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Economic Analysis

Updated on April 11, 2024
Article byPrakhar Gajendrakar
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Economic Analysis?

Economic analysis refers to evaluating costs and benefits to check the viability of a project, investment opportunity, event, or any other matter. In other words, it involves identifying, evaluating, and comparing costs and benefits. In addition, there are many other significant concepts involved.

Economic Analysis

The analysis process contributes to the optimal allocation and use of resources, forming an important element in the decision-making process. For example, the microeconomic analysis makes an effort to describe how people and organizations function in a certain economy, macroeconomic analysis focus on GDP, unemployment, and inflation, and techno economic analysis (TEA) involves the study of the economic performance of an industrial process.

Key Takeaways

  • The economic analysis defines assessing the cost-benefit scenario of a project, event, or action. It helps organizations understand the opportunity cost.
  • There are different economic analysis tools that economists and business owners employ to find the appropriateness of the plan or selection. 
  • Businesses pursue any project or financial activity only after applying economic analysis to restrict potential hazards. Economic variables, slopes, optimization, and linear programming are some tools or concepts involved.
  • It also contributes to explaining the economic growth of a country and how a business operates and establishes inside it.

Economic Analysis Explained

The economic analysis evaluates projects, scenarios, tasks, topics, or actions to understand their profitability or negative consequences. It exhibits a relationship with the study of determining the opportunity cost of any project or task. In business, management uses it in diverse scenarios. For example, companies apply it during new product identification or an expansion or integration process. The analysis process traverses through the pros and cons and understands the matter.

Richard Milhous Nixon, the 37th president of America, founded the U.S. Bureau of Economic Analysis (BEA) in 1972, which, from then on, helped American investors understand the economy of the nation based on relevant data and statistics, The timely and accurate information allow the government, businesses, researchers, and the American public to follow and understand the performance of the nation’s economy.

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Tools

The tools used for the analysis purpose exhibit elements and techniques of statistics and essential mathematics for economic analysis. Furthermore, the process involves various tools and is based on many assumptions.

Let’s look into important tools involved in the analysis:

  • Economic variables: It is the most common tool where variables derive the outcome of the process, and there are generally four types of variables used – dependent, independent, endogenous, and exogenous variables. The value of these variables gives important information. Examples include GDP, inflation, economic growth, interest rates, etc.
  • Slopes: Slopes and graphs are other analysis tools as they portray the change in dependent variables when there is a change introduced in the independent variables. The slope depicts the change and is drafted based on the shared effect of both dependent and independent variables.
  • Optimization: It is used to make managerial decisions and helps define production levels, output costs, and ways to maximize profits. It is done by studying the change in the dependent variable and considering the records and trends that can be used again to predict future market turns.
  • Linear programming: The application of linear programming can provide numerical solutions to various business problems. Linear programming or optimization problems application will help find the best solution from all feasible solutions.

Examples

Let’s look into examples for a better understanding of the concept involving cost and benefit comparison:

Example #1

Paul has a small factory producing specific bottled products; currently, he has twenty workers, and the daily output is 3000 bottled products for delivery. Paul plans to employ heavy equipment and machinery and automate the whole process. However, if he does, it will cost him a fixed amount due to machinery purchase and automation system installation costs.

However, the new step increases the production output and reduces the variable labor costs. Evaluating the cost and benefit associated with automated and manual processes implies that the automated process is better. It is a simple economic analysis example through which Paul will assess and go forward with their decision to install new equipment in his factory.

Example #2

Rudy runs a construction company; he has plans to make a business complex on the land he bought years ago. But before initiating the project, he applied economic analysis to understand the vicinity and the cost-benefit scenario related to the project.

The analysis helps Rudy finds out that the land is near a lake. So the land composition is not solid, and the soil around is mostly wet; this is not only a problematic situation for construction, but it may bring many issues post-construction, and there can be a potential threat to the building.

Also, it may harm the lives and assets of people buying shops. At the same time, people around the land may protest against the construction, and they will have to face many legal issues. So, in the long run,  it can be a bad investment. Hence, Rudy finally decides to let go of the project and looks for different alternatives.

Frequently Asked Questions (FAQs)

What do you understand by positive economic analysis?

It refers to studying or understanding a problem by primarily focusing on positive statements. With the help of an analysis of the actual situation, the statements can be accepted or disapproved.

What do you mean by normative economic analysis?

It is the study of desired results or anticipated outcomes. In this type of analysis, the economists study whether and how a particular system or mechanism will work correctly, what will be the preferred scenario, and how the economic challenges can be solved specifically from a moral and ethical perspective.

How to do an economic analysis?

The process starts with –
 
–         Identifying the problem
–         Defining objectives or goals and also figuring out the consequences of the objectives
–         Study or find alternatives to solve the problems by considering the objectives
–         Ascertain the critical need for economic analysis
–         Choose the method of economic analysis
–         Consider and manage uncertainties and errors
–         Compute and compare economic performance and consequences

This article is a guide to What is Economic Analysis. We explain its tools, techno, micro, and macro-economic analysis, and examples. You can also go through our recommended articles on corporate finance –

Reader Interactions

Comments

  1. Teshome Kefena says

    Thank you!

  2. Jean Bosco says

    It is very helpful. THANKS

  3. Precious Adesewa says

    Thank you so much for the article, i was able to comprehend better and applied it to my project work as a fishery economists.

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