post-autistic economics review
Issue no. 20, 3 June 2003
article 5

 

 

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Towards a Post-Autistic Managerial Economics

 

Sashi Sivramkrishna   (Foundation to Aid Industrial Recovery, India)

© Copyright 2003 Sashi Sivramkrishna

 

 

A course in economics finds a place in almost every management education program.  This course, usually called Managerial Economics, is intended to help students to solve decision-making problems that they will encounter as managers.  Most students find the course quite fascinating and the economic models seem to provide them with tools to solve important problems they are likely to face as managers.  The MC = MR rule, in particular, tells a manager what she needs to know most, price of the product and quantity to be produced so that profits are maximized!


I had a student who came up to me at the end of the Managerial Economics course and asked me to be a consultant for a project to dispense a popular Indian food through vending machines.  He wanted my help in finding p* and Q*.  I had to tell him that a local restaurant manager would be of greater help to him than an economist.  Quite irritated, he asked me of what use then was a microeconomics course to managers.  This led me to think about why economics may have so little to offer managers and entrepreneurs in their actual decision-making problems.


The essential problem with the term Managerial Economics is its vague meaning: is it economics for managers or is it the economics of management?  If Managerial Economics means economics for managers then this course can be considered supportive in nature, providing awareness, insights and a general understanding of the market system – important ingredients for managerial decision-making – but not meant to provide tools to solve managerial decision-making problems per se.  In other words, the course is not intended to teach managers MC = MR type rules that they can “apply” in business.


“Conventional price theory was never intended to serve as a conceptual framework for the study of pricing of the individual firm … price theory has been primarily developed for use in the analysis of broad economic changes and the evaluation of social controls … therefore, it would be unfruitful (and erroneous) to use conventional price theory as a unified framework to guide the theoretical and empirical study of price determination within real-world firms” (Diamantopoulos & Mathews).


Such a managerial economics course, however, becomes essentially an economics course; there is nothing managerial about it.  In this case it is also not necessary to take just a neoclassical approach – economic history, political economy, institutional economics and even Marxist theory could all provide invaluable insights of the working of a capitalist economy to managers.  And what is being discussed in the Post-Autistic Economics Review is of utmost relevance to managerial economics courses.


I usually begin my Managerial Economics course with a reading of Heilbroner’s, “Worldly Philosophers”.   Students must understand that economists, not just the neoclassical ones, try to unravel the mystery of the market system, how it works, when and why it fails, where government intervention may be useful and what are the effects of intervention on societal welfare.  Managerial economics must be seen in this light – putting the market system in perspective – the efficiency of the market system in a perfectly competitive structure, the deadweight loss from tariffs and quotas, the inefficiency of monopolies, the need for regulation of natural monopolies, excess capacity in monopolistically competitive markets, price and output of firms in oligopolistic markets, market failure under information asymmetry or externalities like pollution and so on and so forth.


The problem I find with most Managerial Economics textbooks is that they are written as economics for managers, not in the way discussed above, but as economics providing tools for the manager.  In other words, we can go about using MC = MR kind of rules.   Consider, a popular text, “Managerial Economics: Economic Tools for Today’s Decision Makers” (italics my own) authored by Keat & Young.  This text propagates “managerial economics as the use of economic analysis to make business decisions involving the best use of an organization’s scarce resources”.  The many “applications” (usually in boxes) and numerical examples are intended to make the student feel and reinforce hope that their economics tools will one day be “used” by them.  However, when encountered with a problem like the one my student faced, they realize that such a Managerial Economics course is autistic.  Why?


When advocating economics as a bag of tools to managers, the economist must realize that managerial economics suffers from a case of asymmetric information – what the economist works with and what a manager actually has to work with.  The result:  economics fails to give any answers to, even articulate, problems of managers.  If managerial economics were to be used as a set of tools for managers, we need to begin with the economics of management, articulating problems confronting the manager from a manager’s perspective, taking into account the constraints they actually face, which must then be related to their decision-making problems.


What is this information that an economist assumes but a manager does not have?  Recall Part I of your Managerial Economics course: the actual demand curve.  If you browse through an economics or managerial economics text, you will notice that the demand curve derived from consumer choice models is taken as the actual demand curve with a known slope and location – giving information on what consumers are willing to buy at what price.  If the ceteris paribus assumption is relaxed, the economist also knows by how much the demand curve will shift.  The economist then freely uses this demand curve when she studies firm behavior; whatever might be the market structure.  She is able to know in no uncertain terms what quantity of output the firm must produce and at what price to realize its objectives.


The conventional Managerial Economics text “cheats” the student by introducing a chapter on demand curve estimation: a brief chapter, on how to estimate demand curves.  Even if you are told not to attempt this exercise yourself, given the dangers of estimating a wrong demand curve, the student feels that “it can be done nonetheless”.   Students can then go about the rest of the course feeling assured about the usefulness of the course.  Interestingly, this chapter on demand estimation is missing in many (pure) Economics texts.


As a manager or entrepreneur, are you in the economist’s privileged position?  Do you have the actual or estimated demand curve for your product on your table or computer screen?  Obviously not.  If only we think about all those cases that Jack Trout talks about in his book, “Big Brands Big Trouble”: the failure of New Coke, A.1. Poultry Sauce, Xerox computers, Firestone tires.  If these companies, with access to the best resources, could have estimated the demand curves for their products would they have ended in failures?


The manager does not know or can never know with certainty where the actual demand curve lies.  In fact, if she knows the actual demand curve for the firm’s product, there really isn’t much of a management problem.  With the actual demand curve, all one has to do is to apply the profit-maximizing rule (MR = MC) or any other rule meeting the firm’s objective and the firm’s balance sheet could be prepared, not just for the current year, but maybe even for the next year.  A manager may still have to motivate employees or obtain raw materials from the cheapest source, but those are not usually the problems with which a manager goes to the economist.


It is useful for the economist to delve into the world of managers and entrepreneurs.  Al Ries and Jack Trout  provide some useful tips for the economist trying to understand the economics of management:

q       You can’t predict the future.  So don’t plan on it.

q       The fatal flaw in many marketing plans is a strategy based on “predicting the future”.

q       Seldom are the predictions obvious.  Usually, they are so buried in assumptions that you need a degree in rhetoric to ferret them out.

q       Remember Peter’s Law:  “The unexpected always happens”.

There is something more that an economist needs to learn about management before theorizing about it and that is, management is not about “predicting” the future, but about “creating” the future (Ries & Trout).  It is not enough that top management "sees" the demand curve for their product; they also must create it.  In other words, they must not only know what people want but also make them want it - through advertising, building brands, tactics or whatever.  Management decision-making is not only about setting p* and Q* given the demand curve but also shifting the demand curve to meet the company’s objectives.  In his book on entrepreneurship, “In the Company of Heroes”, David Hall comments that “entrepreneurs do not find high profit opportunities, they create them”.


We must, however, be fair to the economist.  The idea that  the actual demand curve is unknown to a manager is not a novel one in economics.  Diamantopoulos & Mathews quote several economists on this point:

The most challenging problems occur in attempting to estimate the firm’s demand schedule, for typically the pricing executive only knows one point in its demand curve – the number of units being sold for the existing price (Alpert).

 

From the standpoint of decision-making, the relevant demand curve is the one on which management basis its pricing and production decisions.  This need not be the actual demand curve.  From the decision-making standpoint, it suffices that management behaves as if it were the demand curve (Horowitz).

 

The demand curve whose image spurts entrepreneurial action will be referred to indiscriminately as the subjective, or imagined, or anticipated demand curve.  It may even be called the ex ante demand curve (Weintraub).

 

McKenzie & Lee also point out the problem in knowing the actual demand curve:

 

Saying that the firm must choose the ‘right’ price is easier than actually choosing it … Managers can never be completely sure what the demand for their company’s product is”.


The average-cost pricing model in economics recognizes the impossibility of a determinate demand curve:

 

Tastes in the market change continuously and the reaction of the competitors is impossible to predict.  Thus firms cannot estimate their future demand.  Past experience does not help much in reducing uncertainty, because extrapolation of past conditions in the future is hap hazardous given the dynamic changes in the economic structure.  Given this uncertainty average-cost pricing theorists reject the demand schedule as a tool of analysis, thus abandoning half the apparatus of the traditional theory of the firm (Koutsoyiannis).

 

But outright rejection of the demand curve really “reduces” the manager to an accountant.  All she must do is to compute average cost and add required mark-up, leaving it to the market to determine sales.  Do managers then sit back and do nothing?  Don’t they engage with the market?  Try to influence demand for their products?  A Post-Autistic (Neoclassical) Managerial Economics course needs to consider these facts to become less autistic and more useful to managers.


Chamberlin also talks about an actual demand curve and an expected demand curve, the latter being more elastic than the former. This notion of an expected demand curve assumes a manager to be a naïve individual, always repeating the same mistake of not considering the actions of rivals.  Once again this approach may be acceptable if managerial economics is about telling managers what economists think of them.  But the real world is not this way.  Else most companies would have economists as their CEOs.


To conclude, teaching Managerial Economics needs to take a clear stance: is it economics for managers based on an economics of management?  If not, there is no need to restrict course contents to neoclassical theory and one should include a wider understanding of economies and economics.  If one were to look at Managerial Economics as the economics of management, then a neoclassical approach could be useful but is currently inadequate for direct application to business management.  We need a theory based on an unknown or uncertain demand curve.  The present approach of masquerading neoclassical economics with determinate demand curves as economics for managers is certainly autistic.

 


References

 

Edward H. Chamberlin, 1969, The Theory of Monopolistic Competition: A Re-orientation of the Theory of Value, Harvard University Press, Cambridge, Massachusetts.

 

Adamantios Diamantopoulos & Brian Mathews, Making Pricing Decisions: A Study of Managerial Practice, Chapman & Hall, London, 1995.

 

David Hall, In the Company of Heroes: An Insider’s Guide to Entrepreneurs at Work, Kogan Page Limited, London, 1999.

 

Robert L. Heilbroner, The Worldly Philosophers: The lives, times, and ideas of the great economic thinkers, Fifth Edition, Simon and Schuster, N.Y. 1980.

 

Paul G. Keat & Philip K.Y. Young, Managerial Economics: Economic Tools for Today’s Decision Maker, Third Edition, 2000.

 

A. Koutsoyiannis, Modern Microeconomics, ELBS, Second Edition, 1994.

 

Richard McKenzie & Dwight Lee, Microeconomics for MBAs, http://www.gsm.uci.edu/~mckenzie/onlinebooks.htm

 

Al Ries & Jack Trout, Bottom-up Marketing, McGraw-Hill Company, 1998.

 

Jack Trout, Big Brands Big Trouble:  Lessons Learnt the Hard Way, East West Books (Madras) Pvt.Ltd., Chennai

 

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SUGGESTED CITATION:
Sashi Sivramkrishna, “Towards a Post-Autistic Managerial Economics”, post-autistic economics review, issue no. 20,  3 June 2003, article 5, http://paecon.net/PAEReview/issue20/Sivramkrishna20.htm