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Mindware: Economic Thinking

Mindware - Economic Thinking

Continuing with trying to see how we can improve our thinking process, the next series of chapters in Mindware by Richard Nisbett centers around economic thinking. You should get the book because the author has a lot of insightful knowledge about human behavior and I won't be touching those. There are some really interesting tidbits.

But first, before I get into the economic thinking, here is an article about evangelicals disbelieving the media and science and trying to maintain their "Biblical living". The article is an eye opening look at how the religious deny science because they are trying to hold onto their religion. They believe "climate change is not real, that evolution is a myth made up by scientists who hate God, and capitalism is God's idea for society." I don't think science actually negates the idea of God (although it weakens a lot of the ideas about the birth of Earth/universe and the evolution of man but science still hasn't proved that there isn't a superior being behind all of this). But the evangelicals fear that science will weaken religion and it is that fear that makes them susceptible to fake news.

So with that, let's go on with how we can improve our thinking with economic thinking. This should be suitable for the religious because it is the kind of thinking that capitalists go for. Here are the big takeaways from the three chapters on economic thinking:

1. Use Cost Benefit Analysis

I am certain that this is something we all have heard of. You list all of the costs and the benefits of a certain action, apply some probabilities of those costs and benefits happening, and then sum up the parts to get the whole. You go forward if the net sum is positive and you halt if the sum is negative. The cost benefit analysis can't really be a precise science because sometimes you don't know all of the costs or benefits, and even if you did know, you can't really know the precise figure of the costs or benefits or their probabilities. There is a lot of uncertainties with cost benefit analysis. But even with all of those unknowns, it is still a good exercise to go through the cost benefit analysis before making your final decision. Just the activity of doing the analysis makes you consider the impact of the decision and makes you better prepared for when things don't go as plan.

Along with the cost benefit analysis, there is the sensitivity analysis that allows you to play with the unknowns to see if they have a big impact on your decision. If changing the variable of the unknown doesn't change the results much, then you can be fairly certain that that unknown is not as important.

Knowing that one can't really be precise about the cost benefits of a certain decision, especially if the problem is a complex problem with a lot of moving parts, you have to be skeptical if someone offers you a precise number. So if a government official says that such and such action will reduce poverty by 16.34%, you have to look at that statement with a jaundice eye. But you also have to listen to them to evaluate what their thinking process is. It will be the thinking process, the assumptions, and the methodology that will be important. Yes, some topics are complicated, but at least know that Medicare is a government system and that Obamacare is the same as ACA. You have to get informed.

2. Sunk Cost

Tied closely to cost benefit analysis is Sunk cost. Sunk cost is the principle of ...whatever you have spent in terms of money and time, it should not have any bearing on your decision on whether to proceed with a future action. It's water beneath the bridge. This is a hard concept to get around behaviorally because we have a tendency to consider our past investment in an activity. But consider this, if you already spent $150 on something and it turns out you didn't like it, do you continue to use it? You stop using it and return it or you just stop using it. (I suspect a lot of us just stop.) Rely on the economists' motto: the rest of your life begins now. Don't continue to do something you dislike because you have already spent time and money on it.

The author provides an application of this concept: when a company says they need to price their product to recoup their costs, don't accept that notion. That money is gone and they've already made the investment. They made that decision and bore the cost a long time ago. The calculations were embedded into their decision.

Some thinking tools:

  1. Be aware that we don't always know what is going on in our thinking process.
  2. Take into account of the fact that the situation may be driving people's or even your behavior.
  3. Rely on your unconscious to solve some of your problems because there are certain kinds of problems that your subconscious is best at solving.

3. Opportunity Cost

Another concept tied to cost benefit analysis is the idea of opportunity cost. Always weigh what it is you give up doing if you were to do activity A. If doing activity B was going to provide you greater pleasure or accrue to you more wealth, then why are you doing activity A? The greater wealth or the greater pleasure is the opportunity cost if you were to choose to do activity A rather than B.

4. Loss Aversion

Be aware that your aversion to loss is stronger than your propensity to take risks, even if there is a gain. Your fear of loss will stop you from taking that risk. The way to counteract this propensity is to evaluate whether you can afford a relatively minor loss in order to pursue a chance for a much greater gain.

5. Default to the Status Quo

We tend to stick with the status quo so arrange your life where the path of least resistance is most beneficial to you. As a way of understanding this concept, consider that you have a choice of benefit A and benefit B, where benefit B is the more favorable benefit for you. You want the situation to be set up where benefit B is your default choice and you have to opt out in order to choose benefit A. If benefit A is the default choice, you would have to opt out of it and choose benefit B. Being lazy, we'll probably just take the benefit A rather than expend more work to get to B. I can't think of a real life situation where we ourselves can set up situations best for ourselves, but there are plenty of situations where companies can set up things where you would naturally make a better choice.

I will stop here because while there are other psychological tricks to use in the book, they are more for helping other people than something you can use yourself. As an example, "less is more" is where if you want to get people to buy your products, don't offer so many versions. The variety overloads the decision circuits and people end up not buying. Then there is the "social incentives" where social incentives works better than money or threats. The social incentives are of the form where people's behavior is better than yours and so you are kind of induced to follow the crowd. (To my mind, these social incentives are indications of the lemming behavior that most of us fall into - we look at what others are doing and we fall into same behavior in order to fit it. Those behaviors can be good or bad. I'm thinking Nazi Germany.)

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