Think Like an Economist: What it Means and How You Can Do It

These ‘keep calm and carry on’ style pictures have become very popular over the past few years. I came across this one when I was looking for pictures of economics (imagine what that’s like…). I was intrigued and even inspired to use this as a profile picture for my blog’s Facebook page (which you should totally like). I felt like it gave meaning to my writing. It’s nice to think that it helps others understand that my blog posts aren’t just for reading, they’re also for pondering about.

Either way, I after some time, I felt like it was about time that I wrote about what it means to “think like an economist.” After all, I am so thoroughly convinced that if everybody tried thinking as economists think that everybody would be much happier than they were before. Of course, we must first understand what it means to think as an economist.

What It Means

First of all, people need to understand that economics is not the study of the economy. It uses the economy to apply the principles of economics, sure. But it’s a social science that studies the behavior of people. More specifically, decisions people under the conditions of scarcity. It is the mathematical and theoretical side to why people buy less of a good when the price goes up and vice versa. However, it’s not just applied to the economy. It can be applied to law and medicine as well; giving aspiring lawyers and doctors the edge to better understand their professions. It can even be applied to art!

I love how my teacher put it on our first day of class this semester. He said that thinking like an economist consists of six things:

  1. Scarcity
  2. Rational Self-Interest
  3. Marginal Analysis
  4. Unintended Effects
  5. Opportunity Cost
  6. The Scientific Method

Scarcity

Budgets, limitations of space, and other aspects of life are affected or caused by scarcity. Our world and lives have unlimited wants and needs. Having an “economic perspective” is being able to look at scarcity and desires and being able to find the middle ground where you can obtain what you want while still keeping some resources. Because of scarcity, we have rationing devices. Central authority and markets are examples of rationing devices. A budget is another example. Because you can’t purchase a product that is $1,500 with a $50 bill, you need to figure out a budget to plan how to use your scarce money to save here and there so you can get that $1,500 product (I just hope it’s not a pair of shoes or pants).

Rational Self-Interest

In economics, we say that there’s an invisible hand guiding people to make decisions. This invisible hand is also known as self-interest and is recognized as how people make decisions. Think about this for a moment: You go to the store because you want milk and you have money. The store has milk because they want someone like you to bring your money and spend it. When you purchase the milk, you would much rather have the milk than you would the couple dollars it cost. Likewise, the store owner would much rather have your money than the milk they have a lot of. Seems a little selfish when you think about it, but it’s normal selfishness.

Like I said earlier, it’s called a rational self-interest. It’s not like we’re talking about a guy who gets a girl drunk at a party. That’s a very irrational self-interest and extremely selfish. Rational self-interest is why trade even exists and it’s extremely important that we follow it. In a sense, it’s an analysis of benefits vs. costs. Incentives matter in making decisions. If there is no incentive for someone to make a certain deal, why on Earth would they do it in the first place?

Marginal Analysis

This kind of builds on the whole benefits vs. costs thing. It is looking at the additional benefit we gain from doing something and the additional cost of doing it. For example, for one more gallon of gas, we would have the benefit of going another how many ever miles we get per gallon for the cost of what the gas station charges us. My personal favorite example is what my teacher gave us. If the speed limit is 65 (80 if you’re in Idaho) MPH, then why do you go 75 – 90 MPH? Why not go the speed limit or 74 or 91 MPH? Many say they don’t want a ticket. There’s your cost. You would get there faster (the benefit). It’s also a lot more dangerous, which causes the cost to exceed our benefit.

We do it all the time, we just don’t really know that we’re doing it. It’s actually a lot cooler when you’re meaning to do it.

Unintended Effects

Most of the time, economists try to think about the things that they don’t mean to have happen. An example of this would be inflation when we raise the minimum wage. No economist really wants to see inflation happen. They just understand that it does happen. So what can we do to avoid it? How can we minimize the effects of inflation? If something went wrong, what could possibly cause deflation? These are the kinds of things economists think about when they think of different kinds of policies, such as raising the minimum wage.

One other unintended effect is the unemployment rate being higher when we include 16 – 17 year olds. For some reason, they’re included (probably because they’re in the workforce too). If the government were to decide to not count them, an unintended effect would be making the president look really good because the unemployment rate would drop. How about imposing a law that, through natural consequences of the policy, hinders certain rights of others? This would be something to consider when we’re voting for something like gun control. Thinking about unintended effects can really help us avoid trouble with friendships and relationships too.

Opportunity Cost

Believe it or not, everybody thinks about this without really understanding what it’s called. Have you ever wondered how much money you’d be making if you didn’t go to college and just worked? How about the sacrifice in wages that you would be making if you didn’t go to college? This is a concept in economics known as opportunity cost. Opportunity cost helps us understand whether or not a decision would be good for us to make. In other words, it raises the question, “Do the benefits outweigh the costs?” This is also helpful when thinking about accepting a job offer.

Opportunity cost is the cost of an passing up an opportunity. It’s also known as sacrifices that we make when we make a decision, such as to change jobs or to move to another state. Opportunity cost, as humorous as people may find this, can be very useful in deciding whether or not you should get out of a relationship. Of course, your heart is best used for something like that. But for those who aren’t sensitive to their own feelings, this could be of help. Let’s look at an example of a job change.

Let’s say that you work at an investment bank making $65,000 a year. You are approached by another prestigious investment bank that offers you $70,000. If nothing else were to change, then you should take the job. However, if you are offered a steady increase of 5% in your salary where you currently work and this other place only offers bonuses when you produce more than you did the year before, we see that it would be much wiser for you to stay at your current job.

If we taught economics in high school, we could easily show students why it’s so important to go to college. They think about how they could easily make $20,000 per year when we show them that with a college degree, we could easily make that $50,000 per year, depending on what they study. What’s better is that we can show them the opportunity cost of not doing your best in high school by explaining that they are passing up opportunities for scholarships, free money for looking smart. The possibilities are endless.

Scientific Method

As mentioned earlier, economics is a social science. Naturally, because there is a science to the subject, we use the scientific method to test out a policy or idea in the form of an equation. There’s a slow way and a fast way to this. The slow way, as you may have guessed, is to enact a policy that would affect the nation, or some economy, and see what happens. Most of the time, economists make mathematical models using equations and graphs. Because of the equations and graphs, the fast way is possible. The fast way is to execute the equation and observe our graphs. Would it be helpful or would it hurt our economy?

Thinking with the scientific method is another thing that we subconsciously do. Have you every thought about something and seen if it would work? Then you’d used the scientific method in your own life. Most people would call this thinking before doing something. Whatever you want to call it, it’s still the scientific method.

How Everyone Can Think Like Economists

As I said earlier, if everybody tried to think like this they would be much happier than before. We first discussed scarcity. Think of your resources and how you can make them last longer. Maybe you need a budget or a plan to not use them up so quickly. The next thing we discussed was rational self-interest. The easiest way to do think of something like this would be to think about yourself. What are your goals? Is there anything you’d like to accomplish in your life? Think about how you can achieve these things. Next was marginal analysis. Think about incremental details in your life. Would you be happier by making a change here or a change there? Maybe you’d be happier with a better job. Think about the changes you need to make to achieve this goal.

Unintended effects. Think about how you might cause something that you don’t want to have happen through a decision. For example, if you were to spank your children, would it hurt the relationship between you and the spanked child? Surely, you didn’t intend for anything other than for them to learn that what they did wasn’t okay. Thinking about opportunity costs is something we already do subconsciously. Think about what you’re missing out on. The scientific method is a little bit harder for me to come up with an example for. But I know that if we try, we can find something in our lives to apply it to. There we have it! Thinking like an economist isn’t so hard. It’s just something that doing intentionally takes a little while to do.

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