This book is about human irrationality – about our distance from perfection. I believe that recognizing where we depart from the ideal is an important part of the quest to truly understand ourselves, and one that promises many practical benefits. Understanding irrationality is important for our everyday actions and decisions, and for understanding how we design our environment and the choices it presents to us.
My further observation is that we are not only irrational, but Predictably Irrational – that our irrationality happens the same way, again and again. Understanding how we are predictably irrational provides a starting point for improving our decision making and changing the way we live for the better.
As you will see in this book, we are really far less rational than standard economic theory assumes. Moreover, these irrational behaviors of ours are neither random nor senseless. They are systematic, and since we repeat them again and again, predictable.
The Truth about Relativity
Why everything is Relative – even when it shouldn’t be
Humans rarely choose things in absolute terms. We don’t have an internal value meter that tells us how much things are worth. Rather, we focus on the relative advantage of one thing over another, and estimate value accordingly.
Most people don’t know what they want unless they see it in context. Everything is relative, and that’s the point. Thinking is difficult and sometimes unpleasant.
One thing Rapp has learned is that high-priced entrées on the menu boots revenue for the restaurant – even if no one buys them. Why? Because even though people generally won’t buy the most expensive dish on the menu, they will order the second most expensive dish. Thus, by creating an expensive dish, a restaurateur can lure customers into ordering the second most expensive choice (which can be cleverly engineered to deliver a higher profit margin).
We are always looking at the things around us in relation to others. This holds true not only for physical things but for experiences such as vacations and educational options, and for ephemeral things as well: emotions, attitudes, and points of view.
We always compare jobs with jobs, vacations with vacations, lovers with lovers, and wines and wines.
Relativity is (relativity) easy to understand. But there’s one aspect of relativity that consistently trips us up. It’s this: we not only tend to compare things with one another but also tend to focus on comparing things that are easily comparable – and avoid comparing things that cannot be compared easily.
We like to make decisions based on comparisons.
Relativity helps us make decisions in life. But it can also make us downright miserable. Why? Because jealously and envy spring from comparing our lot in life with that of others.
Can we do anything about this problem of relativity? The good news is that we can sometimes control the “circles” around us, moving toward smaller circles that boost our relative happiness. We can also change our focus from narrow to broad.
“I don’t want to live the life of a Boxster, because when you get a Boxster you wish you had a 911, and you know what people who have 911s wish they had? They wish they had a Ferrari.” (James Hong, cofounder Hotornot.com)
That's a lesson we can all learn: The More We Have, The More We Want. And the only cure is to break the cycle of Relativity.
The Fallacy of Supply and Demand
As Mark Twain once noted about Tom Sawyer, “Tom had discovered a great law of human actions, namely, that in order to make a man covet a thing, it is only necessary to make the thing difficult to attain.”
The naturalist Konrad Lorenz demonstrated not only that goslings make initial decisions based on what’s available in their environment, but that they stick with a decision once it has been made. Lorenz called this natural phenomenon Imprinting.
Once we buy a new product at a particular price, we become anchored to that price.
The basic idea of Arbitrary Coherence is this: although initial prices are “arbitrary”, once those prices are established in our minds they will shape not only present prices but also future prices (this makes them “coherent”).
The significance of this is that once the participants were willing to pay a certain price for one product, their willingness to pay for other items in the same product category was judged relative to that first price (the anchor).
This, then, is what we call Arbitrary Coherence. Initial prices are largely “arbitrary” and can be influenced by responses to random questions; but once those prices are established in our minds, they shape not only what we are willing to pay for an item, but also how much we are willing to pay for related products (this makes them coherent).
In life, we are bombarded by prices. But price tags by themselves are not necessarily anchors. They become anchors when we contemplate buying a product or service at that particular price. That’s when the imprint is set. From then on, we are willing to accept a range of prices – but as with the pull of a bungee cord, we always refer back to the original anchor. Thus the first anchor influences not only the immediate buying decision but many others to follow. Anchoring influences all kind of purchases.
Our first decisions resonate over a long sequence of decisions. First impressions are important.
We know we behave like gosling, it is important to understand the process by which our first decisions translate into long-term habits. Herding: it happens when we assume that something is good (or bad) on the basis of other people’s previous behavior, and our own actions follow suit. There’s also another kind of herding, one that we call self-herding. This happens when we believe something is good (or bad) on the basis of our own previous behavior.
With everything you do, you should train yourself to question your repeated behaviors.
We should also pay particular attention to the first decision we make in what is going to be a long stream of decisions. When we face such a decision, it might seem to us that this is just one decision, without large consequences; but in fact the power of the first decision can have such a long-lasting effect that it will percolate into our future decisions for years to come. Given this effect, the first decision is crucial, and we should give it an appropriate amount of attention.
In the real world, anchoring comes from manufacturer’s suggested retail prices, advertised prices, promotions, product introductions, etc. – all of which are supply-side variables.
In the framework of arbitrary coherence, the relationships we see in the marketplace between demand and supply are based not on preferences but on memory. The sensitivity we show to price changes might in fact be largely a result of our memory for the prices we have paid in the past and our desire for coherence with our past decisions – not at all a reflection of our true preferences or our level of demand.
The Cost of Zero Cost
Why we pay too much when we pay nothing
Zero is an emotional hot button - a source of irrational excitement.
Most transactions have an upside and a downside, but when something is FREE! We forget the downside. FREE! Gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is. Why? I think it’s because humans are intrinsically afraid of loss. The real allure of FREE! Is tied to this Fear. There’s no visible possibility of loss when we choose a FREE! Item. We often fall into the trap of buying something we may not want, simply because of that sticky substance, FREE!
The concept of Zero also applies to Time. Time spent on one activity, after all, is time taken away from another.
Zero is not just another discount. Zero is a different place. The difference between 2 cents and 1 cent is small. But the difference between 1 cent and Zero is huge!
If you are in business, and understand that, you can do some marvelous things. Want to draw a crowd? Make something FREE! Want to sell more products? Make part of the purchase FREE!
The price of Zero plays a unique role in our decisions.
The Cost of Social Norms
Why we are Happy to Do things, but Not Happy when we are Paid to Do them
We live simultaneously in 2 different worlds – one where social norms prevail, and the other where market norms make the rules. The social norms include the friendly requests that people make of one another. Social norms are wrapped up in our social nature and our need for community. They are usually warm and fuzzy. Instant paybacks are not required. The second world, the one governed by market norms, is very different. There’s nothing warm and fuzzy about it. The exchanges are sharp-edged: wages, prices, rents, interest, and cost-and-benefits. When you are in the domain of market norms, you get what you pay for.
When we keep social norms and market norms on their separate paths, life hums along pretty well.
When social and market norms collide, trouble sets in.
“The most expensive sex is Free sex” – Woody Allen
There are many examples to show that people will work more for a cause than for cash. Example: when money was mentioned, the lawyers used market norms and found the offer lacking, relative to their market salary. When no money was mentioned they used social norms and were willing to volunteer their time. Once market norms enter our considerations, the social norms depart.
The conclusion: no one is offended by a small gift, because even small gifts keep us in the social exchange world and away from market norms.
Offering people a gift, even a small one, is sufficient to get them to help; but mention what the gift cost you, and you will see the back of them faster than you can say market norms.
So we live in 2 worlds: one characterized by social exchanges and the other characterized by market exchanges. And we apply different norms to these 2 kinds of relationships. Moreover, introducing market norms into social exchanges, as we have seen, violates the social norms and hurts the relationships. Once this type of mistake has been committed, recovering a social relationship is difficult.
When a social norm collides with a market norm, the social norm goes away for a long time. In other words, social relationships are not easy to reestablish. Once the bloom is off the rose – once a social norm is trumped by a market norm – it will rarely return.
If you want a social relationship, go for it, but remember that you have to maintain it under all circumstances.
Cash will take you only so far – social norms are the forces that can make a difference in the long run.
Money, as it turns out, is very often the most expensive way to motivate people. Social norms are not only cheaper, but often more effective as well.
Social norms can play a far greater role in society than we have been giving them credit for.
The Influence of Arousal
Why Hot is Much Hotter than we Realize
“Man is not truly one, but truly two” – Robert Louis Stevenson
All these otherwise good people assume that they understand themselves. But in the heat of Passion, suddenly, with the flip of some interior switch, everything changes. Every one of us, regardless of how “good” we are, underpredicts the effects of Passion on our behavior.
The study suggested that our inability to understand ourselves in a different Emotional state does not seem to improve with Experience;
To make informed decisions we need to somehow experience and understand the emotional state we will be in at the other side of the experience.
We need to explore the 2 sides of ourselves; we need to understand the Cold State and the Hot State; we need to see how the Gap between the Hot and Cold states benefits our lives, and where it leads us astray.
The Problem of Procrastination and Self-Control
Why we can't make ourselves to Do What we Want to DO
Giving up on our long-term goals for immediate Gratification is Procrastination.
Almost everyone has problems with Procrastination, those who recognize and admit their weakness are in a better position to utilize available tools for precommitment and by doing so, help themselves overcome it.
Resisting temptation and instilling self-control are general human goals, and repeatedly failing to achieve them is a source of much of our misery. Without Pre-Commitment, we keep on failing for Temptation.
We have problems with Self-Control, related to immediate and delayed Gratification.
The High Price of Ownership
Why we Overvalue What we Have
When we own something, we begin to value it more than other people do i.e. the Seller of a house usually value that property more than the potential Buyer.
Ownership pervades our lives and, in a strange way, shapes many of the things we do. Much of our life story can be told by describing the ebb and flow of our particular possessions – what we get and what we give up.
Since so much of our lives is dedicated to ownership, wouldn’t it be nice to make the best decisions about this? Wouldn’t it be nice to know exactly how much we would enjoy a new home, a new car…so that we could make accurate decisions about owning them? Unfortunately, this is rarely the case. We are mostly fumbling around in the dark. Why? Because of 3 irrational quirks in our human nature.
The first quirk is that we fall in love with what we already have.
The second quirk is that we focus on what we may lose, rather than what we may gain.
The third quirk is that we assume other people will see the transaction from the same perspective as we do.
Ownership also has what I’d call “peculiarities”. For one, the more work you put into something, the more ownership you begin to feel for it. Another peculiarity is that we can begin to feel ownership even Before we own something.
Ownership is not limited to material things. It can also apply to Points of View.
Keeping Doors Open
Why Options Distract Us from Our Main Objective
Normally, we cannot stand the idea of closing the doors on our alternatives.
In the context of today’s world, we work just as feverishly to keep all our options open. We buy the expandable computer system, just in case we need all those high-tech bells and whistles. We buy the insurance policies that are offered with the plasma high-definition TV, just in case the big-screen goes blank. We keep our children in every activity we can imagine – just in case one sparks their interest in Gymnastics, Piano, French, Tae Kwon Do.
We might not always be aware of it, but in every case we give something up for those options. We end up with a computer that has more functions than we need..
In running back and forth among the things that might be important, we forget to spend enough time on what really IS important. It’s a fool’s game, and one that we are remarkably adept at playing.
What is it about Options that is so difficult for us? Why do we feel compelled to keep as many doors open as possible, even at great expense? Why can’t we simply commit ourselves?
Running from door to door is a strange enough human activity. But even stranger is our compulsion to chase after doors of little worth – opportunities that are nearly dead, or that hold little interest for us. How many times have we bought something on Sale not because we really needed it but because by the end of the sale all of those items would be gone, and we could never have it at that price again?
It should be a reminder to all of us that we have doors – little and big ones – which we ought to shut.
What we failed to do when focusing on the similarities and minor differences between 2 things was to take into account the Consequences of Not Deciding. More important, we all failed to take into consideration the relatively minor differences that would have come with either one of the decisions.
The Effect of Expectations
Why the Mind gets What it Expects
The moral is that if you tell people up front that something might be distasteful, the odds are good that they will end up agreeing with you – not because their experience tells them so but because of their expectations.
When we Believe beforehand that something will be good, therefore, it generally will be good – and when we think it will be bad, it will bad.
Don’t underestimate the power of Presentation.
That’s what Marketing is all about – providing information that will heighten someone’s anticipated and real pleasure.
Expectations also shape Stereotypes. A stereotype, after all, is a way of categorizing information, in the hope of predicting experiences. The brain cannot start from scratch at every new situation. It must build on what it has seen before.
If we acknowledge that we are trapped within our perspective, which partially blinds us to the truth, we may be able to accept the idea that conflicts generally require a neutral third party – who has not been tainted with our expectations – to set down the rules and regulations.
The Power of Price
Why a 50c Aspirin can Do what a penny Aspirin can't
Exploring the placebo effect in this chapter, we’ll see not only that Beliefs and Expectations affect how we perceive and interpret sights, tastes, and other sensory phenomena, but also that our expectations can affect us by altering our subjective and even objective experiences.
The Context of our Character, P1
Why we are Dishonest, and What we can do about it
Why are some crimes, particularly white-collar crimes, judges less severely than others, we wondered – especially since their perpetrators can inflict more financial damage between their 10 o’clock latte and lunch than a standard-issue burglar might in a lifetime?
Given the Opportunity, many honest people will cheat.
Since people engage in a cost-benefit analysis with regard to Honesty, they can also engage in a cost-benefit analysis to be Dis-Honest. According to this perspective, individuals are honest only to the extent that suits them.
This is my take. We care about Honesty and we want to be Honest. The problem is that our internal honesty monitor is active only when we contemplate big transgression, like grabbing an entire box of pens from the conference hall. For the little transgressions, like taking a single pen or two pens, we don’t even consider how these actions would reflect on our honesty and so our superego stays asleep.
So we learned that people cheat when they have a chance to do so, but they don’t cheat as much as they could. When we are removed from any benchmarks of ethical thought, we tend to stray into Dishonesty. But if we are reminded of morality at the moment we are tempted, then we are much more likely to be honest.
Adam Smith reminded us that Honesty really is the best policy, especially in Business.
The Context of our Character, P2
Why dealing with Cash makes us more Honest
Even good people are not immune to being partially blinded by their own minds. This blindness allows them to take actions that bypass their own moral standards on the road to financial rewards. In essence, motivation can play tricks on us whether or not we are good, moral people.
We need to recognize that once Cash is a step away, we will cheat by a factor bigger than we could imagine.
Beer and Free Lunches
What we found was a correlation between the tendency to order alcoholic beverages that were different from what other people at the table had chosen and a personality trait called “need for uniqueness”. In essence, individuals more concerned with portraying their own uniqueness were more likely to select an alcoholic beverage not yet ordered at their table in an effort to demonstrate that they were in fact one of a kind.
What these results show is that people are sometimes willing to sacrifice the pleasure they get from a particular consumption experience in order to project a certain image to others. In essence, people, particularly those with a high need for uniqueness, may sacrifice personal utility in order to gain reputational utility.
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 weighting the ramifications of each potential choices. 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”. 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.
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”.
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, irrelevant emotions, shortsightedness, and other forms of Irrationality.
If 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…) 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.
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.