ENGINEERING AND MANAGERIAL ECONOMICS

NOTES
UNIT-I

Your objectives
After completing this chapter you should be aware of
(a) The problems which the social science of economics attempts to address;
(b) The basic tools of economic analysis;
(c) The alternative systems which have been devised to tackle economic problems;
(d) The assumptions about consumer behaviour which shape the solutions to economic problems.
THE NATURE AND SCOPE OF ECONOMICS
NATURE OF MANAGERIAL ECONOMICS
Managerial economics aims at providing help in decision making by firms. It is heavily dependent on
microeconomic theory. The various concepts of micro economics used frequently in managerial economics
1. Elasticity of demand
2. Marginal cost
3. Marginal revenue
4. Market structures and their significance in pricing policies.
Macro economy is used to identify the level of demand at some future point in time, based on the relationship
between the level of national income and the demand for a particular product. It is the level of national income
only that the level of various products depends.
In managerial economics macro economics indicates the relationship between (a) the magnitude of investment
and the level of national income, (b) the level of national income and the level of employment, (c) the level of
consumption and the level of national income.
In managerial economics emphasis is laid on those prepositions which are likely to be useful to management.

ME deals with Demand analysis, Forecasting, Production function, Cost analysis, Inventory Management,
Advertising, Pricing System, Resource allocation etc.
A social science deals with some aspect or aspects of human society. Economics is a social science which is
concerned with the allocation of scarce resources to provide goods and services which meet the needs and wants
of consumers.

Economics can be called as social science dealing with economics problem and mans economic behavior. It
deals with economic behavior of man in society in respect of consumption, production; distribution etc.
economics can be called as an unending science.
There are almost as many definitions of economy as there are economists. We know that definition of subject is
to be expected but at this stage it is more useful to set out few examples of the sort of issues which concerns
professional economists.
Example:
For e.g. most of us want to lead an exciting life i.e. life full of excitements, adventures etc. but unluckily we do
not always have the resources necessary to do everything we want to do. Therefore choices have to be made or
in the words of economists individuals have to decide-----how to allocate scarce resources in the most
effective ways.
For this a body of economic principles and concepts has been developed to explain how people and also
business react in this situation.
Economics provide optimum utilization of scarce resources to achieve the desired result. It provides the basis
for decision making.

ECONOMICS CAN BE STUDIED UNDER TWO HEADS:

1) Micro Economics
2) Macro Economics
Micro Economics:
It has been defined as that branch where the unit of study is an individual, firm or household. It studies how
individual make their choices about what to produce, how to produce, and for whom to produce, and what price
to charge. It is also known as the price theory is the main source of concepts and analytical tools for managerial
decision making.
Various micro-economic concepts such as demand, supply, elasticity of demand and supply, marginal cost,
various market forms, etc. are of great significance to managerial economics.
Macro Economics:
Its not only individuals and forms who are faced with having to make choices. Governments face many such
problems. For e.g.
How much to spend on health
How much to spend on services
How much should go in to providing social security benefits.

This is the same type of problem facing all of us in our daily lives but in different scales.
It studies the economics as a whole. It is aggregative in character and takes the entire economic as a unit of
study. Macro economics helps in the area of forecasting. It includes National Income, aggregate consumption,
investments, employment etc.
Meaning of managerial economics:
It is another branch in the science of economics. Sometimes it is interchangeably used with business economics.
Managerial economic is concerned with decision making at the level of firm. It has been described as an
economics applied to decision making. It is viewed as a special branch of economics bridging the gap between
pure economic theory and managerial practices.
It is defined as application of economic theory and methodology to decision making process by the management
of the business firms. In it economic theories and concepts are used to solve practical business problem. It lies
on the borderline of economic and management. It helps in decision making under uncertainty and improves
effectiveness of the organization.
The basic purpose of managerial economic is to show how economic analysis can be used in formulating
business plans.
Definitions of managerial economics:
In the words of Mc Nair and Merriam, Managerial Economics consists of use of economic modes of thought to
analyze business situation.
According to Spencer and Seigelmanit is defined as the integration of economic theory with business
practice for the purpose of facilitating decision making and forward planning by the management.
Economic provides optimum utilization of scarce resource to achieve the desired result. MEs purpose is to
show how economic analysis can be used formulating business planning.

Management Decision Problems

Economic Concepts

Decision Science

Managerial
Economics

Optimal Solution to
Managerial Decision Problems
Managerial Economics bridges the gap between purely analytical problems dealt within economic theory and
decision problems faced in real business and thus helps out in making rational choices to yield maximum return
out of minimum efforts and resources by making the best selection among alternative course of action.
How does managerial economics differ from regular economics?

There is no difference in the theory; standard economic theory provides the basis for managerial
economics.

The difference is in the way the economic theory is applied.

Economics in its broadest sense means what economists do. They provide solutions to various economic
problems (inflation, unemployment etc). The one main root cause of all economic problems is SCARCITY and
managerial economics is the use of economic analysis to make business decisions involving the best use of
organizations scarce resources.

Unlimited Wants

Limited resources or means

Scarcity

What to produce?

How to produce?

For whom to produce

Human wants are virtually unlimited and insatiable and economic resources to satisfy them are limited which
give rise to choices between what to produce, how to produce and for whom to produce.
MANAGERIAL ECONOMICS = Economics + Decision Science + Business Management Managerial
economics has evolved by establishing link on integration between economic theory and decision sciences
along with business management in the theory and practice for the optimal solution to business decision
problems. It deals with the application of economic principles and methodologies to the decision making
process within the firm, under the given situation.
CHIEF CHARACTERISTICS
Managerial Economics is micro economic in character: This is because the unit of study is a firm; it is the
problem of a business firm which is studied and it does not deal with the entire economy as a unit of study.
Managerial Economics largely uses economic concepts and principles: Managerial Economics largely
uses economic concepts and principles.
Managerial Economics is pragmatic: It avoids difficult abstract issues of economic theory but involves
complications ignored in economic theory to face the overall situations in which the decisions are made.
Managerial Economics belongs to normative rather than positive economics: Positive economics derives
useful theories with testable propositions about what is and normative economics provides the basis for value
judgment on economic outcomes, what should be. In other words it is prescriptive rather then descriptive. It is
known as the normative micro economics of the firm.
Macro Economics is also useful to managerial economics: Macro economics provides an intelligent
understanding of the environment in which the business unit must operate. This understanding enables a
business executive to adjust in the best possible manner with external forces over which he has no control but
which play a crucial role in the well being of his concern.
SCOPE OF MANAGERIAL ECONOMICS:
Scope is something which tells us how far a particular subject will go. As far as Managerial Economic is
concerned it is very wide in scope. It takes into account almost all the problems and areas of manager and the
firm.
ME deals with Demand analysis, Forecasting, Production function, Cost analysis, Inventory Management,
Advertising, Pricing System, Resource allocation etc.
Following aspects are to be taken into account while knowing the scope of ME:
1. Demand analysis and forecasting:
Unless and until knowing the demand for a product how can we think of producing that product. Therefore
demand analysis is something which is necessary for the production function to happen.
Demand analysis helps in analyzing the various types of demand which enables the manager to arrive at
reasonable estimates of demand for product of his company. Managers not only assess the current demand but
he has to take into account the future demand also.
2. Production function:
Conversion of inputs into outputs is known as production function. With limited resources we have to make the
alternative uses of this limited resource. Factor of production called as inputs is combined in a particular way to

get the maximum output. When the price of input rises the firm is forced to work out a combination of inputs to
ensure the least cost combination.
3. Cost analysis:
Cost analysis is helpful in understanding the cost of a particular product. It takes into account all the costs
incurred while producing a particular product. Under cost analysis we will take into account determinants of
costs, method of estimating costs, the relationship between cost and output, the forecast of the cost, profit, these
terms are very vital to any firm or business.
4. Inventory Management:
What do you mean by the term inventory? Well the actual meaning of the term inventory is stock. It refers to
stock of raw materials which a firm keeps. Now here the question arises how much of the inventory is ideal
stock. Both the high inventory and low inventory is not good for the firm. Managerial economics will use such
methods as ABC Analysis, simple simulation exercises, and some mathematical models, to minimize inventory
cost. It also helps in inventory controlling.
5. Advertising:
Advertising is a promotional activity. In advertising while the copy, illustrations, etc., are the responsibility of
those who get it ready for the press, the problem of cost, the methods of determining the total advertisement
costs and budget, the measuring of the economic effects of advertising ---- are the problems of the manager.
Theres a vast difference between producing a product and marketing it. It is through advertising only that the
message about the product should reach the consumer before he thinks to buy it.
Advertising forms the integral part of decision making and forward planning.

6. Pricing system:
Here pricing refers to the pricing of a product. As you all know that pricing system as a concept was developed
by economics and it is widely used in managerial economics. Pricing is also one of the central functions of an
enterprise. While pricing commodity the cost of production has to be taken into account, but a complete
knowledge of the price system is quite essential to determine the price. It is also important to understand how
product has to be priced under different kinds of competition, for different markets.
7. Resource allocation:
Resources are allocated according to the needs only to achieve the level of optimization. As we all know that we
have scarce resources, and unlimited needs. We have to make the alternate use of the available resources. For
the allocation of the resources various advanced tools such as linear programming are used to arrive at the best
course of action.
TOOLS AND TECHNIQUE OF DECISION MAKING:
Business decision making is essentially a process of selecting the best out of alternative opportunities open to
the firm. The steps below put managers analytical ability to test and determine the appropriateness and validity
of decisions in the modern business world.
Following are the various steps in decision making:
Establish objectives
Specify the decision problem
Identify the alternatives
Evaluate alternatives
Select the best alternatives
Implement the decision
Monitor the performance
Modern business conditions are changing so fast and becoming so competitive and complex that personal
business sense, intuition and experience alone are not sufficient to make appropriate business decisions.

It is in this area of decision making that economic theories and tools of economic analysis contribute a great
deal.
Basic economic tools in managerial economics for decision making:
Economic theory offers a variety of concepts and analytical tools which can be of considerable assistance to the
managers in his decision making practice. These tools are helpful for managers in solving their business related
problems. These tools are taken as guide in making decision.
Following are the basic economic tools for decision making:
1) Opportunity cost
2) Incremental principle
3) Principle of the time perspective
4) Discounting principle
5) Equi-marginal principle
1) Opportunity cost principle:
By the opportunity cost of a decision is meant the sacrifice of alternatives required by that decision.
For e.g.
a) The opportunity cost of the funds employed in ones own business is the interest that could be earned on
those funds if they have been employed in other ventures.
b) The opportunity cost of using a machine to produce one product is the earning forgone which would have
been possible from other products.
c) The opportunity cost of holding Rs. 1000as cash in hand for one year is the 10% rate of interest, which
would have been earned had the money been kept as fixed deposit in bank.
Its clear now that opportunity cost requires ascertainment of sacrifices. If a decision involves no sacrifices, its
opportunity cost is nil. For decision making opportunity costs are the only relevant costs.
2) Incremental principle:
It is related to the marginal cost and marginal revenues, for economic theory. Incremental concept involves
estimating the impact of decision alternatives on costs and revenue, emphasizing the changes in total cost and
total revenue resulting from changes in prices, products, procedures, investments or whatever may be at stake in
the decisions.
The two basic components of incremental reasoning are
1) Incremental cost
2) Incremental Revenue
The incremental principle may be stated as under:
A decision is obviously a profitable one if
a) it increases revenue more than costs
b) it decreases some costs to a greater extent than it increases others
c) it increases some revenues more than it decreases others and
d) it reduces cost more than revenues
3) Principle of Time Perspective
Managerial economists are also concerned with the short run and the long run effects of decisions on revenues
as well as costs. The very important problem in decision making is to maintain the right balance between the
long run and short run considerations.
For example,
Suppose there is a firm with a temporary idle capacity. An order for 5000 units comes to managements
attention. The customer is willing to pay Rs 4/- unit or Rs.20000/- for the whole lot but not more. The short run
incremental cost(ignoring the fixed cost) is only Rs.3/-. There fore the contribution to overhead and profit is
Rs.1/- per unit (Rs.5000/- for the lot)
Analysis:
From the above example the following long run repercussion of the order is to be taken into account:

1) If the management commits itself with too much of business at lower price or with a small contribution it will
not have sufficient capacity to take up business with higher contribution.
2) If the other customers come to know about this low price, they may demand a similar low price. Such
customers may complain of being treated unfairly and feel discriminated against.
In the above example it is therefore important to give due consideration to the time perspectives. a decision
should take into account both the short run and long run effects on revenues and costs and maintain the right
balance between long run and short run perspective.
4) Discounting Principle:
One of the fundamental ideas in Economics is that a rupee tomorrow is worth less than a rupee today. Suppose a
person is offered a choice to make between a gift of Rs.100/- today or Rs.100/- next year. Naturally he will
chose Rs.100/- today. This is true for two reasonsi) The future is uncertain and there may be uncertainty in getting Rs. 100/- if the present opportunity is not
availed of
ii) Even if he is sure to receive the gift in future, todays Rs.100/- can be invested so as to earn interest say as
8% so that one year after Rs.100/- will become 108
5) Equi - marginal Principle:
This principle deals with the allocation of an available resource among the alternative activities. According to
this principle, an input should be so allocated that the value added by the last unit is the same in all cases. This
generalization is called the equi-marginal principle.
Suppose, a firm has 100 units of labor at its disposal. The firm is engaged in four activities which need labors
services, viz, A,B,C and D. it can enhance any one of these activities by adding more labor but only at the cost
of other activities.

RELATIONSHIP BETWEEN MANAGERIAL ECONOMIC, ECONOMIC, AND OTHER SUBJECTS:

Economics and managerial economic:
Economics contributes a great deal towards the performance of managerial duties and responsibilities. Just as
the biology contributes to the medical profession and physics to engineering, economics contributes to the
managerial profession. All other qualifications being same, managers with working knowledge of economics
can perform their function more efficiently than those without it. What is the basic function of the managers of
the business? As you all know that the basic function of the manager of the firm is to achieve the organizational
objectives to the maximum possible extent with the limited resources placed at their disposal. Economics
contributes a lot to the managerial economics.
Mathematics and managerial economics:
Mathematics in ME has an important role to play. Businessmen deal primarily with concepts that are essentially
quantitative in nature e.g. demand, price, cost, wages etc. The use of mathematical logic I the analysis of
economic variable provides not only clarity of concepts but also a logical and systematical framework.
Statistics and managerial economics:
Statistical tools are a great aid in business decision making. Statistical techniques are used in collecting
processing and analyzing business data, testing and validity of economics laws with the real economic
phenomenon before they are applied to business analysis. The statistical tools for e.g. theory of probability,
forecasting techniques, and regression analysis help the decision makers in predicting the future course of
economic events and probable outcome of their business decision. Statistics is important to managerial
economics in several ways. ME calls for marshalling of quantitative data and reaching useful measures of
appropriate relationship involves in decision making. In order to base its price decision on demand and cost
consideration, a firm should have statistically derived or calculated demand and cost function.

Operations Research and Managerial Economics:

Its an inter-disciplinary solution finding techniques. It combines economics, mathematics, and statistics to
build models for solving specific business problems. Linear programming and goal programming are two
widely used OR in business decision making. It has influenced ME through its new concepts and model for
dealing with risks. Though economic theory has always recognized these factors to decision making in the real
world, the frame work for taking them into account in the context of actual problem has been operationalised.
The significant relationship between ME and OR can be highlighted with reference to certain important
problems of ME which are solved with the help of OR techniques, like allocation problem, competitive
problem, waiting line problem, and inventory problem.
Management theory and Managerial economics:
As the definition of management says that its an art of getting things done through others. Bet now a day we
can define management as doing right things, at the right time, with the help of right people so that
organizational goals can be achieved. Management theory helps a lot in making decisions.
ME has also been influenced by the developments in the management theory. The central concept in the theory
of firm in micro economic is the maximization of profits. ME should take note of changes concepts of
managerial principles, concepts, and changing view of enterprises goals.
Accounting and Managerial economics:
There exits a very close link between ME and the concepts and practices of accounting. Accounting data and
statement constitute the language of business. Gone are the days when accounting was treated as just
bookkeeping. Now its far more behind bookkeeping. Cost and revenue information and their classification are
influenced considerably by the accounting profession. As a student of MBA you should be familiar with
generation, interpretation, and use of accounting data. The focus of accounting within the enterprise is fast
changing from the concept of bookkeeping to that of managerial decision making. Mathematics is closely
related to ME. Certain mathematical tools such as logarithm and exponential, vectors, determinants and matrix
algebra and calculus etc.
Rationality
One of the important assumptions in economics, and one on which much economic theory is based, is the
rationality of human behaviour. In order to make predictions about their economic behaviour, economists
assume that human behaviour is 'rational' and that consumers and producers act rationally. For example,
producers and consumers will make reasoned decisions about how much to produce or buy at any given price.
MICROECONOMICS AND MACROECONOMICS
The study of economics is divided into two halves, microeconomics and macroeconomics.
(a) 'Micro' comes from the Greek word meaning small and microeconomics is the study of
individual economic units or particular parts of the economy -e.g. how does an individual
household decide to spend its income? How does an individual firm decide what volume of
output to produce or what products to make? How is the price of an individual product
determined? How are wage levels determined in a particular industry?
(b) 'Macro' comes from the Greek word meaning large, and macroeconomics is the study of
'global' or collective decisions by individual households or producers. It looks at a national or
international economy as a whole -e.g. total output, income and expenditure, unemployment,
inflation, interest rates and the balance of international trade etc, and what economic policies a
government can pursue to influence the condition of the national economy

FOLLOWING ASPECTS ARE TO BE TAKEN INTO ACCOUNT WHILE KNOWING THE SCOPE
OF ME:

1. Demand analysis and forecasting: Unless and until knowing the demand for a product how can we think of
producing that product. Therefore demand analysis is something which is necessary for the production function
to happen. Demand analysis helps in analyzing the various types of demand which enables the manager to
arrive at reasonable estimates of demand for product of his company. Managers not only assess the current
demand but he has to take into account the future demand also.
2. Production function: Conversion of inputs into outputs is known as production function. With limited
resources we have to make the alternative uses of this limited resource. Factor of production called as inputs is
combined in a particular way to get the maximum output. When the price of input rises the firm is forced to
work out a combination of inputs to ensure the least cost combination.
3. Cost analysis: Cost analysis is helpful in understanding the cost of a particular product. It takes into account
all the costs incurred while producing a particular product. Under cost analysis we will take into account
determinants of costs, method of estimating costs, the relationship between cost and output, the forecast of the
cost, profit, these terms are very vital to any firm or business.
4. Inventory Management: What do you mean by the term inventory? Well the actual meaning of the term
inventory is stock. It refers to stock of raw materials which a firm keeps. Now here the question arises how
much of the inventory is ideal stock. Both the high inventory and low inventory is not good for the firm.
Managerial economics will use such methods as ABC Analysis, simple simulation exercises, and some
mathematical models, to minimize inventory cost. It also helps in inventory controlling.
5. Advertising: Advertising is a promotional activity. In advertising while the copy, illustrations, etc., are the
responsibility of those who get it ready for the press, the problem of cost, the methods of determining the total
advertisement costs and budget, the measuring of the economic effects of advertising- -- - are the problems of
the manager. Theres a vast difference between producing a product and marketing it. It is through advertising
only that the message about the product should reach the consumer before he thinks to buy it. Advertising
forms the integral part of decision making and forward planning.
6. Pricing system: Here pricing refers to the pricing of a product. As you all know that pricing system as a
concept was developed by economics and it is widely used in managerial economics. Pricing is also one of the
central functions of an enterprise. While pricing commodity the cost of production has to be taken into account,
but a complete knowledge of the price system is quite essential to determine the price. It is also important to
understand how product has to be priced under different kinds of competition, for different markets.
Pricing = cost plus pricing and the policies of the enterprise .Now it is clear that the price system touches the
several aspects of managerial economics and helps managers to take valid and profitable decisions.
7. Resource allocation: Resources are allocated according to the needs only to achieve the level of
optimization. As we all know that we have scarce resources, and unlimited needs. We have to make the
alternate use of the available resources. For the allocation of the resources various advanced tools such as linear
programming are used to arrive at the best course of action.
APPLICATIONS OF MANAGERIAL ECONOMICS
Some examples of managerial decisions have been provided above. The application of managerial economics is,
by no means, limited to these examples. Tools of managerial economics can be used to achieve virtually all the
goals of a business organization in an efficient manner. Typical managerial decision making may involve one of
the following issues:
Deciding the price of a product and the quantity of the commodity to be produced
Deciding whether to manufacture a product or to buy from another manufacturer
Choosing the production technique to be employed in the production of a given product

Deciding on the level of inventory a firm will maintain of a product or raw material
Deciding on the advertising media and the intensity of the advertising campaign
Making employment and training decisions
Making decisions regarding further business investment and the mode of financing the investment

It should be noted that the application of managerial economics is not limited to profit-seeking business
organizations. Tools of managerial economics can be applied equally well to decision problems of nonprofit
organizations. Mark Hirschey and James L. Pappas cite the example of a nonprofit hospital. While a nonprofit
hospital is not like a typical firm seeking to maximize its profits, a hospital does strive to provide its patients the
best medical care possible given its limited staff (doctors, nurses, and support staff), equipment, space, and
other resources. The hospital administrator can use the concepts and tools of managerial economics to
determine the optimal allocation of the limited resources available to the hospital. In addition to nonprofit
business organizations, government agencies and other nonprofit organizations (such as cooperatives, schools,
and museums) can use the techniques of managerial decision making to achieve goals in the most efficient
manner.
While managerial economics is helpful in making optimal decisions, one should be aware that it only describes
the predictable economic consequences of a managerial decision. For example, tools of managerial economics
can explain the effects of imposing automobile import quotas on the availability of domestic cars, prices
charged for automobiles, and the extent of competition in the auto industry. Analysis of managerial economics
will reveal that fewer cars will be available, prices of automobiles will increase, and the extent of competition
will be reduced. Managerial economics does not address, however, whether imposing automobile import quotas
is good government policy. This latter question encompasses broader political considerations involving what
economists call value judgments.
Broadly speaking managerial economics deals with the following topics.
Demand Analysis and Forecasting: Effective decision making at the firm level depends on accurate
estimates of demand. Demand analysis aims at discovering the forces that determine sales. The demand
analysis mainly relates to the study of demand, determinants, demand distinctions and demand
forecasting.
Cost and Production Analysis: Cost estimates are also essential for effective decision making and
production planning at the firm level. Profit planning, cost control and sound pricing practices call for
accurate cost and production analysis. Cost relations are production function and cost control.
Pricing Decisions, Policies and Practices: Pricing is an important area of managerial economics. Success
of a business firm largely depends on the accuracy of price decisions. Price determinations under
different markets, pricing methods policies, product line pricing and price forecasting are some of the
topics of this area.
Profit Management: Business firms are mainly profit hunting institutions. The success of the firm is
always measured in terms of profits. Nature and management of profit, profit policies and techniques
and profit planning are the important aspects covered in this area.
Capital Management: The most complex, troublesome problem faced by the business manager is the
capital management. Capital management implies planning and control of capital expenditure. Cost of
capital rate of return and selection of projects are the important points under this.
Linear Programming and Theory of Games: Since managerial economics and operations research are
closely connected with each other, managerial economics has started using such techniques of

operations research as linear programming and the theory of games. Recently the linear programming
and the theory of games have been brought as part of managerial economics.
Profits a central point in managerial economics: Profit in other words is the central concept of managerial
economics. Without profits business firms can not run. The maximization of profits is the main objective of any
firm or a business unit. The survival of the firm is determined by the ability of a firm to earn profits. Profit is the
main indicator of firms success.
Optimisation: Optimisation is another important concept used in economic theory and managerial economics.
Managerial economics often aims at optimising a given objective. In recent years, a new concept was found out
called Sub-Optimisation. The greatest merit of this concept is its flexibility.

MANAGERIAL ECONOMICS AND ITS SCOPE IN ENGINEERING PERSPECTIVE

Efficient functioning of any business organization would enable it to provide goods/services at lower price. In
the process of managing organizations, the managers at different levels should take appropriate economic
decisions which will help in minimizing investment, operating and maintenance expenditures besides increasing
the revenue, savings and other related gains of the organization.
Economics in engineering deals with the methods that enable one to take economic decisions towards
minimizing costs and/or maximizing benefits to business organizations.