Predictably Irrational – Dan Ariely (2008)

Predictably Irrational is a book by Dan Ariely, a professor of behavioral economics at MIT, and it’s subtitled ‘The Hidden Forces That Shape Our Decisions’.  Ariely takes issue with the standard economics assumption of the fully rational man, and shows through various experiments a few of the many ways in which we make systematically irrational decisions.  Some topics I’ve heard about before, such as the effect of anchoring (the notion that thinking of a random number, such as a value between 1 and 100, can then influence how much you might be willing to pay for an item), but there’s plenty of new findings here that really make you think about your own habits.

I’ll let Dan himself tell you the bottom line, from page 239:

Standard economics assumes that we are rational – that we know all the pertinent information about our decisions, that we can calculate the value of the different options we face, and that we are cognitively unhindered in weighing the ramifications of each potential choice.

The result is that we are presumed to be making logical and sensible decisions. And even if we make a wrong decision from time to time, the standard economics perspective suggests that we will quickly learn from our mistakes either on our own or with the help of ‘market forces.’ On the basis of these assumptions, economists draw far-reaching conclusions about everything from shopping trends to law to public policy.

But, as the results presented in this book (and others) show, we are all far less rational in our decision making than standard economic theory assumes. Our irrational  behaviors are neither random nor senseless – they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains. So wouldn’t it make sense to modify standard economics and move away from naive psychology, which often fails the tests of reason, introspection, and – most important – empirical scrutiny?

Recommended, an easy yet thought-provoking book.

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Comments

  • Jim  On January 27, 2009 at 10:52 am

    Problem I have with these analyses is I consider them anecdotal. That is, granted on an individual basis “…we are all far less rational in our decision making than standard economic theory assumes…” but an individual is not making the decision, a subset of 300,000,000 people in the U.S. are making the decision.

    My opinion is the larger the set of decision makers the more accurate the decision becomes. That is why the market works!

    Also, this is the reason for cultiviating the intelligience in the society, an area in which we are failing at this time!

  • Curt  On January 27, 2009 at 2:02 pm

    The question here is whether there are systematic errors of rationality. I consider Ariely’s experiments to be much more than anecdotal, though of course they could stand to be re-validated by others.

    Ariely draws the analogy to optical illusions. Try as we might, there are certain drawings that we interpret in a way that is not actually correct (thinking two lines are not equal in length when in fact they are, for example). We can’t stop our brain from operating this way, it’s just how it works, for essentially all of us.

    His findings begin to indicate certain similar predictable errors of economic judgment – so it doesn’t matter how many people are in the marketplace. Now he does feel that if you have an awareness of these types of errors, you can perhaps learn to reduce your errors if you stop and think… so I believe it’s good for people to learn these things about how their own mind seems to operate whether they’re aware of it or not.

  • Jim  On January 28, 2009 at 3:01 pm

    I tried to think of a word other than “anecdotal” and could not. Let me explain what I mean. Ecomomic decisions are made in the market by the 10’s or 100’s of millions. To accept his theory you would have to believe that all those decision makers have the same irrationality. His theory has to be based on a small sampling of people he or someone studied or talked to or?? Maybe 1000 people – if I am generous.

    These studies are anecdotal in my opinion.

    Our behaviour and decision making is a continuum. Therefore the statement:

    “Our irrational behaviors are neither random nor senseless – they are systematic and predictable.”

    is a silly statement in my opinion.

  • Jim  On January 28, 2009 at 3:07 pm

    “We all make the same types of mistakes over and over, because of the basic wiring of our brains.”

    Does he give any examples of these mistakes and how they relate to the hard wiring of our brains?

    Also, does he give examples of poor “market” economic decisions that have been made due to this?

    Sorry I don’t have time to read it!

  • Curt  On January 28, 2009 at 11:38 pm

    Unfortunately I don’t have the book anymore (back at the library!), but here’s a couple bits from a review that try to explain some of his experimental findings. (Note of course that most all statistics ends up basing big conclusions on small sample sizes, but I do think there are valid questions about what findings could be mostly cultural rather than inherent).

    From the review at http://www.iht.com/articles/2008/03/14/arts/idbriefs15C.php by David Berreby:

    “Ariely is not out to overthrow rationality. Instead, he and his fellow social scientists want to replace the “rational economic man” model with one that more accurately describes the real laws that drive human choices. In a chapter on “relativity,” for example, Ariely writes that evaluating two houses side by side yields different results than evaluating three – A, B and a somewhat less appealing version of A. The subpar A makes it easier to decide that A is better – not only better than the similar one, but better than B. The lesser version of A should have no effect on your rating of the other two buildings, but it does.”

    The idea here – if you show home buyers to very different houses that sell for about the same price, it’s hard to compare them exactly. People choose one or the other. But if you throw in a third house that is similar (but run down and clearly inferior) to one of the houses, then the better version is now the vastly preferred choice – for no particularly good reason (i.e. irrationally).

    More from the review:

    “Similarly, he describes the “zero price effect,” which marketers exploit to convince us to buy something we don’t really want or need in order to collect a “free” gift. “FREE! gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is,” Ariely writes. None of this is rational, but it is predictable.”

    I’m sure most of us have experienced this…

    In these two examples, at least, it points out ways that marketers can influence our choices in ways that don’t have much rational basis.

  • Jim  On January 29, 2009 at 12:24 pm

    I agree with the examples, but they say nothing to me. Of the millions of decisions on houses – which is what sets the market – this example is again “anecdotal” in my opinion. Ditto for FREE!

    I understand the point, but feel it is another academician publishing to not perish!!

    I think economists should continue to base their studies on more general wisdom they have gathered over the years.

  • Curt  On January 30, 2009 at 4:39 pm

    Fair enough – I won’t argue against your skepticism.

    However in my opinion, “general wisdom” is too often an excuse for not examining one’s assumptions, and not testing one’s theories in the ‘real world’. I prefer Ariely’s empirical approach to those of economists who assume away complications in order to write very mathematical papers that are of interest to about 3 other people in the world.

  • Jim  On February 2, 2009 at 11:51 am

    “General Wisdom” is the result of mankind examining one’s assumptions for 1000’s of years! It is the ultimate testing of one’s theories in the “real world”.

    The “short term empirical approach” – which is what you are recommending – only makes us set aside this wisdom, and this is not good!

    An example – unrelated to economics but gets the point across: an empirical study of injured children on school grounds and litigation around this fact make a world where my grandchildren cannot swing, teeter totter, play dodgeball or tetherball as they grow – activities which even I, with my limited wisdom, know helped me grow into a contribunting human being. Hopefully, you recognize this also.

    Want to get rid of obesity – one of the latest hot buttons of the left – use some wisdom in allowing the physical activities of children!

    Agreed?

  • Curt  On February 2, 2009 at 12:44 pm

    I’m with you on your chosen example. It seems to point out an interesting paradox, which is that ‘over-protecting’ children can be bad for them! I read something recently about how kids putting all sorts of things in their mouth (such as dirt) seems to play a role in building up the immune system. So this modern idea of trying to use anti-bacterial soap and so forth to get rid of all the germs could be a counter productive idea.

    On the other hand, the food that many children eat now is nothing like what you or I might have eaten when growing up… How many gallons of soda did you drink each week as a child? How many servings of french fries? I know I never had much of that stuff. So in terms of food, it may be a good idea for parents to be protective.

    The trick, it seems to me, is when to rely on the ‘old wisdom’ and when to accept that we’ve learned something new that’s indeed valid and useful. It is perhaps one of the great challenges of life! That said, I’m always interested in empirical study to shed more light on what works and what doesn’t.

    (Another thing that seems a bit paradoxical to me is that markets produce some of the most radical challenges to the ‘old wisdom’ – how often do we hear that “it’s different this time” about some fad or bubble, only to have it turn out that it’s not different at all…)

  • Jim  On February 2, 2009 at 1:21 pm

    “The trick, it seems to me, is when to rely on the ‘old wisdom’ and when to accept that we’ve learned something new that’s indeed valid and useful.”

    Problem is the academician who generates the empirical study has self interest in believing and promoting his conclucions, often with inadequate study. His thoughts have not been validated over time.

    Side Bar: it seems that one of our major problems in reaching agreement on everything is TIME. I like what it does and am willing to wait for its judgement. You would prefer to make your decision without the test of time. I don’t think you are that smart! (“You”, of course, is referring to the entire left!).

    I think you may disagree with this example, but the fact that BHO and Al Gore say that Global Warming is settled science shows a complete disregard for a significant portion of the scientific community in the world that does not agree. How can they say that? SELF INTEREST!

  • Curt  On February 2, 2009 at 2:07 pm

    Your skepticism about academics shines through!

    Taking climate change as the example, I agree that there are outstanding question and issues. Then again, in almost any scientific endeavor there are outstanding questions and issues (as a side note, often it turns out that the most important role of Time in science is simply for an older generation to die off – see Thomas Kuhn’s work on scientific paradigms).

    Climate change study is tough for a variety of reasons – complicated weather systems and long time scales being the big ones. And I think the best approach is to continue empirical study. The problem, of course, is that if the most extreme models turn out to be true, then we may have gone too far down the road to shift course. We’ll never be in a position to say with 100% certainty what will happen in the climate and why.So the big question is at what point will we decide that we have enough evidence to decide that it’s warranted to change course. (If Kuhn is right, then that decision point may come when the generations who can’t imagine making such a change in lifestyle die off)

    But most of the time we just have to make decisions today based on the knowledge we have available. Say, for example, if you have a medical problem. You could choose to try a new treatment that has some good initial results, or you could go with an older treatment that doesn’t have a great track record. I don’t think there’s a right answer, it’s a personal choice – maybe you should do nothing. But I am glad that some people are out there doing empirical study, trying to draw conclusions when warranted, building up our knowledge.

  • Jim  On February 3, 2009 at 1:08 pm

    I hope your point that “…,often it turns out that the most important role of Time in science is simply for an older generation to die off -…” is not applicable to political scientists (albeit amateur!) also!!

    Your second paragraph seems to acknowledge global warming is not “settled science”. Why do they use this term unless they want to shut down any opponents? Very dangerous in my mind. Do you support them using this term?

    Your third paragraph I read as saying Time will solve the problem. We do not need panic now, which seems to be the goal.

    I agree completely with your closing paragraph. Empirical studies are an indispensable part of all human activity, insuring progress of mankind. But they need to be taken “with a grain of salt” – not demagogued by the poitician.

  • Curt  On February 3, 2009 at 2:29 pm

    It’s an interesting question – is science ever really ‘settled’? I’m not sure it is. My sense of things, in terms of climate change, is that there is increasing consensus that the climate is shifting (warming in many areas, but not all). What seems less clear is the role of CO2 in that warming (is there a strict cause/effect relationship?), and whether any current weather models are really accurate. I guess I’d have to say that rather than ‘settled science’ I’d prefer a term like ‘increasing evidence’.

    I think of it like this – if you are the captain of a ship, and you start getting reports about the possibility of a big iceberg ahead, what do you do? You might think, well, there shouldn’t be an iceberg there, so let’s get closer and continue to monitor. As you get closer, you get more information, but you also have less room to maneuver. At some point you have to make the call whether to take the precaution and steer away from whatever it is, or else risk crashing the ship.

    A lot of folks think we’re at that point now where we need to start turning. But admittedly, there are people who don’t think that’s true. So it’s a tough call.

    In terms of the original post, and Ariely’s work, the tough part of climate change is that it’s long-term and relatively slow (though seeing pictures of the melting ice cap can be pretty dramatic), and people aren’t always so good about thinking through the long-term implications of today’s actions.

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