The Undercover Economist

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Your coffee is intriguing to the economist for another reason: he doesn’t know how to make a cappuccino, and he knows thatnobody else does either. Who, after all, could boast of being able to grow, pick, roast, and blend coffee, raise and milk cows, roll steel and mold plastics and assemble them into an espresso machine, and, finally, shape ceramics into a cute mug? Your cappuccino reflects the outcome of a system of staggering comp

page 5 | location 68-73 | Added on Monday, 23 June 2014 04:29:59Your coffee is intriguing to the economist for another reason: he doesn’t know how to make a cappuccino, and he knows thatnobody else does either. Who, after all, could boast of being able to grow, pick, roast, and blend coffee, raise and milk cows, roll steel and mold plastics and assemble them into an espresso machine, and, finally, shape ceramics into a cute mug? Your cappuccino reflects the outcome of a system of staggering complexity. There isn’t a single person in the world who could produce what it takes to make a cappuccino. The economist knows that the cappuccino is the product of an incredible team effort. Not only that, there is nobody in charge of the 14 | location 207-209 | Added on Monday, 23 June 2014 04:47:02When Cornelius arrived, the grassland became the marginal land, meadows became yet more attractive relative to the marginal land, and so the landlords were able to raise the rent on meadows again. It’s important to note here that there is no absolute value: everything is relative to that marginal 15 | location 221-222 | Added on Monday, 23 June 2014 04:49:08The willingness to pay top dollar for convenient coffee sets the high rent, and not the other way 24 | location 355-359 | Added on Monday, 23 June 2014 22:21:43If I want to know whether I am being ripped off by supermarkets, banks, or drug companies, I can find out how profitable those industries are. If they are making high profits, then initially I am suspicious. But if it seems that it is fairly easy to set up a new company and compete, I become less suspicious. It means that the high profits are caused by a natural scarcity: there are not many really good banking organizations in the world, and good banking organizations are much more efficient than bad 34 | location 520-524 | Added on Monday, 23 June 2014 22:40:01Fair trade coffee associations make a promise to the producer, not the consumer. If you buy fair trade coffee, you are guaranteed that the producer will receive a good price. But there is no guarantee that you will receive a good price. The truth is that fair trade coffee wholesalers could pay two, three, or sometimes four times the market price for coffee in the developing world without adding anything noticeable to the production cost of a cappuccino, because coffee beans make up such a small proportion of that cost. Charging an extra ten pence gave a misleading impression of how much it really cost to get hold of that fair trade 44 | location 661-663 | Added on Monday, 23 June 2014 23:00:59My recommendation, if you are convinced of the merits of organic food, is not to let food retailers exploit your enthusiasm: vote with your wallet by supporting any retailer—or direct supplier—who brings the price of organic and nonorganic food closer 46 | location 693-696 | Added on Monday, 23 June 2014 23:04:44So here’s my advice: if you want a bargain, don’t try to find a cheap store. Try to shop cheaply. Similar products are, very often, priced similarly. An expensive shopping trip is the result of carelessly choosing products with a high markup, rather than wandering into a store with “bad value,” because price-targeting accounts for much more of the difference between prices than any difference in value between one store and 48 | location 728-731 | Added on Monday, 23 June 2014 23:09:05But this is an example of a universal truth about supermarkets: they are full of close (or not so close) substitutes, some cheap, some expensive, and with a strong random element to the pricing. The random element is there so that only shoppers who are careful to notice, remember, and compare prices will get the best bargains. If you want to outwit the supermarkets, simple observation is your best weapon. And if you can’t be bothered to do that, you really don’t need to save 52 | location 787-788 | Added on Monday, 23 June 2014 23:15:13So, like the lack of tables in coach-class trains and the uncomfortable seats in airport lounges, the ugly packaging of “value” products is designed to make sure that snooty customers self-target price increases on 53 | location 807-811 | Added on Monday, 23 June 2014 23:17:48Services and convenience products are the most fertile grounds for price-targeting strategies, because they don’t leak. The really great pricing tricks take place on airlines, in restaurants and cocktail bars (not many bookstores have a “happy hour”), in supermarkets, and at tourist attractions. In contrast, some products are inherently leaky: they’re expensive, easy to transport, and nonperishable. The obvious examples are digital media (CDs, DVDs, and software) and 67 | location 1022-1025 | Added on Tuesday, 24 June 2014 22:14:32Because Western society relies heavily on free markets, we find it difficult to imagine what it would be like if we didn’t, or to take a step back and see quite how profound the effect of the market is. Yet any modern democracy provides goods outside the market system, and looking at the way such goods are provided gives us a hint of the strengths and weaknesses of markets. Think of your friendly local police force, which is paid for by a nonmarket system of 69 | location 1057-1059 | Added on Tuesday, 24 June 2014 22:18:23Nonmarket systems have their advantages, but they also lose something important: information, information about wants, needs, and desires, and about inconveniences and costs. Sometimes the loss of information is worthwhile because it is offset by gains in equality or 107 | location 1632-1637 | Added on Wednesday, 25 June 2014 22:23:37Most economics has very little to do with GDP. Economics is about who gets what and why. Clean air and smooth-flowing traffic are part of the “economy” in this sense. It’s possible that congestion charging would increase GDP because people would get to work more quickly and produce more, and prices in stores would be lower because of more efficient distribution. But it’s perfectly possible that congestion charging would reduce GDP. This does not, in fact, matter in the slightest. We know for certain that it would make us better off in a much more meaningful sense: that we would have many new choices open to us about where we go and what we do. There is much more to life than what gets measured in accounts. Even economists know 109 | location 1669-1673 | Added on Wednesday, 25 June 2014 22:28:46Anyone who has ever tried to buy a secondhand car will appreciate that Akerlof was on to something. The market doesn’t work nearly as well as it should; secondhand cars tend to be cheap and of poor quality. Sellers with good cars want to hold out for a good price, but because they cannot prove that a good car really is a peach, they cannot get that price and prefer to keep the car for themselves. You might expect that the sellers would benefit from their inside information, but in fact there are no winners: smart buyers simply don’t show up to play a rigged 111 | location 1702-1705 | Added on Wednesday, 25 June 2014 22:33:12Health insurance is important because illnesses are extremely unpredictable and sometimes cost a lot to treat. Not only can some medical treatment be very expensive, it is often impossible to postpone it until a more convenient moment. It can also coincide with periods of low income because people are more likely to need medical care after retirement, and because those who need medical care may also be too ill to 114 | location 1743-1745 | Added on Wednesday, 25 June 2014 22:39:26Since insurance depends on mutual ignorance, then any advance in medical science, which pushes back the boundaries of ignorance—whether for the insurers, the insured, or both, will weaken the basis of insurance. The more we know, the less we can insure. This is a worrying prospect if we want to give people a chance to protect themselves against the high costs of bad 116 | location 1775-1777 | Added on Wednesday, 25 June 2014 22:42:48The employers are willing to do this despite the fact that the philosophy degree itself does not improve the candidate’s productivity at all. It is merely a credible signal, because a philosophy degree is too much trouble for lazy, dumb people to acquire. Since Spence himself majored in philosophy at Princeton, perhaps there is something in his 133 | location 2037-2042 | Added on Saturday, 28 June 2014 12:11:43In the case of health care, the market works poorly because while we want the reassurance of knowing they can afford expensive medical bills, inside information eats away at the insurance by driving away low-risk customers and forcing premiums to rise. Private companies have developed ways to get around the problem, but they are expensive and bureaucratic. Singapore’s government had the power to tackle the problem head on, by using forced saving and catastrophe insurance to make sure costs were manageable but keeping the power of patient choice at the heart of the system. Governments can replace markets,

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but they will often do better to try to fix them. They are unlikely to succeed unless they appreciate exactly what the problem is in the first 146 | location 2232-2244 | Added on Sunday, 29 June 2014 22:29:18The hidden premise is that if we are in an economic revolution, shares should be very valuable. This premise is wrong. Shares should rise in price only if there’s good reason to think that future profits will be high. As we know, profits derive from scarcity; for instance, ownership of scarce land (protected by legal title), a scarce brand (protected by trademark), or an organization with unique capabilities (protected by nothing more than the fact that most effective organizations are hard to copy). So share prices should rise only if economic transformation increases the degree to which organizations control scarce resources. It’s easy to see that there might be a link between economic transformation and the control of scarcity. It’s far less easy to see what it is, and it seems unlikely that it is as straightforward as “new technologies will increase corporate control of scarce resources.” Some companies will gain; others will lose. Historically, there has been no clear link between economic transformation and high profits for the average company. In fact, the reverse is often true: economic transformation destroys the profitability of old firms (by replacing or duplicating their scarce assets), while the new firms that replace them often face a high failure rate and very large costs of building their businesses. The advantages are enjoyed by workers who are paid higher wages on average and by customers who pay lower prices or get new and better goods and services. For example, Amazon’s profits of $30 million in 2003 should be weighed against the fall in global music industry profits of around $2.5 billion in the same year, a drop that industry executives blame on Internet music downloads and easy piracy. The Internet can destroy profits as well as enable 167 | location 2549-2557 | Added on Monday, 7 July 2014 23:11:10Game theorists have an alternative explanation: bidders were learning from each others’ bids about what the 3G licenses were likely to be worth. This was one of the advantages of the auction’s transparent design. A commonly used alternative would simply have been to run a “sealed bid” auction where everyone handedin an envelope containing a single bid. But such an auction would have left every bidder guessing in the dark, probably leading to much more conservative bidding and a much less profitable outcome for the government. With an open auction, even when the bidding rose higher than anyone had expected, each bidder could see that its twelve competitors were making equally large offers and shared confidence that the licenses would prove hugely valuable. Each company had its own business plan, its own technology partners, its own sales projections. All of these were speculative, but the transparent auction gathered signals of these plans together and put the information at the disposal of all the bidders. (The auction also put the information at the disposal of the government and collected revenue on that basis at the same time—all very neat.)page 169 | location 2579-2584 | Added on Monday, 7 July 2014 23:14:14We learned way back in chapters 1 and 2 that firms will charge the maximum they possibly can, under any circumstance. We also know that their ability to do this is limited by their scarcity power. For the UK, the crucial determinant is that there are five licenses. Five licenses are few enough to give each company enoughscarcity power to be able to charge quite high prices. If only two licenses were available, then the scarcity power would be greater and the prices would be higher. If twenty licenses were available, the scarcity power would be less and the prices would be lower. It is the scarcity power, and not the price of the licenses, which determines the price for 194 | location 2962-2966 | Added on Friday, 11 July 2014 13:40:11Regardless of who was in charge, Bruges continued to prosper: it was the center of gravity for the Hanseatic League of trading cities, its arts scene was flourishing, it was developing new industries such as cutting diamonds from India, and its population was twice that of London. Fine goods from across the world were traded in the tavern owned by the merchant family Van der Beurs—some would have you believe that this is why, to this day, stock exchanges are called “bourses.”page 198 | location 3032-3035 | Added on Friday, 11 July 2014 13:50:48Trade barriers—whether they are subsidies to our farmers, regulations on textiles, or taxes on televisions— make both us and the Chinese worse off. It does not matter if the Chinese really are better than we are at making everything: they should stick to producing whatever their economy is most efficient at turning out. Meanwhile, we, despite (apparently) being worse at everything, should stick to producing what we are least bad at 199 | location 3051-3054 | Added on Friday, 11 July 2014 13:52:57Contrary to popular belief, it is simply not possible for trade to destroy all of our jobs and for us to import everything from abroad and export nothing. If we did, we would have nothing to buy the imports with. For there to be trade at all, somebody in America must be making something to sell to the outside world. This should be obvious, but somehow it isn’ 200 | location 3060-3061 | Added on Friday, 11 July 2014 13:53:45Nobody outside the United States would accept dollars in payment if the United States was not exporting things that the dollars could be used to 203 | location 3105-3110 | Added on Friday, 11 July 2014 14:00:28Economist David Friedman observes, for instance, that there are two ways for the United States to produce automobiles: they can build them in Detroit, or they can grow them in Iowa. Growing them in Iowa makes use of a special technology that turns wheat into Toyotas: simply put the wheat onto ships and send them out into the Pacific ocean. The ships come back a short while later with Toyotas on them. The technology used to turn wheat into Toyotas out in the Pacific is called “Japan,” but it could just as easily be a futuristic biofactory floating off the coast of Hawaii. Either way, auto workers in Detroit are in direct competition with farmers in Iowa. Import restrictions on Japanese cars will help the auto workers and hurt the farmers: they are the modern-day equivalent of “frame breaking.”page 204 | location 3114-3117 | Added on Friday, 11 July 2014 14:02:06Between 1993 and 2002, almost 310 million jobs were lost in the United States. Over the same period, more than 327 million jobs were created. Nearly 18 million more people had jobs in 2002 than in 1993. Each of the 310 million times somebody lost a job, that person was entitled to sympathy and to help, whether or not foreign competition had anything to do with it. Trade or no trade, a healthy economy loses jobs all the time, and creates them as 205 | location 3134-3137 | Added on Friday, 11 July 2014 14:30:26Foreign investment is widely recognized to be good for economic growth in poor countries: it is an excellent way for them to create jobs, learn cutting-edge techniques, and do so without having to invest their own scarce money. Unlike investments in shares, currency, or bonds, foreign direct investment cannot quickly be reversed in a panic. As economics journalist Martin Wolf puts it, “factories do not walk.”page 206 | location 3148-3152 | Added on Friday, 11 July 2014 14:34:50North American imports from the least developed countries were only 0.6 percent of total imports in 2000, down from 0.8 percent in 1980. But 0.5 percent of Western Europe’s imports in 2000 were from the least developed countries, down from 1 percent in 1980. For Japan, the figure is 0.3 percent, down from 1 percent. And for all the major world traders put together, the percentage of their imports from the least developed countries is 0.6 percent,down from 0.9 percent twenty years before. For the really poor countries, their problem certainly isn’t excessive participation in the world trading system. A similar story holds true for foreign 207 | location 3172-3177 | Added on Friday, 11 July 2014 14:41:32If American environmental standards are really so strict, why do the most pollution-intensive American firms spend only 2 percent of their revenues on dealing with pollution? Most spend much less. When companies move abroad they are seeking cheap labor, not a pollution haven. And companies do not pollute for fun; the latest manufacturing techniques are often cheaper and less polluting at the same time. Energy efficiency, for instance, saves money and reduces pollution. This is why many companies regard environmental performance as part of general quality control and good efficient manufacturing. Even if it was possible to save some costs by cutting environmental corners, many firms build factories everywhere in the world using the same latest, cleanest technology from the developed world, simply because that kind of standardization itself saves 232 | location 3554-3555 | Added on Sunday, 13 July 2014 14:52:03Markets do not work well without market-supporting institutions: in a market economy, people need banks for commercial loans, contract law to resolve disputes, and confidence that their profits will not be confiscated. Such institutions cannot be set up 242 | location 3710-3711 | Added on Sunday, 13 July 2014 15:11:45In the end, economics is about people—something that economists have done a very bad job at explaining. And economic growth is about a better life for individuals—more choice, less fear, less toil and hardship. ...more

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