Tuesday, January 13, 2009

All in the Mind - Your Irrational Mind

A great repeat episode of All in the Mind. Natasha Mitchell talks to Dan Ariely, author of Predictably Irrational, about our irrational mind. Since this is an older broadcast, we also get the transcript for those who'd rather read than listen.

Your irrational mind

Like it or not, you're not the beast of reason you think you are. Dan Ariely, a behavioural economist at MIT, argues that we're surprisingly and predictably irrational. Sex, freebies, expectations, placebos, price -- they all cloud our better judgment in rather sobering ways. Dan's unique research was partly inspired by a catastrophic accident which caused third degree burns to 70% of his body. He joins Natasha Mitchell in conversation.

Original broadcast: 29/3/2008

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Natasha Mitchell: You're with All in the Mind on ABC Radio National your network for plenty of rational discussion as you'd know. Today though we're being altogether unreasonable. Natasha Mitchell with you, great to have you on board. Are you the rational, deliberative being you think you are?

Extract from Hamlet:
What a piece of work is a man, how noble in reason, how infinite in faculties, in form and moving how express and admirable, in action how like an angel, in apprehension how like a god! The beauty of the world, the paragon of animals -- and yet, to me, what is this quintessence of dust? Man delights not me...

Dan Ariely: We follow our own behaviour. In a sense it's like you follow yourself in line, you see your own past behaviour you assume it was sensible and you follow it. And the next day you do it again, and again, and again until you stop thinking about whether it makes sense or not.

Natasha Mitchell: Dan Ariely, Alfred P Sloan Professor of Behavioural Economics at MIT in Boston hit the top five New York Times bestseller list this year with his lively book Predictability Irrational: The Hidden Forces that Shape our Decisions. It's based on 20 years of his own renowned research, often mischievous experiments with his subjects, from spiking their beer with vinegar, to having students masturbate, tell fibs -- even steal -- in the name of science. This is serious economic research. He argues in the book that we are fundamentally and predictably irrational when it comes to making decisions -- big and small. The fractured state of our financial markets presently being a prime example, or sub prime example I should say. Dan Ariely is my guest today on the program. Thanks, Dan.

Dan Ariely: My pleasure to be here.

Natasha Mitchell: You're a behavioural economist, it's a field which won Daniel Kahneman a Nobel Prize a few years ago. This is economics injected with psychology. But look in what ways has the field confronted conventional economic thinking?

Dan Ariely: We're doing our best to try it out and I think the question about the sub prime mortgage market is a good example. You know instead of economics thinking, we assume that everybody will pursue their best interest. But imagine I ask you to go now and borrow some money on a house. How much should you borrow, and how easy is it for you to figure out. In fact my wife and I are just about to buy a house, we've been looking for a while and I have to say it's incredible. We have no idea how to compute how much money we should offer on these houses. We know what they're asking but in some sense that's not the right question. The right question is how much is it worth to us? I mean how do we compute the utility and pleasure we would get out of each day about having a sun room and how do we multiply it by the amount of days that we expect to be here and how do we decide about how much of the money we should borrow, versus pay up front.

So what do people do? They basically follow rule of thumb. So they go to the bank and they say how much we should borrow and the bank says you should borrow 30%. So that's what people borrow. And as a consequence...

Natasha Mitchell: It's not rational.

Dan Ariely: It's just too difficult. There's a question of rationality and irrationality, but there's also a question of what does it mean to you to be human, and what can we reasonably expect from people to do.

Natasha Mitchell: Your interest in the nature of our irrational self begins with a truly horrific event that happened to you in your late teens. Tell us about that early experience if you can face sharing it again -- as I know you've had to do quite a lot.

Dan Ariely: Sure. Quite a few years ago I got in an explosion that got about 70% of my body covered with burns and I spent almost three years in hospital.

Natasha Mitchell: These were third degree burns weren't they and you were a young man.

Dan Ariely: Yes, it turns out when you have third degree burns there's no skin and it can't grow, there's not even cells to grow, so you have to get transplants. And when you have a lot of burns there's no places to get the transplants from so it takes a long time. They would take a little bit of skin from my stomach and transplant it and wait for the skin on my stomach to grow and then they would transplant some more. It's a very, very long process and all the while the big fear is of course infection and I got a few of those as well.

Natasha Mitchell: The other think you write about is having to have bandages removed regularly and replaced and in a strange and odd way this has informed your work as a behavioural economist, I gather.

Dan Ariely: Yes. In retrospect the most changing events was the bath treatments. Every day they would take me and the other burns patients into a bath, they would soak us for a while in a bath with iodine water, which stings of course, and then they would take the bandages off. And everybody has a bandage removed at some point and you must have contemplated when you should rip it quickly and have the duration short but the intensity high, or whether you should take it off slowly and have the duration long but the intensity low.

And the nurses had their way, and they would rip the bandages off one after the other quickly as they could and they would basically finish in about 45 to 50 minutes. And it was incredibly agonising because of the ripping. You know when you don't have skin the bandages do stick to the flesh and I debated this with them every day I would try to convince them that it's better to do it slowly and not have this incredible intense moment. And they told me I was wrong. And when I got out of the hospital a few years later and I started doing experiments I learned in a psychology class about experimental methods and I started doing experiments on pain.

In the beginning I didn't have much money so I had a very primitive lab, I bought a carpenter's vice and I would bring people in, I would crunch their fingers. I know it sounds a little bit evil and I would get people to experience longer durations with lower intensity and higher intensity and shorter duration with higher intensity and lower intensity, and pain that went up and pain that went down and with breaks and without breaks. And when I would finish that I would say OK how painful was this, and how painful was that, and which one of those two was more painful and less painful? I learned that the nurses were wrong, that slow would have been better than fast, that starting with the most painful part of my body and moving to the least painful would have been better and taking breaks would have been good.

Natasha Mitchell: So go slow with the bandages, not so fast.

Dan Ariely: That's right and then the big question -- I mean I also went to the burn department and told the nurses about it and there was an interesting discussion. But apart from that the thing that stuck with me is how could the nurses, how could they with all their caring and with all the huge amount of experience they had, how could they get things wrong? And it started me thinking about what other cases in life are there where good intentions and plenty of experience are in no way protecting us against being wrong. And everything I've done since then is about this.

Natasha Mitchell: Your book Predictably Irrational has been described as (and I thought this cute) a 'taxonomy of financial folly' and in fact what it documents is a whole host of experiments that you've done on students over the years. Let's come to some of those experiments -- there's one in which you investigate the irrational way we come up with prices to pay for things. Tell me about how you investigated the concept of anchoring.

Dan Ariely: Let me describe to you an experiment. So I come to a big class of students and I say today we are going to have an auction for all kinds of products. Here is some wine, and some books, and some chocolate, and some computer accessories -- have a look at all of them and get your opinions about them. And then I asked each of the students to write down the last two digits of their social security number and then we turned this into dollars. So in my case my last two digits are 79. I would write $79 next to each of those. And then we asked everybody to answer whether they would pay the price set by those two digits for each of those products.

Natasha Mitchell: A totally arbitrary number.

Dan Ariely: A totally arbitrary number. And then we asked people to bid and we found out the highest bidders and they paid the price and they got the product and everybody went home happy. And basically what we found out is that people with high ending social security numbers, for example people whose number ended in something higher than 80 were sometimes willing to pay two or three times as much as people who had low ending social security numbers.

Natasha Mitchell: So the very fact that they'd been instructed to write down the last two digits of their social security number and consider whether they'd pay that price before they bid at an actual auction, really, really influenced the price that they'd pay.

Dan Ariely: That's right, so think about it. It's basically about the role of your first decision in influencing your decisions down the line. You know many times when we make a first decision in the category -- how much we are willing to pay for this new thing, or this new service, or something like that -- we think about it as just the first decision. But in fact it's rarely just the first decision because when we come to the second decision we will take the result of our first decision into account and therefore we are very likely to repeat it again, and again, and again.

Natasha Mitchell: It's led you to suggest that we are in fact a pack of goslings when it comes to accepting prices.

Dan Ariely: That's right. So Konrad Lorenz was a very famous biologist who basically showed that when ducklings, the first creature they see when they get hatched out is the creature they follow and if they see their parent they follow their parent, if they see Conrad Lawrence the follow Conrad Lawrence -- and that's the kind of analogy I have for this is if it turns out we keep on doing the same thing over and over and over. And let me give you a kind of example for how this would play out in real life. So in economics there is something we call herding behaviour and the best way to think about herding behaviour is about lines in restaurants.

Imagine you walk down the street in a city you don't know and you see two empty restaurants. You don't know which one is better so you pick one at random. Somebody else comes down and they see one restaurant with one person and one restaurant is with nobody -- what do they pick -- of course, the one with one person. Somebody else comes, they see one restaurant with two people, one with zero, they pick the one with two, three, four, five and so on. Eventually one restaurant is a big hit, one is a complete failure and all of that with no information.

Natasha Mitchell: You suggest that all this undermines traditional notions of supply and demand acting to set the prices that we pay?

Dan Ariely: Yes, in standard economics there are two forces that determine prices: there is supply which is about the production and there is demand which is about how much we as consumers are willing to pay for things. And those two forces are supposed to be independent and where they meet this is where the prices are. And in fact when we do what is called the equilibrium analysis, or welfare analysis, in economics, we start from assuming that prices are rational and optimal. Now think about the social security experiment -- in real life where do we get social security-like manipulations, where do they come from? The come from manufacturers suggested retail price, and posted price, and discounted prices: do you want to pay $2.50 for a cup of coffee? Yes or no. Are you willing to pay $30,000 for a car? Yes or no, or $600,000 for a house? Yes or no. Now if those are the anchors, if those are the starting point that we have in society, it means that demand, how much we are willing to pay is not independent from supply but in fact it depends on it.

If we had the world in which supply was different we would have been willing to pay very different prices and as a consequence it means that the relationship between supply and demand is not what economics analysis thinks it is.

Natasha Mitchell: Well Dan Ariely is my guest on All in the Mind here on ABC Radio National and across the known universe on Radio Australia and as podcast. Now look why did you find yourself in a student watering hole lacing beer with vinegar in another of your experiments on irrational behaviour?

Dan Ariely: So one of the things that always interests me is the role of expectations and how expectation actually changes or can change the way we view reality. And here is what we did. We offered people two small samples of beer, one with balsamic vinegar and one without. Now interestingly enough when people don't know that one of the samples has balsamic vinegar they prefer it.

Natasha Mitchell: Only a couple of drops of balsamic vinegar.

Dan Ariely: Only a couple of drops, yeah. By the way I am not suggesting that as a business process because it turns out that balsamic vinegar is much more expensive than beer but it does make the beer a bit stronger, more robust, people seem to like it. Now we take another group of students and we say here are two beers, one has balsamic vinegar, one doesn't; this one has, this one doesn't taste them and tell us which one you like more. Now they hate the one with balsamic vinegar and it doesn't matter how much they taste it their expectation that this will be terrible is overwhelming the real experience. In some sense they are unable to experience the beer as being better because their expectations are so negative that this is it -- and their experience as no influence on that.

Natasha Mitchell: So expectations and presentation it turns out challenge our rational mind when it comes to making buying decisions as you're about to hear further. I'm Natasha Mitchell, MIT based behavioural economist Professor Dan Ariely is my guest on ABC Radio National's All in the Mind author of Predictably Irrational and a further probing our irrational selves Dan and colleagues have just published a very interesting study into price and the placebo effect. A mind boggling phenomenon at the best of times.

Dan Ariely: When I first became interested in placebo in the burn unit and one of the most amazing things to experience is somebody who is screaming in pain and a nurse goes to them with an injection and they immediately fall asleep, they completely get pain relief and later on the nurse tells me this was just saline water, just IV fluid, there was no pain killer in that. And when you experience that it really is amazing just to see how powerful this is. It turns out that the story of placebo for pain is actuarlly quite simple. We have the capacity within us to produce substances very much like morphine, opiates, now interestingly enough we can produce it but we can't directly control it. You can't close your eyes and say please, please, please, can I have some pain killers. But if a doctor injects you with an injection, or you pop a pill and you expected to get pain relief, you actually produce the pain killers that will eventually give you the pain relief. So we create the physiology that we later are going to experience. That's an incredible thought, that our brain can actually change our physiology to achieve what it thinks the physiology will be in the future.

Natasha Mitchell: Absolutely, it's extraordinary. But you've done an experiment that looked at the influence of price, the cost that someone would pay for a placebo. I mean this was a great experiment -- what did you do?

Dan Ariely: So we got people to come to the lab and we told them this was a medical testing facility and we have a new drug called Velladonna X and we had the pens with the logo of the company, and brochures and everybody wore a white coat and we tried to make it look as authentic as we could. And we connected people to a device that gave them a set of electrical shocks and we measured how painful they found those set of shocks and how much pain they could tolerate. And then we gave them a pill which turned out to be just a placebo, but we didn't tell them that of course, we gave them a pill that was supposedly Velladonna X, a new fantastic pain killer, and we asked them to sit for 15 minutes next to old Newsweek and Time magazines to really feel like a doctors office. And then we connected them to the same electrical shock mechanism, gave them the same set of electrical shock and asked them again to estimate the amount of shock pain they have and see how much they could tolerate.

And two things happened. The first is that people experienced pain reduction from the first set to the second set -- that's just the regular placebo experiment, the fact that people expect to get pain relief and their body creates the pain relief. But what we also did is when we gave people the pill we also gave them a brochure about the pill and we told different people different things about the pill. We had four different versions of the brochure. In one of them the pill was made in China and it was cheap, in one of them it was made in China, it was expensive, and in another one it was made in the US, it was cheap, in another one it was made in the US and it was expensive.

Natasha Mitchell: We're talking 10 cents versus $2.50 a pill.

Dan Ariely: That's right, so the price difference was very large -- and by the way when we told them it was cheap we crossed out the expensive price and wrote the discounted price next to it. And now the question is what will the information in the brochure about the price do to the efficacy of these pills. And the biggest effect was in the price. When we gave people discounted pain medication they were much less effective. Another thing that we found was that the price discount was particularly harmful for the people that it actually mattered most, for people who had been taking more pain killers recently, this discount was particularly harmful.

Natasha Mitchell: So it all seems that we literally get the placebos we pay for and a more expensive placebo is a more effective placebo.

Dan Ariely: That's right. Placebo is the body's ability to heal itself, it's just an incredible thing.

Natasha Mitchell: The irrational nature and poor evidence base of many medical interventions is especially of interest to you, especially from your own experience. How does this study further shape your thinking on that front?

Dan Ariely: One thing that really bothers me is how little studies we have on placebo effect and medical efficacy in general. To the extent that we don't do placebo studies, we're actually likely to inflict incredible pain on patients. So in my particular case there's this treatment after people get burns called Jobst which is a pressure bandage that they would put on all of us and it's an awful thing, it's actually quite hard to wear, elastic material, it really presses hard and makes it hard to walk and move, it tears the skin.

Natasha Mitchell: It makes you look like a thug, really, doesn't it, every time you walk into a shop?

Dan Ariely: It makes you look like a bank robber, the only holes I had were for my eyes and ears and mouth and two holes for my nose. And the rest of my body was covered from toes to finger nails. And this was a terrible treatment in a sense that it was incredibly painful every day. And I'd been trying to read on it and trying to figure out, do we have any evidence that it works? And it turns out that there isn't any medical evidence that this works. But because these doctors and physical therapists -- who are very good people -- believe in it they never test it and they basically give everybody this incredibly painful treatment. I wore mine for about two years and it did nothing. So that's something that really bothers me, is the lack of placebo experiments to actually figure out the extent to which medical things work and not work.

Natasha Mitchell: You've given electric shocks to subjects, but you've also done another extraordinary study into how sexual arousal clouds our better judgment. Look there's really no other way to put this study but you managed to get a sample of male students at Berkeley to fill out a computer survey while masturbating. What did you do -- and how is this relevant to your research?

Dan Ariely: Yes. You know we often experience emotions and the question is what do these emotions do to us? And I don't know about you but actually, have you ever gone to a supermarket or a restaurant hungry and as a consequence ordered too much food.=?

Natasha Mitchell: Indeed.

Dan Ariely: Have you learned after once never to do it again?

Natasha Mitchell: Absolutely not.

Dan Ariely: So that's really the question.

Natasha Mitchell: I don't profess to be rational.

Dan Ariely: OK, so the question is what happens when you're taken by hunger and how much do you understand how you would feel when you are not hungry? Now we could of course get our students to be hungry or frustrated or angry or all kinds of bad things, but we chose to get them to feel something happy like arousal and we also wanted arousal because they know it better. Arousal is something that we experience daily, particularly college students, so how much do they understand themself when they're aroused?

So here is what we did. We asked a set of questions about three topics: sexual preference -- and we asked them all kinds of things which ranged from relatively standard; would you enjoy having sex with somebody you hated, all the way to kind of slightly different -- being tied up, tying other people up, threesomes, contacts with animals -- all kinds of behaviours. And we asked them how much they would enjoy those things. And then we asked them about respect to women: would you tell a woman you love her even if you don't, will you try to get her drunk, will you try to get her drugged, would you try to force her to have sex and so on. And finally we asked them questions about condom use.

Now in all cases we asked them, how would you answer those questions when you are aroused? We asked them to predict how they will behave when they are aroused. And if they know anything about how they will behave when they are aroused, they should answer correctly.

Natasha Mitchell: And they were more conservative, very well behaved graduates, undergraduates.

Dan Ariely: Always respect women, always use a condom, not interested in any of our slightly kinky behaviours.

Natasha Mitchell: But then you got them to do the survey in the privacy of their own dormitory while masturbating -- what did you find?

Dan Ariely: That's right, so we gave them the same survey to ask the same questions how would you behave when you are aroused but now they had the benefit that they were aroused. We gave them some pornography and asked them to masturbate. And only when they got to a high level of arousal we asked them to answer the questions.

And now they were very different people. They were interested in all kinds of sexual behaviours. They thought they would not respect women, they were not afraid of STDs and in fact they didn't think they would use condoms very often. The big question here is how much do we really know ourselves when we are grabbed by emotion, and could it be that we become such different people that we in fact don't recognise ourselves in those things. And of course it's usually problematic because when we are in the midst of emotion we do make decisions that influence our life for a long time. We fight with our spouses, we have unprotected sex, we get angry while driving, we do all kinds of things that could have long-term consequences and we might not think about it this way.

Natasha Mitchell: A sort of Jekyll and Hyde phenomenon, and it beats me how you get some of these experiments through your ethics committees.

Dan Ariely: You know I have a lot of experience with them and slowly and slowly they trust me more and more. I think that's one of the benefits.

Natasha Mitchell: In all this, Dan, why don't we learn from our mistakes, why are we so predictably and consistently irrational as you suggest, when we also are creatures of reason as well?

Dan Ariely: Part of the story is that some of those mistakes we don't recognise. Like if you ask people to predict whether their social security number would influence their decisions they just say no, and when we ask people to say whether 'free' would get them overly excited and would get them to choose things that are not in their best interest, people don't think it would. And one of the hopes I have is that once people understand those behaviours a bit better, they might stop and slow down and say when I see 'free' now I'm not going to jump head first, I'm going to go slow and figure out if this is really free and it's really something I could do.

Natasha Mitchell: You suggest that we're pawns in a game whose forces we largely fail to comprehend -- our irrational selves in other words. I mean this is a very pessimistic view of human nature and capacity, surely.

Dan Ariely: Well I don't want to think about it as pessimistic, in some way the economic perspective is that the world is wonderful, that everybody is perfectly rational and the world is in equilibrium. And I look at the world and I see poverty and hunger and diseases and STDs and people drive badly and make repeatedly bad decisions. I don't want them to think this is equilibrium. I in fact want to think that we can do better. Now in economics we're perfect, we're rational and there's nothing we can do to make things better. In behavioural economics we a fallible and we make mistakes, and we're foolish and we're myopic and we're emotional. The good news is that if we understand those things we can actually create a better world.

Natasha Mitchell: But on the other hand people have argued that drawing too many conclusions from behavioural economics research is a risky enterprise, and that even if we're irrational actors at the individual level the market for example itself reflects a sort of aggregate wisdom of the crowd, albeit full of irrational actors.

Dan Ariely: I'm not a behavioural economist by religion, I'm an empiricist and I want to improve the world. If I see that all of these behaviours don't matter in a certain category I'm perfectly happy with that, but at the same time I don't see any evidence that these behaviours would cancel each other out in the market. Think of the most recent market collapse -- look, the stock market is supposed to be the most rational thing we have and we've just discovered with this recent collapse of the American stock market a few really bad structural things in the market.

So we discover that when banks were lending money there was an asymmetry of information, that the banks knew more than the people who were borrowing the money. And we discovered that then the banks went ahead and sold that risk to somebody else and again there was an asymmetry of information. How could it be the most held structure of rational thinking has inherent flaws in it? So I don't necessarily see that markets are necessarily going to fix things, I think they might as well make things worse, we don't know. And I also in terms of your question about are we doing too much with behavioural economics -- again, I'm an empiricists I think we should do more tests, do a bit more sceptical.

Natasha Mitchell: I mean traditionally of course we've seen that market forces can help us learn from our mistakes, can help us grapple with our own individual rationality. You don't think that's enough?

Dan Ariely: Well you know the problem is under what conditions will market forces help you? So think about something trivial, like coffee -- how much pleasure in terms of dollars are you getting from a cup of coffee? I don't know if it's 50 cents, $2.50, $5 -- I have no idea and I've been drinking a lot of coffee and the more coffee I drink and the more prices I encounter make me of course realise what the market is charging for it, but it's not helping me at all figuring out how much am I willing to pay for it. Now let's think about something more complex, buying a house. I have no idea, when I see a house, and I can look at the market and see hundreds of houses and I can see I like this one more than this one -- but how much money is this one worth more than this one? I have no idea. And I'm not even sure what will be the mechanism that would help me learn that.

Natasha Mitchell: Well Dan Ariely thank you. It's been a pleasure to have you on All in the Mind, thank you for excavating our irrational mind and I'm feeling distinctly less reasonable after reading your book. Thank you for joining us from the studios of Cornell University.

Dan Ariely: Thank you, it was a pleasure.

Natasha Mitchell: Dan Ariely, Alfred P Sloan Professor of Behavioural Economics at MIT, his new book Predictably Irrational: The Hidden Forces that Shape our Decisions is published by Harper Collins and you can grab the audio and transcript of the show on All in the Mind's website abc.net.au/rn/allinthemind. Email us from there too. And you can try Dan Ariely's experiments yourself and listen to extra bits of this interview, we'll link to those as well.

Of course you can find me at the All in the Mind Blog another space for your comments and discussion -- go for it. I'm Natasha Mitchell embracing my inner irrational self with pride -- catch you next week.


Professor Dan Ariely
Alfred P Sloan Professor of Behavioural Economics, Sloan School of Managament
Director - e-Rationality Group, MIT Media Lab
Massachusetts Institute of Technology (MIT)

Visiting Professor
The Center for Cognitive Neuroscience, and Economics
Fuqua School of Business, Duke University.

Further Information

All in the Mind Blog post for this program
Join host Natasha Mitchell in the All in the Mind blog....read and post comments.

Extra audio of All in the Mind's interview with Dan Ariely
Incorporated into an extended podcast of this week's program(downloadable for 4 weeks only, above - but also posted on the All in the Mind blog, at the above link).

Dan Ariely's Predictably Irrational website
Includes a blog by Dan Ariely.

Dan Ariely's Door Game
This game was part of an experiment Dan and colleagues undertook exploring how too many options can distract us when making decisions.

Interview with Dan Ariely conducted by Will Wilkinson (Research Fellow, The Cato Institute)
Published by Bloggingheads TV.

Painful lessons: Extended essay by Dan Ariely about his catastrophic burn accident
PDF file.

Academic papers by Dan Ariely and colleagues
PDF files.

What was I thinking? Review of Dan Ariely's work .
Published in the New Yorker Magazine, writtend by Elizabeth Kolbert. February 25, 2008.

Towards a Science of Wellbeing
Excerpt from a speech by Nobel Laureate of Economics and psychologist Daniel Kahneman, originally broadcast on All in the Mind, ABC Radio National (2003).

Behavioural economics article (Wikipedia)
ABC Radio National cannot vouch for the accuracy or emphasis of content published on Wikipedia (or any other external website). Consume at your own risk.


Title: Predictably Irrational
Author: Dan Ariely
Publisher: HarperCollins Publishers, London, 2008
ISBN-13: 978-0-00-726358-5


Natasha Mitchell

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