B28 – You Are Predictably Irrational

In this week’s episode, Dano joins me in discussing some behaviors we as humans typically engage in that don’t make much sense logically–even more so strange, we tend to act irrationally in a consistently predictable manner.

Join us as we break down some of the most common examples in startups, business and life in this week’s edition of Cliff’s Notes.

As always, consume as you wish: read the notes, watch the show and/or read the detailed breakdown of Predictably Irrational below.

Cliff’s Notes – Predictably Irrational

Behavioral economics: we are predictably irrational in many ways
Most people don’t know what they want unless they see it in context so provide them with context

In order to make a man covet a thing, it is only necessary to make it hard to attain –Twain

You can anchor people by asking how much would they pay you for it vs. how much would they need to be paid for it
Cost of Zero: why we often pay too much when we pay nothing (more than money, we pay in time, data, giving up privacy, etc.)
Free can be an advantage in a relationship: biggest pain we feel is from paying $0 to $1, each additional dollar you spend you feel less marginal pain ($88 to $89 far less painful than $0 to $1)
- Pro tip: instead of splitting the check with your friend, pay for the friend and they feel joy of a free meal and no pain of paying and your pain is not as bad as the collective pain where you both to pay half (expecting of course your friend will pick up the check next time)
Customers & Employees: even if you treat as family and give extra perks like free coffee or events, this goodwill towards the company goes away when the company than switches to market norms by being tough
- So if you’re going to treat them eventually like market norms, avoid even trying social norms unless you can brace for the blowback (free service for scale to massive drop in users when enforce paying for service)
In economic exchanges, perfectly normal to have selfish and unfair behavior, but in social factors (like when an item is free), people keep social good in mind and things like fairness govern actions
People can’t predict their reactions if they are in a different emotional state making the prediction from when they will be making the decision (epidural and ice bucket)
Endowment effect: when we own something, we tend to value it more than others do

Deep Dive – Predictably Irrational

Behavioral economics: we are predictably irrational in many ways
Everything is relative: we rarely choose things in absolute terms
- Don’t have an internal value meter that tells us how much things are worth
- We focus on relative advantage of one thing over another and estimate value accordingly when easy to compare, if not we avoid comparing
- Most people don’t know what they want unless they see it in context
  - Bike from tour de France, set of speakers when compared with another set
- Offering high priced alternatives makes thing seem cheaper, just like the circle surrounded by either big or small circles
- When offer three options: -Paris, Paris, or Milan will pick Paris because easiest to find the best
  - So: web – 95, print 145, print + web 145 à go with print + web
- Bread maker: introduce more expensive and bigger one and sales of normal one sky high because now had two to choose from where before was wondering if even needed it
- Single, meeting women, bring a –you
- Publishing CEO salaries in hope of stopping high compensations, resulted in CEO’s demanding more than other person and compensation went up
- Person’s satisfaction with salary is based on comparison with wife’s sister’s husband as which is better
- Counter it: move towards smaller circles that boost our relative happiness by looking only at ones you can afford, look narrow to broad: would waste 15 minutes to save $5 on a sandwich or a suit?
- When meet someone in foreign country who is similar to you, instant bond because no one else is, then when meet at hoe, not special because everyone else similar to you as well
Fallacy of Supply and Demand: Why Price of Pearls and Everything Else is up in the air
- In order to make a man covet a thing, it is only necessary to make it hard to attain –Twain
- Imprinting: anchoring the ideal value once person buys the product of a certain type to pay that amount next time
  - Dutch auction: best way to do an auction, pay the what the second highest bidder bid so that pay what is the maximum price, not something over
- Arbitrary coherence: initial price setting is arbitrary, but once set, shapes expectations of future pricing (coherence)
  - Ask a question to create an anchor—doesn’t have to be related, i.e. last 2 digits of SSN, then based on that sets a price in person’s mind
  - Most powerful is that that sets the anchor for others that are perceived as “more valuable” for directly comparable products
  - Anchor only works when actually contemplating and imaging buying a product or service at that particular price
    - Initial anchors hold with us long after initial decision
  - Price for living: will pay same amount regardless if cost of housing is greater or less in that city
    - Get out of it by renting in new place for a few months to get accustomed to prices in area
  - Anchoring happens on our self with “self-herding”à where we believe something is good or bad on the basis of our own previous behavior
    - Paying so much for Starbucks and then again for larger coffee
      - They broke out of Dunkin Donut’s “anchor” by doing everything possible to feel different than Dunkin to allow for a new anchor
  - Can anchor people by asking how much would they pay vs. how much would they need to be paid to do X
    - Make it fun and optional vs. boring and necessary (aka work)
    - Work is whatever a body is obliged to do, play what it is not obliged to do
- What arbitrary decisions have we made in the past and built our lives on ever since?
  - Assuming original decisions were wise
  - See what we desire and where desire came from: ask how much pleasure you will be getting
    - When do something for first time, it is critical so pause
  - Even if once were reasonable to do something in a way, are they still?
  - Supply and demand: demand and price can be manipulated and market prices themselves that influence consumer’s willingness to pay
  - Sensitivity to price is result of our memory of what paid previously but in long term, will be forgotten and have much smaller LT effect than the ST
  - Free market is good if we are truly rational, we aren’t and need government intervention with policies at times
  - We believe we know what we want, but often it is a gut decision that we look for a rational explanation for
Cost of Zero: why we often pay too much when we pay nothing
- Zero Price effect: getting something for free is a source of irrational excitement
- Free! Can land us into trouble: purchasing things that we would never consider when compared with option of buying another item
- Hershey vs. Lindt: 1 cent and 15 cent à 0 cent and 14 cent…behaved irrationally
- When Free! We forget the downside: afraid of loss
- Free exchange: exchange these two for this 1, if never gave in first place for an exchange, would take the free (3 Hershey’s à 1 for small snickers, 2 for large snickers) but when Free! (3 Hershey’s, 0 for small 1 for large, chose free option)
- com: “free shipping”, free oil changes, free has unjustifiably large influence even vs. $1 shipping, had no effect when “$1 shipping on orders over x” vs. “Free shipping on orders over x”
- Free applies to the concept of time: time taken away from another: free museum day vs. $5, long lines, people wait and not as enjoyable but still do it
- Zero effects on food: 0 calories vs. 1 might feel so good, order fries (unhealthily overcompensating decision)
- When choosing between products, we often overreact to the free one
  - Want to draw a crowd: make something free
  - Want to sell more product: make part of the purchase free
  - Social policy: offer free thing not just decreases the cost
  - Free can be an advantage: splitting meal: pain of paying each dollar hurts less though, biggest pain from $0 to $1, so pay for friend they feel joy of free and no pain of paying and your pain not as bas as collective pain because reduction of each additional dollar
Cost of social norms: why we are happy to do things, but not when we are paid to do them
- We live in 2 worlds: social and market norms
  - Social: friendly, warm and fuzzy, requests, comply due to social nature and need for community, no instant payback necessary
  - Market: sharp, clear, give and take, comparable benefits, and prompt payments
    - When social and market norms collide, trouble set in
- With a task: those paid more worked harder than those paid less, but when asked for a favor did more
  - If was a gift, size of the gift not impact hard work, so can be small gift
    - If list price for gift, eliminates all “gift” effect
  - Non-profit: no volunteers to charge minimally for their service, many if for free
    - Once you enter market norms, social norms depart
  - Why do you not charge for your service? Because you can’t afford me
  - Thinking about money makes us act like money: more self reliance, lower community and willingness to help, less team work
  - Prime someone: scramble a word sentence for them to descramble that has certain connotations
  - When on date, don’t mention price of food because will then shift to market norms = awkward
  - Customers: treat as family: loyal, but all “family efforts” like free coffee or events go away when switch to market norms by being tough, so if going to treat them eventually like market, avoid even trying social
  - Employees: social tends to make them work harder, longer, passionately
    - But company needs to treat employees with LT social: like flexible when sick, job security, medical coverage
    - Often ignored for ST profit making: reason no corporate loyalty
  - $1000 cash or a gift worth $1000?
    - Cash can be used to maximize happiness, but gift creates more goodwill and resulting increase in performance than cash
    - Just don’t tell them how much it costs
  - Education: tie early learning to social implications like curing cancer
  - Money is one of the most expensive ways to motivate people, social cheaper and more effective
Power of a free cookie: ho free can make us less selfish
- When economic and social forces mix, the outcome is different then might expect
  - In economic exchanges, perfectly selfish and unfair behavior, but in social factors (like when an item is free), people keep social good in mind
  - With friends and last piece of sushi left on communal plate: becomes shared resource and usually left
- If obfuscate price for effort instead: middle ground of demand between free and paying or it
- Think about how to get more people to switch from paying for services to investing more of their own efforts
  - Not economically efficient but keeps in social arena and take into account welfare of others
- Cap and trade: make economical: ok to pollute if pay enough
  - Need to make pollution measurable, quantifiable and people to pay attention to social norm
- All this doesn’t work when emotions run high
Influence of Arousal: why hot is much hotter than we realize
- People can’t predict their reactions if they are in a different emotional state from when making the prediction
  - Sexual arousal: willingness to engage in unprotected acts and others go up
  - Child birth: epidural: denied while in “cold” state
- Applies to any kind of emotion
  - Reptilian brain takes over: to make informed decision, need to be in that same state to understand self and how would act
- Safe sex: condoms just in case, walk away before getting too aroused
- Major point: we need to help ourselves realize that we will react differently when calm and cool vs. hot and emotional
- Driving: limit distractions, music, and friends
Problem of procrastination and self control: why we can’t make ourselves do what we want
- When we make long term goals, we are in a cool state, when impulse buy or procrastinate you are in a hot state
- Giving up on long term goals for immediate gratification is procrastination
- Paper deadlines: firm given dates = best, but tools to choose own is second best, waiting until last minute is the worst
- Given freedom + tools to help decid = best, even though some don’t recognize own procrastination
- Recognize and admit it to be in a better state, then add tools and systems to prevent procrastination
  - Chose date of deadline and own punishment if procrastinate
  - Add with simplifying the process and bundle with easy to remember triggers
- Find method to curb impulse in heat of the moment
  - Checking email: 2 working days per week lost on email
- Variable schedule of reinforcement
  - Get a reward for doing action for a random, unknown number of things
  - Much more motivating that fixed reinforcement (know the interval of times it will come)
  - When remove reward variable after having it, people works much longer after it’s gone than fixed
- When negative experience of act you are trying to do for long term goal is coming, add a positive right before that lasts to after the negative (watch movie before getting sick/inject self)
- If desired behavior has immediate negative outcome, very difficult to promote even if long term outcome is desirable
  - So find tips and tricks that match immediate, powerful and positive reinforcements with the not so pleasant steps
- Don’t want to do positive until negative kicks in, if do that then will associate positive with negative feeling and be negative too
High price of ownership: why we overvalue what we have
- Endowment effect: when we own something, we tend to value it more than others do
  - Duke tickets: random event 2 groups, 1 sell wants 16x more than willing to buy even though both stood in line for so long
- Quirks
  - We fall in love with what we already have
  - We tend to focus on what we may lose versus may gain
  - We assume other people will see the transaction from the same perspective we do
    - Our feelings, memories, emotions
- Peculiarities
  - More work you put into something, more ownership you begin to feel “Ikea effect”
  - Feel ownership even before owning it
    - Bidding, ones with longest top bids felt stronger urge to pay more than originally planned “virtual ownership”
    - Trials: 30 day money back guarantee
      - Once we try it, we own it
      - Applies to opinions and points of view
      - Try to avoid a feeling of attachment to each purchase
  - Even stronger attachment when make small adjustments to it each day to make it more to your tastes
- Positivity bias: overly optimistic about anything that has to do with ourselves (better than average driver)
Keeping doors open: why options distract us from our main objective
- We feel compelled to keep as many options open as possible, even at a great expense
- Pillar/room to room game: even when “closing” wasn’t bead or permanent and had practice, still insisted on doing it
- To taste everything in life, we wear ourselves too thin
  - Sale: buy it because we never have another option too do so despite us not really wanting it
- Also when we fail to realize a door is closing: too much time at a job to raise kids
  - A couple living together: spend no quality time, when could only see on weekends, maximize it
- We need to consciously close doors: bigger doors and “dreams” harder to close
  - Need to shut unneeded ones because draw energy and commitment away from others we do need open and drives us crazy because too thin
- When 2 things are similarly attractive: hardest because frequently left stuck in the middle: consequences of not deciding and relatively minor difference between the two that would have come either way
  - Cameras: 3 months to decide = lots of photos not taken in time took to decide
Effect of expectations: why the mind gets what it expects
- If you tell someone up front that something will be distasteful, odds are they will agree with you
  - Not because of experience, but because of expectation
  - Coffee in upscale place vs. not upscale said tasted better
- Explain something after experience to reinforce/provide rational for it, not before
  - Vinegar in beer: allow them to do it and provide detail plan after they experience it and they will follow it
- Other cues we take to develop our perception
  - Ambience,
  - Environment
  - Depth of description/fancy words
  - Presentation
- Expectations play a role in building a brand too
  - Coke vs. pepsi: drug effect of sugar, but added association with coke’s brand, when we know which brand was which, chose coke, blind chose Pepsi
- Stereotyped people react differently when they are aware of the label they are forced to wear “primes” them
- Current sate of mind and how we view ourselves can be primed by thinking of other situations
- Try to approach facts blindly without knowing which side did what
- Acknowledge we are biased and proceed
  - Prime experience first because in absence of expertise or perfect info, we look for social cues to help us figure out how much we are or should be impressed and our expectations take care of the rest
Power of price: why a 50-cent aspirin can do what a penny aspirin can’t
- Placebo’s are highly powerful: can effect our perception and subjective and objective experiences
  - Arthritic knee surgery: power of suggestion
    - We believe in caregiver or drug or product
    - Conditioning: body builds up expectancy after repeated experiences: pain and pleasure
- Familiarity breeds expectations
- Expectations affect outcomes: even negatively to nothing if know
- Higher price vs. discount drugs
  - Even negatively impacts if told price versus had nothing at all
- Message on the bottle and price was arguably more powerful than the product
  - Can break it by stopping to reflect on relationship between price and quality
    - Discount is largely unconscious reaction
  - How the mind achieves success with placebos is not always clear
    - Is with pain it is clear: releases hormones
  - So should doctors do it?
    - Antibiotics to help with should, should do it with great confidence too if do do it
  - How can we provide “discount” medical service to poor without giving them less effective treatments their mind thinks? Are we doomed to have skyrocketing cost of healthcare?
  - Marketers: need to create hype and work to make it real value
  - Shouldn’t always test placebo because might be unethical *non-heart operation), but will cost time and wasted advances in true solutions if don’t do it
Cycle of distrust: why we don’t believe what marketers tells us
- We are always looking for a catch, we’ve been burned in the past by one or another and we’ve taken and applied distrust to most things
  - Tragedy of the commons: all take only what needed and it replenishes itself
    - In short term some take more and more and do better than others, but then unable to resupply itself and community fails in long term
  - Most companies miss or ignore fact that trust is an important public resource and losing it has long term negative consequences for everyone
  - Doesn’t take much to ruin trust and few bad players can spoil for everyone
    - Need to protect as a public resource
  - Even if honest person, will be “discounted” by other as the normal thing is to lie just a little bit
    - Everyone else does it so you have to do it, leads to you doing it a lot
  - Unambiguous statements unattached to anything, people accept, once claim a particular company or political party said it, people mistrust and try to find exceptions
    - Even if it was their political party that they sided with who said it
  - Audio quality: read about it in a “branded” material
    - Willing to pay less and not as good
    - “Unbiased” material like Consumer Report, they liked product more and willing to pay more
    - This is with trusted brands, imagine untrusted brands
  - Distrust stick especially if have to deal with same company again
  - Transparency and sacrifice can restore public’s trust in long term
  - Can proactively address customer complaints on social media or own website “review”
    - Vulnerability is good
  - Markets allow a bit of lying, but too much and bites back hard and distrusts everyone else as well
Context of our character: why we are dishonest and what we can do about it
- All robberies: $525M, workplace theft: $600 B
  - We think 2 types of crooks: bank robber, and take small harmless things
- Majority of people cheated when given opportunity to, but just a little when they could
  - Reducing change of getting caught didn’t increase the amount they would cheat
- Honesty: isn’t a cost benefit analysis, but rather considered a moral virtue where little acts of honest trigger reward centers of brain, regardless if acknowledged for it or not
- Our internal honesty monitor: only when we contemplate big transgressions
  - Off when little transgressions, “it’s okay its so small”
- But groups and government have horrible honesty: outrageous interest, eroding ethics regardless of rules, will find a way around them
- If primed or reminded of honor/honest/a code of conduct before, were honest
- But once professional ethics (social norms) decline, getting back won’t be easy
  - Try to setup rules to avoid dishonest situation altogether
- USE HONOR CODES
Why dealing with cash makes us more honest
- Easy to take small thing like red pencil, hard to take actual cash, even if 10 cents
- Cheating is a lot easier when removed a step from money
- Cheated more on test when got a token for right answer that then exchanged for money with another person
- Wasn’t about cost of item or fear of being caught, was about ability to justify the use of expense account
- Bend even more when have admin assistant fill out expense report
- As we go more electronic in payment: act more and more dishonest because one step removed
  - Need to understand this as a society as cash is coming to a close
  - Corporations doing this by “fine print” and bending rule like blackout dates
Behavioral economics and free lunches
- At table with out=loud ordering: each ordered different beer, even if wanted another, urge increases more the more “desire to be unique” increased
- Means will sacrifice personal utility for reputational utility
- Means when order: trying to maximize utility of what order + portray themselves in positive light to friends
  - In Hong Kong where urge to conform: many ordered same thing vs. different
- Can announce order before it comes or can go first (no change in utility for first to order)
- Economic theory based on us acting rationally, time and again we don’t and that’s where there is “free lunch” because people are susceptible to irrational influences
  - Save more of a percentage of your future salary increase, easier than picking percentage now
- We are limited to tools nature gives us: aka irrational at times
- Doesn’t mean we are helpless, can understand when and where we made erroneous decisions and put processes, rules, policy in place to revise that thinking

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