Applied economics

Applied economics

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Applied economics is a term that refers to the application of economic theory and analysis. While not a field of economics, it is typically characterized by the application of economic theory and econometrics
Econometrics
Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...

 to address practical issues in a range of fields including labour economics
Labour economics
Labor economics seeks to understand the functioning and dynamics of the market for labor. Labor markets function through the interaction of workers and employers...

, industrial organization
Industrial organization
Industrial organization is the field of economics that builds on the theory of the firm in examining the structure of, and boundaries between, firms and markets....

, development economics
Development economics
Development Economics is a branch of economics which deals with economic aspects of the development process in low-income countries. Its focus is not only on methods of promoting economic growth and structural change but also on improving the potential for the mass of the population, for example,...

, health economics
Health economics
Health economics is a branch of economics concerned with issues related to efficiency, effectiveness, value and behavior in the production and consumption of health and health care...

, monetary economics, public economics, economic history
Economic history
Economic history is the study of economies or economic phenomena in the past. Analysis in economic history is undertaken using a combination of historical methods, statistical methods and by applying economic theory to historical situations and institutions...

, and business economics
Business economics
Business economics as a field in applied economics uses economic theory and quantitative methods to analyze business enterprises and the factors contributing to the diversity of organizational structures and the relationships of firms with labour, capital and product markets...

. The process often involves a reduction in the level of abstraction of this core theory. There are a variety of approaches including not only empirical estimation using econometrics
Econometrics
Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...

, input-output analysis
Input-output model
In economics, an input-output model is a quantitative economic technique that represents the interdependencies between different branches of national economy or between branches of different, even competing economies. Wassily Leontief developed this type of analysis and took the Nobel Memorial...

 or simulations but also case studies, historical analogy and so-called common sense or the "vernacular". This range of approaches is indicative of what Roger Backhouse
Roger Backhouse (economist)
Roger E. Backhouse is Professor of the History and Philosophy of Economics at the University of Birmingham. He is a noted scholar in the history of economics and economic methodology and has published in the economics of Keynes, disequilibrium macroeconomics, and the history of recent social...

 and Jeff Biddle argue is the ambiguous nature of the concept of applied economics. It is a concept with multiple meanings.

Origins of the term


The origin and meanings of Applied Economics has a long history going back to the writing of Say
Jean-Baptiste Say
Jean-Baptiste Say was a French economist and businessman. He had classically liberal views and argued in favor of competition, free trade, and lifting restraints on business...

 and Mill
John Stuart Mill
John Stuart Mill was a British philosopher, economist and civil servant. An influential contributor to social theory, political theory, and political economy, his conception of liberty justified the freedom of the individual in opposition to unlimited state control. He was a proponent of...

. Say wrote about "applying" the “general principles of political economy” to "ascertain the rule of action of any combination of circumstances presented to us." The full title of Mill’s (1848) work is Principles of Political Economy with Some of Their Applications to Social Philosophy.

J.N. Keynes discussion


J.N. Keynes
John Neville Keynes
John Neville Keynes was a British economist and father of John Maynard Keynes.-Biography:Born in Salisbury, he was the son of Dr John Keynes and his wife Anna Maynard Neville . He was educated at Amersham Hall School, University College London and Pembroke College, Cambridge, where he became a...

 was perhaps the first to use the phrase “applied economics”. He noted that the "English School" (J.S.Mill
John Stuart Mill
John Stuart Mill was a British philosopher, economist and civil servant. An influential contributor to social theory, political theory, and political economy, his conception of liberty justified the freedom of the individual in opposition to unlimited state control. He was a proponent of...

, J.E. Cairnes
John Elliott Cairnes
John Elliott Cairnes was an Irish economist. He is often described as the "last of the classical economists".-Biography:...

, and N.W. Senior
Nassau William Senior
Nassau William Senior , English economist, was born at Compton, Berkshire, the eldest son of the Rev. JR Senior, vicar of Durnford, Wiltshire.-Biography:...

) believed that political economy was a positive, abstract, deductive science; and that this school made a clear distinction “between political economy itself and its applications to practice" (1917, 12). This School thought that a general body of theory could be established through abstract reasoning – not relying on a wide knowledge of economic facts. From this point of view applying this theory involved making allowances for some of the factors ignored in building the abstract theories. Keynes wrote about applying the political economies hypothetical laws to interpreting and explaining of “concrete industrial facts." The issue of conceptual distinction between political economy as a science (involving formulating laws which govern the production and distribution of wealth) and political economy as an art (using the laws to tackle practical problems).

Whilst noting the rival view of the historical economists, who believed that the goals being pursued by policy makers and the means to pursue them were an integral part of the science of economics J.N Keynes believed in the desirability of the "English School's" distinction between the discovery of principles and their application (1917, 54).

Indeed it was he who proposed using the phrase “applied economics” instead of “the art of political economy”. Keynes further discussed the uses of the phrases applied political economy and applied economics noting three different uses:
  1. in the sense suggested in the text [in association with the art of political economy];
  2. to designate the application of economic theory to the interpretation and explanation of particular economic phenomena, without any necessary reference however, to the solution of practical questions;
  3. to mark off the more concrete and specialized portions of economic doctrine from those more abstract doctrines that are held to pervade all economic reasoning. (1917, 58–59)

Other 19th and early 20th century economists use of the term


Léon Walras
Léon Walras
Marie-Esprit-Léon Walras was a French mathematical economist associated with the creation of the general equilibrium theory.-Life and career:...

, for example, planned to organize his main work into volumes on "pure," "applied," and "social" economics. Jaffé (1983) describes Walras's plan as involving making a distinction between that which is true, is useful, and is just In using the term true, Walras referred to propositions that necessarily followed from the nature of things. Pure economics then involves pure logic. Applied economics involves examining ways to achieve practical goals and requires the making judgments about whether or not the logic of pure economics was relevant to the real world. Social economics also presumed pure economics, but dealt with a different range of questions than did applied economics.

Vilfredo Pareto
Vilfredo Pareto
Vilfredo Federico Damaso Pareto , born Wilfried Fritz Pareto, was an Italian engineer, sociologist, economist, political scientist and philosopher. He made several important contributions to economics, particularly in the study of income distribution and in the analysis of individuals' choices....

 ([1906] 1971, 104) follows as similar usage suggesting economics might begin by eliminating that which is inessential to examine problems as reduced to their principal and essentials. He distinguishes between "pure economics" from "applied economics" with pure economics containing only the principal lines of argument and applied economics involving supplying the details.

Joseph Schumpeter
Joseph Schumpeter
Joseph Alois Schumpeter was an Austrian-Hungarian-American economist and political scientist. He popularized the term "creative destruction" in economics.-Life:...

 (1954, 23) referred to some applied fields in economics the repetition of which might help highlight some of the issues invovlved in what defining applied economics involves. He discussed the following fields:
  1. those that are typically thought of as part of economics but which also looked at individually to allow greater attention to detail – e.g. money and banking, trade, cycles, and location
  2. those that are independent of economics but study of them is needed for economics. These include subjects such as accounting, actuarial science, and insurance
    Insurance
    In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...

  3. those that are areas of public policy: agriculture, labour, transportation, utility industries, control of industry, and public finance
  4. comparative economic systems
    Comparative economic systems
    Comparative economic systems is the subfield of economics dealing with the comparative study of different systems of economic organization, such as capitalism, socialism, feudalism and the mixed economy...

  5. demography
    Demography
    Demography is the statistical study of human population. It can be a very general science that can be applied to any kind of dynamic human population, that is, one that changes over time or space...

  6. area studies
    Area studies
    Area studies are interdisciplinary fields of research and scholarship pertaining to particular geographical, national/federal, or cultural regions. The term exists primarily as a general description for what are, in the practice of scholarship, many heterogeneous fields of research, encompassing...


Mainstream view


Modern mainstream economics holds the view that there is a body of abstract economic theory – the "core" – and applied economics involves the practitioner in the lowering some elements of the abstraction of this to examine particular issues. This lowering of the level of abstraction may involve:
  • relabeling variables as more specific concepts;
  • providing some structure to allow the drawing of more detailed conclusions;
  • producing numerical estimates for some of the parameters ;
  • using the analysis to interpret the real world phenomenon which are interpreted as examples of some more general class of events that the core theory might be used to examine.

Applied economics and economics as a science


Pesaran and Harcourt (2000) describe Stone
Richard Stone
Sir John Richard Nicholas Stone was an eminent British economist who in 1984 received the Nobel Memorial Prize in Economic Sciences for developing an accounting model that could be used to track economic activities on a national and, later, an international scale...

's attempt to face the challenge of making economics into a science by combining theory and measurement within a cohesive framework. They report Stone’s proposal for the establishment of the now famous Department of Applied Economics at Cambridge. Stone argued that:
"The ultimate aim of applied economics is to increase human welfare by the investigation and analysis of economic problems of the real world. It is the view of the Department that this can best be achieved by the synthesis of three types of study which now tend to be pursued in isolation. The Department will concentrate simultaneously on the work of observations, i.e. the discovery and preparation of data; the theoretical appraisal of problems, i.e. the framing of hypotheses in a form suitable for quantitative testing; and the development of statistical methods appropriate to the special problems of economic information. The special character of the Department’s approach to problems of the real world will lie in this attempt at systematic synthesis." (Stone in Pesaran and Harcourt (2000) pp. 149–150)

Other views


The basis for rival approaches tends to be the denial that sound theory can be made without some concrete linking with its area of application. Both the19th century Historical School
Historical school of economics
The Historical school of economics was an approach to academic economics and to public administration that emerged in 19th century in Germany, and held sway there until well into the 20th century....

 and the 20th Century Institutionalists
Institutional economics
Institutional economics focuses on understanding the role of the evolutionary process and the role of institutions in shaping economic behaviour. Its original focus lay in Thorstein Veblen's instinct-oriented dichotomy between technology on the one side and the "ceremonial" sphere of society on the...

 argue in this way. Mitchell
Wesley Clair Mitchell
Wesley Clair Mitchell was an American economist known for his empirical work on business cycles and for guiding the National Bureau of Economic Research in its first decades....

 (1936) noted that those working in "specialized fields" had little use for kind of qualitative theory postulated by Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

 and Jevons
William Stanley Jevons
William Stanley Jevons was a British economist and logician.Irving Fisher described his book The Theory of Political Economy as beginning the mathematical method in economics. It made the case that economics as a science concerned with quantities is necessarily mathematical...

. Mitchell suggested that knowledge of "real markets," would cause the complexion and content of economic theory (Mitchell 1937, 26–28). Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...

 shared this view that theoretical concepts might or rather should arise out of the analysis of real world data. For both Mitchell and Friedman economics should involve an interaction between examining data and formulating hypotheses.

Another issue which is related to the McCloskey critique
McCloskey critique
The McCloskey critique refers to a critique of post-1940s "official modernist" methodology in economics, inherited from logical positivism in philosophy. The critique maintains that the methodology neglects how economics can be done, is done, and should be done to advance the subject...

. This is economists do not necessarily practice what they preach. In this context that is the claim to be an "applied economist," is just shorthand for saying they are looking at the real economy. What is being applied need not be "economic theory", as conventionally defined rather something more basic. Eli Devons
Eli Devons
Ely Devons , an economist and statistician, was born in Bangor, Gwynedd North Wales, lived most of his life in Manchester and died after a long illness at St Thomas Hospital in London...

 made a distinction between three different kinds of "things", any of which might be being applied:
  • theoretical models;
  • commonsense axioms, and
  • theoretical concepts.

The Journal of Applied Economy


A home page editorial statement of the Journal of Applied Economy on its rationale includes the following: "Contemporary markets have become disconnected from fundamental economic theory and rational economic assessment; The Journal of Applied Economy seeks to bridge this gap. Consultation between academics and professionals is central to profitable financial management. Thus, the field of applied economy lies at the nexus of theory and implementation, the practical and the theoretical. By understanding the philosophical foundations of markets and decision making, applied economy can inform us about the role of market structures within larger analytical frameworks.... Each edition will focus on a key question of the discipline."

Applied Economics


Applied Economics is a journal that interprets its subject area as "the application of economic analysis to specific problems in both the public and private sectors" and seeks to publish "quantitative studies, the results of which are of use in the practical field" and thus may help "bring economic theory nearer to reality"; Applied Economics is a leading peer-reviewed journal in economics and its practical applications.

American Economic Journal: Applied Economics


This quarterly journal which began publication in 2009 is from the American Economic Association
American Economic Association
The American Economic Association, or AEA, is a learned society in the field of economics, headquartered in Nashville, Tennessee. It publishes one of the most prestigious academic journals in economics: the American Economic Review...

. It publishes papers on a range of topics in applied economics, particularly empirical microeconomic issues, such as in labor economics, development microeconomics, health, education
Education economics
Education economics or the economics of education is the study of economic issues relating to education, including the demand for education and the financing and provision of education...

, demography
Demographic economics
Demographic economics or population economics is the application of economics to demography, the study of human populations, including size, growth, density, distribution, and vital statistics.Analysis includes economic determinants and consequences of:...

, empirical corporate finance, empirical studies of trade, and empirical behavioral economics.

Critique


Backhouse and Biddle argues that the mainstream view, that there is an accepted "theoretical core" and that this can be applied in a range of areas, relies on this core having specific characteristics. That is that it has a wide scope and can be developed independently of individual applications. But they note that as with the definition of applied economics itself, there is within the economics profession, differing views as to what belongs in the core. Where one draws the line between research that is contributing to the core and research that is applying the core, and the relative importance or significance of research on topics in the core versus applied economics research.

Some examples of the problems of applied economics from various fields and issues:
  • Examples of problems of applied economics: Macroeconomics
    Macroeconomics
    Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...


One example of this is macroeconomics. In the 1960s and 1970s, macroeconomics was a part of the core of the subject. Why? Because macroeconomics was not only sufficiently important to part of any economist's training, but also embodied a set of concepts and principles not found in microeconomic theory. However the replacement of Keynesian approach to macroeconomics with new classical macroeconomics and its successors, macroeconomics might now be regarded by the main stream as merely an application of microeconomic theory.
  • Examples of problems of applied economics: Development Economics
    Development economics
    Development Economics is a branch of economics which deals with economic aspects of the development process in low-income countries. Its focus is not only on methods of promoting economic growth and structural change but also on improving the potential for the mass of the population, for example,...


Another example is the situation within Development Economics. Throughout the 1950s and 1960s most development economist regarded the application of standard "core" microeconomic theory to their area as being entirely inappropriate. An alternative set of models provided their core. This might be best described as the structuralist
Structuralist economics
Structuralist economics originated with the work of the Economic Commission for Latin America and is primarily associated with its director Raul Prebisch and Brazilian economist Celso Furtado. Key to structuralist analysis is the idea that the structural features of developing economies need to be...

 approach. More recently development economics texts have provided applications of mainstream core theory.
  • Examples of problems of applied economics: Economic Growth Theory
    Economic growth
    In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...


Comim uses the history of the economics of growth in order to illustrate the historical nature of the concept of applied economics. He first discusses the perspective of the theorists’ views of the applied dimension of their work and examines each from the perspective of the work carried out at the Department of Applied Economics (DAE) at Cambridge University. He emphasizes the divergences concerning economists’ understanding of the proper use of economic theory, divergences that might ultimately reveal the influence of distinct practices as fas as applied economics is concerned and the role of institutional environments.
  • Examples of problems of applied economics: the Minimum-wage controversy

Leonard notes one area of disagreement amongst applied economists which became famous in the US. That was the minimum-wage controversy. He notes that the fierceness of this controversy was odd because the likely effects were small and that several seemingly more important policy issues such as (entitlement reform, health insurance, CPI calculation) generated nothing like the storm. His explanation is that while this controversy was not especially important to the economy, it was very important to economics and economics as a policy science. His explanation for this is that minimum wage research came to be seen as a test of the usefulness of applying neoclassical price theory to the wages and employment. In other words it was not just a technical quarrel over such things as the sign and size of wage-elasticity but rather an installment in a long running methodological dispute over whether neoclassical price theory is in reality of any use.
  • A critique of the dominance of econometrics
    Econometrics
    Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...


Swann (2006) queries the dominance of such econometric techniques within Applied Economics and suggests what he describes as the "vernacular of the everyday practice of economics" should be taken seriously. Swann points out that econometrics's privileged position has not been supported by its disappointing results and rather suggests other applied techniques, the vernacular, should are also worthy of consideration. These approaches to applied economics, include simulation, engineering economics, case studies and common sense.