Dan Ariely

In today’s economy, consumers and financial institutions alike are constantly on the lookout for new ways to reduce spending. As you read this article, consider these questions: what cost-cutting habits has your organization developed, and are they rational? Do you recognize irrational or habitual spending tendencies in your own customers and members? If so, how can you help them make better decisions that lead to improved savings?

Money is an integral part of modern life. We constantly make decisions about whether we’re willing to pay for different products and, if so, how much we are willing to pay. In fact, we make decisions about money so often that we consider money to be a natural part of our environment.

However, money is a relatively recent invention, and despite its incredible economic usefulness it does come with its own set of problems. In particular, it turns out that decisions about money are often unintuitive and, in fact, quite difficult. Consider the following situation as an example: you are thirsty, tired, and annoyed and just want a cup of coffee. You see two coffee shops across the street from each other. One is a specialty coffee shop that sells handcrafted, designer coffee and the other is Dunkin’ Donuts, which sells standard, decent coffee. The price difference between the two options is $1.75 for your cup-a-joe. Now, how do you decide if the benefit of the handcrafted coffee drink is worth the additional $1.75?

What you should do (if you wanted to be rational about it) is consider all of the things that you could buy with that $1.75, now as well as in the future, and decide to buy the expensive coffee only if the difference between the two coffees is more valuable than all of those other possibilities.

But of course this computation would take hours, it is incredibly complex, and who even knows all the possible options to consider?

Heuristically Speaking

So what do we do when we need to make decisions but making them “correctly” is too time-consuming and difficult? We adopt simplifying rules, which academics call heuristics, and these heuristics provide us with actionable outcomes that might not be ideal but that help us to reach a decision. One of the heuristics we often use is to look at our own past behaviors, and if we find evidence of relevant past decisions, we simply repeat those.

In the case of coffee, for example, you might search your memory for other instances in which you visited regular or fancy coffee shops. Then you might assess which behavior is more frequent, and tell yourself, “If I’ve done Action X more than Action Y in the past, this must mean that I prefer Action X to Action Y” and as a consequence, you make your decision.

The strategy of looking at our past behaviors and repeating them might seem at first glance to be very reasonable. However, it suffers from at least two potential problems. First, it can turn a few mediocre decisions into a long-term habit. For example, after we have gone to a fancy coffee shop three times in a row and paid a premium for the same coffee we could get elsewhere, we might continue with this strategy for a long time without reconsidering how much we are really willing to pay for coffee.

The second downfall is that when market conditions change, we are unlikely to revise our strategy. For example, if the price difference between the regular and fancy coffee used to be $0.25 and over the years has increased to $1.75, we might stay with our original decision even though the conditions that supported it are no longer applicable.

Examine old habits

In light of our current financial situation, many people these days are looking for places to cut financial spending. Once we understand how we use habits as a way to simplify our financial decision making, we can also look more effectively into ways to save money.

If we assume that our past decisions have always been sensible and reasonable then we should not scrutinize our long-term habits. After all, if we’ve done something for five years, it must be a great decision. But if we understand that long-term, repeated behaviors might reflect our habitual decision making in the face of complex financial decisions more than they reflect what is truly best for us, we might first examine our old habits and carefully consider whether they indeed make sense or not. We can examine our subscription to the ESPN Sports Package, our annual subscription to the opera, our yearly Disneyland vacation, or our monthly visit to the hairstylist.

By examining these habits — and quitting them when it makes sense to do so — we might actually discover ways in which we could reduce our spending on a long-term basis.

Yes, money is complex, and it is incredibly difficult for us to carefully examine (and re-examine) every purchasing decision we make. But the advantage of examining our habits is that it might lead us to create better ones that will benefit us for a long time.

May you have a happy and exciting new year,

Dan

This column first appeared at http://www.deluxeknowledgeexchange.com

Here it is again: holiday gift-giving season – the best win-win of the year for some, and a time to regret having so many relatives for others.

Whatever your gift philosophy, you may be thinking that you would be happier if you could just spend the money on yourself – but according to a three-part study by Elizabeth Dunn, Lara Aknin, and Michael Norton, givers can get more happiness than people who spend the money on themselves.

Liz, Lara and Mike approached the study from the perspective that happiness is less dependent on stable circumstances (income) and more on the day-to-day activities in which a person chooses to engage (gift-giving vs. personal purchases).

To that end, they surveyed a representative sample of 632 Americans on their spending choices and happiness levels and found that while the amount of personal spending (bills included) was unrelated to reported happiness, prosocial spending was associated with significantly higher happiness.

Next, they took a longitudinal approach to the topic: they gave out work bonuses to employees at a company and later checked who was happier – those who spent the money on themselves, or those who put it toward gifts or charity. Again they found that prosocial spending was the only significant predictor of happiness.

But because correlation doesn’t imply causation, they next took one more, experimental, look at the topic. Here, they randomly assigned participants to “you must spend the money on other people” and “spend the money on yourself” conditions — and gave them either $5 or $20 to spend by the day’s end. They then had participants rate their happiness levels both before and just after the experiment.

The results here were once more in favor of prosocial spending: though the amount of money  ($5 vs $20) played no significant role on happiness, the type of spending did.

Surprised by the outcome? You’re not the only one: the researchers later asked other participants to predict the results and learned that 63% of them mistakenly thought that personal spending would bring more job than prosocial purchases.

Happy holidays

Dan

Consider some of illusion at the bottom of the demo page (click here to see it).

The two middle color patches look as if they are different, but in fact they are exactly the same. What is gong on here? How can it be that we see wrong? How can it be that eve after we are shown that these two patches are identical we still can’t see them accurately?

It is because our brain is wired in a particular ways and this wiring, while very good for some things, is not perfect — and it makes us susceptible to certain errors and mistakes. Moreover, because these mistakes are a part of us, we are fooled by them in predictable and consistent ways over and over.

Now, vision is our best system. We have lots of practice with it (we see many hours in the day and for many years) and more of our brain is dedicated to vision than to any other activities. So consider this — if we make mistakes in vision, what is the chance that we would not make mistakes in other domains? Particularly in domains which are more complex (dealing with insurance, money, etc.), and ones in which we have less practice? Domains such as decision making and economic reasoning?

Not very high I think — and this is why we have lots of decision illusions. The predictable, repeated mistakes we all make in our financial, medical, and other daily decisions.

Irrationally yours

Dan

Some quick reflections on the ways money is useful and difficult to deal with — and some ways we can fight back.

Direct my steps by Your word, and let no iniquity have dominion over me.

Redeem me from the oppression of man, that I may keep Your precepts.

Make Your face shine upon Your servant, and teach me Your statutes.

Rivers of water run down from my eyes, because men do no keep Your law.

-Psalm 119: 133-136

If you remember from Predictably Irrational, at some point we carried out a cheating study that assessed the value of moral reminders. In the experiment, we asked participants to complete a test, told them they’d receive cash for every correct answer, and made sure they knew they had ample room to cheat. Now here’s the kicker: prior to starting, we had half the participants list ten books off their high-school reading list, and the other half recall the Ten Commandments, a manipulation that turned out to have a marked effect on the results: While many in the first group deceitfully reported a higher number of correct answers, no one in the second group cheated.

How do we explain the findings? A tempting conclusion to draw would be to equate the religious with a higher morality; however, this argument doesn’t hold, since in a follow-up study with atheist participants, the Ten Commandments had the exact same effect. Rather, what was at play here was the power of a moral reminder: Prime a person to think about ethics right before they have an opportunity to cheat, and they’ll avoid immoral behavior.

This experiment also suggests to me that religion can be a good source of ideas for social science research. If you think about religion as a social mechanism that has evolved over time, then you can ask what purpose its many rules serve and how they can help us to better understand human nature.

For example, though religious leaders may not have understood the exact psychology of moral reminders, they’ve certainly had enough of an intuitive sense of their importance to circulate the Ten Commandments and emphasize a whole score of other religious tenets, statutes, and regulations. Whether or not they could cite the causes for it, somewhere along the line they gathered that a good way to keep people in check was to present them with a moral benchmark to keep in mind.

Given religion’s role in society and the way it evolves over time, I think we could benefit from using its wisdom to direct social science research. The key is to zero in on a religious tenet and ask why it’s there and what it suggests about human behavior, and to then empirically test the hypothesis with the hopes of deriving science from religious texts.

God bless.

Money is an integral part of modern life. We constantly make decisions about whether we’re willing to pay for different products and, if so, how much we are willing to pay. In fact, we make decisions about money so often that we consider money to be a natural part of our environment.

However, money is a relatively recent invention, and despite its incredible economic usefulness it does come with its own set of problems. In particular, it turns out that decisions about money are often non-intuitive and, in fact, quite difficult. Consider the following situation as an example: You are thirsty, tired, and annoyed and just want a cup of coffee. You see two coffee shops across the street from each another. One is a specialty coffee shop that sells handcrafted, designer coffee and the other is Dunkin’ Donuts which sells standard, decent coffee. The price difference between the two options is $1.75 for your cup-a-joe. Now, how do you decide if the benefit of the handcrafted coffee drink is worth the additional $1.75?

What you should do (if you wanted to be rational about it) is consider all of the things that you could buy with that $1.75, now as well as in the future, and decide to buy the expensive coffee only if the difference between the two coffees is more valuable than all of those other possibilities. But of course this computation would take hours, it is incredibly complex, and who even knows all the possible options to consider?

So what do we do when we need to make decisions but making them “correctly” is too time consuming and difficult? We adopt simplifying rules, which academics call heuristics, and these heuristics provide us with actionable outcomes that might not be ideal but they help us to reach a decision. In the case of coffee and other, similar decisions, one of the heuristics we often use is to look at our own past behaviors and if we find evidence of relevant past decisions, we simply repeat those. In the case of coffee, for example, you might search your memory for other instances in which you visited regular fancy coffee shops. Assess which one of those two behaviors is more frequent and then you tell yourself “If I’ve done Action X more than Action Y in the past, this must mean that I prefer Action X to action Y” and as a consequence, you make your decision.

The strategy of looking at our past behaviors and repeating them, might seem at first glance to be very reasonable. However, it also suffers from at least two potential problems. First, it can make a few mediocre decisions into a long-term habit. For example, after we have gone to a fancy coffee shop three times in a row, we might reason that this is a great decision for us and continue with the same strategy for a long time. The second downfall is that when the conditions in the market change, we are unlikely to revise our strategy. For example, if the price difference between the fancy & standard coffee shop used to be 25¢ and over the years has increased to $1.75, we might stay with our original decision even though the conditions that supported it are no longer applicable.

In light of our current financial situation, many people these days are looking for places to cut financial spending. Once we understand how we use habits as a way to simplify our financial decision-making, we can also look more effectively into ways to save money. If we assume that our past decisions have always been sensible and reasonable then we should not scrutinize our long-term habits. After all, if we’ve done something for five years, it must be a great decision. But if we understand that long-term, repeated behaviors might reflect our habitual decision-making in the face of complex financial decisions more than they reflect what is truly best for us, we might first examine our old habits and carefully consider whether they indeed make sense or not. We can examine our subscription to the ESPN Sports Package, our annual subscription to the opera, our yearly Disneyland vacation, or our monthly visit to the hairdresser. By examining these habits, and quitting them when it makes sense to do so, we might actually discover ways in which we could reduce our spending on a long-term basis.

Yes, money is complex, and it is incredibly difficult for us to carefully examine every purchasing decision we make. But the advantage of examining our habits is that it might lead us to create good ones that will benefit us for a long time.

We usually accept without argument the notion that man is at the top of the animal hierarchy. After all, only mammals have a neocortex – the most recently evolved part of the brain and the center of higher mental functions – and ours is the most advanced variation, so it makes sense that we’d be at a higher stage of development.

But is this true? Does the neocortex always make us more rational than other animals?

Most of the time, the answer is yes. For instance, it’s thanks to our neocortex that we are able to plan for the future, something that animals have a hard time doing. (They are even worse at saving than we are!)

Still, this isn’t always the case, as the following chimpanzee experiment suggests. In “Chimpanzees are rational maximizers in an ultimatum game,” researchers Keith Jensen, Josep Call, and Michael Tomasello looked into how chimps fare at one of the classic tests of human rationality, the ultimatum game.

In the human version of this game, a “proposer” is handed some money, say $10, and must suggest a division of the sum for himself and another participant. This other person, the “responder,” can then either accept or reject the offer. If he chooses to accept the division, both participants receive their share; if he opts to reject it, neither gets compensated.

Now, if we were to go by the traditional economic model of man as a self-interested rational maximizer, we would suppose that the proposers would always suggest a division that maximized his self-interest (an $9/$1 division) and that the responders would always accept a nonzero offer ($1 may not be $9, but it’s still better than nothing).

Except, this is not what happens. Research has shown that we human beings not only consider how best to maximize our compensation, but we also factor in such notions as cooperation and fairness when we make our decisions. For example, responders in the ultimatum game will often reject a monetary division that is particularly unfair for them (such as a $8/$2 division) – even when this comes at their own cost (they lose the $2, after all). This behavior is of course wonderfully human — but it is not part of the standard rational model.

Chimpanzees, however, go about the ultimatum game (which involves divisions of raisins in their case) without giving fairness any thought. In this experiment, the researchers found that the chimp responders tended to accept any nonzero offer, however unfair. And conversely, the chimp proposers rarely suggested a fair division, choosing instead to maximize their own share.

In this case, then, animals are more rational than we are. Whereas we’re willing to lose a couple bucks so that the other guy gets punished for his inequitable offer, chimps only act according to what will guarantee them the most raisons.

This curious turning-of-tables suggests that we might want to think differently about the neocortex. Overall, we’re better off having it, as without our sense of right and wrong, we would lack empathy and the ability to reinforce societal rules. Yet, in certain contexts, the neocortex can cause us not to maximize our self-interest. Evolution, then, is a mixed blessing: it makes us better some things, and worse at others.

Motivating people is an extremely difficult and delicate task as anyone who’s ever taught, managed, collaborated with or given birth to someone knows. In business, as opposed to say, child-rearing, the debate is slightly less daunting, though not always much clearer. For instance, offering incentives to employees for improved performance is a fairly common approach to encouraging higher sales —though surprisingly unproven by data.

For the most part, the effectiveness of incentives is supported by intuition and some anecdotal evidence. Wouldn’t everyone work at least a little harder for a $100 bill on top of their usual paycheck? Certainly it can’t hurt. But one important open question is whether monetary or tangible (spa retreat, ipod, dinner for two, etc) rewards more efficacious motivators?

Those who advocate for monetary incentives claim they have the greatest appeal given that the winners can do anything with them; what if someone needs an ipod like they need another hole in their head? On the other side, those in favor of tangible incentives argued that money lacks the emotional appeal of, say, a weekend for two at a romantic country inn or swank hotel. But either way, there was nothing to back up either camp.

Thankfully, there is some data on this debate.  A few years ago Goodyear Tire & Rubber Company decided to test which method was more successful in an effort to improve sales of a new line of Aquatred tires. Their plan was simple and elegant: first they ranked their 60 retail districts according to previous sales, then divided them into two groups of equal performance and assigned one group to receive monetary incentives and the other to receive tangible incentives of equal value to the first group.

The results were very interesting; it turned out that the tangible-reward group increased sales by 46% more than the monetary-reward group. They also improved in terms of the mix of products sold by 37%. One explanation, and it seems to me a fairly good one, is that we can visualize tangible rewards (imagine yourself on a Hawaiian beach), which creates an emotional response. Money, on the other hand, is not accompanied by images as often (aside from maybe Scrooge McDuck swimming in piles of it), and lacks the emotional pull that tangible rewards have, so they’re less effective in motivating employees. I guess it’s called “cold, hard cash” rather than “future beach vacation cash” for a reason.

Our prehistoric ancestors spent much of their waking hours foraging for and consuming food, an instinct that obviously paid off. Today this instinct is no less powerful, but for billions of us it’s satisfied in the minutes it takes to swing by the store and pop a meal in the microwave. With our physical needs sated and time on our hands, increasingly we’re finding psychological outlets for this drive, by seeking out and consuming concepts.

Conceptual consumption strongly influences physical consumption. Keeping up with the Joneses is an obvious example. The SUV in the driveway is only partly about the need for transport; the concept consumed is status. Dozens of studies tease out the many ways in which concepts  influence people’s consumption, independent of the physical thing being consumed. Here are just three of the classes of conceptual consumption that we and others have identified.

Consuming expectations. People’s expectation about the value of what they’re consuming profoundly affects their experience. We know that people have favorite beverage brands, for instance, but in blind taste tests they frequently can’t tell one from another: The value that marketers attach to the brand, rather than the drink’s flavor, is often what truly adds to the taste experience. Recent brain imaging studies show that when people believe they’re drinking expensive wine, their reward circuitry is more active than when they think they’re drinking cheap wine – even when the wines are identical. Similarly, when people believe they’re taking cheap painkillers, they experience less relief than when they take the same but higher-priced pills.

Consuming goals. Pursuing a goal can be a powerful trigger for consumption. At a convenience store where the average purchase was $4, researchers gave some customers coupons that offered $1 off any purchase of $6, and others coupons that offered $1 off any purchase of at least $2. Customers who received the coupon that required a $6 purchase increased their spending in an effort to receive their dollar off; more interestingly, those customers who received the coupon that required only a $2 purchase to receive the dollar off actually decreased their spending from their typical $4, though of course they would have received their dollar off had they spent $4. Consuming the specific goal implied by the coupon – receiving a savings on a purchase of a designated amount — trumped people’s initial inclinations. Customers who received the $2 coupon left the store with fewer items than they had intended to buy.

Consuming memories. One study of how memories influence consumption explored the phenomenon whereby people who have truly enjoyed an experience, such as a special evening out, sometimes prefer not to repeat it. We might expect that they would want to experience the physical consumption of such an evening again; but by forgoing repeat visits, they are preserving their ability to consume the pure memory – the concept – of that evening forever, without the risk of polluting it with a less-special evening.

While concepts can influence people to consume more physical stuff, they can also encourage them to consume less. Offering people a chance to trade undesirable physical consumption for conceptual consumption is one way to help them make wiser choices. In Sacramento, for example, if people use less energy than their neighbors, they get a smiley face on their utility bill (or two if they’re really good) – a tactic that has reduced energy use in the district and is now being employed in Chicago, Seattle, and eight other cities. In this case, people forgo energy consumption in order to consume the concept of being greener than their neighbors.

We suggest that examining people’s motivations through the lens of conceptual consumption can help policy makers, marketers, and managers craft incentives to drive desired behavior – for better or for worse.

by Dan Ariely and Michael I. Norton

The full paper on which this article is based is available here.

They say money can’t buy happiness. That might be true, but a new study suggests money holds more benefits in store than just the obvious ones. A clever set of experiments by Xinyue Zhou, Kathleen D. Vohs and Roy F. Baumeister suggest that simply handling money can dull physical and emotional pain.

Previous research has shown that social exclusion and physical pain share common underlying mechanisms. This is due to the way we evolved as social animals. In fact, a 2003 study (Eisenberger et al.) showed that the brain produces similar responses to social rejection as to physical pain. Other work (Vohs et al., 2006) revealed that thoughts of money convey feelings of self-sufficiency, thus soothing the uneasiness of social exclusion. Putting these findings together, Zhou et al. propose that money and physical pain are linked to one another, and they set out to examine this connection as well as the connection money has to social distress.

Three pairs of experiments were carried out on university students, looking to see if:

a. social exclusion and physical pain increase the desire for money
b. money can appease this pain, both physical and emotional
c. losing money intensifies these sensations. As it turns out from the study, the answer to all of these hypotheses is yes.

Since I liked the design of the study I’ll describe it succinctly as I introduce the findings. The impatient reader can skip the part in blue.

The first pair of experiments explored if the desire for money increases with social rejection and physical pain. Researchers let groups of four get acquainted with each other, and then split them to individual rooms. The subjects were then told that they were not picked by any of the others as partners for a dyad task, to stem feelings of social rejection (subjects in the control group were told everyone chose them). After this semi-cruel manipulation, the subjects’ desire for money was measured in three different measures (e.g. the sum they were willing to donate to an orphanage) and in all three the participants in the rejected condition expressed higher desire for money, compared to their ‘popular’ counterparts.

In the second experiment, half the subjects were primed to the idea of physical pain with word-completion tasks, while the other half was exposed to neutral concepts. Simply priming the notion of pain also increased the desire for money.

The next pair of experiments investigated if money can sooth pain. Subjects in the one condition were asked to count eighty $100 bills, in order to invoke the feeling of obtaining money, while the other subjects counted 80 pieces of paper (all this under the pretence of a finger-dexterity task). Then, one experiment had subject play ‘Cyberball’ – a computerized ball-tossing game with other players. The participants were lead to believe the players were human but in fact were a simple computer program. Subjects in the exclusion condition weren’t passed the ball and were effectively left out of the game by the other ‘players’. How tragic it must have been for some of them – it’s the grade school playground all over again. After the game ended participants were questioned about their experience, and – as you might have guessed it – those who counted money beforehand felt less social distress over being left out of the game, and maintained higher self-esteem than those who counted paper.

The other experiment of the pair is possibly the most interesting in the bunch. After that same money/paper counting exercise, the poor participants had to undergo a pain-sensitivity task (and all they got in return was partial course credit!). Zhou et al. used another approach – they put subjects’ hands in an immobilizing contraption and then poured hot water on their fingers. After this ‘pleasantness’, subjects rated how painful was this experience. The results indicate that simply counting money significantly reduced feelings of pain in the high-pain condition, and that it made participants feel stronger than those who counted paper.

The last pair of experiments used similar measures to show that thinking about losing money actually intensifies the sting of social rejection (Cyberball) and exacerbate physical pain (hot water again). Subjects in the money-losing condition indeed reported higher vulnerability in both cases.

To sum up, these experiments suggest that having financial resources diminishes pain, both physical pain and emotional pain caused by social rejection. Possibly the most interesting thing to pinpoint is that the method these findings were obtained indicates a general perception of money as a mean to alleviate pain and suffering. This is because money by itself had no value in the experiments as it could not “buy” any passes of the ball nor a release out of the hand constraints. It is also interesting to notice that merely thinking about having or losing money, without any actual change in resources, had the described effects since the experimenters didn’t award (or take) the subjects any money (neither as a part of the experiments nor for their participation).

This study springs several implications to mind. As for me, I wonder if there will ever come a day that a dentist appointment will kick off with a brief game of monopoly (one where the patient always accumulates great wealth) prior to the actual treatment. It just might alleviate the pain.

Reference: Zhou, X., Vohs, K., & Baumeister, R. (2009). The Symbolic Power of Money: Reminders of Money Alter Social Distress and Physical Pain Psychological Science.