S t u d e n t ’ s G u i d e Volume 1 : Economics

Prepared by J. Lon Carlson Associate Professor Department of Economics Illinois State University

S. Clayton Palmer Instructor of Economics Weber State University www.HarperAcademic.com P r e fa c e

Introduction Welcome to the Student’s Guide to SuperFreakonomics! The purpose of this guide is to help you better understand the analyses presented in SuperFreakonomics by providing a sort of “bridge” between the material covered in a traditional course in Economic principles and topics addressed in what we consider to be one of the most fascinating books we’ve encountered in the economics literature. Many students view economics as a very difficult, if not impossible, course to master. This percep- tion is, however, most likely based on the whining of fellow students who did not apply the proper approach to learning economics. In many courses, simple memorization is enough. In economics, this is not the case. While you need to understand the meaning of basic terms and concepts, you also need to be able to apply economic concepts in specific situations. In other words, you need to develop the ability to think like an economist. The authors of SuperFreakonomics certainly show you how to do just that. The material presented here is intended to make your job easier still.

Organization of the Student’s Guide We organized the material in this guide to help you identify the key points in each chapter and to ensure that you have a firm grasp of the key concepts presented in the book. The first section of each chapter in this guide consists of an overview that highlights the major topics and points pre- sented in the book. The overview is designed to alert you to the major topics and is not intended to serve, in any way, as a substitute for the material in the text. The second section of each chapter highlights key economic concepts that are addressed in the cor- responding book chapter. In addition, we provide graphical illustrations at various points along the way to help you better understand how to use basic economic models to illustrate relationships dis- cussed in the book. The purpose of this discussion is to alert you to the major factors that affect the relationship being illustrated. In order to be able to use graphs to analyze the effects of changes in key economic variables, you must have a clear understanding of how the determinants of the rela- tionship being illustrated in a graph are related. The third section of each chapter consists of a list of what we have termed “core competencies.” How well you are able to respond to each of the questions listed in this section will be a strong indi- cator of the extent to which you understand the material presented in the book.

Using the Student Guide When using the student guide, remember that the overview and discussions of key graphs and terms are not substitutes for reading SuperFreakonomics. Instead they are designed to “flag” key

2 topics and alert you to specific items you may have missed. When completing the “core compe- tency” questions, we strongly recommend that you avoid using your book or notes to answer the questions on your initial run through. Instead, use the questions as a way to flag topics you have not yet mastered. When you cannot answer a specific question, or you answer it incorrectly, you should take that as a signal to go back and devote more study to the topic in question.

Another Useful Suggestion This guide is one of two prepared for the student. The other guide is directed at students taking a class in statistics or quantitative analysis. You may also find this useful.

C h a p t e r 1

How Is a Street Prostitute Like a Department-Store Santa? Summary Levitt and Dubner begin Chapter 1 by describing some of the ways women have been abused and discriminated against over time. Then, they point out that although conditions in certain countries have improved dramatically over the last few decades, women still suffer the effects of discrimina- tion. This is especially true in the labor market, where a significant wage differential between men and women continues to persist despite increased educational opportunities and legislative initia- tives such as Title IX. This leads to consideration of the labor market in which women clearly domi- nate the supply side—the market for prostitution. There is no doubt but that this topic may prove particularly uncomfortable for many of you. The discomfort factor notwithstanding, however, this topic also demonstrates how economic analysis can provide an objective assessment of at least some of the benefits and costs of a profession that provokes a vast range of responses from outside observers. Focus on the data. The authors begin their analysis of the market for prostitution by describing what the market was like at the turn of the century in Chicago, and how the subsequent criminalization of this activity affected wages and working conditions over time. Information on relative wages in absolute and current dollars suggests why so many women would consider working as a prostitute. Focusing on the upscale Everleigh Club, the authors also show how manipulation of supply and demand through product differentiation—supply a service that entails greater marginal costs and target that segment of consumers with greater willingness to pay—could result in a price much higher than the broader market equilibrium. They then provide useful insights regarding how society’s objectives might be best met when it comes to enforcement of certain laws, i.e., it is more effective to focus on demand than supply if certain activities are going to be effectively curtailed.

3 The next part of the chapter focuses on information gleaned from data collection efforts by Sudhir Venkatesh that shed considerable light on the current conditions in the market for prostitution in Chicago, ranging from wages and prices for various services rendered to the effects of relying on marketers (e.g., pimps) to sell one’s products or services. At this point, the authors also demonstrate that what may be true in one market—pimps tend to improve market outcomes for prostitutes— may not hold elsewhere, e.g., procuring the services of a realtor does not necessarily leave the seller of a house better off. This portion of the chapter concludes with an examination of the role the police play in controlling prostitution and how the solutions they devise can be at odds with the objectives of policymakers, i.e., the principal-agent problem. Attention then turns to consideration of how the increase in the range of opportunities for edu- cated women to work outside of teaching has simultaneously increased their average pay and dis- advantaged school children. The latter is simply a result of a decrease in the average level of ability of people entering the labor market for teachers. The authors then consider several possible expla- nations for the wage gap between men and women that continues to exist even after the increase in the availability of higher paying jobs for women. The final section tells the story of a woman who decided to become a prostitute on her own terms, and how she used sound marketing strategies and economic principles to achieve a considerable level of financial success.

Basic Economic Concepts 1. Supply and demand. 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. In addition, the model is used to predict how a change in one or more of the determinants of demand or supply can be expected to alter the existing market equilibrium.

This chapter clearly demonstrates that the market P S2 for labor services, even prostitution, operates like the market for any other good or service. Changes S1 in supply or demand will induce changes in equi- librium price (the wage) and quantity, and create P1 additional incentives for suppliers and consumers to enter or leave the market. Thus for example, P2 criminalizing prostitution and arresting some sup- pliers caused the supply of prostitutes to decrease. This is shown in Figure 1.1, which depicts the market for prostitution, by the shift of the supply curve from S1 to S2. All else constant, this created D1 a shortage at the original equilibrium price, P1. This in turn caused market price to increase, which Q2 Q Q attracted additional workers, whose reservation 2 1 Figure 1.1

4 wage was higher, into the market. The end result was a higher equilibrium price, P2, and lower equi- librium quantity, Q2. The discussion of changes in the market for teachers can also be illustrated in the supply-demand framework. As the authors point out, as more employment opportunities developed for women, many highly skilled women who had previously gone into teaching opted for more financially lucra- tive occupations. As such the average marginal productivity of those individuals entering teaching is presumably lower than it was previously. In this example, marginal product refers to the addi- tion to output, i.e., learning, attributable to each additional teacher who is hired. This caused the demand curve for teachers to shift left, all else constant. This is because the demand for labor is assumed to depend on the marginal productivity of each worker and the market price of the output produced by that worker. Holding market price constant, as the marginal product of each worked declines, the total value of output produced by that worker declines as well. The result is a lower marginal product: students lose. 2. Price elasticity of demand. The price elasticity of demand, which is a measure of the sensitiv- ity of quantity demanded to a change in price, is calculated by dividing the percentage change in quantity demanded by the corresponding percentage change in price. The price elasticity of demand is useful in a number of different situations. For example, if we know whether demand is elastic (the percentage change in quantity demanded is greater than the corresponding per- centage change in price) or in elastic (the percentage change in quantity demanded is less than the corresponding percentage change in price) over a specific range of the demand curve, we can then determine whether a change in price will cause total revenues to increase or decrease. To understand this, begin with the fact that when price changes, quantity demanded changes in the opposite direction. Because total revenue is simply price times quantity, the effect of the price change on total revenue is unclear. However, knowing the price elasticity of demand tells us which effect, the change in price or the change in quantity demanded, is stronger and, hence, whether total revenue will increase or decrease. Two examples in this chapter illustrate the effects of the price elasticity of demand on total rev- enues when price changes. The first is the discussion of how arresting some prostitutes caused prices to increase. The resulting reduction in supply put upward pressure on price, which patrons apparently readily agreed to pay, suggesting demand is relatively price inelastic, i.e., the percentage increase in price is greater than the percentage decrease in quantity demanded. Assuming this is, in fact, the case, the overall effect would be to cause the total revenues of the prostitutes who are still working to increase. The second example involves Allie, who decided to explore the demand curve for her services by steadily increasing her prices over a relatively short period of time. As the discussion implies, demand for her services was in fact rather inelastic. We can conclude this based on the fact that as price increased, so did her total revenues. 3. Price Discrimination. Price discrimination refers to the act of charging different prices to differ- ent groups of customers for the same good or service. For price discrimination to be successful,

5 the seller has to be able to effectively prevent resale of the good or service. If she could not, the customer charged the lower price could profitably resell the item to the customer who is nor- mally charged the higher price at a price that is lower than the seller would charge the higher- price customer. Another other condition for successful price discrimination is some customers must clearly possess identifiable traits that place them in the willingness-to-pay-more category. A street prostitute uses her experience to identify and categorize customers. One of the easiest- to-observe traits her customer possesses is skin color. Based on the data (and, no doubt, the prostitute’s experience), white customers pay more than black customers. Based on the foregoing observations, the market for prostitution clearly satisfies the conditions for successful price discrimination. And the data, combined with information from surveys about the pricing strategies employed by prostitutes, demonstrate how price discrimination can work to the benefit of the supplier. This is because without price discrimination, the same price would be charged to all customers. By price discriminating, however, the seller can increase the revenues earned from different groups of customers and, in so doing, increase profits. 4. Substitutes and market demand. The deter- P minants of the market demand for a good or S1 service include the item’s price, the number of consumers, consumers’ incomes, expecta- tions, tastes and preferences, and the prices of related goods, i.e., substitutes and comple- P1 ments. A change in any of the determinants of demand other than the price of the good or P2 service will cause the demand for the good to increase or decrease. The change in demand causes the entire demand curve to shift. D1 Understanding this, we can then answer the D2 question: Why did the number of prostitutes, measured as a percentage of the population, decline over time? It did so because available Q2 Q Q 1 substitutes for paid sex—in particular, casual 2 Figure 1.2 sex—increased. When the supply of casual sex increased, pushing down its price, the demand for a substitute, i.e., a prostitute, necessarily decreased as well. This is shown in Figure 1.2, which depicts the market for prostitution, by a leftward shift of the demand curve from D1 to D2. All else constant, the decrease in demand in the market for prosti- tutes caused the equilibrium price and quantity to decrease as well, to P2 and Q2. 5. Product differentiation. Firms are constantly trying to escape the forces of competition in hopes of increasing their total profits. An effective way of doing this is through product differentiation. To the extent that a firm is able to successfully distinguish its product from those of its

6 competitors, the number of available substitutes is effectively decreased. Moreover, as the number of substitutes decreases, all else constant, so does the price elasticity of demand for the firm’s product and, hence, the firm’s ability to increase price and total revenue. The discussion of the Everleigh Club provides an excellent illustration of the benefits a firm can reap from product differentiation. By providing services others did not, as well as a better quality service—educated, healthy women who possess an engaging personality—the owners of the club and their employees were able to earn incomes much greater than the average wage in the market for prostitution at that time. In contrast, the data also show that, at the present time, the average price paid for the services of a prostitute at one location doesn’t differ from the average price paid at another location. The expla- nation for this is that although street prostitutes may attempt to differentiate themselves from one another, and while one prostitute may be more attractive than another, their male customers view them as perfect substitutes. 6. Incentives matter. One of the dominant themes in virtually every economics course is “incen- tives matter.” A rather basic assumption is that buyers and sellers will act so as to make them- selves as well off as possible. Consumers try to maximize total satisfaction, while sellers try to maximize profits. This brings us to the title of this chapter. Why would someone dress up in a Santa costume? And, more importantly, why would someone who normally works in a legal profession suddenly engage in prostitution? The answer is simple: When market prices rise and profits dramatically increase. The incentive created by the relative wages offered by prostitution as compared to more mundane jobs (e.g., housekeeper, laborer) also helps explain why so many women engaged in prostitution at the turn of the century.

Core Competencies Once you have read and carefully studied this chapter you should be able to complete the following tasks. (Note: the economic principles illustrated in SuperFreakonomics don’t necessarily “track” with the order in which they appear in an economics text book. Therefore, some of the economic con- cepts described below may be new to you.) 1. Describe how men and women have compared over time with respect to such factors as life expectancy, discrimination, and abuse. How has the comparison between the two changed over the past 100 years? 2. Describe how the incomes earned by men and women compare at the present time. Is there a significant difference? Describe the factors that are believed to account for the observed wage gap. 3. Describe how women have fared with respect to participation in sports, educational opportuni- ties, and incomes in the time since Title IX became law. In addition, to what extent has this law benefitted female coaches of college women’s sports teams?

7 4. Compare and contrast the conventional wisdom and reality regarding prostitution in the United States at the turn of the century. Focus, in particular, on the perception of “white slavery” versus the results of a study of prostitution in the United States by the Department of Justice. 5. Compare the average wages earned by women in legal professions, e.g., seamstress, cleaning woman, to those earned by prostitutes in Chicago at the turn of the century. 6. Describe how the revenues earned by the proprietors and the employees of the Everleigh Club compared to the average for prostitutes in Chicago. What factors accounted for this difference? 7. Using a simple model of supply and demand, explain how efforts to shut down the market for prostitution by curtailing supply compare to the outcome when the focus is on reducing demand. In particular, how would each policy affect the equilibrium price and quantity in the market for prostitution?

8. Explain why the method Sudhir Venkatesh used to collect data on prostitution in Chicago is superior to more traditional survey methods, particularly with respect to the reliability of the resulting data. 9. Describe how the wage premium earned by street prostitutes in Chicago today compares to the wage premium earned 100 years ago. What accounts for this difference? 10. Explain how casual sex has affected the market for prostitution and be able to explain this using the supply and demand model and the impact of an increase in the number of available substitutes on demand. 11. According to Levitt and Dubner, Chicago street prostitutes are able to engage in effective price discrimination. Explain what price discrimination consists of. In addition, be able to explain why prostitutes are able to successfully engage in this practice. 12. Use basic economic principles to construct a possible explanation for why the price of a particu- lar service provided by street prostitutes in Chicago is virtually the same from one prostitute to the next. 13. Explain what Levitt and Dubner mean by the pimpact and the rimpact. In addition, develop an economic explanation for how and why the benefits of the services pimps and realtors provide their respective clients differ. 14. Explain the observed difference between the assumed intent of prostitution laws and the way in which those laws are actually enforced. Refer to the “principal-agent problem” to explain the observed difference you’ve described. 15. Answer the question posed by the chapter’s title, i.e., how is a street prostitute like a depart- ment store Santa? and develop an economic rationale for your answer. 16. Explain how the increase in the range of career options for women has affected the quality of education in the United States.

8 17. Referring to the study by Bertrand, Goldin, and Katz, list and explain the three main factors they identify as the primary causes of the observed wage gap between men and women. In addi- tion, provide an economic explanation for why each of these factors puts downward pressure on women’s wages. 18. Develop an explanation, based on economic principles, for why Allie (the happy prostitute) has done so much better than her street prostitute counterparts.

C h a p t e r 2

Why Should Suicide Bombers Buy Life Insurance? Summary This chapter begins with a description of how certain outcomes a person experiences, e.g., suscep- tibility to certain illnesses, disease, propensity for success in academics and the sports world, can be tied to characteristics of one’s parents, e.g., their religion, name, or success on the field of play, as well the individual’s date of conception. The authors then use the fact that what makes a particular boy 800 times more likely to play in the major leagues than a randomly selected one—the boy’s father played in the majors—to segue to the question: Who produces terrorists? The next part of the chapter focuses on various characteristics of a terrorist, e.g., the family back- ground of the typical terrorist; the distinction between a terrorist and a revolutionary; how the act of terrorism works to achieve the terrorist’s goals, including the public goods aspect of terror- ism; the direct and indirect costs of terrorism; and the unintended benefits a terrorist threat can yield, e.g., a reduction in other types of crime due to increased policing activities and reduced ill- ness because people don’t fly as much. This discussion once again highlights how the conventional wisdom—terrorists are poor and uneducated—can be at odds with reality—terrorists tend to come from well-educated, higher-income families. The discussion of terrorism in turn serves as a springboard to examine the importance of information. The authors focus on how the September 11 attacks in particular, and terrorist acts in general, could easily overwhelm most emergency rooms around the country. The reasons include the design of most emergency rooms and information constraints. Levitt and Dubner’s discussion of Craig Feied’s efforts to transform emergency care at a Washington area hospital provides an interesting snapshot of the evolution of hospital emergency care over the past 50 years and an excellent illustration of the value of information. Adequate information about a patient’s background is critical to successfully treating that patient in an emergency situa- tion. The problem for Feied and his colleague was how to make that information readily available. The answer was object-oriented programming—and the result was Azyxxi, which Microsoft sub- sequently purchased from its creators and renamed Amalga. The adoption of Amalga in turn has

9 resulted in substantially improved medical care for patients. It also has produced a massive amount of data which can be used to, among other things, evaluate the relative effectiveness of doctors. In the next part of the chapter, the authors emphasize the many pitfalls that can be encountered in attempting to answer a question such as: Who are the best and worst doctors in the E.R.? One of the most pressing problems is the lack of correlation between the quality of health care and the death rate of a particular doctor’s patients. After identifying the type of data that are most likely to reflect a doctor’s relative skill the authors note that, in fact, there is relatively little variation among E.R. doctors with respect to skill. That being said, they also point out that some doctors, e.g., females from top-rated medical schools, appear to perform marginally better than their peers. Factors that are actually more important from the patient’s perspective include his/her specific ailment, gen- der, income level, and ability to avoid going to the hospital if at all possible. This leads to a brief discussion of some of the factors that are correlated with longevity, including professional success, religious behavior, and inheritance taxes. This is followed by an examination of the relative ineffec- tiveness of chemotherapy as a treatment for many forms of cancer and a brief exploration of pos- sible explanations for why chemotherapy nonetheless continues to be used so heavily. The final section of the chapter explains the chapter’s title by examining those factors that tend to distinguish a terrorist from the broader population. For example, the typical terrorist owns a mobile phone, is a student, and rents his home. Equally important, the typical terrorist does not have a savings account, does not withdraw money from an ATM on Friday afternoon, and does not buy life insurance. Based on these characteristics, it would be in the terrorist’s interest to purchase life insurance to throw the authorities off of his track. While these characteristics substantially reduce the pool of potential terrorists, there is an unacceptably large number of people who, based on this information, would be falsely accused of being a terrorist. The authors then explain that the rela- tive intensity of an unspecified banking activity (which cannot be described for security reasons) substantially reduces the pool of suspected terrorists and may greatly enhance our ability to thwart future attacks.

Basic Economic Concepts 1. Correlation versus causation. Many principles texts like to address certain fallacies that must be avoided when conducting scientific inquiry. One of these is the problem of confusing correlation with causation. For example, the number of people who drown and ice cream sales are posi- tively correlated to the extent that both tend to increase in the summer. However, we should not then conclude that the increase in ice cream sales causes an increase in drownings (or vice versa). The chapter’s opening discussion of the correlation between health problems and the timing of certain individuals’ conception/birth highlights the importance of digging deep enough to find the actual cause of such correlations, e.g., parents’ religious practices. The same is true of success in sports. It has been observed that the birthdays of kids who perform better in sports tend to fall

10 earlier in the year; however, is not the fact that someone is born earlier in the year that makes them better at sports, but rather the fact for a particular age group, people borne earlier in the year tend to be more physically mature. This same distinction is also critically important when evaluating the relative effectiveness of doctors. To be specific, focusing on patient outcomes could be extremely misleading depending on how patients are assigned to specific doctors. As such, the observation that a particular doctor’s patients have higher mortality rate than another doctor does not allow us to conclude that the first doctor is not as good as the second doctor 2. Marginal productivity. The marginal product of a variable input to production is defined as the change in total output that results from a one unit change in the variable input. Stated more simply, we are asking the question, how much does one more unit of the variable input, e.g., labor, add to total output? Focusing on the production of terrorism, while hate is a powerful motivator, the more competent a terrorist is, the more likely he is to be successful, i.e., the more productive he will be from the terror- ist organization’s perspective. As such, the relatively higher marginal productivity of a better-edu- cated terrorist leads the organization to recruit its members accordingly. The discussions of the value of information and effectiveness of chemotherapy can also be used to illustrate marginal productivity. In the first case, a doctor’s marginal productivity, measured most broadly by the additional amount of treatment per unit of time, is an increasing function of the amount of information she can access regarding the patient and how quickly that information can be gotten. In the second case, an objective assessment of the outcomes of chemotherapy, measured in dollars spent per additional month the patient survives, raises serious questions about the value of certain treatments. In this example we can think of the marginal product of chemotherapy as the additional number of months a patient survives as a result of the chemotherapy. The cost of the chemotherapy treatments includes both the out-of-pocket expenses for the drugs, doctors, hospital facilities, etc., as well as any pain and discomfort the patient experiences that is attributable to the treatments. 3. Public goods and externalities. Economists distinguish between private goods and public goods, focusing on three criteria: rivalry, divisibility, and excludability. Private goods, e.g., gasoline, a shirt, a sandwich, are characterized by rivalry in consumption—two different people cannot consume the same unit of a private good; divisibility—private goods can be divided into indi- vidual discrete units; and excludability—individuals can be excluded from consuming a private good on the basis of price. In contrast, public goods, e.g., national defense and pollution control, are characterized by nonrivalry in consumption—multiple people can consume the same unit of a public good; nondivisibility—public goods cannot be divided into individual discrete units; and nonexcludability—individuals cannot be excluded from consuming a public good. Based on the preceding definitions, there is clearly a public goods dimension to a terrorist act. To be specific, the amount of suffering experienced by one individual does not in any way reduce the amount of pain and suffering, physical or emotional, others might suffer, i.e., there is non-rivalry

11 in consumption. It is also that case that such acts are characterized by non-divisibility and nonexcludability. Levitt and Dubner define an externality as what happens when someone takes an action but someone else, without agreeing, pays some or all the costs of that action. This definition is refer- ring to a negative externality. In a similar manner, we can define a positive externality as what happens when someone takes an action but someone else, without agreeing, enjoys some or all of the benefits of that action. With these definitions in mind, we can see that terrorist acts generate externalities, both positive and negative. Thus, for example, air travelers have experienced a nega- tive externality in the form of the additional costs of increased travel time that has resulted from increased security at airports. At the same time, certain types of crime have decreased in cities that frequently go on terrorist alerts as a result of the increased number of police on the streets. This is an example of a positive externality. 4. The economic value of information. Economists, as much as anyone else, appreciate the value of information. As the discussion in the chapter clearly illustrates, having the right pieces of information in a timely fashion can greatly enhance the effectiveness of emergency room treatments. The problem, of course, is the cost incurred in obtaining the needed information. While there is no doubt that substantial costs were incurred in getting Azyxxi up and running, once it was completed, it provided doctors with much needed information at very little cost in terms of time spent accessing that info. Having speedy access to critical information has in turn increased the marginal productivity of doctors and other medical staff. Efforts to avert terrorist attacks also entail significant information requirements. To be specific, to be able to stop an attack, we have to be able to accurately determine who is most likely to be a ter- rorist. The information needed for that purpose must be especially precise. This is due to the rela- tively low number of terrorists in the population. As the authors point out, even if a technique for identifying terrorists is 99 percent effective, assuming a population of 50 million people and 500 terrorists in the population, 500,000 people would still be incorrectly identified as terrorists. Clearly, much more information is needed to make the technique useful. 5. Cost Effectiveness and Benefit-cost analysis. Generally speaking, cost effectiveness is measured by calculating the benefits of some activity per dollar spent on that activity. For example, one might be considering two different treatments of a particular disease. Assume treatment A extends the patient’s life by one month for every $1,000 dollars spent on the treatment, while treatment B extends the same patient’s life by one month for every $2,000 spent. We would then conclude that treatment A is more cost-effective that treatment B. In contrast, benefit- cost analysis consists of a comparison of total benefits and total costs of different options. The option that yields the greatest net benefits, i.e., the difference between total benefits and total costs is preferred on economic grounds. Even when we consider a subject as sensitive as life-threatening illness, e.g., cancer, an objective analysis necessitates consideration of the costs and benefits of additional medical treatments.

12 This is a result of the opportunity cost that is incurred. Viewed from the perspective of society as a whole, the question then becomes, which treatments yield the greatest number of lives saved for a given period of time per dollar spent on treatment. This is simply a measure of the cost-effective- ness of different medical treatments. The follow-up question that can then be raised is: how do the benefits, measured, for example, in terms of additional days or months the patient continues to live, compare to the costs incurred? 6. Incentives effects of taxes. The public finance literature has a great deal to say about the incen- tives effects of different types of taxes. Consider, for example, the effect of an increase in the sales tax on cars. Because the sales tax increases the effective price of a car, it is likely that the increase in the tax will create an incentive for some people to forego purchasing a new car. In addition, there is an incentive to substitute relatively cheaper cars for more expensive ones to reduce the impact of the tax. A great deal has also been written about the incentives effects of income taxes, especially as it relates to the incentives to work and save. Levitt and Dubner focus on the tax on inheritance and the expected impact increasing or decreas- ing that tax will have on the longevity of older people. And the evidence they cite suggests older people would prefer to see decreases in such taxes pushed off to the future. This is because, as the inheritance tax is reduced, the net amount one’s heirs expect to receive increases. This may in turn reduce the incentive the potential heirs have to undertake efforts that would extend the older per- son’s life.

Core Competencies Once you have read and carefully studied this chapter you should be able to complete the following tasks. (Note: the economic principles illustrated in SuperFreakonomics don’t necessarily “track” with the order in which they appear in an economics text book. Therefore, some of the economic con- cepts described below may be new to you.) 1. Describe how the month in which someone is born can influence his success in sports in his adolescent and early teen years. Use this to explain the difference between correlation and cau- sation. Does astrology explain the correlation between the month one is born in and his or her success in sports? Why or why not? 2. Describe the three key components of “deliberate practice” and explain how each contributes to success in a particular endeavor, e.g., sports or musicianship. 3. Compare and contrast the conventional wisdom as it relates to the characteristics of the typical terrorist and what systematic studies of terrorists have found in this regard. In addition, be able to provide a rationale for the observed differences you’ve described. 4. Use the concepts of public goods and externalities to explain why terrorism is so effective. In particular, discuss how a terrorist act affects more people than just the direct victims of the attack by distinguishing between the direct and indirect costs it imposes on society.

13 5. Describe how hospital emergency care has evolved from the 1950s to the present. In addition, identify weaknesses that still plague hospital emergency rooms. 6. Discuss the importance of information in the provision of treatment in a hospital emergency room. In particular, focus on how the amount of information readily available to doctors can affect their ability to successfully treat patients. 7. List the four characteristics Craig Feied identified as critical for an information system to possess in order for the system to be truly effective. In addition, explain how each characteristic would enhance or increase the effectiveness of the system. 8. Summarize the effectiveness of the Azyxxi information system Craig Feied and his colleagues created, focusing on the relative amount of time doctors spent on information management and treatment of patients before and after the system was introduced.

9. Explain why it is difficult to measure a doctor’s skill, focusing on such factors as patient out- comes, the lag between when treatment is administered and when its effects are felt, and the patient’s behaviors after treatment is received. 10. Based on the analysis of the data assembled by Craig Feied and his colleagues, summarize what can be said about the relative effectiveness of different E.R. doctors. In addition, list the charac- teristics that do appear to distinguish the best doctors and provide an economic explanation for each one. 11. Relying on the notion of incentives, explain how purchasing an annuity or being religiously motivated can prolong one’s life. 12. Explain how a change in the estate tax could affect the longevity of older people, especially those who are likely to leave a considerable amount of money to their heirs. 13. Summarize the available data on the relative effectiveness of chemotherapy as a treatment for cancer. In addition, discuss the cost-effectiveness of chemotherapy as a treatment for lung can- cer and metastasized breast cancer and its effectiveness in extending the patient’s life. 14. Focusing on the incentives oncologists face, provide an economic explanation for why, despite its lack of efficacy, chemotherapy is so widely administered. 15. According to Levitt and Dubner, the fact that the age-adjusted mortality rate for cancer is essen- tially unchanged over the past half century actually hides some good news. Describe this good news. 16. Explain why, given a choice between protecting potential terrorist targets and identifying and apprehending terrorists before they strike, the latter is the preferred alternative on the basis of relative costs. In addition, explain why this is nonetheless such a daunting task. 17. Explain why an algorithm designed to identify the terrorists in a population that is 99 per-

14 cent accurate is nonetheless of limited value, especially as the size of the relevant population increases or the number of terrorists in the population declines. 18. Focusing on the concomitant costs, explain why false positives are a serious problem for both the analyst who is trying to identify the members of a population who possess a particular characteristic and those members of the population who are incorrectly identified as possessing that characteristic. 19. Referring to the analysis conducted by Ian Horsley and his colleagues, describe the typical ter- rorist, focusing on both positive and negative indicators. In addition, answer the question: Why should a suicide bomber buy life insurance?

C h a p t e r 3

Unbelievable Stories About Apathy and Altruism Summary In this chapter, Levitt and Dubner examine the evolution of experimental economics and the sub- field of behavioral economics. They set up the discussion by describing one of the more shocking stories from the 1960s: the brutal murder of Kitty Genovese and the apparent apathy displayed by a large number of bystanders. As they discuss the rise in crime that occurred between 1950 and 1970, they explore a variety of possible explanations for the observed increase, including reduced arrest and imprisonment rates and the baby boom. The most interesting explanation, which also has empirical support, is the advent of television. (Why increased television viewing leads to increased crime is still somewhat of a mystery.) The authors then shift back to the Genovese murder to ask why no one exhibited altruism on that particular night. The next part of the chapter, which examines such questions as why and to what extent altruism exists, begins by considering the distinction between altruism and self-serving behavior. As Gary Becker has argued, many seemingly altruistic actions, e.g., visiting someone in a retirement home, frequently include a strategic element. Subsequent empirical analysis has confirmed this. To better understand altruism, a group of economists moved their work to the laboratory, i.e., experimen- tal economics, to gain additional insights. Building on the work of John Nash and the Prisoner’s Dilemma, two new games, Ultimatum and Dictator, were developed and refined. The overwhelm- ing conclusion that emerged from experiments involving these games was that the vast majority of humans are in fact altruistic. This, in turn, cast considerable doubt on the traditional assumption of the rational, self-interested economic agent. It also raised the possibility that most, if not all, of society’s problems could be solved simply by relying on the altruistic nature of human beings. Take, for example, the case of organ transplants. If humans are indeed altruistic, it seems there would

15 never be a shortage of kidney’s for transplants considering a person is born with two but really only needs one. Attention then shifts to the subfield of behavioral economics and the work of John List. After chronicling List’s career path, including his work in mainstream behavioral economics, the authors describe how List began to explore the relationship between laboratory results and the real world. In short, what List found was that the participants in an experiment behave much differently when they don’t know they are part of an experiment. Moreover, as the experiment more closely resem- bles the real world, results approach what traditional theory would predict, i.e., rational, self-inter- ested behavior. The explanation for why previous laboratory experiments produced the results they did include selection bias, the effects of scrutiny, and context and its corresponding incentives. The last part of the chapter considers what constitutes pure altruism, as opposed to impure altru- ism, and then returns to the case of the Genovese murder. What is really interesting here is that all of the shock waves felt throughout the country in the wake of this story may have been more the result of fiction than fact.

Basic Economic Concepts 1. Incentives matter. As we have noted previously, one of the most fundamental tenets of eco- nomic analysis is that incentives matter. Economists also argue that a rational, self-interested individual will routinely pick that option which maximizes his net benefits. How then, can altruistic behavior be explained? The initial conclusion many observers drew based on the early results of work in experimental economics is that the assumption of a rational, self-interested agent is wrong. What John List subsequently showed, however, was that the earlier results were, in fact, simply the result of the incentives present in the game being played. The same can be said regarding at least some of the behaviors observed in the real world that are labeled as altruistic, e.g., visiting someone in a retirement home or giving to a charity. In these cases, the individual engaging in the act has an incentive in the form of some possible payoff, e.g., inclusion in someone’s will or recognition as a generous human being. Finally, as the authors point out, there is no shortage of kidneys for transplant in Iran, where donors are compensated. The same cannot be said of the situation in the United States, where we rely much more on altruistic behavior. 2. Benefit-cost analysis. As we noted in the previous chapter, benefit-cost analysis consists of a comparison of the total benefits and total costs of different options. The option that yields the greatest net benefits, i.e., the difference between total benefits and total costs, is preferred on economic grounds. The discussion of the rise in crime that occurred over the 1950-1970 time period provides a good illustration of how benefit-cost analysis can guide the decisions of ratio- nal, albeit amoral, economic agents. Begin by assuming that the rational, amoral criminal behaves so as to maximize his net benefits from crime committed. The benefit of another unit of crime is simply the payoff the criminal

16 receives. The cost of committing additional crime, $ on the other hand, is a function of the probability MC1 of getting caught and convicted and the severity MC2 of the resulting punishment. As the probability of arrest and imprisonment decreased between 1950 and 1970, the expected cost of committing addi- MB1 tional crime decreased as well. The result is that, holding marginal benefits constant, additional crime yielded positive net benefits and crime increased. This outcome is depicted in Figure 3.1. In the graph, the quantity of crime is measured on the horizontal axis. The marginal benefits curve is horizontal on the assumption each additional unit of crime yields the same payoff, e.g., amount Q Q2 Q of money stolen from a liquor store. The marginal 1 2 cost curve, which is a function of the probability Figure 3.1 of getting caught and convicted and the severity of the resulting punishment, is upward-sloping on the assumption that both of these variables increase at an increasing rate. The initial equilibrium quantity of crime, viewed from the criminal’s perspective, is then Q1. If the probability of getting caught or the severity of punishment then decreases, all else constant, this causes the marginal cost of committing crime to decrease. This is shown by shifting the marginal cost curve to the right, to something like MC2. The result is an increase in the equilibrium amount of crime to Q2. In a similar fashion, when the participants in an experiment know they are being observed, the cost of certain actions (e.g., taking more money for themselves) in the form of disapproval on the part of the observer increases. This leads the rational individual to behave more generously than he/ she otherwise would. This observed behavior in turn led early researchers to conclude that people are, by and large, altruistic. When that perceived cost, i.e., disapproval on the part of the observer, is eliminated, the rational, self-interested behavior traditional economic theory would predict emerges. 3. Rational behavior. At its core, standard economic theory is built on the assumption that indi- viduals are rational. As such, when confronted with a set of choices, they will choose that option that yields the greatest net benefits. This is what made the results of both the Ultimatum and Dictator games so noteworthy. For example, in the Ultimatum game, given a choice about how to share a particular sum of money with a second party, and knowing that it is in the second party’s interest to accept whatever sum, no matter how small, is offered to her (something is better than nothing), the first party should choose the smallest share possible, i.e., a penny. That being said, the givers behaved in a manner totally inconsistent with this prediction, instead opting, on average, to give the second party a much larger share of the total amount of money.

17 The result was that, as the authors put it, homo economicus was about to be replaced by homo altruisticus. But as John List’s work subsequently has shown, the behavior previous researchers observed was rational given the incentives the participants in the game faced, including how the people running the experiment would judge the participants’ behavior.

4. Supply and demand. The problem that arose $ after kidney transplants became routine is easily illustrated using the model of supply S1 D1 S2 D2 and demand. To be specific, the demand for kidneys steadily increased as the number of doctors who could perform such transplants rose. This is shown in Figure 3.2, by the shift in the demand curve from D1 to D2. The supply of available kidneys, however, grew much more slowly. This is shown by the shift from S1 to S2. The result is an acute shortage, measured by the difference between Qd2 and Qs2. As the authors note, “There are currently 80,000 people in the U.S. on a waiting list for a new Qs1 Qd1 Qs2 Qd2 Q kidney, but only some 16,000 transplants will 22 be performed this year. This gap grows larger Figure 3.2 every year. More than 50,000 people on the list have died over the past 20 years, with at least

13,000 more falling off the list as they became too ill to have the operation.” 5. Model specification. The models we use in economics are abstractions of the real world, meant to capture the salient features of the problem we are trying to analyze while simplifying reality to a level that we can manage within the model. There is the danger, however, that models can be too simple. Thus for example, care is often taken to distinguish between partial and general equilibrium analysis. The latter has the advantage of capturing more of the feedback effects among the various elements of the model, e.g., actors, institutions, or markets, at work in the real world. The initial conclusions derived from the Ultimatum and Dictator games, and the results of John Lists’ subsequent experiments based on modifications of those games, clearly demonstrate that, in order for the results that flow from it to be valid, a model must sufficiently reflect the relevant features of the world it is trying to emulate. The problem with the games in question is that in their original forms they only captured behavior in a specific case, i.e., when the participants were faced with a relatively limited set of choices, and the constraints created by the fact that the experi- menter was observing the participant’s behavior. Modifying the game to more accurately reflect the real world resulted in behaviors much more consistent with what economic would predict, i.e., rational, self-interested behavior.

18 Core Competencies Once you have read and carefully studied this chapter you should be able to complete the following tasks. (Note: the economic principles illustrated in SuperFreakonomics don’t necessarily “track” with the order in which they appear in an economics text book. Therefore, some of the economic con- cepts described below may be new to you.) 1. Explain why the brutal murder of Kitty Genovese raised such serious questions about the seem- ingly limitless apathy of people in the United States. 2. Describe the behavior of crime rates between the mid-1950s and 1970. In addition, describe what was happening to arrests per crime and the rate of imprisonment over this same time period. 3. Summarize the extent to which such factors as changes in arrest and imprisonment rates and the postwar baby boom are able to explain the rise in crime you described previously. 4. Summarize the observed empirical relationship between television viewing habits and the rate of crime in individual cities. In addition, explain how watching programs like The Andy Griffith Show might at least partially explain the observed relationship. 5. Referring to the work of Gary Becker and subsequent researchers who produced evidence in support of his theories, explain how a “strategic element” of seemingly altruistic behavior might manifest itself. Focus, in particular, on the behavior of children toward their aging, wealthy parents. 6. Focusing on how such research is conducted, explain what distinguishes experimental econom- ics and the resulting subfield of behavioral economics from the bulk of economic research that preceded it. 7. Describe the basic features of the Ultimatum game. In addition, describe what traditional eco- nomic theory would predict as the dominant strategies of both players, and how this prediction this differs from the outcomes observed by researchers. Do the same for the Dictator game. Finally, summarize the conclusions these games inspired regarding the accuracy of the textbook representation of Homo economicus. 8. Assuming people are innately altruistic, how should this be expected to affect the relationship between the demand for and supply of kidneys for transplant. In particular, should there ever be a shortage? Why or why not? 9. Summarize the differences between the results of John Lists’ experiments involving baseball trading cards that were conducted first in a lab setting and then on a real trading floor. What did List hypothesize might be the source of the observed differences? 10. Summarize, in general terms, the modifications John List made to the Dictator game, and explain why the results of his experiments ended up casting extreme doubt on the conclusions

19 regarding human beings and altruistic behavior that were based on the initial version of the game. 11. Explain how selection bias, scrutiny, and context can each cause the outcomes of lab experi- ments such as the Ultimatum and Dictator games to differ from behaviors we observe in the real world. 12. Distinguish between pure altruism and impure, or warm-glow, altruism and give examples (other than those suggested by the authors) of each. 13. Describe the current situation in the United States with the respect to the demand for, and available supply of, kidneys for transplant. Compare this to the situation in Iran, which estab- lished a market for kidneys for transplant more than 30 years ago. 14. Summarize the essential differences between the original New York Times article that described the murder of Kitty Genovese and the “real story” of what happened that was subsequently constructed by Joseph De May Jr. What does this suggest about the level of apathy that was assumed to characterize the average U.S. citizen at the time of Genovese’s murder?

C h a p t e r 4

The Fix Is In—and It’s Cheap and Simple Summary This chapter is all about problems, solutions to those problems, and unintended consequences that can arise. The specific problems addressed range from health-related issues (including deaths among mothers of newborns and polio), to deaths due to car accidents, to population growth and species extinction. A recurring theme is that in all of the cases considered, the solution to the prob- lem is invariably simple and relatively cheap, once the problem and its cause are well understood. The chapter begins by describing the puerperal fever epidemic that struck top European hospitals in the mid-1800s. As Levitt and Dubner point out, many of the suspected causes, in one way or another, held women responsible for the outbreak. And it wasn’t until an enterprising administra- tor who relied on statistical observations began to examine the problem, and the accidental death of a leading doctor, that the problem was solved. After all was said and done, the disease was linked to exposure to germs delivered by doctors who did not adequately clean their hands after perform- ing autopsies and just before they delivered babies. And so it was that the solution to the problem was as cheap and simple as one could possibly imagine, i.e., wash your hands, Doctor! The authors discuss a number of solutions to problems that have proven to have unintended, and costly, consequences. The Americans with Disabilities Act has made it easier for these folks to move

20 about in society, but it also has left them with fewer job opportunities because potential employ- ers became afraid of running afoul of the law and simply chose not to hire the disabled. And then there’s the Endangered Species Act, which has led many property owners to engage in habitat destruction, which is the opposite of the law’s intent. The same is true of such policies as per unit pricing of trash disposal, which has encouraged illegal dumping and resulted in more burn victims because people have an increased incentive to burn their trash, and a mandatory debt relief law that ended up limiting the availability of credit to those who need it most. The next part of the chapter focuses on a variety of situations in which major problems have been solved using relatively cheap and simple fixes. Ammonium nitrate, for example, proved to be a rather inexpensive solution to the problem of how to feed a rapidly growing world population. The discovery of oil averted what otherwise would have been the extinction of whales. And a set of vac- cines ultimately eliminated the burgeoning costs polio imposed in the United States and abroad. At this point, the authors also stress the difference between treating a problem after it arises and effectively eliminating the problem. This is the nature of vaccines and other preventive drugs in medicine. There is no doubt that considerable costs are incurred in developing new vaccines and drugs. But it is also true that once the vaccine/drug has been developed, its costs are dwarfed by the benefits in the form of adverse health effects avoided. Levitt and Dubner then return to a topic addressed at some length in their previous book, i.e., deaths associated with automobile accidents. However, this time, they address the problem more broadly, considering deaths of both children and adults. Beginning with death rates in general, they emphasize the distinction between mitigating the adverse effects of an accident ex post, and avoid- ing the harm altogether. This was indeed the motivation for putting seat belts in cars. If someone is prevented from being thrown about the interior of a car when an accident occurs, the injuries suf- fered will be much less than they would be without such a restraint, regardless of how hard or soft objects in the car are. Levitt and Dubner turn to the issue of child safety seats. This time around, the conclusions are more specific, i.e., children under the age of 2 are clearly better off in car seats, while children in the 2-6 age category are equally well off using either seat belts or car seats, especially when it comes to serious injury. They wrap up this part of the chapter by suggesting a possible solu- tion that would be both simple and cheap—design seat belts specifically for children. The last section of the chapter describes a possible solution to one of the more destructive prob- lems created by Mother Nature: hurricanes. After explaining the process by which hurricanes form (you can’t identify a solution if you don’t first understand the problem), they describe a relatively low-cost solution that is currently being tested. The ultimate question, of course, is whether gov- ernments can be persuaded to try something that is both cheap and simple.

Basic Economic Concepts 1. Least-cost production. Most economics principles texts identify three fundamental questions any economic system must answer: 1) what to produce, 2) for whom to produce, and 3) how to produce. The answer to the third question is to rely on least-cost production. Holding constant

21 the benefits obtained from a particular good (or service), net benefits will be maximized when that good is produced as inexpensively as possible, i.e., at least cost. If we think about the production of a reduction in the incidence of puerperal fever, one could imagine quarantining mothers who are about to deliver their babies and employing medical staff dedicated solely to that activity. Doing so would certainly reduce the probability the mother and her baby are exposed to harmful germs, but the reduced probability would come at considerable cost. Alternatively one could simply require that doctors and other medical staff routinely clean their hands and, in so doing, stop the spread of germs and the maladies they create. Of these two solutions—quarantine and hand washing—the latter is clearly the least-cost solution. In a similar fashion, think of the production of increased safety for the passengers in an automobile. The installation of airbags is certainly an option. But as the authors point out, the installation and use of seat belts achieves essentially the same outcome at considerably lower cost.

2. Correlation versus causation. We previously considered this distinction in our discussion of basic economic concepts in Chapter 2. As we pointed out, anyone who has had basic statistics knows that correlation does not imply causation. That being said, the two are often treated synonymously. Thus, it should not be surprising that such factors as personal predisposition (no doubt many mothers about to deliver their baby are quite anxious), foul air in the delivery wards (remember this was happening in the 1800s), the presence of male doctors, and catch- ing a chill or leaving the delivery room too soon were suggested as possible causes of puerperal fever. While there was almost certainly a high correlation between the presumed causes and the fever, hindsight clearly shows the real cause, which was related only to the male doctors; they were performing autopsies before entering the delivery room and failed to adequately clean their hands between the two activities. It is, however, surprising that anyone would suggest that polio was caused by the consumption of ice cream. Such a connection is no more defensible than the suggestion that the number of deaths by drowning is caused by the consumption of ice cream given that both are observed to increase in the summer months. 3. Externalities. Levitt and Dubner introduced the concept of an externality in Chapter 2, where they defined it as what happens when someone takes an action but someone else, without agreeing, pays some or all the costs of that action. Although the authors don’t label it as such, the failure of individual whaling ships to take account of the costs their harvest of whales had on other whalers and the whale population is an example of a negative externality. This is because, when a whale is harvested, in addition to the costs incurred by the ship and crew harvesting the whale, it imposes two types of costs on others. First, that particular whale is not available for anyone else to harvest. Second, and more importantly, as the size of the whale population is reduced though harvesting, the population’s ability to sustain itself through repro- duction is diminished. If the reduction in the population is large enough, it is possible that the harvest rate would exceed the rate of reproduction. In this scenario, the end result is extinction of the species.

22 The end result of the external costs referred to above is that the quantity of whaling in the unre- stricted market is larger than the social optimum. To see this, refer to Figure 4.1, which depicts the supply of and demand for harvested whales. The supply curve labeled Sp reflects only the private costs of the production of harvested whales, e.g., the costs incurred by the whaling company for fuel, men to staff the ship, etc. The intersection on Sp and the demand curve D yields the unre- stricted equilibrium quantity Qp. When we add in the external costs of whaling referred to in the previous paragraph, however, the supply curve shifts left to something like Ss, which reflects the sum of the marginal private and external costs of production. The new socially efficient equilibrium quantity Qs, which reflects consideration of both private and external costs, is clearly less than Qp.

4. Input substitution. The concept of input sub- P Ss stitution can be tied to the discussion of least-cost production. Consider, for example, a Sp very simple production process that employs only two inputs. All else constant, as the price Ps of one of the inputs falls, holding the price of the other input constant, there is an incentive Pp to substitute the now cheaper input for the relatively more expensive one and, in so doing, reduce the total costs of producing a particular level of output. D1 Now consider the rapid decline in the world’s whale population that resulted from its increased exploitation and caused the price of whale oil to Qs Q Q rise. The discovery of petroleum, which was both p abundant and cheap, led to its substitution for Figure 4.1 whale oil in a wide variety of uses, from producing home heating to lighting lamps to lubricating the moving parts in machinery. Along the same lines, the data Levitt and Dubner present on the relative effectiveness of seat belts and child safety seats, especially for children more than 2 years old, suggest properly designed seat belts could be substituted for car seats and produce the same amount of safety at a substantially lower cost than is currently being incurred. 5. Cost effectiveness. As we noted in our discussion of basic economic concepts in Chapter 2, generally speaking, cost effectiveness is measured by calculating the benefits of some activity per dollar spent on that activity. In this chapter, cost effectiveness is implicit throughout the discussion of remedies for a range of problems that have proven to be both simple and cheap. Clearly, the cost effectiveness of washing one’s hands before seeing the next patient cannot be questioned. Nor can the cost effectiveness of vaccines that prevent life-ending or seriously debilitating diseases such as polio and small pox. The discussion of seat belts versus air bags also provides an excellent illustration of the concept of cost effectiveness. The requirement that

23 all vehicles be equipped with seatbelts ends up costing about $30,000 per life saved. Compare this to airbags, which cost about $1.8 million per life saved. 6. Technological innovation. Technological innovation is generally viewed as a means to reduce the costs of producing a particular good or service. For example, as Levitt and Dubner point out, technological innovations in the form of higher-yielding crops and better tools substantially reduced the number of U.S. workers needed to feed the country’s growing population. Every time a new vaccine is developed, the costs of the illness or disease the vaccine is designed to protect against are eliminated or greatly reduced. Consider the flu vaccines that are provided at low or no cost each year in the United States. There is no doubt but that the cost of developing and distributing those vaccines, while substantial, is far less than the costs the economy would suffer if many of the people who are vaccinated, or enjoy the external benefits of associating with people who got the vaccine, were to become ill instead.

Seat belts are another example. When Robert McNamara first began to study the problem of auto- mobile-related accidents, researchers focused their attention on modifying the interior of autos to reduce the damages incurred when someone was thrown about the interior of the car in an acci- dent. The introduction of seat belts, and then seat belts with should straps, constituted a techno- logical innovation that was both relatively cheap and very effective, and substantially reduced the costs per mile driven when the costs of injury and death are factored into the equation. Lastly, the proposed hurricane control device, the inner tube with a skirt, is a technological innova- tion that could result in a substantial reduction in the damage costs resulting from hurricanes. And, if it works, it would be rather cost effective as well.

Core Competencies Once you have read and carefully studied this chapter you should be able to complete the following tasks. (Note: the economic principles illustrated in SuperFreakonomics don’t necessarily “track” with the order in which they appear in an economics text book. Therefore, some of the economic con- cepts described below may be new to you.) 1. Summarize the various (incorrect) proposed explanations for the dramatic increase in puerperal fever that occurred at General Hospital in Vienna in the 1840s. In addition, summarize what the data suggested as the possible cause when comparing the incidence of the fever in the ward staffed by midwives versus the ward staffed by doctors. 2. Explain the scientific process followed by Ignatz Semmelweis to divine what caused the differ- ence in mortality rates between the doctor’s ward and the midwife’s ward. In addition, iden- tify the culprit that was ultimately determined to be the cause of puerperal fever at General Hospital in Vienna. What was the proposed solution and how cost effective was it? 3. Summarize the unintended consequences of the Americans with Disabilities Act, Endangered Species Act, and various polices designed to reduce waste disposal by pricing disposal on the

24 basis of volume that are discussed by Levitt and Dubner. Provide an economic rationale for each of the consequences you have described. 4. List the various innovations in American agriculture cited by the authors that increased pro- ductivity in this sector of the economy. Of the factors you listed, which is considered to be most effective? Why?

5. Explain why whales were so important to the U.S. economy in the 19th century. In addition, explain why this in turn led to their untimely demise. Focusing on the concept of economic sub- stitutes, how did the discovery of oil solve this problem? 6. Summarize the costs, both personal and economic, that resulted from the polio epidemic that struck the United States in the early to mid 1900s. 7. Explain why a vaccine can be considered, as the authors put it, a “simple fix.” As part of your dis- cussion, compare and contrast the costs of creating and administering a vaccine with the costs of simply waiting for a disease to strike and then treating the symptoms. 8. Describe how the number of deaths attributable to traffic accidents has changed over the last 60 years. In addition, explain how consideration of the number of miles driven affects the con- clusions that flow from this comparison and why controlling for miles driven provides a more useful measure of the relative safety of travel by car. 9. Describe the effects of commanding officer Curtis LeMay’s decision to fly the lead plane on bombing missions in World War II, and his vow to court-martial any pilot who turned back, on the abort rate of planes flying those missions. In addition, provide an explanation, based on a consideration of relative costs, for this outcome. 10. Make a list of the potential costs, both real and perceived, of installing and using seatbelts in cars. How do the costs you have listed compare with the benefits that result from wearing seat- belts? Considering the foregoing conclusions, how easy or hard has it been to change behavior as it relates to seat-belt usage? Provide data that support your answer. 11. Summarize the relative cost effectiveness of installing seat belts versus airbags in cars. 12. Focusing on children over the age of two, what do the data tell us about the relative effective- ness of seat belts and child safety seats with respect to deaths resulting from car crashes? How does the use of child-sized crash-test dummies to control for the possible effects of improperly installed safety seats alter this relationship? 13. Explain why data obtained by interviewing parents of children who were injured in car accidents might not produce a reliable assessment of the injuries to children that can be attributable to seat belt use. 14. Based on what the authors argue are relatively reliable data, what can we conclude about the relative effectiveness of seat belts and car seats when it comes to avoiding minor and more seri- ous auto-accident-related injuries suffered by children over the age of two?

25 15. Summarize the potential economic benefits and relative cost effectiveness of replacing the requirement that children ride in car safety seats until the age of seven with a requirement that car manufacturers develop and install seat belts specifically for children in the back seats of all cars. 16. Considering the annual costs hurricanes account for in the United States, explain why Nathan’s “inner tube with a skirt” would be considered cost effective if it in fact works. In addition, describe the benefits that would be enjoyed by other parts of the world if we are able to moder- ate the destructive effects of hurricanes.

C h a p t e r 5

What Do Al Gore and Mount Pinatubo Have in Common? Summary What if much of what’s been proposed to address the problem of climate change is wrong or oth- erwise off the mark? This chapter takes a refreshingly objective look at the problem, focusing on global warming. The first part of the chapter points out that as recently as the 1970s, global cool- ing, not global warming, was the major concern of many climatologists. The subsequent increase in average global temperatures, however, moved global warming to the forefront. The authors explain many of the suspected causes of global warming, ranging from carbon emissions, to methane from cows and other ruminants, to changes in agricultural production. Levitt and Dubner also take a close look at the unique character of the global warming dilemma, emphasizing the considerable challenges scientists face as they try to predict what will happen over the longer term. They wrap up the introduction by considering the near religious dimension of the movement to stop global warming. In the next part of the chapter, the authors present a very accessible discussion of the concept of an externality, beginning with negative externalities such as pollution, and the idea of using a tax to induce parties responsible for negative externalities to internalize them. They also are careful to point out the considerable difficulties that would be encountered in any attempt to use a tax to internalize the externalities that result in global warming. The discussion then moves to the con- cept of positive externalities with a fair amount of attention devoted to specific examples. The first is the adoption of the LoJack by many automobile owners as a means to thwart the efforts of would-be car thieves. This generates external benefits in the form of an increased ability of police to locate and take down the chop shops where most stolen cars end up, and a reduction in auto thefts for both people who install a LoJack and those who do not. The second example considered is the eruption of Mount Pinatubo in 1991 and the decrease in the average global temperature that followed. This serves as a springboard to the work that goes on at Intellectual Ventures (I.V.). It also

26 answers the question: What do Al Gore and Mount Pinatubo have in common? They both suggest a way to cool the planet. We were actually introduced to Intellectual Ventures in the previous chapter when we learned about the approach that is being proposed to mitigate the adverse effects of hurricanes. The authors take the time to acquaint the reader with many of the gifted scientists who work for I.V. and, in particular, those who are working on solutions to the global warming problem. One of the novel aspects of the solutions being proposed is also a carryover from the previous chapter; they are, by and large, simple and relatively cheap. To better appreciate the solutions being proposed by I.V., we are first provided with I.V.’s assessment of the global warming problem, its causes, and the likely effectiveness (little if any) of the solutions that have been proposed by others, e.g., Al Gore’s focus on reducing the amount of CO2 being emitted into the atmosphere. In contrast, I.V. prefers to take its cue from the effects of “big-ass volcanoes,” and reduce global warming by reducing the amount of the sun’s rays that reach the earth. While Budyko’s Blanket, a garden hose to the sky that would extend 22 miles into the stratosphere and spew out sulfur dioxide in much the same manner as would a large volcanic eruption, is currently the focus of much of their attention, the folks at I.V. are also considering other approaches, including extending the smokestacks of specific coal-fired electric plants into the stratosphere, and stimulating cloud formation over the oceans to reflect back more of the sun’s rays. Levitt and Dubner then point out the major obstacle to all of these solutions, which collectively fall under the heading of “geoengineering.” The problem, quite sim- ply, is the often encountered inability to change people’s behavior, especially when the proposed change is considered repugnant by some. The last part of the chapter chronicles the obstacles Ignatz Semmelweis encountered in his efforts to get doctors to wash their hands before seeing each patient. Levitt and Dubner then point out that this problem has persisted into modern times. In fact, only recently have certain hospitals been able, with the help of a computer screen saver featuring bacteria-laden hand prints, to induce doctors to achieve near 100 percent compliance with guidelines for hand washing. A similar chal- lenge was confronted in Africa where the AIDS epidemic continued unabated until intervention in the form of circumcision substantially reduced the incidence of HIV infections among the affected population.

Basic Economic Concepts 1. Externalities. The concept of an externality lies at the core of this chapter. Many of the day- to-day actions of people seeking to maximize their satisfaction are also contributing, unin- tentionally, to the problem of global warming. Transportation that relies on fossil fuels, using ruminants as a source of food, and heating and cooling our homes are all sources of greenhouse gas emissions, e.g., carbon dioxide and methane. The resulting environmental costs are negative externalities, i.e., costs borne by some third party. The key to moving to an efficient level of such externalities is figuring out how to induce the parties who generate the externalities to “inter- nalize” them in their decision-making process. As the authors point out, this is a considerable challenge in the case of global warming.

27 Consider Figure 5.1, which depicts the market for P Ss fossil fuels. The vertical distance between the two supply curves is equal to the marginal cost of the Sp externality, i.e., marginal external cost (MEC). For simplicity, in this example MEC is assumed to be Ps constant. As we noted in the previous chapter, if the externality is not accounted for, the market Pp will produce Qp units of output, which is clearly greater than the socially efficient output level Qs. How then can we move the equilibrium to Qs? One option is to impose a tax on each unit of output produced by suppliers that is equal to the D1 MEC, i.e., the vertical distance between the two supply curves. This would have the effect of shift- Qs Q Q ing Sp to the left until it overlays Ss. By making p suppliers pay this additional tax, which amounts Figure 5.1 to another marginal cost of production, they have, in effect, “internalized” the externality. The result is production of the socially efficient level of out- put. The problem, however, is determining the correct level of the tax and getting legislators to impose it. This problem is not easily solved. The authors also point out that externalities can P be positive, and cite the classic example of a bee S keeper located next to a fruit farmer to make their point. The implications of a positive externality are depicted in Figure 5.2, which depicts the market for honey. The supply curve represents the repre- Ps sentative bee keeper’s marginal costs of produc- tion. The demand curve labeled Dp represents the Pp marginal benefits realized by the consumers of honey. The intersection of these two curves then Ds determines the equilibrium quantity when only honey consumers’ benefits are considered. The Dp production of honey, however, also yields benefits to the fruit farmer located next to the bee keeper. Qp Qs Q This results from the fact that when the bees are collecting pollen (to make honey), they also help Figure 5.2 pollinate the fruit farmer’s trees, which facilitates

28 the production of fruit. Adding these external benefits to the benefits realized by honey consumers causes the demand curve to shift right, to something like Ds. The result is a socially efficient quan- tity of honey production, Qs, which is greater than the privately determined equilibrium. The discussion of the eruption of Mount Pinatubo in 1991 and its environmental impacts is espe- cially interesting insofar as positive externalities are concerned. Pollution is normally thought to be a negative externality. Sulfur dioxide emissions from power plants certainly fall into that category. When Pinatubo spewed massive amounts of sulfur dioxide into the stratosphere, however, it turned out to be a positive externality considering the effect was to reduce the earth’s average tempera- ture by almost 1 degree Fahrenheit for the next two years. 2. Cost effectiveness. The concept of cost effectiveness has been a recurring theme in this book and it plays an important role in this chapter as well. For example, while people may disagree about the benefits of proposed reductions in carbon emissions as a means to offset global warming, most observers on both sides of the debate agree that the costs of doing so will be substantial. Contrast this with the relatively modest cost of installing the garden hose to the sky; even if five sets of hoses are needed. As the authors point out, the annual cost of this innovation would be less than the amount Al Gore is spending to raise public awareness about the problem of global warming. 3. Normative versus positive analysis. When conducting an economic analysis and considering the implications of different strategies that could be employed to address a particular problem, it is important to distinguish between positive and normative analysis. To understand the differ- ence, note that a positive statement is simply a statement of what is. Thus, for example, saying that the price of bread increases the quantity demanded will go down is a positive statement. A normative statement, on the other hand, is a statement of what ought to be. Arguing that the price of bread should be lower so that more people can afford it is an example of a normative statement. By analogy, a positive analysis seeks to simply determine the relationships among a set of variables. A normative analysis, in contrast, seeks to develop a support for what ought to be. As Levitt and Dubner point out, some of the efforts to reduce the pollutants that are believed to contribute to global warming appeal to people’s altruistic motives. This is the approach being taken in Al Gore’s massive PR campaign. While this is not meant to deny that Gore’s position is also based on scientific findings (i.e., positive analysis) there is, nonetheless, a normative aspect to the appeal for the adoption of specific policies. The argument goes something like this: • There is growing evidence of global warming. • Carbon dioxide is one of the greenhouse gasses believed to contribute to global warming. • Many activities people engage in cause the amount of carbon dioxide in the atmosphere to increase. • Humans ought to therefore reduce the amount of CO2 they are emitting into the atmosphere.

29 Compare this to the suggestion by I.V. that we spew sulfur dioxide into the stratosphere to help cool the earth. This policy recommendation is based on the observations of how volcanic activity has induced a cooling of the earth in recent years through essentially the same process. This policy suggestion is then simply a positive statement. It is, however, likely to be met by a normative back- lash that argues against adding more pollution to the atmosphere to counteract the effects of existing pollution. 4. Technological innovation. As we noted in our discussion of basic economic concepts in the pre- vious chapter, technological innovation is generally viewed as a means to reduce the costs of producing a particular good or service. Combine this with the concept of geoengineering and we can readily see how we might avert certain significant environmental problems at consider- ably lower cost than was previously the case. The current policies that are being proposed to address the problem of global warming, e.g., cap- and-trade policies that would restrict the amount of additional CO2 emissions and eventually reduce that amount from current levels, are expected to cost hundreds of billions of dollars (or more). In contrast, Intellectual Ventures puts the estimated costs of Budyko’s blanket (the garden hose to the sky) at somewhere between $20 million in fixed costs and $10 million in annual O&M at the low end, and $150 million in fixed costs and $100 million in annual O&M at the upper end. And when compared to earlier proposals, e.g., a “multiple balloon screen,” that was meant to deflect sunlight by launching billions of aluminized balloons into the sky or a “space mirror” scheme that called for 55,000 reflective sails to orbit high above the Earth it would seem that the technology that underlies geoengineering has indeed progressed significantly.

Core Competencies Once you have read and carefully studied this chapter you should be able to complete the following tasks. (Note: the economic principles illustrated in SuperFreakonomics don’t necessarily “track” with the order in which they appear in an economics text book. Therefore, some of the economic con- cepts described below may be new to you.) 1. Explain why, as recently as the 1970s, climate scientists were worried not about global warming, but about global cooling. As part of your explanation, identify the various adverse outcomes that were associated with global cooling. 2. Summarize the role human activity has played in the observed increase in the earth’s average temperature over the past 30 years or so. In particular, focus on transportation and fossil fuels, and the animals we raise (and eat). 3. List and explain the three primary science-related factors Levitt and Dubner cite as reasons why global warming is a uniquely thorny problem. 4. What do Levitt and Dubner mean when they state that “the movement to stop global warming has taken on the feel of a religion.”

30 5. How does global warming amount to a problem of uncontrolled externalities? Your explanation should include a description of what an externality is and the various sources of the externali- ties in this situation. 6. Explain how a tax could be used to induce responsible parties to internalize, (i.e., explicitly account for) the externalities they create. In addition, explain why the use of taxes to reduce the threat of global warming is much more easily said than done. 7. Why are actions by a single country to reduce the threat of global warming doomed to failure? In addition, explain how the difference in living standards in developed and under-developed countries exacerbates the problem of the need for collective action by all of the earth’s inhabit- ants to effectively address global warming. 8. Explain why, when viewed from society’s perspective, the use of LoJack is considered a much more effective deterrent of auto theft than a device such as the Club. Be sure to include a dis- cussion of positive externalities as part of your explanation. 9. Describe the effect the eruption of Mount Pinatubo had on the earth’s average temperature in the two years following the eruption and explain why this is considered a positive externality. 10. Summarize Intellectual Ventures’ assessment of the current generation of climate-assessment models and what this assessment means for our ability to rely on those models in formulating sound global-warming policy. 11. Identify the major greenhouse gas. In addition, explain how good environmental stewardship, i.e., efforts to reduce the amount of heavy-articulate pollution, may in fact be one of the major causes of the warming we have observed over the past few decades.

12. Explain the significance of the observation that atmospheric CO2 is governed by the law of diminishing returns. In particular, what does this suggest about the relative effectiveness of

modest proposals to reduce current CO2 emissions? Alternatively, what does this suggest about how large such reductions would have to be to have a meaningful effect on global warming? 13. Describe the primary driver behind rising sea levels and contrast this with the argument made by many environmental activists regarding the assumed cause of this phenomenon. 14. Summarize Intellectual Ventures’ three-pronged criticism of the current slate of proposed global warming solutions. As part of your summary, discuss the downside of increased reliance on solar power, as it relates to global warming, to produce electricity. 15. Explain what “geoengineering” consists of. 16. Drawing on the observed effects big-ass volcanoes have on the earth’s temperature, explain how Budyko’s Blanket, i.e., the “garden hose to the sky” would work, at least in theory, to reduce or eliminate the process of global warming. Include a summary of the expected costs, both fixed and variable, of implementing this strategy. Finally, compare this cost with that of Al Gore’s PR campaign regarding global warming.

31 17. Summarize the major objections to the implementation of Budyko’s Blanket, beginning with the question of whether it will work, and then moving on to objections to the basic idea of geo- engineering, the question of who would be responsible for its installation and operation, and the idea of using pollution to fight pollution. 18. Describe, briefly, how Intellectual Ventures’ “chimney to the sky” and “soggy mirrors” would work, at least in theory, to offset the potential for global warming. 19. As Ignatz Semmelweis discovered, it can be maddeningly difficult to change certain human behaviors. Describe how difficult it has been to induce members of the medical profession, most notably doctors, to routinely wash their hands. Use the concept of externalities to develop an explanation for why this might be the case. Finally, explain how one hospital, Cedars-Sinai, was ultimately able to achieve nearly 100 percent compliance with its hand-hygiene policies. Why do you think this strategy worked when so many other strategies had failed?

Students of statistics will find a guide for them at www.HarperAcademic.com

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