In the previous post, I cited a few ways that “economic thinking” can help us analyze data we hear in the news (especially about “inequality”).

What is “economic thinking,” and how can it help you on a daily basis?  Those are the two questions I hope address below through a few simple examples.

There are a handful of concepts that come to mind when I consider economic thinking (please suggest more if you have any!).  I’ve added “Andy Descriptions” behind each one that, although not perfectly accurate, may help those of us who aren’t economists to understand what they mean.

What other examples come to mind for each of these mental models?

• Marginal Analysis–Looking at the benefit or cost of the next additional unit or thing.  Let’s say I manage a portfolio of 100 donors: looking at the average of the entire group I may be happy that I’m pulling in $20,000 each year.  But, by using marginal analysis, I might discover by looking at them individually that alumni who are donors give 10 times as much as non alumni, which might encourage me to change my strategy to a more profitable focus on alumni.  Or, let’s say you mentor 5 people.  Since you don’t have infinite time to help them all, you can take one of two ways to spend your time: you could equally spend your time with all five, and have a small impact on each.  Or, you could identify which individuals are most likely to change or benefit from the experience, and spend the majority of your time with those few.

• Sunk Costs–Realizing that past costs are GONE forever, and shouldn’t affect our decision making today.  For example, if a week ago I bought tickets to the opera, but today I have a fever and am getting sicker, I should realize that just because I bought the tickets (sunk that money in the past) doesn’t mean I have to go to the opera, especially if there’s a chance won’t enjoy it and may get more sick through staying up late.  Or, let’s say you’ve been writing a proposal for the past two weeks, but just found out that someone else in your organization has been working on a very similar project and is further along than you?  Ignoring sunk costs, you might go ahead and finish it as already planned.  Accepting that previous work as ‘sunk,’ though, you might say, “OK.  That’s frustrating.  But from where I am today and looking forward, what’s the best opportunity to spend my time?”  That may include sharing your work with the other person, abandoning the project all together, or spending time trying to figure out what the redundancy occurred in the first place.

• Opportunity Costs–Your next best alternative that you implicitly give up when you chose to do anything.  For example if I have one day for a vacation and I have the option to go skiing up north or visit museums down south, I can’t do both.  I have to give up one when I choose the other.  I go skiing at the opportunity cost of museum’ing (not a real word).  Or, let’s say that I manage someone who is entirely devoted to streamlining our IT process.  He’s gregarious, and everyone loves talking with him; he also knows just about everyone in our industry, it seems.  By taking a few moments to consider the opportunity cost of his time, I would brainstorm other possible ways that he could create value for our organization.  For example, I might way the value he creates with IT vs. the value he could create as, say, a recruiter or salesperson. 

• Transaction Costs–The costs of doing business; the money, time, psychological pain, etc. that are involved in making things happen.  For example, if my friend offers me a “free” pizza across town, I realize that there are actually costs related to making this transaction happen–driving over there, taking time to travel, and gas money, to name a few.  Or, when trying to coordinate multiple people in a project, I might consider how decision rights are slowing us down or speeding us up each day (keeping in mind that a short-term slow down of having a few people “sign off” may avoid a long-term problem of the project failing due to lack of context or challenge). 

Economic Thinking, Marginal Analysis, opportunity cost, Sunk Costs, transaction cost