Although many business executives sat through one, or perhaps several, courses in economics while in school, most probably took away little more than the supply and demand graphs to which they were introduced early in their first course. Ask them if they apply much else from else from economics in their actual business careers, and you’re likely to hear “not much.”
They might be surprised at how certain economic notions have been directly applied in business, with largely positive results. Here a few notable examples.
Auctions. Consider first the increasing use of auctions, which have a distinguished history in the development of economics. In the 1900s, French mathematician-economist Leon Walras envisioned prices in a market economy being set by an auctioneer (since known as the “Walrasian auctioneer”) conducting continuous auctions for all kinds of commodities.
It may be tempting to think that the Walrasian auction is just a theoretical construct, useful primarily in a classroom setting for thinking about markets, and in the real world, only for scarce commodities or unique items, of the kind put up for sale by Sotheby’s or Christies. But that would be a mistake.
The late Julian Simon (better known, perhaps, for his optimistic views about population growth and resource abundance) thought up the idea for having airlines auction off overbooked seats and persuaded the Civil Aeronautics Board, which used to regulate airlines fares and entry, to permit the idea in the 1970s. Economist Ronald Coase proposed auctioning off segments of the electromagnetic spectrum in late 1950s, a policy idea that was later adopted in the 1990s. Many economists since have been hired by the U.S. and other governments to help them design these often complicated auctions and by telecommunications companies trying to figure out the best strategies for bidding.
Two well-known companies have also made auctions famous, and economists have played central roles in the success of each. Google generates most of its revenue through an auction-based system of selling ads that was developed by two engineers but validated by its chief economist, Hal Varian, a former consultant to the company who was also the first Dean of the School of Information Sciences at the University of California at Berkeley. Varian has since overseen the hiring of a large corps of statisticians and economists who developed other innovations for the company, notably Google Trends, which can be used to track the number of search terms that can be helpful in predicting various real world events (such as the progress of the flu or forthcoming official unemployment statistics).
Priceline introduced the “conditional price offer,” an economic notion developed by the company’s founder, Jay Walker, who put his undergraduate economics training to good use to form a company that has revolutionized travel. Walker’s innovation was to bind travelers to pay the prices they bid if the airlines and hoteliers on Priceline accepted the offers. That way, travelers took their offers much more seriously than if they simply could “name their price” without any purchase obligation.
Economics and logistics. All businesses seek to control costs; they don’t need an economist to tell them why it’s important or how to do it. But there are some very important exceptions. Companies in the transportation and communications business face complex optimization problems that mathematicians and economists have figured out how best to solve through “linear” (and later “non-linear”) programming methods. Firms in these industries and their customers who thereby benefit from lower prices (admittedly through processes they never see) benefit greatly.
Economists and big data. For several decades after World War II, economists used statistical techniques to build increasingly complex models to forecast key macroeconomic variables, notably, GDP growth, inflation and unemployment. Economists who had statistical skills worked at leading forecasting firms such as Data Resources, Inc and Wharton Econometric Forecasting Associates (the two have since merged and been absorbed into Standard & Poors). Many large banks, other financial institutions and some large manufacturing companies also had their own economic staffs.
This has all changed. Macro models are now largely out of vogue, though still used along with human judgment at institutions like the Federal Reserve Board and the International Monetary Fund. Forecasters never were very good at predicting turning points in the economy — recessions and recoveries — and it is not clear they will get better over time, though some will try.
Instead, the “Big Data” revolution ushered in by the ease of capturing, storing and analyzing large bodies of data has generated new demands for economists and statisticians. High tech companies like Amazon, Yahoo and Google, among others, now employ economists to sift through all kinds of data — retail transaction data, browsing patterns, mobile phone usage — to fine tune their product offerings, pricing and other business strategies.
Economists and market design. Most markets “clear” by having prices signal producers to make just enough that purchasers are willing to purchase. But a relatively new strand of economics, known as “market design” or “matching theory,” has focused on markets where “fit” is much more important than price in directing resources or decisions is gender neutral: matching of medical residents to hospitals, organ donor banks and on-line dating. For example, drawing on his Nobel prize-winning work shared with Lloyd Shapley, Harvard Business School emeritus professor Alvin Roth has used matching theory to design the national medical resident assignment program and kidney donor exchanges.
In the online dating world, one well-known problem is that women can get flooded with more offers for dates than they can reasonably screen or may want to spend time screening. One online service, cupid.com, hired one economist and drew on the work of another to limit the number of “roses” (requests for dates) men could send per month to women. This greatly incentivized the men to be much more selective, and knowing that, women were much more likely to reply after the limits were put in place.
Economists increasingly are also using insights from matching theory to help companies better design systems for matching potential employees with employers, where finding the right “cultural fit” is as or may be more important than an employee’s initial specific skills.
Economists and finance. Finally, not surprisingly, economists have been active for decades in formulating and testing theories in the financial world, some of which have found their into actual products (not all of them bad, like the complicated sub-prime mortgage securities at the heart of the financial crisis, which economists did not design). Examples include index funds, and their more recent variation, index-based exchange traded funds (EFTs). Index funds initially were brought to market by Vanguard founder Jack Bogle, whose idea for the S&P 500 Index fund was heavily influenced by two economists: late great MIT economist Paul Samuelson and Princeton’s Burton Malkiel, author of the classic, A Random Walk Down Wall Street. (https://bbs.pinggu.org/thread-2962765-1-1.html)
Even more directly, the growth in financial options can be traced largely to the ease of valuing them, which is due to the Nobel-prize winning work of Fischer Black (the MIT economist and later Goldman Sachs partner who died before he certainly would have shared in the award), Myron Scholes (formerly of Stanford) and MIT’s Robert Merton.
Admittedly, better pricing of options has been a mixed blessing. While it is has greatly improved liquidity in the market of options, and facilitated the formation and growth of many tech startups (where option grants are routinely used to compensate employees, directors and advisers), better options pricing may also have contributed to excessive option grants used by companies like Enron, Tyco, and Worldcom to manipulate accounting statements to show illusory profits.
What’s the larger point to be made here? Only the one I assert in my book Trillion Dollar Economists, that business managers may want to pay a bit more attention to the scribbling of academic economists. There can be strategic advantage in consulting the sources where those thoughts are published, especially as translated for a bit broader audience than the economics priesthood (such as here in the Harvard Business Review and even in some relatively accessible professional journals like the Journal on Economic Perspectives). The first step to succeeding wildly as a first mover may be to connect with a first thinker.
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