Economists Do It With Models

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The Real Reason Economics Is The Dismal Science…

January 25th, 2013 · 19 Comments
Decision Making · Econ 101 · Happiness

Just kidding- this is the real reason that economics is called the dismal science, but just go with me here.

Economists are quick to point out that the true cost of something, whether it be a physical good, an activity, etc., is what one has to give up in order to get that thing. This cost includes both explicit costs, which are costs than involve an actual outlay of money or credit card or whatever, and implicit costs, which are the values of the other opportunities that have to be passed over in order to consume a good or perform an activity. One common implicit cost is the value of one’s time, since, by definition, time spent on one activity can’t be spent on other activities.

Economists use this concept of implicit cost (or opportunity cost, though the term “opportunity cost” is sometimes used to refer to the total of explicit and implicit cost) to make predictions about how many hours of labor people will supply. The logic is that, since every hour spent sitting on the couch and eating Cheetos (“leisure” in economic terms) is an hour not spent working, the implicit cost of sitting on said couch is an individual’s wage, since the wage is what the person would have earned by working for an hour instead. Over most normal ranges of wages, this would mean that, as sitting on the couch gets more expensive, people sit on the couch less and work more, which gives a positive relationship between a person’s wage and the number of hours that the person is willing to work.

I’ve taught this concept to my principles students for a number of years now, and I somehow never stopped to think about its depressing implications. Luckily, others have got my back on this:

Like a lot of people, the woman in the cartoon is good at thinking about explicit costs but not so good at thinking about implicit costs. I generally argue that not thinking about implicit costs is suboptimal because it leads to irrational decision making, but, after staring at this for a while, I’m beginning to think that ignorance might be bliss. I guess I can understand why that last graph doesn’t end up in college brochures very often.

Tags: Decision Making · Econ 101 · Happiness

19 responses so far ↓

  • 1 bdbd // Jan 25, 2013 at 6:34 pm

    Is the wise guy drinking a beer or an energy drink?

  • 2 n00bs | I Love Econ! // Jan 25, 2013 at 6:47 pm

    [...] Via Economists Do It With Models: [...]

  • 3 econgirl // Jan 25, 2013 at 6:48 pm

    Given that you described him as wise, I’m going with beer.

  • 4 Bo Zimmerman // Jan 25, 2013 at 6:52 pm

    Ah, the disutility of labor strikes again.

    I’m on the girls side. She understands implicitly that the transaction costs of acquiring a weekend job plus the utility cost of not getting to play her game is far more than the utility she would derive from the marginal supplementary weekend wages.

    Keep playing girl — production makes you wealthy, but wealth can’t satisfy all our human wants. Don’t listen to those who think that the only “rational” choice is continuous 16h/7d production schedules.

  • 5 Colin // Jan 25, 2013 at 7:26 pm

    This argument comes up all the time, but it doesn’t make any sense when you think about it.

    If she is a professional, she likely is paid on a salary basis. If not, her hours are likely not of her own control. Therefore, the amount of money she can make is pretty much capped, unless she takes on trivial other jobs (weekend job at Starbucks) where she will make FAR LESS than $50. The marginal return on an additional hour worked is probably quite low to her.

    Also, leisure time is an important input into productivity. If LeBron James literally played basketball or slept all of the time, it would hurt his basketball playing. he’d get injured and lose his mind.

    All work and no play no only makes Jack a dull boy, but also probably leads to crappy work.

    So the financially optimal allotment actually involves some non-trivial amount of leisure time.

  • 6 Amit // Jan 25, 2013 at 8:04 pm

    But if the utility she gets from playing 3 hours of video games is greater than the opportunity cost of those $300, isn’t she better off?

  • 7 econgirl // Jan 25, 2013 at 8:06 pm

    You’re right – in a lot of cases, workers don’t have what economists would call a “marginal wage”- i.e. extra compensation for extra hours worked. (One could make the argument that extra hours leads to raises, but the relationship is far from clear.) In other cases, however, workers have the option to work overtime or take on side projects and the like, in which case the workers do have a marginal wage, a marginal wage that could even be higher than the worker’s regular wage.

    Personally, I’ve been in both of these scenarios at different points in time, and I’m pretty sure that whether or not I faced a relevant marginal wage did change my behavior.

  • 8 Matt Whittington // Jan 25, 2013 at 8:07 pm

    Actually, even if she were paid hourly, it only costs you that $50 an hour is it is an hour that you would have been otherwise working.

  • 9 econgirl // Jan 25, 2013 at 8:09 pm

    @ Amit: Of course- having an opportunity cost of leisure doesn’t automatically mean that a person should work all the time, it just means that the forgone wages should be taken into account when deciding whether sitting on the couch is worth it.

  • 10 econgirl // Jan 25, 2013 at 8:23 pm

    You guys are making me feel like a weirdo for being able to choose how much I work. :)

  • 11 Colin // Jan 25, 2013 at 8:24 pm

    That’s certainly true…. to a point. It depends on the likelihood of the additional output being enough to outweigh the cost: if you worked 70 hours, how much more are you really getting by working 72?

    Extra hours might lead to raises if you’re a lawyer or consultant, though.

  • 12 Ross Emmett // Jan 25, 2013 at 9:02 pm

    While you’re right about opportunity cost, the real reason economics is called the dismal science is something else:

    http://www.econlib.org/library/Columns/LevyPeartdismal.html

  • 13 Hugo Villeneuve // Jan 25, 2013 at 9:57 pm

    I think about this often and find that it is more intuitive to convert money into hours than the other way around. 1 fun hour = 1 fun hr. 1 smartphone = 8 work hrs. Freelunch if work is fun.

  • 14 Scribmac // Jan 26, 2013 at 9:47 am

    In policing and other shift based labor fields, Overtime (1.5 x hourly wage) can be a substantial motivator to work more. I am familiar with a specific group of 40 officers and can relate that there are about equal numbers of them who work as much OT as offered, rarely take an OT shift, or wish to take more but other factors (not RPG weekends!) prevent it. The factors include whether they have a working spouse, number and age of children, and other interests (hobbies and side businesses) off the job. There are other factors I’m sure.

  • 15 uair01 // Jan 26, 2013 at 4:21 pm

    People with high job skills spend a lot of free time maintaining those skills even if they are not paid. Reading professional magazines, books, weblogs etc. It is both useful and fun. It’s called “working on your market value”.
    But expressing everything in terms of profit and utility feels very inhuman.
    Neque semper arcum tendit Apollo (Apolo is not always straining the bow, meaning that even gods have some fun time on the side)
    :-)

  • 16 BC // Jan 27, 2013 at 2:03 am

    I think there are actually two effects when wages increase: a substitution effect and an income effect. The substitution effect is as described in this blog post: when one’s wages increase, opportunity cost of leisure increases so one substitutes away from leisure to work more. However, the income effect works in the opposite direction: when one’s wages increase, one can afford to consume more things, including leisure, so one works less. From what I gather, the empirical evidence is mixed as to whether the substitution effect or the income effect is larger. The non-dismal way to think about higher wages it that, while it will cost you more to have fun, you will be able to afford it.

  • 17 econgirl // Jan 27, 2013 at 11:36 am

    Right- that’s why I said “over most normal ranges of wages.” It’s generally thought that the income effect (which makes you want to work less because you feel richer and thus like you can consume more leisure) overtakes the substitution effect at very high wages- i.e. you probably wouldn’t work 40 hours per week (if you had the option) if you made a million dollars per hour. Most people, however, aren’t likely at the range of wages where they start feeling that way.

  • 18 Ryan // Jan 29, 2013 at 6:43 pm

    if you work 16 hours a day, your marginal rate of productivity will be so low at the end of the day you’ll be fired or have your work hours restricted
    however for most office jobs, marginal rates of productivity are closely tied to blood sugar levels, if more perfect information was available through the market, workers will be hooked to IV bags with glucose added, encouraged by their bosses
    before multiple workers die from infections
    this can only be balanced out through mandating life or health insurance which would prevent the negative externality from remaining an externality

    fortunately the american public is wise enough not to elect an economist to a position of considerable power

    this is why the federal reserve has only appointed positions

  • 19 Faza (TCM) // Feb 2, 2013 at 10:05 am

    I find it surprising that nobody has mentioned one thing: this comic highlights our tendency to focus on the explicit costs and revenues, though not in the way it intends. This is best explained by illustration and I’ll do so, ‘coz it’s fun.

    Those of us old enough to remember the time where most computer games kept your score, will also remember that most of the time it had very little effect on gameplay (at most, reaching a certain score might mean an extra “life”). If you played Pac-Man, say, the playing experience would be determined by how long you spent playing (and the difficulty of the level you had reached as a result), not by the score you had accumulated. Other than the occasional extra life, your score was just a number. It might be good for bragging rights, but very little else.

    We tend to forget that money is – of itself – worthless. Or rather: it’s only worth as much as you can buy with it. Thus, we will talk of purchasing power and make distinctions between monetary and real value. The mistake this comment makes is that it demonstrates the monetary value of an extra hour spent working, without examining the question of its real value.

    Let’s start with the extreme situation where the girl did nothing but work (being economists, we’ll simply assume its possible). Each hour spent working would add $50 to her bank account. In about 4 years she’d be a millionaire.

    If you were paying attention, you noticed one thing there: she actually isn’t spending any money during all this time (people don’t usually spend money when they’re working; we can further assume that her basic needs are being provided for by her employer by way of the cafeteria, a company dorm, company-provided clothes etc.) Since her ability to work isn’t based on the amount of money she has, her bank account balance becomes just a number. Her life is no different whether she has $0, $1,000 or $1,000,000.

    In order for her wage to be meaningful in any way, she must have time to actually spend it – so she can’t be working all the time. This brings us back to a more realistic scenario and the conversation taking place in the comic.

    “If you stop playing the game and work instead,” the man might say, “you’ll earn $50 per hour to buy more games.”

    It’s a fair statement on its face, until we consider the implications. We’ll assume that if we deduct other spending and savings from each hour’s wage, one hour of work might translate into one new game (okay, at that price point it would more likely be one “not-quite-so-new,-probably-last-year’s” game). So each hour not spent playing games, the woman would earn enough to buy one more game that she won’t be playing.

    Erm…

    What is the utility derived from boxloads of games you aren’t playing? Precious little, I’d say. In fact, they become just another way of “keeping score”.

    In other words, in order for her $50 wage to have any real value, she must not only spend it, but also devote time to deriving utility from whatever it was she spent it on. If she spent an hour’s wage on a game, the more she plays it (deriving enjoyment – and thus utility – from it), the more that $50 is worth to her.

    You go girl! Playing that game is essential to maintaining the value of your earnings.

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