NATURE, SCOPE AND PRACTICE OF
MANAGERIAL ECONOMICS
1
INTENDED LEARNING OUTCOMES
1. Explain how economics can be used for managerial decision-making.
2. Rank the steps of managerial decision making and management process.
3. Distinguish between Public and Private Decisions.
4. State the different phases of planning.
5. Formulate a simple strategic plan thru the use of SWOT analysis.
6. Develop a simple project plan.
Managerial Economics is an application of economic tools and techniques to business and
administrative decision-making; another term for the title of this course, namely economic analysis for
agribusiness and management.
Moreover, it is a branch of economics which studies the application of the theories, tools and
findings of economic analysis to managerial decision-making in all types of organizations, including
government agencies, educational centers, not-for-profit foundations and business enterprises.



Helps decision-makers recognize how economic forces affect organizations and describes the
economic consequences of managerial behavior. How? By linking economic concepts and
quantitative methods to develop tools for managerial decision-making.
Simply put, managerial economics uses economic concepts and quantitative methods to solve
managerial problems.
We place emphasis on the practical application of economic analysis to managerial decision
problems; the primary virtue of managerial economics lies in its usefulness.
THE ECONOMICS OF EFFECTIVE MANAGEMENT
(1) Identify goals and constraints;
(2) Recognize the nature and importance of profits;
(3) Understand incentives;
(4) Understand markets;
(5) Recognize the time value of money; and
(6) Use marginal analysis.
Economic Concepts
• Influence which products to produce, which costs to consider, and the prices to charge;
• Necessitates the collection, organization, and analysis of information.
• Emphasis is placed on microeconomic topics, although macroeconomic relations have
implications for managerial decision-making as well.
• Microeconomics – descriptive in nature
• Managerial economics – prescriptive in nature
Economic Decision-making requires the following:
1)
2)
3)
4)
5)
6)
Optimization techniques (calculus-based and linear programming)
Statistical relations
Demand analysis and estimation (through regression)
Forces of demand and supply
Forecasting of firm activities (sales, production, demand, prices)
Risk analysis
6 Steps to managerial decision-making
1. Define the problem. What is the problem the manager faces? Who is the decision maker?
What is the decision setting or context, and how does it influence managerial objectives or
options?
2. Determine the objective. What is the decision maker’s goal? How should the decision maker
value outcomes with respect to this goal? What if he or she is pursuing multiple, conflicting
objectives?
3. Explore the alternatives. What are the alternative courses of action? What are the variables
under the decision maker’s control? What constraints limit the choice of options?
4. Predict the consequences. What are the consequences of each alternative action? Should
conditions change, how would this affect outcomes? If outcomes are uncertain, what is the
likelihood of each? Can better information be acquired to predict outcomes?
5. Make a choice. After all the analysis is done, what is the preferred course of action? For
obvious reasons, this step (along with step 4) occupies the lion’s share of the analysis and
discussion in this module. Once the decision maker has put the problem in context, formalized
key objectives, and identified available alternatives,
how does he or she go about finding a preferred course of action?
6. Perform sensitivity analysis. What features of the problem determine the optimal choice of
action? How does the optimal decision change if conditions in the problem are altered? Is the
choice sensitive to key economic variables about which the decision maker is uncertain?
Sensitivity analysis considers how an optimal decision is affected if key economic facts
or conditions vary.
Here is a simple example of the use of sensitivity analysis.
“Senior management of a consumer products firm is conducting a third-year review of one of its new
products. Two of the firm’s business economists have prepared an extensive report that projects
significant profits from the product over the next two years. These profit estimates suggest a clear
course of action: Continue marketing the product. As a member of senior management, would you
accept this recommendation uncritically? Probably not. After all, you may be well aware that the
product has not yet earned a profit in its first two years. (Although it sold reasonably well, it also had
high advertising and promotion costs and a low introductory price.) What lies behind the new profit
projection? Greater sales, a higher price, or both? A significant cost reduction? The process of
tracking down the basic determinants of profit is one aspect of sensitivity analysis.”
Potential contributions to decision-making process
• Experience
• Judgement
• Common sense
• Intuition
• Rules of thumb
Four traditional managerial skills needed
•
•
•
•
Planning
Organizing
Leading
Controlling
PUBLIC AND PRIVATE DECISIONS: AN ECONOMIC VIEW
Private Decisions
Main approach to managerial economics is based on a model of the firm: how firms behave and
what objectives they pursue. The main tenet of this model, or theory of the firm, is that management
strives to maximize the firm’s profits. However, a more precise profit criterion is needed when a firm’s
revenues and costs are uncertain and accrue at different times in the future. The most general theory of
the firm states that “Management’s primary goal is to maximize the value of the firm.”
Value maximization is a compelling prescription concerning how managerial decisions should be
made. Although this tenet is a useful norm in describing actual managerial behavior, it is not a perfect
yardstick. Even if value maximization is the ultimate corporate goal, actual decision making within this
complex organization may look quite different. There are several reasons for this:
1. Managers may have individual incentives (such as job security, career advancement, increasing a
division’s budget, resources, power) that are at odds with value maximization of the total firm. For
instance, it sometimes is claimed that company executives are apt to focus on short-term value
maximization (increasing next year’s earnings) at the expense of long-run firm value.
2. Managers may lack the information (or fail to carry out the analysis) necessary for value-maximizing
decisions.
3. Managers may formulate but fail to implement optimal decisions.
Other three behavioral decision models:
1. Satisficing behavior model posits that the typical firm strives for a satisfactory level of performance
rather than attempting to maximize its objective
2. Firms attempt to maximize total sales subject to achieving an acceptable level of profit.
3. Social responsibility of business – social welfare
Public Decisions
In government decisions, the question of objectives is much broader than simply an assessment
of profit. Most observers would agree that the purpose of public decisions is to promote the welfare of
society, where the term society is meant to include all the people whose interests are affected when a
particular decision is made. The difficulty in applying the social welfare criterion in such a general form is
that public decisions inevitably carry different benefits and costs to the many groups they affect.
The principal analytical framework used in guiding public decisions is the Benefit-cost analysis
which begins with the systematic enumeration of all of the potential benefits and costs of a particular
public decision. This analysis will be discuss further in module 9.
CORPORATE PLANNING
Among the traditional managerial skills needed, the most important skill we have to master and
where economics is widely evident is in the planning stage. Private or public decision makers must
undergo this stage.
Corporate planning is a formal, systematic managerial process, organized by responsibility, time,
and information, to ensure that operational planning, project planning and strategic planning are carried
out regularly to enable management to direct and control the future of the enterprise.
1. Operational Planning- Forward planning of existing operations in existing markets with existing
customers and facilities. Example: annual budgets
2. Project Planning - Development planning or capital expenditure planning. Generation and appraisal
of the commitment to and the working out of detailed execution of an action outside the scope of
present operations, which is capable of separate analysis and control. Example: launching of new
product
3. Strategic Planning - Determination of the future posture of the business with special reference to:
-its product-market posture,
-its profitability,
-its size
-Its rate of innovation
-Its relationship with its executives, its employees and external institutions.
Components of Strategic Planning
Basic activities:
a. Objectives formulation
 In establishing corporate objectives, the following Corporate issues should be taken:
a. Survival
b. Growth
c. Diversification
d. Development
b. Environmental appraisal
 Scanning and assessment of the external environment
a. The structure of the industry
b. Demand (both nature and size)
c. Technology
d. The role of the government
c. Corporate appraisal
• Soul-searching by specifically evaluating its strengths, weaknesses and resources
• Possible checklist:
a. Product/market structure
b. Production
c. Finance
d. Technology
e. Organization and management
f. Labor force
d. Strategy formulation
• Essence of this is the intended impact on the future posture of the business towards its
customers, markets, executives, etc. rather than the time span over which the decisions
designed to create such impact is made.
Formulating Strategy
SWOT Analysis - A planning exercise in which managers identify:
-organizational strengths and weaknesses.
• Strengths (e.g., superior marketing skills)
• Weaknesses (e.g., outdated production facilities)
-external opportunities and threats.
• Opportunities (e.g., entry into new related markets).
• Threats (increased competition)
REFERENCES
Samuelson, W. & S. Marks, 2010. Managerial Economics. 2nd edition.
Villegas, B.M. 1999. Managerial Economics; Text and Case Studies. 3 rd ed.