An Economic Analysis (EA) is a systematic approach to selecting the most efficient and cost-effective strategy for satisfying a business or agency’s need. An EA evaluates the relative worth of different technical alternatives, design solutions, and/or acquisition strategies, and provides the means for identifying and documenting the costs and associated benefits of each alternative to determine the most cost-effective solution. [3]
An EA is normally associated with Major Automated Information System (MAIS) acquisition programs. DoD Instruction 5000.02, Enclosure 4, Table 2-1, requires that an EA be performed in support of the Milestone A, Milestone B, and Full-Rate Production Decision (FRPD) (or equivalent) reviews for MAIS. The purpose of the EA is to determine the best AIS program acquisition alternative, by assessing the net costs and benefits of the proposed AIS program relative to the status quo. In general, the best alternative will be the one that meets validated capability needs at the lowest life-cycle cost (measured in net present value terms), and/or provides the most favorable return on investment. [1]
STATUTORY: for Major Automated Information System (MAIS) programs at all Milestones. [4]
A Cost Analysis Requirements Description (CARD) is prepared whenever an Economic Analysis is required for a MAIS. [1]
In performing an EA, it is sometimes difficult to separate out the effects of different factors on decisions or outcomes. To conduct a proper economic analysis requires that all other factors affecting the decision be held constant. [2]
Opportunity Cost
The opportunity cost of a decision that someone makes is the value of the highest valued alternative that could have been chosen but was not.
Economic Analysis Example
Consider an employer’s decision to hire a new worker. The employer must determine the marginal benefit of hiring the additional worker as well as the marginal cost. The marginal benefit of hiring the worker is the value of the additional goods or services that the new worker could produce. The marginal cost is the additional wages the employer will have to pay the new worker. An economic analysis of the decision to hire the new worker involves weighing the marginal benefits against the marginal costs. If the marginal benefits are greater than the marginal costs, then it makes sense for the employer to hire the worker. If not, then the new worker should not be hired. [2]
Common Pitfalls
There are two (2) “pitfalls” that should be avoided when conducting economic analysis:[2]
- Fallacy of Composition: the belief that if one individual or firm benefits from some action, all individuals or all firms will benefit from the same action.
- False-Cause Fallacy: When one observes that two actions or events seem to be correlated, it is often tempting to conclude that one event has caused the other. But by doing so, one may be committing the false-cause fallacy, which is the simple fact that correlation does not imply causation.
AcqLinks and References:
- [1] Defense Acquisition Guidebook (DAG) – Chapter 3.6
- [4] DoD Instruction 5000.02 “Operation of the Defense Acquisition System” – Enclosure 4, Table 2-1
- [2] Website: Cliff Notes – Economic Analysis
- [3] DAU Glossary
Updated: 8/10/2021
