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How do we think about money?
What caused bankers to lose sight of the economy?
What caused individuals to take on mortgages that were not within their means?
What irrational forces guided our decisions?
And how can we recover from an economic crisis?
In this revised and expanded edition of the New York Times and Wall Street Journal bestseller Predictably Irrational, Duke University's behavioral economist Dan Ariely explores the hidden forces that shape our decisions, including some of the causes responsible for the current economic crisis. Bringing a much-needed dose of sophisticated psychological study to the realm of public policy, Ariely offers his own insights into the irrationalities of everyday life, the decisions that led us to the financial meltdown of 2008, and the general ways we get ourselves into trouble.
Blending common experiences and clever experiments with groundbreaking analysis, Ariely demonstrates how expectations, emotions, social norms, and other invisible, seemingly illogical forces skew our reasoning abilities. As he explains, our reliance on standard economic theory to design personal, national, and global policies may, in fact, be dangerous. The mistakes that we make as individuals and institutions are not random, and they can aggregate in the market—with devastating results. In light of our current economic crisis, the consequences of these systematic and predictable mistakes have never been clearer.
Packed with new studies and thought-provoking responses to readers' questions and comments, this revised and expanded edition of Predictably Irrational will change the way we interact with the world—from the small decisions we make in our own lives to the individual and collective choices that shape our economy.
The second option, it seems, is a dud. Paying $125 for the magazine or paying $125 for the magazine and the web site isn't so much a choice as a misprint. The latter option should clearly be pricier. Odd for economists to make such an obvious error. At least it would have been, 20 or 30 years ago. But as Ariely explains in Predictably Irrational, that dud option is a feature, not a bug. The bug, rather, is in us.
For many years, economics operated off the "rational actor" model, often derided as Homo economicus. He was quite a being, this Homo economicus. A perfectly rational consumer, coldly calculating in his purchases, constantly pursuing his self-interest, exquisitely sensitive to the complex information being conveyed through price tags. Think Star Trek's beloved Data, only with a credit card rather than a phaser.
Much of economics was dedicated to studying this rational actor's rational actions, and rightly so. It turned out that the pursuit of self-interest was a powerful motivator. But in recent years, much in economics has been dedicated to studying where the model breaks down. The emergent movement -- which takes cues from psychology, sociology, anthropology, and even neuroscience -- has been termed behavioral economics, and Ariely is one of its foremost practitioners.
The nice thing about traditional economics was that you could simply assume rationality. To find out how humans behave, however, requires constructing elaborate tests that allow you to watch their actions as you tweak certain variables. And that's what Ariely excels at. His book is a compendium of these tests, both the ones he and his colleagues have designed and the ones that life has designed for them. So take The Economist's subscription rates. The traditional neoclassical model would suggest that if the magazine wants to offer three subscription levels, they should be priced in accordance with their value. Then we'll get a bunch of rational consumers making rational decisions and buying rationally priced subscriptions and everyone will go home happy.
But that's not what the Economist subscription department wants. They want to sell a whole lot of copies of their magazine. And so they need to figure out how human beings actually work. "We don't have an internal value meter," writes Ariely, "that tells us how much things are worth. Rather, we focus on the relative advantage of one thing over another, and estimate value accordingly." Staring at those options, we know one thing: The print/web site combo is obviously the best deal. In fact, the online access seems to be...free!
To test this, Ariely gave 100 of his students at MIT The Economist's subscription options and asked them to choose between them. Sixteen of his students chose the Internet-only option. None of his students chose the print-only option. The remaining 84 chose the combo option.
Then he asked another 100 students to choose their preferred subscription package. But he eliminated the print-only option. Now they had a straight comparison between $59 for the web site and $125 for the print edition and the web site. If they were rational actors who had accurately assessed the value of the subscription options the first time, the results shouldn't change. After all, the two plans have remained exactly the same price, and the plan that's been removed wasn't chosen by anyone. But when Ariely took away that dummy print rate, the choices shifted dramatically. Now, 68 students chose the online option, while 32 took the combo -- a total reversal of the original preferences.
Ariely's book goes on much in this vein. Experiment after experiment shows the delicate and unstable edifice on which our rationality rests. He relates an astonishing study in which male college students were asked to answer questions about sexual preferences, then paid money to answer those same questions while masturbating to pornography. The change in emotional state massively transformed the answers. To give two of the more unsettling answers, where 20 percent of the students originally said they would keep trying to have sex after their date said no, 45 percent of the aroused students said they'd keep pressing. And where 23 percent of the non-aroused students said they could imagine being attracted to a 12-year-old, 46 percent of the aroused students said the same. It will not shock too many in the audience to suggest that intense arousal may impede more rational thought. But the implication is significant: It suggests that "we" are not rational. Rather, we're rational at certain times and in certain places, and only then when we're in a certain emotional state.
Elsewhere, Ariely shows how we wildly overvalue things we think of as free, relating experiments in which individuals demonstrate a preference for paying nothing in order to receive a candy of minimal value rather than paying very little for a truffle they perceived of as high value. Make the low value candy a penny, however, and that preference disappears, even though a penny may as well be free. He also shows how expectations govern experiences, and relates studies in which individuals thought the soda they were consuming tasted much better when they were told, beforehand, that it was Coke or Pepsi. And on, and on. Our decisions are based on context, comparisons, emotional states, remembered advertisements, and a whole lot more that doesn't quite fit the description "rational."
But Ariely's point goes far beyond our irrationality -- it is the predictability of our processing flaws that interests him. It isn't that we sometimes make the wrong decision, but that we make it repeatedly, and in the same way, as a response to certain conditions and mental processes. Early on in the book, Ariely tells us about Gregg Rapp, a restaurant consultant who helps establishments figure out their menu pricing. "One thing Rapp has learned," writes Ariely, "is that high-priced entrees on the menu boost revenues for the restaurant -- even if no one buys them. Why? Because even though people generally won't buy the most expensive dish on the menu, they will order the second most expensive dish. Thus, by creating an expensive dish, a restaurateur can lure customers into ordering the second most expensive dish (which can be cleverly engineered to deliver a high profit margin)."
The implication here is that our irrationality is not only predictable, it's actually being predicted. Restaurants know that we anchor our frugality by deciding the priciest item on the menu is too expensive. Electronic stores know that we're likely to go for the marked-down television whose price places it in the middle of the pack. Magazines know we'll go for whichever subscription rate looks like the best deal as compared to the other subscription rates on the page. The problem, then, is not our predictable irrationality, but the world's asymmetric rationality. They know how we're going to screw up, and how to take advantage of it. The only defense is being similarly aware of our flaws and failings, and trying to take into account not only how they affect our judgment, but how they're being used against us. Ariely's book is an excellent place to start. --Ezra Klein
Ezra Klein is a staff writer at The American Prospect.
The Truth about Relativity
Why Everything Is Relative—Even When It Shouldn't Be
One day while browsing the World Wide Web (obviously for work—not just wasting time), I stumbled on the following ad, on the Web site of a magazine, the Economist.
I read these offers one at a time. The first offer—the Internet subscription for $59—seemed reasonable. The second option—the $125 print subscription—seemed a bit expensive, but still reasonable.
But then I read the third option: a print and Internet subscription for $125. I read it twice before my eye ran back to the previous options. Who would want to buy the print option alone, I wondered, when both the Internet and the print subscriptions were offered for the same price? Now, the print-only option may have been a typographical error, but I suspect that the clever people at the Economist's London offices (and they are clever—and quite mischievous in a British sort of way) were actually manipulating me. I am pretty certain that they wanted me to skip the Internet-only option (which they assumed would be my choice, since I was reading the advertisement on the Web) and jump to the more expensive option: Internet and print.
But how could they manipulate me? I suspect it's because the Economist's marketing wizards (and I could just picture them in their school ties and blazers) knew something important about human behavior: humans rarely choose things in absolute terms. We don't have an internal value meter that tells us howmuch things are worth. Rather, we focus on the relative advantage of one thing over another, and estimate value accordingly. (For instance, we don't know how much a six-cylinder car is worth, but we can assume it's more expensive than the four-cylinder model.)
In the case of the Economist, I may not have known whether the Internet-only subscription at $59 was a better deal than the print-only option at $125. But I certainly knew that the print-and-Internet option for $125 was better than the print-only option at $125. In fact, you could reasonably deduce that in the combination package, the Internet subscription is free! "It's a bloody steal—go for it, governor!" I could almost hear them shout from the riverbanks of the Thames. And I have to admit, if I had been inclined to subscribe I probably would have taken the package deal myself. (Later, when I tested the offer on a large number of participants, the vast majority preferred the Internet-and-print deal.)
So what was going on here? Let me start with a fundamental observation: most people don't know what they want unless they see it in context. We don't know what kind of racing bike we want—until we see a champ in the Tour de France ratcheting the gears on a particular model. We don't know what kind of speaker system we like—until we hear a set of speakers that sounds better than the previous one. We don't even know what we want to do with our lives—until we find a relative or a friend who is doing just what we think we should be doing. Everything is relative, and that's the point. Like an airplane pilot landing in the dark, we want runway lights on either side of us, guiding us to the place where we can touch down our wheels.
In the case of the Economist, the decision between the Internet-only and print-only options would take a bit of thinking. Thinking is difficult and sometimes unpleasant. So the Economist's marketers offered us a no-brainer: relative to the print-only option, the print-and-Internet option looks clearly superior.
The geniuses at the Economist aren't the only ones who understand the importance of relativity. Take Sam, the television salesman. He plays the same general type of trick on us when he decides which televisions to put together on display:
36-inch Panasonic for $690
42-inch Toshiba for $850
50-inch Philips for $1,480
Which one would you choose? In this case, Sam knows that customers find it difficult to compute the value of different options. (Who really knows if the Panasonic at $690 is a better deal than the Philips at $1,480?) But Sam also knows that given three choices, most people will take the middle choice (as in landing your plane between the runway lights). So guess which television Sam prices as the middle option? That's right—the one he wants to sell!
Of course, Sam is not alone in his cleverness. The New York Times ran a story recently about Gregg Rapp, a restaurant consultant, who gets paid to work out the pricing for menus. He knows, for instance, how lamb sold this year as opposed to last year; whether lamb did better paired with squash or with risotto; and whether orders decreased when the price of the main course was hiked from $39 to $41.
One thing Rapp has learned is that high-priced entrées on the menu boost revenue for the restaurant—even if no one buys them. Why? Because even though people generally won't buy the most expensive dish on the menu, they will order the second most expensive dish. Thus, by creating an expensive dish, a restaurateur can lure customers into ordering the second most expensive choice (which can be cleverly engineered to deliver a higher profit margin).1
So let's run through the Economist's sleight of hand in slow motion.
As you recall, the choices were:
1. Internet-only subscription for $59.
2. Print-only subscription for $125.
3. Print-and-Internet subscription for $125.
When I gave these options to 100 students at MIT's Sloan School of Management, they opted as follows:
1. Internet-only subscription for $59—16 students
2. Print-only subscription for $125—zero students
3. Print-and-Internet subscription for $125—84 students
Introduction How an Injury Led Me to Irrationality and to the Research Described Here
Ch. 1 The Truth about Relativity: Why Everything Is Relative - Even When It Shouldn't Be 1
Ch. 2 The Fallacy of Supply and Demand: Why the Price of Pearls - and Everything Else - Is Up in the Air 23
Ch. 3 The Cost of Zero Cost: Why We Often Pay Too Much When We Pay Nothing 49
Ch. 4 The Cost of Social Norms: Why We Are Happy to Do Things, but Not When We Are Paid to Do Them 67
Ch. 5 The Influence of Arousal: Why Hot Is Much Hotter Than We Realize 89
Ch. 6 The Problem of Procrastination and Self-Control: Why We Can't Make Ourselves Do What We Want to Do 109
Ch. 7 The High Price of Ownership: Why We Overvalue What We Have 127
Ch. 8 Keeping Doors Open: Why Options Distract Us from Our Main Objective 139
Ch. 9 The Effect of Expectations: Why the Mind Gets What It Expects 155
Ch. 10 The Power of Price: Why a 50-Cent Aspirin Can Do What a Penny Aspirin Can't 173
Ch. 11 The Context of Our Character, Part I: Why We Are Dishonest, and What We Can Do about It 195
Ch. 12 The Context of Our Character, Part II: Why Dealing with Cash Makes Us More Honest 217
Ch. 13 Beer and Free Lunches: What Is Behavioral Economics, and Where Are the Free Lunches? 231
Reflections and Anecdotes about Some of the Chapters 245
Thoughts about the Subprime Mortgage Crisis and Its Consequences 279
List of Collaborators 335
Bibliography and Additional Readings 345
Posted May 17, 2008
¿Do you know why we so often promise ourselves to diet, only to have the thought vanish when the desert cart rolls by?¿ This question is one of several asked by Dan Ariely in the introduction of his recent book ¿Predictably Irrational.¿ He subsequently states that ¿¿By the end of the book, you¿ll know the answers to these and many other questions that have implications for your personal life, for your business life, and for the way you look at the world.¿ An equally tantalizing statement follows in which the author describes how a set of events in his childhood cemented a life perspective that is quite different from 'and presumably more insightful than' your average person. Together, these preliminary contents set the tone for some high expectations. What follows, however, is a mildly interesting, sometimes trite, and often oversimplified set of observations and `clever¿ experiments that come across more as products of extensive free time than brainchildren of a truly deep thinker. While some disappointment stems from the ambitious prologue, a rudimentary problem with Ariely¿s thesis lies in the set-up. He starts early with a summarized definition of classical economics, which surmises that we are all rational and, in every day life, compute the value of all options we face and then select the one that maximizes our gain. Any action we take that is not in our best economic interest, therefore, is irrational, and as Ariely opines, surprising in its very nature. But while rational behavior of participating agents may be the basis of economic theory, very few people spend any time thinking about this theory other than economists. For the rest of us, there is no question and certainly no surprise that our social and economic behavior can be irrational, and we have countless reminders of this every day. We know that too many options can diminish returns 'chapter 8'. We also know that expectations often shape our perceptions 'chapter 9', and nobody doubts the allure of free merchandise 'chapter 3'. At the conclusion of each chapter, then, the reader is left with someone else¿s reinforcing account of what he/she is already aware of. Whereas related offerings such as Tim Harford¿s ¿Undercover Economist¿ or Nassim Taleb¿s ¿Fooled by Randomness¿ offer technical and less-tangible insights into topics such as economics, behavior, and probability, ¿Predictably Irrational¿ relies too heavily on the concept that the author¿s perspective is deeper than our own. This leads to a distillation of complex psychology 'not to mention biochemistry and evolution, among others' into oversimplified explanations and human trials involving free beer. In the end, one is left with the feeling that the author himself is much more interesting than anything uncovered by his experiments on college kids.
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Posted September 25, 2008
Predictably Irrational is an exceptional book on a number of fronts. First, from the writing style, it is absolutely accessible and that isn't always the case when academians convert research into a book designed for the mass market. This book is as accessible and interesting to read as Freakonomics was. Second, this is the first book to do such a thorough job of connecting psychology, human behavior and economics. This book should be an immediate read for every marketer, salesperson, CEO or non-profit without exception. When you read this book you'll learn about how you and I make decisions and if you are honest you'll recognize yourself over and over in the reading. You and I make decisions the same way everyone else does. And, as a marketer, a salesperson, a funds solicitor for a non-profit, we'll make more, get more and achieve more to the extent that we leverage these automatic processes. Most people don't fight or even acknowledge their own decision making processes, they just go through the process. What they think is control is really an illusion as this book so clearly points out. You and I can and are regularly influenced subliminally by the way information is presented. The chapters on Free and the chapter on The Fallacy of Supply and Demand are invaluable. Ariely's explanation of price anchoring will change how you think about MSRP or even your intitial pricing discussion in sales. His experiement using the last two digits of your social security number is very eye opening. This is also an example of something very easy for you to test in your own marketing organization or social group.s Interestingly, where at the time of this review we are facing a recession, I find this book essential reading for those who would change the face of the recession as well as the duration. It was interesting to me to read some of the negative reviews of the book but most of them focused on wanting to challenge the conclusions without reading all of the research papers. And, I didn't see many of the people who were critical provide the level of observational credibility that Mr. Ariely does. This book just made it to my desktop library, the 10 books I'll refer back to again and again when I create marketing material, influence strategies or consult with clients. This book is a powerful read.
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Posted February 24, 2008
I enjoyed reading the book but now that I think about the examples and experiments discussed in the book, I find most of them flawed. So I wondered why I did not catch the flaws when reading the book. I now realize it was because Dan (the author) either cleverly manipulates the readers or he is just a natural at it and does not realize that he is manipulating the audience. So I will reserve personal judgement against him, whether his style is purposely or just inadvertently manipulative. Afterall, he claims to be expert in behaviorial science so I can easily imagine that the book and the manipulative style are an experiment that he is conducting to see how people respond. So without further ado, let me begin. His very first discussion is about his personal experience with a tragic severe skin burn, which led him to question how people perceive things and how they rationalize their behavior. In writing about his own experience he draws the reader's sympathy - i.e., he gets the readers off-guard into a sympathetic and trusting mode, whereby they immediately admire him for overcoming his tragedy and delivering great research to the mass audience. Very clever, Dan! Throughout the book he mentions MIT, Harvard, Berkeley as the places where he conducts research and that he had an offer to be at Stanford - he cleverly drops names of prestigious research schools all in an attempt to create an impression that his work is rigorous. I sub-consciously gave him a pass while reading the book, but now I feel I was duped. Here are some flaws with the examples and/or experiments he discusses: 1) He suggets that perhaps our ethical compass is coarse - i.e., for most people the compass does not respond to petty theft they commit but does respond to large scale theft they might contemplate but not commit to -- like not stealing a carton of pencils but willing to steal one pencial from the stationery room. First of all, we don't steal a pencil from a store but we do take from our workplace -- so clearly it is not about the number of pencils but rather the context where the pencil is to be had. I claim we take a pencil from work without paying for it in cash but not from a shop because we can compensate the firm by working a little harder or longer and at the same time avoiding the transaction cost of purchasing a 10 cent pencil at a store or by trying to compensate our employer with 10 cents in cash. The reason people don't steal the entire box of pencils is because they don't need so many pencils all they need is one pencil. Dan suggests that people could be honest and purchase it at a nearby store for 10 cents. He ignores that going to the store and then paying 10 cents for a pencil also comes with a large transaction cost, which is a pure deadweight cost which can be easily avoided by just taking the pencil from the office. The social welfare is greater if one just takes the pencil instead of imposing a transaction cost on the owner and on oneself. Even leaving 10 cents with the secretary at the firm entails a huge transaction cost for the firm. Therefore, it is better to just take the pencil. Furthermore, our compass works just fine, even for petty stuff, when others take a pencil. Thus, our compasses do in fact respond to petty conduct. By the way, I would take a pencil from work even when the secretary or the boss is observing me. So I don't think Dan has seriously thought about this issues even though he seems to think he has. 2) The experiment about selling a football ticket (which was won in a lottery) and about buying a ticket is also flawed. The reason why the ticket winners wanted $2400 for their ticket was probably because that was the 'going' price for the tickets in the secondary (scalpers) market, just before the game. And, the reason the students who did not win the tickets in the lottery were willing to pay at most $170 or $175 (he reports two different numbers) is because that is all they
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Posted July 25, 2011
Posted April 18, 2008
First of all, this is a fantastic book that should be read by anyone interested in money, or in market forces work. The book delves into those two subjects without ever making it sound like a textbook. Overall, I loved this book, and its experiments and ideas have indeed influenced my method of thinking about things...how I shop, how I perceive things to taste...sometimes generic bread is no different than name brand bread, sometimes we think it works better, but Dan Ariely suggests that we look at it not in terms of 'what do we think will be better' but in terms of 'what do they want you to think is better?' and take a marketing stance. better...right? Fantastic read, I urge everyone to get it and really reflect on it.
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Posted February 17, 2011
I wanted to like this book, I really did, but what a let down. The premise of the book is that the author conducts 'experiments' to determine how people make decisions-not based on facts, but on other factors that make the decisions seem irrational. Great, I make decisions, this probably applies to me. In a word, no. Every 'experiment' suffers from at least one fatal flaw which invalidates the conclusions it generates...but the author even goes further and makes conclusions that don't even apply to the 'experiment'.
1) Selection bias is present in every 'experiment" as the subjects of the 'experiment' are students from liberal universities. (But the author tries very hard to convince us that Cal-Berkeley is a moderate institution...that's irrational!) The problem with students being the primary target of the "experiments" is that they are, well students. I went to college and yes, many decisions I made in college were quite irrational looking back, so maybe the book should be called "college kids make irrational choices."
2) the conclusions are not substantiated by the "experiment". In one, he surveys about sexual issues and asks the group one set of questions, then later asks them the same questions while they masturbate. I'm on the edge...will the results will be different? Duh! My conclusion to this survey is different from the authors, now stopped making decisions while I masturbate, and they are much more rational.
In another survey, he sees if ownership changes perception of value and he uses basketball tickets at Duke. Those that have tickets won't part with them for less than $2400, those that don't have tickets are willing to pay $170...so the conclusion is that having something makes it inherently more valuable just because you own it...funny how the actual value of the tickets is omitted. I'm thinking $2400 was likely the going rate for those tickets, but what student has that kind of money to go to a basketball game? Of course they wouldn't offer that to buy the tickets, if they could, do you think they would have wasted a week in line for a chance to get a ticket? That would have been irrational.
In a third example, he let his students select their own due dates for papers. Those that had their deadlines given to them got better grades than those that set their own deadlines. Fine, so what is the conclusion? College kids are unstructured and need guidance? No, the conclusion is that college kids procrastinate...even though no part of the study indicated when the students began to work on the papers for submission...since they got lower grades, they must have procrastinated. Um, ok, I guess..really?
3)The author clearly has an agenda and even tries to disprove supply/demand theory which in the authors opinion changes based on social/market norms. How does he do this? He charges 1 cent for a Hersey's kiss then offers them for free. They take less once it is free. So because they didn't take the whole bowl even though it was free, it's because social norms have taken over and market rules fail to apply. Really? Go to a homeless shelter and conduct the same experiment or put out free water bottles in Haiti and see if they just take one to be polite. I'm betting the results might be different.
In the end, the book makes no breakthroughs, offers no insight and is highly biased. If that appeals to you, read on, otherwise pass.
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I read this book and loved it so much I've given it as a gift to everyone from my 86-year-old aunt to my 34-year-old sister. It's written in a lively manner and many of its points are pretty eye-opening. I've also heard Mr. Ariely interviewed several times and he is a very engaging and funny guy.
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Posted January 24, 2014
Posted January 19, 2014
Ariely has a talent of presenting human behavior in the most simplistic and clear manner, which helps drive the point home. I enjoyed reading the various behavioral cases outlined in the book and I highly recommend it to anyone. Although I agree with Ariely that consumer behavior is predictable, I would argue that the behavior is rational because there is always a reason behind every decision we make. In my book, Money Anxiety – how financial anxiety impacts consumer behavior and the economy, I show how consumer behavior is influenced by their level of financial anxiety, and that there is always a reason (rationality) to each decision.Was this review helpful? Yes NoThank you for your feedback. Report this reviewThank you, this review has been flagged.
Posted January 5, 2014
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Posted March 20, 2013
I really enjoyed this book! I thought it was very funny and it really showed me that we take a lot of things for granted and by looking at it from a different perspective, it is easier to see that things aren't always as rational as they seem. I loved the experimental designs they were very simple but they revealed a lot. I recommend this book to everyone!Was this review helpful? Yes NoThank you for your feedback. Report this reviewThank you, this review has been flagged.
Posted January 26, 2013
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