Predictably Irrational byDan Ariely is a fascinating and deeply insightful book that is a pleasure to read and full of gems. It is bursting with interesting and ground breaking experiments that completely debunk many of the assumptions of economics. It will reshape how you view economics and how consumers react in real life, as opposed to in economics textbooks. It is a book I would highly recommend and should be considered a behavioural economics classic. In fact it’s so great that I couldn’t fit all I wanted to say about it into one post (or three) so instead I will summarise my favourite chapters (which is most of them) and highlight the important points they make. What is particularly interesting is that the book is heavily based upon evidence and empirical studies, so no claim is made without being backed up. In fact Ariely does most of the experiments himself so you are really hearing it from the horse’s mouth.
Ariely begins with a story of how he was browsing the internet and came across an offer from The Economist magazine.
- Option 1: online subscription to the magazine’s website for $59
- Option 2: print subscription for $125
- Option 3: online and print subscription for $125
He uses this as an example of relativity. It is near impossible to estimate the value of an item by itself, so we instead compare it to something else. In this case option three seems like the best option when compared to the others. It’s almost as though we are getting the online subscription for free. Ariely tested this on 100 students and found that 84% chose the third option and only 16% choose the online subscription even though they could get the same articles at half the price (No one choose the print only option leading Ariely to call it the “decoy” option). However he later repeated the experiment by removing the 3rd option leaving only the choice between an online or a print option. In this case 68% choose the online and only 32% choose the print subscription.
Another example of relativity is a salesman who places three TV’s together costing $690, $850 and $1,450. Most people would go for the middle option, because it is relativity the best mix of cost and luxury. The salesman knows this and has deliberatively placed an expensive option that he knows won’t sell next to the TV he does want to sell. Unlike traditional goods, this TV’s purpose is not to be sold, but rather to make everything else look cheap in comparison. Another example is that of Williams-Sonoma who first tried to sell home bread bakeries for $250. Unfortunately sales were poor. At this point some might conclude that the market didn’t want to buy a home bread bakery and that the company should give up and try something else. Instead, they made a bigger version that cost 50% more and placed it beside the original. Now the original bread bakery was a relatively better option and sales of the original rose (consumers reasoned that if they were going to buy a home bread bakery, they would buy the smaller one). The market is not simply decided by rational consumers, they are open to manipulation and nudges.
The key point Ariely makes about relativity is that it’s how we make choices. We compare goods that are similar and comparable but not does that aren’t. He gives a further example of a real estate agent offering to sell you three houses. The first is a contemporary house, while the second one is a colonial house whose roof needs a repair (and is therefore cheaper) and the third is a colonial house that is in good condition. Ariely argues that we would choose the colonial in good condition for an irrational, but predictable reason. We have nothing to compare the contemporary house with, so it gets pushed to the side. On the other hand we do know that the colonial with a good roof is better than the other one, so it is relatively the better pick.
Relativity doesn’t just have to do with consumer behaviour, it also affects who we date and even marry. To examine this, Ariely conducted a study where he took (with their permission) photos of MIT students. He then got other students to choose between two photos and choose who was better looking. However, Ariely added a third photo which was a photo shopped version of one the other photos. This photo shopped version made the person look worse (this would be the decoy to make the original look better). So people were asked to choose between A, A- and B. In 75% of cases people choose A, as in the original photo of the student who had a decoy made of them. So relativity even affects who were are dating which is why Ariely recommends that you bring a friend with you if you trying to impress a girl, just make sure your friend looks similar but less attractive than you.
Relativity links into inequality and happiness. It has been well documented that although the average American is far wealthier than their parents or grandparents, they are not necessarily happier. As people get older they tend to get richer (through promotion and seniority benefits) but not necessarily happier. Why is this? The answer is relative. Despite the fact that the average American would seem fabulously wealthy compared to the average Mexican, they do not feel wealthy. This is because they don’t compare themselves to the average Mexican, but rather to people they live and work with. So if you earn $100,000 a year, but you work with people who earn $150,000 then you feel relatively poor. This is at the heart of problems in high inequality countries; people compare themselves to the very wealthy, which makes them seem relatively poorer.
Predictably Irrational is all about how people really make decisions, not how they should behave according to neo-classical view of rational actors. We cannot compute decisions in a vacuum, rather we need to compare it and see how it relatively stands. This series will discuss how people act in the real world, as opposed to in economic textbooks.