Tendencies of irrational behavior

Economics and finance are slowly coming to grips with the fact that human beings are simply not rational.  The boom-bust cycle that we are now living gives us a front row seat to that irrationality.

Below is a video by Dan Ariely, a behavioral economist at Duke University, that is not just about market irrationality specifically, but human irrationality more broadly.  Ariely gives a wonderful demonstration of how the human mind works–  and it is not at all the way Economics textbooks would have you believe.

Enjoy.

3 Comments
  1. Wag the Dog says

    Dan Ariely has been one of the few who is benefiting from the financial crisis through media appearances and book plugs. He's been interviewed several times on Marketplace Radio and many other blogs have been posting his videos. Must be working, since I've added his book "Predictably Irrational" to my shopping list. More videos on his website of the same name: http://predictablyirrational.com/

    Daniel Gilbert's TED talk gives more examples of shifting comparisons based not only on present context (i.e. ugly friend) but also on historical record. An item that was once $50 but is now $25 is more likely to be bought than an identical item that was once $15 but is now $25. Certainly the best explanation I've found so far for dead cat bounces.

    Price swings further complicate matters: People are more likely to buy a package vacation for $1600 that previously had cost $2000, but would not buy the same $2000 package if it had dropped to $700 but then risen to $1500

    Volatility messes with the mind.

    Even more exasperating to economists is the following: (See http://www.psychologicalscience.org/observer/getA…)

    "Gilbert asked the audience to imagine the following scenario: On the way to the theater to see your favorite play, you have two $100 bills in your wallet, but you lose one of them on the way. The theater ticket costs $100. Would you spend your remaining bill on the theater ticket? Most people say they would.

    But alter the terms slightly: You have already purchased your $100 ticket; you are on the way to the theater with just $100 in your pocket, as well as your ticket, but you lose the ticket. Would you then spend your remaining $100 on another ticket? Most people say they would not.

    An economist would say that both situations are equivalent, and thus shouldn't produce different actions. Yet people do feel differently about these two scenarios. In the second scenario, it feels like the price of the ticket has gone up — doubled. And just as people love to feel like they're paying less for something than they might have, they hate to feel like they're paying more for something than they should have."

    It's debatable this implies for the current situation, but perhaps all those %70 cuts on the high street will soon start to discourage consumers from spending.

    1. Edward Harrison says

      Interesting application of Ariely's theories and also great examples!

      It does seem that deflation in asset prices and in consumer goods has a whole psychology of its own that is quite perverse. But what about an item that was one $50, moved down to $15 and then up to $25? Isn't that what we have now? It suggests that the $25 selling point is not a sustainable one from a psychological perspective. We are a long way from understanding investor psychology but all of this should definitely dispell the notion that markets are efficient.

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