Managerial Economics

Unit – I

Definition of Economics:

The word economics has come from ancient Greek word “Oikonomia”- management of
household administration. It means that economics is that knowledge which is concerned
with the management of wants by household. Later on this definition changed and
different definitions were given by many experts. The important four basic definitions for
the economics are:

1. Science of wealth - Adam Smith

2. Science of Material welfare - Alfred Marshall
3. Science that Deals with Scarcity - Lionel Robbins
4. Science of Economic Growth - Paul A. Samuelson

Adam Smith (Economics as a Science of Wealth):

Economic laws and practices have been in operation ever since human life came in
existence. Adam Smith is regarded as the “father of economics”, who first time organised
and presented economic thought in a systematic way in his book “ An Enquiry into the
Nature and Causes of the Wealth of Nations.”
This book was first published in the year 1776. This gave raise to whole new science
known as economics. This is how Adam Smith is known as the “father of economics”.

Adam Smith defined economics as “a science which studies the nature and causes of the
wealth of nations” for Adam Smith wealth was to be-all and end-all of economic activity.
Goods have value in use (Utility) and value in exchange (Price). He defined wealth as –
all those goods which command value in exchange. Thus economics seeks to explain and
analyses the generation and distribution of wealth.
This definition came in for sharp criticism for its narrow vision, and hence, since has
largely been abandoned.
Shortcomings of Smith:
a) Ignored man and behaviour
b) Meaning of wealth was restricted to material goods, services are not included.

Alfred Marshall-(Economics as a Science of Material Welfare): Removing the

shortcomings of Adam Smith, he shifted emphasis from wealth to welfare of man.
The great economist considered economics as a means or an instrument to better the
conditions of human life. He defines economics, “Political economy or economics is a
study of mankind in the ordinary business of life, and it examines that part of individual
and social action which is most closely connected with the attainment and with the use of
the material requisites of well- being.” How a man earn income and how he spend it.
Thus economics is the study of man which are related to acquisition and enjoyment of
wealth. It is on the one side a study of wealth and on the other and more important side a
part of the study of man. For Marshall Wealth was only one of the ways to achieve
economic welfare.

The important features of this definition is

• Economics is a study of the ordinary business of life
• Economics is a social science
• Economics studies only the material requirements of well-being.
Shortcomings:
a) But Marshall forgot to talk about scarcity of resources,
b) Also his theory was not scientific. Material Welfare cannot be quantified.
c) Economics is not a social science but a human science.

Lionel Robbins-(Economics as a Science of Allocation of Resources)

Lionel Robbins is famous economist in 1932 out of his famous book, “The nature and
significance of Economic Science,” and introduced the “Scarcity definition of
economics.” The scarcity definition of economics has been pounded by Lionel Robbins.
His definition deals with scarcity.
He defines economics as, “Economics is the science which studies human behavior as
relationship between ends (wants) and scarce means (resources) which have alternative
uses.”
So he discussed human behavior concerned with the utilization of scarce (limited)
resources to achieve unlimited ends (results).

Features of Robbins definitions:

• Economics is a positive science, it states the facts as they are

• Economics studies human behavior relating to decision making regarding the use
of resources
• Human wants are unlimited
• The available means are limited. But these are capable of alternative uses.
Shortcomings:
a) Robbins definition was considered narrow, it covers only valuation but in
economics there are other things too, like capital, labour income etc.
b) It excludes the concept purpose which is the basis of any human action.

Prof. Paul. A. Samuelson (Economics as Science of Growth):

Finally Professor Paul A Samuelson gave a most satisfactory definition of economics. He

added to the utility of Robbins definition. He defines economics as follows, “Economics
is the study of how man and society choose, with or without the use of money, to employ
scarce productive resources which could have alternative uses, to produce various
commodities over time and distribute them for consumption now and in future among
various people and groups of society.”
 • The definition focus on both scarcity and growth.
• It is also known as the growth definition of economics.

He remarked-“logically, there is no fundamental about the traditional boundaries of

economics science. It is not possible to formulate restrict definition of economics. We
accept definition of economics if it is related with
a) Human activities,
b) Activities related with wealth getting and using- more specifically, production,
distribution, consumption etc. Thus it is concerned with activities which can be
quantified.
c) Scarcity
d) Human Welfare- maximization of social welfare

Conclusion: Therefore economics is a science which studies human behaviour in relation

to optimizing allocation of available resources to achieve the given end (result or target).

Economics is about:
a) Choices & Decision- You have taken decision to study Engineering. You have
other options too but you go for your choice. Why you opted for Engineering?
This answer will be given by economics. Since you have to use your scarce
resources (time and money) which are limited.
b) Human action- Purposeful behaviour (why you selected Engg?)Here you will
have some purpose of doing engineering like getting good job, better lifestyle etc
c) Scarcity- Most fundamental in economics is scarcity. If any thing is scarce it is
subject to economics.
d) Tradeoff- In economics you trade off between different resources by choosing one
resource and giving up other resource or increasing consumption of one necessary
thing and decreasing the use of other unimportant resource to reach the optimum
level of combination for best satisfaction.
e) Marginal Analysis- We use marginal analysis to make choices and decision.
Objective is to get maximum result from each additional unit of resources.

Important Concepts of Economics: Some Important concepts of Economics are:

1. Goods
2. Wealth, Capital and Income
3. Money
4. Value and Price
5. Equilibrium
6. Consumption and Wants
7. Slope or Rate of Change
1. Goods: The human wants are the starting point of all economic activity. There are two
things with which he can satisfy these wants – goods and services. Goods mean the
commodities that we use, and services refer to the work that a person may do. Services
are not something tangible or concrete. Generally “goods” refer to those material and
non-material objects which satisfy human wants. But in economics, the term is used in a
narrow sense. For our purpose the “goods” includes only those material objects which
possess the following characteristics.
(i) These can be transferred from one person to another and
(ii) These can be exchanged for one another.
The most important classification of goods is as Free goods and Economic goods.
Free goods are those that exist in plenty that you can with out any payment. E.g. Air,
Water, sunshine, etc
Economic goods are those goods which are scare and exist in limit quantity, man can
have it by paying for the goods. E.g. T.V., Washing machine, mobile phone etc., It can be
further classified into: (i) Consumer goods and (ii) Producer goods (also known as
Capital goods).

(i) Consumer goods: are those goods which directly satisfy human wants, e.g. food,
cloths, house etc. It can be classified into (a) Durable goods (b) Single-use goods
(a) Durable goods: The goods that can be consumed a number of times without
any damages to its utility and its life time is more e.g. furniture, shoes, t.v, etc
(b) Single-use (Non Durable) goods: The goods have limited life and it gets
destroyed as soon as they are consumed e.g. food, cold drinks, vegetables, fruits etc.
(ii) Producer goods (Capital goods): these goods that help in further production and
may durable goods like machines, tools, etc and single use goods like raw materials, coal,
fuel, etc.

2. Wealth, Capital and Income:

Wealth is the stock of all those objects-material or immaterial– which possess the
following characteristics,
(i) it must have utility
(ii) it must be scarce
(iii) it must be transferable
(iv) it must be external to human being
All the economic goods possess the above characteristics; a stock of such goods will be
called wealth. Some immaterial objects like goodwill also form part of wealth. These are
known as immaterial wealth. Wealth can be classified into four as follows:
(i) Personal Wealth- like buildings, ornaments, cloths etc
(ii) Social wealth- like roads, bridges, public hospitals, etc
(iii) National wealth- mines, forests, rivers, etc
(iv) International wealth- like international sea- routes, air-routes etc.

Capital: It is the part of wealth which is used in the process of production like tools,
machinery, raw materials, etc., it would be seen that all capital is wealth but all wealth is
not capital.
Income: The earnings received by various factors of production- land, labour, capital and
organisation- according to a time schedule are called income. It is obtained by producing
goods, performing services or by services or by investing.

3. Money: Money is anything that is generally acceptable as a medium of exchange and

acts as a measure of value. It is accepted in payment of goods and services. It is given and
received without reference to the standing of the person who offers it as payment. It is
classified as
(i) Cash money- it includes currency notes and coins
(ii) Bank money- it consists of cheques, drafts, bills of exchange, etc.

4. Value and Price: The term ‘value’ is used to express the utility or usefulness of a
commodity or services; the term ‘price’ is used to explain the units of money required to
purchase the commodity.

5. Equilibrium: The word Equilibrium has been borrowed from Physics. It is very
frequently used in modern economic analysis. Equilibrium means a state of balance.
When forces acting in opposite direction are exactly equal, the object on which they are
acting is said to be in a state of equilibrium. It also refers to a state when a situation is
ideal or optimum or when complete adjustment has been made to changes in an economic
situation, there is no incentive for any more change, so that no advantage can be obtained
by making a change. For e.g. A consumer is said to be in an equilibrium position when he
is deriving maximum satisfaction.

A producer or a firm is said to be in equilibrium when it is making a maximum profit or

incurring a minimum loss, here there will be no inducement to change.

6. Consumption and Wants:

Consumption means the using up of goods and services in such a manner that the
wants of members of the community are satisfied, thus it may be defined as any
economic activity directed to satisfy human and his wants. If any goods are destroyed by
unforeseen accidents like earthquake, flood, wars etc it is not consumption as there is no
economic purpose is served. It is divided as Consumption of goods- there is always a
time gap between production and consumption and Consumption of services- services are
consumed the moment they are produced.
Wants means a wish or a desire. Which plays a vital role in the economic life are
those which have an urge to effort and which find their satisfaction through that effort.
Wants differ in their intensity, it can be conveniently classified into three categories as (a)
Necessaries (b) Comfort (c) Luxuries.

7. Slope or Rate of Change: The concept of slope or rate of change is essential to gain
an understanding of many economic principles. The slope, of a line or curve is defined as
the rise / run or ∆Y / ∆X, where delta (∆) refers to a ‘change in’

The slope of a line is a rate of change.

Basic Economic Problem:
From the study of the essential processes of an economy, it would appear that some
fundamental problems arise whatever the type of economy. An economy exists because
of two basic facts,
1. Human wants for goods and services are unlimited
2. Productive resources with which to produce goods and services are scare.

Wants are unlimited and resources are limited, the economy has to decide how to use its
scarce resources to give the maximum possible satisfaction to the members of the society.
In doing so, an economy has to solve some basic problems called central problems of an
economy, which are:
1. WHAT to Produce
2. HOW to Produce
3. FOR WHOM to Produce

What ever the type of economy or economic system, these problems has to be solved
some how. These are the basic and fundamental for all economies.

1. WHAT to Produce:
The problem ‘what to produce’ can be dived into two related questions.
a. Which goods are to be produced and which not?
b. What quantities those goods, which the economy has decided to produce,
are to be produced?
If productive resources were unlimited we could produce as many numbers of
goods as we like.
If the resources are in fact scarce relative to human wants, an economy must
choose among different alternative collections of goods and services that it should
produce.
E.g. If it is desired to produce more wheat and less cotton, land use will have to
get diverted for cultivation of cotton to wheat.

2. HOW to Produce:
• The problem ‘how to produce’ means which combination of resources is
to be used for the production of goods and which technology is to be made use
of in production.
• Once the society has decide what goods and services are to be produced
and in what quantities, it must then decide how these goods shall be produced.
There are various alternative methods of producing a good and the economy has
to choose among them. It is always possible to employ alternative techniques of
production to produce a commodity, e.g. labour can more generally, be
substituted by machines, and vice- versa.
 • A choice would have to be made say between labour- intensive techniques
and capital- intensive techniques of production.
• E.g. Bricks and cement can be carried by labour to the upper floors of a
building under construction. Alternatively elevators and lifts can do the job; we
have to make the choice.

3. FOR WHOM to Produce:

• ‘For whom to produce’ it means how the national product is to be
distributed among the members of the society, who should get how much of the
total amount of goods and services produced in the economy.
• The third problem of sharing of the national product, Distribution of
the national product depends on the distribution of national income. Those
people who have larger incomes would have larger capacity to buy goods and
hence will get greater share of goods and services. Those, who have low
incomes would have less purchasing power to buy things. The more equal is the
distribution of income, the more equal will be the distribution of the national
product.
The question arises how is the national income to be distributed, that is, how is it to be
determined as to who should get how much of the national income? Should the people
get equal incomes and hence equal shares from the national product, or whether the
distribution of national income should be done on the basis of the Marxian principle
‘from each according to his ability, to each according to his needs’ or should the
distribution of national income be in accordance with the contribution made to the total
production, that is, should everybody get income exactly equal to what he produces?
The main difficulty in the question of distribution of national product or income is how to
reconcile the equity and justice aspect of distribution with the incentive aspect. From the
point of view of equity distribution of national product or income n the basis of equality
seems to be the best that the problem is that equality in the distribution of national
product or income may adversely affect the incentive to produce more. If this incentive is
destroyed or greatly diminished as a result of promoting equality, the total national output
available for sharing may be so much smaller that the living standards of all may go
down.

The Micro Economics and Macro Economics:

Economic analysis is of two types (a) Micro economic analysis and (b) Macro economic
analysis
1. Micro economics:
According to E. Boulding, “Micro economics is the study of particular firm,
particular household, individual price, wage, income, industry, and particular
commodity.”
In the words of Leftwitch, “Micro economics is concerned with the economic
activities of such economic units as consumers, resource owners and business firms.”
o ‘Micro’ is a Greek word means ‘small’
o Micro economic theory studies the behaviour of individual decision-making
units such as consumers’ resource owners, business firms, individual
households, wages of workers, etc
 o It studies the flow of economic resources or factors of production from the
resource owners to business firms and the flow of goods and services from the
business firms to households. It studies the composition of such flows and
how the prices of goods and services in the flow are determined.
o In this analysis economists pick up a small unit and observe the details of its
operation.
o It provides analytical tools for the study of the behaviour of market
mechanism.
o It is also called as Price theory and
o It is also called as Partial Equilibrium analysis.

Importance of Micro economics:

o Micro economics occupies a very important place in the study of economic
theory.
o It has both theoretical and practical importance.
o It explains the functioning of a free enterprise economy
o It tells how millions of consumers and producers in an economy take
decisions about the allocation of productive resources among millions of
goods and services.
o It explains how through market mechanism goods and services produced in
the community are distributed
o It explains the determination of the relative prices of the various products and
productive services.
o It helps in the formulation of economic policies calculated to promote
efficiency in production and the welfare of the masses.

Limitations:
 It cannot give an idea of the functioning of the economy as a whole. An
individual industry may be flourishing, where as the economy as a whole may
be languishing
 It assumes full employment which is a rare phenomenon, at any rate in the
capitalist world. Therefore it is an unrealistic assumption

2. Macro economics:

According to E. Boulding “Macro economics deals not with individual quantities

as such but with aggregates of these quantities, not with individual income but with
national income not with individual prices but with price levels, not with individual
outputs but with national output.”
According to Gardner Ackely, “Macro economics concerns with such variables as
the aggregate volume of the output of an economy, with the extent to which its resources
are employed, with the size of national income and with the general price level.”
• Macro economics is the obverse of microeconomics.
• It is the study of economic system as a whole.
 • It studies not one economic unit like a firm or an industry but the whole economic
system
• Therefore it deals with totals or aggregates national income output and
employment, total consumption, saving and investment and the genera level of
prices.
• It is also called as Income theory and
• It is also called as aggregative economics.

Importance:

 It helps in understanding the functioning of a complicated economic system

 It gives a bird’s eye view of the economic world
 For the formulation of useful economic policies for the nation macro economics is
of the utmost significance.
 It is far more fruitful to regulate aggregate employment and national income and
to work out a national wage policy
 It occupies most important place in economic theory in its pursuit of the solution
of urgent economic problems.

Limitations:
o Individual is ignored altogether. It is individual welfare which is the main aim of
economics.
o It overlooks individual differences. Say the general price level may be stable, but
the price of food grains may have gone spelling ruin to the poor.

Difference between Micro economics and Macro economics:

The main differences between micro economics and macro economics are the following:
S.n Micro economics Macro economics
o
1. Difference in the degree It studies the individual units of It deals with aggregates like
of aggregation: the economy like a firm, a national income and aggregate
particular commodity. savings. It studies the problem
of the economy as a whole
2. Difference in objectives It is to study of principles, It studies the problems, policies
problems and policies concerning and principles relating full
the optimum allocation of employment of resources and
resources growth of resources.
3. Difference of subject It deals with the determination of It is full employment, national
matter price, consumer’s equilibrium, income, general price-level,
distribution and welfare, etc. trade cycles, economic growth,
etc.
4. Method of study Micro economics laws establish Macro economics elements are
 relationship between the causescategorized into aggregate units
and effects of economics like aggregate demand,
phenomena and it is formulated aggregate supply, total
by taking some assumptions. consumption, total investment,
etc.
5. Different assumptions It analysis how production and It analysis how full employment
factors of production are can be achieved.
allocated among different uses.
6. Difference of the forces of It studies the equilibrium It deals with equilibrium
equilibrium between the forces of individual between the forces demand and
demand and supply or market supply of whole economy.
demand and supply.

Nature of Economics:
Economics as Science: Science is a systemized body of knowledge about a particular
branch of the universe which contains theories and principles, which are based on cause
and effect relationship and are universal in nature. Similarly economics is a science, since
it is a systemized body of knowledge about economic activities.
As science is based on facts, economics is also based on facts which are examined by
economists. As science it uses theories, principles and mathematical tools.
Like science it also go through collection of data, observations of the information,
examining these information, explaining and finally verifying them.
Economics as an Arts: According to JM Keynes,” an arts is a system of rules for
attainment of given ends”. It implies that art is practical. An art is also defined as
collection or body of rules for the execution of external work. Applying this definition we
can also say that economics is an art. Branches like Consumption, Production and Public
Finance provide practical guidance to solve economic problems.
A science teaches us to know while an arts teaches us to do, in other words a science is
theoretical and an arts is practical. Applying this definition, economics is an art. Since
branches like production, consumption provides practical guidance to solve economics
problems.
In words of Samuelson “Economics is the oldest of the arts, the newest of science –
indeed queen of all social science”.

Economics as Positive (Descriptive) Science: Positive science is a systemized

knowledge concerning ‘what is’. It describes things the way they are, that is why they are
called descriptive science.
Classical economist proposed economics should be concerned only with ‘what it is’.
They should not pass moral judgments. If they will do, ethical issues will be involved and
this will lead to disagreement of economists’ theory and finally no growth of economics.
Moral judgments many times may be wrong in practical situation.
Economics as a Normative Science: Normative science is a body of systemized
knowledge relating to the criteria of “what ought to be”. Challenging the view of classical
school, Alfred Marshall put the argument that economics is a normative science, since it
has norms (welfare). It deals with “what ought to be”. Economists must tell what should
be done and what should be avoided. It is realistic and human in nature.
Economics as Social Science: Economics is a social science which suggests that modes
of promotion of economic welfare with limited means. It can be a great service to
mankind. It can help person to get maximum welfare from limited resources.

Significance of Economics:

Economics is useful not only to individual but also to business firms, society and nation
as a whole. Economics provides tools which can be used for solving various household,
business and nations problem. Knowledge of economics is useful in almost all sphere of
life. Our day starts with application of economics policies and ends by it directly or
indirectly.
It helps businessmen in his various decisions making with regard to price, cost, and
production etc. Similarly for policy maker it helps in formulating appropriate policies for
economy.

Importance for Individuals- On individual level the use of economical tools is vital.
Since an individual has a limited source of income and the desire and requirements of his
family are unlimited. A housewife faces a difficult task to manage her family in a fixed
income. Thus an individual has to use economic tools to get optimum output from his/
her limited source. He/ she have to regularly tradeoff between options available and
maximization of satisfaction with given source of income. Theory of opportunity cost &
marginal utility are frequently used by an individual.

Importance for a Businessmen- For any firm it is not possible to run business without
using economic theories and principles. Managerial economics is an important tool for
any business establishment while making any decision. Some of the important tools of
economics used by managers are- law of demand, law of production, law of consumer
behaviour, elasticity of demand and supply, theory of firm and many popular other
principles and policies. Some time they have to use macroeconomics too to understand
external environments and government policies which are very important for their
business.

Importance for Nation- Macroeconomics has a significant role in the growth of any
nation. Government uses different macro economical policies and theories for effective
use of various resources for economic growth of the nation and for raising standard of
living of people. Problem like employment, national income, inflation and growth of
economy in total are solved by suitable macroeconomics tools. Fiscal, monetary,
Industrial, Exim policies are governed by economic theories and these policies are used
for the development of nation as whole.
 Managerial Economics:

In reality decision making is not so easy because the economic world is very complex
and most economic decisions have to be taken under the condition of imperfect
knowledge, risk and uncertainties.
Therefore taking an appropriate decision or making an appropriate choice in an extremely
complex situation is very difficult task.
In their endeavour to study the complex decision making process, economists have
developed a large kit of analytical tools and techniques with the support of mathematics
and statistics. They have developed a large corpus of economic theories with a fairly high
predictive power. Analytical tools, techniques, theories and laws are used in business
decision making and are dealt in separate branch known as managerial economics.
Therefore :-

Managerial economics is a discipline which deals with the application of economic

theory to business management. It deals with the use of economic concepts and
principles of business decision making. Formerly it was known as “Business Economics”
but the term has now been discarded in favour of Managerial Economics.

Managerial Economics may be defined as the study of economic theories, logic and
methodology which are generally applied to seek solution to the practical problems of
business. Managerial Economics is thus constituted of that part of economic knowledge
or economic theories which is used as a tool of analysing business problems for rational
business decisions. Managerial Economics is often called as Business Economics or
Economic for Firms.

Managerial Economics is concerned with application of economic concept, theories to

the problems of formulating rational decision making. It is an integration of economic
theories and business practices for the purpose of facilitating decision making and
forward planning by management. It is concerned with the application of economic
principles and methodologies to the decision making process with in the firm or
organization.

Definition of Managerial Economics:

“Managerial Economics is economics applied in decision making. It is a special branch of

economics bridging the gap between abstract theory and managerial practice.” – Haynes,
Mote and Paul.
“Business Economics consists of the use of economic modes of thought to analyse
business situations.” McNair and Meriam
“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.” – Spencer and Seegelman.
“Managerial economics is concerned with application of economic concepts and
economic analysis to the problems of formulating rational managerial decision.” –
Mansfield
Nature and Scope of Managerial Economics:

The primary function of management executive in a business organisation is decision

making and forward planning. Decision making and forward planning go hand in hand
with each other.
Decision making means the process of selecting one action from two or more alternative
courses of action. Forward planning means establishing plans for the future to carry out
the decision so taken.
The problem of choice arises because resources at the disposal of a business unit (land,
labour, capital, and managerial capacity) are limited and the firm has to make the most
profitable use of these resources. The decision making function is that of the business
executive, he takes the decision which will ensure the most efficient means of attaining a
desired objective, say profit maximisation. After taking the decision about the particular
output, pricing, capital, raw-materials and power etc., are prepared. Forward planning and
decision-making thus go on at the same time.

A business manager’s task is made difficult by the uncertainty which surrounds business
decision-making. Nobody can predict the future course of business conditions. He
prepares the best possible plans for the future depending on past experience and future
outlook and yet he has to go on revising his plans in the light of new experience to
minimise the failure. Managers are thus engaged in a continuous process of decision-
making through an uncertain future and the overall problem confronting them is one of
adjusting to uncertainty. In fulfilling the function of decision-making in an uncertainty
framework, economic theory can be, pressed into service with considerable advantage as
it deals with a number of concepts and principles which can be used to solve or at least
throw some light upon the problems of business management e.g. to profit, demand, cost,
pricing, production, competition, business cycles, national income etc. The way
economic analysis can be used towards solving business problems, constitutes the
subject-matter of Managerial Economics.

There are a number of issues relevant to businesses that are based on economic
thinking or analysis. Examples of questions that managerial economics attempts to
answer are:
What determines whether an aspiring business firm should enter a particular
industry or simply start producing a new product or service? Should a firm continue to be
in business in an industry in which it is currently engaged or cut its losses and exit the
industry? Why do some professions pay handsome salaries, whereas some others pay
barely enough to survive? How can the business best motivate the employees of a firm?
The issues relevant to managerial economics can be further focused by expanding
on the first two of the preceding questions. Let us consider the first question in which a
firm (or a would-be firm) is considering entering an industry. For example, what led
Frederick W. Smith the founder of Federal Express, to start his overnight mail service? A
service of this nature did not exist in any significant form in the United States, and people
seemed to be doing just fine without overnight mail service provided by a private
corporation. One can also consider why there are now so many overnight mail carriers
such as United Parcel Service and Airborne Express. The second example pertains to the
exit from an industry, specifically, the airline industry in the United States. Pan Am, a
pioneer in public air transportation, is no longer in operation, while some airlines such as
TWA (Trans World Airlines) are on the verge of exiting the airlines industry. Why, then,
have many airlines that operate on international routes fallen on hard times, while small
regional airlines seem to be doing just fine? Managerial economics provides answers to
these questions.
In order to answer pertinent questions, managerial economics applies economic
theories, tools, and techniques to administrative and business decision-making. The first
step in the decision-making process is to collect relevant economic data carefully and to
organize the economic information contained in data collected in such a way as to
establish a clear basis for managerial decisions. The goals of the particular business
organization must then be clearly spelled out. Based on these stated goals, suitable
managerial objectives are formulated. The issue of central concern in the decision-
making process is that the desired objectives be reached in the best possible manner. The
term "best" in the decision-making context primarily refers to achieving the goals in the
most efficient manner, with the minimum use of available resources—implying there be
no waste of resources. Managerial economics helps the manager to make good decisions
by providing information on waste associated with a proposed decision.

Chief Characteristics of Managerial Economics:

• It is Micro in Nature- It is an extension of Microeconomics, where we discuss

about an individual firm.
• Use Market theory-It largely uses theory of private firm and general market.
• Goal Oriented- Managerial Economics is used in decision making to reach a
particular goal.
• Science & Arts- Analysis and experiments are done then it is applied and
practiced.
• Normative Science- Decision is taken for what it ought to be.
• Pragmatic Approach- It is a practical subject, manager does not follow 100 %
theory and principles of managerial economics always, rather it incorporates the
practical complications prevailing at that point of time. Since in economic theory
some assumptions are always there and it is not necessary that these assumptions
are always applicable.
• Use Some Theory of Macroeconomics- The Manager should be aware about the
macro level information too e.g. rate of inflation, growth of economy, government
policies in relation to that particular product or industry, since these factors affect
individual firm. Therefore use of macroeconomics by a decision maker in
managerial economics is a common practice.
Scope of Managerial Economics:

The name managerial economics suggest that it includes that part of economics that is
essential for a manager of a firm to run his business in most profitable and smooth way.
Running business means making decision by choosing best among the available
alternatives. The scope extends itself to all those areas of business where economic
consideration for decision making is essential. Since the area of business is a
continuously growing, the scope of managerial economics is not yet clearly laid out.
Even then the following fields may be said to generally fall under Managerial
Economics:

1. Demand Analysis and Forecasting

2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
6. Sales Promotion and Marketing Strategies

These divisions of business economics constitute its subject matter.

Recently, managerial economists have started making increased use of Operation
Research methods like Linear programming, inventory models, Games theory,
queuing up theory etc., have also come to be regarded as part of Managerial
Economics.

1. Demand Analysis and Forecasting: A business firm is an economic organization

which is engaged in transforming productive resources into goods that are to be
sold in the market. A major part of managerial decision making depends on
accurate estimates of demand. A forecast of future sales serves as a guide to
management for preparing production schedules and employing resources. It will
help management to maintain or strengthen its market position and profit base.
Demand analysis also identifies a number of other factors influencing the demand
for a product. Demand analysis and forecasting occupies a strategic place in
Managerial Economics.

2. Cost and production analysis: A firm’s profitability depends much on its cost of
production. A wise manager would prepare cost estimates of a range of output,
identify the factors causing are cause variations in cost estimates and choose the
cost-minimizing output level, taking also into consideration the degree of
uncertainty in production and cost calculations. Production processes are under
the charge of engineers but the business manager is supposed to carry out the
production function analysis in order to avoid wastages of materials and time.
Sound pricing practices depend much on cost control. The main topics discussed
 under cost and production analysis are: Cost concepts, cost-output relationships,
Economics and Diseconomies of scale and cost control.

3. Pricing decisions, policies and practices: Pricing is a very important area of

Managerial Economics. In fact, price is the genesis of the revenue of a firm ad as
such the success of a business firm largely depends on the correctness of the price
decisions taken by it. The important aspects dealt with this area are: Price
determination in various market forms, pricing methods, differential pricing,
product-line pricing and price forecasting.

4. Profit management: Business firms are generally organized for earning profit
and in the long period, it is profit which provides the chief measure of success of
a firm. Economics tells us that profits are the reward for uncertainty bearing and
risk taking. A successful business manager is one who can form more or less
correct estimates of costs and revenues likely to accrue to the firm at different
levels of output. The more successful a manager is in reducing uncertainty, the
higher are the profits earned by him. In fact, profit-planning and profit
measurement constitute the most challenging area of Managerial Economics. How
to manage the profit by taking suitable decision in a recessionary market by
taking proper action at right time is a challenging task for any business manager.

5. Capital management: The problems relating to firm’s capital investments are

perhaps the most complex and troublesome. Capital management implies
planning and control of capital expenditure because it involves a large sum and
moreover the problems in disposing the capital assets off are so complex that they
require considerable time and labour. The main topics dealt with under capital
management are cost of capital, rate of return and selection of projects.

6. Sales Promotion and Marketing Strategy: In a free and competitive market

where there is a cut throat competition, the role of marketing and sales people is
vital for the growth of any company. The team work of sales people play a major
role in the business development of the organization. Decision maker has to be
updated about the marketing strategy and planning of the competitors. They have
to adopt a sales and marketing strategy, which is suitable to nature of the product
and market situation.

Conclusion: The various aspects outlined above represent the major uncertainties
which a business firm has to reckon with, viz., demand uncertainty, cost uncertainty,
price uncertainty, profit uncertainty, and capital uncertainty. We can, therefore,
conclude that the subject-matter of Managerial Economics consists of applying
economic principles and concepts towards adjusting with various uncertainties faced
by a business firm.
 Basic Economical Tools Used By Managerial Economists:
Tools of managerial economics can be used to achieve virtually all the goals of a business
organization in an efficient manner.

The following are the frequently used economical tools by Business Managers.
1. Principle of Scarcity: Economics is the study of how scarce resources are used
to satisfy human wants which are unlimited. The fundamental problem is to
economies the use of resources to satisfy as many wants as possible. It is the
scarcity or short supply of resources which dictates us to make a choice
between alternatives.
2. Opportunity Cost principle: The cost involved in any decision consists of the
sacrifices of alternative required by that decision. If there is no alternative, so
no sacrifices, there are no opportunity costs. In taking managerial decision,
Opportunity cost is quite relevant.
3. Marginalism: Manager has to take into consideration the additional return by
making additional investment. Economists use term ‘marginal’ for all such
additional magnitude of output. A manager can expand production to a level
where marginal revenue is at least equal to marginal cost.
4. Discounting Principal: Managerial economists use this principle to find out
the current value of future output or future flow of funds. Since the value of
money (Purchasing power of money) decreases with the growth of period, the
value of money received in future has to be discounted to know its current
value, so that it can be compared with the fund invested at that time. If the
cash inflow is more than outflow by a required margin only then decision will
be taken in favour of that project.
5. Equi-Marginal Principle: It says that an input should be allocated in such a
way that the value added by the last unit of input is the same in all its uses.
This generalized law is known as equi-marginal principle. Let us take an
example of a firm having workers active in three duties- production of bottled
milk, butter & cheese. The firm must allocate these workers in such a way that
the productivity of last worker (marginal) should be same in all duties. Like is
a marginal worker is adds worth of Rs.100/- of bottled milk then marginal
worker employed on butter and cheese should also earns worth of Rs.100/- by
adding output. The additional out put worth of Rs.100/- produced by marginal
worker is called “Value of Marginal Product” (VMP). VMP of activities a, &c
be should be same i.e. VMPa=VMPb=AMPc.

Specific Function of Managerial Economists:

It should be noted that the application of managerial economics is not limited to profit-
seeking business organizations. Tools of managerial economics can be applied equally
well to decision problems of nonprofit organizations. Mark Hirschey and James L.
Pappas cite the example of a nonprofit hospital. While a nonprofit hospital is not like a
typical firm seeking to maximize its profits, a hospital does strive to provide its patients
the best medical care possible given its limited staff (doctors, nurses, and support staff),
equipment, space, and other resources. The hospital administrator can use the concepts
and tools of managerial economics to determine the optimal allocation of the limited
resources available to the hospital. In addition to nonprofit business organizations,
government agencies and other nonprofit organizations (such as cooperatives, schools,
and museums) can use the techniques of managerial decision making to achieve goals in
the most efficient manner.
While managerial economics is helpful in making optimal decisions, one should be aware
that it only describes the predictable economic consequences of a managerial decision.
For example, tools of managerial economics can explain the effects of imposing
automobile import quotas on the availability of domestic cars, prices charged for
automobiles, and the extent of competition in the auto industry. Analysis of managerial
economics will reveal that fewer cars will be available, prices of automobiles will
increase, and the extent of competition will be reduced. Managerial economics does not
address, however, whether imposing automobile import quotas is good government
policy. This latter question encompasses broader political considerations involving what
economists call value judgments.

Some of the important functions of Managerial Economists are as follows:

• Sales Forecasting
• Market Research
• Analysis of competitive firms
• Pricing Decision
• Evaluation of Capital and Projects
• Security and Investment Analysis
• Production and Inventory control
• Environmental Forecasting
• Social Responsibility of Corporate
• Corporate policies related with corporate structure ( merger,
acquisition, joint venture, takeover etc.)

Science Technology and Managerial Economics:

Science: “Science is a systemized body of knowledge pertaining to a particular field of

enquiry”. Main features of science are-
a) Systemized body of knowledge
b) Scientific method of observation
c) Test of validity
d) Universal application

Engineering: Engineering involves application of scientific knowledge for the

betterment of quality of life. According to “Engineers council for Professional
Development” Engineering is the profession in which knowledge of mathematics and
natural sciences, gained by study, experience & practices are applied with judgment to
develop ways to utilize economically, material and forces for the benefit of mankind.
Engineers facilitates in economic development in two ways-
a) Mechanization of production process
b) Development of Infrastructure

Technology: Technology refers to the body of knowledge, skills and procedures for
preparing, using and doing useful things.

Role of Science and Technology in Economic Development:

a) Utilisation of Natural Resources- full utilization of Natural resources or wealth of
any country was only possible with the development of science and technology.
b) Increased efficiency- With low input to produce high output is not feasible
without the use of technology.
c) Factor Substitution- depending on availability of factors, engineers can substitute
one factor from another by using technology. Sea water can be converted into
drinking water by use of technology.
d) Overcoming Scarcity- Growing rice in desert is possible with help of technology.
Similarly eliminating wastage and increasing production with low raw material or
input is only possible with the help of science and technology.
e) Self Reliance- with the use of science and technology any country can reach to the
goal of self reliance , like India reach to the self reliance after independence in
agriculture products with the introduction of Green Revolution where we used
scientific method of agriculture instead of using the tradition method of farming.

WHY DO ENGINEERS NEED TO LEARN ABOUT ECONOMICS?

Ages ago, the most significant barriers to engineers were technological. The
things that engineers wanted to do, they simply did not yet know how to do, or hadn't yet
developed the tools to do. There are certainly many more challenges like this which face
present-day engineers. However, we have reached the point in engineering where it is no
longer possible, in most cases, simply to design and build things for the sake simply of
designing and building them. Natural resources (from which we must build things) are
becoming scarcer and more expensive. We are much more aware of negative side-effects
of engineering innovations (such as air pollution from automobiles) than ever before.
For these reasons, engineers are tasked more and more to place their project ideas
within the larger framework of the environment within a specific planet, country, or
region. Engineers must ask themselves if a particular project will offer some net benefit
to the people who will be affected by the project, after considering its inherent benefits,
plus any negative side-effects (externalities), plus the cost of consuming natural
resources, both in the price that must be paid for them and the realization that once they
are used for that project, they will no longer be available for any other project(s).
Simply put, engineers must decide if the benefits of a project exceed its costs, and
must make this comparison in a unified framework. The framework within which to
make this comparison is the field of engineering economics, which strives to answer
exactly these questions, and perhaps more. The Accreditation Board for Engineering and
Technology (ABET) states that engineering "is the profession in which a knowledge of
the mathematical and natural sciences gained by study, experience, and practice is
applied with judgment to develop ways to utilize, economically, the materials and forces
of nature for the benefit of mankind".
It should be clear from this discussion that consideration of economic factors is as
important as regard for the physical laws and science that determine what can be
accomplished with engineering.
Physical Environment : Engineers produce products and services depending on
physical laws (e.g. Ohm's law; Newton's law).
Physical efficiency takes the form:
system output(s)
Physical (efficiency ) = -------------------
system input(s)
Economic Environment : Much less of a quantitative nature is known about
economic environments -- this is due to economics being involved with the actions of
people, and the structure of organizations.
Satisfaction of the physical and economic environments is linked through
production and construction processes. Engineers need to manipulate systems to achieve
a balance in attributes in both the physical and economic environments, and within the
bounds of limited resources.

Following are some examples where engineering economy plays a crucial

role:
• Choosing the best design for a high-efficiency gas furnace
• Selecting the most suitable robot for a welding operation on an automotive
assembly line
• Making a recommendation about whether jet airplanes for an overnight
delivery service should be purchased or leased
• Considering the choice between reusable and disposable bottles for high-
demand beverages
With items 1 and 2 in particular, note that coursework in engineering should
provide sufficient means to determine a good design for a furnace, or a suitable robot for
an assembly line, but it is the economic evaluation that allows the further definition of a
best design or the most suitable robot.
In item 1 of the list above, what is meant by "high-efficiency"? There are two
kinds of efficiency that engineers must be concerned with. The first is physical
efficiency, which takes the form:
System output(s)
Economic (efficiency) = -----------------
System input(s)
For the furnace, the system outputs might be measured in units of heat energy,
and the inputs in units of electrical energy, and if these units are consistent, then physical
efficiency is measured as a ratio between zero and one. Certain laws of physics (e.g.,
conservation of energy) dictate that the output from a system can never exceed the input
to a system, if these are measured in consistent units. All a particular system can do is
change from one form of energy (e.g. electrical) to another (e.g., heat). There are losses
incurred along the way, due to electrical resistance, friction, etc., which always yield
efficiencies less than one. In an automobile, for example, 10-15% of the energy supplied
by the fuel might be consumed simply overcoming the internal friction of the engine. A
perfectly efficient system would be the theoretically impossible Perpetual Motion
Machine!
The other form of efficiency of interest to engineers is economic efficiency,
which takes the form:
System worth
Economic (efficiency) = -----------------
System cost
You might have heard economic efficiency referred to as "benefit-cost ratio".
Both terms of this ratio are assumed to be of monetary units, such as dollars. In contrast
to physical efficiency, economic efficiency can exceed unity, and in fact should, if a
project is to be deemed economically feasible. The most difficult part of determining
economic efficiency is accounting for all the factors which might be considered benefits
or costs of a particular project, and converting these benefits or costs into a monetary
equivalent. Consider for example a transportation construction project which promises to
reduce everyone's travel time to work. How do we place a value on that travel time
savings? This is one of the fundamental questions of engineering economics.
In the final evaluation of most ventures, economic efficiency takes precedence
over physical efficiency because projects cannot be approved, regardless of their physical
efficiency, if there is no conceived demand for them amongst the public, if they are
economically infeasible, or if they do not constitute the "wisest" use of those resources
which they require.
There are numerous examples of engineering systems that have physical design
but little economic worth (i.e it may simply be too expensive!!). Consider a proposal to
purify all of the water used by a large city by boiling it and collecting it again through
condensation. This type of experiment is done in junior physical science labs every day,
but at the scale required by a large city, is simply too costly.

Managerial Economics

Unit – I

Definition of Economics:

The word economics has come from ancient Greek word “Oikonomia”- management of
household administration. It means that economics is that knowledge which is concerned
with the management of wants by household. Later on this definition changed and
different definitions were given by many experts. The important four basic definitions for
the economics are:

5. Science of wealth - Adam Smith

6. Science of Material welfare - Alfred Marshall
7. Science that Deals with Scarcity - Lionel Robbins
8. Science of Economic Growth - Paul A. Samuelson
Adam Smith (Economics as a Science of Wealth):
Economic laws and practices have been in operation ever since human life came in
existence. Adam Smith is regarded as the “father of economics”, who first time organised
and presented economic thought in a systematic way in his book “ An Enquiry into the
Nature and Causes of the Wealth of Nations.”
This book was first published in the year 1776. This gave raise to whole new science
known as economics. This is how Adam Smith is known as the “father of economics”.

Adam Smith defined economics as “a science which studies the nature and causes of the
wealth of nations” for Adam Smith wealth was to be-all and end-all of economic activity.
Goods have value in use (Utility) and value in exchange (Price). He defined wealth as –
all those goods which command value in exchange. Thus economics seeks to explain and
analyses the generation and distribution of wealth.
This definition came in for sharp criticism for its narrow vision, and hence, since has
largely been abandoned.
Shortcomings of Smith:
c) Ignored man and behaviour
d) Meaning of wealth was restricted to material goods, services are not included.

Alfred Marshall-(Economics as a Science of Material Welfare): Removing the

shortcomings of Adam Smith, he shifted emphasis from wealth to welfare of man.
The great economist considered economics as a means or an instrument to better the
conditions of human life. He defines economics, “Political economy or economics is a
study of mankind in the ordinary business of life, and it examines that part of individual
and social action which is most closely connected with the attainment and with the use of
the material requisites of well- being.” How a man earn income and how he spend it.
Thus economics is the study of man which are related to acquisition and enjoyment of
wealth.It is on the one side a study of wealth and on the other and more important side a
part of the study of man. For Marshall Wealth was only one of the ways to achieve
economic welfare.

The important features of this definition is

• Economics is a study of the ordinary business of life
• Economics is a social science
• Economics studies only the material requirements of well-being.
Shortcomings:
a) But Marhall forgot to talk about scarcity of resources,
b) Also his theory was not scientific. Material Welfare can not be quantified.
c) Economics is not a social science but a human science.

Lionel Robbins-(Economics as a Science of Allocation of Resources)

Lionel Robbins is famous economist in 1932 out of his famous book, “The nature and
significance of Economic Science,” and introduced the, “Scarcity definition of
economics.” The scarcity definition of economics has been pounded by Lionel Robbins.
His definition deals with scarcity.
He defines economics as, “Economics is the science which studies human behaviour as
relationship between ends (wants) and scarce means (resources) which have alternative
uses.”
So he discussed human behaviour concerned with the utilization of scarce (limited)
resources to achieve unlimited ends (results).

Features of Robbins definitions:

• Economics is a positive science, it states the facts as they are

• Economics studies human behaviour relating to decision making regarding the use
of resources
• Human wants are unlimited
• The available means are limited. But these are capable of alternative uses.
Shortcomings:
c) Robbins definition was considered narrow, it covers only valuation but in
economics there are other things too, like capital, labour income etc.
d) It excludes the concept purpose which is the basis of any human action.

Prof. Paul. A. Samuelson (Economics as Science of Growth):

Finally Professor Paul A Samuelson gave a most satisfactory definition of economics. He

added to the utility of Robbins definition. He defines economics as follows, “Economics
is the study of how man and society choose, with or without the use of money, to employ
scarce productive resources which could have alternative uses, to produce various
commodities over time and distribute them for consumption now and in future among
various people and groups of society.”

• The definition focus on both scarcity and growth.

• It is also known as the growth definition of economics.

He remarked-“logically, there is no fundamental about the traditional boundaries of

economics science. It is not possible to formulate restrict definition of economics. We
accept definition of economics if it is related with
a) Human activities,
b) Activities related with wealth getting and using- more specifically, production,
distribution, consumption etc. Thus it is concerned with activities which can be
quantified.
c) Scarcity
d) Human Welfare- maximization of social welfare
Conclusion: Therefore economics is a science which studies human behaviour in relation
to optimizing allocation of available resources to achieve the given end (result or target).

Economics is about:
f) Choices & Decision- You have taken decision to study Engineering. You have
other options too but you go for your choice. Why you opted for Engineering?
This answer will be given by economics. Since you have to use your scarce
resources (time and money) which are limited.
g) Human action- Purposeful behaviour (why you selected Engg?)Here you will
have some purpose of doing engineering like getting good job, better lifestyle etc
h) Scarcity- Most fundamental in economics is scarcity. If any thing is scarce it is
subject to economics.
i) Tradeoff- In economics you trade off between different resources by choosing one
resource and giving up other resource or increasing consumption of one necessary
thing and decreasing the use of other unimportant resource to reach the optimum
level of combination for best satisfaction.
j) Marginal Analysis- We use marginal analysis to make choices and decision.
Objective is to get maximum result from each additional unit of resources.

Important Concepts of Economics: Some Important concepts of Economics are:

8. Goods
9. Wealth, Capital and Income
10. Money
11. Value and Price
12. Equilibrium
13. Consumption and Wants
14. Slope or Rate of Change

1. Goods: The human wants are the starting point of all economic activity. There are two
things with which he can satisfy these wants – goods and services. Goods mean the
commodities that we use, and services refer to the work that a person may do. Services
are not something tangible or concrete. Generally “goods” refer to those material and
non-material objects which satisfy human wants. But in economics, the term is used in a
narrow sense. For our purpose the “goods” includes only those material objects which
possess the following characteristics.
(i) These can be transferred from one person to another and
(ii) These can be exchanged for one another.
The most important classification of goods is as Free goods and Economic goods.
Free goods are those that exist in plenty that you can with out any payment. E.g. Air,
Water, sunshine, etc
Economic goods are those goods which are scare and exist in limit quantity, man can
have it by paying for the goods. E.g. T.V., Washing machine, mobile phone etc., It can be
further classified into: (i) Consumer goods and (ii) Producer goods (also known as
Capital goods).
(i) Consumer goods: are those goods which directly satisfy human wants, e.g. food,
cloths, house etc. It can be classified into (a) Durable goods (b) Single-use goods
(a) Durable goods: The goods that can be consumed a number of times without
any damages to its utility and its life time is more e.g. furniture, shoes, t.v, etc
(b) Single-use (Non Durable) goods: The goods have limited life and it gets
destroyed as soon as they are consumed e.g. food, cold drinks, vegetables, fruits etc.
(ii) Producer goods (Capital goods): these goods that help in further production and
may durable goods like machines, tools, etc and single use goods like raw materials, coal,
fuel, etc.

2. Wealth, Capital and Income:

Wealth is the stock of all those objects-material or immaterial– which possess the
following characteristics,
(i) it must have utility
(ii) it must be scarce
(iii) it must be transferable
(iv) it must be external to human being
All the economic goods possess the above characteristics; a stock of such goods will be
called wealth. Some immaterial objects like goodwill also form part of wealth. These are
known as immaterial wealth. Wealth can be classified into four as follows:
(v) Personal Wealth- like buildings, ornaments, cloths etc
(vi) Social wealth- like roads, bridges, public hospitals, etc
(vii) National wealth- mines, forests, rivers, etc
(viii) International wealth- like international sea- routes, air-routes etc.

Capital: It is the part of wealth which is used in the process of production like tools,
machinery, raw materials, etc., it would be seen that all capital is wealth but all wealth is
not capital.

Income: The earnings received by various factors of production- land, labour, capital and
organisation- according to a time schedule are called income. It is obtained by producing
goods, performing services or by services or by investing.

3. Money: Money is anything that is generally acceptable as a medium of exchange and

acts as a measure of value. It is accepted in payment of goods and services. It is given and
received without reference to the standing of the person who offers it as payment. It is
classified as
(i) Cash money- it includes currency notes and coins
(ii) Bank money- it consists of cheques, drafts, bills of exchange, etc.

4. Value and Price: The term ‘value’ is used to express the utility or usefulness of a
commodity or services; the term ‘price’ is used to explain the units of money required to
purchase the commodity.
5. Equilibrium: The word Equilibrium has been borrowed from Physics. It is very
frequently used in modern economic analysis. Equilibrium means a state of balance.
When forces acting in opposite direction are exactly equal, the object on which they are
acting is said to be in a state of equilibrium. It also refers to a state when a situation is
ideal or optimum or when complete adjustment has been made to changes in an economic
situation, there is no incentive for any more change, so that no advantage can be obtained
by making a change. For e.g. A consumer is said to be in an equilibrium position when he
is deriving maximum satisfaction.

A producer or a firm is said to be in equilibrium when it is making a maximum profit or

incurring a minimum loss, here there will be no inducement to change.

6. Consumption and Wants:

Consumption means the using up of goods and services in such a manner that the
wants of members of the community are satisfied, thus it may be defined as any
economic activity directed to satisfy human and his wants. If any goods are destroyed by
unforeseen accidents like earthquake, flood, wars etc it is not consumption as there is no
economic purpose is served. It is divided as Consumption of goods- there is always a
time gap between production and consumption and Consumption of services- services are
consumed the moment they are produced.
Wants means a wish or a desire. Which plays a vital role in the economic life are
those which have an urge to effort and which find their satisfaction through that effort.
Wants differ in their intensity, it can be conveniently classified into three categories as (a)
Necessaries (b) Comfort (c) Luxuries.

7. Slope or Rate of Change: The concept of slope or rate of change is essential to gain
an understanding of many economic principles. The slope, of a line or curve is defined as
the rise / run or ∆Y / ∆X, where delta (∆) refers to a ‘change in’

The slope of a line is a rate of change.

Basic Economic Problem:

From the study of the essential processes of an economy, it would appear that some
fundamental problems arise whatever the type of economy. An economy exists because
of two basic facts,
3. Human wants for goods and services are unlimited
4. Productive resources with which to produce goods and services are scare.

Wants are unlimited and resources are limited, the economy has to decide how to use its
scarce resources to give the maximum possible satisfaction to the members of the society.
In doing so, an economy has to solve some basic problems called central problems of an
economy, which are:
4. WHAT to Produce
 5. HOW to Produce
6. FOR WHOM to Produce

What ever the type of economy or economic system, these problems has to be solved
some how. These are the basic and fundamental for all economies.

1. WHAT to Produce:
The problem ‘what to produce’ can be dived into two related questions.
a. Which goods are to be produced and which not?
b. What quantities those goods, which the economy has decided to produce,
are to be produced?
If productive resources were unlimited we could produce as many numbers of
goods as we like.
If the resources are in fact scarce relative to human wants, an economy must
choose among different alternative collections of goods and services that it should
produce.
E.g. If it is desired to produce more wheat and less cotton, land use will have to
get diverted for cultivation of cotton to wheat.

2. HOW to Produce:
• The problem ‘how to produce’ means which combination of resources is
to be used for the production of goods and which technology is to be made use
of in production.
• Once the society has decide what goods and services are to be produced
and in what quantities, it must then decide how these goods shall be produced.
There are various alternative methods of producing a good and the economy has
to choose among them. It is always possible to employ alternative techniques of
production to produce a commodity, e.g. labour can more generally, be
substituted by machines, and vice- versa.
• A choice would have to be made say between labour- intensive techniques
and capital- intensive techniques of production.
• E.g. Bricks and cement can be carried by labour to the upper floors of a
building under construction. Alternatively elevators and lifts can do the job; we
have to make the choice.

3. FOR WHOM to Produce:

• ‘For whom to produce’ it means how the national product is to be
distributed among the members of the society, who should get how much of the
total amount of goods and services produced in the economy.
• The third problem of sharing of the national product, Distribution of
the national product depends on the distribution of national income. Those
people who have larger incomes would have larger capacity to buy goods and
hence will get greater share of goods and services. Those, who have low
incomes would have less purchasing power to buy things. The more equal is the
 distribution of income, the more equal will be the distribution of the national
product.
The question arises how is the national income to be distributed, that is, how is it to be
determined as to who should get how much of the national income? Should the people
get equal incomes and hence equal shares from the national product, or whether the
distribution f national income should be done on the basis of the Marxian principle ‘from
each according to his ability, to each according to his needs’ or should the distribution of
national income be in accordance with the contribution made to the total production, that
is, should everybody get income exactly equal to what he produces?
The main difficulty in the question of distribution of national product or income is how to
reconcile the equity and justice aspect of distribution with the incentive aspect. From the
point of view of equity distribution of national product or income n the basis f equality
seems to be the best that the problem is that equality in the distribution of national
product or income may adversely affect the incentive to produce more. If this incentive is
destroyed or greatly diminished as a result of promoting equality, the total national output
available for sharing may be so much smaller that the living standards of all may go
down.

The Micro Economics and Macro Economics:

Economic analysis is of two types (a) Micro economic analysis and (b) Macro economic
analysis
1. Micro economics:
According to E. Boulding, “Micro economics is the study of particular firm,
particular household, individual price, wage, income, industry, and particular
commodity.”
In the words of Leftwitch, “Micro economics is concerned with the economic
activities of such economic units as consumers, resource owners and business firms.”
o ‘Micro’ is a Greek word means ‘small’
o Micro economic theory studies the behaviour of individual decision-making
units such as consumers’ resource owners, business firms, individual
households, wages of workers, etc
o It studies the flow of economic resources or factors of production from the
resource owners to business firms and the flow of goods and services from the
business firms to households. It studies the composition of such flows and
how the prices of goods and services in the flow are determined.
o In this analysis economists pick up a small unit and observe the details of its
operation.
o It provides analytical tools for the study of the behaviour of market
mechanism.
o It is also called as Price theory and
o It is also called as Partial Equilibrium analysis.

Importance of Micro economics:

o Micro economics occupies a very important place in the study of economic
theory.
 o It has both theoretical and practical importance.
o It explains the functioning of a free enterprise economy
o It tells how millions of consumers and producers in an economy take
decisions about the allocation of productive resources among millions of
goods and services.
o It explains how through market mechanism goods and services produced in
the community are distributed
o It explains the determination of the relative prices of the various products and
productive services.
o It helps in the formulation of economic policies calculated to promote
efficiency in production and the welfare of the masses.

Limitations:
 It cannot give an idea of the functioning of the economy as a whole. An
individual industry may be flourishing, where as the economy as a whole may
be languishing
 It assumes full employment which is a rare phenomenon, at any rate in the
capitalist world. Therefore it is an unrealistic assumption

2. Macro economics:

According to E. Boulding “Macro economics deals not with individual quantities

as such but with aggregates of these quantities, not with individual income but with
national income not with individual prices but with price levels, not with individual
outputs but with national output.”
According to Gardner Ackely, “Macro economics concerns with such variables as
the aggregate volume of the output of an economy, with the extent to which its resources
are employed, with the size of national income and with the general price level.”
• Macro economics is the obverse of microeconomics.
• It is the study of economic system as a whole.
• It studies not one economic unit like a firm or an industry but the whole economic
system
• Therefore it deals with totals or aggregates national income output and
employment, total consumption, saving and investment and the genera level of
prices.
• It is also called as Income theory and
• It is also called as aggregative economics.

Importance:

 It helps in understanding the functioning of a complicated economic system

 It gives a bird’s eye view of the economic world
 For the formulation of useful economic policies for the nation macro economics is
of the utmost significance.
  It is far more fruitful to regulate aggregate employment and national income and
to work out a national wage policy
 It occupies most important place in economic theory in its pursuit of the solution
of urgent economic problems.

Limitations:
o Individual is ignored altogether. It is individual welfare which is the main aim of
economics.
o It overlooks individual differences. Say the general price level may be stable, but
the price of food grains may have gone spelling ruin to the poor.

Difference between Micro economics and Macro economics:

The main differences between micro economics and macro economics are the following:
S.n Micro economics Macro economics
o
1. Difference in the degree It studies the individual units of It deals with aggregates like
of aggregation: the economy like a firm, a national income and aggregate
particular commodity. savings. It studies the problem
of the economy as a whole
2. Difference in objectives It is to study of principles, It studies the problems, policies
problems and policies concerning and principles relating full
the optimum allocation of employment of resources and
resources growth of resources.
3. Difference of subject It deals with the determination of It is full employment, national
matter price, consumer’s equilibrium, income, general price-level,
distribution and welfare, etc. trade cycles, economic growth,
etc.
4. Method of study Micro economics laws establish Macro economics elements are
relationship between the causes categorized into aggregate units
and effects of economics like aggregate demand,
phenomena and it is formulated aggregate supply, total
by taking some assumptions. consumption, total investment,
etc.
5. Different assumptions It analysis how production and It analysis how full employment
factors of production are can be achieved.
allocated among different uses.
6. Difference of the forces of It studies the equilibrium It deals with equilibrium
equilibrium between the forces of individual between the forces demand and
demand and supply or market supply of whole economy.
demand and supply.

Nature of Economics:
Economics as Science: Science is a systemized body of knowledge about a particular
branch of the universe which contains theories and principles, which are based on cause
and effect relationship and are universal in nature. Similarly economics is a science, since
it is a systemized body of knowledge about economic activities.
As science is based on facts, economics is also based on facts which are examined by
economists. As science it uses theories, principles and mathematical tools.
Like science it also go through collection of data, observations of the information,
examining these information, explaining and finally verifying them.
Economics as an Arts: According to JM Keynes,” an arts is a system of rules for
attainment of given ends”. It implies that art is practical. An art is also defined as
collection or body of rules for the execution of external work. Applying this definition we
can also say that economics is an art. Branches like Consumption, Production and Public
Finance provide practical guidance to solve economic problems.
A science teaches us to know while an arts teaches us to do, in other words a science is
theoretical and an arts is practical. Applying this definition, economics is an art. Since
branches like production, consumption provides practical guidance to solve economics
problems.
In words of Samuelson “Economics is the oldest of the arts, the newest of science –
indeed queen of all social science”.

Economics as Positive (Descriptive) Science: Positive science is a systemized

knowledge concerning ‘what is’. It describes things the way they are, that is why they are
called descriptive science.
Classical economist proposed economics should be concerned only with ‘what it is’.
They should not pass moral judgments. If they will do, ethical issues will be involved and
this will lead to disagreement of economists’ theory and finally no growth of economics.
Moral judgments many times may be wrong in practical situation.
Economics as a Normative Science: Normative science is a body of systemized
knowledge relating to the criteria of “what ought to be”. Challenging the view of classical
school, Alferd Marshall put the argument that economics is a normative science, since it
has norms (welfare). It deals with “what ought to be”. Economists must tell what should
be done and what should be avoided. It is realistic and human in nature.
Economics as Social Science: Economics is a social science which suggests that modes
of promotion of economic welfare with limited means. It can be a great service to
mankind. It can help person to get maximum welfare from limited resources.

Significance of Economics:

Economics is useful not only to individual but also to business firms, society and nation
as a whole. Economics provides tools which can be used for solving various household,
business and nations problem. Knowledge of economics is useful in almost all sphere of
life. Our day starts with application of economics policies and ends by it directly or
indirectly.
It helps businessmen in his various decisions making with regard to price, cost, and
production etc. Similarly for policy maker it helps in formulating appropriate policies for
economy.
Importance for Individuals- On individual level the use of economical tools is vital.
Since an individual has a limited source of income and the desire and requirements of his
family are unlimited. A housewife faces a difficult task to manage her family in a fixed
income. Thus an individual has to use economic tools to get optimum out put from his/
her limited source. He/ she have to regularly tradeoff between options available and
maximization of satisfaction with given source of income. Theory of opportunity cost &
marginal utility are frequently used by an individual.

Importance for a Businessmen- For any firm it is not possible to run business without
using economic theories and principles. Managerial economics is an important tool for
any business establishment while making any decision. Some of the important tools of
economics used by managers are- law of demand, law of production, law of consumer
behaviour, elasticity of demand and supply, theory of firm and many popular other
principles and policies. Some time they have to use macroeconomics too to understand
external environments and government policies which are very important for their
business.

Importance for Nation- Macroeconomics has a significant role in the growth of any
nation. Government uses different macro economical policies and theories for effective
use of various resources for economic growth of the nation and for raising standard of
living of people. Problem like employment, national income, inflation and growth of
economy in total are solved by suitable macroeconomics tools. Fiscal, monetary,
Industrial, Exim policies are governed by economic theories and these policies are used
for the development of nation as whole.

Managerial Economics:

In reality decision making is not so easy because the economic world is very complex
and most economic decisions have to be taken under the condition of imperfect
knowledge, risk and uncertainties.
Therefore taking an appropriate decision or making an appropriate choice in a extremely
complex situation is very difficult task.
In their endeavour to study the complex decision making process, economists have
developed a large kit of analytical tools and techniques with the support of mathematics
and statistics. They have developed a large corpus of economic theories with a fairly high
predictive power. Analytical tools, techniques, theories and laws are used in business
decision making and are dealt in separate branch known as managerial economics.
Therefore :-
Managerial economics is a discipline which deals with the application of economic
theory to business management. It deals with the use of economic concepts and
principles of business decision making. Formerly it was known as “Business Economics”
but the term has now been discarded in favour of Managerial Economics.

Managerial Economics may be defined as the study of economic theories, logic and
methodology which are generally applied to seek solution to the practical problems of
business. Managerial Economics is thus constituted of that part of economic knowledge
or economic theories which is used as a tool of analysing business problems for rational
business decisions. Managerial Economics is often called as Business Economics or
Economic for Firms.

Managerial Economics is concerned with application of economic concept, theories to

the problems of formulating rational decision making. It is an integration of economic
theories and business practices for the purpose of facilitating decision making and
forward planning by management. It is concerned with the application of economic
principles and methodologies to the decision making process with in the firm or
organization.

Definition of Managerial Economics:

“Managerial Economics is economics applied in decision making. It is a special branch of

economics bridging the gap between abstract theory and managerial practice.” – Haynes,
Mote and Paul.
“Business Economics consists of the use of economic modes of thought to analyse
business situations.” McNair and Meriam
“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.” – Spencer and Seegelman.
“Managerial economics is concerned with application of economic concepts and
economic analysis to the problems of formulating rational managerial decision.” –
Mansfield

Nature and Scope of Managerial Economics:

The primary function of management executive in a business organisation is decision

making and forward planning. Decision making and forward planning go hand in hand
with each other.
Decision making means the process of selecting one action from two or more alternative
courses of action. Forward planning means establishing plans for the future to carry out
the decision so taken.
The problem of choice arises because resources at the disposal of a business unit (land,
labour, capital, and managerial capacity) are limited and the firm has to make the most
profitable use of these resources. The decision making function is that of the business
executive, he takes the decision which will ensure the most efficient means of attaining a
desired objective, say profit maximisation. After taking the decision about the particular
output, pricing, capital, raw-materials and power etc., are prepared. Forward planning and
decision-making thus go on at the same time.

A business manager’s task is made difficult by the uncertainty which surrounds business
decision-making. Nobody can predict the future course of business conditions. He
prepares the best possible plans for the future depending on past experience and future
outlook and yet he has to go on revising his plans in the light of new experience to
minimise the failure. Managers are thus engaged in a continuous process of decision-
making through an uncertain future and the overall problem confronting them is one of
adjusting to uncertainty. In fulfilling the function of decision-making in an uncertainty
framework, economic theory can be, pressed into service with considerable advantage as
it deals with a number of concepts and principles which can be used to solve or at least
throw some light upon the problems of business management e.g. to profit, demand, cost,
pricing, production, competition, business cycles, national income etc. The way
economic analysis can be used towards solving business problems, constitutes the
subject-matter of Managerial Economics.

There are a number of issues relevant to businesses that are based on economic
thinking or analysis. Examples of questions that managerial economics attempts to
answer are:
What determines whether an aspiring business firm should enter a particular
industry or simply start producing a new product or service? Should a firm continue to be
in business in an industry in which it is currently engaged or cut its losses and exit the
industry? Why do some professions pay handsome salaries, whereas some others pay
barely enough to survive? How can the business best motivate the employees of a firm?
The issues relevant to managerial economics can be further focused by expanding
on the first two of the preceding questions. Let us consider the first question in which a
firm (or a would-be firm) is considering entering an industry. For example, what led
Frederick W. Smith the founder of Federal Express, to start his overnight mail service? A
service of this nature did not exist in any significant form in the United States, and people
seemed to be doing just fine without overnight mail service provided by a private
corporation. One can also consider why there are now so many overnight mail carriers
such as United Parcel Service and Airborne Express. The second example pertains to the
exit from an industry, specifically, the airline industry in the United States. Pan Am, a
pioneer in public air transportation, is no longer in operation, while some airlines such as
TWA (Trans World Airlines) are on the verge of exiting the airlines industry. Why, then,
have many airlines that operate on international routes fallen on hard times, while small
regional airlines seem to be doing just fine? Managerial economics provides answers to
these questions.
In order to answer pertinent questions, managerial economics applies economic
theories, tools, and techniques to administrative and business decision-making. The first
step in the decision-making process is to collect relevant economic data carefully and to
organize the economic information contained in data collected in such a way as to
establish a clear basis for managerial decisions. The goals of the particular business
organization must then be clearly spelled out. Based on these stated goals, suitable
managerial objectives are formulated. The issue of central concern in the decision-
making process is that the desired objectives be reached in the best possible manner. The
term "best" in the decision-making context primarily refers to achieving the goals in the
most efficient manner, with the minimum use of available resources—implying there be
no waste of resources. Managerial economics helps the manager to make good decisions
by providing information on waste associated with a proposed decision.

Chief Characteristics of Managerial Economics:

• It is Micro in Nature- It is an extension of Microeconomics, where we discuss

about an individual firm.
• Use Market theory-It largely uses theory of private firm and general market.
• Goal Oriented- Managerial Economics is used in decision making to reach a
particular goal.
• Science & Arts- Analysis and experiments are done then it is applied and
practiced.
• Normative Science- Decision is taken for what it ought to be.
• Pragmatic Approach- It is a practical subject, manager does not follow 100 %
theory and principles of managerial economics always, rather it incorporates the
practical complications prevailing at that point of time. Since in economic theory
some assumptions are always there and it is not necessary that these assumptions
are always applicable.
• Use Some Theory of Macroeconomics- The Manager should be aware about the
macro level information too e.g. rate of inflation, growth of economy, government
policies in relation to that particular product or industry, since these factors affect
individual firm. Therefore use of macroeconomics by a decision maker in
managerial economics is a common practice.

Scope of Managerial Economics:

The name managerial economics suggest that it includes that part of economics that is
essential for a manager of a firm to run his business in most profitable and smooth way.
Running business means making decision by choosing best among the available
alternatives. The scope extends itself to all those areas of business where economic
consideration for decision making is essential. Since the area of business is a
continuously growing, the scope of managerial economics is not yet clearly laid out.
Even then the following fields may be said to generally fall under Managerial
Economics:

7. Demand Analysis and Forecasting

8. Cost and Production Analysis
9. Pricing Decisions, Policies and Practices
10. Profit Management
11. Capital Management
12. Sales Promotion and Marketing Strategies

These divisions of business economics constitute its subject matter.

Recently, managerial economists have started making increased use of Operation
Research methods like Linear programming, inventory models, Games theory,
queuing up theory etc., have also come to be regarded as part of Managerial
Economics.

7. Demand Analysis and Forecasting: A business firm is an economic organisation

which is engaged in transforming productive resources into goods that are to be
sold in the market. A major part of managerial decision making depends on
accurate estimates of demand. A forecast of future sales serves as a guide to
management for preparing production schedules and employing resources. It will
help management to maintain or strengthen its market position and profit base.
Demand analysis also identifies a number of other factors influencing the demand
for a product. Demand analysis and forecasting occupies a strategic place in
Managerial Economics.

8. Cost and production analysis: A firm’s profitability depends much on its cost of
production. A wise manager would prepare cost estimates of a range of output,
identify the factors causing are cause variations in cost estimates and choose the
cost-minimising output level, taking also into consideration the degree of
uncertainty in production and cost calculations. Production processes are under
the charge of engineers but the business manager is supposed to carry out the
production function analysis in order to avoid wastages of materials and time.
Sound pricing practices depend much on cost control. The main topics discussed
under cost and production analysis are: Cost concepts, cost-output relationships,
Economics and Diseconomies of scale and cost control.

9. Pricing decisions, policies and practices: Pricing is a very important area of

Managerial Economics. In fact, price is the genesis of the revenue of a firm ad as
such the success of a business firm largely depends on the correctness of the price
decisions taken by it. The important aspects dealt with this area are: Price
determination in various market forms, pricing methods, differential pricing,
product-line pricing and price forecasting.

10. Profit management: Business firms are generally organized for earning profit
and in the long period, it is profit which provides the chief measure of success of
a firm. Economics tells us that profits are the reward for uncertainty bearing and
risk taking. A successful business manager is one who can form more or less
 correct estimates of costs and revenues likely to accrue to the firm at different
levels of output. The more successful a manager is in reducing uncertainty, the
higher are the profits earned by him. In fact, profit-planning and profit
measurement constitute the most challenging area of Managerial Economics. How
to manage the profit by taking suitable decision in a recessionary market by
taking proper action at right time is a challenging task for any business manager.

11. Capital management: The problems relating to firm’s capital investments are
perhaps the most complex and troublesome. Capital management implies
planning and control of capital expenditure because it involves a large sum and
moreover the problems in disposing the capital assets off are so complex that they
require considerable time and labour. The main topics dealt with under capital
management are cost of capital, rate of return and selection of projects.

12. Sales Promotion and Marketing Strategy: In a free and competitive market
where there is a cut throat competition, the role of marketing and sales people is
vital for the growth of any company. The team work of sales people play a major
role in the business development of the organization. Decision maker has to be
updated about the marketing strategy and planning of the competitors. They have
to adopt a sales and marketing strategy, which is suitable to nature of the product
and market situation.

Conclusion: The various aspects outlined above represent the major uncertainties
which a business firm has to reckon with, viz., demand uncertainty, cost uncertainty,
price uncertainty, profit uncertainty, and capital uncertainty. We can, therefore,
conclude that the subject-matter of Managerial Economics consists of applying
economic principles and concepts towards adjusting with various uncertainties faced
by a business firm.

Basic Economical Tools Used By Managerial Economists:

Tools of managerial economics can be used to achieve virtually all the goals of a business
organization in an efficient manner.

The following are the frequently used economical tools by Business Managers.
6. Principle of Scarcity: Economics is the study of how scarce resources are used
to satisfy human wants which are unlimited. The fundamental problem is to
economies the use of resources to satisfy as many wants as possible. It is the
scarcity or short supply of resources which dictates us to make a choice
between alternatives.
 7. Opportunity Cost principle: The cost involved in any decision consists of the
sacrifices of alternative required by that decision. If there is no alternative, so
no sacrifices, there are no opportunity costs. In taking managerial decision,
Opportunity cost is quite relevant.
8. Marginalism: Manager has to take into consideration the additional return by
making additional investment. Economists use term ‘marginal’ for all such
additional magnitute of output. A manager can expand production to a level
where marginal revenue is at least equal to marginal cost.
9. Discounting Principal: Managerial economists use this principle to find out
the current value of future output or future flow of funds. Since the value of
money (Purchasing power of money) decreases with the growth of period, the
value of money received in future has to be discounted to know its current
value, so that it can be compared with the fund invested at that time. If the
cash inflow is more than outflow by a required margin only then decision will
be taken in favour of that project.
10. Equi-Marginal Principle: It says that an input should be allocated in such a
way that the value added by the last unit of input is the same in all its uses.
This generalized law is known as equi-marginal principle. Let us take an
example of a firm having workers active in three duties- production of bottled
milk, butter & cheese. The firm must allocate these workers in such a way that
the productivity of last worker (marginal) should be same in all duties. Like is
a marginal worker is adds worth of Rs.100/- of bottled milk then marginal
worker employed on butter and cheese should also earns worth of Rs.100/- by
adding output. The additional out put worth of Rs.100/- produced by marginal
worker is called “Value of Marginal Product” (VMP). VMP of activities a, &c
be should be same i.e. VMPa=VMPb=AMPc.

Specific Function of Managerial Economists:

It should be noted that the application of managerial economics is not limited to profit-
seeking business organizations. Tools of managerial economics can be applied equally
well to decision problems of nonprofit organizations. Mark Hirschey and James L.
Pappas cite the example of a nonprofit hospital. While a nonprofit hospital is not like a
typical firm seeking to maximize its profits, a hospital does strive to provide its patients
the best medical care possible given its limited staff (doctors, nurses, and support staff),
equipment, space, and other resources. The hospital administrator can use the concepts
and tools of managerial economics to determine the optimal allocation of the limited
resources available to the hospital. In addition to nonprofit business organizations,
government agencies and other nonprofit organizations (such as cooperatives, schools,
and museums) can use the techniques of managerial decision making to achieve goals in
the most efficient manner.
While managerial economics is helpful in making optimal decisions, one should be aware
that it only describes the predictable economic consequences of a managerial decision.
For example, tools of managerial economics can explain the effects of imposing
automobile import quotas on the availability of domestic cars, prices charged for
automobiles, and the extent of competition in the auto industry. Analysis of managerial
economics will reveal that fewer cars will be available, prices of automobiles will
increase, and the extent of competition will be reduced. Managerial economics does not
address, however, whether imposing automobile import quotas is good government
policy. This latter question encompasses broader political considerations involving what
economists call value judgments.

Some of the important functions of Managerial Economists are as follows:

• Sales Forecasting
• Market Research
• Analysis of competitive firms
• Pricing Decision
• Evaluation of Capital and Projects
• Security and Investment Analysis
• Production and Inventory control
• Environmental Forecasting
• Social Responsibility of Corporate
• Corporate policies related with corporate structure ( merger,
acquisition, joint venture, takeover etc.)

Science Technology and Managerial Economics:

Science: “ Science is a systemized body of knowledge pertaining to a particular field of

enquiry”. Main features of science are-
e) Systemised body of knowledge
f) Scientific method of observation
g) Test of validity
h) Universal application

Engineering: Engineering involves application of scientific knowledge for the

betterment of quality of life. According to “Engineers council for Professional
Development” Engineering is the profession in which knowledge of mathematics and
natural sciences, gained by study, experience & practices are applied with judgment to
develop ways to utilize economically, material and forces for the benefit of mankind.
Engineers facilitates in economic development in two ways-
c) Mechanisation of production process
d) Development of Infrastructure

Technology: Technology refers to the body of knowledge, skills and procedures for
preparing, using and doing useful things.

Role of Science and Technology in Economic Development:

f) Utilisation of Natural Resources- full utilization of Natural resources or wealth of
any country was only possible with the development of science and technology.
 g) Increased efficiency- With low input to produce high output is not feasible
without the use of technology.
h) Factor Substitution- depending on availability of factors, engineers can substitute
one factor from another by using technology. Sea water can be converted into
drinking water by use of technology.
i) Overcoming Scarcity- Growing rice in desert is possible with help of technology.
Similiarly eliminating wastage and increasing production with low raw material
or input is only possible with the help of science and technology.
j) Self Reliance- with the use of science and technology any country can reach to the
goal of self reliance , like India reach to the self reliance after independence in
agriculture products with the introduction of Green Revolution where we used
scientific method of agriculture instead of using the tradition method of farming.

WHY DO ENGINEERS NEED TO LEARN ABOUT ECONOMICS?

Ages ago, the most significant barriers to engineers were technological. The
things that engineers wanted to do, they simply did not yet know how to do, or hadn't yet
developed the tools to do. There are certainly many more challenges like this which face
present-day engineers. However, we have reached the point in engineering where it is no
longer possible, in most cases, simply to design and build things for the sake simply of
designing and building them. Natural resources (from which we must build things) are
becoming scarcer and more expensive. We are much more aware of negative side-effects
of engineering innovations (such as air pollution from automobiles) than ever before.
For these reasons, engineers are tasked more and more to place their project ideas
within the larger framework of the environment within a specific planet, country, or
region. Engineers must ask themselves if a particular project will offer some net benefit
to the people who will be affected by the project, after considering its inherent benefits,
plus any negative side-effects (externalities), plus the cost of consuming natural
resources, both in the price that must be paid for them and the realization that once they
are used for that project, they will no longer be available for any other project(s).
Simply put, engineers must decide if the benefits of a project exceed its costs, and
must make this comparison in a unified framework. The framework within which to
make this comparison is the field of engineering economics, which strives to answer
exactly these questions, and perhaps more. The Accreditation Board for Engineering and
Technology (ABET) states that engineering "is the profession in which a knowledge of
the mathematical and natural sciences gained by study, experience, and practice is
applied with judgment to develop ways to utilize, economically, the materials and forces
of nature for the benefit of mankind".
It should be clear from this discussion that consideration of economic factors is as
important as regard for the physical laws and science that determine what can be
accomplished with engineering.
Physical Environment : Engineers produce products and services depending on
physical laws (e.g. Ohm's law; Newton's law).
Physical efficiency takes the form:
system output(s)
Physical (efficiency ) = -------------------
system input(s)
 Economic Environment : Much less of a quantitative nature is known about
economic environments -- this is due to economics being involved with the actions of
people, and the structure of organizations.
Satisfaction of the physical and economic environments is linked through
production and construction processes. Engineers need to manipulate systems to achieve
a balance in attributes in both the physical and economic environments, and within the
bounds of limited resources.

Following are some examples where engineering economy plays a crucial

role:
• Choosing the best design for a high-efficiency gas furnace
• Selecting the most suitable robot for a welding operation on an automotive
assembly line
• Making a recommendation about whether jet airplanes for an overnight
delivery service should be purchased or leased
• Considering the choice between reusable and disposable bottles for high-
demand beverages
With items 1 and 2 in particular, note that coursework in engineering should
provide sufficient means to determine a good design for a furnace, or a suitable robot for
an assembly line, but it is the economic evaluation that allows the further definition of a
best design or the most suitable robot.
In item 1 of the list above, what is meant by "high-efficiency"? There are two
kinds of efficiency that engineers must be concerned with. The first is physical
efficiency, which takes the form:
System output(s)
Economic (efficiency) = -----------------
System input(s)
For the furnace, the system outputs might be measured in units of heat energy,
and the inputs in units of electrical energy, and if these units are consistent, then physical
efficiency is measured as a ratio between zero and one. Certain laws of physics (e.g.,
conservation of energy) dictate that the output from a system can never exceed the input
to a system, if these are measured in consistent units. All a particular system can do is
change from one form of energy (e.g. electrical) to another (e.g., heat). There are losses
incurred along the way, due to electrical resistance, friction, etc., which always yield
efficiencies less than one. In an automobile, for example, 10-15% of the energy supplied
by the fuel might be consumed simply overcoming the internal friction of the engine. A
perfectly efficient system would be the theoretically impossible Perpetual Motion
Machine!
The other form of efficiency of interest to engineers is economic efficiency,
which takes the form:
System worth
Economic (efficiency) = -----------------
System cost
You might have heard economic efficiency referred to as "benefit-cost ratio".
Both terms of this ratio are assumed to be of monetary units, such as dollars. In contrast
to physical efficiency, economic efficiency can exceed unity, and in fact should, if a
project is to be deemed economically feasible. The most difficult part of determining
economic efficiency is accounting for all the factors which might be considered benefits
or costs of a particular project, and converting these benefits or costs into a monetary
equivalent. Consider for example a transportation construction project which promises to
reduce everyone's travel time to work. How do we place a value on that travel time
savings? This is one of the fundamental questions of engineering economics.
In the final evaluation of most ventures, economic efficiency takes precedence
over physical efficiency because projects cannot be approved, regardless of their physical
efficiency, if there is no conceived demand for them amongst the public, if they are
economically infeasible, or if they do not constitute the "wisest" use of those resources
which they require.
There are numerous examples of engineering systems that have physical design
but little economic worth (i.e it may simply be too expensive!!). Consider a proposal to
purify all of the water used by a large city by boiling it and collecting it again through
condensation. This type of experiment is done in junior physical science labs every day,
but at the scale required by a large city, is simply too costly.