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Health

Predictably Irrational, behavioral economics in 13 chapters

Gene ExpressionBy Razib KhanApril 28, 2009 6:16 PM

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I first encountered Dan Ariely on the radio show Marketplace, where he offers up little nuggets of research data from the new field of behavioral economics. Because of the individual scale of the research many of Ariely's findings have some personal finance implications. Consider the pain of paying. This is the finding that when people pay with credit as opposed to cash for dinner, they are willing to spend more. Why? Because credit cards decouple the psychic "pain" of payment from the specific act. The act of deferring reduces our pain at the damage done, and allows consumption with less guilt and discomfort. The big-picture implication of this is obvious when it comes to the credit economy, but for myself I have taken to always paying for frequent small purchases with debit or cash. I do put less frequent large purchases on credit cards on occasion, for example when I buy a plane ticket for a trip months into the future. My reasoning is that I can concentrate in a reflective and rational manner on a few large purchases to a far greater extent than I can on the habitual small weekly food purchases. Monthly automatic cell phone payments for example are naturally a different beast than going to the grocery store; not only are the payments infrequent and regular, but the interval of their expense is predictable (totally predictable if you have some sort of unlimited plan). In any case, because of the nature of the topic which Predictably Irrational covers the chapters have an a la carte feel. Ariely attempts to stitch them together into a bigger narrative about the limits of the rational actor..but this is clearly a "they had to do research on that?" insight for the lay audience (though perhaps not for economists). Interesting Ariely reports that strangers are much more interested in his findings since the financial collapse, probably explaining why he's coming out with an expanded and revised edition later this month. To give you a flavor of Predictably Irrational, here are summaries or examples from each chapter. 1) The Truth About Relatively If given these choices to subscriptions to The Economist a) $59 - internet only b) $125 - print only c) $125 - print & internet vs. a) $59 - internet only b) $125 - print & internet Most people choose c) in the first circumstance, but a) in the second ("people" in this case means MIT Sloan School students). 2) The Fallacy of Supply and Demand In auction for various products students were asked to write down their bids, after entering the last 2-digits of their social security number (presumably for purposes of identification, but actually to "prime" them with those numbers as "anchors"). Here are the bids along with SSN's:

3) The Cost of Zero Cost Choice between Lindt truffles & Hershey's Kisses: Lindt truffle - 15 cents (73% prefer) Hershey's Kiss - 1 cent (27% prefer) Lindt truffle - 14 cents (31% prefer) Hershey's Kiss - Free! (69% prefer) 4) The Cost of Social norms From page 71:

Average bids for products by last 2 digits of SNN

00-1920-3940-5960-7980-89Correlation

Cordless trackball $8.64$11.82$13.45$21.18$26.180.42

Cordless keyboard $16.09$26.82$29.97$34.55$55.640.52

Design book $12.82$16.18$15.82$19.27$30.000.32

Neuhaus chocolates $9.55$10.64$12.45$13.27$20.640.42

1998 Cotes du Rhone $8.64$14.45$12.55$15.45$27.910.33

1996 Hermitage $11.73$22.45$18.09$24.55$37.550.33

A few years ago, for instance, the AARP asked some lawyers if they would offer less expensive services to needy retirees, at something like $30 an hour. The lawyers said no. Then the program manager from AARP had a brilliant idea: he asked the lawyers if they would offer free services to needy retirees. Overwhelmingly, the lawyers said yes

5) The Influence of Arousal See this post. 6) The problem of procrastination and self-control Students at MIT are offered a choice when to hand in their 3 papers in terms of date. They could select dates at the end of the term for all 3, or space them, or select the beginning of the term. There was a penalty for handing papers in late after your selected date, but no penalty for handing papers in early. Most students chose to space the papers, so that they would pay a penalty if papers were handed in late. The students who chose not to space the papers but allowed that they could be handed in at the end of the term did worse in terms of grades than those who self-enforced deadlines with consequences. 7) The High Price of Ownership Duke students who didn't manage to get a hold of the tickets for a national title game were asked how much they would pay to purchase a ticket from a student who managed to get one (tickets being distributed by lottery). Those who had them were asked how much they would sell them for. The average offered purchase price was $170, the average selling price was $2400. None of the students who wanted tickets were willing to pay the prices that the students with tickets were willing to sell them for. 8) Keeping Doors Open The experiment in this chapter is hard to describe easily, and there are no charts. So all I'll say that many times people perform better when given fewer options. If the number of options increase so that the range of outcome is greater (you could do way better or way less than the bounds of events with smaller numbers of options) it seems that people do worse than you would expect, frivolously exploring options. 9) The Effect of Expectations MIT students are given two beers to sample. One is Sam Adams, the other Sam Adams + vinegar. Students told the nature of the options for the taste test prior to tasting rate Sam Adams better. Students told after the tasting rate Sam Adams + vinegar higher, and will add vinegar to Sam Adamsi> to have some more of the brew. 10) The Power of Price Individuals were given a Vitamin C placebo which supposedly reduced pain in ~10 minutes. They were also placed in a waiting room before administration with brochures about the drug that listed its price as $2.50 per single dose. All reported subjective feelings of pain reduction afterward. The same experiment was run with the change that the brochure listed the price as 10 cents, instead of $2.50. Only 50% reported pain reduction. 11) The Context of our Character, Part I Students are given a test, and allowed to cheat in a variety of ways. The likelihood of being caught varied between experiments. The results show once cheating was possible, gradually reducing the likelihood of being caught did not result in more cheating. Rather, there was a threshold effect and stasis beyond the threshold. 12) The Context of our Character, Part II 6-packs of Coke and 6 dollar bills are left in dorm fridges. After 72 hours all the cokes were consumed (by individuals who did not buy the Coke 6-packs, so they were stealing). After 72 hours all the plates of dollar bills remained. 13) Beer and Free Lunches When people are forced to order beers out loud in sequence they choose different beers; there is a uniform distribution of preference. When people order by writing down their selection privately they have strong preferences and there is modality, as some beers are preferred and others are seldom ordered. The book has a website with blog.

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