Economics #101: Strategy

Consider this: A friend scores 80% marks in an exam, and our first reaction usually is, "Ohh, I must study harder and score 85% next time."

This is relative thinking, it overlooks the fact that exam allows us to aim for *100%* marks. Even if we succeed in scoring 85% and overtaking our friend, we have still fallen short of 15% marks we could have aimed for, and potentially achieved.

There's another advantage. When we choose 100 marks as the new "rival" to compete against, our friend and we cease to become competitors and can instead become partners. We can study together, help each other to score more and in the overall process, lift both of us to a higher level than we could have achieved individually.

And this strategy is not limited to schools and exams; it can succeed in factories, offices, businesses, and every other field.

When PepsiCo entered the beverages market, they soon realized that their biggest competitor wasn't the current dominant player -- Coca Cola-- but it was something else: Drinking Water and fruit juices, which practically had a 100% 'market share'. So they targeted their marketing campaigns to replace these two drinks in the minds of people by a can of Pepsi. When Coca Cola perceived the importance of this strategy, they too soon followed suit. The result is for all to see.

Economics #101: Game Theory

Game Theory

Consider this game: There's a pair of two players A and B, and a moderator M. Two players together can hunt a deer and gain, say 100 points. Or, each player individually can hunt a rabbit and get, say 20 points.

Moderator calls each player aside separately and asks: Do you want to cooperate with the other player to hunt the deer, or would you rather hunt a rabbit individually?
If each player separately agrees to cooperate with the other, they can avail the deer. But if A choses to cooperate and B choses the rabbit, A is left with nothing.

Interestingly, although each player wants to cooperate with the other and hunt the deer, the fear and distrust ("the other player may ditch me") makes both of them choose the rabbit.

This is called the "deer hunt game" and it provides an insight into Game Theory, a mathematical tool to analyse what happens when people or corporations cooperate, compete or interact with each other.

Remember John Nash, the genius mathematician portrayed in the movie "A Beautiful Mind"? His Nobel prize for Economics was primarily for his work in the area of game theory.

Economics #101: Punishment Capital

Economics isn't always about money, cost and stock markets; it also provides good insights into other areas of our life, such as parenting.

As all parents are aware, getting young kids do the right thing is a tough job. Usually we have two options: Offering them a carrot ("if you complete your homework, i will take you to the park") or threatening them with a stick ("if you don't do your homework, papa will punish you"). Experimental research by behavioural economists shows that it is better to deny the carrot rather than picking up the stick.

From the kid's perspective, completing the work and earning the carrot boosts their self esteem. With proper choice of carrots - books, sports gear, musical instruments - it can turn out to be a win- win situation.

From the parents perspective too, it is less stressful to deny the carrot rather than meet out a punishment.

Note: This is relevant to young kids.. For the older ones, there are two more options available.

Economics #101: diminishing marginal utility and diminishing returns

Consider this: You buy a pair of jeans, your first one. You enjoy the experience, so you buy another. The utility of each one reduces by about half. The more pairs you buy, less chance for each pair to be worn and hence less the utility. 
This, is called diminishing marginal utility. 


In some cases, it can proceed to negative values. For example, the first cup of tea in the morning is invigorating, it has 100% utility. The next cup less so. And if you keep drinking more cups, at some point, it starts having a bad impact on health.

Now, consider this: The quality of a Rs. 500/- shirt is usually better than that of a Rs. 200/- one, and that of a Rs. 2000/- is much better than a 600/- one. But, there comes a price point, beyond which there is not much determinable difference in the quality of the product. 


This, is the law of diminishing returns. 


Cheap wine is said to taste not very good, and there's an appreciable improvement in the taste in proportion to its price. But beyond a certain price range, it becomes more and more difficult to distinguish between the tastes of more costlier ones. 


At such point, the price becomes less of an indicator of quality and more about the brand and its positioning in the market.

Economics #101: Hyperbolic discounting

Consider this: If asked what we would like to do over the next six months, most of us will talk of virtuous activities such as exercising, reducing intake of junk food, learning new skills. But if asked to pick up activities for today, we would be more inclined towards watching T.V., eating pizza or surfing the internets.


Perhaps this is basic human nature, but it's also got a swanky name: Hyperbolic discounting. 

Simply stated, it's our tendency to favour short-term instant gratification over long-term benefits. We keep putting off good things to tomorrow but when that "tomorrow" becomes "today", we are still stuck on those cakes, Coke and pizza.

Economics #101: Opportunity cost

Consider this: You're invited to a social event next week. You're in a dilemma: To accept, or to decline?

These decisions matter because of an important economic principal: Opportunity cost. Time is a limited commodity. When we agree to do one thing, it means less time or no time for many others.

Now, about the invitation... There are two approaches: 

One) Ask to yourself whether, assuming the event was *today* , would you really want to go? Based on your gut-feeling to this, you can respond.

Second) Don't respond, just accept the invitation non-commitedly, then analyse your priorities later and convey your acceptance.

Economics #101: Taleb distribution

Consider this: You are driving to office. You are getting late. So what do you do? You take your chances, jump the traffic signals and cut in front of other vehicles.
Sounds familiar? Well, this is an example of Taleb Distribution (named after Nasim Taleb, author of "Black Swan" and " Fooled by Randomness").


Taleb distribution indicates scenarios that contain high probability of small positive gains (with risky driving you may usually reach office on time), and low probability of huge negative losses ( a single bad judgement in rash driving can lead to accident).


Next time, before we press down on the accelerator looking at the watch, let's think if it's really worth the risk.