Fundamental Concepts of Managerial Economics

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Educate yourself on the fundamentals of economics
Educate yourself on the fundamentals of economics (Image: business image by peter Hires Images from <a href='http://www.fotolia.com'>Fotolia.com</a>)

Managerial economics involves applying mathematical and statistical equations to help managers find the most optimal allocation of limited resources. Analysts analyze the data from the results of previous decisions to predict or forecast future decisions. A classic example is analyzing data associated with customer buying habits and behavior patterns to predict what customers will buy in the future. To accomplish this, according to the website Reference for Business, "managerial economics uses a wide variety of economic concepts, tools and techniques in the decision-making process." These concepts, tools and techniques can be organized under three primary categories referred to as the theory of the firm, the theory of consumer behavior and the theory of market structure and pricing.

Theory of the Firm

Theory of the firm deals with the primary decision motive of a firm which is to make a profit. The profit motive is the goal of all decisions. Of course, to make a profit, the firm must provide a product or service that consumers want to buy, treat employees well, satisfy demands of stockholders and meet the demands of society, such as environmental concerns. Some of these are competing concerns, such as how environmental concerns could curtail production objectives. So, under this theory, a firm must weigh the pros and cons and come up with the optimal solution.

Theory of Consumer Behavor

Theory of consumer behavior involves consumer buying habits. Many factors feed this theory such as income, demographics and socioeconomic issues. While a firm's focus is to maximize profit, consumers' primary objective is to maximize the utility of satisfaction, such as purchasing and consuming the maximum amount of goods for the minimum amount of dollars.

Theory of Market Structure and Pricing

When companies seek to maximize profits, they must consider the competitive market structure. There are four basic market structures: perfect competition, monopolistic competition, oligopoly and monopoly. Each of these identify the level of competition that exist in a given market. Competition affects pricing and the amount of profit companies can make by entering a market.

Application

Using these theories and the formulations that economists have come up with based on them, managerial economics can be applied to any business within any industry. Companies can integrate their own customer buying habits and behavior data into the applicable formulation and get useful decision-making results. The results can help decision makers determine the most optimal allocation of scarce resources in finance, marketing, inventory management and production.

Application Example

Wal-Mart has a very sophisticated supply chain where managers have to make purchase decisions regarding thousands of suppliers and the decision variables vary per location. This is an "allocation of capital resources problem" they have to address and solve on a daily basis, and managerial economics concepts and analytical tools play a critical role. To address it, Wal-Mal collects data each time a customer checks out at the retail counter. It uses this data to determine customer buying habits and behavior patterns. This data is then fed into optimization, statistical and forecasting models associated with managerial economics, and the results are used by purchasing managers to help them determine how much inventory to purchase per location. In addition, the managers can use the results to optimize and forecast exactly when they should have the inventory on hand to minimize the amount of inventory sitting in warehouses, thus saving inventory overhead cost.

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