Most of us would believe that we consistently make rational choices, that we are in control, and that we usually get decisions right. But we often make choices that can only be described as irrational. What's more, it appears we make the same types of mistakes again and again, in a systematic and predictable way.
As a researcher in behavioural economics, most recently as a professor at the Michigan Institute of Economics, I have spent more than 20 years trying to figure out what really influences the decisions we make. The mistakes we make are what the field of behavioural economics tries to explore.
In addition to improving our personal lives, this understanding can help businesses and policy makers revise their thinking and design policies and products so that they benefit society at large. This is where the true promise of behavioural economics lies. Follow these examples that have come up in my research, then take the quiz to learn a little more about how you make the decisions that run your life.
Health
In an experiment at the MIT, we gave a group of students a painkiller which we said cost a dollar a pill. Later they were given a pill costing, supposedly, one pence. When the students took the more expensive pill it turned out to be 50 per cent more effective than the cheap one, even though they were the same pill, and that pill turned out to be nothing more than Vitamin C. It appears that when it comes to our health we aren't looking for bargains.
Dishonesty
After the Enron scandal in 2001, we started wondering what made these people cheat and how pervasive this tendency is. After all, the total cost of employees' theft and fraud from the workplace is estimated at $600bn in the US. Yet most of us would consider ourselves "honest".
So my research team and I created a series of experiments designed to tempt people to steal from us. We found that when people are tempted to steal, the majority of them do, but only a "little bit". This cheating doesn't seem to be related to the amount of money, or the probability of being caught.
So what does influence the extent to which they cheat? Being asked to recite the Ten Commandments or sign an honour code eliminates cheating altogether, while getting paid in non-monetary currency (tokens that were converted into money a few seconds later) increases cheating dramatically. Like the Enron executives, being one step removed from the money seemed to release our students from moral constraints. Cheating is a function of our conscience, not a cost-benefit analysis. Cheating just a little allows us to get the benefits but at the same time consider ourselves honest upright citizens.
Relativity
Next time you hit the town in search of a date, take a friend who looks similar to you, but is slightly less attractive. We presented participants with two portraits – Mike and John – and asked them to choose whom they'd rather date. For half the participants we distorted the picture of Mike and added it to the set, so they had John, Mike and an ugly version of Mike to choose from. For the other half of the students, we distorted John, so they had Mike, John and an ugly John.
When the ugly version of Mike was presented, the attractive version of Mike became the most desirable date. And when the ugly version of John was presented, John's attractive version became the most desirable.
It is very hard for us to evaluate things in absolute terms. So, we evaluate products and people in relative terms, which makes us vulnerable to this kind of trap, called the asymmetric dominance effect.
Spending power
We asked a group of MBA students to write down the last two digits of their Social Security number next to the descriptions of a few products. We then asked them if they would pay the amount of money indicated by these numbers (79 became $79 and so on) for each of the products.
We then asked them to bid on the items in an auction. It turned out that people with higher Social Security numbers were willing to pay more.
What was going on? It's not that people with high Social Security numbers are willing to pay more for everything in general. Instead, it is what's known as the power of first decision. Once people start thinking of something as having a specific value, they do so not just once, but repeatedly.
Social Norms
Have you ever wondered what would happen if, at the end of a date, as you are leaning in for that goodnight kiss, you mentioned how much the date cost you? Both parties are aware of how much it cost, so why would mentioning the cost make a difference?
Behavioural economics tells us that people live in two markets: in one, market norms prevail (when we pay money in exchange for goods or a service), and the other is ruled by social norms (when your neighbour asks you to take their mail when they are on holiday and you happily oblige without expecting anything back).
These markets are not additive – when you add a financial dimension, it often reduces overall motivation in a social situation. So a stranger is likely to help you change your tyre without the promise of something in return, but offering a stranger £1 in exchange for help is offensive.
Free!
Another hot button that we discovered is the concept of "Free!" If we are overly excited by Free! we make mistakes.
We asked people to choose between an expensive Lindt truffle and a much cheaper equivalent, a Hershey's Kiss. When we set the price of the truffle at 15 cents and the Kiss at one cent, 73 per cent chose the truffle, and 27 per cent chose the Kiss.
Then we offered the Lindt truffle for 14 cents and the Kisses for free. The humble Hershey's Kiss was still 14 cents cheaper – just as it had been – but suddenly it became a big favourite. 69 per cent chose the Kiss, forgoing the opportunity to get the Lindt truffle for a very good price.
But if you are convinced that you are immune to your in-built irrationality, why not take our test (below) to find out how rational you really are.
Dan Ariely is Professor of Behavioural Economics at the MIT's Sloan School of Management. His new book, Predictably Irrational, is published by HarperCollins, £14.99
Click here to take the irrationality test
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