MCom I Semester Nature Scope Managerial Economics Study Material Notes
Table of Contents
MCom I Semester Nature Scope Managerial Economics Study Material Notes: Meaning and Definition of managerial Economics Scope of managerial Economics Characteristics of managerial Economics Nature of Managerial Economics Distinction Between Economic Theory and Managerial Theory Meaning of Managerial Economist Role or Functions of managerial economist in a Business Firm Functions of managerial Economist Responsibilities of managerial Economist :
MCom I Semester Accounts Holding Companies Study Material Notes
Nature, and Scope of Managerial Economics
MEANING AND DEFINITION OF MANAGERIAL ECONOMICS
The basic function of management of business and industrial enterprise is to achieve the objectives of the organization. To fulfill this responsibility, the management has to take many decisions on a variety of business issues. Decision-making is the process to select a particular course of action from among a number of alternatives. Clear understanding of the technical and environmental conditions under which decisions are to be taken is necessary to take appropriate business decisions. Therefore, the decision-maker should have good knowledge of those aspects of economic theory and its tools of analysis which are involved in the process of decision-making.
Managerial Economics is concerned with those aspects of Economics and its tools of analysis which are used in the process of decision-making of business enterprise. The tern ‘Managerial Economics’ has been defined as under:
Haynes Mote and Paul, “Managerial Econmics is the economics applied in decision-making. It is a special branch of economics bridging the gap between abstract theory and managerial practice.”
Spencer and Siegelman, “Business Economics (Managerial Economics) is the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management.”
Mc. Nair and Meriam, “Business Economics consists of the use of economic modes of thought to analyse business situations.”
Joel Dean, “Use of economic analysis in formulating policies is known as Managerial Economics.”
Edwin Mansfield, “Managerial Economics is concerned with application of economic concepts and economic analysis to the problems of formulating rational managerial decisions.”
On the basis of above definitions, it can be concluded that Managerial Economics is not a new discipline or a new branch of economics. It is simply the process of application of the principles, techniques and concepts of economics to solve the managerial problems of a business and industrial enterprise. Managerial Economics is also known as-Business Economics. Economics of Enterprise, Applied Economics, Managerial Analysis etc.
Nature Scope Managerial Economics
CHARACTERISTICS OF MANAGERIAL ECONOMICS
On the basis of study of meaning and definition of Managerial Economics, Characteristics of Managerial Economics may be summarised as follows:
(1) Managerial Economics is Micro Economics. Managerial Economics is Micro Economics in character becuase it is concerned with smaller units of the economy. It studies the problems and principles of an individual business firm or an individual industry. It assists the management in forecasting and evaluating the trends of market.
(2) Managerial Economics is Normative Economics. Managerial Economics belongs to Normative Economics. Managerial Economics is concerned with what management should do under particular circumstances. It determines the goals of the enterprise and then develops the ways to achieve these goals. It deals with future planning, policy-making, decision-making and making full utilisation of the available resources of the enterprise.
(3) Managerial Economics is Pragmatic. Managerial Economics is pragmatic. It avoids difficult issues of economic theory. It tries to solve the managerial problems in their day-to-day functioning.
(4) Managerial Economics uses Theory of Firm. Managerial Economics Uses that economic concepts and principles which are known as the theory of Firm or Economics of the Firm. Thus, the scope of Managerial Economics is narrower than that of Pure Economic Theory.
(5) Managerial Economics Takes the Help of Macro Economics Also. Though Managerial Economics is Micro Economics in character and deals with the study of problems of an individual firm or industry but it takes the help of Macro Economics also because it needs an understanding of the circumstances and environment in which an individual firm or an industry has to work. Knowledge of many issues of Macro Economics is necessary for the successful management of a firm or an industry. These issues are—Business Cycles, Taxation Policies, Industrial Policy of the Government, Price and Distribution Policies, Wage Policies and Anti-monopoly Policies etc.
(6) Main Aim of Managerial Economics is to Help the Management. Main aim of Managerial Economics is to help the management in taking correct decisions and preparing plans and policies for future.
Nature Scope Managerial Economics
SCOPE OF MANAGERIAL ECONOMICS
Managerial Economics is the process of application of economic principles, techniques and concepts etc., to solve managerial problems of a business enterprise or an industry. Managerial Economics helps the management in efficient and economical use of scarce resources of the firm or industry. The scope of managerial economics is narrower than that of pure economic theory because economic theory includes both the micro economics and macro economics but the managerial economics includes micro economics only. Though no uniform pattern has been followed in respect of the scope of managerial economics, however, it can be said that the Scope of Managerial Economics, includes following subjects
(1) Theory of Demand. According to Spencer and Siegelman, “A business firm is an economic organisation which transforms productivity sources into goods that are to be sold in a market.” Thus, demand forecasting is an important part of managerial decision-making because an estimate of future sales is essential before preparing production schedule and employing productive resources. Demand analysis helps management is identifying various factors that influence the demand for the products of a firm. Therefore, demand analysis and forecasting is essential for business planning.
Demand Theory is the study of behaviour of consumers. It answers various questions regarding behaviour of consumers like. Why do the consumer buy a particular commodity ? In how much quantity do they purchase a commodity ? What is the effect of the income, habit and taste of consumers on the demand of a commodity ? What are other factors influencing the demand of a commodity ? Why and when do the consumers stop to consume a commodity ? etc.
(2) Theory of Production. Production and cost analysis is also important for the smooth functioning of production process and for project planning. To earn a certain level of profit, certain amount of goods has to be produced and to obtain such production, some coasts have to be incurred. The problem before management in this regard is to determine the level of production at which average cost of production may be minimum.
Production Theory explains how average and marginal costs change with the change in production. Under what conditions do the costs increase or decrease? How does total production increase when input of one of the factors of production is increased keeping other factors constant ? How can one factor of production substitute another when all the factors are increased simultaniously? How can optimum size of production be obtained ? Thus, Production Theory helps in determining the size of firm and the level of production.
(3) Theory of Exchange Or Price Theory. Pricing is an important area of managerial economics. The fact is that the success of a business and industrial firm largely depends upon the accuracy and correctness of price decisions taken by it. Price Policy affects the demand of products to a great extent. It includes the determination of prices under different market conditions, pricing methods, pricing policies, differential pricing, product line pricing and price forecasting.
Theory of Exchange (Popularly known as Price Theory) explain how the prices are determined under different types of market conditions ? How price discrimination is made ? How and to what extent advertisement can be helpful in increasing sales of a firm in a market. Thus, Price Theory can be helpful in determining price policy of the firm, and the theories of price and production together.
(4) Theory of Profit. Main object of every business and industrial enterprise is to earn maximum profit. Profit is the difference between total revenue and total cost. An important point of consideration in this regard is the element of uncertainty about profit. Profit is always uncertain because of the following factors– (i) Demand of the product; (ii) Prices of the factors of production; (iii) Nature and degree of competition in the market; (iv) Price behaviour under changing conditions. Therefore, Profit Planning and Profit Management are necessary for improving profit earning efficiency of the firm. Profit management necessiates that most efficient technique should be used for predicting future. The possibility of risks should be minimised as far as possible.
(5) Theory of Capital and Investment. Another important area of managerial economics is the management of capital and invesment. Capital is the foundation of a business. Like other factors of production, capital is also a scarce and expensive factor of production. It should be allocated in most efficient manner. Theory of capital and invesment explains the following important issues—(i) Selection of most suitable invesment project; (ii) Most efficient allocation of capital; (iii) Assessing the efficiency of capital; (iv) Minimising the possibility of Under-capitalisation or Over-capitalisation.
(6) Environmental Issues. There are certain issues of macro economics also that form a part of managerial economics. These issues relate to general business, social and political environment in which a business and industrial firm has to operate. Some of the important factors are-(i) The type of economic system of the country; (ii) Business cycles; (iii) Industrial policy of the country; (iv) Trade and fiscal policy of the country; (v) Taxation policy of the country; (vi) Price and labour policy; (vii) General trends in economy with regards to the production, employment, income, prices, saving and invesment etc.; (viii) General trends in the work of financial institutions in the country; (ix) Social factors like value system of the society; (x) General trends in foreign trade of the country; (xi) General attitude and significance of social organisations like trade unions, producers’ unions and consumers’ co-operative societies etc.; (xii) Social structure and class character of various social groups
Nature and Scope of Managerial Economics siii) Political system of the country. The management of a firm cannot have any control over these factors. Therefore, the need is to adjust the plans, policies and programmes of the firm according to these factors so that their adverse effect on the firm may be offset
Nature Scope Managerial Economics
NATURE OF MANAGERIAL ECONOMICS
The Nature of Managerial Economics may be explained in the following
paragraphs :
(1) Managerial Economics is a Science. Science is that branch of systematic knowledge which establishes relationship between causes and effects of an event. It studies why and how a particular things happens ? What are the effects of an event? What will happen in a particular case or a particular condition ? From this point of view, we can say that managerial economics is also a science because it establishes relationship between causes and effects. It studies the effects of a change in price of a commodity factors and forces on the demand of a particular product. It also studies the effects and implications of the plans, policies and programmes of a firm on its sales and profit.
(2) Managerial Economics is an Art. Art is that branch of systematic knowledge which develops the best way of doing things. It also develops the ways for attainment of a particular object. From this point of view, managerial economics may also be called an art. Because it also develops the best way of doing things. It helps management in the best and most efficient utilisation of limited economic resources of the firm. It helps in selecting the best alternative from among different alternatives. It helps management in the achievement of organisational objectives.
(3) Managerial Economics is a Micro Economics. Entire study of Economics may be divided into two segments- Macro Economics and Micro Economics. Macro economics is concerned with the whole economy. It studies the trends, conditions and problems of the whole economy. Micro Economics is concerned with smaller parts of the economy. It studies the trends, conditions and problems of a particular business firm. From this point of view, it can be said that managerial economics is micro economics in character because it is concerned with the problems of an individual business or industrial firm.
(4) Managerial Economics is a Normative Science. There are two types of science-Normative Science and Positive Science. Positive science studies what is being done. Normative science studies what should be done. From this point of view, it can be concluded that managerial economics is normative science because it suggests what should be done under particular circumstances. It determines the goals of the enterprise and then develops the ways to achieve these goals.
(5) Managerial Economics is Pragmatic. There are two theories of the study of Micro Economics-Pure Micro Economic Theory and Pragmatic Theory. Pure Micro economic theory analysis are carried on the basis of certain exceptions. Pragmatic theory of micro economics avoids difficult issues of economic theory. It tries to solve the managerial problems in their day-to-day functioning. From this point of view, it can be said that managerial economics is pragmatic.
Nature Scope Managerial Economics
IMPORTANCE OF MANAGERIAL ECONOMICS Or, SIGNIFICANCE OF ECONOMIC ANALYSIS IN BUSINESS DECISIONS
Main aim of all the business and industrial enterprises is to earn maximum profit. To achieve this object, managerial executives have to take many decisions. Decision-making is the process of selecting a particular course of action from among the number of alternatives. A sound decision can be taken only when the decision-maker has fairly good knowledge of the aspects of economic theory and the tools of economic analysis which are directly involved in the process of decision-making. Managerial Economics is concerned with such aspects and tools. Thus, Managerial Economics plays an important role in the decision-making process of a firm.
In its decision-making process, the management of a firm is to identify the factors which influence the firm. These factors can broadly be divided into two categories-External Factors and Internal Factors. External factors are the factors over which a firm cannot have any control. These factors relate to the social, economic and political environment in which the firm is to operate. Internal factors are the factors that are within the control of a firm. These factors relate to business operation. Through knowledge of these factors helps the management in making sound business decisions. Spencer and Siegelman have described the Importance of Managerial Economics in a business and industrial enterprise as follows:
(1) Reconciling Traditional Theoretical Concepts to the Actual Business Behaviour and Conditions. Managerial Economics attempts to reconcile the tools, techniques, models and theories of traditional economics with actual business practices and with the environment in which a firm has to operate. Edwin Mansfield said in this regard, “managerial Economics attempts to bridge the gap between purely analytical problems that intrigue many economic theories and the problems of policies that management must face.”
(2) Estimating Economic Relationships. Managerial Economics plays an important role in business planning and decision-making by estimating economic relationships between different business factors such as-income, elasticity of demand and cost volume profit analysis etc.
(3) Predicting Relevant Economic Quantities. Sound business plans and policies for future can be formulated on the basis of economic quantities. Managerial Economics helps the management in predicting various economic quantities such as-cost, profit, demand, capital, production, price etc. Since a business manager has to work in an environment of uncertainity, future should be well predicted in the light of these quantities.
(4) Understanding Significant External Forces. The managament has to identify all the important factors that influencee firm. These factors can broadly be divided into two parts-Intemal Factors and External Factors. External Factors are the factors over which a firm cannot have any control. Therefore, the plans, policies and programmes of the firm should be adjusted in the light of these factors. Important external factors affecting decision-making process of a firm are-Economic system of the country, business cycles, fluctuations in national income and national production, industrial policy of the Government, trade and fiscal policy of the Government, taxation policy, licensing policy, trends in foreign trade of the country, general industrial relation in the country etc. Managerial Economics plays an important role by assisting management in understanding these factors.
(5) Basis of Business Policies. Managerial Economics is the foundation of all business policies. All the business policies are prepared on the basis of studies and findings of Managerial Economics. It warns the management against all the turning points in national as well as international economy.
Thus, it may be concluded that Managerial Economics is very helpful in taking sound decisions in a firm. It provides the base that can be used by management in its decision-making process.
DISTINCTION BETWEEN ECONOMIC THEORY AND MANAGERIAL THEORY
Both the managerial theory and economic theory are closely related with each other. Some persons are of the view that managerial theory and economic theory are the same but this view is not true. There are major differences between economic theory and managerial theory. This difference can be explained as under:
1 Economic theory is a system of inter-relationships while managerial theory is an application of inter-relationships.
2. Economic theory deals with the study of concepts, principles and laws of Economic Analysis whereas Managerial Theory deals with the application of these economic principles and laws to the problems of an individual firm.
3. Economic theory deals with the body of principles. But managerial theory deals with the application of certain principles to solve the problem of a firm.
4. Economic theory has the characteristics of both micro and macro economics. But managerial theory is essentially micro in character.
5. Managerial theory studies only about individual firm while economic theory deals with a study of individual consumer as well as individual firm.
6. Managerial theory studies the problems of a firm from all the practical points of view. It deals with practical aspects but economic theory deals with practical aspects but economic theory deals with theoritical aspects only.
7. Economic theory is both positive and normative in character but managerial theory is essentially normative in nature.
8. Economic theory is based on certain assumptions. But in managerial theory these assumptions disappear due to practical situations.
9. Managerial theory deals with a study of only profit theories whereas economic theory deals with a study of distribution theories of rent, interest, wage and profit.
10. Managerial theory studies economic and non-economic aspects whereas economic theory studies only economic aspects of the problem.
Nature Scope Managerial Economics
RELATIONSHIP OF MANAGERIAL ECONOMICS WITH OTHER BRANCHES OF LEARNING
Growth and development of Managerial Economics has been possible over a long period of time and with the co-operation of many other branches of knowledge. Macro Economics, Statistics, Mathematics, Accounts etc., have contributed a lot in the growth integrates the concepts, methods and techniques of all of these disciplines to solve managerial problems. D. C. Hague has stated in this regard, “Managerial Economics uses the logic to Economics, Mathematics and Statistics to provide effective ways of thinking about
Nature and Scope of Managerial Economics business decision problems.” Relationship of Managerial Economics with other branches of learning can be explained as under:
(1) Managerial Economics and Macro Economics. Managerial Economics and Macro Economics are closely related. The reality is that Managerial Economics is a branch of Macro Economics. The principles of Macro Economics provide a base for the solution of managerial problems of a firm. Managerial Economics is also known as the use of methods and techniques of economics in the field of management. It is a special branch of economics which bridges the gap between economic theory and managerial practice. For example the law of demand, the law of supply, the laws of returns, concept of marginal and average cost, the concept of marginal and average revenue, hypothecation of different stages of competition, effects of such hypothecation, business and taxation policies of the Government, policy of foreign trade etc., are the policies and laws of macro economics that provide an important base for the solution of managerial problems of a firm. Thus, it may be concluded that Managerial Economics is closely related with Macro Economics.
Haynes & William Warren stated in this respect, “The relation of managerial economics to economic theory (of either the micro or macro varieties) is much like that of engineering to physics, or of medicine to biology of bacteriology. It is the relation of an applied field to the more fundamental but more abstract basic discipline from which it borrows concepts and analytical tools. The fundamental theoretical fields will no doubt in the long run make the greater contribution to the extension of human knowledge. But the applied fields involve the development of skills that are worthy of respect in themselves and that require specialised training. The practising physician may not contribute much to producing the fruits of progress in theory. The managerial economist stands in a similar relation to theory, with perhaps the difference that the dichotomy between the ‘pure’ and the applied’ is less clear in management than it is in medicine.”
(2) Managerial Economics and Statistics. Managerial Economics is closely related with Statistics in a number of ways. The relationship of Managerial Economics with Staistics can be summarised as follows(i) Statistics provides the basis for empirical testing of theory. The results of a theory cannot be accepted in a firm unless and until they are verified. (ii) Statistics provides the measures of appropriate functional relationship involved in decision-making. (iii) A Managerial Economist has to deal with the uncertainty of future events. Theory of probability, upon which many of the statistical studies are made, is important in providing logic for dealing with such uncertainty. (iv) Technique of linear programming is also important for a managerial Economist because it helps him in finding the best solution of a problem or the best alternative.
(3) Managerial Economics and Mathematics. Mathematics is another very important subject closely related with Managerial Economics. A knowledge of Geometry, Trigonometry and Algebra is essential for estimating various economic relationships, predicting required economic quantities and decision-making. In addition to this, certain mathematical tools and concepts are also useful in Managerial Economics.
(4) Managerial Economics and Operation Research. Operation Research is also very useful in Managerial Economics. Operation Research is concerned with model building, minimisation, maximisation and optimisation. Construction of theoritical models is helpful in decision-making and maximisation of profits or minimisation of costs. Operation research is helpful in business firm in studying the inter-relationship and relative efficiencies of the various aspects of business such as-sales, production and financing. Operation research may encompass the complete cycle of the flow of goods and services from suppliers to company and from company to consumers. Primary purpose of operation research as applied to a business firm is to find the optimum combination of various factors to achive the objects of maximisation of profit, minimisation of cost, saving of time or any other object. Haynes & William Warren have stated in this regard, “It is not important to determine where managerial economics begins and operations research ends. But it is important to recognise the closer relation of the two subjects and the contribution that each makes to the other. The student who intends to do more advanced work in managerial economics should obtain a thorough training in mathematics and statistics, for the models which are likely to be important for future.”
(5) Managerial Economics and Accounting. Managerial Economics is related with Accounting also. Accounting is concerned with recording and analysing the financial activities of a business firm. Accounting information provides the data required by a managerial economist for the purpose of decision-making. For example, Funds Flow Statement provides the information how the funds have been generated by a firm during a certain period and how these funds have been applied in the firm. Profit and Loss Account of a firm indicates the expenses and incomes of the firm during a particular period. D.C. Hague has explained the relationship between managerial economics and accounting in the words, “The main task of management accounting is now seen as being to provide the sort of data which managers need if they are to apply the idea of managerial economics to solve business problems correctly; the accounting data are also to be provided in a form so as to fit easily into the concepts and analysis of managerial economics.”
Thus, it may be concluded that Managerial Economics is closely related with certain subjects such as-Economics, Statistics, Methematics, Operation Research and Accounting. A Managerial Economist cannot achieve any success without co-operation of all these subjects.
Nature Scope Managerial Economics
MEANING OF MANAGERIAL ECONOMIST
One of the most important object of management in its decision-making process is to identify the key factors which influence the business firm over a period of time. The person responsible for assisting top managment in this task is called Managerial Economist. Managerial Economist helps the management in arriving at sound business decisions. He is known as a Managerial Economist, a Business Economist and an Economic Advisor also. He helps the top management in analysing all the internal and external factors related with business firm so that sound business decision may be taken. Importance of Managerial Economists is increasing day by day in business and industrial firms due to their ability and efficiency in arriving at sound business decisions and in solving the complicated managerial problems.
Nature Scope Managerial Economics
ROLE OR FUNCTIONS OF MANAGERIAL ECONOMIST IN A BUSINESS FIRM
Decision-making is one of the most important functions of management of a business and industrial firm. A Managerial Economist can play key role in the process of the firm by assisting management in using the specialised and complicated techniques and methods which are required to make the process of decision-making and planning easy. That is why, in developed countries, all the large business and industrial enterprises employ one or more Managerial Economist is being growingly recognised and all the big business and industrial houses are employing Managerial Economist. Managerial Economist studies and analyses all the internal and external factors that may influence the activities of a firm so that the uncertainties may be predicated and business risks may be minimsed. These factors may be divided into two parts as follows:
(II) Internal Factors. Internal factors affecting managerial decisions are the factors over which the management has control. These factors lie within the scope and operation of a firm, such as-determination of price policy. decision of contraction or expansion of business activities, determination of the level of efficiency and operation, determination of wage policy etc. Managerial Economist can assist management in decision-making by playing an important role with regards to all these factors. He can advise management on following questions related with internal factors:
1 What shold be the sales budget for the next year?
2. What should be the policy regarding inventory for next year?
3. What should be the production shedule for next year?
4. What changes should be introduced in pricing policy of the enterprise during the next year?
5. What should be the wage policy for next year?
6. What types of changes are required in the credit policy of the enterprise ?
7. What should be the policy regarding cash for next year?
8. What should be the profit budget for next year?
Though all the decisions discussed above are taken independently by the managers of every enterprise but the atmosphere of business uncertainties creates complications in the process of decision-making. Various economic principles help in minimising these uncertainties. Managerial Economist can help by analysing these economic principles.
[II] External Factors. External factors are the factors over which the management has no control. These factors relate to business environment, in which a firm has to operate such as- Business policy of the Government, situation of money inflation or money deflation, labour laws. Government controls, competition, economic policy of the Government, cyclical fluctuations in the industries etc. These factors are of great importance for a firm. Managerial Economist has to keep himself in constant touch with these factors so that he may assist top management in the process of decision-making. He can advise top management of the following problems related with external factors :
1 What changes have taken place in economic policies of Government and what more changes are expected in near future in this field ?
2. What types of cyclical fluctuations are expected in national economy in future ?
3. What are the expectations of demand of goods being produced by the enterprise ?
4. What policies are expected to be adopted by competitors during coming period ?
5. What changes are expected to take place in the prices of raw materials in the coming period?
6. What changes are expected in the wage policy of Government in coming year?
7. What changes are expected to take place in the cost of production.
8. What is the outlook of national economy for coming year? What are the important economic trends of national economy that may affected the activities of the firm ?
9. What is the outlook of taxation policy, foreign trade policy, industrial policy of the Government?
10. What is the outlook of market and customer outlooks during coming period ?
11. What are the main components of the five year plan?
Though the management of an enterprise cannot have any control over any of the factors discussed above, yet an assessment and analysis of these factors will help the management in defining the scope, direction and limitations of business activities. A Managerial Economist can guide the management about general outlook of the economy and its impact on the activities of the firm.
Nature Scope Managerial Economics
FUNCTIONS OF MANAGERIAL ECONOMIST
K.J. W. Alexander and G. Kemp Alexander have explained the functions of a Managerial Economist as follows:
1 Sales forecasting,
2. Individual market research,
3. Economic analysis of competing companies,
4. Pricing policy of industry,
5. Capital projects,
6. Production programmers,
7. Security/investment analysis and forecasts,
8. Advice on trade and public relations,
9. Advice on primary commodities,
10. Advice on foreign exchange,
11. Economic analysis of agriculture,
12. Analysis of undeveloped economics,
13. Environmental forecasting,
A study of functions of Managerial Economist makes it clear that he is responsible to perform many functions. He can play an important role in successful decision-making and forward planning. He must ensure that he is undertaking his responsibilities and obligations properly.
Nature Scope Managerial Economics
RESPONSIBILITIES OF MANAGERIAL ECONOMIST
Managerial Economist has a great responsibility in a big business and industrial enterprise. He can serve the managment of his firm in the best possible manner only if he keeps in mind the main objects of his firm and his responsibilities to achieve these objects. Responsiblities of Managerial Economist can be explained under following heads :
(1) To Search the Measures for the Increase in the Earning Capacity of Firm. Every business firm has a object of earning maximum profit. A Managerial Economist has a great responsibility in his regard. He has to play an important role in the achievement of this object. If he does not undertake his responsibility properly, capacity of the firm cannot be utilised fully and the firm cannot achieve its objects. Therefore, the Managerial Economist should continue his efforts in increasing the earning capacity of his firm.
(2) To Make Successful Forecasting. Success of every business firm is largely determined by the degree of accuracy and correctness of the forecasts made by it. A Managerial Economist is responsbile of making successful forecasts by analysing all the internal and external factors and by predicting their impact on profitability and working of the firm. He must make his best efforts to minimise the uncertainties of future. If he finds an error in his forecasts, he should alert the management at the earliest so that necessary changes may be made in plans, policies and programmes.
(3) To Establish Contact with the Sources of Economic Information and Experts. A Managerial Economist is responsible for providing all the relevant economic information to the management so that the plans and programmes of the firm may be chalked out after taking into consideration these factors. Therefore, the Managerial Economist should establish and maintain contacts with all the possible sources from where he can collect the information relevant for his firm. He should take the help of experts also in analysing such information so that the information may be more accurate and useful. He can join all the academic and professional associations from where he can get the information that are useful for his firm.
(4) To Keep the Management Informed of All the Possible Economic Trends. A Managerial Economist should keep himself in touch with the latest developments of national economy and business environment so that he can get the management familiar with these developments and expected trends of the economy.
(5) To Make his Status Respectable in the Firm. Managerial Economist should earn respectful status in the firm. He can get it only when he performs his duties and responsibilities sincerely and seriously. He should be helpful to the management in successful decision-making. He should be ready and offer him-self to take up special assignment assigned to him by the management. He should work in the manner that top management may realise his need in the firm and respect his ideas. He should explain his findings to the manangement in a simple and easy language.
(6) To Perform Specific Functions. Most important responsiblity of a Managerial Economist is to perform his functions most sincerely. O Q.6. Explain Five Fundamental Concepts of Managerial Economics.
Nature Scope Managerial Economics
BASIC ECONOMIC TOOLS IN MANAGERIAL ECONOMICS OR, FUNDAMENTAL CONCEPTS OF MANAGERIAL ECONOMICS
Future is always uncertain. With this realization, the management Takes numerous decisions and formulates plans for future. Some fundamental concepts and techniques help the management to take correct decisions. These concepts are as follows:
[1] Principle of Incremental Cost. Incremental cost is the differential cost that must be incurred if a business is taken and that need not be incurred if the business is not taken. According to Haynes, Mote and Paul, “It involves estimating the impact of decision on alternatives on costs and revenues, stressing the changes in total cost and total revenue that result from changes in prices, products producers, investments or whatever may be at stake in the decision.” Thus, it may be said that incremental cost is a change in total cost due to a change in the level of the activity.
There are two fundamental concepts involved in this analysis–the concept of incremental cost and the concept of incremental revenue. Incremental cost means the change in total cost and incremental revenue means the change in total revenue resulting from a decision. W. W. Haynes stated that a decision is profitable, if –
Nature Scope Managerial Economics
[II] Principle of Opportunity Cost. Opportunity cost means the cost of foregone opportunities. Opportunity of a product or service means the revenue expected to be earned by that product or service if put to an alternative use. According to Benham, “The opportunity cost of anything is the next best alternative could be produced instead by the same factors or by an equivalent group of factors, costing the same amount of money.” According to W. W Haynes, “Opportunity cost of a decision means and sacrifice of alternatives required by that decision.” W. W. Haynes has clarified the meaning of the concept of opportunity cost with the help of following examples :
1 The opportunity cost of the funds ties up in one’s own business is the interest (or profits corrected for differences in risk) that could be earned on those funds in other ventures.
2. The opportunity cost of the time one puts into his own business is the salary he could earn in other Occupations (with a correction for the relative’s psychic income in the two occupations).
3. The opportunity cost of using a machine to produce one product is the sacrifice of earnings that would be possible from other products.
4. The opportunity cost of using a machine that is useless for any other purpose is nil, since its use requires no sacrifice of other opportunities.
The above examples make it clear that opportunity cost requires the measurement of sacrifices. If there is not sacrifice involved by a decision, there will be no opportunity cost. It is also important to note in this regard that the opportunity cost is not recorded in the books of accounts, but it is an important consideration in business decisions.
[III] Principle of Time Perspective. All the decisions of a business firm should be taken only after considering the short-run and long-run effects of decisions on costs and revenues. Short-run refers to a period of time which is long enough to allow the variable factors of production to be used in different amounts. Long-run refers to a period of time, which is long enough to bring about all the possible changes in all inputs. Proper balance should be maintained between short-run and long-run effects. In the words of W. W. Haynes, “The management should take a long-range view of effects on costs and revenues rather than merely a ‘short sighted’ view. A decision may be made on the basis of short-run considerations, but may, as time passes, have long-run repercussions that make it more or less profitable than at first seemed.” This principle can be explained with the help of an example.
Example. Suppose that a firm is not utilising its production capacity in full. The firm is manufacturing a particular product and selling it at Rs. 100 per unit. The cost of producing the product in Rs. 80 per unit (Rs. 60 per unit on variable cost and Rs. 20 on fixed costs). firm gets an order of supplying 1,000 units at the rate of Rs. 75 per unit. If this order is evaluated with short-run perspective, it seems to be profitable because it will fetch a net revenue of Rs. 15,000. If it is evaluated with long-run perspective, the following questions arise-(i) If such orders are accepted repeatedly at the same price, profitability of the firm will decrease substantially. (ii) If the regular customers of the firm come to know about the practice of firm of accepting orders below full cost, they may demand reduction in regular selling price of the production. (iii) The decision of accepting an offer at a price that does not cover the cost of production in full may adversely affect the image of the firm.
Therefore, it is important to give due consideration to the time factor. A decision should be taken only after considering the short-run and long-run effects on the costs and revenues.
[IV] Principle of Discounting. A fundamental principle of economics which is used by almost all the persons in their daily life is that the worth of a rupee of tomorrow is lesser than that of a rupee of today. This principle is based on a well-known proverb, “A bird in hand is better than two in the bush” It means that a difference should be made between cash received at different times. Money received today could be invested to earn additional money immediately. On the other hand, an amount to be received after certain period of time could not be invested until it is received, therefore, it is less valuable than a rupee received today. Therefore, the time of receipt of amount should be duly taken into consideration in the solution of a particular problem.
Example. Suppose you get an offer to make a choice between a gift of Rs. 1,000 today or Rs. 1,050 next year. Naturally, you will prefer to get Rs. 1,000 today for two reasons– (i) Future is always uncertain. So, there may be uncertainty in getting Rs. 1,050, if the present opportunity is not availed of. (ii) The amount of Rs. 1,000 received today will earn interest for one year and thus, it will be more than Rs. 1,050. Therefore, the principle of discounting is very important, particularly in investment decisions.
[V] Principle of Equi-marginal. This principle is also known as the principle of maximum satisfaction. It is the most popular principle of economics. According to this principle, an input should be allocated in such a manner that the value added by the last unit of input is same in all uses. Thus, this principle provides a base for maximum exploitation of all the productive resources of a firm so that the profitability of the firm may be maximised.
Example. Assume that there are 200 workers working in a firm and the firm is producing four types of product Product A, Product B, Product C and Product D. All the products require the services of labour. The firm has allocated these workers on the production of these products on a certain basis. Firm can increase the production of any of these products, but to do so, the production of any other commodity will have to be reduced. If the firm decides to increase the production of Product A, the production of either Product B or Product Cor Product D will have to be reduced. Labour should be shifted from low marginal value activity to the high marginal value activity so that the total value of all the products may be maximum.
