Thursday, July 05, 2007

The Undercover Economist by Tim Harford

Good but a bit too much like being back at university and trying to get my head around hard ideas. Slightly too educational to be enjoyable.

I got this book because I read Freakonomics about two years ago and I thought it was soooo good. (By the way, if you haven't read Freakonomics, you should! It's really interesting and thought-provoking. Plus, it's dead easy to read.)

Anyway, back to The Undercover Economist. The ideas in the book are certainly very intriguing. Tim Harford explains complex ideas clearly and uses really good examples to illustrate his point.

When I read about price-targeting, which is practised by big companies (he uses coffee companies as an example) - it made me smile because it's also practised by fake handbag/watch sellers all over Asia.

In summary - if you are "seller", you want to sell as many items as possible while still making a profit. The last thing you want to do is to turn away any potential buyers. Afterall, a profit is a profit, right? But how can you maximise the profit from your buyers?

What you really need is a magic sign that senses how much people are willing to pay.

For example -
for people who have lots of money and are willing to pay £2.50 for a coffee - Price £2.50
for people who have less money and only want to spend £1.00 for a coffee- Price £1.00

But these magic signs don't exist, so how can you get people to pay different prices for essentially the same product?

Well, as Tim Harford explains, companies cunningly make products slightly different so that "price-insensitive" consumers will tend to spend more money.

For example

Cappuccino - £1.00
Cappuccino with chocolate sprinkles - £1.20
Hot chocolate - £1.30
Mocha - £1.45

In reality, the actual cost of the product in the cup is the same or only varies slightly. The main costs to the coffee company are rent, staff costs, advertising etc. However, by providing an option for customers to spend more money, they make more money. At the same time, they are not "turning away" the customers who are more stingy and only want to spend £1.00.

Back to the fake handbag/watch sellers in KL or Beijing - they practise the same thing! In general, the customer sets the price - as long as the vendor makes a profit, they will sell. No vendor will ever sell at a loss, no matter what kind of story he tells you.

When my in-laws went to China, they didn't like the idea of bargaining at all. They always felt that they were being ripped off.

I said to them - yes, but surely, when you see something you like, you must have some idea of what you want to pay for it? Whether it is £5 or £500, you know yourself how much you prepared to pay. It's just a question of whether the seller will do the deal. Or else you could argue that Marks and Spencer are ripping you off too. Who is to say whether that flowery blouse is worth £50 or £5?

My in-laws are still not convinced. They like a fixed price!

Anyway, he describes other ideas like this in the book so if you found that interesting, you will probably enjoy this book. If there are any proper economists out there who have read this book, I would love to hear your opinion of it. As for me, it took me ages to read because often after a hard day at work I couldn't face more "facts" and "explanations". Back to light reading!

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