Predictably Irrational
If you have considered yourself a rational decision-maker, this book will make you think twice.
We are all far more irrational than we and the standard economic theory would like to believe. What's more, our irrationality is not random and chaotic. It happens in repeatable, predictable patterns which we tend to underestimate or completely ignore. Understanding these patterns has wide implications for life, business, and policy.
Grounded in behavioral economics, "Predictably Irrational" by Dan Ariely attempts to answer the fundamental question of what makes people tick. Each chapter describes a force that influences our behavior. It invites the reader to think beyond the experiments and stories described in the book and see how the understanding of our irrationality can be used for better products, policies, and decision-making.
My key takeaways:
We are all far less rational than the standard economic theory assumes.
Moreover, we are predictably irrational: our irrationality happens the same way, again and again.
Understanding irrationality and its predictable patterns is important for our everyday actions and decisions and for designing our environment and the choices it presents to us.
Behavioral economics deals with human nature and our predicable irrationality, our heuristics, and biases. They have wide implications for life, business, and public policy.
Everything is Relative
Humans rarely choose things in absolute terms. We are always looking at the things around us in relation to others.
We not only tend to compare things with one another but also tend to focus on comparing things that are easily comparable—and avoid comparing things that cannot be compared easily.
The decoy effect is built around relativity.
Relativity helps make decisions in life. But it can also make us downright miserable. Why? Because jealousy and envy spring from comparing our lot in life with that of others.
The more we have, the more we want. And the only cure is to break the cycle of relativity.
2. The Fallacy of Supply and Demand
Mark Twain: "In order to make a man covet a thing, it is only necessary to make the thing difficult to attain."
Anchoring: When we encounter a new product, for instance, we accept the first price that comes before our eyes. And more importantly, that price (which in academic lingo we call an anchor) has a long-term effect on our willingness to pay for the product from then on.
Arbitrary coherence: although initial prices are “arbitrary,” once those prices are established in our minds they will shape not only present prices but also future prices (this makes them “coherent”).
Similarly, our first decisions resonate over a long sequence of decisions.
Behavior herding: It happens when we assume that something is good (or bad) on the basis of other people’s previous behavior, and our own actions follow suit. But there’s also another kind of herding, one that we call self-herding. This happens when we believe something is good (or bad) on the basis of our own previous behavior.
With everything you do, in fact, you should train yourself to question your repeated behaviors.
What consumers are willing to pay can easily be manipulated, and this means that consumers don’t in fact have a good handle on their own preferences and the prices they are willing to pay for different goods and experiences.
Market prices themselves influence consumers’ willingness to pay. What this means is that demand is not, in fact, a completely separate force from the supply.
if our choices are often affected by random initial anchors, as we observed in our experiments, the choices and trades we make are not necessarily going to be an accurate reflection of the real pleasure or utility we derive from those products.
A free market based on supply, demand, and no friction would be ideal if we were truly rational. Yet when we are not rational but irrational, policies should take this important factor into account.
3. The Cost of Zero Cost, or Paying Too Much When We Pay Nothing
Zero is not just another price, it turns out. Zero is an emotional hot button—a source of irrational excitement.
FREE! can lead us into trouble: things that we would never consider purchasing become incredibly appealing as soon as they are FREE!
The critical issue arises when FREE! becomes a struggle between a free item and another item—a struggle in which the presence of FREE! leads us to make a bad decision.
Most transactions have an upside and a downside, but when something is FREE! we forget the downside. FREE! gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is.
The concept of zero also applies to time. Time spent on one activity, after all, is the time taken away from another.
Most policy strategists realize that FREE! is an ace in their hand, let alone know how to play it. It’s certainly counterintuitive, in these times of budget cutbacks, to make something FREE! But when we stop to think about it, FREE! can have a great deal of power, and it makes a lot of sense.
4. The cost of social norms
We are happy to do things, but not when we are paid to do them.
We live simultaneously in two different worlds—one where social norms prevail, and the other where market norms make the rules.
People are willing to work free, and they are willing to work for a reasonable wage; but offer them just a small payment and they will walk away.
Story: The sensei (the master teacher) was not charging the group for the training. The students, feeling that this was unfair, approached the master one day and suggested that they pay him for his time and effort. Setting down his bamboo shinai, the master calmly replied that if he charged them, they would not be able to afford him.
If you want a social relationship, go for it, but remember that you have to maintain it under all circumstances.
Money, it turns out, is very often the most expensive way to motivate people. Social norms are not only cheaper but often more effective as well. There are social rewards that strongly motivate behavior—and one of the least used in corporate life is the encouragement of social rewards and reputation. In social exchange, after all, people believe that if something goes awry the other party will be there for them, to protect and help them. If companies want to benefit from the advantages of social norms, they need to do a better job of cultivating those norms.
Education: standardized testing and performance-based salaries are likely to push education from social norms to market norms.
5. How free can make us less selfish
When we add money to a situation that operates on social norms, motivation can decrease rather than increase.
When we offer people a financial payment in a situation that is governed by social norms, the added payment could actually reduce their motivation to engage and help out.
When the price is not a part of the exchange, we become less selfish maximizers and start caring more about the welfare of others.
The dark side of putting a price on pollution: policymakers should be careful not to add market norms that could undermine the social ones.
6. The influence of arousal: hot is much hotter than we realize
Every one of us, regardless of how “good” we are, underpredicts the effect of passion on our behavior.
In Freudian terms, each of us houses a dark self, a brute that can unpredictably wrest control away from the superego.
“Just say no” assumes we can turn off passion at will, at any point, whereas our study shows this assumption to be false.
Lesson: not to "drive" when their emotions are at a boil.
7. The problem of procrastination and self-control
Giving up on our long-term goals for immediate gratification is procrastination.
Tightly restricting freedom (equally spaced deadlines, imposed from above) is the best cure for procrastination.
Without pre-commitments, we keep on falling for temptation.
When we have problems with self-control, sometimes we delay tasks that we should do immediately. But we also exhibit problems with self-control when we attend too frequently to tasks that we should put off—such as obsessively checking our e-mail.
If a particular desired behavior results in an immediate negative outcome (punishment), this behavior will be very difficult to promote, even if the ultimate outcome (in my case, improved health) is highly desirable.
By pairing something that we love with something that we dislike but that is good for us, we might be able to harness desire with the outcome—and thus overcome some of the problems with self-control we face every day.
8. The high price of the ownership
We overvalue what we have.
The endowment effect: when we own something—whether it’s a car or a violin, violin, a cat or a basketball ticket—we begin to value it more than other people do.
We fall in love with what we already have. We focus on what we may lose, rather than what we may gain. We assume other people will see the transaction from the same perspective as we do.
We can begin to feel ownership even before we own something. “Virtual ownership,” of course, is one mainspring of the advertising industry.
One approach to overcome the endowment effect is to try to view all transactions (particularly large ones) as if we were a nonowner, putting some distance between ourselves and the item of interest.
9. Keeping doors open
Options can distract us from our main objective.
Normally, we cannot stand the idea of closing the doors on our alternatives. We might not always be aware of it, but in every case, we give something up for those options.
In running back and forth among the things that might be important, we forget to spend enough time on what really is important.
In 1941 the philosopher Erich Fromm wrote a book called Escape from Freedom. In a modern democracy, he said, people are beset not by a lack of opportunity, but by a dizzying abundance of it.
What we need is to consciously start closing some of our doors. Yet, even when there are just two left, the choice is not easy. In fact, choosing between two things that are similarly attractive is one of the most difficult decisions we can make. This is a situation not just of keeping options open for too long, but of being indecisive to the point of paying for our indecision in the end.
When we focus on the similarities and minor differences between two things, we often forget to take into account the consequences of not deciding.
10. The Effect of Expectations
Expectations can influence nearly every aspect of our life.
If you tell people up front that something might be distasteful, the odds are good that they will end up agreeing with you—not because their experience tells them so but because of their expectations.
When the coffee ambiance looked upscale, in other words, the coffee tasted upscale as well.
That’s what marketing is all about—providing information that will heighten someone’s anticipated and real pleasure.
Expectations also shape stereotypes. A stereotype is a way of categorizing information, in the hope of predicting experiences. The brain cannot start from scratch in every new situation.
Research on stereotypes shows not only that we react differently when we have a stereotype of a certain group of people, but also that stereotyped people themselves react differently when they are aware of the label that they are forced to wear (in psychological parlance, they are “primed” with this label).
Even our own behavior can be influenced by our stereotypes.
Ambiance and expectations do add a great deal to our enjoyment.
Best advice to live an objective life: "Blessed is he who expects nothing, for he shall never be disappointed.” (Alexander Pope)
And at the same time, positive expectations allow us to enjoy things more and improve our perception of the world around us. The danger of expecting nothing is that, in the end, it might be all we’ll get.
11. The power of price
Expectations change the way we perceive and appreciate experiences.
Placebo effect: placebos run on the power of suggestion. They are effective because people believe in them. Two mechanisms shape the expectations that make placebos work. One is belief—our confidence or faith in the drug, the procedure, or the caregiver. The second mechanism is conditioning. Like Pavlov’s famous dogs (that learned to salivate at the ring of a bell), the body builds up expectancy after repeated experiences and releases various chemicals to prepare us for the future.
When it comes to medicines, then, you get what you pay for. Price can change the experience.
If placebos can make us feel better, should we simply sit back and enjoy them? Or are placebos patently bad—shams that should be discarded, whether they make us feel good or not?
In reality, physicians provide placebos all the time.
Experiments, particularly those involving medical placebos, raise many important ethical questions.
12. The cycle of distrust
People, in general, are starting to understand that the offers companies put before us are in their best interest and not ours. As a consequence, we’ve become more distrustful—not only of those who are trying to swindle us but of everyone.
Trust, like money, is a crucial lubricant for the economy.
The tragedy of the commons: when we use a common resource at a rate that is slower than the rate at which it replenishes, all is well. However, if a few individuals get greedy and use more than their share, the system of consumption becomes unsustainable, and in the long term, everybody loses. In essence, the tragedy of the commons is about two competing human interests. On one hand, an individual should care about the sustainability of shared resources in the long term because everyone, including the individual, benefits from it. At the same time, in the short term, the individual benefits immediately from taking more than his or her fair share.
Because human beings tend to focus on short-term benefits and our own immediate needs, such tragedies of the commons occur frequently.
If we start to think about trust as a public good (like clean air and water), we see that we can all benefit from higher levels of trust in terms of communicating with others, making financial transitions smoother, simplifying contracts, and many other business and social activities.
Yet as the tragedy of the commons exemplifies, in the short term it is beneficial for each individual to violate and take advantage of the established trust.
Despite the difficulties of overcoming broken trust, I think that it is possible to repair it, given the right amount of investment and direction (Johnson & Johnson Tylenol story). Another promising way for companies to create trust is by proactively addressing consumers’ complaints. A more extreme version of this idea is for companies to make themselves transparent and vulnerable.
The boy who cried wolf. There are two morals to the story. The first is that people are willing to forgive a bit of lying. But the second, more important moral—one that we are just beginning to understand—is that trust, once eroded, is very hard to restore.
13. Why we are dishonest, and what we can do about it
There might be two types of dishonesty. The first, classical. On the basis of this cost-benefit calculation, they decide whether to rob the place or not. The second kind is committed by people who generally consider themselves honest.
When given the opportunity, many honest people will cheat. Once tempted to cheat, they don't seem to be as influenced by the risk of being caught as one might think.
If honesty makes us feel good, why are we so frequently dishonest? Our internal honesty monitor is active only when we contemplate big transgressions.
The cure against dishonesty? Public affirmation: professional oaths, public commitments, signing honor code.
A simple evoking of the Ten Commandments before an act reduces cheating. The effect of signing a statement about an honor code exists even if an institution does not have an honor code.
People cheat when they have a chance to do so, but they don’t cheat as much as they could. Moreover, once they begin thinking about honesty—whether by recalling the Ten Commandments or by signing a simple statement—they stop cheating completely.
14. Dealing with cash makes us more honest
When we look at the world around us, much of the dishonesty we see involves cheating that is one step removed from cash. Cheating is a lot easier when it’s a step removed from money.
The lower boundary of human dishonesty: the level of dishonesty practiced by individuals who want to be ethical and who want to see themselves as ethical—the so-called good people.
15. What is behavioral economics, and where are the free lunches?
We are not noble in reason, not infinite in faculty, and rather weak in apprehension.
We are all far less rational in our decision-making than standard economic theory assumes. Our irrational behaviors are neither random nor senseless—they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains. So wouldn’t it make sense to modify standard economics and move away from naive psychology, which often fails the tests of reason, introspection, and—most important—empirical scrutiny?
Wouldn’t economics make a lot more sense if it were based on how people actually behave, instead of how they should behave?
The fact that we make mistakes also means that there are ways to improve our decisions—and therefore that there are opportunities for “free lunches.”
ONE OF THE main differences between standard and behavioral economics involves this concept of “free lunches.” According to the assumptions of standard economics, all human decisions are rational and informed, motivated by an accurate concept of the worth of all goods and services and the amount of happiness (utility) all decisions are likely to produce. Under this set of assumptions, everyone in the marketplace is trying to maximize profit and strive to optimize his experiences. As a consequence, the economic theory asserts that there are no free lunches—if there were any, someone would have already found them and extracted all their value.
Behavioral economists, on the other hand, believe that people are susceptible to irrelevant influences from their immediate environment (which we call context effects), irrelevant emotions, shortsightedness, and other forms of irrationality (see any chapter in this book or any research paper in behavioral economics for more examples). What good news can accompany this realization? The good news is that these mistakes also provide opportunities for improvement.
One main lesson from the research described in this book is that we are pawns in a game whose forces we largely fail to comprehend. We usually think of ourselves as sitting in the driver’s seat, with ultimate control over the decisions we make and the direction our life takes; but, alas, this perception has more to do with our desires—with how we want to view ourselves—than with reality.
Each of the chapters in this book describes a force (emotions, relativity, social norms, etc.) that influences our behavior. And while these influences exert a lot of power over our behavior, our natural tendency is to vastly underestimate or completely ignore this power.
Visual illusions are also illustrative here. Just as we can’t help being fooled by visual illusions, we fall for the “decision illusions” our minds show us. The point is that our visual and decision environments are filtered to us courtesy of our eyes, our ears, our senses of smell and touch, and the master of it all, our brain. By the time we comprehend and digest information, it is not necessarily a true reflection of reality. Instead, it is our representation of reality, and this is the input we base our decisions on. In essence, we are limited to the tools nature has given us, and the natural way in which we make decisions is limited by the quality and accuracy of these tools.
A second main lesson is that although irrationality is commonplace, it does not necessarily mean that we are helpless. Once we understand when and where we may make erroneous decisions, we can try to be more vigilant, force ourselves to think differently about these decisions or use technology to overcome our inherent shortcomings. This is also where businesses and policymakers could revise their thinking and consider how to design their policies and products so as to provide free lunches.