Managerial economics is a form of economics that focuses on the application of economic analysis and statistics for business or management decisions. It is usually a combination of traditional economic theory and the 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 businesses use some form of managerial economics in their business operations.
Companies often include risk in a managerial economic process to determine what might happen if a significant shift occurs in the economy or competing companies began selling similar goods and services to consumers. Risk analysis is the business function of assessing the amount of risk in business decisions and the overall economic environment. Common economic risk models include decision trees, Nash game theory or the capital asset pricing model (CAPM).
Production analysis is a managerial economics function that focuses on the internal production processes of a company. Managers review internal production processes to determine how efficient the company is using economic resources or inputs to produce goods and services sold to consumers. This economic function may include the use of management 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 an economy of scale, which is the economic theory that companies that maximize their production processes can lower overall business costs.
Pricing analysis is a classic economic tool based on the economic theory of supply and demand curves. Basic supply and demand theory states consumers will purchase more goods at cheaper prices and fewer goods at more expensive prices. Companies who supply too many goods at low prices may not make enough profit, while offering goods at higher prices can limit the company’s market share. Managerial economics uses pricing analysis to find the equilibrium point, which is where the company will maximize its profits through a specific amount of sales to consumers.
Capital budgeting is the investment process companies use when purchasing major business assets to produce goods or services for consumers. Companies may use the corporate finance function found in managerial economics to determine how much debt the company should use when purchasing major assets. Using a mix of bank debt or equity and private investment financing can help companies maximize their capital resources when making capital investment or budget decisions.