3 Economic Principles You Can Apply to Your Life

Time to rewind back to Economics 101. The beautiful topic of Economics is based on the principal of scarcity: we have a limited amount of time and resources available to us and must make choices of how to allocate what we DO have. In college, this means balancing the 3 S’s: Sleep, Studying and Socializing. Take a look at the following three principles you can apply to your life. Then, think about how your new awareness can make a big difference in your future.

Opportunity Cost

This balancing act presents an opportunity cost: what you need to give up to attain what you want. For example, you can choose to study for an exam or go party with friends. If you choose to study, your opportunity cost is partying with friends. Opportunity costs do not always have a monetary value associated with them, rather, the cost is: anything of value to the person assessing the situation including energy and time.

We are faced with many situations where evaluating opportunity cost can be very valuable. Here are some examples:

-Should I go to grad school that costs $X,000 per year, or continue at my job making $X,000 per year?
-Should I save that extra $100/month or put $100/month towards my high interest credit card debt?
-Should I go out to a trendy new restaurant with friends, or stay in to work on my freelance projects?
-Should I grow my side business, or put more hours in at my day job?
-Should I stay at this job or should I find a new one?

These are not questions that other people can answer for you. In order to make better decisions, you have to figure out what you value first. Perhaps easier said than done for most twentysomethings, when we are still in the stage of figuring out what we want and value. We are so accustomed to listening to our professors, parents and bosses. But, at some point we need to figure out what WE value and want for ourselves.

Sunk Costs

Sunk Costs are costs that are already incurred and cannot be changed regardless of what action we take. For example, a gym membership that you’ve never used or a car you’ve already purchased. A dangerous trap is the irrational thinking of “well, I’ve already put so much money and time into this so I might as well just keep going.” In many cases, this type of thinking leads to throwing “good money at a bad investment.”

Instead, it is more economically rational to think of your decision going forward and leave your past expenditures out of it; your money and time are already gone. From there you can determine your values and use the principal of opportunity cost to make your decision.

The Law of Diminishing Returns

The law of diminishing returns states that if one factor of production is increased while the others remain constant, the overall returns will relatively decrease after a certain point. “For example, if more and more laborers are added to harvest a wheat field, at some point each additional laborer will add relatively less output than his predecessor did, simply because he has less and less of the fixed amount of land to work with.” (http://www.encyclopedia.com/doc/1E1-diminish.html)

Here are some real life examples that might make more sense:
-Eating your 4th hot dog brings you less satisfaction than your first or second did.
-A drug addict needs more and more of a drug to feel the same pleasure he did from his first high to get the same effect.
-An extra hour of studying at 2am is less productive than your 1st hour of studying at 9pm was.

There are mathematic ways of calculating the point at which your action has less of an effect. The truth is, being aware of this basic principle should help you keep things in check in terms of spending money, buying too many new shoes, over eating, sleep, work etc. At some point the things you do in your daily life have a diminishing return.