Managerial economics is concerned with the application of economic concepts and analysis to the problem of formulating rational managerial decisions. There are four groups of problem in both decision making and forward planning.
Resource allocation: Scarce resources have to be used with utmost efficiency to get optimal results. These include production programming, problem of transportation, etc.
Inventory and queuing problem: Inventory problems involve decisions about holding of optimal levels of stocks of raw materials and finished goods over a period. These decisions are taken by considering demand and supply conditions. Queuing problems involve decisions about installation of additional machines or hiring of extra labour in order to balance the business lost by not undertaking these activities.
Pricing problems: Fixing prices for the products of the firm is an important part of the decision making process. Pricing problems involve decisions regarding various methods of pricing to be adopted.
Investment problems: Forward planning involves investment problems. These are problems of allocating scarce resources over time. For example, investing in new plants, how much to invest, sources of funds, etc.
Study of managerial economics essentially involves the analysis of certain major subjects like:
Demand analysis and methods of forecasting
Pricing theory and policies
Profit analysis with special reference to break-even point
Capital budgeting for investment decisions
The business firm and objectives
An analysis of scarcity of resources and choice making poses three basic questions:
What to produce and how much to produce?
How to produce?
For whom to produce?
A firm applies principles of economics to answer these questions. The first question relates to what goods and services should be produced and in what quantities. Demand theory guides the manager in the selection of goods and services for production. It analyses consumer behaviour with regard to:
Type of goods and services they are likely to purchase in the current period and in the future, Goods and services which they may stop consuming,
Factors influencing the consumption of a particular good or service, and
The effect of a change in these factors on the demand of that particular good or service.
A detailed study of these aspects of consumer behaviour help the manager to make product decision. At some particular time, a firm may decide to launch new goods and services or stop providing a particular good or service. Knowledge of demand elasticities helps in setting up of prices in context of revenue of a firm. Methods of demand forecasting help in deciding the quantity of a good or service to be produced.
How to produce the goods and services is the second basic question. It involves selection of inputs and techniques of production. Decisions are made with regard to the purchase of items ranging from raw materials to capital equipment. Production and cost analysis guides a manager in personnel practices such as hiring and staffing and procurement of inputs. For example, the decision to automate clerical activities using PC network results in a more capital-intensive mode of production. Capital budgeting decisions also constitute an integral part of the second basic question. Allocation of available capital in long-term investment projects can be done through project appraisal methods.
Firms’ third basic question relates to segmentation of market. A firm has to decide:
For whom it should produce the goods and services. For example, it has to decide whether to target the domestic market or the foreign market. Production of a premium good is another example of market segmentation. An analysis of market structure explains how price and output decisions are taken under different market forms.
Appropriate business decision making with the help of economic tools has gained recognition in view of complex business environment. Since the macroeconomic environment is dynamic, it changes over time; managerial decisions have to be reviewed constantly. In this context, concepts of consumer behaviour, demand elasticities, demand forecasting, production and cost analysis, market structure analysis and investment planning help in making prudent decisions.