Our Favourite Chapters from Predictably Irrational

Posted 5 December By PlugAdminOtherNo Comments

In his wildly popular book, Predictably Irrational, Dan Ariely disrupts everything you learned about traditional economics as he writes about the world of behavioral economics in which consumers are irrational, biased, and, luckily, predictable. Besides being a professor at Duke University, founder of The Center for Advanced Hindsight, and co-founder of BEworks, Ariely has mastered the art of observing decision-making and how seemingly irrelevant and random context clues and product information fill the gaps in our brain and consequently influence us to choose one product over the other in a systematic fashion.

His keen talent and simple diction are what make Predictably Irrational, “far more revolutionary book than its unthreatening manner lets on,” (New York Times’ David Berreby). We thought so too and, as a result, have summarized our favorite chapters for you. Enjoy!

The Truth about Relativity

Everything is relative. Including price. In this chapter, Dan Ariely convinces the reader that there is a way to manipulate consumers into choosing the option you, the seller, want them to choose by playing the pricing game. The key to winning this game is understanding that people are generally bad at evaluating the worth of an item or service, if not provided with any context. Smart marketers use the notion of needing comparisons in order to make decisions as the basis of their pricing strategy and thereby create “anchors” and decoy options.  

In his study, Dan Ariely used MIT students as subjects in his study about The Economist, a magazine trying to optimize its pricing options for both digital and print subscriptions. At the beginning of the experiment, 68% of students chose the internet-only option for $59 and 32% chose the print and internet for $125.

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Figure 1

Then, Ariely implemented a third “decoy” option of print only but for the same price as print and internet. After the three subscription plans were offered, the number of people signing up for the print and internet, the desired option for The Economist, spiked up to a shocking 84%. What about the new print only option? Zero students signed up for that plan which is anticipated since it was a decoy option designed specifically to make the print and internet plan more appealing.

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Figure 2

Do you see what he did there? By providing the reference point of $125 for the print only subscription, he made the print and internet one seem like double the value for the same amount.

The Cost of Social Norms

This chapter discusses the difference between market and social norms, how important it is to understand the difference, and potential consequences of when the two are integrated. First off, it is important to explain what both are – market norms are guidelines for our actions that directly bring us money whereas social norms are standards we adhere to around friends/family/general public.

Ariely walks us through an experiment where he asked Duke students to do a mundane task on the computer: drag a circle into a box from different parts of the screen repeatedly over the course of five minutes. The group that was paid $5 for the task dragged an average of 159 circles, those that were paid 50 cents dragged 101 circles and those who did it for free dragged an average of 168 circles. The first discrepancy in average circles dragged is expected, people work harder for more pay. What about the third group? This is proof that social norms can trump market norms.

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Figure 3

The logic is quite simple: when people work for pay, they put in as much effort as they think is fair according to the payout thereby following the rules of traditional economics. When people work for free, however, they do it as a favor and put in however much effort makes us feel good about ourselves. And typically it turns out to be high. The tricky part comes in when we try to mix the two. Imposing market norms on a social situation, for example, pay your mother in law for her input into the Thanksgiving dinner, can result in an unforgivable offense on your part. Bringing in social norms into the marketplace, however, is a very smart marketing ploy. Think of Google. Why is it the single most desirable company to work for? Why does it have the highest employee satisfaction rate? In simple terms, its because it has introduced social norms of a friendly work environment with free food and nap pods into an office. While Google employees are paid to do their job, they often go above and beyond the effort level that their pay deserves because they feel like they are bound by a social contract.

The High Price of Ownership

This chapter primarily focuses on endowment effect, the idea that individuals ascribe more value to things merely because they own them. In addition to loss aversion, this results in a significant price gap between buyers and sellers of say, used IKEA furniture or Duke basketball tickets. That is, once we’ve put in effort and time into assembling a table or camped outside of the box office for 24 hours, our mind automatically inflates the value of that item. This goes against everything we’ve learned in classic economics and results in plain market failure.

What’s more interesting is the effect of pre-ownership loss. That is, we project the feeling of ownership on certain items before the actual purchase. eBay’s success can be partially attested to this notion because once most people start the bidding process, they start to take ownership of that item, fear the loss, and thus pay more.

The marketing implications of these psychological patterns are almost revolutionary for modern day companies. Think of every free trial or free return option you’ve ever received. Its hard to let go, isn’t it?

The Cost of Zero Cost

What goes through your mind when you hear that something that used to cost $1 is now $0? Most don’t think of it as just another discount, now that item is FREE. Being handed something for free is admittedly one of the most exciting experiences. So exciting, in fact, that this action consequently prompts a lot of impulsive and irrational behavior in consumers.

In his experiment, Dan Ariely offered Lindt truffles for 15 cents and Hershey kisses for 1 cent. Lindt is objectively a luxury, premium chocolate and should, therefore, cost more. 73% of students chose Lindt and 27% chose Hershey’s. Then, Ariely reduced the price of both by one cent, bringing Lindt to 14 cents and Hershey’s to 0 cents (there was an imposed limit of one candy per person). The relative cost of chocolates did not change; however, the outcome was significantly different. Instead, 69% chose Hershey’s and 31% chose Lindt.

A great real life application of this is Amazon. Once the website started offering free shipping, an overwhelming number of consumers started purchasing items they might not have necessarily needed, had it not been for free shipping. And we do this all the time. We buy more expensive cars just because they come with free oil changes or sign up for “free” credit cards.

Overall, the book does a great job of walking the reader through consumer behavior patterns, psychology, and concepts that can be applied to almost any industry. Dan Ariely shed some light to quirky and humorous everyday actions of the general public.

Written by: Aliya Serikpayeva

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