Predictably irrational explains why we we are irrational and how our irrationality follow in a predictable fashion.
How would you know if a circle is big or small?
When you see another circle that is bigger or smaller in comparison.
We understand the world in terms of relative terms, rather than absolute.
Imagine you were browsing the Economist and you were given to pick one of three options:
- Internet Only subscription for $59
- Print Only subscription for $125
- Internet and Print subscription for $125
It’s a no-brainer for majority of rational beings. Obviously why would anyone pick 2? Sure enough, that’s what MBA students did. A vast majority picked 3. But what about this:
- Internet Only subscription for $59
- Internet and Print subscription for $125
Now the decision becomes harder. In fact, most students now picked 1 over 2. What’s happening here?
You can see sales representatives capitalize on relativity all the time.
Remember you were taken to the beat-up property before the sales agent give you a better and for that matter the real property that you were supposed to see? That’s relativity in effect. Whatever comes after the worst property looks much better in comparison.
Restaurants don’t have to worry about the priciest menu not generating revenue.
Other less pricey menus will generate more revenue since it makes the decision easier. Either order the most expensive dish on the menu and project your image or order the less expensive dish and go economical. For majority of us, we go for the latter.
Meet the ‘Decoy’ effect
In the above example, option 2: Print only subscription was a decoy. Option 3 at the same exact price offers electronic edition for free, which makes it a steal in comparison to the decoy. Here’s another example.
Imagine you’re undecided between a holiday in Venice and Paris. Both packages come with free breakfast, and you like both places. Your travel agent knows this, and so he throws you in a third option – a minus version of one of the options, say Venice without free breakfast. It looks like this:
- Package A: Venice with free breakfast
- Package B: Paris with free breakfast
- Package C: Paris without free breakfast
As soon as we introduce option C, B- version, option B looks superior to not only option C also to option A. That’s a pretty interesting stuff.
So when you’re going for a date, try to look for a male who is not as good looking as you. It will make you stand out.
Simply adding a more expensive option can increase your sales
When the sales of bread machines were slow,Williams-Sonoma added a new ‘deluxe’ version that was 50% more expensive. The original version now becomes a bargain and started to fly off the shelves.
Would you save $7 for a pen or a suit?
Majority of people would drive to a distance to save $7 when purchasing a pen. That’s not the case when buying a suit. The amount of savings are equal yet we make decisions based on relative scale. It’s wired to all of us.
Fallacy of supply and demand, a black pearl story
Savador Assael, the Pearl King, single-handedly created the black pearl market. His first attempt was an utter failure. He failed to sell a single pearl. Instead of lowering the price, which seems like a rational decision, he increased teh price outrageously. He also run ads in glossy magazines with black pearls next to diamonds, rubies and emeralds. Soon, black pearls were considered precious by the public.
You’re more likely to be price aware when moving to a new city
People who move to a new city remain anchored to the prices they paid in their previous city. Imagine you’re moving from Lubbock to Pittsburgh. You might have to squeeze your family to smaller flat to pay the same amount. But when you’re moving from LA to Pittsburgh, you will just move into a mansion.
You can consider a high anchor early by mentioning an extreme price
Simply saying “I’m not going to charge you a million dollar” would make anything that come after that seems like a very small number.
You might not like Starbucks now, but that can change from tomorrow
Imagine tomorrow you happen to forget your lunch box and go to Starbucks instead. You enjoyed a good time. The ambience was top-notch and the coffee was amazing. The following days you decide to give it another shot and another and another. As positive experiences build up, you start to build new habits.
That’s social herding in effect, which means assuming something is good (or bad) on the basis of people’s previous behavior. In the case above, we were herding ourselves.
But we can get a cheaper coffee at Dunkin. Why would you pay more for Starbucks?
Glad you asked. Howard Schultz is aware that people are anchored to traditional prices with traditional experience. So he made Starbucks as different as possible from Dunkin or any other coffee shop for that matter. He named differently (tall, venti), priced differently and bet heavily on the walk-in experience. In effect, Starbucks managed to produce a new anchor.
Knowing the impact of anchoring, ask yourself your repeated decisions and pay attention to your very first decision.
It may seem like just one decision but that could have a long-lasting impact for years to come.
Price memory can also have a major impact.
Doubling the price of milk and halving the price of wine would have a short-term impact but it’s unlikely to have a long-term impact on consumption patterns. And if you induced amnesia about the previous prices, it might nearly have no impact at all.
Free can come with a huge cost.
Imagine two chocolate brands were on sale: Lindt at $0.15 and Hershey at $0.01. Majority of people bought Lindt over Hershey.
Now imagine we reduced 0.01$ for both brands, so Lindt becomes $0.14 and Hershey becomes free. According to the standard economic theory, the price reduction shouldn’t lead to any behavior change. But it did. Majority now picked free Hershey instead of their favorite Lindt.
The difference between 0 and 1 is larger than that of 1 and 2.
Imagine a zero-calorie coke and a 1 calorie coke. In almost all the cases, you would pick a zero option over one. But what if you are given 1-calorie and 2-calorie options. The difference is still 1-calorie, but it seems almost negligible.
Here’s one more. Would you take a free 10$ gift card or a 20$ gift card for 7$? Think quickly.
So what makes us so attracted to Free? Two words. Loss Aversion.
When an item, we see no signs of loss. Most of the kids overwhelmingly chose the small free snicker than trading in a small one for large, despite the latter option wins on the absolute scale with higher net weight. The zero price affect applies even when the money is not involved.
We all have fallen into this trap. Remember free shipping? Spending hours in queue for a free ice-cream?
Amazon saw its sales went through the roof after introducing free shipping over $25 purchases. However France was an exception. But it turned out French division offered $0.2 pricing instead of free pricing. When they changed to free option, Amazon saw the same soaring sales.
Social norms and the market norms. Why sometimes we are happy to do things for free? And sometimes we’re not even if we’re paid to?
Social norms carry warm and fuzzy reciprocity with no explicit quid pro quo. Market norms are explicit and hard. You get what you pay for.
The two norms explain why the most expensive sex is free sex.
You can’t wine and dine a woman and then say “you know this relationship is costing me a fortune”, nor you can ask her to have sex in return to the favor.
Lawyers just like the rest of us live in these two worlds.
When asked to provide their services to needy retirees at a discounted price, lawyers are unwilling to do so. But they’re willing to offer for free of charge.
The two norms can never collide.
Either market norms drive out social norms, or social norms drive out market norms.
Thinking money puts one in a market frame of mind.
Experiments show the subjects when doing so were more selfish and self-reliant. They wanted to spend more time alone, more likely to select individual tasks than those required team work.
Imposing a fine can put one to a market frame of mind.
Without a fine, parents felt guilty about being late when picking up their children. Imposing a fine inadvertently replaced social norms with market norms. Parents then chose to be late since they were being fined anyway. They saw it as a transaction.
Here’s an interesting twist. A few weeks later, day care center removed the fine. But it didn’t restore the social norms. Instead the situation worsened. Parents now concluded there was no penalty for tardiness.
Conclusion is when a social norm collides with market norm, it goes away for a long time.
It is social norm that is difficult to establish. It takes years to build a bridge, but it only takes minutes to burn. Once a social norm is gone, it’s gone for a long time.
Companies should think in terms of social norms than market norms.
It’s remarkable how much start ups can get out of people when social norms are in effect. The excitement of building something together are stronger than salaries stepping up with each promotion.
Break one big deadline into small multiple deadlines.
The author conducted a study on his class:
- Group A was given self-selected deadlines. All three papers are expected to turn in on the last day of class.
- Group B was given no deadlines. All three papers are due on the last day.
- Group C was given three deadlines for three papers.
The results? Group C got the best grades. Group B worst and the interesting group, Group A fell in the middle. Conclusion?
Allowing students to pre-commit to deadlines improved performance. Students who spaced out their commitments did well. Students who did the logical thing and gave no commitments did badly.
We over-value things we own because we focus on what we might lose rather than what we might gain.
The author ran an experiment on Duke students, who sleep out for weeks to get basketball tickets.
- Those who didn’t get were willing to pay up to $170 for a ticket.
- Those who did get were not willing to accept less than $2,400 for a ticket.
We can begin to feel ownership even before we own somthing.
Remember trials, free returns and money back guarantees. They work so well because people hate to give up ownership. To counteract this pitfall, ask yourself
“Assuming I hadn’t done X, would I still do it now?”
Open doors subconsciously draw energy and commitment.
People were actually willing to accept less money or even pay to keep the options option, as the author suggests. It’s sometimes better to choose something then burn the bridges so they don’t distract you any longer.
When you tell people the odds are good, they can end up agreeing with you.
Again the author ran multiple studies on this. The subjects who were told something might be distasteful say a beer, they found it indeed distasteful because of self expectations.
This is why caterers use exotic descriptions like chipotle-mango sauce to improve the perceived taste of their food.
When the ambience looked upscale, the coffee looked upscale as well.
The study subjects were much more likely to like a coffee and are willing to pay more for it when the coffee was served in fancy containers.
The shape of wine glass had no impact in blind taste test.
This is why Pepsi wins in the blind taste tests while Coke wins while the brands are shown. When a person knew they were about to get a drink of Coke, the DLPFC, an area involved in higher-order brain functions was also activated. In other words, Coke brand was able to henahce activity in bran’s pleasure center thereby changing the experience of drinking Coke.
Prime people with words like “Ancient”, people walked more slowly. Prime with words like “Considerate”, they are more likely to be patient and polite.
Not only do we react differently based on stereotype of others, we react differently based on stereotypes about ourselves.
Placebo doesn’t just fool us, it can actually trigger endorphins other biological reactions that actually change body and experience.
Perhaps this is why a dollar aspirin can do what a penny aspirin cannot. When told that the drug costs $2.5 per dose, nearly all subjects reported pain relief. When told the drug costs $0.1 per dose, only half reported relief.
Your performance can be improved more by expensive drink than discounted drink.
The author ran a study at the gym. The results show the control group that consumed expensive drink got 9/15 puzzles correct. Group that consumed cheap drink got 6.5/15 puzzles correct.
One more thing, when the bottles show “Drinks such as X drink have been shown to improve mental functioning.” both groups performed slightly better.
Mere contemplation of a moral benchmark can encourage honesty.
Merely acknowledging “I understand that this sudy falls under the MIT honor system” can significantly reduce one’s likelihood of cheating in an exam.
The further it’s from money, the easier the cheating becomes.
Answer a question. Which one will make you feel worse? Stealing a 6-pack of Coke or 6 $1 bills. The two are economically identically but very different in terms of moral benchmark. The experiments show merely switching from cash to non-monteary equivalnet doubled cheating. Perhaps this is also why business people are more likely to claim dubious expenses when their assistants are submitting the claims, and exaggerate the travel claims across country than in country.
When people order out loud, the table might end up with more types of beer.
This is because of people with need for uniqueness. The same people are sometimes willing to sacrifice the pleasure they get in order to project a certain image to others. But this is not always the case. In cultures where conformity is valued such as in Hong Kong, the opposite thing happened. Uniformity rose as people ordered what others ordered.