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Why every student needs a bit of economics

By Gary Foreman

The New Frugal You
New Frugal You columnist Gary Foreman
Gary Foreman is a former financial planner who currently edits The Dollar Stretcher website and newsletters. He writes "New Frugal You," a weekly Q&A column about frugal living, for CreditCards.com

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Question for the CreditCards.com expert

Dear New Frugal You,
My parents tell me that I should take some economics courses in college. I'm a sociology major and don't see how that would help me. Isn't economics just for business or finance majors? What could I possibly learn that would have any value? -- Undergrad Sally

Answer for the CreditCards.com expert

Dear Sally,
Hate to disappoint you, but I agree with your parents. Everyone should have some basic economic knowledge. It's not that we think you'll become an economist, but the concepts you'll learn from economics will affect the decisions you'll make. A lack of understanding of economic principles can lead you to make some very bad choices. In fact, I'd argue that an economics class could have a major effect on your future happiness!

Take one of the basic concepts of economics: opportunity cost. It's likely you've never heard of the term, even though you are exposed to it many times every day.

Let's begin with an expert definition. The Economist website defines opportunity cost as "the true cost of something is what you give up to get it. This includes not only the money spent in buying (or doing) the something, but also the economic benefits that you did without because you bought (or did) that particular something and thus can no long buy (or do) something else."

Let's translate that definition into everyday English. In its simplest form, it means that to get something you have to give up something else. Pretty simple concept, eh?

For instance, suppose you stop and buy a can of soda on the way home from work. You give the cashier $1.25 and take the soda. In this case, $1.25 is the price that you paid for having a soda.

The opportunity cost is what else you could have done with that $1.25. For instance, you could have gone down the street and ordered something off of the fast food dollar menu and had change to spare. You could have put it into an account where you're saving for a big screen TV. Or you might have put it into your 401(k) account and watched it grow to $4, $8 or even $16 by the time you retire. You get the idea.

Opportunity cost is what you give up today or in the future when you make a purchase.

There's another way that opportunity costs work. Suppose that you live and work in Milwaukee, and you're offered a job in Los Angeles. If you choose to stay in Milwaukee, the opportunity cost is the job you turned down and the chance to live in L.A. You'll be giving up warmer weather, but also a higher cost of living. The point is by choosing one thing, you're eliminating others.

Or, have you ever considered how much time a purchase costs you? Suppose that you make $20 an hour and when taxes are taken out, you end up with $15. Every time you spend $15, your opportunity cost is one hour of work. That might not seem like much, but it should cause you to think when you're about to buy a $30,000 car -- that's 2,000 hours or 50 full-time weeks.

There are other economic theories that the average consumer should learn. Most of us are aware of the law of supply and demand. But have you ever thought about it when you want to ask for a raise? If the demand for your services is high, you'll stand a better chance of getting more money. On the other hand, if there are unemployed people lining up for a job like yours, then now might not be the time to have that talk with your boss.

In economics class, you'll also learn about the time value of money. It's another simple theory that crosses your path every day.

The Economist would say that having a dollar today is worth more than having a dollar tomorrow. Doubt that he's right? Then ask yourself why you pay interest on your student loans. The answer is that the dollar you borrow today is worth more than the dollar you'll repay years from now.

Or, if you flip the concept, you'd rather have someone give you a dollar today rather than give it to you a year from now. If you had the dollar today, you could put it in a savings account and earn a little (OK, right now a very little) interest. Or you could put it toward that soda we talked about earlier.

So Sally, I'd advise you to take that economics class, even if it's not part of your major. In fact, it's especially smart to take it if it's not part of your major. One thing you'll learn is that you invest today to reap benefits tomorrow. That's exactly why you should take the course: to learn something today that will pay dividends for the rest of your life.

See related: Understanding opportunity costs

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Published: October 13, 2011


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