Freakonomics

This chapter is all about information: the advantages it grants to those who have it, the disadvantages it

imposes on those who do not,the ways it can be misused, and the ways it can be abused.The first

part of the chapter describes how the Ku Klux Klan first came into being and, how, over time, it was

able to exert considerable influence over the lives of those it considered the “enemy,” e.g., blacks, Jews,

Catholics.What the discussion also shows very clearly is how the acquisition and dissemination of

information that had been known only to members of the Klan–secret coded greetings, the Klan’s

organizational structure–took away much of the power the Klan had previously enjoyed. Once the

“secret” was out,much of the membership was no longer willing to participate for fear of being

exposed to the public.

6The remainder of the chapter explores how specific individuals can capitalize on an informational

advantage by exploiting informational asymmetries, as well as human emotions such as fear and

sorrow. Real estate agents have a much better sense of the current condition of local housing markets

than do buyers and sellers.They can combine this superior knowledge with the buyer’s (seller’s) fear

that he/she won’t be able to find a house (sell his/her house) to achieve a deal which is in the agent’s

best interest but not necessarily the best interests of the buyer or seller.The same can be said of

funeral directors, and car salesmen.The chapter also considers the effects of misinformation, e.g.,

misrepresentation on corporation balance sheets, and the potentially discriminatory behavior that

can flow from incorrect or biased information.The chapter concludes with a discussion of the

misinformation people post on Internet dating sites, and how voters respond to polls.

Basic Economic Concepts

In this section we identify basic economic principles that underlie the analysis presented in this

chapter. In addition, we show how basic models economists rely on can be used to help explain

some of the authors’ conclusions.

1.The economic value of information.The model of supply and demand is used to illustrate how

the equilibrium price and quantity of a good or service are determined by the interaction of sellers

(supply) and buyers (demand) in a market. One of the underlying assumptions of the model is that

buyers and sellers have perfect information.

Consider Figure 2.1,which illustrates the supply and demand for housing in City A (all houses are

assumed to be the same). If buyers and sellers both have perfect information, and all of the other

conditions for a competitive market are satisfied, P1 and Q1 represent the equilibrium price and

quantity of houses.However, what if some group of people,

say real estate agents, has information other participants in

the market, i.e., buyers and sellers, do not.Consider first

suppliers.As the authors suggest, real estate agents may

convince sellers they are better off selling at a lower price

because waiting for a better offer might not pay off.To the

extent sellers accept this logic, the supply curve shifts to

something like S2. If, at the same time, agents provide

information to potential buyers that houses can be had at

a lower price than the buyers thought possible, demand is

affected as well.To the extent that buyers revise their

willingness to pay downward, the demand curve will shift to

something like D2.The result is that equilibrium price in the

housing market is lower than what it would be if buyers and sellers had perfect information. Note

also that, according to available data, real estate agents who sell their own houses get the price of

P1 rather P2 (because they have the superior information).

2. Incentives matter. One of the dominant themes in virtually every economics course is “incentives

matter.” A rather basic assumption is that buyers and sellers will act so as to make themselves as

well off as possible. Consumers try to maximize total satisfaction, while sellers try to maximize

profits.This explains why real estate agents don’t work to get the highest price possible for the

seller, and why funeral directors sell someone who has just lost a loved one a high-priced casket the

7buyer doesn’t really need. In the first case, selling more quickly makes it easier for the agent to sell

more homes, making more total profit. In the second case, the seller can take advantage of the

buyers’ vulnerability and, in so doing, increase his profits.

3.Technological change. Over time, technological change has had profound impacts on our lives,

ranging from how the goods we consume are produced, to how we communicate and how we

travel.The list goes on and on.While technological change takes a variety of forms, one thing that

almost all technological changes have in common is their effect on costs, i.e., costs tend to go down.

Consider personal computers. Over the past two decades, the computing power of the typical

home PC has increased by an astonishing

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