In his best-selling new book Predictably Irrational, behavioral economist Dan Ariely examines the bizarre decisions people make at work and in life and uncovers some surprising truths about the way we think. Ariely recently discussed his findings with AMA's podcast program Edgewise. (Click here for the full interview.) In this excerpt, Ariely tells us about the "decoy effect" and other irrational forces.
Q: Let’s talk a little bit about the background of Predictably Irrational. The framework for the book is the emerging field of behavioral economics. What exactly is behavioral economics, and how does it differ from traditional economics?
Dan Ariely: The basic idea is that economics assumes that people are rational, and everything that comes from it. Behavioral economics is interested in the same questions about shopping and buying and falling in love and making investments in the stock market and so on, but without assuming people are rational. Instead it’s using experimental methods to find out what people are really doing, and it has very different predictions about what we should be doing in society as a consequence of that.
Q: People act irrationally. There’s no news there. They always have. But where your research stands out is that it shows while people may act irrationally, they don’t act randomly. Their irrational behavior follows predictable patterns that you identify in the book.
One example of that behavior you discuss is what you call the “decoy effect." What is the decoy effect?
DA: Imagine I offered you a trip to Rome, all expenses paid, or a trip to Paris, all expenses paid. Now, those two choices are hard to compare. It’s hard to know whether Rome is better than Paris. They have different food, different culture, and so on. But imagine that now I add another thing to the mix. I add an option that nobody wants, but is similar to one of those things. So, it’s a trip to Rome, all expenses paid, but it doesn’t include espresso in the morning. So, it’s very similar to the trip to Rome, but it’s without espresso.
Now, nobody in his right mind would choose the one without espresso. But what is interesting is that Rome without espresso makes Rome with espresso look better. And it makes it better not just relative to itself, but relative to Paris as well, and therefore people start choosing Rome.
The real funny thing here is if you think about it, you can actually introduce products into the market that nobody chooses but nevertheless have effect on what people end up getting.
Q: When it comes to managing and leading people, what are some of the other lessons you think can be learned from your research?
DA: One of the things about management is the idea that we live in two worlds. We live in the social world in which we do favors for people, and we live in the financial world in which we work for money. Let me give you an example. Imagine you invite me to come to your house for dinner and I am going to spend $40 buying you a bottle of wine. Now, it’s a very inefficient gift. I don't know if wine is the best thing to get for you, and even if it was, I’m not sure what wine would be the ideal wine to get you.
So, what I should be doing from a traditional economics perspective is to say, “Thank you very much for the invitation. Here is $40. Please buy yourself the best thing you can.” And financially this is best. But has it in any way increased our friendship? I don't think so.
So, gifts, while being financially inefficient, are actually very socially efficient because it would create a bond between you and me. Businesses, I think, are ignoring that. And, as a consequence, they are standing to lose loyalty and dedication for their employees.
Q: What about recognition? If somebody receives a plaque for something that he's done on the job and it comes with a check, do you press both the social recognition and the monetary buttons? Do the two cancel each other out? What have been your observations?
DA: It turns out that the money can sometimes chase the other part around. We did an experiment in which we gave people no money, a little bit of money, or a lot of money to do a boring task or to move a sofa. People worked very hard for no money. They don’t work at all for a little bit of money. When we pay them a lot, they work again.
When we substituted gifts for money—in other words we either gave them nothing, a small gift or a big gift—the response was different. While they were unwilling to work for a small amount of money, nobody got upset by a small gift, and people kept on working very hard.
Now, your question is, what happens when we do both? So, in our experiment, we gave people either nothing, a small gift, or a large gift, but when we gave them the gift we told them how much it cost us—“Here is a 50 cent candy bar.” “Here is a $5 Godiva chocolate box.” And the question is, which one of those would win, the money or the gift. And in our case what we saw was that the money won and people again were much less likely to work hard for a small gift when the money was mentioned.
So when money is mentioned, we apply the money norms. We think of it as job, and we’re less likely to do it. Interestingly enough, there are ways to hide it. You don’t have to give it in cash. You can give it as a gift. And all of those things, while being financially inefficient, can actually create more of a social relationship.
Imagine you worked for me, and I asked you what you would rather have, a weekend in the Bahamas, which will cost me $1,000, or the $1,000 in cash? You as the employee might prefer the cash. But as the employer, it might not give me the benefit desired. For example, if two weeks later I asked you to work longer or to do something extra for me, the Bahama trip may be the better motivator than the cash to induce you to accede to my wishes.