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.