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Economics of everyday life

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Matt Smith:

Welcome to a La Trobe University podcast. I would be your host Matt Smith and my guest today is Dr Wayne Geerling, a lecturer in the School of Economics and Finance at La Trobe University. Thank you for joining me, Wayne.

Wayne Geerling:

Thanks for having me.

Matt Smith:

You teach a lot about the economics of everyday life and there are a lot of misconceptions about economics. What does economics mean to you?

Wayne Geerling:

Economics is a very interesting phenomena. It originally evolved from a social science perspective. Economists basically describe the way we think, feel and act. It's a social science in that it explores the various agencies of human behaviour.

Matt Smith:

So most people would think that it's to do with number crunching, but it goes beyond that?

Wayne Geerling:

Oh absolutely. The common perception these days tends to be about data and number crunching, and markets and growth and macro-economic concepts like that. But economics as a social science is much broader than that. I think one of the great things about economics is that it can help us understand the way in which the world works.

Matt Smith:

How does an economist see the world?

Wayne Geerling:

An economist sees the world basically through a typical micro-economic toolkit. That involves things like thinking at the margin, rationality, opportunity cost, trade-offs – economists like any other discipline or dogma has its own jargon and its own rules and its own way of seeing the world. So basically economics, or economists in general tend to apply micro-economic concepts like that to explain the way humans behave and to make predictions about the future.

Matt Smith:

Is it a more efficient way of looking at things?

Wayne Geerling:

Compared to …?

Matt Smith:

I'd say a conventional way to look at it is an economist takes the humanity out of being human sometimes.

Wayne Geerling:

Well, that's a claim or accusation made against economics. In general the neo-classical paradigm which is the dominant paradigm of our time has often been accused of exactly what you mention there. But economics is a very broad discipline. There are many different ideologies and sub-disciplines within that. There is not one way of looking at the world. I mean, economists rarely agree about anything, to be honest. But there are certainly different ways of looking at economic problems. Economics brings a different element, compatible to some extent, and they all offer pluralism in life, which I think is important.

Matt Smith:

So one of the subjects, a second year subject that you're teaching, is the Economics of Everyday Life. What are you trying to teach in that?

Wayne Geerling:

What I'm trying to do there is basically teach students to think intuitively about economics. I mean, students who study economics, some of them do a Bachelor of Economics. La Trobe also offers a Politics, Philosophy and Economics Degree. But the majority of students that we have doing Economics at first or second year level are doing it as a service subject. That means they're doing a different degree. So most students don't have a proper understanding of what economics is about. They don't study it at high school and if they do study it in first year, they only get a brief exposure to that. What I try to do in Economics of Everyday Life is show students that economics actually influences basic human behaviour, from the conventional financial decisions to the non-conventional – dating, alcohol, drugs, sport, gambling. Economics is all around us, whether we like it or not. So what I try to do is show students that it's relevant, that economics can be used to explain phenomena that they probably had never conceived of. And also that there's a counter-intuitive streak in economics, the recent publication of books like The Undercover Economist, The Economic Naturalist, Freakonomics was a best-seller. These types of books basically specialise in showing people how to relate economics to their everyday life. So what I'm really trying to do is teach students to think intuitively, to understand economics as a way of seeing the world, rather than number crunching, rote learning, memorising, abstract sort of modelling concepts. I mean, they are important in economics, and people who study economics need exposure to the models and the theories and the concepts, but I believe that when we're trying to broaden the interest in economics, we need to appeal to other interests in students, we need to make subjects that are relevant to their lives. Economics doesn't have to be dry and abstract. It can pretty much be used to explain so many political, social, personal and environmental phenomena.

Matt Smith:

Let's get to a couple of specific things here. In the supermarket, when you buy a bottle of Coke, and the bottles that are smaller, the 325ml, cost a lot more than the larger bottles, the 2 litre bottles. What's an economist's view on that. Where's the logic in that?

Wayne Geerling:

Well, economists start from the view that humans are rational. Rational behaviour explains most of what we do in life. Now there are exceptions to the rule. So when an economist sees that example of a small bottle of Coke costing more per litre than a large bottle of Coke, we assume that there is a rational explanation to that. When people walk into a supermarket and buy a bottle of Coke, the cost per litre is displayed on the shelf. So if somebody chooses to buy a small bottle of Coke when it costs more per litre than a large bottle of Coke, they do so with full knowledge of the cost transaction. So there are various economic factors which explain that. A small bottle of Coke which is bought by the cashier is probably cold, so there's convenience. A large bottle of Coke is at room temperature – you don't often drink Coke at room temperature. So the convenience factor explains one aspect of it. Also, when you are in line, and you are waiting to be served, there is a high opportunity cost of leaving that line, especially if the supermarket is busy. So in economic parlance, we talk about elasticity, that is, the responsiveness of quantity demanded to a change in price. When you're in a line, a long line, and you're tired, hungry, thirsty and you want to be served, the cost of leaving that line to go to a shelf and pick up a larger bottle of Coke and then come back is actually quite high. Therefore people's demand is relatively inelastic. The opportunity cost of leaving that line is high. So demand factors explain a lot of that. The other obvious factor is supply factors, that the 2 litre bottle of Coke is a standard bottle of Coke and has been a popular item for many years. Therefore, more 2 litre bottles of Coke are made. The economies of scale argument is that when you increase the production of something, the cost falls. So because these bottles are more desirable by consumers, the average cost of making them is lower. So therefore a 600ml bottle of Coke probably costs more to make than we would expect. So supply and demand side factors show that there's actually a rather intuitive answer to what appears to be a counter-intuitive problem, but when you think like an economist, you observe patterns and irregularities in behaviour and what you try and do is find rational means to solve them.

Matt Smith:

When I'm at the supermarket, and I see something that's cheaper if I buy more, it's generally called a multi-buy. Is that actually a good deal for the consumer?

Wayne Geerling:

Again, it's all about preferences, taste, needs and wants. The buy in bulk argument is similar to the economies of scale principle – you buy more, the average cost falls. Ultimately it depends on what the consumer wants. But the consumer is given a choice – you don't have to buy more. I mean, these schemes are very, very common in England – I spent a few months there earlier this year and in Sainsbury's, pretty much every second product you see you can buy two, or three, or ten of. It makes sense. The supermarkets realise that they have the consumers' attention for fifteen to twenty minutes, when you're in there. Therefore they try to flog off as much as possible. But consumers have full information. Information about per kilogram, per pound, per litre, is displayed. So consumers realise what they're paying. It's a win-win. If you don't want more, you don't need to buy it. But supermarkets in general face a lot of competition. Therefore they have to extract as much consumer surplus, which in economic parlance talks about the marginal willingness to pay of consumers to extract as much money as possible out of them, because when they leave the supermarket they may not come back for a long time. So it's a great idea, provided you want more food of course.

Matt Smith:

Does all of this go through your head when you're in a supermarket?

Wayne Geerling:

Absolutely, absolutely. Some people buy more purely because they derive extra utility from seeing that something's cheap. Some consumers will buy ten or twenty items – they may not need them, but they're driven by the cost savings. Others are more practical. How much can I afford to eat, how much do I want to eat, how much would I like to drink? Bargains are good for consumers, because it drives the average cost down. Good for supermarkets, because they can clear unwanted stock. And that's the biggest thing for the supermarket. So they function a little bit like warehouses with clearance sales – bring it in, and get it out.

Matt Smith:

In recent months we've seen a lot of stiff competition between our supermarket chains and they've actually started undercutting each other – they're selling milk for under market price. Is that a sustainable thing and is that a good idea from an economist's point of view?

Wayne Geerling:

OK, for the consumer it's a wonderful thing. If I can get 2 litres of milk for one dollar, rather than two dollars, I'm happy. In fact very few consumers would be unhappy about that. It's great from a supermarket's point of view because again, the major cost for the supermarket is holding stock, and something like milk requires electricity, therefore it's a very expensive item to shelf. And it's got a very short use-by date. Extra competition means lower prices, it means consumers buy things cheaper, it means they have more money to spend on other items. The big losers here are the producers. Producers are unhappy because if the sale price falls, then the price that supermarkets are willing to pay them to produce the milk will logically fall as well, so the big losers here are the producers, who rely on higher prices to sustain their operations, because if prices keep falling, somebody's got to lose. I mean, economics is all about trade-offs. If you change the price of an item, there's usually going to be a winner and a loser. In this case, with the milk wars, the big losers are the producers who want to keep their market power – lower prices to consumers, lower prices on the shelves mean lower prices that they receive for their produce.

Matt Smith:

Do you find that there's a lot of benefit thinking this way and I assume living your life this way as well?

Wayne Geerling:

When you learn to live like an economist and in the shortest possible use of words, thinking at the margins means weighing up benefits and costs. Rationality involves rationalising decisions, thinking logically about what you're doing. Give on one hand, you take with the other, that type of stuff. So, when you see the world like this, it actually makes things a lot easier, and buying groceries at the supermarket is a great example of that. And economics can be used in many non-conventional settings as well. I mean, going to the supermarket is about buying products, having budgets, trying to work out what you can afford to buy – when you think like an economist, you can actually apply the rules of economics to areas which people would not normally associate with economics. Crime and punishment, alcohol, cigarettes and addictions, going out, university life. Not crime and punishment is an obvious one that has economic connotations. Rational choice theory, the economic approach to crime type-thing. But dating's a great one as well. Why is it hard to find a taxi on a wet day? Those types of things. There are so many questions which you can pose about life when you understand how economics actually works, and I think it's important that we try to change the popular perception of economics. Too often it's viewed as a dry, abstract, boring science, and to a certain extent, it's not completely unfounded. It's necessary in economics – you need a quantitative background to understand how economics works, but for most people, it's not really important, and I think it's very difficult to get students and people in general to take economics seriously when it's associated with macro-economic concepts like growth, inflation, unemployment and financial markets, because it's very difficult to make prognoses about the future. And with macro-economic elements, when an economist is trying to make a prediction about how the economy will grow, or what will happen to unemployment if the government spends more, things like that. They're very hard to actually get right, because there are so many variables that make up the equation. And at any point in time the economist only has x amount of data available. So when they build the models, they're built on assumptions. And if you change one or two assumptions, the whole model goes kaput. So, economists get a bad rap for mis-diagnosing, or mis-predicting events, getting it wrong. But that happens in any walk of life. But I find the micro-economics aspect of economics more interesting – trying to understand the way humans behave, because I think it's much easier to sort of predict, and what I try to do in my subject is expose students to a series of real life events. With quantitative economics, you can often come up with a correct answer. What I try to do is get the students to consider various hypotheses. I'll give you an analogy. When I worked at the Economics Network earlier this year – the Economics Network is the United Kingdom education authority into the study of economics – and at one of the awards nights they had a guest speaker, a CEO from one of the big banks in England. He was talking about the quality of graduates, and he said, listen, their technical skills are fantastic. They understand how economic models work. But what I like to do in a job interview is give them a series of questions which are not from the sheet, test their intuitive skills. And he asked one candidate – imagine you are the Minister for Congestion – you're living in London. How would you go about reducing road congestion in London? And the applicant replied, I don't know – we didn't study congestion in Economics. I mean, the student was obviously talented, very smart, book-smart, good marks, good degree, but he hadn't learned how to apply economics to real life, and congestion is a real problem in life. If this student had been asked, with a pigovian tax, illustrate the welfare effects of this tax on consumers and producers, he or she would be able to draw an elaborate graph, they'd be able to use differential calculus to show an answer. But when asked a question in plain English, the student lacked the fundamental understanding of how economics actually applies to life. So what I try to do in my subject is show students that economics is all around us, we can choose to embrace it, we can choose to become smarter, more cultured, more interesting people, or we can ignore it. But ultimately economics graduates need intuitive understanding of the real world, because when they leave university, they will be doing your superannuation, they will be advising you on the share market, they will be advising governments on policy, and if they don't understand how the real world works, well, they're not very good graduates.

Matt Smith:

That's all the time we've got for the La Trobe University podcast today. If you have any questions, comments or feedback about this podcast, or any other, you can send us an email at podcast@latrobe.edu.au. Dr Wayne Geerling, thanks for your time today.

Wayne Geerling:

Oh, it's been a pleasure. Thank you very much.