There is an economic way of thinking, and it can be really helpful and clarifying . If you can master these 5 elements, you’ll make better decisions in all aspects of your life.
1) Take Economizing Actions
Economics is about economizing. To economize means to allocate whatever scarce resources are available to you in a way that, consistent with ethical considerations, makes you feel that you have used those resources in the most productive way: you get the most you can of what it is that you want. Scarcity makes economizing necessary – if we had access to unlimited resources, no economizing would be necessary. Time is one of those scarce resources – once we’ve used it up its gone, and we can’t do two things at once, so we must make an economizing choice.
Sometimes we do it badly, especially if we are missing some relevant information. Information is also a scarce good, and we have to sacrifice other goods – like time and energy – to get more of it. At some point we make the decision that more time and energy spent on a decision will not be justified, and we make our incompletely informed choice. The economic way of thinking is to make these calculated choices very consciously.
2) Make Trade-offs
Economizing means trade-offs. We would like to have more of one thing, but we give it up in order to have more of something else. Trade-offs don’t have to be all or nothing. We may feel we have a “need” for something, but we find ways to economize as it becomes more expensive. We “need” water, but as the price goes up, we may irrigate our land less, wash our cars less frequently, and install water-saving devices on our toilets and showers. It’s never all or nothing. The trade-off decision is always at the margin – and we find there are many margins. If the city imposes a traffic congestion fee on driving into the city, we might start car-pooling, or walking to work or taking public transit or working remotely. There are always alternatives at the margin. Make your trade-offs thoughtfully and carefully.
3) Recognize Opportunity Costs
When we make a decision at the margin, we are calculating, as best we can, incremental benefits and incremental costs of every choice. These benefits and costs are largely emotional: do we feel better or worse as a result of our choice? Only actions have costs, not things. Choice is an action. The cost is the value of the opportunity we will have to give up if the action is taken. If I choose to spend $15 to go to the movies, I am giving up the chance to enjoy myself in the bar next door for a couple of hours. The cost of going to the movies is not $15, it is the value of what I otherwise would have been able to do – and the pleasure I would have gained – with the $15.
Note that, at the time of the choice, the opportunity cost lies in the future. It is the cost of what will be foregone.
4) Coordinate with others
The core problem for the economizing actions of individuals is scarcity. The core problem for economic interactions between individuals is a multiplicity of diverse projects. The solution to this interaction problem is coordination.
Economizing individuals specialize. They find what they are best at and what they can get paid the most for. Specialization without co-ordination would be chaos. Coordination is an exchange process. Co-ordination may not necessarily be efficient – it just has to work for everyone’s benefit. If a writer chooses to specialize in writing articles about economics, it is important to have cooperation from the editors, internet technicians, farmers and service workers who make writing possible and help to keep the writer fed, nourished and healthy. The job of economics is to explain how this coordination process – the market – works, and to explain to those who wish to impede or intervene in this coordination why they are wrong to do so, and the damage they would inflict.
Don’t try to maximize efficiency in your collaboration with others. Just try to make it work for all parties.
5) Use markets and prices to make deals that are mutually beneficial, irrespective of regulations.
These explanations of how the market works focus on relative prices and price movements, because prices provide the information and the incentives for coordination. When demanders want more than suppliers have made available, they will compete among themselves for the scarce supply, and bid prices up. This incents some demanders to put up with less than they thought they needed because the price is higher than their opportunity cost. At the same time, some suppliers will be induced to supply more than they originally planned to. Competition among suppliers will have a downward influence on price. How it all settles out depends on the specific circumstances of time and place and the clarity and speed of the information exchange.
Interventions to “fix” prices (like minimum wage laws and rent controls) will have unintended consequences because they change the circumstances. The ignorance and uncertainty facing the price fixers – they can’t know how every market participant will react to the new information – means that they can never be sure of or in control of the consequences of their actions. For example, if an employer wants to hire and a worker wants to work, if the wage is fixed, the two parties can negotiate the non-wage components of the arrangement until they arrive at a mutual agreement. The market has settled, and the two parties have created new information of which the interventionist is ignorant. This is not market failure, it is the subjective value preferences of the two individual parties aligning through cooperation, irrespective of the unaligned values of the interventionist.
Recognize that there are many components of an exchange, and many of them are not monetary – they have no price but they have a benefit or a cost. Make your deal by recognizing both monetary factors and intangibles.
Adapted from Paul Heyne, Economics Is A Way Of Thinking, at The Best Of Online Library Of Liberty
