ECONOMIC ANALYSIS AND TYPICAL MANAGERIAL DECISIONS
Despite the differences between microeconomic analysis and macroeconomic analysis, there is considerable overlapping and interdependence. This is true, especially in the case of decision making process - in an individual, corporate unit or the economy in aggregate.
Decisions within a corporate unit are taken at various levels from the junior executive up to the chief executive. Decisions at the lowest levels pertain to the day to day operations of the unit - production schedules, overtime, ordering supplies, etc. and tend to be routinized. Decisions at the middle management level pertain to the current and near-future operations of the firm. These might include prices, discounts to be offered, choice of suppliers, lower level recruitment etc. The decisions at the highest levels concern the long-term plans of the company. These include diversification, expansion, new products, major advertising campaigns, research and development policy, competitive posture, etc.
A convenient distinction used in the management literature is that between strategic or policy decisions and tactical or operational decisions. The former pertain to the long-term needs of the firm during which the product-market mix may be significantly altered and competitive posture may be radically changed. Such decisions are made at the highest level and constitute the core of the corporate plan. Tactical decisions arise during the course of execution of the plan and are made within the framework of the existing product-market mix, competitive policy, etc.
As we have seen, economic concepts and techniques employed in analyzing tactical decisions broadly belong to 'microeconomics analysis'. This is the part of economics that deals with individual decision making - individual consumers, firms, etc. - in a given environment of tastes, technology and overall economic structure. Strategic decisions require a more aggregative analysis, at the level of an entire industry, a broadly defined sector of the economy, the entire economy and even the world economy. The part of economics which adopts such a broad view is called 'macroeconomics analysis'. It deals with the behavior of economic aggregates, their prediction and control by means of macroeconomic policies.
In our view every practising manager needs a good understanding of both microeconomics and macroeconomics. While firm-level decisions are the manager's immediate concern, these are made within an industry and economy and developments in the latter significantly affect individual firms. In the following section we will explain this view by means of several examples of typical corporate decisions.
i. Demand Forecasting
Short-term sales forecasts are routinely required for budgeting and medium to long-term demand forecasts for existing products of the firm are an important ingredient in planning for capacity expansions. Demand forecasts for new markets and/or new products are the starting point of a systematic appraisal of a diversification proposal.
Knowledge of demand theory and economic demand forecasting techniques are a prerequisite for obtaining reliable demand forecasts. While demand forecasts can be obtained by other methods such as customer surveys, end- use methods, etc. economic demand forecasting techniques are cheaper and in many cases more powerful than these alternative methods.
ii. Pricing and other Marketing Decisions
A large part of microeconomics is concerned with price formation in different markets. Optimum pricing rules with different market structures provide important insights into and reference points for pricing in practice. Other than prices, marketing decision variables like advertising can also be analyzed with the techniques of economics. Competitive analysis involves estimating the effect of a firm's marketing actions on its sales, market share, etc. after taking into account the likely response of the competitors. Here again economic analysis of industry structure provides a frame of reference.
iii. Cost Analysis
Estimation of costs at various levels of output is normally the province of cost accountants. However an economic analysis of costs provides additional insights which render the cost accounting information more meaningful from a decision maker's point of view. Also, occasionally, the production process is so complex - e.g. refinery operations - that an engineering-cum-economic model building exercise is required for accurate estimation of costs.
Financial appraisal of capital expenditure projects is an important function of every organization. Economists can contribute significantly to it by way of providing market forecasts, interest rate forecasts, forecasts of inflation, etc. Risk analysis is another area where economic insights into decision making under uncertainty are very useful. It might be said in passing that some of the important developments in recent times in the theory of finance, e.g. portfolio analysis, originated in economics.
v.Specific Industry Analysis
Structural analysis and forecasting of specific industries is often required in corporate planning. The top management might be interested in the analysis of the trends in output, prices, competition, etc. in a particular industry. The oil crisis has made the industry increasingly aware that supply bottlenecks in crucial raw material can create serious disruptions. And supply forecasting has become more important in this context. Economics provides powerful tools for these purposes.
vi.Government, Regulation and Policy Impact Analysis
Governments in most countries impose some controls on business behavior in the interest of better resource allocation, promoting competition, protection of environment, etc. Economic effects of these regulations are deep and wide ranging. Economists have to collaborate with the legal profession in analyzing the firm and industry level implications of these regulations.
In addition, the government's fiscal, monetary and trade policies affect a number of key variables such as the inflation rate, tax rates, exchange rates, credit availability, disposable income, etc. changes which in turn have substantial impact on a firm's costs, revenues and profitability. Understanding the implications of these changes and predicting the future path of economic policy is one of the most important functions of an economist in a corporate setting.
The corporate plan is an expression of the top management's hopes and desires regarding where the company should be in the coming 5-10 years. It defines the company's goals, specifies the business portfolio which the company should have and lays out the plans for the various functional areas.
Preparation of a corporate plan requires detailed analyses of emerging trends in technology, consumer tastes, government policy, raw material supplies, etc. Growth areas must be identified and assessed in the light of the strengths and weaknesses of the firm. Competitive structure in several industries must be analyzed to determine the best strategy for effective entry, consolidation or expansion. Long-term trends in GNP, disposable incomes, industrial production, capital and money markets, etc. must be assessed to identify the constraints. All of these require a substantial input from macroeconomics, international economics and industrial economics.