Business Question

Objective: To deepen understanding of the foundational research behind a book chapter by exploring related literature, summarizing key findings, and presenting on a relevant paper.

MY CHAPTER STARTS ON PAGE 195 AND ENDS ON PAGE 216

Instructions:

Research on Google Scholar:

??Use the author of the book chapter and the bibliography in the back of the book to perform a Google Scholar search on the foundation of your assigned book chapter.

Paper Summaries:

??Choose five papers from the compiled list.

??Provide a summary of the findings in each paper, including key points, methods, results, and implications. Write a paragraph for each summary

Presentation:

Please create a presentation based upon each article’s summary.

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• W h y do our headaches persist after taking a one-cent
aspirin but disappear when we take a 50-cent aspirin?
• Why does recalling the Ten Commandments reduce our
tendency to lie, even when we couldn’t possibly be
caught?
• W h y do we splurge on a lavish meal but cut coupons
to save 25 cents on a can of soup?
• W h y do we go back for second helpings at the unlimited
buffet, even when our stomachs are already full?
• And how did we ever start spending $4.15 on a cup of
coffee when, just a few years ago, we used to pay less
than a dollar?
hen it comes to making decisions in our lives, we
think we’re in control. We think we’re making
smart, rational choices. But are we?
In a series o f illuminating, often surprising experi­
ments, M I T behavioral economist Dan Ariely refutes the
common assumption that we behave in fundamentally
rational ways. Blending everyday experience with ground­
breaking research, Ariely explains how expectations,
emotions, social norms, and other invisible, seemingly
illogical forces skew our reasoning abilities.
N o t only do we make astonishingly simple mistakes
every day, but we make the same types of mistakes, Ariely
discovers. We consistently overpay, underestimate, and
procrastinate. We fail to understand the profound effects
of our emotions on what we want, and we overvalue what
we already own. Yet these misguided behaviors are neither
random nor senseless. They’re systematic and predict­
able—making us predictably
irrational.
From drinking coffee to losing weight, from buying a
car to choosing a romantic partner, Ariely explains how
to break through these systematic patterns o f thought to
make better decisions. Predictably
Irrational
will change
the way we interact with the world—one small decision
at a time.
0208
DAN
ARIELY is the Alfred P. Sloan Professor o f
Behavioral E c o n o m i c s at M I T , where he holds a joint
appointment between M I T ‘ s Media Laboratory and the
Sloan School of Management. He is also a researcher at the
Federal Reserve B a n k of Boston and a visiting professor
at Duke University. Ariely wrote this book while he was
a fellow at the Institute for Advance Study at Princeton.
His work has been featured in leading scholarly journals
and a variety of popular media outlets, including the New
York
Times,
the Wall Street Journal,
Post, the Boston
Globe,
Scientific
the
American,
Washington
and
Science.
Ariely has appeared on C N N and National Public Radio.
He divides his time between Durham, North Carolina,
Cambridge, Massachusetts, and the rest o f the world.
www.predictablyirrational.com
A U T H O R
P H O T O G R A P H
JACKET
DESIGN
COURTESY
OF T H E A U T H O R
BY CHRISTINE
V A N BREE
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Predictably
Irrational—it’s
not what you think.
“A marvelous book that is both thought-provoking and highly entertaining, ranging from
the power o f placebos to the pleasures o f Pepsi. Ariely unmasks the subtle but powerful
tricks that our minds play on us, and shows us how we can prevent being fooled.”
—Jerome Groopman, Recanati Chair of Medicine, Harvard Medical School,
and New York Times bestselling author o f How Doctors
Think
” D a n Ariely is a genius at understanding human behavior: no economist does a better
job of uncovering and explaining the hidden reasons for the weird ways we act, in the
marketplace and out. Predictably
Irrational
will reshape the way you see the world, and
yourself, for good.” — J a m e s Surowiecki, author o f The Wisdom
of
Crowds
“Filled with clever experiments, engaging ideas, and delightful anecdotes. D a n Ariely
is a wise and amusing guide to the foibles, errors, and bloopers o f everyday decision
making.” — D a n i e l G i l b e r t , Professor o f Psychology, Harvard University, and
New
York Times
bestselling author o f Stumbling
on
Happiness
” T h i s is going to be the most influential, talked-about b o o k in years. It is so full o f daz­
zling insights—and so engaging—that once I started reading, I couldn’t put it down.”
— D a n i e l M c F a d d e n , 2 0 0 0 N o b e l Laureate in E c o n o m i c s ,
M o r r i s C o x Professor o f E c o n o m i c s , University o f C a l i f o r n i a at Berkeley
“Predictably
Irrational
is wildly original. It shows why—much more often than we usu­
ally care to admit—humans make foolish, and sometimes disastrous, mistakes. Ariely
not only gives us a great read; he also makes us much wiser.”
— G e o r g e Akerlof, 2 0 0 1 N o b e l Laureate in E c o n o m i c s ,
Koshland Professor o f E c o n o m i c s , University o f C a l i f o r n i a at Berkeley
” T h e most difficult part o f investing is managing your emotions. D a n explains why that
is so challenging for all o f us, and how recognizing your built-in biases can help you
avoid c o m m o n mistakes.”
— C h a r l e s Schwab, C h a i r m a n and C E O , T h e Charles S c h w a b C o r p o r a t i o n
predictably
irrational
predictably
irrational
The Hidden Forces
Our Decisions
That
Shape
Dan Ariely
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PREDICTABLY IRRATIONAL. Copyright © 2 0 0 8 by Dan Ariely. All
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To my mentors, colleagues,
who make research
and
students—
exciting
Contents
INTRODUCTION:
How an Injury Led Me to Irrationality
Research
Described
and to the
Here
xi
CHAPTER
I
The Truth about Relativity:
Why Everything Is Relative—Even When It Shouldn’t Be
1
CHAPTER
2
The Fallacy of Supply and Demand:
Why the Price of Pearls—and
Everything
Else—
Is Up in the Air
23
CHAPTER 3
The Cost of Zero Cost:
Why We Often Pay Too Much When We Pay Nothing
49
contents
CHAPTER
4
The Cost of Social Norms:
Why We Are Happy
to Do Things, but Not
We Are Paid to Do
When
Them
67
CHAPTER 5
The Influence of Arousal:
Why Hot Is Much Hotter
Than We
Realize
89
CHAPTER
6
The Problem of Procrastination and Self-Control:
Why We Can’t Make Ourselves
Do
What We Want to Do
109
CHAPTER
7
The High Price of Ownership:
Why We Overvalue
What We Have
127
CHAPTER 8
Keeping Doors Open:
Why Options Distract Us from Our Main Objective
139
CHAPTER 9
The Effect of Expectations:
Why the Mind Gets What It
155
viii
Expects
contents
CHAPTER
IO
The Power of Price:
Why a SO-Cent Aspirin Can Do What a Penny
Aspirin
Can’t
173
CHAPTER I I
The Context of Our Character, Part I:
Why We Are Dishonest,
and
What
We Can Do about It
195
CHAPTER
12
The Context of Our Character, Part II:
Why Dealing with Cash Makes
Us More
Honest
217
CHAPTER
13
Beer and Free Lunches:
What Is Behavioral
Economics,
the Free
and Where
Lunches?
231
Thanks
245
List of Collaborators 249
Notes 255
Bibliography and Additional Readings 259
Index 269
ix
Are
Introduction
How an Injury Led Me to Irrationality
to the Research Described Here
I
and
have been told by many people that I have an unusual way
of looking at the world. Over the last 20 years or so of my
research career, it’s enabled me to have a lot of fun figuring out
what really influences our decisions in daily life (as opposed to
what we think, often with great confidence, influences them).
Do you know why we so often promise ourselves to diet,
only to have the thought vanish when the dessert cart rolls
by?
Do you know why we sometimes find ourselves excitedly
buying things we don’t really need?
Do you know why we still have a headache after taking a
one-cent aspirin, but why that same headache vanishes when
the aspirin costs 50 cents?
Do you know why people who have been asked to recall
the Ten Commandments tend to be more honest (at least im­
mediately afterward) than those who haven’t? Or why honor
codes actually do reduce dishonesty in the workplace?
introduction
By the end of this book, you’ll know the answers to these
and many other questions that have implications for your
personal life, for your business life, and for the way you look
at the world. Understanding the answer to the question about
aspirin, for example, has implications not only for your choice
of drugs, but for one of the biggest issues facing our society:
the cost and effectiveness of health insurance. Understanding
the impact of the Ten Commandments in curbing dishonesty
might help prevent the next Enron-like fraud. And under­
standing the dynamics of impulsive eating has implications
for every other impulsive decision in our lives—including
why it’s so hard to save money for a rainy day.
My goal, by the end of this book, is to help you funda­
mentally rethink what makes you and the people around you
tick. I hope to lead you there by presenting a wide range of
scientific experiments, findings, and anecdotes that are in
many cases quite amusing. Once you see how systematic cer­
tain mistakes are—how we repeat them again and again—I
think you will begin to learn how to avoid some of them.
But before I tell you about my curious, practical, enter­
taining (and in some cases even delicious) research on eating,
shopping, love, money, procrastination, beer, honesty, and
other areas of life, I feel it is important that I tell you about
the origins of my somewhat unorthodox worldview—and
therefore of this book. Tragically, my introduction to this
arena started with an accident many years ago that was any­
thing but amusing.
O N WHAT W O U L D otherwise have been a normal Friday after­
noon in the life of an eighteen-year-old Israeli, everything
changed irreversibly in a matter of a few seconds. An exploxii
introduction
sion of a large magnesium flare, the kind used to illuminate
battlefields at night, left 70 percent of my body covered with
third-degree burns.
The next three years found me wrapped in bandages in a
hospital and then emerging into public only occasionally,
dressed in a tight synthetic suit and mask that made me look
like a crooked version of Spider-Man. Without the ability to
participate in the same daily activities as my friends and fam­
ily, I felt partially separated from society and as a conse­
quence started to observe the very activities that were once
my daily routine as if I were an outsider. As if I had come
from a different culture (or planet), I started reflecting on the
goals of different behaviors, mine and those of others. For
example, I started wondering why I loved one girl but not
another, why my daily routine was designed to be comfort­
able for the physicians but not for me, why I loved going rock
climbing but not studying history, why I cared so much about
what other people thought of me, and mostly what it is about
life that motivates people and causes us to behave as we do.
During the years in the hospital following my accident, I had
extensive experience with different types of pain and a great
deal of time between treatments and operations to reflect on it.
Initially, my daily agony was largely played out in the “bath,” a
procedure in which I was soaked in disinfectant solution, the
bandages were removed, and the dead particles of skin were
scraped off. When the skin is intact, disinfectants create a lowlevel sting, and in general the bandages come off easily. But
when there is little or no skin—as in my case because of my
extensive burns—the disinfectant stings unbearably, the ban­
dages stick to the flesh, and removing them (often tearing them)
hurts like nothing else I can describe.
Early on in the burn department I started talking to the
xiii
introduction
nurses who administered my daily bath, in order to under­
stand their approach to my treatment. The nurses would
routinely grab hold of a bandage and rip it off as fast as pos­
sible, creating a relatively short burst of pain; they would re­
peat this process for an hour or so until they had removed
every one of the bandages. Once this process was over I was
covered with ointment and with new bandages, in order to
repeat the process again the next day.
The nurses, I quickly learned, had theorized that a vigor­
ous tug at the bandages, which caused a sharp spike of pain,
was preferable (to the patient) to a slow pulling of the wrap­
pings, which might not lead to such a severe spike of pain but
would extend the treatment, and therefore be more painful
overall. T h e nurses had also concluded that there was no dif­
ference between two possible methods: starting at the most
painful part of the body and working their way to the least
painful part; or starting at the least painful part and advanc­
ing to the most excruciating areas.
As someone who had actually experienced the pain of the
bandage removal process, I did not share their beliefs (which
had never been scientifically tested). Moreover, their theories
gave no consideration to the amount of fear that the patient
felt anticipating the treatment; to the difficulties of dealing
with fluctuations of pain over time; to the unpredictability of
not knowing when the pain will start and ease off; or to the
benefits of being comforted with the possibility that the pain
would be reduced over time. But, given my helpless position,
I had little influence over the way I was treated.
As soon as I was able to leave the hospital for a prolonged
period (I would still return for occasional operations and
treatments for another five years), I began studying at Tel
Aviv University. During my first semester, I took a class that
xiv
introduction
profoundly changed my outlook on research and largely de­
termined my future. This was a class on the physiology of
the brain, taught by professor Hanan Frenk. In addition to the
fascinating material Professor Frenk presented about the work­
ings of the brain, what struck me most about this class was
his attitude to questions and alternative theories. Many times,
when I raised my hand in class or stopped by his office to
suggest a different interpretation of some results he had pre­
sented, he replied that my theory was indeed a possibility
(somewhat unlikely, but a possibility nevertheless)—and would
then challenge me to propose an empirical test to distinguish
it from the conventional theory.
Coming up with such tests was not easy, but the idea that
science is an empirical endeavor in which all the participants,
including a new student like myself, could come up with al­
ternative theories, as long as they found empirical ways to
test these theories, opened up a new world to me. On one of
my visits to Professor Frenk’s office, I proposed a theory ex­
plaining how a certain stage of epilepsy developed, and in­
cluded an idea for how one might test it in rats.
Professor Frenk liked the idea, and for the next three
months I operated on about 50 rats, implanting catheters in
their spinal cords and giving them different substances to
create and reduce their epileptic seizures. One of the practi­
cal problems with this approach was that the movements of
my hands were very limited, because of my injury, and as a
consequence it was very difficult for me to operate on the
rats. Luckily for me, my best friend, Ron Weisberg (an avid
vegetarian and animal lover), agreed to come with me to the
lab for several weekends and help me with the procedures—a
true test of friendship if ever there was one.
In the end, it turned out that my theory was wrong, but
xv
introduction
this did not diminish my enthusiasm. I was able to learn
something about my theory, after all, and even though the
theory was wrong, it was good to know this with high cer­
tainty. I always had many questions about how things work
and how people behave, and my new understanding—that
science provides the tools and opportunities to examine any­
thing I found interesting—lured me into the study of how
people behave.
With these new tools, I focused much of my initial efforts
on understanding how we experience pain. For obvious rea­
sons I was most concerned with such situations as the bath
treatment, in which pain must be delivered to a patient over a
long period of time. Was it possible to reduce the overall ag­
ony of such pain? Over the next few years I was able to carry
out a set of laboratory experiments on myself, my friends,
and volunteers—using physical pain induced by heat, cold
water, pressure, loud sounds, and even the psychological pain
of losing money in the stock market—to probe for the an­
swers.
By the time I had finished, I realized that the nurses in the
burn unit were kind and generous individuals (well, there
was one exception) with a lot of experience in soaking and
removing bandages, but they still didn’t have the right theory
about what would minimize their patients’ pain. How could
they be so wrong, I wondered, considering their vast experi­
ence? Since I knew these nurses personally, I knew that their
behavior was not due to maliciousness, stupidity, or neglect.
Rather, they were most likely the victims of inherent biases in
their perceptions of their patients’ pain—biases that appar­
ently were not altered even by their vast experience.
For these reasons, I was particularly excited when I re­
turned to the burn department one morning and presented
xvi
introduction
my results, in the hope of influencing the bandage removal
procedures for other patients. It turns out, I told the nurses
and physicians, that people feel less pain if treatments (such
as removing bandages in a bath) are carried out with lower
intensity and longer duration than if the same goal is
achieved through high intensity and a shorter duration. In
other words, I would have suffered less if they had pulled
the bandages off slowly rather than with their quick-pull
method.
The nurses were genuinely surprised by my conclusions,
but I was equally surprised by what Etty, my favorite nurse,
had to say. She admitted that their understanding had been
lacking and that they should change their methods. But she
also pointed out that a discussion of the pain inflicted in the
bath treatment should also take into account the psychologi­
cal pain that the nurses experienced when their patients
screamed in agony. Pulling the bandages quickly might be
more understandable, she explained, if it were indeed the
nurses’ way of shortening their own torment (and their faces
often did reveal that they were suffering). In the end, though,
we all agreed that the procedures should be changed, and
indeed, some of the nurses followed my recommendations.
My recommendations never changed the bandage removal
process on a greater scale (as far as I know), but the episode
left a special impression on me. If the nurses, with all their ex­
perience, misunderstood what constituted reality for the pa­
tients they cared so much about, perhaps other people similarly
misunderstand the consequences of their behaviors and, for
that reason, repeatedly make the wrong decisions. I decided to
expand my scope of research, from pain to the examination of
cases in which individuals make repeated mistakes—without
being able to learn much from their experiences.
xvii
introduction
T H I S J O U R N E Y INTO the many ways in which we are all ir­
rational, then, is what this book is about. T h e discipline
that allows me to play with this subject matter is called
behavioral
economics,
or judgment and decision making
(JDM).
Behavioral economics is a relatively new field, one that
draws on aspects of both psychology and economics. It has
led me to study everything from our reluctance to save for
retirement to our inability to think clearly during sexual
arousal. It’s not just the behavior that I have tried to under­
stand, though, but also the decision-making processes behind
such behavior—yours, mine, and everybody else’s. Before
I go on, let me try to explain, briefly, what behavioral eco­
nomics is all about and how it is different from standard
economics. Let me start out with a bit of Shakespeare:
What a piece of work is a man! how noble in
how infinite in faculty! in form and moving
express
and admirable!
in apprehension
reason!
how
in action how like an angel!
how like a god! The beauty of the
world, the paragon
of animals.
—from Act II,
scene 2 , of Hamlet
The predominant view of human nature, largely shared
by economists, policy makers, nonprofessionals, and every­
day Joes, is the one reflected in this quotation. O f course,
this view is largely correct. Our minds and bodies are capable
of amazing acts. We can see a ball thrown from a distance,
instantly calculate its trajectory and impact, and then move
our body and hands in order to catch it. We can learn new
languages with ease, particularly as young children. We can
master chess. We can recognize thousands of faces without
xviii
introduction
confusing them. We can produce music, literature, technol­
ogy, and art—and the list goes on and on.
Shakespeare is not alone in his appreciation for the hu­
man mind. In fact, we all think of ourselves along the lines of
Shakespeare’s depiction (although we do realize that our
neighbors, spouses, and bosses do not always live up to this
standard). Within the domain of science, these assumptions
about our ability for perfect reasoning have found their way
into economics. In economics, this very basic idea, called ra­
tionality^ provides the foundation for economic theories, pre­
dictions, and recommendations.
From this perspective, and to the extent that we all believe
in human rationality, we are all economists. I don’t mean that
each of us can intuitively develop complex game-theoretical
models or understand the generalized axiom of revealed pref­
erence (GARP); rather, I mean that we hold the basic beliefs
about human nature on which economics is built. In this book,
when I mention the rational
economic model, I refer to the
basic assumption that most economists and many of us hold
about human nature—the simple and compelling idea that we
are capable of making the right decisions for ourselves.
Although a feeling of awe at the capability of humans is
clearly justified, there is a large difference between a deep
sense of admiration and the assumption that our reasoning
abilities are perfect. In fact, this book is about human
nality—about
irratio­
our distance from perfection. I believe that
recognizing where we depart from the ideal is an important
part of the quest to truly understand ourselves, and one that
promises many practical benefits. Understanding irrational­
ity is important for our everyday actions and decisions, and
for understanding how we design our environment and the
choices it presents to us.
xix
introduction
My further observation is that we are not only irrational,
but predictably
irrational—that
our irrationality happens
the same way, again and again. Whether we are acting as
consumers, businesspeople, or policy makers, understanding
how we are predictably irrational provides a starting point
for improving our decision making and changing the way we
live for the better.
This leads me to the real “rub” (as Shakespeare might
have called it) between conventional economics and behav­
ioral economics. In conventional economics, the assumption
that we are all rational implies that, in everyday life, we com­
pute the value of all the options we face and then follow the
best possible path of action. What if we make a mistake and
do something irrational? Here, too, traditional economics
has an answer: “market forces” will sweep down on us and
swiftly set us back on the path of righteousness and rational­
ity. On the basis of these assumptions, in fact, generations of
economists since Adam Smith have been able to develop farreaching conclusions about everything from taxation and
health-care policies to the pricing of goods and services.
But, as you will see in this book, we are really far less ra­
tional than standard economic theory assumes. Moreover,
these irrational behaviors of ours are neither random nor
senseless. They are systematic, and since we repeat them
again and again, predictable. So, wouldn’t it make sense to
modify standard economics, to move it away from naive
psychology (which often fails the tests of reason, introspec­
tion, and—most important—empirical scrutiny)? This is
exactly what the emerging field of behavioral economics,
and this book as a small part of that enterprise, is trying to
accomplish.
xx
introduction
As YOU W I L L see in the pages ahead, each of the chapters in
this book is based on a few experiments I carried out over the
years with some terrific colleagues (at the end of the book, I
have included short biographies of my amazing collabora­
tors) . Why experiments ? Life is complex, with multiple forces
simultaneously exerting their influences on us, and this com­
plexity makes it difficult to figure out exactly how each of
these forces shapes our behavior. For social scientists, experi­
ments are like microscopes or strobe lights. They help us slow
human behavior to a frame-by-frame narration of events,
isolate individual forces, and examine those forces carefully
and in more detail. They let us test directly and unambigu­
ously what makes us tick.
There is one other point I want to emphasize about ex­
periments. If the lessons learned in any experiment were
limited to the exact environment of the experiment, their
value would be limited. Instead, I would like you to think
about experiments as an illustration of a general principle,
providing insight into how we think and how we make
decisions—not only in the context of a particular experi­
ment but, by extrapolation, in many contexts of life.
In each chapter, then, I have taken a step in extrapolating
the findings from the experiments to other contexts, attempt­
ing to describe some of their possible implications for life,
business, and public policy. The implications I have drawn
are, of course, just a partial list.
To get real value from this, and from social science in gen­
eral, it is important that you, the reader, spend some time
thinking about how the principles of human behavior identi­
fied in the experiments apply to your life. My suggestion to
you is to pause at the end of each chapter and consider
xxi
introduction
whether the principles revealed in the experiments might
make your life better or worse, and more importantly what
you could do differently, given your new understanding of
human nature. This is where the real adventure lies.
And now for the journey.
xxii
predictably
irrational
C H A P T E R
1
The Truth about Relativity
Why Everything Is Relative—Even
When It Shouldn’t Be
ne day while browsing the World Wide Web (obviously
for work—not just wasting time), I stumbled on the fol­
lowing ad, on the Web site of a magazine, the
Economist.com
OPINION
WORLD
BUSINESS
FINANCE & ECONOMICS
Economist.
SUBSCRIPTIONS
Welcome to
The Economist Subscription Centre
Pick the type of subscription you want to buy
or renew.
SCIENCE & TECHNOLOGY
PEOPLE
BOOKS & ARTS
M A R K E T S & DATA
DIVERSIONS
• Economist.com subscription – US $59.00
One-year subscription to Economist.com.
Includes online access to all articles from
The Economist since 1997.
• Print subscription – US $125.00
One-year subscription to the print edition
of The Economist.
• Print & web subscription – US $125.00
One-year subscription to the print edition
of The Economist and online access to all
articles from The Economist since 1997.
predictably irrational
I read these offers one at a time. The first offer—the Inter­
net subscription for $59—seemed reasonable. The second
option—the $125 print subscription—seemed a bit expen­
sive, but still reasonable.
But then I read the third option: a print and Internet sub­
scription for $125.1 read it twice before my eye ran back to the
previous options. Who would want to buy the print option
alone, I wondered, when both the Internet and the print sub­
scriptions were offered for the same price? Now, the print-only
option may have been a typographical error, but I suspect that
the clever people at the Economist’s
London offices (and they
are clever—and quite mischievous in a British sort of way) were
actually manipulating me. I am pretty certain that they wanted
me to skip the Internet-only option (which they assumed would
be my choice, since I was reading the advertisement on the Web)
and jump to the more expensive option: Internet and print.
But how could they manipulate me? I suspect it’s because
the Economist’s
marketing wizards (and I could just picture
them in their school ties and blazers) knew something impor­
tant about human behavior: humans rarely choose things in
absolute terms. We don’t have an internal value meter that
tells us how much things are worth. Rather, we focus on the
relative advantage of one thing over another, and estimate
value accordingly. (For instance, we don’t know how much a
six-cylinder car is worth, but we can assume it’s more expen­
sive than the four-cylinder model.)
In the case of the Economist,
I may not have known whether
the Internet-only subscription at $59 was a better deal than the
print-only option at $125. But I certainly knew that the printand-Internet option for $125 was better than the print-only
option at $125. In fact, you could reasonably deduce that in
the combination package, the Internet subscription is free! “It’s
2
the truth about relativity
a bloody steal—go for it, governor! ” I could almost hear them
shout from the riverbanks of the Thames. And I have to admit,
if I had been inclined to subscribe I probably would have taken
the package deal myself. (Later, when I tested the offer on a
large number of participants, the vast majority preferred the
Internet-and-print deal.)
So what was going on here? Let me start with a funda­
mental observation: most people don’t know what they want
unless they see it in context. We don’t know what kind of
racing bike we want—until we see a champ in the Tour de
France ratcheting the gears on a particular model. We don’t
know what kind of speaker system we like—until we hear a
set of speakers that sounds better than the previous one. We
don’t even know what we want to do with our lives—until
we find a relative or a friend who is doing just what we think
we should be doing. Everything is relative, and that’s the
point. Like an airplane pilot landing in the dark, we want
runway lights on either side of us, guiding us to the place
where we can touch down our wheels.
In the case of the Economist, the decision between the Internetonly and print-only options would take a bit of thinking. Think­
ing is difficult and sometimes unpleasant. So the
Economist’s
marketers offered us a no-brainer: relative to the print-only op­
tion, the print-and-Internet option looks clearly superior.
The geniuses at the Economist
aren’t the only ones who un­
derstand the importance of relativity. Take Sam, the television
salesman. He plays the same general type of trick on us when
he decides which televisions to put together on display:
36-inch Panasonic for $690
42-inch Toshiba for $850
50-inch Philips for $1,480
3
predictably irrational
Which one would you choose? In this case, Sam knows
that customers find it difficult to compute the value of differ­
ent options. (Who really knows if the Panasonic at $690 is a
better deal than the Philips at $1,480?) But Sam also knows
that given three choices, most people will take the middle
choice (as in landing your plane between the runway lights).
So guess which television Sam prices as the middle option?
That’s right—the one he wants to sell!
Of course, Sam is not alone in his cleverness. The New
York Times ran a story recently about Gregg Rapp, a restau­
rant consultant, who gets paid to work out the pricing for
menus. He knows, for instance, how lamb sold this year as
opposed to last year; whether lamb did better paired with
squash or with risotto; and whether orders decreased when
the price of the main course was hiked from $39 to $41.
One thing Rapp has learned is that high-priced entrées on
the menu boost revenue for the restaurant—even if no one
buys them. Why? Because even though people generally won’t
buy the most expensive dish on the menu, they will order the
second most expensive dish. Thus, by creating an expensive
dish, a restaurateur can lure customers into ordering the sec­
ond most expensive choice (which can be cleverly engineered
to deliver a higher profit margin).
So
LET’S RUN
1
through the Economist’s
sleight of hand in
slow motion.
As you recall, the choices were:
1. Internet-only subscription for $59.
2. Print-only subscription for $125.
3. Print-and-Internet subscription for $125.
4
the t r u t h a b o u t r e l a t i v i t y
When I gave these options to 100 students at M I T ‘ s Sloan
School of Management, they opted as follows:
1. Internet-only subscription for $59—16 students
2. Print-only subscription for $125—zero students
3. Print-and-Internet subscription for $ 1 2 5 — 8 4 students
So far these Sloan M B A s are smart cookies. They all
saw the advantage in the print-and-Internet offer over the
print-only offer. But were they influenced by the mere pres­
ence of the print-only option (which I will henceforth, and
for good reason, call the “decoy”). In other words, suppose
that I removed the decoy so that the choices would be the
ones seen in the figure below:
Economist.com
OPINION
WORLD
BUSINESS
FINANCE & ECONOMICS
SUBSCRIPTIONS
Welcome to
The Economist Subscription Centre
Pick the type of subscription you want to buy
or renew.
SCIENCE & TECHNOLOGY
PEOPLE
BOOKS & ARTS
M A R K E T S & DATA
DIVERSIONS
• Economist.com subscription – US $59.00
One-year subscription to Economist.com.
Includes online access to all articles from
The Economist since 1997.
• Print & web subscription – US $125.00
One-year subscription to the print edition
of The Economist and online access to all
articles from The Economist since 1997.
5
predictably irrational
Would the students respond as before (16 for the Internet
only and 84 for the combination)?
Certainly they would react the same way, wouldn’t they?
After all, the option I took out was one that no one selected,
so it should make no difference. Right?
Au contraire!
This time, 68 of the students chose the
Internet-only option for $59, up from 16 before. And only 32
chose the combination subscription for $125, down from 84
1
before/ ”
r.ntnomKuom
SUBSCRIPTIONS
The Economist Subscript!
Pick t h e t y p e of subscription
Dn C e n t r e
you want to buy
FINANCE I ECONOMICS Pick t h e type of subscription you want to buy
SCIENCE & TECHNOLOGY
SCIENCE & TECHNOLOGY
MARKETS S DAT)
SUBSCRIPTIONS
OPINION
Welcome to
•;:V.••’
The Economist Subscription Centre
Welcome to
• E c o n o m i s t . c o m s u b s c r i p t i o n – US $ 5 9 . 0 0
BOOKS I ARTS One-year subscription to Economist.com.
Includes online a c c e s s t o all articles from
VAftKE-ISS.lV.T.1.
The Economist since 1 9 9 7 .
• E c o n o m i s t . c o m s u b s c r i p t i o n – US $ 5 9 . 0 0
O n e – y e a r subscription to E c o n o m i s t . c o m .
Includes online a c c e s s t o all articles from
The Economist since 1 9 9 7
• P r i n t & w e b s u b s c r i p t i o n – US $ 1 2 5 . 0 0
One-year subscription t o t h e print edition
of The Economist and online a c c e s s to all
articles from The Economist since 1 9 9 7 .
• P r i n t s u b s c r i p t i o n – US $ 1 2 5 . 0 0
O n e – y e a r subscription to t h e print edition
of The Economist.
(0>
• P r i n t & w e b s u b s c r i p t i o n – US $ 1 2 5 . 0 0
O n e – y e a r subscription to t h e print edition
of The Economist and online a c c e s s to all
articles from The Economist since 1 9 9 7 .
What could have possibly changed their minds? Nothing
rational, I assure you. It was the mere presence of the decoy
that sent 84 of them to the print-and-Internet option (and 16
to the Internet-only option). And the absence of the decoy
had them choosing differently, with 32 for print-and-Internet
and 68 for Internet-only.
This is not only irrational but predictably irrational as
well. Why? I’m glad you asked.
As a convention in this book, every time I mention that conditions are different from
each other, it is always a statistically significant difference. I refer the interested reader
to the end of this book for a list of the original academic papers and additional readings.
6
the t r u t h a b o u t relativity
L E T ME O F F E R you this visual demonstration
of relativity.
As you can see, the middle circle can’t seem to stay the same
size. When placed among the larger circles, it gets smaller.
When placed among the smaller circles, it grows bigger. The
middle circle is the same size in both positions, of course, but it
appears to change depending on what we place next to it.
This might be a mere curiosity, but for the fact that it
mirrors the way the mind is wired: we are always looking at
the things around us in relation to others. We can’t help it.
This holds true not only for physical things—toasters, bicy­
cles, puppies, restaurant entrées, and spouses—but for expe­
riences such as vacations and educational options, and for
ephemeral things as well: emotions, attitudes, and points of
view.
We always compare jobs with jobs, vacations with vaca­
tions, lovers with lovers, and wines with wines. All this
relativity reminds me of a line from the film
Dundee,
Crocodile
when a street hoodlum pulls a switchblade against
our hero, Paul Hogan. “You call that a knife?” says Hogan
7
predictably irrational
incredulously, withdrawing a bowie blade from the back of
his boot. “Now this” he says with a sly grin, “is a knife.”
R E L A T I V I T Y IS (RELATIVELY) easy to understand.
But there’s
one aspect of relativity that consistently trips us up. It’s this:
we not only tend to compare things with one another but
also tend to focus on comparing things that are easily
comparable—and avoid comparing things that cannot be
compared easily.
That may be a confusing thought, so let me give you an
example. Suppose you’re shopping for a house in a new town.
Your real estate agent guides you to three houses, all of which
interest you. One of them is a contemporary, and two are colo­
nials. All three cost about the same; they are all equally desir­
able; and the only difference is that one of the colonials (the
“decoy”) needs a new roof and the owner has knocked a few
thousand dollars off the price to cover the additional expense.
So which one will you choose?
The chances are good that you will not choose the con­
temporary and you will not choose the colonial that needs
the new roof, but you will choose the other colonial. Why?
Here’s the rationale (which is actually quite irrational). We
like to make decisions based on comparisons. In the case of
the three houses, we don’t know much about the contempo­
rary (we don’t have another house to compare it with), so
that house goes on the sidelines. But we do know that one of
the colonials is better than the other one. That is, the colo­
nial with the good roof is better than the one with the bad
roof. Therefore, we will reason that it is better overall and go
for the colonial with the good roof, spurning the contempo­
rary and the colonial that needs a new roof.
8
the truth about relativity
To better understand how relativity works, consider the
following illustration:
A
-A
B
Attribute 2
In the left side of this illustration we see two options,
each of which is better on a different attribute. Option (A)
is better on attribute 1—let’s say quality. Option (B) is bet­
ter on attribute 2—let’s say beauty. Obviously these are two
very different options and the choice between them is not
simple. Now consider what happens if we add another op­
tion, called (-A) (see the right side of the illustration). This
option is clearly worse than option (A), but it is also very
similar to it, making the comparison between them easy,
and suggesting that (A) is not only better than (—A) but also
better than ( B ) .
In essence, introducing (-A), the decoy, creates a simple rela­
tive comparison with (A), and hence makes (A) look better, not
just relative to (-A), but overall as well. As a consequence, the
inclusion of (-A) in the set, even if no one ever selects it, makes
people more likely to make (A) their final choice.
Does this selection process sound familiar? Remember the
pitch put together by the Economist}
T h e marketers there
knew that we didn’t know whether we wanted an Internet
subscription or a print subscription. But they figured that, of
9
predictably irrational
the three options, the print-and-Internet combination would
be the offer we would take.
Here’s another example of the decoy effect. Suppose you
are planning a honeymoon in Europe. You’ve already decided
to go to one of the major romantic cities and have narrowed
your choices to Rome and Paris, your two favorites. The
travel agent presents you with the vacation packages for each
city, which includes airfare, hotel accommodations, sightsee­
ing tours, and a free breakfast every morning. Which would
you select?
For most people, the decision between a week in Rome
and a week in Paris is not effortless. Rome has the Coliseum;
Paris, the Louvre. Both have a romantic ambience, fabulous
food, and fashionable shopping. It’s not an easy call. But sup­
pose you were offered a third option: Rome without the free
breakfast, called – R o m e or the decoy.
If you were to consider these three options (Paris, Rome,
– R o m e ) , you would immediately recognize that whereas
Rome with the free breakfast is about as appealing as Paris
with the free breakfast, the inferior option, which is Rome
without the free breakfast, is a step down. The comparison
between the clearly inferior option (-Rome) makes Rome
with the free breakfast seem even better. In fact, – R o m e
makes Rome with the free breakfast look so good that you
judge it to be even better than the diffkult-to-compare op­
tion, Paris with the free breakfast.
O N C E YOU SEE the decoy effect in action, you realize that it is
the secret agent in more decisions than we could imagine. It even
helps us decide whom to date—and, ultimately, whom to marry.
Let me describe an experiment that explored just this subject.
10
trie t r u t h a b o u t r e l a t i v i t y
As students hurried around M I T one cold weekday, I asked
some of them whether they would allow me to take their pic­
tures for a study. In some cases, I got disapproving looks. A
few students walked away. But most of them were happy to
participate, and before long, the card in my digital camera
was filled with images of smiling students. I returned to my
office and printed 60 of them—30 of women and 30 of men.
The following week I made an unusual request of 25 of my
undergraduates. I asked them to pair the 30 photographs of
men and the 30 of women by physical attractiveness (matching
the men with other men, and the women with other women).
That is, I had them pair the Brad Pitts and the George Clooneys of M I T , as well as the Woody Aliens and the Danny DeVitos (sorry, Woody and Danny). Out of these 30 pairs, I
selected the six pairs—three female pairs and three male
pairs—that my students seemed to agree were most alike.
Now, like Dr. Frankenstein himself, I set about giving
these faces my special treatment. Using Photoshop, I mutated
the pictures just a bit, creating a slightly but noticeably less
attractive version of each of them. I found that just the slight­
est movement of the nose threw off the symmetry. Using an­
other tool, I enlarged one eye, eliminated some of the hair,
and added traces of acne.
No flashes of lightning illuminated my laboratory; nor
was there a baying of the hounds on the moor. But this was
still a good day for science. By the time I was through, I had
the M I T equivalent of George Clooney in his prime (A) and
the M I T equivalent of Brad Pitt in his prime (B), and also a
George Clooney with a slightly drooping eye and thicker
nose (-A, the decoy) and a less symmetrical version of Brad
Pitt ( – B , another decoy). I followed the same procedure for
the less attractive pairs. I had the M I T equivalent of Woody
11
predictably irrational
Allen with his usual lopsided grin (A) and Woody Allen with
an unnervingly misplaced eye (—A), as well as Danny DeVito
(B) and a slightly disfigured version of Danny DeVito ( – B ) .
For each of the 12 photographs, in fact, I now had a regu­
lar version as well as an inferior ( – ) decoy version. (See the
illustration for an example of the two conditions used in the
study.)
It was now time for the main part of the experiment. I
took all the sets of pictures and made my way over to the stu­
dent union. Approaching one student after another, I asked
each to participate. When the students agreed, I handed them
a sheet with three pictures (as in the illustration here). Some
of them had the regular picture (A), the decoy of that picture
(—A), and the other regular picture (B). Others had the regu­
lar picture (B), the decoy of that picture (—B), and the other
regular picture (A).
For example, a set might include a regular Clooney (A), a
decoy Clooney (—A), and a regular Pitt (B); or a regular Pitt
(B), a decoy Pitt (—B), and a regular Clooney (A). After se­
lecting a sheet with either male or female pictures, according
to their preferences, I asked the students to circle the people
they would pick to go on a date with, if they had a choice. All
this took quite a while, and when I was done, I had distrib­
uted 6 0 0 sheets.
What was my motive in all this? Simply to determine if the
existence of the distorted picture (-A or – B ) would push my
participants to choose the similar but undistorted picture. In
other words, would a slightly less attractive George Clooney
(-A) push the participants to choose the perfect George Cloo­
ney over the perfect Brad Pitt?
There were no pictures of Brad Pitt or George Clooney in
my experiment, of course. Pictures (A) and (B) showed ordi-
12
the t r u t h a b o u t
relativity
predictably irrational
nary students. But do you remember how the existence of a
colonial-style house needing a new roof might push you to
choose a perfect colonial over a contemporary house—simply
because the decoy colonial would give you something against
which to compare the regular colonial? And in the
Econo­
mist’s ad, didn’t the print-only option for $125 push people to
take the print-and-Internet option for $125? Similarly, would
the existence of a less perfect person (-A or – B ) push people
to choose the perfect one (A or B ) , simply because the decoy
option served as a point of comparison?
It did. Whenever I handed out a sheet that had a regular
picture, its inferior version, and another regular picture, the
participants said they would prefer to date the “regular”
person—the one who was similar, but clearly superior, to the
distorted version—over the other, undistorted person on the
sheet. This was not just a close call—it happened 75 percent
of the time.
To explain the decoy effect further, let me tell you some­
thing about bread-making machines. When Williams-Sonoma
first introduced a home “bread bakery” machine (for $275),
most consumers were not interested. What was a home breadmaking machine, anyway? Was it good or bad? Did one really
need home-baked bread? Why not just buy a fancy coffeemaker sitting nearby instead? Flustered by poor sales, the
manufacturer of the bread machine brought in a marketing
research firm, which suggested a fix: introduce an additional
model of the bread maker, one that was not only larger but
priced about 50 percent higher than the initial machine.
Now sales began to rise (along with many loaves of bread),
though it was not the large bread maker that was being sold.
Why? Simply because consumers now had two models of bread
makers to choose from. Since one was clearly larger and much
14
the t r u t h a b o u t relativity
more expensive than the other, people didn’t have to make
their decision in a vacuum. They could say: “Well, I don’t
know much about bread makers, but I do know that if I were
to buy one, I’d rather have the smaller one for less money.”
And that’s when bread makers began to fly off the shelves.
2
OK for bread makers. But let’s take a look at the decoy
effect in a completely different situation. What if you are
single, and hope to appeal to as many attractive potential
dating partners as possible at an upcoming singles event? My
advice would be to bring a friend who has your basic physical
characteristics (similar coloring, body type, facial features),
but is slightly less attractive (—you).
Why? Because the folks you want to attract will have a
hard time evaluating you with no comparables around. How­
ever, if you are compared with a “-you,” the decoy friend
will do a lot to make you look better, not just in comparison
with the decoy but also in general, and in comparison with
all the other people around. It may sound irrational (and I
can’t guarantee this), but the chances are good that you will
get some extra attention. O f course, don’t just stop at looks.
If great conversation will win the day, be sure to pick a friend
for the singles event who can’t match your smooth delivery
and rapier wit. By comparison, you’ll sound great.
Now that you know this secret, be careful: when a similar
but better-looking friend of the same sex asks you to accompany
him or her for a night out, you might wonder whether you have
been invited along for your company or merely as a decoy.
R E L A T I V I T Y HELPS US make decisions in life. But it can also
make us downright miserable. Why? Because jealousy and
envy spring from comparing our lot in life with that of others.
15
predictably irrational
It was for good reason, after all, that the Ten Command­
ments admonished, “Neither shall you desire your neighbor’s
house nor field, or male or female slave, or donkey or any­
thing that belongs to your neighbor.” This might just be the
toughest commandment to follow, considering that by our
very nature we are wired to compare.
Modern life makes this weakness even more pronounced.
A few years ago, for instance, I met with one of the top execu­
tives of one of the big investment companies. Over the course
of our conversation he mentioned that one of his employees
had recently come to him to complain about his salary.
“How long have you been with the firm?” the executive
asked the young man.
“Three years. I came straight from college,” was the
answer.
“And when you joined us, how much did you expect to be
making in three years?”
“I was hoping to be making about a hundred thousand.”
The executive eyed him curiously.
“And now you are making almost three hundred thou­
sand, so how can you possibly complain?” he asked.
“Well,” the young man stammered, “it’s just that a couple
of the guys at the desks next to me, they’re not any better
than I am, and they are making three hundred ten.”
The executive shook his head.
An ironic aspect of this story is that in 1993, federal secu­
rities regulators forced companies, for the first time, to reveal
details about the pay and perks of their top executives. The
idea was that once pay was in the open, boards would be re­
luctant to give executives outrageous salaries and benefits.
This, it was hoped, would stop the rise in executive compen­
sation, which neither regulation, legislation, nor shareholder
16
the truth about relativity
pressure had been able to stop. And indeed, it needed to stop:
in 1976 the average C E O was paid 36 times as much as the
average worker. By 1993, the average C E O was paid 131
times as much.
But guess what happened. Once salaries became public
information, the media regularly ran special stories ranking
CEOs by pay. Rather than suppressing the executive perks,
the publicity had CEOs in America comparing their pay with
that of everyone else. In response, executives’ salaries sky­
rocketed. The trend was further “helped” by compensation
consulting firms (scathingly dubbed “Ratchet, Ratchet, and
Bingo” by the investor Warren Buffett) that advised their
CEO clients to demand outrageous raises. The result? Now
the average C E O makes about 369 times as much as the aver­
age worker—about three times the salary before executive
compensation went public.
Keeping that in mind, I had a few questions for the execu­
tive I met with.
“What would happen,” I ventured, ” i f the information in
your salary database became known throughout the com­
pany?”
The executive looked at me with alarm. “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 indi­
vidual would feel underpaid—and I wouldn’t be surprised if
they went out and looked for another job.”
Isn’t this odd? It has been shown repeatedly that the link
between amount of salary and happiness is not as strong as
one would expect it to be (in fact, it is rather weak). Studies
even find that countries with the “happiest” people are not
among those with the highest personal income. Yet we keep
17
predictably irrational
pushing toward a higher salary. Much of that can be blamed
on sheer envy. As H. L. Mencken, the twentieth-century
journalist, satirist, social critic, cynic, and freethinker noted,
a man’s satisfaction with his salary depends on (are you ready
for this?) whether he makes more than his wife’s sister’s hus­
band. Why the wife’s sister’s husband? Because (and I have a
feeling that Mencken’s wife kept him fully informed of her
sister’s husband’s salary) this is a comparison that is salient
and readily available.*
All this extravagance in C E O s ‘ pay has had a damaging
effect on society. Instead of causing shame, every new out­
rage in compensation encourages other CEOs to demand
even more. “In the Web World,” according to a headline in
the New York Times, the “Rich Now Envy the Superrich.”
In another news story, a physician explained that he had
graduated from Harvard with the dream of someday receiv­
ing a Nobel Prize for cancer research. This was his goal. This
was his dream. But a few years later, he realized that several
of his colleagues were making more as medical investment
advisers at Wall Street firms than he was making in medi­
cine. He had previously been happy with his income, but
hearing of his friends’ yachts and vacation homes, he sud­
denly felt very poor. So he took another route with his
3
career—the route of Wall Street. By the time he arrived at
his twentieth class reunion, he was making 10 times what
most of his peers were making in medicine. You can almost
see him, standing in the middle of the room at the reunion,
drink in hand—a large circle of influence with smaller circles
gathering around him. He had not won the Nobel Prize, but
* N o w t h a t you k n o w this f a c t , a n d a s s u m i n g t h a t you a r e not m a r r i e d , t a k e this into
a c c o u n t when you s e a r c h for a soul m a t e . L o o k for s o m e o n e w h o s e sibling is m a r r i e d to
a p r o d u c t i v i t y – c h a l l e n g e d individual.
18
the truth a b o u t relativity
he had relinquished his dreams for a Wall Street salary, for a
chance to stop feeling “poor.” Is it any wonder that family
practice physicians, who make an average of $160,000 a year,
are in short supply?*
CAN WE DO anything about this problem of relativity?
The good news is that we can sometimes control the “cir­
cles” around us, moving toward smaller circles that boost
our relative happiness. If we are at our class reunion, and
there’s a “big circle” in the middle of the room with a drink
in his hand, boasting of his big salary, we can consciously
take several steps away and talk with someone else. If we are
thinking of buying a new house, we can be selective about
the open houses we go to, skipping the houses that are above
our means. If we are thinking about buying a new car, we
can focus on the models that we can afford, and so on.
We can also change our focus from narrow to broad. Let
me explain with an example from a study conducted by two
brilliant researchers, Amos Tversky and Daniel Kahneman.
Suppose you have two errands to run today. The first is to
buy a new pen, and the second is to buy a suit for work. At an
office supply store, you find a nice pen for $25. You are set to
buy it, when you remember that the same pen is on sale for
$18 at another store 15 minutes away. What would you do?
Do you decide to take the 15-minute trip to save the $7? Most
people faced with this dilemma say that they would take the
trip to save the $7.
Now you are on your second task: you’re shopping for
*Of c o u r s e , physicians have o t h e r p r o b l e m s as well, including i n s u r a n c e f o r m s ,
b u r e a u c r a c y , and t h r e a t s of lawsuits for m a l p r a c t i c e .
19
predictably irrational
your suit. You find a luxurious gray pinstripe suit for $455
and decide to buy it, but then another customer whispers in
your ear that the exact same suit is on sale for only $448 at
another store, just 15 minutes away. Do you make this sec­
ond 15-minute trip? In this case, most people say that they
would not.
But what is going on here? Is 15 minutes of your time
worth $7, or isn’t it? In reality, of course, $7 is $7—no matter
how you count it. T h e only question you should ask yourself
in these cases is whether the trip across town, and the 15 ex­
tra minutes it would take, is worth the extra $7 you would
save. Whether the amount from which this $7 will be saved is
$10 or $10,000 should be irrelevant.
This is the problem of relativity—we look at our decisions
in a relative way and compare them locally to the available
alternative. We compare the relative advantage of the cheap
pen with the expensive one, and this contrast makes it obvi­
ous to us that we should spend the extra time to save the $7.
At the same time, the relative advantage of the cheaper suit is
very small, so we spend the extra $7.
This is also why it is so easy for a person to add $200 to a
$5,000 catering bill for a soup entrée, when the same person
will clip coupons to save 25 cents on a one-dollar can of con­
densed soup. Similarly, we find it easy to spend $3,000 to up­
grade to leather seats when we buy a new $25,000 car, but
difficult to spend the same amount on a new leather sofa (even
though we know we will spend more time at home on the sofa
than in the car). Yet if we just thought about this in a broader
perspective, we could better assess what we could do with the
$3,000 that we are considering spending on upgrading the car
seats. Would we perhaps be better off spending it on books,
clothes, or a vacation? Thinking broadly like this is not easy,
20
the t r u t h about relativity
because making relative judgments is the natural way we think.
Can you get a handle on it? I know someone who can.
He is James Hong, cofounder of the Hotornot.com rating
and dating site. (James, his business partner Jim Young,
Leonard Lee, George Loewenstein, and I recently worked on
a research project examining how one’s own “attractiveness”
affects one’s view of the “attractiveness” of others.)
For sure, James has made a lot of money, and he sees even
more money all around him. One of his good friends, in fact,
is a founder of PayPal and is worth tens of millions. But Hong
knows how to make the circles of comparison in his life
smaller, not larger. In his case, he started by selling his
Porsche Boxster and buying a Toyota Prius in its place.
4
“I don’t want to live the life of a Boxster,” he told the New
York Times, “because when you get a Boxster you wish you
had a 911, and you know what people who have 911s wish
they had? They wish they had a Ferrari.”
That’s a lesson we can all learn: the more we have, the
more we want. And the only cure is to break the cycle of rela­
tivity.
21
CHAPTER
2
The Fallacy of Supply
and Demand
Why the Price of Pearls—and
Everything
Is Up in the Air
A
Else—
t the onset of World War II, an Italian diamond dealer,
James Assael, fled Europe for Cuba. There, he found a
new livelihood: the American army needed
waterproof
watches, and Assael, through his contacts in Switzerland,
was able to fill the demand.
When the war ended, Assael’s deal with the U.S. govern­
ment dried up, and he was left with thousands of Swiss
watches. The Japanese needed watches, of course. But they
didn’t have any money. They did have pearls, though—many
thousands of them. Before long, Assael had taught his son
how to barter Swiss watches for Japanese pearls. The busi­
ness blossomed, and shortly thereafter, the son, Salvador As­
sael, became known as the “pearl king.”
The pearl king had moored his yacht at Saint-Tropez one
day in 1973, when a dashing young Frenchman, Jean-Claude
predictably irrational
Brouillet, came aboard from an adjacent yacht. Brouillet
had just sold his air-freight business and with the proceeds
had purchased
an atoll in French Polynesia—a blue-
lagooned paradise for himself and his young Tahitian wife.
Brouillet explained that its turquoise waters abounded with
black-lipped oysters, Finctada
mar gar iti fera. And from the
black lips of those oysters came something of note: black
pearls.
At the time there was no market for Tahitian black pearls,
and little demand. But Brouillet persuaded Assael to go into
business with him. Together they would harvest black pearls
and sell them to the world. At first, Assael’s marketing efforts
failed. The pearls were gunmetal gray, about the size of mus­
ket balls, and he returned to Polynesia without having made a
single sale. Assael could have dropped the black pearls alto­
gether or sold them at a low price to a discount store. He
could have tried to push them to consumers by bundling them
together with a few white pearls. But instead Assael waited a
year, until the operation had produced some better speci­
mens, and then brought them to an old friend, Harry Win­
ston, the legendary gemstone dealer. Winston agreed to put
them in the window of his store on Fifth Avenue, with an out­
rageously high price tag attached. Assael, meanwhile, com­
missioned a full-page advertisement that ran in the glossiest
of magazines. There, a string of Tahitian black pearls glowed,
set among a spray of diamonds, rubies, and emeralds.
The pearls, which had shortly before been the private
business of a cluster of black-lipped oysters, hanging on a
rope in the Polynesian sea, were soon parading through Man­
hattan on the arched necks of the city’s most prosperous di­
vas. Assael had taken something of dubious worth and made
it fabulously fine. Or, as Mark Twain once noted about Tom
24
the fallacy of supply and d e m a n d
Sawyer, “Tom had discovered a great law of human action,
namely, that in order to make a man covet a thing, it is only
necessary to make the thing difficult to attain.”
How DID THE pearl king do it? How did he persuade the
cream of society to become passionate about Tahitian black
pearls—and pay him royally for them? In order to answer
this question, I need to explain something about baby geese.
A few decades ago, the naturalist Konrad Lorenz discov­
ered that goslings, upon breaking out of their eggs, become
attached to the first moving object they encounter (which is
generally their mother). Lorenz knew this because in one ex­
periment he became the first thing they saw, and they fol­
lowed him loyally from then on through adolescence. With
that, Lorenz demonstrated not only that goslings make ini­
tial decisions based on what’s available in their environment,
but that they stick with a decision once it has been made.
Lorenz called this natural phenomenon
imprinting.
Is the human brain, then, wired like that of a gosling? Do
our first impressions and decisions become imprinted? And if
so, how does this imprinting play out in our lives? When we
encounter a new product, for instance, do we accept the first
price that comes before our eyes ? And more importantly, does
that price (which in academic lingo we call an anchor)
have a
long-term effect on our willingness to pay for the product
from then on ?
It seems that what’s good for the goose is good for hu­
mans as well. And this includes anchoring. From the begin­
ning, for instance, Assael “anchored” his pearls to the finest
gems in the world—and the prices followed forever after.
Similarly, once we buy a new product at a particular price,
25
predictably irrational
we become anchored to that price. But how exactly does this
work? Why do we accept anchors?
Consider this: if I asked you for the last two digits of your
social security number (mine are 7 9 ) , then asked you whether
you would pay this number in dollars (for me this would be
$79) for a particular bottle of Côtes du Rhône 1998, would
the mere suggestion of that number influence how much you
would be willing to spend on wine? Sounds preposterous,
doesn’t it? Well, wait until you see what happened to a group
of M B A students at M I T a few years ago.
“Now HERE WE have a nice Côtes du Rhône Jaboulet Paral­
lel,” said Drazen Prelec, a professor at M I T ‘ s Sloan School
of Management, as he lifted a bottle admiringly. “It’s a
1998.”
At the time, sitting before him were the 55 students from
his marketing research class. On this day, Drazen, George
Loewenstein (a professor at Carnegie Mellon University), and
I would have an unusual request for this group of future mar­
keting pros. We would ask them to jot down the last two dig­
its of their social security numbers and tell us whether they
would pay this amount for a number of products, including
the bottle of wine. Then, we would ask them to actually bid
on these items in an auction.
What were we trying to prove? T h e existence of what we
called arbitrary
coherence.
The basic idea of arbitrary coher­
ence is this: although initial prices (such as the price of As­
sad’s pearls) are “arbitrary,” once those prices are established
in our minds they will shape not only present prices but also
future prices (this makes them “coherent”). So, would think­
ing about one’s social security number be enough to create
26
the fallacy of supply and d e m a n d
an anchor? And would that initial anchor have a long-term
influence? That’s what we wanted to see.
“For those of you who don’t know much about wines,”
Drazen continued, “this bottle received eighty-six points
from Wine Spectator.
It has the flavor of red berry, mocha,
and black chocolate; it’s a medium-bodied, medium-intensity,
nicely balanced red, and it makes for delightful drinking.”
Drazen held up another bottle. This was a Hermitage
Jaboulet La Chapelle, 1996, with a 92-point rating from the
Wine Advocate
magazine. “The finest La Chapelle since
1990,” Drazen intoned, while the students looked up curi­
ously. “Only 8,100 cases made . . .”
In turn, Drazen held up four other items: a cordless track­
ball (TrackMan Marble F X by Logitech) ; a cordless keyboard
and mouse (iTouch by Logitech); a design book (The Perfect
Package:
How to Add Value through Graphic Design); and a
one-pound box of Belgian chocolates by Neuhaus.
Drazen passed out forms that listed all the items. “Now I
want you to write the last two digits of your social security
number at the top of the page,” he instructed. “And then
write them again next to each of the items in the form of a
price. In other words, if the last two digits are twenty-three,
write twenty-three dollars.”
“Now when you’re finished with that,” he added, “I want
you to indicate on your sheets—with a simple yes or no—
whether you would pay that amount for each of the products.”
When the students had finished answering yes or no to
each item, Drazen asked them to write down the maximum
amount they were willing to pay for each of the products
(their bids). Once they had written down their bids, the stu­
dents passed the sheets up to me and I entered their responses
into my laptop and announced the winners. One by one the
27
predictably irrational
student who had made the highest bid for each of the products
would step up to the front of the class, pay for the product,*
and take it with them.
The students enjoyed this class exercise, but when I asked
them if they felt that writing down the last two digits of their
social security numbers had influenced their final bids, they
quickly dismissed my suggestion. No way!
When I got back to my office, I analyzed the data. Did the
digits from the social security numbers serve as anchors? Re­
markably, they did: the students with the highest-ending social
security digits (from 80 to 99) bid highest, while those with the
lowest-ending numbers (1 to 20) bid lowest. The top 20 per­
cent, for instance, bid an average of $56 for the cordless key­
board; the bottom 20 percent bid an average of $16. In the end,
we could see that students with social security numbers ending
in the upper 20 percent placed bids that were 216 to 346 percent
higher than those of the students with social security numbers
ending in the lowest 20 percent (see table on the facing page).
Now if the last two digits of your social security number are
a high number I know what you must be thinking: “I’ve been
paying too much for everything my entire life!” This is not the
case, however. Social security numbers were the anchor in this
experiment only because we requested them. We could have just
as well asked for the current temperature or the manufacturer’s
suggested retail price (MSRP). Any question, in fact, would
have created the anchor. Does that seem rational? Of course
not. But that’s the way we are—goslings, after all.*
::
T h e price t h e highest bidder paid for an item w a s based not on his o w n bid, but on that
o f t h e s e c o n d highest bidder. T h i s is called a s e c o n d price a u c t i o n . W i l l i a m Vickrey
received the N o b e l prize in e c o n o m i c s for d e m o n s t r a t i n g t h a t this t y p e of a u c t i o n
c r e a t e s the c o n d i t i o n s w h e r e it is in people’s best interest to bid the m a x i m u m a m o u n t
they a r e willing t o pay for e a c h item (this is also the general logic behind the auction
system on e B a y ) .
f W h e n I’ve tried this kind o f e x p e r i m e n t on e x e c u t i v e s a n d m a n a g e r s (at the M I T E x e c u –
28
the fallacy of supply and d e m a n d
Average prices paid for the various products for each of the five groups of
final digits in social security numbers, and the correlations between these
digits and the bids submitted in the auction.
Range of last two digits of SS number
Products
00-19
20-39
40-59
60-79
8 0 – 9 9 Correlations*
Cordless trackball
$8.64
$11.82 $13.45
$21.18
$26.18
0.42
Cordless keyboard
$16.09 $26.82 $29.27
$34.55 $55.64
0.52
Design book
$12.82
$16.18 $15.82
$19.27 $30.00
0.32
Neuhaus chocolates
$9.55
$10.64 $12.45
$13.27 $20.64
0.42
1998 Côtes du Rhône
$8.64
$14.45 $12.55
$15.45
$27.91
0.33
1996 Hermitage
$11.73 $22.45
$18.09
$24.55
$37.55
0.33
•Correlation is a statistical measure of how much the movement of two variables is related. The
range of possible correlations is between – 1 and + 1 , where a correlation of 0 means that the change
in value of one variable has no bearing on the change in value of the other variable.
The data had one more interesting aspect. Although the
willingness to pay for these items was arbitrary, there was also
a logical, coherent aspect to it. When we looked at the bids for
the two pairs of related items (the two wines and the two com­
puter components), their relative prices seemed incredibly logi­
cal. Everyone was willing to pay more for the keyboard than
for the trackball—and also pay more for the 1996 Hermitage
than for the 1998 Côtes du Rhône. The significance of this is
that once the participants were willing to pay a certain price
for one product, their willingness to pay for other items in the
same product category was judged relative to that first price
(the anchor).
tive E d u c a t i o n P r o g r a m ) , I’ve had similar success m a k i n g their social s e c u r i t y n u m b e r s
influence the prices they w e r e willing t o pay for c h o c o l a t e s , b o o k s , a n d o t h e r p r o d u c t s .
29
predictably irrational
This, then, is what we call arbitrary coherence. Initial
prices are largely “arbitrary” and can be influenced by re­
sponses to random questions; but once those prices are estab­
lished in our minds, they shape not only what we are willing
to pay for an item, but also how much we are willing to pay
for related products (this makes them coherent).
Now I need to add one important clarification to the story
I’ve just told. In life we are bombarded by prices. We see the
manufacturer’s suggested retail price (MSRP) for cars, lawn
mowers, and coffeemakers. We get the real estate agent’s
spiel on local housing prices. But price tags by themselves are
not necessarily anchors. They become anchors when we con­
template buying a product or service at that particular price.
That’s when the imprint is set. From then on, we are willing
to accept a range of prices—but as with the pull of a bungee
cord, we always refer back to the original anchor. Thus the
first anchor influences not only the immediate buying deci­
sion but many others that follow.
We might see a 57-inch L C D high-definition television on
sale for $3,000, for instance. The price tag is not the anchor.
But if we decide to buy it (or seriously contemplate buying it) at
that price, then the decision becomes our anchor henceforth in
terms of L C D television sets. That’s our peg in the ground,
and from then on—whether we shop for another set or merely
have a conversation at a backyard cookout—all other highdefinition televisions are judged relative to that price.
Anchoring influences all kinds of purchases. Uri Simonsohn (a professor at the University of Pennsylvania) and George
Loewenstein, for example, found that people who move to a
new city generally remain anchored to the prices they paid for
housing in their former city. In their study they found that
people who move from inexpensive markets (say, Lubbock,
30
the fallacy of supply and d e m a n d
Texas) to moderately priced cities (say, Pittsburgh) don’t in­
crease their spending to fit the new market.* Rather, these
people spend an amount similar to what they were used to in
the previous market, even if this means having to squeeze
themselves and their families into smaller or less comfortable
homes. Likewise, transplants from more expensive cities sink
the same dollars into their new housing situation as they did
in the past. People who move from Los Angeles to Pittsburgh,
in other words, don’t generally downsize their spending much
once they hit Pennsylvania: they spend an amount similar to
what they used to spend in Los Angeles.
It seems that we get used to the particularities of our
housing markets and don’t readily change. T h e only way out
of this box, in fact, is to rent a home in the new location for a
year or so. That way, we adjust to the new environment—
and, after a while, we are able to make a purchase that aligns
with the local market.
So WE ANCHOR ourselves to initial prices. But do we hop
from one anchor price to another (flip-flopping, if you will),
continually changing our willingness to pay? Or does the
first anchor we encounter become our anchor for a long time
and for many decisions? To answer this question, we decided
to conduct another experiment—one in which we attempted
to lure our participants from old anchors to new ones.
For this experiment we enlisted some undergraduate stu­
dents, some graduate students, and some investment bankers
who had come to the campus to recruit new employees for
their firms. Once the experiment started we presented our
* T h e result w a s not due t o w e a l t h , t a x e s , o r o t h e r financial r e a s o n s .
31
predictably irrational
participants with three different sounds, and following each,
asked them if they would be willing to get paid a particular
amount of money (which served as the price anchor) for hear­
ing those sounds again. One sound was a 30-second highpitched 3,000-hertz sound, somewhat like someone screaming
in a high-pitched voice. Another was a 30-second fullspectrum noise (also called white noise), which is similar to
the noise a television set makes when there is no reception.
The third was a 30-second oscillation between high-pitched
and low-pitched sounds. (I am not sure if the bankers under­
stood exactly what they were about to experience, but maybe
even our annoying sounds were less annoying than talking
about investment banking.)
We used sounds because there is no existing market for an­
noying sounds (so the participants couldn’t use a market price
as a way to think about the value of these sounds). We also
used annoying sounds, specifically, because no one likes such
sounds (if we had used classical music, some would have liked
it better than others). As for the sounds themselves, I selected
them after creating hundreds of sounds, choosing these three
because they were, in my opinion, equally annoying.
We placed our participants in front of computer screens at
the lab, and had them clamp headphones over their ears.
As the room quieted down, the first group saw this mes­
sage appear in front of them: “In a few moments we are go­
ing to play a new unpleasant tone over your headset. We are
interested in how annoying you find it. Immediately after you
hear the tone, we will ask you whether, hypothetically, you
would be willing to repeat the same experience in exchange
for a payment of 10 cents.” The second group got the same
message, only with an offer of 90 cents rather than 10 cents.
Would the anchor prices make a difference? To find out,
32
the fallacy of supply and d e m a n d
we turned on the sound—in this case the irritating 30-second,
3,000-hertz squeal. Some of our participants grimaced. Oth­
ers rolled their eyes.
When the screeching ended, each participant was pre­
sented with the anchoring question, phrased as a hypotheti­
cal choice: Would the participant be willing, hypothetically,
to repeat the experience for a cash payment (which was 10
cents for the first group and 90 cents for the second group) ?
After answering this anchoring question, the participants
were asked to indicate on the computer screen the lowest price
they would demand to listen to the sound again. This decision
was real, by the way, as it would determine whether they
would hear the sound again—and get paid for doing so.*
Soon after the participants entered their prices, they
learned the outcome. Participants whose price was suffi­
ciently low “won” the sound, had the (unpleasant) opportu­
nity to hear it again, and got paid for doing so. The participants
whose price was too high did not listen to the sound and
were not paid for this part of the experiment.
What was the point of all this? We wanted to find out
whether the first prices that we suggested (10 cents and 90
cents) had served as an anchor. And indeed they had. Those
who first faced the hypothetical decision about whether to
listen to the sound for 10 cents needed much less money to be
willing to listen to this sound again (33 cents on average)
relative to those who first faced the hypothetical decision
about whether to listen to the sound for 90 cents—this sec­
ond group demanded more than twice the compensation (73
T o ensure that the bids we got were indeed the lowest prices for w h i c h the p a r t i c i p a n t s
would listen to the a n n o y i n g s o u n d s , we used the ” B e c k e r – D e G r o o t – M a r s c h a k
p r o c e d u r e . ” T h i s is an auction-like p r o c e d u r e , in w h i c h e a c h of the p a r t i c i p a n t s bids
against a price r a n d o m l y d r a w n by a c o m p u t e r .
33
predictably irrational
cents on average) for the same annoying experience. Do you
see the difference that the suggested price had?
B U T THIS WAS
only the start of our exploration. We also
wanted to know how influential the anchor would be in fu­
ture decisions. Suppose we gave the participants an opportu­
nity to drop this anchor and run for another? Would they do
it? To put it in terms of goslings, would they swim across the
pond after their original imprint and then, midway, swing
their allegiance to a new mother goose? In terms of goslings,
I think you know that they would stick with the original
mom. But what about humans? The next two phases of the
experiment would enable us to answer these questions.
In the second phase of the experiment, we took partici­
pants from the previous 10-cents and 90-cents groups and
treated them to 30 seconds of a white, wooshing noise. “Hypothetically, would you listen to this sound again for 50
cents?” we asked them at the end. The respondents pressed a
button on their computers to indicate yes or no.
“OK, how much would you need to be paid for this?” we
asked. Our participants typed in their lowest price; the com­
puter did its thing; and, depending on their bids, some partici­
pants listened to the sound again and got paid and some did
not. When we compared the prices, the 10-cents group offered
much lower bids than the 90-cents group. This means that al­
though both groups had been equally exposed to the suggested
50 cents, as their focal anchoring response (to “Hypothetically, would you listen to this sound again for 50 cents?”), the
first anchor in this annoying sound category (which was 10
cents for some and 90 cents for others) predominated.
Why? Perhaps the participants in the 10-cents group said
34
the fallacy of supply and d e m a n d
something like the following to themselves: “Well, I listened
previously to that annoying sound for a low amount. This
sound is not much different. So if I said a low amount for the
previous one, I guess I could bear this sound for about the
same price.” Those who were in the 90-cents group used the
same type of logic, but because their starting point was dif­
ferent, so was their ending point. These individuals told
themselves, “Well, I listened previously to that annoying
sound for a high amount. This sound is not much different.
So since I said a high amount for the previous one, I guess I
could bear this sound for about the same price.” Indeed, the
effect of the first anchor held—indicating that anchors have
an enduring effect for present prices as well as for future
prices.
There was one more step to this experiment. This time we
had our participants listen to the oscillating sound that rose
and fell in pitch for 30 seconds. We asked our 10-cents group,
“Hypothetically, would you listen to this sound again for 90
cents?” Then we asked our 90-cents group, “Would you lis­
ten to this sound again for 10 cents?” Having flipped our
anchors, we would now see which one, the local anchor or
the first anchor, exerted the greatest influence.
Once again, the participants typed in yes or no. Then we
asked them for real bids: “How much would it take for you
to listen to this again?” At this point, they had a history with
three anchors: the first one they encountered in the experi­
ment (either 10 cents or 90 cents), the second one (50 cents),
and the most recent one (either 90 cents or 10 cents). Which
one of these would have the largest influence on the price
they demanded to listen to the sound?
Again, it was as if our participants’ minds told them, ” I f I
listened to the first sound for x cents, and listened to the
35
predictably irrational
second sound for x cents as well, then I can surely do this one
for x cents, too!” And that’s what they did. Those who had
first encountered the 10-cent anchor accepted low prices,
even after 90 cents was suggested as the anchor. On the other
hand, those who had first encountered the 90-cent anchor
kept on demanding much higher prices, regardless of the an­
chors that followed.
What did we show? That our first decisions resonate over
a long sequence of decisions. First impressions are important,
whether they involve remembering that our first DVD player
cost much more than such players cost today (and realizing
that, in comparison, the current prices are a steal) or remem­
bering that gas was once a dollar a gallon, which makes ev­
ery trip to the gas station a painful experience. In all these
cases the random, and not so random, anchors that we en­
countered along the way and were swayed by remain with us
long after the initial decision itself.
N o w THAT W E know we behave like goslings, it is important
to understand the process by which our first decisions trans­
late into long-term habits. To illustrate this process, consider
this example. You’re walking past a restaurant, and you see
two people standing in line, waiting to get in. “This must be
a good restaurant,” you think to yourself. “People are stand­
ing in line.” So you stand behind these people. Another per­
son walks by. He sees three people standing in line and
thinks, “This must be a fantastic restaurant,” and joins the
line. Others join. We call this type of behavior herding. It
happens when we assume that something is good (or bad) on
the basis of other people’s previous behavior, and our own
actions follow suit.
36
the fallacy of supply and d e m a n d
But there’s also another kind of herding, one that we call
self-herding. This happens when we believe something is
good (or bad) on the basis of our own previous behavior. Es­
sentially, once we become the first person in line at the res­
taurant, we begin to line up behind ourself in subsequent
experiences. Does that make sense? Let me explain.
Recall your first introduction to Starbucks, perhaps sev­
eral years ago. (I assume that nearly everyone has had this
experience, since Starbucks sits on every corner in America.)
You are sleepy and in desperate need of a liquid energy boost
as you embark on an errand one afternoon. You glance
through the windows at Starbucks and walk in. The prices of
the coffee are a shock—you’ve been blissfully drinking the
brew at Dunkin’ Donuts for years. But since you have walked
in and are now curious about what coffee at this price might
taste like, you surprise yourself: you buy a small coffee, enjoy
its taste and its effect on you, and walk out.
The following week you walk by Starbucks again. Should
you go in? The ideal decision-making process should take
into account the quality of the coffee (Starbucks versus
Dunkin’ Donuts); the prices at the two places; and, of course,
the cost (or value) of walking a few more blocks to get to
Dunkin’ Donuts. This is a complex computation—so instead,
you resort to the simple approach: “I went to Starbucks be­
fore, and I enjoyed myself and the coffee, so this must be a
good decision for me.” So you walk in and get another small
cup of coffee.
In doing so, you just became the second person in line,
standing behind yourself. A few days later, you again walk
by Starbucks and this time, you vividly remember your past
decisions and act on them again—voilà! You become the
third person in line, standing behind yourself. As the weeks
37
predictably irrational
pass, you enter again and again and every time, you feel more
strongly that you are acting on the basis of your preferences.
Buying coffee at Starbucks has become a habit with you.
B U T T H E STORY doesn’t end there. Now that you have gotten
used to paying more for coffee, and have bumped yourself up
onto a new curve of consumption, other changes also become
simpler. Perhaps you will now move up from the small cup for
$ 2 . 2 0 to the medium size for $3.50 or to the Vend for $4.15.
Even though you don’t know how you got into this price
bracket in the first place, moving to a larger coffee at a relatively greater price seems pretty logical. So is a lateral move to
other offerings at Starbucks: Caffè Americano, Caffè Misto,
Macchiato, and Frappuccino, for instance.
If you stopped to think about this, it would not be clear
whether you should be spending all this money on coffee at
Starbucks instead of getting cheaper coffee at Dunkin’ Donuts or even free coffee at the office. But you don’t think
about these trade-offs anymore. You’ve already made this
decision many times in the past, so you now assume that this
is the way you want to spend your money. You’ve herded
yourself—lining
up
behind
your
initial experience at
Starbucks—and now you’re part of the crowd.
H O W E V E R , T H E R E IS something odd in this story. If anchor-
ing is based on our initial decisions, how did Starbucks manage to become an initial decision in the first place? In other
words, if we were previously anchored to the prices at Dunkin’
Donuts, how did we move our anchor to Starbucks? This is
where it gets really interesting.
38
the fallacy of supply and d e m a n d
When Howard Shultz created Starbucks, he was as intuitive
a businessman as Salvador Assael. He worked diligently to
separate Starbucks from other coffee shops, not through price
but through ambience. Accordingly, he designed Starbucks
from the very beginning to feel like a continental coffeehouse.
The early shops were fragrant with the smell of roasted
beans (and better-quality roasted beans than those at Dunkin’
Donuts). They sold fancy French coffee presses. T h e showcases presented alluring snacks—almond croissants, biscotti,
raspberry custard pastries, and others. Whereas Dunkin’ Donuts had small, medium, and large coffees, Starbucks offered
Short, Tall, Grande, and Venti, as well as drinks with highpedigree names like Caffè Americano, Caffè Misto, Macchiato, and Frappuccino. 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.
G E O R G E , D R A Z E N , AND
I were so excited with the experi-
ments on coherent arbitrariness that we decided to push the
idea one step farther. This time, we had a different twist to
explore.
Do you remember the famous episode in The
Adventures
of Tom Sawyer, the one in which Tom turned the whitewashing of Aunt Polly’s fence into an exercise in manipulating his
friends? As I’m sure you recall, Tom applied the paint with
gusto, pretending to enjoy the job. “Do you call this work?”
Tom told his friends. “Does a boy get a chance to whitewash
a fence every day?” Armed with this new “information,” his
39
predictably irrational
friends discovered the joys of whitewashing a fence. Before
long, Tom’s friends were not only paying him for the privi­
lege, but deriving real pleasure from the task—a win-win
outcome if there ever was one.
From our perspective, Tom transformed a negative expe­
rience to a positive one—he transformed a situation in which
compensation was required to one in which people (Tom’s
friends) would pay to get in on the fun. Could we do the
same? We thought we’d give it a try.
One day, to the surprise of my students, I opened the day’s
lecture on managerial psychology with a poetry selection, a
few lines of “Whoever you are holding me now in hand”
from Walt Whitman’s Leaves of Grass:
Whoever
you are holding
Without
one thing all will be
I give you fair warning
me now in hand,
useless,
before you attempt
me
further,
I am not what you supposed,
but far
Who is he that would
my
become
Who would sign himself
different.
follower?
a candidate
for my
affections?
The way is suspicious,
the result uncertain,
perhaps
destructive,
You would have to give up all else, I alone
expect
to be your sole and exclusive
Your novitiate
would
standard,
would even then be long and
exhausting,
The whole past theory of your life and all
conformity
to the lives around
be abandon
d,
Therefore
release me now before
40
you would have to
troubling
yourself
the fallacy of supply and d e m a n d
any further, let go your hand from my
shoulders,
Put me down and depart on your way.
After closing the book, I told the students that I would be
conducting three readings from Walt Whitman’s Leaves
of
Grass that Friday evening: one short, one medium, and one
long. Owing to limited space, I told them, I had decided to
hold an auction to determine who could attend. I passed out
sheets of paper so that they could bid for a space; but before
they did so, I had a question to ask them.
I asked half the students to write down whether, hypothetically, they would be willing to pay me $10 for a 10minute poetry recitation. I asked the other half to write down
whether, hypothetically, they would be willing to listen to me
recite poetry for ten minutes if I paid them $10.
This, of course, served as the anchor. Now I asked the
students to bid for a spot at my poetry reading. Do you think
the initial anchor influenced the ensuing bids?
Before I tell you, consider two things. First, my skills at
reading poetry are not of the first order. So asking someone
to pay me for 10 minutes of it could be considered a stretch.
Second, even though I asked half of the students if they would
pay me for the privilege of attending the recitation, they
didn’t have to bid that way. They could have turned the tables
completely and demanded that I pay them.
And now to the results (drumroll, please). Those who an­
swered the hypothetical question about paying me were indeed
willing to pay me for the privilege. They offered, on average,
to pay me about a dollar for the short poetry reading, about
two dollars for the medium poetry reading, and a bit more
than three dollars for the long poetry reading. (Maybe I could
make a living outside academe after all.)
41
predictably irrational
But, what about those who were anchored to the thought
of being paid (rather than paying me) ? As you might expect,
they demanded payment: on average, they wanted $1.30 to
listen to the short poetry reading, $2.70 to listen to the me­
dium poetry reading, and $4.80 to endure the long poetry
reading.
Much like Tom Sawyer, then, I was able to take an ambig­
uous experience (and if you could hear me recite poetry, you
would understand just how ambiguous this experience is) and
arbitrarily make it into a pleasurable or painful experience.
Neither group of students knew whether my poetry reading
was of the quality that is worth paying for or of the quality
that is worth listening to only if one is being financially com­
pensated for the experience (they did not know if it is pleasur­
able or painful). But once the first impression had been formed
(that they would pay me or that I would pay them), the die
was cast and the anchor set. Moreover, once the first decision
had been made, other decisions followed in what seemed to be
a logical and coherent manner. The students did not know
whether listening to me recite poetry was a good or bad expe­
rience, but whatever their first decision was, they used it as
input for their subsequent decisions and provided a coherent
pattern of responses across the three poetry readings.
O f course, Mark Twain came to the same conclusions: ” I f
Tom had been a great and wise philosopher, like the writer of
this book, he would now have comprehended that work con­
sists of whatever a body is obliged to do, and that play con­
sists of whatever a body is not obliged to do.” Mark Twain
further observed: “There are wealthy gentlemen in England
who drive four-horse passenger-coaches twenty or thirty
miles on a daily line in the summer because the privilege
costs them considerable money; but if they were offered
42
the fallacy of supply and d e m a n d
wages for the service, that would turn it into work, and then
they would resign.”*
W H E R E DO THESE thoughts
lead us? For one, they illustrate
the many choices we make, from the trivial to the profound,
in which anchoring plays a role. We decide whether or not to
purchase Big Macs, smoke, run red lights, take vacations in
Patagonia, listen to Tchaikovsky, slave away at doctoral dis­
sertations, marry, have children, live in the suburbs, vote
Republican, and so on. According to economic theory, we
base these decisions on our fundamental values—our likes
and dislikes.
But what are the main lessons from these experiments
about our lives in general? Could it be that the lives we have
so carefully crafted are largely just a product of arbitrary co­
herence? Could it be that we made arbitrary decisions at
some point in the past (like the goslings that adopted Lorenz
as their parent) and have built our lives on them ever since,
assuming that the original decisions were wise? Is that how
we chose our careers, our spouses, the clothes we wear, and
the way we style our hair? Were they smart decisions in the
first place? Or were they partially random first imprints that
have run wild?
Descartes said, Cogito
ergo sum—”I
think, therefore I
am.” But suppose we are nothing more than the sum of our
first, naive, random behaviors. What then?
These questions may be tough nuts to crack, but in terms
of our personal lives, we can actively improve on our irrational
*We will return to this astute o b s e r v a t i o n in the c h a p t e r on social and m a r k e t n o r m s
(Chapter 4 ) .
43
predictably irrational
behaviors. We can start by becoming aware of our vulnera­
bilities. Suppose you’re planning to buy a cutting-edge cell
phone (the one with the three-megapixel, 8 x zoom digital
camera), or even a daily $4 cup of gourmet coffee. You might
begin by questioning that habit. How did it begin? Second,
ask yourself what amount of pleasure you will be getting out
of it. Is the pleasure as much as you thought you would get?
Could you cut back a little and better spend the remaining
money on something else? With everything you do, in fact,
you should train yourself to question your repeated behav­
iors. In the case of the cell phone, could you take a step back
from the cutting edge, reduce your outlay, and use some of
the money for something else? And as for the coffee—rather
than asking which blend of coffee you will have today, ask
yourself whether you should even be having that habitual cup
of expensive coffee at all.*
We should also pay particular attention to the first deci­
sion we make in what is going to be a long stream of deci­
sions (about clothing, food, etc.). When we face such a
decision, it might seem to us that this is just one decision,
without large consequences; but in fact the power of the first
decision can have such a long-lasting effec…