[Business Economics, Nature and Scope of Business Economics, Managerial Economics,Business Economics Notes]
NATURE AND SCOPE OF
BUSINESS ECONOMICS
[Business Economics Notes for NEP 2023 BCOM 3rd Semester]
Meaning of Business Economics / Managerial Economics
Business Economics also known as Managerial
economics is the study of economic theories, logic and tools of economic
analysis that are used in the process of business decision making. Economic
theories and techniques of economic analysis are applied in analyze business problems;
evaluate business options and opportunities with a view to arriving at an
appropriate business decision. Managerial economics is thus constituted of that
part of economic knowledge, logic theories and analytical tools that are used
for rational business decision making.
Managerial economics is that subject which describes how economic analysis is used in taking business decisions. The purpose of Managerial Economics is to show how economic analysis can be used in formulating business policies.
Definition of Managerial Economics:
According to McNair and Meriam “Managerial
economics ……. Is the use of economics modes of thought to analyze business
situation.”
According to Mansfield: “Managerial
economics is concerned with the application of economic concepts and economics
analysis to the problems of formulating rational decision making”.
Conclusion on Business Economics:
From the above discussion we can say that Managerial economics is that
discipline which uses economic concepts, principles and economic analysis in
taking business decision and formulating future plans. It integrates economic
theory with business practice for choosing business policies. Managerial
economics lies on the borderline between economics and business management and
bridges the gap between the two.
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Table of
Contents |
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1. Meaning of Business Economics 2. Nature and Scope of Business
Economics a) Nature of Business Economics b) Scope of Business Economics 3. Importance / Significance of Business Economics 4. Basic / Central Problems of an Economy 5. Relationship between Business Economics and Economics / Traditional Economics 6. Difference between Business Economics and Economics / Traditional Economics 7. Price Mechanism b) Advantages and Disadvantages of Price Mechanism Also Read: Business Economics Multiple Choice Questions and Answers (MCQs) |
Nature and Scope of Business Economics
Characteristics or Nature of Business Economics / Managerial Economics:
a) Managerial Economics is a Science:
Managerial economics is a science because it establishes relationship between
causes and effects. It studies the effects of a change in price of a commodity
factors and forces on the demand of a particular product. It also studies the
effects and implications of the plans, policies and programmes of a firm on its
sales and profit.
b) Managerial Economics is an Art:
Managerial economics may also be called an art. Because it also develops the
best way of doing things. It helps management in the best and most efficient
utilization of limited economic resources of the firm.
c) Managerial Economics is a Micro
Economics: Entire study of economics may be divided into two segments – Macro
economics and Micro economics. Managerial economics is mainly micro-economics.
Micro economics is the study of the behaviour and problems of individual
economic unit. In managerial economics unit of study is firm or business
organization and an individual industry. It is the problem of business firms
such as problem of forecasting demand, cost of production, pricing, profit
planning, capital, management etc.
d) Managerial Economics is the
Economics of firms: Managerial economics largely use that body of economic
concepts and principles which is known as ‘Theory of the Firm’ or ‘Economics of
the Firm’.
e) Managerial Economics uses Macro
economic Analysis: Managerial economics also uses macro-economics to analysis
and understand the general business environment in which the business firm must
operate. Business management must have the adequate knowledge of external
forces that affect the business of the firm. The important macro-factors that
affect the firm are trends in national income and expenditure, business cycle,
economic policies of the government, trends in foreign trade etc.
f) Managerial Economics is Pragmatic:
It is concerned with practical problems and results. It has nothing to do with
abstract economic theory which has no practical application to solve the
problems faced by business firms.
g) Managerial Economics is Normative
Science: There are two types of science – Normative Science and Positive
Science. Positive science studies what is being done. Normative science studies
what should be done. From this point of view, it can be concluded that
managerial economics is normative science because it suggests what should be
done under particular circumstances.
h) Aims at helping the management: Managerial
economics aims at supporting the management in taking corrective decisions and
charting plans and policies for future.
i)
Prescriptive
rather than descriptive: Managerial economics is a normative and applied
discipline. It suggests the application of economic principles with regard to
policy formulation, decision-making and future planning. It not only describes
the goals of an organisation but also prescribes the means of achieving these
goals.
Scope of Business Economics / Managerial Economics
Managerial economics is the
application of economics theories in the process of decision making and
formulation of future plans. The management will have to analyze the business
problems that are faced by the firm. Thus, the principles relating to following
topics constitute the scope of subject matter of managerial economics.
1) Demand Analysis: A business
firm is in 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 Analysis: Cost estimates
are most useful for management decision. The different factors that cause
variations in cost estimates should be given due consideration for planning
purpose. There is the element of uncertainty of cost as other factor
influencing costs are either uncontrollable or not always known.
3) Pricing Practices and Policies: As
price gives income to the firm, it constitutes as the most important field of
Managerial Economics. The success of a business firm depends very much on the
correctness of the price decision taken by it. The various aspects that are
deal under it cover the price determination in various market forms, pricing
policies, pricing method, different pricing, productive pricing and price
forecasting.
4) Profit Management: The chief
purpose of a business firm is to earn the maximum profit. There is always an
element of uncertainty about profits because of variation in cost and revenue.
It knowledge about the future were perfect, profit analysis would have been
very easy task. But in this world of uncertainty expectations are not always
realized. Hence profit planning and its measurement constitute the most
difficult area of managerial economics. Under profit management we study nature
and management of profit, profit policies and techniques of profit planning like
Break Even Analysis.
5) Capital Management: The problems
relating to firm’s capital investments are perhaps the most complex and the
troublesome. Capital management implies planning and control of capital
expenditure. The main topics deal with under capital management is cost of
capital, rate of return and selection of projects.
6) Analysis of Business Environment:
The environmental factors influence the working and performance of a business
undertaking. Therefore, the managers will have to consider the environmental
factors in the process of decision-making. The factors which constitute
economic environment of a country include the following factors:
Ø Economic System of the Country.
Ø Business Cycles.
Ø Fluctuations in National Income
and National Production.
Ø Industrial Policy of the
Government.
Ø Trade and Fiscal Policy of the
Government.
Ø Taxation Policy.
Ø Licensing Policy etc.
Ø Political Environment.
Ø Social Factors.
Ø Trend in labour and capital
markets.
7) Inventory Management: It
refers to stock of raw materials which a firm keeps. If it is
high, capital is unproductively tide up which might, if stock of inventory is
reduced, be used for other productive purpose. On the other
hand, if the level of inventory is low, production will be hampered. Hence,
managerial economics with methods such as ABC analysis a simple simulation exercise
and some mathematical models with a view to minimize inventory cost.
8) Advertising: Managerial
economics helps in determining the total advertising cost and budget, the
measuring of economic effects of advertising and form an integral part of decision
making and forward planning.
9) Resource Allocation: Managerial
economics with the help of advanced tools such as linear programming are used to
arrive at the best course of action for the maximum use of the available
resources and its substitutes.
10) Risk and Uncertainty Analysis: As
business firm have to operate under conditions of risk and uncertainty
both decision making and forward planning becomes difficult.
Hence managerial economics helps the business firm in decision making
and formulating plans on the basis of past data, current information and
future prediction.
Significance / Importance of Business Economics in Managerial Decision Making
The most important function of
management of a business firms is decision making and future planning. Business
decision-making is essentially a process of selecting the best out of
alternative opportunities open to the firm. The process of decision-making comprises
following phases:-
a) Determining and defining the
objective to be achieved.
b) Developing and analyzing possible
course of action; and
c) Selecting a particular course of
action.
Advantages of Business Economics
to the management:
1) Reconciling, Theoretical Concepts
of economics to the Actual Business Behaviour and Conditions: Managerial
economics attempts to reconcile the tools, techniques, models and theories of
economics with actual business practices and with the environment in which a
firm has to operate. Analytical techniques of economic theory builds models by
which we arrive at certain assumptions and conclusions are reached thereon in
relation to certain firms. There is need to reconcile the theoretical principles
based on simplified assumptions with actual business practice and develop the
economic theory, if necessary.
2) Estimating Economic Relationship: Managerial
economics plays an important role in business planning and decision making by
estimating economic relationship between different business factors – income,
elasticity of demand like price elasticity, income elasticity, cross elasticity
and cost volume profit analysis etc. The estimates of this economic
relationship can be used for purpose of business forecasts.
3) Predicting Relevant Economic
Quantities: Sound business plans and policies for future can be formulated on
the basis of economic quantities. Managerial economics helps the management in
predicting various economic quantities such as:
Ø Cost.
Ø Profit.
Ø Demand.
Ø Capital.
Ø Production.
Ø Price etc.
Since
a business manager has to work in an environment of uncertainty, future should
be well predicted in the light of these quantities.
4) Understanding Significant External
Forces: The management has to identify all the important factors that influence
firm. These factors broadly divided into two parts – Internal Factors and
External Factors. External factors are the factors over which a firm cannot
have any control. Therefore, the plans, policies and programmes of the firm
should be adjusted in the light of these factors. Important external factors
affecting decision-making process of a firm are:
Ø Economic System of the Country.
Ø Business Cycles.
Ø Fluctuations in National Income
and National Production.
Ø Industrial Policy of the
Government.
Ø Trade and Fiscal Policy of the
Government.
Ø Taxation Policy.
Ø Licensing Policy etc.
Managerial
economics plays an important role by assisting management in understanding
these factors.
5) Basis of Business Policies: Managerial
economics is the foundation of all business policies. All the business policies
are prepared on the basis of studies and findings of managerial economics. It
warns the management against all the turning points in national as well as
international economy.
6) Clear Understanding of Economic
Concepts: It gives clear understanding of various economic concepts (i.e. cost,
price, demand etc.) used in business analysis. For example, the concept of cost
includes ‘total’ ‘average’, ‘managerial’, ‘fixed’, ‘variable’, ‘actual cost’,
and opportunity cost. Economics clarifies which cost concepts are relevant and
in what context.
7) Increases the Analytical Capabilities:
Managerial Economics provides a number of tools and methods which increases the
analytical capabilities of the business analysis.
Basic Problems of an economy or economic system or Problems of business economics
The problem of scarcity of
resources which arises before an individual consumer also arises collectively
before an economy. On account of this problem and economy has to choose between
the following:
(i) Which goods should be produced
and in how much quantity?
(ii) What technique should be
adopted for production?
(iii) For whom goods should be
produced?
These three problems are known as
the central problems or the basic problems of an economy. This is so because
all other economic problems cluster around these problems. These problems arise
in all economics whether it is a socialist economy like that of North Korea or
a capitalist economy like that of America or a mixed economy like that of
India. Similarly, they arise in developed and under-developed economics alike.
The central problems of an economy are listed below:
1. What to produce?
There are two aspects of this
problem— firstly, which
goods should be produced, and secondly, what
should be the quantities of the goods that are to be produced. The first
problem relates to the goods which are to be produced. In other words, what
goods should be produced? An economy wants many things but all these cannot be
produced with the available resources. Therefore, an economy has to choose
what goods should be produced and what goods should not be. In other words,
whether consumer goods should be produced or producer goods or whether general
goods should be produced or capital goods or whether civil goods should be
produced or defense goods. The second problem is what should be the quantities
of the goods that are to be produced.
2. How to produce?
The second basic problem is which
technique should be used for the production of given commodities. This problem
arises because there are various techniques available for the production of a
commodity such as, for the production of wheat, we may use either more of
labour and less of capital or less of labour or more of capital. With the help
of both these techniques, we can produce equal amount of wheat. Such
possibilities exist relating to the production of other commodities also.
Therefore, every economy faces the
problem as to how resources should be combined for the production of a given
commodity. The goods would be produced employing those methods and techniques,
whereby the output may be the maximum and cost of production be the minimum.
3. For whom to produce?
The main objective of producing a
commodity in a country is its consumption by the people of the country.
However, even after employing all the resources of a country, it is not
possible to produce all the commodities which are required by the people.
Therefore, an economy has to decide as to for whom goods should be produced.
This problem is the problem of distribution of produced goods and services.
Therefore, what goods should be consumed and by whom depends on how national
product is distributed among various people.
All the three central problems
arise because resources are scarce. Had resources been unlimited, these
problems would not have arisen. For example, in the event of resources being
unlimited, we could have produced each and every thing we had wanted, we could
have used any technique and we could have produced for each and everybody.
4. The problem of efficient use of resources: An economy has to face the problem of efficiently
using its resources. Production can be increased even by improving the use of
resources. Resources will be deemed to be better utilised when by reallocating
them in various uses, production of a commodity can be increased without
adversely affecting the production of other commodities.
5. The problem of fuller employment of
resources: In many economies, especially in
developing economies, there is a tendency towards under-utilisation of
resources. Resources lying idle or not being utilised fully is a recurring
problem in many economies. This problem is particularly acute in
labour-abundant economies like that of India where large scale unemployment
exists. In many economies, a vital resource like land too remains
under-utilised. Resources being relatively scarce, they should not be allowed
to remain idle as it is a waste.
6. The Problem of Growth: The last problem is of growth. Every economy strives
to increase its production for increasing standards of living of its people.
Economic growth of a country depends upon the fact as to what extent; it can
increase its resources. This problem is not confined to developing economies
alone. It is also faced by developed economies which strive for increasing
their resources in order to increase the material comforts of their technically
advanced societies
Relationship and Difference between Business Economics and Economics / Traditional Economics:
Relationship between Managerial Economics and Traditional Economics
In the words of Haynes “The
relation of managerial economics to economic theory is much like that of
engineering to physics, or of medicine to biology or bacteriology. It is the
relation of an applied field to the more fundamental but more abstract basic
discipline from which it borrows concepts and analytical tools. The fundamental
theoretical fields will no doubt on the long run make the greater contribution
to the extension of human knowledge. But the applied fields involve the
development of skills that are worthy of respect in themselves and that require
specialized training. The practicing physician may not contribute much to the
advance of biological theory but he plays an essential role in producing the
fruits of progress in theory. The managerial economist stands in a similar
relation to theory with perhaps the difference that the dichotomy between the
pure and the “applied” is less clear in management than it is in medicine.”
Managerial economics has been
defined as economics applied in decision-making. It is a special branch of
economics bridging the gap between economic theory and managerial practice. The
relationship between managerial economics and traditional economics is
facilitated by considering the structure of traditional study. The
traditional fields of economic study about theory,
Micro economics focuses on individual consumers firms and
industries. Macro economics focuses on aggregations of economics
units, especially national economics. The emphasis on normative
economics focuses on prescriptive statements that are established rules on
the specified field. Positive economics focuses on description that
describes that manner in which economics forces operate without
attempting to state how they should operate. The focus of each field of study
is sufficiently well defined to warrant the breakdown suggested.
Since each area
of economics has some bearing on managerial decision making,
managerial economics draws from them all. In practice, some are more
relevant to the business firm that others and hence to
managerial economics. Both micro-economics and macro-economic are
important in managerial economics but the micro economic theory of
the firm is especially significant. The theory of firm is the single most
important element in managerial economics. However, because the
individual firm is influenced by the general economy, that is domain
of macro economics. Managerial economics is certainly on
normative theory. We want to establish decision rules that will help managers
attain the goals of their firm, agency or organization; this is the essence of
the word normative. If managers are to establish valid decision rules, however,
they must thoroughly know the environment in which they operate for this reason
positive or descriptive economics is important.
Surveys conducted in various
countries showed that business economists have found economic concepts such as
price elasticity of demand, income elasticity of demand, opportunity casts, the
multiplier, propensity to consume, marginal revenue products,. Speculative
motive, production function, balanced growth, liquidity preference etc., quite
useful and of frequent application. They have also found the following main areas
of economics as useful in their works:
1. Demand theory
2. Theory of the firm-price and
output
3. Business financing
4. Public Finance and Fiscal Policy
5. Money and banking
6. National income and Social
accounting
7. Theory of international trade, and
8. Economics of developing countries.
Difference between Business Economics and Economics / Traditional Economics in Tabular Form
The difference between Business
economics and economics can be understood with the help of the following
points:
1. Managerial economics involves
application of economic principles to the problems of a business firm whereas;
economics deals with the study of these principles only. Economics ignores the
application of economic principles to the problems of a business firm.
2. Managerial economics is
micro-economic in character; however, Economics is both macro-economic and
micro-economic.
3. Managerial economics, though micro
in character, deals only with a firm and has nothing to do with an individual’s
economic problems. But microeconomics as a branch of economics deals with both
economics of the individual as well as economics of a firm.
4. Economics is both positive and
normative science but the Managerial Economics is essentially normative in
nature.
5. Economics deals mainly with the
theoretical aspect only whereas Managerial Economics deals with the practical
aspect.
6. Managerial Economics studies the
activities of an individual firm or unit. Its analysis of problems is micro in
nature, whereas Economics analyzes problems both from micro and macro point of
views.
7. Under Economics we study only the
economic aspect of the problems but under Managerial Economics we have to study
both the economic and non-economic aspects of the problems.
8. Economics studies principles
underlying rent, wages, interest and profits but in Managerial Economics we
study mainly the principles of profit only.
9. Sound decision-making in
Managerial Economics is considered to be the most important task for the
improvement of efficiency of the business firm; but in Economics it is not so.
10. The scope of Managerial Economics
is limited and not as wide as that of Economics. Thus, it is obvious that
Managerial Economics is very closely related to Economics but its scope is
narrow as compared to Economics.
11. Under microeconomics, the
distribution theories, viz., wages, interest and profit, are also dealt with.
Managerial economics on the contrary is mainly concerned with profit theory and
does not consider other distribution theories.
12. Economics involves the study of
certain assumptions like in the law of proportion where it is assumed that “The
variable input as applied, unit by unit is homogeneous or identical in amount
and quality”. Managerial economics on the other hand, introduces certain
feedbacks. These feedbacks are in the form of objectives of the firm,
multi-product nature of manufacture, behavioral constraints, environmental
aspects, legal constraints, constraints on resource availability, etc.
Thus managerial economics,
attempts to solve the complexities in real life, which are assumed in
economics. this is done with the help of mathematics, statistics, econometrics,
accounting, operations research, etc.
Price Mechanism
Price mechanism refers to the
system where the forces of demand and supply determine the prices of
commodities and the changes therein. It is the buyers and sellers who actually
determine the price of a commodity. Price mechanism is the outcome of the free
play of market forces of demand and supply. However, sometimes the government
controls the price mechanism to make commodities affordable for the poor people
too. For example, the Government of India recently passed an order to
decontrol the prices of diesel and remove it from the jurisdiction of the
government. Now the prices will be determined by the demand from consumers and
supply from the oil companies.
Advantages and Disadvantages of Price Mechanism
Role and Importance of price mechanism:
The price mechanism solves the
problem of allocation of resources which is associated with what, how and for
whom to produce.
1. What to produce?
In a free market economy,
producers are guided by profit motive. When price of a commodity increases with
the increase in demand, the profits increase and this would encourage the
production of this commodity. Producers would shift resources from the
production of other commodities to this commodity. Therefore, the price
mechanism would automatically solve the problem what to produce.
2. How to produce?
It is the question of choice of
production technique. There are generally two techniques of production
available:
a) Labour-intensive technique (in which
more of labour is used than capital)
b) Capital-intensive technique (in
which more of capital is used than labour)
If capital is available at a lower
rate, firms adopt capital-intensive technique of production. If labour is
available at lower rate, firms adopt labour intensive techniques. Therefore, it
is the price of labour or the price of capital that will help the producer in
deciding whether they should choose capital intensive or labour intensive
technique.
3. For whom to produce?
In a market economy, the producers
must produce for those who have the ability and willingness to pay the highest
price. The income of the consumers determines the ability to pay i.e.; there is
a direct relationship between income and consumption pattern. Hence, both the
ability and willingness to pay determines who gets the available commodities.
4. Fuller Utilization of the
factors
It is through price-mechanism that
fuller utilization of the factors is attained in a capitalist economy .Volume
of full employment depends upon the volume of production which in its turn,
depends upon the level of investment. Amount of investment depends upon
saving. Equality between saving and investment is brought about by change in
price of capital i.e.; rate of interest. If at any given time, total savings
are large and condition of unemployment prevails in the economy, the rate of
interest will fall. Due to fall in the rate of interest there will be increase
in investment. Increase in investment will result into increase in production and
the condition of less than fuller utilization of the factors will become
possible. Classical economists were of the view that under condition of less
than full employment of labour, price of labour, i.e.; wage will fall. Fall in
wage rate will stimulate demand and condition of full employment of labour will
be achieved. In this way, price mechanism will help to achieve fuller
utilization of the factors.
Shortcomings / Limitations Price mechanism
(1) Imperfection
of completion: the working of the price mechanism assumes the existence of
perfect completion in the economic system. But in practice, perfect completion
does not exist; instead monopolistic forces prevail in many industries. These
reduce supply and raise prices which are against the interests of the consumers.
(2) Loss of
consumer’s sovereignty: it is stated that under market mechanism the consumers
enjoyed complete freedom in choice of goods and services. Producers produced
those goods and services that are demanded by the consumers. But in the real
world consumer’s sovereignty is limited. For instance the demand of consumer is
influenced by advertisement, personal selling social customs etc. Further there
is in inequality of incomes among people and consequently the market demand but
only the demand of well to do consumers.
(3) Elimination
of completion: price mechanism is to encourage completion. But according to
critics it is price mechanism itself that accounts for the elimination
completion. In their desire of profit, competing firms attempt to eliminate is
rightly said that “Monopoly is the mechanism of completion and at the same time
its logical conclusion.” It is the negation of all the values for which market
mechanism stands.
(4) Unequal
Distribution of Income: the price mechanism through completion brings huge
profits to big producers, the landlords, the entrepreneurs and the traders who
accumulate vast amount of wealth and luxury the poor live in poverty and
squalor.
(5)
Non-utilization if resources: the price mechanism fails to employ the country’s
resources fully. Free and cut throat competition, inequalities of income
distribution over production and consequent depression lead to wastage also, as
frivolous luxury goods are produced poor. Similarly natural resources are
exploited for the short-run effect on the economy, for example soil erosion
occurs when forests of timber are cut down by greedy contractors.
(6) Ignores
social goods: price mechanism mainly takes into account individual wants but
does not provide for social goods and social overheads like education, health,
care, transport & communication services. These goods and services needed
for the overall economic growth of the system may not be provided/produced by
private individuals. This is because in such industries, huge investments are
required; having there is a need for some intervention from some entity to
overcome this limitation of the price mechanism.
(7) Ignores
social cost: While determining his cost of production the producers include
only the private cost of production (the price paid to factors of production
and other inputs). He fails to include the social costs (e.g. air, water, and
noise pollution) on his production process. Since social costs are not included
in the market price, the producer produces an output which is larger than
desirable.
The above
shortcoming of price mechanism have led the free enterprise economics of West
to modify the capital system by regulating and controlling the institutions of
private property and freedom of enterprise to serve the best interests of the
community at large.
Conclusion: After going through this article,
you will definitely understand the concept of managerial economics or business
economics. Basic problems of an economy and advantages and disadvantages of
price mechanism are also clearly explained. Relationship and difference between
business economics and traditional economics are explained in this article. Thanks
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