ME/U1 Topic 1 Nature and Scope of Managerial Economics
Managerial economics generally refers to the integration of economic theory with business practice. Economics provides tools managerial economics applies these tools to the management of business. In simple terms, managerial economics means the application of economic theory to the problem of management. Managerial economics may be viewed as economics applied to problem solving at the level of the firm.
It enables the business executive to assume and analyse things. Every firm tries to get satisfactory profit even though economics emphasises maximizing of profit. Hence, it becomes necessary to redesign economic ideas to the practical world. This function is being done by managerial economics.
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.”
To Christopher Savage and John R. Small: “Managerial Economics is concerned with business efficiency”.
Milton H. Spencer and Lonis Siegelman define Managerial Economics as “the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management.”
In the words of Me Nair and Meriam, “Managerial Economics consists of the use of economic modes of thought to analyse business situations.”
D.C. Hague describes Managerial Economics as “a fundamental academic subject which seeks to understand and analyse the problems of business decision making.”
In the opinion of W.W. Haynes “Managerial Economics is the study of the allocation of resources available to a firm of other unit of management among the activities of that unit.”
According to Floyd E. Gillis, “Managerial Economics deals almost exclusively with those business situations that can be quantified and dealt with in a model or at least approximated quantitatively.”
The above definitions emphasise the interrelationship of economic theory with business decision making and forward planning.
The Nature of Managerial Economics
- It analyses towards solving business problems, constitutes the subject-matter of Managerial Economics.
- It helps in decision making and forward planning.
- The problem of choice arises because resources are limited and the firm has to make the most profitable use of these resources.
- As future is unpredictable, a business manager’s task is to prepare the best possible plans for the future depending on past experience and future outlook .
- It assists the managers of a firm in a rational solution of obstacles faced in the firm’s activities.
- It helps in formulating logical managerial decisions.
- It lessens the gap between economics in theory and economics in practice.
- It guides the managers in taking decisions relating to the firm’s customers, competitors, suppliers as well as relating to the internal functioning of a firm.
- It makes use of statistical and analytical tools to assess economic theories in solving practical business problems.
- It helps in enhancement of analytical skills, assists in rational configuration as well as solution of problems.
- It can also be used to help in decision-making process of non-profit organizations (hospitals, educational institutions, etc).
- It enables optimum utilization of scarce resources in such organizations as well as helps in achieving the goals in most efficient manner.
Scopes of Managerial Economics
- Demand Analysis
A business firm is an economic organization which is engaged in transforming productive resources into goods that are to be sold in the market.
A major part of managerial decision-making depends on accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production schedules and employing resources.
It will help management to maintain or strengthen its market position and profit-base. Demand analysis also identifies a number of other factors influencing the demand for a product. Demand analysis and forecasting occupies a strategic place in Managerial Economics.
- Cost Analysis
Cost estimates arc most useful for management decisions. The different factors that cause variations in cost estimates should be given due consideration for planning purposes.
There is the clement of uncertainty of cost as other factors influencing cost arc either uncontrollable or not always known.
If one is able to measure cost it is very important for more sound profit planning, cost control and often for sound pricing practices.
- Pricing practices and policies
As price gives income to the firm, it constitutes as the most important field of Managerial Economics.
The success of a business firm depends very much on the correctness of the price decisions taken by it.
The various aspects that are dealt under it cover the price determination in various market forms, pricing policies, pricing method, differential pricing, productive pricing and price forecasting.
- Profit Management
The chief purpose of a business firm is to earn the maximum profit. There is always an element of uncertainty about profits because of variation in costs and revenues.
If knowledge about the future were perfect, profit analysis would have been very easy task. But in this world of uncertainty expectations are not always realized.
Hence profit planning and its measurement constitute the most difficult area of Managerial Economics.
Under profit management we study nature and management of profit, profit policies and techniques of profit planning like Break Even Analysis.
- Capital Management
The problems relating to firm’s capital investments are perhaps the most complex and troublesome.
Capital management implies planning and control of capital expenditure because it involves a large sum and moreover the problems in disposing the capital assets of arc so complex that they require considerable time and labour.
- Analysis of business environment
The environmental factors influence the working and performance of a business undertaking. Therefore, the managers will have to consider the environmental factors in the process of decision-making.
Decisions taken in isolation of environmental factors would prove harmful to the firm. Therefore, the management must be fully aware of economic environment, particularly those economic factors which constitute the business climate.
Nevertheless, the management must have an idea of social and political trends. Also the main factors that affect the business climate are : general trend in national income and consumption expenditure, general price trends, trading relations with other countries, trends in world market, economic and business policies of the government, industrial relations etc.
Certain macro-economic theories such as income and employment theory, monetary theory etc. help in analyzing business climate.
Analysis of monetary policy, fiscal policy, industrial policy, foreign trade policy and other direct controls also help in forecasting business climate.
Therefore, macro- economic theory and government policies arc also included in the scope of managerial economics.
- Allied Disciplines
The concepts that help the management in taking business decision are quantitative in nature. Therefore, mathematical tools are widely used in determining relationships between economic variables.
The linear programming techniques, which is mathematical, is used by firms to maximize or minimize their objective function.
Similarly statistical and accounting principles are used in taking business decision. Therefore, mathematical tools, statistical technique and accounting principles that are used in analyzing business problems also come under the scope of Managerial Economics.