What is Applied Economics?
Applied Economics is the implementation of theoretical economics principles to help solve a particular cause, issue or situation. It is the use of economics as tools rather than just describing the theory and is an extension of the scope of economics from the text to the real world.
Applied Economics can be applied at two levels micro and macro. While the application at the micro-level tries to put the use of theoretical economics into solving issues at the individual level let’s say the production amount for a specific shoe factory, the macro level is used at a city/state/national level to work on the problems or help bring more efficiency into the current work practices.
Applied Economics is not restricted to a specific principle or theory. It is general in nature using the basic of economics as the seed, therefore it is difficult to ascribe any particular formula which can explain or portray this subject.
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Examples of Applied Economics
Example #1 – Opportunity Cost
- One of the ways that help a business take decisions on whether to invest or not invest in an asset is the concept of opportunity costConcept Of Opportunity CostThe difference between the chosen plan of action and the next best plan is known as the opportunity cost. It's essentially the cost of the next best alternative that has been forgiven.read more. It is the next best alternative where the money can be put to use. So, for example, if a business is to make a decision on buying a truck for the transport of its goods, it can do a cost-benefit analysisCost-benefit AnalysisCost-benefit analysis is the technique used by the companies to arrive at a critical decision after working out the potential returns of a particular action and considering its overall costs. Some of these models include Net Present Value, Benefit-Cost Ratio etc.read more of the utility of the truck in delivering trucks over the life of the asset.
- With the given analysis, it can compare this outflow of cash with the decision of not purchasing the asset but taking the trucks on hire and investing the saved money may be in the production of the goods. The comparison between the returns in both cases would help the management in deciding the future course of action. For future cash inflows and outflows, it should be remembered to apply the appropriate discounting factorDiscounting FactorDiscount Factor is a weighing factor most often used to find the present value of future cash flows, i.e., to calculate the Net Present Value (NPV). It is determined by, 1 / {1 * (1 + Discount Rate) Period Number}read more to bring to a comparable value for the present.
Example #2 – Marginal Utility
- The benefit that one derives from a product/service is called the utility and this keeps decreasing as the consumption is carried on. For example – the fourth glass of water that you have right after the first three will not quench your thirst or give you as much satisfaction as let’s say the first one. This becomes the basis of a lot of decisions. A customer knows that a 100gm toothpaste for $5 will last for a month and so he will not be eager to buy a 250gm toothpaste for $12.5 sacrificing additional resources given the larger product is linearly priced and holds no additional value for him.
- He would rather purchase the smaller pack again after a month. However, the firms know that is the case and so they price the bigger version at let’s say $11. This influences the purchasing decision of the customer and he might now be willing to buy the toothpaste since it delivers him utility in the form of an additional discount.
- Similarly, when a person is to receive additional payments of $50 for working on a weekend, it will depend on his base salary. If he is at a lower spectrum he would be willing to work extra, however, if he is already a substantial amount then this amount does not add to his marginal utilityMarginal UtilityA customer's marginal utility is the satisfaction or benefit derived from one additional unit of product consumed. It could be calculated by dividing the additional utility by the amount of additional units.read more. He would rather spend time with his family than worry about this extra amount.
Example #3 – Pricing Strategy
- Customers are usually prompted to buy things if they realize that there is a big discount or something is given for free. The marketers make use of this behavior and inflate the price of their products and then denote the actual price.
- So, for example, the price of a t-shirt might actual by $20 but they marketers will hype it up to say $30 and on maybe on Christmas or year-end sale offer a $10 discount to make it to $20. The customers will lap up to this and think that they are getting a good offer.
- Similarly, the inclusion of a free product with an existing buy, let’s say a Hershey chocolate along with a pack of Pringles potato chips will egg the customers to purchase the product although the price of the Hershey might already be included in the price of the Pringles pack for which the customer is paying. This behavioral aspect is utilized by the marketers to get a tab on the prices of their products.
Advantages
- Applied economics helps the business in taking business decisions whether it be in the decision to purchase an asset or the price that they should charge customers for their products/services.
- Applied economics solves some of the issues that mathematics or accountancy could never answer. It studies a lot of theoretical and behavioral aspects for which is there is no solid principle in place by the other subjects.
- At a macro level, for let’s say a government or the regulator of a market the affected population is a congregation of a lot of individual market sections which may have separate features but the general principles of economics are the only way by the help of which the decisions could be taken.
Disadvantages
- Applied Economics works on certain assumptions, like the customer being rational or law of diminishing marginal utility.Law Of Diminishing Marginal Utility.The law of diminishing marginal utility states that the amount of satisfaction provided by consuming every additional unit of goods decreases as we increase that goods consumption. Marginal utility is the change in the contentment derived from consuming an extra unit of goods.read more It might not apply to all individuals or all situations. Also, certain places or markets may be an exception to general economic principles.
- One can’t base all the decisions only on the applied economics principles. The decisions should be a product of the principles, the market situations, and the actions of the competitors, regulations, and resultant impact on society. One can’t just produce something even if it profitable if it affects the environment in a negative way.
Conclusion
Applied Economics is inadvertently part of many business decisions and strategies. It is difficult to imagine businesses growing if they do not account for the application of economics. Also, it is important to not be swayed by the general principles since situations and time periods might be exceptions to one.
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