Predictably Irrational (30 page)

In many ways, the standard economic and Shakespearean views are more optimistic about human nature, since they assume that our capacity for reasoning is limitless. By the same token the behavioral economics view, which acknowledges human deficiencies, is more depressing, because it demonstrates the many ways in which we fall short of our ideals. Indeed, it can be rather depressing to realize that we all continually make irrational decisions in our personal, professional, and social lives. But there is a silver lining: the fact that we make mistakes also means that there are ways to improve our decisions—and therefore that there are opportunities for “free lunches.”

O
NE OF THE
main differences between standard and behavioral economics involves this concept of “free lunches.” According to the assumptions of standard economics, all human decisions are rational and informed, motivated by an accurate concept of the worth of all goods and services and the amount of happiness (utility) all decisions are likely to produce. Under this set of assumptions, everyone in the marketplace is trying to maximize profit and striving to optimize his experiences. As a consequence, economic theory asserts that there are no free lunches—if there were any, someone would have already found them and extracted all their value.

Behavioral economists, on the other hand, believe that people are susceptible to irrelevant influences from their immediate environment (which we call context effects), irrelevant emotions, shortsightedness, and other forms of irrationality (see any chapter in this book or any research paper in behavioral economics for more examples). What good news can accompany this realization? The good news is that these mistakes also provide opportunities for improvement. If we all make systematic mistakes in our decisions, then why not develop new strategies, tools, and methods to help us make better decisions and improve our overall well-being? That's exactly the meaning of free lunches from the perspective of behavioral economics—the idea that there are tools, methods, and policies that can help all of us make better decisions and as a consequence achieve what we desire.

For example, the question why Americans are not saving enough for retirement is meaningless from the perspective of standard economics. If we are all making good, informed decisions in every aspect of our lives, then we are also saving the exact amount that we want to save. We might not save much because we don't care about the future, because we are looking forward to experiencing poverty at retirement, because we expect our kids to take care of us, or because we are hoping to win the lottery—there are many possible reasons. The main point is that from the standard economic perspective, we are saving exactly the right amount in accordance with our preferences.

But from the perspective of behavioral economics, which does not assume that people are rational, the idea that we are not saving enough is perfectly reasonable. In fact, research in behavioral economics points to many possible reasons why people are not saving enough for retirement. People procrastinate. People have a hard time understanding the real cost of not saving as well as the benefits of saving. (By how much would your life be better in the future if you were to deposit an additional $1,000 in your retirement account every month for the next 20 years?) Being “house rich” helps people believe that they are indeed rich. It is easy to create consumption habits and hard to give them up. And there are many, many more reasons.

The potential for free lunches from the perspective of behavioral economics lies in new methods, mechanisms, and other interventions that would help people achieve more of what they truly want. For example, the new and innovative credit card that I described in Chapter 7, on self-control, could help people exercise more self-control within the domain of spending. Another example of this approach is a mechanism called “save more tomorrow,” which Dick Thaler and Shlomo Benartzi proposed and tested a few years ago.

Here's how “save more tomorrow” works. When new employees join a company, in addition to the regular decisions they are asked to make about what percentage of their paycheck to invest in their company's retirement plan, they are also asked what percentage of their future salary raises they would be willing to invest in the retirement plan. It is difficult to sacrifice consumption today for saving in the distant future, but it is psychologically easier to sacrifice consumption in the future, and even easier to give up a percentage of a salary increase that one does not yet have.

When the plan was implemented in Thaler and Benartzi's test, the employees joined and agreed to have their contribution, as a percentage, increase with their future salary raises. What was the outcome? Over the next few years, as the employees received raises, the saving rates increased from about 3.5 percent to around 13.5 percent—a gain for the employees, their families, and the company, which by now had more satisfied and less worried employees.

This is the basic idea of free lunches—providing benefits for all the parties involved. Note that these free lunches don't have to be without cost (implementing the self-control credit card or “save more tomorrow” inevitably involves a cost). As long as these mechanisms provide more benefits than costs, we should consider them to be free lunches—mechanisms that provide net benefits to all parties.

I
F I WERE
to distill one main lesson from the research described in this book, it is that we are pawns in a game whose forces we largely fail to comprehend. We usually think of ourselves as sitting in the driver's seat, with ultimate control over the decisions we make and the direction our life takes; but, alas, this perception has more to do with our desires—with how we want to view ourselves—than with reality.

Each of the chapters in this book describes a force (emotions, relativity, social norms, etc.) that influences our behavior. And while these influences exert a lot of power over our behavior, our natural tendency is to vastly underestimate or completely ignore this power. These influences have an effect on us not because we lack knowledge, lack practice, or are weak-minded. On the contrary, they repeatedly affect experts as well as novices in systematic and predictable ways. The resulting mistakes are simply how we go about our lives, how we “do business.” They are a part of us.

Visual illusions are also illustrative here. Just as we can't help being fooled by visual illusions, we fall for the “decision illusions” our minds show us. The point is that our visual and decision environments are filtered to us courtesy of our eyes, our ears, our senses of smell and touch, and the master of it all, our brain. By the time we comprehend and digest information, it is not necessarily a true reflection of reality. Instead, it is our representation of reality, and this is the input we base our decisions on. In essence we are limited to the tools nature has given us, and the natural way in which we make decisions is limited by the quality and accuracy of these tools.

A second main lesson is that although irrationality is commonplace, it does not necessarily mean that we are helpless. Once we understand when and where we may make erroneous decisions, we can try to be more vigilant, force ourselves to think differently about these decisions, or use technology to overcome our inherent shortcomings. This is also where businesses and policy makers could revise their thinking and consider how to design their policies and products so as to provide free lunches.

T
HANK YOU FOR
reading this book. I hope you have gained some interesting insights about human behavior, gained some insight into what really makes us tick, and discovered ways to improve your decision making. I also hope that I have been able to share with you my enthusiasm for the study of rationality and irrationality. In my opinion, studying human behavior is a fantastic gift because it helps us better understand ourselves and the daily mysteries we encounter. Although the topic is important and fascinating, it is not easy to study, and there is still a lot of work ahead of us. As the Nobel laureate Murray Gell-Mann once said, “Think how hard physics would be if particles could think.”

Irrationally yours,

Dan Ariely

PS: If you want to participate in this journey, log on to www.predictablyirrational.com, sign up for a few of our studies, and leave us your ideas and thoughts.

Thanks

O
ver the years I have been fortunate to work on joint
research projects with smart, creative, generous individuals. The research described in this book is largely an outcome of their ingenuity and insight. These individuals are not only great researchers, but also close friends. They made this research possible. Any mistakes and omissions in this book are mine. (Short biographies of these wonderful researchers follow.) In addition to those with whom I have collaborated, I also want to thank my psychology and economics colleagues at large. Each idea I ever had, and every paper I ever wrote, was influenced either explicitly or implicitly by their writing, ideas, and creativity. Science advances mainly through a series of small steps based on past research, and I am fortunate to be able to take my own small steps forward from the foundation laid down by these remarkable researchers. At the end of this book, I have included some references for other academic papers related to each of the chapters. These should give the avid reader an enhanced perspective on, and the background and scope of, each topic. (But of course this isn't a complete list.)

Much of the research described in this book was carried out while I was at MIT, and many of the participants and research assistants were MIT students. The results of the experiments highlight their (as well as our own) irrationalities, and sometimes poke fun at them, but this should not be confused with a lack of caring or a lack of admiration. These students are extraordinary in their motivation, love of learning, curiosity, and generous spirit. It has been a privilege to get to know you all—you even made Boston's winters worthwhile!

Figuring out how to write in “non-academese” was not easy, but I got a lot of help along the way. My deepest thanks to Jim Levine, Lindsay Edgecombe, Elizabeth Fisher, and the incredible team at the Levine Greenberg Literary Agency. I am also indebted to Sandy Blakeslee for her insightful advice; and to Jim Bettman, Rebecca Waber, Ania Jakubek, Erin Allingham, Carlie Burck, Bronwyn Fryer, Devra Nelson, Janelle Stanley, Michal Strahilevitz, Ellen Hoffman, and Megan Hogerty for their role in helping me translate some of these ideas into words. Special thanks to my writing partner, Erik Calonius, who contributed greatly to these pages, with many real-world examples and a narrative style that helped me tell this story as well as it could be told. Special thanks also go to my trusting, supporting, and helpful editor at HarperCollins, Claire Wachtel.

I wrote the book while visiting the Institute for Advanced Study at Princeton. I cannot imagine a more ideal environment in which to think and write. I even got to spend some time in the institute's kitchen, learning to chop, bake, sauté, and cook under the supervision of chefs Michel Reymond and Yann Blanchet—I couldn't have asked for a better place to expand my horizons.

Finally, thanks to my lovely wife, Sumi, who has listened to my research stories over and over and over and over. And while I hope you agree that they are somewhat amusing for the first few reads, her patience and willingness to repeatedly lend me her ear merits sainthood. Sumi, tonight I will be home at seven-fifteen at the latest; make it eight o'clock, maybe eight-thirty; I promise.

List of Collaborators

On Amir

On joined MIT as a PhD student a year after me and became “my” first student. As my first student, On had a tremendous role in shaping what I expect from students and how I see the professor-student relationship. In addition to being exceptionally smart, On has an amazing set of skills, and what he does not know he is able to learn within a day or two. It is always exciting to work and spend time with him. On is currently a professor at the University of California at San Diego.

Marco Bertini

When I first met Marco, he was a PhD student at Harvard Business School, and unlike his fellow students he did not see the Charles River as an obstacle he should not cross. Marco is Italian, with a temperament and sense of style to match—an overall great guy you just want to go out for a drink with. Marco is currently a professor at London Business School.

Ziv Carmon

Ziv was one of the main reasons I joined Duke's PhD program, and the years we spent together at Duke justified this decision. Not only did I learn from him a great deal about decision making and how to conduct research; he also became one of my dear friends, and the advice I got from him over the years has repeatedly proved to be invaluable. Ziv is currently a professor at INSEAD's Singapore campus.

Shane Frederick

I met Shane while I was a student at Duke and he was a student at Carnegie Mellon. We had a long discussion about fish over sushi, and this has imprinted on me a lasting love for both. A few years later Shane and I both moved to MIT and had many more opportunities for sushi and lengthy discussions, including the central question of life: “If a bat and a ball cost $1.10 in total, and the bat costs a dollar more than the ball, how much does the ball cost?” Shane is currently a professor at MIT.

Ayelet Gneezy

I met Ayelet many years ago at a picnic organized by mutual friends. I had a very positive first impression of her, and my appreciation of her only increased with time. Ayelet is a wonderful person and a great friend, so it is a bit odd that the topics we decided to work on together were mistrust and revenge. Whatever drove us to start exploring these topics initially, it ended up being very useful both academically and personally. Ayelet is currently a professor at the University of California at San Diego (and if you happen to see another Gneezy on my list of collaborators, that is not because it is a popular last name).

Uri Gneezy

Uri is one of the most sarcastic and creative people I have ever met, and both of these skills make him able to effortlessly and rapidly turn out important and useful research. A few years ago, I took Uri to Burning Man, and while we were there, he completely blended into the atmosphere. On the way back, he lost some bet to me, and as a consequence, he was supposed to give a gift to a random person every day for a month—but sadly, once back in civilization, he was unable to do this. Uri is currently a professor at the University of California at San Diego.

Ernan Haruvy

Ernan and I got to spend some time together when he was at Harvard Business School and I was on the other side of the river. Ernan was one of the first people to think carefully about how the Internet can change the anonymity of human interactions and, as a consequence, the way we treat one another. He is smart and hardworking, and has an amazing willingness to help. Ernan is currently a professor at the University of Texas at Dallas.

James Heyman

James and I spent a year together at Berkeley. He would often come in to discuss some idea, bringing with him some of his recent baking outputs, and this was always a good start for an interesting discussion. Following his life's maxim that money isn't everything, his research focuses on nonfinancial aspects of marketplace transactions. One of James's passions is the many ways behavioral economics could play out in policy decisions, and over the years I have come to see the wisdom in this approach. James is currently a professor at the University of St. Thomas (in Minnesota, not the Virgin Islands).

Günter Hitsch

Günter is funny, smart, and charming—and not just relative to other economists. He is the sort of guy that you want to have a beer with, and talking with him is always an interesting yet somewhat unexpected experience. Günter is also one of the most meticulous econometricians I know, and he can spend years (I am not joking) running very complex computer models to properly estimate some obscure parameters. Günter is currently a professor at the University of Chicago.

Ali Hortaçsu

Ali is one of the most well-balanced individuals I have ever met. Nothing seems to faze him, and he is always oozing goodness (well, this is not completely true—he does seem to become a different person when the Turkish soccer team is playing). Ali was one of the first economists to take a careful look at online auctions, helping us understand how people actually behave in such auctions. Working with him on online dating has been a very educational experience for me. Ali is currently a professor at the University of Chicago.

Leonard Lee

Leonard joined the PhD program at MIT to work on topics related to e-commerce. Since we both kept long hours, we started taking breaks together late at night, and this gave us a chance to start working jointly on a few research projects. The collaboration with Leonard has been great. He has endless energy and enthusiasm, and the number of experiments he can carry out during an average week is about what other people do in a semester. In addition, he is one of the nicest people I have ever met and always a delight to chat and work with. Leonard is currently a professor at Columbia University.

Jonathan Levav

Jonathan loves his mother like no one else I have met, and his main regret in life is that he disappointed her when he didn't go to medical school. Jonathan is smart, funny, and an incredibly social animal, able to make new friends in fractions of seconds. He is physically big with a large head, large teeth, and an even larger heart. Jonathan is currently a professor at Columbia University.

George Loewenstein

George is one of my first, favorite, and longest-time collaborators. He is also my role model. In my mind George is the most creative and broadest researcher in behavioral economics. George has an incredible ability to observe the world around him and find nuances of behavior that are important for our understanding of human nature as well as for policy. George is currently, and appropriately, the Herbert A. Simon Professor of Economics and Psychology at Carnegie Mellon University.

Nina Mazar

Nina first came to MIT for a few days to get feedback on her research and ended up staying for five years. During this time we had oodles of fun working together and I came to greatly rely on her. Nina is oblivious of obstacles, and her willingness to take on large challenges led us to carry out some particularly difficult experiments in rural India. For many years I hoped that she would never decide to leave; but, alas, at some point the time came: she is currently a professor at the University of Toronto. In an alternative reality, Nina is a high-fashion designer in Milan, Italy.

Elie Ofek

Elie is an electrical engineer by training who then saw the light (or so he believes) and switched to marketing. Not surprisingly, his main area of research and teaching is innovations and high-tech industries. Elie is a great guy to have coffee with because he has interesting insights and perspectives on every topic. Currently, Elie is a professor at Harvard Business School (or as its members call it, “The Haaarvard Business School”).

Yesim Orhun

Yesim is a true delight in every way. She is funny, smart, and sarcastic. Regrettably, we had only one year to hang out while we were both at Berkeley. Yesim's research takes findings from behavioral economics and, using this starting point, provides prescriptions for firms and policy makers. For some odd reason, what really gets her going is any research question that includes the words
simultaneity
and
endogeneity
. Yesim is currently a professor at the University of Chicago.

Drazen Prelec

Drazen is one of the smartest people I have ever met and one of the main reasons I joined MIT. I think of Drazen as academic royalty: he knows what he is doing, he is sure of himself, and everything he touches turns to gold. I was hoping that by osmosis, I would get some of his style and depth, but having my office next to his was not sufficient for this. Drazen is currently a professor at MIT.

Kristina Shampanier

Kristina came to MIT to be trained as an economist, and for some odd but wonderful reason elected to work with me. Kristina is exceptionally smart, and I learned a lot from her over the years. As a tribute to her wisdom, when she graduated from MIT, she opted for a nonacademic job: she is now a high-powered consultant in Boston.

Jiwoong Shin

Jiwoong is a yin and yang researcher. On one hand he carries out research in standard economics assuming that individuals are perfectly rational; on the other hand he carries out research in behavioral economics showing that people are irrational. He is thoughtful and reflective—a philosophical type—and this duality does not faze him. Jiwoong and I started working together mostly because we wanted to have fun together, and indeed we have spent many exciting hours working together. Jiwoong is currently a professor at Yale University.

Baba Shiv

Baba and I first met when we were both PhD students at Duke. Over the years Baba has carried out fascinating research in many areas of decision making, particularly on how emotions influence decision making. He is terrific in every way and the kind of person who makes everything around him seem magically better. Baba is currently a professor at Stanford University.

Stephen Spiller

Stephen started his academic career as a student of John Lynch. John was my Ph.D. adviser as well, so in essence, Stephen and I are academic brothers, and I feel as though he is my little (but much taller) brother. Stephen is smart and creative, and it has been a privilege to watch him advance on his academic adventures. Stephen is currently a doctoral student at Duke University, and if his advisers had any say in the matter, we would try to never let him graduate.

Rebecca Waber

Rebecca is one of the most energetic and happiest people I have ever met. She is also the only person I ever observed to burst out laughing while reading her marriage vows. Rebecca is particularly interested in research on decision making applied to medical decisions, and I count myself as very lucky that she chose to work with me on these topics. Rebecca is currently a graduate student at the Media Laboratory at MIT.

Klaus Wertenbroch

Klaus and I met when he was a professor at Duke and I was a PhD student. Klaus's interest in decision making is mostly based on his attempts to make sense of his own deviation from rationality, whether it is his smoking habit or his procrastination in delaying work for the pleasure of watching soccer on television. It was only fitting that we worked together on procrastination. Klaus is currently a professor at INSEAD.