Economic analysis offers a systematic approach to evaluating costs, benefits and impacts of economic decisions. It can be helpful for CFOs looking to make the best use of their business resources, and it also helps them understand how a company fits with its local economy.
It’s important to consider the time horizon of any economic study as it relates to the decision context it is examining. The horizon must be sufficiently long to capture the full range of consequences from a decision or action but not so long that it becomes unrealistic to construct the model used for the study. Often, the choice of the appropriate horizon is obvious from the specifics of the problem at hand.
For example, if an analyst is analyzing the effects of a bioterrorist attack in the United States, it would be impractical to include the cost of hospitalization for patients suffering from diarrhea due to the agent (which may have long-term health consequences). Instead, the analysis should focus on the immediate and relatively short-term costs and benefits associated with the incident.
When conducting economic analysis, it is common to discount future costs and rewards. This practice recognizes that inflation and opportunity costs (the value of the next best alternative you must forego to take a particular action) make a dollar in the future worth less than a dollar today.
There are a variety of different methods for economic analysis but two are seen as primary: deductive method and inductive method. Deductive method starts with a general principle or theory and tests it with specific observations. Inductive method starts with specific observations and uses them to form a general theory. The two methods are seen as complementary and work best when used together.