Managerial economics

applies economic theory and methods to business and administrative decision making.
Managerial economics prescribes rules for improving managerial decisions. Managerial
economics also helps managers recognize how economic forces affect organizations and
describes the economic consequences of managerial behavior. It links economic concepts with
quantitative methods to develop vital tools for managerial decision making.

Evaluating Choice Alternatives

Managerial economics identifies ways to efficiently achieve goals. For example, suppose a small
business seeks rapid growth to reach a size that permits efficient use of national media
advertising. Managerial economics can be used to identify pricing and production strategies to
help meet this short-run objective quickly and effectively. Similarly, managerial economics
provides production and marketing rules that permit the company to maximize net profits once it
has achieved growth or market share objectives.

Uses of Managerial Economics in Business Decision Making

Managerial Economics Is a Tool for Improving Management Decision Making

Importance of Managerial Economics to Managers

Managerial economics has applications in both profit and not-for-profit sectors. For example, an
administrator of a nonprofit hospital strives to provide the best medical care possible given
limited medical staff, equipment, and related resources. Using the tools and concepts of
managerial economics, the administrator can determine the optimal allocation of these limited
resources. In short, managerial economics helps managers arrive at a set of operating rules that
aid in the efficient use of scarce human and capital resources. By following these rules,
businesses, nonprofit organizations, and government agencies are able to meet objectives
efficiently.

Making the Best Decision

To establish appropriate decision rules, managers must understand the economic environment in
which they operate. For example, a grocery retailer may offer consumers a highly price-sensitive
product, such as milk, at an extremely low markup over cost—say, 1 percent to 2 percent—while
offering less price-sensitive products, such as nonprescription drugs, at markups of as high as 40
percent over cost. Managerial economics describes the logic of this pricing practice with respect
to the goal of profit maximization. Similarly, managerial economics reveals that auto import
quotas reduce the availability of substitutes for domestically produced cars, raise auto prices, and
create the possibility of monopoly profits for domestic manufacturers. It does not explain
whether imposing quotas is good public policy; that is a decision involving broader political
considerations. Managerial economics only describes the predictable economic consequences of
such actions.

Managerial economics offers a comprehensive application of economic theory and methodology

to management decision making. It is as relevant to the management of government agencies,
cooperatives, schools, hospitals, museums, and similar not-for-profit institutions as it is to the
management of profit-oriented businesses. Although this text focuses primarily on business
applications, it also includes examples and problems from the government and nonprofit sectors
to illustrate the broad relevance of managerial economics.

BASIS FOR NORMAL

ACCOUNTING PROFIT ECONOMIC PROFIT
COMPARISON PROFIT

Meaning Accounting Profit is the net
income of the company
earned during a particular
accounting year.
Economic Profit is the Normal Profit is
remaining surplus left the least amount
after deducting total of profit needed
costs from total for its survival.
revenue.

Calculation Accounting Profit = Total Economic Profit = Total Total Revenue =

Revenue - Total Explicit Revenue - (Total Total Cost (i.e.
Cost Explicit + Total Implicit explicit and
Cost) implicit)
 BASIS FOR NORMAL
ACCOUNTING PROFIT ECONOMIC PROFIT
COMPARISON PROFIT

Advantage Reflects the Profitability of Shows how well the Helpful in

the company. company is allocating knowing the
its resources. future prospects
of the company.

Factors Affecting Economic Environment

Economic environment is affected by following factors, components
and elements:

1. Natural Resources

Economic environment is affected by natural resources available in

country, including land, quality of soil, mineral wealth, water
resources, vegetation, formation of surface and climate.

If the natural resources are abundantly available, their utilisation will

result in economic development and large volume of employment.

If these are scarce then poverty, starvation, unemployment and

backwardness will adversely affect the economic environment also.

Learn More: 20 Importance of The Study of Business Environment.

2. Human Resources

Human resource is an important determining factor for economic

environment. A country having human resources healthy, intelligent,
efficient trained and adequate then Rapid economic development is
possible.

Shortage of labour force and unhealthy and inefficient Labour force

obstacles in the way of economic development.
However, excessive human resources (overpopulation) also cause
several problems and checks the proper excavation of natural
resources.

3. Forms of Economic System

The forms of economic system also affect the economic development

environment. The economic system has positive as well as negative
impact both.The main systems are:

Capitalist Economic System

It is also termed as “Free economy system” Private entrepreneurs play
active role in development of economy.

The possession of property, profit motivation, economic freedom,

competition and free price mechanism individualism and consumer
sovereignty are basic characterstics of such economy.

Socialist Economic System

This system has total control over all production resources of the
country. The government plays and active role in economic
development. Maximum goals of social welfare are achieved through
economic planning, social ownership, efficient and professional
management.

However, it main result into corruptions, strictness and rigidiyies,

mismanagement and inefficient as also.

Mixed Economic System

Both the private and government sector business operate,
Simultaneously. Hence, personal profits are kept under control, in the
social interests and efforts are made for achieving Rapid economic
development through decentralization.
Besides, social welfare is also effectively coordinated with overall
economic development.

4. Economic Policies

Economic environment is also affected by economic policies of

Government. The industrial policy, licensing policy, monetary
policy, fiscal policy, agricultural policy, price policy, labour policy, and
Employment policy, all have impact on economic Industrial
Development.

If these policies are effective, suitable, strong and progressive,

development of Agricultur, industries and trade is quite sure.

Good policies help in increasing production, incomes, savings,

investments, capital formation and bringing about Rapid economic
development of the country.

However, the faulty polices result in creating obstacles in the way of

economic development. 13 Features & Nature of Business
Environment (Updated).

5. Economic Laws

Economic laws include various laws, including trade law, Industrial

law, Factories Act and labor law, monopolies restrictive and trade
policies act, various taxation laws for income tax, sales tax, wealth
tax, FEMA, etc.

These laws regulate business environment. It also develops faith in

stability of economic environment and its continuity.

6. Capital Formation and Investment

Capital formation is an important factor of economic environment.

Rate of capital formation, development of capital market and
availability of investments in the country directly affect the business
environment.
A conducive atmosphere is created for the development and continuity
of business in the country. On the contrary, business environment in
the country remains disappointing and undeveloped.

7. Monetary and Fiscal Policies

The monetary policy, controls the volume of currency and credit in the
country to achieve the desired objectives. During the period of boom,
economic stability is sustained by controlling inflation, through
reducing the volume of money and credit.

Factors Affecting Economic Environment

On the contrary, during periods of depression, momentum of

economic development is speed up by increasing the volume of
money and credit. So, monetary measures are adopted to safeguard
the economy, against trade eycles.

The fiscal policy, plays a vital role to raise income from various
taxes, which is spent for developmental activities by government.
Taxation policy, expenditure policy, public debit policy of the
government affect economic environment.

So, the government stops extravagances through fiscal policy and

invests financial resources for developmental activities. A proper
balance and coordination between monetary and fiscal policy is helps
in development of the economy.
8. Situations of Market

Economic environment is affected also by the market situation, as

follows:

1. In situation of perfect competition, optimum utilisation of

resources is achieved through over production, low costs,
competitions and moderate profits, etc.
2. In Monopoly market, development of the country is blocked due
to high costs, high prices, low production, Monopoly profits and
exploitation of consumers. Besides, optimum utilisation of sources
for production is also not possible in monopolistic situations.
3. In situation of imperfect competition, cut throat competition
emerges as the result of diversified production, higher profits, low
production and advertisement costs.

Thus, economic environment is determined in consonance with the

aforesaid conditions and sometimes, the government is required to
enforce control on market system.

9. Entrepreneur and Innovation

Entrepreneur and innovation is an important factor among several

factors which effects the economic environment of any country.
Prof. Schumpeter has said “Economic development depends upon
technical progress and innovations.

The entrepreneur provides contribution towards economic

development by taking advantage of technical knowledge, in utilisation
of the resources. The entrepreneur has foresightedness and self
confidence, which he utilizes for production activities.

In developing countries, there is a shortage of efficient and

competententrepreneurs. There are established facts of success not
only in our country, but in foreign countries also. 16 Need and
Importance of Business Environment (Updated).
10. Capital and Money Market

These both are important factors of economic environment.

The money marketarranges short term credit, whereas capital
market arranges long term credit.

The capital of any country is a dynamic phenomena and two markets

are developed organised.

If the money market of the countries active in the proper direction, the
pace and directions of economic development will also be proper.
Otherwise, the country may remain in the grip of inflation or deflation.

Similarly, the capital markets also has its own control on Financial
Institutions, savings investments, capital formation. The economic
development will get momentum with the activeness and sound
organisation of the capital market.

11. Economic Conditions

The economic conditions of any country will determine the economic

environment of that country. If the economic condition is good, it may
be said that the economic environment is good, otherwise, it is bad.

National and per capita income position of employment, availability of

infrastructural facilities, living standards of the people of the country,
rate of capital formation, balance of trade, situation of Balance of
payments, exchange rate, and foreign currency reserve are the
indicators of economic condition if these conditions.

If these indicators are favourable, then the economic environment in

that country will also be conducive for development. If these indicators
are adverse, then the economic environment will be adverse to
development.
12. Foreign Capital and Debt

Availability of foreign capital and debt is also a major factor affecting

economic environment. If foreign capital is available, not only the
availability of consumer and capital goods increase, but it is also
helpful in creating efficient human resources for development.

However, if not used cautiously, it may harm the national security,

encourgecentralisation of economic sources and push the country
even towards political dependence. Factors Affecting Economic
Environment

Read More: 14 Nature of Business Environment (Explained).

13. Infrastructural Facilities

Economic environment is directly affected by infrastructural facilities

and composition. The countries, where the infrastructural facilities are
sound, economic development will be rapid and strong in those
countries.

Factors Affecting Economic Environment

In India, infrastructural facilities has lacked and even today these are
not adequate.
As a result, the pace of development is not only slow, but even the
foundation is also not very strong. Now, the cooperation of private
sector is beling sough in development of the infrastructural facilities.

14. Occupational Distribution

Occupational distribution refers to he volume of population of any

particular country, engaged in various activities of production.

Occupational distribution of population is of three types:

Primary Sector
Includes agriculture,fisheries, Forestry, dairy and animal husbandry.

Secondary Sector
Includes industries, mining, constuction and public utility services.

Service Sector
Include all types of services, like banking, insurance, transportation,
education, medical, administration and entetainment, etc.

Occupation of higher proposition of working population in primary

sector indicate low level of development. It causes pressure of
population on land and productivity of labour is also low.

On the contrary, occupation of higher proportion of population in

secondary and service sectors indicate Rapid economic development
and high living standards of people. 15 Characteristics of
Entrepreneurial Environment.

15. National Income and Distribution

Economic environment is also affected by the volume of national

income and its distribution. With higher National income in the country,
the economic environment will also be as conducive to the
development.

The per capita income will also be high due to high national income,
which will increase in demand of commodities and services, and
encouragement to various activities of development.

The creation of economic environment is also affected by the

distribution of national income. If the distribution of income is in favour
of rich people, the savings will increase.

But, since consumtion will not increase by it, development will not get
Momentum. On the contrary, when income distribution is in favour of
poorer sections, the demands increase quite substantially and
development gets faster. 17 Importance and Role of Small-Scale
Industries (Economy).

16. Efficient Organisation

Efficient organisation of the country also significantly influences

economic environment.

According to Prof. Daab, “The problem of economic development is

not mainly the financial problem, rather it is a problem of economic
organisation and system.” more Rapid development is possible even
by lesser resources, if the organisation and system are good. Japan is
its example. Human capital is required to be developed to make the
organisation efficient.

Prof. Schultz has said, “Development of human capital is the most

important characteristics of economic system. Without doing it, we
cannot get free from poverty and hard manual labour. Development of
human capital may be done only by development of Knowledge
Science and incorporation of efficiency.”
According to Prof. Marshal, “The most valuable capital is that which is
invested in mankind. Economic development may be speeded up by
maximum utilisation of available resources by the effcient
organisation.”

The economic environment of a country comprises the

following factors:
a. The type of economic system of the country

b. The pattern of national income, employment, saving, and

investment of the country

c. The functioning of the financial sector of the country

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d. The structure and nature of foreign trade in the country

e. The trends of labor supply and capital market strength of the

country

f. The economic policies of government

g. The value system of society, property rights, customs, and habits

h. The political system of the country

i. The functioning of private and public sectors

j. The impact of globalization on the country