Predictably Irrational

• Behavioral economics, or judgment and decision making, attempts to square the predictable ways that individuals are irrational with the orthodoxy that “market forces” should regulate everyone back to rationality.
  • Rationality is the assumption that individuals operate with perfect reasoning.
  • The book argues that humans are irrational and the ways we are irrational are predictable and systemic.
• We don’t have absolute sense of intrinsic value, we value things relative to one another to estimate value.
• Most people don’t know what they want unless they see it context (low, medium, high options).
• Making a choice based on easy comparison for a singular attribute is called the Decoy Effect.
• “We could get over a lot of things here—insider trading, financial scandals, and the like—but if everyone knew everyone else’s salary, it would be a true catastrophe. All but the highest-paid individual would feel underpaid—and I wouldn’t be surprised if they went out and looked for another job.”
• People are more likely to try exercise a savings when it large relative to the item purchase. For example, saving $7 on $15 pen vs. $7 on a $200 jacket. In rationale terms, they should spend the same amount of effort to achieve the same value.
  • The take away here is that we must think about how we deploy resources globally rather than focus on what we achieve locally (e.g. a small savings locally while losing more in an another locality).
• The more we have, the more we want (hedonic treadmill). We change our goals based on our present state.
• People keep their consumption patterns when changing housing markets due to Arbitrary Coherence, however, you can break this pattern by renting in the new market and re-evaluating what you need.
• Herding is one people’s consumption patterns influence others. We assume that something is good (or bad) on the basis of other people’s previous behavior and our actions follow suit.
  • We also self herd where we believe something is good (or bad) on the basis of our own previous behavior
• “Starbucks did everything in its power, in other words, 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. And that, to a great extent, is how Starbucks succeeded.”
• We should pay particular attention to the first decision we make in what is going to be a long stream of decisions (about clothing, food, etc).
• Demand can be easily manipulated if consumers don’t have a good handle on their own preferences
• While standard economics says that supply and demand are independent, anchoring manipulations suggest that demand is influenced by market prices.
  • Discounts show that consumption is not always based on preference but on memory
  • Our memory of the prices we paid in the past and desire for coherence with past decisions can create price sensitivity not coupled to demand
• Because of arbitrary coherence, and our inability to accurately measure how valuable something is to us, we may make trades against our best interest.
• The Cost of Free
• “The pain of paying” - the unpleasantness of spending our money regardless of the circumstances.
  • One positive manipulation is the pain of paying should occur for only one person in a friend group (in rotation for a meal). The relative cost of paying is felt less, whereas for the rest of the group it is not felt at all.
• Social Norms and Market Norms
  • Communal plates at dinner invoke social norms of sharing
  • When price is not a part of the exchange, we become less selfish maximizers and care more about the welfare of others.
  • The theory of demand is solid until price drops to 0
• Money is often the most expensive way to motivate people. Social norms are cheaper and more effective
• The ability to obfuscate exchanges in non-financial terms, and avoid bringing in market norms, is important for social norm interactions.
  • This also applies to “effort” / sweat equity exchanges
    • However, effort tends to fall somewhere between gifts and monetary compensations for the Social Norms and Market Norms spectrum
• Emotional state from anger, hunger, arousal, or fear will naturally causes us to behave irrationally.
• Procrastination can be avoided with strict deadlines (dictatorial), but it can also be avoided through simple pre-comittals.
  • Those who reocognize and admit the weakness of procrastination will fare better through pre-commitals.
  • One application of pre-commital might be to have people place deposits returnable on getting regular healthcare checkups.
• Variable reinforcement is a powerful tool in maintaining engagement, think gambling and the lottery.
• If a a particular desired behavior results in a an immediate negative outcome (punishment), but is beneficial in the long term. It will be very difficult to promote. Therefore, we must find ways trick our selves to push through that.
• The Endowment Effect
• Pride of ownership is inversely proportional to the effort of acquisition.
• We begin to feel ownership even before we own something
• “My own approach is to try to view all transactions (particularly large ones) as if I were a nonowner, putting some distance between myself and the item of interest. In this attempt, I’m not certain if I have achieved the uninterest in material things that is espoused by the Hindu sannyasi, but at least I try to be as Zen as I can about it”
• The Lake Wobegone Effect
• We cannot stand the idea of closing the doors on our alternatives.
• We often fail to weigh the costs of not deciding, particularly missed opportunity costs.
• 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.
• The placebo effect is driven by our confidence in the remedy as well as our conditioning to expect a response.
  • Placebo effect is also sensitive to price determination, pricier drugs generate a better effect than lower priced drugs.
  • This was confirmed by the SoBe drink experiment, where a higher priced drink caused better performance on a puzzle. Additionally, simply priming the person that drinks can improve performance, improved performance.

“Marian Friestad and Peter Wright, suggested that people in general are starting to understand that the offers companies put before us are in their best interest and not ours. As a consequence, we’ve become more distrustful—not only of those who are trying to swindle us but of everyone”

• People mistrust situations where they are getting something for nothing. This lack of trust is likely driven by a Collective Action Problem, where these types of situations are never what they seem. For individuals, it is often useful to violate the trust, but it erodes the common good of trust in each other and institutions.
• When everyone is lying, there is little use in telling the truth (e.g. online dating sites and resumes).