Book Review: Predictably Irrational

Posted: June 14th, 2009 under book review, education, food, philosophy, psychology.
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I just read a fascinating book called Predictably Irrational by Alfred P. Sloan Professor of Behavioral Economics at MIT, Dan Ariely. He explores the idea that our irrationality happens the same way again and again. He performs several experiments and examines the way we make decisions, coming up with some interesting findings.

Predictably Irrational by Dan Ariely

Ariely begins the first chapter by discussing relativity:

There’s one aspect of relativity that trips us up. It’s this: 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.

He writes that evaluating two houses side by side yields different results than evaluating three: A, B, and a somewhat less appealing version of A. The subpar A makes it easier to decide that A is better–not only better than the similar one, but better than B. The lesser version of A should have no effect on your rating of the other two buildings, but it does.

Most people don’t know what they want unless they see it in context. Ariely performed an experiment at MIT in which he selected pairs of photos of random people: one of them physically attractive (A), and the other one noticeably less so (B) in each pair. He then doctored the photo in Photoshop, creating a slightly but noticeably less attractive version of each of them–a decoy (-A and -B). He then approached students, presenting them with three pictures. Some of them had the regular picture (A), the decoy of that picture (-A), and the other regular picture (B). Others had the regular picture (B), the decoy of that picture (-B), and the other regular picture (A).

Whenever I handed out a sheet that had a regular picture, its inferior version, and another regular picture, the participants preferred the regular person–the one who was similar, but clearly superior, to its distorted version over the other, undistorted person on the sheet. This was not just a close call; it happened 75 percent of the time.

Humans rarely choose things in absolute terms. We don’t have an internal value meter that tells us how much things are worth. Rather, we focus on the relative advantage of one thing over another, and estimate value accordingly.

Ariely discusses our inability to broaden our focus, using an ink pen and a dress suit as an example.

Suppose you found a nice pen for $25, then remember the same pen is on sale for $18 at a store 15 minutes away. Would you make the trip to save the $7? Most people faced with this dilemma say that they would take the trip to save $7. Now suppose you found a luxurious suit for $455, but then find out you could purchase the same suit for only $448 at another store, 15 minutes away. In this case, most people say they would not make this trip to save the $7.

This seems rather ridiculous! Is the trip across town–the extra time and fuel–worth the extra $7 you would save? $7 is $7, no matter how you spend it.

We look at our decisions in a relative way and compare them locally to the available alternative. We compare the relative advantage of the cheap pen with the expensive one, and this contrast makes it obvious to us that we should spend the extra time to save the $7. At the same time, the relative advantage of the cheaper suit is very small, so we spend the extra $7. This is why it is so easy for a person to add $200 to a $5000 catering bill for a soup entrée, when the same person will clip coupons to save 25 cents on a one-dollar can of condensed soup.

I like Ariely’s illustration of demand and supply in chapter 2:

Imagine two new taxes on milk and wine will be introduced tomorrow. One will cut the price of wine by 50% and the other will increase the price of milk by 100%. These prices changes will surely affect consumption, and many people will walk around slightly happier and with less calcium. I suspect that the price changes would make a huge impact on demand if people remembered the previous prices and noticed the price increases; but I also suspect that if people had no memory of past prices, the consumption of milk and wine would remain essentially the same, as if the prices had not changed. If the government one day decided to impose a tax that doubled the price of gasoline, people would initially compare the new prices with their anchor and might pull back on their gasoline consumption, and maybe even get a hybrid car. But over the long run, and once consumers readjusted to the new price and the new anchors, our gasoline consumption at the new price might in fact get close to the pretax level.

Comparison changes the value of things, and we use “anchors”ť to determine value. Smart retailers will place very pricey wine on the shelf, for instance, to make the slightly less pricey wine seem cheaper and therefore more appealing.

Chapter 3 explains how zero/free is a source of irrational excitement. Ariely calls this the “zero price effect.” His theory is that for normal transactions, we consider both upside and downside. But when something is free, we forget about the downside. “Free” gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is. People will wait in line for absurdly long times to get something for free. They will purchase an item just to get a second item free, even though they would not have otherwise purchased the first item. They will eagerly collect free items, only to throw them away or allow them to take up valuable space.

Humans are loss-averse; when considering a normal purchase, loss-aversion comes into play. But when an item is free, there is no visible possibility of loss.

Ariely, Kristina Shampanier, and Nina Mazar conducted an experiment using fine Lindt truffles and ordinary Hershey’s Kisses. They set up a table at a large public building and offered the two different kinds of chocolates with a sign that read “One chocolate per customer.” When a truffle was 15 cents and a Kiss was a penny, 73% of subjects chose the truffle and 27% selected the Kiss. They reduced the prices by one penny. When the truffle was priced at 14¢ and the Kiss was free, 69% chose the kiss and 31% chose the truffle. Ariely said “According to standard economic theory, the price reduction shouldn’t lead to any behavior change (relative price and expected pleasure should be equal between the two experiments).”

Ariely theorizes in chapter 4 that we are happy to do things, but not when we are paid to do them. We live in two worlds; one where social norms prevail, and another where market norms make the rules. Social norms such as reciprocity are warm and fuzzy, with no explicit quid pro quo, while market norms are explicit and hard–you get what you pay for. Introducing market norms into social exchanges violates the social norms and hurts the relationships. Once this type of mistake has been committed, recovering a social relationship is difficult.

A few years ago, the AARP asked some lawyers if they would offer less expensive services to needy retirees, at something like $30 an hour. The lawyers said no. Then the program manager from AARP had a brilliant idea: he asked the lawyers if they would offer free services to needy retirees. Overwhelmingly, the lawyers said yes.

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.

In chapter 5 Ariely discusses the influence of arousal. He and George Loewenstein conducted an experiment on Berkeley undergrads. They asked the students a series of questions while they were in a cold, dispassionate state. The students predicted what their sexual and moral decisions would be if they were aroused. Then they had the participants stimulate themselves to a state of sexual arousal, and asked them to answer the same set of questions predicting their decisions.

This time, since they were actually in the grip of passion, they were presumably more aware of their preferences in that state. The results showed that people simply don’t realize how different their decision-making is during a state of arousal. Sexual prevention, protection, conservatism, and morality disappeared completely once they became aroused.

Ariely covers procrastination and self-control in the sixth chapter. He conducted an experiment on his class in which students were required to write three papers. He asked the first group to commit to self-imposed dates by which they would turn in each paper. Late papers would be penalized 1% per day, but there was no penalty for turning papers in early. The logical response is to commit to turning all three papers in on the last day of class. The second group was given no deadlines; all three papers were due in the last day of class. The third group was directed to turn their papers in on the 4th, 8th, and 12th weeks. Group 3 (imposed deadlines) got the best grades. Group 2 (no deadlines) got the worst grades, and Group 1 (self-selected deadlines) finished in the middle. Allowing students to pre-commit to deadlines improved performance. Students who spaced out their commitments did well; students who did the logical thing and gave no commitments did badly.

These results suggest that although almost everyone has problems with procrastination, those who recognize and admit their weakness are in a better position to utilize available tools for pre-commitment and by doing so, help themselves overcome it.

In chapter 9 we find that previously held expectations can cloud our point of view; the mind gets what it expects. Ariely, Leonard Lee, and Shane Frederick performed an experiment on MIT students. They let students taste two different beers, and then choose to get a free pint of one of the brews. Brew A was Budweiser, and brew B was Budweiser, plus 2 drops of balsamic vinegar per ounce. When students were not told about the nature of the beers, they overwhelmingly chose the balsamic beer. When students were told about the true nature of the beers ahead of time, they overwhelmingly chose the Budweiser. If you tell people up front that something might be distasteful, the odds are good they’ll end up agreeing with you—because of their expectations.

When we believe something will be good, it generally will be good, and when we think it will be bad, it will be bad. But does finding out the truth after the experience change one’s mind? Ariely conducted the beer experiment again, but with a twist. The students would taste the beer first. Only then they would be told the truth. And after that, they would be asked their opinions. If the knowledge merely informs us, whether you found out about the vinegar before or after the tasting should be irrelevant. On the other hand, if the knowledge actually reshapes sensory experiences, being told beforehand would have a radically different effect. People who were told afterward about the vinegar liked the beer just as much as those who weren’t aware of the vinegar at all. In other words, knowledge affected the sensory experience.

Ariely, Elie Ofek, and Marco Bertini conducted another experiment using coffee. They offered students a free cup of coffee and asked them to indicate how much they liked the coffee, and how much they’d be willing to pay for it. They also set out a table of condiments, some usual, some unusual (cloves, nutmeg, cardamom, etc.). None of the students used the unusual condiments. When the condiments were served in fancy containers (versus white Styrofoam cups), the students were much more likely to say that they liked the coffee, and were willing to pay more for it.

When the coffee ambiance looked upscale, the coffee tasted upscale as well. Beliefs and expectations affect how we perceive and interpret sights, tastes, and other sensory phenomena, and our expectations can affect us by altering our subjective and even objective experiences—sometimes profoundly so.

Ariely illustrates the power of price in the tenth chapter of his book. In 1955 Dr. Leonard Cobb, a cardiologist, decided to try to prove the efficacy of a procedure called internal mammary artery litigation.

He performed the operation of half his patients and fake the procedure on the other half. Then he would see which group felt better, and whose health actually improved. The real surgery meant opening the patient up and tying up the internal mammary artery. In the placebo procedure, the surgeon merely cut into the patient’s flesh with a scalpel, leaving two incisions. Both sets of patients reported immediate relief from their chest pain. In both groups, the relief lasted about 3 months—and then complaints about chest pain returned. Meanwhile, the electrocardiograms showed no difference between those who had undergone the real operation and those who got the placebo operation.

More recently in 1993, a different medical procedure was submitted to a similar test, with surprisingly similar results: arthroscopic surgery for a particular arthritic affliction of the knee.

The effectiveness of placebos is based on the power of suggestion. They are effective because people believe in them. The placebo effect is a real psychobiological phenomenon whereby the brain is actively involved and anticipates a clinical benefit. Ariely maintains that placebos can actually trigger endorphins and opiates and other biological reactions that actually change body and experience. What is interesting, however, is that price has an impact on efficacy.

Ariely, Rebecca Waber, Baba Shiv, and Ziv Carmon made up a fake painkiller, Veladone-Rx. Subjects were told that 92% of patients receiving Veladone reported significant pain relief in 10 minutes, with relief lasting up to 8 hours. They were then attached to electrodes which delivered a series of electrical shocks. The initial shocks were merely annoying, then gradually became more painful. The subjects were then given the Veladone capsules. When told that the drug cost $2.50 per dose, nearly all of the subjects reported pain relief. When told that the drug cost 10 cents per dose, only half of the subjects reported pain relief. A similar study at University of Iowa showed that students who paid list price for cold medications reported better medical outcomes than those who bought discount (but clinically identical) drugs.

Our mind controls our body by reducing the level of stress, changing hormonal secretions, changing the immune system, etc. In reality, physicians prescribe placebos all the time. Even if they know a cold is viral rather than bacterial, they will still prescribe antibiotics because they know the patient wants some sort of relief; most commonly, the patient wants to walk out with a prescription.

America already spends more of its GDP per person on health care than any other Western nation. How do we deal with the fact that expensive medicine may make people feel better than cheaper medicine? Do we indulge people’s irrationality, thereby raising the costs of health care? Or do we insist that people get the cheapest generic drugs and medical procedures on the market? How do we structure the cost and co-payment of treatments to get the most out of medications, and how can we provide discounted drugs to needy populations without giving them treatments that are less effective? We’ve seen that the perception of value can become real value. If people actually get more satisfaction out of a product that has been hyped, has the market done anything worse than sell the sizzle along with the steak?

The mind actually has the power to anticipate a clinical benefit and act on some physiological functions. It’s not just a matter of fooling oneself; placebos can be a truly effective remedy and relief.

Experiments, particularly those involving medical placebos, raise many important ethical questions. The idea of sacrificing the well-being and perhaps even the life of individuals in order to learn whether a particular procedure should be used on other people at some point in the future is difficult to swallow. At the same time, by not carrying out placebo experiments can result in hundreds or thousands of people undergoing useless (but risky) operations. In the United States very few surgical procedures are tested scientifically. For that reason, we don’t really know whether many operations really offer a cure or whether they are effective merely because of their placebo effect.

Ariely examines the context of our character in chapters 11 and 12. He conducted an experiment on Harvard students. He gave students a 50-question, multiple-choice quiz. They would take the quiz, and then transfer the answers to a bubble sheet. The students received 10 cents for each correct answer. The results of the experiment demonstrated that given the opportunity, many honest people will cheat, yet still don’t become wildly dishonest (similar experiments were conducted at MIT, Princeton, UCLA, and Yale with similar results).

We care about honesty and want to be honest. The problem is that our internal honesty monitor is active only when we contemplate big transgressions, like grabbing an entire box of pens. For little transgressions like taking a single pen, we don’t even consider how these actions would reflect on our honesty.

Nina Mazur, On Amir, and Ariely held another experiment in which they asked one group to write down 10 books they had read in high school, and the other group was asked to try to recall and write down the Ten Commandments. When cheating was not possible, the average score was 3.1. When cheating was possible, the book group reported a score of 4.1 (33% cheating), and the Ten Commandments group scored 3.1 (0% cheating). Most of the subjects couldn’t even recall all of the Commandments! Ariely performed a similar experiment using an MIT “honor code” statement to replace the Ten Commandments. The results were strikingly similar.

This indicated that it was not the Commandments themselves that encouraged honesty, but the mere contemplation of a moral benchmark of some kind. In the cost-benefit analysis, individuals are honest only to the extent that suits them. As we grow up in society, we internalize the social virtues; this leads to the development of the superego. When we are removed from any benchmarks of ethical thought, we tend to stray into dishonesty. But if we are reminded of morality at the moment we are tempted, then we are much more likely to be honest.

Would you feel bad about taking a pen for you child? How about taking 10 cents from petty cash to pay for a pen for your child? The two are economically identical, but get very different reactions. Ariely suggests that cheating is a lot easier when it’s a step removed from money. He asked students to solve 20 simple math problems and promised them 50 cents for each correct answer. Students told the proctor their score. The control group which had no opportunity to cheat solved 3.5 questions. The other two groups had the opportunity to cheat; however one group was immediately rewarded the 50 cents while the other received tokens in which they could exchange for the cash (within a matter of seconds). The cash group claimed to have solved 6.2 questions…definite cheating. The token group claimed to have solved 9.4 problems…brazen dishonesty. Switching from cash to an equivalent non-monetary currency doubled cheating! We have no idea how dishonest we are.

Ariely determines that people who have their assistants turn in their expense reports (rather than turning them in personally) are much more likely to cheat. Businesspeople are more likely to claim dubious expenses when they are traveling across the country than when they are in their home city, or even just returning from the airport. When consumers report losses on their homes and cars, they creatively stretch their claims by about ten percent.

We need to wake up to the connection between non-monetary currency and our tendency to cheat. We need to recognize that once cash is a step away, we will cheat by a factor bigger than we could ever imagine. We need to wake up to this–individually and as a nation.

I highly recommend reading this book. It will certainly change the way you think about and interact with the world, and make more rational choices. Once we see how systematic certain mistakes are and how we repeat them again and again, we will begin to learn how to avoid some of them.



3 Comments »

  1. Great post! Thanks for taking the time to write it. Saves me from reading the book :-)

    One thing that struck me, is that much of this research has useful applications in marketing. For example, the “A, -A, B” stuff reminds me of an important principle: “good, better, best”.
    For a few reasons, it’s proven to be better to offer three levels of product or service than just one or two. Firstly, you cater to cheapskates, “only the best” people, and those in the middle. But also, most people will indeed choose the middle option when you have three – even if they wouldn’t have chosen that same option if it was merely the cheaper or more expensive of only two. The ‘reasoning’, I guess, being that “I don’t want the crappy option but I don’t need the expensive one – the ‘regular’ one should be fine”.

    The stuff about deadlines and perceived scarcity is also well-known to marketers, even to the point where people invent deadlines where none exists. Actually, a line I’ve seen used by people who want to use the deadline technique without inventing a bogus reason for it, goes something like, “this offer only applies until (insert date), because I prefer to do business with decisive people”

    The vinegar beer experiment reminds me of an American Wine Economists study I read about recently, where blindfolded participants were given duck pate, expensive organic dog food, and Spam… only 1 in 6 could tell the difference. They said they disliked whichever one they thought was the dog food – even if it wasn’t. (We’ll be reporting on that study in an upcoming episode of Hound TV).

    Comment by Steven Pam — June 14, 2009 @ 4:53 pm

  2. @Steven – Thanks! There was so much good information in the book, I couldn’t help but cover the entire thing. So no, I guess you don’t need to read it now. ;-)

    It’s interesting that you mention the good-better-best principal. We do tend to go for the middle ground when making decisions.

    Maybe I’ll purchase organic dog food and see how my family likes it. Ha ha! I must admit though that I do not like Spam, and I have never had the desire to try duck pate. I’m interested in watching your Hound TV study on that.

    Comment by Kirsten Uhler — June 15, 2009 @ 11:49 pm

  3. The dog food / spam study is not ours, we are merely reporting on it. Full details here: http://www.wine-economics.org/workingpapers/ (see AAWE Working Paper No. 36)

    Comment by Steven Pam — June 15, 2009 @ 11:57 pm

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