I was recently asked to run a session on the basic principles of economics for a group of university students.
This got me thinking: why would such a group of diverse individuals – most of whom were not studying economics – be interested in economics? Their focus areas likely ranged from choosing between academic courses, dividing time between work and friends or taking their first step on their own career ladders. How could economics help them?
For someone like me who spends much of his day obsessing over how policy or growth or inflation data impacts investments in stocks, bonds or commodities, it is easy to find many reasons why economics matters.
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For most individuals not in the economics or finance domains, though, Economics professor Gregory Mankiw’s Ten principles of economics offers up ten very good reasons why economics matters.
Trade-offs and opportunity costs
Mankiw’s first principle acknowledges that we face trade-offs in most decisions we make. The university students, for example, must choose how to divide their time between studying and heading out with friends, or whether to start professional work after an undergraduate degree or pursue an advanced degree. In my own field, investors must choose whether to direct their savings in low risk but lower-yielding deposits or to potentially higher-return but higher-risk stocks.
A somewhat less-appreciated second principle can help with making decisions amid trade-offs – this is the idea of opportunity costs. Mankiw notes: “The cost of something is what you give up to get it”. The students in my group who choose to do a two-year Masters degree will have to consider not only the direct cost of completing the degree, but also the opportunity cost of the income they could have earned had they started working instead.
Opportunity costs play a central role in investing. One common example is choosing between investing in real estate or in cash deposits. In most markets, it is reasonable to expect real estate to deliver positive returns over the next decade. However, the opportunity cost of this investment is not zero. The question investors should instead ask themselves is whether the real estate investment, after costs, will outperform a comparable investment (bonds, for example) over the same decade. This is a harder threshold to outperform, but this approach to thinking is much more useful to help an investor get the most out of their investments.
Should you do everything yourself?
While this may be an increasingly controversial topic in today’s world, most modern economics textbooks will argue trade can make everyone better off. Indeed, this principle also gains a spot in Mankiw’s top ten principles.
The original argument focuses on trade between two economies, arguing that while the two economies can be self-sufficient across goods, both economies can be better off by specialising in goods which each can produce more efficiently, and buying the remaining goods from the other.. This can hold true for organisations or individuals as well.
For example, it is possible I would be able to repair a leaky tap in my house if armed with a few tools and a reasonable amount of time. However, based on my experience, it’s reasonable to believe that I would be better off focusing on my day job analysing markets and, instead, using those earnings to hire someone with the knowledge and skills to undertake the repairs far more efficiently and effectively.
The argument is very similar with one’s personal investments. Given enough time, most of us would probably be able to invest our savings reasonably well. However, if investing is not your day job, would you really be able to build a better portfolio than an advisor or portfolio manager whose skills and time are solely focused on investing?
Diversifying equity exposure, favouring Asia
Mankiw’s final principle is more macro in nature, stating that society faces a trade-off between inflation and unemployment. The reason I see this principle as being of interest to our university-age group, and indeed most readers across age groups, is because this principle impacts interest rates.
Policymakers, particularly central banks, spend much of their time focused on managing this trade-off by setting interest rates. The US Federal Reserve, for example, faces a dual mandate of ensuring stable inflation and full employment in the US economy. It achieves this policy goal by setting interest rates, which in turns sets the cost of borrowing for the economy.
Most of us would be acutely aware of how interest rates impact us. As investors, these policy interest rates influence the yields we can earn on fixed income investments. As borrowers, policy rates influence the rate at which we borrow to finance a house, a car or a business investment. Investors spend a lot of time assessing the impact of interest rates on the future expected returns of major investment asset classes such as stocks and bonds. In this way, the trade-off between inflation and unemployment impacts our personal finances. Understanding the principle gives us the knowledge to make better borrowing and saving decisions in our daily lives.
Economics can help you make better decisions
My main conclusion from walking the group of university-age individuals through some basic economic principles was that economics is more relevant than they might expect to their lives. These range from how to think through the opportunity costs of each decision to understanding what influences interest rates. Regardless of whether you are applying these to your investments or in day-to-day life, economics can help you make better decisions over time.
Manpreet Gill is Chief Investment Officer for Africa, Middle East and Europe at Standard Chartered Bank’s Wealth Solutions unit
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I was recently asked to run a session on the basic principles of economics for a group of university students.
This got me thinking: why would such a group of diverse individuals – most of whom were not studying economics – be interested in economics? Their focus areas likely ranged from choosing between academic courses, dividing time between work and friends or taking their first step on their own career ladders. How could economics help them?
For someone like me who spends much of his day obsessing over how policy or growth or inflation data impacts investments in stocks, bonds or commodities, it is easy to find many reasons why economics matters.
Follow The Standard
channel
on WhatsApp
For most individuals not in the economics or finance domains, though, Economics professor Gregory Mankiw’s
Ten principles of economics
offers up ten very good reasons why economics matters.
Trade-offs and opportunity costs
Mankiw’s first principle acknowledges that we face trade-offs in most decisions we make. The university students, for example, must choose how to divide their time between studying and heading out with friends, or whether to start professional work after an undergraduate degree or pursue an advanced degree. In my own field, investors must choose whether to direct their savings in low risk but lower-yielding deposits or to potentially higher-return but higher-risk stocks.
A somewhat less-appreciated second principle can help with making decisions amid trade-offs – this is the idea of opportunity costs. Mankiw notes: “The cost of something is what you give up to get it”. The students in my group who choose to do a two-year Masters degree will have to consider not only the direct cost of completing the degree, but also the opportunity cost of the income they could have earned had they started working instead.
Opportunity costs play a central role in investing. One common example is choosing between investing in real estate or in cash deposits. In most markets, it is reasonable to expect real estate to deliver positive returns over the next decade. However, the opportunity cost of this investment is not zero. The question investors should instead ask themselves is whether the real estate investment, after costs, will outperform a comparable investment (bonds, for example) over the same decade. This is a harder threshold to outperform, but this approach to thinking is much more useful to help an investor get the most out of their investments.
Should you do everything yourself?
While this may be an increasingly controversial topic in today’s world, most modern economics textbooks will argue trade can make everyone better off. Indeed, this principle also gains a spot in Mankiw’s top ten principles.
The original argument focuses on trade between two economies, arguing that while the two economies can be self-sufficient across goods, both economies can be better off by specialising in goods which each can produce more efficiently, and buying the remaining goods from the other.. This can hold true for organisations or individuals as well.
For example, it is possible I would be able to repair a leaky tap in my house if armed with a few tools and a reasonable amount of time. However, based on my experience, it’s reasonable to believe that I would be better off focusing on my day job analysing markets and, instead, using those earnings to hire someone with the knowledge and skills to undertake the repairs far more efficiently and effectively.
The argument is very similar with one’s personal investments. Given enough time, most of us would probably be able to invest our savings reasonably well. However, if investing is not your day job, would you really be able to build a better portfolio than an advisor or portfolio manager whose skills and time are solely focused on investing?
Diversifying equity exposure, favouring Asia
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Mankiw’s final principle is more macro in nature, stating that society faces a trade-off between inflation and unemployment. The reason I see this principle as being of interest to our university-age group, and indeed most readers across age groups, is because this principle impacts interest rates.
Policymakers, particularly central banks, spend much of their time focused on managing this trade-off by setting interest rates. The US Federal Reserve, for example, faces a dual mandate of ensuring stable inflation and full employment in the US economy. It achieves this policy goal by setting interest rates, which in turns sets the cost of borrowing for the economy.
Most of us would be acutely aware of how interest rates impact us. As investors, these policy interest rates influence the yields we can earn on fixed income investments. As borrowers, policy rates influence the rate at which we borrow to finance a house, a car or a business investment. Investors spend a lot of time assessing the impact of interest rates on the future expected returns of major investment asset classes such as stocks and bonds. In this way, the trade-off between inflation and unemployment impacts our personal finances. Understanding the principle gives us the knowledge to make better borrowing and saving decisions in our daily lives.
Economics can help you make better decisions
My main conclusion from walking the group of university-age individuals through some basic economic principles was that economics is more relevant than they might expect to their lives. These range from how to think through the opportunity costs of each decision to understanding what influences interest rates. Regardless of whether you are applying these to your investments or in day-to-day life, economics can help you make better decisions over time.
Manpreet Gill is Chief Investment Officer for Africa, Middle East and Europe at Standard Chartered Bank’s Wealth Solutions unit
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By Manpreet Gill