by Shreyashree Dey
I asked a layman, “What do you think economists do?” After a little pause, she answered, “Well, they make predictions and policies for the economies and some businesses.”
According to the conventional textbook definition, economists study how society distributes the limited resources, such as land, labor, raw materials, and machinery, to produce goods and services. With time, the work of an economist has evolved in many ways. They conduct research, collect and analyze data, monitor economic trends, and develop forecasts on a wide variety of issues.
Economic thinking has revolutionized economies, society and the business world. Starting from Adam Smith’s Invisible hand and the barter system to understanding the problem in it and finally the successful execution of paper money as currency. One can also say that you can imprison an economist, but he will remain an economist. R A Radford, a young man who went to Cambridge University to study economics had to interrupt his studies and join the British Army when the World War 2 started. Later, he was captured as a prisoner of war (POW) by enemy forces in Libya. During his stay in POW camps, Radford observed fellow prisoners as they exchanged goods and services. Those observations were gathered in an article entitled “The Economic Organization of a P.O.W. Camp”, published in November 1945. The Red Cross brought care packages to the prisoner of war camps and gave prisoners little packages that contained chocolate, cheese, other goods, and cigarettes. What can one do with cigarettes after they quit smoking? Well, trade it for something they want instead. With time, cigarettes began to circulate as money.
Let’s look at the role of economists in the modern business world, after the invention of internet. Here, we’ll see economists playing a slightly different role wherein their ideas or economic thinking has saved million-dollar businesses from shutting down and in a way, also the development of the internet economy. One excellent example is the invention of “name your price” travel by Priceline,com. Well, the key to success of Priceline was not just a simple “name your price”, because obviously as rational individuals prefer to be free riders, they’ll name the price as zero or any such low amount that the hotels and airline chains won’t have any incentive to accept. It was neither the clever TV advertising starring William Shatner from Star Trek. The key to the success of the $60 billion plus market capital company was the economic thinking of inventor Jay Walker who came up with the “conditional price offer”. The proposition is that if you bid a particular price for a hotel room or a flight and Priceline accepts it, you are bound to pay it. This induces one set of people to take the offer seriously and thus, make reasonable bids.
Another great example is the success of the online dating apps such as cupid.com. Most markets clear by having prices as the signal. But a relatively new strand of economics, known as “market design” or “matching theory” has focused on markets where fit is more important than price in directing resources. In this case, the notion of artificial scarcity has also been utilised. One well known problem in the online dating world had been women getting too many date requests and most men getting turned down which would eventually lead the men to quit the site. This also means cupid is in trouble. So, whom to call to solve this problem? Call an economist! Infact call two. Dan Ariely of Duke University and Muriel Niederle of Stanford University studied the artificial scarcity and abundance in the online dating context and they had a simple yet clever idea for the problem. By putting a sharp limit on the date offers each month that the men can make to women or the other way round, that is, by artificially constraining the date proposals made them take the date proposals more seriously than before. People would actually check profiles properly and then make a proposal and people receiving the proposals knowing this, were more likely to accept them. Hence, cupid.com was saved and so were the other dating sites that copied the technique. Today, online dating is a two-billion-dollar industry. In fact, economists are increasingly also using insights from matching theory to help companies better design systems for matching potential employees with employers. “Matching theory” is also used in matching of medical residents to hospitals and organ donor banks.
How can one forget the success of google ads which collects a revenue of $50 billion dollars a year from advertisers – large and small? Google auctions off the sites. Although, when Google was launched, online advertising was far from a hype, and Google had to go from advertiser to advertiser persuading them to place an advertisement next to their search bar. This would definitely not get them the success that they’ve achieved. Two engineers came up with the “second price auction” theory which also solved the problem of “the winner’s curse”. After the first auction, the winning auction would be the second highest price that was bid plus one penny. Erich Schmidt who was the CEO of Google during that time found out from Hal Varian almost by accident that the engineers basically reinvented the theory that fetched William Vickery, an economist at Columbia University, the Nobel Prize in Economics in 1996. He proved mathematically that the second price auction was the ideal solution to the winner’s curse, the regret of having paid too much. After this, Erich Schmidt on realizing that economists may be able to help Google, persuaded Hal Varian to leave Berkley and join Google as their first Chief Economist.
These interesting and profound examples are just a little flavour of the kind of work economists do or economic thinking has done to revolutionise the economy in various ways in various sectors in the modern world. Economists made it possible for amazon and other web retailers to deliver all the stuff that people order to their doorsteps efficiently and promptly 24*7 by shaping the much-required transportation system. It was the economic thinking that shaped the system of online advertising. Economists made it possible for people to get five-star hotels at three-star prices. Economists may even have made it possible for people to have met their dates, and in some cases, their spouses too !