Review: Predictably Irrational

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Each Sunday, The Simple Dollar reviews a personal productivity or personal development book.

predictablyI find that time and time again, my greatest opponent when trying to make intelligent and well-reasoned personal finance and time management issues is myself. I’m my own weakness. I regularly make irrational decisions – I’ll stop in the middle of work flow to surf the internet, or I’ll spend my time talking myself into a replacement workstation that’s far more expensive than what I actually need. This is a persistent problem for pretty much anyone who strives for something greater in their lives. We rely on their own rational behavior, but are often undermined by our own irrational impulses. Why?

Predictably Irrational focuses in on this exact question, digging deep into the causes of such irrational steps and laying bare some useful solutions. It’s written by Dan Ariely, the Sloan Professor of Behavioral Economics at MIT, so the book comes with some authority behind it as well.

As always, the question I’m looking for is what this book can teach me to apply to my own life. Does it provide some useful material, or is it focused on pie-in-the-sky nuances of behavioral economics? Let’s dig in and take a look.

Thumbing Through Predictably Irrational

Chapter 1 – The Truth about Relativity
Why Everything Is Relative – Even When It Shouldn’t Be

Predictably Irrational opens with a discussion of relative decision making – in other words, the idea that we use comparisons, whether fair or not, as a piece of our decision making process. A great example of this is the phenomenon of “keeping up with the Joneses” – we make choices based on a comparison of ourselves with our neighbors, not on a basis of whether or not a particular item suits our particular needs. We also do this when choosing among several options at the store – we rarely choose the cheapest one or the most expensive one and instead choose one in the middle (usually the next-to-most expensive one). Knowing that, retailers can organize the prices such that they get maximum profit not from the expensive item, but from that middle item. Yep, the middle item is often the one with the biggest markup in the store.

Chapter 2 – The Fallacy of Supply and Demand
Why the Price of Pearls – and Everything Else – Is Up in the Air

Ariely argues here that we tend to anchor ourselves to initial prices. For example, when we’re going to look for a DVD player at the store, we look at the price of the first one we see and then use that as an “anchor” by which we judge the other ones. That first price becomes a criteria in judging all other prices. As a result, when a new item comes out, it makes a lot of sense for a retailer to grossly overprice the item and thus set in our minds a very high “anchor” price, so that later on when the price drops a bit, it seems like a huge bargain when in truth there’s still a big fat profit margin for the business.

We do this to ourselves in a lot of ways. For example, during my first day as a full time writer, I more or less arbitrarily made up a schedule for the day, alternating between writing and other tasks. Even by the second day, this schedule had begun to seem natural to me and I used that natural schedule to judge my choices for the day – and by default, I followed that pattern of the first day.

Chapter 3 – The Cost of Zero Cost
Why We Often Pay Too Much When We Pay Nothing

Almost everyone behaves irrationally when the concept of “free” is introduced. The idea of getting something for “free” persuades us to engage in completely irrational behaviors that undermine any benefit we might get from “free.” The most stellar example of this I can think of is Amazon’s “free” Super Saver shipping on orders of more than $25. Let’s say I pop onto Amazon and want to order just one book, like Predictably Irrational, for instance. It’s a new hardback, costing $14.27, so I add it to my cart and see that if I just spend $10.73 more, I can get “free” Super Saver shipping! So I try to think of something to add to the cart so I can get that “free” shipping. Meanwhile, the profit margin on that extra purchase makes Amazon substantially more money than the cost of that “free” shipping, so I pay extra to get an item I don’t really want or need while Amazon pads their profit margin. But it’s “free,” right?

Chapter 4 – The Cost of Social Norms
Why We Are Happy to Do Things, but Not When We Are Paid to Do Them

Social norms also play a big role in our decisions. On our block, quite often people will pitch together to help someone do something like move a couch or rearrange deck furniture. No money is expected, though a cold beer is often accepted as a thank offering. However, if you were to give someone a dollar for this work – a fair wage for lifting a couch for a moment – you’d be quickly ostracized for being a jerk. Why is this? It’s because social norms often far outweigh market norms. This happens time and time again, when we make money decisions and time decisions not based upon what is a fair price, but based on what is socially accepted.

Chapter 5 – The Influence of Arousal
Why Hot Is Much Hotter Than We Realize

The conclusion from this chapter is stunning: our emotions are the single biggest factor in dictating our responses to a situation, to the point where we can almost behave like different people depending on our state. This chapter largely focused on the differences in decision making between a “normal” state and a state of sexual arousal and the study concluded that the decisions made were different enough that it might as well have been different people making the choices. In fact, any emotional state causes some significant changes in the decisions that we make.

Chapter 6 – The Problem of Procrastination and Self-Control
Why We Can’t Make Ourselves Do What We Want To Do

The first real solution to these problems is described here and it comes in the form of precommitments. In other words, we are much better at controlling our impulsive nature if we clearly state goals and set deadlines before we even start, and our biggest failures are often the result of not having concrete goals when we begin the process. For example, if we’re going to make a major purchase, we’re always better off doing the research in advance, checking on Consumer Reports and determining the exact nature of the item that we need. The same goes for managing our time: setting self-imposed deadlines and milestones helps us to keep making progress towards a bigger goal instead of falling into the easy trap of procrastination.

Chapter 7 – The High Price of Ownership
Why We Overvalue What We Have

All of us overvalue the things we own. They are a source of pride for us, an example of some sort of commitment of effort. Not all ownership is equal, though – things that we invest a lot of time in have an even greater value for us. Ariely uses the example of individuals waiting for tickets before Duke basketball games – they go through a long and agonizing ritual to get the tickets and some who participate don’t make the cut. Immediately after the tickets are distributed, the people who have the tickets radically overvalue them, while the ones without tickets value them substantially less. The difference is in the perception brought about by owning the tickets – the ticket owners see the investment of time and effort put into acquiring the ticket and the potential memories of a crazy day at Cameron, while the non-owners see the many possibilities for the hundreds of dollars that a ticket might cost.

This effect is true for anything we’re passionate about that we consider ours. I think of my children – I know quite well my opinion of them is higher than any other male on earth. Sure, that’s because I’m a parent, right? That status of parent is the result of a lot of time and emotional investment in my children, and thus that investment gives me a stronger sense of connection – and thus a higher value – than there would otherwise be.

Chapter 8 – Keeping Doors Open
Why Opinions Distract Us from Our Main Objective

Almost always, we prefer to keep our options open when making a choice, but we often do this to our own detriment. For example, let’s say you were about to buy a new car and you began researching models. With so many out there, it’s easy to keep finding new variations to look at and investigate and thus keep researching and putting off the purchase. Most of us quickly discover the first coping mechanism – eliminating a lot of choices and keeping just a few. But what do we do when confronted with just a few choices, all of which seem pretty equal to one another? Often, we get locked into making irrational decisions – we invest so much time in the choice that any difference between the options is negated by the loss of time and energy spent on making the decision.

I did this myself when trying to decide whether to pursue a full time career as a writer/involved parent. I weighed both options incredibly carefully and found myself going over the choice again and again and again. Yet, when I finally made the choice, it was incredibly clear, quick, and decisive, and I realized that for all the hemming and hawing about the decision, I would have been much better off just choosing based on my initial instinct and analysis and then investing that left over energy into making this adventure work.

Chapter 9 – The Effect of Expectations
Why the Mind Gets What It Expects

Most of us have expectations about what will happen in the future. We root for our favorite team in the World Cup and expect on some level that “our” team will win – and we’re deeply disappointed when they lose, even if it was expected. I know I felt this way watching the 2002 World Cup with friends – I was rooting for the United States and although I rationally knew they weren’t likely to do well, I was crushingly disappointed when they lost in the quarterfinals to Germany.

Interestingly enough, this chapter described a study using two samples of beer: one was Budweiser and the other was Budweiser with a few drops of balsamic vinegar mixed into it. Without knowing the “extra” ingredient, most people preferred the vinegar-laced beer; when they did know, virtually no one preferred it. I tried it myself and, interestingly enough, a drop or so of balsamic vinegar in several ounces of a typical Pilsner beer does make it taste better (though more than a drop makes it taste like vinegar).

Chapter 10 – The Power of Price
Why a 50-Cent Aspirin Can Do What a Penny Apsirin Can’t

The idea that an expensive item can do things that an identical inexpensive item cannot is often called the “placebo effect,” and it pops up all the time. Go to the grocery store, walk down the aisle, and grab a box of generic dry spaghetti and a box of “name brand” spaghetti. Compare the ingredients. I’ll go ahead and tell you what the differences will be: very little. Yet we’ll often buy the name brand spaghetti because the placebo effect of the brand convinces us (irrationally) that it will be better than the generic.

It’s really a fun experiment – try it sometime. Do some side by side blind comparisons of generic products and regular products and see which one is actually better. Quite often, you’ll find that they’re basically indistinguishable, and when you do that, you’ve gone a long way towards cutting down the placebo power of brand names and you’ll be well on your way to making better rational decisions.

Chapter 11 – The Context of Our Character, Part I
Why We Are Dishonest, and What We Can Do about It

Dishonesty is a short term gain in exchange for a long term loss. Here’s an example: if you’re dishonest in a few short-term exchanges, you might make a quick buck or two, but eventually you will acquire a bad reputation and you won’t be able to enjoy the benefits of a trusting relationship – you won’t have repeat customers and people won’t believe in the promises you make or the prices you set.

I like to think of eBay in this context. I usually prefer to deal only with people that have a high reputation and a lot of positive feedback – I tend to distrust people without it. I’m not alone in feeling this way, and thus quite often you’ll wind up paying a premium when buying from a seller with a high reputation. That premium is trust and eBay clearly shows that trust has significant value in business.

Chapter 12 – The Context of Our Character, Part II
Why Dealing with Cash Makes Us More Honest

Interestingly, though, when dealing directly with cash, most people tend to be quite honest. Cheating and dishonesty tend to occur more often when the money is abstract – for example, it’s much easier and more justifiable to us to take a Coke out of the fridge at work than it would be to take a dollar off of someone’s desk. I actually think that this is a big part of the reason people get into credit card debt – they’re abstracted from the money, so it’s easier to delude ourselves into believing we’re doing the right thing.

Chapter 13 – Beer and Free Lunches
What Is Behavioral Economics and Where Are the Free Lunches?

The book closes on a subdued note, surveying the general idea that traditional economics often doesn’t provide a good model of how humans actually behave and arguing that behavioral economics – a mix of economics and psychology – models individual human behavior much better.

Buy or Don’t Buy?

Predictably Irrational is one of those books that’s profoundly worthwhile to read and would be quite wonderful to discuss in a book club environment. It looks at human issues, makes you reconsider them a bit, and leaves you with some food for thought to chew on. Unfortunately, it also falls into the same trap that many of the newer “pop” books on behavior and economics fall into – they’re clearly “read once, think about it a bit, and move on” books, not offering the kind of meat that rewards repeat readings.

I enjoyed Predictably Irrational quite a bit and I’m going to recommend it to many of my friends and also to you, but this is definitely a book worth checking out at the library or buying in conjunction with a friend or two so that you can read it in quick succession and discuss it with each other.

In fact, that’s probably the greatest value this book could have – the interesting discussions it could generate with the people around you. For me, that’s the sign of a very good book, but perhaps not a truly great one. It’s a book that can deeply be enjoyed and leave you thinking for a while, but in a year or two the only memory you’ll have of it is in the few subtle things it subtly inserted into your body of knowledge and understanding of the world.

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7 thoughts on “Review: Predictably Irrational

  1. Trent,
    This review hits strikingly close to home with me. I don’t have much trouble purchasing things that I don’t need, but I have fallen victim to the “buy the model in the middle” routine.
    I find that I end up buying the middle priced item when I have not done the proper research to compare the options available.
    It is funny how I realize this and yet continue to make the purchase. It sounds like this book could help me to understand why I do this. And, only by understanding “why”, will I be able to take steps to prevent it from happening in the future.
    Thanks,
    Tyler

  2. From my experience working with Dan as an advisor at our startup, his research has some really interesting implications not only for individuals, but how we solve some of our larger social issues. Ideas like the “self-control credit card” (ch. 6) and “save more tomorrow” (ch. 13) could go a long way to help with our relative inability to control our spending and give up present benefits for future gain.

    What’s great about his research is that he has a policy orientation and wants to help create more “free lunches” so that everyone benefits, in spite of our shortcomings. I’m really looking forward to his future research. Anyone interested in learning more should check out blog (with entries like “Obama and online dating” it’s really a fun read).

  3. Hi Trent,

    Sounds like this is a book I really need to read. I have the best intentions sometimes and I’m off on a tangent before I know it. Its frustrating and it sounds like this book can bring some insights as to why this happens. Thanks for the review.

  4. One point about chapter 10, the power of price, I saw in action. Some years ago I happened to be in a very high end retailer store’s sporting goods department and saw cans of tennis balls on sale. I needed some, so picked up the can and checked the price. It was more than triple what I could have gotten the can for at Walmart or Kmart on any given day. I checked the can multiple times to see if there was something special about the tennis balls I was missing. Finally I went over to the clerk and asked him why they were so expensive on sale.
    His explaination was that he was well aware of how much they sold at other stores, but they had found if they discounted them to a Walmart price, their customers thought the balls were factory rejects, some actually complained about their selling shoddy merchandise, and noone would buy them. When they jacked the price up, then dropped them a little, they sold out pretty quick. Apparently the clientele of the store were more interested in appearing to get a deal, than actually getting one.

  5. I’m currently reading this book. I was suprised at many of the scenarios and will admit to falling prey to some of the irrational thinking it points out.

    There was one chapter however that has really stuck out. It was an example of children trick or treating and willing to trade one type of candy for another, the author assumed that the only factor in the decision should be net weight of candy, it never took into account something more subjective, that some things taste better (or are more appealing) regardless of weight (or quantifiable trait).

    Life choices are not always about the numbers, there are some factors that play into our decision making that you just can’t put on a chart. The one thing that anyone can take away from this book is to be cognicant of what those factors are for themselves and not to be blindly lead by them.

  6. My husband and I learned the hard way that buying the bottom-tier of things like electronics and appliances is usually a mistake. First we define the features/benefits we want, then we look at what is available. Every time we have bought the bottom end we have soon regretted it, as for just a little more money we could have either had something that lasted a lot longer or proved to be much more useful, or both.

    For some things, we spring for the top of the line. Our freezer is a commercial model. We got it in 1982, and it has never given us a moment’s trouble. When you consider the value of the frozen foods, the expense of having to rush out and buy a replacement in a hurry and the extreme inconvenience factor, putting more money up front in a top of the line model made sense.

    Also, as you get older, “luxuries” become necessities. We always drove stick shift, well-used cars. When my husband became ill with chronic fatigue syndrome, we found that an automatic shift car became essential for his ability to drive. Likewise, cruise control became an important factor in his ability to drive longer distances safely. And let me tell you–when you hit menopause, air conditioning is NOT a luxury! The cars are now air conditioned, automatic shift, cruise-controlled well-used cars. We’ll let the financial idiots buy new!

    For things that don’t really matter, like pasta, by all means avoid the middle ground and head for the cheapest. If you want something that needs to last, almost always the middle ground is exactly what you want.

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