1. Economics as a tool for decision making
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 one‟s 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 earnings forgone which would have been possible
from other products) 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 are1) Incremental cost2) 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) it increases some revenues more than it decreases others and) 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
management‟s 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

2. 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. “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 reasons-i) 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, today‟s 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 In the analysis of economic variable provides not only clarity of concepts but also a logical
and systematical framework.

3. 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
thereal 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:
It‟s 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 it‟s an art of getting things done through others. Bet
now a days 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

4. revenue information and their classification are influenced considerably by the accounting
profession.
Meaning of Economics:
Economics can be called as social science dealing with economics problem and man‟s 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. butun
luckily 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.
Management Decision Problems Economic Concepts Decision Science Managerial
Economics
Optimal Solution to Managerial Decision Problems

5. 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 organization‟s 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 Econo
micslargely 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

6. 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

7. 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. There‟s 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