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Tools for economic analysis help companies make informed decisions. These tools go beyond the basic managerial and accounting information that is common in companies. A few tools used for economic analysis include opportunity cost versus sunk cost, comparative advantage, and the production possibilities frontier. Though many other tools exist and are available to use, those listed above are often a part of all types of economic analysis. The use of economic theory when making decisions usually allows a company to make the best use of limited resources in a given market.
Opportunity costs and sunk costs are two of the most common economic costs that need review in a company. An opportunity cost is the result of choice; in short, the definition is the cost given up when choosing one method over another. For example, producing widgets instead of cogs means the company has forgone the benefits from producing cogs by choosing widgets. A sunk cost is no longer recoverable. The example here would be the purchase of major equipment to produce goods; once purchased, that money is no longer recoverable in economic terms.
Choice is often a driving factor in the tools for economic analysis that involve opportunity and sunk costs. By having to make a choice between two or more items, the company will be unable to go back and make changes to these decisions. Making the wrong choice may lead to little or no profits from the end result. Spending money to go in a certain business direction can even be worse as the company spends more and more capital on a potentially profitless venture.
Comparative advantage is when a company engages in activities where it is most efficient. Tools for economic analysis here indicate the proper use of natural resources, capital, and labor skills. In short, one company — or country for that matter — is usually unable to produce all goods in the same efficient manner. Economic analysis allows for a determination of which production is most profitable and brings the most advantage to the company. Poorly competitive companies do not tend to last long.
The production possibilities frontier allows a company to determine how much of a certain good or service it may handle under certain conditions. For example, tools for economic analysis may determine that a company can produce more goods than it is currently producing. The other side of this equation, however, is the ability for a market to handle this extra supply. The production possibilities frontier is a detailed analysis that helps companies review these opportunities and the resulting decisions.
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