Subject : Managerial economics

Explain how Managerial Economics serves as a link between

traditional economics and decision making science , for business
decision making.
























Submitted To: Submitted By:

Ms. Gulnaz Banu P MFM/14/188 Srishti Raut
Table Of Content





Defining Managerial Economics 4
Relationship with Economic Theory 5
Understanding the dynamics of Decision Making 7
How Managerial Economics plays a crucial role in Decision Making ? 8
The link between Managerial Economics & Decision Making 9
Case Study 10
Bibliography 11
3
Defining Managerial Economics

The terms Managerial Economics and Business Economics are often synonyms and used
interchangeably in managerial studies. In a lay mans language, Managerial Economics is an
Applied Economics in the sphere of business management. It is an application of economic theory
and methodology to decision-making problems faced by the business firms. By nature Managerial
Economics (M.E) is goal oriented in perspective, it aims at maximum achievement of objectives.
Thus, it is the economics of business or managerial decisions or it is the process of application of
principles, concepts and techniques and tools of economics to solve the managerial problems of
business organisations.
Managerial Economics however has been viewed differently by different scholars.Following are
some of the popular definitions known and followed:

Managerial Economics is economics applied in decision-making. It is a special branch of
economics bridging the gap between the economic theory and managerial practice. Its stress is on
the use of the tools of economic analysis in clarifying problems in organising and evaluating
information and in comparing alternative courses of action. -W. W. Haynes
Managerial Economics is the integration of economic theory with business practice for the
purpose of facilitating decision-making and forward planning by management. - Spencer &
Siegelman
The purpose of Managerial Economics is to show how economic analysis can be used in
formulating business policies. -Joel Dean

Management deals with principles which helps in decision making under uncertainty and improves
effectiveness of the organisation. On the other hand economics provide a set of preposition for
optimum allocation of scarce resources to achieve a desired result. By analysing the various
definitions of managerial economics given above, we come to the conclusion that managerial
economics is the study of economic theories, logic, concepts and tools of economic analysis that are
used in the process of business decision-making by the business managers in taking rational, correct
and timely decisions.

From this point of view, managerial economics is both conceptual & metrical. An intelligent
application of quantitative techniques to business presupposed considered judgement & hard &
careful thinking about the nature of the particular problem to be solved. M.E provides necessary
conceptual tools to achieve this. Moreover, it helps the decision maker by providing measurement
of various economic entities & their relationships.This metrical dimension of managerial economics
is complementary to its conceptual framework.

Therefore, Managerial economics lies on the borderline of Economics and Business
Management act as complementarity and bridge between Economics and Management.


4
Relationship with Economic Theory

In general the relationship between Managerial economics and economic theory is very much like
the relation of engineering to physics and of medicine to biology. It is intact the relation of an
applied field to its more fundamental and conceptual counterpart.Economics provides certain basic
concepts and analytical tools which are applied suitable to a business situation. The main branch of
economic theory with which managerial economics is related is microeconomics, which deals
essentially with how markets work and interactions between the various components of the
economy. In particular, the following aspects of microeconomic theory are relevant:
1. Theory of the firm
2. Theory of consumer behaviour (demand)
3. Production and cost theory (supply)
4. Price theory
5. Market structure and competition theory
These theories provide the broad conceptual framework of ideas involved; these theories are
examined and discussed largely in a neoclassical framework. This is essentially an approach that
treats the individual elements within the economy namely - consumers, firms and workers as
rational agents with objectives that can be expressed as quantitative functions which are utilities and
profits that are to be optimised, subject to certain quantitative constraints. This approach is often
criticised as dated and unrealistic, but can be defended on three grounds.
The first is that it is very versatile and can easily be extended to take into account many of the
aspects which it is often assumed to ignore, for example transaction costs, information costs,
imperfect knowledge, risk and uncertainty, multi-period situations and so on.
The second and third grounds of defence are related to scientific method and pedagogy.
There is one main difference between the emphasis of microeconomics and that of managerial
economics:
Microeconomics tends to be descriptive, explaining how markets work and what firms do in
practice, while Managerial economics is often prescriptive, stating what firms should do, in order
to reach certain objectives.
Another very important distinction: that between positive and normative economics. This is
sometimes referred to as the is/ought distinction, but this is actually somewhat misleading.
Essentially positive statements are factual statements whose truth or falsehood can be verified by
empirical study or logic. Normative statements involve a value judgement and cannot be verified
by empirical study or logic. For illustration, compare the following two seemingly similar
statements:
A. The distribution of income in the India is unequal.
B. The distribution of income in the India is inequitable.
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The first statement is a positive one while the second is a normative one. Normative statements
often imply a recommendation, in the above example that income should be redistributed. For
that reason they often involve the words ought or should. However, not all such statements are
normative, they may in fact be prescriptive. For example, the statement Firm X should increase
its price in order to increase profit is a positive statement. This is because the word should is
here being used in a different sense, a conditional one; there is no value judgement implied. In
practice it can sometimes be difficult to distinguish between the two types of statement,
especially if they are combined together in the same sentence.
What is the relevance of the above to the study of managerial economics?
First, we need to understand that Economics and Managerial economics both deal with identical
problems - they both are concerned with the problems of scarcity and resource allocation. Since
labour and capital resources with a firm and business are always limited, it must find the best way
in which to utilise them for achieving the set goals. secondly Economists mainly concentrate on the
study of type of markets, Managerial Economists are more concerned with problems like the
impacts of markets or technological changes on competitive position of the firm and the likely
reactions of their own actions in the market.
But Managerial Economist can get answers of the questions regarding the working of the market
mechanism only when they analyse the problems from a broader perspective of an Economist.
Thus the main contributions of Economics to M.E are :
To help in understanding the market conditions and general economic environment within which
the firm operates.
To provide a philosophy for understanding and analysing resource allocation problems.
We know business efficiency is the result of Technical and Economic efficiency. M.E is concerned
with both kinds of efficiencies. It takes the help of economic analysis for achieving both technical
and economic efficiency in business operations.

6
Understanding the dynamics of Decision Making

Decision making is not something which is related to managers only or which is related to corporate
world, but it is something which is related to everybodys life. One needs to make decision
irrespective of the work you are doing. Decision making is the most important function of business
managers. Decision making is the central objective of Managerial Economics. Decision making
may be defined as the process of selecting the suitable action from among several alternative
courses of action. The problem of decision making arises whenever a number of alternatives are
available. Such as:
What should be the price of the product?
What should be the size of the plant to be installed?
How many workers should be employed?

Therefore we can say that the problem of decision making arises due to the scarcity of resources.
We have unlimited wants and the means to satisfy those wants are limited, with the satisfaction of
one want, another arises, and here arises the problem of decision making. While performing his
function manager has to take a lot of decisions in conformity with the goal of the firm. Most of the
decisions are taken under the condition of uncertainty, and involves risks. The main reasons behind
uncertainty and risks are uncertain behaviour of the market forces which are as follows:
The demand and supply
Changing business environment
Government policies
External influence on the domestic market
Social and political changes
The maximum use of limited resources.

Where do the principles of Economics fit in the arena of Managerial Decision making ?

Renowned economist Herbert Simon identifies the primary activities in decision making :

1. Finding occasions for making decisions
2. Identifying possible course of action
3. Evaluating the revenues and costs associated with each course of action
4. Choosing that one course that best meets the goal or objective of the firm.

Much of economic theory is based on the assumption of a single goal - Maximisation of profit for
the firm or utility for the consumer. It also usually rests on the assumption of certainty , in contrast ,
decision making recognises the multiplicity of goals and pervasiveness of uncertainty in the real
world of management.

As both Economic theory and Decision making are contradictory to each other in nature, it becomes
essential for Managerial Economics to take the theories of Economics and optimise them to suit
managerial decision making.The primary role of M.E is evaluating the implications of alternative
courses of Action and choosing the best or optimal course of action from amongst those several
alternatives.
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How Managerial Economics plays a crucial role in Decision Making ?

Till now we have managed to understand how economics forms the DNA of Managerial Economics
and Managerial economics is a very crucial aspect for Decision Making. But there is a need to
understand how exactly does Managerial Economics enables decision making at a Managerial level
in business.

Decision making implies to the need for optimising behaviour.The marketing vice president strives
to maximise the sales revenue , the production manager attempts to minimise cost or maximise
production. These management targets are contained by other parameters relating to that decision.
The essence of efficient and rational management is contained optimisation. Virtually all choices
and decisions are subject to limitations and this is where the tools of managerial economics are
most useful. The manager who can achieve the most despite those constraints will be rewarded.

Optimisation principles of Managerial Economics are very crucial to decision making.Decision
making needs a balance between simplification of analysis to be manageable and complications for
handling a variety of factors and objectives. Moreover, it needs common sense and good judgement.
Managerial economics helps the decision making in the following ways:

1. In order to enable the manager to become a more competent model builder, managerial
economics provides number of tools and techniques. With help of these models, the manager
can capture the essential relationships that represent the real situation while eliminating the
relatively less important details.
2. It provides most of the concepts that are needed for the analysis of business problems,Over the
years these concepts have proved their value in solving various kind of managerial problems.
Concept of elasticity of demand, Price elasticity of demand , Income elasticity of demand ,Cost
and output relationship ,Opportunity cost , Multiplier ,Propensity to consume ,Marginal revenue
product , Production function, Demand theory ,National income ,Theory of international trade ;
all help in understanding and solving problems.
3. The above cited concepts not only increase the vigour of the managers thinking, but also
provide a common terminology and way of thought for managers.
4. Managerial economics also assists in making decisions regarding what product mix should be
suggested ? Which is the production technique and the input mix that is least costly ? How to
take investment decisions ?

Good decisions require the ability to analyse problems logically and clearly. It is here that
managerial economics helps.


8



The link between Managerial Economics & Decision Making


9
Managerial Economics
Use of Economic Concepts and
Decision Science Methodology
to Solve Managerial Decision
Problems
Decision Sciences
(Tools & Techniques of Analysis)
Numerical Analysis
Statistical Analysis
Forecasting
Game Theory
Optimisation
Traditional Economics
Framework for Decisions
Theory of Consumer
Behaviour Theory of the Firm
Theory of Market Structure
and Pricing
Decision Problem
Product Price and Output
Make or Buy
Production Technique
Internet Strategy
Advertising Media and Intensity
Investment & Financing

Optimal Solution to
Business problems
Case Study

Eastman Kodak

1. The different factors that motivated Kodak to change its organisational architecture are:
Stiff competition - For many years, Eastman Kodak had control on the film production industry.
The firm had managed to time the release of its new products to meet customer demands.
However, in the 1980s, Eastman Kodaks virtual monopoly of the film production industry was
rattled by the entry of Fuji Corporations high quality film. The new product from Fuji
Corporation wore away the big market share of Eastman Kodak. In addition, other generic store
brands of film began to emerge in the market, making the competition in film production
industry tougher. The entry of new players as well as the improving market share of competitors
has eroded Eastman Kodaks virtual monopoly of the film production industry.
Technological advancement - While Eastman Kodak may have been one of the pioneers in film
production, technological advances have paved the discovery and creation of new products.
Advancement in robotics, design capabilities and improved communications has allowed faster
and easier development of products. Thus, new products can be introduced in the market within
months instead of years. Thus, consumers are presented different products in various styles with
numerous functions. The availability of many products in the market made the film production
industry more competitive.
Changing market environment - With technological advancement and entry of new players in
the film production industry, Eastman Kodak was faced with a very tough competition. The
once biggest market share of Eastman Kodak was slowly falling apart. As Eastman Kodak loses
its market share, the prices of its stock also went down. In 1982, Eastman Kodaks stock was
valued at over $85 per share by 1984; the firms stock price has fallen to $71. Consequently,
earnings per share at Eastman Kodak also dropped.
2. In its goal to regain its profits and market share, Eastman Kodak decided alter its organisational
structure which turned out to detrimental to the operations of the firm. One change in the
organisational structure was the assignment of decision-making process. From its centralised
decision making system where top-level approval was a requirement for most major decisions,
Eastman Kodak decided to restructure its decision-making process. This resulted to the creation
of 17 new business units with profit-and-loss responsibility. Business-unit managers were given
the responsibility to decide on new products, pricing, and other important policy choices. The
shift from centralised to decentralised decision-making process failed to help Eastman Kodak
achieve its goal of recovering the lost market share and regain profits. The decentralisation of
decision did not make a substantial impact on the over-all market performance of Eastman
Kodak.
3. The experience of Eastman Kodak exemplifies the concept of economic Darwinism or survival
of the fittest (Spencer, 1867, qtd. Blom, 1996). Eastman Kodak failed to respond to the
challenges presented by tough competition, thus, the company lose its market share and profit.
Eastman Kodak needed to be fit and tough in order to survive in the competitive market. In the
same way, the top-level executives of Eastman Kodak must be fit, tough and competitive. When
Eastman Kodak failed to achieve its organisational goal after restructuring its organisational
architecture, the firms CEO was fired by the Board of Directors of Eastman Kodak. Both
Eastman Kodak and Kodak CEO in 1993 were victims of the economic Darwinism. The CEO
was fired because he was not tough and fit enough to survive the competitive world of film
production. Eastman Kodak lost its market share and profit because it was not ready to compete
head-on.
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Bibliography

Managerial Economics - A problem Solving approach by Nick Wilkinson
Managerial Economics -Sultan Chand

EIILM University - Managerial Economics
http://www.advanceessays.com/samples/Managerial_Economics_Case_Studies.pdf
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