Introduction
Managerial economics is concerned with the application of economic concepts and analysis to the problem of formulating rational managerial decisions. There are four groups of problems in both decision-making and forward planning.
Resource Allocation
Scarce resources have to be used with utmost efficiency to get optimal results. These include production programming and problems of transportation etc. How does resource allocation take place within a firm? Naturally, a manager decides how to allocate resources to their respective uses within the firm, while the resource allocation decision outside the firm is primarily done through the market.
Thus managerial economics is the study of allocation of resources available to a firm or a unit of management among the activities of that unit. Resource allocation is a major challenge for any organization. Managerial economics involves an analysis of the allocation of the resources available to a firm, or a unit of management among the activities of that unit.
The Scope of Managerial Economics
The scope of managerial economics refers to its area of study. Managerial economics provides management with a strategic planning tool that can be used to get a clear perspective of the way the business world works and what can be done to maintain profitability in an ever-changing environment.
Managerial economics is primarily concerned with the application of economic principles and theories to five types of resource decisions made by all types of business organizations:
- The selection of product or service to be produced
- The choice of production methods and resource combinations
- The determination of the best price and quantity combination
- Promotional strategy to be employed
- Selection of the location of business
Demand Analysis and Forecasting
A firm relies on converting inputs into outputs and generates revenue from them. A clear and accurate estimation of demand ensures continuous efficiency of the firm. Several external factors like price, income, and consumer preferences affect the demand that need to be analyzed. The scope of managerial economics includes demand analysis and forecasting to help managers understand market conditions.
Cost and Production Analysis
A company makes a profit in two ways: by increasing the demand or by reducing the cost. The determinants of assessing costs, the connection between cost and yield, and the gauge of cost and benefit are indispensable to a firm. Cost analysis is an important exercise for any company.
A component of cost vulnerability always exists since all the elements deciding expenses are not generally known or controllable. By taking the help of managerial economics, the management of a company identifies the factors causing a variation in costs. The company then uses the cost estimates in their decision making like pricing a product.
Production analysis is more of a physical exercise. It involves examining the factors of production, also known as inputs, and obtaining the best combination so as to get the least cost combination.
Pricing Decisions
Pricing decisions have always been within the preview of managerial economics. Among the 4Ps of marketing, Price finds an important place. For any firm, Pricing is a very important aspect of Managerial Economics as a firm's revenue earnings largely depend on its pricing policy.
However, it is a bit challenging as other players are competing in the same price segment. When pricing a product is done, the costs of production are also taken into account. Managerial economics helps the management to go through all the analyses and then price a product. In an oligopoly market condition, the knowledge of pricing a product is essential.
Profit Management
Managerial economics deals with techniques of averting or minimizing risks. Profit theory guides in the measurement and management of profit, in calculating the pure return on capital, besides understanding profit policies of individual firms.
Capital Management
Capital is the foundation of business. Lack of capital may result in small size of operations. Availability of capital from various sources like equity capital, institutional finance etc. may help to undertake large-scale operations. Hence efficient allocation and management of capital is one of the most important tasks of the managers.
Knowledge of capital theory can help very much in taking investment decisions. This involves capital budgeting, feasibility studies, analysis of cost of capital etc. Every asset a business owns is known as its capital. Capital management thus becomes an important practice. Planning and control of capital expenditures is a basic executive function.
Microeconomic Foundation
At its core, managerial economics is rooted in microeconomics, focusing on the behavior of individual firms and consumers. It examines how businesses allocate resources, set prices, and make production decisions to maximize their objectives, considering factors such as demand, supply, costs, and market structure.
Basic Characteristics of Managerial Economics
The basic characteristics of managerial economics can be enumerated as:
- It is concerned with "decision making of an economic nature"
- It largely uses that body of economic concepts and principles, which is known as "theory of the firm"
- Managerial economics is both "conceptual and metrical" - it includes theory with measurement
- It is pragmatic in nature, emphasizing practical applications over theoretical abstraction
Relationship with Other Disciplines
Managerial economics draws from both economics and management disciplines. It integrates economic theories, principles, and tools with managerial concepts, providing a framework for decision-making in a business context.
When you read a newspaper or switch on a television, you hear economic terminology used with increasing regularity. For a manager, some of these economic terms are of direct relevance and therefore it is essential to not only understand them but also apply them in relevant situations.
For example, GDP growth rate could impact the product a manager is marketing, change in money supply by the RBI could impact inflation and affect the demand for your product, fiscal deficit could affect interest rates and therefore investment spending by a manager etc.
Conclusion
The focus of managerial economics is on how the firm reacts to changes in the economic environment in which it operates and how it predicts these changes and devises the best possible strategies to achieve the objectives that underlie its existence. Managerial economics is a developing subject and its empirical and prescriptive nature widens its scope.