Predictably Irrational

Author Dan Ariely

As an Economic Unit in a Capitalist Economy, you probably spend most of your time scurrying about Maximizing your Utility. Right?

You buy things which give you pleasure, or sell them when the cash you’d receive is greater than the pleasure of keeping them. You choose the job that offers the best tradeoff between things like pay, stress, and time consumed, in an industry you chose based on the same criteria.

Even your leisure time is rationally allocated, optimized to get the most happiness from a finite amount of time, with cost factored in and weighed against the amount of extra work required to pay for leisure spending.

Although you’re probably having a good laugh at my deliberately optimistic oversimplification, this is the basis of free-market capitalism itself, and to a certain extent it works. In fact, most of the good aspects of our great leaps forward since the industrial revolution are byproducts of this free enterprise and trade. Neat inventions in food production, medicine, clothing, and everything else that brings us long lives and comfort, are side effects of the incredible ingenuity unleashed by setting smart and hard-working people free to run.

If that were the whole story, we could just shut down the government and sign an Ayn Rand novel into law and be done with it. But anyone with a deeper understanding of the market system is probably waiting to point out the other side of it:

Most of the bad aspects of modern society are brought about by the failure of humans to properly maximize their utility.

In other words, we make some incredibly stupid decisions. And the byproduct is pain, untimely death, and inefficiency.

The standard opinion on this inefficiency is that it’s just a few bad apples in an otherwise good system. Most of us do well at running our lives, don’t we? We know what we want, and our system is good at delivering it to us. But I’d say there is more to the story.

Most Americans, for example, are deep in unnecessary debt, overweight and poorly nourished, inactive and stressed out, and self-sentenced to a mandatory career of unsatisfying work just to stay afloat. We constantly buy things we can’t afford and don’t need, and the majority of the trading we do does not increase our net happiness.

We’re so easily manipulated that advertisers and politicians can pull our emotional strings with ridiculous ease just by replaying the same transparent ruses day after day, decade after decade.

• “This $60,000 truck will bring you power and freedom to escape to the Hills of Freedom while towing your bigass boat.”
• “This $60,000 SUV will keep your children save while adding a nice veneer of prestige and quality to your suburban life”
• “Vote for my political party, and I’ll protect you from the other side who wants to drive this country into the shitter, attack your most core values, and take away all your prosperity for themselves.”

And all of this is done with virtually no awareness of how we are affecting our own ecosystem – the tiny veneer of air and plants that is the only thing between us and the lifeless vacuum of space. In fact, it would be difficult to imagine a less efficient way to maximize “Utility” than what the modern consumer does.

Given all this freedom, why do we screw things up so royally? Is there a way to maintain the power of the market while getting around the general idiocy of our own species?

Fortunately, the answer is built right into you, in the form of the genetic program you received at birth. The reason we suck at running our own lives is that we are evolved and programmed for a completely different set of surroundings. But this handicap can be overcome: by learning about our own weaknesses, we can compensate for them and lead much more productive, powerful and happy lives.

This is where the title of this article comes in. I recently read the book Predictably Irrational by Dan Ariely at the recommendation of some readers.  It’s not often that I find a book that crystallizes so many interesting concepts in one swipe, but this book does it.  Everything the author proposes just makes so much sense. But as an MIT behavioral economist with mutiple books and over 75 published papers on his resume,  these are not just the blowhard opinions of a financial blogger – the man actually does his own research and has an uncanny way of sharing it with the world with perfect accessibility.

There were a few key lessons that stuck with me after finishing this book. They are useful not just as curiosities of human nature, but as practical tools for overriding our innate ridiculousness and learning to live life more sensibly. When applied to personal finance, this equates to easily amassing way more money than everyone else. 

And then of course, using that wealth in a more rational way in order to have a much more fun and generous life.

Relativity

 Humans make decisions in relative terms, rather than absolute ones. Given a restaurant menu with varying prices, people tend to avoid the most expensive item, but are very comfortable choosing the second one on the list. Restaurants have learned this, so they will often insert a “decoy” expensive dish (which may cost no more to prepare than the others), which allows them to raise the price of everything else, making all alternatives look like comparative bargains. The same thing happens when shopping for clothes, cars, or television sets.

Rationally, we should be comparing list prices to all other ways of meeting the same needs, and to our own income. But our genetic wiring wants us to make quick decisions and move on, and in prehistoric times, comparing in relative terms was the way to get this done.

But this built-in flaw has implications on much bigger things than restaurant choices. We design our entire lifestyles by looking around us to see what everyone else is doing. Most of us position ourselves in the middle of the herd, and start feeling deprived if we sense we are near the bottom. The problem arises when the herd is comprised mostly of sheep, responding blindly to their own irrational instincts. So as a society we have a tendency to automatically run ourselves straight off of the nearest cliff.

Market Norms vs. Social Norms

Most of us know that it is socially inappropriate to ask our friends to cough up money when we invite them over for dinner, or to offer money to a romantic partner in exchange for sex. But if you take those exact two human needs and reframe them differently: it is normal to pay for a meal at a restaurant and the world’s oldest profession continues to thrive.

This is the core of the distinction between “market” and “social” norms. As it turns out, humans obey different rules when operating in a business environment, than they do when they perceive they are among friends and family.

We are more generous when we are reading from the Social Norms playbook, and we enjoy our lives more when doing it. This is why countries and cultures with stronger family and friendship bonds tend to be happier than the cold and impersonal market-driven ones – even if their incomes are lower.

You can use this to your advantage. By bringing more social exchanges into your life, you can live more happily and build a safety net that protects you from the sharpest edges of the market system. I saw a nice example of this about a year ago, when a close friend stopped by and saved my house from flooding as part of a routine visit to water the plants. Invite your neighbors over for dinner, share children back and forth for babysitting, and loan out your tools, lawnmower, and weekend labor as much as you can.

And if you run a company, bring some social norms into the way you treat customers and employees. Instead of dinging people with every conceivable fee or squeezing employees with the lowest legal level of vacation allowance, expand your trust and generosity towards them. Watch as their dedication to you grows and provides benefits much greater than the costs.

 Loss Aversion and Overvaluing What We Have

When I wrote the opening story about ‘losing’ $12,000 in an earlier article about Strength, I took some heat in the comments about it:

“You did’t lose the twelve grand, Mustache, you just didn’t get the money in the first place! Totally different.”

But that choice of words was deliberate. I work hard to remind myself that although it feels different to have a brand-new $12,000 car roll off a cliff because I forgot to set the parking brake, or have an expected $12,000 deal fail to materialize after doing all the work, the financial effect is exactly the same, and thus I should not worry about either of them.

In everyday life, loss aversion messes with us more than we realize. We hesitate to sell things we are no longer using, because we become attached to them.

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The way to get around this is to recognize your own irrational loss aversion, and work to compensate for it.

For example, I keep a Craigslist app on my phone and fairly ruthlessly fire out ads to sell unused things when I stumble across them in the storage area of our house. I try to replace emotion with the more rational friend of statistics when deciding whether I should invest money, buy a more full-coverage type of  insurance, or take any other form of risk.  And in our upcoming move where we are “losing” over 1000 square feet of living space, I remind myself that there is no fundamental rule of humanity that dictates three people will be any more happy with 2600 square feet of interior space than they will be with 1532 square feet. I program myself to feel the “ChaChing!” instinct, which creates immediate gratification in the event of good monetary decisions, to compensate for my natural tendency to want shiny things NOW instead of investing for later.

Marketing and How it Plays Your Ass Like a Puppet

The thing about all of these cognitive biases is that even if you don’t round them up and get control of them, somebody else will. For over a century, the field of Psychology has been unearthing these things and studying them rigorously, discovering the joys and hilarious downfalls of the human animal. And for almost as long, marketers have been picking up the research and honing it for their own advantage. I recently read a quote from the head of one of the country’s largest ad agencies, which went something like this,

“It is generally understood in our industry that we aren’t fulfilling wants and needs – we are creating them. A new product first needs to create a market for itself, before it can be sold into it.”

Isn’t that revealing? I still admire many of the funny and creative people of the advertising industry and my own Dad worked most of his career in it, running his own one-man agency for much of my childhood.  In fact, some of the lessons of that industry have surely soaked into my own approach, and you could view this blog as an ongoing Anti-Advertisement which aims to apply some of those principles in reverse.

But by golly, if you are going to be out there trying to kick ass in life and as an Economic Unit, you’d better go to battle with proper armor. And that means understanding your evolutionary weaknesses so you can avoid their tendency to turn you into a Consumer Sucka. We are all idiots at heart, but the more successful among us learn to compensate for our idiocy.

So I’d like to give my thanks to Dan Ariely for writing this book and his amazing contributions to society so far – I’m off to read the rest of what he has written.