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The Economic Truth

December 5th, 2012 by dimpledbrain

Many people, I presume, occasionally vow to learn something new, only to find themselves beaten down a couple of months later. This enthusiasm sometimes coincides with yearly resolution setting.

In his book The Economic Naturalist, Professor Robert H. Frank shared how he and many others find it difficult to learn a new language. The focus is always on the peculiarity of the language e.g. bizarre grammatical rules or sentence structures that the instructors thought essential. Put these students on the street and surprise, surprise, they can hardly converse with anyone. The solution, he discovered, was to adopt a childlike approach to learning. Start with useful yet practical sentence structures like ‘this is a cup’ and repeat it with ‘this is a spoon’ and so on.

If you are equally interested to learn economics, Professor Robert Frank offers the following ‘sentence structures’ in economics (as opposed to many mathematical equations and meaningless graphs):

(1) Opportunity Cost

  • There is a simple question on opportunity cost in the book that even economics graduates or lecturers couldn’t answer correctly!
  • The question ( I know you are dying to prove that you are smarter than the average) is this: You won a ticket to A concert. B is performing on the same night and costs RM40 and you are willing to pay as much as RM50 to see B perform. What is the opportunity cost of attending the A concert?*
    • (a) RM0
    • (b) RM10
    • (c) RM40
    • (d) RM50
  • Do you know that it’s also probably the only cost that accountants couldn’t capture?

(2) Cost Benefit Analysis

  • Another question from the book: You can buy an RM20 alarm clock at the campus store or get it for RM10 at the supermarket. Where will you buy it? Similarly you can also buy a laptop for RM2,510 at the campus store or get it for RM2,500 at the supermarket. Where will you buy it?**
  • There is no right or wrong answer here, but your answer should be the same in both cases.
  • The incremental view point (i.e. do it when the extra benefit is more than the extra cost) is a powerful framework even though many may have the tendency to omit some important factors in arriving at their decisions.

(3) Demand and Supply

  • If you have read Jim Rogers’ Hot Commodities, you can see how he structured his analysis and thought process into demand and supply. No wonder he is such a successful investor!
  • We can further break it down into demand driven or supply driven markets.
  • Question: when iPhone 5 is made available, should you immediately get one or look at iphone 4s instead?

Suggested leisure reading: The Economic Naturalist by Robert H. Frank. Now the trick is to constantly evaluate different scenarios using these three structures (i.e. opportunity cost, cost benefit analysis and supply and demand) to internalize the concepts.

p/s: Answers:

*(b) RM10.  Opportunity cost is the value of the next best alternative forgone. If you don’t attend B concert, you’ll miss out on a performance worth RM50 but save RM40 on the cost. Therefore the value of not seeing B is RM50-RM40 = RM10.

** The benefit of going to the supermarket is RM10 in both cases. The cost is x value that you assign to the hassle of going to the supermarket, which is the same in both cases. If the costs and benefits are the same in both cases, then the answer must be the same as well.

 

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