Speed sign showing speed of 82

A Dismal Truth

I go around a lot telling people that having even a rudimentary understanding of economics is like a minor superpower. I stole that from Scott Adams, creator of Dilbert, and the example he used was that the little automated "your speed" indicator sign on a street invariably means there are no actual police watching that street. You can go as fast as you want, because it would be a stupid waste of resources to put that sign and a police officer on the same street. You can put one on this street and one on that street, and you cover two streets for the same price.

Similarly, when that sign is missing, guess what that means? You got it: they put a cop there. Slow the fuck down. And just past the area where that sign used to be, you'll look in your rear view mirror and see mister state trooper camped out in a little honey-hole with his radar gun.

In fact, most police departments do this in phases: they put up the sign and people slow down for a while. They've got a pretty good idea how long it takes people to figure out there's no actual cop, so after that time passes, they move the sign and put in a cop. That cop issues an arseload of tickets, and after a certain amount of time, everybody slows the fuck down. Now they can move the cop and have nothing on that street for a while, because people will behave for a certain amount of time. And then they put the sign back. It's all very scientific and very well-understood. So let's examine some basic economic principles.

Economics is called the dismal science, not because it is particularly dismal to study... but because pretty much everything that comes out of it points to the fundamental reality that people suck, the world is horrible, and everyone is out to get you. Which, if you've been paying attention at all, is kind of what I'm on about in the first place.

There are six principles of economic thought which I consider absolutely essential. The first five are from M. Gregory Mankiw at Harvard, and the final one is from Tilman Slembeck at Zurich University of Applied Sciences. Slembeck calls this "the economic principle," but I prefer to call it "Slembeck's Principle" because it's pretty unique to him... but absolutely brilliant all the same. I don't know why it's not more widely recognised. But first, let's cover Mankiw's first five (he actually has ten, but the last five are less applicable to badassery).

People face tradeoffs. This is kind of the "well, duh" of economics. The entire reason people are making economic decisions is because the choices aren't the same. There are different good and bad points for both. The good points are what we call the utility.

The cost of something is what you give up to get it. This seems like another "well, duh" until you start considering hidden costs. You might think this blog is free, but it actually costs some time and effort out of your day to read it. There is also an opportunity cost that you did not do what you would have done otherwise, and potentially an externality if what you read on this blog causes you to alter your behaviour, thereby altering the cost someone else pays.

Rational people think at the margin. This is easiest to understand with a walkway. If I show you a two-foot wide sidewalk that leads from my front door to my neighbour's front door, you won't have the slightest problem walking down it. But if I show you a two-foot wide catwalk suspended eighty feet above the smelting pot in a steel mill with no handrails, suddenly that same two-foot walkway is far too risky to walk down. The simple presence of risk alters the decision, even if the risk is minimal. You walk down two-foot wide paths every day and never think twice about it.

People respond to incentives. If I offer you enough cash to go across that walkway, you will stop thinking about the risk and just do it. An incentive is either a reduction of cost or an increase in utility. Risk is potential cost. Suspending the walkway produced a very large potential cost which, while unlikely, was simply unacceptable. Similarly, a reduction in utility creates a negative incentive.

Trade can make everyone better off. This is the one I want to beat into everyone's head. You do not have to rip someone off to get their money. Trade is not a cheat or a trick or a dodge where someone always has to get screwed. You can, indeed, get paid enough to make you happy while delivering a product or service that makes your customer happy. Everyone can be happy. Karl Marx was wrong.

Finally, Slembeck's principle: you can optimise for low cost or high utility, but never for both at once. Your customer is always making one of these optimisations, and trying to optimise for the other on your end is not going to work. When your customer wants to spend $10, and your product costs $20, there is no added utility which will optimise for the customer's needs. You must reduce cost, without removing the customer's target utility.

Look around for examples of these. Notice them. Apply them to your decision making. You will find yourself making better decisions almost immediately, because economics has very little to do with actual money: it is the science of how people make decisions.

I'll apply some of this to common business questions tomorrow.