Book Review - Predictably Irrational by Dan Ariely

The primary principal of economics is that people are rational. However, anyone who has ever interacted with people knows this principal does not hold at all times. Economics does not recognize that people make decisions out of guilt, spite, loyalty, desire to be an individual, desire to fit in or any other number of emotions.

Here's a game to test how rational you are:
You are Player A. I am Player B. We start with $1,000,000. As Player A, you get to decide initially how to split the money. Make me an offer. As Player B, I will decide whether to accept or reject your offer. If I accept, the game is over. If I reject, I get to make you an offer, but now we have only $900,000 to split.

If this game were being played by 2 economists, (and I first played this game with another Econ student), Player A would make an offer that resulted in Player B getting close to $900,000 and keeping around $100,000.

In a rational world, Player A would accept any positive offer since something is better than nothing. Therefore, since Player A should accept any amount, Player B would make an offer giving him almost nothing and keeping nearly $900,000 for himself. If Player A wants more money, he needs only to offer Player B nearly $900,000.

(If anyone has nearly $1,000,000 and would like to play this game with me, please let me know. I'll even accept being Player A!)

Dan Ariely is a behavioral economist who sits in both the Business and Media schools at MIT. His book discusses many situations when the 'people are rational' pillar breaks down. He has conducted numerous experiments that revel that irrationality runs rampant - but that people are consistently irrational in some of their behaviors.

By understanding the causes of irrationality and why people do things that economists would say don't make sense, people can better understand why certain decisions are made. There are numerous beneficial results from deeper understanding of irrationality. Additionally, by understanding irrationality, it doesn't seem quite so strange.

The Economics of Peeps

Let's start by being less formal. There are a few things you need to know about me if you're reading this post: 1. I am a nerd. A card-carrying, proud nerd. 2. I love Peeps. I try and avoid sugars most of the time, but Peeps are an exception. There is something about the marshmallow chickens that break down my best intentions.

As a kid, there were two key varieties of Peeps - chickens and bunnies. They were packaged with either 15 chickens or 16 bunnies to a package. The stores always charged the same prices for these two types. I figured out pretty quickly - around the age of 8 or 9 - that although there were fewer chickens, they were heavier and therefore the better value. I have been happily eating chickens (always yellow ones) since.

However, everything changed this spring. Now, instead of 15 chickens or 16 bunnies, the packages contain 10 chickens or 12 bunnies. This means that a package of bunnies is now the better value. Does this mean that I am being a good economist and switching to bunnies? Sometimes, old habits trump pennies - I'm still hooked on chickens!

Predictably Irrational - A Comment about 'Free'

For much of the last week, I have been reading the book Predictably Irrational by Dan Ariely. One of the chapters displays the crazy decisions people make when they hear the word 'free'. In one experiment, he compares how many people will pay $.15 for a Lindor Truffle or $.01 for a Hershey's Kiss. The bulk of purchasers choose to buy the truffle. Each customer was limited to one chocolate.


In a subsequent experiment, he reduced the price of each by a penny. He found that despite the fact that each chocolate was reduced by the same amount, there was a huge shift in demand and customers overwhelming purchased a Kiss instead of a Truffle.


Ariely calculates utility as the difference (in some sort of unit) between the benefit received from the item purchased and the cost required to purchase it. Using this definition, the gap in utility between the Truffle and the Kiss will remain constant.


In the micro classes I have taken, the relationship between two products is the amount of one you would have to give up to purchase the other. Therefore, in the first experiment, a customer would need to forego 15 Kisses for one Truffle. However, when the Kiss is free, there is no amount of Kisses that could be foregone to earn the Truffle. Using this calculation to determine utility results in the customers being less irrational.

The Fattening of America - mini review and a critique of another study

I recently finished reading The Fattening of America by health economist Eric A. Finkelstein and Laurie Zuckerman. The basic premise of the book is that obesity rates in the U.S. have skyrocketed in the last 20 years due to advances that make food cheaper and make activity more expensive in terms of opportunity cost. If you look at the cost to buy a certain number of calories, you can buy more calories for less money if you purchase snack foods and soda rather than healthy items like fruits and vegetables. Additionally, advances in technology result in the automation of many jobs, creating far more sedentary workers in office jobs.

I've read several studies published in recent weeks that suggest the U.S. is over-reacting to the high rates of obesity and that since the obese will have shorter expected lifespans, the cost of obesity is negligible, if not positive. I disagree with the findings of Pieter van Baal at the Netherlands' National Institute of Public Health. The study estimated, using models and not actual subjects, the lifespan and health care costs for three groups: thin non-smokers, obese non-smokers and smokers. The following table are their estimates for lifespan and health care costs from the age of 20 forward:

	Lifespan	Health care cost	Incremental cost for final years	Average Cost
Thin non-smoker	84	$ 417,000	$ 11,500	$ 6,516
Obese non-smoker	80	$ 371,000	$ 15,000	$ 6,183
Smoker	77	$ 326,000		$ 5,719

Essentially, this analysis suggests that the obese non-smoker will live four fewer years than their non-obese peers, and save $11,500 per year in medical costs. As people in their 80's are also receiving Social Security from the government, there would be additional savings.

The study was again based solely on models and not actual data. Additionally, a lifespan of 80 or 84 years is longer than the average lifespan observed today. Also, the costs in the final years of life are high enough to drive the average health costs per year up nearly $800 for a 60 year period. My final critique is that there was no estimate for lost productivity or a decrease in quality of life between the groups.

This would be very interesting analysis to see, however, I feel the van Baal study has enough holes to draw the findings into question. If anyone is aware of a study with normalized data from actual subjects, please let me know.

Thank you.

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