ms-09 mba assignment july dec 2010 Question 1

1. “A close relationship between management and economics has led to the development of managerial economics.” Explain this statement

            The primary role of economics in management is in making optimizing decisions where constraints apply. The application of the principles of managerial economics will help managers ensure that resources are allocated efficiently within the firm, and that the firm makes appropriate reactions to changes in the economic environment.

            A close relationship between management and economics has led to the development of managerial economics. Management is the guidance, leadership and control of the efforts of a group of people towards some common objective. While this description does inform about the purpose or function of management, it  tells us little about the nature of the management process. Koontz and O’Donell define management as the creation and maintenance of an internal environment in an enterprise where individuals, working together in groups, can perform efficiently and effectively towards the attainment of group goals. Thus, management is –

·         Coordination

·         An activity or an ongoing process

·         A purposive process

·         An art of getting things done by other people

            On the other hand, economics as stated above is engaged in analysing and providing answers to manifestations of the most fundamental problem of scarcity. Scarcity of resources results from two fundamental facts of life:

·         Human wants are virtually unlimited and insatiable, and

·         Economic resources to satisfy these human demands are limited.

            Thus, we cannot have everything we want; we must make choices broadly in regard to the following:

·         What to produce?

·         How to produce? and

·         For whom to produce?

            These three choice problems have become the three central issues of an economy as shown in figure 1.1. Economics has developed several concepts and analytical tools to deal with the question of allocation of scarce resources among competing ends. The non-trivial problem that needs to be addressed is how an economy through its various institutions solves or answers the three crucial questions posed above. There are three ways by which this can be achieved. One, entirely by the market mechanism, two, entirely by the government or finally, and more reasonably, by a combination of the first two approaches. Realistically all economies employ the last option, but the relative roles of the market and government vary across countries. For example, in India the market has started playing a more important role in the economy while the government has begun to withdraw form certain activities. Thus, the market mechanism is gaining importance.

            A similar change is happening all over the world, including in China. But there are economies such as Myanmar and Cuba where the government still plays an overwhelming part in solving the resource allocation problem. Essentially, the market is supposed to guide resources to their most efficient use. For example if the salaries earned by MBA degree holders continue to rise, there will be more and more students wanting to earn the degree and more and more institutes wanting to provide such degrees to take advantage of this opportunity. The government may not force this to happen, it will happen on its own through the market mechanism. The government, if anything, could provide a regulatory function to ensure quality and consumer protection. According to the central deduction of economic theory, under certain conditions, markets allocate resources efficiently. ‘Efficiency’ has a special meaning in this context. The theory says that markets will produce an outcome such that, given the economy’s scarce resources, it is impossible to make anybody better-off without making somebody else worse-off.

            Managerial economics is concerned with the application of economic concepts and analysis to the problem of formulating rational managerial decisions. There are four groups of problem in both decisions-making and forward planning.

Resource Allocation:

            Scare resources have to be used with utmost efficiency to get optimal results. These include production programming and problem of transportation etc. How does resource allocation take place within a firm.

            Naturally, a manager decides how to allocate resources to their respective uses within the firm, while as stated above, the resource allocation decision outside the firm is primarily done through the market. Thus, one important insight you can draw about the firm is that within it resources are guided by the manager in a manner that achieves the objectives of the firm.

Inventory and queuing problem:

            Inventory problems involve decisions about holding of optimal levels of stocks of raw materials and finished goods over a period. These decisions are taken by considering demand and supply conditions. Queuing problems involve decisions about installation of additional machines or hiring of extra labour in order to balance the business lost by not undertaking these activities.

Pricing Problem:

            Fixing prices for the products of the firm is an important decision-making process. Pricing problems involve decisions regarding various methods of prices to be adopted.

Investment Problem:

            Forward planning involves investment problems. These are problems of allocating scarce resources over time. For example, investing in new plants, how much to invest, sources of funds, etc.

            Study of managerial economics essentially involves the analysis of certain major subjects like:

·         The business firm and its objectives

·         Demand analysis, estimation and forecasting

·         Production and Cost analysis

·         Pricing theory and policies

·         Profit analysis with special reference to break-even point

·         Capital budgeting for investment decisions

·         Competition.

            Demand analysis and forecasting help a manager in the earliest stage in choosing the product and in planning output levels. A study of demand elasticity goes a long way in helping the firm to fix prices for its products. The theory of cost also forms an essential part of this subject. Estimation is necessary for making output variations with fixed plants or for the purpose of new investments in the same line of production or in a different venture. The firm works for profits and optimal or near maximum profits depend upon accurate price decisions. Theories regarding price determination under various market conditions enable the firm to solve the price fixation problems. Control of costs, proper pricing policies, break-even analysis, alternative profit policies are some of the important techniques in profit planning for the firm which has to work under conditions of uncertainty. Thus managerial economics tries to find out which course is likely to be the best for the firm under a given set of conditions.