how managerial economics bridge the economic gap between economic theories and business practice

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MANAGERIAL ECONOMICS BRIDGE THE GAP

BETWEEN ECONOMIC THEORY AND BUSINESS

PRACTICES

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1.0 Introduction

Managerial economics is the part of microeconomic that describe the pure economic concept into

form that managers can use to reach optimal decision about how much to production , what

quantity of labor should be hired get maximized total product, at what level price should be set

and how to maximize profit with a minimization of costs . The whole content of managerial

economic is about quantitative estimates (regression, correlation and calculus) and illustrations

which support manager at every with a greater precision and support.

1.1 Managerial decision problems and the tools of managerial economics

Figure 1: Managerial economics 10e

Management decision problems

Determine the best output and

pricing level

Organizational decision

Set optimal input level

Economic benefit to invest in a new

project

Economic concepts

Marginal analysis

Demand analysis

Theory of firm

Optimal choice decision

Quantitative tools

Numerical analysis

Statistical tools

Forecasting techniques

Optimization techniques

Managerial economics

Use both economical and

mathematical tools to resolve

managerial decision problems

Optimal

management

decision

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Here we will discuss some important economic concepts and their business application -

Marginal analysis Measure additional befit added or additional cost due to

particular action taken by managements.

Demand analysis Describe how consumers demands effects with different

influencing factors with inclusion of the degree at which their

demand pattern changes

Optimal choice theory Describe the alternative opportunity available in market which

can give the consumer or producer best utility at a given

budget constraint

2.0 Marginal Analysis Concepts Applications in Business Practice

Optimal input level selection

Without exerting input into production process we can’t expect output in real world.

Proper handling of input in production process facilitate a firm to maximize output thus

minimize cost incurred in per unit of output produced. It is true that deploying more input

maximize production but up to a certain production level. Hereby Marginal product (MP)

assists a lot through determining the optimal input level.

Rules to hire additional input: hire until MRP (marginal revenue product; MP from input

* price of the input) = MC. ( applicable for short run where TP increase due to increase in

L ( labor ) )

In long run when organization allows all input to very; them MP of each dollar paid to a

input must be same to that of other inputs. that means-

��/�� =………………=……………=………………..= ��/ ��

Input combination will be optimal ; when we can’t produce additional output at the same

cost

Several efficient input combinations show the firm the path to grow optimal output in

long run; called expansion path.

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Notify optimal production stage

From the very beginning of production of a firm; these marginal concept help the firm in

the decision about to continue production or stop production. Firms can locate its position

in production horizon and then take necessary action plans which are releva

time.

There are three stages of production which is true for production of any goods and

services in any industry

MP help firm to decide about how

always suggest continuing production until MP from input became ne

production stage I and II there are enough scope to increase production via specialization

and teamwork and utilization of fixed input up to its maximum level.

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in production horizon and then take necessary action plans which are releva


to decide about how much time the firm should continue production

always suggest continuing production until MP from input became negative. In


and teamwork and utilization of fixed input up to its maximum level.

Figure:

Managerial

Economics; 10e

Figure 1: Stages of

production; Principle of

microeconomics-----

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in production horizon and then take necessary action plans which are relevant on that


time the firm should continue production –

gative. In


Figure:

Managerial

Economics; 10e

Stages of

; Principle of

-----10e

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To set optimal price

Firm can’t charge price by itself rather should look around the market condition to set

price (competitor’s price, market structure, and cost of production).

MC help firm to find the optimal price at optimal quantity through equating itself with

MR

1. When a firms MC is high then the firm need to charge high price

2. When a firm’s MC is low then the firm need to set optimal price at lower level

2.1 Demand Analysis Applications in Business Practice

Law of demand

The law of demand is all about to explain negative relationship in between price and the demand for a

product if all other determinant held constant.

It suggest firm that due to diminishing marginal utility (benefit or satisfaction achieved from attaining or

consuming or using additional unit decrease gradually) and substitution effect ( when price of substitute

falls consumer always go for consumption of them rather consuming firm’s products) consumer demand

less/ more when price increase / decrease.

With the use of law of demand firm decide to –

Charge reasonable price when there are large number of substitute available in market

Ensuring higher satisfaction to the customer through providing quality goods which somehow

reduce the extent at which MU falls.

Rules to

optimize

price

P= ��

��

��

When MC high; Ed

low

Higher optimal

price

When MC Low;

Ed high Lower optimal

price

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Elasticity of demand

Law of demand describe the truth that change in price inversely effects quality demanded but

doesn’t describe at which extent the quantity demanded would change. Here Elasticity gives

greater precision in making decision about to raise or to reduce price level.

Price elasticity:

1. When firm’s product face an elastic demand the firm should set price at low level

which will increase volume of sale at a greater extent thus boost TR

2. When firm’s product face an inelastic demand the firm should set price at high

level which doesn’t decrease volume of sale at a greater extent thus boost TR

3. When firm’s product face an elastic demand the firm should set price at same ;

keeps TR unchanged

A rational firm always thinks to belong in product market in which demand is

inelastic; because they might have scope to increase price.

Besides price elasticity firm sometime concerned about income elasticity to forecast

impact of increased income of consumers.; cross price elasticity about to forecast

changes in demand for two related good ( complementary or substitute); that the firm

dealing with; due to increase in price of one of the related goods

2.2 Forecasting demand on the basis of changes in determinants of demand

Based on proper anticipation firm arrange their future action plans. For proper and succinct

anticipation firm should look over some important determinant except price and then based upon

that they set up the best action that will maximize firm’s sale, revenue or reduce cost.

1. If substitute products price decrease then firm should readjust the price level with a

consideration of their product quality in comparative to substitute product

2. If complementary product price is supposed to be reduced then the firm will face an

increasing demand for its product.

3. When there are larger number of buyer rooming around the market; where supply of

goods is not sufficient; then firm usually anticipate a rise in sales volume and price.

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4. Consumer’s expectation about to possible increase in price level drive them to purchases

more goods and service at present ; so firm should react with increasing supply if they

want high sales volume or reduce supply for future if they want high price for their

goods and services.

5. If real foreign exchange

because import cost of raw material is reduced.

2.3 Comparative statistics analysis

Comparative statistic analysis is a most prominent tool of demand and supply analysis ; where we see

how a change in determinant of supply and demand creates a disequilibrium situation from an equilibrium

situation and how the market forces resorted this d

and how to make a comparison among these 2 equilibrium condition

Suppose –

1. Demand increase; supply decrease

will obviously increase price bu

relative shift of demand and supply function. It infers that firm can charge a high price in this

situation.

2. Demand decrease; supply increase

which will obviously decrease price but changes in quantity demanded will be determined based

on relative shift of demand and supply function. It infers that firm should charge a low price in

this situation.

3. Demand decrease; supply decrease

which will obviously decrease quantity but changes in price will be determined based on relative

Deal with

Changes in

Determinants of

demand in form

of quantitative

format

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Consumer’s expectation about to possible increase in price level drive them to purchases


t high sales volume or reduce supply for future if they want high price for their

exchange rate appreciated then the firm will face higher derived demand

because import cost of raw material is reduced.

Comparative statistics analysis



situation and how the market forces resorted this disequilibrium situation into a new equilibrium situation

to make a comparison among these 2 equilibrium condition

Demand increase; supply decrease due to changes in determinant of demand and supply; which

will obviously increase price but changes in quantity demanded will be determined based on


Demand decrease; supply increase due to changes in determinant of demand and supply;



Demand decrease; supply decrease due to changes in determinant of demand and supply;


Set action plans

to boost the

demand as well

as revenue

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Consumer’s expectation about to possible increase in price level drive them to purchases


t high sales volume or reduce supply for future if they want high price for their

firm will face higher derived demand



isequilibrium situation into a new equilibrium situation

due to changes in determinant of demand and supply; which

t changes in quantity demanded will be determined based on


due to changes in determinant of demand and supply;



due to changes in determinant of demand and supply;


Set action plans

to boost the

demand as well

as revenue

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shift of demand and supply function. It infers that firm should mea

demand and supply and based on that should set price

4. Demand increase; supply increase

will obviously increase quantity but changes in price will be determined based on re

demand and supply function. It infers that firm should measure the relative shift of


5. Demand increase (only) causes a right shift

which will increase price as well as quantity. So firm should increase supply as a respond

to higher prices

6. Supply increase (only) causes a right shift

which will decrease price as well as increase quantity. Firm should decrease suppl

reduce surplus by giving low piece offer

2.4 Optimal choice theory applications in business practice

Optimal choice theory is theory from the perspective of business firm is all about to determine

optimal input and quantity of output that give maximized output with economy of scale.

Optimal input:

Input combination that gives the maximum output level; above which cost of producing

additional unit increased. In managerial economics optimal input persist in the tangent point of

both isoquant and isocost in long run and the input level which exist at total production at whic

MR=0 and MRP of labor is equal to MC of labor in short run.

K

B (optimal input)

A

Isoquant is the curve that shows most preferred combi

will give the same level output and Isocost is the curve that shows all

combinations of input that costs whole money allotted by firm to be

expended in purchasing inputs.

Here we see a point along isocost line (A) which is represent

combination which affordable but doesn’t reflect most preferred

combination; because it positioned bellow the isocost line.

So to meet the most preferred (K, L) within a budget constraint firm should

pick up a combination which is common to both

(tangent point); where Slope of isocost and isoquant is equal

When firm want to increase Q then they prefer

positioned

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shift of demand and supply function. It infers that firm should measure the relative shift of


Demand increase; supply increase due to changes in determinant of demand and supply; which

will obviously increase quantity but changes in price will be determined based on re



Demand increase (only) causes a right shift of demand curve along the supply curve

e price as well as quantity. So firm should increase supply as a respond

Supply increase (only) causes a right shift of supply curve along the supply curve

which will decrease price as well as increase quantity. Firm should decrease suppl

reduce surplus by giving low piece offer.

ptimal choice theory applications in business practice



gives the maximum output level; above which cost of producing


in long run and the input level which exist at total production at whic

nd MRP of labor is equal to MC of labor in short run.

L

Isoquant is the curve that shows most preferred combi



expended in purchasing inputs.

Here we see a point along isocost line (A) which is represent




pick up a combination which is common to both isocost and isoquant curve


When firm want to increase Q then they prefer to chose optimal input point

positioned far away from origin to the North East direction

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sure the relative shift of

due to changes in determinant of demand and supply; which

will obviously increase quantity but changes in price will be determined based on relative shift of


of demand curve along the supply curve

e price as well as quantity. So firm should increase supply as a respond

of supply curve along the supply curve

which will decrease price as well as increase quantity. Firm should decrease supply to



gives the maximum output level; above which cost of producing


in long run and the input level which exist at total production at which

Isoquant is the curve that shows most preferred combinations of inputs that



Here we see a point along isocost line (A) which is represent an input




isocost and isoquant curve


to chose optimal input point

far away from origin to the North East direction

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Economies of scale prevalence among different output level

With the use of coefficient of output elasticity business firm determine the extent at which they

are enjoying economies or diseconomies of scale. Output elasticity is mainly % changes in

quantity due to % changes in all inputs.

Firm’s decisions on the coefficient of output elasticity are –

If firm get Eq= 1 ; then firm should realize that they are getting doubled output with an

implication of doubled input.( Constant Return to Scale )

When Eq>1; then firm should realize that they are getting more than doubled output with

an implication of doubled input ( Increasing Return to Scale)

When Eq<1 ; then firm should realize that they are getting less than doubled output with

an implication of doubled input ( Decreasing Return to Scale )

In long run production; firm at initial stage of production face increasing return; then constant

return to scale; later decreasing return to scale.

TP

IRTS CRTS DRTS All Inputs

3.0 conclusion

The things that we described above are just a small portion of the whole bridge that makes a linage in

between business and economics concepts. Due to limitation of time, knowledge, and reliable study

material / resources we selectively discussed some of the important economics concept and their

application to the individual firms. All the things covered above up leaved the importance of managerial

economics in the modern business era.

how managerial economics bridge the economic gap between economic theories and business practice

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