How are economic theories used in the real world
The simple act of shortening Adam Smith’s iconic book ‘An Inquiry Into The Nature And Causes Of The Wealth Of Nations’ into its three-word, more commonly-known title ‘Wealth Of Nations’ already feels like a misrepresentation.
To search for the cause of something hints at an adverse event. We go searching for the cause of a virus or a global banking crisis or terrible leadership. We don’t go looking for the cause of happiness; then it’s the source.
Semantics you say, but the application of the economics that Smith investigated in his 1776 book reveal the same kinds of misrepresentation.
His ideas of the invisible hand and benefits of specialisation for a corporation were never intended as an advocate for total market deregulation
I doubt that Smith would have celebrated the news this week that Amazon founder Jeff Bezos is worth $200 billion. Not in a country that can’t offer healthcare for all of its citizens, in a world that grows less equitable each day.
Russ Roberts, economist and author, has written a book, ‘How Adam Smith Can Change Your Life; An Unexpected Guide To Human Nature And Happiness.’ On the Free Thoughts Podcast Roberts shares two aims for writing this book.
Firstly, it was an attempt to counter the misguided legacy that Smith was an intentional advocate for greed and selfishness.
Secondly, related to the point above was that when people looked at the field of economics, they thought of money and the sole act of acquiring wealth but,
So with that sentiment in mind, I want to share three simple economic theories that I turn to when I’m feeling stuck or in a period of stagnation.
The Law of Diminishing Returns
The law of diminishing returns applies to the production process of a firm, and the principle is that all other things kept equal the output value of adding one additional input at some point will start to drop off.
The theory predicts that after some optimal level of capacity is reached in the resources used for production to carry on, adding another input will not yield any larger increases in output.
Put simply; you can’t just keep adding the same thing over time to get better results.
There are many reasons for the law of diminishing returns, one being you’re yielding less efficient use of the fixed factors (think land on a farm or machinery in a factory) or a change in technology but let’s leave economics here for now.
An article in Reuters reports that diminishing returns are used in health and fitness training, especially weight loss, where increasing one element of your programme will ultimately lead to a flatlining or drop in the outcome if everything else remains the same.
On a personal growth level, this means that just throwing more of one unit of resource at your desire will have a peak point after which point the results will start to diminish.
Think of the money spent on a marketing campaign. At some stage, the process needs to be adjusted because more dollars will not equate to more clients.
Or what about the learning process? At some point, just adding more practice time will reach its limitations.
Improving My Short Stories With Additional Writing Time
I’m interested in transitioning from writing scripts for the stage and film to short story and novel writing, so I decided to take on Ray Bradbury’s good advice that it’s not possible to write 52 bad short stories in a row.
I get the point. Writers need to write and without self-consciousness. So I set myself the task of writing a short story a week. I also work with clients and own my own business, so I scheduled in the writing time for each week.
The first four hours for each story over the week were fantastic. I took an idea from my head, or heart onto the page. I had character and setup, but after the first draft, the act of sitting in front of the laptop no longer yielded results in the quality of the story.
After the first draft, splurge just adding time to my process was no longer efficient. I needed analysis, I needed craftwork, I needed more input. In short, I needed deliberate practice.
As you can see from the diagram above, simply adding more writing time had a positive impact on the quality of the stories up to a certain point.
I had to re-define the process of a short story to include craftwork and reading alongside practice. The immediate returns were slower, but the quality continued to increase at a steadier state.
If you’re already thinking that your practice isn’t leading to satisfaction, you’re halfway there. Map out the factors of production for your craft or hobby and play around with the emphasis you are putting on each of them.
Perhaps there’s something as simple as a tidy desk or a different slot of the day to work.
You know this one and probably apply it to the more significant decisions that you make in life; such as where to live, which job offers and clients to seek out and those to avoid.
In economics, the opportunity cost is simply the measurement of loss between the choice you made and the next best available.
This is applied at a microeconomic scale; how we as, consumers or producers spend and allocate our available resources.
We measure the opportunity in financial terms. Likewise, a government may calculate the opportunity cost of investing in different areas of national governance.
If we go back to Robert’s theory that economics is a measure of how to get the most out of life, we should see different measurements of opportunity cost.
Time, energy, goodwill, motivation, creativity, passion etc.
Any big decision you make in life will have an emotional output. You may need to go to a specific workplace where a bully controls a terrified workforce. You get paid x amount to go there.
What’s your next best offer? Maybe it involves less money but less stress. Maybe not.
As freelancers, we have more freedom than we give ourselves credit for. What matters? High rate, quality relationships, quality of work, the regularity of work?
Sometimes we don’t stop to put all of the priorities in order when all it takes is a little analysis of what you’re getting out of your current situations whether it’s work, relationships, study or hobbies.
Tough Conversations About Money
This year I’ve spent a lot of time putting energy into significant project proposals that a potential client then decides they don’t have the budget for.
This is a freelancer’s life, and there are certainly efficiencies required at my end, but it’s a time and love loss I need to be aware of as I grow as a business and a business-person.
I had a lead contact me recently about a medium-sized digital content package. They gave me the basics over a message and requested a Zoom.
I wondered; should I bring up money or should I just go with the flow and bring it up at the right moment?
The first option meant potentially putting off the client by being too abrupt too soon but the second option involved losing time on the zoom, the energy of engaging with someone else’s project, the will to carry on in my business and ultimately losing the project anyway because the budget wasn’t available.
The difference between the two options was quite large, and you know what, the lead was fine with me bringing up the budget.
What is the opportunity cost in terms of risk or reward for the day to day decisions you make? Maybe one action isn’t as dangerous as it seems when compared to another.
Economies of Scale
Economies of scale are cost advantages reaped by companies when production becomes efficient. Companies can achieve economies of scale by increasing production and lowering costs.
Over the hundreds of years and multiple industrial revolutions since the publication of An Enquiry Into The Nature And Causes Of The Wealth Of Nations’ the factors of production have changed significantly.
Even now, as we head into Industry 4.0, the aspects of efficiency are shifting. 3D printing and other manufacturing elements, the crash, temporary or not of commercial business premises will all have their part to play in a business achieving economies of scale.
And that balance between inputs and output to achieve equilibrium transfers easily to our well being and personal growth. In New Zealand, the Jacinda Arden government is one of the latest to abolish GDP in favour of a happiness index measure of wealth. Bhutan was reportedly the first country to do this in 2008.
If national economies can start to recognise the alternative factors that contribute to making their citizens thrive, shouldn’t we be able to do the same with our H factor?
It may sound a bit glib right now with traditional jobs at risk because of the virus, but this has always been the case throughout history. When elements such as national economic governance are so far out of your control, it’s an excellent time to take a look at the other factors that drive a sense of equilibrium in your life.
Health and Fitness
Friends and Families
Maybe if your corporation or your clients are a bit up in the air themselves, it’s time to get some re balance in your life by focusing on the non-financials.
Focus on the things that increase your happiness index because if you fix the finances alone, you’re not fixing the other elements. On the flip side, something like happiness and satisfaction may drift over into the finances.
Writing has been an enormous calming force in my life; from discovering how to construct a character and plot to putting together a huge story, it had given me a reason not to be as reckless as I was when I was younger.
My own storytelling in terms of productions and awards wouldn’t make much of an appearance on any financial chart. Yet!
But a month ago, after spending hours every day marketing my business and feeling tired and square-eyed from looking at the screen, I shut everything down and took to my notepad.
Within five minutes, I swear I was in bliss; just me and my story world and what happens after that? You feel primed and ready to take on the universe. once more.
What are these bliss points for you? What are things that you can’t quantify that make you happy or satisfied in life? Find them and then maximise them. They’re not moments that you need to share. They’re moments with yourself that make your personal development flourish.
I hope this has given you some ideas to start to manoeuvre yourself if you’re feeling stuck. Trust in the good nature of our Enlightenment friend Smith and look inside the field of economics for insights into areas for personal growth in your own life.
Remember, when all else is unequal there are answers to be found within these ideas in economics:
- The Law Of Diminishing Returns
- Opportunity Cost
- Economies of Scale
Thanks for reading.