We all know economics as a subject being equipped with various concepts. Apart from being a subject, concepts in economics also act as a tool that make organizations capable of surviving in a market.
Managerial economics is one such concept of economics. It can be defined as the incorporation of economic theories with business practices. This makes the process of decision making easy for organizations, as they can leverage the concepts of economics to change the dynamics of the market.
Managerial economics is considered as an essential scholastic field. This field of economics exhibits many characteristics that make it crucial for businesses. Managerial economics is in no way different from a science as it fulfills the criteria of being a science.
Managerial economics is used by organizations to solve multiple business problems. It is also reckoned as the scope of managerial economics. Ready to learn? Let’s get started about the scope of managerial economics and understand its use in the business world.
What is Managerial Economics?
Managerial economics is a subject that was first introduced by Joel Dean in 1951. This branch of economics is essentially concerned with the application of various economic concepts in decision-making.
We can also look at managerial economics as economics that is applied to problem-solving at the level of the firm. Managerial economics works as a bridge between economics theories and business practices. It is based on economic analysis for identifying problems, organizing information, and evaluating alternatives.
Resource allocation is a major challenge for any organization. Managerial economics involves an analysis of the allocation of the resources available to a firm, or a unit of management among the activities of that unit. It makes use of economic theories and concepts and assists managers to make rational decisions.
What is the Scope of Managerial Economics?
Managerial economics is a developing subject and its empirical and perspective nature widens its scope. It works as a tool for businesses that is used to understand the functioning of a market and also how to sustain themselves in an ever-changing market.
From analyzing demands and forecasting future demand to capital management, managerial economics provides help with almost everything. It also helps companies in Pricing Decisions, Policies, and Practices, cost and production analysis, and manage their profits.
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1. Demand Analysis and Forecasting
A firm relies on converting inputs into outputs and generates revenue from them. A clear and accurate estimation of demand ensures a continuous efficiency of the firm. Several external factors like price, income, affect the demand that need to be analyzed.
Upon analyzing these factors affecting the demand for a product, managers can decide on the production. After estimating the current demands, managers move ahead to predict future demands for the product. This is referred to as demand forecasting.
The ability to forecast demands allows the management to capitalize on the opportunities available and strengthen the market position of the firm. During the process of demand analysis, the management also gets to know about the external factors affecting it and hence work on them to nullify any negative effect.
2. Cost and Production Analysis
Cost Analysis is yet another function of Managerial economics. A company makes a profit in two ways: by increasing the demand or by reducing the cost. The determinants of assessing costs, the connection between cost and yield, the gauge of cost and benefit are indispensable to a firm.
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Cost analysis is an important exercise for any company. A component of cost vulnerability always exists since all the elements deciding expenses are not generally known or controllable.
By taking the help of managerial economics, the management of a company identifies the factors causing a variation in costs. The company then uses the cost estimates in their decision making like pricing a product.
Production analysis is more of a physical exercise. It involves examining the factors of production, also known as inputs, and obtaining the best combination so as to get the least cost combination.
In case of price rise in the inputs, the management looks beyond and tries out the alternatives. The analysis helps them get instant ideas in such uncertain situations.
The topics covered during cost and production analysis are production function, least-cost combination of factor inputs, factor productiveness, returns to scale, cost concepts and classification, cost-output relationship, and linear programming.
3. Pricing Decisions, Policies, and Practices
Among the 4Ps of marketing, Price finds an important place. For any firm, Pricing is a very important aspect of Managerial Economics as a firm's revenue earnings largely depend on its pricing policy. However, it is a bit challenging as other players are competing in the same price segment.
When pricing a product is done, the costs of production are also taken into account. Managerial economics helps the management to go through all the analyses and then price a product. In an oligopoly market condition, the knowledge of pricing a product is essential.
Scope of Managerial Economics
4. Capital Management
Every asset a business owns is known as its capital. Capital management thus becomes an important practice.
Planning and control of capital expenditures is a basic executive function. It involves the Equi-marginal principle. The prime objective is to ensure the sustainable use of capital. This means that funds should be kept at a bay when the managerial returns are less than in other uses.
The main topics dealt with during capital management are Cost of Capital, Rate of Return, and Selection of Projects.
5. Profit Management
A business firm is an organization designed with an intention to make profits and profits reflect the success of a company. After all the analyses, it all rolls down to profits.
To maximize profits a firm needs to manage certain things like pricing, cost aspects, resource allocation, and long-run decisions. This would mean that the firm should work from the very beginning, evaluate its investment decisions and frame the best capital budgeting policies. Profit management is considered as a difficult area of managerial economics.
The important aspects covered under this area are: nature and measurement of profit, profit policies, and techniques of profit planning like break-even analysis, cost-volume-profit analysis, etc.
Tools Used in Managerial Economics
Managerial economics makes use of different economic tools. The concepts of micro vs macroeconomics are applied for effective decision-making. Let’s explore the uses of some economic tools in managerial economics:
Economic Tools used in Managerial Economics
1. Opportunity Cost Principle
The Opportunity Cost Principle is concerned with the cost of the next best alternative of the good we are buying or opting for. The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else.
This principle has significant use in the process of decision making. Comparing the opportunity cost of one decision with another one gives an idea about the ideal decision.
2. Incremental Principle
Managerial economists make use of the incremental principle in the theories of consumption, product pricing, and distribution.
The principle states that the firm can maximize its profit if it is able to equate its marginal cost with the marginal revenue it generates. This helps managers decide on the expansion of their business, as it guides them to keep expanding until they reach the desired point: when marginal costs stand equal to the marginal revenue.
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3. Principle of Time Perspective
The principle of time perspective states that a decision should take into account both the short and long-run effects on revenue and costs. It should maintain the right balance between the short-run and the long-run perspectives.
This principle helps managers in decision-making in output, prices, advertising, and expansion of the business.
4. Discounting Principle
The discounting principle states that if a decision taken today affects the cost and revenues of the future, those costs and revenues must be discounted today to avoid any comparisons with alternatives.
This economic tool is used by managers in deciding on the prices of the product and also in investment decisions.
5. Equi-Marginal Principle
The Equi marginal principle states that consumers will choose a combination of goods to maximize their total utility. The principle works on the basic idea of human nature. We tend to compare the utility of two products and opt for those which are efficient.
In a similar fashion, managers in a firm would want to utilize all their resources to the same extent.
Examples of Managerial Economics
Different tools of managerial economics can be used to achieve all the goals of a business organization in an efficient manner. The examples of managerial economics applications are:
Managerial economics finds its use in deciding the price of a product.
It also helps firms to decide on the manufacturing of a product or to purchase it from another manufacturer.
To decide on the production technique to be used in the manufacturing of a product
It also helps in inventory management. A firm can decide on the level of inventory it will maintain of a product or a raw material.
Decide on the advertising media and the intensity of advertising campaigns.
Managerial economics is used by businesses to decide on employment and training.
After all the analyses, the management looks at the opportunities for further investment.