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Friday, April 30, 2010

Review: Predictably Irrational

Predictably Irrational: The Hidden Forces That Shape Our Decisions is Dan Ariely's book about his adventures with behavioral economics. It's a compelling read, but has also woven itself so much into popular culture that you may already be familiar with most of it.

The book covers many human foibles, with a chapter devoted to each one. These are:
  • Comparison Failures: We judge objects and people by comparison, rather than by absolute worth, so we get anchored to the comparables rather than to true value.
  • Anchoring: We get locked to the first number we see, even if it's utterly random. That's why Steve Jobs hawks the iPad by saying, how much would you pay for the device? $1000? $800? How about $499. So the $499 price looks like a bargain in comparison to the $1000 price.
  • Free almost overpoweringly over-rides everything else. Even if it is a worse value than a non-free product. The experiment here was great. He offered people a $8 coupon or a $20 coupon for $10. Even though the $20 coupon was a better deal, most people took the $8 coupon.
  • Social norms versus market norms. Basically, when you do a favor for a friend, an offer to pay is an insult. That's why companies try to motivate employees by trying to lock employees into social norm, so you feel bad for saying no to working on weekends (after all, you wouldn't say no to visiting your mom on a weekend). The problem comes when employers make business decisions and then cause the employee to feel betrayed (your mom wouldn't lay you off!).
  • Decisions made in the heat of the moment. It turns out that we under-estimate our lack of judgement when we are in emotionally heated situations. That's why major decisions are best made after sleeping on them, or better yet, if there's a time delay between when you feel the emotion and when you make the decision.
  • Overvaluing what we own. This one is all over popular culture. Once you own something, you feel much worse about giving it up than if you had never tried it in the first place. That's why free trials work.
  • Analysis Paralysis. I see this all the time, when people try to keep so many options open that they fail to see that they would have been better off committing to one in the first place. My favorite example in this book was of the woman who still kept trying to keep her old boyfriend even though she liked her new one better. She felt bad losing the option to her old boyfriend, even though it was irrational to do so.
  • The Placebo Effect. This one is so well known I was surprised he bothered to spend so much time on it in the book.
  • Cheating. It turns out that we cheat less if we are reminded of the usual high minded values before being exposed to temptation, and we cheat more if the cheating is one-step removed from tangibles. In other words, it's way easier to steal credit card numbers than it is to steal cash, and it's even easier to sell CDOs and bad mortgages than to actively bilk you of your money.
Quite a lot of topics were covered, but and the book's an easy read. The only disappointment, I guess, is that so much of it already permeates popular knowledge, so it's easy to go through the book nodding at every chapter and then asking, "Why does it take so many experiments to show what we already know?" Of course, that's precisely the state of behavioral economics: it's so new that smart people like Ariely have to prove what should be first principles. Ultimately, I recommend this book, but I do hope that in the future, we see less obvious irrationalities from Ariely's research. I'm glad I borrowed it from the library, because I would have felt about paying even the Kindle price for a bunch of stuff I already knew. If you don't have time to read the book, watch Ariely on YouTube:

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