Managerial Economics

Managerial Economics

Introduction


Managerial decisions are an important cog in the working wheel of an organisation.

The success or failure of a business is contingent upon the decisions taken by managers.

Increasing complexity in the business world has spewed forth greater challenges for

managers. Today, no business decision is bereft of influences from areas other than the

economy. Decisions pertinent to production and marketing of goods are shaped with a view

of the world both inside as well as outside the economy. Rapid changes in technology,

greater focus on innovation in products as well as processes that command influence over

marketing and sales techniques have contributed to the escalating complexity in the

business environment. This complex environment is coupled with a global market where

input and product prices are have a propensity to fluctuate and remain volatile. These

factors work in tandem to increase the difficulty in precisely evaluating and determining the

outcome of a business decision. Such evanescent environments give rise to a pressing need

for sound economic analysis prior to making decisions. Managerial economics is a discipline

that is designed to facilitate a solid foundation of economic understanding for business

managers and enable them to make informed and analysed managerial decisions, which are

in keeping with the transient and complex business environment.

Nature of Managerial Economics:


Managerial Economics and Business economics are the two terms, which, at times have been used interchangeably. Of late, however, the term Managerial Economics has become more popular and seems to displace progressively the term Business Economics

The prime function of a management executive in a business organization is decision making and forward planning. Decision Making means the process of selecting one action from two or more alternative courses of action whereas forward planning means establishing plans for the future. The question of choice arises because resources such as capital, land, labour and management are limited and can be employed in alternative uses. The decision making function thus becomes one of making choices or decisions that will provide the most efficient means of attaining a desired end, say, profit maximization. Once decision is made about the particular goal to be achieved, plans as to production, pricing, capital, raw materials, labour, etc., are prepared. Forward planning thus goes hand in hand with decision making.



A significant characteristic of the conditions, in which business organizations work and take decisions, is uncertainty. And this fact of uncertainty not only makes the function of decision making and forward planning complicated but adds a different dimension to it. If knowledge of the future were perfect, plans could be formulated without error and hence without any need for subsequent revision. In the real world, however, the business manager rarely has complete information and the estimates about future predicted as best as possible. As plans are implemented over time, more facts become known so that in their light, plans may have to be revised, and a different course of action adopted. Managers are thus engaged in a continuous process of decision making through an uncertain future and the overall problem confronting them is one of adjusting to uncertainty.



In fulfilling the function of decision making in an uncertainty framework, economic theory can be pressed into service with considerable advantage. Economic theory deals with a number of concepts and principles relating, for example, to profit, demand, cost, pricing production, competition, business cycles, national income, etc., which aided by allied disciplines like Accounting. Statistics and Mathematics can be used to solve or at least throw some light upon the problems of business management. The way economic analysis can be used towards solving business problems. Constitutes the subject matter of Managerial Economics.

  Definition of Managerial Economics


According to McNair and Meriam, "Managerial Economics consists of the use of economic modes of thought to analyse business situation."

Spencer and Siegelman have defined Managerial Economics as "The integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management."
We may, therefore define Managerial Economics as the discipline which deals with the application of economic theory to business management. Managerial Economics thus lies on the borderline between economics and business management and serves as a bridge between economics and business management.


Chart 1 – Economics, Business Management and Managerial Economics.

Concept of Managerial Economics


The discipline of managerial economics deals with aspects of economics and tools of

analysis, which are employed by business enterprises for decision-making. Business and

industrial enterprises have to undertake varied decisions that entail managerial issues and

decisions. Decision-making can be delineated as a process where a particular course of

action is chosen from a number of alternatives. This demands an unclouded perception of

the technical and environmental conditions, which are integral to decision making. The

decision maker must possess a thorough knowledge of aspects of economic theory and its

tools of analysis. The basic concepts of decision-making theory have been culled from

microeconomic theory and have been furnished with new tools of analysis. Statistical

methods, for example, are pivotal in estimating current and future demand for products.

The methods of operations research and programming proffer scientific criteria for

maximising profit, minimising cost and determining a viable combination of products. 

Decision-making theory and game theory, which recognise the conditions of uncertainty and


imperfect knowledge under which business managers operate, have contributed to

systematic methods of assessing investment opportunities.

Almost any business decision can be analysed with managerial economics

techniques. However, the most frequent applications of these techniques are as follows:

• Risk analysis: Various models are used to quantify risk and asymmetric information and

to employ them in decision rules to manage risk.

• Production analysis: Microeconomic techniques are used to analyse production

efficiency, optimum factor allocation, costs and economies of scale. They are also

utilised to estimate the firm's cost function.

• Pricing analysis: Microeconomic techniques are employed to examine various pricing

decisions. This involves transfer pricing, joint product pricing, price discrimination, price

elasticity estimations and choice of the optimal pricing method.

• Capital budgeting: Investment theory is used to scrutinise a firm's capital purchasing

decisions.     CHARACTERISTICS OF MANAGERIAL ECONOMICS

1. Microeconomics: It studies the problems and principles of an individual business firm or

an individual industry. It aids the management in forecasting and evaluating the trends

of the market.

2. Normative economics: It is concerned with varied corrective measures that a

management undertakes under various circumstances. It deals with goal determination,

goal development and achievement of these goals. Future planning, policy-making,

decision-making and optimal utilisation of available resources, come under the banner of

managerial economics.

3. Pragmatic: Managerial economics is pragmatic. In pure micro-economic theory, analysis

is performed, based on certain exceptions, which are far from reality. However, in

managerial economics, managerial issues are resolved daily and difficult issues of

economic theory are kept at bay.

4. Uses theory of firm: Managerial economics employs economic concepts and principles,

which are known as the theory of Firm or 'Economics of the Firm'. Thus, its scope is

narrower than that of pure economic theory.

5. Takes the help of macroeconomics: Managerial economics incorporates certain aspects

of macroeconomic theory. These are essential to comprehending the circumstances and

environments that envelop the working conditions of an individual firm or an industry.

Knowledge of macroeconomic issues such as business cycles, taxation policies, industrial

policy of the government, price and distribution policies, wage policies and antimonopoly

policies and so on, is integral to the successful functioning of a business enterprise.

6. Aims at helping the management: Managerial economics aims at supporting the

management in taking corrective decisions and charting plans and policies for future.

7. A scientific art: Science is a system of rules and principles engendered for attaining given

ends. Scientific methods have been credited as the optimal path to achieving one's goals.

Managerial economics has been is also called a scientific art because it helps the

management in the best and efficient utilisation of scarce economic resources. It

considers production costs, demand, price, profit, risk etc. It assists the management in

singling out the most feasible alternative. Managerial economics facilitates good and

result oriented decisions under conditions of uncertainty.

8. Prescriptive rather than descriptive: Managerial economics is a normative and applied

discipline. It suggests the application of economic principles with regard to policy

formulation, decision-making and future planning. It not only describes the goals of an

organisation but also prescribes the means of achieving these goals.     Application of Economics to Business Management


The application of economics to business management or the integration of economic theory with business practice, as Spencer and Siegelman have put it, has the following aspects :-
Reconciling traditional theoretical concepts of economics in relation to the actual business behavior and conditions. In economic theory, the technique of analysis is one of model building whereby certain assumptions are made and on that basis, conclusions as to the behavior of the firms are drown. The assumptions, however, make the theory of the firm unrealistic since it fails to provide a satisfactory explanation of that what the firms actually do. Hence the need to reconcile the theoretical principles based on simplified assumptions with actual business practice and develops appropriate extensions and reformulation of economic theory, if necessary.

Estimating economic relationships, viz., measurement of various types of elasticities of demand such as price elasticity, income elasticity, cross-elasticity, promotional elasticity, cost-output relationships, etc. The estimates of these economic relationships are to be used for purposes of forecasting.

Predicting relevant economic quantities, eg., profit, demand, production, costs, pricing, capital, etc., in numerical terms together with their probabilities. As the business manager has to work in an environment of uncertainty, future is to be predicted so that in the light of the predicted estimates, decision making and forward planning may be possible.

Using economic quantities in decision making and forward planning, that is, formulating business policies and, on that basis, establishing business plans for the future pertaining to profit, prices, costs, capital, etc. The nature of economic forecasting is such that it indicates the degree of probability of various possible outcomes, i.e. losses or gains as a result of following each one of the strategies available. Hence, before a business manager there exists a quantified picture indicating the number o courses open, their possible outcomes and the quantified probability of each outcome. Keeping this picture in view, he decides about the strategy to be chosen.

Understanding significant external forces constituting the environment in which the business is operating and to which it must adjust, e.g., business cycles, fluctuations in national income and government policies pertaining to public finance, fiscal policy and taxation, international economics and foreign trade, monetary economics, labour relations, anti-monopoly measures, industrial licensing, price controls, etc. The business manager has to appraise the relevance and impact of these external forces in relation to the particular business unit and its business policies.   SCOPE OF MANAGERIAL ECONOMICS

The scope of managerial economics includes following subjects:

1. Theory of demand

2. Theory of production

3. Theory of exchange or price theory

4. Theory of profit

5. Theory of capital and investment

6. Environmental issues, which are enumerated as follows:


1. Theory of Demand: According to Spencer and Siegelman, “A business firm is an

economic organisation which transforms productivity sources into goods that are to be

sold in a market”.

a. Demand analysis: Analysis of demand is undertaken to forecast demand, which is a fundamental component in managerial decision-making. Demand forecasting is of importance because an estimate of future sales is a primer for preparing production schedule and employing productive resources. Demand analysis helps the management in identifying factors that influence the demand for the products of a firm. Thus, demand analysis and forecasting is of prime importance to business planning.

b. Demand theory: Demand theory relates to the study of consumer behaviour. It addresses questions such as what incites a consumer to buy a particular product, at what price does he/she purchase the product, why do consumers cease consuming a commodity and so on. It also seeks to determine the effect of the income, habit and taste of consumers on the demand of a commodity and analyses other factors that

influence this demand.

2. Theory of Production: Production and cost analysis is central for the unhampered

functioning of the production process and for project planning. Production is an

economic activity that makes goods available for consumption. Production is also

defined as a sum of all economic activities besides consumption. It is the process of

creating goods or services by utilising various available resources. Achieving a certain

profit requires the production of a certain amount of goods. To obtain such production

levels, some costs have to be incurred. At this point, the management is faced with the

task of determining an optimal level of production where the average cost of production

would be minimum. Production function shows the relationship between the quantity of

a good/service produced (output) and the factors or resources (inputs) used. The inputs

employed for producing these goods and services are called factors of production.

a. Variable factor of production: The input level of a variable factor of production can

be varied in the short run. Raw material inputs are deemed as variable factors.

Unskilled labour is also considered in the category of variable factors.

b. Fixed factor of production: The input level of a fixed factor cannot be varied in the

short run. Capital falls under the category of a fixed factor. Capital alludes to

resources such as buildings, machinery etc.

Production theory facilitates in determining the size of firm and the level of production. It elucidates the relationship between average and marginal costs and production. It highlights how a change in production can bring about a parallel change in average and marginal costs. Production theory also deals with other issues such as conditions leading to increase or decrease in costs, changes in total production when one factor of production is varied and others are kept constant, substitution of one factor with another while keeping all increased simultaneously and methods of achieving optimum production.

3. Theory of Exchange or Price Theory: Theory of Exchange is popularly known as Price

Theory. Price determination under different types of market conditions comes under the

wingspan of this theory. It helps in determining the level to which an advertisement can

be used to boost market sales of a firm. Price theory is pivotal in determining the price

policy of a firm. Pricing is an important area in managerial economics. The accuracy of

pricing decisions is vital in shaping the success of an enterprise. Price policy impresses

upon the demand of products. It involves the determination of prices under different

market conditions, pricing methods, pricing policies, differential pricing, product line

pricing and price forecasting.

4. Theory of profit: Every business and industrial enterprise aims at maximising profit.

Profit is the difference between total revenue and total economic cost. Profitability of an

organisation is greatly influenced by the following factors:

• Demand of the product

• Prices of the factors of production

• Nature and degree of competition in the market

• Price behaviour under changing conditions

Hence, profit planning and profit management are important requisites for

improving profit earning efficiency of the firm. Profit management involves the use of most

efficient technique for predicting the future. The probability of risks should be minimised as

far as possible.

5. Theory of Capital and Investment: Theory of Capital and Investment evinces the

following important issues:

• Selection of a viable investment project

• Efficient allocation of capital

10 Managerial Economics

• Assessment of the efficiency of capital

• Minimising the possibility of under capitalisation or overcapitalisation. Capital is the

building block of a business. Like other factors of production, it is also scarce and

expensive. It should be allocated in most efficient manner.

6. Environmental issues: Managerial economics also encompasses some aspects of

macroeconomics. These relate to social and political environment in which a business

and industrial firm has to operate. This is governed by the following factors:

• The type of economic system of the country

• Business cycles

• Industrial policy of the country

• Trade and fiscal policy of the country

• Taxation policy of the country

• Price and labour policy

• General trends in economy concerning the production, employment, income, prices,

saving and investment etc.

• General trends in the working of financial institutions in the country

• General trends in foreign trade of the country

• Social factors like value system of the society

• General attitude and significance of social organisations like trade unions, producers’

unions and consumers’ cooperative societies etc.

• Social structure and class character of various social groups

• Political system of the country

The management of a firm cannot exercise control over these factors. Therefore, it

should fashion the plans, policies and programmes of the firm according to these factors in

order to offset their adverse effects on the firm.   WHY MANAGERS NEED TO KNOW ECONOMICS

The contribution of economics towards the performance of managerial duties and

responsibilities is of prime importance. The contribution and importance of economics to

the managerial profession is akin to the contribution of biology to the medical profession

and physics to engineering. It has been observed that managers equipped with a working

knowledge of economics surpass their otherwise equally qualified peers, who lack knowledge of economics. Managers are responsible for achieving the objective of the firm to the maximum possible extent with the limited resources placed at their disposal. It is important to note that maximisation of objective has to be achieved by utilising limited resources. In the event of resources being unlimited, like air or sunshine, the problem of economic utilisation of resources or resource management would not have arisen.

Resources like finance, workforce and material are limited. However, in the absence of

unlimited resources, it is the responsibility of the management to optimise the use of these

resources.

• How economics contributes to managerial functions

Though economics is variously defined, it is essentially the study of logic, tools and

techniques, to make optimum use of the available resources to achieve the given ends.

Economics affords analytical tools and techniques that managers require to accomplish the

goals of the organisation they manage. Therefore, a working knowledge of economics, not

necessarily a formal degree, is indispensable for managers. Managers are fundamentally

practicing economists.

While executing his duties, a manager has to take several decisions, which conform

to the objectives of the firm. Many business decisions fall prey to conditions of uncertainty

and risk. Uncertainty and risk arise chiefly due to volatile market forces, changing business

environment, emerging competitors with highly competitive products, government policy,

external influences on the domestic market and social and political changes in the country.

The intricacy of the modern business world weaves complexity in to the decision making

process of a business. However, the degree of uncertainty and risk can be greatly condensed

if market conditions are calculated with a high degree of reliability. Envisaging a business

environment in the future does not suffice. Appropriate business decisions and formulation

of a business strategy in conformity with the goals of the firm hold similar importance.

Pertinent business decisions require an unambiguous understanding of the technical

and environmental conditions under which business decisions are taken. Application of

economic theories to explain and analyse technical conditions and business environment,

contributes greatly to the rational decision-making process. Economic theories have many

pronged applications in the analysis of practical problems of business. Keeping in view the

escalating complexity of business environment, the efficacy of economic theory as a tool of

analysis and its contribution to the process of decision-making has been widely recognised.

• Contributions of economic theory to business economics

According to Baumol, there are three main contributions of economic theory to

business economics.

1. The practice of building analytical models, which assist in recognising the structure of

managerial problems and eliminating minor details, which might obstruct decisionmaking

has been derived from economic theory. Analytical models help in eradicating

peripheral problems and help the management in retaining focus on core issues.

2. Economic theory comprises a founding pillar of business analysis- ‘a set of analytical

methods’, which may not be applied directly to specific business problems, but they do

enhance the analytical capabilities of the business analyst.

3. Economic theories offer an unequivocal perspective on the various concepts used in

business analysis, which enables the manager to swerve from conceptual pitfalls.

• Importance of managerial economics

Business and industrial enterprises aim at earning maximum proceeds. In order to

achieve this objective, a managerial executive has to take recourse in decision-making,

which is the process of selecting a specified course of action from a number of alternatives.

A sound decision requires fair knowledge of the aspects of economic theory and the tools of

economic analysis, which are directly involved in the process of decision-making. Since

managerial economics is concerned with such aspects and tools of analysis, it is pertinent to

the decision-making process.

Spencer and Siegelman have described the importance of managerial economics in a

business and industrial enterprise as follows:

1. Accommodating traditional theoretical concepts to the actual business behaviour and

conditions: Managerial economics amalgamates tools, techniques, models and theories

of traditional economics with actual business practices and with the environment in

which a firm has to operate. According to Edwin Mansfield, “Managerial Economics

attempts to bridge the gap between purely analytical problems that intrigue many

economic theories and the problems of policies that management must face”.

2. Estimating economic relationships: Managerial economics estimates economic

relationships between different business factors such as income, elasticity of demand,

cost volume, profit analysis etc.

3. Predicting relevant economic quantities: Managerial economics assists the

management in predicting various economic quantities such as cost, profit, demand,

capital, production, price etc. As a business manager has to function in an environment

of uncertainty, it is imperative to anticipate the future working environment in terms of

the said quantities.

4. Understanding significant external forces: The management has to identify all the

important factors that influence a firm. These factors can broadly be divided into two

categories. Managerial economics plays an important role by assisting management in

understanding these factors.

• External factors: A firm cannot exercise any control over these factors. The plans,

policies and programmes of the firm should be formulated in the light of these

factors. Significant external factors impinging on the decision-making process of a

firm are economic system of the country, business cycles, fluctuations in national

income and national production, industrial policy of the government, trade and fiscal

policy of the government, taxation policy, licensing policy, trends in foreign trade of

the country, general industrial relation in the country and so on.

• Internal factors: These factors fall under the control of a firm. These factors are

associated with business operation. Knowledge of these factors aids the

management in making sound business decisions.

5. Basis of business policies: Managerial economics is the founding principle of business

policies. Business policies are prepared based on studies and findings of managerial

economics, which cautions the management against potential upheavals in national as

well as international economy.

Thus, managerial economics is helpful to the management in its decision-making

process.     Managerial Economics and Other Subjects

Yet another useful method of throwing light upon the nature and scope of Managerial Economics is to examine its relationship with other subjects. In this connection, Economics, Statistics, Mathematics and Accounting deserve special mention.


Managerial Economics and Economics



Managerial Economics has been described as economics applied to decision making. It may be viewed as a special branch of economics bridging the gulf between pure economic theory and managerial practice.



Economics has two main divisions :- (i) Microeconomics and (ii) Macroeconomics. Microeconomics has been defined as that branch of economics where the unit of study is an individual or a firm. Macroeconomics, on the other hand, is aggregate in character and has the entire economy as a unit of study.



Microeconomics, also known as price theory (or Marshallian economics) is the main source of concepts and analytical tools for managerial economics. To illustrate various micro-economic concepts such as elasticity of demand, marginal cost, the short and the long runs, various market forms, etc., all are of great significance to managerial economics. The chief contribution of macroeconomics is in the area of forecasting. The modern theory of income and employment has direct implications for forecasting general business conditions. As the prospects of an individual firm often depend greatly on general business conditions, individual firm forecasts depend on general business forecasts.







A survey in the U.K has shown that business economists have found the following economic concepts quite useful and of frequent application :-





Price elasticity of demand,

Income elasticity of demand,

Opportunity cost,

The multiplier,

Propensity to consume,

Marginal revenue product,

Speculative motive,

Production function,

Balanced growth, and

Liquidity preference.



Business economics have also found the following main areas of economics as useful in their work :-





Demand theory,

Theory of the firm-price, output and investment decisions,

Business financing,

Public finance and fiscal policy,

Money and banking,

National income and social accounting,

Theory of international trade, and

Economics of developing countries.



Managerial Economics and Management Accounting



Managerial Economics is also closely related to accounting, which is concerned with recording the financial operations of a business firm. Indeed, accounting information is one of the principal sources of data required by a managerial economist for his decision making purpose. For instance, the profit and loss statement of a firm tells how well the firm has done and the information it contains can be used by managerial economist to throw significant light on the future course of action - whether it should improve or close down. Of course, accounting data call for careful interpretation. Recasting and adjustment before they can be used safely and effectively.



It is in this context that the growing link between management accounting and managerial economics deserves special mention. The main task of management accounting is now seen as being to provide the sort of data which managers need if they are to apply the ideas of managerial economics to solve business problems correctly; the accounting data are also to be provided in a form so as to fit easily into the concepts and analysis of managerial economics.

Techniques of Managerial Economics


Managerial economics draws on a wide variety of economic concepts, tools and

techniques in the decision-making process. These concepts can be categorised as follows: (1)

the theory of the firm, which explains how businesses make a variety of decisions; (2) the

theory of consumer behavior, which describes the consumer's decision-making process and

(3) the theory of market structure and pricing, which describes the structure and

characteristics of different market forms under which business firms operate.

1. Theory of the firm: A firm can be considered an amalgamation of people, physical and

financial resources and a variety of information. Firms exist because they perform useful

functions in society by producing and distributing goods and services. In the process of

accomplishing this, they employ society's scarce resources, provide employment and pay

taxes. If economic activities of society can be simply put into two categories- production

and consumption- firms are considered the most basic economic entities on the

production side, while consumers form the basic economic entities on the consumption

side. The behaviour of firms is usually analysed in the context of an economic model,

which is an idealised version of a real-world firm. The basic economic model of a

business enterprise is called the theory of the firm.

2. Theory of consumer behaviour: The role of consumers in an economy is of vital

importance since consumers spend most of their incomes on goods and services

produced by firms. Consumers consume what firms produce. Thus, study of the theory

of consumer behaviour is accorded importance. It is desirous to know the ultimate

objective of a consumer. Economists have an optimisation model for consumers, which

is analogous to that applied to firms or producers. While it is assumed that firms attempt

at maximising profits, similarly there is an assumption that consumers attempt at maximising their utility or satisfaction. While more goods and services provide greater utility to a consumer, however, consumers, like firms, are subject to constraints. Their consumption and choices are limited by a number of factors, including the amount of disposable income (the residual income after income taxes are paid for). A consumer's choice to consume is described by economists within a theoretical framework usually termed the theory of demand.

3. Theories associated with different market structures: A firms profit maximising output

decisions take into account the market structure under which they are operate. There

are four kinds of market organisations: perfect competition, monopolistic competition,

oligopoly and monopoly.     Role and Responsibilities of Managerial Economist


A managerial economist can play a very important role by assisting the Management in using the increasingly specialized skills and sophisticated techniques which are required to solve the difficult problems of successful decision making and forward planning. That is why, in business concerns, his importance is being growingly recognized. In developed countries like the U.S.A., large companies employ one or more economists. In our country (India) too, big industrial houses have come to recognize the need for managerial economists, and there are frequent advertisements for such positions. Tatas and Hindustan Lever employ economists. Indian Petrochemicals Corporation Ltd., a Government of India undertaking, also keeps an economist.

In this connection, two important questions need be considered :-





What role does he play in business, that is, what particular management problems lend themselves to solution through economic analysis?

How can the managerial economist best serve management, that is, what are the responsibilities of a successful managerial economist?


Role of Managerial Economist

One of the principal objectives of any management in its decision making process is to determine the key factors which will influence the business over the period ahead. In general, these factors can be divided into two category, viz., (i) External and (ii) Internal. The external factors lie outside the control management because they are external to the firm and are said to constitute business environment. The internal factors lie within the scope and operations of a firm and hence within the control of management, and they are known as business operations.



To illustrate, a business firm is free to take decisions about what to invest, where to invest, how much labour to employ and what to pay for it, how to price its products and so on but all these decisions are taken within the framework of a particular business environment and the firm’s degree of freedom depends on such factors as the government’s economic policy, the actions of its competitors and the like.

Environmental Studies


An analysis and forecast of external factors constituting general business conditions, e.g., prices, national income and output, volume of trade, etc., are of great significance since every business from is affected by them.



Certain important relevant questions in this connection are as follows :-



What is the outlook for the national economy? What are the most important local, regional or worldwide economic trends? What phase of the business cycle lies immediately ahead?

What about population shifts and the resultant ups and downs in regional purchasing power?

What are the demands prospects in new as well as established markets? Will changes in social behavior and fashions tend to expand or limit the sales of a company’s products, or possibly make the products obsolete?

Where are the market and customer opportunities likely to expand or contract most rapidly?

Will overseas markets expand or contract, and how will new foreign government legislation’s affect operation of the overseas plants?

Will the availability and cost of credit tend to increase or decrease buying? Are money or credit conditions ahead likely to be easy or tight?

What the prices of raw materials and finished products are likely to be?

Is competition likely to increase or decrease?

What are the main components of the five-year plan? What are the areas where outlays have been increased? What are the segments, which have suffered a cut in their outlay?

What is the outlook regarding government’s economic policies and regulations?

What about changes in defense expenditure, tax rates, tariffs and import restrictions?

Will Reserve Bank’s decisions stimulate or depress industrial production and consumer spending? How will these decisions affect the company’s cost, credit, sales and profits?



Reasonably accurate answers to these and similar questions can enable management to chalk out more wisely the scope and direction of their own business plans and to determine the timing of their specific actions. And it is these questions which present some of the areas where a managerial economist can make effective contribution.



The managerial economist has not only to study the economic trends at the macro level but must also interpret their relevance to the particular industry / firm where he works. He has to digest the ever growing economic literature and advise top management by means of short, business like practical notes.



In a mixed economy like India, the managerial economist pragmatically interprets the intentions of controls and evaluates their impact. He acts as a bridge between the government and the industry, translating the government’s intentions and transmitting the reactions of the industry. In fact, government policies charge out of the performance of industry, the expectations of the people and political expediency.


Business Operations

A managerial economist can also be helpful to the management in making decisions relating to the internal operations of a firm in respect of such problems as price, rate of operations, investment, expansion or contraction.



Certain relevant questions in this context would be as follows :-



What will be a reasonable sales and profit budget for the next year?

What will be the most appropriate production Schedules and inventory policies for the next six months?

What changes in wage and price policies should be made now?

How much cash will be available next month and how should it be invested?



Specific Functions



A further idea of the role of managerial economists can be seen from the following specific functions performed by them as revealed by a survey pertaining to Britain conducted by K.J.W. Alexander and Alexander G. Kemp :-



Sales forecasting.

Industrial market research.

Economic analysis of competing companies.

Pricing problems of industry.

Capital projects.

Production programs.

Security/investment analysis and forecasts.

Advice on trade and public relations.

Advice on primary commodities.

Advice on foreign exchange.

Economic analysis of agriculture.

Analysis of underdeveloped economics.

Environmental forecasting.



The managerial economist has to gather economic data, analyze all pertinent information about the business environment and prepare position papers on issues facing the firm and the industry. In the case of industries prone to rapid technological advances, he may have to make a continuous assessment of the impact of changing technology. He may have to evaluate the capital budget in the light of short and long-range financial, profit and market potentialities. Very often, he may have to prepare speeches for the corporate executives.



It is thus clear that in practice managerial economists perform many and varied functions. However, of these, marketing functions, i.e., sales forecasting and industrial market research, has been the most important. For this purpose, they may compile statistical records of the sales performance of their own business and those relating to their rivals, carry our analysis of these records and report on trends in demand, their market shares, and the relative efficiency of their retail outlets. Thus while carrying out their functions; they may have to undertake detailed statistical analysis. There are, of course, differences in the relative importance of the various functions performed from firm to firm and in the degree of sophistication of the methods used in carrying them out. But there is no doubt that the job of a managerial economist requires alertness and the ability to work under pressure.



Economic Intelligence



Besides these functions involving sophisticated analysis, managerial economist may also provide general intelligence service supplying management with economic information of general interest such as competitors prices and products, tax rates, tariff rates, etc. In fact, a good deal of published material is already available and it would be useful for a firm to have someone who understands it. The managerial economist can do the job with competence.


Participating in Public Debates



Many well-known business economists participate in public debates. Their advice and views are being sought by the government and society alike. Their practical experience in business and industry ads stature to their views. Their public recognition enhances their stature in the organization itself.


Indian Context



In the indian context, a managerial economist is expected to perform the following functions :-



Macro-forecasting for demand and supply.

Production planning at macro and micro levels.

Capacity planning and product-mix determination.

Economics of various productions lines.

Economic feasibility of new production lines/processes and projects.

Assistance in preparation of overall development plans.

Preparation of periodical economic reports bearing on various matters such as the company’s product-lines, future growth opportunities, market pricing situation, general business, and various national/international factors affecting industry and business.

Preparing briefs, speeches, articles and papers for top management for various Chambers, Committees, Seminars, Conferences, etc.

Keeping management informed o various national and international developments on economic/industrial matters.



With the adoption of the New Economic Policy, in 1991, the macro-economic Environment in India is changing fast at a pace that has been rarely witnessed before. And these changes have tremendous implications for business. The managerial economist has to play a much more significant role. He has to constantly gauge the possibilities of translating the rapidly changing economic scenario into viable business opportunities. As India marches towards globalization, he will have to interpret the global economic events and find out how his firm can avail itself of the carious export opportunities or of establishing plants abroad either wholly owned or in association with local partners.


Responsibilities of Managerial Economist


A managerial economist can serve management best only if he always keeps in mind the main objective of his business, viz., to make a profit on its invested capital. His academic training and the critical comments from people outside the business may lead a managerial economist to adopt an apologetic or defensive attitude towards profits. Once management notices this, his effectiveness is almost sure to be lost. In fact, he cannot expect to succeed in serving management unless he has a strong personal conviction that profits are essential and that his chief obligation is to help enhance the ability of the firm to make profits.




Most management decisions necessarily concern the future, which is rather uncertain. It is, therefore, absolutely essential that a managerial economist recognizes his responsibility to make successful forecasts. By making best possible forecasts and through constant efforts to improve upon them, he should aim at minimizing, if not completely eliminating, the risks involved in uncertainties, so that the management can follow a more orderly course of business planning. At times, he will have to reassure the management that an important trend will continue; in other cases, he may have to point out the probabilities of a turning point in some activity of importance to management. In any case, he must be willing to make considered but fairly positive statements about impending economic developments, based upon the best possible information and analysis and stake his reputation upon his judgment. Nothing will build management confidence in a managerial economist more quickly and thoroughly than a record of successful forecasts, well-documented in advance and modestly evaluated when the actual results become available.



A few corollaries to the above proposition need also be emphasized here.



First, he has a major responsibility to "alert management at the earliest possible moment" in case he discovers an error in his forecast. By promptly drawing attention to changes in forecasting conditions, he will not only assist management in making appropriate adjustment in policies and programs but will also be able to strengthen his own position as a member of the management team by keeping his fingers on the economic pulse of the business.



Secondly, he must establish and maintain many contacts with individuals and data sources, which would not be immediately available to the other members of the management. Extensive familiarity with reference sources and material is essential, but it is still more important that he knows individuals who are specialists in particular fields having a bearing on his work. For this purpose, he should join professional associations and take active part in them. In fact, one of the best means of determining the caliber of a managerial economist is to evaluate his ability to obtain information quickly by personal contacts rather than by lengthy research from either readily available or obscure reference sources. Within any business, there may be a wealth of knowledge and experience but the managerial economist would be really useful if he can supplement the existing know-how with additional information and in the quickest possible manner.



Again, if a managerial economist is to be really helpful to the management in successful decision making and forward planning, he must be able to earn full status on the business team. He should be ready and even offer himself to take up special assignments, be that in study teams, committees or special projects. For, a managerial economist can only function effectively in an atmosphere where his success or failure can be traced not only to his basic ability, training and experience, but also to his personality and capacity to win continuing support for himself and his professional ideas. Of course, he should be able to express himself clearly and simply and must always try to minimize the use of technical terminology in communicating with his management executives. For, it is well-known that if management does not understand, it will almost automatically reject. Further, while intellectually he must be in tune with industry’s thinking the wider national perspective should not be absents from his advice to top management.


TOOLS OF DECISION SCIENCE AND MANAGERIAL ECONOMICS


Managerial decision-making draws on economic concepts as well as tools and

techniques of analysis provided by decision sciences. The major categories of these tools

and techniques are optimisation, statistical estimation, forecasting, numerical analysis and

game theory. Most of these methodologies are technical. The first three are briefly

explained below to illustrate how tools of decision sciences are used in managerial decisionmaking.

1. Optimisation: Optimisation techniques are probably the most crucial to managerial

decision making. Given that alternative courses of action are available, the manager

attempts to produce the most optimal decision, consistent with stated managerial

objectives. Thus, an optimisation problem can be stated as maximising an objective

(called the objective function by mathematicians) subject to specified constraints. In

determining the output level consistent with the maximum profit, the firm maximises

profits, constrained by cost and capacity considerations. While a manager does not

resolve the optimisation problem, he or she may make use of the results of

mathematical analysis. In the profit maximisation example, the profit maximising

condition requires that the firm select the production level at which marginal revenue

equals marginal cost. This condition is obtained from an optimisation model/technique.

The techniques of optimisation employed depend on the problem a manager is trying to

solve.


2. Statistical estimation: A number of statistical techniques are used to estimate economic

variables of interest to a manager. In some cases, statistical estimation techniques

employed are simple. In other cases, they are much more complex and advanced. Thus,

a manager may want to know the average price received by his competitors in the

industry, as well as the standard deviation (a measure of variation across units) of the

product price under consideration. In this case, the simple statistical concepts of mean

(average) and standard deviation are used.

Estimating a relationship among variables requires a more advanced statistical

technique. For example, a firm may desire to estimate its cost function i.e. the relationship

between cost concept and the level of output. A firm may also wish to the demand function

of its product that is the relationship between the demand for its product and factors that

influence it. The estimates of costs and demand are usually based on data supplied by the

firm. The statistical estimation technique employed is called regression analysis and is used

to engender a mathematical model showing how a set of variables are related. This

mathematical relationship can also be used to generate forecasts.

An example from the automobile industry is befitting for illustrating the forecasting method

that employs simple regression analysis. Let us assume that a statistician has data on sales of

American-made automobiles in the United States for the last 25 years. He or she has also

determined that the sale of automobiles is related to the real disposable income of

individuals. The statistician also has available the time series data (for the last 25 years) on

real disposable income. Assume that the relationship between the time series on sales of

American-made automobiles and the real disposable income of consumers is actually linear

and it can thus be represented by a straight line. A rigorous mathematical technique is used

to locate the straight line that most accurately represents the relationship between the time

series on auto sales and disposable income.

3. Forecasting: It is a method or a technique to predict many future aspects of a business or

any other operation. For example, a retailing firm that has been in business for the last

25 years may be interested in forecasting the likely sales volume for the coming year.

Numerous forecasting techniques can be used to accomplish this goal. A forecasting

technique, for example, can provide such a projection based on the experience of the

firm during the last 25 years; that is, this forecasting technique bases the future forecast

on the past data.


While the term 'forecasting' may appear technical, planning for the future is a critical

aspect of managing any organisation or a business. The long-term success of any

organisation has close association with the propensity of the management of the

organisation to foresee its future and develop appropriate strategies to deal with the likely

future scenarios. Intuition, good judgment and knowledge of economic conditions enables

the manager to 'feel' or perhaps anticipate the likelihood in the future. It is not easy,

however, to metamorphose a feeling about the future outcome into concrete data for

instance, as a projection for next year's sales volume. Forecasting methods can help predict

many future aspects of a business operation, such as forthcoming years' sales volume

projections.

Suppose a forecast expert has been asked to provide quarterly estimates of the sales

volume for a particular product for the next four quarters. How should he attempt at

preparing the quarterly sales volume forecasts? Reviewing the actual sales data for the

product in question for past periods will give a good start. Suppose that the forecaster has

access to actual sales data for each quarter during the 25-year period the firm has been in

business. Employing this historical data, the forecaster can identify the general trend of

sales. He or she can also determine whether there is a pattern or trend, such as an increase

or decrease in sales volume over time. An in depth review of the data may unearth some

type of seasonal pattern, such as, peak sales occurring around the holiday season. Thus, by

reviewing historical data, there is a high probability that the forecaster develops a good

understanding of the pattern of sales in the past periods. Understanding such patterns can

result in better forecasts of future sales of the product. In addition, if the forecaster is able

to identify the factors that influence sales, historical data on these factors (variables) can

also be used to generate forecasts of future sales.

There are many forecasting techniques available to the person assisting the business

in planning its sales. Take for example a forecasting method in which a statistician

forecasting future values of a variable of business interest—sales, for example, examines the

cause-and-effect relationships of this variable with other relevant variables. The other

pertinent variable may be the level of consumer confidence, changes in consumers'

disposable incomes, the interest rate at which consumers can finance their excess spending

through borrowing and the state of the economy represented by the percentage of the

labour force unemployed. This category of forecasting technique utilises time series data on

many relevant variables to forecast the volume of sales in the future. Under this forecasting technique, a regression equation is estimated to generate future forecasts (based on the

past relationship among variables).     Summary

Managerial Economics: The discipline of managerial economics deals with aspects of

economics and tools of analysis, which are employed by business enterprises for decision

making. Business and industrial enterprises have to undertake varied decisions that entail

managerial issues and decisions. Decision-making can be delineated as a process where a

particular course of action is chosen from a number of alternatives. This demands an

unclouded perception of the technical and environmental conditions, which are integral to

decision making. The decision maker must possess a thorough knowledge of aspects of

economic theory and its tools of analysis, which are integral to decision making. The basic

concepts have been culled from microeconomic theory and have been furnished with new

tools of analysis.

Characteristics of Managerial Economics: Following are the characteristics of managerial

economics:

• Microeconomics

• Normative economics

• Pragmatic

• Uses theory of firm

• Takes the help of macroeconomics

• Aims at helping the management

• A scientific art

• Prescriptive rather than descriptive

Scope of managerial economics: The scope of managerial economics includes

following subjects: 1) Theory of Demand 2) Theory of Production 3) Theory of Exchange or

Price Theory 4) Theory of Profit 5) Theory of Capital and Investment 6) Environmental Issues

Importance of managerial economics: Spencer and Siegelman have described the

importance of managerial economics in a business and industrial enterprise as follows:

• Reconciling traditional theoretical concepts to the actual business behaviour and

conditions

• Estimating economic relationships

• Predicting relevant economic quantities

• Understanding significant external forces

• Basis of business policies

Techniques of managerial economics: Managerial economics uses a wide variety of

economic concepts, tools and techniques in the decision-making process. These concepts

can be enlisted as follows:

• The theory of the firm, which elucidates how businesses make a variety of decisions

• The theory of consumer behaviour, which describes decision making by consumers

• The theory of market structure and pricing, which opens a window into the structure and

characteristics of different market forms under which business firms operate.