Predictably Irrational Book by Dan Ariely
Predictably Irrational - The Hidden Forces That Shape Our Decisions by Dan Ariely
1. Everything is relative
We don’t know what we want unless we see it “in context.” For example, our role models and our mentors inspire our life and career choices. Our minds take decisions within specific contexts, comparing and weighing the advantages of one thing or option over the other. This is “relativity.” It is how we “know” that a 6-cylinder car model is more expensive than the 4-cylinder version.
In a study, 100 respondents were asked to choose one of three kinds of subscriptions to The Economist magazine — Internet-only for $59 or Internet + print for $125. 68 respondents chose the Internet-only subscription, while the remaining 32 respondents chose the Internet + print subscription. The research question was asked again but in a different context. A third option — an annual print-only subscription for $125 — was added. Only 16 of the respondents now chose the Internet-only subscription, a 76% decrease from the initial 68 respondents. 84 respondents now preferred the Internet + print subscription, a 262% increase from the initial 32 respondents.
The presence of the third option-the “decoy”-“messed up” the seemingly rational decisions the respondents took in the first research scenario; as the print + Internet subscription became a steal and the Internet-only subscription became less attractive. In actual fact, the Internet-only subscription became free once you chose the Internet + print option.
Relativity is real and it colors our decision making, as Gregg Rapp, a Restaurant Consultant, would find out. Most restaurant customers will default to the second most pricey dish on the menu — usually engineered to deliver high-profit margins — if the most pricey dish is made pricey enough as to be “unattractive.”
Research done on relativity shows that we compare things that are readily comparable and avoid those that cannot be easily compared. Also, given three choices for which we cannot compute their relative values, we will default to the middle choice most of the time.
Relativity helps us to arrive at decisions in life. But then, it breeds jealousy and envy in us as we compare our lives to those of others. It hurts society too. It's the reason, for instance, why there are not enough family practice doctors in the US. Most of them have gone on to Medical Investment Advisory roles in Wall Street firms. It's the reason CEO pay spiked from 36 to 369 times the average worker’s pay from 1976 to 2008.
So what can you do about the problem with relativity?
Start by making the “circles” around you smaller to boost your relative happiness. For instance, at the class reunion, don’t feel compelled to be part of the main conversation in the middle of the room. Find someone on the sidelines to have a quiet conversation with, you will have just as much fun. Shop for houses you can really afford to buy. The same goes for cars.
Also, change your focus from the narrow to the broad. Why splurge that $3,000 to upgrade your new car seats from fabric to leather when you can invest it in travel, books, or on a new wardrobe.
2. First impressions last
Konrad Lorenz, the Naturalist, found out that when goslings — baby geese — break out of their eggs, they become attached to the first moving object they encounter. So goslings make their initial decisions based on what they can see in their environment and stick with this decision once it has been made. This is “imprinting.”
Our impressions and decisions are imprinted like goslings. The first price we accept as a possibility, as we try to buy a product or a service becomes an “anchor.” We judge our willingness to pay for the product or service presently and in the future, based on it.
Italian jewelry dealer, James Assael, turned worthless black pearls obtained from oysters into an item of desire Manhattan divas wore on their necks by anchoring them on diamonds.
Anchoring happens through a process known as “arbitrary coherence.” The initial price for a product or a service that we encounter is arbitrary, but once it establishes in our minds, it shapes the present and future prices for the product or service and for similarly related products or services. This behavior, on our part, is irrational; just like goslings that follow the first moving animal or bird, they see for the rest of their lives.
One implication of anchoring is “herding.” We assume something is good or bad on the basis of other people’s behavior and we follow likewise. This is what happens when we choose a hotel lodging based on online reviews. There is self-herding too, which happens when we follow our own previous behavior. When we “self-herd” repeatedly, we form habits.
Economic theory would have us believe that our decisions — where we live, what we eat, the clothes we wear, the style of our hair, and so on — are the result rationally from what we like or don’t like. Anchoring and arbitrary coherence, tells us another story — those decisions are predictably irrational.
3. Why free is not free
Which would you choose — a free $10 Amazon gift certificate or a $20 Amazon gift certificate for $7? Write your answer down on a piece of paper and read on.
Getting something for free feels good. It is irresistible, it makes us happy. But zero cost is just another price. Zero cost is an emotional hot button, a source of irrational excitement. And zero cost will often lead us into trouble.
“Free,” offered with no strings attached, is fine. Where “free” becomes problematic is when it is offered alongside another “not-free” item. In that instance, we end up making bad, irrational decisions. We give up on a good deal and settle for a bad one, imposed on us by “free.”
Most transactions have an upside and a downside. When “free” is a part of a transaction, we forget its downside. The lure of “free” charges us emotionally to perceive what is on offer as being more valuable than it actually is. This happens because we are afraid to lose out on any transaction. “Free” gives us that assurance. And if we choose the not-free item over its free counterpart, we are left wondering if we have not made a bad decision. So, given a choice, we go for free.
Going back to the question we started with, if you chose the free $10 Amazon gift certificate over the $20 Amazon gift certificate for $7, you just acted predictably irrational and lost $3 on the deal. The free $10 Amazon gift certificate will earn you a $10 profit, while the $20 Amazon gift certificate for $7 will earn you a $13 profit.
4. Keep it social
Imagine how disgusted your mother-in-law would be if after a Thanksgiving dinner she hosted, you announced to everyone’s that you would love to pay her for the cost of putting the dinner together.
We live simultaneously in two worlds — a social one and a market one. In our social worlds, social norms are standard. In our market worlds, market norms are the standard. We apply different standards of behavior to these kinds of relationships, and there is a delicate balance between the two. Also, introducing a market norm into a social exchange will hurt the social relationship which might prove hard to recover.
Social norms are the favors we ask of each other. They are part of our social nature and are an expression of our need for community. Social norms are warm and fuzzy, and we don’t expect payments for them. They are pleasurable experiences for both the giver and the receiver, and reciprocity is not required. A good example is when you help move a neighbor’s couch. You wouldn’t demand that he or she comes around to help you move yours, would you?
The world governed by market norms is different. There’s no warmth or fuzziness there. The exchanges there are sharp-edged: wages, prices, rents, interests, and costs-and-benefits. You get what you pay for in the domain of market norms. Do note that market relationships are not evil or mean, they just imply comparable benefits and prompt payments.
When we learn to separate the social and market domains of our lives, our lives play out easy. Trouble happens when both domains collide. Sex is a good example. Within the context of a marriage; a social domain, it is free, warm and emotionally nourishing. On the flip side, sex, as a commodity, in the marketplace is cold and impersonal. No husband or wife would come home asking for a $50 trick and no sex worker would hope for everlasting love.
The author’s research showed most people would rather work free for a social cause than for cash. For instance, the American Association of Retired Persons was unable to get lawyers to work at subsidized $30-per-hour rates for needy retirees. When lawyers were asked to come work free for the same needy retirees, the majority willingly obliged. That transaction moved from a market context to a social one.
How would exchange of a gift in return for social favors play out? Research shows this is acceptable as no one would take offence at a small gift. The exception is if the cost of the gift is announced to the hearing of the proposed receiver — that takes the exchange into the market domain.
So buy your mother-in-law a good bottle of wine, wrap it up and present it after the Thanksgiving meal as a token of your appreciation for her effort in putting the Thanksgiving dinner together. Everyone will go home happy.
5. The aroused, irrational us
How do rational, intelligent people behave in an impassioned state? How does arousal affect our behavior and influence our decision-making?
The author’s research showed that when we are in a cold, rational, superego-driven state, we are respectful of the other sex, we usually will not agree to indulge in odd sexual encounters like having sex with an animal, we would always take the moral high ground and always use a condom.
However, in our aroused state, we would care less about society’s sexual ethos — prevention, protection, conservatism, and morality. All of these disappears completely from our radar screen.
Robert Louis Stevenson wrote, “Man is not truly one, but truly two.” He would, on the basis of this belief, go on to write the highly successful Dr. Jekyll and Mr. Hyde, a story representative of the two sides of us — the side that exhibits repressive propriety (the mild-mannered Dr. Jekyll) and the side whose passion is uncontrollable (the murderous Mr. Hyde). Dr. Jekyll thought he knew enough to control himself, but once Mr. Hyde took over, well, he became something else.
So there’s good and evil inside of us at the same time. It is the reason the pleasant friendly neighbor would crash his car into a semi in a fit of rage, or a teenager would grab a gun and shoot his friend. Or a priest would rape a boy. All of these people thought they understood enough of themselves, but they lose it in the heat of passion.
Everyone then, no matter how “good” we perceive ourselves to be, underestimates the effect of passion on our behavior. In the heat of passion, whoever we thought we were becomes absolutely and completely divorced from who we really are. In that state of arousal, our reptilian brain takes over and we become unrecognizable to ourselves; and our emotions blur the boundary between what is right and what is wrong. Our irrational self comes alive.
We can protect ourselves from ourselves in the area of sex by making condoms widely available. Then sex education in our schools should tilt from a focus on the physiology and biology of the reproductive system to the psychology of dealing with the emotions that rise up in our aroused states.
Also, we should teach ourselves not to drive when we are on an emotional high. Speed limiters that activate in certain neighborhoods or on the exhibition of certain driving behaviors would also be helpful.
6. Why we procrastinate and what we can do about it
Americans do not save much because of procrastination. In 2006, the average rate of savings of Americans dropped to -1%. Americans no longer saved but now spent more than they earned.
Consumerism is to be blamed. Americans buy and buy and buy, and then borrow to buy some more. The average American home today is equipped with a walk-in closet. Some are bigger than the bedrooms they adjourn and are filled from one end to the other.
Consumer credit also takes a part of the blame. In 2005, the average American family had six credit cards, with an average debt of $9,000 on each card. Direct-mail offers, sent to families, for new credit cards totaled 6 billion in the same year. 7 out of 10 households borrowed on their credit cards in the same year to cover basic living expenses — food, utilities, and clothing.
We try to instill some self-control in ourselves and resist temptation on our way towards our long-term goals but often fail, and end up being miserable.
One way out is to use “precommitments” to ginger us to do what we have to do at the right time to do it. You could, for instance, have your 401 (k) automatically deducted from your income.
Another alternative is to get people to commit upfront to their preferred paths of action. For instance, a group of friends could agree to go for a specific series of health checks by a given deadline and come back to share the results with one another.
The general idea here is that every procrastination problem we face has potential self-control mechanism or precommitment tool that can solve it.
7. The ills of ownership
Ownership defines our lives and shapes our decisions. Our life stories can be told by describing the ebb and flow of our possessions — what we get and what we give up over time.
People have three irrational peculiarities about the way we behave around the things we own, sometimes lead us to take predictably irrational decisions:
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The more work we put into an item — for example, putting together a piece of furniture — the more the ownership we feel for it. Think how more attached we are to a baby we bathed, dried, powdered, diapered, dressed up and tucked away in the crib.
Also, we feel ownership before we own. It’s the reason we tend to stake more in an auction in which we have emerged as a top bidder. It causes the upward spirals we see in auctions.
Adverts trick us into buying a product or service using the concept of virtual ownership as a tool. We see a happy couple cruising in a BMW Convertible along California’s coast and we imagine the couple to be us. Companies also hook us into virtual ownership through product or service “trials.” Once we “try,” we get hooked. Our aversion to loss takes over and we rationalize the extra cash we will spend to hold on to the product or service. The “30-day money-back guarantee” works the same way. In all of these instances, our perspective changes once we take virtual ownership, such that we treat the return or stoppage of the product or service as a loss.
Ownership plays a role in radicalization. We love an idea or a concept, we take ownership. We don’t yield any ground to contrary views.
To be immune from the ill-effects of ownership, we should be aware, first, that it exists and that we are vulnerable to it. Then as we buy things as we journey through life, we should not be afraid to revert back to our pre-ownership states. Just as the author does, we should distance and detach ourselves from the things we own.
8. Options to nowhere
It is part of our culture to keep our options open. For example, we buy SUVs so we can have some ground clearance just in case we hit rough terrain or drive off the highway.
Keeping our options open costs us big time. Look at how we raise kids and “keep their options open.” We expose them to a lot of curricular and extracurricular activities. They lose their time, we lose ours; and they end up not being good in any particular activity. In our adult lives, we move from one activity to the next and forget what matters in the process. We play the fool’s game.
It’s an irrational way to live our lives, to chase every option that is available to us. It is stressful and not economical. According to the Philosopher, Erich Fromm in his book, Escape from Freedom, “people are beset not by a lack of opportunity, but by a dizzying abundance of it.” The culture compounds it by reminding us ever so often that we can do anything and be anything we want to be. So we try to live it up. We have a bucket list, there are 1000 items in it. 999 of those are worthless endeavors, only 1 is worth our time. But we chase all and won’t stop, not even at #999. We spread ourselves too thin, chasing doors that lead nowhere and suffer the implications of our irrationality. Important things slide by us as we chase after the unimportant. For instance, our children’s childhoods slip by us in a blur as we put in extra hours, often unnecessary, in our jobs so we can earn a little more accolades, money or both.
To cure yourself of this irrationality, focus. Begin consciously closing doors you don’t need. For instance, forgo all of those extra training, effort, time, money and energy you are investing so you can switch to a new career. Specialize in your present career. Let go of relationships that are unhelpful. Be realistic about your goals and dreams. Drop out of committees that are a waste of your time. Don’t play golf, play squash, watch basketball and still hang out with your family. Focus your recreational efforts on one sport and invest the remaining time creating memories with your family.
9. On expectations
Our expectations influence our views of subsequent events. If you tell people that something might be distasteful, the odds that they will agree with you are in your favor because their expectations, not experiences, are already set in that direction.
If we expect that something will be good, it will be. If we expect it to turn out bad, it will. But do these beliefs change the physiology of our experiences or are they just on the surface? Actually, they do, as the author found out from his research. Our beliefs reshape the underlying chemistry behind our sensory perceptions so that they align with our expectations. Caterers use this fact to their advantage, by describing their rather simple menus using elaborate terms. For example, “tomato and goat cheese salad” ends up being described as “melange of the freshest romacherry tomatoes and crisp field greens, paired with a warm circle of chèvre in a fruity raspberry vinagrette.” The sheer depth of the description sets our expectations of enjoying the meal high and modifies the neural activity underlying the taste itself.
The setting of expectations finds use in commercial setups. For instance, knowing a book or a movie got rave reviews heightens our expectations and enjoyment.
Expectations also shape our stereotypes — our way of categorizing information — in the hope of predicting our experiences. Because our brains will not think from scratch in every situation, it builds on what it already knows — stereotypes! Stereotypes provide us with specific expectations about members of a particular group. They influence our perceptions and behaviors. So, for example, we expect that an elderly man or woman would need help crossing the freeway.
Expectations are very important for us to function effectively as social animals. For instance, they enable us to make sense of a conversation in a noisy room, not minding the fact that we sometimes lose track of the conversation due to the ambiance. We are able to make sense of text messages we receive on our phones, even if there are parts that are scrambled.
On the flip side, expectations make us foolish under some circumstances. They also cause wars.
10. Price and the placebo effect
As stated earlier, expectations change the way we perceive and appreciate experiences.
Going a bit further along this line of thinking, beliefs and expectations affect how we perceive and interpret sights, tastes, and all other sensory phenomena. They do so by altering our subjective and objective experiences. A good example is our belief in placebos.
A placebo is a medicine or a procedure prescribed purely for the psychological benefit of the patient, rather than for any physiological effect. It has no therapeutic effect whatsoever. Placebos have been with us since our beginnings here on earth. Medical science, as we know it today, originated from placebos.
Placebos work because we believe in them. They run on the power of suggestion, in two ways — belief, which is the confidence that we have in the drug, the procedure, or the caregiver; and conditioning, a situation where our bodies build up expectations after repeated experiences and releases various chemicals to prepare us for the future.
So, is price a placebo?
The author’s research findings reveal that price is placebo indeed; because it suggests effectiveness to us. The more pricey a drug or a procedure is, the more we tend to believe in its efficacy.
Furthermore, the price-placebo effect is not the same for everyone. It is more pronounced for those dealing with recent pain. As expected, when the price of the placebo is discounted for this group of people, they feel less relief; reinforcing, again, that price is indeed a placebo.
By the author’s research, the same price-discounted price-placebo effect plays out in all consumer goods — soft drinks, cosmetics, cars; etcetera; which begs the question, are we left with no choice but to settle for lower benefits every time we get a discount? What should be our appropriate reaction to discounts? Should we despair because we are getting lower benefits?
Not necessarily. If we stop and ponder, once in a while, on the relationship between price, quality, and how the placebo effect figures into the equation, we won’t fall into the trap of thinking that a discounted item or service is of less quality than its full-price counterpart. This is important because a lack of understanding of the price-discounted price-placebo effect has a lot of implications for the consumer. You could, for instance, be frittering away your life’s savings on brand-name medication when equivalent FDA-approved generics would be just as effective.
Lastly, placebos are for real. There is nothing sham about them. So long as our minds control our bodies in a process we know nothing about, placebos will continue to benefit us. For a fact, its standard, even in the practice of medicine for doctors to prescribe placebos.
11. We are innately dishonest
There is a lot of white collar criminal activity going on, which inflict more financial damage on society than blue collar crimes; even though our society’s criminal justice system cracks down more severely on blue collar crimes.
For example, the data for 2004 shows that some $600 billion was lost to employee theft and fraud, $24 billion in bogus insurance claims on property losses, $16 billion in retail losses on “wardrobing,” and by the IRS, $350 billion per year in dodged taxes. That’s some $1, 040 billion worth of white crime. In the same year, the total value of all robberies, burglaries, larceny-theft and automobile thefts in the US for the same year was $16 billion.
Dishonesty explains the prevalence of white collar criminal activity in our society. By the author’s research:
According to Adam Smith, we are not wildly dishonest because nature has created us to seek to please our fellow humans. We do this because our success depends on the goodwill of our neighbors and our equals, which we wouldn’t have if we were not well-behaved. So individuals are honest only to the extent that it suits them and their desire to please others.
Sigmund Freud has a somewhat different perspective. As we grow up in society, we internalize its virtues and develop a “superego.” Our superego is pleased when we comply with society’s rules and is not pleased when we do not comply. It is the reason we stop at a red traffic light at 4:00 a.m., even when no one is around; it is the cause of the warm feeling we get when we return a lost wallet.
If honesty is so important to us, why are we dishonest? Again, our superego is responsible. It “activates” only when we consider a “big” offence against society, such as when we want to steal an entire box of pens from a conference hall. For the “little” offences like taking just one pen from the box, our superego goes to sleep. In the absence of our superego’s help, rational cost-benefit analysis is our only defence against these small transgressions. But then, who has the time or energy to ponder the benefits of taking a hotel room towel against the risk of getting caught or of adding extra receipts to a tax statement? This, exactly, is why dishonesty and the chaos it causes is prevalent in our society.
The US government has tried battling the menace. The Sarbanes-Oxley Act of 2002 sought to prevent another “Enron” from happening, US Congress restricts the practice of “earmarking,” and the SEC continues to require more disclosure of executive pay; amongst other such initiatives. Do these work? No. According to William A. Niskanen, Chairman of the Cato Institute, “the Sarbanes-Oxley Act has not cleaned up corruption, it has only forced companies to jump through hoops.”
But honesty is important for our society to function well. We are a global economic powerhouse because our corporate governance standard is the highest in the world. Our systems — credit, risk, banking, insurance, justice; etcetera — all work because of our basic honesty as a society. We only need to look in the direction of China, where business contracts cannot be enforced across regions or Latin America, where family-run cartels are the norm, to see what dishonesty will do to our society if we don’t tackle it now.
So, how do we cure our society of dishonesty?
Bringing back our holy books into public life in some palatable form is one way. Another option would be to bring back professional oath-taking, which would serve to reinforce the bedrock of ethics and values on which the professions had been built. This would reduce compromise in the face of economic pressure, as the author’s extensive researches have shown.
Also, we might want to recognize and acknowledge this weakness of ours for what it is, and create systems that stop conflict-of-interest situations from cropping up. For instance, doctors could be banned from ordering patients to run tests that would benefit them financially, and Accountants and Auditors banned from consultancy roles in the companies in which they worked.
Finally, we might want to look at how we can reintroduce cash transactions back into our society. Most of the dishonesty going on happen because the transactions are one step or more removed from cash. It is easier for us to rationalize our dishonesty when it is a step removed from cash. In actual fact, by the author’s research, most people would not cheat if actual cash was involved.
12. Conclusion
There is nothing rational about our decision making. We are prone to being predictably irrational, as several of the author's experiments have proven. That makes us susceptible to erroneous decisions, which have serious implications for the quality of our lives and the society we live in.
But all hope is not lost. If we become aware of our irrationality by accepting the fact of its existence, and work individually and collectively to reset the faulty decision making that results from it, we would well be on our way to making a success of our lives and the society we live in.
Practice Lessons
Be blessed by the Divine!
Krish Murali Eswar.