Predictably Irrational
by Dan Ariely

  • Behaviour
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  • Jonesy = 7/10
Predictably Irrational

Predictably Irrational – by Dan Ariely

Economists start with the assumption that all humans are fully informed, rational decision makers. They use this to form all of their economic theories and models. But, as Dan Ariely points out, we’re NOT rational. In many cases, we’re very IRRATIONAL: we make decisions that aren’t in our own best interest. More than that, Dan recognized that we are irrational in very PREDICTABLE ways – we all make the same kinds of mistakes. He shows how we are influenced by things like comparisons, arousal, price, ownership and our own expectations. This is an absolutely phenomenal book with wide-ranging applications.

‘The hidden forces that shape our decisions’

 

 

Predictably Irrational  Summary

The basis of economics is that we human are fully informed entities making completely rational decisions to maximise our personal interests. This core assumption that we’re all fully and perfectly rational is kind of the building block for every other economic theory developed since then. Without this core assumption, without the guarantee that we can predict what choices a person will make given the options and incentives presented to them, without humans being perfectly rational, then the rest of the ideas of economics kind of fall over. Well… when it comes to being rational… we’re not. Dan Ariely says that we’re very irrational in our behaviour and decision making. Thankfully though, we’re not wildly irrational – we’re predictably irrational. We made decision that don’t serve our own interests, but we make the same incorrect decisions over and over. 

Some of the common flaws in our decision making and some of our irrationalities are outlined by Dan Ariely, such as: the difference between social norms and market norms, anchoring and relativity determines our decision making, without the right systems in place it’s almost guaranteed that we’ll procrastinate on our tasks, the idea of ‘free’ does crazy things to us, we overvalue the things that we already own, and we often neglect opportunity costs. 

Social Norms VS Market Norms 

Say you go over to your mother-in-law’s on a Sunday night for a delicious roast dinner. The food is outstanding, you’ve been getting given drinks all night, you had great conversations and lots of hearty laughs with your family. After you polish off your apple crumble dessert with ice cream, as the night is drawing to a close, you rock back in your chair and say: “thanks Delilah, that was a magnificent evening – how much do I owe you for the dinner and the experience? Will $100 cover it?”. It doesn’t matter what her name is, or how much you offered, either way you’re probably sleeping on the couch tonight and won’t be invited back for another Sunday night dinner in quite a while. You’ve commit behavioural economics sin: you confused social norms with market norms. 

‘Social Norms’ are the things we do the satisfy our innately social nature as a species and fulfil our need for community and personal relationships. ‘Market Norms’ are purely financial or economic exchanges. Changes set in when social and market norms collide. There are plenty of applications of these concepts beyond not pissing off your partner’s family:

  • Dating: don’t mention the price of the meal or the drinks you’re paying for. They’re clearly printed on the menu, but directly mentioning how much you’re paying for the date shifts it from a social relationship to a market-based transactional relationship. 
  • Business: Offering money-back guarantees, don’t charge people late fees, look for other simple ways in which you can offer non-monetary value. Offering these social graces helps keep the business-customer relationship out of a purely transactional market norm.
  • Management: Often social norms can be more effective than market norms when it comes to motivating employees. Praise is the cheapest form of motivation you can offer, and its far more effective than cash bonuses. Other small social gestures might include giving a non-monetary gift, buying team lunches, offering a day off or letting someone work from home if they have a late night. 

For more on this idea, like studies on day cares and blood donations, see book #XX – Freakonomics, where they talk about ‘Moral Incentives VS Economic Incentives’. 

Relativity

Everything is relative, even when it shouldn’t be. When making a purchase decision, we don’t actually weigh up the benefits we’ll get and compare it to the cost we have to pay, we really just look at the price relative to other similar options. Ariely’s suggestion is that we go for things that are easier to compare. Say we’re offered A, B or B’ (b-dash being a variation of B). In this case, we would go for the better out of B and B’ – it’s too hard to compare A to B so A is neglected, but we can compare the other two options and pick whichever is best. Researchers found this to be the case in the following studies:

  • When subscribing to The Economist, users had three options. An online subscription for $59, a print subscription for $125, or a print + online package for $125. It’s too hard to compare which will give you more benefit – print or online, but clearly the package where you get both for the same price as the print on its own seems like a great deal. Even if you only ever read it online, you’ll probably get suckered into paying more than double that price to get the package.
  • On a travel booking site, users were presented with three options for similar accommodation: Paris including a free breakfast, Rome with no breakfast, or Rome with a free breakfast. It’s too hard to compare our preferences for going to either Rome or Paris and trying to analyse which will give us more value, so instead we compare between the two Rome options – they’re easy to compare, so we pick the one with the free breaky. 
  • In sales, provide three options. People often pick the middle one. If you’ve only got two offerings, create a third offering that is the most expensive, and you’ll probably sell more of your now middle-tier item (which was previously your most expensive). Even if you don’t sell ANY at the top price, you’ll still gain.

Is ‘Free’ really free?

The difference between $11 and $10 is one dollar. The difference between $1 and $0 is also one dollar, but that impacts are so much greater. ‘Free’ turns out to be an emotional hot button, a source of irrational excitement that affects our decision making. 

Most transactions always have an upside and a downside. When you buy something, there is the risk that it won’t work and you wasted your money, or that you paid more than it was worth. However, when it’s free, that perceived downside completely disappears. This idea of ‘free’ plays on our intrinsic fear of loss – if we don’t pay for something, how could we possibly lose? This can often work against us though… buying a car with ‘no money down’ or getting a new couch ’60 months interest free’ causes us to make irrational decisions. If we had to pay full price in cash right now, we may not buy that car. But if we can get it for free and worry about the money later, we might make the irrational decision. 

We can also use this for good. If governments wanted to cut down on carbon emissions, they could offer free registration for electric vehicle, or free installation on solar panels on residential roofs. 

It’s important to considered the costs involved in getting something for free. Lining up for an hour for a free ice cream means you’re valuing your own time at about $6 per hour. Instead of waiting 30 minutes for the free donut, go down the road and pay the $2.5 and saving yourself the wasted time.

 

 

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