I love behavioral economics, the study of how thoughts and emotions influence our decisions.  My specific interest is in behavioral finance, which would be how those thoughts and emotions influence our relationship with money.  Months ago, I had run out of good behavioral economics books to read, so I contacted one of the editors of “The Journal of Behavioral Finance”, Dr. John Payne of Duke University and asked him to recommend some books.  He rightfully pimped the new book of one of his colleagues, Dr. Dan Ariely, Predictably Irrational.

Dan is not your every day professor.  He survived an explosion as a teenager in Israel and spent a lot of time in a hospital recovering from burns all over his body.  Not that you really care about his personal strife, but it helps to paint a picture of how he became so brilliant.  Someone that spends an enormous amount of time trapped in a prison of any kind becomes either crazy, or an intellectual.  For Dan it was a hospital, others could be in jail, in my case it was church.  Spending so much time alone with your thoughts allows your mind to explore the vastness of humanity.  Most of us either fall asleep or get lost in these thoughts dreaming of BMWs, but Dan put his to good use.  He carries high honors for his work from both MIT and Duke University’s business schools (both top 10 programs), having earned his PhD from the latter.

The book sets out to illustrate how life affects the decisions we make.  The premise is of course that we often make the wrong decision.  Chapters are broken into different topics that Dan and his partners in crime have set out to test.  I won’t cover them all, you must read the book.  The following three examples (two of which are from his book, the other is a personal experience) should sufficiently illustrate how the book works:

Balsamic Budweiser And Why Your Expectations Ruin Your Life
Would you like to try some beer with balsamic vinegar in it?  Yumm.  Dan made that compelling offer to local college students.  When he didn’t tell the students they were drinking Budweiser with balsamic vinegar in it, they actually liked the taste and enjoyed the beer; many opted to have a full glass.  The students that were told of the secret ingredient before they tried the tainted Bud did not enjoy it nearly as much.  Ariely’s conclusion was that prior knowledge does not influence an actual event, only the perception of the event. Liken this to something in your life.  It’s why you aren’t supposed to test the pool water before you jump in.  It’s why you shouldn’t assume Weakonomics is a boring site simply because this writer has poor creativity with titles.  When you go into something having already decided what the outcome will be, your mind will alter your perception of it to match your expectation.  It’s why people are rarely surprised.

Relatively Speaking, You Have No Choice
Dan was reading The Economist, a magazine that I’ve contemplated suing for not actually having an author named “The Economist”, and saw an ad for a subscription.  There were 3 options: Online Only – $59, Print Only – $125, Online and Print – $125.  Think that’s odd?  You’d think instead that online and print should be $184 or something like $150.  At $150 it would still appear to be a value.  However this pricing structure gives you no real options.  if you want the print version you might as well get the online that comes with it.  You likely won’t opt for the online thing only, since it’s “free” with the print/online package.  Humans don’t like making decisions, we prefer to have them made for us, even if we don’t know it.  In the case of The Economist, you will go for the Online and Print option because it has the best value relative to the other choices.

Pay Me In Beer And It’s Called A Favor
This is my example, derived from one of Dan’s chapters.  My brother and I used to live in the same town, one summer he decided to move closer to work after his roommate moved to another city.  He’s my brother, so I wouldn’t charge him money to help move.  We don’t normally charge people we are close to for help.  However sometimes the one receiving the favor feels compelled to offer something in return for services rendered.  My brother offered beer.  There is an unwritten social contract that makes my brother paying me with money seem offensive. For the 4+ hours I may have helped him, an $8 six pack is not equitable to what I could make at work.  Had he paid me $2 an hour I might have stabbed him.  Instead, giving a gift in return for a favor is perfectly acceptable.  We like to pretend that $8 is the same whether it’s in beer or cash, but when you are handed currency, a line is crossed that generally cannot be uncrossed.  Ariely refers to these as market norms and social norms.

You’ve no doubt noticed a pattern with alcohol in my example and one of Dan’s.  One of the greatest strengths of his book is how he speaks to the reader.  He’s done many of his experiments with wine and beer, but he’s smart enough to know this isn’t the entire world of Americans.  Every time he does an experiment, he relates it to an activity we do regularly.  Whether it’s going out to eat, having a beer, or camping out for tickets, he knows how to test his ideas in the real world.

If you haven’t figured it out, I loved this book.  It is the best book I’ve read this year.  Normally I recommend going to the library, but I would tell you to buy this book so you can share it with people.  When you realize how often your behavior influences poor decisions you can really benefit your own wallet.

Finally, if it wasn’t enough to enjoy Dan’s writing, I enjoy the guy.  I felt like he was my friend after reading the book and his accessibility was most appreciated.  I sent him an email asking for some advice and he was kind enough to respond. Dan has a fan in me, and this is my favorite book of all time.

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categories: books, personal finance