CHAPTER 1: Thinking like an Economist Podcast

How do you quantify the enjoyment you get from a purchase?

Determine the maximum you are willing to pay for the item. (In order to compare costs and benefits, you need to use the same unit of measurement. Economists use money as a measuring stick. When deciding whether to buy something you should begin by determining the maximum you are willing to pay for the item. If the price is less than what you are willing to pay, then the benefits exceed the cost and you should buy it.)

Marginal Principle

helps decide about quantities Example: how many cups of coffee to drink or how many hours to work

You are launching a new consulting business and you need to decide how many employees to hire. Applying the marginal principle, what question should you consider?

Should I hire one more employee?

Which question uses the Opportunity Cost Principle to help make the best decision?

Should I look for a new job or should I go back to school? (When you apply the Opportunity Cost Principle to make a decision, you consider the alternative uses of your time and money. Instead of just asking yourself if you should look for a new job, you consider whether you should look for a new job or what else you could be doing.)

Sunk Costs are

Sunk costs are money you have spent that you can't get back.

You buy an expensive mattress on clearance which is nonreturnable. After a few weeks, you realize it's very uncomfortable and you are not getting a good night's sleep because of the mattress. Thinking like an economist, you should ignore the sunk costs and get a new mattress.

Sunk costs are money you have spent that you can't get back. The mattress is nonreturnable, so the price you paid for it is a sunk cost. When making a decision it is important that you ignore sunk costs.

Edward charges $100 to landscape his neighbors' lawns. His neighbors should hire Edward if the marginal benefit of having their lawn landscaped is greater than $100.

The $100 Edward charges is the marginal cost of landscaping. His neighbors should apply the cost-benefit principle to determine if the marginal benefit they receive of having their lawn landscaped exceeds the $100 marginal cost.

Cost-Benefit Principle Summary

The cost-benefit principle reminds you that any decision you face, there's going to be benefits, and there are going to be costs. And if you want to make a good decision, you want to tally up all the benefits and all the costs and only do things where the benefits are at least as big as the costs. It's all the benefits, not just the financial ones. All the costs, not just the financial ones. You don't have to be selfish when you apply this, but you do have to be systematic.

Competing against other potential employees for a job is an example of the second set of interdependencies.

The second set of interdependencies are dependencies between people or between businesses. Your best choice depends on the choices made by others in the economy. Your likelihood to get a job depends on who else applies for the same position.

Interdependence Principle

Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of these factors changes, your best choice might change. - about how all our decisions are interconnected Example: if I decide to drink more coffee, that's money I can't spend on tea. If I drink more coffee, it leaves less for others. And it'll also impact the market for related goods, like milk or sugar, not to mention the effects on global trade flows, as most coffee comes from overseas.

You take a job driving for Lyft. It's a slow night and you are trying to decide whether to continue working or go home. You should

continue working until the marginal benefit you receive from working additional time equals your marginal cost of working additional time. (Applying the rational rule, you should continue working until the marginal benefit is equal to the marginal cost. In this case, the marginal benefit is equal to the fair you receive for making an additional ride. The marginal cost is your opportunity cost of working, the best alternative you give up to work additional time.)

Your expectations of the future

have a large impact on your investment choices (Investing involves delaying current consumption for the reward of greater future consumption. If you are optimistic about future economic conditions, you are more likely to invest in the future. If you are pessimistic about future economic conditions, you are unlikely to invest.)

In the podcast, the authors use the interdependence principle to illustrate how an increase in interest rates can lead to

more parents returning to the labor market. (Increases in interest rates make home mortgages more expensive. This will lead to a lower demand for homes. The decrease in home demand leads to entrepreneurs converting houses into other uses such as childcare centers. Having a better choice of childcare centers makes it easier for parents to return to work. This is an illustration of the third set of interdependencies, the connection between different markets.)

You are offered a position at FedEx. You should to take the job if

the benefits of taking the job at FedEx are more than the costs of taking the job (Applying the cost-benefit principle, you choose something if the benefits of that choice are more than the cost of making that choice. Salary, work environment, and how stable your current position is all factor into your decision making. However, using the cost-benefit principle you take into account all benefits and all costs in order to make the best decision.)

One example cited in the podcast of a factor that may cloud your decision making is

the framing effect (The framing effect occurs when you are influenced by how something is sold. The example given on the podcast is a restaurant that adds an expensive lobster on the menu to make the other items seem less expensive in comparison. You can avoid the framing effect by asking yourself how much you are willing to pay for an item before looking at the price.)

Framing Effect

the tendency for people's choices to be affected by how a choice is presented, or framed, such as whether it is worded in terms of potential losses or gains Marketers use the framing effect all the time to fool buyers into buying stuff, even if the benefits are less than the costs Example: Restaurants add an outrageously expensive item on the menu(fancy lobster) to make everything else look like a bargain by comparison. ( truth is a $60 lobster doesn't make a $20 burger a bargain )

When applying the Opportunity Cost Principle, you consider

the trade-offs of your decisions (The Opportunity Cost states that the true cost of something is the next best alternative you must give up to get it. This includes alternative uses for your time and your money.)

**Tip from podcast

Be careful that other factors don't cloud your decision-making, and focus on the costs and benefits. A common pitfall is being influenced by how something is being sold. Example: People might be more likely to buy something they don't really want simply because it's on sale.

Core Principles

Cost-Benefit Principle Opportunity Cost Principle Marginal Principle Interdependence Principle

Cost-Benefit Principle

You should choose something if the benefits of that choice are the same or more than the costs of making that choice Everyone wins when this principle is applied ( I want coffee; the cafe wants my money. I buy coffee, so I'm happy. The cafe sells it to me, so they're happy. ) Example: Listening to this podcast Benefit of listening to this podcast right now is that I'lll learn how to think like an economist so I'll make better decisions. The cost is my time, which I could be using to watch TV. Example 2: I buy a cup of coffee. Benefit: enjoyment of drinking coffee Cost: money spent

You are willing to pay full price for a new shirt, but you end up finding it half-off from an online retailer. Applying the cost-benefit principle, determine what has changed.

Your cost has decreased, but your benefit remains the same. (The price of the item represents your cost. When an item goes on sale the cost decreases. The benefit that you receive from the shirt has nothing to do with the price. The benefit is an expression in dollars of how much joy the purchase brings you.)

Opportunity Cost Principle

the true cost of producing an additional unit of a good or service is the value of other goods or services that must be given up to obtain it // looking at the next best alternative Example: " What would I do if I didn't buy a coffee?"