Book Summary: Freakonomics by Steven D. Levitt

Are you looking for a book summary of Freakonomics by Steven D. Levitt and Stephen J. Dubner? You have come to the right place.

I jotted down a few key insights from Steven D. Levitt and Stephen J. Dubner’s book after reading it.

You do not have to read the entire book if you don’t have time. This book summary provides an overview of everything you can learn from it.

You may also read some popular quotes from Freakonomics here.

Let’s get started without further ado.

In this Freakonomics: A Rogue Economist Explores the Hidden Side of Everything book summary, I’m going to cover the following topics:

What is Freakonomics About?

The book Freakonomics applies rational economic analysis to everyday situations, from online dating to buying a house. The book reveals why the way we make decisions is often irrational, why conventional wisdom is frequently wrong, and how and why we are incentivized to do what we do.

Who is the Author of Freakonomics?

Steven D. Levitt teaches economics at the University of Chicago. His unorthodox approach of using the tools of economics to reveal hidden aspects of everyday decisions has triggered debate in the media and academic circles.

Stephen J. Dubner is a former writer and editor at the New York Times Magazine. He is also the author of Turbulent Souls, Confessions of a Hero-Worshiper, and the children’s book The Boy with Two Belly Buttons.

Who is Freakonomics For?

It is not for everyone to read Freakonomics. If you are one of the following types of people, it may be right for you:

  • Anyone interested in human decision-making.
  • Managers with an interest in the impact of incentives and risk analysis
  • Economists looking for a more creative approach to using the tools of economics

Freakonomics Book Summary

Introduction

Hundreds of people are probably trying to influence your behavior right now: politicians, police, your doctor, your boss, your parents, or even your spouse. No matter the tactics used, they all rely on incentives, whether it is threats, bribes, or charm and deceit.

An incentive is nothing more than a way of getting people to do more of a good thing or less of a bad thing.

There are three general types of incentives: economic, social, and moral. Most successful incentives – those that achieve the desired change in behavior – combine all three types of incentives.

In the criminal justice system, incentives play a crucial role. There are many opportunities for people to cheat, steal, and defraud, so it is interesting to determine what incentives prevent them from doing so.

Prison and the related losses of employment, housing, and freedom are all economic in nature, and certainly act as a strong deterrent to crime.

People are also motivated by morals, as they don’t want to do something they feel is wrong.

Last but not least, there is a strong social incentive, since people do not want to be viewed as bad by others. This can often be a more powerful incentive than economic penalties, depending on the crime.

Most people refrain from committing crimes because they combine all three types of incentives.

Your wallet, your pride, or your conscience can be affected by incentives.

Lesson 1: Incentives can affect people’s behavior in unexpected ways

Behavior is often incentivized through incentives. Incentives dangled in front of everyone, including parents rewarding their children for doing schoolwork or companies offering bonuses to employees who hit sales targets.

Adding incentives to influence behavior can, however, be a more complex process than it may seem at first. It is often the case that incentives operate in an environment in which small changes can have radical effects, and not always in the manner in which its initiators hope.

Economists studied day care centers in Haifa, Israel, in an effort to reduce parents’ late arrivals. To achieve this, a small $3 fine was introduced as an economic disincentive.

The change actually doubled the number of late pickups, rather than reducing them. Can it be that this disincentive has backfired?

Perhaps the amount was too small, sending the message to parents that late pick-ups were not an issue.

Mainly, however, this small economic incentive replaced an existing moral disincentive: parental guilt for arriving late. With a few dollars, parents could buy themselves out of their guilt, so they were less concerned about being late.

In addition, once the signal has been sent, its effects cannot be reversed. Removing the fines did not reduce the number of late pickups.

The example illustrates how setting incentives can be tricky, especially when there are already other forms of incentive in place. Consider carefully whether new incentives may displace existing ones when introducing them.

Lesson2: Different incentives work for different situations: what works in sunny conditions might not work when it’s raining

Do you have any experience robbing banks? Probably not, since there are a number of disincentives to trying (e.g., prison, loss of social status, a guilty conscience). Even with these disincentives, some people rob banks. How come?

The same incentive may have different results on different people.

Generally speaking, this is fairly self-evident, but perhaps more surprisingly, even the same person can respond differently to the same incentives at different times.

Take the example of Paul Feldman, whose business provided bagels to office snack rooms. Each day, he picked up the cash and leftover bagels from an unattended cash box. As all customers had the same incentives to pay – the desire to appear honest – the variation in payment rates each day and at the different locations revealed some interesting trends about honesty under changing conditions.

Customer honesty was largely determined by his mood, which was influenced by other factors:

Unseasonably warm days resulted in higher payment rates and unseasonably cold days resulted in lower rates. Paying rates dropped during more stressful holidays such as Christmas and Thanksgiving while they climbed during more relaxed holidays.

People in happy offices were more likely to pay, as was office morale. Additionally, the author notes that payment rates increased following 9/11 due to an increase in empathy.

It is important to understand that the incentives that work for some people one day may not work the next, depending on shifts in global, local, or personal circumstances affecting their moods.

Lesson 3: Experts can exploit laypeople for economic gain by using their informational advantages

From time to time, everyone needs expert advice. When you are getting something fixed, buying a big item or dealing with a legal issue, you rely on someone with specialist knowledge to guide you.

Asymmetry of information exists since experts have access to a wealth of information that lay people do not. Experts are usually paid fees or commissions for their expertise, but they can also use their informational advantage to defraud laypeople for extra gain.

The sale of a house is usually the biggest financial transaction in a person’s lifetime. Because you are relying on your real estate agent, who is aware of market trends and prices and may also be motivated to get the best price in order to maximize her commission, it can be a complicated business. Being able to rely on this level of expertise gives you a sense of security.

Even though this thinking is reassuring, it is a bit simplistic. If we look at the incentive story from a broader perspective, it becomes clear that although the estate agent’s commission is linked to the final sale price, the additional benefit is small compared to closing the deal. A new sale incentive outweighs the incentive that is meant to align with the customer’s goal.

In a study comparing estate agents to clients, it was found that when estate agents sell their own houses, they leave them on the market longer and get a higher price. It is in the estate agent’s interest to maximize their profit, not yours, when they encourage you to accept the first reasonable offer on your house.

Lesson 4: Experts can manipulate the fear of laypeople to cheat them

It can be quite scary to face the unknown. If you are dealing with a subject you are unfamiliar with, you will likely feel anxious and concerned. The experts often take advantage of your fear for financial gain.

The car salesman can convince you not to buy a cheaper model if he or she instills the fear that it is unsafe. Using the fear of missing out on your dream house, a real estate agent can get you to put in a higher bid. You can get advice from a stockbroker about investing in a particular stock now, or else you’ll miss the boat and regret it for the rest of your life.

Experts use fear to scare us into making decisions we would not have made otherwise, because fear impairs our ability to make rational decisions.

Social fears can exacerbate this problem in face-to-face situations: the expert can exploit our fear of looking dumb, cheap or dishonorable.

You can imagine how stressful it would be to arrange a funeral for a loved one. Because you know little about the funeral business, the funeral director can take advantage of your anxiety to steer you to a more expensive casket than you otherwise may have chosen.

When an expert seems to be playing on your fears, especially when you’re told that you must make a decision immediately, be wary. Make sure you have strategies in place that will give you time and space to think about your options, such as telling people you need a second opinion. 

By researching the topic of the transaction in advance, you can try to even out the information asymmetry.

Lesson 5: Experts’ informational advantage has been greatly reduced by the Internet

Life insurance prices dropped dramatically in the 1990s. There were no significant shifts in the business or customer base of any other types of insurance. So how come prices suddenly dropped?

This has been made possible by the emergence of the Internet, or more specifically price comparison websites. In a matter of seconds, customers were able to compare insurance quotes from dozens of companies. 

Only a few years ago, obtaining price information would have been extremely time-consuming. The policies were essentially similar, so the price of the policies went down as the more expensive companies lowered their prices.

The Internet has helped to erode and reduce information asymmetries all over the world in this example. At its core, it is a highly effective means of sharing and redistributing information from those who have it to those who don’t.

Now that consumers can easily and conveniently gather information regarding products and prices, they have a much better idea of what they should pay and what should be included in their price, removing much of the expert’s informational advantage and therefore unfair financial gain.

Rather than relying on the word of your estate agent when you buy a house today, you can go online and figure out what a reasonable offer would be.

Lesson 6: Customers often assume the worst when sellers withhold information

As a result of an information asymmetry, even a perceived or real lack of information can have a profound effect.

When a new car is purchased, it instantly loses up to a quarter of its value. Those who bought a car yesterday for $20,000 can expect to get less than $15,000 for it today.

Why did the value of the stock drop so dramatically in just 24 hours?

Information asymmetry is to blame. Since the buyer is unaware of the seller’s reasons for selling their new car, they logically assume there is something wrong with it. Even if this is not true, the buyer assumes the seller holds information they are not disclosing, and fills in the information gap with their own beliefs. Hence, the seller is penalized.

Another example of this effect can be found in a study of online dating sites. In terms of reducing the amount of interest a user generates, omitting their photo is the single worst thing a user can do. Other users assume the worst when they see this.

The lesson here is that in any transaction, it is imperative not only to consider the information you provide, but also the information that the other party expects you to provide, and what conclusions they may make if you omit it.

Lesson 7: People worry excessively about risks that are especially prominent or over which they have little control

Despite what we like to believe, we are far less rational when it comes to assessing risks.

Our ability to visualize a risk has a disproportionate effect on how we assess it. Due to their extensive media coverage, plane crashes, gun crimes, and terrorist attacks can easily occur, although they are very rare. Therefore, we overestimate their risk.

Consider another example. Would you feel safer if your child were playing at a friend’s house where a gun was kept, or would you feel safer if your child was playing at the pool house?

Shooting a child with a gun is a horrible thought and creates outrage. We probably feel safer about swimming pools because they do not have these hazards. In reality, accidents involving swimming pools are more likely to kill a child than gunshots.

In addition to feeling in control, we also evaluate risk based on how we are feeling. People may fear flying disproportionately compared to driving because they feel in control when they’re actually driving a car, whereas on a plane they feel helpless. Nevertheless, the risk of death is the same regardless of the mode of transportation.

The first step toward resisting our biases is becoming aware of them. In the second step, you should search for solid facts about risks in order to countergut reactions and make rational decisions.

Lesson 8: When two things occur simultaneously, we usually assume that one of them is causing the other

Washington DC has more officers and homicides per capita than Denver, even with similar populations. The higher rate of homicide may be caused by the extra officers, wouldn’t you say?

If there is an increase in one factor, X, and a subsequent increase in another factor, Y, then it is tempting to think that the two factors are causally related and that the increase in X is responsible for the increase in Y. We tend to assume causality when, in fact, correlation may exist.

Money and politics are good examples. Almost everyone agrees that money plays a significant role in elections, and data proves that candidates with the most expensive campaigns often win. Money, we tend to infer logically, accounts for the victory. But is that the case?

Campaign contributors are pragmatic, and therefore tend to use one of two strategies: either to make a difference in a close race or to back a clear favorite. Their candidate of choice will not be worth their time or effort.

Successful candidates receive more money as a result of these trends. But did the money actually help them succeed?

According to an analysis of candidates who run in successive elections, the amount of money spent hardly affects the outcome. By reducing spending in half, a winning candidate could lose just 1% of the vote; by doubling spending, a losing candidate could gain only 1% of the vote. It seems that money doesn’t win campaigns after all.

Lesson 9: Our tendency is to overlook distant causes in favor of more immediate ones when attributing causality

Our tendency to jump to conclusions about causality between two events goes along with our tendency to look for causality in the most immediate and obvious places, ignoring more distant or indirect causes.

At the end of 1989, crime in the United States was at an all-time high. Experts predicted that violent crime would only increase by 80 percent over the next 15 years. When crime figures suddenly fell in the early 1990s, it came as a bit of a surprise.

Those same experts are now rushing to explain the drop. Improved economic conditions, tougher gun control, innovative policing, an increase in police numbers, and an increased reliance on prisons have been proposed as contributing factors.

Although many of these explanations are popular and plausible, later analysis has shown that most of these factors have very little effect on crime rates. Factors like abortions didn’t even come up at the time, yet they had a major impact.

Growing up in a single-parent household and living in poverty are two of the biggest predictors of future criminal behavior. The most common reasons for having an abortion also coincide with these factors. Roe v. Wade, the landmark case that legalized abortion across the United States in 1973, made such situations possible for women. 

It significantly reduced the cohort of criminals who would have turned 16 in 1989 or later, which contributed to the decline in crime from then on.

It’s important to be wary of obvious and immediate causes, because even experts can be misled by them.

Final Summary

We make simple decisions and interact with others in our everyday lives, from raising children to selling a house. As Freakonomics challenges conventional wisdom, explains how incentives affect us, and analyzes data from all walks of life, it reveals unexpected and often irrational factors at work in people’s interactions. 

Until we acknowledge these hidden aspects, we will not be able to develop strategies to counter them.

Freakonomics Review

Although you might not like some of the conclusions in Freakonomics, the book is gutsy, fascinating, and post-modern. The authors claim that there is no unifying theme, only the ‘thread’ of people chasing incentives. In other words, it focuses on the influence of money on individuals. 

Putting it even more simply, Paul the Apostle once said: “Money is the root of all evil.”

Even though Economics is sometimes referred to as the “dismal science” due to its focus on numbers, a rogue economist like Steve Levitt, with the assistance of NY Times writer Steve Dubner, has been able to uncover some probable answers to a number of questions. 

Even though the population has increased, crime has decreased. Why is a real estate agent so eager to sell your house for a lower price, and does he do the same for his own house? How about sumo wrestlers, teachers, and on-your-honour doughnut clubs? Do they also cheat?

It’s no secret that Roe V. Wade, the 1973 ruling legalizing abortion, is declared to be the cause of crime decreasing in recent years; it’s widely known that the book says this. Levit dispels the conventional wisdom that a strong economy, ageing of the population, gun control issues, etc., lead to a reduction in crime by showing that abortions among certain segments of the population have made that possible. 

Due to Roe V. Wade, there are a lot of criminals who were never born. I must agree with his conclusion despite being 100% pro-life and remaining so regardless of any book. 

Levit reiterates that economics has no moral foundation, poses no moral questions, and asks no questions at all. Furthermore, he says that people are more comfortable with immediate and tangible causes than those from the past, and I cannot argue with that. His right-brained approach impressed me.

Further Reading

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