Unit - 1 Managerial Economics: An Introduction

Unit structure

1.0 Objectives
1.1 Introduction
1.2 Meaning and Definition of Managerial Economics
1.3 Characteristics of Managerial Economics
1.4 Nature of Managerial Economics
1.5 Scope of Managerial Economics
1.6 Relationship of Managerial Economics with other Disciplines
1.7 Summary
1.8 Key Words
1.9 Self Assessment Test
1.10 Suggested Books / References

1.0 Objectives

After studying this unit, you should be able to understand:

• The Meaning of Managerial Economics.
• The Nature and Characteristics of Managerial Economics.
• The Scope of Managerial Economics.
• The Relationship of Managerial Economics with other branches of knowledge.

1.1 Introduction

Managerial Economics is indeed an off-shoot of the Second World War. Before the
outbreak of this war, the study of economics was purely an academic exercise, while business
was a pure practice based on common practical sense of human mind. The Second World War
created a tremendous pressure on scarce economic resources of the world. Thus, the need for
optimum utilization of resources intensified further, which ultimately gave birth to a new
discipline popularly known as Managerial Economics.
The present business world has become very dynamic, complex, uncertain and risky.
Therefore taking appropriate, correct and timely decision has become a challenging and
tedious task. The existence/ survival and growth of business basically depends on such
decisions. Undoubtedly, Managerial Economics is a friend. philosopher and guide to the
business leaders and managers. Further, the growing complexity of decision-making process,
the increasing use of economic logic, concepts, theories and tools of economic analysis in the
process of decision-making and rapid increase in the demand for professionally trained
managerial man power increased the importance of the study of managerial economics as a
separate discipline of managerial curriculum. In this unit, we would be studying the meaning,
nature and scope of Managerial Economics and its relationship with other branches of
knowledge.
 1.2 Meaning and Definition of Managerial Economics

The terms ‘Managerial Economics’ and ‘Business Economics’ are often synonyms
and used interchangeably in managerial studies. It is also known as ‘Economics for
Managers’. Basically, Managerial Economics is an Applied Economics in the sphere of
business management. It is an application of economic theory and methodology to decision-
making problems faced by the business firms. Thus, it is the economics of business or
managerial decisions or it is the process of application of principles, concepts and techniques
and tools of economics to solve the managerial problems of business organizations. Some
important definitions of Managerial Economics are given below :
“Managerial Economics is economics applied in decision-making. It is a special branch
of economics bridging the gap between the economic theory and managerial practice. Its
stress is on the use of the tools of economic analysis in clarifying problems in organizing and
evaluating information and in comparing
alternative courses of action.” -W. W. Haynes
“Managerial Economics is the integration of economic theory with business practice for
the purpose of facilitating decision-making and forward planning by management.”
- Spencer &
Siegelman
“The purpose of Managerial Economics is to show how economic analysis can be used in formulating
business policies.” -Joel Dean
By analyzing the various definitions of managerial economics given above, we come to
the conclusion that managerial economics is the study of economic theories, logic, concepts
and tools of economic analysis that are used in the process of business decision-making by the
business managers in taking rational, correct and timely decisions. Managerial Economics is
that part of economic theory which, in general, is concerned with business activities and in
particular, concerned with providing solutions to problems arising in decision-making of
business organizations. Indeed, it is an integration of economic theory and business
practices. Therefore, Managerial economics lies on the borderline of Economics and Business
Management act as complementarity and bridge between Economics and Management. From
this point of view, managerial economics is that branch of knowledge in which the concepts,
methods and tools of economic analysis are used for analyzing and solving the practical
managerial problems with the purpose of formulating rational and appropriate business
policies. Basically managerial economics concentrates on decision process,
decision models and decision variables .This can be explained

by the following schematic chart:

 Economic T heories,
Concepts, Business management
Methodology and Decision Problems
Tools

Managerial Economics

Application of Economics
in analyzing and solving
Business problems

Optimum solutions to
business problems

1.3 Characteristics of Managerial Economics

Prof. D .M .Mithani has mentioned the following broad salient features of Managerial
Economics as a specialized discipline:
• It involves an application of Economic theory – especially, micro economic
analysis to practical problem solving in real business life. It is essentially
applied micro economics.

• It is a science as well as art facilitating better managerial discipline. It

explores and enhances economic mindfulness and awareness of business
problems and managerial decisions.

• It is concerned with firm’s behaviour in optimum allocation of resources. It

provides tools to help in identifying the best course among the alternatives
and competing activities in any productive sector whether private or public.
For the sake of clear understanding of the nature and subject matter of managerial
economics, the point-wise analysis of main characteristics of managerial economics is
given below:

• Micro economic analysis: The main part of the study of managerial

economics is the behaviour of business firm/s, which is micro economic unit.
Therefore, managerial economics is essentially a micro economic analysis.
Under the study of managerial economics, the problems of firm are analyzed
and solved through the application of economic methods and tools. It does not
study the whole economy.

• Economics of the firm: According to Norman F. Dufty, Managerial

Economics includes, that portion of “Economics known as the theory of firm,
a body of the theory which can be of considerable assistance to the
businessman in his decision-making”. For instance, the study of managerial
economics includes the study of the cost and revenue analysis, price and
output determination, profit planning, demand analysis and demand
forecasting of a firm. As already stated earlier, the another name of
managerial economics is ‘Economics of the Firm.’
• Acceptance of use & utility of macro economic variables: In understanding
the overall economic environment of an economy and its influence on a
particular firm, the study and knowledge of macro economic variables or
macro economics is a must. For example, the study of Monetary, Fiscal,
Industrial, Labor and Employment and EXIM policy, National Income,
Inflation etc. is done in managerial economics as to know the influences of
these on the business of a firm. The study of macro economic variables helps
in understanding the influence of exogenous factors on business activities of a
firm. Without the study of important macro economic variables, proper
environmental scanning is not possible.

• Normative approach: Managerial Economics is basically concerned with

value judgment, which focusses on ‘what ought to be’. It is determinative
rather than descriptive in its approach as it examines any decision of a firm
from the point of view of its good and bad impact on it. It means that a firm
takes only those decisions which are favourable to it and avoids those which
are unfavourable to it. The emphasis is on ‘Prescriptive’ models rather than
on ‘Descriptive’ models.

• Emphasis on case study: In place of purely theoretical and academic

exercise, managerial economics lays more emphasis on case study method.
Hence, it is a practical and useful discipline for a business firm. It diagnises
and solves the business problems. Therefore, it serves as lamp post of
knowledge and guidance to business professionals / organizations in arriving
at optimum solutions.

• Sophisticated and developing discipline: Managerial Economics is more

refined and sophisticated discipline as compared to Economics because it uses
modern scientific methods of statistics and mathematics. Not only this, the
methods of Operational Research and Computers are also used in it for
building scientific and practical models for analyzing and solving the real
business problems under uncertain and risky environment.
• Applied/Business Economics: Managerial Economics is an application of
economics into business practices and decision-making process; therefore, it
is an applied economics/business economics. The concepts of economic
theory that are widely used in managerial economics are the following:

• Demand and Elasticity of demand

• Demand forecasting
• Production Theory
• Cost Analysis
• Revenue Analysis
• Price determination under different market conditions/structures
• Pricing methods in actual practice
• Break-even analysis
• Linear Programing
• Game Theory
• Product and Project Planning
• Capital Budgeting and Management
• Criteria for public investment decisions
 Basic concepts of Managerial Economics/Economic concepts applied to business
analysis

• Marginalism / Marginal Principle

• Incrementalism / Incremental Principle
• Equi-Marginalism /Equi- Marginal Principle
• Discounting Principle
• Opportunity Cost principle
• Risk and uncertainty
• Profits
• Firm, Industry and Market
• Economic and Econometric Models
• Study of business environment: Business environment in present world has
not only become more complex, but also more dynamic. In a very complex
and rapidly changing environment, making correct and timely decisions is a
tedious task. Managerial Economics helps in understanding the business
environment of firm/s.

1.4 Nature of Managerial Economics

Generally, it is believed that Managerial Economics is a blend of science and art

because on one hand, it is a systematic study of economic concepts, principles, methods &
tools, which are used in business decision-making process and on the other hand, it is the
study of how these are used and applied in best possible manner in analyzing and solving
business problems. In fact, science is a knowledge acquiring discipline, whereas arts is a
knowledge applying discipline.
The following basic questions arise about the nature of Managerial Economics:
1. Whether managerial economics is a science or an art or both; and
2. If it is a science- then it is a positive science or a normative science or both
We would examine these issues systematically one by one in the coming paragraphs.
Managerial Economics is both knowledge acquiring and knowledge applying
discipline. Thus, it can be concluded that managerial economics is science and arts both.
The best method of doing a work is an art and managerial economics is also an art as it
helps us in choosing the best alternative from among the many available alternatives. Not only
this, it also implement best alternative with best possible method.
After knowing the answer of first question, we would examine whether the managerial
economics is a positive science or a normative science or a blend of both. Before knowing the
answer of this question, we should understand the meaning of positive and normative science.
Positive Science is a systematic knowledge of a particular subject wherein we study the
cause and effect of an event. In other words, it explains the phenomenon as: What is, what
was and what will be. Under the study of positive science, principles are formulated and they
are tested on the yardstick of truth. Forecasts are made on the basis of them. From this point of
view, managerial economics is also a positive science as it has its own
principles/theories/laws by which cause and effect analysis of business events/activities is
done, forecasts are made and their validities are also examined. For instance, on the basis of
various methods of forecasting, demand forecasts of a product is made in managerial
economics and the element of truth in forecast is also examined/tested.
Normative Science studies things as they ought to be. Ethics, for example, is a
normative science. The focus of study is ‘What should be’. In other words, it involves value
judgment or good and bad aspects of an event. Therefore, normative science is perspective
rather than descriptive. It cannot not be neutral between ends.
Managerial economics is also a normative science as it suggests the best course of an
action after comparing pros and cons of various alternatives available to a firm. It also helps in
formulating business policies after considering all positives and negatives, all good and bad
and all favours and a disfavours. Besides conceptual/theoretical study of business problems,
practical useful solutions are also found. For instance, if a firm wants to raise 10% price of its
product, it will examine the consequences of it before raising its price. The hike in price will
be made only after ascertaining that 10% rise in price will not have any adverse impact on the
sale of the firm.
On the basis of the above arguments and facts, it can be said that managerial economics
is a blending of positive science with normative science. It is positive when it is confined to
statements about causes and effects and to functional relationships of economic variables. It is
normative when it involves norms and standards, mixing them with cause and effect analysis.
Managerial economics is not only a tool making, but also a tool using science. It not only
studies facts of an economic problem, but also suggests its optimum solution.
Business ethics forms the core of managerial economics as cultural values, social
customs and religious sentiments of the people coin the normative aspect of business
activities. These things matter in designing production pattern and planning of the business in
a country/area. For instance, a modern multi-national corporation has to consider the socio-
cultural and religious moods / sentiments of the people before launching its product. The main
purpose is not to hurt the sentiments of the people but to promote the well-being of the people
along with business. Thus, we can conclude by saying:
• Managerial economics is a science as well as an art.
• Managerial economics a positive and normative science both.
• Being of the determinative/perspective nature, the focus is on what should be or
business decisions are based an value judgment considering the beneficial and
harmful aspects of such decisions.

1.5 Scope of Manegerial Economics

Economics has two major branches namely Microeconomics and Macroeconomics and
both are applied to business analysis and decision-making directly or indirectly. Managerial
economics comprises all those economic concepts, theories, and tools of analysis which can
be used to analyze the business environment and to find solutions to practical business
problems. In other words, managerial economics is applied economics
The areas of business issues to which economic theories can be applied may be broadly
divided into the following two categories:

•Operational or Internal issues; and

 • Environmental or External issues
Micro Economics Applied to Operational Issues
Operational problems are of internal nature. They arise within the business
organization and fall within the perview and control of the management. Some of the
important ones are:

• Choice of business and nature of product, i.e., what to produce;

• Choice of the size of the firm, i.e., how much to produce;
• Choice of technology, i.e., choosing the factor combination;
• Choice of price, i.e. ,how to price the commodity;
• How to promote sales, i.e., sales promotion measures;
• How to face price competition;
• How to decide on new investment;
• How to manage profit and capital;
• How to manage inventory, i.e., stock of both finished goods and raw material
The above mentioned issues fall within the ambit of micro economics, therefore, the
following constitute the scope of managerial economics:
Theory of demand

• Consumer behaviour- maximization of satisfaction

• Utility analysis
• Indifference curve analysis
• Demand analysis and elasticity of demand
• Demand forecasting and its techniques/methods
Theory of production and production decisions

• Production function [Inputs and output relationship] in short-run and long-run

• Cost and output relationship in short-run and long-run
• Economies and diseconomies of scale
• Optimum size of firm and determining the size of firm.
• Deployment of resources [labor and capital] for having optimum combination of
factors of production.
Analysis of market structure and pricing theory

• Determination of price under different market conditions

• Price discrimination
• Multiple pricing policy
• Advertising in competitive markets
• Different pricing policies and practices
Profit analysis and profit management

• Nature and types of profit

 • Profit planning and policies
• Different theories of profit
Theory of capital and investment decisions

• Cost of capital and return on capital-choice of investment projects

• Assessing the efficiency of capital
• Most efficient allocation of capital
• Capital budgeting
Macro Economics Applied to Business Environment
Environmental issues relate to general environment in which business operates. They
are related to overall economic, social and political environment of the country. The following
are the main ingredients of economic environment of a country :

• The type of economic system- capitalist, socialist or mixed economic system.

• General trends in production, employment, income, prices, saving and investment.
• Volume, composition and direction of foreign trade.
• Structure of and trends in the working of financial institutions- Banks, NBFCs,
insurance companies an other financial institutions.
• Trends in labour and capital market.
• Economic policies of the government- Fiscal policy, Monetary policy, EXIM- policy,
Industrial policy, Price policy etc.
• Social factors- value system, property rights, customs and habits.
• Social organizations- Trade unions, consumer unions and consumer co-operatives and
producers unions.
• Political environment is constituted of the following factors:
• Political system-democratic, socialist, communist, authoritarian or any other type.
• State’s attitude towards private sector• Policy, role and working of public sector •
Political stability.
• The degree of openness of the economy and the influence of MNCs on domestic
markets- Integrations of nation’s economy with rest of the world (Policy of
globalization) The environmental factors have a far reaching influence on the
functioning and performance of firm/s. Therefore, business managers have to consider
the changing economic, social and political environment before taking any decision.
Managerial economics is however, concerned with only the economic environment
and in particular with those which form the business climate. The study of social
and political factors falls out of the perview of managerial economics. It should,
however, be borne in mind that economic, social and political factors are inter-
dependent and interactive.
The environmental issues mentioned above fall within fourwalls of macro
economics, therefore the following constitute the scope of managerial economics:
Issues related to Macro Variables

• General trends in economic activities of the country

 • Investment climate
• Trends in output
• Trends in price - level (state of inflation)
• Consumption level and its pattern• Profitability in business expansion
Issues related to Foreign Trade

• Trade relation with other countries

• Sector and firms dealing in exports and imports
• Exchange rate fluctuations
• Inflow and outflow of capital
• Trends in international trade- volume, composition, and direction
• Trends in international prices of various goods and services
• International monetary mechanism
• Rules, regulations and policies of WTO
Issues related to Government Policies

• Regulation and control of economic activities of private sector business enterprises

• Enforcing the government rules and regulations for imposing of social responsibility
• Striking balance between firm’s objective of profit maximization and society’s
interest• Policy and regulatory measure for reducing social costs in terms of
environmental pollution, congestion and slums in cities, basic amenities of life such
as means of transportation and communication, water, electricity supply etc.

1.6 Relationship of Managerial Economics with Other Disciplines

By its nature, managerial economics borrows heavily from several other disciplines. The
nature and scope of managerial economics can also be understood well by studying its
relationship with other disciplines. Managerial economics draws heavily from the following
disciplines:
Economics and Econometrics – As stated earlier that managerial economics is an
application of economic theory into business practices / management. Managerial economics
uses both micro and macro economics-their concepts, theories, tools and techniques. In
managerial economics, we also use various types of models such as schematic models
(diagrams) analog models (flow charts) and mathematical models and stochastic models.
The roots of most of these models lie in economic logic. Economics also tells us the art of
constructing models. Empirically estimated functions, which are being used in managerial
economics are basically econometric estimates.
Mathematics and Statistics – Mathematical tools are widely used in model building for
exploring the relationship between related economic variables. Most of the decision models
are constructed in terms of mathematical symbols. Geometry, trignometry and algebra are
different branches of mathematics and they provide various tools & concepts such as
logarithms, exponentials, vectors, determinants, matrix algebra, and calculus, differentials
and integral.
 Similarly, statistical tools are a great aid in business decision-making. Statistical tools
such as theory of probability, forecasting techniques, index numbers and regression analysis
are used in predicting the future course of economic events and probable outcome of business
decisions. Statistical techniques are used in collecting, processing & analyzing business data,
and in testing the validity of economic laws.
Operational Research (OR) – OR is used for solving the problems of allocation,
transportation, inventory building, waiting line etc.. Linear programming and goal
programming models are very useful for managerial decisions. These are widely used OR
techniques. In fact, OR is an inter-disciplinary solution finding technique. It combines
economics, mathematics and statistics to build models for solving specific problems and to
find a quantitative solution there by.
Accountancy – It provides business data support for decision-making. The data on
costs, revenues, inventories, receivables and profits is provided by the accountancy. Cost
accounting, ratio analysis, break-even analysis are the subject matters of accountancy and they
are of great help to managers in decision-making.
Psychology and Organisation Behaviour (OB)–In fact, managerial economics
analyses the individual behaviour of a buyer and seller [microeconomic units]. Psychology is
helpful in understanding the behavioural aspects like attitude and motivation of individual
decision making unit. Psychological Economics-a new discipline of recent origin analyses the
buyer’s behaviour useful for marketing management. Behavioural models of firms have also
been developed based on organization psychology and micro economics to explain the
economic behaviour of a firm.
Management Theory – Management theories bring out the behaviour of the firm in its
efforts to achieve some predetermined objectives. With change in environment and
circumstances, both the objectives of firm and managerial behaviour change. Therefore
sufficient knowledge of management theory is essential to the decision-makers. The basic
knowledge of the principles of personnel, marketing, financial and production
management is required for accomplishing the task.

1.7 Summary

It is now universally accepted that the Managerial Economics has emerged as a separate
branch of knowledge in management studies. Managerial Economics is the study of economic
theory, logic and tools of economic analysis that are used in the process of business decision
making. Economic theories and techniques of economic analysis are applied to analyze
business problems, evaluate business options and opportunities with a view to arriving at an
appropriate business decision. Infact, it is an applied economics. The important features of
Managerial Economics are: Micro economic nature, economics of the firm, use of macro
economic variables, normative nature, focus on case study method, applied use of economics
and more refined and developing discipline.
The scope of managerial economics spreads both to micro and macro economics. The
theory of demand, theory of production, analysis of market structure and pricing theory, profit
analysis and management, theory of capital and investment decisions are the subject matter of
micro economics.
Macro economic issues pertain to macro economic variables, foreign trade and various
policies of the government. Operational issues are internal and they are part of micro
economics, while environmental issues are exogeneous and they are part of macro economics.
Both these together constitute the subject matter and scope of managerial economics.
Managerial economics is a science as well an art. It is basically a normative science
involving value judgment. It is a tool making as well as tool using discipline. The most
important disciplines on which managerial economics draws heavily are Economics and
Econometrics, Mathematics and Statistics, Operational Research, Accountancy, Psychology &
Organizational Behaviour and Management.

1.8 Key Words

• Managerial Economics : is an applied Economics in the field of business management. It

is an application of economic theory and methodology in the business decision-making
process. It is an integration of economic theory with business practices.

• Micro Economics: It is that branch of Economics in which the study of an individual

economic unit is done. For instance, the study of a firm is a subject matter of micro
economics. It is also known as the method of slicing.

• Macro Economic: It is that branch of Economics in which the economy as a whole is

studied. It is also known as the economics of lumping / aggregation.

• Macro Economic Variables : These are the variables which relate to the entire economy
of a nation / globe such as National Income, Inflation, Recession and they constitute the
part of overall economic environment.

• Positive Science: It pertains to the cause and effect relationship of an event. It is a factual
analysis, therefore, it studies ‘What is”.

• Normative Science: A science which studies “What ought to be”. In other words, it
involves value judgement, hence it is perspective in nature.

1.9 Self Assessment Test

1. What does economic theory contribute to Managerial Economics?

2. What is the contribution of psychology and organization behavior to Managerial
Economics?
3. How is mathematics & statistics and operational research useful to Managerial
Economics?
4. List the important characteristics of Managerial Economics.
5. Summarize the scope of Managerial Economics as a learner.
6. Why should you study the Managerial Economics?