January 6, 2008

Everyday Economics

I never knew it was possible to apply economic thought to so many aspects of one's life. Author Tim Harford explores several daily economic issues in his book, The Undercover Economist. In the first five chapters of his book, Harford discusses (among others) the issue of scarcity power, price targeting, price gouging, perfect markets, lemons & market failure, health care, externalities and pollution.

Chapter two of his book really got me thinking about the economics that might be involved in the bridal store that I manage. Although it is not exactly like the example he points out, it is similar in some ways. The store seems to have a small amount of scarcity power over the brides in Colorado Springs and many of the surrounding areas because of a regional exclusivity agreement with certain designers. If any bride wants to purchase a gown by those designers, they have to pay the price that is quoted by our store or risk purchasing by means of the internet (which doesn't seem like a big deal to many, but in the bridal industry they are taking a rather large and possibly costly risk as seen by four years of dealing with these types of problems...) The internet could be considered a type of leak in the bridal industry. Although there are legitimate ways to sell gowns online, often times it is prohibited by the designers. Some gowns may be found online at a significantly lower price without the customer service and no guarantees.

Harford also clearly points out another place in the market where there are no guarantees, for buyer or for sellers, when he writes about "lemons" as a type of market failure. Uncertainty and "incomplete information" prevents some transactions from taking place and other transactions are altered. This altering is visible in the market for cars.

"The market doesn't work nearly as well as it should; secondhand cars tend to be cheap and of poor quality. Sellers with good cars want to hold out for a good price, but because they cannot prove that a good car really is a peach [typically a lemon], they cannot get that price and prefer to keep the car for themselves. You might expect that sellers would benefit from their inside information, but in fact there are no winners: smart buyers simply don't show up to play a rigged game."

The market for cars has now changed slightly because of useful tools such as CarFax. This is however still a relevant discussion because of the bearing that lemons have on other areas of the market. Harford's analysis moves to the market for health insurance which has very similar implications. Seemingly healthy individuals are forced to pay higher rates for health insurance because of the lack of complete information and a balancing effect to offset those beneficiaries who are insured and unhealthy (or may become that way.) This is one very costly market failure to the general public, but is there really a feasible solution?
Source: Tim Harford, The Undercover Economist. 2005

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