ROBERT SIEGEL, host:
Dan Ariely conducts great experiments. They involve mock auctions, trick or treating on Halloween, selling chocolate to college students on campus. Ariely is on the faculty at MIT. He's on leave, teaching at Duke. He is a behavioral economist.
Dan Ariely tries to answer the question, how do we make economic decisions. And here's his conclusion: we don't do it the way economists typically say we do. We are predictably irrational. That's the title of his book.
Here's one of his concerns. How do we come to attach a value, a price that we're willing to pay for a piece of candy?
Professor DAN ARIELY (Behavioral Economist, MIT; Author, "Predictably Irrational"): Think about a piece of chocolate. It's melting in your mouth, you feel it, you smell it, you taste it, there's a little nut inside. In standard economic lingo, you should have a reservation price you should have the maximum willingness to pay for this particular experience. But if you reflect on it and you say, how do I actually do it; how do I take this experience and translate into money, you would realize that it is in fact a very hard exercise. It's completely unclear how we map pleasure onto money.
SIEGEL: Mm-hmm. Yeah. I'm thinking of this piece of chocolate. If it's inside the mini bar of a hotel room in a multi-star hotel with a fancy European label, I might be willing to pay a lot more then, though, than something at the office that's standing on a counter.
Prof. ARIELY: And the experience will not be very different itself. It's just that the - our willingness to pay, it turns out, is not just a function of the utility of the pleasure that we expect to get from it, it's also influenced by all kinds of irrelevant factors that change our psychology but not our economic reasoning.
SIEGEL: Now, I'd like you to relate the actual field work, the experiments that you've done on, I guess, somewhat unwilling MIT students with the price of chocolate.
Prof. ARIELY: So we came to a big class of students and we asked them all to give us their last two digits of their social security number. So in my case, it will be 79. And then we asked them to write that number next to each of the products - there were wine bottles, there were computer parts, there were books, there were chocolates - so I would write $79 next to each of those. And after that we asked them to write whether they would pay that number. So whether they would pay, in my case, $79 for each of those products and they wrote yes or no.
And then we got to the crux of the experiment, in which we asked them to bid in an auction on each of those items - any price that they would. And everybody bid. We found out who was the highest winner. They got up. They paid their price and they got their product.
But then what we did was to calculate the relationship between people's social security numbers and their willingness to pay in the auction. Now, this sounds like a very strange idea.
Prof. ARIELY: Aside from the fact that they have made a decision about the social security number. They said, would I pay $79 for this thing, yes or no. and the question was, would this initial decision penetrate their next decision. And the answer was very much so and, in fact, the correlation between their social security numbers and how much they'll pay for the product ended up being at about 0.5.
SIEGEL: That the lower the person's social security number - the last two digits -the lower the price they'd be willing to bid.
Prof. ARIELY: That's right. But it's not the fact that people with high social security are prone to pay a lot of money for everything in their lives, it's the fact that they contemplated that number. I mean, we could have made them contemplate all kinds of things. We could have made them contemplate the weather, their shoe size, whatever it was. But once they contemplated something, when they came to their next decision, the first contemplation lasted and influences their later decisions as well.
SIEGEL: Because you've made me think about a number in my head - the last two digits of my social security number - and relate it to things, it remains a benchmark in my mind.
Prof. ARIELY: That's right. So in my case, I would think, yes, I said $79 was too much for this wine. How much is okay? Well, maybe 65. But I stay too close to that number.
SIEGEL: Now, you also have an experiment in which you illustrate the remarkable power of giving away things for free, where the price is zero.
Prof. ARIELY: Yes. The interesting thing is that many times, free things are good but the question is, what happens when free actually has a downside. What happens that to get a free cone of ice cream, you have to stand two hours in line? Are people going to overvalue free and be willing to do too much for it and in fact end up paying too much?
So we did a large set of experiments. Maybe the most cute one is one in which kids who came to, on Halloween to my house one day, and I first gave them all three Hershey Kisses, and asked them to keep their hand open and to keep the three Hershey Kisses outside, not in their bag. And then I gave them another option. I said, here I have two Snickers bar, a small Snickers bar and a large Snickers bar. And I will give you one of those - and only one of those - but here's the deal, if you want the small one, give me one Hershey Kiss. If you want the big one, give me two Hershey Kisses.
SIEGEL: You just gave them the Hershey Kisses before this?
Prof. ARIELY: That's right. So I knew they had them. And now they had to decide basically was it worthwhile giving me an extra Hershey Kiss for the bigger one compared to the small one. And virtually everybody saw that this was a fantastic deal, you know. Just chocolate per chocolate, they got eight times their investment...
(Soundbite of laughter)
Prof. AREILY: ...for getting their...
(Soundbite of laughter)
Prof. ARIELY: ...for getting the large Hershey Kiss. But here is the other thing that I gave to another set of kids. I discounted both Snickers bar by the same amounts. I said, you could have the small one for free, or you could get the big one for one Hershey Kiss. Now, the relationship was the same. They should have still asked themselves it is worthwhile to give an extra Hershey Kiss to get the big one and, in fact, it was still a tremendous deal.
But in this case, the kids went largely for the free one. Basically giving up a better deal, a fantastic deal, just because of the allure of free. And, by the way, this is not just with kids. We replicated experiments with Amazon gift certificates and products and chocolates with MIT students and adults. And everybody has the same issue: that free is such a hot button that many times it tempts us so much that we end up paying a high price or give up something better just for the allure of free.
SIEGEL: By the way, did you happen to catch any of the conversations between the trick-or-treating kids and their parents as they left your front door on that Halloween?
Prof. ARIELY: So many of the parents were very concerned.
SIEGEL: I'm not surprised. Yes.
Prof. ARIELY: You know, some of them would let the kids walk alone so they kids feel a little bit independent. But as I started the offer, they would get closer and closer, checking out that I'm not doing anything fishy with their kids. And the kids actually took it very well. They're used to trading chocolates at Halloween and so on. But the parents were curious, and many of them remained and asked me questions about it.
SIEGEL: Well, just one last question before I let you go, which is, if indeed we are as irrational as you would have us, does behavioral economics pretty well make a mess of regular economics and say, that can't be describing human behavior since it's not the way we behave?
Prof. ARIELY: That's right. So behavioral economics flies in the face of standard economics in two ways. One is we say, your model of human being is wrong. And the second and more important thing is saying, as a consequence of this, your prescription for policy is also wrong. And that's actually the most important part of this. If you understand the places where people are irrational and make mistakes, you need to think differently about the policies for health care, for saving, for driving, for smoking, for anything you want that is different from the one that standard economics prescribes.
SIEGEL: Well, Dan Ariely, thank you very much for talking with us.
Prof. ARIELY: My pleasure. Thank you.
SIEGEL: Dan Ariely's book is called "Predictably Irrational." In the introduction he writes about the time in his life when he became intrigued by these questions: three years as a patient in an Israeli burn unit. You can hear that story at our Web site, npr.org.
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