Freakonomics — Summary

Explore the incredible hidden side effects of interactions with complex systems

Incentives affect peoples behavior

Incentives are a way of influencing the behavior of people. Lawmakers, for example, can create incentives which bring people to smoke less by simply raising the taxes on cigarettes. There are a lot of people using incentives to affect your behavior, the police, health professionals, your spouse, your boss, your friends to name a few.

An incentive is simply a thing that motivates or encourages someone to do something.

The three fundamental categories of incentives are economic, moral and social. Although they affect behavior on their own, the biggest result occurs when all three are combined.

In the field of crime, incentives are what prevent people from stealing, defraud, cheat, etc. Economic incentives, in this case, are prison, loss of employment, loss of freedom.

Sometimes social incentives can be even stronger. People care about what others think about them. So they are encouraged to behave according to law.

Then there are moral incentives, which stem from the inherent feelings of people. If the individual has high morals, he or she will feel bad while committing a crime.

Setting incentives can have unexpected side effects

In a study daycare in Haifa, there was a problem with parents arriving late to pick up their children. The children were supposed to be picked up at 4 p.m. but very often parents ver late. The results were anxious children and at least one unhappy teacher who had to wait until the parents arrive.

Some economists heard about this rather common dilemma and offered a solution. Fining the parents, why should the day-care center take care of the kids for free?

The economists decided to conduct a study of their offered solution. The outcome was different than expected, once the small 3$ fine was enacted, instead of reducing the number of late pickups, they more than doubled. When before there were about ten late pickups on average, now there were 20.

The reason? Parents could replace their existing moral disincentive of feeling guilty when arriving late. Now they could simply buy off their guilt with a few dollars, so arriving late was less of a worry for them.

Even worse, this backfire couldn’t be undone by removing the fees. The signal had been sent.

The lesson learned is that introducing incentives is often a much more complicated affair than it seems. People and society are very complex, and one incentive will inevitably have unexpected outcomes in some places.

When introducing incentives, carefully analyze what effect they will have on existing ones.

Incentives are context-dependent

People react differently to the same incentives which might seem obvious, but what is more interesting is that they also respond differently depending on the occasion. Other factors like mood play a huge role.

Consider the honor-system commerce scheme of Paul Feldman. He had started out bringing bagels to his work on Christmas parties. Initially, it had been an incentive for his employees, whenever they won a research contract he brought bagels. Then it turned into a habit. Every Friday he would bring some bagels with cream cheese. The demand for his bagels grew when employees from neighboring floors hear about the bagels. Eventually, he ended up bringing fifteen dozen bagels per week. To recoup his costs he set out a cash basket with the suggested price.

Eventually, Feldman decided to quit his job and sell bagels. He used the same system used at his office. He delivered bagels to companies snack rooms earlier in the morning, and then returned before lunch to pick up the money and leftovers. The honor-system commerce scheme worked, within a few years, Feldman was delivering 8,400 bagels a week to 140 companies. His business was a success and made him happy, but he also ran a big economic experiment which offered a lot to learn from.

Specifically about something which academics call white-collar crime. It is a form of cheating, like for instance, taking bagels without leaving money in the basket. Feldman collected rigorous data on his bagel business and knew exactly how much customers stole from him.

All of his customers had the same moral incentive, in this case, the desire to be honest. But despite that common incentive, payment rates changed and revealed interesting trends.

The biggest contributing factor seemed to be personal mood, which was again affected by other factors like weather, stressful holidays, and office morale.

On particularly warm days payment rates were higher and on particularly cold days they lowered. On stressful holidays payment rates lowered and on more relaxed ones they went up. Office morale was a factor too, people in happy offices were likely to pay more.

Another interesting correlation was the increased payment rates following 9/11 which the author attributes to a surge in empathy in the population.

The lesson is that incentives are context dependent and don’t work in isolation. They are interconnected with the whole “system” which makes the effect harder to predict.

Be aware of Information asymmetry

We all need experts from time to time but be aware of the information asymmetry between you and them. They obviously have an information advantage over laypeople, which they use to take advantage of them.

Real estate agents, for instance, may convince you to buy the first house deal you get so that they can maximize their own profit, not yours.

A car salesman may tell you that a cheaper car is unsafe so that you end up buying a more expensive one, leading to bigger profits for him. That was one example of using fear to undermine rational decision-making.

The fear of missing out on something is often used in marketing. Much more serious than that would be real estate agents can play on your fear of missing out the house of your dreams.

A stockbroker may convince you to buy a certain stock now or otherwise miss the boat.

The problem is clear. Experts often exploit layman people and use fear against them for their profit. Be aware of this especially when someone wants to force you to make an immediate decision.

Research on te topic may be the best way to prevent information asymmetry from being used against you. Before you ask an expert, do some research on the topic on your own first.

The internet vs informational advantage of experts

The rise of the Internet in the 90’s has greatly reduced the life insurance prices and other types of insurances. This price drop is a result of people started to have access to information, undoing a big part of the information asymmetry which enabled companies to maintain artificially high prices.

With the rise of the internet, a plethora of comparison websites arose. Enabling customers to compare insurance prices from dozens of companies in little time. Price information which was previously difficult to access now was available with the click of a mouse. Naturally, the more expensive companies were forced to reduce their prices after their customer base reduced.

In information asymmetry, omitted information is often penalized

When people don’t have access to all the information, they assume the worst case when there is a lack of information. A famous example is the sudden value drop of a vehicle. After buying a new car, after only as little as 24 hours it loses a big percentage of its value. The reason is information asymmetry. The buyer of a used car cannot know if there is something wrong with the car. He naturally assumes that the seller is hiding information from him and that there is something wrong with the car. The seller is punished by an information asymmetry.

The lesson: In any transaction, it is useful to provide the information the other party expects you to provide. Otherwise, they will likely jump to worst case scenario conclusions.

It is often hard to distinguish correlation from causation

A human tendency is to assume that if X increased in correlation with Y, that X is related to Y and that X caused Y or vice-versa. But often it is only correlation, not causation.

Most people believe that money plays a huge role in politics, and in fact, data shows that candidates with expensive campaigns usually win. The tendency is to attribute their success to the money they invested in their campaign. But in fact, the correlation can be traced back to the pragmatic tendency of people.

When people don’t always back up their favorite candidate, they either try to make a difference in a close race between several candidates or they back a clear favorite.

Studies have shown that a winning candidate could cut his or her spending in half and lose only 1% of the votes while a losing candidate could only expect a 1% increase in votes while doubling the amount spent in his campaign.

Causality is hard to trace down, even for experts

In 1989 the crime rates increased by 80% over the previous 15 years. Experts predicted that the situation would only get worse. When in the 1990’s the crime rates suddenly dropped wild speculations were made by the experts.

Everything from tougher gun control, an improving economy, increased police force, innovative policing, and increased prison reliance was proposed as an explanation. But it turns out that the real factor was much more remote.

Later analysis has shown that the proposed factors had only a small effect on crime rates.
The biggest factor of all wasn’t even mentioned at the time.

One study showed that children who went unborn in the earliest years of legalized abortion would’ve been 50% more likely to live in poverty and 60% more likely to grow up in a single-parent household. Growing up in a single-parent household roughly doubles the child’s propensity to crime. Since 1973, 16 years after the legalization of abortion, there were significantly less grown ups likely to become criminals, hence the drop in crime from then on.

The lesson: Don’t rush to make predictions, they often so distant that even experts look in the wrong places.

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Karl Niebuhr

Karl Niebuhr

I'm Karl! I like to read, learn and share knowledge
Karl Niebuhr