Managerial economics applies economic analysis and statistics to business decisions, using risk analysis, production analysis, pricing analysis, and capital budgeting. Companies use it to assess risks, increase production efficiency, determine pricing strategies, and make investment decisions.
Managerial economics is a form of economics that focuses on the application of economic analysis and statistics to business or management decisions. It is usually a combination of traditional economic theory and practical economics seen every day in the business environment. Managerial economics provides users with a more quantitative analysis of business situations through the use of mathematical formulas and other calculations, including risk analysis, production analysis, pricing analysis, and capital budgeting. Most companies use some form of managerial economics in their business operations.
Companies often build risks into a managerial economic process to determine what might happen if a significant change in the economy occurs or if competing companies start selling similar goods and services to consumers. Risk analysis is the business function of assessing the amount of risk in business decisions and the general economic environment. Common economic risk models include decision trees, Nash game theory, or the capital asset pricing model (CAPM).
Production analysis is a managerial economic function that focuses on the internal production processes of a company. Managers review internal production processes to determine the firm’s efficiency in using economic resources or inputs to produce goods and services sold to consumers. This economic function may include the use of managerial accounting, which develops cost allocation methods that apply business costs to individual goods or services. Finding ways to increase production efficiency can help companies achieve economies of scale, which is the economic theory that companies that maximize their production processes can reduce overall costs of doing business.
Price analysis is a classic economic tool based on the economic theory of supply and demand curves. The basic theory of supply and demand states that consumers will buy more goods at cheaper prices and fewer goods at higher prices. Companies that supply too many products at low prices may not make enough profit, while offering products at higher prices may limit the company’s market share. Managerial economics uses price analysis to find the break-even point, where the firm will maximize its profits through a specified amount of sales to consumers.
Capital budgeting is the investment process that companies use in purchasing large business assets to produce goods or services for consumers. Companies can use the corporate finance function found in managerial economics to determine how much debt the company should use when purchasing large assets. Using a combination of bank debt or equity and private investment financing can help companies maximize their capital resources when making capital budgeting or investment decisions.
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