The Economics of Relationships

This one has been long overdue. I thought of writing this article after I had my finance and economics classes at Purdue. While hanging out with a friend in the common area at school, we extended some of the concepts we learnt in these classes to a different area, human behavior and relationships. It’s amazing how closely some business concepts support human interactions. Sometimes we might have gone overboard while trying to fit in things, but nonetheless, it was fun!! 

Probably the most important concept in finance is the Net Present Value or NPV. It is the present value of future cash flows. Many important decisions and deals depend on this NPV. We observed that human interactions are greatly influenced by this concept. Every person has an NPV and this changes depending on the other person involved. But here the present value is not of actual cash flows (maybe sometimes it is) but of something intangible; probably some favors or expected good times with the person or something with an emotional value. The NPV of my best friend is far greater for me than for someone who is just an acquaintance of his. For me this NPV is based on all the reasons due to which the person is my best friend. The NPV of smart students is high for others because of all the possible help which they could expect, but for the smart students the NPV of the others is not as much or sometimes negative because of the possible hindrance to their study time… hahaha.

Sometimes we may not know a person but still his or her NPV for you exists and can be significant. Take for example, all applicants for a job you have applied for. Most certainly all have a negative NPV for each other since one getting a job means no future cash flows, literally. I have observed changes in people’s behavior towards each other from ‘my dear friend’ to ‘do I know you?’ within a span of few weeks. It’s all got to do with how valuable or important the person is going to be; which is basically NPV.

Now let us extend this concept to incorporate Options. When you are dating someone, the persons NPV is quite high for you since there is a potential of a long term (hopefully lifelong) partnership. However, like in any big project, we make sure that we have a chance to exercise an option of backing out of this partnership if you see the NPV going negative once more information about the project is available. Thus, engagement is the time when each party gets the right, with no obligations to exercise the option in either way; stay (marry) or back out.

Having said all this, we know how unpredictable human behavior is. In so many situations we end up doing things that a rational mind would not think of doing. This is where the above concepts fall apart. Maybe this is where the concepts of speculation, risk/return tradeoff can be brought into picture. But I won’t delve into those now. I am done with my MBA and leave it to current management students who have some free time to spend in the common rooms J