The Undercover Economist

by Tim Harford

This book is a veritable treasure trove of ideas, all entertainingly presented.

Why is coffee so much more expensive in subway stations? Why is fair trade coffee much more expensive than the extra cost of fair trade? Why do stores have sales? Why do students get cheaper entry fees? Why do prices for roofing in Kenya rise when there is frost in Brazil? Why are there traffic jams in cities? Why are used car often crap? Why do you have to pay a deductible with insurances? When should you bluff at poker? Why are corrupt countries poor?

Learn answers to all that and more with Economy 101 concepts such as free markets, competition and marginal cost, the signaling function of prices, price discrimination, and market failures: the power of scarcity, negative externalities and how to tackle them, asymmetric information and adverse selection. He also covers stock markets and random walks, game theory, the effect of corruption and the rule of law on economic outcomes, free trade, comparative advantage and globalization.

Some points I found especially interesting:

1. David Ricardo's insight how scarcity drives pricing power. If demand > supply, prices will be as high as intrinsic value, the value relative to marginal value.
The value of an asset in this case is determined relative to the one of an asset in surplus supply, or "marginal". Think of a fertile piece of ground to grow grain compared to a piece of barren ground, or like a spot in a subway station with heavy customer traffic to sell coffee compared to a spot in the backwoods where nobody goes. Only if supply > demand, prices will be as high as intrinsic or "transaction" cost, that is the hassle you incur if you do not buy it but get it by other means.

2. The price also carries information. In a perfect competitive market price = marginal cost.

3. Price discriminiation, that is finding ways to charge people as much as they are willing to pay. First degree price discrimination evaluates each customer individually, and is used for high price items, where the effort to do so is less costly than the gains realized by it. Un-individualized price discrimination strategies include targeting price-insensitive customers, by offering high priced premium versions that add comparatively little to cost, or vouchers or sale pricing, that attracts customers who take the extra effort to cut them out or go shipping in a sale, because they are cost conscious.

4. Market "failures" for free markets arise when companies have scarcity power (monopolies), when externalities are not priced in (think pollution where the polluter normally does not have to pay the cost of cleaning up, or vaccination where you may be a "free rider" if everybody else gets vaccinated), and when there is assymetric information (Akerlof; think used car market, where the seller knows how good the car is, but the buyer does not).

5. Stock shares ideally are the value of assets plus claim on future profits. Compare investing in shares to long term fixed interest. Without growth share price would be so that both yield about the same returns. Otherwise, why buy the weaker. As it is, when you go for fixed interest you ignore value but gain stability. If interest doubles, then share price should about halve, because returns vs fixed otherwise would half, and if it halves, shares price should double.

6. Rule of the law required for successful economy. Why create value if it will be taken from you by corruption and thieves?

7. Comparative advantage maximises overall value. Thus, do what you do best.