Title
The Undercover Economist
Author
Tim Harford
Date of Publication
2005
Reason for reading
As I’ve mentioned before, I’m trying to learn more about economics in order to better understand the current financial climate, as well as to be a more informed voter. Josh Miller (Ryan’s old roommate) recommended the book, in addition to a textbook, and I have to say it was a good recommendation.
Synopsis
“‘The economy isn’t a bunch of a rather dull statistics with names like GDP (gross domestic product),’ notes Tim Harford, columnist and regular guest on NPR’s Marketplace. ‘Economics is about who gets what and why.’” This is a pretty good description of the book, in which Harford describes how and why things cost what they do, such as a cup of coffee, items at the grocery store, & used cars, as well as discussing health care, countries in poverty, and China’s recent economic ascension.
Review
I thought it was a very good book. I had started another book (Arrowsmith by Sinclair Lewis), but I bought this one while shopping for a book for my niece, and it caught my attention so much that I didn’t go back to Arrowsmith. The author does a very good job of explaining the concepts of economics to an average reader, then reinforcing them by using modern examples that may be a little more complex. For instance, he introduces David Ricardo’s theory of scarcity power originally published in 1817 and gives Ricardo’s example of the cost of rent for farmland at the time. He then expands to include such things as the price of coffee or the price of oil.
A particularly good example for me was the concept of price targeting, essentially trying to get the most out of a given customer in order to maximize profits. It may sound bad, and it definitely involves some trickery in some cases, but many who would criticize it would also contradict themselves depending on the product being sold. The first example is coffee, in which he doesn’t think a coffee company can advertise coffee for the lavish as ₤3, while the same coffee for the thrifty is 60p (British currency). However, they can do the same thing by marketing it differently. His first example of this is using fair trade coffee in a cappuccino. By his research and calculations, 90% of the price markup still goes to the company, due to the small amount the coffee costs to begin with, and the small amount of coffee in a cappuccino. Only 10% of the price difference makes it to the fair trade farmer. He also discusses this for the various drinks and the difference in their prices, despite the fact that they cost almost identical amounts to get to the consumer. But where the potential hypocrisy comes in is in the pricing of drugs, where Americans end up paying the most because they can spend the most on medication. Without this potential profit, the company may not have the incentive to produce the drugs. However, at this price, people in poorer countries can’t afford it. To deal with this, the company offers the drug at a price that they’re making minimal profit on, at least in comparison with the American price. But they’re still making a profit, so it both increases their profits overall, but also is able to provide the drug to countries where you might otherwise think they’re not able to.
Also Chapter 5 on inside information is interesting. He discusses the problem of uneven inside information, using the example of used cars, which I believe was the original example used by the author who originally published the idea. In this case, whenever one side of a trade has more information than the other, it could kill the whole deal. To briefly summarize, a used car dealer has a lot full of cars. Half are lemons (worth very little), and half are good (worth $4000), and the dealer knows this. If a customer offers him $4000 for a lemon, the dealer will agree quickly. If he offers $2000 for a lemon, the dealer still agrees, but the same price on a good car, and he won’t. Since the customer risks buying a lemon at a high price, he may walk away. However, if the dealer doesn’t know which cars are lemons and which aren’t, he could sell any car for $2000, knowing that it’s a 50% chance of being good or bad, so that price for all the cars still gets him the total value he should get. The consumer knows he has the potential for a lemon, but it’s at a more reasonable price to take that risk. In effect, when the dealer knows more than the buyer, the market collapses. This concept forms the basis of the chapter on which he discusses health care, with a focus on the United States.
Freakonomics by Steven Levitt has gotten a lot more publicity that I’ve noticed, but in my opinion, The Undercover Economist is better if your goal is to learn economics in the sense most people think of it. Freakonomics was using an economics mindset to look into other issues such as cheating on standardized tests in Chicago, or bringing down the KKK.
Quotes
“I would like to thank you for buying this book, but if you’re anything like me you haven’t bought it at all. Instead, you’ve carried it into the bookstore café and even now are sipping a cappuccino in comfort while you decide whether it’s worth your money.” (ix)
-From the introduction. I specifically added this one for Jarrod
“But many of us love the fact that Ricardo was able, nearly two hundred years ago, to produce insights that illuminate our understanding today. It’s easy to see the difference between nineteenth-century farming and twenty-first-century frothing, but not so easy to see similarity before it is pointed out to us. Economics is partly about modeling, about articulating basic principles and patterns that operate behind seemingly complex subjects like the rent on farms or coffee bars.” (11)
“So Ricardo’s model can’t explain everything. But we are able to discover that it goes farther than Ricardo himself could ever have imagined. It doesn’t just explain the principles behind coffee bars and farming. If applied correctly, it shows that environmental legislation can dramatically affect income distribution. It explains why some industries naturally have high profits, while in other industries high profits are a sure sign of collusion. It even manages to explain why educated people object to immigration by other educated people, while the working classes complain about immigration by other unskilled workers.” (13)
“If the health insurance market doesn’t work well, the results will be excessively high premiums and a large number of uninsured people. This will sound very familiar to readers in the United States, where markets do not, in fact, do a good job of providing medical insurance, precisely because of Akerlof’s ‘lemons’ problem.” (107)
Further Reading
“The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism”
Quarterly Journal of Economics (August, 1970)
George Akerlof
“An economic analysis of a drug-selling gang’s finances,”
Steven Levitt & Sudhir Alladi Venkatesh
NBER Working Paper Series 6592 (June 1998)
(this was discussed in Freakonomics, but it’s also mentioned here & noted in the bibliography)
“Paying for national health insurance—and not getting it”
S Woolhandler and D Himmelstein
Health Affairs 21 (August 2002): 88-98
The Undercover Economist
Author
Tim Harford
Date of Publication
2005
Reason for reading
As I’ve mentioned before, I’m trying to learn more about economics in order to better understand the current financial climate, as well as to be a more informed voter. Josh Miller (Ryan’s old roommate) recommended the book, in addition to a textbook, and I have to say it was a good recommendation.
Synopsis
“‘The economy isn’t a bunch of a rather dull statistics with names like GDP (gross domestic product),’ notes Tim Harford, columnist and regular guest on NPR’s Marketplace. ‘Economics is about who gets what and why.’” This is a pretty good description of the book, in which Harford describes how and why things cost what they do, such as a cup of coffee, items at the grocery store, & used cars, as well as discussing health care, countries in poverty, and China’s recent economic ascension.
Review
I thought it was a very good book. I had started another book (Arrowsmith by Sinclair Lewis), but I bought this one while shopping for a book for my niece, and it caught my attention so much that I didn’t go back to Arrowsmith. The author does a very good job of explaining the concepts of economics to an average reader, then reinforcing them by using modern examples that may be a little more complex. For instance, he introduces David Ricardo’s theory of scarcity power originally published in 1817 and gives Ricardo’s example of the cost of rent for farmland at the time. He then expands to include such things as the price of coffee or the price of oil.
A particularly good example for me was the concept of price targeting, essentially trying to get the most out of a given customer in order to maximize profits. It may sound bad, and it definitely involves some trickery in some cases, but many who would criticize it would also contradict themselves depending on the product being sold. The first example is coffee, in which he doesn’t think a coffee company can advertise coffee for the lavish as ₤3, while the same coffee for the thrifty is 60p (British currency). However, they can do the same thing by marketing it differently. His first example of this is using fair trade coffee in a cappuccino. By his research and calculations, 90% of the price markup still goes to the company, due to the small amount the coffee costs to begin with, and the small amount of coffee in a cappuccino. Only 10% of the price difference makes it to the fair trade farmer. He also discusses this for the various drinks and the difference in their prices, despite the fact that they cost almost identical amounts to get to the consumer. But where the potential hypocrisy comes in is in the pricing of drugs, where Americans end up paying the most because they can spend the most on medication. Without this potential profit, the company may not have the incentive to produce the drugs. However, at this price, people in poorer countries can’t afford it. To deal with this, the company offers the drug at a price that they’re making minimal profit on, at least in comparison with the American price. But they’re still making a profit, so it both increases their profits overall, but also is able to provide the drug to countries where you might otherwise think they’re not able to.
Also Chapter 5 on inside information is interesting. He discusses the problem of uneven inside information, using the example of used cars, which I believe was the original example used by the author who originally published the idea. In this case, whenever one side of a trade has more information than the other, it could kill the whole deal. To briefly summarize, a used car dealer has a lot full of cars. Half are lemons (worth very little), and half are good (worth $4000), and the dealer knows this. If a customer offers him $4000 for a lemon, the dealer will agree quickly. If he offers $2000 for a lemon, the dealer still agrees, but the same price on a good car, and he won’t. Since the customer risks buying a lemon at a high price, he may walk away. However, if the dealer doesn’t know which cars are lemons and which aren’t, he could sell any car for $2000, knowing that it’s a 50% chance of being good or bad, so that price for all the cars still gets him the total value he should get. The consumer knows he has the potential for a lemon, but it’s at a more reasonable price to take that risk. In effect, when the dealer knows more than the buyer, the market collapses. This concept forms the basis of the chapter on which he discusses health care, with a focus on the United States.
Freakonomics by Steven Levitt has gotten a lot more publicity that I’ve noticed, but in my opinion, The Undercover Economist is better if your goal is to learn economics in the sense most people think of it. Freakonomics was using an economics mindset to look into other issues such as cheating on standardized tests in Chicago, or bringing down the KKK.
Quotes
“I would like to thank you for buying this book, but if you’re anything like me you haven’t bought it at all. Instead, you’ve carried it into the bookstore café and even now are sipping a cappuccino in comfort while you decide whether it’s worth your money.” (ix)
-From the introduction. I specifically added this one for Jarrod
“But many of us love the fact that Ricardo was able, nearly two hundred years ago, to produce insights that illuminate our understanding today. It’s easy to see the difference between nineteenth-century farming and twenty-first-century frothing, but not so easy to see similarity before it is pointed out to us. Economics is partly about modeling, about articulating basic principles and patterns that operate behind seemingly complex subjects like the rent on farms or coffee bars.” (11)
“So Ricardo’s model can’t explain everything. But we are able to discover that it goes farther than Ricardo himself could ever have imagined. It doesn’t just explain the principles behind coffee bars and farming. If applied correctly, it shows that environmental legislation can dramatically affect income distribution. It explains why some industries naturally have high profits, while in other industries high profits are a sure sign of collusion. It even manages to explain why educated people object to immigration by other educated people, while the working classes complain about immigration by other unskilled workers.” (13)
“If the health insurance market doesn’t work well, the results will be excessively high premiums and a large number of uninsured people. This will sound very familiar to readers in the United States, where markets do not, in fact, do a good job of providing medical insurance, precisely because of Akerlof’s ‘lemons’ problem.” (107)
Further Reading
“The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism”
Quarterly Journal of Economics (August, 1970)
George Akerlof
“An economic analysis of a drug-selling gang’s finances,”
Steven Levitt & Sudhir Alladi Venkatesh
NBER Working Paper Series 6592 (June 1998)
(this was discussed in Freakonomics, but it’s also mentioned here & noted in the bibliography)
“Paying for national health insurance—and not getting it”
S Woolhandler and D Himmelstein
Health Affairs 21 (August 2002): 88-98
Posts
Thanks for the review Steve, it definitely sparked my interest. Perhaps I will go to B&N this weekend to sit and read it.
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