Accountant VS Economist... FIGHT!

Let me teach you how to make rational decisions.

Thinking like an Economist

People have unlimited wants and needs. The problem is that there are limited resources available, meaning that we can not have everything or be everywhere all at once. Hence, we often have tough decisions to make: How to spend our money, who to spend our time with, and what career path to pursue.

The crux of the matter? Every choice we make contains an implicit trade-off. If you spend your savings on X, you give up spending it on Y. If you enter a relationship with Sam, you sacrifice a potential relationship with everyone thats not Sam. If you choose to study engineering, you give up the chance of becoming a doctor. In economics, this trade-off is called opportunity cost.

Opportunity Cost

Opportunity cost refers to the value sacrificed in order to pursue an action or decision. One of the most common trade-offs in the finance sphere is Saving vs Investing:

The average bank savings rate in South Africa is 3%, whereas the average return in the stock market is 10%. So, if you put your money in a savings account, you are "missing out" on the returns you could have made in the market. The opportunity cost of saving money in the bank is thus 7% per year (10% - 3%).

Accountant VS Economist FIGHT!

As Economists, we have to include opportunity costs when making decisions. Whilst accountants only include the actual value of the product or service purchased, economists also include the foregone benefit in the cost calculation.

Scenario: You earn R30 per hour working as a waiter at a local coffee shop. Today you decide to go home an hour early to spend time with a friend. Whilst hanging out, you buy an ice cream of R20.

Accounting costs: Accountants only include the actual cost of an item. The accounting cost is R20 that you paid for the ice cream.

Economic costs: Economists include both the accounting cost and the opportunity costs in the calculation. The opportunity cost is R30 because you gave up an hour of working in order to spend time with your friend. The total economic cost of this decision is thus R50 (R20 + R30).

So, how should we make decisions?

Well, basically how weve been doing it all along. We view outcomes A and B and make a decision based on the option that gives us the most (perceived) value. The benefit of thinking like an economist is having an awareness of opportunity costs, thereby improving the quality of our decision-making processes.