The thought of Economics as a Social Science brings to the mind a vast field of study held together by relative unanimity and uniformity in decisions and ideas. However, a closer look reveals the real picture. You might hear an economist waging war for tax cuts and another one pleading the government to increase the tax rate. How is it that two people who have access to the same set of laws and information make varied decisions?
The reasons can be manifold. Economists tend to subject this variety to positive and normative statements. While a given set of data can explain the cause of the problem or explain how the world is, it is only the normative sense of the economist that helps him or her explain what can be done about it or how the world ought to be.
The inherent variability of human nature which is primarily fueled by personal motivation and self-interest does help to a certain extent to fathom this induced distinction in the field of economics. Now is the time for fallacies to step in. These crusaders of economic confusion derail the economist from the path of sound logic and reasoning and entrap him or her in a deepening spiral of accepted misconceptions. To steer clear of these fallacies or perceived truths is the ideal trajectory for every economist. Fallacies are contagious enough for scholars who spend years studying economic laws but they are solely propagated by the common man and form important chapters of folk economics.
This article delves deeper into fallacies that hinder us from making logical, rational, and informed decisions. It also throws light on some implications and vouches to connect all aspects of life in an intricate web with these fallacies at the focal point.
THE SUNK COST FALLACY
No matter how smart you consider yourself to be, it is delusional to presume that you’ve never succumbed to this one!
How many times do you wear those uncomfortable pair of shoes only because they cost you a fortune? How many times do you sit through a dreadfully boring movie only because you spent a considerable chunk of your weekly budget on that ticket?
The sunk cost theory reiterates the fact that it of no use to cry over spilled milk. On the contrary, the sunk cost fallacy reiterates the fact that people make decisions that are not dependent on the future value of their investment and long-term gains. They make decisions based on their tainted
rational sense, tainted by the fear of loss, the pain of losing, and most importantly their emotional investment. Therefore, this fallacy is not solely related to money. It also relates to the way you spend your time. (You may of course argue that time is money!). The addiction to playing a stupid yet long progress storing game also stems from this fallacy. It further builds up to why failing investments are not abandoned and why someone would spend more time and money getting an old product repaired than buy a new one.
In retrospect, how many times have you chosen a less useful or comfortable option only because you spent more money on it? Take the example of a concert ticket you got for 50 bucks. Your generous friend gives you a ticket for another concert but on the same day. This one costs 100 bucks. When asked to make a choice, instead of gauging the value of the experience in terms of how much you would enjoy (future gain) your pseudo rationality tells you to value the latter since it costs more (based on a past decision).
The sunk cost fallacy brings to light all those instances where our sole purpose was not to maximize gains but to avert loss. We do not play to win. We play to not lose. This leads us to feel differently about losses and gains even if they are of the same magnitude. This economic caveat is what good salesmen play upon. When you are convinced that the joy of buying or the reward is much more than the pain of losing, you stop weighing pros against cons and buy things you do not need.
Sunk cost in totality reflects those investments and purchases that cannot be recovered. Technically this is where the story ends and the next purchase is an independent decision. However, decoding the way folks see it, loss lingers longer and has the ability to influence future decisions and fan them towards an economically unfavorable side.
You probably don’t see a future in the course you are studying right now. But what you can see is the amount of time, money, energy, and effort you invested in it. Are you deciding to continue just because of a decision you made in the past? Are you neglecting the future prospective again and thus entering into this never-ending cycle of disastrous and ignorant decisions?
The fallacy debars you from realizing and actualizing the fact that greater good lies in resorting to what benefits in the future. It makes you cling to decisions that promise to negate the feeling of loss that comes from failed decisions of the past.
THE FALLACY OF COMPOSITION
Another fallacy that makes its presence felt very frequently through diverse applicability is the fallacy of composition. It is the misleading practice of assuming that what is true for a one (a part) is true for the whole. A classic example would be a cricket match. You stand up for a better view of the field. But what if everyone thought it was a great idea to stand up to get a better
view. It eliminates the possibility of even a view. This is how the fallacy of composition plagues economic thought. Advancement in technology and better crop yield would fetch a higher price for the farmer and is good for him. But what if every farmer gains access to the same resources and witnesses a good crop yield. The demand being the same, the prices would fall and ultimately no one is better off. Thus, it is completely baseless to infer that what is true for one would also hold for the whole.
The fallacy of composition explains why decisions taken on the micro-level fail drastically when imposed in macro and global economic scenarios. It is the influence of this very fallacy that makes people believe that deficits reduce national income.
A closely followed disciple of this fallacy is the paradox of thrift. Saving for a rainy day is good for the individual but not so suitable for the entire economy. The Great Recession is a glaring example of the same. As people save more at all income levels and cut back on spending, total revenues for all companies will decline, causing production to suffer a fatal blow. This leads to the contraction of output that further leads to unemployment and a fall in income levels. Eventually, the population’s total savings will be the same or even decline because of lower incomes and a weaker economy thus directly pointing out to demand-side economic failures.
Similarly, if all countries decide to impose hiked tariffs to safeguard local businesses, there will be no global trade at all. Keeping in mind comparative cost advantage and the fact that trade makes everyone better off, this wouldn’t be the most desirable outcome of our intended actions.
Many politicians, since time immemorial, have used the ‘Nation is like a Household’ example. While elections have been won on these promises, economics helps us understand how absurd they are. A common implication of the fallacy of composition is when individual debt and national debt are treated equally. We fail to realize that countries can plan long term and do not have finite lives and that individuals do not have central banks. This fallacy also finds honorable mention in decisions concerning outsourcing and export of jobs.
If you go ahead and ask businesses about what’s good for them, the answer to the question is generally ‘No Competition’. But does that mean it is beneficial to the economy as well? You’re free to be your own judge here. This difference lies in partial thinking that wishfully ignores wider implications. The same could be observed when business luminaries seconded the UK’s decision to join the European Union. They saw the elimination of exchange rate risk but couldn’t see what instability it would impose on the country.
A sound business sports positive cash flow. When thinking of a country at large, the wrongheaded mercantilist way of thinking makes people believe that negative external balance is bad for the country as well. What’s true for business may certainly not be true for the entire economy.
Economics is not an exact science. However, over time pure economic thought has been littered with several fallacies. Some have now ingrained themselves into the ordinary order of life. These fallacies also find use in important political structures and decisions around the globe. Sometimes these arise out of misinformation and sometimes they are deliberately used for deception. Whatever be the cause, the end result is a shift from logical decision making to outright irrational behavior. It is said that the good economist neither sees the trees and ignores the forest nor sees the forest and ignores the trees; he is conscious of the entire “picture.” It is about time that we understand what plagues our sense and take a step back to understand the most fundamental concepts of economics through bias-free glasses. It’s about time that we stop inviting chaos into our lives and our economies. It is about time that we stop fancying these fallacies.
Pw, A. (2018, October 19). The fallacy of composition. Affinity PW. https://affinitypw.com/news-and-views/article/fallacy-composition
Fallacy of Composition. (2020, July 27). Wikipedia. https://en.wikipedia.org/wiki/Fallacy_of_composition
Why Trump’s Wrongheaded Trade Strategy Is A Bust. (2019, November 12). Forbes. https://www.forbes.com/sites/stevehanke/2019/11/12/why-trumps-wrongheaded-trade-strategy-is-a-bust/#4a3d51824256
The Sunk Cost Fallacy. (2011, March 25). You Are Not So Smart. https://youarenotsosmart.com/2011/03/25/the-sunk-cost-fallacy/
“Wait, Is Saving Good or Bad? The Paradox of Thrift” – Page One Economics® – St. Louis Fed. (2012, May 1). Economic Research, Federal Reserve Bank of St Louis. https://research.stlouisfed.org/publications/page1-econ/2012/05/01/wait-is-saving-good-or-bad-the-paradox-of-thrift/#:%7E:text=A%20simple%20example%20can%20illustrate,some%20portion%20of%20their%20income).