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Dan Ariely: Predictably Irrational

One of the basic assumption of economic science is that people respond to economic incentives. People also respond to sexual incentives, but that is only of interest from an economic point of view insofar as it either leads to economic behavior or influences their decision making, for example when in their excitement people are tempted to do things they would otherwise avoid, such as having unprotected sex with a stranger.

Many people exhibit strange and, from the point of view of standard economics textbooks, irrational behavior. As Dan Ariely, a professor of behavioral economics at Duke University and a visiting professor at MIT’s Media Lab, argues in Predictably Irrational: The Hidden Forces That Shape Our Decisions, this kind of behavior is often predictable, hence the title of his book. Perhaps you are one of those people who will walk or drive 15 minutes to visit a store because the DVD’s are 2 dollar (or euro) cheaper. But would you go through the same effort to save 2 dollar (euro) on a 1,500 dollar (euro) flatscreen? If you’d do the first thing but not the second, don’t worry, you belong to the majority, the irrational majority that is. And do you sometimes add one item to your online order just because the shipping will be free when you spend more than a certain amount, even though you don’t really need it?

Predictably Irrational is a fun read and if you're unfamiliar with behavioral economics you may do some interesting discoveries about yourself that as a reader you can take advantage of. If however you are already familiar with behavioral economics you may find the book a bit flimsy. Since Ariely only discusses his own research the book also fails as a general introduction to behavioral economics.

A more serious problem is that Ariely doesn’t really define anywhere what he means by rational and irrational. He just assumes that the outcomes of his experiments are evidence of irrational behavior, because, well, he thinks it is irrational or because it is not optimal with respect to the assumption of utility maximizing behavior. He also appears to think that the examples of irrational behavior in his experiments can and should be overcome. In other words, rational behavior is not just the hallmark, it is also the goal.

I also disagree with Ariely's conclusion in several chapters that, because people often act irrationally, the government should intervene. Governments are made up of people and quite often engage in irrational behavior on a grand scale. There is no difference here between companies, governments and individuals.

After reading Ariely the kind of problems addressed in behavioral economics may seem rather trivial. Like so much psychological research the experiments Ariely discusses in Predictably Irrational establish experimentally what seems rather obvious. For example it has been known for a long time in marketing and advertizing that people are seduced by free gifts, free shipping, three for the price of two etc. One may also wonder whether any of this is all that harmful. Well it is, once the scale increases from spending a few dollars to investing a few billion and when the decision is not about a purchase but about safe sex.

One area where findings from behavioral economics are highly relevant is development economics. Many farmers in developing countries don’t use fertilizer. Is this because the market doesn’t function? Are prices too high? Do farmers lack knowledge of modern farming methods?

A recent field experiment in Kenya by researchers from MIT’s Poverty Action Lab suggests that farmers fail to save money after the harvest to buy fertilizer when they need it. Oddly they do buy fertilizer directly following the harvest, but only when it is freely delivered. There may be something wrong with these findings, but they may also suggest an irrational bias. The study also shows that farmers who don’t use fertilizer don’t appear to learn from their neighbours who do. The higher yield doesn’t raise their curiosity, possibly because traditionally yields are attributed to divine intervention. The farmers who use fertilizer don’t seem to be inclined to tell their neighbours to do so as well. A better understanding of the reasons why farmers in these regions act the way they do may help policy makers and aid agencies better target their initiatives.

Links

Esther Duflo, Michael Kremer and Jonathan Robinson (2006), Understanding Technology Adoption: Fertilizer in Western Kenya. Preliminary Results from Field Experiments. Working paper, Poverty Action Lab, MIT.

A list of Dan Ariely's downloadable academic papers.