Relation of Managerial Economics with Traditional Economics

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Relation of Managerial Economics with Traditional Economics

Managerial decision problems can be solved by the application of traditional economic theories which are used for determining the optimal behavior of the organizations. Traditional economics is basically categorized into microeconomics and macroeconomics. Microeconomics is the study of the economic behavior of individual economic agents like individual consumers, resource owners, and business firms, in a market-based mixed economy. Macroeconomics, on the other hand, is the study of the total or aggregate economic variables like income, employment, output, consumption, investment, price level, etc. Microeconomics, as a theory of the firm, is concerned with how an individual firm decides ‘what to produce’, ‘how to produce’, ‘how much to invest, etc., and also decides ‘how and on what basis to determine to price’. In short, it helps in solving operational issues faced by firms from their internal business environment. Macroeconomics, on the other hand, is concerned with the nature and extent of the business environment and government policy measures in which firms are operating. In short, it provides answers to the environmental issues related to business activities. Economic theories also seek to predict and explain economic behavior through models based on relevant assumptions. Specifically, mathematical economics is used to formalize the economic models postulated by economic theory. Econometrics then applies statistical tools i.e. normally regression analysis to real-world data to estimate the models of economic theory and for forecasting.

For example, the economic theory postulates, that quantity demanded of a commodity X depends upon the price of X, the income of the consumer, and the price of related commodities i.e. price of complements (Pc)’ and the price of substitutes (Ps) commodities respectively. Assuming constant tastes, we can postulate the following formal mathematical model.

Qx= a0- b1Px + b2Y + b3Ps byPc

Now by collecting data on Qx, PX, Pc, Ps, and Y for a particular commodity, we can estimate the empirical (econometric) relationship by using the tool of regression analysis. This will enable the firm to determine how much output (Qx) would change by a change in the price of X, income, Pc, and Ps and to forecast the future demand for this commodity, This information is essentially required for management to ‘achieve the goal or objective of the firm’ most effectively:

Baumol has pointed out three main contributions of economic theory to business economics. They are as follows:

  • Economic theories can contribute to the management science in building analytical models, This process helps to recognize the structure of managerial problems, eliminate the minor details that might obstruct decision making, and help to concentrate on the main issues (or problems).
  • Economic theory contributes to business analysis as a set of analytical methods. They do enhance the analytical capabilities of the business analyst,
  • Economic theories offer clarity to the various concepts used in business analysis, which enables managers to avoid conceptual pitfalls.

Does Managerial economics differ from traditional economics?

Although managerial economics originates from economics yet there are varieties of differences between the two. The main points of difference are as under:

  1. Traditional economics deals with the body of the economic principles itself whereas managerial economics involves the application of economic principles to the problems of the firm.
  2. Traditional economics is both macroeconomic and microeconomic in character whereas business economics is microeconomic in character.
  3. Managerial economics, though micro in character, deals only with the firm and has nothing to do with an individual’s economic problems of households. But microeconomics as a branch of economics deals with both the economics of the households as well as the economics of the firms. Macroeconomics deals with the economics of the whole society.
  4. Under microeconomics as a branch of economics, distribution theories, viz., wages, interest, and profit are also dealt with but in business economics, mainly profit theory is used. Other distribution theories do have not much use in business economics. Thus, the scope of economics is wider than that of business economics.
  5. The economic theory hypothesizes economic relationships and builds economic models but managerial economics adopts, modifies, and reformulates economic models to suit the specific managerial problems.
  6. Economic theory makes certain assumptions whereas managerial economics introduces certain feedbacks such as objectives of the firm, multi-product nature of manufacturing firms, behavioral constraints, environmental aspects, legal constraints, constraints on resource availability, etc.

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