An economic analysis is a process followed by experts to understand how key economic factors affect the functioning of an organization, industry, region or any other particular population group, with the purpose of making wiser decisions for the future. It is a broader term that can mean simple and concise or sophisticated and complex identification, study and projection of economic variables.
Economic analysis allows to incorporate the elements from the economic environment such as inflation, interest rates, exchange rates and GDP growth into the corporate planning. Every organization is an open system that impact and is impacted by the external context. This means that a proper assessment of economic variables facilitates the identification of opportunities and threats that could affect the company’s performance.
Organizations tend to carry out corporate planning processes every one or two years and often define two or three possible economic scenarios for short and medium terms. Then they evaluate how each scenario would affect company decisions and achievement of goals. Economic analysis is also made when evaluating specific projects in order to consider economic and financial feasibility.
Economic analysis is very significant as it allows organizations and their donors to compare the impact of social intervention to the cost of implementing it. These comparisons aid in determining the most effective resource allocation.
Economic analysis is a type of assessment that helps answer the question “is it worth it?” in addition to the question “does it work?” that other impact evaluations address. Economic analysis has been more prominent in the impact measurement practices of charities and donors in recent years, as the sector has been under increasing pressure to give estimates of what value is created for every pound invested.
But, economic analysis isn’t necessarily the most persuasive piece of evidence for demonstrating a charity’s impact. Because it relies on solid outcomes data and a strong evidence basis, charities may not have the essential pieces in place to perform good economic analysis and may find it hard.
Economic analysis must be reliable; otherwise, it will be simple to identify flaws in calculations. If the economic analysis is done incorrectly, it might lead to erroneous charity resource allocation decisions.
- First, we have to define the problem and determine the objective of the problem. Then, we have to determine feasible options for achieving the goal, taking into account any limits.
- It is very important to recognize if the economic analysis is actually necessary for the problem, and if so, what is the level of effort required. Then, we have to select one or more methods of economic analysis.
- If the data to be used with the economic method are unclear, we have to choose a strategy that compensates for uncertainty and/or risk. We need to gather information and make the assumptions that the economic analysis methods and risk analysis approaches require.
- Calculate an economic performance indicator.
- Finally, we compare the economic repercussions of different options and make a decision, taking into account any non-quantifiable effects and the decision maker’s risk attitude.
For companies, the goal of an economic analysis is to provide a clear picture of the current economic climate. Specifically, what the impact of the economic climate is or might be on the company’s ability to operate commercially.
In this context, ‘economic climate‘means ‘economic conditions,’ i.e., the state of the overall economy.
The people conducting the analysis carry out an in-depth appraisal of the market’s strengths and weaknesses. They may choose from several different methods.
In this type of analysis, we weigh a project’s effectiveness against its price. In this case, however, a low cost does not necessarily mean superior effectiveness.
Using the same ‘warehouse and robots’ scenario, researchers have also determined that human workers are better at spotting defects.
The warehouse workers’ duties do not include checking the quality of the goods. However, they often identify faults and report them.
The company addresses the defects before shipping out the products.
This type of economic analysis tries to determine a project’s feasibility. Some people may refer to it as a feasibility study.
As the term suggests, cost-minimization analysis focuses on finding the cheapest cost to complete a project. This is one of the economic evaluation methods that business owners use when cost savings are at a premium and outweigh all other considerations. It is also used when there are two or more ways to accomplish the same task. Cost-minimization analysis is most often used in healthcare. For example, drug manufacturers may compare two drugs that have been shown to produce the same effect in patients, or a pharmaceutical company may implement cost-minimization analysis, to determine which of two medications that treat the same illness will cost the least amount of money to produce. In many instances, the generic equivalent of a name-brand drug is the least expensive drug to manufacture, especially if it produces the same therapeutic effect in patients.
There are two “pitfalls” that should be avoided when conducting economic analysis: the fallacy of composition and the false‐cause fallacy.
The fallacy of composition is the belief that if one individual or firm benefits from some action, all individuals or all firms will benefit from the same action. While this may in fact be the case, it is not necessarily so. For example, suppose an airline decides to lower the fares it charges on all of its routes. The airline expects to benefit from the fare reduction because it believes the lower fares will attract customers away from other airlines. If, however, the other airlines follow suit and lower their airfares by the same amount, then it is not necessarily true that all airlines will be better off; while more people may choose to fly, each airline will receive less money per passenger, and each airline’s market share is unlikely to change. Hence, the profits of all airlines could fall.
The false‐cause fallacy often arises in economic analysis of two correlated actions or events. When one observes that two actions or events seem to be correlated, it is often tempting to conclude that one event has caused the other. But by doing so, one may be committing the false‐cause fallacy, which is the simple fact that correlation does not imply causation. For example, suppose that new‐car prices have steadily increased over some period of time and that new‐car sales have also increased over this same period. One might then conclude that an increase in the price of new cars causes an increase in new‐car sales. This false conclusion is an example of the false‐cause fallacy; new‐car prices and new‐car sales may be positively correlated, but that correlation does not imply that there is any causation between the two. In order to explain why both events are taking place simultaneously, one may have to look at other factors for example, rising consumer incomes, inflation, or rising producer costs.