Lesson 1 in Managerial Economics PDF

LESSON 1 IN MANAGERIAL ECONOMICS INTRODUCTION Managerial economics, or business economics, is a division of microeconomics that focuses on applying economic theory directly to businesses. The application of economic theory through statistical methods helps businesses make decisions and determine str...

LESSON 1 IN MANAGERIAL ECONOMICS INTRODUCTION Managerial economics, or business economics, is a division of microeconomics that focuses on applying economic theory directly to businesses. The application of economic theory through statistical methods helps businesses make decisions and determine strategy on pricing, operations, risk, investments, and production. In general, the overall role of managerial economics is to increase the efficiency of decision making in businesses to increase profit. The problem of choice arises because of scarcity and Economics is the study about making choices in the presence of scarcity. The study of such choice problem at the individual, social, national, and global level is what Economics is all about. Hence, Economics as a social science studies the human behavior as a relationship between numerous wants and scarcity pertains to the limitations of resources to satisfy these unlimited human wants. Further, it is broadly classified into two categories: Macroeconomics and Microeconomics. Macroeconomics is the study of the economic system as a whole while Microeconomics focuses on the behavior of the individual economic activity, firms and individuals, and their interaction in markets. Managerial economics is a stream of management studies which emphasizes solving business problems and decision making by applying the theories and principles of macroeconomics and microeconomics. NATURE OF MANAGERIAL ECONOMICS To know more about managerial economics, we must know about its various characteristics by studying the nature of this concept in the following points: 1. Art and Science: Managerial economics requires a lot of logical thinking and creative skills for decision making or problem solving. It is also considered to be a stream of science by some economists claiming that it involves the application of different economic principles, techniques and methods, to solve business problems. 2. Microeconomics: in managerial economics, managers generally deal with the problems related to a particular organization instead of the whole economy. Therefore, it is considered to be a part of microeconomics. 3. Uses Macroeconomics: A business functions in an external environment, i.e. it serves the market, which is a part of the economy as a whole. Therefore, it is essential for managers to analyze the different factors of macroeconomics such as market conditions, economic reforms, government policies, and their impact on the organization.  4. Multi-disciplinary: It uses many tools and principles belonging to various disciplines such as accounting, finance, statistics, mathematics, production, operation research, human resource, marketing, etc. 5. Prescriptive/Normative Discipline: it aims at goal achievement and deals with practical situations or problems by implementing corrective measures. 6. Management Oriented: it acts as a tool in the hands of managers to deal with business-related problems and uncertainties appropriately. It also provides for goal establishment, policy formulation, and effective decision making. 7. Pragmatic: it is a practical and logical approach towards the day-to-day business problems. TYPES OF MANAGERIAL ECONOMICS: 1. Liberal Managerialism: A market is a democratic place where people are liberal to make their choices and decisions. The organization and managers have to function according to the customer’s demand and market trend. Otherwise, it may lead to business failure. 2. Normative managerialism: The normative view of managerial economics states that administrative decisions are based on real-life experiences and practices. They have a practical approach to demand analysis, forecasting, cost management, product design and promotion, recruitment, etc. 3. Radical managerialism: Managers must have a revolutionary attitude towards business problems, i.e. they must make decisions to change the present situation or condition. They focus more on the customer’s requirement and satisfaction rather than only profit maximization. PRINCIPLES OF MANAGERIAL ECONOMICS: 1. Principles of how people make decisions. To understand how the decision making takes place in real life, let us go through the following: a. People face trade-offs. To make decisions, people have to make choices when they have to select among the various options available. b. Opportunity cost. Every decision involves an opportunity cost which the cost of those options which we let go while selecting the most appropriate one.  c. Rational people think at the margin. People usually think about the margin or the profit they will earn before investing their money or resources at a particular project or person. d. People respond to incentive. Decision making highly depends upon the incentives associated with a product, service or activity. Negative incentives discourage people, whereas positive incentives motivate them. 2. Principles of how people interact. Communication and market affect business operations. To justify the statement, let us see the following related principles. a. Trade can make everyone better off. This principle says that trade is a medium of exchange among people. Everyone gets a chance to offer those products or services which they are good at making. And purchase those products or services too, which others are good at manufacturing. b. Markets are usually a good way to organize economic activity. Markets mostly act as a medium of interaction among the consumers and producers. The consumers express their needs whereas the producers decide whether to produce goods or services. c. Government can sometimes improve market outcomes. Government intervenes business operations at the time of unfavorable market conditions or for the welfare of society. One such example is when the government decides minimum wages for labor welfare. 3. Principles of how economy works a whole. The following principles explain the role of the economy in the functioning of an organization. a. A country’s standard of living depends on its ability to produce goods and services. For the growth of the economy of a country, the organizations must be efficient enough to produce goods and services. It ultimately meets the consumer’s demand and improves GDP to raise the country’s standard of living. b. Prices rise when the government prints too much money. If there are surplus money available with people, their spending capacity increases, ultimately leading to a rise in demand. When the producers are unable to meet the consumer’s demand, inflation takes place. c. Society faces a short-run trade-off between inflation and unemployment. To reduce unemployment, the government brings in various economic policies into action. These policies aim at boosting the economy in the short run. SCOPE OF MANAGERIAL ECONOMICS 1. MICROECONOMICS APPLIED TO OPERATIONAL ISSUES. To resolve the organization’s internal issues arising in business operations, the various theories or principles of microeconomics applied are as follows: a. Theory of demand: The demand theory emphasizes on the consumer’s behavior towards a product or service. It takes into consideration the needs, wants, preferences and requirement of the consumers to enhance the production process. b. Theory of production and production decisions: This theory is majorly concerned with the volume of production, process, capital, and labor required, cost involved, etc. it aims at maximizing the output to meet the customer’s demand. c. Pricing theory and analysis of market structure: It focuses on the price determination of a product keeping in mind the competitors, market conditions, cost of production, maximizing sales volume, etc. d. Profit analysis and management: The organizations work for a profit. Therefore, they always aim at profit maximization. It depends upon the market demand, cost of input, competition level, etc. e. Theory of capital and investment decisions: Capital is the most critical factor of business. This theory prevails the proper allocation of the organization’s capital and making investments in profitable projects or venture to improve organizational efficiency. 2. MACROECONOMICS APPLIED TO BUSINESS ENVIRONMENT. Any organization is much affected by the environment it operates. The business environment can be classified as follows: a. Economic environment: The economic conditions of a country, GDP, economic policies, etc. indirectly impacts the business and its operations. b. Social environment: The society in which the organization functions also affect it like employment conditions, trade unions, consumer cooperatives, etc. c. Political environment: The political structure of a country, whether authoritarian or democratic; political stability; and attitude towards the private sector; influence organizational growth and development.