There are many definitions of economics, but almost all of them revolve around the same thing. Economics is the science that studies how resources are managed to satisfy human needs. From here, the idea arises that resources are scarce and demand, supply, and, consequently, prices appear.
However, you have to pay close attention to the end of the concept: “satisfy human needs”. Some would say that to maximize profit, a very interesting economic concept. Therefore the goal of economics is to understand how satisfaction, utility, and happiness of human beings can be maximized.
Throughout the hundreds of years of history, economic studies have discovered many things about human behaviour and how to maximize this satisfaction. And some teachings can be taken on an individual level.
The economy as an aggregate
It is true that economics often focuses on the aggregate and not on the individual. Supply and demand, one of the foundations of any economics course, speaks in large numbers, not at the individual level. Macroeconomics speaks of the large countries, with millions of individuals. The large numbers that we see in the media are aggregated.
But some study economics on an individual level. How to make the best individual decisions to maximize satisfaction. For example, the 2017 Nobel Laureate in Economics, Richard H. Thaler, studied the economics of individual behavior.
In his studies, he found that the human being is not really rational (at least at the individual level) and is carried away by the short term, It has an aversion to losses that is higher than reasonable and mentally creates separate compartments to simplify decision-making.
That is why humans do absurd things, such as not investing in the long term, not selling stocks when they are falling. All in the hope of recovering the investment or spending the same time deciding to buy a 100 euros as a 20,000 Euro car.
But what can we do to maximize satisfaction? What does economics tell us that human beings can do to try to be happier?
The cost of the opportunity
It is complicated to stop being irrational. All these mechanisms that take us away from the typical homo economicus who makes his decisions rationally, valuing costs and benefits are intricate. We make many decisions unconsciously, without much thought. This has its advantages, such as that we can go up and down stairs without making a great mental effort and without falling (if we think about it, it does not seem so easy) or are able to recognize faces without consciously paying attention to the details.
Now, these advantages turn into disadvantages when automatic mechanisms boycott us. So at least in conscious decisions, you have to try to give them a bit of rationality. Assessing the cost of the opportunity in our choices can help us.
The opportunity cost is what you give up when making a decision. And we are not talking only about monetary value, but also about time. For example, suppose we decide to go out on a Saturday night and drink a lot. In that case, we know (or should know) that the morning (or even the afternoon, depending on the hangover) on Sunday will be wasted. All those plans that can be made for Sunday, like going for a walk, meeting for a coffee, having a brunch, or simply going to a family meal, are canceled.
What gives more satisfaction? That is the question we must ask ourselves. In every plan we accept, what are we missing? And of course also in shopping. If I have a vacation budget that allows me to go a month to the beach or a week of exotic tourism, what is the most satisfying thing to do? Because by choosing one thing, you give up another.
Also, for example, when choosing a home. Maybe you have to choose between living in a more beautiful neighborhood (or closer to work) or having a terrace. What brings more satisfaction? In important decisions (choosing a home, work, partner, important purchases such as a car), it is advisable to assess the opportunity costs since the decisions will strongly shape the future.
The sunk cost
Another interesting concept to make better decisions is sunk cost. As Thaler explained, the human being has irrational adversity to losses. And this makes you sometimes make wrong decisions (if what you want is to maximize satisfaction).
The sunk cost is the cost that has already been given, and that cannot be recovered in the future. Human beings confuse them with an investment, but there is no return. It is a cost, and it has already been made.
A clear example is going to the cinema and discovering that the film is very bad at the beginning. Most people will stay because they have already paid for the entrance. But the cost has already been paid, regardless of whether one stays in the cinema or not. Does staying in the cinema maximize satisfaction? No. And there is also an opportunity cost since something else more attractive could be done.
The sunk cost also occurs in other situations, for example, in relationships. Sometimes people stay with their partners despite an apparent dissatisfaction with the time invested in the relationship. But no, it is not an investment; it is a cost already paid. Furthermore, continuing in an unsatisfactory relationship also has an opportunity cost, finding someone more satisfactory.
Therefore, in situations where the typical “I would not do this but with everything I have invested” arises in the brain, it is necessary to assess whether it is an investment or a sunk cost. And also evaluate the cost of the opportunity.
Only with these two concepts in mind, the historical study of economics can help us make better decisions and be happier. So later they say that the economy is boring.