Managerial Economics : Definition, Nature, Scope

Managerial economics is a discipline which deals with the application of economic theory to business management. It deals with the use of economic concepts and principles of business decision making. Formerly it was known as “Business Economics” but the term has now been discarded in favour of Managerial Economics.

Managerial Economics may be defined as the study of economic theories, logic and methodology which are generally applied to seek solution to the practical problems of business. Managerial Economics is thus constituted of that part of economic knowledge or economic theories which is used as a tool of analysing business problems for rational business decisions. Managerial Economics is often called as Business Economics or Economic for Firms.

Definition of Managerial Economics:

“Managerial Economics is economics applied in decision making. It is a special branch of economics bridging the gap between abstract theory and managerial practice.” – Haynes, Mote and Paul.

“Business Economics consists of the use of economic modes of thought to analyse business situations.” - McNair and Meriam

“Business Economics (Managerial Economics) is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management.” - Spencerand Seegelman.

“Managerial economics is concerned with application of economic concepts and economic analysis to the problems of formulating rational managerial decision.” – Mansfield

Nature of Managerial Economics:

• The primary function of management executive in a business organisation is decision making and forward planning.
• Decision making and forward planning go hand in hand with each other. Decision making means the process of selecting one action from two or more alternative courses of action. Forward planning means establishing plans for the future to carry out the decision so taken.
• The problem of choice arises because resources at the disposal of a business unit (land, labour, capital, and managerial capacity) are limited and the firm has to make the most profitable use of these resources.
• The decision making function is that of the business executive, he takes the decision which will ensure the most efficient means of attaining a desired objective, say profit maximisation. After taking the decision about the particular output, pricing, capital, raw-materials and power etc., are prepared. Forward planning and decision-making thus go on at the same time.
•  A business manager’s task is made difficult by the uncertainty which surrounds business decision-making. Nobody can predict the future course of business conditions. He prepares the best possible plans for the future depending on past experience and future outlook and yet he has to go on revising his plans in the light of new experience to minimise the failure. 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 as it deals with a number of concepts and principles which can be used to solve or at least throw some light upon the problems of business management. E.g are profit, demand, cost, pricing, production, competition, business cycles, national income etc. The way economic analysis can be used towards solving business problems, constitutes the subject-matter of Managerial Economics.
• Thus in brief we can say that Managerial Economics is both a science and an art.

Scope of Managerial Economics:

The scope of managerial economics is not yet clearly laid out because it is a developing       science. Even then the following fields may be said to generally fall under Managerial Economics:

    1.  Demand Analysis and Forecasting

    2.  Cost and Production Analysis

    3.  Pricing Decisions, Policies and Practices

    4.  Profit Management

    5.  Capital Management

These divisions of business economics constitute its subject matter.

Recently, managerial economists have started making increased use of Operation Research methods like Linear programming, inventory models, Games theory, queuing up theory etc., have also come to be regarded as part of Managerial Economics.

   1.Demand Analysis and Forecasting: A business firm is an economic organisation which is engaged in transforming productive resources into goods that are to be sold in the market. A major part of managerial decision making depends on accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production schedules and employing resources. It will help management to maintain or strengthen its market position and profit base. Demand analysis also identifies a number of other factors influencing the demand for a product. Demand analysis and forecasting occupies a strategic place in Managerial Economics.

  2.Cost and production analysis: A firm’s profitability depends much on its cost of production. A wise manager would prepare cost estimates of a range of output, identify the factors causing are cause variations in cost estimates and choose the cost-minimising output level, taking also into consideration the degree of  uncertainty in production and cost calculations. Production processes are under the charge of engineers but the business manager is supposed to carry out the production function analysis in order to avoid wastages of materials and time. Sound pricing practices depend much on cost control. The main topics discussed under cost and production analysis are: Cost concepts, cost-output relationships, Economics and Diseconomies of scale and cost control.

  3.Pricing decisions, policies and practices: Pricing is a very important area of Managerial Economics. In fact, price is the genesis of the revenue of a firm ad as such the success of a business firm largely depends on the correctness of the price decisions taken by it. The important aspects dealt with this area are: Price determination in various market forms, pricing methods, differential pricing, product-line pricing and price forecasting.

    4.Profit management: Business firms are generally organized for earning profit and in the long period, it is profit which provides the chief measure of success of a firm. Economics tells us that profits are the reward for uncertainty bearing and risk taking. A successful business manager is one who can form more or less correct estimates of costs and revenues likely to accrue to the firm at different levels of output. The more successful a manager is in reducing uncertainty, the higher are the profits earned by him. In fact, profit-planning and profit measurement constitute the most challenging area of Managerial Economics.

   5.Capital management: The problems relating to firm’s capital investments are perhaps the most complex and troublesome. Capital management implies planning and control of capital expenditure because it involves a large sum and moreover the problems in disposing the capital assets off are so complex that they require considerable time and labour. The main topics dealt with under capital management are cost of capital, rate of return and selection of projects.

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

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Basic tools in Managerial EconomicsBusiness decision making

Islamic Banking: Basic Concepts and Principles

Islamic banking (or participant banking) is banking or banking activity that is consistent with the principles of sharia law and its practical application through the development of Islamic economics. Sharia prohibits the fixed or floating payment or acceptance of specific interest or fees (known as riba, or usury) for loans of money.

Shariah concepts in Islamic banking

The common Shariah concepts are as follows:

Wadiah (Safekeeping)

Wadiah means custody or safekeeping. In a Wadiah arrangement, you will deposit cash or other assets in a bank for safekeeping.The bank guarantees the safety of the items kept by it.

Here is how it works:

1) You place money in a bank and the bank guarantees to return the money to

    you.

2) You are allowed to withdraw the money anytime.

3) Bank may charge you a fee for looking after your money and may pay hibah  

    (gift) to you if it deems fit.

4) This concept is normally used in deposit-taking activities, custodial services   

    and safe deposit boxes.

Mudharabah (Profit sharing)

Mudharabah is a profit sharing arrangement between two parties, that is, an investor and the entrepreneur.  The investor will supply the entrepreneur with funds for his business venture and gets a return on the funds he puts into the business based on a profit sharing ratio that has been agreed earlier.

The principle of Mudharabah can be applied to Islamic banking operations in 2 ways: between a bank (as the entrepreneur) and the capital provider, and between a bank (as capital provider) and the entrepreneur. Losses suffered shall be borne by the capital provider.

Here is how it works:

1) You supply funds to the bank after agreeing on the terms of the Mudharabah   

    arrangement.

2) Bank invests funds in assets or in projects.

3) Business may make profit or incur loss.

4) Profit is shared between you and your bank based on a preagreed ratio.

5) Any loss will be borne by you.This will reduce the value of the assets/  

    investments and hence, the amount of funds you have supplied to the bank.

Bai’ Bithaman Ajil – BBA (Deferred payment sale)

This refers to the sale of goods where the buyer pays the seller after the sale together with an agreed profit margin, either in one lump sum or by instalment.

Here is how it works:

1) You pick an asset you would like to buy.

2) You then ask the bank for BBA and promise to buy the asset from the bank   

    through a resale at a mark-up price.

3) Bank buys the asset from the owner on cash basis.

4) Ownership of the goods passes to the bank.

5) Bank sells the goods, passes ownership to you at the mark-up price.

6) You pay the bank the mark-up price in instalments over a period of time.

Murabahah (Cost plus)

As in BBA, a Murabahah transaction involves the sale of goods at a price which includes a profit margin agreed by both parties. However, in Murabahah, the seller must let the buyer know the actual cost for the asset and the profit margin at the time of the sale agreement.

Musyarakah (Joint venture)

In the context of business and trade, Musyarakah refers to a partnership or a joint business venture to make profit. Profits made will be shared by the partners based on an agreed ratio which may not be in the same proportion as the amount of investment made by the partners. However, losses incurred will be shared based on the ratio of funds invested by each partner.

Ijarah Thumma Bai’ (Hire purchase)

Ijarah Thumma Bai’ is normally used in financing consumer goods especially motor vehicles.There are two separate contracts involved: Ijarah contract (leasing/renting) and Bai’ contract (purchase).The contracts are made one after the other.

Here is how it works:

1) You pick a car you would like to have.

2) You ask the bank for Ijarah of the car, pay the deposit for the car and     

    promise to lease the car from the bank after the bank has bought the car.

3) Bank pays the seller for the car.

4) Seller passes ownership of the car to the bank.

5) Bank leases the car to you.

6) You pay Ijarah rentals over a period.

7) At end of the leasing period, the bank sells the car to you at the agreed sale  

    price.

Wakalah (Agency)

This is a contract whereby a person (principal) asks another party to act on his behalf (as his agent) for a specific task.The person who takes on the task is an agent who will be paid a fee for his services.

Example

A customer asks a bank to pay someone under certain terms.The bank is

therefore the agent for carrying out the financial transaction and the bank

will be paid a fee for its services.

Qard (Interest-free loan)

Under this arrangement, a loan is given for a fixed period on a goodwill basis and the borrower is only required to repay the amount borrowed. However, the borrowe may, if he so wishes, pay an extra amount (without promising it) as a way to thank the lender.

Example

A lender who lent RM5,000 to a borrower on Qard will expect the borrower to return exactly RM5,000 to him at a later date.

Hibah (Gift)

This refers to a payment made willingly in return for a benefit received.

Example

In savings operated under Wadiah, banks will normally pay their Wadiah depositors hibah although the accountholders only intend to put their savings in the banks for safekeeping.

Good and service tax (GST)

  

One of the biggest taxation reforms in India -- the Goods and Service Tax (GST) -- is all set to integrate State economies and boost overall growth.

GST will create a single, unified Indian market to make the economy stronger.

Finance Minister Pranab Mukherjee while presenting the Budget on July 6, 2009, said that GST would come into effect from April 2010.

(The date of implementation of GSTN is set on August 2012. GST might not be implemented before 1 April 2013.)

The implementation of GST will lead to the abolition of other taxes such as octroi, Central Sales Tax, State-level sales tax, entry tax, stamp duty, telecom licence fees, turnover tax, tax on consumption or sale of electricity, taxes on transportation of goods and services, et cetera, thus avoiding multiple layers of taxation that currently exist in India.

But just what is GST all about and how will it impact you?

What is GST?

Goods and Services Tax -- GST -- is a comprehensive tax levy on manufacture, sale and consumption of goods and services at a national level.

Through a tax credit mechanism, this tax is collected on value-added goods and services at each stage of sale or purchase in the supply chain.

The system allows the set-off of GST paid on the procurement of goods and services against the GST which is payable on the supply of goods or services. However, the end consumer bears this tax as he is the last person in the supply chain.

Experts say that GST is likely to improve tax collections and boost India's economic development by breaking tax barriers between States and integrating India through a uniform tax rate.

What are the benefits of GST?

Under GST, the taxation burden will be divided equitably between manufacturing and services, through a lower tax rate by increasing the tax base and minimizing exemptions.

It is expected to help build a transparent and corruption-free tax administration. GST will be is levied only at the destination point, and not at various points (from manufacturing to retail outlets).

Currently, a manufacturer needs to pay tax when a finished product moves out from a factory, and it is again taxed at the retail outlet when sold.

How will it benefit the Centre and the States?

It is estimated that India will gain $15 billion a year by implementing the Goods and Services Tax as it would promote exports, raise employment and boost growth. It will divide the tax burden equitably between manufacturing and services.

What are the benefits of GST for individuals and companies?

In the GST system, both Central and State taxes will be collected at the point of sale. Both components (the Central and State GST) will be charged on the manufacturing cost. This will benefit individuals as prices are likely to come down. Lower prices will lead to more consumption, thereby helping companies.

What type of GST is proposed for India?

India is planning to implement a dual GST system. Under dual GST, a Central Goods and Services Tax (CGST) and a State Goods and Services Tax (SGST) will be levied on the taxable value of a transaction.

All goods and services, barring a few exceptions, will be brought into the GST base. There will be no distinction between goods and services.

Which other nations have a similar tax structure?

Almost 140 countries have already implemented the GST. Most of the countries have a unified GST system. Brazil and Canada follow a dual system where GST is levied by both the Union and the State governments.

France was the first country to introduce GST system in 1954.

Will this be an extra tax?

It will not be an additional tax. CGST will include central excise duty (Cenvat), service tax, and additional duties of customs at the central level; and value-added tax, central sales tax, entertainment tax, luxury tax, octroi, lottery taxes, electricity duty, state surcharges related to supply of goods and services and purchase tax at the State level.

What will be the rate of GST?

The combined GST rate is being discussed by government. The rate is expected around 14-16 per cent. After the total GST rate is arrived at, the States and the Centre will decide on the CGST and SGST rates.

Currently, services are taxed at 10 per cent and the combined charge indirect taxes on most goods is around 20 per cent.

Will goods and services cost more after this tax comes into force?

The prices are expected to fall in the long term as dealers might pass on the benefits of the reduced tax to consumers.

Why are some States against GST; will they lose money?

The governments of Madhya Pradesh, Chhattisgarh and Tamil Nadu say that the information technology systems and the administrative infrastructure will not be ready by April 2010 to implement GST. States have sought assurances that their existing revenues will be protected.

The central government has offered to compensate States in case of a loss in revenues.

Some States fear that if the uniform tax rate is lower than their existing rates, it will hit their tax kitty. The government believes that dual GST will lead to better revenue collection for States.

However, backward and less-developed States could see a fall in tax collections. GST could see better revenue collection for some States as the consumption of goods and services will rise.

How will GST be implemented?

The empowered committee is likely to finalize the details of GST by August. But States have to sort out several issues like agreement on GST rates, constitutional amendments and holding talks with industry associations. Experts feel the drafting of legislation and the implementation of law will take time.

What are the items on which GST may not be applied?

Alcohol, tobacco, petroleum products are likely to be out of the GST regime.

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New Direct Tax Code

New Direct Tax Code

The New Direct Tax Code (DTC) of India is expected to substitute the Income Tax Act of 1961 that is presently in operation. The bill had been presented at the Parliament on August 30th, 2010. According to experts, the new code has lesser benefits compared to the Income Tax Act of 1961.

The Union Finance Minister Pranab Mukherjee had reiterated while presenting the 2010 Union Budget, that he will ensure the new DTC came into force on April 1st, 2011. 

Direct Tax Code Highlights

1. The new DTC does away with majority of the categories that were earlier exempted from taxes such as Unit Linked Insurance Plans (ULIPs), Long term infrastructure bonds, Equity Mutual Funds (ELSS), repayment of house loan principal, Term deposits, stamp duties, National Savings certificates (NSC), and registration fees for buying residential properties.
2. There will be no tax exemption for leave travel allowances.
3. The upper limit for tax saving investments will be INR 100,000. But in case of pure life insurance there will be an addition of 50,000 rupees – the sum of insurance should be, at the minimum, 20 times more than the premium. This facility will also be available for health insurance, tuition fees of children, and mediclaim policies. Tax payers will be able to make tax saving investments up to 1 lakh rupees in provident funds, gratuity funds, superannuation funds, and new pension schemes.
4. Tax exemptions provided for education loans will remain the same as earlier.
5. As before, tax exemption will remain the same in case of the interest paid for home loans – INR 1.5 lakhs per year.
6. Corporate taxes have been reduced to 30 percent from 34%. This will be inclusive of the education surcharge and cess.
7. Short term capital gains will be taxed at 50 percent. Long term capital gains such as equity mutual funds and equities, where STT is being paid, will be exempted from taxes.
8. The upper limit for medical repayments has been increased from INR 15,000 per year to 50,000 rupees per year.
9. Tax exemption will be provided for savings, withdrawals and accretions of GPF, PPF, and EPF. This benefit will also be applicable for the New Pension Scheme being managed by the PFRDA, pure life insurance products, and retirement benefits such as leave encashment and gratuity, and annuity schemes.
10. Equity mutual funds will be subjected to a dividend distribution tax (DDT) rate of 5 percent. DDT from non equity funds will be taxed as per the yearly income of the concerned investor. If dividend from non-equity funds exceeds INR 10 thousand the TDS will be 10 percent. In case of companies and NRIs this rate will go up to 20%.
11. Education cess and surcharge have been removed.
12. In case an NRI stays in India for a minimum of 60 days he will be required to pay a tax on his aggregate income. 
13. Deductions for rent and maintenance will be brought down to 20 percent from 30% of the gross rent. Interest paid for house loans in case of a rented property will now be deducted from the rent.

Direct Tax Code – Slabs

The following table shows the new income tax rates to be applicable from April 1st, 2012 onwards:

Yearly income	Tax rates
More than 10 lakh rupees	30 percent
Within 5 lakh and 10 lakh rupees	20 percent
Within 2 lakh and 5 lakh rupees	10 percent
Up to 2 lakh rupees (in case of senior citizens this amount will go up to INR 250,000)	Exempted

Direct Tax Code – Capital Gains from Property Sales

As per the new direct tax code, in case of properties sold within a year the income will be added to the taxable salary. For long term gains, like in case of properties sold after more than one year of buying them, the gains will be added to the taxable income after indexation.The tax will be deducted as per the annual income of the concerned tax payer. The base date for calculating the acquisition costs has been changed to April 1, 2000 from April 20, 1980.