Managerial Economics
Managerial Economics = Manager+Economics
Economy is concerned with the production, consumption,
distribution and investment of goods and services.
Basic characteristics of ME:
•It is concerned with “decision-making of an economic nature”
•ME is both “conceptual and metrical”
Management & Economics
Management is:
 Coordination
 An activity or an ongoing process
 A purposive process
 An art of getting things done by other people
Economics is based on two fundamental facts of life:
 Human wants are virtually unlimited and insatiable, and
 Economic resources to satisfy these human demands are
limited.
Three central problems of any economy:
 What to produce
 How to produce, and
 For whom to produce
Definitions
 According to Spencer and Siegalman: “Managerial economics
is the integration of economic theory with business practice
for the purpose of facilitating decision making and forward
planning by management.”
Decision making process:
1. Defining the problem.
2. Determining the objective
3. Exploring the alternatives
4. Predicting the consequences
5. Making a choice
6. Implementation
Check list for business success – an
overview/scope of ME
To stay ahead of the competition and to anticipate and react
effectively to changes in markets requires an understanding
of the forces of demand and supply and their impact on
optimal prices and outputs in different market environments.
1. Understanding the business objectives
 What are my objectives for each of the products, e.g.
short-term profit maximization (using products' as 'cash
cows'), sales maximization (increasing market share), etc.?
 Are current product prices set at a level to achieve the
desired objective?
 Is my competitive strategy primarily focused on being the
low-cost producer or does it rely more on product
differentiation? If my products are 'stuck in the middle',
what action might be taken to change the product focus and
how might rivals react?
Check list for business success– an
overview/scope of ME
2.Understanding the competitive market
 In what types of markets do I operate (highly competitive,
monopolistic, etc.) and what are the implications for longerterm prices and profits?
 How do my main competitors set their prices and determine
their expenditure on other aspects of the 'marketing mix'?
 Is there a threat from new competition? What barriers to
entry into my markets exist and can be legally reinforced?
Do I understand the limitations imposed by domestic and
international competition law?
 What does new competition imply for my competitive position
over the longer term?
 How might I best respond to changes in the market by
altering the 'marketing mix' for my products?
Check list for business success – an
overview/scope of ME
3.Understanding consumer behaviour
 Do I know how different market factors affect the demand
for my products and hence do I know (even in general
terms) the demand function for each of my products?
 Is it likely that my prices will have to be changed in the
immediate future and if so what are the own price
elasticities of the products?
 Are the prices of substitute and complementary products
likely to change and if so what are the relevant cross-price
elasticities with my products?
 What is true income elasticity of demand for my products
and what is the forecast for income changes in the next
few years?
 Is it possible and would it be useful to have an economist
estimate the demand coefficients for my products?
 Is price set mainly with a view to consumer demand or
mainly with a view to covering supply costs (e.g. a 'costplus' pricing policy)? Is this consistent with my business
objective?
Check list for business success – an
overview/scope of ME
4. Understanding the costs of production
 How elastic is the supply of each of the products I produce
and hence how fast could I respond to changes in demand?
How might supply elasticity be increased?
 What is the current marginal cost for each of my products
and is it rising or falling and why? What does this mean for
future competitiveness?
 Is there evidence of diminishing returns given current plant
size and what does this imply for the investment
programme?
 Am I getting the maximum economies of scale in production,
and if not why not? What does this mean for my
competitive position?
Check list for business success – an
overview/scope of ME
5. Understanding the investment decision
 Are discounted cash flow estimates consistently used in
investment appraisal?
 Am I fully aware of available regional and other
government financial incentives?
 Do I calculate the internal rate of return?
 What is the opportunity cost of capital investment alternative business investment opportunities or a riskfree return in a bank account?
 Are all costs and benefits (internal and external) taken
into consideration in investment appraisal?
 On what basis is the cost of capital calculated?
Check list for business success – an
overview/scope of ME
6. Understanding the employment decision
 Do decisions on employment take into account the marginal
revenue product (i.e. the added value) of labour?
 Are wages set with regard to any rational economic
criteria? What factors determine the supply of labour to
the business? .What are the implications for labour supply
of current demographic trends?
 What action is being taken to anticipate unfavourable
movements in labour costs?
 Are current wage differentials economically justified?
Check list for business success – an
overview/scope of ME
7. Understanding the external environment
 Is there a regular briefing in my company concerned with
developments in the macroeconomic environment and related
government policy and their likely impact on the business?
 Do I know what would be the demand for my products if
interest rates rose or fell, or if the exchange rate
depreciated or appreciated, or if there was a change in the
rate of growth of consumer spending or investment?
 In developing business plans do I make use of any
macroeconomic forecasts prepared by the various
forecasting bodies, e.g. London Business School, etc.?
 Are there any likely changes in the political, economic,
social and technological (PEST) environment which will impact
on my business?
 How should I respond to these events?
Cycle of business success
Basic factors in ME
 A. The Incremental concept
- Incremental cost (IC): change in cost with change in
output
- Incremental revenue (IR): change in revenue with change
in output
A decision is profitable if IR>IC:
 It increases revenue more than it increases cost
 It reduces some cost more than it increases others
 It increases some resources more than it decreases
others
 It decreases costs more than it decreases revenues
Basic factors in ME
 B. The Equi-marginal principle
It states that a rational decision maker would allocate or hire
his resources in such a way that the ratio of marginal
returns and marginal costs of various uses of a given
resource or of various resources in a given use is the
same, e.g., a consumer seeking maximum utility
(satisfaction) from his consumption basket will allow his
consumption budget on goods and services such that
MU1/MC1=MU2/MC2=......=MUn/MCn;
Where, MU1 = marginal utility from product 1
MC1 = marginal cost of product 1, and so on.
Basic factors in ME
 C. The Discounting principle
Example: One may ask how much money today would be
equivalent to Rs 100 a year from now if the rate of
interest is 5%.
The present value of Rs 100 to be received after one year is:
PV = Rs 100/1+i = Rs 100/1.05 = Rs 95.24
Hence, PV = Rn/(1+i)n ; where
PV = present value, R = amount to be received in future, i =
rate of interest, n = number of years lapsing between the
receipt of money
Basic factors in ME
 D. Opportunity cost principle: The Opportunity costs or
alternative costs are the returns from the second best
use of the firm’s resources which the firm forgoes in
order to avail itself of the returns from the best use of
the resources.
The opportunity costs, thus, are the “costs of sacrificed
alternatives.”
 E. The “Invisible hand” belief: Adam Smith
According to him, the economic system, left to itself, is selfregulating. Technically speaking, we can say that the basic
economic problems in a society are solved by the operation
of market forces.