The Hindu Business Line : <I>Newtonian Economics </I>

If you a student of physics, you will know the Principle of Inertia or Newton's First Law of Motion. It is the principle that states that if a body is in a state of rest or in motion, it will continue to rest or be in motion unless an external force acts on it. This principle holds good in economics and the financial markets too! How?

Returns policy

You walk into a department store with your spouse or friend. Half-an-hour later, you have a cart load of unwanted goods and a huge bill. You console yourself that you can return the goods within 45 days because of the store's returns policy. Of course, you forget about it in the next 45 days. The unwanted goods that you bought stay unused till you have a garage sale.

The fact is that you would not have bought the goods if the store did not have such a generous return policy. Retailers such as Wal-Mart use such returns policy to their advantage. This is because inertia sets in when it is time to return the goods.

Taking action

Inertia hampers our investment decisions too. A study found that employees do not actively open retirement accounts even if their employers made a matching contribution every year. If the account was, however, opened by default, the employee contributed every month. Why? He or she had to take an action to cancel it!

Some US companies have such a default policy to enable employees to save for their retirement. The less fortunate employees have to go without a retirement plan, unless they break their inertia and take action. Then, their retirement accounts will be brimming and their garages, empty.

(The author is based in Surrey, BC in Canada.)