What is managerial economics?

 

What is managerial economics?

 

Managerial economics is a science that helps to explain how resources such as labor, technology, land, and money can be allocated efficiently.  Managerial economics focuses on decisions individuals make. 

 

Comparing economic approach to a decision with alternative perspectives.-

 

1)       If you go to Starbucks on regular basis, you may want to sign in on the Starbucks customer program. If you pay with your Starbucks gold card you get some points, and for 125 points you get a free drink. -An economic decision, because you save an important resource, your money, to get your coffee. 

2)       Decision to skip Starbucks and brew your coffee at home. You'll get zero Starbucks points, but the coffee's may be 10 times cheaper.- An economic decision

3)       However, if you go to Starbucks because it makes you feel happy, then this not an economic decision, but a psychological one. 

4)       Also, if you're Italian, and absolutely truly and forever hate Starbucks because they stole all the fancy Italian's expressions, such as macchiato and cappuccino, then you might boycott Starbucks. This is not an economic or psychological decision, but a cultural one. 

 

 

In 1950, John Forbes Nash, Professor at Princeton, US, published his paper on game theory where he described the Nash Equilibrium. For this seminal work, he won the Nobel Memorial Prize in Economic Sciences, 1994, 44 years later, but Nash economic theories are still used in every day decisions in economics, computing, evolutionary biology, artificial intelligence, accounting, computer science, politics, and military theory. 

 

Use economics to solve business problems

Managerial economics is a way to make better decisions. Those decisions don't have to be about the monetary policies of country. They can be very personal decisions, like whether you should buy or rent a place to live or to use as commercial shop. When you face such a decision in your life, you are confronted with many different questions, options, constraints, and variables. You can address this question from a psychological point of view. For example, which living situation would make you more happy? Traditional economists would not ask that question. They would ask a simple question: is it cheaper to rent or to buy? Of course, you can counter-argue that the cheapest option might not be the one that makes you happy, and I'm sure you deserve to be happy, but whatever decisions you're going to make, it it still important to know whether it's cheaper to rent or to buy. 

 

Netflix, some of the most innovative ideas are triggered by an economic dilemma. In 2011, Netflix realized that the licensing fee for their content was about to increase from 200 million per year to over two billion per year. New market entrants such as Amazon Prime and Apple's iTunes Store were bidding for the same licenses for TV shows and movies. 

Netflix had to make a decision. 

Should they buy those expensive licenses? Should they accept a less attractive program? 

Or should they try to make their own series? 

Netflix went with producing a series. Netflix invested $100 million to produce House of Cards, which was a huge success in almost every dimension. 

 

First, we need to define what decision we wanna take. 

Second, we have to clearly outline at least two choices or alternatives. 

Third, we need to define a measurable objective. 

Fourth, we have to define a small set of variables that we are going to use for our analysis. 

Finally, we need to have a theory of how the different variables are related. 

 

We can illustrate these five elements by a businessman’s approach. 

First, what is the decision he has to take? The question is whether he should hire a salesperson or not. 

Second, his choices are hire a salesperson, pay someone a commission, or do it by himself. The measurable objective could be revenues minus sales cost. However, this might affect the decision, because he wouldn't pay a salary to himself. But if he took over the sales function, he would probably need to hire someone for the production. Therefore, the best measurable objective is overall profitability of his firm. 

The most important input variables are revenues and total costs, which include salaries and commissions. 

Finally, the relationship between the objective profitability and revenues and costs is straightforward. 

Given the small size of his business and his network among restaurant owners, he decided to take over the sales function by himself. 

It would have been too expensive to hire a fully dedicated salesperson. 

 

I can imagine that some of you wonder whether managerial economics is really that simple. Indeed, economists are sometimes criticized for making a difficult problem too simple. However, the simplicity often helps to define a few variables that really matters. Forcing a group of decision maker to formalize the decision within the structure of these five elements often creates clarity and triggers an important discussion about what the heck is really going on.

 

To be continue…

Source - Lynda. for educational purpose

Avnish Kumar Gupta
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PGDIM-27