Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions Paperback – April 27, 2010

Among the various books available that cover the topic of human behavior, Predictably Irrational is among the top ten (interested readers should also read Sway by Rom Brafman). It's not quite an economics book (for a much better analysis of the many failings of neoclassical economics, read Debunking Economics by Keen) and it's not quite a behavioral psychology book (read Sway) so it falls somewhere in the middle - and therein lies its main weakness.

There are some very interesting anecdotes (for example, do you know why we think black pearls are valuable when originally no one wanted to buy them at any price?) and these are where most of the book's value lies.

The principal weakness comes from Ariely's conclusions based on the work he's carried out. He acknowledges that we humans are "irrational" compared to the straw man of the "rational optimizer" beloved of neoclassical economic theory, but while some of his examples are interesting he fails to see the entire picture. Thus whereas Keen shows that the neoclassical model is computationally impossible, Ariely merely shows that we have different decision-making processes in two distinct contexts: interpersonal and financial. This is valid, but Ariely then goes on to show that he hasn't really explored the interpersonal context with any degree of rigor.

A couple of examples will illustrate what I mean. In the first example Ariely talks about how companies strive to create a "social exchange" in the workplace because people generally work harder and more diligently in social exchange settings than in compensation-based settings. We can think of how we might keep on struggling to get a friend's piano up the stairs of a narrow apartment building long after we'd have given up if we were simply being paid $10 per hour by a stranger to perform the same task. So Ariely notes that companies try to exploit our social side in order to get more work out of us (he doesn't look at the ethics of this attempt, or even at its many infeasibilities). Then he suggests that in order to reinforce the social dynamic and avoid corrupting it with the financial dynamic (because it's not possible to combine the two) companies should not give bonuses but instead should send employees off on a paid-for vacation. The problem, of course, is that most employees don't want to be placed in a parent-child relationship. Most employees think of themselves as independent adults. Saying "here's a vacation we've arranged for you" violates an employee's independence. Worse still it assumes the employee's plans for their free time are irrelevant (the cost of leaving one's home, family, and friends for the duration of the enforced vacation are apparently zero where the company is concerned...). Obviously this recommendation would be disastrous under real-world conditions and one wonders how Ariely failed to think through his proposal.

A second example of this failure to think things through comes with Ariely's analysis of cap-and-trade. Rightly he points out that when you set a price on something (in this case pollution) then people may elect to pay more in order to get more. Just as we might only take a single candy from a tray being passed around the group but might buy ten if the candies are being sold, so too might companies pollute less if pollution were a "social good" rather than a priced good. With cap-and-trade companies might simply elect to pay more in order to feel free to pollute more. So Ariely proposes making pollution a "social good." But again a moment's thought shows this to be absurd. Not only do we have far too many examples of companies being quite happy to pollute when it's a cost-free exercise, Ariely's own book shows that executives will ignore social factors when their focus in on financial rewards. As executives are almost exclusively motivated by fat financial rewards, the notion that they would take social norms into account when deciding whether or not (or how much) to pollute is like saying that investment bankers would put the needs of their clients and the financial system in general ahead of their own desire for the $100 million bonus they get from pushing CDOs onto unsuspecting dupes.

So in the end the book is worth reading for its anecdotal value but not for Ariely's own conclusions or policy suggestions. He's not-quite an economist and not-quite a behavioral psychologist and ultimately that means he's not-quite useful as a guide to policy formulation on either the micro or the macro scales.

Alas, I read “Thinking, Fast and Slow (TFS)” before I read this book. So, a lot of stuff in this seemed to be a repetition.

So, how is this different from TFS. While both the books are on the subject of Behavioral Economics, hower, Dan has kept the topics brief and discussions to the point, so that the interest is sustained. While he would have conducted innumerable number of experiments in course of the research, he has only referred to a select few in this book. And whatever his criteria for selection was, it was pretty good, as it kept the interest of the readers on. I would prefer it over TFS

A brief overview of the interesting concepts in this book, which can of good use in product and pricing decisions are:
Relativity – to make a line look smaller (or a product affordable), draw a bigger line next to it (or a more expensive model). You need not really put an effort to sell the expensive model, but it gives a relative idea. The important thing is that the products should be comparable, as human mind cannot function with incomparables.

Anchoring – Daniel had labored on this a lot in his book TFS. For a consumer to make a purchase, an appropriate anchor is important, which could be even the MRP. So, low MRP does not necessarily help to sell. The interesting revelation was that “ our first decisions resonate over a long sequence of decisions”!! So, get the customer first. Of course, one can de-anchor (don’t know if there is a word like that), for which uncomparable variants need to be introduced (Starbucks case ) and for which its own MRP becomes the anchor

Reaction to price changes : It lasts only as long as the memory of the old price persists, demand soon normalizes

Zero cost : Free is a powerful tool, although expensive to the consumer ( Woody Allens quote that “The most expensive sex is free sex” is so apt, although that was quoted more from the social norms context). So, make the consumers buy something for nothing. Add freebies for upselling, nothing much new about it. But using FREE! to drive social policies is interesting.

Social norms : Very powerful, but cuts both ways. Once a social norm it established, bringing in market norm will destroy it forever (the example of late pickup being charged at day care is a perfect example). Keep sending small gifts to the customer , they will yield good returns.

Influence of arousal : Frankly, not of much use in commercial, but was quite astounded to read and the experiment was an eye opener.

Price of ownership or endowment effect: Giving an option of refund if not satisfied is a very powerful hook in durable segment, as the endowment effect generally inhibits any urge to return.
Keeping doors open : This concept is quite detailed out in the book Paradox of Choice by Barry Schwartz. Too many options only destroy value

Effect of expectation and power of price : When we believe something beforehand that something will be good, it generally will be good an vice versa. So, manage your customer expectation. A high price only enhances the expectation

The continuum message is that human beings are mere pawns in a game whose forces they largely fail to comprehend. And that is where behavioral economics will be a strong feed into marketing – making sure that consumers make the right choice!!

The author does a good job of presenting a wide range of psychological traps and irrational tendencies to which humans fall prey. The book is well written(although somewhat wordy at times) and easy to read. There are many enlightening passages which resonated well and were profound. If anything, most people will come away much better informed about a range of human flaws after reading this book. Some of the reasons that I didn't give this book the full five stars is that the author often rehashes previous research and findings by other scholars and taylors experiments which confirm already known ideas. Also, the book is written rather unevenly in the sense that you have to get through many tedious and laborious passages to get to an interesting point. I definitely felt at many points while reading this book that the author was adding a lot of non-value added filler material to meet a certain page # quota for the publisher. Still, this is a good book which I recommend as the author has gathered some very interesting information from which many people can benefit.