Apr

6

 Predictably Irrational by Dan Ariely is a very interesting book. A common premise in the study of economics is that people act rationally in their self-interest. Professor Ariely presents much evidence that this assumption is false. For example, most people would be willing to drive across town to save $7 on a $25 pen, but would not be willing to drive across town to save $7 on a $455 suit. Why should the answers be different? Either the expenditure of additional time and gasoline to save $7 is justified or it is not.

Most people are scrupulously honest when dealing with money, but their consciences don’t seem to be as vigilant against dishonesty in nonmonetary exchanges. While few employees would raid their employers’ petty cash drawers, many find it easy to justify taking office supplies for home use. Professor Ariely conducted an experiment in which students would be paid for each correct answer on a test. Students who were paid in cash were less likely to cheat than students who were paid in tokens that could later be redeemed for cash. In a similar experiment, people who were asked to recall the Ten Commandments before the test were less likely to cheat.

Most people have a set of social values that they consider to be on a higher plane than market or monetary values. Lawyers were more willing to provide their services to charitable causes for free than at reduced rates. Interestingly, if a relationship starts as a social relationship and “degenerates” to a mere market relationship, it is very, very hard to make it a social relationship again. At a day care center, for example, parents were initially prompt to pick up their children because they felt guilty about inconveniencing the day care workers. However, when the center introduced fines to discourage late pickups, late pickups increased, as parents no longer felt guilty; they were simply paying for additional services.

People are irrationally attracted to things they can get for free. In an experiment Professor Ariely conducted, nearly three quarters of students offered a choice between a piece of fine Swiss chocolate for 15 cents and a Hershey’s kiss for one cent chose the Swiss chocolate. However, when the professor lowered the price of each by one cent, so that the Hershey’s kisses were free, more than two thirds of the students chose the Hershey’s kisses.

There are many other interesting topics in the book, including the bias introduced by anchoring, the effects of strong emotions on behavior, the surprising effectiveness of placebos, and the tendency to overvalue things one owns. I found the insights valuable and recommend the book for specs.

Stephen Jovanovich adds:

A few empirical observations from a predictably irrational former lawyer and parent of an after-school program child:

1. People cheat with things other than money because money theft is the oldest, most easily proven crime in all cultures so humans have a very rational reason for treating money theft differently. Taking office supplies or "borrowing" tokens from other people are human actions that leave open far greater possibilities of plea bargaining.

2. Laywers donate their services to charitable causes for the same reason that companies do marketing; it is to add to their net profits through broadening their name recognition.

3. Lawyers heavily discount their fees. They do not reduce their published rates because a high "retail" rate is seen by the clients as a guarantee of quality. It is also another form of marketing/advertising.

4. The after school programs that are run by someone other than the government itself have late fees from the day they open their doors. Those late fees are their profit, and they want the parents to run behind schedule. (Some even set their clocks ahead a few minutes.) When the program's employees and owner maintain the fiction that "lateness" is a social infraction, it is for very rational reasons. The late fee is the same whether the parent is 5 minutes or 55 mintues late. By being "offended" the providers can use social pressure to push parents to be "not very" late, and make the same amount of money for a smaller expenditure of time.

As Harold Hill's competitors said, "you got to know the territory."
 


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3 Comments so far

  1. manuel bravochico on April 6, 2009 9:01 pm

    A good predecessor, Thaler "Winner's Curse". Interesting stuff, but not as readily applicable to trading as one might initially conclude. Last time I got update, Thaler was about even with the SP500 on a 5 year lookback. Still, Behavorial Econ is fun to read and listening to Thaler speak ain't bad either.

  2. Rocky Humbert on April 7, 2009 8:00 am

    These sorts of pop-social science books are frequently written with a political undertone, with little or no credit given to personal preference and personal utility curves. [Note that the author, an MIT professor, wrote a paper entitled "Dishonesty in Everyday Life and Its Policy Implications"] (1) It is entirely rational to drive across town to save $7 on a $25 pen if the purchaser derives sufficient "utils" (such as the pleasure of saving 28%) versus saving 1% on a suit. (2) Most folks buy a lot more pens than suits — hence that $7 pen savings is repeatable while the suit savings is not. (3) A pen is a fungible commodity. A suit may require repeated fittings, a skilled salesman/taylor etc. Hence there may be good functional reasons to buy a suit at a slightly more expensive shop. There are plenty of legitimate examples which suggest that folks are not profit-optimizing; however that is very different from being irrational. Happiness is not measured by one's P&L. At the risk of sounding overly cynical, the most irrational behavior is spending $25.95 to purchase this book.

  3. jeff watson on April 7, 2009 2:20 pm

    I started reading Cowen's book, "Discover Your Inner Economist" which covers much of this material in an easy read format. Although I'm only 75% through the book, I would recommend the book to everyone. Jeff

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