Freakonomics is another all-time popular book about the intersection of economics and social behavior.
[From the Great Books Series. Also see The Success Manual - Encyclopedia of Advice, which contains summaries of 100+ Most useful books.]
Concepts in ‘Freakonomics’
- Incentives are the cornerstone of economic life
- The conventional wisdom is often wrong
- Dramatic effects often have distant, even subtle, causes
- Experts use their informational advantage to serve their own agenda
- Knowing what to measure and how to measure it makes life simpler
Topics under discussion in the book
1. Incentives
2. ‘ Snob’ effect
3. Information Asymmetry
4. Correlation v/s Causation
5. Conventional Wisdom
6. ‘ Winner take all’ labor market
Types of Incentives
A means of urging people to do more of a good thing and less of a bad thing.
Conventional wisdom turns to be “wrong”
Economists love incentives
1.1 Economic
1.2 Social
1.3 Moral
Economic Incentive
* are those which people respond to in a market place
* Discounts
* Bonuses
* Fines – Libraries, Traffic
Social Incentive
* “ Urge people to do things in a way that is accepted by all”
* Consequences of Social Networks in Workplace
o Presence of friends affects productivity
o Workers conform to a norm
o Overall effect on firm performance?
* Parallel can be drawn upon on CGPA
Moral Incentive
* “ Appealing to the sense of a person’s right vs wrong”
* Advertising
* Donations
* CSR
Why People Cheat
* “ Something worth having is something worth cheating for”
* Examples of cheating
o Class Teachers
o Sumo Wrestlers
* Not Always True
o Bagel Example
Conflicting Incentives
* What do you expect to happen when a fine is imposed on parents who do not pick up their children from the day care centre on time?
Snob Effect
* “ Desire to own exclusive or unique goods”
* Demand increased with price
* Art, Designer Clothes, Sports Cars, Stamps, Coins
* Mac users
o Tooth-whitening products
o Starbucks
o Organic food
o Hybrid cars
Information Asymmetry
* One party has more info than the other
o Sellers > Buyers
o Buyers > Sellers
Market for Lemons
* Relates quality and uncertainty
o Bad cars drive out good
o Impossible for buyer to distinguish
* Economic cost of dishonesty
Other examples..
* Insurance market for the elderly
* Credit market in rural India
o Local moneylender v/s Banks
Counteracting Info. Asymm.
* Guarantees
o Risk borne by seller than buyer
* Brand-name good
* Licensing
o ISI mark
o The IIT degree, in our case
o Nobel Prizes!
Correlation & Causation
Case study: Olympic Medals and GDP!
* =
Factors
* Population
* GDP
* Influence of Soviet Union
o Political importance of sports
* Host or not?
o “ Home-advantage”
* Medals in the previous editions
* Top 30 countries will win 82 % medals
* Top 30 countries account for 84 % GDP
* A University of South Australia analysis found that one gold medal typically costs a country $37 million in training funds
Conventional Wisdom
* Explanations that are generally accepted as true
* Conventional Wisdom is not necessarily true
Creation of Conventional Wisdom
* Often, conventional wisdom is generated by experts and journalists
* Advertising is a great tool for creating conventional wisdom
Conventional Wisdom
* A typical drug dealer’s resources?
In Reality
* Most of the people involved in illicit drug trade earn less than the minimum wage and have legitimate jobs to supplement their earnings
* It is also a highly dangerous job
* A drug dealing gang is very similar to a capitalist enterprise like McDonald’s
Why do it then?
* To succeed in an extremely competitive field
* Every street dealer aspires to one day reach the top of the pyramid
* This constitutes a “Winner-take-all” market
Winner-take-all Market
* Large amount of competition for a few highly coveted positions
* The positions usually have a lot of money, fame and respect associated with them
* Everyone usually starts off at the same level
* The large competition leads to measly pay at the lower levels
* The pyramid has a tiny apex and a very large base
The tragedy of the commons
* If there is only one player in a winner-take-all market, adding a second player might significantly improve the market output
* But if there are already a large number, adding more players will only marginally increase the market output and these players will contribute less to the economy than if they were in some other field
Winner-take-all Market
* Once a firm in such a market gets a considerable lead it is very difficult for other firms to catch-up
* Case-in-point – Google:
o The search engine market has zero switching cost
o Google had a better product than others and this gave them a huge market lead
o Even if it has a marginally better product now users will not switch their preferred search engine
o Even if the competitors have an identical product now, they still have to overcome the “brand perception gap”
o Economic and social forces form a positive feedback loop for the leader
Education
* Number of students applying to a University depends on the ranking of the University
* The better students go to the higher ranked universities
* A positive feedback loop is formed
. Impact of New Technology
* Personal Computer
o Computers were limited to large organisations
o IBM was the leader in making computers for large corporations
o Apple came out with a Personal Computer which revolutionised the market and gave it the market lead
Permalink 
