Predictably Rational - Part 2

In his book, Predictably Irrational, Dan Ariely tackles a very interesting phenomenon. The inpact of the word FREE in our decision making. With the help of some clever 'experiments', Ariely has 'proved' that human shoppers go beserk when they see the word 'free'. In other words they act irrationally.

The basis of this assertion is what economists term value or relative value. As per the economists the value you derive from any buy, is the value you associate with the satisfaction you obtain from the purchase minus the cost of the product (in same units).

So, if you value the satisfaction from eating a high quality Swiss or Belgian chocolates at 100 units and the satisfaction from a low-priced, non-hyped, Indian chocolate at say 75 units. Also assume that you have to pay 15 units for the high quality chocolate, and 10 units for the Indian chocolate, the value of Belgian chocolate is 100 - 15 = 85 units. The value of the Indian chocolate is 75 - 10 = 65 units. So, you would go for the Belgian chocloate (if you can afford, I presume).

Now, if you drop the cost of both chocolates by 5 units, your buying pattern should not change since the relative increase in value is identical. That is what the economist will say.

Dan Ariely goes on to indicate, in his (very readable, by the way) book, that when the cost is dropped to zero, humans become irrational. In our example, if the cost of obtaining the Indian chocolate is made zero and the cost of the Belgian chocolate is made 5 units, the rational model breaks down. People will shoot for the free chocolates. We behave predictably irrational. (By the way, Dan Ariely is not using the word irrational in a bad way, it is just that the standard economist assume a rational response to incentives and Ariely is 'proving; it otherwise.

But let us see where both stadard economists and Dan Ariely fail.

Before I give my explanation, please do consider that I have no formal (or for that matter informal) training on economics. Having made that disclaimer (ahem!) let us proceed.

I think, the economist evaluate value in a totally different way than the common (sense) person. We derive value not by subtraction but by division.

Here are the formulae ...

Economist's Value = Satisfaction - Cost
Common Person's Value = Satisfaction / Cost

So when the cost drops to zero, the value tends towards a very high value. That is the only reason why we behave the way we do. Absolutely rationally!

By the way, there is no such thing as free lunch. Dan Ariely explains this beautifully in the chapter The Cost of Zero Cost of the book.

Predictably Rational - Part 1

This is not a crticism of the book Predictably Irrational by Dan Ariely. In fact, it is a brilliant book and I would recommend it to everyone. The book essentially debunks the theories of a rational economic man as preached by Standard Economics. The book is on Behavioural Economics which starts with the assumption that uman beings could be irrational also. And goes on to prove that we are not only irrational, but predictably irrational and that we demonstrate the same irrational behaviour time and again.

This series of posts will try to prove that we may be irrational but perhaps not predictable. I will take each of the chapters (not in any particular order and show that it is not a good idea to predict how someone would behave in, say, India, based on experiments carried out in United States.

To be fair to Dan Ariely and other behavioural economists, they do claim that behaviour is contextual. But I think they are way off mark when they conclude based on experiments.

Let me take an example from the book. In an experiment, Dan and his team, served four kinds of (free) beer and took orders (in a bar near MIT, I think). When order was taken aloud, people around the table chose four different beer. On taking a survey after serving the beer, the economists found that the one ordering first always enjoyed the beer and the rest didn't enjoy it that much. When the people being served were asked to write down their orders the variety of beer ordered per table was reduced. The average enjoyment however went up.

The conclusion: (as per the book) [P]eople are willing to sacrifice the pleasure they get from a particular consumption experience in order to project a certain kind of image to others. ... In Hong Kong, individuals also selected food that they did not like when they selected in public rather than in private, but these particpants are more likely to select the same item as the people ordering before them.

So in essence, people would strive to conform to an image that is driven by their respective culture.

Now is this reaaly so? India must be very unique then. Why? I have been to innumerable such gatherings. When I was younger and unmarried, we had this tradition among friends to eat out to celebrate birthdays. SO essentially the birthday boy or girl pays. The food for rest of us was therefore free. We also had to announce our choice in public for the waiter to hear what we wanted. Sometimes one person would take the initiative to write down waht we wanted and give it to the waiter. Given the scene that is very similar to the Dan Ariely experiment, my experience is very different. We always ordered different food but just sufficient for all to have a little taste of an item. So if we are 6 of us, we would, say, 2 plates of 4 items each. The idea was to taste as many items as possible. The idea was also to ensure that we are within budget. And also that we should not waste food.

Those days there were occassions when I had to eat alone - I was a bachelor, remember? I did the same. I order "thali" (a plate with assortment of food in small quantity; "thali" means a plate - so basically a platter) to taste as many different varieties as possible but still keep th bill with budget. Not always, but often.

Now I am married, but when we go out to eat we still do the same. Yes the budget has expanded, but we try to include as many dishes as possible within the budget.

Now is that being irrational? To maximize pleasure within budgetary constraints is a perfectly normal way to behave. In fact it is rational. Predictably rational.

Party Games

This could be a party game.

Heard of wine tasting? This one is cola tasting.

Get a few bottles of Pepsi and Coke.
Each of your guest gets to be a tester by turn.
Give your tester 3 glasses.
Fill two of the glasses with, let's say, Coke and one with Pepsi.
The tester is *not* required to say which is Pepsi and which is Coke.
All you they need to say is which one is different from the other two.

You think it is easy. Here's what I read in Blink: The Power of Thinking Without Thinking by Malcolm Gladwell:

In the beverage business, this is called a triangle test. ... Believe it or not, you will find this task incredibly hard. If a thousand people were to try this test, just over one-third would guess right - which is not much better than chance; we might as well guess.


Of course, Gladwell does not recommend this as a party game. I just thought this could be one.

If conducted with flair it could engage your guests for some time. The success lies in everyone having equal opportunity to win.