Managerial economics is a branch of economics involving the application of economic methods in organizational decision-making process.*
Economics is the study of the production, distribution, and consumption of goods and services. Managerial economics involves the use of economic theories and principles to make decisions regarding the allocation of scarce resources. It guides managers in making decisions relating to the company's customers, competitors, suppliers, and internal operations.Directorate of Distance Education (no date) Directorate Of Distance Education. Available at: https://distanceeducationju.in/ (Accessed: April 23, 2023).
Managers use economic frameworks in order to optimize profits, resource allocation and the overall output of the firm, whilst improving efficiency and minimizing unproductive activities. These frameworks assist organizations to make rational, progressive decisions, by analyzing practical problems at both micro and macroeconomic levels. Managerial decisions involve forecasting (making decisions about the future), which involve levels of risk and uncertainty. However, the assistance of managerial economic techniques aid in informing managers in these decisions.
Managerial economists define managerial economics in several ways: It is the application of economic theory and methodology in business management practice. Focus on business efficiency. Defined as "combining economic theory with business practice to facilitate management's decision-making and forward-looking planning." Includes the use of an economic mindset to analyze business situations. Described as "a fundamental discipline aimed at understanding and analyzing business decision problems". Is the study of the allocation of available resources by enterprises of other management units in the activities of that unit. Deal almost exclusively with those business situations that can be quantified and handled, or at least quantitatively approximated, in a model.
The two main purposes of managerial economics are: To optimize decision making when the firm is faced with problems or obstacles, with the consideration and application of macro and microeconomic theories and principles. To analyze the possible effects and implications of both short and long-term planning decisions on the revenue and profitability of the business.
The core principles that managerial economist use to achieve the above purposes are: monitoring operations management and performance, target or goal setting talent management and development.
In order to optimize economic decisions, the use of operations research, mathematical programming, strategic decision making, game theory and other computational methodsFor a journal on the last subject, see Computational Economics, including an Aims & Scope link are often involved. The methods listed above are typically used for making quantitate decisions by data analysis techniques.
The theory of Managerial Economics includes a focus on; incentives, business organization, biases, advertising, innovation, uncertainty, pricing, analytics, and competition.W. B. Allen, Managerial Economics Theory, Applications, and Cases, 7th Edition. Norton. In other words, managerial economics is a combination of economics and managerial theory. It helps the manager in decision-making and acts as a link between practice and theory. Furthermore, managerial economics provides the tools and techniques that allow managers to make the optimal decisions for any scenario.
Some examples of the types of problems that the tools provided by managerial economics can answer are: The price and quantity of a good or service that a business should produce. Whether to invest in training current staff or to look into the market. When to purchase or retire fleet equipment. Decisions regarding understanding the competition between two firms based on the motive of profit maximization. The impacts of consumer and competitor incentives on business decisions
Managerial economics is sometimes referred to as business economics and is a branch of economics that applies microeconomic analysis to decision methods of businesses or other management units to assist managers to make a wide array of multifaceted decisions. The calculation and quantitative analysis draws heavily from techniques such as regression analysis, correlation and calculus.NA (2009). "managerial economics," Encyclopædia Britannica. Cached online entry.
Economic theories relevant to managerial economics
Microeconomics is the dominant focus behind managerial economics, some of the key aspects include:
Supply and Demand
The law of supply and demand describes the relationship between producers and consumers of a product. The law suggests that price set by the producer and quantity demanded by a consumer are inversely proportional, meaning an increase in the price set is met by a reduction in demand by the consumer. The law further describes that sellers will produce a larger quantity of the good if it sells at a higher price.
Excess demand exists when the quantity of a good demanded is greater than the quantity supplied. Where there is excess demand, sellers can benefit by increasing the price. The inverse applies to excess supply.
Production theory
Production theory describes the quantity of a good a business chooses to produce. This decision is informed by a variety of factors, including raw material inputs, labor, and capital costs like machinery. The production theory states that a business will strive to employ the cheapest combination of inputs to produce the quantity demanded. The production function can be described in its simplest form by the function where denotes the firm's production, is the variable inputs and is the fixed inputs.
Opportunity cost
The opportunity cost of a choice is the foregone benefit of the second best choice. Determining the opportunity cost requires detailing the costs and benefits of each action the business is considering to pursue, and the cost of choosing one activity over another. The decision-maker is then in the position to choose the action with the highest payoff.
Theory of Exchange or Price Theory
The principle uses the conjecture of supply and demand to set an accurate price for a good. The aim of price theory is to allocate a price for a good such that the supply of a good is met with equal demand for the product. If a manager sets the price of a good too high, the consumer may think it is not worth the cost and decide not to purchase the good, hence creating excess supply. The opposite occurs when the price is set too low, causing demand for a good to be greater than supply.
Theory of Capital and Investment Decisions
Capital investment decisions are a critical factor in an enterprise. They involve determining the rational allocation of funds that will enable an organization to invest in profitable projects or enterprises to improve the efficiency of organizations. The rational allocation of funds may include acquiring business, investing in equipment, or determining whether an investment will improve the business at all.
Elasticity of demand
The elasticity of demand is a prominent concept in managerial economics. Established by Alfred Marshall, elasticity of demand describes how sensitive a change in the quantity demanded is to a unit change in price. In his own words, Marshall describes the concept as: "The elasticity of demand in a market is great or small according to whether the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price."
Microeconomic principles are useful in informing managers' decision-making. Managerial economics draws upon all of these analytical tools to make informed business decisions.
Analytical methods used in managerial economics
Price Elasticity of Demand Analysis
The price elasticity of demand is a highly useful tool in managerial economics as it provides managers with the predicted change in demand associated with an increase in the price charged for its goods and services. The price elasticity principle also outlines the changes in demand for goods with changes in the income of a populous.
Where is the change in quantity demand for the respective change in price , with and representing the quantity and price of the good before a change was made. The price elasticity is important for managerial economics as it aids in the optimization of marginal revenue of firms.
Marginal analysis
In economics, marginal refers to the change in revenue and cost by producing one extra unit of output. Both the marginal cost and marginal revenue are extremely important in economics as a firm's profit is maximized when the marginal cost is equal to the marginal revenue. Managers can make business decisions on the output level based on this analysis in order to maximize the profit of the firm.
Marginal Analysis is considered one of the chief tools in managerial economics, as it involves a comparison between marginal benefits and marginal costs to arrive at optimal variable decisions. Managerial economics uses explanatory variables such as output, price, product quality, advertising, and research and development to maximise net benefits.
Mathematical model analysis
The use of econometric analysis has grown with the development of economics and management, as has the use of differential calculus to determine profit maximisation.
By taking the derivative of a function, the maximum and minimum values of the function are easily determined by setting the derivative equal to zero. This can be applied to a production function to find the quantity of production that maximizes the profit of the firm. This concept is important for managers to understand in order to minimize costs or maximize profits.
The main applications of mathematical models are:
Demand forecasting. Before determining the scale of production of a certain product, enterprises need to forecast the development potential of the market. Relevant mathematical models can be created to represent the quantitative changes in the various factors affecting the development of the market, and then analyse the magnitude of the impact of these changes on demand. Production analysis. The input of production factors, the choice of the form of production organisation and the determination of the product structure can all be analysed and decided by creating mathematical models. Cost decision. Cost is a factor that directly affects profit, and is one of the most important concerns for enterprise development. An enterprise's cost level can be determined by applying mathematical models. When an enterprise changes the direction of production and operation, or expands its scale these methods can help determine the optimal level under the goal of maximising profit. Market analysis. The market is a fundamental concept in economics and in practice manifests itself in many different forms. Mathematical models can be created to analyse the size, price and competitive strategies that a company may choose under various market conditions. Risk analysis. Risk analysis is the prediction of future states. Mathematical models can be created to represent the magnitude of the various factors involved in an investment and the impact that changes in magnitude may have on the benefits.
Decision making in managerial economics