Objective of a Firm

Conventional theory of firm assumes profit maximization is the sole objective of business firms. But recent researches on this issue reveal that the objectives the firms pursue are more than one. Some important objectives, other than profit maximization are:
(a) Maximization of the sales revenue

(b) Maximization of firm’s growth rate

(c) Maximization of Managers utility function

(d) Making satisfactory rate of Profit

(e) Long run Survival of the firm

(f) Entry-prevention and risk-avoidance

.

Optimization theories:

Profit Business Objectives:

Profit means different things to different people. To an accountant “Profit” means the excess of revenue over all paid out costs including both manufacturing and overhead expenses. For all practical purpose, profit or business income means profit in accounting sense plus non-allowable expenses.
Economist’s concept of profit is of “Pure Profit” called ‘economic profit’ or “Just profit”. Pure profit is a return over and above opportunity cost, i. e. the income that a businessman might expect from the second best alternatives use of his resources

Sales maximization

1.      Baumol's model of sales maximization/ Sales Revenue Maximization: 

According to Baumol, every business firm aims at maximization it sales revenue (price x quantity0 rather than its profit. Hence his hypothesis has come to be known as sales maximization theory & revenue maximization theory. According to baumol, sales have become an end by themselves and accordingly sales maximization has become the ultimate objective ofthe firm. Hence, the management of a firm directs its energies in promoting and maximizing itssales revenue instead of profit.


The goal of sales maximization is explained by the management’s desire to maintain the firm’s competitive position, which is dependent to a large extent on its size. Unlike the shareholderswho are interested in profit, the management is interested in sales revenue, either because largesales revenue is a matter of prestige or because its remuneration is often related to the size ofthe firm’s operations than to its profits. Baumol, however does not ignore the cost of production which has to be covered and also a margin of profit. In fact, he advocates the adoption of a price, which will cover the cost and also will yield a minimum rate of profits. That is, while the firm is maximizing its revenue from sales, it should also “enough or more than enough profits” to keep the shareholders satisfied. According to Baumol the typical digopolists objective can usually be characterized approximately as sales maximization output does not yield adequate profit, the firm will have to choose that output which will yield adequate profit even through it may not achieve sales maximization.

Sales Revenue Maximisation:   The reason behind sales revenue maximisation objectives is the Dichotomy between ownership & management in large business corporations. This Dichotomy gives managers an opportunity to set their goal other than profits maximisation goal, which most-owner businessman pursue. Given the opportunity, managers choose to maximize their own utility function. The most plausible factor in manager’s utility functions is maximisation of the sales revenue.

The factors, which explain the pursuance of this goal by the managers are following:.

• First: Salary and others earnings of managers are more closely related to sales revenuethan to profits
• Second: Banks and financial corporations look at sales revenue while financing the corporation.
• Third: Trend in sales revenue is a readily available indicator of the performance of the firm.

2.     Marris’s model of managerial enterprise

Managerial Behaviour and the goals of management have long been identified by many as independent of the goals of shareholders . Two models have attempted to explain why the goals are different and how these goals are achieved; Baumol’s Theory of Revenue Maximisation and Marris’s Model of Managerial Enterprise . Initially the Two models will be briefly explained. Then, by reference to determinants of managerial remuneration, the empirical evidence of the occurrences of the determinants, the two models will be examined. This is to come to a conclusion on which model is best supported by the empirical evidence.

Models
Marris’s model of managerial enterprise is based on the goal of the manager to increase the balanced growth of the firm . This balance is achieved by offsetting two opposite goals; Maximisation of the growth of demand for goods/services of the firm and maximisation of growth of capital. Both of these goals require opposite treatment of retained profit.

To maximise growth in capital the management must distribute as much profit as possible back to the shareholders. This keeps the shareholders content with their investment and they will not sell shares or remove the directors. It can result in rising share values and reduce the risk of the firm being taken over. This therefore appeals to the management’s main aims, job security by not being taken over or removed.

The flip side of the coin is to increase the demand customers have for the firm’s goods or services. This is achieved by using as much of the firms profits for investment and increase the firms growth. This would increase the management’s utility at the sacrifice of shareholder utility.

Marris’s model requires that these to aims be balanced to achieve the maximum use of retained profit use for investment and still keeping the shareholders content. To achieve this balance it is necessary to employ two constraints; Managerial constraint and Job security constraint.

The managerial constraint is set by the skills of the current management team or by the limit by which the management team can be increase to increase those skills. Therefore, this limit is the maximum growth achievable. R & D would also limit the growth of the firm. If new products or new designs of existing products can’t be produced, the product will only have a certain life cycle.

Job security constraint is set by the amount the manager has to do to reduce the chances of dismissal. The manager may have to distribute a certain amount of profits to share holders to keep them happy with the manager’s performance. It is also necessary to keep share prices at a high enough level to reduce the chance of take over. Reducing risky investments will have similar effects.

The effects of these constraints can be seen from figure 1 (see below) and it can be seen that a balanced growth point is where management feel the trade off between job security and maximisation of growth is most desirable. The y-axis on the graph shows the profit distributed to shareholders and the x-axis depicts the growth achievable from investment. The growth curve symbolises the managerial constraint. This is curved because the most profitable investments are undertaken first. Management can undertake a policy which would maximise growth (point B) but at the sacrifice of distributed profit which would risk job security. A more appropriate trade off may be point A where distributed profits are much higher and growth is reduced by a smaller amount.

Baumol’s Theory states that the goal of management is not profit maximisation (shareholder goal) but revenues maximisation (increased sales). Baumol gives several reasons for this belief . The reasons to focus on are to do with remuneration of management, job security and prestige (which undoubtedly can lead to increased or decreased remuneration).

Baumol feels there is evidence that directors’ salaries and slacks are more closely correlated with sales of the firm than profit. So it would follow from this that managers would maximise sales for self interest.

Job security in Baumol’s theory is shown from the desire of management to have satisfactory profits, apposed to maximised profits. Maximised profit in one year may look bad for management when in subsequent years profits are not at the same maximised level.

Prestige can come from high sales. This prestige can increase remuneration (from head hunting or shareholder retaining their services) or if bad, increase the threat of management being replaced or reduce remuneration.

To achieve sales maximisation managers have to calculate the conditions which will achieve the maximum revenue. This is not the same as profit maximisation. Point A represents profit maximisation. Point B represents the point where sales maximisation, point Z, appears on the profit ability curve. It can be seen that profit maximisation and sales maximisation are not normally the same thing. Point A is the desired position for the shareholder and point B is the desired position for, in Baumol’s theory, management.

However shareholders will require dividends to stay happy with the firm’s performance. In Baumol’s theory there an Operative profit constraint.

The operative profit restraint is the minimum amount of net profit that the shareholder will be satisfied with. If this restraint is active it may reduce the maximum sales the directors can achieve. If this operative profit constraint is active then output will be greater as a sales maximiser than a Profit maximiser. When a operative profit constraint is operative then the maximum sales drop to point Y and the intersection on the profitability falls to point C. It can be seen that management can be limited in their sales maximisation policy if operative profit is closer to the profit maximisation point.

Empirical Analysis
When discussing which model best reflect the reality of managerial behaviour it is necessary to examine what motivates managers and what determines there objectives. Focusing on remuneration as manager main motivation gives the opportunity to examine empirical evidence of what determines the amounts management receive.

Martin Conyon and Paul Gregg Examined 170 firms between 1985 and 1990 . They looked into what factors determined top directors’ pay. In conclusion of their results, it is commented that the results they received pointed to previous, earlier studies , which showed that directors’ pay had very little to do with corporate performance. Therefore, from this evidence, profit, considered a major factor in determining corporate, would not affect the directors’ pay. This would be consistent with Baumol’s model and to a certain extent Marris’s model too. Baumol’s theory identifies sales maximisation as the primary aim. Marris’s model identifies the importance of growth which is identified as a factor with similar directors’ pay correlations. Conyon and Gregg also found from there results that there seemed to definite correlation between increases in directors’ remuneration and increase in sales again consistent with Baumol’s model.

Paul Gregg, Stephen Machin and Stefan Szymanski, came to a similar conclusion in a later study (this study included the period from 1988 – 1991 when Britain was in recession). Higher sales had a direct correlation with high directors’ remuneration and identified growth as a primary salary driver.

David Shipley published a study in to pricing policies in British manufacturing firms in 1981 . Although his study was more specifically on the pricing policies his finding suggested that there was some support for profit maximisation in manufacturing firms’ management . The majority of firms in the study used multiple goals when setting pricing policies . This would not entirely be consistent with Baumol’s theory which states focus of management to maximise sales only and primarily. All other goals displayed by the study were, if not profit orientated, practiced under the premise that profit targets would be met. This is consistent with the operative profit constraint in Baumol’s theory and the job security constraint in Marris’s model. This study would point more towards Marris’s model as there is more emphasis on increasing profit if for no other reason than to improve the amount of money available to put into investment and improve growth while still satisfying shareholders.

While sales are quoted to be a major factor in managerial remuneration. It is also stated that this is not the only factor which would affect their pay. It is therefore assumed that manager’s should consider all factors that affect them. Baumol does not identify other factors which in his theory management should consider. It has been has been suggested that early studies do not reflect the current sensitivity of remuneration of management to performance of firms. This is closer to Marris’s model.

Size of firms has been identified as the most important factor in terms of remuneration. For the size of a firm to increase it must grow. Marris’s model identifies the importance of growth to management.

There have been articles and studies that point to the unreliability of empirical evidence on corporate governance and managerial remuneration factors. So many methodical issues relating to principal and agency theory have been identified as the reasons.

Conclusion
Only remuneration factors have been considered when examining the two models. This makes the discussion incomplete as factors such as corporate structure, managerial labour market factors and personal managerial preferences have not been discussed. There are other managerial behaviour models and theories which have not been included which may be more consistent with the empirical evidence gathered in studies referred to, such as Williamson’s model of managerial discretion. Also more detail explanations of the two models referred to may have allowed closer examination of empirical evidence. Due to these factors, the discussion is limited. However, as I feel that management has the greater ability to influence there pay and it could be argued this is the most important reward for anyone in employment; this was the most appropriate factor to use.

To generate a conclusion from the arguments in this discussion is difficult as with many studies and opinions no conclusive results have been shown. It is my opinion that although sales may be an important factor in remuneration, many other factors exist. Baumol’s theory does not allow for management to apply other factors to their management goals. Marris’s model identifies growth in general as an important factor to the agent (management) and shows the constant battle between satisfying the principal (shareholders) and achieving managements’ utility. This appears more consistent with the difficulties shareholders have in aligning their managements’ interests with their own.

3.     Williamson’s Model/ Maximization of Managerial Utility function:

                Williamson argues that managers have discretion in pursuing policies which maximize their own utility after a minimum profit is attained. A minimum profit level is necessary for job security of the manager.

                The manager utility function includes variables such as salary, security, status, prestige and professional excellence. It is expressed as

U= f(S, M, I_D)

Where S = additional expenditure of the staff

M= Managerial emoluments

I_D = Discretionary Investments

Non optimization theories:

1.  Cyert and March Behavioural Theory

1. The Firm as a Coalition of Groups with Conflicting Goals

based on a large multiproduct  group operating under uncertain conditions in an imperfect market - difference between ownership and control - firm treated as a multi-goal, multi-decision organisational coalition of managers, workers, share-holders, customers, suppliers, bankers.

2. Goal Formation – The Concept of the Aspiration Level

                Individuals may have (and usually do have) different goals to those of the organisation-firm.

3.  The Goals of the Firm: Satisficing Behaviour

Goals set by top management.

The main goals:

©  Production goal - smooth running.

©  Inventory goal - adequate stock of suitable raw material.

©  Sales goal - from sales department.

©  Share of the market goal – also from sales department.

©  Profit goal – shareholders, finances.

4   Means for the Resolution of Conflict

©     Conflict is inevitable. Nevertheless the groups and the firm as a whole may remain in a stable position - limited time to bargain, etc.  Behaviour, goals and decisions are largely based on past history.

5.  The Theory of Decision Making

©  - At Top Management Level

©    Resource allocation - implemented by the budget - share of budget taken by each department. Largely determined by bargaining power which is itself determined by past performance.

6.  Uncertainty and the Environment of the Firm

©  Two types of uncertainty:

©  - market (cannot be avoided)

©  - competitor's reactions (overcome by tacid collution, eg. trade associations)

2.  Maximisation of Firms Growth rate: Managers maximize firm’s balance growth rate subject to managerial & financial constrains balance growth rate defined as:

G = G_D – G_C

Where G_D = Growth rate of demand of firm’s product & G_C= growth rate of capital supply of capital to the firm.

In simple words, A firm growth rate is balanced when demand for its product & supply of capital to the firm increase at the same time.

The utility functions which manager seek to maximize include both quantifiable variables like salary and slack earnings; non- quantifiable variables such as prestige, power, status, Job security professional excellence etc.

Long run survival & market share: according to some economist, the primary goal of the firm is long run survival. Some other economists have suggested that attainment & retention of constant market share is an additional objective of the firm’s. the firm may seek to maximize their profit in the long run through it is not certain.

Entry-prevention and risk-avoidance, yet another alternative objectives of the firms suggested by some economists is to prevent entry-prevention can be:

1.     Profit maximisation in the long run

2.     Securing a constant market share

3.     Avoidance of risk caused by the unpredictable behavior of the new firms

Micro economist has a vital role to play in running of any business. Micro economists are concern with all the operational problems, which arise with in the business organization and fall in with in the preview and control of the management. Some basic internal issues with which micro-economist are concerns:

                      i.        Choice of business and nature of product i.e. what to produce

                     ii.        Choice of size of the firm i. e how much to produce

                    iii.        Choice of technology i.e. choosing the factor-combination

                    iv.        Choose of price i.e. how to price the commodity

                     v.        How to promote sales

                    vi.        How to face price competition

                   vii.        How to decide on new investments

                  viii.        How to manage profit and capital

                    ix.        How to manage inventory i.e. stock to both finished & raw material

These problems may also figure in forward planning. Micro economist deals with these questions and like confronted by managers of the enterprises.

Managerial Economics

Definition Of Managerial Economics

According to McNair and Meriam, Managerial Economics consists of the use of economic modes of thought to analyse business situation Spencer and Siegelman have defined Managerial Economics as “the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management”. We may, therefore define Managerial Economics as the discipline which deals with the application of economic theory to business management. Managerial Economics thus lies on the borderline between economics and business management and serves as abridge between economics and business management and serves as a bridge between the two disciplines.See Chart1

Nature Of Managerial Economics

Managerial Economics and Business economics are the two terms, which, at times have been used interchangeably. Of late, however, the term Managerial Economics has become more popular and seems to displace progressively the term Business Economics.

The prime function of a management executive in a business organization is decision-making and forward planning. Decision-making means the process of selecting one action from two or more alternative courses of action whereas forward planning means establishing plans for the future. The question of choice arises because resources such as capital, land, labour and management are limited and can be employed in alternative uses. The decision-making function thus becomes one of making choices or decisions that will provide the most efficient means of attaining a desired end, say, profit maximization. Once decision is made about the particular goal to be achieved, plans as to production, pricing, capital, raw materials, labour, etc., are prepared. Forward planning thus goes hand in hand with decision-making.

A significant characteristic of the conditions, in which business organizations work and take decisions, is uncertainty. And this fact of uncertainty not only makes the function of decision-making and forward planning complicated but adds a different dimension to it. If knowledge of the future were perfect, plans could be formulated without error and hence without any need for subsequent revision. In the real world, however, the business manager rarely has complete information and the estimates about future predicted as best as possible. As plans are implemented over time, more facts become known so that in their light, plans may have to be revised, and a different course of action adopted. Managers are thus engaged in a continuous process of decision-making through an uncertain future and the overall problem confronting them is one of adjusting to uncertainty.

In fulfilling the function of decision-making in an uncertainty framework, economic theory can be pressed into service with considerable advantage. Economic theory deals with a number of concepts and principles relating, for example, to profit, demand, cost, pricing production, competition, business cycles, national income, etc., which aided by allied disciplines like Accounting. Statistics and Mathematics can be used to solve or at least throw some light upon the problems of business management. The way economic analysis can be used towards solving business problems. Constitutes the subject-matte of Managerial Economics.

Chart 1 – SEE ABOVE

Aspects of Application Of Economics

The application of economics to business management or the integration of economic theory with business practice, as Spencer and Siegelman have put it, has the following aspects:

1.     Reconciling traditional theoretical concepts of economics in relation to the actual business behavior and conditions. In economic theory, the technique of analysis is one of model building whereby certain assumptions are made and on that basis, conclusions as to the behavior of the firms are drown. The assumptions, however, make the theory of the firm unrealistic since it fails to provide a satisfactory explanation of that what the firms actually do. Hence the need to reconcile the theoretical principles based on simplified assumptions with actual business practice and develops appropriate extensions and reformulation of economic theory, if necessary.

2.     Estimating economic relationships, viz., measurement of various types of elasticities of demand such as price elasticity, income elasticity, cross-elasticity, promotional elasticity, cost-output relationships, etc. the estimates of these economic relation-ships are to be used for purposes of forecasting.

3.     Predicting relevant economic quantities, eg., profit, demand, production, costs, pricing, capital, etc., in numerical terms together with their probabilities. As the business manager has to work in an environment of uncertainty, future is to be predicted so that in the light of the predicted estimates, decision-making and forward planning may be possible.

4.     Using economic quantities in decision-making and forward planning, that is, formulating business policies and, on that basis, establishing business plans for the future pertaining to profit, prices, costs, capital, etc. The nature of economic forecasting is such that it indicates the degree of probability of various possible outcomes, i.e. losses or gains as a result of following each one of the strategies available. Hence, before a business manager there exists a quantified picture indicating the number o courses open, their possible outcomes and the quantified probability of each outcome. Keeping this picture in view, he decides about the strategy to be chosen.

5.     Understanding significant external forces constituting the environment in which the business is operating and to which it must adjust, e.g., business cycles, fluctuations in national income and government policies pertaining to public finance, fiscal policy and taxation, international economics and foreign trade, monetary economics, labour relations, anti-monopoly measures, industrial licensing, price controls, etc. The business manager has to appraise the relevance and impact of these external forces in relation to the particular business unit and its business policies.

Chief Characteristics Of Managerial Economics

It would be useful to point out certain chief characteristics of Managerial Economics, inasmuch it’s they throw further light on the nature of the subject matter and help in a clearer understanding thereof.

1.     Managerial Economics micro-economic in character.

2.     Managerial Economics largely uses that body of economic concepts and principles, which is known as ‘Theory of the firm’ or ‘Economics of the firm’. In addition, it also seeks to apply Profit Theory, which forms part of Distribution Theories in Economics.

3.     Managerial Economics is pragmatic. It avoids difficult abstract issues of economic theory but involves complications ignored in economic theory to face the overall situation in which decisions are made. Economic theory appropriately ignores the variety of backgrounds and training found in individual firms but Managerial Economics considers the particular environment of decision-making.

4.     Managerial Economics belongs to normative economics rather than positive economics (also sometimes known as descriptive economics). In other words, it is prescriptive rather than descriptive. The main body of economic theory confines itself to descriptive hypothesis, attempting to generalize about the relations among different variables without judgment about what is desirable or undesirable. For instance, the law of demand states that as price increases. Demand goes down or vice-versa but this statement does not tell whether the outcome is good or bad. Managerial Economics, however, is concerned with what decisions ought to be made and hence involves value judgments.

Production and Supply

Production analysis is narrower in scope than cost analysis. Production analysis frequently proceeds in physical terms while cost analysis proceeds in monetary terms. Production analysis mainly deals with different production functions and their managerial uses.

Supply analysis deals with various aspects of supply of a commodity. Certain important aspects of supply analysis are supply schedule, curves and function, law of supply and its limitations. Elasticity of supply and Factors influencing supply.

Pricing Decisions, Policies and Practices

Pricing is a very important area of Managerial Economics. In fact, price is the ness of the revenue of a firm and as such the success of a business firm largely depends on the correctness of the pries decisions taken by it. The important aspects alt with under this area is: Price Determination in various Market Forms, Pricing methods, Differential Pricing, Product-line Pricing and Price Forecasting.

Profit Management

Business firms are generally organized for the purpose of making profits and, in long run, profits provide the chief measure of success. In this connection, an important point worth considering is the element of uncertainty exiting about profits because of variations in costs and revenues which, in turn, are caused by torso both internal and external to the firm. If knowledge about the future were fact, profit analysis would have been a very easy task. However, in a world of certainty, expectations are not always realized so that profit planning and measurement constitute the difficult are of Managerial Economics. The important acts covered under this area are: Nature and Measurement of Profit. Profit iciest and Techniques of Profit Planning like Break-Even Analysis.

Capital Management

Of the various types and classes of business problems, the most complex and able some for the business manager are likely to be those relating to the firm’s investments. Relatively large sums are involved, and the problems are so complex that their disposal not only requires considerable time and labour but is a term for top-level decision. Briefly, capital management implies planning and trolls of capital expenditure. The main topics dealt with are: Cost of Capital. Rate return and Selection of Project.

The various aspects outlined above represent the major uncertainties which a ness firm has to reckon with, viz., demand uncertainty, cost uncertainty, price certainty, profit uncertainty, and capital uncertainty. We can, therefore, conclude the subject-matter of Managerial Economic consists of applying economic cripples and concepts towards adjusting with various uncertainties faced by a ness firm.

Managerial Economics And Other Subjects

Yet another useful method of throwing light upon the nature and scope of managerial Economics is to examine is relationship with other subjects. In this connection, Economics, statistics, Mathematics and Accounting deserve special mention.

Managerial Economics and Economics

Managerial Economics has been described as economics applied to decision- making. It may be viewed as a special branch of economics bridging the gulf between pure economic theory and managerial practice.

Economics has two main divisions: microeconomics and macroeconomics. Microeconomics has been defined as that branch where the unit of study is an individual or a firm. Macroeconomics, on the other hand, is aggregate in character and has the entire economy as a unit of study.

Microeconomics, also known as price theory (or Marshallian economics.) Is the main source of concepts and analytical tools for managerial economics. To illustrate various micro-economic concepts such as elasticity of demand, marginal cost, the short and the long runs, various market forms, etc. are all of great significance to managerial economics. The chief contribution of macro-economics is in the area of forecasting. The modern theory of income and employment has direct implications for forecasting general business conditions. As the prospects of an individual firm often depend greatly on general business conditions, individual firm forecasts depend on general business forecasts.

A survey in the U.K. has shown that business economists have found the following economic concepts quite useful and of frequent application:

1.     Price elasticity of demand

2.     Income elasticity of demand

3.     Opportunity cost

4.     The multiplier

5.     Propensity to consume

6.     Marginal revenue product

7.     Speculative motive

8.     Production function

9.     Balanced growth

10.   Liquidity preference.

Business economics have also found the following main areas of economi9cs as useful in their work

1.     Demand theory

2.     Theory of the firm-price, output and investment decisions

3.     Business financing

4.     Public finance and fiscal policy

5.     Money and banking

6.     National income and social accounting

7.     Theory of international trade

8.     Economics of developing countries.

Managerial Economics and Accounting

Managerial Economics is also closely related to accounting, which is concerned with recording the financial operations of a business firm. Indeed, accounting information is one of the principal sources of data required by a managerial economist for his decision-making purpose. For instance, the profit and loss statement of a firm tells how well the firm has done and the information it contains can be used by managerial economist to throw significant light on the future course of action-whether it should improve or close down. Of course, accounting data call for careful interpretation. Recasting and adjustment before they can be used safely and effectively.

It is in this context that the growing link between management accounting and managerial economics deserves special mention. The main task of management accounting is now seen as being to provide the sort of data which managers need if they are to apply the ideas of managerial economics to solve business problems correctly; the accounting data are also to be provided in a form so as to fit easily into the concepts and analysis of managerial economics.

Uses Of Managerial Economics

Managerial economics accomplishes several objectives. First, it presents those aspects of traditional economics, which are relevant for business decision making it real life. For the purpose, it culls from economic theory the concepts, principles and techniques of analysis which have a bearing on the decision making process. These are, if necessary, adapted or modified with a view to enable the manager take better decisions. Thus, managerial economics accomplishes the objective of building suitable tool kit from traditional economics.

Secondly, it also incorporates useful ideas from other disciplines such a psychology, sociology, etc., if they are found relevant for decision making. In face managerial economics takes the aid of other academic disciplines having a bearing upon the business decisions of a manager in view of the carious explicit and implicit constraints subject to which resource allocation is to be optimized.

Thirdly, managerial economics helps in reaching a variety of business decisions.

(i) What products and services should be produced?

(ii) What inputs and production techniques should be used?

(iii) How much output should be produced and at what prices it should be sold?

(iv) What are the best sizes and locations of new plants?

(v) How should the available capital be allocated?

Fourthly, managerial economics makes a manager a more competent model guilder. Thus he can capture the essential relationships which characterize a situation while leaving out the cluttering details and peripheral relationships.

Fifthly, at the level of the firm, where for various functional areas functional specialists or functional departments exist, e.g., finance, marketing, personal production, etc., managerial economics serves as an integrating agent by co-coordinating the different areas and bringing to bear on the decisions of each department or specialist the implications pertaining to other functional areas. It thus enables business decision- making not in watertight compartments but in an integrated perspective, the significance of which lies in the fact that the functional departments or specialists often enjoy considerable autonomy and achieve conflicting coals.

Finally, managerial economics takes cognizance of the interaction between the firm and society and accomplishes the key role of business as an agent in the attainment of social and economic welfare. It has come to be realized that business part from its obligations to shareholders has certain social obligations. Managerial economics focuses attention on these social obligations as constraints subject to which business decisions are to be taken. In so doing, it serves as an instrument in rehiring the economic welfare of the society through socially oriented business decisions.

Managerial Economist Role And Responsibilities

A managerial economist can play a very important role by assisting the Management in using the increasingly specialized skills and sophisticated techniques which are required to solve the difficult problems of successful decision-making and forward planning. That is why, in business concerns, his importance is being growingly recognized. In advanced countries like the U.S.A., large companies employ one or more economists. In our country too, big industrial houses have come to recognize the need for managerial economists, and there are frequent advertisements for such positions. Tatas, DCM and Hindustan Lever employ economists. Indian Petrochemicals Corporation Ltd., a Government of India undertaking, also keeps an economist.

Let us examine in specific terms how a managerial economist can contribute to decision-making in business. In this connection, two important questions need be considered:

1.     What role does he play in business, that is, what particular management problems lend themselves to solution through economic analysis?

2.     How can the managerial economist best serve management, that is, what are the responsibilities of a successful managerial economist?

Role Of Managerial Economist

One of the principal objectives of any management in its decision-making process is to determine the key factors which will influence the business over the period ahead. In general, these factors can be divided into two-category (i) external and (ii) internal. The external factors lie outside the control management because they are external to the firm and are said to constitute business environment. The internal factors he within the scope and operations of a firm and hence within the control of management, and they are known as business operations.

To illustrate, a business firm is free to take decisions about what to invest, where to invest, how much labour to employ and what to pay for it, how to price its products and so on but all these decisions are taken within the framework of a particular business environment and the firm’s degree of freedom depends on such factors as the government’s economic policy, the actions of its competitors and the like.

Environmental Studies

An analysis and forecast of external factors constituting general business conditions, e.g., prices, national income and output, volume of trade, etc., are of great significance since every business from is affected by them. Certain important relevant questions in this connection are as follows:

1.     What is the outlook for the national economy? What are the most important local, regional or worldwide economic trends? What phase of the business cycle lies immediately ahead?

2.     What about population shifts and the resultant ups and downs in regional purchasing power?

3.     What are the demands prospects in new as well as established markets? Will changes in social behavior and fashions tend to expand or limit the sales of a company’s products, or possibly make the products obsolete?

4.     Where are the market and customer opportunities likely to expand or contract most rapidly?

5.     Will overseas markets expand or contract, and how will new foreign government legislation’s affect operation of the overseas plants?

6.     Will the availability and cost of credit tend to increase or decrease buying? Are money or credit conditions ahead likely to be easy or tight?

7.     What the prices of raw materials and finished products are likely to be?

8.     Is competition likely to increase or decrease?

9.     What are the main components of the five-year plan? What are the areas where outlays have been increased? What are the segments, which have suffered a cut in their outlay?

10.   What is the outlook regarding government’s economic policies and regulations?

11.   What about changes in defense expenditure, tax rates, tariffs and import restrictions?

12.   Will Reserve Bank’s decisions stimulate or depress industrial production and consumer spending? How will these decisions affect the company’s cost, credit, sales and profits?

Reasonably accurate answers to these and similar questions can...

Enable management’s to chalk out more wisely the scope and direction of their own business plans and to determine the timing of their specific actions. And it is these questions which present some of the areas where a managerial economist can make effective contribution.

The managerial economist has not only to study the economic trends at the macro-level but must also interpret their relevance to the particular industry/firm where he works. He has to digest the ever-growing economic literature and advise top management by means of short, business-like practical notes.

In a mixed economy like India, the managerial economist pragmatically interprets the intentions of controls and evaluates their impact. He acts as a bridge between the government and the industry, translating the government’s intentions and transmitting the reactions of the industry. In fact, government policies charge out of the performance of industry, the expectations of the people and political expediency.

Business Operations

A managerial economist can also be helpful to the management in making decisions relating to the internal operations of a firm in respect of such problems as price, rate of operations, investment, expansion or contraction. Certain relevant questions in this context would be as follows:

1.     What will be a reasonable sales and profit budget for the next year?

2.     What will be the most appropriate production Schedules and inventory policies for the next six months?

3.     What changes in wage and price policies should be made now?

4.     How much cash will be available next month and how should it be invested?

Specific Functions

A further idea of the role managerial economists can play, can be had from the following specific functions performed by them as revealed by a survey pertaining to Britain conducted by K.J.W. Alexander and Alexander G. Kemp:

1.     Sales forecasting

2.     Industrial market research.

3.     Economic analysis of competing companies.

4.     Pricing problems of industry.

5.     Capital projects.

6.     Production programs.

7.     Security/investment analysis and forecasts.

8.     Advice on trade and public relations.

9.     Advice on primary commodities.

10.   Advice on foreign exchange.

11.   Economic analysis of agriculture.

12.   Analysis of underdeveloped economics.

13.   Environmental forecasting.

The managerial economist has to gather economic data, analyze all pertinent information about the business environment and prepare position papers on issues facing the firm and the industry. In the case of industries prone to rapid technological advances, he may have to make a continuous assessment of the impact of changing technology. He may have to evaluate the capital budget in the light of short and long-range financial, profit and market potentialities. Very often, he may have to prepare speeches for the corporate executives.

It is thus clear that in practice managerial economists perform many and varied functions. However, of these, marketing functions, i.e., sales forecasting and industrial market research, has been the most important. For this purpose, they may compile statistical records of the sales performance of their own business and those relating to their rivals, carry our analysis of these records and report on trends in demand, their market shares, and the relative efficiency of their retail outlets. Thus while carrying out their functions; they may have to undertake detailed statistical analysis. There are, of course, differences in the relative importance of the various functions performed from firm to firm and in the degree of sophistication of the methods used in carrying them out. But there is no doubt that the job of a managerial economist requires alertness and the ability to work under pressure.

Economic Intelligence

Besides these functions involving sophisticated analysis, managerial economist may also provide general intelligence service supplying management with economic information of general interest such as competitors prices and products, tax rates, tariff rates, etc. In fact, a good deal of published material is already available and it would be useful for a firm to have someone who understands it. The managerial economist can do the job with competence.

Participating in Public Debates

May well-known business economists participate in public debates. Their advice and views are being sought by the government and society alike. Their practical experience in business and industry ads stature to their views. Their public recognition enhances their stature in the organization itself.

Indian Context

In the Indian context, a managerial economist is expected to perform the following functions:

1.     Macro-forecasting for demand and supply.

2.     Production planning at macro and micro levels.

3.     Capacity planning and product-mix determination.

4.     Economics of various productions lines.

5.     Economic feasibility of new production lines/processes and projects.

6.     Assistance in preparation of overall development plans.

7.     Preparation of periodical economic reports bearing on various matters such as the company’s product-lines, future growth opportunities, market pricing situation, general business, and various national/international factors affecting industry and business.

8.     Preparing briefs, speeches, articles and papers for top management for various
Chambers, Committees, Seminars, Conferences, etc.

9.     Keeping management informed o various national and international developments on economic/industrial matters.

With the adoption of the New Economic Policy, the macro-economic Environment is changing fast at a pace that has been rarely witnessed before. And these
changes have tremendous implications for business. The managerial economist has to play a much more significant role. He has to constantly gauge the possibilities of translating the rapidly changing economic scenario into viable business opportunities. As India marches towards globalization, he will have to interpret the global economic events and find out how his firm can avail itself of the carious export opportunities or of establishing plants abroad either wholly owned or in association with local partners.

Responsibilities Of Managerial Economist

Having examined the significant opportunities before a managerial economist to contribute to managerial decision-making, let us next examine how he can best serve the management. For this, he must thoroughly recognize his responsibilities and obligations.

A managerial economist can serve management best only if he always keeps in mind the main objective of his business, viz., to make a profit on its invested capital. His academic training and the critical comments from people outside the business may lead a managerial economist to adopt an apologetic or defensive attitude towards profits. Once management notices this, his effectiveness is almost sure to be lost. In fact, he cannot expect to succeed in serving management unless he has a strong personal conviction that profits are essential and that his chief obligation is to help enhance the ability of the firm to make profits.

Most management decisions necessarily concern the future, which is rather uncertain. It is, therefore, absolutely essential that a managerial economist recognizes his responsibility to make successful forecasts. By making best possible forecasts and through constant efforts to improve upon them, he should aim at minimizing, if not completely eliminating, the risks involved in uncertainties, so that the management can follow a more orderly course of business planning. At times, he will have to reassure the management that an important trend will continue; in other cases, he may have to point out the probabilities of a turning point in some activity of importance to management. In any case, he must be willing to make considered but fairly positive statements about impending economic developments, based upon the best possible information and analysis and stake his reputation upon his judgment. Nothing will build management confidence in a managerial economist more quickly and thoroughly than a record of successful forecasts, well documented in advance and modestly evaluated when the actual results become available.

A few corollaries to the above proposition need also be emphasized here.

First, he has a major responsibility to alert ‘management at the earliest possible moment in case he discovers an error in his forecast. By promptly drawing attention to changes in forecasting conditions, he will not only assist management in making appropriate adjustment in policies and programs but will also be able to strengthen his own position as a member of the management team by keeping his fingers on the economic pulse of the business.

Secondly, he must establish and maintain many contacts with individuals and data sources, which would not be immediately available to the other members of the management. Extensive familiarity with reference sources and material is essential, but it is still more important that he knows individuals who are specialists in particular fields having a bearing on his work. For this purpose, he should join professional associations and take active part in them. In fact, one of the best means of determining the caliber of a managerial economist is to evaluate his ability to obtain information quickly by personal contacts rather than by lengthy research from either readily available or obscure reference sources. Within any business, there may be a wealth of knowledge and experience but the managerial economist would be really useful if he can supplement the existing know-how with additional information and in the quickest possible manner.

Again, if a managerial economist is to be really helpful to the management in successful decision-making and forward planning, he must be able to earn full status on the business team. He should be ready and even offer himself to take up special assignments, be that in study teams, committees or special projects. For, a managerial economist can only function effectively in an atmosphere where his success or failure can be traced not only to his basic ability, training and experience, but also to his personality and capacity to win continuing support for himself and his professional ideas. Of course, he should be able to express himself clearly and simply and must always try to minimize the use of technical terminology in communicating with his management executives. For, it is well known that hat management does not understand, it will almost automatically reject. Further, while intellectually he must be in tune with industry’s thinking the wider national perspective should not be absents from his advice to top management.