Predictably Irrational (6 page)

One day, to the surprise of my students, I opened the day's lecture on managerial psychology with a poetry selection, a few lines of “Whoever you are holding me now in hand” from Walt Whitman's
Leaves of Grass
:

          
Whoever you are holding me now in hand,

          
Without one thing all will be useless,

          
I give you fair warning before you attempt me further,

          
I am not what you supposed, but far different.

          
Who is he that would become my follower?

          
Who would sign himself a candidate for my affections?

          
The way is suspicious, the result uncertain, perhaps destructive,

          
You would have to give up all else, I alone would expect to be your sole and exclusive standard,

          
Your novitiate would even then be long and exhausting,

          
The whole past theory of your life and all conformity to the lives around you would have to be abandon'd,

          
Therefore release me now before troubling yourself any further, let go your hand from my shoulders,

          
Put me down and depart on your way.

After closing the book, I told the students that I would be conducting three readings from Walt Whitman's
Leaves of Grass
that Friday evening: one short, one medium, and one long. Owing to limited space, I told them, I had decided to hold an auction to determine who could attend. I passed out sheets of paper so that they could bid for a space; but before they did so, I had a question to ask them.

I asked half the students to write down whether, hypothetically, they would be willing to pay me $10 for a 10-minute poetry recitation. I asked the other half to write down whether, hypothetically, they would be willing to listen to me recite poetry for ten minutes if I paid them $10.

This, of course, served as the anchor. Now I asked the students to bid for a spot at my poetry reading. Do you think the initial anchor influenced the ensuing bids?

Before I tell you, consider two things. First, my skills at reading poetry are not of the first order. So asking someone to pay me for 10 minutes of it could be considered a stretch. Second, even though I asked half of the students if they would pay me for the privilege of attending the recitation, they didn't have to bid that way. They could have turned the tables completely and demanded that I pay them.

And now to the results (drumroll, please). Those who answered the hypothetical question about paying me were indeed willing to pay me for the privilege. They offered, on average, to pay me about a dollar for the short poetry reading, about two dollars for the medium poetry reading, and a bit more than three dollars for the long poetry reading. (Maybe I could make a living outside academe after all.)

But, what about those who were anchored to the thought of being paid (rather than paying me)? As you might expect, they demanded payment: on average, they wanted $1.30 to listen to the short poetry reading, $2.70 to listen to the medium poetry reading, and $4.80 to endure the long poetry reading.

Much like Tom Sawyer, then, I was able to take an ambiguous experience (and if you could hear me recite poetry, you would understand just how ambiguous this experience is) and arbitrarily make it into a pleasurable or painful experience. Neither group of students knew whether my poetry reading was of the quality that is worth paying for or of the quality that is worth listening to only if one is being financially compensated for the experience (they did not know if it is pleasurable or painful). But once the first impression had been formed (that they would pay me or that I would pay them), the die was cast and the anchor set. Moreover, once the first decision had been made, other decisions followed in what seemed to be a logical and coherent manner. The students did not know whether listening to me recite poetry was a good or bad experience, but whatever their first decision was, they used it as input for their subsequent decisions and provided a coherent pattern of responses across the three poetry readings.

Of course, Mark Twain came to the same conclusions: “If Tom had been a great and wise philosopher, like the writer of this book, he would now have comprehended that work consists of whatever a body is obliged to do, and that play consists of whatever a body is not obliged to do.” Mark Twain further observed: “There are wealthy gentlemen in England who drive four-horse passenger-coaches twenty or thirty miles on a daily line in the summer because the privilege costs them considerable money; but if they were offered wages for the service, that would turn it into work, and then they would resign.”
*

W
HERE DO THESE
thoughts lead us? For one, they illustrate the many choices we make, from the trivial to the profound, in which anchoring plays a role. We decide whether or not to purchase Big Macs, smoke, run red lights, take vacations in Patagonia, listen to Tchaikovsky, slave away at doctoral dissertations, marry, have children, live in the suburbs, vote Republican, and so on. According to economic theory, we base these decisions on our fundamental values—our likes and dislikes.

But what are the main lessons from these experiments about our lives in general? Could it be that the lives we have so carefully crafted are largely just a product of arbitrary coherence? Could it be that we made arbitrary decisions at some point in the past (like the goslings that adopted Lorenz as their parent) and have built our lives on them ever since, assuming that the original decisions were wise? Is that how we chose our careers, our spouses, the clothes we wear, and the way we style our hair? Were they smart decisions in the first place? Or were they partially random first imprints that have run wild?

Descartes said,
Cogito ergo sum
—“I think, therefore I am.” But suppose we are nothing more than the sum of our first, naive, random behaviors. What then?

These questions may be tough nuts to crack, but in terms of our personal lives, we can actively improve on our irrational behaviors. We can start by becoming aware of our vulnerabilities. Suppose you're planning to buy a cutting-edge cell phone (the one with the three-megapixel, 8× zoom digital camera), or even a daily $4 cup of gourmet coffee. You might begin by questioning that habit. How did it begin? Second, ask yourself what amount of pleasure you will be getting out of it. Is the pleasure as much as you thought you would get? Could you cut back a little and better spend the remaining money on something else? With everything you do, in fact, you should train yourself to question your repeated behaviors. In the case of the cell phone, could you take a step back from the cutting edge, reduce your outlay, and use some of the money for something else? And as for the coffee—rather than asking which blend of coffee you will have today, ask yourself whether you should even be having that habitual cup of expensive coffee at all.
*

We should also pay particular attention to the first decision we make in what is going to be a long stream of decisions (about clothing, food, etc.). When we face such a decision, it might seem to us that this is just one decision, without large consequences; but in fact the power of the first decision can have such a long-lasting effect that it will percolate into our future decisions for years to come. Given this effect, the first decision is crucial, and we should give it an appropriate amount of attention.

Socrates said that the unexamined life is not worth living. Perhaps it's time to inventory the imprints and anchors in our own life. Even if they once were completely reasonable, are they still reasonable? Once the old choices are reconsidered, we can open ourselves to new decisions—and the new opportunities of a new day. That seems to make sense.

A
LL THIS TALK
about anchors and goslings has larger implications than consumer preferences, however. Traditional economics assumes that prices of products in the market are determined by a balance between two forces: production at each price (supply) and the desires of those with purchasing power at each price (demand). The price at which these two forces meet determines the prices in the marketplace.

This is an elegant idea, but it depends centrally on the assumption that the two forces are independent and that together they produce the market price. The results of all the experiments presented in this chapter (and the basic idea of arbitrary coherence itself ) challenge these assumptions. First, according to the standard economic framework, consumers' willingness to pay is one of the two inputs that determine market prices (this is the demand). But as our experiments demonstrate, what consumers are willing to pay can easily be manipulated, and this means that consumers don't in fact have a good handle on their own preferences and the prices they are willing to pay for different goods and experiences.

Second, whereas the standard economic framework assumes that the forces of supply and demand are independent, the type of anchoring manipulations we have shown here suggest that they are, in fact, dependent. In the real world, anchoring comes from manufacturer's suggested retail prices (MSRPs), advertised prices, promotions, product introductions, etc.—all of which are supply-side variables. It seems then that instead of consumers' willingness to pay influencing market prices, the causality is somewhat reversed and it is market prices themselves that influence consumers' willingness to pay. What this means is that demand is not, in fact, a completely separate force from supply.

A
ND THIS IS
not the end of the story. In the framework of arbitrary coherence, the relationships we see in the marketplace between demand and supply (for example, buying more yogurt when it is discounted) are based not on preferences but on memory. Here is an illustration of this idea. Consider your current consumption of milk and wine. Now imagine that two new taxes will be introduced tomorrow. One will cut the price of wine by 50 percent, and the other will increase the price of milk by 100 percent. What do you think will happen? These price changes will surely affect consumption, and many people will walk around slightly happier and with less calcium. But now imagine this. What if the new taxes are accompanied by induced amnesia for the previous prices of wine and milk? What if the prices change in the same way, but you do not remember what you paid for these two products in the past?

I suspect that the price changes would make a huge impact on demand if people remembered the previous prices and noticed the price increases; but I also suspect that without a memory for past prices, these price changes would have a trivial effect, if any, on demand. If people had no memory of past prices, the consumption of milk and wine would remain essentially the same, as if the prices had not changed. In other words, the sensitivity we show to price changes might in fact be largely a result of our memory for the prices we have paid in the past and our desire for coherence with our past decisions—not at all a reflection of our true preferences or our level of demand.

The same basic principle would also apply if the government one day decided to impose a tax that doubled the price of gasoline. Under conventional economic theory, this should cut demand. But would it? Certainly, people would initially compare the new prices with their anchor, would be flabbergasted by the new prices, and so might pull back on their gasoline consumption and maybe even get a hybrid car. But over the long run, and once consumers readjusted to the new price and the new anchors (just as we adjust to the price of Nike sneakers, bottled water, and everything else), our gasoline consumption, at the new price, might in fact get close to the pretax level. Moreover, much as in the example of Starbucks, this process of readjustment could be accelerated if the price change were to also be accompanied by other changes, such as a new grade of gas, or a new type of fuel (such as corn-based ethanol fuel).

I am not suggesting that doubling the price of gasoline would have no effect on consumers' demand. But I do believe that in the long term, it would have a much smaller influence on demand than would be assumed from just observing the short-term market reactions to price increases.

A
NOTHER IMPLICATION OF
arbitrary coherence has to do with the claimed benefits of the free market and free trade. The basic idea of the free market is that if I have something that you value more than I do—let's say a sofa—trading this item will benefit both of us. This means that the mutual benefit of trading rests on the assumption that all the players in the market know the value of what they have and the value of the things they are considering getting from the trade.

But if our choices are often affected by random initial anchors, as we observed in our experiments, the choices and trades we make are not necessarily going to be an accurate reflection of the real pleasure or utility we derive from those products. In other words, in many cases we make decisions in the marketplace that may not reflect how much pleasure we can get from different items. Now, if we can't accurately compute these pleasure values, but frequently follow arbitrary anchors instead, then it is not clear that the opportunity to trade is necessarily going to make us better off. For example, because of some unfortunate initial anchors we might mistakenly trade something that truly gives us a lot of pleasure (but regrettably had a low initial anchor) for something that gives us less pleasure (but owing to some random circumstances had a high initial anchor). If anchors and memories of these anchors—but not preferences—determine our behavior, why would trading be hailed as the key to maximizing personal happiness (utility)?