Approach to managerial Decision making

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Approach to managerial Decision making

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Application of the Theories of Economics in Business Decisions

The following are the main theories in economics that help the firm in the decision-making process.

  1. Theory of Demand

Demand theory explains the consumer’s behavior. The theory helps to understand the behavior of consumers when the determinants of demand such as income, taste and fashion, prices of substitutes etc change. Knowledge of demand theory is vital in the choice of commodities for production.

  1. Theory of Production

The basic function of a firm is to produce goods and services and sell them in the market. Production requires employment of various factors of production. The factors are substitutes among themselves to a certain extent. To maximize production and profit, it is necessary to achieve the least-cost combination of factors. Production theory is of immense use in determining the size of the firm, the size of the total output, and the optimum factor combination.

  1. Theory of Price

Price explains price determination under various different market structures like perfect competition, monopoly, oligopoly etc. it is also useful to determine the optimal advertisement budget that is necessary to maximize sales. Thus price theory is a valuable guide in framing the price policy of a firm.

  1. Theory of Profit

Profit making is the basic objective of business concerns. But, making a satisfactory level of profit is not always certain, due to the presence of risk and uncertainty in business operations. Some of the factors which influence profit are (i) nature of demand for the product (ii) prices of inputs in the factor market and (iii) the degree of competition in the factor market. An element of risk is always there, even if most advanced techniques are used for predicting the future, and even if business actitivities are systematically planned.

 Therefore, minimizing risks is of paramount importance to safeguard the welfare of the firms. Profit theory guides in the measurement of profit and in estimating a reasonable return on the capital employed.

  1. Theory  of Capital and Investment

Capital like all other inputs is a scarce and an expensive factor. Rational utilization of scarce resources is one of the important tasks of the managers. The major issues related to capital are (i) choice of investment projects (ii) assessing the efficiency of capital, and (iii) the most efficient allocation of capital. Knowledge of capital theory can contribute a great deal in investment decisions, choice of projects, maintaining capital intact, capital budgeting etc.

  1. Macro Economic Theories

Though managerial economics is basically micro in nature, macro theories are not altogether irrelevant for decision-making at the firm level. This is because, the macro economic environment, which includes the behavior of national aggregates such as price level, national income, unemployment, poverty and, macro economic policy aspects, such as economic policy, industrial policy, subsidies, administered prices and controls, licensing policy, etc affect firms’ decisions.

 

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