The Undercover Economist

by Tim Harford

Troy Shu
Troy Shu
Updated at: March 12, 2024
The Undercover Economist
The Undercover Economist

What are the big ideas? 1. The importance of understanding scarcity power and externalities in markets: The book emphasizes that scarcity power, where one or a few

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What are the big ideas?

  1. The importance of understanding scarcity power and externalities in markets: The book emphasizes that scarcity power, where one or a few people control a resource that many need, and externalities, which are costs or benefits that impact others, can destroy markets. Understanding these concepts is crucial for recognizing how markets function and identifying potential issues.
  2. Aligning individuals' interests with the country's welfare: The book argues that the best way to encourage development is by aligning individuals' interests with the country's welfare. This perspective goes beyond traditional economic theories, which often focus on market mechanisms alone, and highlights the importance of incentives in shaping institutions and driving growth.
  3. Singapore's unique health-care system: The book discusses how Singapore's health-care system deals with the issue of inside information by providing catastrophe insurance and a medical savings account for each citizen. This is a novel approach that combines market mechanisms and government intervention to address the challenges of private information in an insurance market.
  4. The role of economic freedom and trade in reducing poverty: The book argues that economic freedom, which comes from being able to trade freely, is beneficial for the poor, as it increases opportunities for employment and better wages. This perspective contrasts with some development theories that prioritize government intervention or targeted aid programs.
  5. The potential of economic growth to improve people's lives: The book emphasizes that economic growth can lead to tangible improvements in people's lives, such as escaping poverty, increasing life expectancy, and providing more opportunities for individuals to flourish. This perspective is unique in its emphasis on the human aspect of economics, rather than focusing solely on market mechanisms or abstract theories.




  • Economists view the world as an intricate game of interactions and negotiations, and they can explain how complex systems like bookstores and coffee production function without a central authority.
  • Companies will try to exploit these systems, but understanding how they work can help you make better decisions as a consumer and fight back.
  • Economists study a wide range of topics beyond just traditional economic issues, including poverty, development, psychology, history, and voting behavior.
  • Economic principles can be used to solve everyday puzzles and mysteries, like why secondhand cars are so expensive.
  • By seeing the world like an economist, you can become a more savvy consumer and voter, able to recognize the truth behind political stories and avoid being taken advantage of.


“To the economist, there is a story to tell about the contrast between the chaos of the traffic and the smooth running of the bookshop. We can learn something from the bookstore that will help us avoid traffic jams.”

ONE Who Pays for Your Coffee?


  • Economics is the study of how people allocate resources to satisfy their wants.
  • Scarcity creates value, which is why resources are allocated.
  • The value of a good or service is determined by the marginal utility of the last unit of that good or service consumed.
  • The opportunity cost is what you give up in order to do something else.
  • Markets allocate resources through supply and demand.
  • A market price reflects the marginal cost of the last unit of a product or service produced, which is equal to the marginal revenue of the last unit sold.
  • Externalities are costs or benefits that fall on people other than those who produce or consume goods and services.
  • Government policies can lead to deadweight loss, which is a social cost that occurs when resources are not allocated efficiently due to government intervention.
  • Tariffs are taxes imposed on imported goods and services that increase prices for consumers and reduce trade, leading to a loss in economic efficiency and potential welfare gains for foreign producers at the expense of domestic consumers.
  • Immigration affects wages and conditions for skilled and unskilled workers differently depending on whether they are inside or outside the unionized labor force and whether they compete with new immigrants for jobs in declining industries or expanding ones.


“Reading accounts is dull; economic detective work is the easy way to get to the same conclusion.”

“But many of us love the fact that Ricardo was able, nearly two hundred years ago, to produce insights that illuminate our understanding today. It’s easy to see the difference between nineteenth-century farming and twenty-first-century frothing, but not so easy to see the similarity before it is pointed out to us. Economics is partly about modelling, about articulating basic principles and patterns that operate behind seemingly complex subjects like the rent on farms or coffee bars.”

TWO What Supermarkets Don’t Want You to Know


  • Price-targeting is a way for companies to use their scarcity power to make more money.
  • When price-targeting is efficient, it makes everybody better off: the company and its customers.
  • When price-targeting is inefficient, it denies customers products that they value more than the next best alternative.
  • Group price-targeting, like TrainCorp’s, is inefficient because it moves products from people who value them more to people who value them less.
  • Individual price-targeting, like PillCorp’s, is efficient because it expands the market and serves customers who wouldn’t otherwise be served.
  • Sometimes, private greed (PillCorp’s) can serve the public interest (expanding access to life-saving drugs).
  • Sometimes, private greed (TrainCorp’s) can be at odds with the public interest (denying low-value customers access to life-saving drugs).
  • A good rule of thumb: when private greed is aligned with social welfare, let it be; when it isn’t, let it go.


“By charging wildly different prices for products that have largely the same cost, Starbucks is able to smoke out customers who are less sensitive about the price. Starbucks doesn’t have a way to identify lavish customers perfectly, so it invites them to hang themselves with a choice of luxurious ropes.”

“When technology allows, firms with scarcity power may use highly sophisticated methods to target customers.”

“The nineteenth-century French economist Emile Dupuit pointed to the early railways as an example: It is not because of the few thousand francs which would have to be spent to put a roof over the third-class carriage or to upholster the third-class seats that some company or other has open carriages with wooden benches … What the company is trying to do is prevent the passengers who can pay the second-class fare from travelling third class; it hits the poor, not because it wants to hurt them, but to frighten the rich … And it is again for the same reason that the companies, having proved almost cruel to the third-class passengers and mean to the second-class ones, become lavish in dealing with first-class customers. Having refused the poor what is necessary, they give the rich what is superfluous.”

THREE Perfect Markets and the “World of Truth”


  • Markets are the most efficient way to allocate scarce resources, but they do not always produce fair outcomes.
  • Economists often advocate for lump-sum taxes and subsidies to adjust for market failures that result in unfair or inefficient outcomes.
  • In the absence of perfect competition, companies can gain scarcity power, allowing them to set prices above their true cost.
  • A world with perfect markets would be the best possible outcome, but it is unrealistic to expect this to occur naturally.
  • When markets fail, economists advocate for government intervention to correct for the failure.
  • The head start theorem is a theoretical concept that suggests that instead of interfering with markets themselves, governments can use lump-sum taxes and subsidies to adjust the starting blocks of individuals in a market economy.
  • This strategy allows markets to function efficiently while ensuring a more equal distribution of resources.
  • While this concept is impractical in some cases, it is a useful tool for understanding how economies can balance efficiency and fairness.


“if there’s a profitable deal to be done between somebody who has something unique and someone who has something which can be replaced, then the profits will go to the owner of the unique resource.”

“Taxes are often higher when price-sensitivity is low. For example, the government charges high taxes on petrol and cigarettes, not for environmental and health reasons but because people who buy these products need to drive and are addicted to smoking; they won’t change their behaviour much even in the face of large taxes. (If you think that taxes on petrol are motivated by environmental concerns, think again: despite the environmental impacts of air travel, electricity and domestic heating, 90 per cent of all ‘environmental’ taxes in the UK in 2009 were paid by motorists.)”

FOUR Crosstown Traffic


  • Externalities are the costs or benefits of an action that do not accrue to the person taking the action.
  • Negative externalities are costs that people impose on others; positive externalities are benefits that people confer on others.
  • Externalities can be solved by bringing them into the market through an externality charge (for negative externalities) or an externality subsidy (for positive externalities).
  • Externalities are best dealt with by markets because they have better information about costs and benefits than any government can, and because markets provide incentives for people to act efficiently.
  • Government intervention in markets is often a blunt instrument that may overcompensate or undercompensate for the problem, or may create other problems of its own.
  • Economists often measure economic activity using GDP, which measures the total cost of production, but GDP does not measure all important aspects of human well-being and can be misleading.
  • Economics is about who gets what and why, and so is “the economy.”

100% True!


“We should aim to make ours a world where people feel free to do things they enjoy, even if others are mildly inconvenienced, but also one where we all refrain from harming other people if the effort involved to avoid harming them is small.”

“We're kidding ourselves if we think we can opt out of these decisions. Every policy the government adopts, and every individual choice you make, implies that a valuation has been made, even if no one has been honest enough to own up to it or even admit it to themselves.”

“There is much more to life than what gets measured in accounts. Even economists know that.”

FIVE The Inside Story


  • Markets work because they provide the right incentives and information for people to produce what consumers want.
  • Scarcity power, externalities, and inside information can destroy markets.
  • Scarcity power occurs when one or a few people control a resource that many people need, and use that power to raise its price.
  • Externalities occur when one person’s actions have an impact on someone else's well-being.
  • Inside information destroys insurance markets because it allows low-risk people to leave the market, leaving only high-risk people behind, which raises the cost of insurance for those who remain.
  • Singapore’s health-care system fixes the problem of inside information by providing catastrophe insurance to pay for expensive procedures and a medical savings account for each citizen to pay for routine expenses.
  • Singapore’s system is more effective than the British system because it provides more choice and more responsibility to patients; and more effective than the American system because it avoids the bureaucracy and expense of private insurers.


“(Screening, the theory of which won enfant terrible Joe Stiglitz a share of the Nobel Prize in 2001, is the art of finding out hidden information by forcing people to act, rather than simply murmur sweet nothings.)”

“It is not polite to say so, but it is obvious that paying people to be unemployed encourages unemployment. Yet, if a government scrapped unemployment benefit, there would still be jobless people, and supporting the jobless is something that every civilised society should do. The truth is that we have a trade-off: it is bad to encourage unemployment but good to support those without incomes.”

SIX Rational Insanity


  • The stock market is not a lottery.
  • It's not about getting there first.
  • It's about being the best.
  • Long-term profitability for a company comes from having some capability that others cannot match.
  • A powerful brand in a conservative market, control of a standard like Microsoft's, or simple superior expertise, like General Electric's are examples of capabilities that can lead to long-term profitability.
  • eBay has such a capability, drawn from its locked-in base of loyal buyers and sellers.
  • Very few other Internet companies do, and if you looked inside Graham Bailey's story thoughtfully you would have found it very unconvincing in 1998.

SEVEN The Men Who Knew the Value of Nothing


  • The wealth of a country is determined by its institutions, and the institutions are determined by the incentives they create.
  • Corruption is caused by the perverse incentives that powerful people have to exploit the system for their own gain.
  • Development projects often fail because the people who commission them do not care whether they succeed or not, and the people who carry them out are not held accountable for their performance.
  • The best way to encourage development is to align the interests of individuals with those of the country as a whole.


“Someone who knows the price of everything and the value of nothing. Oscar Wilde’s definition of a cynic, now commonly applied to economists Imagine”

“According to one story, Von Neumann was asked to assist with the design of a new supercomputer, required to solve a new and important mathematical problem which was beyond the capacities of existing supercomputers. He asked to have the problem explained to him, solved it in moments with pen and paper and then turned down the request. Von”

“The dictator has to keep the economy functioning in order to keep stealing from it.”

“Consider the situation: Money that was provided because of social networks rather than need; a project designed for prestige rather than to be used; a lack of monitoring and accountability; and an architect appointed for show by somebody with little interest in the quality of the work. The outcome is hardly surprising: a project that should never have been built was built, and built badly.”

“We still don't have a good word to describe what is missing in Cameroon, indeed in poor countries across the world. But we are starting to understand what it is. Some people call it 'social capital, or maybe 'trust'. Others call it 'the rule of law', or 'institutions'. But these are just labels. The problem is that Cameroon, like other poor countries, is a topsy-turvy world in which it's in most people's interest to take action that directly or indirectly damages everyone else.”

NINE Beer, Fries, and Globalization


  • Trade makes us richer.
  • Trade increases economic freedom.
  • Economic freedom is good for the poor.
  • Economic freedom is good for workers, too.
  • Trade barriers are not a good way to protect sweatshop workers; they only make them poorer.
  • The best way to help the poor is to let them trade freely with us and with each other.
  • The best way to help the poor is to let them work in factories that pay better than picking trash in landfills or farming on dry, infertile land.
  • The best way to help the poor is to let them move from the countryside to cities, where they can work in factories, where they can buy cheap manufactured goods, and where they can live longer and healthier lives than they would in the countryside.
  • The best way to help the poor is to let them become middle class, and that will only happen when we let them make the most of their talents by trading with us and with each other.
  • We should let people in poor countries do what we have done: use trade as a stepping-stone to prosperity, and not try to stop them from doing so by erecting trade barriers or boycotting their products because we don’t like their working conditions.


“The question is wether any environmental catastrophe, even severe climate change, could possibly inflict the same terrible human cost as keeping 3 or 4 billion people in poverty. To ask that question is to answer it.”

“Hours are long. Wages are pitiful. But sweatshops are the symptom, not the cause, of shocking global poverty. Workers go there voluntarily, which means—hard as it is to believe—that whatever their alternatives are, they are worse. They stay there, too; turnover rates of multinational-owned factories are low, because conditions and pay, while bad, are better than those in factories run by local firms. And even a local company is likely to pay better than trying to earn money without a job: running an illegal street stall, working as a prostitute, or combing reeking landfills in cities like Manila to find recyclable goods.”

TEN How China Grew Rich


  • The world is becoming more economically integrated and interdependent.
  • China’s economic growth has been one of the most dramatic in history, but it still has a long way to go before reaching the level of prosperity of developed countries.
  • Economic growth can help people escape poverty, increase life expectancy, and provide more opportunities for individuals to flourish.
  • The Chinese government has pursued policies to attract foreign investment, including special economic zones, which have helped to drive the country's economic growth.
  • Despite the challenges and difficulties that come with economic growth, people like Yang Li are finding new opportunities and making choices about their own lives that were unimaginable a generation ago.
  • Economics is about people and their well-being, and economic growth can help improve people's lives in tangible ways.


“Fight scarcity power and corruption; correct externalities; try to maximise information; get the incentives right; engage with other countries; and most of all embrace markets, which do most of these jobs at the same time.”

“In the end economics is about people ... And economic growth is about a better life for individuals - more choice, less fear, less toil and hardship. ... Yang Li tried factory work and decided that it wasn't for her. Now she says that 'I can close the salon whenever I want.' Economics is about Yang Li's choice.”


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