations
with other countries. The sectors and firms dealing in exports and imports
are
affected directly and more than the rest of the economy. Fluctuations
in the
international market, exchange rate and inflows and outflows of
capital in an open
economy have a serious bearing on its economic environment and,
thereby, on the
functioning of its business undertakings. The managers of a firm would,
therefore,
be interested in knowing the trends in international trade, prices, exchange
rates and
 11
NATURE AND SCOPE OF MANAGER1AL ECONOMICS

prospectsintheinternationalmarket.Answerstosuchproblemsareobtainedthrough
thestudyofintemationaltradeandmonetarymechanism.Theseaspectsconstitutea
part of macroeconomic studies'
3./ssaesRelatedtoGovernmentPolicies.Govemmentpoliciesdesignedtocontrol
private business affect the functioning of the
and regulate ..onori. ..tivities of the
activities as producers and their attempt
private business unO.rtut irgt. Besides,_firms'
to considerable social costs' in terms
to maximize tfreir private g?1nt o, profits leads
cities, creation of slums' etc. Such
of environment pottution, iraffic congestion in the
social costs not only bring a firm's iiterests
in conflict with those of the society' but
also impose a social iesp"onsiUifity on the
firms. The govemment's policies and its
to minimize such social costs aud
regulatory measures ,. i.rign.a, uy 1na large,
conflicts. the managers shorild, ih.i.fo..,
be-fully aware of the aspirations of the
peopleandgivesuchfactorsadueconsiderationintheirdecisions.Theforced
closure of po[uting industrial units set up
in the residential areas of Delhi and the
consequentlossofbusinessworthbillionofrupeesinzo!!isanexampleofthe
responsibility by the businessmen'
result of ignoring ttr.-pttfl. laws and the.sociaf costs and
The economi. .on..pl, and toots of analysis help in determining such
benefits.
Concludlng Economictheories,bothmicroandmacro,haveawiderangeofapplicationsin.the
lemarks processofbusinessdecision-making.Someofthemajortheorieswhicharewidely
appliedtobusinessanalysishavebeenmentionedabove.Itmust,however,beborne
of analysis do not offer readymade
in mind that economic tireories, models and tools
firms. They provide only the logic and
answers to the practi."r-pi"tr.*r of individual
as such. It depends on the managers' own
methods to find answers, not the answers
training,and theii competence to use the tools
understanding, experience, intelligence,
answers to the practical problems
of economic analysis to find reasonably approfriate
of business'
Brieflyspeaking,microeconomictheoriesincludingthoseofdemand'
budgeting, and macroeconomic
production, pri.e a.6rmination, profit and capital
theoriesincludingofnationalincome,thoseeconomicgrowthandfluctuations,
and the study of state policies and
intemational trade and monetary mechanism,
activities, by and large' constitute the
their repercussions ;; th; private business
scopeofmanagerial".o,o.i...Thisshould,however,notmeanthatonlythese
economictheoriesformthesubject-matterofmanagerialeconomics.Nordoesthe
knowledge of tfrese theories fuintt wtrotly
the requirement.of economic logic in
decision-mat.ing.enouerallstudyofeconomicsandawiderunderstandingof
firms and state would always be
economic behavioui of the society, individuals,
desirable and more helPful'

1.7 Some Other Toplcs ln Managerial Economics

essentially the study of economic
As mentioned earlier, managerial economics is
problems of business undertakings' There are'
analysis appliedto find solut[ns to the
however,certainotherdisciplineswhichprovideenornousaidtotheeconomic
 4 Part 1: INTRoDUCTIoN

"Managerial economics is concemed,rvith

the application of econom_ir: principles
to the decision'making and methodologies
process within^ the
principles to facilitate the attainment
ffi ;;-;;;*ization. It seeks to establish rules and
, of the desireJ..o"no.i. goals of management,{.

':Managerial economics applies the principles -Douglas

and methods of economics to analyze problems
by management of a business, or.other faced
oig-i;;;..
ryp.r or and to help find solutions that advance
the best interests of such organizations,; _Davis and Chang
rhese definitions of managerial economics
together reveal the nature
discipline even though they do "r"t pr""ialirl..r..t of the
definition.
1.4 Why do Managers Need to Know Economics?
Economics contributes a sreat deal towards
the performance of managerial duties
and
"esponsibilities' Just u. uiaogv .on;il;;; io"tfl" ,.ai.al profession-
and physics to
''rgineering, economics conlributes to the'--managErial
profession. AII other
professional qualifications being
:' ilr. ru*, ,unug.., witt a *.kirg rrrowledge
economics can perform their dnctiort;;;;iLciently -r"iti,out of
basic function of the managers of than those it. The
o* a businesr fi;
is to achieve the objective
Lo,
the maximu, poJribl. extent *irr, ir*'ri*ffH;.::: "oil..o of the
disposal' The emphasis irere is on the at their
,u*l*iruiion of the objective and limitedness
of the resources' Had the resources been
unlimited, the prob-l'em-oiJonornizing
resources or resource management on
would have never arisen. But resources
disposal of a firm, be it finance' men at the
or material, ale by urr ,.*, ri*it.a.
the basic task of the management is Therefore,
to optimirl-tr,eir use.

.to.ii,,_U[;;; #tff.1'::1,?,,"#,-,Y,ilir?Ti-li:ii:,f:];:]:?fr::;*',T,:'*Tffi,1".:
Manasertar aDove, economics, though variously difined,
is essentially rh;;;ry,';iigrr, toot,
Functlons techniques of making optimum use of the'available resources ond
to ichtive the given
'' ends' Economics thui piovides anatytical
io;[;
techniques that managers need to
achieve the goals of tlie organiratlon
t1e1;;;;;;
of economics, not necessar-ily. a ro""ur t.g..loi-s Therefore, a working knowledge
words, managers are essentialty practicingT.ono*oo. essential for managers. In other

In performing their functions, managers

have to take a number of decisions
conformity with the goals of th; fi;.'Mury in
conditions of uncertainty and rist<,
uurin.rr-oljJon, are taken under
ihese *ir. ,nuirty d*;;
of the marketforces, changing Er-;-ir.;;^;;rironment, uoqqr.tain behaviour
emergence of compeiiiois with
highly bompetitive p.oau.i., "gotu..il.ri
policy, irti."tioi"J-factors impacting
domestic market dui mainlrtJin.r*ring the
changes in the country. 'Th. grouuiirution;ili as social and political
.;;pffity of the *oa.o.--uusiness world adds
complexity to business decision-making.
ibweuer,-trrr-0"g.; # uncertainty and risk
can be greatry reduced if market
.o,ioiiion, are predicLd with a high degree
reliability' Economics offers model.,-tootr'*a of
of market conditions and businesi'pi*f..tr. techniques to predict the future course
Notes

- 4' Dougras, Evan J. Managerial Economics: Anarysis and strategt, (prentice-Hall,

5' Davis Ronnie and semoon chang. Principles *.r.,' ,rli-
of Managerial Econromics, (prentice-Hall,
N.J., lgg6), p. 3.