Freakonomics - Book Summary

Unraveling the motive behind incentives.

Imagine a world spinning around you, full of people wanting to shape your behavior. This ensemble includes the politicians aiming for your vote, law enforcement striving for your compliance, your boss nudging you to up your productivity, or simply your partner coaxing you to put the toilet seat down. Tactics they use might differ—from gentle persuasion and financial rewards, to absolute trickery or strong-arming. But they all hinge on a common underlying principle: the power of incentives.

At its core, an incentive is a catalyst— a way to encourage more of a positive action or discourage a negative one.

Three broad types of incentives color our lives: economic, social, and moral. The truly effective ones—a nifty blend of these categories—tend to foster the desired shift in conduct.

Take crime as an example. We're constantly presented with moments of temptation to trespass, pilfer, or swindle. So, what keeps the majority from straying off the lawful path? Incentives.

The fear of jail time and the subsequent ripple effects—an evaporating job, lost home, vanished freedom—pose substantial economic deterrents.

Then, there's the moral compass guiding us. The reluctance to engage in activity we perceive as incorrect serves as a powerful restraint.

The social impetus is significant too. No one desires the stigma of wrongdoers, and for many, this social disapproval could be a more compelling preventive measure than any financial blowback.

It's this finely balanced cocktail of economic, moral, and social incentives that helps keep a majority of us on the right side of the law.

When you think about it, incentives possess the power to touch upon the trifecta of your life: your finances, your honor, and your conscience.

The intriguing fallout of introducing incentives.

Incentives are common levers we all encounter in our lives. It may be as straightforward as parents promising rewards to their kids for diligently completing homework, or organizations handing out bonuses to motivate their salesforce to perform. So, most of us have found ourselves at the receiving end of incentives at some point or another.

However, using incentives as nudges to modify behavior is a more intricate process than one might think. In the wild ecosystem of incentives, even minute alterations can trigger a seismic shift. And unfortunately, the results may not always align with the orchestrators' original intentions.

Let's delve into an investigation conducted at daycare centers in Haifa, Israel. Economists wanted to curtail the number of parents showing up late to collect their children. Their proposed solution—an economic deterrent in the form of a small $3 fine.

But against all expectations, this strategy backfired. Instead of declining, the count of tardy pick-ups sky-rocketed—nearly doubled!

So, what went wrong?

One speculation could be that the fine was relatively nominal, giving parents the impression that tardiness wasn't such a big deal after all.

The core issue, however, lay in the sudden displacement of an existing moral deterrent— the twinge of guilt parents felt for being late. The introduction of a modest fee effectively allowed parents to pay off their remorse. The result? Less worry about punctuality.

What's more, once this behavioral shift was set into motion, it proved irreversible. Even retracting the fine couldn't rectify the uptick in late pick-ups.

This case study underscores how designing incentives is an intricate art. Especially when pre-existing incentives, of varying forms, are already in play. So, tread cautiously when integrating incentives, keeping an eye out for potential unintended shifts in behavior.

Indeed, introducing incentives can often ripple into unforeseen effects on people's behavior.

The influence of incentives oscillates with the weather.

Ever been tempted to rob a bank? Chances are, you haven't. A mix of hefty disincentives— imprisonment, social ostracization, and the burden of guilt— probably dissuaded you. Yet, there are those who make that choice, braving the identical set of deterrents. What's the explanation?

The answer lies in the simple truth that individuals react differently to the same incentives.

Though it may seem obvious, the deeper surprise is that even within a single individual, responses to the same incentives can oscillate depending on the circumstance.

This theory finds evidence in data gathered by Paul Feldman, who ran an intriguing bagel supply venture for office break rooms. Along with the bagels, he left a cash box—unguarded—for customers to deposit their payment and picked up the leftover bagels and cash at the day's end. Given that all his customers had the same incentive to pay—the wish to maintain an honest front—the fluctuations in daily payments and across different offices offered rich insights into honesty under changing conditions.

Feldman's observations revealed a fascinating correlation—personal mood seemed to influence the level of honesty, and it was, in turn, shaped by several factors:

Weather, surprisingly, had a say in honesty levels. Payment rates climbed on unusually warm days, while frosty weather nudged them down. Stressful holiday periods such as Christmas and Thanksgiving saw a dip in payments, while laid-back holidays registered a boost.

Office morale also played a role—brighter work environments encouraged more payments. And a collective surge in payment rates following the 9 11 events, Feldman believes, stemmed from a heightened sense of empathy in society.

These patterns tell an engaging tale—that incentives can hold varying degrees of sway over even the same individuals, depending on the ebbs and flows of personal, local, and global circumstances influencing their moods.

To put it simply, incentives aren't static— their effectiveness can change with the weather.

Unraveling the hidden motives of experts.

At some juncture in our lives, we all lean on the wisdom of an expert. Be it for mending something, making a significant purchase, or navigating legal hurdles, their specialized knowledge is like a lighthouse guiding us through uncharted waters.

Experts possess an information reservoir that average people can't tap into. This gives rise to an asymmetry of information. And though experts earn their due through fees or commissions, their upper hand in knowledge can sometimes be manipulated to outwit non-specialists for an extra buck.

Imagine you're selling your home—arguably one of the heaviest financial decisions you'll ever make. The process can be labyrinthine. So, you trust your real estate agent, equipped with data on property prices and market trends, to get you the best deal. Their commission, you believe, hinges on the final sale price. It feels comforting to have someone with such depth of knowledge in your corner.

While this belief is somewhat comforting, it's also naive. To see the full picture, we need to dissect the incentive equation a bit more. Sure, an agent's commission is tied to the sale price. But the incremental gain from a higher price pales in comparison to closing a deal swiftly. This creates a situation where the agent's urge to wrap up a sale quickly might override any alignment with their client's objectives.

A study showed that estate agents tend to keep their own houses on the market for a longer duration and fetch higher prices compared to when they're brokering for a client. So, tread cautiously. When your agent nudges you towards the first decent offer, it's likely not aimed at fattening your wallet, but theirs.

So, it's true. Experts can exploit their information advantage to milk laypeople for monetary gains.

The tactic of fear-mongering in the world of experts.

Fear of the unknown can be overpowering. Whenever you're dealing with something outside your area of expertise, it's natural to feel apprehensive and nervous. Unfortunately, professionals in that field can sometimes cash in on this fear to their advantage.

This manipulation can take various forms. A car salesperson might nudge you away from a budget-friendly model by suggesting it's unsafe. An estate agent might exploit your fear of losing your dream house to push you towards an inflated bid. A stockbroker might pester you to invest in a particular stock right away or risk a lifetime of regret.

Fear, being an emotional response, clouds our rational thinking, making us susceptible to decisions we wouldn't typically make.

In face-to-face scenarios, social fears— fear of appearing ignorant, cheap, or unprincipled— can further fuel this issue, providing the expert more leverage to exploit our vulnerabilities.

Picture the emotionally charged process of arranging a funeral for a loved one. In this scenario, a funeral director, understanding that you're not familiar with the trade, can use your anxiety around providing a respectful farewell to sway you towards a pricier casket than you initially planned.

So, be watchful when it feels like a professional is playing on your fears, especially when pressured to make a hasty decision. In such situations, it's wise to arm yourself with strategies that offer you some breathing room to ponder your options calmly. Resort to needing a second opinion, or buy time by suggesting that you will consult with others. You could also level the information asymmetry by conducting some research on the subject in question beforehand.

The dark truth is, experts can employ fear and anxiety as tools to cheat laypeople.

The Internet is disrupting the information monopoly of experts.

The 1990s marked a significant plunge in the cost of life insurance. Strangely, other insurance forms remained unaffected, with no substantial shifts witnessed in the life insurance landscape or its consumer base. So, what caused this abrupt dip in prices?

The game-changer was the advent of the Internet, more so the rise of price comparison websites. These digital platforms empowered consumers to swiftly juxtapose insurance prices from a multitude of companies. The time-consuming process of price gathering, a daunting task until a few years prior, was now just a click away. Given the similar nature of the policies, pricier companies had little choice but to slash their rates, pushing down the overall pricing scale.

This instance underscores the pivotal role the Internet has played in dismantling information asymmetries across the globe. Essentially, it's a potent conduit for disseminating and redistributing information from the knowledgeable to the uninformed.

Today's consumers can conveniently amass information about products and their prices before engaging with an expert. This equips them with a fair understanding of what the appropriate price should be and what it should entail, curtailing the expert's informational upper hand and their potential for unscrupulous financial gain.

If you're house-hunting now, for instance, you can browse the web to ascertain what a fair offer would be, instead of solely trusting the guidance of your real estate agent.

Indeed, the Internet has considerably helped dismantle the informational leverage that experts once held.

The penalty of information gaps in a seller's narrative.

A striking consequence of information asymmetry culture is that even the mere absence of information, whether intentional or otherwise, can have a substantial impact.

Take for instance the well-known fact that a newly purchased car loses about a quarter of its value almost instantly. A car bought yesterday for $20,000 would probably fetch less than $15,000 today.

So, what prompts this drastic depreciation within 24 hours?

The answer lies in the dark alleys of information asymmetry. The buyer is typically in the dark about the seller's true motive for selling their new car. The logical assumption is that there might be a glitch with the vehicle. Even if this isn't true, the buyer's conjecture is that the seller is withholding some information. This information void is then filled with their own assumptions, thus penalizing the seller due to the information imbalance.

The world of online dating presents a similar scenario. Research reveals that one of the quickest ways for a user to dwindle the interest they attract is by not posting their picture. The moment others notice this, they instinctively brace for the worst.

These examples underscore the criticality of transparency in any transaction. It's not just about the information you share, but also about the data the other party anticipates you to divulge. They are likely to draw their own conclusions if you leave out certain details.

So yes, when sellers withhold information, customers often penalize them by assuming the worst.

Perceived risks are often distorted by prominence and control.

Our evaluation of risks can be far from rational than what we'd prefer to believe.

One element that significantly influences our assessment is the ease with which we can visualize the risk. Incidents like plane crashes, gun crimes, or terrorist attacks, although statistically rare, are easily imaginable due to their excessive media coverage. Consequently, we tend to overrate the risk associated with these events.

Consider this scenario: Would you be more comfortable with your child playing at a friend's house that has a firearm or at a house with a swimming pool?

The chilling thought of a child getting shot triggers an instinctive horror and outrage. In contrast, swimming pools don't evoke the same response, leading us to believe that they are safer. However, the reality is that a child is statistically more likely to be fatally injured in a swimming pool accident than in a gun-related incident.

Another determinant in risk perception is the sense of control. This could explain why people are more fearful of flying than driving. Behind the wheel, we're in control, whereas in a plane, we're at the mercy of the pilot. Yet, the risk of fatality in either mode of transportation is almost identical.

Recognizing these inherent biases is the initial step towards mitigating them. The next step involves seeking concrete facts about potential risks to counter our gut reactions and make more rational assessments.

Indeed, people's anxiety about risks tends to amplify disproportionately when such risks are particularly high-profile or beyond their control.

Our propensity to mistake correlation for causation.

Given that Washington DC, despite having a population similar to Denver, employs three times the number of police officers and experiences eight times the number of homicides, would you infer that the increased police force is the cause of the heightened homicide rate?

When we observe a simultaneous surge in two variables, say X and Y, it's tempting to infer that an increase in X leads to an increase in Y. This inclination to presume a causal link where there might just be a correlation is typical of human nature.

Take, for example, the relationship between money and politics. It's a widely held view that money exerts a considerable influence on electoral outcomes. And indeed, data reflects that candidates who pump the most money into their campaigns often come out victorious. This prompts us to logically conclude that money causes the victory. But is that really the case?

Generally, political campaign contributors are pragmatic and employ one of two strategies: they either try to tip the scales in a close race or back the obvious front-runner. They perceive that supporting the candidate they are against isn't worth their effort.

These patterns result in successful candidates pulling in more funding. But is money the catalyst for success or is it the other way round?

In analyzing candidates who have contested in multiple elections, it's been found that the amount of money spent has a negligible impact on election results. A victorious candidate could slash their campaign expenses by half and lose just 1% of the vote, whereas a losing candidate could double their spending, only to see a meager 1% bump in their vote share. This suggests that money isn't necessarily the winning ticket in elections after all.

Therefore, we often fall into the trap of erroneously deducing that because two things occur concurrently, one is the cause of the other.

The common mistake of neglecting distant causes in favor of proximate ones.

Apart from drawing quick conclusions about causal relationships between two events, we often have a tendency to seek causality in the most conspicuous and immediate factors, brushing off more remote or indirect causes.

Take the issue of crime: Toward the end of 1989 in the United States, crime rates seemed to be skyrocketing. Violent crime had surged by 80% over the preceding 15 years, and experts were forecasting a continued worsening trend. Therefore, it came as a shock when crime rates abruptly and significantly plunged in the early 1990s.

The same experts who had predicted a crime wave now scrambled to explain the unexpected dip. Several causes were suggested, including a booming economy, stricter gun control measures, innovative policing strategies, an increase in police numbers, and a heavier dependence on prisons.

Despite the widespread acceptance and seeming plausibility of these reasons, subsequent analysis revealed that most of these factors had only a minor impact on crime rates. The factor with the most profound effect was one that nobody even considered at the time: abortions.

Two key indicators of a child's propensity to engage in criminal activities in the future are being raised in a single-parent home and living in poverty. These circumstances also happen to align with the most common reasons for choosing to have an abortion. When the historic Roe v. Wade ruling in 1973 made abortion legal across the United States, women in such situations suddenly had the option to abort. This considerably shrank the group of potential criminals who would turn 16 in 1989 or later, and thereby contributed to the ensuing drop in crime.

This serves as a reminder to be cautious about jumping to conclusions based on immediate and obvious causes – even seasoned experts can fall into this trap.

Indeed, when attribiting causality, we are inclined to ignore distant causes and focus on more immediate ones.

Wrap-up

The primary takeaway from this book:

Whether it's parenting, making a real estate transaction, or just going about our daily lives, we continually make decisions and interact based on seemingly simple logic. Freakonomics challenges traditional wisdom by scrutinizing how we respond to incentives and by analyzing real-world data, uncovering surprising and often irrational factors that drive our actions in various aspects of life. Acknowledging these hidden influencers is the first step towards understanding them and developing strategies to counteract their impacts.

The queries this book resolves:

What should we consider while evaluating incentives and their influences?

Incentives can impact your financial standing, self-esteem, or your moral compass.

Introducing incentives can inadvertently trigger unforeseen changes in people's behavior.

Incentives are subject to the context: what works under sunny skies may fail in a downpour.

How does the asymmetry of information in a transaction affect the involved parties?

Experts can exploit their knowledge superiority to take economic advantage of laypeople.

Experts can harness fear and anxiety as tools to deceive the uninformed.

The advent of the internet has significantly leveled the informational playing field, diluting the advantage of experts.

When vendors withhold information, customers typically penalize them by assuming the worst-case scenario.

What human biases sway our evaluation of risks and causality?

People tend to worry excessively about risks that are particularly conspicuous or beyond their control.

We often mistakenly presume that when two events occur concurrently, one must be causing the other.

In attributing causality, we have a tendency to ignore distant or indirect causes, focusing instead on the immediate ones.