Fall 2006

The Every Day Life of Economics

Dr. Andrew Brod discusses how fundamental economic principles affect the everyday life of business.

There’s a misperception that the study of economics is an academic affair – that it’s one of those things you learn while in school, take your exam and get your paper for the real world of work. Not so, says Brod, an economist and director of the Office of Business and Economic Research.

Q: How does economics affect the everyday life of business?
A: I think that’s a mistake a lot of people make about economics, and frankly a lot of other fields. There are a lot of ways, even if they don’t realize them, that they impact everyday life. Economics being the “liberal art” of the business school, isn’t about how to run a day-to-day business in the way that, say business administration or operations management is, but it’s the study of economic relationships. There are a number of principles in economics that pop up again and again in the business world. It may well be that people don’t realize they are operating on these principles, but that’s exactly what they are doing.

Q: For example?
A: One example is the notion of marginal costs: The idea that your best decision at a given point in time may not be a function of how you are doing on average, but rather how you can do from here on. Sometimes profit’s out of the picture, but if you can minimize lost, then you’ve done the best you can for that situation. So, understanding what the decision at the margin is about is extremely valuable to business people, whether or not they put that particular label on it.

Q: How is that different in a traditional economy as opposed to the current economy?
A: One of the things that we see, when we look at the knowledge economy, is that the nature of costs has changed. Additional cost is fractional. When you are talking about producing software, for example, or providing expertise in a consulting service – the upfront costs are everything. Once you produce that thing in the knowledge-based economy, whether it’s a piece of software or an area of expertise, the marginal cost of doing it again and again and again is very, very small.

That’s where the study of economics comes in: The situation, the traditional versus the nontraditional economy, has changed, but the economic principle has remained constant.

Q: What’s another example of an economic principle that has application in the everyday life of businesses?
A: Opportunity cost. That’s another fundamental concept. It’s a thing that may well be that opportunity cost is the single most important, biggest concept in economics. Economics is the study of costs. Opportunity cost is the idea that every action involves a cost – even if it looks like it’s free. There’s some other way to use your time, your resources or, when we are talking about business, use your people. As a manager, one has to have an intuitive understanding of opportunity costs. If you have an employee spending half a day explaining, say, employee benefits, that’s a half a day that person could be spending elsewhere.

Q: What about the concept of supply and demand?
A: Opportunity cost may well be the defining concept of economics, but supply and demand are pretty darn important, too. One of the things a business person has to do in any setting, whether it's old economy activity or new economy activity, is to understand the market around him or her. That means on some level, these people need to understand something about price formation. What does it mean that price goes up? Does it mean that there a lot of it available? A price can go up because the demand for it has risen dramatically. The price can go up because there’s a restraint on supply. So we spend a lot of time talking about shifts in supply and demand curves rather than movements along those curves... If you can understand something like that, then you can –with relatively little informational input– have a very good idea of the market environment. Understanding the difference between whether a rise in costs is a result of an increase in demand or a decrease in supply is very important to making everyday business decisions.