1.

6 Managerial Economics and Financiel Analysin

The Manager
A manager gets things done through people in an organisation. He directs the resources such as men,
materials, machines, money and technology. A manager is responsible for achieving the targeted results
The manager's task is to maximise the profits of the firm. In the process of fulfilling this task, he has to
take several decisions such as planning the production. fixing the selling price, adding a particular produc1
or dropping it from the product line, and the like. A knowledge of economics is essential for a manager to
optimise costs and revenues for the firm.

MANAGERIAL ECONOMICs DEFINED

Spencer and Siegelman define managerial economics as "the integration of economic theory with
busincss practice for the purpose of facilitating decision-making and forward planning by man.
agement"
Pappas believe that managerial
cconomics is "the application of economic theory and
n
Brigham and
methodology to business administration practice"
economics is a
observes that "managerial
fundamental academic subject seks which
3. Haguce
understand and to analyse the problems of business decision-making".
cconomics applies economic theory and metho
4. In the words of Pappas and Hirshey, managerial
Because it uses the tools and techniques of er
to business and administrative decision-making.
economics links traditionat economie
nomic analysis to solve managerial problems, managerial
tools for managerial decision-making.
with decision sciences to develop important
economics refers to the application of economic theory a
Salvatore observes that "Managerial
can achieve its aims an
thetools of of decision science to examine how an organisation
analysis
objectives most efficiently".
economics as economics applied to problem solving at th
6. Mote. Paul and Gupta view managerial
refer to issues underlying the choices and allocation
level of the firm. Here, the problems
the managers all the time
resources, which are basically
economic in nature and are faced by all
as *the study of how to direct scarce resources:
Michael R. Baye defines managerial economics
a way that most efficiently
achieves a managerial goal".
economics as 'economics applied in decision-makin
8. Haynes, Mote and Paul define managerial
between the abstract theory and the managerial practice.
They consider this as a bridge
observe that managerial economics
From the above definitions, we can

to solve the managerial problems such

efers to the application of principles of economics
minimising cost or maximising production and productivity
directs the utilisation of scarce resources in goal-oriented manner
a

seeks to understand and to analyse the problems of business decision-making

facilitates forward planning m
examines how an organisation can achieve its aims and objectives most efficiently
allocation of
'economic' issues underlying the choice and (
analyses and decides upon the economic 1ssues
levels have to find optimum solutions to such
eac
sources. The managers at all
bet
in and day-out.

Optimise means minimising costs

and maximising revenues.
 1.7
Economics
of Managerial
and Scope
Nature

ECONOMICS
MANAGERIAL from Eco-
OF Since it originates
NATURE social sciences. s a m e (or
of all the remaining the
is, perhaps, the
youngest other things
that managcrial
such as assuming
economics
Managerial features of Economics, the complexity ofthe
has the basic made to simplify simulta-
nomics, it paribus). This assumption is things are changing
ceteris many
equivalent environment-so
such a case,
the Latin in a dynamic
business
remaining the s a m e . In
under study
phenmenon cannot really
hold other things economics also
a limitation that we or value. Managerial
sets
neously. This will have a
limited purpose
made out of such a study
observations not
the
this problem from economics. (which normally does
has inherited
m a n n e r
rational
acts in a so on, and,
that the firm o r the buyer incentives and
assumed loyalties,
Further, it is advertisements, brand Unfortu-
carried away by the realistic assumption.
The buyer is be rational is not a
happen). the c o n s u m e r will such assumptions.
the innate behaviour of other than by making
therefore, understand the subject
other alternatives to
nately, there are no
consumer is a complex phenomenon.
the behaviour of a firm
or a
This is because as below:
economics are explained
other features of managerial
different
The the solutions for
economics is concerned with f nding
microeconomics Managerial microeconomics.
J Close to it is m o r e close to
of a particular firm. Thus,
managerial problems macroeconomic
conditions of the economy

the backdrop of
macroeconomics The economist has to be
b) Operates against factors for the firm to operate. In other words(the managerial industrial policy,
inflation,
as limiting
are also seen conditions such as government
macroeconomic
by the
aware of the limits set

implies the words 'ought'

or
and so on.
usually includes or
A normative statement to do.
e Normative statements team of people ought
expressions of what a
moral attitudes and are
should. They reflect people's the economy'. Such
such as 'Government
of India should open up
or 'bad', 'right'
statements
For instance,it deals with
or
and express views of what is 'good'
statements are based on value
judgements at the facts,
statements is that they
cannot be verified by looking
with normative settled by
Wrong'. One problem future. Disagreements about
such statements are usually
mostly deal iwith the
because they
voting on them.
Given a problem and the objectives of the
Prescriptive actions Prescriptive action is goal oriented.
of actionfrom the available alternatives for optimal
solution! It does not merely
fim, it suggests the course
a given context or not. For
whether the concept can be applied in
mention the concept, it also explains
are marginal costs can be
used to judge the feasibility of an export
instance, the fact that variable costs
order.
built to reflect the real life complex business situations
and these
Models' are
(e) Applied in nature
The different areas where models are
models are help to
of immense managers for decision making.

extensively inventory control, optimisation, project management etc. In managerial econom-

used include
the alternatives and deter
ics, we also employ case study method to conceptualise the problem| identify
mine the best course of action.

(ofers seopeto evaluate each alternative Managerial economics provides an opportunity to evaluate
each alternative in terms of its costs and revenues. The managerial economist can decide which is the
better alternative to maximise the profits for the firm
 Managorlal Economics and
14C Financial Anal
Financial
) Interdiseiplinary The contonts, tools and techniqucs of managerial cconomics are Nature
lerent subjetw sueh as economien, management, mathematics, statistics, accountaney n
rgnnisational behaviour, sociology, ctc.
ountancy, psychol, the decis
4h) Assumptions and imitatioms Every conccpt and theory of managerial economics is based .. is forec=
aNwumptions and as such their validity is not universal. Where therc is change in assumptions on cer tomer ba
may not hold good at all. the the tute the

AInpu
SCOPE OF MANAGERIAL ECONOMICS profits.
costs at
The main tocus in managerial economics is to find an others ar
optimal solution to a given managerial
problem may relate to production, reduction or control of costs, determination of price of a problen addition=
addition:
or service, make or given tr innuts -
buy decisions, inventory decisions, capital management
or
profit planing, (maximi
management, investnment decisions or human resource management. While all these are the
the managerial economist makes usc of
the concepts, tools and probl the cost
related disciplines to find an techniques of economics and environr
Fig. 1.1.
optimal solution to a given managerial problem. This concept
is
explaite3. Price
different
Managerlal decision areas: nopolisti
Production The fe
Reduction or control of costs studied h
Detemination of price of a given manageer.
Concepts and product
techniques applied
or service A. Prof
of managerial Make or buy decisions
to for reductior=
economics Inventory decisions Optimum
solutions concerne
Capital management getting p
Profit planning and the produ
management
Investmentdecisions deal with
level of p
Fig. 1.1 Concepts, Decision Areas and the firm.
Optimal Solutions in Managerial accountir
Managerial economics is
Economics
exeomic decision variable, concerned with the economic 5/Inve=
certain behaviour of the firm. At
ies to maximise
profit. The assumptions are made.
For instance, we assume that the each sta nvoive C-
agerial economist functions.concept and
techniques
The economist is of economics set firm a nce h
hereas the framework within whid uses. The-
snge inm. managerial economist is concerned with
essentially concerned with analysis of the
making economy as aW expensive
The Main Areas decisions in the
contex necessar
of are com
The main areas
of
Managerial Economics /6. Econ
1. applications in managerial planning.
Demand
first task of the Decision The analysis and
economics are discussed The exter
below:
responses to
managerial economist. The forecasting of demand for price and
a
given change behavioural finance a
implications such giventheproduct
a
changes in prices, income in the and ser
levels and price supply
or
are as
needs of the market a
prices of alternativeanalysed in a scientific manner.Iecimpa of invest
products/services are assessed and o cond
u future.
Nature and Scope of Managerial Economics 1.9

thedecisions are taken to maximise the profits. Demand at different price levels at different points of time
is forecast to plan the supply accordingly and initiate changes in price, if necessary, to enlarge the cus-
tomer base and gain more profits. Determination of elasticity of demand and demand forecasting consti-
tute the strategic issues that the managerial economist handles in a scientific way.
2. Input-output Decision Here, the costs of inputs in relation to output are studied to optimise the
profits. Production function and cost functions are estimated given certain parameters. The behaviour of
costs at different levels of production is assessed here. Some costs are fixed, some are semi-variable and
others are perfectly variable. The quantity of production increases, remains constant or decreases with
additional increase in the inputs. This decision deals with changes in the production following changes in
inputs which could be substitutes or complementary. The entire focus of this decision is to optimise
(maximise) the output at minimum cost. It is necessary for the manager to know the relationship between
the cost and output both in the short-run and long-run to position his products amidst the competitive
environment.
S. Price-output Decision Here, the production is ready and the task is to determine price these in
different market situations such as perfect market and imperfect markets ranging from monopoly, mo-
nopolistic competition, duopoly and oligopoly.
The features of these markets and how price is determined in each of these competitive situations is
studied here. The pricing policies, methods, strategies and practices constitute crucial part of the study of
managerial economics.
A. Profit-related Decisions Here, we employ the techniques such as break even analysis, cost
reduction and cost control and ratio analysis to ascertain the level of profits. In break even analysis, we are
concerned with profit planning and control. We determine break even point beyond which the firm starts
getting profits. In other words, if the firm produces less than break even point, it loses. We can also plan
the production needed to attain a given level of profits in the short-nrun. Cost reduction and cost control
deal with the strategies to reduce the wastage and thereby reduce the costs. These indirectly enhance the
level of profits. Ratio analysis helps to determine the liquidity, solvency and profitability
of the activities of
the fim. There are certain ratios used to analyse and interpret the profitability of the firm given a set of
accounting data.
5/Investment Decisions Investment decisions are also called capital budgetingdecisions, These
fnvolve commitment of large funds, which determine the fate of the firm. These decisions are irreversible.
Hence the manager needs to be more attentive while committing his scarce funds, which have alternative
uses. The allocation and utilisation of the investments is of paramount importance. Capital has a cost. It is
expensive. Hence, it is to be utilised in such a way as to maximise the returm on the capital invested. It is
necessary study
to the cost of capital, choice of capital stracture and investment projects before the funds
are committed.
6. Economic Forecasting and Forward Planning Economic forecasting leads to forward
planning. The firm operates in an environment which is dominated by the external and internal factors.
The external factors include major forces such as govemment policy, competition, employment, labour,
price and income levels and so on. These influence its decisions relating to production, human resources,
finance and marketing. The internal factors include its policies and procedures relating to finance, people,
in
products. It is necessary to forecast the trends in the economy to plan for the future
terms
market and
the
investments, profits, products and markets. This will minimise the risk and uncertainty about
future.