The gap between theory and practise and the role of managerial economics: We have noted above that application of theories to the process of business decision making contributes a great deal in arriving at appropriate business decisions. In this section we highlight the gap between the theoretical world and the real world and how managerial economics bridges the gap between the two worlds.
The gap between theory and practise: It is widely knows that there exists a gap between theory and practise in all walks of life, more so in the world in the economic thinking and behaviour. A theory which appears logically sound may not be directly applicable in practise. For example, when there are economic of scale, it seems theoretically sound that if inputs are doubled, output will be, more or losses doubled and of the inputs are trebled, output will be more. This theoretical conclusion may not hold well in practise. This gap between theories and practise has been very well illustrated in the form of a story by a classical economist, "there is a story of a man who thought of getting the economy of large scale production in pillowing, and build a plow three times as long, three times as wide and three as deep as an ordinary plow and harnesses six horse the usual number to pull it, instead of two. To his surprise, the plow the plow refused to budge, and to his greater surprise it finally took fifty horses to move the refractory machine .... and the fifty horses to move the refractory and the fifty could not pull together as well as two. The gist of the story is that managers assuming they have abundant resources may increase the size of their capital and labour, but may not obtain the expected results. The man in the story did not get the expected result most probably because he was either not aware of or he ignored or could not measure the resistance of the soil to a huge plow. This incident clearly shows the gap between theory and practise. In fact the real economic world is extremely complex. The reason is that in an economy, everything is linked to everything else. Economic decisions and economic activities of economic entities individuals, households, firms and the government are therefore, interlinked and independent. Change in one important economic variable generates a wave of changes, beginning with a change in the one economic variable causes change in a large number of related variables. As a result, the entire economic environment will be changes. Changing economic environment changes peoples economic goals, motivations and as prints which in turn change economic decisions, in fact economic system becomes a continuous process, the entire system becomes a hopeless chaotic. Under the condition of the changing environment and changing environment, it is extremely difficult to predict human behaviour. On the contrary economic theories are rather simplistic because they are propounded on the basis of economic models which are based on simplifying assumptions; economic models assume away the inter dependence of economic variables. In fact though economic models, economic create a simplified world with its respective boundaries from which they derive their own conclusions. It is another thing that some economic, rather economic models or more complex than the real world itself. Although economic models are said to be an extraction from the real world, how close is the extraction reality depends on how realistic are the assumptions of the model. The assumption of economic model are often claimed to be unrealistic. The most common assumption of the economic model is the certain paribus assumption. Other thing remains constant. For example, consider the law of the demand. It states that demand for a commodity changes in other thing remains constant. The goods, consumer tests and preferences advertisement consumer expectations about the commodity further price, demonstration effect, and snob effect etc. in reality however these factors do not remain constant. Since other thing do not remain constant, the ceteris paribus assumption is alleged to be the most unrealistic assumption. Economic theories are no doubt, hypothetical in nature but not only away from reality. Economic theory are, in fact a caricature of reality. In their abstract form, however, they do not straight away applied to real life situations. This should however not mean that economic models and theories do not serve any useful purpose. Micro economic theory facilitates the understanding of what would be a hopelessly complicated confusion of billions of facts by construction simplified models of behaviour which are sufficiently similar to the actual phenomenon to be of help in understanding them. Never it cannot be denied that there is apparently a gap between economic theory and practise. This gap arises mainly due to the inevitable gap between the abstract world of economics models and the real world. Managerial economic fills the gap there is undeniably a gap between economic theory and the real world economic. But at the same time it is also a mistaken view that economic theories can be directly applied to business decision making. As already mentioned, economic theories do not offer a cousom made or readymade solution to business problems, what economics theories actually do is to provide a framework arises because the real economic facts that influence economic decisions. In the world of Keynes, the objective of economic analysis is not to provide a machine, or method to bind manipulation which will furnish an infallible answer, but to provide ourselves with an organized and orderly method of thinking our particular problem. In the opinion of bounding, the objective of the economic analysis is to present the map of reality rather than a perfect picture of it. In fact the economic analysis presents us with a road map. It guides us to the destination; it does not carry us to the destination. Managerial economics can also be compared with medical science, just as the knowledge of medical science helps in diagnosing the disease and prescribing an appropriate medicine, managerial economics helps in the analysing the business problems and in arriving at an appropriate decision. Let us now see how managerial economics bridges this gap. It is far beyond the powers of a single business firm, how so ever large it may be, to determine and guide the course of economic, social and political factors of the nation, although all the firms together or at least giant business houses may jointly influence the economic and political environment of the country. For the business community in general, however, the economic, social and political factors are to be treated as business parameters. The environment factors have a far reaching bearing upon the functioning and the performance of firms. Therefore, business decisions makers have to talk into account the changing economic, political and social conditions in the country and give due to consideration to the environment factors in the process of decision making this is essential because business decisions take in isolation of environment factors may not only prove in functions, but may also lead to heavy losses. For instance, a decision of set up a new alcohol manufacturing unit or to expend the existing ones ignoring the impending prohibition a political on the side, there is the complex business world and on the other, are economic abstract theories. The big gap between the problems of logic that intrigue economic theorists and the problems of the policy that plague practical management needs to be bridged in order to give execute access to the practical contributions that economic theories can make to top managerial policies. Managerial decision makers deal with the complex, rather chaotic business conditions of the real world and they have to find their way of their destination, achieving the goal that they set for themselves. Managerial economics applies economic logic and analytical tools to shift wheat when from the chaff. The economic logic and tools of analysis guide them in (1) identifying their problems in achieving their goal, (2) collecting the relevant data and related facts, (3) processing and analyzing the facts, (4) drawing the relevant conclusions, (5) determining and evaluating the alternative means to achieve the goal, and (6) taking a decision. Without application of economic logic and tools of the analysis, business decisions are likely to be irrational and arbitrary which are often counter productive.