Fundamentals of Managerial Economics
- A knowledge of managerial economics can add a great deal of context to a manager's decision making.Andrew Bret Wallis/Pixland/Getty Images
Managerial economics is a branch of economics catering to the needs of business and management concepts. Specifically, the focus of managerial economics is mirco-economic principals that directly impact or strongly influence decision-making in a business setting. Some important fundamentals of managerial economics are goals and constraints, profits, incentives, markets and the time value of money. - Every organization must have goals and every individual within that organization must have their own goals aimed at furthering the goals of the organization. A goal may be to increase profits by 15 percent in the next fiscal year or to enter a new product market. Ideally, sufficient effort and resources would be put towards achieving all of an organization's goals. However, organizations are faced with constraints. There are only limited hours per day, week and year that an employee can work on any one goal; there is only so much money that the organization may devote to marketing, sales and operations. The interplay between goals and constrains is the fundamental concern of managerial economics: how can an organization maximize the achievement of its goals when faced with constraints?
- For most organizations, the ultimate goal is to generate a profit from their business operations. It is important to distinguish between accounting profits and economic profits. Accounting profits are generated when the business brings in more money than it spends. For example, if a business has expenses of $500 and revenues of $1,000, it has an accounting profit of $500. Economic profits, on the other hand, take opportunity costs into account. Using the same business, if the same $500 could have generated $1,500 in another investment, there would have been no economic profit. In fact, there would be an economic loss of $500.
- Incentives drive the behavior of businesses, consumers and employees. Understanding what incentives are most important to these groups is essential in driving their behavior. For example, a marketing manager may use fear as an incentive to induce customers to purchase insurance products.
- Understanding markets is crucial for business managers. Markets have two general categories of participants: buyers and sellers. Various factors will influence the relative strength of these groups and their corresponding influence on the market and prices within the market. For example, in a market dominated by a single seller (a monopoly), the seller has much greater power than in a market in which there are numerous sellers selling identical products.
- The time value of money is important when making investment decisions and is the fundamental principal underlying industries such as banking and insurance. Put simply, a dollar today is typically worth more than a dollar a year from today. Exactly how much more that future dollar is worth will help determine interest rates and other incentives for saving and investment.
