Managerial economics applies economic theory and methods to business and administrative decision making. Managerial economics prescribes rules for improving managerial decisions. Managerial economics also helps managers recognize how economic forces affect organizations and describes the economic consequences of managerial behavior. It links economic concepts with quantitative methods to develop vital tools for managerial decision making.

Managerial economics identifies ways to efficiently achieve goals. For example, suppose a small business seeks rapid growth to reach a size that permits efficient use of national media advertising. Managerial economics can be used to identify pricing and production strategies to help meet this short-run objective quickly and effectively. Similarly, managerial economics provides production and marketing rules that permit the company to maximize net profits once it has achieved growth or market share objectives.

Managerial economics has applications in both profit and not-for-profit sectors. For example, an administrator of a nonprofit hospital strives to provide the best medical care possible given limited medical staff, equipment, and related resources. Using the tools and concepts of managerial economics, the administrator can determine the optimal allocation of these limited resources.

In short, managerial economics helps managers arrive at a set of operating rules that aid in the efficient use of scarce human and capital resources. By following these rules, businesses, nonprofit organizations, and government agencies are able to meet objectives efficiently.

Making the Best Decision

To establish appropriate decision rules, managers must understand the economic environment in which they operate. For example, a grocery retailer may offer consumers a highly price-sensitive product, such as milk, at an extremely low markup over cost—say, 1 percent to 2 percent—while offering less price-sensitive products, such as nonprescription drugs, at markups of as high as 40 percent over cost. Managerial economics describes the logic of this pricing practice with respect to the goal of profit maximization. Similarly, managerial economics reveals that auto import quotas reduce the availability of substitutes for domestically produced cars, raise auto prices, and create the possibility of monopoly profits for domestic manufacturers. It does not explain whether imposing quotas is good public policy; that is a decision involving broader political considerations. Managerial economics only describes the predictable economic consequences of such actions.

Managerial economics offers a comprehensive application of economic theory and methodology to management decision making. It is as relevant to the management of government agencies, cooperatives, schools, hospitals, museums, and similar not-for-profit institutions as it is to the management of profit-oriented businesses. Although this text focuses primarily on business applications, it also includes examples and problems from the government and nonprofit sectors to illustrate the broad relevance of managerial economics.

Organizing is the development of the company resources to achieve strategic goals. The deployment of resources is reflected in the company division of labor into specific departments and jobs, formal lines of authority, and mechanisms for coordinating diverse company tasks.

Organization structure

The organizing process leads to the creation of organization structure, which defines how tasks are divided and resources deployed. Organization structure is defined as:

• The set of formal tasks assigned to individuals and departments;
• formal reporting relationships, including lines of authority, decision responsibility, number of hierarchical levels, and span of managers’ control; and
• The design of systems to ensure effective coordination of employees across departments. Ensuring coordination across departments is just as critical as defining the departments to begin with. Without effective coordination systems, no structure is complete.

Characteristics of the business organization structure

A. Organization chart

The set of formal tasks and formal reporting relationships provides a framework for vertical control of the organization. The characteristics of vertical structure are portrayed in the organization chart, which is the visual representation of an organization’s structure.

The plant has four major departments—accounting, human resources, production, and marketing. The organization chart delineates the chain of command, indicates departmental tasks and how they fit together, and provides order and logic for the organization. Every employee has an appointed task, line of authority, and decision responsibility.

B. Work Specialization

Organizations perform a wide variety of tasks. A fundamental principle is that work can be performed more efficiently if employees are allowed to specialize. Work specialization, sometimes called division of labor, is the degree to which organizational tasks are subdivided into separate jobs. Employees within each department perform only the tasks relevant to their specialized function. When work specialization is extensive, employees specialize in a single task. Jobs tend to be small, but they can be performed efficiently. Work specialization is readily visible on an automobile assembly line where each employee performs the same task over and over again. It would not be efficient to have a single employee build the entire automobile, or even perform a large number of unrelated jobs.

Despite the apparent advantages of specialization, many organizations are moving away from this principle. With too much specialization, employees are isolated and do only a single, boring job. In addition, too much specialization creates separation and hinders the coordination that is essential for organizations to be effective. Many companies are implementing teams and other mechanisms that enhance coordination and provide greater challenge for employees.

C. Chain of Command

The chain of command is an unbroken line of authority that links all persons in an organization and shows who reports to whom. It is associated with two underlying principles. Unity of command means that each employee is held accountable to only one supervisor. The scalar principle refers to a clearly defined line of authority in the organization that includes all employees. Authority and responsibility for different tasks should be distinct. All persons in the organization should know to whom they report as well as the successive management levels all the way to the top. The payroll clerk reports to the chief accountant, who in turn reports to the vice president, who in turn reports to the company president.

D. Authority, Responsibility, and Delegation

The chain of command illustrates the authority structure of the organization. Authority is the formal and legitimate right of a manager to make decisions, issue orders, and allocate resources to achieve organizationally desired outcomes. Authority is distinguished by three characteristics:

1. Authority is vested in organizational positions, not people. Managers have

authority because of the positions they hold, and other people in the same positions would have the same authority.

2. Authority is accepted by subordinates. Although authority flows top-down through the organization’s hierarchy, subordinates comply because they believe that managers have a legitimate right to issue orders. The acceptance theory of authority argues that a manager has authority only if subordinates choose to accept his or her commands. If subordinates refuse to obey because the order is outside their zone of acceptance, a manager’s authority disappears.
3. Authority flows down the vertical hierarchy. Positions at the top of the hierarchy are vested with more formal authority than are positions at the bottom. Responsibility is the flip side of the authority coin. Responsibility is the duty to perform the task or activity as assigned. Typically, managers are assigned authority commensurate with responsibility. When managers have responsibility for task outcomes but little authority, the job is possible but difficult. They rely on persuasion

and luck. When managers have authority exceeding responsibility, they may become tyrants, using authority toward frivolous outcomes.

E. Accountability

Accountability is the mechanism through which authority and responsibility are brought into alignment. Accountability means that the people with authority and responsibility are subject to reporting and justifying task outcomes to those above them in the chain of command. For organizations to function well, everyone needs to know what they are accountable for and accept the responsibility and authority for performing it. Accountability can be built into the organization structure. For example, at Whirlpool, incentive programs tailored to different hierarchical levels provide strict accountability. Performance of all managers is monitored, and bonus payments are tied to successful outcomes. Another example comes from Caterpillar Inc., which got hammered by new competition in the mid-1980s and reorganized to build in accountability.

F. Span of Management

The span of management is the number of employees reporting to a supervisor. Sometimes called the span of control, this characteristic of structure determines how closely a supervisor can monitor subordinates. Traditional views of organization design recommended a span of management of about seven subordinates per manager. However, many lean organizations today have spans of management as high as 30, 40, and even higher. For example, at Consolidated Diesel’s team-based engine assembly plant, the span of management is 100.11 Research over the past 40 or so years shows that span of management varies widely and that several factors influence the span.12 Generally, when supervisors must be closely involved with subordinates, the span should be small, and when supervisors need little involvement with subordinates, it can be large. The following section describes the factors that are associated with less supervisor involvement and thus larger spans of control.

G. Delegation

Some top managers at Caterpillar had trouble letting go of authority in the new structure because they were used to calling all the shots, but the new structure was an important part of returning the company to profitability. Another important concept related to authority is delegation. Delegation is the process managers use to transfer authority and responsibility to positions below them in the hierarchy. Most organizations today encourage managers to delegate authority to the lowest possible level to provide maximum flexibility to meet customer needs and adapt to the environment. However, as at Caterpillar, many managers find delegation difficult. When managers can’t delegate, they undermine the role of their subordinates and prevent people from doing their jobs effectively.

H. Line and Staff Authority

An important distinction in many organizations is between line authority and staff authority, reflecting whether managers work in line or staff departments in the organization’s structure. Line departments perform tasks that reflect the organization’s primary goal and mission. In a software company, line departments make and sell the product. In an Internet-based company, line departments would be those that develop and manage online offerings and sales. Staff departments include all those that provide specialized skills in support of line departments. Staff departments have an advisory relationship with line departments and typically include marketing, labor relations, research, accounting, and human resources.

I. Line authority

Line authority means that people in management positions have formal authority to direct and control immediate subordinates. Staff authority is narrower and includes the right to advise, recommend, and counsel in the staff specialists’ area of expertise. Staff authority is a communication relationship; staff specialists advise managers in technical areas. For example, the finance department of a manufacturing firm would have staff authority to coordinate with line departments about which accounting forms to use to facilitate equipment purchases and standardize payroll services.

J. Centralization and Decentralization

Centralization and decentralization pertain to the hierarchical level at which decisions are made. Centralization means that decision authority is located near the top of the organization. With decentralization, decision authority is pushed downward to lower organization levels. Organizations may have to experiment to find the correct hierarchical level at which to make decisions. For example, most large school systems are highly centralized. However, a study by William Ouchi found that three large urban school systems that shifted to a decentralized structure giving school principals and teachers more control over staffing, scheduling, and teaching methods and materials performed better and more efficiently than centralized systems of similar size.

In the United States and Canada, the trend over the past 30 years has been toward greater decentralization of organizations. Decentralization is believed to relieve the burden on top managers, make greater use of employees’ skills and abilities, ensure that

decisions are made close to the action by well-informed people, and permit more rapid response to external changes. However, this trend does not mean that every organization should decentralize all decisions. Managers should diagnose the organizational situation and select the decision-making level that will best meet the organization’s needs.

Factors that typically influence centralization versus decentralization are as follows:

• Greater change and uncertainty in the environment are usually associated with decentralization.

A good example of how decentralization can help cope with rapid change and uncertainty occurred following Hurricane Katrina. Mississippi Power restored power in just 12 days thanks largely to a decentralized management system that empowered people at the electrical substations to make rapid on-the-spot decisions.

• The amount of centralization or decentralization should fit the firm’s strategy.

Top executives at New York City Transit are decentralizing the subway system to let managers of individual subway lines make almost every decision about what happens on the tracks, in the trains, and in the stations. Decentralization fits the strategy of responding faster and more directly to customer complaints or other problems. Previously, a request to fix a leak causing slippery conditions in a station could languish for years because the centralized system slowed decision making to a crawl. Taking the opposite approach, Procter & Gamble recentralized some of its operations to take a more focused approach and leverage the giant company’s capabilities across business units.

• In times of crisis or risk of company failure, authority may be centralized at the top.

When Honda could not get agreement among divisions about new car models, President Nobuhiko Kawamoto made the decision himself.

Goals determine a substantial amount of human behavior. Motivation to achieve these goals is a major factor in a business company and in any organizational effectiveness. For these reasons we devote a full post to this topic to show the relationship between individual goal and company goal and how does motivations take place through it. Individuals have goals and organizations have goals.

For maximal business company effectiveness it is important to make these two sets of goals compatible. In fact, that is the major role of management. The business company manager must have a clear understanding of both sets of goals and find ways to make them similar, overlapping, and at least non contradictory. Business company effectiveness depends on

• Individual motivation for organizational effectiveness (i.e., individual goals that are compatible with the goals of the organization),
•  Individual performance (just because one has the right goals does not automatically result in effective performance), and
• Adequate coordination of individual performances. Performance depends on more than motivation.

One must have adequate skills and abilities and proper training, and there must be a good match between the individual and the business company goals. Coordination depends on adequate communication, and it can be improved when there is participation by employees in decisions that affect them and when company goals overlap with personal ones.

In order to understand performance better, it is useful to focus on a model that links the probability of an act to particular determinants.

1. A MODEL OF HUMAN BEHAVIOR

For our purposes here an act is a short sequence of behaviors that eventually results in some outcome, such as the publication of a paper or the development of a good research design. In other words, we are using the word “act” in a very specific way. Hundreds of these acts are necessary to produce a publication or to develop a product. What we are trying to understand is what makes these small acts more or less probable. Actions have results that are evaluated, and considered as the outcomes of action that may satisfy individual needs.

Two variables are important in this case: previous habits and self-instruction. For example, when a person says, “I should look up these references,” that is a self-instruction or behavioral intention. Research has shown that behavioral intentions predict behaviors quite well. The model thus states that the probability of an act is dependent on two kinds of variables: habits and behavioral intentions.

However, even when people have the proper habits and intentions to carry out a particular act, they may fail to do so because external conditions may not be favorable. We utilize the concept of facilitating conditions in order to explain the phenomenon that even though the individual may have all that is required, the act may not occur. Reasons beyond the intentions of the individual may not allow it. For example, there may be a lack of proper equipment or there may be distractions in the environment. Facilitating conditions can be measured both with data obtained “outside the individual” (e.g., by asking objective observers, who know the conditions of work well, to judge if the act can occur) and with data obtained from “inside the individual,” by measuring the individual’s sense of “self-efficacy.” This can be measured by asking the individual, “Can you do that?” A scale can be constructed that measures the individual’s beliefs that the behavior can take place under different kinds of circumstances. The circumstances described in the scale can be more and more difficult. Those who think that they can do the behavior under the most difficult circumstances are highest in self-efficacy.

Thus, a high sense of self-efficacy is an especially important facilitating condition. For instance, we can ask, “Can you solve this equation?” A person who says no is very low in self-efficacy. Those who answer yes are higher in self efficacy. A person who says yes when the question is “Can you solve this equation when you are waiting to board a plane in a noisy airport?” is very high in self efficacy. Consider a more specific example. If a person said, “I will look up this reference,” but the book that contains the particular reference is not around, the probability that the act will occur decreases. Facilitating conditions modify the probability that habit and intention in them will result in the act. They reflect the situation within which behavior may occur.

Determinants of Habits

What are some of the variables that determine a habit? Habits build up as a result of previous rewards. We call such rewards “reinforcements” because they reinforce the link between stimulus conditions and behavior. Behavior is a function of its consequences. As people engage in a particular behavior in the presence of a certain configuration of stimuli, and when desirable events follow the behavior, the probability increases that the configuration of stimuli will in the future produce the same behavior. The behavior eventually becomes automatic, without thinking. When this happens, we say that the act has become “overlearned” and occurs under the control of habits. In that case, behavioral intentions are not relevant as explanations of the behavior.

Determinants of Intentions

Let us now examine what determines behavioral intentions. Three classes of variables are relevant for the determination of behavioral intentions: social factors, act satisfaction, and perceived consequences.

Social Factors. Social factors include norms, roles, self-concept of the person, and interpersonal agreements.

1. Norms. Ideas about correct behavior for all members of the organization. They emerge in discussions among members of the organization. For instance, arriving at 8 a.m. would be a norm since it applies to all members of the group.
2. Roles. Ideas about correct behavior for the specific position that a member of the organization holds. These are evident when a person says to him or herself, “I am supposed to be doing this because it is my job.” In short, the role has become embedded in the person’s thinking and has certain activities associated with it. The probability of these activities (acts) increases when the person thinks that he or she is doing the job. Researchers who feel it is their job to keep supervisors informed are more likely to do
   • For instance, what behaviors are expected of a “principal investigator”? In some cases, these expectations are quantitative, such as “producing three papers a year.” In other cases, they are qualitative—for example, the expectation of an important scientific contribution, or the development of a new product that will benefit the company.
3. Self-Concept of the Person. This includes the ideas a person has about the types of activities that are appropriate for him or her. For example, if a researcher feels it is appropriate to present his or her views, even though they differ from others, he or she is more likely to participate actively in discussions and meetings.
4. Interpersonal Agreements. These are similar to management by objectives. The supervisor and subordinate agree that the subordinate will try to reach a particular goal. Interpersonal agreements increase the probability that the goal will be reached through behavioral intention (self-instruction). Some research projects use milestones that are really interpersonal agreements as conceptualized here.

Act Satisfaction. The second class of variables that determines behavioral intentions is satisfaction associated with the act itself. Many acts are enjoyable in themselves, such as eating certain types of foods, playing the piano, or working on computer problems. Often such acts associated with pleasure have been formed through classical conditioning. In other words, the activity itself was associated with pleasant events in the past and is pleasant to think about, so this factor involves affect (emotion) toward the behavior itself. This affect motivates the person to self-instruct to do the act, and this in turn becomes the behavioral intention that causes the behavior. Working on a challenging research project or working with a noted scientist could fall in this category.

Facilitating Conditions

There are a number of factors that facilitate the performance of a behavior. Most of them are situational, such as helpful conditions, the right setting, or access to the resources needed to carry out the behavior. However, there are also internal conditions over which the individual does not have much control, such as the person’s physiological state (e.g., hormonal balance), beliefs that the behavior is possible and likely to lead to the successful reaching of goals (sense of self efficacy), and the level of difficulty of the task relative to the person’s ability. For instance, no matter how intensive a researcher’s intention to invent a new product, and how brilliant the past record of inventions (habits), there are situations in which no invention will be possible because the person is feeling depressed, or he or she believes that they are not able to have a new idea, or the task is much too difficult relative to the available talent. Some of these conditions can be measured objectively, and others may be estimated by objective observers of the total situation. The point about the F component of Equation 1 is that when it is zero, it can bring the probability of the act to zero, no matter how high the levels of habits or intentions.

• STRUCTURING THE ORGANIZATION FOR OPTIMAL COMMUNICATION

People are more motivated if they have clear goals and know how their job fits the goals of the business company than if they do not have this information. Thus, structuring the company for optimal communication can help individual motivation. There has been a good deal of literature on the question of how to expose members of research and development department to the information they need to have to do their jobs well. One concern has been the accessibility of technical literature to the members of the department.

• REWARDS AND MOTIVATION

A variety of factors can be used to motivate an individual. Nonetheless, individuals will be just that when it comes to personal motivations, motivations for performance were based around pay and benefits, recognition, and opportunities for achievement. They concluded that motivations are dependent upon the employees and are likely to change within differing industries. Therefore the individual, company, and industry must be taken into account when motivators are applied.

The reason business company lack creativity or success is usually found in the nature and frequency of the rewards that are being distributed. Rewards can be given every month, such as salary, but this is not nearly as motivating as rewards that occur with a variable schedule. There is evidence that a variable schedule of rewards is much more motivating than one that occurs on a regular basis. Receiving recognition after each publication is less effective than getting a major recognition following a series of publications. While motivation is an important aspect of individual performance, we must not neglect to mention that the availability of proper skills and adequate training is also crucial to good performance. Furthermore, the rewards that the person receives from the business company should be tied to company performance.

Otherwise, the person may function extremely effectively, but his or her performance may have no impact on the company. Consider, for example, the case of an employee who is inspired on the job to invent something that could make a million dollars. However, the organization has neither the need for such a product nor the resources to take advantage of the invention. Such a person is performing well at the individual level, but not at the organizational level. The most important principles of compensation are

• Equity,
• Competitiveness, and
• Link to performance.

Equity is achieved by making sure that employees are rewarded according to their education and merit. Competitiveness requires salary surveys. Links to performance are difficult to establish but are important. Specifically, if salary is the major means of compensation, it does not correlate sufficiently to performance. Bonuses do so much more. Systems of compensation that review the employee’s achievements every few months and that provide a raise according to the outcomes of these reviews link compensation and performance even more effectively.

• SENSE OF CONTROL AND COMMUNITY

Business company effectiveness does depend on individual motivation and individual effectiveness. It obviously depends on individual performance, but it also depends on communication and coordination among individuals as well as between the individual and the company. Techniques such as gain sharing and profit sharing bring the goals of the individual and the company into line with each other and are also methods for motivating the individual. One of the most successful plans to motivate employees has been developed by Lincoln (1951) and involves profit sharing.

In addition, openness of information is necessary so that the individual knows what the company expects and hopes to get from him. Job rotation can help the individual get a better feel for what the business company is trying to achieve, and intrinsic rewards (getting a kick out of doing the job) that are tied to individual performance can help the individual line up his or her own rewards and goals with the goals of the business company.

Finally, designing jobs in such a way that individuals have a sense of control over their activities is very important. Individuals must feel that a lot of what they do is consistent with their goals. Thus, the individual should have a certain amount of choice. Individuals who see themselves as having some alternatives are much more satisfied and have a greater sense of control than individuals who are told “this is it.” Having only one alternative is demotivating.

The basic elements required for a business company to develop are

• People
• Ideas
• Cultural elements.

These three basic ingredients have to be coordinated with skill by the management of research and development in a business company in order to achieve high productivity and excellence. In this lesson we will cover some of the introductory topics concerning these basic elements. In the next lesson we will focus more specifically on the task of coordinating and managing.

It is obvious that the most important element is creative people. Such people have the bright ideas and skills to do develop ideas and then translate ideas results into useful products. However, these people must be organized into structures that permit effective cooperation. In doing so it is important to keep in mind that certain mixes of people work better than others. To ensure a smoothly functioning organization, one need unstated assumptions, beliefs, norms, and values—in other words, an organizational culture that will favor creativity and innovation. Last, but not least, one needs funds.

PEOPLE

People in Business Company normally would have graduate training and relatively high aptitude. They are socialized during their graduate training to work autonomously and show considerable initiative. An anecdote will help convey more clearly what is special about personnel. There are identified four different personality traits relevant to business in order to develop:

• Creative Type. Creative types are idea generators, comfortable with abstract problem solving and have a preference for working alone.
• Entrepreneurial Type. Entrepreneurial individuals are more likely to take and manage risk while giving the profitability of a product or project high priority.
• Analytical Type. Analytical people do well with complexity and prefer to have order and organization while also avoiding risk.
• Development Type. Development-oriented personalities tend to gravitate toward team projects and maintain high energy levels while cooperating with others.

IDEAS

Ideas in a business company are generated through research and development process, research and development brings knowledge and innovation. The personnel in a business company need to be technically competent in one or more fields and have the ability to conceptualize. They must be comfortable with abstract thinking and have a real interest in Business Company.

An invention is an idea, a concept, a sketch, or a model for a new or improved product, device, process, or system. Inventing is the creation of new knowledge or new ideas. The innovation process is the integration of existing technology and inventions to create a new or improved product, process, or system. Innovation in the economic sense is accomplished through the first utilization and commercialization of a new or improved product, process, or system. Various business companies look at the overall innovation process differently.

In a general sense, the innovation process includes

• Identifying the market need or technology opportunity,
• Adopting or adapting existing technology that satisfies this need or opportunity,
• Inventing (when needed), and
• Transferring this technology/opportunity by commercialization or other institutional means.

The innovation process integrates project need, invention and development, and technology transfer. Ideas and concepts are generated in each of these three major stages; the innovation process is accomplished when these three stages culminate in the utilization and commercialization of a new or improved product, process, or system.

A CULTURE FOR A BUSINESS COMPANY

The culture of an organization relates to both objective and subjective elements. For a business company , objective elements such as research department facilities and equipment and office buildings are different from those of other business company. Subjective elements such as rules, laws, standard operating procedures and unstated assumptions, values, and norms for an R&D organization are also different. For example, scientific discoveries, whatever their source, are subjected to impersonal judgments, and scientists often participate in organized skepticism and critically evaluate scientific ideas and discoveries.

This permeates all aspects of a business function. Management decisions affecting individuals are thus critically evaluated and questioned by the researchers. After attending a senior management conference, a newly assigned deputy administrator of a federal research organization stated that he had never worked in a business company where people were so vocal and where management decisions were reviewed and discussed as openly and fully.