11 Life Lessons From Economics & Finance

"If it's a free lunch, it's a scam"

I will graduate college this month with a BA in Economics and minors in Finance, Business, and Spanish. I’ve been studying the economy for four years, and I wanted to share some insights that the field offers, not just for people who work in finance or economics, but for life in general. The economy is like a living creature, reacting and evolving in response to news and events. This is because it is made up of the aggregate actions of the people that comprise it. The economy is a bellwether for human nature in many ways, and studying it can provide insight into how we make choices, react to changes, and deal with uncertainty. For my college application essay, I wrote about life lessons from chemistry, so now I would like to share some life lessons from economics.

1. Scarcity

The first concept taught in principles of economics is that economics is the study of scarcity: how limited resources are allocated to limitless needs and wants. Naturally, this principle applies beyond economics to how we allocate not only our money, but also our time, energy, and attention to what matters most. How do you want to budget yourself between life’s many priorities?

2. Opportunity Cost

There is an opportunity cost to every choice. The opportunity cost is what is given up to do something else instead, ie, the next best use of your time. For example, if you decide to spend time with friends over the weekend, you are giving up time you could spend studying. When making a decision, ask yourself what is the next best thing you can be doing with that time, and if it is worth giving up. To make the best decision, economics teaches us to do a cost-benefit analysis by weighing both the direct costs and opportunity costs against the benefits of each option.

3. The Fallacy of the Sunk Cost: Cut Your Losses

The sunk cost is probably the most applicable lesson from economics, and a fallacy that most people follow unknowingly. A sunk cost is a cost that cannot be recovered. The lesson from economics is that in making a decision for the future, do NOT factor in sunk costs because they are already lost and have no impact going forward. This mindset can be life-changing.

Avoiding the fallacy of the sunk cost will help you move forward and not feel stuck in something just because of the time or effort you put into it. That time, money, or effort is already spent, so the best thing to do is to leave or get rid of something that isn’t beneficial. Examples include holding a stock that’s losing money because you’ve already invested in it, staying in a career or major you don’t love simply because of the time and work you spent getting there, or even staying in a toxic relationship because of the effort and time you put in. An economist would say to cut your losses now and get out because you aren’t getting the time and money back anyway.

4. The Economic Cycle

The economic cycle is made up of a repeating cycle of booms and busts. Within the economy, individual asset prices will rise and fall in a ‘random walk’, that cannot consistently be predicted, but tend to revert back to their average, an occurrence known as mean reversion. This happens with stocks, exchange rates, and interest rates. However, if you look at the general trends of the stock market, it has been going up for longer than the past 100 years. Think of life like this, although there are ups and downs, they even each other out, and the general trend is upwards. This is also a good strategy for long-term investments. Look at the big picture and don’t let short-term fluctuations throw you off; it's best to hold your positions since they should keep growing in the long run.

5. The Nudge

This is a lesson from behavioural economics, specifically from Dr. Richard Thaler, who spoke at my university several years ago. The nudge involves “framing”, or the idea that how you present a choice to someone will impact their decision-making. This concept of  libertarian paternalism involves subtly influencing the subject into making the choice you want them to, of their own free will. The classic example is the opt-in/opt-out default. In a 401K situation, having opt-in be the default resulted in many more people signing up versus when they had to go out of their way to opt in. Another example is anchoring, where a store might have a “sale” price and then a fake original price that makes it look like it's on sale (when it's actually not), nudging you to buy it since it appears to be a bargain.  Knowing about the nudge can help you influence others, but it's also good to be aware of how institutions and corporations may be covertly influencing you through the nudge.

6. Laissez Faire is Best

Ever since Adam Smith introduced the idea of the 'invisible hand' in The Wealth of Nations in 1776, the concept of the free market economy has played a central role in economic thought, and history has demonstrated its power. The economy will generally take care of itself, finding the optimal price to balance supply and demand. Rather than a command economy, letting the economy set its own prices will lead to equilibrium and maximum efficiency. Interventions in the market lead to inefficiencies and deadweight loss. The same can be said for life. Sometimes, it's best not to worry about events that are out of our control or have no impact on us. Letting things work out on their own, considering the big picture rather than every detail, and focusing on our personal life where we do have control, rather than what others are doing, is best.

7. Risk and Reward Tradeoff: Know Your Risk Aversion

The risk and return tradeoff is an important part of economics and finance, and they have a positive relationship: increased risk equals increased return. In finance, if you are helping a client build a portfolio, you have them take a risk aversion test to see how much risk they are willing to tolerate to have increased returns. Then, you construct a complete portfolio based on their given level of risk tolerance. In life, it's important to know your level of risk aversion and take it into account when making decisions, and it's okay to have a different amount of risk that you are comfortable with versus someone else. It is also important to understand, however, that taking risks is often necessary for greater success.

8. There’s no Such Thing as a Free Lunch

As my investments professor said, “if it's a free lunch, it's a scam”. The phrase, “there’s no such thing as a free lunch” was made popular in economics by Milton Friedman, who championed free markets and developed the theory of monetarism, which significantly influenced modern monetary policy. “There’s no such thing as a free lunch” means that everything has a cost, even if it is not apparent. For example, a “free” government program is just paid for by taxes. A free website or app might be selling your data, and at the very least, you are paying for it with your time. Always ask yourself what the financial motive is and what the true cost is. It is good to be aware of hidden costs, and of course, if it looks too good to be true, it's probably a scam.

9. Expectations Matter

The self-fulfilling prophecy is a phenomenon in economics in which expectations for an event cause that event to happen. Bank failures, for example, are a vicious cycle caused by people expecting a bank to fail, which leads them to run the bank and withdraw all their money at the same time, depleting its reserves and leading the bank to become insolvent. Inflation expectations are self-fulfilling as well. As people expect money to lose value, they raise prices or demand higher wages, causing inflation. While there are underlying issues creating these situations in the first place, the irony is that expecting them to happen actually causes them. In daily life, expectations are also self-fulfilling. You can use this to your advantage by believing that you are capable of something, ultimately giving yourself the confidence to succeed. On the other hand, if you doubt yourself (or others), you may subconsciously hold yourself back, only reinforcing that belief. Just as the market responds to sentiment, people do as well. The first step toward success is expecting it.

10. Comparative Advantage

The concept of comparative advantage has to do with how individuals, companies, and nations benefit by specializing in what they are relatively the best at, rather than the absolute best. For example, the US is capable of both growing wheat and developing software, but it still imports wheat from other countries because it has a comparative advantage in technology versus other countries. The US can create more value by focusing on software development because the opportunity cost of not doing so would be higher. Comparative advantage is the economic argument recently used by Warren Buffet in favor of free trade over tariffs.

Comparative advantage can also apply to the division of labor. In a group project, one person might be the best student overall, but if they are especially good at brainstorming and only slightly better than others at presenting, it makes sense for them to focus on idea generation while the other group members work on the slideshow. Comparative advantage can be helpful in your career and personal life. If you have multiple talents, interests, and skills, you should focus on the one that’s the most unique and valuable compared to what other people have to offer. 

11. Everything is a Market

Everything is a market. You may be familiar with the stock market, the labor market, and the housing market, but everything with a supply and demand is a marketplace and functions like one. Consider the dating market or the college admissions market, or even the attention market in which news and social media profiles compete for likes and views. Framing things as markets helps depersonalize them and also shows that we can apply economic principles to navigate them, such as scarcity, the opportunity cost, and the sunk cost fallacy. Ultimately, by thinking like an economist, we can save precious time, money, and effort. Economic principles protect our emotional and mental well being, allowing us to leave deadweight loss behind and become the best version of ourselves.

To Conclude

I hope you enjoyed these life lessons from economics and find them useful, whether you’re analyzing the financial market or making everyday decisions. Which one resonates with you most? Leave your thoughts in the comments below.