Predictably Irrational

“Predictably Irrational: The Hidden Forces that Shape Our Decisions” is a 2008 book by Dan Ariely in which he challenges readers’ assumptions that people make decisions based on rational thought. Ariely discusses many modes of thinking and situations that may refute the traditional rational choice theory.
Ariely describes the ways in which people frequently perceive their habitats in terms of their relations with those they live with. He gives a funny example of subscription offers of The Economist magazine. Subscription to economist.com costs $59, subscription to the hard copy of the journal costs $125, and subscription to both the web magazine and hard copy version costs $125. He carried out an experiment in his class at the Massachusetts Institute of Technology (MIT) and made the same offer of The Economist magazine. Eighty-four students preferred to buy the web and hard copy versions together, whereas 16 preferred to buy the web version only. Nobody chose to buy only hard copy magazine subscription. Actually there is a trap here since there is no reason to offer the hard copy magazine alone because everybody prefers to buy the web version and hard copy version at the same price. However, the hard copy alone offer provides a reference point for the potential customer and the customer immediately figures out that the web version plus hard copy journal offer is better. In another experiment, Ariely made an offer of the web version versus web and hard copy version. With simple reasoning, in these two options everything is the same and the results would be the same 16 to 84 in favor of web and hard copy version together. However, surprisingly 68 students preferred the web version and 32 students the other offer. Why? Because we make our decisions based on references, not based on facts. Ariely is a behavioral economist, and he challenges the traditional theories of economics. In the chapter “The Fallacy of Supply and Demand,” he argues that prices are not always set by supply and demand. The methods of assigning value to an object with no previous value is susceptible to irrational pricing. Take, for example, any merchandise that is not rare and not so valuable but has been put up for sale at a very luxurious shop, say, on Fifth Avenue in Manhattan. People will perceive it as a valuable item simply because it is sold there but not somewhere else. When consumers buy a product at a certain price, they become “anchored” to that price, i.e., they associate the initial price with the same product over a period of time. An anchor price of a certain object, say a plasma television, will affect the way they perceive the value of all plasma televisions henceforth. Other prices will seem lower or higher in relation to the original anchor. In other words, decisions about future LCD television purchases become coherent after an initial price has been established in the consumer’s mind. A person’s perception of value for services rendered can also be affected by anchor prices; one can irrationally price his/her abilities or services based on an anchor price proposed. Using the concepts of anchor price and arbitrary coherence, Ariely challenges the theory of supply and demand. He states that demand, the determinant of market prices, can be easily manipulated. Furthermore, supply and demand are dependent on each other (for instance, a manufacturer’s suggested retail prices affect consumers’ willingness to pay). Finally, the author claims that the relationships between supply and demand are based on memory rather than on preferences. Ariely explains how humans react to the words “free” and “zero.” People are very sensitive to these two particular words. For example, if you offer a high quality piece of chocolate for 1 cent and a lower quality piece of chocolate for free, people prefer the free one. The “free” motivates people. Ariely in his book gives very interesting examples of human irrationality based on the strange experiments and surveys he did together with his students. It is a thought-provoking book that you might like to read.