Predictably Irrational — Dan Ariely

One of the central tenets of economics is that we behave rationally, and yet much of what we see on a day-to-day basis defies rationality like some Modernists defy the conventions of plot. We become irrationally attached to concepts like “free,” even if something else is a better value, and our price preferences are relative: experiments in Dan Ariely’s Predictably Irrational show that we’re willing to forgo what seems to be a better deal just so we don’t have to risk even tiny amounts of money. These tendencies can be manipulated to some extent; Ariely says that the main lesson that could be distilled is that “we are pawns in a game whose forces we largely fail to comprehend.” I disagree with the chess metaphor, as it seems to deny us the will and ability we have to learn about the game and not move forward just one square at a time, but the thought it expresses is accurate, and throughout the book I could think of parallel examples to the ones Ariely gives. We don’t see the blindness in others as well as ourselves, and we become attached to prices, things or ideas.

I remember turning 21 and being able to drink legally for the first time and being shocked at the price of going to bars; parties in college and high school usually charged three to five dollars for a cup and as much beer as you could drink. Girls got in free. If the door guy raised the price from three to five, I would try negotiating and sometimes leave. If I came with a group of attractive girls, which wasn’t often, I’d sometimes get in free. In contrast, at bars five dollars only gets you the first beer; to be fair, however, that beer is usually of higher quality than keg beer. Nonetheless, the price increase of an evening out caused much consternation at first, but now I’ve acclimated to the idea that, although Ariely says “[…] first decisions resonate over a long sequence of decisions,” I also use anchoring points in my price expectation continuum. Now paying $15 to $20 at a bar seems normal and $5 at a party would seem cheap. These “anchors” can change over time and with context. If I went to New York or L.A., where trendy bars allegedly now charge $15 a drink, I’d be astonished. When I was a freshman in college and a New York club accidentally gave me a band that allowed me to drink even though I was 18, I was shocked at having to pay $10 per drink and consequently didn’t drink much, even when a 23-year-old girl wanted to get me to buy shots. Buying her shots isn’t a good idea for reasons Richard Feynman goes into in Surely You’re Joking, Mr. Feynman! Nonetheless, I’m wandering far afield from the central point, which is that original decisions about price can resonate powerfully over time and can be hard to change.

Ariely uses Starbucks versus Dunkin’ Donuts as an example: Dunkin’ Donuts coffee was and probably still is much less expensive than Starbucks and, I would argue, not much worse if it is at all, but Starbucks still manages to charge millions of people three or more dollars for various drinks. They can do so in part because they’ve changed expectation through decor, drink names, and the like. “Starbucks did everything in its power […] to make the experience feel different—so different that we would not use the prices at Dunkin’ Donuts as an anchor, but instead would be open to the new anchor that Starbucks was preparing for us.” In other words, Starbucks created a new anchor. This raises fundamental questions about the nature of things like supply and demand—or, as Ariely says, “As our experiments demonstrate, what consumers are willing to pay can easily be manipulated, and this means that consumers don’t in fact have a good handle of their own preferences and the prices they are willing to pay for different goods and experiences.” I agree to some extent, as I didn’t like paying extra money to go to bars and avoided it to the extent I could when I first turned 21, but now all my friends go and they’ve become the new norm. In the land of companies, Apple might be the best example of a company manipulating consumer expectations: only its operating system and industrial design separates it from other manufacturers, and yet it can get away with offering unusual machines and limited, premium product lineup.

I wonder if Ariely has read Trading Up: The New American Luxury, which describes how some companies are trying to harness these price point anchors—and redefine them. One point of Trading Up, however, is that the new or luxury products must have at least some technical advantage of what they replace. Starbucks does: it offered espresso drinks when, to my knowledge, they were not readily available at most places. Not surprisingly, the book also covers Apple and BMW. Apple offers a real technical advantage to me in the form of OS X, but you can’t buy a regular desktop tower and separate monitor. Where Apple does compete it offers hardware at prices similar to competitors, but you can’t get low-cost towers stripped of the computer equivalent of bells and whistles. In addition, this morning Apple released new versions of its MacBook and MacBook Pro laptops. The base-level MacBook is $1,100—or, thanks to Apple’s marketing, $1,099—but comes without a DVD burner, an extra gigabyte (GB) of RAM, and the extra 40 GB hard drive. Its processor is also slower. Given these drawbacks, it makes sense to buy the $1,300 version—but Apple’s website touts that the MacBook starts at $1,099. Yet buying the middle version is better, for resale value if no other reason. In doing so, the company might have differentiated itself enough to set new anchors for many consumers. And we either fall for it or make a rational choice, depending on one’s perspective.

Ariely doesn’t specifically cover Apple because he’s more interested in experiments where you have two things that are absolute equivalents, rather than OS X versus Windows. But I begin to see examples of some of his thinking in the world I see. There are limits to manipulation—I won’t pay $10 for coffee or $2,000 for any computer with the capabilities of a present-day MacBook. But I might pay marginally more for some products, like beer, depending on the setting and my age. In addition, product preferences change; in Ariely’s next chapter, “The cost of zero cost,” he describes how people will often take free even when it appears to be a better value to take money. He offered a $10 Amazon gift certificate for free or a $20 gift certificate for seven dollars. Buying the larger certificate nets more profit, but most people take the free one. To conventional economics, this would seem irrational, but for some people an Amazon gift certificate might not be of as much use as cash; they might not read much, or want to buy DVDs, and the like. In essence, I believe their demand is lower on the demand curve for Amazon products. I would take the $20 certificate because I buy too much from them already. In addition, he describes how Amazon’s free shipping policies can cause people to buy more than they would otherwise to reach the $25 free shipping threshold, but I often will add an extra book to reach it because I always have a backlog waiting. Not all those who act in response to Amazon’s offer act irrationally.

Still, the issues of Amazon gift certificates and free shipping are mostly nitpicks. My bigger question concerns some of his methods for generating data—many of the stories and anecdotes come from experimenting on convenient undergraduates at good Universities, who might not be representatives of the general population. Though he follows up many with experiments elsewhere, I’m still leery of drawing overly broad conclusions based on limited samples. In addition, how reliably can we extrapolate data from a limited number of people in artificial settings and then apply it to the bigger world? Posing the question is much easier than answering it, and to Ariely’s credit he has given us a framework for exploring the issue, while I throw popcorn from the sidelines and offer stories about drinking. But the issues are real, and there’s a perpetual danger of finding a correlation that works only to discover that some other variable drives the correlations or causes experiments to turn out as they do. Will our tendency to cheat and steal more when dealing with abstractions for cash rather than cash itself, as Ariely describes in “The context of our character, Part II,” really scale up to the level of Enron-style fraud? He makes a convincing case, but not one beyond all reasonable doubt, even if I can certainly agree that he meets the lower legal standard of a preponderance of the evidence.

And even if some of his conclusions make you go, “Really?”, his book is still fun to read. The chapters I discussed in-depth were just a small part of Predictably Irrational, and to give every chapter the same treatment would lead to a document almost as long as his book. But maybe I’m inclined to like his book more because Tim Harford recommend it (in addition, Ariely sent me an e-mail about my Harford post, and, as often happens with famous authors, I have a slight tendency towards being star-struck. But I can also admit that, perhaps alleviating some of its effects). In “The effect of expectations,” he describes experiments that show “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 be bad.” He finds the influences go deep, and that signaling that an experience will be good can often make it good. Compare this, however, to Chris Matthews’ advice that one was better served by setting expectations low and exceeding them than setting them high and missing, even if the ultimate result was the same. He discussed politics, however, and Ariely is describing, well, something more domestic and more grand at the same time. I feel like there is a way to reconcile the views even if I have not found it yet, and it might speak to the depth of both writers that I have not been able to (incidentally, you should read Mattews’ Hardball).

Harford’s signal that this book will be good has an impact on the pleasure I derive from reading it, and I can’t help comparing The Logic of Life and Predictably Irrational, given their similar subject matter and proximity in both publishing date and my reading. Arguably, Harford is the better writer, with more journalistic zing, but this tendency also gets him into trouble: he jumps without transitions from idea to idea too often, and his chapters seem more loosely linked than Ariely’s. To be sure, both books are similar in that their chapters are more or less independent, but Ariely’s passes what I now call “the blog test” in that its content doesn’t seem to have been replicated on blogs and its form is not necessarily better suited to that medium. The buffet approach in Predictably Irrational by its nature lacks total coherence, but also allows one to skip chapters at will and not lose much. It also makes generalizing about an entire book more difficult, which is why I focused on particular chapters. The largest difference between The Logic of Life and Predictably Irrational is that the former makes the case for logic and rationality in a larger, social, macro sense, while the latter makes the case for irrationality in a smaller, individual, micro sense. And yet I can’t help but wonder if the latter approach supports the former approach, much the same way that the self-interest of capitalism might end up altruistically benefitting society on a large scale, or the way we might not be able to predict how an individual will act but can sometimes guess how large bodies of individuals turn out. Take two people with different SAT scores and you can’t know that one will do better than the other, but take 100,000 people with very different scores and you’ll know that most of the top group will outperform most of the bottom. So too, maybe, with Ariely’s Predictably Irrational on the small scale and Harford’s The Logic of Life on the larger. Both books also have a self-help aspect to them in that if you can understand your own weakness and how others will behave, you’ll be more likely to correct those weaknesses and exploit them in others. Of course, if enough people read both books, then their behavior could change en masse, leading to the books changing what they seek to measure, but this seems unlikely. Ariely knows about the issues with weakness, too: “[…] these results suggest that although almost everyone has problems with procrastination, those who recognize and admit their weakness are in a better position to utilize available tools for precommittment and by doing so, help themselves overcome it.”

Perhaps that is also true of readers of what I call, tongue-in-cheek, econ-for-dummies books.

Many of Ariely’s chapters are structured like this post: they tell a story, conduct an experiment, and then draw more general conclusions. The story could be a personal one from Ariely or drawn from another source. In my case, I tell a story, link it to Ariely’s experiments, and then draw a more general conclusion about his book and methods. Mostly, I suspect his book shows that we don’t really know what we want, which probably shouldn’t be a surprise given all the lonely hearts columns, uncertainty, regret, and the like we collectively experience. As such, it helps us better evaluate what we want and why we act the way we do, and that the book is fun to read helps as well. And it has enough substance to fuel more than 2,000 words of commentary and analysis.

NOTE: Ariely will be in Seattle tomorrow night, and I’ll be at Town Hall to hear him.For more about Ariely and behavioral economics, read What Was I Thinking? The latest reasoning about our irrational ways, an excellent New Yorker article, or this much shorter post on Marginal Revolution. Finally, the Economist’s Free Exchange has a very negative review that I think is wrong, as my comments above should illustrate. Its biggest complaint seems to be that Ariely doesn’t define what he means by rational, but if the writer missed that, I’m not sure he understood the book.For a descriptive but positive view, see The New York Times’ story, which is in the science rather than books section.EDIT: Dan Ariely’s visit was excellent, and I wrote about it here.