Economics isn’t the sexiest subject. You probably remember the law of supply and demand from high school, but don’t know as much about opportunity costs, shadow prices, price elasticity of demand, information asymmetry, and so on.
This article will not attempt to teach you Economics. You won’t learn what any of those terms mean. Instead, this article will influence you to learn more about the subject on your own as an essential part of Marketing (and life).
Economics leads us to some counter-intuitive explanations for people’s behavior. For example, it can show us that every natural death is a suicide, and that people have higher incomes in New York because time costs more there.
The Economic Approach to Marketing will re-frame your understanding of customer behavior. It will enable you to market your product, service, or idea in a way that directly addresses the unfulfilled needs of your customer. It is a way of thinking about the observations we make as marketers.
Why I Care About Economics
In school, I studied Political Science. Most of my classes were in the Political Economy department, as the two fields are so interrelated.
For instance, “The Political Economy of Development” was about how Economics explained the dichotomy between developed and developing countries. The class was a survey of all the ways we’ve tried to use our economic might to turn the developing world around, and how we’ve failed.
What fascinated me most about these classes was the way basic laws were used to explain a diverse set of behaviors and outcomes.
Self-enlightenment is a pet hobby of mine. I read about Psychology and Philosophy in order to better understand myself and others (I told you I was a geek). Like those disciplines, Economics can help us understand why our world is the way it is. My classes trained me to think like an Economist, even though I am not one, and I weave that training into everything I do.
I believe that thinking like an Economist is helpful no matter what you do, but especially in Marketing. Marketing requires understanding why your customers behave the way they do, and Economics is a convincing source for that understanding.
A Brief History of The Economic Approach
The Economic Approach to Marketing is the new application of an idea from Classical Economics.
It is inspired by the work of Gary Becker, who in 1992 won the Nobel Prize in Economics for using economic analysis to explain a wide range of human behavior, from racial discrimination to marriage.
He is the father of The Economic Approach to Human Behavior, and the author of a book by that name.
Becker, of course, wasn’t the first to apply economic principles to unconventional disciplines. In 1776, Adam Smith used the economic approach to explain political behavior in An Inquiry into the Nature and Causes of the Wealth of Nations, the original defense of free market economics.
Example: Why Every Natural Death is a Suicide
People know smoking is bad for them. So why do they smoke?
According to Becker, we can apply an economic model to an individual’s choice to smoke. Let’s say that each person has in mind, subconsciously, a lifespan he would like to achieve. At 30 years old, for instance, we might subconsciously wish to live to 92. Living to 93 might be nice, but we might not be willing to give up smoking to gain that extra year.
If we frame this decision in economic terms, a year lived pleasurably from 30 to 31 is more “valuable” than a year lived in likely decrepitude from 92 to 93.
People who smoke aren’t blind to the consequences on their health. They just find the shortening of their lifespan less onerous than the high cost of quitting. If a long life were the only reason to live, this would be illogical. But smokers also have other goals, such as immediate pleasure.
This principle applies to every person, not just smokers. We could all spend every moment working towards a long life, exercising for hours each day and eating an ideally balanced diet, but we don’t. We’d rather have more fun. Therefore, every natural death is a choice, and hence a suicide.
[If you're curious about these controversial claims, check out Becker's book. Watch out for the mathematical formulas and hardcore economics. Becker also writes for a blog that is more digestible at The Becker-Posner Blog.]
How The Economic Approach Affects Marketing
At the basic level, Economics allows us to determine outcomes based on the interplay between supply, demand, and prices. At a more advanced level, other considerations come into play, but the important takeaway is what does not affect outcomes: irrational customers or changes in their fundamental needs.
The Economic Approach to Human Behavior is about understanding the reasons behind what people do without dismissing anything as irrational because it doesn’t fit with our theory. If someone’s behavior does not match our expectations, it is not because they are irrational, but because our expectations are wrong.
This approach illuminates the core reasons for a consumer’s behavior, and facilitates reaching our goal: to make money by giving people what they want. Incidentally, this is also our customer’s goal: to spend money on what they want.
What a beautiful thing.
Part of marketing is easy. Once you know what someone wants, all you have to do is clearly demonstrate why you satisfy that want. But sometimes the hard part is finding out what people want. Any framework that helps you in that quest is worth trying.
Example: Why New Yorkers Have Higher Incomes
The median New Yorker has a higher yearly income than the median Mississippian – $48,472 versus $34,343 (2006 U.S. Census). A simple explanation would be that New York has higher paying jobs, but that would miss the valuable customer insight. After all, why does New York have higher paying jobs?
According to the basic laws of Economics, a New Yorker must make more money per year because in New York, time is a more valuable resource than in Mississippi. New Yorkers have a comparative scarcity of time. The marginal cost of working (the cost of working one more hour) is higher than in Mississippi.
To get a New Yorker to work one more hour, you need to pay him more. The opportunity cost of working is higher (the cost of losing the ability to do things besides work). Not only is an hour of work more valuable in New York, so is an hour of non-work.
Let’s bring this example back to the subject at hand.
Why Should A Marketer Care?
What does understanding Economics do for us as marketers? Let’s say we are marketing a product that has a unique advantage over its competitors; it works twice as fast.
We could market this product as “works twice as fast” to New Yorkers, but that only scrapes the surface of the underlying customer need. We could be much more creative, and market the product by describing all the other valuable activities the customer could be doing with the time saved by our product.
Once we know how much an hour of our customer’s time is worth, and how many hours a year our product saves, we can quantify the value it has to that customer.
But this is a different message than the one that we would use in Mississippi. Maybe the relative abundance of time as a resource in Mississippi means that this product must be marketed in an entirely different way, possibly with a completely different value offering.
The key is in finding that customer pain point, the problem that the customer would find tremendous value in solving.
Pricing the product below the value it offers to our customer, our only remaining challenge is in articulating that value. Marketing can’t change customers’ tastes, but it can educate them. Customers want your valuable product.
You can learn a lot about how your customers behave by familiarizing yourself with Economics. You’ll be surprised how often thinking like an Economist leads you to counter-intuitive insights that you would otherwise miss.
Economics, like Psychology, is a tool in your arsenal. It equips you with the skills to understand your customer, which is the largest challenge a marketer faces.
After all, once you know what your customer wants, you know how to shape your offer, and business success is right around the corner.
I urge you to learn more about Economics. Try Steven Landsburg’s Armchair Economist. It skips all of the math, and teaches you the fundamentals.
Like Becker, Landsburg makes controversial claims, like that seat belts kill people. It’s a fascinating read, and a good place to start.