ECONOMICS AND MANAGERIAL DECISION

MAKING
Managerial Economics may be viewed as economics applied to problem
solving at the level of firm.

Economics is “the study of the behaviour of human beings in producing,

distributing and consuming material goods and services in a world of
scarce resources.” Management is the discipline of organizing and
allocating a firm’s scarce resources to achieve its desired objectives.
These two definitions clearly point to the relationship between economics
and managerial decision making.

The Three Basic Economic Questions

FROM THE STANDPOINT OF THE COUNTRY FROM THE STANDPOINT OF THE COMPANY

1. What goods and services should be produced? 1. The product decision.

2. How should these goods and services be 2. The hiring, staffing, procurement, and capital
produced? budgeting decisions.
3. For whom these goods and services be produced? 3. The market segmentation decision.
MANAGERIAL ECONOMICS AND OTHER BUSINESS
DISCIPLINES
Finance
Marketing Capital budgeting
Demand Break-even analysis
Price elasticity Opportunity cost
Economic value
added

Managerial Economics
Management Science
Linear Programming
Managerial Accounting Regression analysis
Relevant cost Forecasting
Break even analysis
Incremental cost analysis
Opportunity cost

Strategy
Types of competition
Structure-conduct-
Performance analysis
Managerial Economics provides managers with a basic framework for making
key business decisions about the allocation of their firm’s resources. In
making these decisions, managers must essentially deal with the
following questions:
1. What are the economic conditions in a particular market in which we are or could be competing?
In particular:
b. Market structure?
c. Supply and demand conditions?
d. Technology?
e. Government regulations?
f. International dimensions?
g. Future conditions?
h. Macroeconomic factors?
2. Should our firm be in this business?
3. If so, what price and output levels should we set in order to maximize our economic profit or
minimize our losses in the short run?
4. How can we organize and invest in our resources in such a way that we maintain a competitive
advantage over other firms in this market?
a. Cost leader?
b. Product differentiation?
c. Focus on market niche?
d. Outsourcing, alliances, mergers, acquisitions?
e. International dimension—regional or country focus or expansion?
5. What are the risks involved?
Perhaps the most fundamental question is question 2, which concerns
whether a firm should be in business in which they are operating.
Note that question 5 has to do with a firm’s risk. Typical of the types of
risks that businesses face would include:
• Changes in demand and supply conditions.
• Technological changes and the effect of consumption.
• Changes in interest rates and inflation rates.
• Exchange rate changes for companies engaged in international
trade.
• Political risk for companies with foreign operations.
 IMPACT OF CHANGING ECONOMICS ON WELL ESTABLISHED
COMPANIES
The impact of changing economics on well established companies can be
better understood and appreciated within the framework of a ‘four-stage
model’ of change.
STAGE I STAGE II STAGE III STAGE IV
Cost plus Cost management Revenue management Revenue plus

Changing economics
* Competition
* Technology
* Customers

STAGE I can be called “the good old days” for companies such as IBM, Kodak and any number of other
solid, blue chip companies whose dominance of the market allowed them with a suitable level of profit.
Then changes in technology, competition and customers put pressures on their profit margins as well
as market share and forced them into STAGE II, where they sought refuge through cost cutting,
downsizing, restructuring and re-engineering. In the US, this began to occur in the 1980s and
continued on to the early 1990s, when consultants touted the benefits of “reengineering” as a means of
dealing with these changes. From the mid 1990s companies sought to enter STAGE III when they
realized that the continual focus on cost had its limits insofar as its ability to increase profits. Therefore
in STAGE III “top-line growth” became the major focus. Thus STAGE IV becomes a necessary part of
a company’s full recovery from the impact of changing economics.
 DEFINATIONS OF MANGERIAL ECONOMICS

• According to Edwin Mansfield, “ Managerial economics is concerned

with the ways in which managers should make decisions in order to
maximize the effectiveness or performance of the organizations they
manage.”

• Prof. Even Douglas says, “ Managerial Economics is concerned with

the application of economic principles and methodologies to the
decision making process within the firm or organization under the
conditions of uncertainty.”

• According to Spencer and Siegelman, “Managerial Economics is the

integration of economic theory with Managerial practices for the
purpose of facilitating decision making and forward planning by
management.”
 SCOPE OF MANAGERIAL ECONOMICS
The scope of managerial economics is very wide as it involves the
application of economic concepts and analysis to all the problems
and areas of the manager and the firm. Managerial Economics
deals with four problems in both decision making and forward
planning. These problems are:
1.Resource allocation for optimal results, 2. Inventory and queuing
problem, 3. Pricing problems i.e. fixing prices for the products of the
firm, 4. Investment problems i.e. forward planning regarding
allocation of scarce recourses over time.
Thus the scope of Managerial Economics covers the following areas-
• Theory of Demand Analysis and Forecasting.
• Theory of Production and Production Decisions.
• Analysis of Market-Structure and Pricing Theory.
• Cost Analysis.
• Profit Analysis and Profit Management.
• Theory of Capital and Investment Decisions.
• Inventory Management.