You Decide: Where Can We Cut Back?
Both of my grandfathers were farmers in southwestern Ohio. One had a hog farm and the other raised beef cows. This was a century ago, and farming then – like now – was very risky and unpredictable. My grandfathers and their families had to be prepared to periodically tighten their belts when adverse economic conditions popped up.
My father didn’t take up farming. After returning from World War II, he trained to become a carpenter, and he stayed in that occupation for over 40 years. I don’t know if he pursued that career to have more stable finances, but if he did, he was wrong. My father typically didn’t have work for several months during Ohio winters. His family – including me – had to hunker down and cut back until he went back to work.
Many households today are faced with a challenging economy. For two years, prices households pay have outpaced the incomes households earn. Simply put, people can’t buy the same amounts of products and services today that they bought two years ago. Standards of living have dropped.
To make matters worse, the job market seems to be weakening, and some economists are predicting unemployment will eventually rise. If this happens, it will put a further strain on household finances.
What can people do? Can economists like me use our training to make any useful recommendations? I think we can.
The first task is to know where you stand, financially speaking. Get pencil and paper together and begin to track where your money is going. Also, tally both the current values of your investments and debts. This information will allow you to see how much of a financial challenge you have.
Now comes the hard part – assuming you have a financial challenge, what do you do? Here’s where some economic principles can help.
One important economic principle is substitution. Simply put, we are constantly looking for ways to meet the same need less expensively. So, when one way becomes costlier, we’ll try to find another way that gives us the same result but at a lower cost.
Let’s say you enjoy eating meat. While meat prices in general have risen during the last two years, some meat prices have risen less than others. Among the top three meats – beef, pork and poultry – beef prices are up 4 percentage points less than pork and 8 percentage points under poultry. Eating more beef and less pork and poultry would therefore help you budget.
One of the biggest changes in eating has been in meal preparation. When I was a child in the 1950s, eating out at a restaurant was saved for special occasions, and delivery of meals to homes was unheard of. Meals were prepared at home using ingredients from supermarkets.
Today, 40% of meals are eaten away from home. But eating meals at restaurants can be up to five times more expensive than making and eating that same meal at home. The reason is you’re paying someone else to prepare your meals in a restaurant.
Therefore, by substituting making and eating meals at home for meals served in a restaurant or delivered to your home is one way to reduce spending. You’re substituting your time for the money you would spend in a restaurant.
Another economic principle is the time value of money. The value of money depends on when it is spent or earned. A dollar today is worth more than a dollar in future years because prices will likely be higher then. Therefore, to move future dollars to now, you’ll need to pay a cost. This is why an interest rate is paid to borrow against your future income.
With interest rates rising and expected to increase even more, borrowing is more expensive. As a result, it makes sense to postpone borrowing when interest rates are high. For example, if you want to buy a house but don’t want to pay today’s mortgage interest rate – which is more than double from a year ago – then put that dream aside until rates come down. And P.S., I think interest rates will be dropping a year from now.
A third applicable economic concept is productivity. In business terms, productivity is output compared to inputs. For example, productivity in an auto factory is the number of vehicles rolling off the assembly line compared to the amount of labor and machinery used to make those vehicles. Higher productivity – meaning more vehicles per worker and machine – usually results in more profits for the company.
Even if you don’t have a home-based business, you want to run your household productively. You want to use your two major resources – time and money – in ways that give the highest results.
A good example is driving. Given the level of gas prices today, cutting back on driving can produce big savings. If you can consolidate driving trips by doing numerous errands on the same trip, then you can drive less and reduce spending at the pump.
These are some economic ideas for coping with a difficult economy. Can you use them to ease some of the economic pain of today’s world? You decide.
Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.