I have been unfair to the economists in my last post. I found out over the weekend (source: Chaotics by Philip Kotler and John A. Caslione) that an economist did indeed confess that nobody knows what is going on.
When asked the same question [when would the recession end?] in October 2008, Gary Becker, the Nobel Prize-winning economist, said, "Nobody knows. I certainly don't know."
Though I suspect this is largely a response in frustration rather than acknowledgment of truth.
It took me a while to get used to the idea of 'experiments' in behavioral economics. My idea of experiments is as follows:
(i) It should be possible to control parameters in an experiment
(ii) The 'unit' under experiment should not know that there is an experiment going on (quantum mechanics seem to suggest that this may not be possible - "the photons know" - but that is another story)
(iii) The experiment should be repeatable
(iv) Most importantly, the results should not be known before the start of the experiment.
(v) And finally, once an experiment is performed and results concluded, every subsequent similar (but not identical) experiment should be predictable. (A result of such experiments that does not behave as predicted becomes the basis of the next hypothesis).
The experiments in Predictably Irrational, seem to be following the above criteria, more or less. So over a period of time you get used to the word experiment being used in not-strictly scientific context.
But athere is one fatal flaw, as I see it. One vital parameter has been tampered with. In many of the experiments, an economic gain is made without any cost to the particpant. What is economics without cost? Dan Ariely goes all out to prove that humans behave irrationally when encountering the word FREE! and then proceeds to perform experiments where the objects of experiment get easy money or goods that are free. Doesn't that make experiments unrealistic? After all you are trying to predict human behaviour in normal circumstances.
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.
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.
This is taken from the book by Peter L. Bernstein Against The Gods.
John Maynard Keynes, the great English economist had predicted today’s financial chaos.
“When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill-done.”
In the coming days I will extract some more interesting extracts from this international bestseller.
Note: The picture used belongs to Richard Styles. To see more of his photographs visit his gallery.
Posts
All Comments
