Predictably Irrational
Free cookies — take them all
Economics puzzled me — "Taken the assumption of human rationality, these conclusions can be drawn." It made no sense, especially when attending organizational behavior, where you perceive the influence of different forces that lead to a collective wrong course of action.
I now understand the difficulty of creating a predictive model where humans are taken as irrational. But what if our irrationality is predictable? We won't take all the free samples. We will take the least preferred chocolate even though our favorite one is cheaper. We won't take free money easily, because "where is the catch?"
Dan Ariely, a psychologist, and behavioral economics professor covers some of our irrationalities in his great book Predictability Irrational. This book, alongside Thinking Fast and Slow by Daniel Kahneman, gave me a fresh pair of eyes to look around and question Standard Economic Theory assumptions.
According to the author, we are predictably irrational in our behavior, but we are not random. This creates room for better predictions in Economics if taken into account.
You're heading to the supermarket, and on the entrance, there is a man selling cookies. As the law of supply and demand predicts, when the price rises, fewer people buy the cookies; the price falls, and more people are waiting in line. Numerous experiments have been done and they all show this predictable result. Human rationality, right?
But what happens when the cookies are free? According to Dan's experiments, people only take one or two, a lower number of cookies compared to when they paid a price. This goes against Standard Economic Theory, which, in this scenario, predicted that people would fill their pockets with dozens of free cookies. We're not so greedy after all.
What explains this phenomenon is the market and social norms that rule in different situations and lead to completely different behaviors. Market rules emerge when payment is involved. Social rules are associated with emotion, a sense of community, and favors.
You're leaving your apartment, and your neighbor kindly asks your help to move a heavy object. You immediately say yes and get the job done. What if he offered you 1$ for the service? I don't know about you, but I would find an excuse and leave quickly, even though it was a better deal. When social and market norms get mixed, things get predictably weird.
Back to the cookies, when you pay for them, you're not thinking of leaving some for other customers — you're paying your share and so you have the right to buy as many as you want. But when the cookies are free, it's the social norms that prevail, and they will stop you from taking the whole box.
Economics represents consumer preferences through a map of indifference curves. In each curve, you have a combination of two different goods, that provide you a certain satisfaction. If no restrictions were added, we would get all the available quantity of both goods, and have infinite levels of satisfaction. But money is a concerning restriction, and so we represent the budget line to limit satisfaction levels. The optimal point is obtained when the budget line is tangential to the highest indifference curve. The zero price effect contradicts this model, as it is shown in the experiment below.
You are offered two choices: a Hershey's chocolate for $0.01 or Lindt chocolate for $0.15. The latter is considered a much better choice, and it is picked by you, and by the majority. Now, imagine the price of Lindt gets reduced by $0.01. Great news! Your favorite candy (which gives you higher levels of satisfaction) is cheaper, so, the optimal solution is to buy more. But this $0.01 sale was also extended to the Hershey's. This should not change much, right? If you previously preferred the Lindt, now that is cheaper, you should want it even more. So, why did the Hershey became the newest favorite?
This experiment shows the emotional reaction we have to free offers. We prefer free, over a better deal. But do we really prefer what is free?
In an experiment, a sign with "Free Money" and a stack of bills was placed on a table in a public building. When the offer was $1, only 1% of people stopped by. When the amount was $50, 19% were interested, still, they asked questions and were suspicious. But why didn't more people grab the money? They thought it was a marketing scheme.
Trust and the lack of it, plays an important role in the way we perceive these "deals", and we don't always make the optimal choice.
“Standard economics assumes that we are rational... But, as the results presented in this book (and others) show, we are far less rational in our decision making... Our irrational behaviors are neither random nor senseless- they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains.”