Managerial Economics Definition

To quote Mansfield, Managerial economics is concerned with the application of economic

concepts and economic analysis to the problems of formulating rational managerial decisions.
Spencer and Siegelman have defined the subject as the integration of economic theory with
business practice for the purpose of facilitating decision making and forward planning by
management.
Subject Matter of Marginal Economics:
(i) Demand Analysis and Forecasting
(ii) Cost and Production Analysis
(iii) Inventory Management
(iv) Advertising
(v) Pricing Decision, Policies and Practices
(vi) Profit Management
(vii) Capital Management
Managerial Economics and Statistics:
Statistics is important to managerial economics. It provides the basis for the empirical testing
of theory. Statistics is important in providing the individual firm with measures of the
appropriate functional relationship involved in decision making. Statistics is a very useful
science for business executives because a business runs on estimates and probabilities.
Statistics supplies many tools to managerial economics. Suppose forecasting has to be done.
For this purpose, trend projections are used. Similarly, multiple regression technique is used.
In managerial economics, measures of central tendency like the mean, median, mode, and
measures of dispersion, correlation, regression, least square, estimators are widely used. The
managerial economics is constantly faced with the choice between models ignoring
uncertainty and those that explicitly incorporate probability theory.
Statistical tools are widely used in the solution of managerial problems. For example,
sampling is very useful in data collection. Managerial economics makes use of correlation
and multiple regression in business problems involving some kind of cause and effect
relationship.
2. Derived Demand
Derived demand occurs when there is a demand for a good or factor of production resulting
from demand for an intermediate good or service.
Example of Labour as Derived Demand
The demand for economic tutors depends on the demand for students wishing to study
economics. If students sign up to an economics course, then the college will demand tutors to
be able to teach the students.
The demand for steel workers, is highly dependent upon the demand for steel. As the demand
for British coal fell in the 1980s, demand for coal miners declined.
1.Demand for a basic good (wanted not for its own sake but for the goods derived from it)
such as textiles, that is due to its use in the production of another good such as apparels.

2. Demand for an input to a production process, dependent on the output of a final or

finished product. These inputs include factors of production (capital, labor, land), raw
materials, or intermediate (semi-finished) goods.
3. DEFINITION of 'Sunk Cost'
A cost that has already been incurred and thus cannot be recovered. A sunk cost differs from
other, future costs that a business may face, such as inventory costs or R&D expenses,
because it has already happened. Sunk costs are independent of any event that may occur in
the future.
Money already spent and permanently lost. Sunk costs are past opportunity costs that are
partially (as salvage, if any) or totally irretrievable and, therefore, should be considered
irrelevant to future decision making. This term is from the oil industry where the decision to
abandon or operate an oil well is made on the basis of its expected cash flows and not on how
much money was spent in drilling it. Also called embedded cost, prior year cost, stranded
cost, or sunk capital.
4. Margin of Safety
The margin of safety is the amount of sales over a company's break-even point. In other
words, the margin of safety is the amount of sales a company can lose before it actually starts
to lose money or stops making a profit.

Example
The margin of safety is also an important figure because it shows how safe the business is in
producing products. For example, assume a manufacturer calculates its breakeven to be 100
units. Based on its sales projections, the company anticipates selling 150 units during the next
quarter. The margin of safety on this product is 50 units.
5. Monopoly
Monopoly is an extreme form of market structure. The word monopoly is derived from two
Greek words-Mono and Poly. Mono means single and Poly means 'seller'. Thus monopoly
means single seller. Monopoly is a firm of market organization for a commodity in which
there is only one single seller of the commodity.
As monopoly is a form of imperfect market organization, there is no difference between firm
and industry. A monopoly firm is said to be an industry. Thus monopoly means the absence of
competition. There are strong barriers to entry into the industry. As a result, seller has full
control over the supply of the commodity.
Features of Monopoly:
1. One seller and large number of buyers:
Monopoly is a form of imperfect market structure where there is only one seller of a product.
A monopoly firm may be owned by a person, a few numbers of partners or a joint stock
company. The characteristic feature of single seller eliminates the distinction between the

firm and the industry. A monopolist firm is itself 'the industry. Under monopoly there are
large numbers of buyers although the seller is one. No buyer's reaction can influence the
price.
2. No close substitute:
Under monopoly a single producer produces single commodities which have no close
substitute. As the commodity in question has no close substitute, the monopolist is at liberty
to change a price according to his own whimsy. Monopoly can not exist when there is
competition.
A firm is said, to be monopolist only when it is the single producer and supplier of the
product which have no close substitute. Under monopoly the cross elasticity of demand is
zero. Cross elasticity of demand shows a change in the demand for a good as a result of
change in the price of another good.
3. Strong barriers to the entry into the industry exist:
In a monopoly market there is strong barrier on the entry of new firms. Monopolist faces no
competition. As there is one firm no other rival producers can enter the market of the same
product. Since the monopolist has absolute control over the production and sale of the
commodity certain economic barriers are imposed on the entry of potential rivals.
4. Nature of demand curve:
In case of monopoly one firm constitutes the whole industry. The entire demand of the
consumers for a product goes to the monopolist. Since the demand curve of the individual
consumers lopes downward, the monopolist faces a downward sloping demand curve.
A monopolist can sell more of his output only at a lower price and can reduce the sale at a
high price. The downward sloping demand curve expresses that the price (AR) goes on
falling ns sales are increased. In monopoly AR curve slopes downward mid MR curve lies
below AR curve. Demand curve under monopoly la otherwise known as average revenue
curve.
6. Mark-up Pricing
The practice of adding a constant percentage to the cost price of an item to arrive at its selling
price.
Markup pricing is a strategy in which a company first calculates the cost of the product, then
adds a proportion of it as mark-up.
Mark-up pricing ensures a seller against unpredictable or unexpected later costs.
Even if a firm handles many products, this approach provides the means by which fair prices
can be easily found.
Price increases can be justified in terms of cost increases
Disadvantages of Markup Pricing
Disadvantages of this strategy include:
Provides incentive for inefficiency
Tends to ignore the role of consumers
Tends to ignore the role of competitors
Uses historical rather than replacement value

Uses "normal" or "standard" output level to allocate fixed costs

Includes sunk costs rather than just using incremental costs
Ignores opportunity cost
7. PROFIT FORECASTING
Forecasting, particularly on a short-term basis (one year to three years), is essential to
planning for business success. This process, estimating future business performance based on
the actual results from prior periods, enables the business owner/manager to modify the
operation of the business on a timely basis. This allows the business to avoid losses or major
financial problems should some future results from operations not conform with reasonable
expectations.
Forecasts - or Pro Forma Income Statements and Cash Flow Statements as they are usually
called - also provide the most persuasive management tools to apply for loans or attract
investor money. As a business expands, there will inevitably be a need for more money than
can be internally generated from profits.
Profit forecast is the amount of profit a company expects to make at the end of the period.
The monthly profit and loss forecast will consist of the following:

Sales
Cost of sales
Gross Profit
Overheads
Total Overheads
Miscellaneous income
Net Profit

STAGES IN MAKING PRO FORMA INCOME STATEMENT:

The important stages are as follows:

communicating details of profit forecasting policy and guidelines to those people

responsible for the preparation of pro forma income statement;
determining the factor that restricts output;
preparation of the sales budget;
initial preparation of various budgets of pro forma income statement;
negotiation of budgets with superiors;
coordination and review of budgets of pro forma income statement;
final acceptance of pro forma income statement;
Ongoing review of budgets.
BENEFITS OF PROFIT FORECASTING
Profit forecasting serves a number of useful purposes. They include:
planning annual operations;
coordinating the activities of the various parts of the organization and ensuring that
the parts are in harmony with each other;

communicating plans to the various responsibility centre managers;

motivating managers to strive to achieve the organizational goals;
controlling activities;
Evaluating the performance of managers.

LIMITATIONS OF PROFIT FORECASTING

De-motivation
Generally profit forecasting increases motivation but it could also be a reason of demotivation of employees if they feel that the budgeted figures are way too high to achieve.
Budgetary Slack
Budgetary slack or padding the budgets can occur as managers will intentionally blow up
their budget figures for fear of top managements reprimanding them.
Bad Decision Making
Unrealistic budgets can lead managers to make decisions that might be detrimental to the
company. A good example of over-ambitious sales budget will lead to disastrous impact like
giving steep discount to increase volume, etc.
Doesnt Reflect Complexities
No matter how well prepared a budget might be, it will never be able to reflect truly the
reality/complexities faced by the company.
Regularly Updating
There is a need to revise/update the budget which at the time was based on a certain set of
circumstances/best information.
8. National Income (NI)
National income is the total value a countrys final output of all new goods and services
produced in one year.
The total net value of all goods and services produced within a nation over a specified period
of time, representing the sum of wages,profits, rents, interest, and pension payments to reside
nts of the nation.
National Income is also known as National Income at factor cost. National income at factor
cost means the sum of all incomes earned by resources suppliers for their contribution of
land, labor, capital and organizational ability which go into the years net production. Hence,
the sum of the income received by factors of production in the form of rent, wages, interest
and profit is called National Income. Symbolically,
NI=NNP+Subsidies-Interest Taxes
or,GNP-Depreciation+Subsidies-Indirect Taxes
or,NI=C+G+I+(X-M)+NFIA-Depreciation-Indirect Taxes+Subsidies

National income is the monetary measure of

The net value of all products and services

In an economy during a year

Counted without duplication

After allowing for depression

Both in the public and private sector of products and services

In consumption and capital goods sector

The net gains from international transactions

Explain the significance of economic analysis in business decision.

http://analysisproject.blogspot.in/2013/05/usessignificance-ofmanagerial.html

Discuss briefly the different cost concepts relevant to managerial decision of

planning and control.

http://www.jbdon.com/cost-concepts-and-analysis-i.html
How does the equilibrium of the firm under perfect competition differ from
that of
a monopolist?

http://www.economicsdiscussion.net/monopoly/monopoly-and-perfect-competitiondifference/7250
Profit Maximisation is the only aim of business do you agree? Explain.

When a firm applies profit maximization, it is basically saying that its primary focus is on
profits, and it will use its resources solely to get the biggest profits possible, regardless of the
consequences or the risk involved. Profit maximization is a generally short-term concept.
Application usually lasts less than one year, although some companies employ this strategy
exclusively, constantly jumping on the next big trend.
http://www.managementguru.net/is-profit-maximization-an-appropriate-goal/
http://www.yourarticlelibrary.com/firm/5-major-objectives-that-a-firm-wants-toachieve-apart-from-earning-profit/7492/

http://www.humanresourcesiq.com/hr-management/articles/the-purpose-of-business-isnot-to-make-a-profi/
Define trade cycle: Explain the various phases of a trade cycle.

http://studypoints.blogspot.in/2011/05/what-is-trade-cycle-and-describe-its_2385.html
http://kalyan-city.blogspot.in/2011/06/4-phases-of-business-cycle-in-economics.html
http://www.yourarticlelibrary.com/microeconomics/trade-cycle-4-phases-of-a-tradecycle-explained/25993/
Explain the various types of price elasticity of demand. Discuss the factors on
which the elasticity of demand depends.
http://wikieducator.org/Elasticity_of_Demand
http://accountlearning.blogspot.in/2014/01/determinants-of-elasticity-ofdemand.html
Describe the concept of Break Even Point and point out the assumption while
constructing Break Even Chart.
http://www.yourarticlelibrary.com/economics/the-break-even-analysis-explainedwith-diagrams-economics/29085/
Discuss the different methods of pricing a product and state the method that
would be adopted by a firm under monopolistic competition.
http://www.yourarticlelibrary.com/managerial-economics/8-types-of-pricingstrategies-normally-adopted-by-firms-economics/29028/

Describe the concept of economic welfare, and its relationship with National
Income of a country.

http://www.psnacet.edu.in/courses/MBA/economics%20notes/4.pdf