5 Lessons on Economic Behaviour
"Freakonomics," the captivating collaboration between Steven D. Levitt and Stephen J. Dubner, is a remarkable journey into the unconventional realm of economics. The book challenges conventional wisdom and offers readers a fresh perspective on the world around them. In this article, we'll explore the valuable lessons and insights "Freakonomics" provides, shedding light on how economic thinking can illuminate the hidden dynamics of human behavior and society.
This book explores the unconventional economic concepts and their applications. Here are five key lessons and why they are relevant for business professionals:
Let's dive in...
1. Incentives Matter
The central message of "Freakonomics" is that incentives matter. People respond to incentives, whether it's the allure of financial rewards, recognition, or even a sense of moral duty. Understanding these motivations can help explain why individuals and groups make certain choices and decisions.
Look at the behavior of real estate agents as an example. They may push sellers to accept lower offers in order to close deals more quickly, prioritizing their own commission incentives over maximizing the seller's profit.
We can use this knowledge to design effective incentive systems for employees, customers, and partners to achieve desired outcomes.
Many companies offer performance bonuses to employees based on their individual or team achievements. For instance, a sales team might receive a bonus for exceeding monthly sales targets.
This financial incentive motivates employees to work harder and achieve specific goals, ultimately benefiting both the employees and the company. It aligns the interests of the employees with the company’s objectives, leading to increased productivity and better results. It's a win-win.
However, we should remember that some
incentive structures come with a price. The downside of sales bonuses, is that they can lead to short-term thinking and unethical behavior among employees, such as pushing unnecessary products or engaging in deceptive sales tactics to meet targets and earn bonuses.
2. Unconventional Thinking
"Freakonomics" encourages readers to think outside the box and question established norms. It demonstrates that economic principles can be applied to a wide range of scenarios, leading to surprising and thought-provoking conclusions. In essence, it encourages us to challenge the status quo.
Levitt and Dubner challenge conventional wisdom in various areas. Business professionals can learn to question industry norms and explore unconventional solutions to business challenges.
Remember renting a DVD in Blockbuster?
Unconventional thinking is the approach Netflix took when it transitioned traditional DVD rental service to a streaming video platform. At the time, the conventional thinking in the entertainment industry was centered around physical media rentals and cable TV subscriptions.
Netflix disrupted this model by embracing technology. Instead of resisting digital distribution, Netflix invested heavily in streaming technology, making it convenient for viewers to access content online. Additionally, Netflix offered a subscription model where users could watch as much content as they wanted for a fixed monthly fee, diverging from the traditional pay-per-view or cable subscription model.
This unconventional thinking revolutionized the entertainment industry, leading to the decline of traditional cable TV and the rise of streaming platforms. The Netflix-case demonstrates how challenging industry norms and adopting innovative approaches can lead to significant success.
3. Causation vs. Correlation
One of the critical lessons from the book is the distinction between causation (one thing causing another) and correlation (two things occurring together).
Just because two things are associated doesn't mean one causes the other. Take the relationship between ice cream sales and drowning incidents, as a example.
Correlation: During the summer months, both ice cream sales and the number of drowning incidents tend to increase. If you were to look at the data, you might find a strong positive correlation between the two variables, meaning that when one goes up, the other tends to go up as well.
Causation (incorrect assumption): It would be a mistake to assume that ice cream sales cause drowning incidents or vice versa. There's no direct cause-and-effect relationship between eating ice cream and drowning.
Instead, a third variable, in this case, warm weather, is causing both phenomena. In hot weather, people are more likely to buy ice cream to cool off, and they are also more likely to engage in water-related activities, which increases the risk of drowning incidents.
"Freakonomics" teaches us to be cautious when interpreting data and strive to establish causation to make informed decisions and just like in this example, it's important not to jump to conclusions about causation based solely on observed correlations. Establishing causation often requires more in-depth research and consideration of potential confounding variables.
4. Economics of Information
The book delves into the economics of information and highlights how disparities in knowledge can lead to market inefficiencies. It demonstrates how access to information can affect decision-making and market dynamics.
An example of the economics of information is the market for used cars. In this market, information plays a crucial role in determining prices and facilitating transactions.
Asymmetric Information: Sellers typically have more information about the quality and history of a used car than potential buyers. This information asymmetry can lead to issues because buyers are uncertain about the true condition of the car.
Lemon Problem: The economics of information also relates to the "lemon problem," a term coined by economist George Akerlof. It refers to the situation where the presence of low-quality (lemon) cars in the market drives out high-quality cars. Buyers, fearing they might purchase a lemon due to information asymmetry, are only willing to pay a price that reflects the average quality of cars in the market, leading sellers of high-quality cars to exit the market.
When life gives you lemons, right?
In this example, the economics of information demonstrates how the availability and transparency of information can affect market dynamics, pricing, and consumer behavior in a specific economic context.
Generally, economics of information is vital because it underpins many aspects of economic activity, from efficient resource allocation to consumer protection and innovation. It plays a central role in shaping how markets function and how individuals and organizations make decisions in an information-rich world.
5. Ethical Considerations
The book raises ethical questions about the consequences of economic decisions too. It encourages readers to grapple with the moral implications of various choices and actions, sparking critical thinking about the ethical dimensions of economics.
An ethical dilemma based on economic decisions often involves a situation where policymakers or individuals in positions of authority must make choices that balance economic considerations with ethical principles or societal values.
Example: Minimum Wage Increase
Suppose a government is considering raising the minimum wage significantly. This policy decision can lead to an ethical dilemma:
On one hand, increasing the minimum wage may reduce poverty and improve the standard of living for low-wage workers. This aligns with ethical principles of fairness, social justice, and the well-being of citizens.
On the other hand, some argue that a substantial minimum wage increase could have negative economic consequences. It might lead to job losses, increased prices for goods and services, or reduced business competitiveness. This raises ethical concerns about the potential harm to businesses, job seekers, and economic stability.
In this scenario, policymakers face the ethical dilemma of balancing the desire to improve the lives of low-wage workers with concerns about potential adverse economic effects. They must carefully consider how to implement the policy in a way that minimizes harm while maximizing benefits, which often involves complex trade-offs and ethical decision-making.
Final remarks (and a bonus lesson)
I nice little bonus lesson it that "Freakonomics" - above all - encourages curiosity and exploration. It teaches us that delving beneath the surface of everyday phenomena can lead to fascinating and unexpected discoveries. It's a call to embrace our nature and question the world around us.
It's not just a book about economics; it's a guide to understanding the quirky and often surprising aspects of our world. It reminds us that economy thinking can provide valuable insights into human behavior, society, and even ethics. By adopting an analytical and curious mindset, we can unveil hidden truths and navigate the complexities of our interconnected world with greater clarity and understanding.
So, let's take these lessons to heart and continue to explore the fascinating economic forces that shape our lives.