Economics was already addressing various issues pertaining to these ‘functional’ areas and the development of a comprehensive platform wherein economic theory can be blended with management practice was inevitable. Thus, an application science, called Managerial Economics, emerged as a separate branch of study.
Economic theory assumes special significance in managerial economics because the methodology available in economic theory provides a definite, logical and precise guideline in determining the decision variables for satisfying the objectives of a firm under different forms of market structure.
Thus, a relationship of mutual sustenance between management practice and economic theory exists. As management practice has gradually ( developed and changed with the passage of time, consumer perceptions, competition and consequent pressures on profitability, existing theory of economics or new developments have kept pace with this change.
Managerial economics has become inter-functional, addressing all the key issues that confront management. There is hardly any discipline like economics that can be readily applied in the study of various branches of management.
Sometimes, it is believed that managerial economics is an extension of microeconomics. But these two are not identical. Managerial economics deals with several issues pertaining to what to produce, where to produce, what technology is to be used, how much to produce, how much to spend on advertisement, from where to generate funds, what strategy to select during recession, when to diversify etc.
All of these issues are not related to microeconomics. Secondly, microeconomics covers some of these issues in an isolated way, whereas managerial economics focuses on evaluation and choice of alternatives and addresses all the issues simultaneously in a comprehensive manner.
Managerial economics does not remain confined to a particular organization, because in recent times we hardly find any business unit operating in isolation. Managerial economics, though primarily concerned with the theory of the firm, it also requires proper understanding of the structure of the industry within which it operates.
So, not only the variables specific to the organization in consideration becomes relevant in decision making, but also information of competing and related organizations are to be considered as significant in managerial decision making. By related organizations, we mean suppliers, customers and manufacturers of complementary products.
Today’s buzz words are Just-in-Time (JIT) inventory, franchising, supply chain management, outsourcing etc. The suppliers and customers have gained importance because the corporate planners have identified outsourcing and contract manufacturing as successful strategic postures.
Manufacturers of complementary products also play significant roles because the customers perceive it as a single product and hence a fluctuation in price of one product causes change in the other, given the budget constraint. As a result, managerial economics helps in working out bundling strategies.
This has assumed special significance with the emergence of the concept of ‘global village’, whereby a large number of firms, transnational in nature, face different market structures in different countries.
The experience in one country, very often, cannot be extrapolated to another. While management knowledge may proclaim ‘think global, act local’, it is managerial economics that helps understanding complexities of one, few or many buyers and/or suppliers.
Managerial economics cannot ignore the knowledge about unemployment inflation, business cycles etc. because the” influences of macroeconomic environment on the decision variables can hardly be denied. The only permanent thing is change. Nothing else could describe today’s business environment better.
With interventions from the World Trade Organisation (WTO), galloping movement towards full convertibility of the local currency, increasing pressure to enhance trade, development of market blocs – all come under the purview of managerial economics, for, these issues directly affect business environment.
Managerial economics is also linked and interconnected with the functional areas of management which has been represented in Diagram 1.1. Overall managerial decision-making can hardly afford to ignore these interrelationships.
For example, advertising is a branch of marketing, but optimal expenditure on advertising by a firm, given the advertisement expenditure of rival firms, is regarded as an important decision variable of managerial economics.
Similarly, feasibility of a project, which occupies a significant area of financial management, relies heavily on the projected values of revenue and profit that ultimately reveals the importance of price, cost, output and elasticity.
Moreover, feasibility of a project also depends on two important concepts of managerial economics – total demand and minimum efficient scale constraint, given the size of the market.