To solve the business decisions problems is the task of a managerial economist. Resources at the disposal of an organisation are scarce.
Therefore optimum solution to the business decision-making problem requires that resources should be so used as to achieve the objective efficiently.
The limited amount of resources is one type of constraint faced by the manager of a firm.
The other type of constraint faced by the manager of a firm is imposed by the economic environment which includes the state of the economy, the phase of business cycles, the competition from the rival firms, government’s fiscal and monetary policies, export and import policies etc. Given these constraints the manager has to make business decisions. Therefore, the decision-making problem faced by a manager is one of constrained decision-making.
Decision-making problem requires a choice among alternative courses of action so as to achieve the objective. These alternative courses of action among which choice has to made are often called business strategies.
The nature of decision-making problem faced by business firms is therefore of the following type:
‘To identify the alternative courses of action of achieving given objective(s), and then to select the course of action that achieves the objective in the economically most efficient way’.
An example will make clear the nature of decision-making problem requiring solution by the managers of business firms. Consider Maruti Udyog Limited which manufactures cars. Suppose it has identified two possible courses of action (generally called strategies) to meet the growing market demand for its products. First course of action or strategy is to plan for its internal expansion of productive capacity. The second course of action is to take over the premier Auto Limited and use its capacity to increase output to meet growing demand of its product.
The objective of Maruti Udyog Limited is to maximise profits (that is, the present value of expected returns) to be earned from expansion of output. Let S1 stand for strategy 1 or the first course of action (that is, expanding its internal capacity), S2 for strategy 2 or the second course of action, that is, to take over the other firm.
The objective function for the above decision-making problem can be stated as:
Maximise profits (S1, S2)
To choose from the two alternative strategies, the following decision rule can be made:
Choose strategy S1 if profits from > profits from S2.
Choose strategy S2 if profits from S2> profits from S1.
The above simple example only brings out the essential feature of the decision-making problem faced by the managers of business firms and the rule for their rational solution. It is important to note that the knowledge of economic theory for decision-making by managers is important to formulate the objective function and to arrive at the decision rule for choosing a strategy or a course of action.
Modern economics is divided into two broad branches: microeconomics and macroeconomics. Microeconomics is concerned with theory of individual choice: Choice by a consumer and choice by a business firm. On the other hand, macroeconomics focuses on analyzing the economy as a whole and its aggregates such as GNP, the general price level, the level of employment, etc. Managers or rational businessmen get assistance from both the microeconomics and macroeconomics while making business decisions, but concepts and techniques of microeconomic theory is of greater help for them.
This is because microeconomics tells us how to make a rational choice in allocating scarce resources of the firm while making decisions regarding price, output, technology, advertising expenditure, and capital investment expenditure which are the direct concern of business management. Through their individual actions and choice managers can do little to affect the aggregate economy, with which macroeconomics is concerned.
But macroeconomics tells him how his business environment will change as a result of movements in the aggregate economy such as situations of recession or inflation, changes in economy’s balance of payments and the Government policy adopted to tackle them. All these factors which affect the outcome of business decisions. Thus, the managers during their decision-making process must take into the account the current macroeconomic outlook and likely changes in it in the future.