Applied Economics

By INVESTOPEDIA STAFF

Reviewed By ROBERT C. KELLY

Updated Nov 28, 2020

What Is Applied Economics?

Applied economics applies the conclusions drawn from economic theories and empirical studies to real-
world situations with the desired aim of informing economic decisions and predicting possible
outcomes. The purpose of applied economics is to improve the quality of practice in business, public
policy, and daily life by thinking rigorously about costs and benefits, incentives, and human behavior.
Applied economics can involve the use of case studies and econometrics, which is the application of
real-world data to statistical models and comparing the results against the theories being tested.

KEY TAKEAWAYS

Applied economics is the use of the insights gained from economic theory and research to make better
decisions and solve real-world problems.

Applied economics is a popular tool in business planning and for public policy analysis and evaluation.

Individuals can also benefit from applying economic thinking and insights to personal and financial
decisions.

Understanding Applied Economics

Applied economics is the application of economic theory to determine the likely outcomes associated
with various possible courses of action in the real world. By better understanding the likely
consequences of choices made by individuals, businesses, and policy makers, we can help them make
better choices. If economics is the science of studying how people use various, limited means available
to them to achieve given ends, then applied economics is the tool to help choose the best means to
reach those ends. As a result, applied economics can lead to "to do" lists for steps that can be taken to
increase the probability of positive outcomes in real-world events.

The use of applied economics may first involve exploring economic theories to develop questions about
a circumstance or situation and then draw upon data resources and other frames of reference to form a
plausible answer to that question. The idea is to establish a hypothetical outcome based on the specific
ongoing circumstances, drawn from the known implications of general economic laws and models.

Applied Economics Relevance in the Real World

Applied economics can illustrate the potential outcomes of financial choices made by individuals. For
example, if a consumer desires to own a luxury good but has limited financial resources, an assessment
of the cost and long-term impact such a purchase would have on assets can compare them to the
expected benefit of the good. This can help determine if such an expense is worthwhile. Beyond
finances, understanding the meaning of the economic theories of rational choice, game theory, or the
findings of behavioral economics and evolutionary economics can help a person make better decisions
and plan for success in their personal life and even relationships. For example, a person who wants to
quit smoking might recognize that they are prone to hyperbolic discounting and might choose to employ
precommitment strategies to support their long-term preference to quit over more powerful short-term
preferences to smoke. Or a group of friends sharing a large bowl of popcorn might explicitly or implicitly
agree to limits or shares on how much popcorn each will take in order to avoid a tragedy of the
commons situation.

Applied economics can also help businesses make better decisions. Understanding the implications of
economic laws of supply and demand combined with past sales data and marketing research regarding
their target market can help a business with pricing and production decisions. Awareness of economic
leading indicators and their relationship to a firm's industry and markets can help with operational
planning and business strategy. Understanding economic ideas such as principal-agent problems,
transaction costs, and the theory of the firm can help businesses design better compensation schemes,
contracts, and corporate strategies.

Applied economics is an invaluable tool for public policy makers. Many economists are employed to
predict both the macro- and microeconomic consequences of various policy proposals or to evaluate the
effects of ongoing policy. Applied macroeconomic modeling is routinely used to project changes in
unemployment, economic growth, and inflation at the national, regional, and state level. Understanding
the way the economic incentives and compensating behaviors created by public policy impact real-world
trends in things like job growth, migration, and crime rates is critical to implementing effective policy
and avoiding unintended consequences. For example, understanding what the application of the laws of
supply and demand imply about the effects of price floors, along with case studies and empirical
research, can inform better policy regarding minimum wage laws.
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