003：How Understanding Economics Can Make You Better Shopper

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Hello, Himalaya subscribers. My name is Timothy Taylor.Today we're going to discuss the topic: understanding economics makes you a better shopper .

A few years ago, I was over visiting my parents. I noticed their cooking pots were very old, many of them had dense sum of the handles were falling off. Some of the pots had become worn or bent over time, so the top wasn't round any more. And the lid didn't fit. Some of the lids had been lost, so they were using lids of a different size. And the pots and pans were not all that expensive to begin with. Well, many years ago, when my wife and I got married, we'd found out that some makers of cooking pots in the US have what they call a stir kit. Uh, you can buy about eight pots and lids, all different size pots and lids all at once.

It gets you started. It gives you most the pots you need most of the time. Now, here's where the story gets a little more interesting. The cost of buying a new starter kit of eight pots and pans was about the same as it would cost if my parents took me, my wife and our three children out for dinner at a fancy restaurant. Now my parents are happy to take us out to dinner a few times every year, but they had not bought new cooking pans in thirty years. Even though they would use the cooking pans almost every day.

But he story is intended to raise a question for you. Are there some things you spend money on very quickly without thinking about it too much? Like taking family out to dinner or there are other things you don't spend money on, even when they might give you just as much or even more pleasure every day over time. If you remember that you live in a world of scarcity and tradeoffs, and you think about those like an economist, maybe some of your choices would change.

Let's dig into this topic in three pieces. First, we'll talk about how economists insist on taking tradeoffs seriously, and not everyone else does. Second, we'll talk about opportunity cost, an idea that economists use to focus on tradeoffs. And third, we'll talk about sunk costs. Another idea from economics and something that you should ignore. Our first topic is about how economists insist on taking tradeoffs seriously. You might say to yourself, well, doesn't everybody do that? Really? I mean, doesn't everyone think about tradeoffs? And honestly, I really don't think so.

Sometimes, someone is explaining this great new thing that they bought, and they're so happy. Or they’re explaining the great new idea and all the positive stuff sounds just wonderful. And the economist is that person's standing off on the corner saying, well, let's think about the tradeoffs. Let's start with an example from public policy. Many countries like China, the United States, and many others have corporate taxes, taxes on corporations. And in many of those countries, it's popular. A lot of the time to say corporations should pay more in taxes.

You'll hear people say, well, the corporation should pay more, so people don't have to pay so much. But when economists hear this argument, they say, look, a corporation is just an organization. When a corporation pays more, the money must come out of someone's pocket. Maybe the corporation ends up charging higher prices to consumers to cover the tax bill. Maybe it ends up paying lower wages to workers. Maybe it ends up paying the top executives less. Maybe there's a lower rate of return for people who buy stock in the company.

Now, I’m not going to argue here over which one of these is most likely. I'm just going to say one of them happens. There is a trade off  here. When corporations are tax, the money does not come out of thin air. It comes from someplace. I was once talking to a friend of mine about this kind of argument, not an economist. Uh, and I was trying to say, you know, somebody has to pay for it. My friend thought about for a little while. And then she said, I just don't like thinking about it that way.

And I thought, that's exactly right. Lots of people, including lots of politicians, don't like thinking about tradeoffs. They don't like thinking that the choices you make or maybe worth making-they have some good side, but they also have some things you give up. So how can we force ourselves or push ourselves to think about the tradeoffs and the choices that we make in our personal lives？ Economists often use the idea of opportunity cost, which is our second main theme for this talk. What is the actual cost of something? And economists would say the cost of something is giving up the opportunity to do something else. And that's what opportunity cost means.

But for economists, the real costs are the opportunity costs. Most economists don't think about it this way. Most non-economists think of costs in terms of money. You can imagine someone saying, oh, I heard your family had a great vacation to Thailand. What did it cost? Oh, it cost about twelve thousand yuan. Now, giving the amount of money it cost can make some sense. It's a useful description. It's not bad shorthand, but economists prefer to think about cost in terms of opportunity cost.

What specific actual thing was given up? If you had not taken that vacation, what was the next best choice? Because the next best choice is the real cost. If it cost twelve thousand yuan for the vacation trip, well, that's one yuan per month for an entire year, That money could have been spent on something else. Ah, nice meals at the restaurant, going to a show, maybe some smaller trips. The money could have been saved; it could have been given as a gift to someone. Uh, maybe it would have even been possible not to work quite as many hours.

But there was something. There was some tradeoff that happened. There was some opportunity cost. Now economists don't tell you what choice you personally should prefer. Economics doesn't give you the answer. It's a method of analysis. This idea of opportunity cost can get complicated for several different reasons. Say I go shopping to buy some shirts, and I find one shirt I really love. And I find some other shirts that are fine, although I don't quite love them.

But it turns out the shirt I really love is expensive.So the issue isn't just what do I want. The issue is, do I want one expensive shirt I really like? Or do I want two shirts? Or maybe a shirt and a pair of pants, too?

Lots of people have a pattern where they buy a few things that are expensive. And then they buy some other things as cheaply as they can. But the economist says, you have to be clear on the opportunity cost. You have to recognize the tradeoff. Another complication is that not all tradeoffs are expressed in terms of money. An example I often use in college classes is to think about the opportunity cost of going to college. Part of the cost of college is a financial cost. It's whatever you pay to attend.

But another part of the cost is the cost of your time. If you weren't in college, you could be working full time at a job getting money and experience. So the opportunity cost of college isn't just what you pay. It's also the opportunity cost of lost wages and experience. It's probably still worth going to college, but recognize the opportunity cost. Some people are in a similar position after they live in their house for many years. What's the cost of just staying in the house after you've already paid for it? It might seem like the cost is very low, almost zero, but what is the opportunity cost of staying in the house?

If you move to a smaller place or less expensive place, you could maybe have some trips or you could give a gift to the grandchildren, or you could go off and rent places. Uh, you could do different things. I'm not saying one or the other choice is better. I'm just saying looking at only the out of pocket cost can obscure the real tradeoff. Sometimes when you make the opportunity cost more clear, it changes behavior. Imagine you buy a cup of coffee from a store almost every day on your way to work.

It's little expensive, but you can afford it. And it's kind of a little treat to get your day started. Well, what's the opportunity cost? You would have to calculate how much money you would have at the end of the year. If you didn't buy that coffee, or maybe if you only bought one time per week. And think about what would be the thing you could spend that money on? Maybe it would be a nice vacation or a new computer or television, or maybe it would be more pod casts.

I'm not saying which one is best. I'm just saying you need to think about the opportunity cost, not in terms of money, but in terms of what you give up. That example about coffee or money at the end of the year is a tradeoff between the short run and the long run. And often it's hard to think about something where the benefits are off in the future and the costs are in the present.

Our third big concept for this talk are sunk costs and why you should ignore them. What is a sunk cost? It's a term used by economists. It's closely related to the idea of opportunity cost. When thinking about opportunity cost, you need to look forward in time at the future costs and benefits, not backward. If you have costs in the past, and you can't get those costs back, you shouldn't pay attention to those costs. They're gone. They're sunk. They're in the past.

For example, say you buy a ticket to a show or a movie, you watch for about a half hour. And it's just terrible. It's so bad. It isn't even funny. It's just boring and annoying. Do you say to yourself I'm already here, I bought my ticket, I might as well stay to the end, or do you get up and leave? The money you spent for the ticket is a sunk cost. You can't get that money back. The opportunity cost of staying at this event that you hate is that you're giving up an hour or two doing anything else. And if you really hate the show, doing anything else should be a good idea. So you should ignore the sunk cost of the ticket and move on with your life. Many companies pay too much attention to sunk costs. Think of a company that's trying to start a new product or open a new store, or maybe start a company from scratch. And let's say they work really hard. They try hard, they spend time and energy and money, but they don't succeed and they don't succeed, and they don't succeed. Should they keep going? The idea of some cost tells you the time and energy and money you have already put into the idea is gone. You can't get it back.

So when thinking about whether you should keep moving ahead, you need to clear those sunk costs out of your mind. And instead, think about does it make sense moving forward comparing costs and benefits?

In fact, there are  even times when sunk, costs can be encouraging. Say you're doing a big project, and you've done ninety five percent of it. You just have a little bit left to finish. Think about the costs and benefits here. The ninety five percent you've done is a sunk cost. You can't get it back, so you should ignore it. But looking ahead, finishing off the last five percent of the work, if that's what's left, will get you the entire reward. If it seemed like a good deal to start the product, the project, it should seem like a really good deal just to finish it off .

Here are a couple of review questions. Do you get specific about the opportunity costs you face in your own decisions, not just the monetary cost, but the actual specific alternatives? Do you include the tradeoffs of time that are involved also? Make sure you river review the idea of opportunity cost and sunk cost in your mind, because we'll be coming up again throughout these lectures. One of the main ways in which societies think about tradeoffs between what to produce and what to consume is using forces of supply and demand. The next dozen lectures or so will dig into these issues of supply and demand and how they address choice and scarcity. We’ll look at supply and demand in markets for goods, in markets for labor and in financial markets.

I’m Timothy Taylor. Thank you for listening to Himalaya.