Let's make a deal

A column I wrote for Saturday's editorial page had this as the opening paragraph:

I recently read “Freakonomics,” the book that uses economic models to show how people respond to incentives. Most of the case studies are straightforward, showing, for example, that real-estate agents use their knowledge in a way that benefits them but not necessarily home-sellers, or that inner-city crack dealers use a business model not unlike McDonald's.

I got a call from a local Realtor yesterday who was put off by the real-estate reference, feeling that perhaps his integrity was being called into question. That wasn't the intent, though such a passing reference can be interpreted in any number of ways. So here is the rest of the story, from economist Steven D. Levitt's "Freakonomics."

A study was done of nearly 100,000 home sales in suburban Chicago, more than 3,000 of them owned by the real-estate agents themselves. Analyzing the data showed that agents kept their own houses on the market an average of 10 days longer than the houses they sold for other people, for a sale price of over 3 percent more -- or $10,000 more on a $300,000 house going into the agents' pockets, a strong incentive for an agent to keep a house on the market longer.

If an agent is selling your house, the incentive is not nearly so great. The typical sales commission of 6 percent is split between the seller's agent and the buyer's agent, with each agent then kicking half back to his or her agency. So if an agent gets a $300,000 offer on your house, his incentive to hold it on the market for 10 more days to get an extra $10,000 is only 1.5 percent of that $10,000, or $150. It makes much more sense for the agent to convince you that $300,000 is the offer that should be accepted.

Levitt isn't saying there's anything evil going on. There are no villains, merely people behaving in predictable ways based on the incentives they have before them.