The first time I met Dan Ariely was about half a year ago at Harvard when both of us were attending ‘Happiness, Adaptation, and Prediction’ conference together. I had absolutely no idea who he was or what he does. All I knew was that he had a very visible scar on his face, which, I later learned, came from a horrible magnesium flare accident when he was still a young student in Israel.
He was very sharp – not surprisingly for an Alfred P. Sloan Professor of Behavioural Economics at MIT – and witty, and I thoroughly enjoyed his presentation (it was primarily an account of how his scar still has an attentional impact on his experiences today). And I was pleasantly surprised to find out just last week that he has recently published a book on the economics of irrationality, which he elegantly called Predictably Irrational: The Hidden Forces that Shape Our Decisions.
There are many interesting topics in this book, including the Cost of Social Norms, the Cost of Zero Cost, and even the Influence of Arousal. But what I find most interesting in Dan’s book is the role of ‘anything relative’ on our seemingly rational decisions. To give Dan’s own example, imagine that we want to subscribe to the Economist magazine. There are three subscription options we could choose from, and these are:
1) $55 – online version
2) $125 – print version
3) $125 – online and print version
So, which of these options would you choose?
If you’re like most of Dan’s students, you would have picked the 3rd option ($125 – online and print version). Some of you will probably choose option one ($55 – online version). But I would bet any money that none of you would have gone for the 2nd option ($125 – online and print version). Now, you might think that’s a rational thing to do, and you’re probably right – given the three options. You’ve probably thought in your head that comparing between the three the third option seems like the best option as it is definitely better than the 2nd option (who in their right mind would pay $125 to get a print version when you can pay exactly the same amount to get both!). The 1st option may seem good too for some, but it’s still quite difficult to compare it with the 2nd option (online only versus print only, hmm…). Given the price difference, it is also difficult to compare between the 1st option and the 3rd option – we are just not sure whether one option is better than the other. All we definitely know for certain is that the 3rd option is a better option than the 2nd option, and so it seems like a good reason to think that a $125 for online and print version is the best overall.
Is this a rational decision? You might think so. Economic theory would have suggested that if the 3rd option is preferred to the 2nd and the 1st, then that preference will always remain in that order, all else equal. But what happen if the Economist decides to remove the 2nd option from your choice together? Well, that’s what Dan did with his second class of students – he removed the 2nd option, or the option that he called the decoy option.
Now, an amazing thing happens. Almost 70% of his students prefer the ‘$55 – online only version’ than the ‘$125 – online and print version’ (this compares to the 84% who preferred the online and print version than the online version only when there is a decoy option present). That doesn’t seem very rational to me.
And what’s more amazing is that this kind of phenomenal keeps appearing everywhere in our daily lives. We go to restaurants and find that we don’t normally buy the most expensive food on the menu (that is, if you’re not one to always splash your cash unnecessarily) but more likely to buy the second most expensive food on the menu. We go into a mall to find many shops displaying ridiculously expensive set of clothes that we would never buy, but we go in anyway to buy the cheaper ones in the shop. We go to nightclubs and find ourselves much more attracted to somebody who comes with a slightly uglier version of himself or herself than somebody who’s equally attractive but alone. We vote (well, actually, don’t get me started there)…
The truth is it is not a rational decision, but it is a predictable one at that. The problem is all the market people also know this (hence, putting up very expensive food to drive up sales for the 2nd most expensive one, etc.) and most of us would happily go along with that. I’ll let you decide, however, how massive this problem it actually is.
He was very sharp – not surprisingly for an Alfred P. Sloan Professor of Behavioural Economics at MIT – and witty, and I thoroughly enjoyed his presentation (it was primarily an account of how his scar still has an attentional impact on his experiences today). And I was pleasantly surprised to find out just last week that he has recently published a book on the economics of irrationality, which he elegantly called Predictably Irrational: The Hidden Forces that Shape Our Decisions.
There are many interesting topics in this book, including the Cost of Social Norms, the Cost of Zero Cost, and even the Influence of Arousal. But what I find most interesting in Dan’s book is the role of ‘anything relative’ on our seemingly rational decisions. To give Dan’s own example, imagine that we want to subscribe to the Economist magazine. There are three subscription options we could choose from, and these are:
1) $55 – online version
2) $125 – print version
3) $125 – online and print version
So, which of these options would you choose?
If you’re like most of Dan’s students, you would have picked the 3rd option ($125 – online and print version). Some of you will probably choose option one ($55 – online version). But I would bet any money that none of you would have gone for the 2nd option ($125 – online and print version). Now, you might think that’s a rational thing to do, and you’re probably right – given the three options. You’ve probably thought in your head that comparing between the three the third option seems like the best option as it is definitely better than the 2nd option (who in their right mind would pay $125 to get a print version when you can pay exactly the same amount to get both!). The 1st option may seem good too for some, but it’s still quite difficult to compare it with the 2nd option (online only versus print only, hmm…). Given the price difference, it is also difficult to compare between the 1st option and the 3rd option – we are just not sure whether one option is better than the other. All we definitely know for certain is that the 3rd option is a better option than the 2nd option, and so it seems like a good reason to think that a $125 for online and print version is the best overall.
Is this a rational decision? You might think so. Economic theory would have suggested that if the 3rd option is preferred to the 2nd and the 1st, then that preference will always remain in that order, all else equal. But what happen if the Economist decides to remove the 2nd option from your choice together? Well, that’s what Dan did with his second class of students – he removed the 2nd option, or the option that he called the decoy option.
Now, an amazing thing happens. Almost 70% of his students prefer the ‘$55 – online only version’ than the ‘$125 – online and print version’ (this compares to the 84% who preferred the online and print version than the online version only when there is a decoy option present). That doesn’t seem very rational to me.
And what’s more amazing is that this kind of phenomenal keeps appearing everywhere in our daily lives. We go to restaurants and find that we don’t normally buy the most expensive food on the menu (that is, if you’re not one to always splash your cash unnecessarily) but more likely to buy the second most expensive food on the menu. We go into a mall to find many shops displaying ridiculously expensive set of clothes that we would never buy, but we go in anyway to buy the cheaper ones in the shop. We go to nightclubs and find ourselves much more attracted to somebody who comes with a slightly uglier version of himself or herself than somebody who’s equally attractive but alone. We vote (well, actually, don’t get me started there)…
The truth is it is not a rational decision, but it is a predictable one at that. The problem is all the market people also know this (hence, putting up very expensive food to drive up sales for the 2nd most expensive one, etc.) and most of us would happily go along with that. I’ll let you decide, however, how massive this problem it actually is.
3 comments:
Wow, next time I go to a restaurant, I will sure have fun observing how my dinner fellows place their orders. That would really explain why most menus would list out their dishes in price order, ascending order in particular!
For me, I would normally check out the price of the food on the list, cross out the cheapest one, and of course the expensive ones. But I do tend to select my choice from what fits into my ‘affordable range’ rather than the second cheapest. Would the theory of predictability be able to account for this? I am very curious to know. Second of all, the relativity is much simpler with very few choices available. However, once the variety gets more complex, rational judgement not only fails, people may actually seek for alternative means to make their judgement…something less mathematically intellect. Would this reflect the failure of the individual rationality or something the theory is not yet account for? In Evolutionary Efficiency and Happiness, by Gary Becker & Luis Rayo (Journal of Political Economy: 2007), their model is built on a theoretical argument that rational individual would always fail to make a rational ranking among choices, even between choice 1 & 2.
Last but not least, my choice of dinner dish won’t be manipulated by the role of price at once whenever someone else is paying for it!!!!
Someone once told me that if all theory that you can think of fail, always bet on relativity to succeed!
You should buy Dan Ariely's book, Warn. He shows how to make sense of something that doesn't make sense. Also, it makes a very good read!
Oh, and to answer your question, most of the comparisons we make in our lives take place at the subconscious level rather at the conscious level. Hence, you may think that you are selecting your choice based on 'your affordable price'. However, you might not even realise that relativity has already pulled you into the kind of restaurant that -- if you were on your own or with friends who earn relatively less than you do --you wouldn't be in there in the first place!
And things get even more complex with choice. Rationality often fails not only because of relativity but because of regrets: Will I gain more utility from eating this green chicken curry than that panang curry? The behaviour is persistent even when we know we prefer green chicken curry to the panang curry! Take dating, for example. I'm sure most of us have come across a friend (or even ourselves) who has two choices but cannot decide one over the other even though one of the relationships is likely to be a destructive one in the long-run.
It's just the human nature, I guess - but it can explain a lot of our seemingly irrational behaviours!
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