# Applied Economics: Definition, How It Works, and How It's Used

![Applied Economics: Using insights gained from economic theory and research to make better decisions and solve real-world problems.](https://www.investopedia.com/thmb/6ChEsrQEHH7BLPXP6LFb45nfhwM=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Applied-economics_final-8a154467690a48f48eb379678f1cb91a.png)

*— Investopedia / Michela Buttignol*

## What Is Applied Economics?

The aim of applied economics is to inform economic decisions and predict possible outcomes. Applied economics relates the conclusions drawn from economic theories and empirical studies to real-world situations.

The purpose of applied [economics](https://www.investopedia.com/terms/e/economics.asp) is to improve the quality of practice in business, public policy, and daily life by thinking rigorously about costs versus benefits, incentives, and human behavior. It can involve the use of case studies and [econometrics](https://www.investopedia.com/terms/e/econometrics.asp), 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 policymakers, 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 inform a "to-do" list identifying 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 drawing 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 Financial Choices

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](https://www.investopedia.com/terms/c/cost-benefitanalysis.asp). Beyond finances, understanding the meaning of the economic [theories of rational choice](https://www.investopedia.com/terms/r/rational-choice-theory.asp), [game theory](https://www.investopedia.com/terms/g/gametheory.asp), or the findings of [behavioral economics](https://www.investopedia.com/terms/b/behavioraleconomics.asp) and [evolutionary economics](https://www.investopedia.com/terms/e/evolutionary-economics.asp) can help a person make better decisions and plan for success in their personal life and 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](https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3465853/) 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, for how much popcorn each will take in order to avoid a [tragedy of the commons](https://www.investopedia.com/terms/t/tragedy-of-the-commons.asp) situation.

## Making Better Business Decisions

Applied economics can also help businesses make better decisions. Understanding the implications of economic [laws of supply and demand](https://www.investopedia.com/terms/l/law-of-supply-demand.asp) 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](https://www.investopedia.com/terms/l/leadingindicator.asp) 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](https://www.investopedia.com/terms/p/principal-agent-problem.asp), [transaction costs](https://www.investopedia.com/terms/t/transactioncosts.asp), and the [theory of the firm](https://www.investopedia.com/terms/t/theory-firm.asp) can help businesses design better compensation schemes, contracts, and corporate strategies. 

## Bottom Line

Applied economics is an invaluable tool for public policymakers. Many economists are employed to predict both the [macro-](https://www.investopedia.com/terms/m/macroeconomics.asp) and [microeconomic](https://www.investopedia.com/terms/m/microeconomics.asp) consequences of various policy proposals or to evaluate the effects of ongoing policy. Applied [macroeconomic modeling](https://www.investopedia.com/terms/b/bioeconomics.asp) is routinely used to project changes in unemployment, economic growth, and inflation at the national, regional, and state levels.

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](https://www.econlib.org/library/Enc/UnintendedConsequences.html). For example, understanding what the application of the laws of supply and demand implies about the effects of price floors, along with case studies and empirical research, can inform better policy regarding minimum wage laws.