Today we started off this venture into economics by defining what exactly economics is and what its practitioners study and try to accomplish. Basically, economists seek to answer three questions: what, how, and for whom. Economics was one of my favorite business topics to discuss when I was in grad school (second only to marketing) — in a lot of ways economics is just as much about the psychology of people as it is about “chartsngrafs”.
If you wanted to boil down economics, you could basically say that all humans, regardless of our own backgrounds, cultures, etc., all want to satisfy our wants. Add that to the fact that none of us can actually satisfy all of those wants. Economists call that gap scarcity, and it causes every last one of us to make choices. Economics studies how we make those choices.
Some economists argue that every person makes choices that are in their own self-interest; others argue that some make their choices based on what is best for society as a whole. Still many believe (Adam Smith, for instance) that society’s best interest can be achieved by its individuals each looking out for their own self-interest.
In order to make this semester as successful it possibly can for us, it will be helpful to learn how to think like an economist. That basically boils down to 5 core economic ideas, as identified by our text (emphasis mine):
- People make rational choices by comparing costs and benefits
- Cost is what you must give up in order to get something.
- Benefit is what you gain when you get something and is measured by what you are willing to give up to get it.
- A rational choice is made on the margin.
- Choices respond to incentives.
Rational choice can be easily misunderstood if you’re not careful. Rational in this context means that that choice is the best choice to achieve the goals of the person making the choice. For me, buying a pickup truck is not a rational choice because I have three small kids that I cart around on a regular basis. That, and I live in the city and very rarely find myself hauling things off. For someone with no kids who lives out in the country who finds themselves landscaping on a very regular basis, buying a truck would be a rational decision. Same decision, but the person making that decision is the one who dictates whether or not that decision is a rational one.
The cost of something can also be misunderstood. Cost does not mean the same thing as price, at least in economic terms. Cost is what you must give up in order to obtain the thing it is you’re trying to get. You might think of the price of coming to school being the amount of money spent on tuition and books for your classes, but its actually so much more. The cost does include the cash you throw down for both of those things, but it also includes the time that you would be spending working as well. We call that specific thing the opportunity cost, the item that must be given up in order to achieve another option. By teaching an evening class on Tuesday evenings, my opportunity cost is the night I would have otherwise gotten to spend with my family. As the text points out, be careful not to lump in things with opportunity cost that shouldn’t belong there. For example, the opportunity cost of teaching an evening class on Tuesday nights is the time I lose with my kids, but it doesn’t include the price of dinner, since I would be eating dinner whether or not I taught class that night or not. Believe me, dinner is a very important part of my life!
Of course, it’s not all about costs. Obviously, there are benefits to the decision, or else we wouldn’t make that decision. The textbook definition of benefit is the gain or pleasure that it brings or, in other words, what the person feels about the decision. Simply put, if the benefit of a decision outweighs that decisions costs, a person will make that decision.
Margin refers to the “edge of the decision” or studying all of the possible alternatives in a systematic way. 
The marginal cost, for example, is the amount of increase that you must endure for the next unit of something. If you’ve been walking all day without food and you come across a Wendy’s restaurant, the cost of getting a hamburger is something like 3 bucks, along with all of the “health costs” that go along with it. However, the benefits of having food after walking all day far outweigh those costs, and so you get the hamburger. Then, you’re faced with another decision: do you get a second hamburger? You must determine what the marginal cost of a second hamburger is and decide if the benefits outweigh the costs. The second, third and fourth hamburgers each cost marginally more; not in price (in some instances, you might actually be cut a better deal for buying so many hamburgers), but the health costs certainly are greater. Marginal benefit, on the other hand, is the amount of benefit you gain when you get that additional something. Marginal benefit decreases for each item that you buy. Returning to hamburgers, if you do decide to buy that extra hamburger, it doesn’t have that immediate satisfaction of the first burger. The third has even less — in fact the third will likely make you sick.
A rational choice is made whenever the marginal cost of something is less than the marginal benefit of that additional item.
So how do we make those choices? We’re still missing an essential ingredient: incentives. Incentives are rewards or penalties (I like to call them negative rewards) that go along with certain actions. Basically, it comes down to “what’s in it for me?”. If you don’t see the value in lacing on your running shoes and going out and pounding three miles, you won’t do it. If you perceive a reward of losing weight, then you will be more likely to do it. If you have a goal such as running a race in a certain amount of time, you’re even more likely to do it. If you know that you will feel so much better if you do the run, you are definitely more likely to do it. Likewise, if you know that a pack of wild boars will track you down and possibly rip you apart if you go out, that might be enough to keep you home on the couch. One of the most fascinating elements of economics is the study of studying incentives and predicting changes in behavior based on those changes in incentives. Fun stuff.
Homework:
one of the most important (if not *the* most important) function that Human Resources performs. Without the right people in a job, the job (their job and everyone else’s) is going to suck.