Business Economics | Managerial Economics | Features | Scope
Business Economics | Managerial Economics
Business economics is also known as managerial economics.
Basically, it is an applied economics in the field of business management.
It is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management.
Generally, business economics refers to the integration of economic theory with business practice.
While the theories of economics provide the tools, which explain various concepts such as demand, supply, costs, price, competition etc.
Business Economics applies these tools in the process of business decision making.
A business firm has to decide ‘what goods and services to produce by using the available land, labour, capital and basic raw material?
Business economics helps the manager of a firm or an organization to make decisions in production and other-related issues.
It is a study of the sue of principles of economics and tools of decision science e.g. correlation, regression analysis, game theory, linear programming, econometrics on business decision making relating to costs of production, level of optimal production, prices of products, pricing of factors of production, demand forecasting and investment decision.
Managerial economics works as a bridge between economic theory and practical economics.
Definitions of business economics or managerial economics
According to J.L. Pappas and D. Whigham, “Managerial economics is the application of economic theory and methodology to business administration practice… to analyze and solve the managerial problems.”
According to D.C. Hague, “Managerial economics is a fundamental academic subject which seeks to understand and to analyze the problems of business decision making.”
J. Sloman, D. Garratt, J. Guest and E. Jones, “Business economics is about the study of economic decisions made by business and the influences upon this. It is also concerned with the effects that this decision making has upon other businesses and the performance of the economy in general.”
From the above cited definitions, it is obvious that business economics or managerial economics is the study of the uses of microeconomic theories.
It is the tools of decision science in the managerial decision-making process.
Therefore, business economics is a subject which links economic theory to business practice of decision-making by management.
It is a fusion of microeconomic theory and quantitative methods to find optimal solutions to managerial decision-making problems to achieve the firm’s objectives most efficiently.
Business economics is the study of the firm and of the environment in which it operates and makes its decisions.
Nature of Business Economics or Managerial Economics
Managerial decision problems arise in any organizations.
They may be non-profit organization such as a hospital, a university, government unit or profit-making organizations. Profit making organizations are the business of private sector.
They try to achieve some objectives in view of the available resources and legal limits/environment.
First, let us take the case of a hospital.
A hospital may seek to provide treatment to as possible as many patients at a satisfactory medical standard with its limited physical resources and budget.
Physical resources of a hospital are physicians, technicians, nurses, equipment, beds etc.
Second, let us consider the case of a university.
The goal of a state-run university may be to provide a satisfactory education to as possible as many students depending on the physical resource and financial limitations it faces.
Physical resources of a university are class room, computers, human resource (professors and supporting staffs.
Further, let us take the case of a government body e.g. Ministry of Health, Ministry of Education
A government body may consider providing a particular service to as many as possible people at the lowest possible cost.
Finally, let us think about a private business organization.
Before starting and establishing a business project, a business firm has to decide on:
What goods and services to produce?
How to produce them?
For whom to produce?
How to promote market for the sale of the products?
How to set price of the products and earn profit?
In all these cases, the related organization faces management decision problems when it seeks to achieve its own goals within the limit of available men, material and monetary resources and legal environment.
It is important to note that the goals and constraints of organizations may differ from case to case, but the basic decision-making process is the same: How to allocate available scarce resources to produce and distribute valuable goods and services.
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Business Economics is a Science or Arts
Business economics is a science
The nature of business economics is similar to the nature of a science because like science it establishes cause and effect relationship between variables affecting the operation of a firm by collecting, classifying and analyzing evidences.
Similar to the methodology of science, business economics observes economic events related to business firms and explains the behaviour.
Business firm takes production decision, product pricing, factor pricing and investment decision etc.
Business economist takes decisions by utilizing valuable past experience and observations of business firms’ activities.
Principles and theories of business economics are usually applicable at least partially everywhere in the world but they are less exact than the theories of physical science because they depend upon human behaviour and social and political events.
Generally, applied policies may also be periodically modified.
Business economics is an art
Those who want to use concepts and theories of business economics need to have an art of utilizing them to achieve the organizational objective.
They should have skill and talent to put their theoretical knowledge in practice with proper understanding of their business and economic environment.
Without a good understanding of the current state of production costs, market demand, price and profit of the firm, attempt to apply different theories of microeconomics may not help achieve the goal of the enterprise.
Features or Characteristics of Business Economics
Business economics is a mix of microeconomic theory and quantitative methods of decision science to find best solutions to managerial decision-making problems.
Business economics is an area of study which draws heavily on economic concepts, theories and models, but it also utilises ideas and approaches from other subject areas including marketing and human resource management.
Although business economics or managerial economics combines different academic disciplines, it has the following commonly agreed commonly agreed natures, features or characteristics which reveal its nature:
Microeconomic character
Business economics is microeconomics in character because it studies a unit of a firm.
It only deals the problems of firms but does not deal with the entire economy.
It deals with the problems faced by an individual organization such as demand for its product, price of its product, available substitute and complimentary goods, supply of inputs and raw material and target or probable consumers of its products etc.
Multi-disciplinary
Business economics is a combination of different academic disciplines like Economics, accounting, finance resource (personnel) management, statistics, mathematics, operational research and psychology.
It provides a link between traditional economics and the tools of decision sciences for managerial decision-making.
Pragmatic
Managerial economics is pragmatic (practical) in character.
It is concerned with those analytical tools which are useful in improving decision-making.
Economic theory appropriately ignores the variety of backgrounds and training found individual firms but managerial economics considers the particular environment decision making.
Normative
Business economics belongs to normative economics rather than positive economics.
Normative economics also called policy economics.
It makes value judgments and advises what should be done to solve economic problems.
It analyses outcomes of economic behaviour, evaluates them as good or bad and recommends courses of action.
Business economics suggests the application of economic theories with regard to policy formulation, decision-making and future planning of business firm.
It describes the goals of an enterprise and also recommends the means of achieving these goals.
Keep in Mind
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Positive economic studies economic behaviour without making value judgments. It focuses on facts and cause and effect relationships. It includes description, theory development and theory testing. It tries to establish scientific statements about economic behaviour and deals with what the economy is actually like. |
Considers macroeconomic environment/variables
Business economics understands the macroeconomic situations or environment because an individual firm or an industry has to work within that environment.
Knowledge of macroeconomic issues like Taxation and Subsidy Policies of the Government, Industrial Policy of the Government, the State of Business, Trade Cycle, Minimum Wage Policy, Anti-Monopoly Policy among others are essential for the successful operation of a firm or an industry.
These macroeconomic factors affect several decisions of organizations and business firms.
Goal oriented
Business economics is goal-oriented.
It deals with how decisions should be formulated by managers to achieve the organizational goals.
These goals are earning profit, increasing market share etc.
Uses theory of the firm
Business economics uses economic concepts and principles which are known as the theory of the firm or economics of the firm.
For instance, managerial economics includes the study of the cost and revenue analysis, price and output determination, profit planning, demand analysis and demand forecasting of a firm.
Thus, scope of managerial economics is narrower than that of pure economic theory.
Guides in optimum resource allocation
All economic resources are scarce but have alternative uses.
Managers need to use these limited resources optimally (in a best way).
The manager decides business decisions with his knowledge of economics and tools of decision science.
Managers use alternatives available resources of production to achieve the objective of the firm.
Theories of business economics guide managers in the matter of optimum resource allocation.
Dynamic and developing discipline
Business economics is a dynamic and not a static subject.
A business firm has to deal with human element related to the organization.
They are employee, consumers, fund providers and government tax authority etc.
Over the times, the demand of the employees would increase, consumers taste and preferences would change, business-doing environment would change, and competition in the market would change.
This makes business economics more refined and advanced discipline as it uses modern scientific methods of statistics and mathematics, methods of operational research and computers.
Business ethics
Business ethics affects the core of business economics as business firms cannot ignore cultural values, social customs and religious sentiments of the people.
These elements make the normative aspect of business activities.
These essentials carry some weight in designing production pattern and planning of the business in a country or area.
A modern multi-national corporation has to consider the socio-cultural and religious sentiments of the people before launching its product.
The intension should not be to hurt the sentiments of the people
Business firms should promote their well-being along with doing their business.
Scope of Business Economics
The scope of business economics is wider because it covers most of the problems that the manager of a firm or an organization faces.
It deals with resource allocation, demand analysis and forecasting, production and cost analysis, inventory management, advertising for sales promotion, product pricing, factor pricing and so on.
A firm faces both internal issues and external issues.
Internal issues are mostly firm-centric in nature.
They arise within the business organization and come within the range and control of the management.
External issues are related to social and political environment over which a business firm has no control but it has to consider them for its operation and survival.
(A) Internal Issues
Internal issue is also known as operational issues
Some of the internal issues considered in business economics include:
(a) What goods and services to produce? (An issue related to the choice of business and nature of product).
(b) How much to produce? (An issue related to the choice of the firm’s size).
(c) How to produce? (An issue related to the choice of technology, choice of factor combination).
(d) How to price the commodity? (An issue related to pricing of a firm’s product).
(e) How to promote sales? (An issue related to marketing activities and expenses).
(f) How to face price competition? (An issue related to firm’s price changing policies).
(g) How to decide on new investment? (An issue related to the selection of investment projects).
The management of a firm has to make decision on the above-mentioned issues which fall within the area of microeconomics.
Therefore, the following topics make the scope of business economics on the internal issues which are microeconomic in nature:
Analysis of demand
Analysis of demand of a product is necessary for carrying out actual production activities.
Without knowing the demand for a product, a firm cannot think of producing that product.
Proper demand analysis helps the manager to arrive at reasonable estimates of demand for the product of the firm.
Managers have to estimate the current demand and also forecast the future demand.
Forecast of future demand is an essential part in managerial decision-making because an estimate of future sales is a standard indicator for preparing production schedule and employing productive resources.
Analysis of demand theory covers following topics:
(a) Analysis of consumer behaviour along with their maximization of satisfaction:
(b) Demand analysis and elasticity of demand
(c) Demand forecasting and its techniques and methods
Theory of production and production decisions
Production is the transformation of inputs into outputs of goods and services.
There are two types of productions; they are both consumer goods and capital goods.
Theories of production help in determining the size of the firm and the level of production.
It explains the relationship between average and marginal products and their average and marginal costs.
Change in production can bring change in average and marginal costs.
Production theory also deals with issues like conditions leading to increase or decrease in costs, changes in total production when one factor of production is varied and others are kept constant, substitution of one factor for another, simultaneous change in all factors and methods of achieving optimum production.
A firm has to make decision for the best use of the limited resources to produce the targeted amount of output of output at minimum cost possible.
Considering the possible changes in input prices and market demand, the management is faced with the task of determining an optimal level of output where the average cost of production would be the minimum.
Cost analysis
Cost analysis is helpful in understanding the cost of a particular product.
It takes into account all costs incurred while producing a particular product.
The cost analysis of a firm takes into account the determinants of costs, method of estimating costs, cost and output relationship, the forecast of the cost and profit.
These terms are very important to any firm.
The cost analysis covers following topics:
(i) Cost and output relationship in short-run and long-run
(ii) Economies and diseconomies of scale
(iii) Choosing optimum size of the firm.
Analysis of market structure and pricing theory
A firm may be operating in a market of perfect competition, monopoly, monopolistic competition or oligopoly.
The firm needs to know about the nature and level of competition in the market.
An in-depth analysis of the market structure provides information on the nature and level of completion.
With the help of such information, firms get certain ability to determine prices in the market.
In addition, this information helps firms make strategies under the given competitive conditions.
Price theory is also known as theory of exchange.
It helps managers of business firms in understanding how prices are determined under different kinds of market conditions.
In pricing a product, the information on cost of production is incomplete without a complete knowledge of the price system.
Pricing policy makes an impact on the demand for products.
Market Structure and Pricing Theory covers following topic:
(i) Determination of price under different perfect completion, monopolistic competition and oligopoly
(ii) Multiple pricing policies
(iii) Advertising in competitive markets
(iv) Different pricing policies and practices
Profit analysis and profit management
Every business firm managed and operated at maximizing profit.
Profit is the difference between total revenue (TR) and total economic cost (TC).
Profitability of an organization is very much affected by following factors:
(i) Demand for the product
(ii) Prices of factors of production
(iii) Nature and degree of competition in the market
(iv) Pricing behaviour under changing conditions
For this reason, profit planning and profit management are important basics for improving profit earning efficiency of the firm.
Profit management involves the use of most efficient technique for predicting the future.
Keep in Mind
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In order to understand profit, the management the firms analysis: |
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(i) Nature and types of profit |
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(ii) Profit planning and policies |
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(iii) Different theories of profit |
Theory of capital and investment decisions
Capital is the major part of a business.
Like other factors of production, capital investment is also an expensive factor.
Investors of firms calculate internal rate of return (IRR), net present value (NPV) and make cost-benefit analysis (CBA) before undertaking any investment projects.
Theory of capital and investment decisions focus on following:
(i) Cost of capital and return on capital: choice of investment projects
(ii) Assessing the efficiency of capital
(iii) Most efficient allocation of capital
(iv) Capital budgeting
Inventory management
The term inventory means stock or merchandise.
There are three types of stock; they are raw materials, work in process and finished goods.
Inventory keeping block a lots of capital.
Here one question arises, “How much of the inventory is ideal inventory?”
Both the high inventory and low inventory is not good for the firm.
Business economics uses some mathematical models to minimize inventory cost.
They are reorder level, minimum stock level, maximum stock level, economics order quantity etc.
It also helps in inventory controlling.
(B) External Issues
Business economics also considers several macroeconomic factors that affect business decision making.
Some of the important factors include:
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Constraints from policies imposed by the government in relation to competition, minimum wages paid, taxation, price control (ceiling and floor), subsidy and so on. |
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Constraints imposed on them by the economy, for instance, in times of economic recession, falling consumer demand due to reduced incomes and rising unemployment may limit the ability of business to launch new products, diversify into new markets or even survive. |
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Monetary Policy and Foreign Exchange Rate (FOREX) Policy of the country |
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General trends in the working of financial institutions (bank and non-bank financial institutions) in the country |
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General trends in foreign trade (export and import) of the country |
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General attitude and significance of social organizations like trade unions, producers’ unions and consumers’ cooperative societies. |
The management of a firm cannot keep control over the external factors as mentioned above.
In this context, business economics seeks to analyze these external constraints which affect businesses.
Differences between Traditional Economics and Business Economics
Business economics uses largely the same concepts and terminology as economics and addresses many of the same issues.
However, there are basic differences between business economics and traditional economics.
Some of the major points of differences between traditional economics and business economics are as given in table.
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Bases |
Traditional economics |
Business economics |
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Including |
Traditional economics has both micro and macro aspects. |
Business economics is basically micro in character. |
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Nature |
Economics is both positive and normative science. |
Business economics is basically normative in nature. |
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Theory or Practical |
Economics deals mainly with the theoretical aspects. |
Business economic deals with the practical aspect. |
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Assumptions |
Economics studies human behaviour on the basis of certain assumptions. |
Business economics concerns mainly with practical problems of firms. |
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Scope |
The scope of pure economics is very wide. |
The scope of business economics is limited. |
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Aspect |
In pure economics we study only the economic aspect of the problems. |
Under business economics we have to study both the economic and non-economic aspects of the problems. |
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Simple or Specific |
Economic theory hypothesizes economic relationships and builds simplified economic models to analyze the economic reality. |
Business economics adopts, modifies and reformulates economic models to fit the specific conditions and specific problem of the firm. |
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decision-making |
Sound decision-making is not considered in economics. |
Sound decision-making is considered in business economics; it is the most important task for the improvement of efficiency of the business firm. |
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