What Was I Thinking?('Predictably Irrational: The Hidden Forces That Shape Our Decisions')(Book review)

A couple of months ago, I went on-line to order a book. The book had a list price of twenty-four dollars; Amazon was offering it for eighteen. I clicked to add it to my "shopping cart" and a message popped up on the screen. "Wait!" it admonished me. "Add $7.00 to your order to qualify for FREE Super Saver Shipping!" I was ordering the book for work; still, I hesitated. I thought about whether there were other books that I might need, or want. I couldn't think of any, so I got up from my desk, went into the living room, and asked my nine-year-old twins. They wanted a Tintin book. Since they already own a large stack of Tintins, it was hard to find one that they didn't have. They scrolled through the possibilities. After much discussion, they picked a three-in-one volume containing two adventures they had previously read. I clicked it into the shopping cart and checked out. By the time I was done, I had saved The New Yorker $3.99 in shipping charges. Meanwhile, I had cost myself $12.91.

Why do people do things like this? From the perspective of neoclassical economics, self-punishing decisions are difficult to explain. Rational calculators are supposed to consider their options, then pick the one that maximizes the benefit to them. Yet actual economic life, as opposed to the theoretical version, is full of miscalculations, from the gallon jar of mayonnaise purchased at spectacular savings to the billions of dollars Americans will spend this year to service their credit-card debt. The real mystery, it could be argued, isn't why we make so many poor economic choices but why we persist in accepting economic theory.

In "Predictably Irrational: The Hidden Forces That Shape Our Decisions" (Harper; $25.95), Dan Ariely, a professor at M.I.T., offers a taxonomy of financial folly. His approach is empirical rather than historical or theoretical. In pursuit of his research, Ariely has served beer laced with vinegar, left plates full of dollar bills in dorm refrigerators, and asked undergraduates to fill out surveys while masturbating. He claims that his experiments, and others like them, reveal the underlying logic to our illogic. "Our irrational behaviors are neither random nor senseless--they are systematic," he writes. "We all make the same types of mistakes over and over." So attached are we to certain kinds of errors, he contends, that we are incapable even of recognizing them as errors. Offered FREE shipping, we take it, even when it costs us.

As an academic discipline, Ariely's field--behavioral economics--is roughly twenty-five years old. It emerged largely in response to work done in the nineteen-seventies by the Israeli-American psychologists Amos Tversky and Daniel Kahneman. (Ariely, too, grew up in Israel.) When they examined how people deal with uncertainty, Tversky and Kahneman found that there were consistent biases to the responses, and that these biases could be traced to mental shortcuts, or what they called "heuristics." Some of these heuristics were pretty obvious--people tend to make inferences from their own experiences, so if they've recently seen a traffic accident they will overestimate the danger of dying in a car crash--but others were more surprising, even downright wacky. For instance, Tversky and Kahneman asked subjects to estimate what proportion of African nations were members of the United Nations. They discovered that they could influence the subjects' responses by spinning a wheel of fortune in front of them to generate a random number: when a big number turned up, the estimates suddenly swelled.

Though Tversky and Kahneman's research had no direct bearing on economics, its implications for the field were disruptive. Can you really regard people as rational calculators if their decisions are influenced by random numbers? (In 2002, Kahneman was awarded a Nobel Prize--Tversky had died in 1996--for having "integrated insights from psychology into economics, thereby laying the foundation for a new field of research.")

Over the years, Tversky and Kahneman's initial discoveries have been confirmed and extended in dozens of experiments. In one example, Ariely and a colleague asked students at M.I.T.'s Sloan School of Management to write the last two digits of their Social Security number at the top of a piece of paper. They then told the students to record, on the same paper, whether they would be willing to pay that many dollars for a fancy bottle of wine, a not-so-fancy bottle of wine, a book, or a box of chocolates. Finally, the students were told to write down the maximum figure they would be willing to spend for each item. Once they had finished, Ariely asked them whether they thought that their Social Security numbers had had any influence on their bids. The students dismissed this idea, but when Ariely tabulated the results he found that they were kidding themselves. The students whose Social Security number ended with the lowest figures--00 to 19--were the lowest bidders. For all the items combined, they were willing to offer, on average, sixty-seven dollars. The students in the second-lowest group--20 to 39--were somewhat more free-spending, offering, on average, a hundred and two dollars. The pattern continued up to the highest group--80 to 99--whose members were willing to spend an average of a hundred and ninety-eight dollars, or three times as much as those in the lowest group, for the same items.

This effect is called "anchoring," and, as Ariely points out, it punches a pretty big hole in microeconomics. When you walk into Starbucks, the prices on the board are supposed to have been determined by the supply of, say, Double Chocolaty Frappuccinos, on the one hand, and the demand for them, on the other. But what if the numbers on the board are influencing your sense of what a Double Chocolaty Frappuccino is worth? In that case, price is not being determined by the interplay of supply and demand; price is, in a sense, determining itself.