Posted by: sepalot | March 27, 2009

The Economics of Prostitution

I found two interesting articles from on one of my favourite areas of reseach, the economics of the underground economy (via Free Exchange):

The first on is an article from The Economist’s Intelligent Life, which you might have read already. It is concerned with the consequences of asymmetrical information in the market for escort services.

“I only charged $300 when I lived in San Francisco,” Andrea says. Unlike most industries, escorts can charge higher prices when they are in greater supply. This is because price is one of the few metrics sex suppliers can use to convey quality. (In this way it is not unlike the hedge-fund industry.) There are only about 30 VIPs in San Francisco, but nearly 100 in New York, so Andrea can charge more here. The customer demographic is also wealthier, and a higher price deters customers from bargaining, which is considered poor taste.

In any non-competitive industry, setting a price is a supplier’s way of communicating value to a customer. When information is imperfect or asymmetrical (ie, when customers don’t know enough about a product, or when suppliers are ignorant of their value relative to their competition), prices deviate from their market value and the market becomes riddled with inefficiency. This is why tourists in midtown Manhattan spend too much money on fake antiques, and why my local laundromat will wash and dry my clothing for half the price of rival cleaners across the street.

For a prostitute, the asymmetry is more profound. On the supply side, it is challenging for Andrea to price herself relative to her competition. Despite the publicly available listings of prices, photos and expertise of fellow escorts on Eros, it is impossible to know if these other women provide comparable services. On the demand side customers cannot be certain that the product resembles the advertising. And much of the value is merely hinted at, owing to the illegality of prostitution.

The article also draws parallels between the market for prostitution and Akerlof’s lemons-problem:

In cases of extreme uncertainty on the part of consumers, such as when shopping for a used car, the convention is to expect a “market for lemons”. Used-car salesmen are widely seen as a sleazy bunch owing to incentives they have to lie about a car’s quality. Because buyers presume a good chance of fibbing, most will only pay a low price for a used car. This could deter honest brokers, and ensure that only lemons are indeed on the market. Honest salesmen of quality cars can break this cycle and charge more, but only after building a reputation for good value.

Similarly, some assume that the only kind of women who would sell themselves at any price are of poor quality–ie, lemons. Especially valuable escorts who are exceptionally attractive, appealing and skilled, say (ie, in short supply), can break this perception of low value by charging exorbitant prices. (The high prices are also a factor of the illicit nature of the product.) Fees can reach astronomical heights as a supplier builds a reputation. In this way high-end prostitutes can escape the “market for lemons” perception.

I can’t remember though whether reputation-building was actually named in Akerlof’s original article as a way of preventing the break-down of markets.

The second article from Forbes is on a new project by Sudhir Venkatesh, the guy who as a graduate student spent six years hanging around with Crack dealers to learn about their business, and whose story ended up in Dubner and Levitt’s Freakonomics. Again he’s doing field work, this time out in the prostitution business.

He hired a group of former sex workers as research assistants and assigned each woman to track 25 to 50 active hookers, on street corners and in brothels, and record information about each transaction immediately after a customer left. What kind of sex was performed? Was there violence? Was the client black or white, a gang member or a cop? The project yielded data on 2,200 tricks performed by about 160 prostitutes.

“No one has really taken them seriously as workers before,” Venkatesh says. “They tend to either treat them seriously as victims or as self-empowered women, exercising agency over their bodies,” Venkatesh adds, referring to other social science literature. “I was interested in them as workers. We have to give them some credit. Why do they choose this? They don’t have a choice to do this over being a lawyer, but why do they choose this over fast food?”

Answer: Chicago streetwalkers earn $25 to $30 an hour, four times what they’d get in other jobs available to them. Venkatesh has also tried to assess the value of having a pimp versus self-managing, which he calls “a classic business school, industrial organization question.” Prostitutes who work with pimps, it turns out, appear to earn more and get arrested less frequently.

This latter story will be published in the sequel to Freakonomics, which apparently will be realeased in about a year from now.

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