Managerial economics can be applied to solve certain managerial decision problems continually faced by business enterprises. With the help of managerial economics, business firms can make decisions in setting goals, demand forecasting, resource allocation, pricing, analysis of the business environment, etc.
The main uses of managerial economics are as follows:
Efficient Utilization of Resource Allocation:
Managerial economics helps business firms to select highly efficient and least-cost production techniques with the application of tools like the law of substitution, linear programming, etc. Linear programming helps a farmer or an entrepreneur to mix the factors of production in an optimum manner and can increase his income. It also investigates the best possible production process among the alternative production processes to attain maximum income.
Similarly, the law of substitution helps the producers to make optimum allocation of resources with a view to achieving their goals like output maximization or cost minimization.
A producer will maximize his output when the ratio of marginal productivity of factors of production is equal to the ratio of their prices.
Also, a producer maximizes output or minimizes costs
MPk/MPl = Pk/Pl or MPk/Pk = MPl/Pl = …= MPn/Pn ( =r/w)
MPl = Managerial Productivity of labor
MPk = Managerial Productivity of Capital
r = rate of interest
w = wage rate
Based on the figure, the R point is the point of optimal employment of two variable inputs at minimum cost.
The basis for Prediction.
Theories of managerial economics establish cause and effect relationships between two or more two economic events. It also provides the basis for predicting the future course Of economic events like demand forecasting, cost estimation, etc. Such predictions help the policy-makers to formulate policies regarding the prices of commodities and the managers formulate business strategies like production planning, sales planning, financial planning, pricing, profit planning, etc.
Managerial economics offers various concepts, theories, and models which are useful in pricing the products. For example, under perfect competition, the demand-supply model is used to determine the price. The model states that price is determined by the forces of demand and supply, and at the equilibrium price, the quantity demanded equals the quantity supplied. Similarly, in a firm under monopoly and monopolistic competition, the firm determines product price on the basis of the law of demand, opportunity cost, the elasticity of demand, etc. For example, the concept of price elasticity of demand is used to determine the price of joint products and also to follow the policy of price discrimination, discounts, etc. Under oligopoly, pricing models like a cartel, price leadership, kinked demand curve model, etc. are practiced.
Theories of managerial economics are very useful in setting goals for the firms or managers. Goals like, profit maximization, value maximization, sales maximization, etc. depends upon the strategies followed by firms for both periods, i.e. short period and long periods.
To examine the business environment:
Managerial economics provides the knowledge for macroeconomic principles, issues, and policies that will be more useful to examine economic aspects of the business environment.