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“Undercover Economist” by Tim Harford Essay (Book Review)


Introduction

This paper will present an appraisal of Undercover Economist written by Tim Harford and first published in 2005 by Random House. The analysis of Harford’s work has shown that there five different topics that should be discussed in better detail since they directly relate to the nature of modern economics and provide readers with an understanding of economics as a discipline.

Scarcity and Its Effect on Prices

The first topic of discussion is associated with the idea that scarcity has a direct influence on the way prices on the market are shaped. This can be explained by the fact that market forces that rely on resources, both natural and human-made, change prices on the market on the basis of unavailability or availability of those resources. Furthermore, there is an idea that people have the freedom to establish specific prices on resources they own. If to provide an example, rent can explain this concept. On the one hand, a property owner will only set prices that possible tenants will be willing to pay. On the other hand, these prices are directly linked to the level of availability of houses or apartments for rent. This means that the scarcer the resources for rent are, the lesser the bargaining power of potential tenants is. Moreover, if the resources are scarce, owners of the property will set much higher prices on rent because they have a reason to believe that resources in their possession are valuable.

If to reverse the example of rent and suggest that the resources are abundant, it is essential to understand that the owner could not have the liberty of putting high prices on rent. Potential tenants will not pay high prices for rent when the resource is abundant and thus does not require the same amount of effort put into its search and selection. As mentioned by Conrad in Resource Economics, modern economists see scarcity as a dynamic condition that constantly changes, in which the adaptive behavior of the society helps people eliminate the scarcity of one resource, “only to face it in another” (154). Therefore, demand can shift depending on the scarcity of resources given that other characteristics of the market remain unchanged.

Harford used the Ricardian model of bargaining power to explain the concepts of demand and scarcity in the market. The model emphasized resource conversion for addressing their scarcity (Barnett and Morse 127). When discussing Harford’s argument on resource scarcity, he suggested that it could be created either naturally (as in the example of a landowner and rent) and artificially. The artificially created scarcity of resources relates to the scenario, in which owners of property joined forces for establishing higher prices on their land. As mentioned by Harford, artificial resource scarcity is an issue that can be avoided if there is a desire to so, which is a valid argument (19). For instance, shops located in a city area with high rent are more likely to sell their goods at higher prices. Apart from high rent prices, factors such as customers’ willingness to pay higher prices for goods because their income allows them to do so.

Perfect Markets

Another topic for discussion relates to the concept of truth and perfect markets. Harford pointed out that customers buy products, which, in their opinion, have the right prices (22). As mentioned by Simons from Harvard Business Review, companies can charge higher prices for goods and services that are unique and of high quality. If to use the same example of shops in an expensive neighborhood, the price of goods should align with the conditions on the market and therefore, should reflect their actual value. In the case if prices are high, profits should also be high; thus, it causes new shops to open in that area, leading to reduced scarcity and lower prices.

On the other hand, if prices are smaller than the margin, the majority of shops in the high-cost area will not make any profit. In a perfect market, the cost of products should align with their marginal costs (Harford 23). According to Calcagnini and Saltari, in a perfect market, the price for products should align with their marginal cost; businesses are more likely to “react to changes in the user cost of capital, but they do not respond to changes in the mix of financial resources (equity, bonds, bank loans, cash flow)” (1). It is also important to mention that customers have the right to boycott a product if case when they are being overcharged. To conclude, in free markets, businesses are only eligible to set prices on their products based on the prevailing conditions.

Different Customers are Targeted Differently

The third topic for discussion relates to the idea that different customers should be targeted differently. In the chapter “Who Pays for Your Coffee?” the author provided an example of Costa Coffee, a global chain of coffee shops, to explain the behaviors of different types of customers (Harford 8). According to Harford, there are two types of customers: those concerned with the social well-being and not money and those who only pay attention to items’ prices rather than social wellbeing. In the example of Costa, the company needed to gather information about types of customers that visit their shops and thus get an idea of whether an increase in prices was possible. To do this, Costa introduced two new kinds of coffee to the menu: one with a standard price and one with a higher price, informing customers that the extra profit earned from more expensive coffee will go to a charitable cause (Harford 9). If customers were willing to pay more for the expensive option, Costa would have increased its prices.

Many businesses use the same strategy when assigning different prices on their products. As a rule, companies want to imply that higher prices equal higher quality, although, in reality, the quality of both cheaper and more expensive goods is on the same level. It is also important to understand that businesses do not go to lengths for making an expensive product; rather, they need to address customers’ desires to pay more. This means that customers usually choose prices because businesses cannot reveal to the general public which type of customers usually pays more. According to Harford, there are two different strategies companies can use for identifying customers that do not pay attention to prices and thus are willing to pay more (10).

The first strategy is individualized; it assesses customers’ habits of purchasing the same product over and over. The second strategy is not as individual-oriented and targets customer groups; companies offer different prices on goods to customers who have been differentiated into specific groups. An example of this is Disney World offering discount coupons to locals. This strategy is explained by the fact that customers who live near Disney World rarely visit the attraction and thus are likely to use discount coupons since prices are lower. Tourists, on the other hand, will show up regardless of prices. Again, this is explained with the idea that the scarcity of resources influences customers’ willingness to pay more; since locals can visit Disney World at any time they want (the resource is abundant), they will not pay high prices.

Information and Smooth Transactions

Harford also discussed the role of information regarding making transactions in a free market. The author mentioned that when sellers or customers possess too much information about a specific product, operations on a free market might be limited (Harford 41). As stated by Doede, too much information can cause confusion for both customers and companies, making it complicated to distinguish between important and not important transactions (122). Inside information can ruin the operations on a free market because usually, customers need some support when making purchasing decisions while companies are reluctant to provide such support. Furthermore, in the case when companies have enough information about the products they sell, customers will become losers against sellers. Nevertheless, Harford pointed out that there were no losers of winners when it comes to dealing with inside information (42).

An example of the harmful effect of inside information can be illustrated with the help of a case with used cars. While buyers decide to purchase used cause because they have a value, sellers want to get rid of their used cars because the value of them dropped. This means that if a particular buyer knew that a car is being sold due to its valuelessness, he or she would refrain from making a purchase. Thus, when both the seller and the buyer are oblivious to the value of the car being sold and purchased, the entire transaction will go much better. In such transactions, buyers will be more likely to pay larger amounts of money for goods of unknown quality, while sellers will be open to accepting lower prices because they do not know the true value of products. It can be concluded that the lack of inside information balances transactions and the exchange of information. However, such scenarios do not include an instance when one party cheated another, so it is always important to ensure that transactions are based on the willingness of parties to negotiate.

Health insurance is another example to illustrate the value of information during transactions. According to Harford, high-quality healthcare is usually too expensive for an average consumer (54). Because of this, people buy insurance coverage to address their healthcare needs in cases of emergency or if they become ill in the future. The health insurance market is currently divided, covering healthy clients and those who are more likely to fall sick. Besides, healthy customers rarely seek insurance, which results in companies serving the majority of clients who will inevitably make insurance claims to address their health conditions. To prevent the constant loss of funds, companies usually try to attain as much information about their clients as possible. More patients can be covered by health insurance if companies, if such businesses have reliable information about their clients. Such an assertion cannot be regarded as false because the entire institution of insurance coverage is based on the premise that there is a lack of knowledge about what is going to happen to clients in the future. This means that insurance companies are more likely to provide medical coverage to their clients when either party is not sure that the risk of illness will take place.

Externality Payments

The last topic discussed by Harford is associated with the concept of externalities. The author stated that externalities referred to benefits’ costs that are not considered when deciding on buying a product; however, such costs end up affecting that decision. As mentioned by Harford, people who only aim toward things that make them happy without considering the implications of their choice will inevitably influence others (24). For example, driving for fun is associated with a kind of enjoyment for some people. However, driving can cause inconveniences for others, such as traffic jams, which subsequently lead to air pollution and delays in people’s schedules. It is noteworthy that inconveniences such as traffic jams occur when people who drive are not required to pay the price for the issues that may cause. In this case, it can be proposed to force drivers to pay a fee used for compensating third parties who have suffered from the adverse impact of driving. Despite this, it is highly unlikely that imposing fees on driving could make any difference regarding eliminating traffic jams.

When it comes to limiting the extent of air pollution, the idea of marginal costs can be applied. Such costs associated with driving refer to how much money it takes to make an extra trip. Usually, drivers are required to pay taxes for using public roads on the basis of average estimates. According to Harford, a number of money drivers pay is not enough for compensating other traffic participants (25). The right solution with regards to average estimations is considering the exact number of trips by car one driver makes. This means that drivers should be forced to pay at the margin instead of an average price. Following this logic, a question arises on whether the taxes imposed on drivers are enough to cover the damage they cause to others. An example of this is differences in traffic commotion in rural and urban areas while all drivers pay the same tax.

Harford’s argument regarding the externality charge can be considered valid because the size of taxes drivers’ current pay is not enough to stop them from harming others and the environment. When speaking about such externality charges, they should take into consideration the specific characteristics of areas, differentiate between trouble and pleasure, as well as judge the imposed taxes at margin rates as opposed to average prices. Put simply, externality charges should be equal to the extent of the damage caused by the inconveniences of driving. To conclude, it is important to understand that free markets exist for the purpose of people having the freedom to do anything they want without causing any inconveniences to others.

Overall, Undercover Economist is a valuable work that covered the basics of economics and provided an insightful view of the author on specific concepts. The book is enthralling and lively; by providing real-life examples, Harford managed to educate his readers without subjecting them to irrelevant terminology and a complicated language.

Works Cited

Barnett, Harold, and Chandler Morse. Scarcity and Growth: The Economics of Natural Resource Availability. RFF Press, 2011.

Calcagnini, Giorgio, and Enrico Saltari. The Economics of Imperfect Markets: The Effects of Market Imperfections on Economic Decision-Making. Springer, 2009.

Conrad, Jon. Resource Economics. Cambridge University Press, 2010.

Doede, Keuning. Management: A European Perspective. Routledge, 2007.

Harford, Tim. The Undercover Economist. Oxford University Press, 2012.

Simons, Robert. HBR, 2014, Web.

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