Meanning of Managerial Economics

Managerial economics/applied microeconomics can be defined as the use of economic analysis to make business decisions involving the best use of organizations scarce resources/the application of economic theory and the tools of analysis of decision science to examine how an organization can achieve her objectives most efficiently.

M.E may also be defined as the study of economic theories, logic and methodology, which are generally applied to seek solutions to the practical problems of business. M.E is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management

It can also be defined as the application of economic theory (Micro and macro economics) and decision science tools (Mathematical economics and Econometric) to find the optimal solution to managerial decision making problems.

The meaning of this definition can best be explained with the aid of the following diagram.

Managerial economics provides a link between economic theory and decision sciences in the analysis of managerial decision making. Economic theory which consists of microeconomics (focusing on individual consumers, firms and industries) and macroeconomics (focusing on total output, incomes and employment) contains materials that bear on managerial decision making particularly microeconomics. That is, managerial economics draws heavily from microeconomics as compared to other areas of economic theory.

In theory, there is no difference between regular economic and managerial economics.

The standard economic theory provides the basis for managerial economics. The difference between economic theory and managerial economics is in the way economics is applied.

The emphasis of microeconomic theory is in how individual decision of buyers and sellers leads to efficient outcome of the society as a whole.

The application concerns the effects of the actions of the private or governmental decision makers on the economy. The focus is on the cost and benefit of the decisions to the society as a whole and not the way decisions should be made. Microeconomics is largely descriptive. That is, attempts to describe how the economy works and not how it should work e.g. its concerned with how a firm prices its products.

Managerial economics on the other hand, deals with how decisions should be made to achieve the firm’s objectives/goals in particular how to maximize profits. These decisions or their outcomes may or may not be beneficial from the society point of view. Managerial economics is largely prescriptive. That is, managerial economics attempts to establish rules and techniques to fulfill specified goals e.g. it’s concerned with how firms should price their products.

Managerial economics also draws heavily on decision sciences which provide ways to analyze the impact of alternative courses of action. M.E uses optimization techniques e.g. differential calculus and linear programming to determine optimal courses of action for decision makers (mathematical economics). To implement these techniques, statistical methods must be employed to estimate the relationships between relevant variables and to forecast their values (econometrics)

Management decision problem can arise in any organization (a firm, not for profit organization) when it seeks to achieve some goal or objective subject to some constraints. For example,

A firm may seek to maximize profits subject to limitations on the availability of essential inputs and in the face of legal constraints.

A hospital may seek to treat as many patients as possible at adequate medical standards with its limited physical resources (physicians, Nurses, beds e.t.c) and budget.

Government agency may seek to provide a public utility to as many people as possible at the lowest possible cost given budget allocation.

In all these and many other cases, the organization faces management decision problems as it seeks to achieve its goals or objectives subject to constraints it faces. The goals and constraints may differ from one case to another but the basic decision making problem is the same.