Characteristics of Managerial Economics
Following are the main characteristics of business economics which throw full light on the nature of the subject matter:
- Microeconomic in Character
Managerial economics is microeconomic in character. This is because the unit of study is a firm or an industry; it is the problems of a business organization that are studied in managerial economics. It does not deal with the entire economy as a unit of study.
- Help of Macroeconomics
Managerial economics takes the help of macroeconomics to examine the nature and trend of the business environment in which the firm operates. It takes the help of macroeconomics to answer the following questions: (i) What is the nature and trend of the domestic and international business environment? (ii) What is the nature and impact of social costs and government policy measures on business activities?
Managerial economics is pragmatic. It avoids difficult abstract issues of economic theory and focuses on the application of only those economic concepts and theories which are more useful in solving managerial decision problems.
Managerial economics belongs to normative economics rather than positive economics. In other words, it is prescriptive rather than descriptive. It is concerned with what decisions ought to be made and hence involves value judgments. This has two aspects: first, it tells what aims and objectives a firm should pursue; and secondly, it tells how best to achieve these aims in particular situations. Managerial economics, therefore, has also been described as ‘normative microeconomics of the firm.
- Conceptual and Metrical
It is both conceptual and metrical. It takes the help of conceptual and quantitative analysis to understand and analyze the managerial decision problems.
- Theory of Firm
Managerial economics is concerned with the decision-making of the economic nature of the firms. This implies that managerial economics deals with the identification of economic choices and allocation of scarce resources,
It deals with how decisions should be made by managers to achieve organizational goals. Its choices and actions are directed towards the achievement of goals.
- Coordination between Theory and Practice
Managerial economics establishes coordination between theoretical and practical aspects of the various analyses Of micro and macroeconomics in order to follow managerial practices,
- Wise Choices
Knowledge of managerial economics helps in making wise choices. Managers continue to face the problem of scarcities and, consequently, must continue to make choices. Managerial economics, is the study of the allocation of the resources available to a firm among the activities of that unit, is useful as it is goal-oriented and aims at the maximum achievement of objectives.
Managerial economics is related to different disciplines like statistics, management, operational research, mathematics, and psychology. It draws upon not only Economics but on other subjects also. As such it is regarded as multidisciplinary.
Scope of Managerial Economics
The scope of managerial economics is very wide as it involves the application of economic concepts and analysis of all the problems and areas of the manager and the firm (i.e., basically on operational problems and environmental issues) with the link of decision science tools. Managerial economics deals with five problems in both decision-making and forward planning. These problems are:
(a) Resource allocation for optimal results, (b) Inventory and queuing problems, (c) Pricing problems i.e. fixing prices for the products of the firm, (d) Investment problems i.e. forward planning regarding allocation of scarce resources over time (e) Environmental issues.
Thus the scope of business or managerial economics covers the following area:
A. Operational Issues
They include all those problems which arise within the business organization and fall within the control of management. To address these issues, the following concepts and principles of economics are studied:
- Demand Analysis and Forecasting
Demand analysis consists of the demand function, the elasticity of demand, and demand forecasting. Demand theory explains the consumer’s behavior in reference to the optimum allocation of scarce resources. It answers the question: How do the consumers decide whether or not to buy a commodity? How do they decide on the quantity of a commodity to be purchased? When do they stop consuming a commodity? How do the consumers behave when the price of the commodity, their income, tastes, fashions, etc, change? The knowledge of demand theory can, therefore, be helpful in the choice of commodities for production. Demand forecasting is essential for managerial planning.
- Production and Cost Analysis
Production theory, also called “Theory of Firm,” consists of production functions, cost functions, tools of optimization, i.e. linear programming, etc. In other words, it explains the behavior of firms in reference to the optimum allocation of scarce resources. It provides the answers to the questions: under what conditions do cost increase or decrease; how does total output increase; when units of one factor (input) are increased keeping other factors constantly; or when all factors are simultaneously increased or how can output be maximized from a given quantity of resources; and how can’ optimum size of output be determined? Production theory, thus, helps in determining the size of the firm, the size of the total output and the amount of capital and labor to be employed.
- Pricing Theory and Practices
Price theory explains how prices are determined under different market structures when price discrimination is desirable, feasible, and profitable; to what extent advertising can be helpful in expanding sales in a competitive market; what types of pricing methods are followed by firms in practice, etc. Thus, price theory can be helpful in determining the pricing policy of the firm. Price and production theories together, in fact, help in determining the optimum size of the firm.
- Profit Analysis and Profit Management
Profit-making is the most common objective of all business undertakings. But, making a satisfactory profit is not always guaranteed because a firm has to carry out its activities under conditions of uncertainty with regard to (i) demand for the product; (ii) input prices in the factor market, (iii) nature and degree of competition in the product market, and (iv) price behavior under changing conditions in the product market, etc. Therefore, an element of risk is always there even if the most efficient techniques are used for predicting the future and even if business activities are meticulously planned. The firms are, therefore, supposed to safeguard their interest and avert, as far as possible the
possibilities of risk or try to minimize it. Profit theory guides firms in the measurement and management of profit, in ‘making allowances for the risk premium, in calculating the pure return on capital and pure profit, and also in future profit planning.
- Capital and Investment Decisions
Capital, like all other inputs, is a scarce and expensive factor. Capital is the foundation of business. Its efficient allocation and management are one of the most important tasks of the managers and a determinant of the success level of the firm. The major issues related to capital are (i) choice of the investment project, (ii) assessing the efficiency of capital, and (iii) most efficient allocation of capital. Knowledge of capital and investment decisions can contribute a great deal to investment-decision making, choice of projects, maintaining capital intact, capital budgeting, etc.
- Inventory Management
An inventory refers to a stock of raw materials or finished goods which a firm keeps. Now the question is how much of the inventory the ideal stock is. If it is high, capital is unproductively tied-up, which might, if the stock of inventory is reduced, be useful for other productive purposes. On the other hand, if the level of the inventory is low, production will be hampered. Thus, managerial economics will use such methods which are helpful in minimizing the inventory cost.
B. Environmental Issues
Environmental issues pertain to the general business environment in which a business operates, They are related to the overall economic, social, and political atmosphere of the
country. The main factors which constitute the economic environment of the country are: (i) general trends of macroeconomic indicators (ii) magnitude of trends in foreign trade (iii) political environment (iv) macroeconomic policies (v) growth and trends of financial markets, etc.
Environmental issues basically concerned with the following three questions:
- What is the nature and trend of the domestic business environment?
- What is the nature and trend of the international business environment?
- What is the nature and impact of social costs and government policy measures on business activities?
These questions can be answered only by the study of components and principles of macroeconomics, macroeconomic issues, problems, and macroeconomic policies. The scope of managerial economics can be presented in the following chart.
The components that can be used to solve environmental issues are:
- Macroeconomic theories and components
- Macroeconomic issues and problems
- Macroeconomic policies
The components that can be used to solve operational issues are:
- Demand analysis and forecasting
- Production and Cost Analysis
- Pricing and pricing practices
- Profit analysis and profit management
- Capital and investment decisions
- Inventory management