27 – Thinking like an economist 7: Economics and money

People tend to think that economics is primarily about money. I guess it is an understandable mistake, but actually economics is primarily about making decisions that require trade-offs because resources are in limited supply. These decisions may or may not be centred around money.

Money commonly features in economists’ ideas about these decisions because it provides a common unit of measurement, which is helpful when evaluating the trade-offs, and because money itself is usually one of the resources in short supply.

Having a common unit is so useful that economists have developed a range of tools for attempting to convert non-monetary values onto monetary values. But they are not doing this because they are obsessed with money. The fundamental motivation is to help with decision making.

Even without going to that point, economic models are routinely used to look at trade-offs between monetary and non-monetary outcomes. Decision makers find this very useful, even without the benefits of a common unit of measure.

If you look at a microeconomics text, you’ll see that the theory of consumer choice starts by talking about the quantities of consumer goods, the “utility” (something like happiness) that people get from consuming them, and the relationships between goods. No mention of money up to this point. This theory applies just as much to non-market goods (e.g., some environmental values) as it does to market goods (e.g., food).

Money does come into it when we get to the point of asking, how much can people afford, and how much will they consume as prices change.

Sometimes people confuse economists with accountants. Economists pay a lot more attention to non-monetary issues. There are some other key differences too (from the perspective of an economist who knows little about accounting).

Economists and accountants use different measures of “cost”. Accountants focus on financial transactions, whereas economists use a much broader concept: the opportunity cost. You don’t have to spend one dollar to suffer an opportunity cost. It is the benefit that you forego by choosing one course of action over another. If a farmer plants trees over an area, he or she bears the direct cost of seed, fertilizer, machinery, etc., but also the opportunity cost of not being able to use the land for other purposes (e.g., wheat production).

Economists focus on changes at the margin, whereas accountants tend to look at totals and averages. We focus on marginal changes because they are central to good decision making.

Economists and accountants use completely different frameworks and models. As one example from many, economists often use optimisation models, but I have not heard of an accountant doing so.

And finally, economists are generally better looking.

David Pannell, The University of Western Australia

Further reading

Handsome, V.V. (2003). Physical attractiveness of money-related disciplines: a meta-analysis, American Journal of Disciplinary Beauty 56, 145-156.

Pannell, D.J. (2001). Economic Dimensions of Landcare, State Landcare Conference 2001, 11-14 September 2001, Mandurah Western Australia, pp. 131-144. full paper (74K)

Weersink, A., Jeffrey, S. and Pannell, D.J. (2002). Farm-Level Modelling For Bigger Issues. Review of Agricultural Economics 24(1): 123-140. (Awarded outstanding RAE journal article for 2002).