Predictably Irrational by Dan Ariely
Traditional economic theory assumes that all participants in an economy are rational and self-serving, systematically finding ways to maximize their utility. However, anyone would agree that these assumptions are oversimplifications and that people make plenty of irrational decisions in practice. The field of behavioral economics (economics plus psychology) is studying economic irrationality. The field’s main conclusion is that human irrationality isn’t a random or scattershot phenomenon, but something systemic and predictable that stems from universal cognitive biases. Here are some of the most common lapses in rationality that people make.
People make relative choices. To reduce cognitive load, people compare their options against each other rather than compute the absolute utility for each option individually. This means that choices that are easily comparable are more likely to stand out as really good or really bad. When choosing between three choices (A, B, C), if A is clearly better than B but A vs C is unclear and B vs C is unclear, nobody will choose B and most people will choose A over C.
People can get anchored. People are strongly swayed by the first price they see or by numbers that get imprinted into their heads. An initial price point appears reasonable and assessments of future prices are done by comparing to past precedents. It is possible to convince people that a certain product is inherently a luxury or premium product just by bumping up the price.
People get overexcited about anything free. The psychological pain of paying for something is a non-linear function with an enormous jump between “free” and $0.01. A free choice appears to be all upside with no downside and no possibility of regret. People overvalue any free add-ons to whatever they are buying and ignore other opportunity costs such as time that are spent in pursuit of free things.
People maintain a separation between social and market norms. People follow social norms (courtesies, favors, gifts) in some contexts and market norms (contracts, payments, obligations) in other contexts. People who would refuse to work for a low wage can be persuaded to work for free under the guise of volunteering; all you have to do is reframe the work from being a market exchange to being a social exchange. Workers react strongly and positively to intangible incentives like employee benefits, office perks, good interpersonal relationships, and work with social meaning. In situations where market forces prevail instead, people act more rationally, but also more selfishly and cynically, coming out feeling less happy overall.
People act irrationally when emotionally aroused. When people are feeling intense emotions or are experiencing intense stimulation, they become more impulsive and short-sighted. People consistently overestimate how much self-control they would retain in moments of high passion. However, even in moments of low passion, people continue to have problems with delayed gratification and self-control if there is no element of shame or urgency involved.
People overvalue what they own. Almost every peer-to-peer negotiation begins with the seller wanting a higher price than the buyer. For the owner/seller, ownership comes with memories and with the pain of loss, but a buyer’s idea of a fair price isn’t tainted by either of these things. This positivity bias extends beyond possessions and also affects people themselves; people consistently view themselves as above-average in many ways and also deem negative events to be less likely to happen to them than to other people.
People obsessively try keeping their options open. People feel a sense of loss when an old option or opportunity closes behind them, even when that option wasn’t good. People often get caught up in an analysis paralysis between choices, agonizing over small details and failing to recognize that a refusal to commit comes with opportunity costs of its own.
People’s experiences are warped by their expectations. At the neurological level, people with positive expectations enjoy things more, while people with negative expectations enjoy them less. Fancy marketing, fancy presentation, or a high price can all boost after-the-fact evaluations of a product’s quality even if the product isn’t any different.
People are fearful of getting conned. People are scared of being suckers to the point that they are automatically skeptical of any deal that feels too good to be true. People are also very slow to gain back trust if it ever gets lost. Societies are vulnerable to downward spirals, with dishonesty prompting distrust, a culture of distrust making it harder for honest participants to get ahead, honest participants turning dishonest out of necessity, and dishonesty prompting even more distrust.
People are petty criminals. People’s outrage at dishonest behavior depends on the brazenness of the act rather than on the amounts involved; society is much more concerned about robberies than about insurance claim exaggerations, even though the latter costs the economy much more money. Dishonesty is widespread, but most dishonest acts are minor, petty, subtle, and morally grey. Even when people have the opportunity to exploit a situation to the max, they nearly always restrain themselves to keep the transgression minor and rationalizable. People acting dishonestly do not get swayed much by the likelihood of getting caught or by potential punishments, even though a rational analysis would take such factors into account. People are more forgiving of dishonesty when in a market context (as opposed to a social context), when whatever is being stolen is highly specific (as opposed to money), and if the victim is an institution (as opposed to an identifiable person).
People make different choices when in groups. When people make choices privately and anonymously, they choose according to their preferences and come out feeling more satisfied. However, when people are in groups and their choices are public, they consider both their own preferences and the image of themselves they want to project to their group. Sometimes people want to conform so they make the same choice as their group mates, while at other times they will intentionally diverge for the sake of taking an individualist stand.