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What happens when economics is shifted outside the boardroom and into the bedroom; when it is used to examine criminals rather than companies? What transpires when its tools are transplanted to studying everything from the black market to family life?
So powerful and universal are the tools of economic tier, from supply and demand to game theory that they can be used to shed light on all sorts of apparently unconnected issues.
Consider the parable of the bagel seller, one of many examples set out by Steven Levitt and Stephen Dubner in their 2005 book “Freakonomics”. It goes something like this: an entrepreneur who delivers bagels to companies decides that, rather than hanging around and waiting for each customer to pay him in turn, he will simply leave behind a cash box and a note asking them to pay what they owe. Reassuringly, he does pretty well out of this honor system. And, more interestingly, his accounts unearth some fascinating trends, for instance, people are more honest when they work in smaller offices, when the weather is good, and when a holiday is round the corner.
The book comes up with unconventional conclusions about some of modern society’s most contentious issues, abortion and race for instance. Among other things, it reveals surprising links between the Ku Klux Klan and estate agents, as well as uncovering the cheating habits of Chicago school teachers and sumo wrestlers.
The point, however, is that even in the most offbeat, non-market-related environments, the fundamental rules of economics can apply whether this means supply and demand, the invisible hand, human incentives or any other parts of the pantheon of economic rules. After all, economics is the study of human decision-making, which does not necessarily need a money-oriented backdrop against which to function.
However, Levitt and Dubner’s book, which was highly successful and spawned a number of imitators in the following years, did not represent the first time a trained economist applied these rules to normal everyday life. The real pioneer of such an approach was Gary Becker, an economist at the University of Chicago.
Becker, who was awarded the Nobel Prize in 1992, showed that everyone from criminals to racists to families to drug addicts, is in some way influenced by economic forces such as rational decision-making and incentives. At the heart of Becker’s theories and arguments is the idea that there is almost always a cost attached to something even if it is a social or emotional cost as opposed to an explicit sum of money. For instance, one of his ideas is that those who discriminate against minorities will often mentally increase the cost of a transaction if it involves interacting with them.
Gary Becker’s Eureka moment came when he found himself having to decide between parking in an illegal spot or driving to a designated car park a few blocks away at the cost of his extra time and effort. He opted for the illegal spot, judging that the risk of being caught and punished did not outweigh the extra effort of having to drive the car to the further spot and walk all the way back again. Similar judgments, he concluded, were taken by criminals in deciding whether to break the law.
The conclusion has important implications for how politicians run their justice systems, since it supports the idea that fines and penalties should be more severe. The tougher the penalty, the greater the cost of getting caught and the greater the deterrent. It was this insight which helped Becker toward his Nobel Prize. The theory was proven some years later by Levitt, who compared juvenile crime rates in various US states and compared them with the crime rates for adults. He found that as soon as these criminals became old enough to face the far harsher sentences meted out to adults their criminal activity tended to become less frequent.
Indeed, Tim Harford, the author of “The Undercover Economist”, saw this firsthand when he was driven by Becker to a restaurant, where the Nobel Prize-winner parked in a bay with a 30-minute time limit, which he far exceeded. Since the bays were not checked too often, he judged the risk of being caught worth taking, given the convenience of the location. He did it all the time, he said, and while he occasionally got fined it was never so frequent as to deter him from parking there. He was merely behaving rationally.
Economics, of course, does not just apply to criminal situations. Tim Harford, for example, has shown that those in speed-dating sessions tend to raise or lower their expectations for the quality of mate they are seeking based not on their absolute demands but on the quality of the field they encounter. The number of people who successfully select tends to remain constant, regardless of whether the field is devastatingly attractive or not.
Steven Levitt uses economic theories to prove that children are defined less by the way they are brought up than by their parents’ economic and often ethnic background. He also famously argued that the reason US crime rates dropped in the 1990s was because the legalization of abortion in the 1970s meant families in deprived areas no longer reproduced uncontrollably.
Steven Levitt stated that macroeconomics isn’t really about human behavior. He noted that “economics is one of a set of broad tools for looking at the world. But it tells you to put in place policies that are absurd, because it doesn’t worry about things like fairness or morality, or psychological factors. In economics, the right punishment for parking in a handicapped parking spot would be execution with a very low frequency, or torture with a very low frequency and that would be completely reasonable”.
While there are limits as to the applicability of economic theories to everyday life, there is also a clear lesson for policymakers: economics is not a perfect framework for viewing the world. However, it is the best method available for determining how to influence people and how to predict their behavior. And that goes just as equally for our social peccadilloes as it does for our financial trials and tribulations. It is a conclusion Adam Smith would have heartily approved of.