Managerial economics refers to how economic tools, concepts, theories, and methodologies are applied to solve practical problems. To put it simply, managerial economics means the amalgamation of the theories of economy and management. A manager with a good knowledge of managerial economics has a strong decision-making skills. Managerial economics is also called business economics sometimes. It is that branch of economics that uses microeconomic analysis to determine a decision in business and other management units. Managerial economics takes a cue from the quantitative techniques that include calculus, correlation, and regression analysis. The only unifying aspect that goes through managerial economics is the effort to enhance decision-making in business, especially if the business has some scarcity or constraints.
This effort is put through using mathematical programming, game theory, operations research and computational methods of other types. Managerial economics as a subject has materialized into a fully-fledged subject only in recent years. The rising unpredictability and variability have compelled business managers to worry about uncovering the more practical ways of regulating an abusive environmental change. These problems caught the attention of academicians across the globe, who then came up with managerial economics. The subject became popular during the 1950s in the United States after Joel Dean published his trendy book titled Managerial Economics in 1951. Different economists have provided different definitions of managerial economics. As Brigham and Pappar define, managerial economics involves the function of the theories and methodology of economic into the practice of business administration.
Managerial economics has several concepts that make it a unique subject and an essential subject for business managers.
The concept of increment –
Although incremental reasoning is easy to explain, the concept is difficult to apply. In the views of T.J. Coyne, the incremental concept of managerial economics includes approximating the influence of the alternatives to decisions on the total revenue and cost yielding from differences in price procedures, products, and investments. Thus, incremental analysis has two fundamental concepts at its heart, including incremental cost and revenue. While the incremental cost means the change in the cost due to a decision taken, incremental revenue refers to the change seen in the total revenue owing to the decision taken.
Time perspective concept –
In the field of economics, people often distinguish between the long-run and the short-run. Managerial economics states that the factor is based on the rate of decisions made and the variations in the production factors rather than a fixed period. The short-run is the time during which the managers can bring variations to certain factors barring others. In contrast to this, the long run is when all the factors could be varied. To provide an instance, with the help of increased raw materials and labour, the increased output could be achieved in the short run.
Discounting principle concept –
The discounting principle states that managers discount the future profit because of the uncertainty associated with it. However, this concern is wrong because even with no uncertainty, it is essential to discount the future profit to turn them equal to the present-day profit. A strong example of the discounting principle could be given as a person is offered 1000 dollars as a gift today or a year later. The person would choose the first option, although there is no uncertainty that they will not receive the gift after a year. The individual choosing the first option is that in the present era, where the interest rate is anything but zero, there is a possibility to invest 1000 dollars at the market's interest rate and collect interest from the principle.
Apart from benefitting the business managers, managerial economics has advanced to benefit the engineers as well. Each engineer has to evolve, and at some point in life, the chances of evolving cease. Therefore, economics is a healthy subject for every decision-maker and engineer to make crucial decisions in their careers. Business economics or managerial economics should be easy for an engineer because it involves many subjects taught in engineering. Concepts such as linear programming, operations research and statistics and probability are taught more elaborately in engineering. However, it is essential to note that engineers at the testing, developing and designing levels do not have anything to do with managerial economics. For other engineers, having a good knowledge of managerial economics would greatly help in valuing the subject. Engineering yielding too much cost in building something is not good engineering. To become a good engineer who knows how to manage cost and prices while providing engineering solutions, one must have a stronghold in managerial economics.
In managerial economics, the differential cost is the incremental cost, which finds the total relevant cost between two alternatives. In general, these alternatives include two distinct levels of activity, make or buy, amongst others. Therefore, the differential cost is the additional cost incurred when one alternative has opted over the other. In simpler terms, managers compare two options to find out the total costs of the two and to know the difference between the total costs of the two options. After finding the difference between the two options' total costs, the change is known as incremental or differential revenue. Differential cost analysis takes place to make crucial decisions related to making or buying, making changes in the activity level, adding any new product, changing the product mix, exporting orders, etc. In the differential cost analysis, the users take into consideration only the relevant costs.
Costs, which have been acquired in the past already, are considered not relevant. This is also known as a fixed cost. On the other hand, future costs are considered relevant because these costs are variable. Joel Dean explains that managerial economists always look for future costs because important management decisions are made using forecasts of future prices. Therefore, forecasting cost is high, especially to control expenditure. It is further important to learn about the income statements in the future, decisions related to capital investment, pricing, dropping and developing old and new products, respectively. It is also important to note that the differential cost analysis is only considered to make management decisions and is irrelevant to bookkeeping or accounting.
Role of managerial economics –
The first important role of managerial economics is to enhance the decision-making efficiency in business to increase profit.
The second role of managerial economics is to study the economic pattern at the macro-level to analyze the significance of the subject in an organization and its functioning.
Third, managerial economics examines how the changing environment maximizes the organization perfectly.
Fourth, managerial economics helps make good decisions when choosing an alternative that could reduce cost.
Fifth, managerial economics plays a crucial role of to help in making investment decisions for individual investors as well as for corporations.
Sixth, it helps the business companies decide the strategies of pricing and the correct pricing levels to be given to their services and products.
Sixth, managerial economics helps in the decision-making related to a company's internal working of a company like price changes, plans of investment, types of services to be given, inputs utilized, and so on.
Seventh, managerial economics plays the role of analyzing the changes in indicators showing macroeconomics, including population, business cycles, national income and their probable influence on the company's working.
Importance of managerial economics –
Managerial economics is vital in analyzing managerial policies. Organizations have certain policies, especially operational policies, that tend to produce no return and are of no use. These policies also play no role in altering the market conditions as well. Managerial economics helps make crucial evaluations and that too in crucial time to solve upcoming obstacles before harming the organization.
Managerial economics is important also because it helps the business recognize its strengths and weaknesses. It helps the business identify where it excels as well as where it lags. With the help of managerial economics, managers could ensure certain activities, which could influence business development.
Advantages of managerial economics –
Managerial economics helps evaluate past policies to decide whether they are suitable for the business or need to be improved. However, it sometimes happens that the policies introduced and executed by the business are outdated and hold no relevance in the market that keeps on changing. Hence, policy evaluation becomes vital to find a better solution to the problem.
As an advantage, managerial economics assists the managers in identifying the economic strengths and weaknesses, which could impact the company.
One of the other advantages of managerial economics is that it helps establish a policy of decision, which aligns with the company's operational standards. Every company comprises distinct operational standards and different regulations and policies made to suit the type of company.
Managerial economics is advantageous because it helps identify the costs to be as competitive as possible.
Disadvantages of managerial economics –
Managerial economics concentrates on the analysis of the management based on cost accounting and financial data. Hence, the dependability of this database on the information accuracy of financial accounting.
Analysis of the data depends on past information. Thus, relying on past information would be disadvantageous if the company plans to bring in new schemes and the situations change.
Managerial economics encourages individual managers' personal preferences that could affect the final decision largely.
Managerial economics has the disadvantage of being very expensive as a process for any business. A company would commonly need to employ more than just one manager to ensure smooth functioning.
One of the most visible disadvantages of managerial economics is its newness. Therefore, many experts believe that it might be ambiguous in some situations.
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