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Discovering your inner economist

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Wednesday, Sept. 26, 2007
 

Economics cannot tell you what the price of gold will be next week. But it can help you choose good restaurants.

Contrary to popular myth, economics is not a science for forecasting asset values. If it were, economists would be the richest people in the world -- and the thousands of us who work as college professors would long ago have resigned our faculty positions so that we could devote our efforts full-time to investing.

Among the most valuable insights that economics does offer about investing is to ignore anyone who announces publicly that he knows what will happen to stock prices tomorrow. Anyone who sincerely believes himself to possess such knowledge will not give it away or sell it on the cheap. To do so would be like passing out hundred-dollar bills to strangers or offering to sell hundred-dollar bills for $25 apiece: Very few people are so selfless. If I am confident that shares of, say, IBM will rise tomorrow, I don't want other people competing with me to scoop up IBM shares.

But finding a good meal, well, that's a different story.

In his new book, "Discover Your Inner Economist," my George Mason University colleague Tyler Cowen explains that those of us who enjoy unique and tasty flavors in our meals should avoid restaurants located in fancy shopping malls or on major thoroughfares.

These restaurants must pay high rents to occupy such locations and, therefore, they need customers in high volumes. Because these restaurants must appeal to large audiences, meals there will be more predictable and bland than those served in restaurants located off beaten paths.

So if you're hankering for dinner at a restaurant featuring bold or unusual tastes -- at a restaurant that serves ethnic dishes that are truly authentic -- you'll have better luck going to a Chinese or Ethiopian or Cajun (or whatever ethnic variety you crave) restaurant that is located on a side street or in a suburban strip mall. With lower rents to pay, such off-the-beaten-path eateries are more likely than are restaurants in high-rent locations to cater to serious foodies.

Choosing a restaurant is just one of many important and surprising insights offered in Cowen's book. The most interesting insight for me is that bygones are not always best treated as bygones.

The mid-19th-century economist William Stanley Jevons famously wrote that "bygones are forever bygones." Economists have overwhelmingly taken Jevons' statement as advice to ignore sunk costs. This advice generally is sensible.

Suppose you've spent $10 million building a machine that can do nothing but produce chocolate-covered pickles. You discover soon afterward that no one wants to buy your product. Your wisest course from this point forward is to suck up the loss. Continuing to produce chocolate-covered pickles that no one wants to buy will only deepen your losses, doing nothing to help you recover your investment.

But Cowen shows that bygones should not be treated as bygones in all areas of life. When our self-image is at stake, past choices -- costs that are irrevocable -- often remain relevant for guiding our decisions today.

For example, many of us think of ourselves as physically fit. Because of this self-image, we often buy memberships in gyms. But on many an evening, after a long day at work, we're typically tempted to relax at home rather than spend an hour exercising at the gym. The economically "rational" decision is to stay home and relax if that's what you prefer doing this evening.

After all, whether you go to the gym or not, the money you've spent on your gym membership is already spent. You'll not get that money back if you don't use the gym this evening. So the fact that you've already paid for a gym membership should not factor into your decision on whether to go to the gym today.

But sometimes this fact does indeed matter. Sometimes we think, "Geez, I've paid for that gym membership. I should go." And we then summon our remaining energy and head off for some exercise -- even though if we hadn't paid for the gym membership, we definitely would avoid the gym this evening.

Again, as a narrow economic matter, that's a silly thing to say and do. From a less-narrow perspective it's entirely reasonable. By going to the gym we reinforce our positive self-interest. And if the mental trick of pretending that sunk costs are relevant helps in this effort, it's a worthwhile thing to think.

For a wonderfully enjoyable and practically useful read you can do no better than to discover your inner economist by reading Tyler Cowen's new book.

 

 
 


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