There’s been a lot written about cognitive biases in the last decade. If you walk into the Psychology section of Barnes of Noble today or browse Amazon for “decision-making,” you’re sure to see a library of books on how irrational humans can be.

In my last two posts, I spoke about two of the most pernicious biases affecting businesses today—confirmation bias and over-confidence. But the most important, and troubling, error we make in our thinking just may be the Fundamental Attribution Error (FAE).

What’s the fundamental attribution error?

The FAE is our tendency to attribute another’s actions to their character, while attributing our own behavior to external situational factors. If you’ve ever chastised a “lazy employee” for being late to a meeting and then proceeded to make an excuse for being late yourself later that same day, you’ve made the FAE. It’s our tendency to cut ourselves a break while holding others 100% accountable for their actions.

But don’t feel too bad—the FAE is perfectly human. And similar to confirmation and overconfidence biases, its impact can be reduced by taking a number of measures.

FAE exists because of the way in which we perceive the world. While we have at least some idea of our own character, motivations, and the situational factors affecting us day-to-day, we rarely know all of the things going on with someone else.

In working with our colleagues, for example, we form a general impression of their character based on pieces of situations, but never see the whole picture. While it would be nice to give them the benefit of the doubt, our brains use limited information to make judgments. And thus we only have their perceived character available to us to chastise them for being tardy to the big corporate strategy review.

Within organizations, FAE causes everything from arguments to firings and ruptures in organizational culture. In fact, it’s at the root of any misunderstanding in which human motivations have the potential to be misinterpreted.

Think of the last time you thought a coworker should be fired or the last time a customer service representative was incompetent. How often have you really tried to understand the situational factors that could be affecting this person’s work? Probably not much.

FAE is so prevalent because it’s rooted in psychology, so completely overcoming it is impossible. However, one tool that I’ve found helpful in combating FAE is gratitude. When you become resentful at someone for a bad “quality” they demonstrate, try to make a list of five positive qualities the person also has—this will help balance out your perspective. 

Another method is to practice becoming more emotionally intelligent. Emotional intelligence has become a buzzword in the business world over the past 20 to 30 years, but all it involves is practicing self-awareness, empathy, self-regulation and other methods of becoming more objective in the service of one’s long-term interests and the interests of others. Practicing empathy, in particular, such as having discussions with coworkers about their opinions on projects and life out of the office, is a good first step.

FAE is impossible to overcome completely. But with a combination of awareness and a few small tools and tactics, you can be more gracious and empathetic with your coworkers.

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It’s that time of year again: college graduation! When professors wear ridiculous robes, the band plays Pomp and Circumstance, and weepy parents watch their babies don caps and gowns and walk across the stage to get their hard-earned diplomas.

It’s a magical time, full of hopes, dreams, and, for many graduates, intense anxiety about what’s next.

After diplomas are handed out and the band plays its final tune, it’s time for newly minted graduates to head out into the real world. If you’re in this boat, this may be your first time living on your own, managing your finances, and doing your own grocery shopping. It’s an exciting (and scary) new chapter of life, full of responsibilities and big decisions. And, if you’re like me back in 2013, you’ll probably have little idea what to do or how to make those decisions.

Never fear, economics is here to lend a hand! You're probably thinking, “Economics? You mean that class I never took in college?” Yep, that’s the one!

Most people think economics has to do with investing or the stock market (that’s finance actually). But in reality, economics is mostly concerned with how people make decisions and the ways their choices interact. To that end, the field of economics contains several principles, tools, and frameworks that you can use to think about the decisions you’ll make after school (and those you face every day).

Few concepts are more important than the principle of opportunity cost.

After graduation, you’ll undoubtedly face many decisions: where to live, what to do for work, who to date, and countless others. In each of these choices, you will face trade-offs. If you take a job at a consulting firm, for example, you’ll likely have to travel a lot and won’t be able to sleep in your own bed. If you date Lily or James, you (presumably) won’t be able to date Arthur or Molly. No choice is the “perfect” one because you must always give up something else in order to get it.

Economists like to say that “there’s no such thing as a free lunch.” The idea is that even if someone offers to buy you lunch, the meal isn’t costless. You still “pay” for it in the form of the time you spend at lunch not doing other things (like reading the new book you brought to work or dining with someone more interesting).

In fact, you incur costs with every decision you make. The opportunity cost of a decision is the value of the next best thing you give up to make that choice. In other words, it’s what you sacrifice in order choose one course of action over another. 

Post-graduate life (and life in general) is full of opportunity costs that you should account for when making decisions. For example, suppose you’re thinking about going to graduate school. If you do, you’ll need to pay tuition, buy books, and incur other expenses. The full price tag? $100,000 over two years. But the actual cost of attendance is much higher than this!

Why? Because, if you do attend, you forego the salary you could have earned by working. If you could get a job paying $50,000 per year, for instance, the total cost of grad school (accounting for this opportunity cost of not working for two years) has just doubled! 

But opportunity costs don’t just factor into career decisions. For example, suppose you’ve gotten a job in a new city and are now looking for a place to live. Your salary is modest, so you are hoping to rent as cheap a place as possible. You look in the city, but the apartments are so expensive! You eventually find a place for $300 per month less than ones right by work, but it is an hour train ride away. Should you take the apartment?

Well, it depends how much you value your time. If you do take it, that’s 2 hours in the car each day. 30 days per month, and that’s 60 hours total of time lost to driving (more with traffic). Is 60+ hours of your time worth $300 dollars to you?

Economics can’t tell you whether or not to exchange time for money. But it can provide important principles and frameworks with which to help you make these decisions.

So when you’re making big decisions as a newly minted graduate, remember to consider opportunity costs—there’s no such thing as a free lunch!

Although, if you do value your time, you can always get lunch delivered.

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Interested in learning more about Economics, Financial Accounting, and Business Analytics? Our fundamentals of business program, HBX CORe, may be a good fit for you:

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About the Author

Pat is a member of the HBX Course Delivery Team and currently works on the Economics for Managers course for the Credential of Readiness (CORe) program. He is also currently working to design courses in Management and Negotiations for the HBX platform. Pat holds a B.A. in Economics and Government from Dartmouth College. In his free time he enjoys playing tennis and strumming the guitar.

There’s been a lot written about cognitive biases in the last decade. If you walk into the Psychology section of Barnes of Noble today or browse Amazon for “decision-making,” you’re sure to see a library of books on how irrational humans can be. In my last post, I spoke of the first of the three - confirmation bias.

What's second on our list?

Over-Confidence

For newbies to the literature on cognitive biases, this one should at least be familiar. We’ve all met over-confident jerks that think planets revolve around them (you might even work for one), or the wishful thinkers with their head in the clouds, but all of us, myself included, have fallen victim to moments and sometimes stretches of over-confidence. If you’re like me, these stretches have usually ended with bitter disappointment, or even catastrophic failure. And yet, despite what we think we have “learned” for next time, we continue to be over-optimistic about our abilities and the state of the future. The same mistakes occur again and again.

In business, over-confidence is rampant. And it’s no surprise to see why. In complex organizations filled with many individuals with diverse ideas and views, you have to speak up to be heard and market your abilities to get noticed. Being humble takes a back seat to arguing without legs to stand on. How many M&As have you heard about that have failed? Quaker buying Snapple, anyone?

One outcome of over-confidence is missed deadlines and delayed projects on account of the planning fallacy. When’s the last time your business finished a project early? Or under budget? And yet we continue to create unrealistic project plans in hopes that the future will somehow be different than the present; this is over-confidence at its best/worst. Another classic example of over-confidence is the illusion of control, the idea that if we can quantify something, we can measure it, understand it, and thus manage it. Many financiers have fallen victim to this illusion for decades. And yet, as the market collapse of 2008 showed, confidence can sometimes only be an illusion.

If over-confidence is not constantly checked, poor business outcomes often result. Thus, businesses and individuals need to install objectivity into their systems to keep them in balance. For projects, teams should look at historical averages for timelines and past budgets to plan future projects. Another option is hiring consultants. There’s an old joke that consultants have made money for decades telling companies the things they already know but don’t want to hear. This is because companies were over-confident but didn’t want to admit it.

Look out for the third bias that befalls many organizations, coming soon.

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There’s been a lot written about cognitive biases in the last decade. If you walk into the Psychology section of Barnes of Noble today or browse Amazon for “decision-making,” you’re sure to see a library of books on how irrational humans can be.

These human flaws, or biases, are fun to learn about—it can be amusing and informative for us to discover things about the way we may operate. In my opinion, most cognitive biases really stem from three core human distortions—a trio of errors that can befall even the smartest of fellows. This trio extends to all reaches of the globe and can afflict all individuals and businesses alike. In this series of posts, I’ll address this trio and what managers and employees can do about them.

So—what is the first of these three major biases?

Confirmation Bias

Anyone who has ever been in a decision-making meeting knows this bias well. Confirmation bias is the human tendency to search for, favor, and use information that confirms one’s pre-existing views on a certain topic. It goes by other names as well: cherry-picking, my-side bias, or just insisting on doing whatever it takes to win an argument. We all know someone like this. 

Confirmation bias is dangerous for many reasons, but most notably because it leads to flawed decision-making. Imagine a business considering launching a new product. The head of the company has the best idea for the “next big thing” so he directs his team to conduct market research to explore its feasibility. The team then conducts surveys, focus groups, and competitive analyses with this in mind.

I hope you see how there is confirmation bias all over this scenario. First, the company head is using market research as a sham to confirm his preconceived beliefs about a product idea. He’s not letting data do the talking at all. Next, the team is launching into the product development process knowing what their boss wants. As a result, the questions they craft for their research will likely be biased to give him the answers that he wants. While this is a hypothetical scenario, it’s all too common for companies to do this today.

How can you, as a business leader, combat confirmation bias? Taking a page out of a statistics textbook may actually be helpful. When gathering data, it’s always important to remember that the question you ask and your method of measurement will have a big impact on your results. When conducting a survey, for example, what you get depends upon what questions you ask. And what questions you ask depends upon what answer you want to get. Make sure to try to craft unbiased survey questions and have an objective third party vet your survey before releasing it. For example, instead of asking, “Do you think x is a good idea for a product? Would you be interested?” you might ask consumers to rank features of products in the form of a conjoint analysis to discover their preferences.

Another option would be to appoint someone on your team to play the role of a “devil’s advocate” when a big decision needs to be made. A devil’s advocate is someone who takes a position they don’t necessarily agree with for the sake of debate. Does your company create dissent in its decision-making process?

Confirmation bias is also the culprit behind many regrettable hiring decisions. Think about a traditional hiring process. HR or a hiring manager typically sits down with a candidate and asks them to sell themselves to the company. If they like the candidate, they might even give them a softball question about weaknesses for them to knock out of the park, just to assure themselves they are going with the right person. If all goes well, they then proceed to ask the person trying to get the job to provide their own references. How much negative or even neutral information do you think is revealed about the candidate in this process? Probably little to none. For many companies, the whole process is nothing more than a series of confirmatory checkboxes on the way to hiring the wrong person. And the result? Employee turnover and big headaches.

A better way would be to structure the interview process completely around disconfirming evidence. “Why aren’t you the person for this job?” “What did you hate about your last job?” Ask references for contact information of other employees that the individual worked with. They are much more likely to provide an objective perspective on their work.

Confirmation bias is extremely difficult to overcome, in both our personal and professional lives. Humans don’t like to be wrong and we will search for any evidence to prove the path we are pursuing is right. But, through some of the strategies above, you as a manager can stir up debate and ask some of the tough questions necessary to become a more rational, and successful, organization.

To learn more about confirmation bias, check out THIS article from Scientific American.

Check out the second bias that befalls many organizations here.

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How many times have you been in a meeting at work or conversing with a colleague, listening intently, and then suddenly have no idea what the speaker is talking about? It’s as if the person started speaking another language.

This is a great example of The Curse of Knowledge (TCOK). What is this "curse" exactly? It's not the result of a magical incantation, but it can be just as deadly to a company’s health as an Avada Kedavra off the wand of a powerful wizard (where my Harry Potter fans at?). The term was coined by Professors Chip and Dan Heath in their book Made to Stick, to describe a situation in which experts are unable to communicate their ideas to novices because they have forgotten what it’s like to be unfamiliar with their area of interest. But TCOK also exists in other fields—from professors that excel in their research but fail to teach basic concepts effectively, to scientists that struggle to communicate their findings to the public.

I had my own experience with TCOK recently at HBX. It occurred while recording an interview for one of our new courses in development (more details on such courses coming soon!). After I finished asking a question to the interviewee, red lights on our two cameras suddenly began flashing.

“Hey Pat,” said the multimedia producer on the shoot with me. “The chip is full, we’re gonna take five. Hold the roll for tail sticks.” The words flew over my head as soon as they left his mouth.

“Come again, Chuck?” I inquired.

“The card is full,” he said. “We have to hold the roll for a sec…”

“The roll?” I said with ignorance. “The roll of film...” he replied. “The card is full and we have to put in another.” He seemed dumbstruck that I didn’t know such basic film lingo.

“OK, well what are tail sticks?” I asked. He launched into a five minute explanation. I still don’t know what tail sticks are…

In the case of my HBX film shoot, it can be said that my buddy Chuck was “cursed” by his knowledge of film—he couldn’t help but rely on insider lingo to try to explain to me nuanced concepts (without success I might add).

Now, I must admit that I am completely ignorant about many things (film definitely being one of them). However, I’m guessing that many of you can relate to such an experience, whether in the world of film or in some other realm. If so, you’ve come into close contact with the curse and lived to tell the tale.

But organizations can fall victim too. TCOK is especially common in traditional businesses in which teams are comprised of functional specialists. From product development to marketing, to finance, operations, HR and down the line, specialization often makes communication across functional groups more difficult (especially if unnecessary jargon is involved). For example, how often have you seen engineers and salesmen talking past each other at your company? Or maybe tech and HR butting heads? The result is lost productivity and general frustration.

But hold on, the curse not only exists horizontally across functions, but also vertically across levels. For example, leaders at the top will oftentimes speak rather abstractly about corporate strategy. A CEO may aim to “unlock shareholder value” with some new complicated maneuver or “exploit synergies” through an acquisition. But what exactly does this mean for employees on the front lines? What actions should they take to align with such a strategy? Your guess is as good as mine.

So, how can we combat The Curse of Knowledge to make our companies more productive? In my experience, there are two keys:

1. Find a common language that everyone in your business speaks

To be clear, this is different than “dumbing things down.” It’s more like finding a lowest common denominator that everyone, no matter their role or position, can understand. For example, if a manufacturing business consists of architects, engineers, and floor workers operating machines, the architects and engineers will likely be able to understand the machines they helped build, but the floor workers might not be able to decipher the designs and prototypes of said machines. If a problem with a machine arises, it makes most sense then for all three groups to go down to the floor and speak in the language of the floor workers to resolve the problem. Abstracting to design-speak would be far less effective. This takes practice and empathy but is well worth the effort.

2. Always use concrete language whenever possible

Vague language never helped anyone (except maybe to get out of a lawsuit). For example, if you’re a leader trying to convey a new strategy to your organization, you should favor the specific over the broad. Your mission can be broad, but your strategy should be as specific as possible. Stories and images can work wonders. For example, instead of aiming to “become the leader in customer service” you might tell your employees that you aim to become “the type of company that would order a pizza for your customers to close a sale.” That conveys the extent you’re willing to go to (and the actions the employees might need to take) to execute on the strategy.

Lifting The Curse of Knowledge from your organization won’t be easy. Experts have been around for ages and, like it or not, workers are often still paid for what they know and for what they have done than for how well they can collaborate. However, by using a common language, one that’s concrete and filled with images and stories, you may just break the curse.

Please comment below with your thoughts, and tell me what tail sticks are!

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In my last post, I looked at the role of a business as a creator of value. In short, companies make money by producing and delivering value for which customers are willing to pay in order to satisfy a want or need.

I also explored three ways in which aspiring entrepreneurs can build a viable business model based upon different forms of value. Namely, start-ups can earn revenue by:

1. Creating a product, a tangible item of value for which people are willing to pay
2. Offering a service, some type of assistance or skill to someone else for a fee
3. Selling access to a shared asset, a resource that can be used by many people (i.e. gyms, aquariums, and museums)

In this post, I look at five additional forms of value to help you find a solid business model. Some of these forms of value are a bit more niche than products, services, or shared assets, but no less viable in creating a profitable, lasting enterprise. So here we go!

Subscription

A subscription is a type of program in which a user pays a recurring fee for access to certain specified benefits. These benefits often include recurring provision of products or services. Unlike a shared asset, however, your experience with the product or service is not affected by others. To have a successful subscription-based offering, you ideally want to build a subscriber base by providing reliable value over time, while at the same time taking constant efforts to attract new customers to keep customer attrition low. As you may have seen, the number of subscription services has exploded in recent years. From magazines to Netflix to Amazon Pantry for groceries and even subscriptions for wine, businesses are turning to a subscription-based model with seemingly great success.

• Pros: This model provides certainty in the form of predictable revenue streams, making financial forecasting a bit easier. It also benefits from a loyal customer base and customer inertia (lazy customers forgetting to cancel or switch to a competitor).
• Cons: In order to run this model, your business operations must be VERY strong. If you can’t deliver the value when the customer wants it, you may want to consider something else.

Lease/Rental

A lease involves obtaining an asset and renting it out to another person for an agreed upon amount of time in exchange for a fee. People can lease pretty much anything, but leases are typically only for things that are durable enough to be rented and returned in good condition. This is so the owner can lease the good multiple times or eventually sell it. To provide value and profit from leases, the key is to ensure that the revenue you get from leasing the asset before it wears out is greater than the purchase price that you paid for it. This requires being smart with financing and potentially NOT leasing to those you don’t think will be responsible with the asset. Leases are pretty common—you may have one right now for an apartment, car, or old movie that you rented!

• Pros: You don’t have to have some great idea to make money this way. You can purchase assets from others and rent them to others that wouldn’t buy them for full value otherwise, earning a premium.
• Cons: You’ll need to protect yourself from unexpected damage to your assets. One way to do so is through is…

Insurance

Insurance entails the transfer of some type of risk from a customer to a seller of an insurance policy. In exchange for the seller of the policy taking on the risk of some specified thing occurring, the buyer receives periodic payments (“premiums” in insurance lingo). If the bad thing doesn’t happen, the insurance company keeps the money, but if it does, the company has to pay the policyholder. So, in a sense, insurance is the sale of safety—it provides value by protecting people from unlikely, but catastrophic risks. Buyers can take insurance out on almost anything: life, health, house, car, boat, etc. To run a successful insurance company, you have to be able to accurately estimate the likelihood of bad events and charge higher premiums than the claims that you pay out to your customers.

• Pros: If they calculate risks accurately, insurance companies are guaranteed to make money.
• Cons: If they calculate risks inaccurately, insurance companies are guaranteed not to make money. Insurance only works because it spreads risk over large numbers of people. Insurance companies can fail if the same people are all impacted by a big terrible event that they didn’t see coming (think about the Global Financial Crisis).

Reselling

Reselling is as simple as it sounds—it’s the purchasing of an asset from one seller and the subsequent sale of that asset to an end buyer at a premium price. Reselling is the process through which most major retailers purchase the products that they then sell to us buyers. Companies make money through resale by purchasing large quantities of items (usually at a bulk discount) from wholesalers and selling single items for a multiple of that price to individuals. Think of farmers supplying fruits and vegetables to a grocery store or manufacturers selling goods to WalMart.

• Pros: Mark-ups can often be high for retail sales. For example, a bottle of water might cost maybe 10 cents to produce, whereas a customer may be willing to pay $1.50 or more for a single bottle.
• Cons: You need to be able to gain access to quality products at low costs for reselling to work. You’d also better have the room to store a lot of inventory to manage sales cycles.

Agency/Promotion

Agents create value typically by marketing an asset that they don’t own to an interested buyer. They then earn a fee or a commission for bringing together buyer and seller. Thus, instead of using their own skills to create value, they are teaming up with others with value to help promote them to the world. Running a successful agency requires good connections, excellent negotiation skills, and a willingness to work with a diverse set of individuals. One example is a sports agent. They promote players to teams and negotiate on behalf of the player to get the best deal. And in return, they usually get something like 10% of the value of the contract.

• Pros: You can highly profit from expertise and connections in one industry, be it publishing, acting, advertising, etc.
• Cons: You only get paid if you seal the deal, so you have to be able live with some uncertainty.

These eight forms of value are by no means the only ones out there. For example, the world of finance has a LOT of different instruments that aim to create value for investors. However, if you’re looking to start a business, and need a place to start, well, one of these could just be your underlying business model. Good luck!

So you want to start a company, but you aren’t sure about a viable business model. How might you create something that people would be willing to pay for from which you could earn a profit?

Before diving deep into potential strategies, it’s important to understand what exactly a business is and does. It’s surprising how many people work for businesses, but don’t actually know what they do.

A successful business creates something of value. The world is filled with opportunities to fulfill people’s wants and needs and your job as a potential entrepreneur is to find some way to capitalize on these opportunities. A viable business model is one that allows a business to charge a price for the value that it’s creating, such that the business brings in enough money to make it worthwhile to continue operating over time. Whatever the business is offering must also satisfy the customer’s needs and anticipations of quality.

Admittedly, value is quite a subjective term. What’s valuable to one person may be far less valuable to another. Moreover, the concept of value excludes any moral judgments about the intrinsic worth of an offering. For example, while most would agree that human life is more valuable than sports, Pablo Sandoval still makes far more playing baseball than the average brain surgeon does in the operating room.

Nonetheless, the concept of value provides a useful bedrock upon which to begin building your business model. In particular, one should first think about what form(s) of value that people would be willing to pay for. Here are three classic forms of value along with some pros and cons for each to get you started.

Product

A product is a tangible item of value. To run a successful product-focused business, you ideally want to produce the item for as low of a cost as possible, while maintaining a passable level of quality. Once the item is produced, your objective should be to sell as many units as you can for as high a price as people are willing to pay to maximize profits. Products are all around us. From laptops to books to HBX courses (products don’t have to be physical), products are a classic form of value with high upside if you can get them right.

• Pros: Many products can be easily duplicated. Thus, firms can achieve economies of scale after bearing some upfront costs of production.
• Cons: Physical products need to be stored as inventory, which can increase costs. They can also be damaged or lost more easily than, say, a….

Service

A service involves offering your assistance to someone else for a fee. To make money from your service, you ideally want to provide some skill to others that they either can’t or won’t do themselves. And you want to keep providing this benefit to them at a high quality over and over again. Like products, services are in abundance, especially in the knowledge economy. From hairdressers to construction workers to consultants to teachers, people with lucrative skills can earn good money for their time.

• Pros: If you have a skill in high demand or a skill that very few others have, you can get paid a lot!
• Cons: If you don’t charge enough for your services, or many people have your skill, you will have to work a lot for not very much money.

Shared Assets

A shared asset is a resource that can be used by many people. Such resources allow the owner to create or purchase the good once and then charge customers for its use. To run a profitable business around shared assets, you need to balance the tradeoff of serving as many customers as you can without affecting the overall quality of the experience too much. Think of a fitness center: a gym typically buys treadmills, ellipticals, free weights, bikes and other equipment and then charges customers for monthly memberships for access to all these shared assets. The key then for Golds Gym or 24 Hour Fitness is to charge their customers enough to maintain and, if needed, replace their assets over time. Finding the right range of customers is the key to making a shared asset model work.

• Pros: This model provides people access to a lot of assets that they would not have access to otherwise. In addition, many people are willing to pay a lot for access to trendy social spaces.
• Cons: Because they don’t own the assets, customers have little incentive to treat your resources well. Make sure you have enough cash on hand for quick fixes if necessary.

These are just three forms of value possible to the aspiring business owner. Stay tuned for my next post which will discuss five more.

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Click here to see part 2!

Last week we featured part 1 of our list of economic relationships you need to know (found here). This week we are rounding out the list with three more key economic relationships:

3. Interest Rates Up, Investment Up: How does a business, household or country determine how much money to invest? There are a lot of factors that go into that decision, but probably no other factor is as important as the prevailing interest rate. Interest is the money received for lending one’s money to another party (or, from the opposite perspective, the money paid to a lender for the right to borrow). The interest rate is then the ratio of money paid as interest to the amount lent/borrowed, usually quoted as a percent (so if you pay $5 to borrow $100, the rate is 5%). As an investor, you want to look for the highest possible rate of return for your money. Thus, the higher the prevailing interest rates in your country, the higher will be your incentive to invest your money. As a result, when interest rates increase (as they did in the US recently), investment will typically go up.

4. Money Supply Up, Interest Rates Down: If interest rates determine investment, what determines interest rates? Well, in a way, the interest rate is the “price” of borrowing money and, in economics, prices are usually determined by quantities. Quantities of goods, quantities of services and, in the case of interest rates, the quantity of available money. Interest rates are largely determined by the supply of money in the economy. The more money there is available to firms and individual borrowers, the less banks and other lenders will be able to demand for the right to borrow that money. If a bank charges too much, potential borrowers can just go to another source to get money. This gives lenders the incentive to all charge around the same amount for access to that money. This relationship is what gives central banks so much power. A central bank, such as the U.S. Federal Reserve, has the legal right to print money and thus effectively controls the supply of money in the economy. If the Fed wants to stimulate the economy, like it needed to during the Great Recession, it can (effectively) lower interest rates by printing money, pumping money into the financial system and providing businesses the incentive to invest more. There’s more to it than that, but if you hear that the Fed plans to raise (lower) interest rates, just know that it’s doing so by decreasing (increasing) the supply of money.

5. Economic Growth Up, Unemployment Down: As discussed, the amount of money in the economy plays a major role in determining interest rates. And interest rates largely determine how much businesses and households invest. Investment is crucial for a business to undertake new projects and be able to offer new products and services to consumers. But investment is only one part of the equation. To determine the overall “health” of an economy and the potential for individuals to buy their products, businesses also need to know how much domestic consumers, foreigners and the government are currently spending on goods and services. On the macro level, the amount spent on consumption, investment, government services and net exports (less imports) is known as gross domestic product (GDP). If spending on goods and services is not increasing (GDP is not growing) or has been decreasing (recession), it may not make sense for a business to bring a new product to market. And if that’s the case, businesses may not need as many workers to create such products. Thus, there exists a key link between GDP and unemployment. If GDP is growing, it’s more than likely that more workers are being hired to create products and services and thus unemployment will be declining.

Economics and finance is more complicated than the simple relationships described here, but these offer a rough depiction of how the decisions made by various actors play out in the real world to distribute resources and create an economy. As you hopefully see from these examples, economics and finance are largely influenced by human motivations. And by understanding humans, you just may be able to use those insights to improve your household, business or country.

What do you think of when you hear the word “economics” or “finance?” For many, words like these bring to mind complicated formulas and jargon, men in suits making irresponsible decisions with other people’s money, or bad memories of supply and demand graphs from college.

Fair enough. But economics and finance don’t need to be difficult. And you certainly don’t need to know a lot about either topic for you or your business to benefit greatly from them. Indeed, as a manager, employee, or policymaker, even a basic knowledge of economics and finance can be enough for you to make informed decisions that can result in increased profitability, smarter investment decisions, and better public policy.

Here’s a list of some key economic relationships for a business owner or policymaker to remember when making decisions:

1. Price Up, Demand Down: This relationship is the foundation behind those pesky demand curves you may have had to draw in Econ 101, but is absolutely necessary for any business to understand in order to make money. Luckily, it’s pretty easy to comprehend, so we can skip the graphs altogether. Here’s the chase: when a business increases prices, it will almost always see sales for its product or service fall. This is because consumers prefer to pay less for something than more for it (but you probably didn’t need to be told that), so fewer people will be able to afford the good. Price up, demand down. It’s common sense.

2. Price Up, Supply Up: This is the flipside to the previous relationship. When prices go up, consumers demand less, but, boy, would businesses sure like to supply more. Why would they not? If the product or service a business is supplying can command a higher price, it’s in the business’ best interest to supply more of it to make more revenue. So, price up, supply up. Like demand, its incentives at work here too.

Check out part 2 of our list here!

Materiality. Can you use it in a sentence please? No, it’s not related to the accumulation of physical wealth or some obsession with material possession. That’s materialism. Materiality is a key accounting principle utilized by accountants and auditors as they create a business’s financial statements.

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Materiality: an accounting principle which states that all items that are reasonably likely to impact the decision-making of investors must be recorded or reported in detail in the financial statements of the business.

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Why does it matter? In essence, materiality is related to significance. Is some transaction or business decision significant enough to warrant reporting to investors or other users of the financial statements? If it is, we say that the information is “material” to the business.

What’s considered to be material will differ based on the size and scope of the firm in question. For example, while a small mom and pop grocer may need to record a small expense for promotional coupons, Whole Foods may not need to record a large one for a similar customer offer. It’s all relative.

Material items can be financial (measurable in monetary terms) or non-financial. So a business might need to report a pending lawsuit to the same degree it reports its revenues. Indeed, of late there has been a big push to include more non-financial material information in financial statements.

For example, with a bigger investor focus on sustainability nowadays, a business might want to include information related to its environmental, social, and corporate governance (ESG) practices to assure shareholders that the business itself is a “green investment.” In fact, as Professor Robert G. Eccles discusses in a recent HBR article, there has even been talk of creating new accounting standards to better measure material information related to sustainability.

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Interested in learning more about materiality and other topics in finance, economics, and business analytics?