Friday, November 26, 2010

SuperFreakonomics: Chapter 3

Many of our decisions, both inside and outside the investment world, are often based on anecdotal information, anomalies, emotions, or existing opinions. SuperFreakonomics illustrates how applying an economic approach can help us change this. Investors can use the tools described in this book, including better and more prevalent use of data, along with an an understanding of the power of incentives to make better decisions.

This chapter is about altruism. In classical economics, the belief is that everyone is out for themselves and so people will make decisions only if it helps them out. However, recent studies and experiments (including the Dictator Game) have suggested that people are also altruistic to some degree, which has thrown a wrench into the idea that people are rational, self-interested beings who make decisions that are in their best interests.

The authors spend a fair bit of time debunking the idea that people are unselfishly altruistic. Yes, people will help out others, but they often do so for self-serving reasons, including reducing their own guilt, or because they hope to receive similar benefits when they are in need, or because someone is watching. The authors cite a few variants of the Dictator Game introduced by John List (the economist, not the mass murderer) that suggest people are not as altruistic as originally thought.

Though people may give money away in supervised games, outside of the laboratory the authors suggest the practical evidence suggests people are not all that altruistic (prompting the quip: "sure it may work in practice, but does it work in theory?")

One example the authors use to illustrate this has to do with organ donation. Would a stranger give another stranger one of his kidneys out of the goodness of his heart? To the detriment of those needing a transplant, US law prohibits monetary gain from organ donation. As a result, there are 80,000 people in need of a kidney in the US, but only 16,000 transplants will be performed this year. In Iran, where donors are paid, there is no such gap. While the authors recognize that Iran is not considered a forward-thinking country, it should receive some credit for recognizing that incentives, not altruism, are a more effective method in saving lives.

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