I teach many concepts and principles in my economics classes. But if I only had one brief class session with my students, I would want them to understand three key concepts. Here’s what I’d like them — and you — to know in the hope of viewing different situations and voluntary exchanges in a new and more useful light.
1. Sunk Costs — All the Single Ladies
I tell my students that after my class, their Facebook status will change from “in a relationship” to “single” or at least, “it’s complicated.” This is because they will learn the concept of sunk costs.
A common example to help explain sunk costs is the movie theater experience, where a person buys a ticket and, 20 minutes into the movie, she realizes that it is a horrible movie and it will only get worse. But then the devil on her shoulder says, “You had better stay and get your money’s worth.” The reality is that the money is already gone. What this person needs to understand is that the only costs that should matter in decision-making are future opportunity costs.
What does this lesson have to do with relationship status? Learning about sunk costs opens students’ eyes and leads some of them to tell me at the end of term that they have broken up with their boyfriend or girlfriend.
Many people find themselves in a situation where they have been dating someone for a long time and they think that if they do not continue investing in the relationship or even get married to that person, then their investment of time was a waste. So, they rationalize their decision to stay in the relationship even though their gut tells them something is off. My students unfortunately listen to too much of Beyonce’s “All the Single Ladies.” I tell them, “If you like yourself, then don’t let him put a ring on it” or “Don’t put a ring on it.”
Once they understand that their future is what matters and not their previous investment of time, they realize that it is better to be single and potentially find a new partner than to move forward with the unsatisfactory relationship. Those past years of dating are gone, but that loss doesn’t have to ruin their future too.
If Match.com claims that that no other dating service has resulted in more marriages, I think I can claim that no other professor has broken up more relationships and prevented more marriages. And I’m proud of that!
2. Nothing Is Free — Price vs. Cost
What is the difference between the words price and cost? In everyday speech, people will say, “The movie ticket cost me $15,” or “The cappuccino cost me $4.” The problem is that when people do not pay money for something, they will use the F word — free — or some will say, “ I got it at no cost.” This is wrong! Nothing is free.If someone gets something without having to pay money for it, then they should say they received the item for a zero price. However, there is always a cost — the highest-valued alternative given up. Using the movie ticket example, the correct way to characterize the transaction is that the price of the movie ticket was $15, but the cost was the next best thing that the money (and time) could have been used for.
Why am I so picky about this issue? Because I want my students to understand that even though they may not pay money to get certain items, nothing is free; there is always an opportunity cost involved. Zero price is very different than zero cost.
3. Revealed Preference — Actions Speak Louder Than Words
On the first day of class, I tell my students in a soft voice, as if to make sure nobody outside can hear me, “If you saw my paycheck, you would know that I am being exploited. I am being taken advantage of.”
Many students nod their heads in agreement, as if they are in solidarity with me. They have probably heard from other professors how teachers are underpaid and undervalued. I then ask, “How many of you would do something voluntarily if it was not worth it to you?” No one raises a hand.
In a voluntary exchange, both parties expect to benefit. That is why my institution hired me and has kept me on as faculty, and that is why I choose to go to work each day. Obviously, I would love the number on my paycheck to be much higher, and the institutions would love to pay me nothing; nevertheless, that I choose to go to work each day and that the university continues to give me paychecks proves that both sides of this exchange are winning.
Actions speak louder than words, and that is what revealed preference is. I might say, “I am being exploited by my employers,” but my action of choosing to work at my institution proves otherwise. Revealed preference sheds light on numerous discussions that arise in my economic class, including the debate on “sweatshops.”The same lesson applies to our purchases. People often say they are “being ripped off” at the movies by the “high” price of the ticket and the “exorbitant” prices of popcorn and soda. Interestingly enough, though, I have never been to a movie theater where I was forced to go inside — I have always chosen to enter the theater and pull out my wallet. Once inside the theater, I have never been tackled and then dragged to the concession stand and had money forcibly taken from my wallet — I have only voluntarily chosen to stop, smell the popcorn, go the cash register, and order the popcorn.
My choice to go to the movie and buy the soda or popcorn proves I do not think the experience is a rip-off. Obviously, I would not do something if I expected the benefit to be lower than the cost — the next-best thing I could have done with my time and money.
To be clear, I am not arguing that there is no such thing as a rip-off. My point is that if the exchange is voluntary and there is no fraud or misrepresentation, then it is a win-win transaction.
There are, of course, more topics and concepts that students learn about in an economics class, but the concepts of price vs. cost, sunk costs, and revealed preference are three foundational points that clearly address many real-life situations students find themselves in, from dating to complaining about getting “ripped off.” These lessons give them the tools to make better decisions and be happier in their personal lives.