Managerial Economics is the economics for managers, which helps managers to make rational business decisions using economic theories and tools under the given resources and situation of risk and uncertainty. The managers have to make several decisions, such as production decisions, pricing decisions, HR decisions, marketing decisions, and financing decisions, among many others. In order to make such a decision effective, the managers require some theories and tools as guidelines for decision-making. Such economic theories and tools are provided to the manager to make the best possible decision.
For example, the organization is facing a continuous decline in its sales over the last few quarters, so to find the reasons for such a decline in sales and a solution, the economic theories, such as consumer behavior, help to explain what determines the demand for the product and what is the best strategy to increase sales.
So, managerial economics bridges the gap between economics and management. It helps managers with day-to-day business decision-making by using economic theories and analysis tools. Managerial economics is microeconomic in nature. It is applied economics that is normative or prescriptive, helping to resolve the business problems of an organization.
Scopes of Managerial Economics
- Demand analysis and forecasting
- Production technology, cost of production, and supply analysis
- Nature of market analysis, pricing, and output decision
- Risk and uncertainty analysis and investment decision
- Factor (input) market analysis and factor pricing
- Profit analysis and profit management
- Policy and strategy making under the given macroeconomic situation and government policy
Economic Analysis and Business Decision
Economic analysis uses economic theories and tools for decision-making. It uses the economic concept, theories, and tools such as market demand and supply analysis, cost-benefit analysis, in order to make the efficient allocation of available resources by comparing the feasible alternatives.
So, the economic analysis is a comprehensive analysis of any business decision in order to make the decision most rational and relevant.
For any business decision-making, economic analysis is a must because such analysis compares the different possible alternatives using economic theories and tools. Such a decision, after the economic analysis, not only justifies the decision but also helps to optimize the objective of the organization.
The economic analysis uses economic profit as an indicator, and the business is said to be profitable and sustainable if the economic profit is positive. Since every business decision directly or indirectly affects the profit of the organization, economic analysis considers all such dimensions affecting the profit.
In the economic analysis, both explicit (direct) and implicit (indirect) costs are analyzed, and the economic profit from the business decision should be positive.
Now, the economic profit is given as
- Economic Profit = Total Revenue – Total Cost
- Or Economic Profit = Total Revenue – (Explicit Cost + Implicit Cost)
The economic profit must be positive for the decision to be acceptable. The higher the economic profit, the better the business decision.
Gap Between Theories & Practice in Managerial Economics
Managerial economics tries to bridge the gap between theory and practice, where economic theories are used to make managerial decisions. However, there still exists a gap between the theories and practice in business decisions. The following are the major reasons for the existence of a gap between theory and practice.
- Theories are based on assumptions; however, the reality may be different from such assumption which create the gap between theory and practice.
- The society is dynamic and changing over the period, where the static theories are unable to guide business decisions, which creates a gap between theory and practice.
- Theories are developed using quantitative information or proxies for the qualitative characteristics, where the business decision-making may not always be based on the quantitative factors, and the qualitative factors considered as a proxy may not represent the behavior of the management and organization.
- Some situations may emerge newly, and there may be no theories developed to address the situation, which may create a gap between theory and practice.
- The decision maker may not always be economically rational, and his/her decision may be guided by human intuition, which may be different than the economic theory.