The latest entry in the Chicago Graduate School of Business podcast series is a talk given by Freakonomics author Steven Levitt. Levitt uses a number of the business case studies he has analyzed to illustrate a few broad points about business. His main argument is that in the business world (not to mention life in general) the most difficult decisions are those that we don’t get any meaningful feedback on. Two examples he gave were determining profit-maximizing pricing, because companies are typically loath to change their prices often or risk alienating customers by charging them differently for the same good, and advertising, because few organizations have solid ROI numbers on their advertising expenditure. Those who have read Freakonomics (seems like nearly everyone at this point, according to the bestseller charts) won’t be surprised to hear that Levitt recommends finding ways to build feedback into the decisions you make and implement, most notably by designing effective ways of running experiments and generating data.

Here are a few of his notable comments:

• Demand curves, which are a staple of the type of microeconomic analysis taught in school, are very rarely known in real world situations. Even when we observe changes in the level of demand after a price change, it’s not clear whether we’re learning something new about the existing demand curve or if we’ve simply moved to a new curve based on other market factors.
• When MBA students are asked to rank the importance of the subjects they studied, two years out of school, they typically put organizational behavior classes dead last. However, 10 or 15 years out of school, they typically put them first. Their focus has shifted from simply determing optimal corporate behavior to actually getting those behaviors adopted amidst all of the messy realities of modern organizations.
• Levitt claims that one of the few business people he has successfully convinced to adopt the unconventional Freakonomics approach to decision making is a Chicago prostitute who offered to share the data she had collected on her “transactions” with customers over the years. Levitt was interested in understanding how she set prices, and how her thought process compared to that predicted by the completely rational homo economicus of the traditional economics literature. The simple heuristic Levitt proposed for evaluating her pricing was this: when the phone rings with a call from a potential client, does it make her happy, or sad? When she told him that it made her a little sad, he responded that she must not be charging enough; if she was charging enough, the “costs” of lost free time and potential unpleasantness would be more than made up for by the gains of revenue from an additional client.
• Pilot programs are much more effective than focus groups according to Levitt, for the following reasons:
• The focus group process itself brings a level of scrutiny to people’s decision making that can cause them to alter their behavior.
• Forceful individuals can effect group dynamics enormously in a focus group situation, distorting the outcome and causing unanimity which is uncommon in the real world. Levitt once told a Hollywood executive that if he was allowed to sneak one or two “confederates” into an advance screening, he thought he could significantly alter the ratings the move got from the screening audience as a whole. His hypothesis is that the presence of a loud, boisterous laugher at a comedy, or conversely of a weepy crier at a sad movie, is enough to broadly change other audience members’ perceptions of the quality of the movie.

Read more, and listen here: Audio coverage of Steven Levitt, Professor of Economics, speaking at the Executive MBA Kick-off week at Gleacher Center.

The AEI-Brookings Joint Center for Regulatory Studies has just published a new book on information markets, and the whole thing is available online as a PDF — Information Markets: A New Way of Making Decisions.

Information markets are markets for contracts that yield payments based on the outcome of an uncertain future event. They are used to predict a wide range of events, from presidential elections to printer sales. These markets frequently outperform both experts and opinion polls, and many scholars believe they have the potential to revolutionize policymaking. At the same time, they present a number of challenges.

This collection of essays provides a state-of-the-art analysis of the potential impact of information markets on public policy and private decision-making. The authors assess what we really know about information markets, examine the potential of information markets to improve policy, lay out a research agenda to help improve our understanding of information markets, and explain how we might systematically improve the design of such markets.

Via Marginal Revolution