Predictably Irrational – the hidden forces that shape our decisions

Seeing that I make my fair share of irrational decisions, I was curious about why I do that. Dan Ariely, a Professor of Psychology and Behavioral Economics at Duke, explains some of our irrational behavior in his book, Predictably Irrational. It was on offer this month for the princely sum of $1.99 (Kindle edition) so I treated myself. Otherwise your local library may have the book for free.

Here’s the author touching on some of the topics in the first chapter of the book at a TED talk.

The book is full of anecdotes and scientific studies across all kinds of topics that illustrate irrational behavior we do, which make for an entertaining read. It’s an easy read covering irrational behaviors in financial choices, social interactions, selfishness, procrastination, integrity and yes, even sex.

An irrational example

Suppose you were shopping for an expensive suit in a store and had found the perfect suit for $450. Just before you were going to buy it, you learned that the exact same suit is on sale for $443 in another store 15 minutes away. Chances are, that you’d likely go ahead with the purchase compared to the effort of going to the other store. After all it’s only seven dollars cheaper.

But, instead of buying a suit, suppose you were buying a book for $10 and learned that it was only $3 in the other store. You’re now much more likely to go to the other store since the savings are so much ‘higher’. Yet you’ve still only saved $7. So what’s up with that?

Many of our decisions are¬†framed by relative comparisons. In the same way, adding $3,000 to a $25,000 car purchase for leather seats is an easier decision than buying a brand new $3,000 leather sofa, even if you’ll likely spend much more time on the sofa.

And of course smart companies know this when they price their products, especially when selecting from within a given product range. It’s a subtle form of anchoring where the high and low prices drive you to pick something in the middle since it feels ‘better value’ yet also makes you feel good because it’s ‘not the most expensive’.

Anchoring

Chapter two expands on anchoring and also gives some insight into the psychology of Starbucks. By making a coffee-house environment that seemed more up-market and fashionable than competitors, they made a new price anchor for their products. Once you’ve bitten the price bullet so to speak, then over time the purchase decision moves away from “should I go to Starbucks?” towards “should I buy a Venti instead of a Grande?”. Going to Starbucks now becomes a habit.

Blinded by Free!

Chapter three looks at the distraction that a “Free” service or product provides. When something is free there’s no perceived risk to it so it’s inherently more attractive.

In a choice between a free $10 Amazon Gift Card, or paying $7 for a $20 Gift card, the free $10 option is commonly picked even though the $7 for $20 choice is better value.

Yet when choosing between a $10 Gift Card for $1 or paying $8 for a $20 Gift Card, the $20 Gift card becomes the most popular choice as expected.

Social Norms

Chapter four discusses the difference between two different worlds: the social world and the market world. We live in both simultaneously. A simple example of this is going to someone’s house for dinner. As the host greets you, would you offer them a $10 bill or give them a $10 gift?

Giving a gift is squarely in the social world, even if the host might not value the $10 bottle of wine as much as you do. Yet offering cold cash invokes the market world and probably ensures you won’t be re-invited. Dinner just became a business transaction.

The last chocolate standing

Chapter five combines the effects of free with social behavior. You’re sitting at a table with a group of friends with a plate of chocolates in the middle. Should you take just one, or two or more? And have you noticed how hard it is for the last chocolate to be taken?

That’s because the plate has become a shared resource so now social behavior is affecting your decisions. If you had to pay ten cents per chocolate, these conflicts go away and you’d have as many as you chose to pay for. Paying for things tends to make people more selfish (an “it’s mine! I paid for it” mentality), whereas a group resource tends to make people less selfish.

Irrational behavior when aroused

This was probably a fun subject to study in Chapter six, but as you might already know, people make poor decisions in the throes of passion. Men in particular. I will say no more.

Don’t do today what you can do tomorrow

Procrastination, a topic I’m very familiar with, is covered in Chapter seven. I did not know that the word comes from the Latin pro (meaning for) and cras (meaning tomorrow). Here procrastination is defined as “giving up long-term goals for immediate gratification“.

One offered solution is to find a way to reward yourself for something that you don’t like doing. So to encourage exercise, you might only watch a movie after the session as a reward.

Over-valuation

Chapter eight discusses how we over-value things that we own, be it a house, a car, a music collection etc. There are exceptions due to ignorance (otherwise the Antiques Roadshow wouldn’t be much fun), but generally speaking our emotions cloud the value we put on things.

When pricing something we consider more what we would lose (the memories and effort that went into the item) than what we will gain (money). And this is one of the tricks behind “trial” offers since companies know that once you have something, you’re more likely to value it more and so keep it.

Too many choices

Chapter nine was probably my favorite chapter as it talks about the problem of having too many choices. It’s human nature to want to keep as many options as possible in front of us, yet sometimes it’s better to focus, pick something and move on. Ironically the hardest choice is to pick between two similarly attractive options. Yet there are opportunity costs to not making any decision.

Another way I look at this is in the quote “Perfect is the enemy of Good”, popularized by Voltaire back in the 1700’s. Incidentally the phrase also showed up in Shakespeare’s King Lear from the 1600’s but it seems “striving to better, oft we mar what’s well” wasn’t as catchy. Either searching for the best solution or choice can result in not doing anything or wasting time for little gain.

Making investment decisions falls into this category too. It’s better to focus on a strategy than continually trying out different things to see “if they work”. And having some mechanical rules on buy/sell decisions can help take away some of the emotional impulses.

Expected results

Chapter ten highlights how our expectations shape our decisions. This touches on brand recognition but also our biases. Is “Asian-style ginger chicken” going to be tastier than a “succulent organic breast of chicken roasted to perfection and drizzled with a merlot demi-glace”? We’d likely expect the second to be better and might well pay more for it based on the description alone.

This is similar to the effect of giving someone some unusual food. Typically they’ll enjoy the food better if they don’t know what it was until afterwards. But knowing that they’re about to eat something that appears unappealing lowers their expectations.

The effect of price

The placebo effect is well-known and discussed in chapter eleven. The benefits are a function of expectation; partly from the belief that the drug or procedure will work and party from the body’s response in expectation of the treatment.

But more expensive medicine also makes people feel better too, and this effect is discussed too. Is a 50-cent aspirin better than a 1-cent aspirin? For most people, it is.

The effect of trust

Trust is a hard-earned and easily lost currency. The Public Goods Game is shown as an example where total returns drop once trust in a player is lost.

For companies in particular, losing trust can be a big deal and hard to regain. Johnson & Johnson are cited in the book for going the extra mile to regain consumer trust after the 1982 Tylenol incident. The author makes the case that the more successful companies will embrace building a trusting relationship with their customers, even if there’s no tangible return on investment. Timberland is listed as one example here.

Honesty

In 2004, the total cost of all robberies, burglaries and consumer theft in the US was estimated at $16 million. Yet the total cost of theft and fraud in the workplace was estimated at $600 billion. Chapter thirteen looks at what makes typically ‘honest’ people cheat. The conclusion is that most people have a tendency to cheat “a little bit”.

Interestingly enough, when the same tests were performed with the students first signing a “I’ve read the honor code” statement, nobody cheated. Even though the honor code wasn’t read (it didn’t exist).

The effect of cash

Chapter fourteen continues the look into honesty and the irrational behavior regarding cash. Many people would take home a ten-cent pencil from work. Yet few people would take ten cents from an open jar of money and use that to buy a ten cent pencil. Logically it’s the same thing, yet it’s considered differently. So how much worse might honesty suffer in a cash-less society?

Free beer

The final chapter of the book discusses the differences between standard economics and behavioral economics. We’re always presumed to be making logical decisions. And even if we make a bad decision, we’re expected to learn from it and correct it the next time. Yet we typically fall into irrational behavior that’s largely predictable.

Americans in general have a pretty low savings rate. Partly this is due to increased consumerism – new houses today have large closets (which must be filled) whereas in the 50’s they didn’t. Yet in standard economic theory, people are saving exactly the right amount of money since they’re rational: perhaps they don’t care about the future, expect their children to look after them, etc.

But in behavioral economics, the savings rate is clearly too low, since it considers people as being irrational. People don’t save for many reasons even when earning a large salary.

Summary

There’s a lot of information in this 382 page book and I enjoyed reading it. I agree with the author’s premise that “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 [and perception] than with reality.

The good news is that once we’re aware of our limitations, we can learn to recognize when we’re being irrational in our decision-making and re-evaluate. In trying to improve myself, it helps to understand the “why” behind some of my wants, and be able to question them. The two chapters on Procrastination (seven) and Choices (nine) are two areas I want to improve on in 2017.

 

Quote of the day

Either write something worth reading or do something worth writing.

 


4 thoughts on “Predictably Irrational – the hidden forces that shape our decisions”

    1. Hi Stal,
      Thanks for stopping by. I hope you’re enjoying the holidays!
      The book was certainly interesting and covered a variety of topics. Well worth a read if you can find a copy.
      Best wishes,
      -DL

  1. I love books like this, I will have to check it out. I have a goal for 2017 of reading 75 books… add it to the list!

    Have you read the book, The Power of Mathematical Thinking, or Thinking Fast and Slow? These books also talk about unique things that humans do that are not rational.

    Erik

    1. Hi Erik,
      Thanks for the recommendations! I’ve added them to my reading list too. I’ve not read a book from Dan Kahneman yet; just read some of his research indirectly so will probably start there.
      You might be interested in The Drunkard’s Walk by Leonard Mlodinow. It’s more a history of probability and how we misunderstand it, but it’s also an interesting read.
      Thanks for stopping by & wishing you a happy and healthy 2017,
      -DL

Leave a Reply

Your email address will not be published. Required fields are marked *