Applied Economics

Applied economics is the substantial science of social organization. It advises policy and decision-making across all areas of society, public and private.

According to a well-known saying, Politics is the "art of the possible." However, when it is being expressed differently, politics is the art of governance; it is about how we structure and categorize our social life. 

What is Applied Economics?

Applied Economics studies economic theories when applied to specific real-world scenarios or situations. There are two separate areas of distinction in the field of study and economics research. The first area is "core," and the second area is "applied."

It can be applied at two levels:

1. Micro-Level.
2. Macro-Level.

Every possible application at the micro-level aims to use theoretical economics to solve problems at the independent level. The macro-level is utilized at a wide level (city/state/national) to work on various issues and bring more competency into the current work practices.

This particular branch of economics is not confined to a fixed principle or theory. Instead, the basics of the economy are used as a setting stone. Therefore it is difficult to set down any formula to explain this subject.

This advanced branch of economics is at the epicenter of everything we do and is key to analyzing and conveying market principles.

Business leaders and managers learn from the lessons to avoid potential damage and make strong decisions. For example, even daily consumers can better understand the prices they are paying at a grocery store by explaining why certain prices rise and fall.

The purpose is to improve the quality of practice in business, policies of public, and daily regular life by thinking about costs, economic benefits, incentives, and human basics.

Understanding Applied Economics

It is the application of economic theory to determine the favorable and likely outcomes associated with various possible courses of action in a real-world situation or scenario. 

In the study of economics, there are two fundamental areas of distinction - core and applied. It uses the insights gained from economic theory and research to make better decisions and solve real-world situations or scenarios.

It is a popular tool in business planning, public policy analysis, and evaluation. The theories allow us to test and formulate hypotheses. For example, it can help us understand the prices we pay, how delivery works, and why things may go on sale.

The mainstream view generally consists of the following:

1. First, label the variables as core-specific.
2. Deliver numerical impressions.
3. Clarifying real-life situations or scenarios.
4. Finally, conclusions are drawn depending on the structure.

Using this branch of economics first involves exploring economic theories and laws to develop queries about a real-life circumstance, situation, or scenario and then concurring some data resources and other reference forms to form a plausible answer to the question.  

For example, suppose a consumer aspires to possess a high-end luxury item but has a short supply of financial resources. In that case, a thorough check of the cost and the long-term impact of this particular purchase on the assets can be compared to the expected outcome of the item.

The idea is to establish a hypothetical outcome based on the specific real-world circumstances, situations, or scenarios drawn from the known implications of general economic laws and theories.

Key Economic Concepts

At the most basic level, economics attempts to explain how and why consumers make their economic choices. 

Four key economic concepts can explain many decisions that people make.

The four key economic concepts are listed below:

1. Scarcity 

It explains the basic economic problem: the world has limited or scarce resources to meet seemingly endless demands. 

This reality forces people to take steps regarding how to allocate resources in the most efficient way possible so that most of their highest priorities are met. For example, there is little wheat grown every year. Therefore, some people want bread, whereas some would prefer beer. 

How do we decide how much flour should be made for bread and beer? The first and most important way to fix this problem is a market system, which is generally operated by supply and demand.

2. Supply and Demand 

A market system is operated by supply and demand. 

Let's take the example of beer: if most people want to buy beer, the demand for beer is considered to be at its peak. 

As a result, the cost of beer increases, and more money is made on average by using wheat than by using wheat to make flour.

Theoretically, this could lead to a situation where more people start making beer. After a few production cycles, there would be an abundant amount of supply of beer in the market, leading to a decrease in the price of beer.

Even though this is a simple example, the concept of supply and demand helps us to explain why the market system is driven by supply and demand.

3. Costs and Benefits 

The concept of costs and benefits is associated with the theory of rational choice (and rational expectations) based on economics.

If demand for beer is high, then the breweries will hire more employees for beer production, but it can only be done when the price of beer and the amount sold justifies the extra added costs of their wages and the materials needed to brew more beer.

Cost and benefits also apply to other decisions unrelated to financial and economic transactions.

4. Incentives 

Economic incentives explain how the operation of supply and demand encourages the producers to supply the goods that consumers want or are in demand. It teaches consumers to conserve limited or scarce resources.

When demand for goods increases from the customer's end, the market price of that particular good rises, giving producers an incentive to produce more of the good in demand to receive a higher price.

When incentives are correctly in line with organizational goals, then the benefits can be tremendous. These practices include profit sharing, performance bonuses, and employee stock ownership.

Advantages and Disadvantages

It is unintentionally part of many business decisions and strategies. This is because it focuses on executing strategies more than basic economic theory and principles.

However, there are various advantages and disadvantages to this topic. 

1. Advantages

• It helps the business to make valuable decisions, whether it is the purchase of valuable property or the price they should charge customers for their products/services to make a profit.
• It solves some of the problems that neither mathematics nor accountancy could ever answer. Moreover, it studies many theoretical and behavioral aspects of practical situations for which no solid and fixed principle exists.
• At a macro level, it is utilized at a wide level (city/state/national) to work on various issues and bring more competency into the current work practices. 

2. Disadvantages

• Despite having advantages, it works on certain speculations, such as the law of diminishing marginal utility. 
  It might not appeal to all individuals or all situations and scenarios. Also, certain places or markets may be an exception to general principles or laws of basic economics.
• All decisions regarding profits can not be based solely on principles of applied economics. 
  All the decisions are bound to be a product of the principles, market situations, competitors' actions, regulations, and the resultant impact on society. 

The purpose of applied economics is to improve the quality of practice in business, policies of public, and daily regular life by thinking about costs, economic benefits, incentives, and human basics.

Even if there are various disadvantages to this particular branch of economics, it still is more relevant in real-life situations and scenarios. 

Consumers, economists, and scholars use applied economic theories and principles to test existing laws or even develop new and evolving ones.

Examples

As we have read above, it has advantages and disadvantages, which can be useful and cause problems. 

Therefore, we will learn about useful examples and discover how they can cause problems.

1. Useful Examples 

• Opportunity Cost: 
  The concept of opportunity cost helps a business decide whether to invest in an asset or not. Thus, when a company buys a truck to transport goods, it can do a Cost-Benefit Analysis.
• Healthcare Economics: 
  Even before COVID-19 came into existence, healthcare was an industry of rapid transition and severe stress. 
  The important roles of applied economics in healthcare are analysis by prediction, allocation of resources, and determination of policy initiatives supporting public and private healthcare systems.
• Law and Economics:
  Ethics, markets, and human actions are codified by law. The effectiveness of a rule may be predicted by applied economics.
• Marketing and Economics:
  Applied Economics offers analytical tools for marketing and economics. Effective marketing relies on well-informed and proof-based decision-making.

2. Examples of problems

• Macroeconomics:
  During the 1960s and 1970s, it was a part of the core subject, as it incorporated the set of concepts and theories not found in microeconomic theory. 
  However, now macroeconomics is regarded as an applied theory of microeconomics after the Keynesian approach to macroeconomics was replaced by a new view of macroeconomics and its successors.
• Development Economics:
  Throughout the 1950s and 1960s, various development economists termed the use of "core" microeconomic theory in this area to be improper. Instead, the structuralist approach provided its core. 
• Economic Growth Theory:
  The history of economic growth theory is used to describe the concept of applied economics. In addition, it illustrates the difference in the understanding of economic theory.
• Minimum-Wage Controversy:
  It is an area of disagreement among applied economists, which became famous in the US. The minimum-wage research is seen as a test of applying neoclassical price theory to wages.

Relevance in the Real World

It helps in understanding the probable results of financial decisions made by individuals. 

For example, suppose a consumer aspires to possess a high-end luxury item but has a short supply of financial resources. In that case, a thorough check of the cost and the long-term impact of this particular purchase on the assets can be compared to the expected outcome of the item.

This can help in deciding if such an expense is justified.

Apart from the finances, a better understanding of:

• game theory, 
• theories of rational choice, 
• evolutionary economics, and
• the findings of behavioral economics 

can help an individual make better choices and plans for success in both personal and professional relationships.

This applied branch of economics can also help businesses in making better choices. 

They understand the innuendos of economic laws of supply and demand, which, when incorporated with early sales data and marketing research concerning their target market, can help a business with cost and production choices. 

Awareness of the economy's leading indicators and their relation with a particular firm's sector and market can help with planning, strategy, and business operations. 

A basic understanding and knowledge of economic ideas such as the theory of the firm, principal-agent problems, and transaction costs can help businesses design better corporate strategies, contracts, and schemes.

For example, understanding the innuendos of economic laws of supply and demand surrounding the effects of price floors, various case studies, and substantial research can deduce better policy regarding minimum wage laws.

Understanding the way of economic incentives and behaviors are compensated by public policy creates an impactful change for real-life trends like job employment and migration, which are crucial in implementing policy and avoiding unintentional consequences.

Researched & Authored by Ananya Dutta | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Nash Equilibrium
• Economies of Scale
• Macroeconomics
• Opportunity Cost
• Gross Domestic Product (GDP)