Make Economics a Part of Civics Education
By Harlan Day, Ph.D.
The recent financial crisis has proven that financial literacy is an essential citizenship skill. The collapse of the housing market, volatility in other financial and commodity markets, and high rates of unemployment have all contributed to financial insecurity and hardship for many people. Many of these problems were created or accelerated due to making poor financial decisions. This suggests that a key remedy to protect against future economic pain or at least to mitigate economic downturns is teaching citizens how to think economically and to manage their finances more effectively.
There issue of debt illustrates the uneven landscape that Americans are travelling on a path toward fiscal health. According to the Federal Bank of New York, since the height of the financial crisis at the end of 2008, there has been a reduction in overall household debt of $1.3 trillion. This has primarily come through reductions in loans secured by real estate and also through reductions in credit card balances (down 23% from their peak in 2008). However, there has been a major increase in debt since 2008 from student loans (an increase of $303 billion, nearly 50%), as students have borrowed heavily to finance further education during the very tight job market. Unfortunately, recent evidence shows that students are having difficulty repaying these education loans. The delinquency rate on student loan balances more than 90 days delinquent is now 8.9% and has increased in recent years. So despite some recent improvements in certain areas, it is fair to say that Americans are still burdened by much debt and often struggle to manage their finances. (Federal Reserve Bank of New York, 2012)
One purpose of this essay is to reinforce the view that improving financial literacy is a “team effort.” That is, the issue is just too important to be left only to educators who happen to teach a personal finance course. All teachers need to be aware of this important issue and do their best to help students become financially literate. Certainly, teachers must focus primarily on teaching the specific content of their courses. But there are real opportunities to reinforce personal finance concepts in disciplines such as math, consumer and family sciences, business, and economics. Doing so also helps students see valuable connections in what they are learning. Furthermore, because of the seriousness of this challenge, I believe that we must think even more broadly. We cannot leave the responsibility of financial literacy to schools only. In our various societal roles as parents, siblings, aunts and uncles, non-profit volunteers, business supervisors, and religious leaders, we all should try to be more purposeful in helping our young people learn how to manage their finances more effectively. There are many opportunities, ranging from teaching specific personal finance lessons and activities to reinforcing financial literacy in more informal ways, including general conversation.
The other purpose of this essay is to encourage readers to consider using some of the basic principles of economics to help students learn about personal finance. For some readers, this statement probably seems confusing. After all, isn’t personal finance the same thing as economics? Well, not really. Certainly, economics and personal finance are related. However, it is helpful to view economics as a set of fundamental principles that provide a foundation for the teaching of personal finance. The good news is that knowledge of these fundamental economic concepts equips students with some very powerful tools for mastering the basic ideas of personal finance. The other piece of good news is that these fundamental economics concepts really aren’t that difficult to understand and apply; most people have an intuitive understanding of them, even though the terminology may be new. In the rest of this essay, we will examine some of these concepts and give examples of how to use them to teach some key ideas in personal finance. People will make better financial decisions if they use basic economics principles and good economic reasoning.
Scarcity and Choice
The concept of scarcity is probably the most fundamental concept in economics. Simply put, scarcity means that we can’t have all of the goods and services that we want. In other words, in a world of scarcity, goods and services are not freely available. They have a price and must be purchased in the marketplace. Furthermore, and very important, because we can’t have everything we want, we must choose which goods and services to consume. In fact, scarcity requires choice.
It is not difficult to see how the fundamental concepts of scarcity and choice apply to virtually all aspects of personal finance. An obvious example is budgeting. Why do students need to know how to make a budget? Because their income is scarce. They can’t purchase everything they want and they must therefore make choices – and often tough choices at that. In fact, recognizing the fundamental fact that we can’t have everything that we want is the most fundamental idea in teaching our students how to save and build wealth. As an article on the Investopedia web site bluntly states, “In most cases [of financial hardship], the biggest challenge you face isn’t financial, but the need to curb your desire to spend.” (Investopedia, 2012)
The idea of scarcity also applies when choos- ing a career. Sarah wants to go to college to develop the skills, knowledge, and experiences (i.e. human capital) that will help her get a better and more fulfilling job. However, upon arriving on campus, she realizes that she has a scarcity problem. She thinks she would like a career in nursing, but she also thinks being an accountant would be very rewarding. In her four-year course of study, she can’t train to be a nurse and an accountant. She must choose which career she really wants.
Closely related to the ideas of scarcity and choice is the concept of opportunity cost. In economics, opportunity cost simply means the value of the best forgone alternative. In other words, it’s the value of the alternative (opportunity) we don’t select. For example, suppose Gerald has a $20 dollar gift certificate. He really likes a particular shirt, but also has his eye on a new pair of jeans, each of which costs $20. In making his decision, Gerald should first carefully weigh the advantages and disadvantages of his two alternatives. Suppose he chooses the shirt. In this case, the shirt would be his choice and the jeans would be his op- portunity cost. If he chooses the jeans, the jeans would be his choice and the shirt would be his opportunity cost.
How important this concept is! At a conference several years ago, economic educators were asked to identify their most important instructional goal. Their answer? To help students think in terms of opportunity cost.
Like scarcity and choice, opportunity cost can be applied in many ways to help manage one’s financ- es. Take the budgeting example again. Suppose Lucas doesn’t have a lot of money, but still wants to buy an expensive pair of name brand basketball shoes. You might be inclined to counsel Lucas into buying a less expen- sive, yet still adequate pair of shoes. After all, he doesn’t “need” such an expensive pair of shoes – right? Actually, it may be more effective to challenge Lucas to consider the opportunity cost of his purchase. (Gallagher, S. & Hodges, S., 2010) He would be able to purchase the less expensive pair of shoes and still have money left over to purchase something else he values – or even to save.
A personal anecdote reinforces this point. One of my sons went straight into the Marine Corps after high school. Saving money had never been one of his strengths, but before he left for basic training, I happened to show him a compound interest example that I often use with teachers in training workshops. (KidsEcon Posters web site) He was simply amazed at seeing how compound interest could make his savings grow and he insisted that he wanted to start an IRA (Individual Retirement Account) after basic training. To be honest, I forgot about this incident, but sure enough, 13 weeks later he reminded me, and so I helped him set up an IRA. Each month for 4 1⁄2 years, money was deducted automatically from his military pay check and invested in stock mutual funds. Stock values increased during this time, and when he left the service, he had accumulated a rather large sum of money in his IRA. He had also invested in some non-IRA mutual funds and used this money as a down payment on his first home. (Although the stock market is more risky and more volatile than other investments, over the very long term it has performed well, averaging approximately10% per year. (MarketWatch, The Wall Street Journal, September 17, 2010) Young people have more time to ride out the short term ups and downs of the market, especially with long- term accounts like IRAs.) The point is, I didn’t have to lecture my son about “needing” to save instead of spend – I just showed him the opportunity cost of not doing so!
The concept of opportunity cost can also help students realize the seriousness of acquiring too much debt. Certainly we must counsel students against this danger. But it may be more effective to show them the opportunity cost of their decision to acquire too much debt. Ask your students to guess the answer to this problem: Suppose you choose to accumulate a $3,000 credit card balance, with an interest rate of 19.8. Also suppose that you choose to pay only the minimum balance each month (how tempting this is!). How long would it take to pay off this $3,000 debt, and how much interest would you pay? Answer – over 33 years with interest of over $9,000! But don’t stop here! Also show your students the compound interest example noted above. Then ask, “Is the opportunity cost of your choice really worth it? Do you want to take over 33 years and pay over $9,000 in interest, or do you want to accumulate a large amount of money through saving and investing?” These kinds of powerful examples are very effective in showing students how compound interest can work for them as well as against them. Every student may not heed your advice, but you certainly will get their attention. (KidsEcon Posters web site)
A fundamental idea of economics is production. It is through production that we get the scarce goods and services that we want. This may seem to be rather obvious, but it is important to emphasize this basic reality to our students. Goods and services don’t just appear magically in stores – they must be produced. More important, we must teach students that as adults, each of them, as they are able, must work to produce a good or service. This production may or may not take place in the marketplace, but as adults, we should all be involved in some sort of meaningful work: as plumbers, accountants, web site developers, teachers, caregivers, cafeteria workers, store clerks, home managers, office workers, etc. The list is as long as there is work to be done. One way to drive this point home to students when teaching about jobs and careers is not to ask them what they want to be as an adult, but rather ask them what good or service they want to produce. It’s quite a probing question and really gets students thinking.
Specialization and Human Capital
After introducing the concept of production, it’s an easy step to introduce the concepts of specialization and human capital. For example, after your students realize that as adults they must produce something, the next logical question is, “Well, what good or service should I produce?” Now is the time to introduce the concept of specialization, the idea that we all have special interests, aptitudes, and abilities that enable us to be better producers of certain kinds of goods or services. Certain students are mechanically inclined; others have better communication skills. Some are artistic, while others have a special aptitude for math. An excellent teaching activity is to have students research the kinds of jobs or careers that fit their areas of interest and ability. Put in economic terms, ask them to research occupations in which they might want to specialize.
After students identify certain job interests, the next logical step is to get them to examine the skills, experience, and knowledge they will need in that occupation. In other words, what human capital will they need to acquire? Students begin to think, “If I want to provide plumbing services, what human capital will I have to have? What training will help me develop that human capital and how will I get it? By asking these questions, your students are beginning to engage in responsible thinking about their future.
Supply and Demand
For economists, no list of economics principles is complete without the concepts of supply and demand. The mention of these can bring a feeling of dread to those of us who wrestled with supply and demand graphs in our economics classes. Should we really teach this to our students? Well, yes. The concepts of supply and demand are very important because they impact students every day. The good news is that we can teach these important concepts at a very intuitive level and don’t have to introduce com- plicated graphs. In a nutshell, here are the basics:
Think how helpful this can be when looking at career choices with your students – probably the most important financial decision they will make. Because a career choice is so important, when researching the job market, students need to be acutely aware of the possible future demand for certain jobs. Do students really want to invest a significant amount of time and money (possibly borrowed) training for a career in which there is a declining demand for jobs? Similarly, if students are seeking a certain level of income, a future decrease in demand for a certain job may translate into a much lower wage or salary than desired.
In fact, applying supply and demand and also several of the other economic concepts we have discussed will help students understand why jobs have such differing levels of income. Why does a sports star like Lebron James earn so much money? Answer: The supply of people who possess his scarce set of specific skills (human capital) is very limited – in fact, he is extremely unique in having them. Also, having a star like Lebron on your team will increase crowds and team revenues, perhaps significantly. For this reason, the demand for his services is also very great. Voila! The very limited supply of someone with Lebron’s unique basketball skills coupled with the great demand for his services translates into a huge income.
True, this is a rather unique example, but the same principles apply to other careers. The supply of brain surgeons is much less than the supply of truck drivers because of the extra effort and expense it takes to acquire the necessary knowledge and skills (human capital) to become a surgeon. The demand for brain surgeons is also significant. It should come as no surprise to your students that brain surgeons earn a higher income than truck drivers.
Another obvious area where the concepts of sup- ply and demand apply is when teaching about saving and investing. In a nutshell, prices of stocks, bonds, mutual funds, commodities, and interest rates rise and fall because of changes in supply and demand. While this basic knowledge should be understood by all your students, certain students will be especially fascinated by financial markets. You can encourage this interest by having students research and keep track of the prices of certain investments. One motivating and effective way to do this is to encourage student participation in simulations such as the Stock Market GameTM. Research has shown that students who participated in this simulation significantly increased their knowledge of personal finance, economics, and even math. (See Hinojosa, T., et al., and also Walstad, W.B., et al.)
Another practical area where an understanding of supply and demand is very helpful is the decision about whether to purchase a home or to rent. The answer depends on supply and demand in the markets for homes, rental rates, and interest rates. As prices in these markets change, this means different incentives and different opportunity costs for individuals to consider when making this important decision.
Most people agree that basic financial literacy - teaching students how to manage their financial resources effectively – is important. Financial illiteracy not only harms individuals and families, but also society as a whole. Most would also agree that we should do our best to promote financial literacy in all of our various societal roles and not leave it only to our schools, and certainly not just to those teaching a personal finance course. Fortunately, to do this task, it isn’t necessary to be an expert on all the ideas and concepts of personal finance. A basic understanding of the principles of economics discussed in this article will go a long way in effectively helping students in this crucial area of their lives.
Federal Reserve Bank of New York. August 2012. Quarterly Report on Household Debt and Credit.
Gallagher, S. & Hodges, S. “Let’s Teach Students to Prioritize: Reconsid- ering “Wants” and “Needs,” Social Studies and the Younger Learner 22(3), pp. 14-16, © 2010, National Council for the Social Studies.
Hinojosa, T., Miller, S., Swanlund, A., Kelly, H., Brown, M., & O’Brien, B. (2009). The Stock Market GameTM Study: Brief report. Retrieved from http://www.learningpt.org/smg/SMG_Study.pdf.
Investopedia, (www.investopedia.com/articles/pf/08/generation-debt.asp). “Avoid the Generation Debt Trap,” Jan. 1, 2012.
KidsEcon Posters, (www.kidseconposters.com - click on Posters). Indiana Council for Economic Education, Purdue University.
Walstad, W. B., & Buckles, S. (2008). The National Assessment of Educa- tional Progress in Economics: Findings for General Economics. American Economic Review: Papers & Proceedings, 98(2), 541-546.
Dr. Day directs the Sagamore Institute’s economic education programs and serves as an economic education professor at Purdue University . He formerly served as director of the Indiana Council for Economic Educa- tion. He has authored many K-12 curriculum materials, including The Classroom Mini-Economy and Playful Economics.