Monday, December 15, 2008

The Illusion of Irrationality: Free Is Fun

A friend loaned me his copy of Predictably Irrational, by Dan Ariely. Ariely's a behavior economist, exploring all the ways people don't react in quite the same ways theory predicts. It's a fascinating area of research, a blending of economics and psychology. The book itself is well written and the content makes you think. But it goes way too far.

Because people don't act as theory predicts, Ariely proclaims they are irrational. In reality, the theory doesn't capture all the elements in play (or Ariely's not acknowledging they do). For example, Ariely dedicates chapter three to how people will get something just because it's free, even if it's not the better deal. They'll choose the free $10 gift certificate over a $20 gift certificate which costs seven dollar (effectively choosing $10 over $13). But people like getting things for free. Even if it's not really free, even if we know it's not really free.

Ironically, Ariely said it best: "FREE! gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is." (p54) If it gives us that emotional charge, it really is more valuable. People also gamble though few will think they actually come out ahead. The joy comes from those few times you win. That joy, that emotional charge of getting something for nothing, is valuable to people and they'll gladly pay for it in the form of a lost opportunity.

My theory is easily testable (though expensive). Start by offering the $10 gift certificate versus $20 certificate for $7. Then increase that value from $20 to $30 then $40 then $50, steadily increasing the (opportunity) cost of the indulgent from $3 to $13 to $23 to $33. I'll bet you'll see more people start grabbing for their wallets, rationally determining that the joy of FREE! isn't worth the cost.


Anonymous said...

I saw that book and thought about you, David.

Yep, darn free will getting in the way of perfectly good theories. That's why psychology, economics, political science are the soft sciences. It's hard to evoke a theory with so many variables. In your example, I would be aware that it would be to my advantage to pay the $7 and get a net profit of $13. But since I rarely carry much cash with me, I may not have the $7 to give. Even if other forms of payment are accepted, the hassle may be worth more than $3.

It reminds me of supermarket advertising. Buy one get one free is not the same as half off because you're required to get 2 items. If I just need one (say milk), the free item will be wasted and result in a loss.

I think that's the biggest problem with deregulation of businesses and similar ideas. They assume that people act rationally according to the highlighted theory. But people don't act rationally according to the theory, people can have a thousand reasons to do or not do something which the theory does not take into account. That leads the a failure of the theory and the solution it's suppose to provide.


CalLady said...

Keep in mind that gift card dollars aren't worth as much as US$. How many "free" gift card dollars do you need to add to your US$7 in order to make the customer think he's even getting a fair exchange? There are some places that I wouldn't accept "completely" free gift cards for.

-Jenny's li'l sis

locksmith mesa said...

Freedom is more fun!