Managerial Economics is the science of directing scarce resources to manage effectively. Whenever resources are scarce, a manager can make more effective decisions by applying the discipline of managerial economics. These may be decisions regarding customers, suppliers, competitors or the internal workings of the organization. It does not matter whether the setting is a business, not for profit organization or home. In all these settings, managers must make the best use of scarce resources.
Scope of Managerial Economics
Managerial economics must be distinguished from microeconomics and macroeconomics. Microeconomics is the study of individual economic behavior where resources are costly. It addresses issues such as how consumers respond to changes in prices and income and how businesses decide on employment and sales. Microeconomics also extends to such issues as how voters choose between political parties and how governments should set taxes. Managerial economics has a limited scope as it is the application of microeconomics to managerial issues. Managerial economics consists of three branches namely: Competitive markets, market power and imperfect markets.
By contrast, the field of macroeconomics focuses on aggregate economic variables. Macroeconomics addresses such issues as how a cut in interest rates for example can affect the inflation rate and how a depreciation of a currency will affect unemployment, exports and imports. While it is certainly true that the whole economy is made up of individual consumers and businesses, the study of macroeconomics often considers economic aggregates directly rather than as the aggregation of individual consumers and businesses.
Some issues overlap in both microeconomics and macroeconomics. For example, energy has such an important role to play in the economy that changes in the price of energy have both macroeconomic and microeconomic effects. If the price of oil were to rise by 10% , it would trigger increases in other prices and hence generate price inflation, which is a macroeconomic effect. The increase in the price of oil would also have microeconomic effects, for instance, power stations might switch to other fuels, drivers might cut back on using their cars and oil producers might open up new fields.
The fundamental premise of managerial economics is that individuals share common motivations that lead them to behave systematically in making economic choices. If economic behavior is systematic, then it can be studied. Managerial economics proceeds by constructing models of economic behavior. An economic model, is a concise description of behavior and outcomes. By design, the model omits considerable information so as to focus on a few key variables. Economic models are abstractions, like maps; a map with too much detail is confusing rather than helpful. Models are constructed by inductive reasoning. For instance, inductive reasoning suggests that the demand for new software increases with the amount that the publisher spends on advertising. We can build a model in which the demand for a product depends on advertising expenditure. The model should then be tested with accrual empirical data. If the tests support the model.
In managerial economics, many analyses resolve to a balance between the marginal values of two variables. Accordingly, it is important to understand the concept of marginal value. Generally, the marginal value of a variable is the change in the variable associated with a unit increase in a driver. By contrast, the average value of a variable is the total value of the variable divided by the total quantity of a driver.
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