Monday, January 12, 2009

Predictably Irrational: Dan Ariely

Taste of Chicago is an annual event that claims to be the world's largest annual open air food festival. When I went there in the summer of 2008, a local restaurant was giving away free slices of cheesecake to everyone attending. No surprise, the lines to get free cheesecake were excruciatingly long. When my wife and I joined the line, we couldn't see the actual stall with the cheesecake. That's how far back we were. After waiting for a little while, I asked my wife this: If I were to offer you $2 to go stand in a wait line for me for 25 minutes, would you do it? She looked at me like I was crazy to think she would be interested in a deal like that. Yet, here we were, taking exactly that deal, and feeling great about it!

Traditional economics is built on the premise that economic players act rationally. They know what something is worth to them, and will take whatever actions are necessary and rational to maximize their happiness, or 'utility'. Behavioral economics has no such illusions about us humans. As Dan Ariely says in this phenomenal book, "we are all far less rational in our decision making than standard economic theory assumes. Our irrational bejaviors are neither random nor senseles - they are systematic and predictable." Predictably Irrational is a convincing case to back up this claim.

Dan Ariely is a professor of Behavioral Economics at MIT. He is a prolific publisher of research in this field, if the bibliography is anything to go by. He is also - and this is what makes Predictably Irrational the great book that it is - a sharp, insightful and more than slightly mischievous, experimenter. Ariely picks 10-12 different ways humans make what might be called 'irrational' economic decisions. He performs tens (maybe hundreds) of carefully designed scientific experiments to test the different hypothesis around these, and describes his results and their implications in a chapter for each 'irrationality'.

There are some truly intriguing insights here into the fallibility of human decision making. Sample these -

- When a restaurant adds a really expensive wine to their wine list, their total $ sales go up, even if no one buys this expensive wine. (Ariely calls this the 'decoy effect').

- If you were to get your mom-in-law a gift for hosting a nice Thanksgiving dinner, you would be a hit. But if you were to try to pay her that same amount of money as cash, you have probably broken the relationship for ever. (Ariely calls this the conflict of 'social norms' vs 'market norms')

- FREE! is not just another price point. When a snack stand sells Hershey's Kisses for 1cent and Lindt Truffles for 15 cents, customers prefer the Lindt over the Hersheys 3:1. Now give the Kisses for FREE! and the Lindt for 14 cents, and the demand doesn't just change marginally. It flips to the Hersheys 3:1! (Forget all the stuff about demand and supply as a function of price!)

... and there are tens more where these come from. The most joyful parts of Predictably Irrational are the ones describing Ariely's experiments. They often start with testing a potential irrationality that you think "I am sure this happens ... why do you need an experiment to figure that out?" Ariely performs that experiment, proves that indeed we act in that irrational way and then (here is where he gets really interesting) designs a series of follow-up experiments to see how far that irrationality stretches.

In some cases, the best part is figuring out how one would even design an experiment to get at a hypothesis. For instance, Ariely makes the assertion that when we operate under passion (anger, frustration, sexual arousal), we often make decisions contrary to what we confidently predict in our calm state. Now, how do you create an experiment that tests this assertion? Ariely does create such an experiment, and it is fun to read about.

While the experiments are the best part of the book, I am not sure I was totally sold on Ariely's synthesis of the implications of such irrational behaviors. On some questions, his implications make sense. But in others, like the chapter on social vs market norms, I was left unconvinced that there was a clear 'so what' coming out of these insights. The sub-title of the book boldly states 'The Hidden Forces That Shape Our Decisions'. I don't believe the book comes anywhere close to unearthing such 'Hidden Forces'.

That said, this is as good an introduction to Behavioral Economics as I could have dreamed of. To me, it made the case convincingly that inspite of the Bard's proclamations to the contrary, man is in fact 'not noble in reason, not infinite in faculty and is rather weak in apprehension'. With such whetting of the appetite, the question I have is, where are the other popular books on Behavioral Economics? Know of any?

1 comment:

  1. Check out this paper: