The Economic Way of Thinking: The Key to Financial Literacy

Professor Jamie Wagner discusses how economics is the key to financial literacy. She is a Professor and Teaching Fellow with the Foundation for Teaching Economics, as well as an Associate Professor of Economics and Director of the Center for Economic Education at the University of Nebraska at Omaha. In this series, Dr. Wagner will discuss best practices for teaching economic principles, as well as current events and their economic implications.

April is Financial Literacy Month, a time dedicated to enhancing our understanding of money management, saving, and investing. However, beyond the fundamentals of budgeting and banking lies a crucial skill that significantly improves financial decision-making: the economic way of thinking. In order to make sound financial decisions, it is essential to first adopt the mindset of an economist and apply economic principles to everyday choices.

Economics extends beyond the study of markets and money—it serves as a framework for understanding how individuals make choices in a world of scarcity. The Foundation for Teaching Economics (FTE) highlights five key Economic Reasoning Propositions (ERPs) that offer valuable insights into financial literacy. By incorporating these principles, individuals can develop a deeper comprehension of financial decision-making and lay the groundwork for long-term financial success. In celebration of Financial Literacy Month, I’ve adapted some of the ERPs to highlight their importance in personal finance.

1. People Choose

Every financial decision involves a choice. Resources, whether time, money, or effort, are limited, meaning we must prioritize how we use them. For example, when you decide to spend money on a vacation rather than investing it in a retirement fund, you are making a choice based on personal preferences and values. Recognizing that every decision involves trade-offs allows us to make more informed and intentional financial choices.

2. Choices Involve Costs

Nothing is free—not even “free” services. Every choice carries an opportunity cost, which is the value of the next best alternative that is given up. When you choose to finance a new car rather than save for a down payment on a house, the opportunity cost is homeownership delays. By understanding opportunity costs, individuals can weigh the true impact of their financial decisions and ensure their spending aligns with their long-term goals.

3. People Respond to Incentives

Financial decisions are influenced by incentives, which can be rewards or penalties that shape behavior. For instance, employer-sponsored retirement plans with matching contributions incentivize employees to save for retirement. On the other hand, high credit card interest rates serve as a disincentive for carrying a balance. Recognizing how incentives affect behavior enables individuals to take advantage of beneficial financial opportunities and avoid costly mistakes.

4. Institutions Shape Choices

Institutions, including banks, governments, and financial regulations, play a significant role in economic decision-making. They create rules and structures that influence choices and economic outcomes. For example, tax laws can encourage homeownership through mortgage interest deductions, while financial regulations protect consumers from fraudulent investment schemes. Understanding these institutions helps individuals make informed decisions and navigate financial systems more effectively.

5. Understanding Based on Evidence and Knowledge Enhances Decision-Making

The best financial decisions are those grounded in research, critical thinking, and empirical evidence. Many financial myths and misconceptions can lead individuals to make poor choices. For example, the belief that renting is always a waste of money ignores important factors such as market conditions, mobility needs, and maintenance costs. By seeking out reliable financial information and analyzing data, individuals can make smarter choices that align with their unique circumstances.

Applying the Economic Way of Thinking to Financial Literacy

Integrating these economic principles into personal finance can help individuals make more rational and effective financial decisions. Whether budgeting, investing, or planning for major life expenses, the economic way of thinking provides a structured approach to evaluating choices and their consequences.

Financial literacy is not just about understanding how to balance a checkbook or build credit—it’s about applying the economic way of thinking about money and making informed choices. The Economic Reasoning Propositions outlined by FTE offer a powerful framework for analyzing financial decisions and achieving long-term financial stability. This Financial Literacy Month, take the time to cultivate an economic mindset and empower yourself with the tools necessary for lifelong financial success. High school students can learn more about the economic way of thinking by enrolling in FTE’s Economics for Leaders program.