ECONOMY ECONOMICS

Applied Economics
By JIM CHAPPELOW | Updated Jul 14, 2019

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
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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
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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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Related Terms
Paradox of Rationality Definition
The paradox of rationality is the empirical observation that players who make irrational choices often
receive better payoffs than those making rational choices. more

Mathematical Economics
Mathematical economics is a form of economics that relies on quantitative methods to describe
economic phenomena. more

Neuroeconomics
Neuroeconomics tries to link economics, psychology, and neuroscience to better understand economic
decision making. more

Shapley Value
In game theory, the Shapley value is a manner of fairly distributing both gains and costs to several actors
working in coalition. more

Experimental Economics Definition

Experimental economics studies human behavior in a controlled laboratory setting, to test economic
theories by seeing how people respond to incentives. more

Who Is Daniel Kahneman?

Daniel Kahneman is a psychologist well-known for his contributions to behavioural economics. He was
awarded the Nobel Memorial Prize in Economic Sciences in 2002. more

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