Economic analysis tools help companies make informed decisions, including opportunity cost versus sunk cost, comparative advantage, and the production possibilities frontier. Making the wrong choice can lead to little or no profit, while comparative advantage ensures a firm engages in activities where it is most efficient. The production possibilities frontier helps companies determine how much of a given good or service it can handle under certain conditions.
Economic analysis tools help companies make informed decisions. These tools go beyond basic management and accounting information common in companies. Some tools used for economic analysis include opportunity cost versus sunk cost, comparative advantage, and the production possibilities frontier. While there are many other tools available for use, the ones listed above are often part of all types of economic analysis. The use of economic theory in decision-making often allows a company to make the best possible use of limited resources in a given market.
Opportunity costs and sunk costs are two of the most common economic costs that need to be reviewed in a company. An opportunity cost is the outcome of choice; in short, the definition is the cost conceded when choosing one method over another. For example, producing widgets instead of gears means that the company has lost the benefits of producing gears by choosing widgets. A sunk cost is no longer recoverable. The example here would be the purchase of large equipment to produce goods; once purchased, this money is no longer recoverable in economic terms.
Choice is often a determining factor in economic analysis tools involving opportunities and sunk costs. By having to choose between two or more items, the company will not be able to go back and make changes to these decisions. Making the wrong choice can lead to little or no bottom line profit. Spending money to pursue a certain business direction can be even worse as the company spends more and more capital on a potentially non-profit venture.
Comparative advantage is when a firm engages in activities where it is most efficient. The tools for economic analysis here indicate the proper use of natural resources, capital and labor skills. In short, a firm – or country – is generally incapable of producing all goods in the same efficient way. Economic analysis allows you to determine which production is more profitable and brings more advantages to the company. Uncompetitive companies do not tend to last long.
The production possibilities frontier allows a firm to determine how much of a given good or service it can handle under certain conditions. For example, tools for economic analysis can determine that a company can produce more goods than it is currently producing. The other side of that equation, however, is a market’s ability to handle that extra supply. The production possibilities frontier is a detailed analysis that helps companies review these opportunities and the resulting decisions.
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