Real-World Applications of Economics
A common misconception about economics is that the field of study is a highly academic subject with little practical use in daily life (hence the nickname, “the dismal science”). Although at times, complicated mathematical models are used to prove easily understood theories, economics can be used in daily life to improve returns on the investments (both monetary and non-monetary) you make. Here are some examples of how you can use economics in your daily transactions.
Cost-Benefit Analysis
No matter what your profession, you come into contact with countless numbers of transactions from day-to-day. Cost-benefit analysis may be used in many day-to-day transactions in order to measure the most optimal outcome. For example, when maintaining your budget, it is obviously important to account for individual transactions. You can easily find records of these by looking at receipts or your monthly bank statements.
What some people do not take into account when budgeting, however, are transaction costs which are easily forgotten. Budgeting for a trip to the grocery store? Don’t forget about the cost of gas to drive to the grocery store. Accounting for online purchases? Don’t forget to count the shipping and handling costs.
While transaction costs may seem marginal, correctly accounting for these costs may change your consumption levels, as each cost may add up to result in a considerable sum.
Interest Rate Calculations
Using interest rates as a benchmark for discounting the value of your wealth is another important aspect of personal finance. Interest calculations have real effects on many aspects of life. For example, when buying a house, it is important to find a bank willing to offer a mortgage at a reasonable rate. Many times, banks may offer a mixture of fixed and floating rates over the life of your mortgage. It will be important to take current and future rates into account when determining the “cost” of taking out a mortgage.
Another example of this is in determining the value of your job. While many salaries are based on an annually-determined number, the real value of your salary may depend on the current interest rate. Using an oversimplified example, getting paid $100,000 a year when inflation is 10% will reduce your real salary to $90,000.
Game Theory
Game theory is a useful tool to help determine your best course of action in response to the interests of others. It is a useful tool, as it takes into account how others will react to your behavior, leading to equilibrium where everyone may realize their best outcomes.
An example of this might be seen in your relationship with a business partner. For example, although your interests may be different compared to a supplier for your company, and both of you would rather charge each other higher prices for your respective services, you may determine that given the longevity of your potential partnership, charging lower prices will actually improve relations, leading to better outcomes for both you and your partner over the life of the contract.