Economic Naturalist

Have you ever wondered why milk cartons are square but soft drink cans are round? Or why CDs and DVDs have different size packaging? Or why some cars have the gas cap on the left side and others on the right side? Or why you pay $90 to rent a $500 tuxedo for a day while you pay $40 to rent a $20,000 car for the same length of time? Or why fast food chains promise a free meal if the cashier doesn’t offer a receipt, even though most customers don’t want one?

Cornell University Economics Professor Robert H. Frank has been using writing assignments based on such questions to help his students discover economics in its natural state. And they have come up with quite a few of these “everyday enigmas” which Prof. Frank has compiled into a book with the example he uses to explain the concept to his students. You can find some of these answers in these NY Times and International Herald Tribune pieces.

Although it’s been released earlier this year, I only recently read about “The Economic Naturalist” a book that promises to unlock many of these design and everyday enigmas. Since many of the questions posed are from his students, and that his writing assignments are for 500 words or less, it sounds by the reviews that I have read (since I have not read the book itself) that many of the answers are “too simplistic and unsatisfying”. Nonetheless, it sounds like an entertaining book that brings back economics into our everyday lives.

Here’s an excerpt from the first chapter which you can read on-line:

The Cost-Benefit Principle

The mother of all economic ideas is the cost-benefit principle. It says that should take an action if, and only if, the extra benefit from taking it is greater than the extra cost. How simple could a principle be? Still, as the following examples illustrate, not everyone finds it easy to apply.

Example 1. You are about to buy a $20 alarm clock at the campus store next door when a friend tells you that the same clock is available for $10 at the Kmart downtown. Do you go downtown and get the clock for $10? Or do you buy it at the nearby campus store? In either case, if the clock malfunctions while under warranty, you must send it to the manufacturer for repairs.

Of course, there is no universally right or wrong answer. Each person has to weigh the relevant costs and benefits. But when we ask people what they would do in this situation, most say they would buy the clock at Kmart.

Now consider this question:

Example 2. You are about to buy a laptop for $2,510 at the campus store next door. You can get the very same laptop downtown at Kmart for $2,500 (and it comes with the same guarantee: no matter where you buy it, you have to send it to the manufacturer for repairs if it breaks). Where would you buy the laptop?

This time, most people say they would buy it at the campus store. By itself, that isn’t a wrong answer. But if we ask what a rational person should do in these two cases, the cost-benefit principle makes clear that both answers must be the same. After all, the benefit of going downtown is $10 in each case, the dollar amount you save. The cost is whatever value you assign to the hassle of going downtown. That is also the same in the two cases. And if the cost is the same and the benefit is the same in both cases, then the answer should be the same as well.

Most people seem to think, however, that saving 50 percent by buying the clock downtown is somehow a bigger benefit than saving only $10 on the $2,510 laptop. But that is not the right way to think about it. Thinking in percentage terms works reasonably well in other contexts, but not here.

So weighing costs and benefits is obviously what you should do. Seeing how the cost-benefit principle works in the context of a surprising example gives you an interesting story to tell. Pose these questions to friends and see how they do. Having these conversations will deepen your mastery of the cost-benefit principle.

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