- Date : 23/03/2020
- Read: 6 mins
Just as addition and subtraction help you in your daily life and tasks, understanding some basic economic concepts can come in equally handy.
Subjects like mathematics, science, and language are considered to be essential for building a child’s intellect and enhancing their understanding of the world. The social science of economics may not be considered as important, but it should be. Economic concepts, in addition to those of demand and supply, play a recurring and significant role in one’s daily life. If you know some of these essential concepts, you can make smarter decisions when it comes to time, money, work, and even personal relationships.
Before we get started, it is important to note that there’s no need to be intimidated by the idea of economics. As long as you’re living a functional life, you will understand, relate to, and be able to apply these concepts easily and effectively.
Related: 5 Economic concepts you need to know
1. Opportunity cost
Do you often feel as if you don’t have enough time and energy for everything on your plate? What you need to do is learn to prioritise and manage your time better. Understanding opportunity cost allows you to do just that! Economics exists because of two reasons – first, resources are limited; and second, human wants are unlimited. Economics is the study of how society uses its limited resources in the best possible way.
Opportunity cost is the cost of lost alternatives when you pick an option or make a choice. Picture this: You have an hour before bedtime and three ways to spend it – finish reading the book you started a month ago, scroll through social media, or video call your best friend. If you pick scrolling through social media, the opportunity cost of that is reading as well as catching up with your friend.
When you start putting things in terms of opportunity cost, you’ll realise what’s worth your time and what isn’t. It will also help you make daily choices that are in line with your goals and focus on the bigger picture. So, the next time you have to decide whether you should invest your time, energy, or other resources on a project, social event, or task, just ask yourself: ‘What’s the opportunity cost of this?’ It will help you determine if the effort is truly worth it or if there’s a better way to utilise your resources.
2. The Veblen effect
Do you tend to pay more for certain products – say, clothes, bags, or electronics – instead of going for cheaper alternatives even though the quality and features seem pretty much the same? That could be because of the Veblen Effect.
When people use price as an index of quality, they end up paying more money for a product than they need to. This is often because they don’t know how to make a rational comparison between the two products. They either lack the knowledge or capacity to examine the physical properties of a product (durability, reliability, etc.) and end up thinking that whichever product is priced more would automatically be of better quality. They choose a product based on that assumption alone.
A name-brand product can often be twice as expensive as an unbranded product and still provide the same utility. Now that you know about the Veblen effect, you can save more and budget better by making smarter choices when shopping.
3. Diminishing marginal utility
When was the last time you felt as though the efforts you were putting into something – your daily job, a relationship, working out – were just not reaping benefits, at least not in the right measure? Understanding the law of diminishing marginal utility could give you the answer to fix that. But first, it’s important to know that utility here means ‘satisfaction’ or ‘happiness’ – basically a positive value addition.
As per the law of diminishing marginal utility, beyond a certain level of consumption, the utility derived from each additional unit decreases. Think of when you’re hungry. The first bite you take gives you immense utility (satisfaction) since you’re finally eating after being hungry for a while. The second bite you eat also provides you satisfaction but slightly less than the first bite since now you’ve already had some food. As you keep eating, the utility you get from each bite keeps on decreasing. Finally, at some point, if you eat any further, you will not get any utility – in fact, it may result in negative utility. This happens when you continue eating even when your stomach is full simply because it’s your favourite food.
Just because doing something in a specific way worked at some point, it doesn’t mean it will keep working if you do more and more of it. Maybe you need to change your strategy. For instance, doing the exact same exercise week after week isn’t going to be as helpful for your body as changing workouts from time to time.
4. Sunk cost fallacy
It’s hard to admit losses, but it’s harder to stop and exit at the right time. This applies to investments, relationships, and just about everything else that requires you to put in significant amounts of money, time, effort, and other important resources. A lot of people, however, fall victims to the sunk cost fallacy.
Sunk cost is basically the cost you have incurred and cannot recover. Sunk cost fallacy is when a person continues a specific endeavour, behaviour, or commitment even if it is failing – simply because of the previous investment they have made in terms of time, money, or effort. For instance, if you order too much food and instead of leaving the extra food once you’re full, you end up overeating just because you have already paid for it, that’s sunk cost fallacy at play.
You would know at least one person who continues to be in a failing relationship that is clearly unhealthy just because of how long they have already been in that relationship. That, too, is sunk cost fallacy. It’s critical to cut your losses at the right time and know when to walk out, and now you can be mindful of that.
That wasn’t hard, was it? Go ahead and share these economic concepts with your friends and family. For one thing, they will be super impressed that you have such a good understanding of economics. Second, they too would benefit from applying these concepts in their daily lives.