Chapter

NATURE AND SCOPE OF

BUSINESS/MANAGERIAL ECONOMICs

1, BUSINESS ECONOMICS
Business Economics is also called Managerial Economics these days. According to McNair
and Meriam, Business Economics deals with the use of economic modes of thought to analyse
business situations. In other words, business economics is the applied branch of economics
which analyses business situations. Economics has developed some well known 'principles' or
'modes of thought'. These 'principles' are utilised to solve business problems of an economic
nature. In business, a management executive has the prime function of a business executive in
decision-making and forward planning.
(a) Decision-making means the process of choosing one action from two or more alternatives
available to the business executive.
(6) Forward-planning means establishing plans for the future. These plans relate to the
future programme of action by the business unit. The problem of choice arises because resources
at the disposal of abusiness unit (land, labour, capital and managerial capacity) are limited and the
fim has to make the most profitable use of these resources. The decision-making function is that
of the busines executive. He takes decisions which will ensure the most efficient means of
ataining adesired objective, say profit-maximisation. After taking the decision about the particular
goal and the targets to be achieved over a period of time, plans regarding output, pricing, capital,
raw-materials and power etc. are prepared. Forward planning and decision-making thus go on at
the same time.
A DUSiness manager's task is made difficult by the uncertainty which surrounds business
decision making. Nobody can predict accurately the future course of business conditions. At the
most, abusiness executive can make an intelligent guess of likely conditions in the future. Yet a
ss S only a guess and actual events may belie these guesses. If knowledge of the future were
perfect, planscould be formulated without eror. There would not arise any need for subsequent
4
BUSINESS ECONOMICS
business manager has therefore to contend wit
revision of the plans after their formulation. A
attaching to his plans about sales, costs capital conditions and profit. He nre
some uncertainty depending on past experionce and future outlook and
vet
the best possible plans for the future t
of new experience. The business manager has
has to go on revising his plans in the light and sales inorder to adjust to the uncertainty os
continuously take decisions about his output business mane
it unfolds to him. Business economics is the discipline which helps a
future as
for achieving the desired results. Therefore Spencer and Siegelman hau
in decision making integration of economic theory with business practice for d
defined business economics as "the management,"1
of facilitating decision-making and forward planning by
purpose
business economics as the discipline which deals with the application
We can define
management.
economic theory to business

OF ECONOMIC THEORY TOBUSINESS

2. APPLICATIONS
PRACTICE
applied to business management in the following directions.
Economics is
economic theory for business management. The
1. Reformulation of
economic theory to problems of business management is the theory of the
most relevant part of far away from the
the traditional economic theory of firm behaviour is removed so because the
firm. But
its present form the theory is not at all useful. This is
facts of business life that in so simple as to be misleading in actual business
decision
assumptions of economic theory render it policy formulation
explains why firms behave in particular ways nor helps in
making. It neither
is a definite need to make the theory of the firm more practicable by
about the future. Thus, there can illustrate this point by taking up the assumption
integrating it with actual business practices. We determination of the firm
profit-maximisation on which the whole theory of price and output assumption. Actual studies of
of conduct have been built up on this
is based. Elegant models of firm not always maximise profits. To the
extent firms
however, indicate that firms do theory fails
firm behaviour, profit- maximisation-assumption based
objectives, the
attach importance to non-profit
to explain firm behaviour.
sharp differences between the concepts employed in economic theory
Moreover, there are talk of Gross
definitions of the same terms used in practice. For example, economists
and the
accountants have their own definition of profit. There is thus a genuine
and Pure profit while the economic theory to make these more suitable
for
of the terms often used in
need for redefining
use in decision making and forward planning.
relationships. To integrate economic theory with
2. Measurement of economicmeasurement of important economic relationships like
business management, we must attempt at of sucn
various elasticities of demand, returns to scale and factor-elasticities. Estimates
the which is so very necessary for deciSIOl
relationships are the basis of economic forecasting
making in a firm.
A business manager needs quantitate
3. Predicting relevant economic quantities. availability etc. along with thet
estimates of demand, production costs, prices and capital
Milton M. Spencer and Louis Siegelman, Managerial Economics. Homoewood. llinois. Richard
1.
Iswrn, 1959, p.l.
NATURE AND SCOPE
OF BUSINESS/MANAGERIAL ECONOMICS 5

probabilities for decision-making and forward planning. The necessity of such estimates arises
uncertain environment in which the fim operates.
due to
Eormulation of business policies. Economics needs studies of actual business
decision-making and policy formulation through the use of economicforecasts of varied accuracy.
Economic forecasting is costly and a firm likes to know how much accuracy a forecasting
for its policy formulation. Economic forecasts paint afuture picture of the
technique can ensure
policy alternatives available to a manager along with the probabilities attached to each of these
view, a business manager's task in decision making would be
dltematives. Keeping this picture in
facilitated. The present state of economic forecasting is far from satisfactory.
K Understanding the business environment. Economic theory must help in
understanding the economic environment in which business has to operate and to which it has to
adinst Business environment is constituted by business cycles, changes in national income and
govermment policies relating to taxation, foreign trade, labour relations, anti-monopoly measures,
industrial licensing and price controls. A business manager has to appraise the relevance and
imnact of these external forces on his decision-making and forward planning.

5. CHIEF CHARACTERISTICS OF BUSINESS ECONOMICS

Business economics has characteristics which distinguish it from business management and
economics both. We can be clearer about the nature and scope of business economics by studying
its characteristics.
1. Business economics is micro-economic in nature. This is due to the study of business
economics mainly at the level of the firm. A business manager is usually concerned with problems
of his own business unit. He does not study the economic problems of an economy as a whole.
2. Business economics largely uses the theory of markets and private enterprise. It uses the
theory of the firm and resource allocation in private enterprise economy.
the
3. Business economics is pragmatic in its approach. It does not involve itself with
theoretical controversies of economics. Yet it does not relegate the realities of business decision
making to the background by bringing in abstract assumptions. While economic theory abstracts
from realities of the individual business units to build up its theories, managerial economics takes
due note of the particular economic environment in which a firm works.
4. Business economics belongs to what is called normative economics which prescribes
standards or norms for policy making. Business economics is prescriptive rather than descriptive
In nature. In economic theory, we try to explain economic behaviour : in business economics,
We try toprescribe policies for a business manager which are most likely to achieve his objectives.
In economic theory, we build laws' such as the Law of Demand and the Law of Diminishing
Returns. In business economics we apply these laws for policy planning at the level of a fim.
5, Macro economics which deals with the principles of economic behaviour for the economy
as a whole is also useful for business economics. Abusiness unit operates within some economic
environment which is in turm shaped by the behaviour of the economy as a whole. Abusiness
Inanager must understand the external forces working over his business environment. He has to
intelligently adjust himself to the uncertainties of his business. The important aspects of macro
CConomics of special interest to business economist are national income accounting, business
Cycles, economic policies of the government in relation to business etc.
6 BUSINESS ECONOMICS
4. SCOPE OF MANAGERIAL/BUSINESS ECONOMICs
managerial economics is not yet clearly laid out because it is a
scope
science.The Even of the
then developing
following fields may be said to generally fall under business economics :
1. Demand Analysis and Forecasting.
2. Cost and Production Analysis.
3. Pricing Decisions, Policies and Practices.
4. Profit Managemènt.
5. Capital Management.
matter.
These divisions of business economics constitute its subject
Operations Researok
Recently, managerial economists have started making increased use of Therefore, modern
methods like programming, games theory, queing up theorywell. and input-output.
business economics includes a study of these mnethods as
1. Demand analysis and forecasting. A business firm is an economic unitaccurafe which
transforms productive resources into saleable goods. Since all output is meant to be sold,
estimates of demand help a firm in minimising its costs of production and storage. A firm must
resources to
decide its total output before preparing its production schedule and deciding on the maintaining its
be employed. Demand forecasts can also serve as a guide to the management for
also
market share in competition with its rivals, thereby securing its profits. Demand analysis product
facilitates the identification of the various factors affecting the demand for a firm's
are the
which helps the firm in manipulating the demand for its output. In fact, demand forecasts
covered under demand
starting point for a firm's planning and decision-making. The main topics Forecasting.
analysis are : Demand Determinants, Demand Distinctions and Demand
2. Cost and production analysis. A firm's profitability depends much on its costs
identify the
of production. A wise manager would prepare cost estimates of a range of output,
factors causing variations in costs and choose the cost-minimising output level, taking also into
consideration the degree of uncertainty in production and cost calculations. Production processes
are under the charge of engineers but the business manager is supposed to carTy out the production
function analysis in order to avoid wastages of materials and time. Sound pricing practices depend
much on cost control. The main topics discussed under cost and production analysis are : Cost
control.
concepts, cost-output relationships, Economies and Diseconomies of scale and cost
3. Pricing decisions, policies and practices. Pricing of the firm's products is a
very important task before a business manager. Since a firm's income and profit depend crucially
on the price decision, the pricing practices, policies and decisions are to be taken after careful
analysis of the nature of the market in which the firm operates. The important topics covered in
this field of study are : Market Structure Analysis, Pricing Practices and Price Forecasting.
4. Profit management. Business firms are generally organized for earning profit and
in the long period, it is profit which provides the chief measure of success of a firm. Economics
tells us that profits are the reward for uncertainty bearing and risk taking. Asuccessful busines
manager is one who can form more or less correct estimates of costs and revenues likely to
accrue to the firm at different levels of output. The more successful a manager is in reducing
uncertainty, the higher are the profits earned by him. In fact, profit-planning and profit measurement
constitute the most challenging area of Business Economics.
 NATURE AND SCOPE OF BUSINESS/MANAGERIAL ECONOMICS 7
s Capital management. Perhaps the most
capital challenging problem for a business manager
isof planning investment. Investments in plant and machinery, buildings and copyrights
arerelatively large. Therefore, capital management requires top-level
management implies planning and control of capital decisions. Put simply, capital
expenditure. The main topics dealt with in
this area of study are :Cost of capital, Rate of Return and Selection of
projects.
The different areas of study under business economics outlined above are
interrelated in
Aat all these types of analysis are required to achievethe objectives before the business
manager.
These divisions are made simply to facilitate the study of various topics.

6. ECONOMIC THEORIESAPPLIED TO BUSINESS ANALYSIS

Economic theory has got a variety of concepts and analytical tools which can be of great
mse to a business economist. Of course, economics does not have ready-made laws for immediate
nse in solving business problems. But it does offer a variety of broad principles which the
managerial economist can put to useful practice. In applying the economics principles for solving
his practical problems of decision-making, the business economist has to use additional skills and
tools to makeup the gap between economic theory and business practices. We can study the
basic economic tools which are used widely in managerial economics. The basic principles or
tools are as under :

1. The opportunity cost principle. This principle is of great use in decision

making. It can be stated as follows :
The cost involved in any decision consists of the sacrifices of alternatives required by that
decision. If there are no sacrifices there are no costs.
The opportunity costs of doing something are measured by the sacrifices in terms of goods
and services involved in the decision. The opportunity cost of the funds employed in one's own
business is the amount of interest income which could be earned had been employed in other
ventures. The opportunity cost of using a machine to produce one product is measured as the
income which could have been obtained by renting it out to somebody else. If a machine has only
one use, its opportunity cost is zero. Similarly, the opportunity cost of the time which an
entrepreneur devotes to his business is the salary he could earn by working with some other fm
of which he has knowledge. For decision-making, opportunity costs are the only relevant costs.
2. The incremental principle. Economists make a wide use of the incremental
principle in the theories of consumption,production pricing and distribution. In price-determination,
this principle states that afirm would maximise its profits if it equates its marginal costs to its
marginal revenue. In other words, this principle tells a business manager that he should expand
his business in each direction only so long as the incremental benefit to his firm is more than the
incremental cost. The moment the incremental benefit (marginal revenue) is equated to the
Incremental cost (marginal cost), it is the point wherethe activity has to be limited. This principle
applies to changes in prices, products, procedures, investments or whatever may be at stake in a
business decision.
3. The principle of time perspective. Economics has brought out the importance
Or keeping a time perspective in decision-making on output, prices, advertising and
expansion of
business. Economists distinguish between the short run and the long run in discussing the
determination of price in a given market form because in the long run a firm must cover its full
8
BUSINESS ECONOMICS
its (fixed) costs. Modern economiste
costs while in the short-run it can afford to ignore some of
between the short run and the long run in order
have started making use of an intermediate run'" which there i
is called oligopoly (a market in
to explain pricing and output behaviour under what perspective can be stated as under :
competition among the few). The principle of time
run and the long run effects on revenues
A decision should take into account both the short
the long run and the short run perspectives
and costs and mnaintain a right balance between
4. The Discounting principle. A fundamental fact of life is that people consider a
be worth less than a rupee today. This is also implied by the common saving
rupee tomorrow to
hand is worth two in the bush. Anybody will prefer R 100today to 100next vear
that a bird in uncertain and it is preferable to get 100 today
There are two reasons for this : (1) the future is next year, one would do well
to receive the ? 100
rather than a vear after: (2) even if one is sure one vear
100 now and invest it for a year and earn a rate of interest on 100 for
to receive
present worth (PW) of 100 obtainable after one year? The relevant fomula
What is the
for finding this out is
7 100
PW =
1+i
Where iis the rate of interest.
(1 + 8%) = 100 12+ 108=92.59.
We find that PW of 100 =100
applies to longer periods. A sum of 100 two years after will have a
The same reasoning
present worth :
7 100 7100 100
= 85.73
PW = 1.1664
(1+ i)2 (1.108)2
economics used in the calculations given above is called the discounting
The principle of
principle. It can be stated as follows : discount those
at future dates, it is necessary to
If a decision affects costs and revenues alternatives
of both before a valid comparison of
costs and revenues to obtain the present values
can be made.
equi-marginal principle. This is a very widely-used principle of economics.
5. The input should be allocated in such a way that the
value adaed
This principle or law states that an
This generalized law is known as the equ
by the last unitof the input is the same in allits uses. help of a
marginal principle. We can illustrate the use of the equi-marginal principle with the
numerical example. productionof
Suppose that a firm has got 50 workers to employ on three activities, say
workers in such a way that
bottled milk, butter, and cheese. The firm must allocate these same. To put
marginal productivity of the last worker employed in each of these activities is the bottled milk,
it more clearly, we can say that if the marginal worker given the duty of producing
cheese
production
adds to output worth ? 20, then the marginal worker employed on butter and firm will notthe be
must also earn neither more nor less than? 20 for the milk plants. Otherwise the by
of additional output pproduced
making the best use of the employed labour. The 20 worth equi-marginal
marginal worker is called 'value of marginal product or VMP We can state the
principle in short as follows :
NATURE AND SCOPE OF BUSINESS/MANAGERIAL ECONOMICS
VMPA = VMPg = VMPc
Where A, B andC indicate the activities A, Band C.
The equi-marginal principle stated above has been given a very simple form. It needs to be
oorrected further for practical use. The first correction is that we must find the net value of the
marginal products before we compare these. This is because adding a worker to an activity also
necessitates adding other inputs like machine, time, electricity etc. And to find out the worker's
net marginal value product, we must deduct from his VMP the value of the additional materials
nsed in the process. Suppose the value of these additional materials is 5, then the net VMP of
the worker will be 20 5 =7 15.
The second correction needed is with regard to the price of the output
produced by
additional worker. When more bottles of milk are produced these may have to be offered the to
consumers at lower prices which means that the revenue earned by the firm from additional
bottles of milk would be less than that of the earlier bottles. If we subtract the
reduction in
revenue from the VMP of the worker, we get the net marginal revenue product of the worker.
The third correction to be made in the equi-marginal principle is to discount the
made available to the firm from the sale of the additional production in the future. revenues
Labour has to
be paid today while the output of labour has to be sold in future. If a year's period is
for the sale of output we have to discount the net product for one year necessary
before comparing the net
products of labour in each activity.
It should be remembered that the equi-marginal principle is
workable only under ideal
conditions. A business enterprise may also work under some non-economic pressures and pulls.
For example, an activity may be carried on simply because of inertia on the part of
arising from well-set routines even though activities add less to the revenues of a firmmanagement
than others
which have to be started for the first time. Other activities may be just
continued because the
managers have a sentimental attachment to them. For example, the cotton cloth section of a
textile mill might be earning only a nominal profit while the rayon yarn section earns
much
yet the management may not close the former because the founding father had started it. more,
Another
example of the violation of the principle of equi-marginal returns is found in those
where the management would not agree to retrench workers as they are rendered departments
introduction of machinery simply because that would spoil over-all labour relations.surplus the
by
We can sum up by saying that economic theories are of great use in
business
although these have to be considerably refined and modified to suit the nature of theeconomics
enterprise. There are definite gaps between the theory of the firm and managerial business
Economic theory is meant for generalized study and application to economic economics.
managerial economics is downright practical science. Most of the assumptions of models while
the economic
heory of the firm are abstract in nature. For example, the
be a thoroughly calculating man who strives to entrepreneur of a firm is assumed to
maximise
Wn marginal revenue. Now this is not borne out by many profit by equating its marginal cost
studies of business enterprises made
O.K. and the U.S.A. It has been observed that under imperfect
found in markets, firms have no compulsion competition which is commonly
to maximise profit. Rather the firms tend to have
non-profit goals of along-run nature such as stability and liquidity of the firm which considerably
modify their decision-making processes and
policy planning.
10 BUSINESS ECONOMICS
6. MANAGERIAL ECONOMIST: ROLE AND
RESPONSIBILITIES
Amanagerial economist plays a very important role. He helps the management of afiro :
decision making and forward planning by using his skills and techniques, In the U.S.A., UK
Canada, almost all big fims employ managerial economists. In India also leading business firme
are employing business economists. Tatas, Hindustan Lever and Reliance have managerial
economists on their staff. The role of a managerial economist is that of a business analyst and of
an advisor. Accordingly, his responsibilities are also heavy.
Role of a managerial economist
The factors influencing the business of a firm over a period of time can be divided into
external factors and internal factors. The external factors are those which lie outside the control
of a firm's management. Therefore, these factors are called the Business environment. The ínternal
factors are within the control of arrangement. These are the various types of decisions undertaken
by the management. Therefore, the internal factors are also called business operations. Examples
of external factors are government's economic policy, the actions of competitors and weather
conditions. Examples of internal factors are the amount of investment, the number of workers
employed, the quantity of output to be produced and the price of the product.
Study of the business environment. Every firm has to take into consideration
such external factors as the growth of national income, volume of trade and the general price
trends, for its policy decision. A firm works within a business environment. The most important
elements of business environment for a firm are the trend of growth of national economy and
world economy and the phase of the business cycle in which the economy is. At what rate and
where is population getting concentrated? Where are the demand prospects for established and
new products ? Where are the prospective markets ? These questions lead the economist int
purposeful studies of the economic environment.
The international economic outlook is a very important environmental factor for exporting
firms. Will overseas markets expand or contract ? How will the new international agreements
affect the chances of imports and exports ? The economist studies the World Development
Report for possible answers to these questions.
The nature and degree of competition within the industry in which a fim is placed are also
a part of the business environment. Will rivals increase or reduce their prices ? Does the fim
expect newentrants ? Do customers' tastes give some monopoly power to the firm ? These
questions are answered with the help of the trends within the industry.
The kind of economic policies pursued by the government constitute a powerful element of
the business environment of a firm. What are the priorities of the new five-year-plan ? In which
sectors of the economy have the outlays been increased ? What are the segments suffering a cut
in outlays ? What are the budgetary trends ?What about changes in defense expenditure, tax
rates tariffs and import restrictions ? What export incentives are being given ? The answers to
these questions are to be found in the latest five year plan, the economic survey and the buget
speech and in the reports of the Reserve Bank of India.
business plan by
The business economist can help the management in the formation oftheir andlocating
thetiming
forecasting the economic environment. The management can easily decide national economic
trends
of their specific action. The managerial economist has to interpret the
 NATURE AND SCOPE OF BUSINESS/MANAGERIAL ECONOMICS 11
and industrial outlock for their relevance to the firm in which he is working. He has to digest the
evergrowing economic literature and advise top management by means of short, business like
practical notes. In a partially controlled economy like India, the business economist translates the
oVermment's intentions in business jargon and also transmits the reaction of the industry to
proposed changes in government policy.
Study of business operations. The managerial economist can also help the
management in decision making relating to the internal operations of a firm, that is, in deciding
about price, rate of operations, investment and growth of the firm for offering this advice : the
economist has specific analytical and forecasting techniques which yield meaningful conclusions.
What will be the reasonable sales and profit budget for the next year ? What are the
suitable
Droduction schedules and inventory policies ? What changes in wage and price policies are imperative
now 2What would be the sources of finance ? The managerial economist is
trained to answer
Such questions posed by the top management.
Specific functions. Business economists are now performing specified functions as
consultants also. Their specific functions are demand forecasting, industrial market research,
pricing problems of industry, production programmes, investment analysis and forecasts. They
also offer advice on trade and public relations, primary commodities and
foreign exchange.
Managerial economists also carry out analytical studies relating to capital projects in agriculture,
industry, transport and tourism and also of the export environment.
Economic intelligence. The managerial economist also provides general intelligence
services by supplying the management with economic information of general interest so that they
can talk intelligently in conferences and seminars. They are also supplied the facts and
figures for
preparing the annual reports of the firm. Those facts and figures are collected by the managerial
economist because he understands the vast literature available in publications.
Participation in public debates. Well-known managerial
public debates. Both governments and society seek their advice. Theireconomists
practical
participate in
business and industry gives value to their observation. An example is the famous experience
in
jurist and tax
consultant Nani Palkhiwala in India.
In short, amanagerial economist can play a multi-faceted role. He is not only an
analyst of
current trends and policies for his employers but also a bridge between the businessmen in the
specific industry and the government. He acts as an intelligent interpreter of government policies
and a spokesman of his firm.
Responsibilities of a Managerial Economist
In order to best serve the management, a business economist
ought to know his
responsibilities. He must keep in the mind the main objective of making a reasonable profit on the
invested capital in his firm. Firms are not always after
DUsiness, every firm
profit-maximization, but to continue in
has to operate for profit. Therefore, a business economist has the chief
Ooigation of helping the management to make more profits than before. Allhis other responsibilities
flow from this basic obligation. His main
responsibilities are as under :
1. Making successful forecasts. Managements have to take
e future and future is uncertain. This uncertainty cannot be decisions concerning
eliminated altogether but it can be
Teduced through scientific forecasts of the economic environment to his
can follow an orderly employers, so that they
course of business planning. If a managerial economist can make successful
 12 BUSINESS ECONOMICS

forecasts about business trends, the management will hold him in great esteem. Awise managerial
economist will revise his forecasts from time to time in the light of new developments in his
business. As soon as he finds a change in his forecasts, he has to alert the management about it.
Thereby he can assist the management in making the needed adjustments. This will also strengthen
his position as a member of the
managerial team.
2. Maintaining contacts. The managerial economist must
establish and maintain
contacts with data sources for his analysis and forecasts. He must have familiaríty
who are specialists in the fields having some link with his with individuals
work. He must join professional
associations and subscribe to the journals giving him fresh information. The biggest quality of a
managerial economist is his ability to obtain information quickly by
sources of such information. establishing contacts with the
3. Earning full status on the
to participate in decision-making and managerial team. A managerial economist has
status on the business team. He must beforward-planning. For this he must be able to earn full
He should be able to express himself prepared to take up assignments on special project also.
clearly and non-technically so that his advice is
and accepted. Further, while he must be in understood
tune with the industry's thinking, he should
lose the national perspective in giving also not
advice to the management.
We can conclude by saying that
managerial team only if he understands managerial economists can earn an important place in the
and undertakes his
proves useful to the management, he will be cared responsibilities. To the extent he
for. On the opposite, a managerial
would always feel unwanted, if he is not useful to his firm. economist

Questions
1. What is Business Economics ? What are its chief characeristics ?
2. Explain the scope of Business Economics ?
3. Explain how economic theories are applied to Business Economics.
4. What are the role and responsibilities of a managerial economist ?