Relationship between managerial economics and business

Managerial Economics Overview

relationship between managerial economics and business

Theories and principles in business economics/managerial economics help us in getting answers to these questions. Knowledge of the. it is a full explanation about Managerial economics relationship with other As such this new branch of knowledge is useful to business firms. The continuous changes in the economic and business environment make it ever more The issues relevant to managerial economics can be further focused by expanding .. Assume that the relationship between the time series on sales of.

Economics basically comprises of two main divisions namely Micro economics and Macro economics. Managerial economics covers both macroeconomics as well as microeconomics, as both are equally important for decision making and business analysis.

Macroeconomics deals with the study of entire economy. It considers all the factors such as government policies, business cycles, national income, etc. Microeconomics includes the analysis of small individual units of economy such as individual firms, individual industry, or a single individual consumer. All the economic theories, tools, and concepts are covered under the scope of managerial economics to analyze the business environment.

The scope of managerial economics is a continual process, as it is a developing science. Demand analysis and forecasting, profit management, and capital management are also considered under the scope of managerial economics. Demand Analysis and Forecasting Demand analysis and forecasting involves huge amount of decision-making!

Introduction of Managerial Economics - MBA - Gagandeep Singh Sir

Demand estimation is an integral part of decision making, an assessment of future sales helps in strengthening the market position and maximizing profit. In managerial economics, demand analysis and forecasting holds a very important place.

Profit Management Success of a firm depends on its primary measure and that is profit. Firms are operated to earn long term profit which is generally the reward for risk taking. Appropriate planning and measuring profit is the most important and challenging area of managerial economics. Capital Management Capital management involves planning and controlling of expenses.

There are many problems related to capital investments which involve considerable amount of time and labor. Cost of capital and rate of return are important factors of capital management.

Demand for Managerial Economics The demand for this subject has increased post liberalization and globalization period primarily because of increasing use of economic logic, concepts, tools and theories in the decision making process of large multinationals.

Also, this can be attributed to increasing demand for professionally trained management personnel, who can leverage limited resources available to them and maximize returns with efficiency and effectiveness. What determines whether an aspiring business firm should enter a particular industry or simply start producing a new product or service? Should a firm continue to be in business in an industry in which it is currently engaged or cut its losses and exit the industry?

Why do some professions pay handsome salaries, whereas some others pay barely enough to survive? How can the business best motivate the employees of a firm? The issues relevant to managerial economics can be further focused by expanding on the first two of the preceding questions.


Let us consider the first question in which a firm or a would-be firm is considering entering an industry. For example, what led Frederick W. Smith the founder of Federal Express, to start his overnight mail service?

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A service of this nature did not exist in any significant form in the United States, and people seemed to be doing just fine without overnight mail service provided by a private corporation. One can also consider why there are now so many overnight mail carriers such as United Parcel Service and Airborne Express. The second example pertains to the exit from an industry, specifically, the airline industry in the United States.

Pan Am, a pioneer in public air transportation, is no longer in operation, while some airlines such as TWA Trans World Airlines are on the verge of exiting the airlines industry. Why, then, have many airlines that operate on international routes fallen on hard times, while small regional airlines seem to be doing just fine?

Managerial economics provides answers to these questions. In order to answer pertinent questions, managerial economics applies economic theories, tools, and techniques to administrative and business decision-making. The first step in the decision-making process is to collect relevant economic data carefully and to organize the economic information contained in data collected in such a way as to establish a clear basis for managerial decisions.

The goals of the particular business organization must then be clearly spelled out. Based on these stated goals, suitable managerial objectives are formulated. The issue of central concern in the decision-making process is that the desired objectives be reached in the best possible manner.

The term "best" in the decision-making context primarily refers to achieving the goals in the most efficient manner, with the minimum use of available resources—implying there be no waste of resources. Managerial economics helps the manager to make good decisions by providing information on waste associated with a proposed decision. The application of managerial economics is, by no means, limited to these examples.

Tools of managerial economics can be used to achieve virtually all the goals of a business organization in an efficient manner. Typical managerial decision making may involve one of the following issues: Deciding the price of a product and the quantity of the commodity to be produced Deciding whether to manufacture a product or to buy from another manufacturer Choosing the production technique to be employed in the production of a given product Deciding on the level of inventory a firm will maintain of a product or raw material Deciding on the advertising media and the intensity of the advertising campaign Making employment and training decisions Making decisions regarding further business investment and the mode of financing the investment It should be noted that the application of managerial economics is not limited to profit-seeking business organizations.

Tools of managerial economics can be applied equally well to decision problems of nonprofit organizations. Mark Hirschey and James L. Pappas cite the example of a nonprofit hospital. While a nonprofit hospital is not like a typical firm seeking to maximize its profits, a hospital does strive to provide its patients the best medical care possible given its limited staff doctors, nurses, and support staffequipment, space, and other resources.

The hospital administrator can use the concepts and tools of managerial economics to determine the optimal allocation of the limited resources available to the hospital.

In addition to nonprofit business organizations, government agencies and other nonprofit organizations such as cooperatives, schools, and museums can use the techniques of managerial decision making to achieve goals in the most efficient manner.

While managerial economics is helpful in making optimal decisions, one should be aware that it only describes the predictable economic consequences of a managerial decision. For example, tools of managerial economics can explain the effects of imposing automobile import quotas on the availability of domestic cars, prices charged for automobiles, and the extent of competition in the auto industry. Analysis of managerial economics will reveal that fewer cars will be available, prices of automobiles will increase, and the extent of competition will be reduced.

Managerial economics does not address, however, whether imposing automobile import quotas is good government policy. This latter question encompasses broader political considerations involving what economists call value judgments. These concepts can be placed in three broad categories: A firm can be considered a combination of people, physical and financial resources, and a variety of information.

Firms exist because they perform useful functions in society by producing and distributing goods and services. In the process of accomplishing this, they use society's scarce resources, provide employment, and pay taxes. If economic activities of society can be simply put into two categories—production and consumption—firms are considered the most basic economic entities on the production side, while consumers form the basic economic entities on the consumption side.

The behavior of firms is usually analyzed in the context of an economic model, an idealized version of a real-world firm. The basic economic model of a business enterprise is called the theory of the firm.

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Under the simplest version of the theory of the firm it is assumed that profit maximization is its primary goal. In this version of the theory, the firm's owner is the manager of the firm, and thus, the firm's owner-manager is assumed to maximize the firm's short-term profits current profits and profits in the near future. Today, even when the profit maximizing assumption is maintained, the notion of profits has been broadened to take into account uncertainty faced by the firm in realizing profits and the time value of money where the value of a dollar further and further in the future is increasingly smaller than a dollar today.

In this more complete model, the goal of maximizing short-term profits is replaced by goal of maximizing long-term profits, the present value of expected profits, of the business firm. Defining present value of expected profits is based on first defining "value" and then defining "present value.

The value of the firm is defined as the present value of expected future profits net cash flows of the firm. Thus, to obtain an estimate of the present value of expected profits, one must identify the stream of net cash flow in future years. Once this is accomplished, these expected future profit values are converted into present value by discounting these values by an appropriate interest rate. Let us assume that the prevailing interest rate is 10 percent per annum. The present value of expected profits is a key concept in understanding the theory of the firm, and maximizing this profit is considered the primary goal of a firm in most models.

It should be noted that expected profit in any one period can itself be considered as the difference between the total revenue and the total cost in that period. Thus, one can, alternatively, find the present value of expected future profits by subtracting the present value of expected future costs from the present value of expected future revenues. Profit maximization is subject to various constraints faced by the firm. These constraints relate to resource scarcity, technology, contractual obligations, and laws and government regulations.

In their attempt to maximize the present value of profits, business managers must consider not only the short-term and long-term implications of decisions made within the firm, but also various external constraints that may limit the firm's ability to achieve its organizational goals. The first external constraint of resource scarcity refers to the limited availability of essential inputs including skilled laborkey raw materials, energy, specialized machinery and equipment, warehouse space, and other resources.

Moreover, managers often face constraints on plant capacity that are exacerbated by limited investment funds available for expansion or modernization. Contractual obligations also constrain managerial decisions. Labor contracts, for example, may constrain managers' flexibility in worker scheduling and work assignment. Labor contracts may also determine the number of workers employed at any time, thereby establishing a floor for minimum labor costs.

Finally, laws and regulations have to be observed.

relationship between managerial economics and business

The legal restrictions can constrain decisions regarding both production and marketing activities. Examples of laws and regulations that limit managerial flexibility are: The present value maximization criterion as a basis for the study of the firm's behavior has come under severe criticism from some economists. The critics argue that business managers are interested, at least partly, in factors other than the firm's profits.

In particular, they may be interested in power, prestige, leisure, employee welfare, community well-being, and the welfare of the larger society. The act of maximization itself has been criticized; there is a feeling that managers often aim merely to "satisfice" seek solutions that are considered satisfactoryrather than really try to optimize or maximize seek to find the best possible solution, given the constraints.

This question is often rhetorically posed as: Under the structure of a modern firm, it is hard to determine the true motives of managers. A modem firm is frequently organized as a corporation in which shareholders are the legal owners of the firm, and the manager acts on their behalf. Under such a structure, it is difficult to determine whether a manager merely tries to satisfy the stockholders of the firm while pursuing other goals, rather than truly attempting to maximize the value the discounted present value of the firm.

It is, for example, difficult to interpret company support for a charitable organization as an integral part of the firm's long-term value maximization. Similarly, if the firm's size is increasing, but profits are not, can one attribute the manager's decision to expand as being motivated by the increased prestige associated with larger firms, or as an attempt to make the firm more noticeable in the marketplace?

As it is virtually impossible to provide definitive answers to these and similar questions, the attempt to analyze these issues has led to the development of alternative theories of firm behavior. Some of the preeminent alternate models assume one of the following: While each of the alternative theories of the firm has increased our understanding of how a modern firm behaves, none has been able to completely take the place of the basic profit maximization assumption for several reasons.

Numerous academic studies have shown that intense competition in the markets for goods and services of the firm usually forces the manager to make value maximization decisions; if a firm does not decide on the most efficient alternative implying the need to seek the minimum costs for each output level, given the market price of the commodity the firm is producingothers can outcompete the firm and drive it out of existence.

Managerial economics - Wikipedia

Competition also has its effects through the capital markets. As one would expect, stockholders are primarily interested in their returns on stocks and stock prices, which in turn, are determined by the firm's value the discounted present value of expected profits.

Thus, managers are forced to maximize profits in order to maximize firm value, an important basis for returns on common stocks in the long run. Managers who insist on goals other than maximizing shareholder wealth risk being replaced.

An inefficiently managed firm may also be bought out; in almost all such hostile takeovers, managers pursuing their own interests will most likely be replaced. Moreover, a number of academic studies indicate that managerial compensation is closely correlated to the profits generated for the firm. Thus, managers themselves have strong financial incentives to seek profit maximization for their firms. Before arriving at the decision whether to maximize profits or to satisfice, managers like other economic entities have to analyze the costs and benefits of their decisions.

relationship between managerial economics and business

Sometimes, when all costs are taken into account, decisions that appear merely aimed at a satisfactory level of performance turn out to be consistent with value-maximizing behavior. Similarly, short-term firm-growth maximization strategies have often been found to be consistent with long-term value maximization behavior, since large firms have advantages in production, distribution, and sales promotion.