Managerial Economics Theory Applications And Cases
Kenneth
Managerial economics is a branch of economics involving the application of economic methods in the organizational decision-making process.[1] Economics is the study of the production, distribution, and consumption of goods and services. Managerial economics involves the use of economic theories and principles to make decisions regarding the allocation of scarce resources.[2]It guides managers in making decisions relating to the company's customers, competitors, suppliers, and internal operations.[3]
Managers use economic frameworks in order to optimize profits, resource allocation and the overall output of the firm, whilst improving efficiency and minimizing unproductive activities.[4] These frameworks assist organizations to make rational, progressive decisions, by analyzing practical problems at both micro and macroeconomic levels.[5] Managerial decisions involve forecasting (making decisions about the future), which involve levels of risk and uncertainty. However, the assistance of managerial economic techniques aid in informing managers in these decisions.[6]
In order to optimize economic decisions, the use of operations research, mathematical programming, strategic decision making, game theory[8][9] and other computational methods[10] are often involved. The methods listed above are typically used for making quantitate decisions by data analysis techniques.
The theory of Managerial Economics includes a focus on; incentives, business organization, biases, advertising, innovation, uncertainty, pricing, analytics, and competition.[11] In other words, managerial economics is a combination of economics and managerial theory. It helps the manager in decision-making and acts as a link between practice and theory.[12]Furthermore, managerial economics provides the tools and techniques that allow managers to make the optimal decisions for any scenario.
Managerial economics is sometimes referred to as business economics and is a branch of economics that applies microeconomic analysis to decision methods of businesses or other management units to assist managers to make a wide array of multifaceted decisions. The calculation and quantitative analysis draws heavily from techniques such as regression analysis, correlation and calculus.[15]
The law of supply and demand describes the relationship between producers and consumers of a product.[16] The law suggests that price set by the producer and quantity demanded by a consumer are inversely proportional, meaning an increase in the price set is met by a reduction in demand by the consumer.[16]The law further describes that sellers will produce a larger quantity of the good if it sells at a higher price.[16]
Excess demand exists when the quantity of a good demanded is greater than the quantity supplied. Where there is excess demand, sellers can benefit by increasing the price. The inverse applies to excess supply.
Production theory describes the quantity of a good a business chooses to produce.[17] This decision is informed by a variety of factors, including raw material inputs, labor, and capital costs like machinery.[17] The production theory states that a business will strive to employ the cheapest combination of inputs to produce the quantity demanded.The production function can be described in its simplest form by the function Q = F [ L , K ] \displaystyle Q=F[L,K] where Q denotes the firm's production, L is the variable inputs and K is the fixed inputs.[18]
The opportunity cost of a choice is the foregone benefit of the second best choice.[19] Determining the opportunity cost requires detailing the costs and benefits of each action the business is considering to pursue, and the cost of choosing one activity over another.[20] The decision-maker is then in the position to choose the action with the highest payoff.
The principle uses the conjecture of supply and demand to set an accurate price for a good.[21] The aim of price theory is to allocate a price for a good such that the supply of a good is met with equal demand for the product.[21] If a manager sets the price of a good too high, the consumer may think it is not worth the cost and decide not to purchase the good, hence creating excess supply. The opposite occurs when the price is set too low, causing demand for a good to be greater than supply.[21]
Capital investment decisions are a critical factor in an enterprise. They involve determining the rational allocation of funds that will enable an organization to invest in profitable projects or enterprises to improve the efficiency of organizations.[22]The rational allocation of funds may include acquiring business, investing in equipment, or determining whether an investment will improve the business at all.[22]
The price elasticity of demand is a highly useful tool in managerial economics as it provides managers with the predicted change in demand associated with an increase in the price charged for its goods and services.[24] The price elasticity principle also outlines the changes in demand for goods with changes in the income of a populous.[24]
Where Δ Q \displaystyle \Delta Q is the change in quantity demand for the respective change in price Δ P \displaystyle \Delta P , with Q and P representing the quantity and price of the good before a change was made.[25]The price elasticity is important for managerial economics as it aids in the optimization of marginal revenue of firms.[25]
In economics, marginal refers to the change in revenue and cost by producing one extra unit of output. Both the marginal cost and marginal revenue are extremely important in economics as a firm's profit is maximized when the marginal cost is equal to the marginal revenue.[26] Managers can make business decisions on the output level based on this analysis in order to maximize the profit of the firm.
Marginal Analysis is considered the one of most chief tools in managerial economics which involves comparison between marginal benefits and marginal costs to come up with optimal variable decisions. Managerial economics uses explanatory variables such as output, price, product quality, advertising, and research and development to maximise net benefits.
By taking the derivative of a function, the maximum and minimum values of the function are easily determined by setting the derivative equal to zero. This can be applied to a production function to find the quantity of production that maximizes the profit of the firm.[28] This concept is important for managers to understand in order to minimize costs or maximize profits.[29]
As "the application of economic theory and methods to business decision-making",[30] managerial economics is fundamentally about making decisions. The discipline is partially prescriptive in nature because it suggests a course of action to a managerial problem.[4] Managerial economics aims to provide the tools and techniques to make informed decisions to maximize the profits and minimize the losses of a firm.[4] Managerial economics has use in many different business applications, although the most common focus areas are related to the risk, pricing, production and capital decisions a manager makes.[31] Managers study managerial economics because it gives them the insight to control the operations of their organizations. Organizations will function well if managers rationally apply the principles that apply to economic behavior.[3]
It is important to understand what pricing decisions should be made regarding the products and services of the firm. Efficient pricing is required to maintain desired levels of revenue and profit, whilst also maintaining customer satisfaction.[36] Setting a price too low reduces profitability, negatively affects the perceived quality of the product, and sets an expectation of price for the consumer. Setting a price too high may negatively affect the image of an organisation from the perspective of the consumer.[37]
Managers may price using intuitive or technocratic decision-making styles. A technocratic approach relies on quantitative analysis and optimisation, and typically involves a compensatory method of evaluation.[38] Compensatory evaluation allows one attribute to compensate for another attribute. For example, a manager may price a product at a lower price to compensate for its lower quality.[39] Intuitive decision-making relies on consumer heuristics, defined as cognitive processes of fast decision-making, which occur by limiting the amount of information analysed.[40]
Economic concepts such as competitive advantage, market segmentation, and price discrimination are relevant to pricing strategy.[30] In order to set a price that drives sales and firm performance, managers must understand the economic environment in which they are operating.[41]
Price discrimination involves selling the same or similar good at different prices to different consumer segments.[42] Consumer segments are separated by a significant variation in the amount they are willing to pay. In order for price discrimination to occur, firms must be able to separate customer segments according to differing price elasticities, have some market power and prevent customers from re-selling the product.[43]
Additional forms of price discrimination include bundling, intrapersonal price discrimination and purchase-history price discrimination.[45] A firm's ability to price discriminate effectively can improve their profitability and/or increase their customer base, but only if the conditions required for price discrimination are met.
The Psychology of Pricing is used to understand how pricing affects consumers perception of goods and their willingness to consume. The way a good is priced has implications for the perceived value of that good. Firms can capitalise on consumers willingness to pay by influencing their price perception, reducing the pain of paying and exploiting switching costs.
Consumer's price perception can be altered by priming a smaller number (e.g. pricing a good as $4.99 instead of $5), anchoring to a high reference price or separating costs into individual components (e.g. the price of the good and shipping cost).
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