Economic analysis is a process of studying the costs and benefits of desired outcomes or potential changes to existing circumstances. This type of analysis helps managers, individuals and governments make informed decisions. The principles of economic analysis are applied to lawmaking, business practices and societal issues such as welfare and poverty.
One of the central concepts of economic analysis is opportunity cost. This is the value of an alternative choice that you must forego in order to pursue a given choice. For example, if you decide to study for an economics exam instead of going to the movies, then you must forfeit the chance to watch the movie as a result of your decision to study. Opportunity cost is a very important part of the PPF (Producer’s Price Function) model, which represents an economy’s efficient production possibilities.
In conducting an economic analysis, you must keep in mind that your perspective could dramatically change the results. Your perspective may be that of a single individual or organization, or it may be that of a group such as a city or country. In addition, your analysis should be clear about the assumptions and parameters you have used in your study.
In performing economic analysis, you must also avoid the common pitfalls of correlation and false cause. For example, it’s easy to believe that because two events or actions are correlated, they must have the same causal relationship. This fallacy is known as the fallacy of composition. A related mistake is the false-cause fallacy, which occurs when an individual observes that one factor causes another. To avoid this mistake, you must always remember that “ceteris paribus” means all other things remain the same when analyzing the relationship between any two variables.