1
Module I
BUSINESS ECONOMICS
INTRODUCTION
Managerial Economics consists of that part of economic theory which helps the business manager to take
rational decisions. Economic theories help to analyse the practical problems faced by a business firm.
Managerial Economics integrates economic theory with business practice. It is a special branch of
economics that bridges the gap between abstract theory and business practice. It deals with the use of
economic concepts and principles for decision making in a business unit It is otherwise called Business
Economics or Economics of the Firm.
The terms Managerial Economics and Business Economics are used interchangeably. The term Managerial
Economics is more in use now a-days. Managerial Economics is economics applied in business decision-
making. Hence it is also called Applied Economics.
Definition of Business Economics
In simple words, business economics is the discipline which helps a business manager in decision making
for achieving the desired results. In other words, it deals with the application of economic theory to
business management.
i. Business economics is "the integration of economic theory with business practise for the
purpose of facilitating decision-making and forward planning by management”. (Spencer and
Siegelman)
ii. "Business economics deals with the use of economic modes of thought to analyse business
situation”. (Mc Nair and Meriam )
CHARACTERISTICS OF BUSINESS ECONOMICS
The following characteristics of business economics will indicate its nature:
1. Micro economics: Managerial economics :s micro economic in character. This is so because it studies
the problems of an individual business unit. It does not study the problems of the entire economy.
2. Normative science: Managerial economics is a normative science. It is concerned with what
management should do under particular circumstances. It determines the goals of the enterprise. Then it
develops the ways to achieve these goals.
3. Pragmatic: Managerial economics is pragmatic. It concentrates on making economic theory more
application oriented. It tries to solve the managerial problems in their day-today functioning.
4. Prescriptive: Managerial economics is prescriptive rather than descriptive. It prescribes solutions to
various business problems.
5. Uses macro economics: Marco economics is also useful to business economics. Macro-economics
provides an intelligent understanding of the environment in which the business operates. Managerial
economics takes the help of macro-economics to understand the external conditions such as business
cycle, national income, economic policies of Government etc.
6. Uses theory of firm: Managerial economics largely uses the body of economic concepts and principles
towards solving the business problems. Managerial economics is a special branch of economics to bridge
the gap between economic theory and managerial practice.
, 2
7. Management oriented: The main aim of managerial economics is to help the management in taking
correct decisions and preparing plans and policies for future. Managerial economics analyses the problems
and give solutions just as doctor tries to give relief to the patient.
8. Multi disciplinary: Managerial economics makes use of most modern tools of mathematics, statistics
and operation research. In decision making and planning principles such accounting, finance, marketing,
production and personnel etc.
9. Art and science.-Managerial economics is both a science and an art. As a science, it establishes
relationship between cause and effect by collecting, classifying and analyzing the facts on the basis of
certain principles. It points out to the objectives and also shows the way to attain the said objectives.
OBJECTIVES OF BUSINESS ECONOMICS
Managerial economics provides such tools necessary for business decisions. Managerial economics
answers the five fundamental problems of decision making. These problem are : (a) what should be the
product mix (b) which is the least cost production technique and input mix (c) what should be the level of
output and price of the product (d)how to take investment decisions (e) how much should be the selling
cost. In order to solve the problems of decision- making, data are to be collected and analysed in the light
of business objectives. Business economics supplies such data to the business economist.
As pointed out by Joel Dean "The purpose of managerial economics is to show how economic analysis can
be used in formulating business policies"
Main Objectives
1. To integrate economic theory with business practice.
2. To apply economic concepts: and principles to solve business problems.
3. To employ the most modern instruments and tools to solve business problems.
4. To allocate the scarce resources in the optimal manner.
5. To make overall development of a firm.
6. To help achieve other objectives of a firm like attaining industry leadership, expansion of the market
share etc.
7. To minimise risk and uncertainty
8. To help in demand and sales forecasting.
9. To help in operation of firm by helping in planning, organising, controlling etc.
10. To help in formulating business policies.
11. To help in profit maximisation.
Business economics is useful because: (i) It provides tools and techniques for managerial decisions, (ii) It
gives answers to the basic problems of business management,(iii) It supplies data for analysis and
forecasting, (iv) It provides tools for demand forecasting and profit planning, (v) It guides the managerial
economist. -Thus, Business economics offers a number of benefits to business managers. It is also useful to
individuals, society and government.
, 3
SCOPE OF MANAGERIAL OR BUSINESS ECONOMICS
Managerial economics is a developing science which generates the countless problems to determine its
scope in a clear-cut way. From the following fields, we can examine the scope of business economics.
1. Demand analysis and forecasting. The foremost aspect regarding scope is demand analysis and
forecasting. A business firm is an economic unit which transforms productive resources into saleable
goods. Since all output is meant to be sold, accurate estimates of demand help a firm in minimising its
costs of production and storage A firm must decide its total output before preparing its production
schedule and deciding on the resources to be employed. Demand forecasts serves as a guide to the
management for maintaining its market share in competition with its rivals, thereby securing its profit.
2. Cost and production analysis. A firm's profitability depends much on its costs of production. A wise
manager would prepare cost estimates of a range of output, identify the factors causing variations in costs
and choose the cost-minimising output level, taking also into consideration the degree of uncertainty in
production and cost calculations. Production process are under the charge of engineers but the business
manager works to carry out the production function analysis in order to avoid wastages of materials and
time. Sound pricing policies depend much on cost control. The main topics discussed under cost and
production analysis are: Cost concepts, cost-output relationships, Economies and Diseconomies of scale
and cost control.
3. Pricing decisions, policies and practices. Another task before a business manager is the pricing of a
product. Since a firm's income and profit depend mainly on the price decision, the pricing policies and all
such decisions are to be taken after careful analysis of the nature of the market in which the firm operates.
The important topics covered in this field of study are : Market Structure Analysis, Pricing Practices and
Price Forecasting.
4. Profit management. Each and every business firms are tended for earning profit, it is profit which
provides the chief measure of success of a firm in the long period. Economists 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 at different levels of output. The more successful a manager is
in reducing uncertainty, the higher are the profits earned by him. It is therefore, profit-planning and profit
measurement constitute the most challenging area of business economics.
5. Capital management. Still another most challenging problem for a modern business manager is of
planning capital investment. Investments are made in the plant and machinery and buildings which are
very high. Therefore, capital management requires top- level decisions. It means capital management i.e.,
planning and control of capital expenditure. It deals with Cost of capital, Rate of Return and Selection of
projects.
6. Inventory management: A firm should always keep an ideal quantity of stock. If the stock is too much,
the capital is unnecessarily locked up in inventories At the same time if the level of inventory is low,
production will be interrupted due to non-availability of materials. Hence, a firm always prefers to have an
optimum quantity of stock. Therefore, managerial economics will use some methods such as ABC analysis,
inventory models with a view to minimising the inventory cost.
7. Linear programming and theory of games : Linear programming and theory of games have came to be
regarded as part of managerial economics recently.
, 4
8. Environmental issues: There are certain issues of macroeconomics which also form apart of managerial
economics. These issues relate to general business, social and political environment in which a business
enterprise operates.
9. Business cycles: Business cycles affect business decisions. They refer to regular fluctuations in economic
activities in the country. The different phases of business cycle are depression, recovery, prosperity, boom
and recession. Thus, managerial economics comprises both micro and macro-economic theories. The
subject matter of managerial economics consists of all those economic concepts, theories and tools of
analysis which can be used to analyse the business environment and to find out solution to practical
business problems.
FUNDAMENTAL CONCEPTS OF APPLIED MANAGERIAL ECONOMICS
Decision making is the core of Managerial Economics. Some fundamental concepts and techniques help
the management to take correct decisions. The following are the six fundamental concepts used in
Managerial Economics:
1. Principle of opportunity cost: Every scarce goods or activity has an opportunity cost. Opportunity cost
of anything is the cost of the next best alternative which is given up. It refers to the cost of foregoing or
giving up an opportunity. It is the earnings that would be realised if the available resources were put to
some other use. It implies the income or benefit foregone because a certain course of action has been
taken. Thus opportunity costs are measured by the sacrifices made in the decision. If there is no sacrifice
involved by a decision there will be no opportunity cost. It is also called alternative cost or transfer cost.
The opportunity cost of using a machine to produce one product is the income forgone which would have
been earned from the production of other products. If the machine has only one use, it has no opportunity
cost. Similarly, the opportunity costs of funds invested in one's own business is the amount of interest
earned if the amount had been used in other projects. If an old building is proposed to be used for a
business, likely rent of the building is the opportunity cost. These are called opportunity costs because they
represent the opportunities which are foregone .Devenport, an American Economist explains the concept
of opportunity cost with reference to an example. Suppose a girl had two kinds of fruits- one pear and one
peach, and if a bad boy is after her to seize the fruits, then the best way for the girl is to drop one fruit and
run with the other, so that, she can at least save one fruit, at the cost of the other. When the girl so drops
by the way - side one fruit and runs with the other, then the opportunity cost of the fruit she saves is the
foregone alternative of the fruit she lost. Thesis the opportunity cost theory. The concept of opportunity
cost plays an important role in managerial decisions. This concept helps in selecting the best possible
alternative from among various alternatives available to solve a particular problem. This concept helps in
the best allocation of available resources.
2. Principle of incremental cost and revenue: Two important incremental concepts used in Managerial
Economics are fundamental concepts of Managerial Economics are incremental cost and incremental
revenue. Incremental cost is a change in total cost resulting from a decision. Incremental revenue means
the change in total revenue resulting from a decision. A decision is profitable only if
(i) It increases revenue more than costs,
(ii) It decreases some costs more than it increases others,
(iii) It increases some revenue more than it decreases others, and
Module I
BUSINESS ECONOMICS
INTRODUCTION
Managerial Economics consists of that part of economic theory which helps the business manager to take
rational decisions. Economic theories help to analyse the practical problems faced by a business firm.
Managerial Economics integrates economic theory with business practice. It is a special branch of
economics that bridges the gap between abstract theory and business practice. It deals with the use of
economic concepts and principles for decision making in a business unit It is otherwise called Business
Economics or Economics of the Firm.
The terms Managerial Economics and Business Economics are used interchangeably. The term Managerial
Economics is more in use now a-days. Managerial Economics is economics applied in business decision-
making. Hence it is also called Applied Economics.
Definition of Business Economics
In simple words, business economics is the discipline which helps a business manager in decision making
for achieving the desired results. In other words, it deals with the application of economic theory to
business management.
i. Business economics is "the integration of economic theory with business practise for the
purpose of facilitating decision-making and forward planning by management”. (Spencer and
Siegelman)
ii. "Business economics deals with the use of economic modes of thought to analyse business
situation”. (Mc Nair and Meriam )
CHARACTERISTICS OF BUSINESS ECONOMICS
The following characteristics of business economics will indicate its nature:
1. Micro economics: Managerial economics :s micro economic in character. This is so because it studies
the problems of an individual business unit. It does not study the problems of the entire economy.
2. Normative science: Managerial economics is a normative science. It is concerned with what
management should do under particular circumstances. It determines the goals of the enterprise. Then it
develops the ways to achieve these goals.
3. Pragmatic: Managerial economics is pragmatic. It concentrates on making economic theory more
application oriented. It tries to solve the managerial problems in their day-today functioning.
4. Prescriptive: Managerial economics is prescriptive rather than descriptive. It prescribes solutions to
various business problems.
5. Uses macro economics: Marco economics is also useful to business economics. Macro-economics
provides an intelligent understanding of the environment in which the business operates. Managerial
economics takes the help of macro-economics to understand the external conditions such as business
cycle, national income, economic policies of Government etc.
6. Uses theory of firm: Managerial economics largely uses the body of economic concepts and principles
towards solving the business problems. Managerial economics is a special branch of economics to bridge
the gap between economic theory and managerial practice.
, 2
7. Management oriented: The main aim of managerial economics is to help the management in taking
correct decisions and preparing plans and policies for future. Managerial economics analyses the problems
and give solutions just as doctor tries to give relief to the patient.
8. Multi disciplinary: Managerial economics makes use of most modern tools of mathematics, statistics
and operation research. In decision making and planning principles such accounting, finance, marketing,
production and personnel etc.
9. Art and science.-Managerial economics is both a science and an art. As a science, it establishes
relationship between cause and effect by collecting, classifying and analyzing the facts on the basis of
certain principles. It points out to the objectives and also shows the way to attain the said objectives.
OBJECTIVES OF BUSINESS ECONOMICS
Managerial economics provides such tools necessary for business decisions. Managerial economics
answers the five fundamental problems of decision making. These problem are : (a) what should be the
product mix (b) which is the least cost production technique and input mix (c) what should be the level of
output and price of the product (d)how to take investment decisions (e) how much should be the selling
cost. In order to solve the problems of decision- making, data are to be collected and analysed in the light
of business objectives. Business economics supplies such data to the business economist.
As pointed out by Joel Dean "The purpose of managerial economics is to show how economic analysis can
be used in formulating business policies"
Main Objectives
1. To integrate economic theory with business practice.
2. To apply economic concepts: and principles to solve business problems.
3. To employ the most modern instruments and tools to solve business problems.
4. To allocate the scarce resources in the optimal manner.
5. To make overall development of a firm.
6. To help achieve other objectives of a firm like attaining industry leadership, expansion of the market
share etc.
7. To minimise risk and uncertainty
8. To help in demand and sales forecasting.
9. To help in operation of firm by helping in planning, organising, controlling etc.
10. To help in formulating business policies.
11. To help in profit maximisation.
Business economics is useful because: (i) It provides tools and techniques for managerial decisions, (ii) It
gives answers to the basic problems of business management,(iii) It supplies data for analysis and
forecasting, (iv) It provides tools for demand forecasting and profit planning, (v) It guides the managerial
economist. -Thus, Business economics offers a number of benefits to business managers. It is also useful to
individuals, society and government.
, 3
SCOPE OF MANAGERIAL OR BUSINESS ECONOMICS
Managerial economics is a developing science which generates the countless problems to determine its
scope in a clear-cut way. From the following fields, we can examine the scope of business economics.
1. Demand analysis and forecasting. The foremost aspect regarding scope is demand analysis and
forecasting. A business firm is an economic unit which transforms productive resources into saleable
goods. Since all output is meant to be sold, accurate estimates of demand help a firm in minimising its
costs of production and storage A firm must decide its total output before preparing its production
schedule and deciding on the resources to be employed. Demand forecasts serves as a guide to the
management for maintaining its market share in competition with its rivals, thereby securing its profit.
2. Cost and production analysis. A firm's profitability depends much on its costs of production. A wise
manager would prepare cost estimates of a range of output, identify the factors causing variations in costs
and choose the cost-minimising output level, taking also into consideration the degree of uncertainty in
production and cost calculations. Production process are under the charge of engineers but the business
manager works to carry out the production function analysis in order to avoid wastages of materials and
time. Sound pricing policies depend much on cost control. The main topics discussed under cost and
production analysis are: Cost concepts, cost-output relationships, Economies and Diseconomies of scale
and cost control.
3. Pricing decisions, policies and practices. Another task before a business manager is the pricing of a
product. Since a firm's income and profit depend mainly on the price decision, the pricing policies and all
such decisions are to be taken after careful analysis of the nature of the market in which the firm operates.
The important topics covered in this field of study are : Market Structure Analysis, Pricing Practices and
Price Forecasting.
4. Profit management. Each and every business firms are tended for earning profit, it is profit which
provides the chief measure of success of a firm in the long period. Economists 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 at different levels of output. The more successful a manager is
in reducing uncertainty, the higher are the profits earned by him. It is therefore, profit-planning and profit
measurement constitute the most challenging area of business economics.
5. Capital management. Still another most challenging problem for a modern business manager is of
planning capital investment. Investments are made in the plant and machinery and buildings which are
very high. Therefore, capital management requires top- level decisions. It means capital management i.e.,
planning and control of capital expenditure. It deals with Cost of capital, Rate of Return and Selection of
projects.
6. Inventory management: A firm should always keep an ideal quantity of stock. If the stock is too much,
the capital is unnecessarily locked up in inventories At the same time if the level of inventory is low,
production will be interrupted due to non-availability of materials. Hence, a firm always prefers to have an
optimum quantity of stock. Therefore, managerial economics will use some methods such as ABC analysis,
inventory models with a view to minimising the inventory cost.
7. Linear programming and theory of games : Linear programming and theory of games have came to be
regarded as part of managerial economics recently.
, 4
8. Environmental issues: There are certain issues of macroeconomics which also form apart of managerial
economics. These issues relate to general business, social and political environment in which a business
enterprise operates.
9. Business cycles: Business cycles affect business decisions. They refer to regular fluctuations in economic
activities in the country. The different phases of business cycle are depression, recovery, prosperity, boom
and recession. Thus, managerial economics comprises both micro and macro-economic theories. The
subject matter of managerial economics consists of all those economic concepts, theories and tools of
analysis which can be used to analyse the business environment and to find out solution to practical
business problems.
FUNDAMENTAL CONCEPTS OF APPLIED MANAGERIAL ECONOMICS
Decision making is the core of Managerial Economics. Some fundamental concepts and techniques help
the management to take correct decisions. The following are the six fundamental concepts used in
Managerial Economics:
1. Principle of opportunity cost: Every scarce goods or activity has an opportunity cost. Opportunity cost
of anything is the cost of the next best alternative which is given up. It refers to the cost of foregoing or
giving up an opportunity. It is the earnings that would be realised if the available resources were put to
some other use. It implies the income or benefit foregone because a certain course of action has been
taken. Thus opportunity costs are measured by the sacrifices made in the decision. If there is no sacrifice
involved by a decision there will be no opportunity cost. It is also called alternative cost or transfer cost.
The opportunity cost of using a machine to produce one product is the income forgone which would have
been earned from the production of other products. If the machine has only one use, it has no opportunity
cost. Similarly, the opportunity costs of funds invested in one's own business is the amount of interest
earned if the amount had been used in other projects. If an old building is proposed to be used for a
business, likely rent of the building is the opportunity cost. These are called opportunity costs because they
represent the opportunities which are foregone .Devenport, an American Economist explains the concept
of opportunity cost with reference to an example. Suppose a girl had two kinds of fruits- one pear and one
peach, and if a bad boy is after her to seize the fruits, then the best way for the girl is to drop one fruit and
run with the other, so that, she can at least save one fruit, at the cost of the other. When the girl so drops
by the way - side one fruit and runs with the other, then the opportunity cost of the fruit she saves is the
foregone alternative of the fruit she lost. Thesis the opportunity cost theory. The concept of opportunity
cost plays an important role in managerial decisions. This concept helps in selecting the best possible
alternative from among various alternatives available to solve a particular problem. This concept helps in
the best allocation of available resources.
2. Principle of incremental cost and revenue: Two important incremental concepts used in Managerial
Economics are fundamental concepts of Managerial Economics are incremental cost and incremental
revenue. Incremental cost is a change in total cost resulting from a decision. Incremental revenue means
the change in total revenue resulting from a decision. A decision is profitable only if
(i) It increases revenue more than costs,
(ii) It decreases some costs more than it increases others,
(iii) It increases some revenue more than it decreases others, and
