|
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
______________________________
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
|