Predictably irrational

Marketplace Staff Mar 28, 2008

Predictably irrational

Marketplace Staff Mar 28, 2008


Tess Vigeland: I love the field of behavioral economics. At last, someone trying to figure out why I — and you, I’m guessing — make such utterly irrational decisions involving money.

When I saw MIT professor Dan Ariely’s new book, “Predictably Irrational,” I knew I had to talk to him.

Vigeland: Welcome to the program.

Dan Ariely: Thank you very much for having me.

Vigeland: Tell us briefly about one of the earlier experiments in your book which had to do with Social Security numbers. How did this demonstrate predictable irrationality?

Ariely: We went to a big class of students with six products and after they finished examining them, we asked them to write the last two digits of their Social Security numbers. So, what’s yours for example?

Vigeland: Uh… six-zero.

Ariely: So you will write six-zero next to each of those products and then we will ask you whether, hypothetically, you would pay $60 for each of those products and you will say yes or no. Now we said we will have an auction and everybody is asked to bid for each of those items and then we calculated the correlation between peoples’ Social Security numbers and their bid. So, in fact, if you look at the people that the number ended between zero and 20, you would have bid much lower numbers for these items and the people who ended between 80 and 99, those people were willing to pay sometimes three or four times more for the same items.

Vigeland: So that really teaches us then, doesn’t it, that we are very much prompted by whatever our surrounding is

Ariely: That’s right. Imagine that tomorrow somebody doubles the price of milk and halves the price of alcohol. What would happen? I’m guessing that people would have less calcium and would walk a little happier in the streets, right? We will remember the price of yesterday and we will behave accordingly: we will stop buying milk and start buying alcohol. Now, what would happen if these same price changes are also accompanied by amnesia. We wouldn’t remember any prices that we paid in the past. In that case, I’m assuming that our sensitivity to these price changes will be much, much lower and that’s part of the point is that we don’t really have a true reservation price and part of what we are making decisions about is a reaction to the prices of the market and not as a function of our own preferences.

Vigeland: I want to toss a couple of questions back to you that you ask in the book and get your take on them. One is why are we willing to splurge on a really nice meal, but then we go home and cut coupons for the grocery store?

Ariely: Part of the answer is that we think of money in relative terms. If we’re in a restaurant and it’s going to cost us $150 anyway, what’s another $50? But if we’re in the grocery store and there’s a tomato for $2 and there’s a tomato for $3.50, that looks like a tremendous difference.

Vigeland: And I love this one: why do our headaches not go away after $0.01 aspirin, but like magic, they’re gone after a $0.50 one?

Ariely: What we found is that when you have a cold medication that you buy on full price, you expect this cold medication to work and indeed, it works better, and when you get a cold medication on discount, you expect it to be worse and indeed, it’s worse. Expectations are not just things in our minds; they are the tools by which we see reality and they actually play a role in making the reality different.

Vigeland: If we are such predictably irrational creatures, what’s the best way for us to recognize our own behavior and try to change it?

Ariely: I think there are some things we understand that we are irrational and we are already starting to fight it and there’s some things we don’t understand. So, think about savings. How much od you think would be the saving rate in the U.S. if we didn’t have 401(k) plans? Presumably, it would be much lower. Now what’s the magic of 401(k)? It has the matching contribution, which is a part of the answer, but it also has the issue of deducting the money at the beginning of the month — it’s not under our discretion. So the main lesson is we have to understand where we fall short and come up with mechanisms. It could be a mechanism to take the decision out of our control, like, you know, 401(k), or it could be things that use other things that we care about to get us to do the things that we actually don’t seem to be doing and I’ll give you one example for this. AARP a few years ago spent about $4 million on a campaign to try to get people to walk and it turns out it’s very hard to get people to walk, but we did a little study in which we got people to arrange meetings with other people and you know what? When people have a meeting with somebody else to walk with them, they just don’t cancel those meetings, so we created a mechanism that got them to behave better in a way that was good for them.

Vigeland: So we can become predictably rational?

Ariely: I think we can understand where we fail and we can try to fix some of those things, but it’s not easy.

Vigeland: Dan Ariely is the author of “Predictably Irrational: The Hidden Forces That Shape Our Decisions.” Thanks so much for coming in.

Ariely: My pleasure. Thank you.

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