Managerial Economics: Nature, Scope, and Principles

Managerial Economics can define as the amalgamation of economic theory with business practices to ease decision-making and future planning by management. The Concept of Managerial Economics Study: Meaning, Definition, Nature of Managerial Economics, Scope of Managerial Economics, and Principles of Managerial Economics. Managerial Economics assists the managers of a firm in a rational solution to obstacles faced in the firm’s activities. It makes use of economic theory and concepts. It helps in formulating logical managerial decisions.

Learn, Explain Managerial Economics: Nature, Scope, and Principles.

The key to Managerial Economics is the microeconomic theory of the firm. It lessens the gap between economics in theory and economics in practice. Managerial Economics is a science dealing with the effective use of scarce resources. 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.

Study of Managerial Economics:

They help in the enhancement of analytical skills, assists in rational configuration as well as a solution to problems. While microeconomics is the study of decisions made regarding the allocation of resources and prices of goods and services, macroeconomics is the field of economics that studies the behavior of the economy as a whole. Managerial Economics applies microeconomic tools to make business decisions. It deals with a firm.

The use of Managerial Economics not limits to profit-making firms and organizations. But it can also use to help in the 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 the most efficient manner. Managerial Economics is of great help in price analysis, production analysis, capital budgeting, risk analysis, and determination of demand. Managerial economics uses both economic theories as well as Econometrics for rational managerial decision making.

Econometrics defines:

As the use of statistical tools for assessing economic theories by empirically measuring the relationship between economic variables. It uses factual data for the solution of economic problems. Managerial Economics associates with the economic theory which constitutes “Theory of Firm”. The theory of the firm states that the primary aim of the firm is to maximize wealth. Decision making in managerial economics generally involves the establishment of a firm’s objectives, identification of problems involving in the achievement of those objectives, development of various alternative solutions, selection of best alternative, and finally implementation of the decision.

Nature of Managerial Economics:

Managers study managerial economics because it gives them insight to reign the functioning of the organization. If the manager uses the principles applicable to economic behavior in a reasonably, then it will result in the smooth functioning of the organization.

Managerial Economics is a Science:

Managerial Economics is an essential scholastic field. It can compare to science in the sense that it fulfills the criteria of being a science in the following sense:

• Science is a Systematic body of Knowledge. It bases on methodical observation. Managerial economics is also a science of making decisions about scarce resources with alternative applications. It is a body of knowledge that determines or observes the internal and external environment for decision making.
• In science, any conclusion arrives at after continuous experimentation. In Managerial economics also policies are made after persistent testing and training. Though the economic environment consists of the human variable, which is unpredictable, thus the policies made are not rigid. A managerial economist takes decisions by utilizing his valuable experience and observations.
• Science principles are universally applicable. Similarly, policies of Managerial economics are also universally applicable partially if not fully. The policies need to change from time to time depending on the situation and attitude of individuals to those particular situations. Policies are applicable universally but modifications are requiring periodically.

Managerial Economics requires Art:

The managerial economist requires to have an art of utilizing his capability, knowledge, and understanding to achieve the organizational objective. The managerial economist should have art to put in practice his theoretical knowledge regarding elements of the economic environment.

Managerial Economics for the administration of the organization:

Managerial economics helps the management in decision making. These decisions are based on the economic rationale and are valid in the existing economic environment.

Managerial economics is helpful in optimum resource allocation:

The resources are scarce with alternative uses. Managers need to use these limited resources optimally. Each resource has several uses. It is the manager who decides with his knowledge of economics that which one is the preeminent use of the resource.

Managerial Economics has components of microeconomics:

Managers study and manage the internal environment of the organization and work for the profitable and long-term functioning of the organization. This aspect refers to the microeconomics study. The managerial economics deals with the problems faced by the individual organization such as the main objective of the organization, demand for its product, price and output determination of the organization, available substitute and complementary goods, the supply of inputs and raw material, target or prospective consumers of its products, etc.

Managerial Economics has components of macroeconomics:

None of the organizations works in isolation. They affecting by the external environment of the economy in which it operates such as government policies, general price level, income and employment levels in the economy, stage of the business cycle in which economy is operating, exchange rate, the balance of payment, general expenditure, saving and investment patterns of the consumers, market conditions, etc. These aspects are related to macroeconomics.

Managerial Economics is dynamic:

Managerial Economics deals with human-beings (i.e. human resources, consumers, producers, etc.). Nature and attitude differ from person to person. Thus to cope up with dynamism and vitality managerial economics also changes itself over some time.

The Scope of Managerial Economics:

Managerial Economics deals with allocating scarce resources in a manner that minimizes the cost. As we have already discussed, Managerial Economics is different from microeconomics and macroeconomics. Managerial Economics has a more narrow scope – it is solving managerial issues using micro-economics. Wherever there are scarce resources, managerial economics ensures that managers make effective and efficient decisions concerning customers, suppliers, competitors as well as within an organization. Also, understand the scope of managerial economics below is.

The fact of scarcity of resources gives rise to three fundamental questions:

• What to produce?
• How to produce?
• For whom to produce?

To answer these questions, a firm makes use of managerial economics principles.

The first question;

Relates to what goods and services should produce and in what amount/quantities. The managers use demand theory for deciding this. The demand theory examines consumer behavior with respect to the kind of purchases they would like to make currently and in future; the factors influencing purchase and consumption of a specific good or service; the impact of change in these factors on the demand of that specific good or service; and the goods or services which consumers might not purchase and consume in future. To decide the number of goods and services to produce, the managers use methods of demand forecasting.

The second question;

Relates to how to produce goods and services. The firm has now to choose among different alternative techniques of production. It has to decide on the purchase of raw materials, capital pieces of equipment, manpower, etc. The managers can use various managerial economics tools such as production and cost analysis, project appraisal methods, etc for making these crucial decisions.

The third question;

It is regarding who should consume and claim the goods and services producing by the firm. The firm, for instance, must decide which is its niche market-domestic or foreign? It must segment the market. It must conduct a thorough analysis of the market structure and thus take price and output decisions depending upon the type of market.

Managerial economics helps in decision-making as it involves logical thinking. Moreover, by studying simple models, managers can deal with more complex and practical situations. Also, a general approach implements. Managerial Economics take a wider picture of the firm, i.e., it deals with questions such as what is a firm, what are the firm’s objectives, and what forces push the firm towards profit and away from profit.

In short, managerial economics emphasizes the firm, the decisions relating to individual firms, and the environment in which the firm operates. It deals with key issues such as what conditions favor entry and exit of firms in a market, why are people paid well in some jobs, and not so well in other jobs, etc. It is a great rational and analytical tool. Managerial Economics is not only applicable to profit-making business organizations but also non- profit organizations such as hospitals, schools, government agencies, etc.

Principles of Managerial Economics:

Managerial Economics principles assist in rational reasoning and define thinking. They develop the logical ability and strength of a manager.

Some important principles of managerial economics are:

Marginal and Incremental Principles:

These principles state that a decision says to be rational and sound if, given the firm’s objective of profit maximization, it leads to an increase in profit, which is in either of two scenarios:

• If total revenue increases more than the total cost.
• If total revenue declines less than total cost.

The marginal analysis implies judging the impact of a unit change in one variable on the other. Marginal generally refers to small changes. Marginal revenue is the change in total revenue per unit change in output sold. The marginal cost refers to change in total costs per unit change in output produced (While incremental cost refers to change in total costs due to change in total output). The decision of a firm to change the price would depend upon the resulting impact/change in marginal revenue and marginal cost. If the marginal revenue is greater than the marginal cost, then the firm should bring about the change in price.

The incremental analysis differs from marginal analysis only in that its analysis the change in the firm’s performance for a given managerial decision, whereas marginal analysis often generates a change in outputs or inputs. Incremental analysis is a generalization of the marginal concept. It refers to changes in cost and revenue due to a policy change.

For example – adding a new business, buying new inputs, processing products, etc. Change in output due to change in process, product or investment considers as an incremental change. The incremental principle states that a decision is profitable if revenue increases more than costs; if costs reduce more than revenues; if the increase in some revenues is more than the decrease in others; and if the decrease in some costs is greater than the increase in others.

Equi-marginal Principles:

Marginal Utility is the utility derives from the additional unit of a commodity consumed. The laws of Equi-marginal utility state that a consumer will reach the stage of equilibrium when the marginal utilities of various commodities he consumes are equal. According to modern economists, this law has been formulating in the form of the law of proportional marginal utility. It states that the consumer will spend his money-income on different goods in such a way that the marginal utility of each good is proportional to its price, i.e.,

MUx / Px = MUy / Py = MUz / Pz

Where MU represents marginal utility and P is the price of the good.

Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the technique of production which satisfies the following condition:

MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3

Where MRP is the marginal revenue product of inputs and MC represents the marginal cost.

Thus, a manager can make the rational decision by allocating/hiring resources in a manner which equalizes the ratio of marginal returns and marginal costs of various use of resources in specific use.

Opportunity Cost Principles:

By opportunity cost of a decision is meant the sacrifice of alternatives require by that decision. If there are no sacrifices, there is no cost. According to Opportunity cost principle, a firm can hire a factor of production if and only if that factor earns a reward in that occupation/job equal or greater than it’s an opportunity cost.

Opportunity cost is the minimum price that would be necessary to retain a factor-service in it’s given us use. It also defines the cost of sacrificed alternatives. For instance, a person chooses to forgo his present lucrative job which offers him Rs.50000 per month and organizes his own business. The opportunity lost (earning Rs. 50,000) will be the opportunity cost of running his own business.

Time Perspective Principles:

According to these principles, a manager/decision-maker should give due emphasis, both to the short-term and long-term impact of his decisions, giving apt significance to the different periods before reaching any decision. Short-run refers to a period in which some factors are fixed while others are variable. The production can increase by increasing the number of variable factors.

While long-run is a period in which all factors of production can become variable. Entry and exit of seller firms can take place easily. From consumer’s point of view, the short-run refers to a period in which they respond to the changes in price, given the taste and preferences of the consumers, while long-run is a period in which the consumers have enough time to respond to price changes by varying their tastes and preferences.

Discounting Principles:

According to these principles, if a decision affects costs and revenues in the long-run, all those costs and revenues must discount to present values before the valid comparison of alternatives is possible. This is essential because a rupee’s worth of money at a future date is not worth a rupee today. Money has a time value. Discounting can define as a process uses to transform future dollars into an equivalent number of present dollars. For instance, $1 invested today at 10% interest is equivalent to $1.10 next year.

FV = PV*(1+r)t

Where FV is the future value (time at some futures time), PV is the present value (value at to, r is the discount (interest) rate, and t is the time between the future value and present value. Maybe you’d better know about Managerial Economics and their topics Nature, Scope, and Principles.