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1-Page Summary of The Undercover Economist
Morning Coffee and Scarcity
Commuters pay a lot to buy coffee from train station vendors. The reason is scarcity. Usually, only one vendor has the right to sell coffee in each station, and this means that commuters have no choice but to pay extra for their morning cup of joe. However, it’s not really the vendor who benefits from this arrangement; the owner of the real estate where that kiosk sits does. This is a pattern I’ve seen repeated all over town.
In the nineteenth century, economist David Ricardo analyzed how scarcity affects prices. He offered an example of a region rich in fertile land but sparsely settled. Landowners couldn’t charge high rents because land was abundant and farmers were few. However, if many more farmers arrived to take advantage of cheap land, then there would be a shortage of it. As a result, landlords could charge higher rents for their meadowland as competition increased over time for that particular piece of property. The same thing happened with marginal or less desirable farmland near the meadows—as new people began settling on it and competing for it, its rent price would also increase over time due to its proximity to prime farmland (meadowland).
Ricardo’s theory is applicable to the real world. It can be used by coffee vendors, for example, who want to sell their products in a crowded area where prices are high and customers aren’t too sensitive about them. However, such areas are scarce, so it would help if one were able to identify prime locations like train stations which have an abundance of people but limited space for vendors. Anything that increases scarcity—for example zoning laws that prevent building in certain places—helps raise rents elsewhere by making housing scarcer.
Logically, special interests work to make their resources scarce and thus more profitable. Organized crime gangs discourage competition by threatening violence. Labor unions control the supply of skilled workers. Professionals lobby legislatures to enact laws requiring licensing and educational standards that restrict the number of people in a profession, thereby making it harder for new competitors to enter an industry and driving up prices because there is less supply than demand. Without scarcity, there is no pricing power; therefore, coffee growers are poor and probably will remain poor if they don’t find a way around this problem. Initiatives such as “fair trade coffee” cannot change the underlying economic facts; however, fair trade can be used as a marketing ploy to make extra money off consumers who want “ethical” products or feel guilty about supporting unethical business practices (at least if you think about it in terms of coffee).
Some people are willing to pay more for a cup of coffee than others, but the vendor does not know who is willing to pay extra. If the vendor can identify those consumers, he/she will make more profit by selling them their product at a higher price. A company called Fair Trade helps vendors identify these consumers by providing an alternative that costs more and promotes the social aspect of purchasing goods from companies in third-world countries.
Marketers have other ways to identify those who are willing to pay more. Supermarkets, for example, change the sale items weekly and use price-sensitive people’s tendency to wait for sales. They also profit from organic food by charging a premium price. Organic foods are usually placed in separate stands so that customers cannot easily compare prices of organic products with nonorganic ones.
Some companies have figured out ways to identify their best customers and charge them higher prices. For example, in the computer industry, some chips, printers and software programs come in two versions: one with more speed or power than the other. It actually takes manufacturers more time and effort to make the lower-priced version because they deliberately cripple certain features so that they can sell it for less. In other industries like travel, vendors offer discounts on certain products or services to certain groups of people who are willing to pay a premium price for those things.
