Economic Concepts In "Freakonomics" Written By Steven D. Levitt And Stephen J. Dubner
Economic concepts can be observed in many daily situations and scenarios. Often times, we are unaware of the world around us, especially when it pertains to economics. Economics is in everything, we just have to keep our eyes open to see it. While reading Freakonomics, by Steven D. Levitt and Stephen J. Dubner, we are exposed to various economic concepts such as asymmetric information, adverse selection, incentives and correlations. These concepts are found in places like a Chicago gang, the real estate market, and how to name your children. The authors take the reader through these places and sometimes the way of life for some people to continue to explore the world of economics as it is seen through their eyes; the eyes they desire the reader to obtain when they finish the book.In the early 1990’s the rate of crime in America was beginning to rise rapidly. Experts predicted that it was not going to turn around anytime soon; some even predicted that the rate would double. President Clinton himself believed that we would be living in a chaotic world if we did not fix something soon. However, expert’s predictions were completely wrong and instead of seeing huge increases, we began to see the exact opposite. It was a common thought that this was due to the booming economy or the changing gun control laws, but neither were the true reason.
Twenty years earlier the case of Roe vs. Wade took place, which, in turn, legalized abortion in the United States. Women who were very poor and unfit to be parents could now have a legal abortion. This was slowly but surely shrinking the number of kids that would be born in harsh conditions, which was diminishing the number of future criminals. This goes to show you that not all experts make the best predictions. This also explains the economic concept that “dramatic effects often have a distant, even subtle, causes” (Freakonomics, pg 12).
In the case of a Real Estate Agent and her client, the agent urges the client to sell their home at a lesser price explaining that she is in her client’s best interest when it actually the opposite. Using math to justify this, the additional commissions that would be received from getting a $10,000 higher offer on a house would only put $150 more in the agent’s pocket. This is not in the client’s best interest because he gets an additional $9,400 from the extra $10,000 offer. Because Realtors have information that is not available to their clients there is an economic concept called asymmetric information that takes place. Asymmetric information is defined as, “one party to a transaction has relevant information that another party lacks” (Microeconomics, definitions). Further proving the point, Realtors always hold out on their own houses to get the best possible offer.
Experts are only looking out for themselves and use their knowledge to do so. If you know what and how to measure the right data you can find out the real underlying issues. This book shows just how to find the hidden reasons behind everything in life. It provides you with a different way of looking at the world. For instance, if we understand people’s incentives such as the example with the real estate agent, we can find a better understanding of how people operate. This book challenges the conventional way of thinking and proves that sometimes the answer isn’t what it may seem. This was the case when people thought that the economy and gun control laws were responsible for the declination of crime, when in reality it was the legalization of abortion 20 years prior.
As described earlier, people respond to incentives. There are three types of incentives that include: economic, social, and moral. In one case, an Israeli daycare began to charge parents for being late to pick up their children. Surprisingly, the number of late parents more than doubled. That was because instead of the parents feeling bad about being late, they could just pay a few dollars extra and not feel guilty about it. The effect of a moral incentive surpassing an economic one was again proven when a study was done on donating blood. People stopped giving as much blood when it became a way to make money versus just feeling good about it.
Often times more than one of the three incentives take place simultaneously. Chapter 1 asks how sumo wrestlers and schoolteachers are similar. The Chicago Public School system imposed economic incentives that enticed teachers to cheat by providing answers to the children for tests. Teachers whose students underperformed on the tests would not receive a raise. They could even lose their jobs if the entire school did not perform well because the CPS would cut funding or even shut down the school entirely. On the other side, teachers could have a moral or even a social incentive not to cheat. Sumo wrestlers that obtained a record with at least eight wins would not be demoted in rankings and in pay. So, when a sumo wrestler with an 8-6 record fought another with a 7-7 record there are incentives for the two to cheat. There could be an economic incentive between the two before the fight if they were to agree to a monetary value in order to let the wrestler with the 7-7 record win. There could also be a moral incentive if the two were friends and the better wrestler did not want to see the other get demoted. However, the percentage of sumo wrestlers that did not lose to those with a 7-7 record declined with the more wins the sumo wrestler had. That is because of another economic incentive: sumo wrestlers with more than 10 wins had a higher chance of receiving the grand prize of $100,000. In conclusion, in order to understand people’s reasons for doing or not doing something, one must observe all of the possible incentives that are available to them.
In the second and third chapters of Freakonomics, they cover a variety of economical issues such as supply and demand, but the main point covered in these chapters is asymmetric information. In the chapters, How is the Ku Klux Klan Like a Group of Real Estate Agents and Why Do Drug Dealers Still Live With Their Moms, they break down the demographics and societal factors that influenced the leaders in each organization to act selfishly and abuse information.
In chapter 2, we learn about the ins-and-outs of the Ku Klux Klan throughout the years. The Klan started as a violent and aggressive organization in the 1800s that created fear through these actions. After going dormant in the early 1900’s, the clan grew rapidly as World War 2 approached, gaining as many as eight million members by the late 1920’s. There was a difference within the KKK, as they were more bark than bite. Despite being known for their lynching antics, there were only 159 cases of lynching from 1930 to 1970. In reality, the organization had become more of a grown man’s club and not the aggressive juggernaut of the past. Through the reports of Stetson Kennedy, we get an inside view into the life of a KKK member as he sought to tear them down. Kennedy used his insider information on the Ku Klux Klan against them by sharing their secrets to a public radio host who told the world of their secret acronyms, nicknames, and meetings. This drove the Klan mad. Kennedy collected vast amounts of information without them knowing and this sharing of information actually led to their downfall.
