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The Undercover Economist

Tim Harford

Imagine a wild frontier with few settlers but plenty of fertile meadow available for growing crops. One day an aspiring young farmer named Axel comes to town and offers to pay rent for the right to grow crops on an acre of good meadow. There is plenty of unused land around, and each landlord would rather collect a small rent than nothing, so each will undercut his rivals until Axel gets to rent the land for very little. So the first lesson is that the person who owns the resource does not always have as much power as you would think. Bargaining power comes through scarcity. Farmers are scarce and land is plentiful, so landlords have no bargaining power.

But the meadow land fills up as other frmers drift in. When Bob arrives, all that is left is abundant, but inferior, scrubland. Bob doesn't want to farm there, so he offers good money to any landlord who will evict Axel or any of earlier arrivals, and let him farm there instead. The arrival of one new farmer suddenly tips the balance, because all the meadow farmers will be prepared to pay good money not to be kicked out. The land is now scarce and the landlord has the bargaining power. The price is easy to set. If the difference between meadow and scrub is five bushels of grain a year, then the rent will also be five bushels. If landlord tries to charge more, his tenants will leave to farm scrubland. If the rent is any less, the scrub farmer will be willing to offer more.

Obviously this is a simplified version of real life. But same principle applies to coffee bars. Because rush hour commuters are in a hurry they will pay almost anything for a coffee at train station Starbucks. This willingness to pay top dollar sets the high rent, not the other way round. Nobody tries to sell Chinese meals or used cars at station, because there is no shortage of places with lower rents where they can be sold. But for coffee bars, cheaper rent is no compensation for the loss of a flood of price-blind customers.

Starbucks goes further. They give customer every chance to signal that they aren't paying attention to price. It costs very little to make a bigger drink, or add a bit of choc powder. But by charging wildly different prices for virtually the same product, Starbucks smokes out the lavish spenders.

Supermarkets do the same. Best pricing policy is to have either high prices to gouge loyal/lazy customers, and low prices to attract bargain seekers. But if those prices were consistent, customers would notice that one place was dearer than another. So shops jump between extremes. From a buyer's POV it makes more sense to see the discount price as the real price, and the non-standard price as just a random price increase to catch the unwary. Bananas are classic case - they may randomly double in price from one week to the next. Customers who notice will just buy something else; customers who don't, will just pay the price.

First class air travel. Economy class doesn't have to be such a poor experience, but it's main purpose is to encourage passengers to pay extra for premium seats. Supermarkets do same in more subtle way. In-store brands are generically labelled, not because it would cost too much to have attractive designs, but because they want to emphasize the quality 'difference' between them and the dearer brands.

The price of corruption. Rich countries perform basic bureaucratic tasks quickly and cheaply. Poor countries over-regulate and draw out the process to pocket extra cash at each stage, thus ensuring that the officials support the autocrats in power. But this is also part of reason why they are poor, because entrepreneurs turn down attractive opportunities when they know contract enforcement will be difficult.

The argument that trade leads to economic growth, which leads to climate change, leads us then to a stark conclusion that we should cut our trade links to make sure the Chinese Indians and Africans stay poor. The question then is whether any environmental catastrophe could possibly inflict the same terrible human cost as keeping three or four billion people in poverty? To ask that question is to answer it.

Problem of road congestion. Driving is like the "all you can drink for $40" bars. The first drink is very expensive, but every otherdrink is free, so every incentive to drink until you pass out. Same with cars - first trip costs a lot up front to buy the car, but after that it's just price of gas. We don't pay anything for the inconvenience to others. A congestion charge would change things. Drivers expect roads to be 'free', but because they are free we have run out of space.

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