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Economics for Everyman
on 2 February 2006
Reading the popular press, one might be forgiven for thinking that economists are people who make forecasts which are of little relevance to most of us and almost always wrong, or who write about esoteric subjects using language and mathematics which we find impenetrable. This book is quite different. It shows, with great clarity and many examples, how economics can be used in our daily lives to understand what is happening and make better decisions.
It shows why coffee bars charge such high prices for cappuccinos; they are on prime sites, which are scarce, and much of the profit goes to the owners of those sites. Scarcity is also created by planning restrictions, trade unions, professional bodies and immigration policies, which raise prices to the benefit of some but the detriment of others.
It discusses how supermarkets seek to maximise revenue, differentiating customers who are sensitive to prices from those who are not by analysing purchasing habits, using special offers and ‘value’ lines, and by placing similar but differently priced products side by side or on different shelves.
The chapter on free markets shows how they reveal what people are prepared to pay for something, and such markets adjust – often incrementally, invisibly and in myriad ways – to changes in supply and demand. In contrast, markets that are distorted by subsidies, taxes or controls, are inefficient and result in misallocation of resources.
In many actions, what we do has a deleterious effect on other people or the environment, a so-called externality. For example, driving to work increases congestion on the roads and CO2 in the atmosphere. Alternatively, what we do can have a beneficial effect; installing energy efficiency measures reduces pollution. The book shows how economics can value externalities such as pollution and reduce them in the most economical manner, for example by auctioning pollution permits.
Many transactions involve asymmetric information, where one party knows more than the other. If we buy a used car, the seller knows more about it than we do; it may be good car or it may be a ‘lemon’. On the other hand, if we buy medical insurance, we know more about our health than the insurance company. The author explains why it can be impossible to buy a good used car, why the cost of health insurance is so high, and how the information gap between buyer and seller can be narrowed.
In Rational Insanity, it explains why share prices behave erratically, why it is difficult to make money trading them without information or insights not available to others, and why fund managers often run with the herd. But sometimes, as in the 1990s boom, the herd can be wrongfooted.
One of the more illuminating chapters is on Game Theory, which can be employed in poker, nuclear war and many other interactions. Particularly fascinating is the account of how this was used in the auction of UK third generation cell-phone licences to raise over £22 billion for the government, against an initial estimate of £3 billion. The economists who designed the auction certainly earned their fees, but may have been disappointed to see the proceeds used just to reduce the national debt.
To illustrate why poor countries are poor, the author describes a visit to Cameroon. The country is racked by corruption, and the government and its acolytes are seen to be no better than bandits. However, in the example of Nepal, one of the problems is misallocation of aid, due to failure of agencies to understand the motivations of those being helped.
The chapter on globalisation shows how much richer the world has become by trading in goods and services. It shows that in such a world we should stick to doing what are most efficient at, even if someone else can do it better. Barriers to trade, such as duties, import restrictions and subsidies, hinder this process, benefiting one part of the economy but damaging another. They can also have other undesirable consequences; subsidies to US sugar producers harm farmers in Colombia, who have turned to producing cocaine.
How China Grew Rich describes the story of the remarkable transformation, as Deng Xiaoping slowly loosened the strings of a centrally-controlled economy in ways that encouraged entrepreneurship and wealth generation, without damaging those who were less able to change. This contrasts with Russia, where the relatively rapid changes after 1990 have made billionaires but left many people worse off.
Tim Harford in not only an accomplished economist but a prolific writer. His book is enjoyable, easy to read and contains not a single equation. But, being written from the clearly-stated viewpoint of an economist, those with other perspectives may reach different diagnoses and prescriptions.
It is perhaps unfortunate that his book was published in the US in the wake of Freakonomics, which has been widely praised. But whilst the latter describes some pathbreaking economic studies, not all of which are of practical application to most readers, The Undercover Economist contains numerous examples and ideas which show that economics, far from being a ‘dismal science’, can be applied by all of us in everyday activities. Read it and find out how.