Book review

This book tells us we often pay irrational prices for what we buy (and why we do it)

How to fix your overspending problem. Yes, you have one.

What do you imagine might be the link between unwanted teenage pregnancies and spiralling credit card debt? You wouldn’t blink an eyelid before buying/accepting anything that was being offered “FREE!!”, because, as any child can reason, what do you have to lose? And talking about prices, how are those determined in the first place? As even those who haven’t taken Economics 101 know, it’s all supply and demand, right?

The answers that you will find to these questions in Dan Ariely’s Predictably Irrational are likely to not only surprise you but also to open up new ways of thinking about a large number of issues. Ariely’s area of expertise is Behavioural Economics, which seeks to identify human characteristics and impulses that are not strictly – or even at all – rational as assumed by classical economists, and then to validate them through controlled experiments with the aim of drawing insights that can improve our lives.

Consider, for example, what’s common to various forms of sexual action that lead to undesired pregnancies, and the completely out-of-control credit card debts that some people pile up. Clearly these are not examples of rational behaviour, and therefore beyond the ambit of much of conventional economic analysis. Naturally, classical economists do not have any policy recommendations.

Ariely posits that we humans are not integrated beings and that in fact we are remarkably like Robert Louis Stevenson’s Dr Jekyll and Mr Hyde. How does he know this? He sets up controlled experiments in which respondents are first asked about whether they would engage in any form of violent or immoral sexual activity. Predictably, everybody indicates their preference for morally and ethically correct activities. The same set of respondents are then asked the same questions when in states of arousal. Equally predictably, many then say that they would, at that moment, engage in those very actions that they had said that they would not.

Spiralling credit card debt is much the same story. In their Dr Jekyll states, people do not run up unmanageable amounts of debt, but when they let go of cold rationality and give in to their Mr Hyde state of irrational impulses – buying things for which they have little or no use – the credit card bills are a foregone conclusion. Car accidents caused by reckless driving by (usually) teenagers and young adults are yet another outcome of our dual – cold and hot, if you will – personalities.

So what can be done?

As it turns out, quite a lot. Sex education should focus much less on anatomy and physiology, and make young people much more aware of the perils of giving in to momentary temptations. Condoms should be abundantly available. Credit cards should be configurable in ways that the user can set their own budgets for meals, clothing, entertainment, etcetera – so that when those limits are crossed, the card can start alerting the user, or can even auto-freeze.

Likewise, technology for cars is evolving at such a fast pace that preset conditions such as speeding, choice of music when driving, vulnerable times – such as weekend evenings – can easily be programmed in, with attendant and automatic protective actions.

But what about patronising products or services with zero price – what could possibly be the problem? Ariely shows that the “FREE!!” sign anywhere is an emotional trigger, the appeal of which few can resist, and not always without adverse consequences. Any psychological resistance that we might have to buying things which we do not really want collapses when something else that we do want is given free with it.

So, many of us will remember the inconvenience and cost of using a SUV for city driving –until we give straight in to the “FREE!!” bells and whistles that might be offered with it. And even for goods that are not bundled, we can make bad decisions and waste time that could be otherwise used profitably.

Think of which of these one-time offer you are likely to accept – one “FREE!” Amazon voucher of $10, or a $20 Amazon voucher that you can buy for $7. Clearly, the benefit of paying for the $20 Amazon voucher is more than that of the “FREE!” voucher, but how many of us will make the right choice?

How can we deal with this irrational exuberance over the lure of zero? On an individual level, we should stop and think about whether any offer for “FREE!” goods is really aligned with our aims and interests, or whether we can make other, better choices. Governments and companies can both capitalise on the zero obsession by, for example, making some essential medical tests free in a bouquet of other tests – society, buyer and seller will all come out winners.

Why we pay what we pay

How are other (non-zero) prices determined? If one were to look for similarities in what was taught in schools and colleges in the 17th century and now across all subjects, perhaps the winner by a long margin would be supply and demand. And yet, Ariely asks, are supply and demand as completely different from each other as they are made out to be in Economics classrooms? And do they always determine prices?

To illustrate his point, he tells the story of a diamond dealer who introduced Tahitian black pearls in the late 1940s without any success. He tried every trick in the book and failed, until he had the great idea of persuading the famous jeweller, Harry Winston, to display the black pearls, priced exorbitantly high, alongside expensive stones in his Fifth Avenue store. You can imagine what happened next – the demand for black pearls soared as did the price. No self-respecting, rich socialite could afford to be seen without one.

Whither supply, whither demand? The price was set by the anchoring effect, decided by the first impression of the product in a contrived context. Thus, we anchor ourselves to prices that have no rational basis and sometimes keep on paying those prices over our lifetimes. The logical extension of this concept is what Ariely calls “arbitrary coherence” – once initial prices are imprinted in our mind (the arbitrariness) we pay not only that price for that product, but also for related products (the coherence).

What should we do to be not taken for a ride? Clearly, be very careful when buying a product for the first time and ask ourselves exactly why we should pay the price at which it is offered. We should also consider the trade-offs involved – specifically what we are foregoing when we first adopt a herd mentality in paying some prices, and then self-herd ourselves into paying many such prices over time.

There are many other stimulating questions that Ariely asks in the book, not all of which have clear answers. Doctors routinely prescribe placebos, for example, and clinical trials clearly establish that for a large majority of patients, placebos work. But it is also a huge wastage of resources to inflict expensive and sometimes painful treatments that have no basis in reason. The answer may not be clear, but certainly bears thinking about.

The death of old assumptions

What makes this dense, ideas-rich book very readable are Ariely’s easy writing style and gift for the appropriate example, as you would have guessed already. His methodology is strictly scientific – hypothesise, experiment, validate, draw conclusions and make policy recommendations – but his prose is quite unlike that of weighty academic volumes.

Also on display on virtually every page is his sly sense of humour. In taking the hatchet to classical economists, for example, he writes: “A passing economist, twirling his cane and espousing conventional economic theory, in fact, would have said....”

And there he has summed up the classical economist perfectly. For long, and particularly since the 2008 recession, much of the old assumptions, including the one about rational consumers, has been discredited, but classical economists, turned out in top hats and twirling their canes, as it were, have for the most part stuck to obscure and mathematical arcana that have little or no relevance to bettering our lives. They will find it hard to dismiss Ariely, an MIT economist who has collaborated with his peers and colleagues from virtually every well-known American university.

One final poser. Wouldn’t you think that cash would be the most effective inducement for dishonesty? If you left some currency about, it would be most likely to be stolen, right? Turns out that cash is the most effective deterrent for white-collar crime – the likes of B Ramalinga Raju or Jeffrey Skilling or any other perpetrator of stock market scams will gladly bankrupt the pension funds of old ladies, but they are very, very unlikely to physically steal their cash!

To know how we could use this knowledge to greatly reduce white-collar crime, one of the most expensive and immoral acts that afflict all modern economies, and for many such startling insights, do not miss this book!

Predictably Irrational, Dan Ariely, Harper Perennia.

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