I’ve read Freakonomics and I didn’t really like it. I mean, it’s written well and Steven Levitt is obviously really smart, but the book didn’t impress me so much. To me, it just made economists seem like smart-asses who like to point out clever explanations for interesting but not especially important things. Plus, maybe it’s my antipodean sensitivities, but I really didn’t like the bits of the book praising Levitt as some sort of econo-god. What was the point of that?

Anyway, I don’t want to talk about Freakonomics. I want to talk about Tim Harford’s book, The Undercover Economist. I know, I’m really behind the times, this book came out and I read it last year. Everyone is probably buzzing over Tyler Cowen’s Discover Your Inner Economist, which I haven’t read yet. But I have to say that I really liked Harford’s book. He doesn’t deal with trivial things like behaviour of drug dealers or some such junk. He talks about some of the really big and deep ideas in economics, only he does it in such a gentle way that you don’t really realise it. Harford writes very well and clearly, and can explain things like the first and second fundamental welfare theorems while making you feel like you’re reading Harry Potter. In fact, The Undercover Economist is much less confusing than Harry Potter. The other thing that really stood out for me in Harford’s book is his understanding of what a market is and what it does.

After reading The Undercover Economist, you will realise that markets are really like computers. They exist to extract and process information. To illustrate, imagine that you live in a communist dictatorship, and the good dictator put you in charge of pencil production. He is a benevolant dictator, so he genuinely cares about the welfare of his people. This means that resources should be used to produce pencils as efficiently as possible (without wasting any), and the pencil production should go to those people who value pencils the most. Now think about the information you would need to do this job. You’d need to know how to produce a pencil, what raw materials are required in what quantities, who wants pencils how badly, where these consumers live, their preferences for HB, 2B etc pencils, and so on.

As you can see, the problem of organising pencil production is a problem of information. In priciple it can be solved, but it would be really difficult. On the other hand, as Harford explains, markets can achieve this transparently. If the market for pencils functions properly, the incentives inherent in the system will ensure that pencils are produced efficiently, and that the supply of pencils is allocated to those who value them the most. The market extracts the necessary information and processes it. From this, it’s easy to see that prices in well-functioning markets are signals that convey information about what it costs to produce something and how badly people want that thing compared to the other things that they could consume. Harford explains these powerful ideas, and more, in a highly readable format.

Overall, I highly recommend this book to anyone interested in economics.