MANAGERIAL ECONOMICS

Material No. 2
Reference:
MANAGERIAL ECONOMICS 14TH EDITION BY: HIRSCHEY AND BENTZEN (2016)

Introduction

One standard definition for economics is the study of the production, distribution, and
consumption of goods and services. A second definition is the study of choice related
to the allocation of scarce resources. The first definition indicates that economics
includes any business, nonprofit organization, or administrative unit. The second
definition establishes that economics is at the core of what managers of these
organizations do.
Economic concepts and principles from the perspective of “managerial economics,”
which is a subfield of economics places special emphasis on the choice aspect in the
second definition. The purpose of managerial economics is to provide economic
terminology and reasoning for the improvement of managerial decisions.
Microeconomics studies phenomena related to goods and services from the
perspective of individual decision-making entities—that is, households and businesses.
Macroeconomics approaches the same phenomena at an aggregate level, for example,
the total consumption and production of a region.
Microeconomics and macroeconomics each have their merits. The microeconomic
approach is essential for understanding the behavior of atomic entities in an economy.
However, understanding the systematic interaction of the many households and
businesses would be too complex to derive from descriptions of the individual units.
The macroeconomic approach provides measures and theories to understand the
overall systematic behavior of an economy.
Since the purpose of managerial economics is to apply economics for the
improvement of managerial decisions in an organization, most of the subject material
in managerial economics has a microeconomic focus.
However, since managers must consider the state of their environment in making
decisions and the environment includes the overall economy, an understanding of how
to interpret and forecast macroeconomic measures is useful in making managerial
decisions.
What is Managerial Economics?

Managerial Economics applies economic theory and methods to business and

administrative decision making. Managerial prescribes rules for improving managerial
decisions. Managerial economics also helps managers how economic forces affect
organizations and describes the economic consequences of managerial behavior. It links

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traditional economics with sciences to develop vital tools for managerial decision-
making (Dilts, 2006).

Managerial economics offers a comprehensive application of economic theory and

methodology to management decision-making. It is as relevant to the management of
government agencies, cooperatives, schools, hospitals, and similar non-profit
institutions as it is to the management of profit-oriented businesses. Managerial
economics is applicable to different types of organizations.

The organization providing goods and services is often called as “business” or “firm” that
connote a for-profit organization. However, managerial economics is relevant to
nonprofit organizations and government agencies as well as conventional, for-profit
businesses.

Although the underlying objective may change based on the type organization, all these
organizational types exist for the purposes of creating goods or services for persons or
other organizations.

Managerial economics identifies ways to achieve goals efficiently. For example, suppose
a small business seeks to rapid growth to reach a size that permits efficient use of
national media advertising, managerial economics can be used to identify pricing and
production strategies to help this short-run objective quickly and effectively.

Role of Managerial Economics in Managerial Decision-Making

Managerial economics helps managers recognize how economic forces affect

organizations and describes the economic consequences of managerial behavior. It also
links economic concepts, data and quantitative methods to develop vital tools for
managerial decision making.

Any business firm wants to make the best use of the economic resources available to it,
particularly to maximize its profit or its sales revenue. Hence, business executives (or
the managers of different business firms) have to take prudent decisions regarding the
production, type of product-mix, purchase of inputs, product-price, etc., keeping in view
the targets or definite goals of the business firm.

Since future is always uncertain, such tasks of decision making for the future progress
of the business firm are really difficult. Managerial economics makes this difficult task
a bit easier and systematic.

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 Figure 1.1 above shows the role of Managerial Economics in managerial decision making.
Managerial Economics uses economic concepts and decision science
techniques to solve managerial problems.

What are the Characteristics of Managerial Economics?

Managerial economics has some special characteristics, and these characteristics

indicate the nature of managerial economics. Some of the important characteristic
features of managerial economics are noted below:

1. Managerial economics is microeconomic in nature: Economic theories can

broadly be divided into two parts, viz., macroeconomics and microeconomics.
While macroeconomics is concerned with the economic magnitudes relating

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 to the whole economy (such as national income, national production, etc.)
microeconomics is concerned with the decision-making of a single economic
entity (such as a business firm) within this system. Since managerial
economics deals with the economic problems of individual business firms in
an economy, it is microeconomic in nature. However, the firm works within a
given macroeconomic environment.

2. Prescriptive in nature: Managerial economics actually prescribes the ways

through which a business firm can achieve its goal within its constraints. It
prescribes the policies that should be undertaken by any business firm for
achieving its specific target. Hence, managerial economics is not concerned
with mere description of economic theories.

3. Pragmatic in its approach: Managerial economics is pragmatic in its approach

because it emphasizes on the real-life problems faced by any business firm
and their possible solutions, rather than concentrating only on some abstract
economic theories (which are based on restrictive assumptions).

4. Emphasizes on quantitative analysis: Managerial economics is mainly

concerned with some of the quantitative aspects of business decisions.
Business decisions relating to (a) output to be produced, (b) inputs to be used,
(c) prices to be fixed, (d) estimated cost and revenue schedules, etc., are
expressed in quantitative terms. Some of the qualitative aspects of production
such as efficiency of labor or the efficiency of factor inputs, are also estimated
in quantitative terms. For instance, average productivity of the workers can
be estimated to reflect their efficiency.

Why Managerial Economics is Relevant to Managers

We rely on others in the society to produce and distribute nearly all the goods and
services we need. The sources of those goods and services are not usually other
individuals but organizations created for the explicit purpose of producing and
distributing goods and services.

Nearly every organization in our society-whether it is a business, non-profit entity, or

governmental unit can be viewed as providing a set of goods, services, or both. The
responsibility for overseeing and making decisions for these organizations is the role of
executives and managers.

Managerial Economics is one of the subjects that are classified as applied business
discipline, together with marketing, production operation management, finance and
business strategy. These subjects form the core of curriculum for most academic
business and management programs, and most managers can readily describe their

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role in their organization in terms of one or more of these applied subjects. Study
reveals that economics provides key terminology, and theoretical foundation.

Although we can apply techniques from marketing, production/operations management,

and finance without understanding the underlying economics, anyone who wants to
understand the why and how behind the techniques needs to appreciate the economic
rationale for the technique.

We live in a world of scarce resources, which is why economics is a practical science.

We cannot have everything we want. Further, others want the same scarce resources
we want. Organizations that provide goods and services will survive and thrive only if
they met the needs for which they were created to do so effectively.

Since the organization’s customers also have limited resources, they will not allocate
their resources to acquire something of little or no value. And even if the goods or
services are of value, when another organization can meet the same need with a more
favorable exchange for the customer, the customer will shift to the other supplier. The
organizations must create value for their customers, which is the difference between
what they acquire and what they produce.

Managers who understand economics have a competitive advantage in creating value.

How is Managerial Economics Useful?

Economic theory and methodology lay down rules for improving business and public
policy decisions.

1. Evaluating Choice Alternatives helps managers recognize how economic forces

affect organizations and describes the economic consequences of managerial
behavior. It also links economic concepts, data and quantitative methods to
develop tools for managerial decision-making.

2. Managerial economics identifies ways to achieve goals efficiently. For example,

suppose a small business seeks rapid growth to reach a size that permits
efficient use of national media, advertising, managerial economics can be used to
identify pricing and production strategies to help meet this short-run objectively
quickly and effectively.

3. Managerial economics provides production and marketing rules that permit the
company to maximize net profits once it has achieved growth or market share
objectives.

4. Managerial economics had application in both profit and non-profit sectors. For
example, an administrator of non-profit hospital strives to provide the best

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 medical care possible given limited medical staff, equipment, and related
resources. Using the tools and concepts of managerial economics, the
administrator can determine the optimal allocation of these limited resources. In
short, managerial economics helps managers arrive at a set of operating rules in
the efficient use of scarce human and capital resources. By following these rules,
businesses, non-profit and government agencies are able to meet objectives
efficiently.

What is the Scope of Managerial Economics?

Since the purpose of managerial economics is to apply economics for the improvement
of managerial decisions in an organization, most of the subject matters in managerial
economics has a microeconomic focus. However, since managers must consider the
state of their environment in making decisions and the environment includes the overall
economy, an understanding of how to interpret and forecast macroeconomic measures
is useful in making managerial decisions (Saylor.org, 2010).

Managerial Economics takes into account almost all the problem areas of manager and
firm, specifically it deals with:

1. Demand Analysis and Forecasting: Unless and until knowing the demand for a
product how can we think of producing the product. Demand analysis therefore,
helps in analyzing the various types of demand which enables the manager to
arrive at reasonable estimates of demand of the product of his firm. Managers
not only assess the current demand but he has to take into account the future
demand as well.

2. Production Function: Conversion of inputs into an output is known as production

function. With limited resources managers have to make the alternate uses of
this limited resource. Factors of production called inputs is combined in a
particular way to get the maximum output. When the price of input rises the firm
is forced to work out a combination of inputs to ensure the least cost of
combination.

3. Cost Analysis: Cost analysis is helpful in understanding the cost of a particular

product. It takes into account all costs incurred while producing a particular
product. Under cost analysis we will take into account determinants of costs,
method of estimating costs, the relationship between cost and output, and the
forecast of the cost and profit.

4. Inventory Management: Inventory refers to stock of raw materials which a firm

keeps. The question is – how much of the inventory is ideal stock. Both high and
low inventory is not good for the firm. Managerial economics uses such methods

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 as ABC Analysis, simple simulation exercises, and some mathematical models,
to minimize inventory cost. It also helps in inventory controlling.

5. Advertising: Advertising is a promotional activity. In advertising while the copy,

illustrations, etc., are the responsibility of those who get it ready for press, the
problem of cost, the methods of determining the total advertising costs and
budget, the measuring of the economic effects of advertising – are problems of
the manager. There is a vast difference between producing a product and
marketing it. It is through advertising only that the message about the product
should reach the consumer before he thinks to buy it. Advertising forms the
integral part of decision making and forward planning.

6. Pricing System: Pricing system as a concept was developed by economics and it

is widely used in managerial economics. Pricing of a product is one of the central
functions of an enterprise. While pricing commodity the cost of production has to
be taken into account, but a complete pricing knowledge of the price system is
quite essential to determine the price. It is also important to understand how
product has to be priced under the different kinds of competition for different
markets. Pricing is equals to cost plus pricing and the policies of the enterprise
– in this definition of pricing, it is clear that the price system touches the several
aspects of managerial economics and helps managers to take valid and profitable
decisions.

7. Resource Allocation: Resources are allocated according to the needs only to

achieve the level of optimization. As we all know that we have scarce resources,
and unlimited needs. Managers have to make the alternate use of the available
resources. For allocation of the resources various