aWpTiMuS

Jeff Atwood over at Coding Horror normally has good posts, but his last post is perhaps one of the most offensive posts I have ever read. Irrational posts from irrational bloggers are one thing, and irrational posts from rational bloggers are another. But an irrational post about rationality from a rational blogger is completely unacceptable.

Now, Jeff is merely acting as a filter in this post, his contribution is negligible as he is merely reposting an article from here. But since I read it from him, and both are apparently applauding the same book (Predictably Irrational). If this is an accurate portrayal of what is in this book, then I would be surprised if the author were capable of tying his own shoes.

The point of the excerpts in the posts are to highlight things that are supposed to appear to be glaringly irrational but are examples of human behavior, and therefore assumed rational when made. The problem is that it is doing that very thing! it’s assuming it’s being rational by pointing out these behaviors but is actually being irrational!

Let’s begin:

The first example is

When Williams-Sonoma introduced bread machines, sales were slow. When they added a “deluxe” version that was 50% more expensive, they started flying off the shelves; the first bread machine now appeared to be a bargain

When contemplating the purchase of a $25 pen, the majority of subjects would drive to another store 15 minutes away to save $7. When contemplating the purchase of a $455 suit, the majority of subjects would not drive to another store 15 minutes away to save $7. The amount saved and time involved are the same, but people make very different choices. Watch out for relative thinking; it comes naturally to all of us.

• Realize that some premium options exist as decoys — that is, they are there only to make the less expensive options look more appealing, because they’re easy to compare. Don’t make binding decisions solely based on how easy it is to compare two side-by-side options from the same vendor. Try comparing all the alternatives, even those from other vendors.
• Don’t be swayed by relative percentages for small dollar amounts. Yes, you saved 25%, but how much effort and time did you expend on that seven bucks?

Hold.The.Phone. Talk about comparing apples and oranges! I do not have the original context, but they’re supposed to give the context, so I must assume this is the full context necessary. The first one is tricky and I will leave it well enough alone, but there could be other contexts that could have caused increased sales. For example, was there increased advertising for the deluxe version that caused the old version to get more attention from potential buyers? Again, I’ll leave it alone because I will accept that the scenario is possible and therefore will accept that as a brand of irrationality.

The second case however, is the author being irrational. When assessing value of an object, one must determine their gain from it. Since this claim of irrationality is blatantly in my territory, economics, I am free to use any economic principles I wish and mock it for not applying them. If I am to purchase an item, I am saying that I value that item as much or more than the sum of its cost. So when it comes to suits there is one universal reason to buy one: they look good and make you look good in them. Sometimes it’s merely for non-remunerative reasons: you want to look good at a party and have photographs for nostalgia. Other times there are remunerative and therefore comparative (read: relative!) reasons. This is called an investment. A suit can be an investment to a higher paying job, so if all else being equal a $455 suit is the difference between landing the $10,000/year more job or not, then the suit is worth more to you than the $455, so you buy the stupid suit!

Here the author is simply looking at the fact that $7=$7. This much is true, however, the value is not the same. To be the same you would have to say that the value of the pen to you is the same as the value of the suit to you, which is just silly. So let’s break this down with a real easy model for valuation: arbitrage. If you had $455 dollars, you could buy 25 pens for $18 or one suit for $448, drive to the other store and sell the pens for $625 or the suit for $455. If we set the travel costs equal in each of the options, which one seems like a better idea? How about the one where your profit is $163 more? Relativity wins. Think of it in terms of stocks. Would you buy a $18 stock you know will go to $25 or a $448 stock you know will go to $455. If you had $455 dollars you better buy 25 shares of the first one. You have to look relatively! See how far you get as an investor if you thing $7 profit is good no matter what the margin.

To prove even one more time that this is an irrational example, imagine if the pens were $7.01 at the first store and $0.01 at the second, or imagine they were $6.00 at the first and you get paid $1.00 at the second. Come on!

Next:

Savador Assael, the Pearl King, single-handedly created the market for black pearls, which were unknown in the industry before 1973. His first attempt to market the pearls was an utter failure; he didn’t sell a single pearl. So he went to his friend, Harry Winston, and had Winston put them in the window of his 5th Avenue store with an outrageous price tag attached. Then he ran full page ads in glossy magazines with black pearls next to diamonds, rubies, and emeralds. Soon, black pearls were considered precious.

Simonsohn and Loewenstein found that people who move to a new city remain anchored to the prices they paid in their previous city. People who move from Lubbock to Pittsburgh squeeze their families into smaller houses to pay the same amount. People who move from LA to Pittsburgh don’t save money, they just move into mansions.
 

• Scale your purchases to your needs, not your circumstances or wallet size. What do you actually use? How much do you use it, and how frequently?
• Try to objectively measure the value of what you’re buying; don’t be tricked into measuring relative to similar products or competitors. How much does buying this save you or your company? How much benefit will you get out of it? Attempt to measure that benefit by putting a concrete dollar amount on it.

Hold.The.Phone.Again. For the first, why are any of the other, supposedly legitimately precious, items worth so much? If you have no basis with which to start — white pearls are ______ which is why they are valuable but black pearls are not — then this is just a pointless exercise. There is no irrationality at all. People buy “precious” items because they a) look good by someone’s standard, which is non-remunerable and above rational discussion, and b) someone in the future will be willing to exchange cash for that item. The second brings us back to arbitrage. If something is absent the subjective value (i.e. it’s pretty, which is the supposed point of this claim) then it still has a potential for higher valuation as long as someone is willing to exchange for it. In this case if no one has actually ever liked or ever will like black pearls to wear them, then they are essentially a medium of exchange, just like money or tradable gold, and there are markets for that.

You see, the main problem with this example is it assumes its conclusion: that when black pearls were introduced at a low price everyone knew about them and concluded they had no value. But reality says this isn’t probable. I can easily give a scenario in which this phenomenon is perfectly rational. Black Pearls are priced high by a respectable jewelry dealer. This is the only Jewelry dealer selling the Black Pearls. The reputation of the dealer signals to investors that this is a rare and potentially profitable commodity. Investors wish to commit time-lapsed arbitrage: they buy them assuming there is a limited supply, and try to hold them to turn a profit. This trading then gets people exposed to Black Pearls. These people think Black Pearls are pretty and wish to buy them for reason (a), even though it didn’t originally exist as a reason. Every single actor acted rationally; therefore it is irrational to conclude it irrational.

To further prove my point, I’ll ask a simple question: why aren’t they valuable?

The second example is really, really poor. Really. Is the author really saying that no matter how much money is in question it is always better to save it rather than spend it? Is there nothing to gain from bigger houses? Do people not have limited quantities of money? Do people know all of the relative prices in an area to which they are moving? What a stupid example. If I were to move to a new city where the housing costs were lower (bigger houses for the same money), why would I get a house with the same space as my current one? Well, it depends on that old thing called details that are what people use when they make rational decisions and are what irrational people throw out. Going back to my first discussion, we need to talk about valuation: if you gain more from the extra space than the money you’d save, you buy the bigger house! I have a small recording studio. It’s all in one room the size of a small bedroom. If I could move into a place with more space for the same price, I would benefit. Even if it were the same number of rooms, I would still have more space to spread out my studio. It could perhaps, depending on the wall’s material, give me less reverb, therefore giving me more control over the quality of my recordings. These things are examples of things to consider when assessing a value. How is it irrational?

OK, what about people moving and squeezing into a smaller house for the same money? What are they supposed to do, pay more money? What if their current income did not change? What if the reason they are moving is better job growth opportunities and not an immediate salary increase? Oh.My.God.This.Is.A.Horrid.Example. Q.E.D.

Ariely, Shampanier, and Mazar conducted an experiment using Lindt truffles and Hershey’s Kisses. When a truffle was $0.15 and a kiss was $0.01, 73% of subjects chose the truffle and 27% the Kiss. But when a truffle was $0.14 and a kiss was free, 69% chose the kiss and 31% the truffle.According to standard economic theory, the price reduction shouldn’t have lead to any behavior change, but it did.

Ariely’s theory is that for normal transactions, we consider both upside and downside. But when something is free, we forget about the downside. “Free” makes us perceive what is being offered as immensely more valuable than it really is. Humans are loss-averse; when considering a normal purchase, loss-aversion comes into play. But when an item is free, there is no visible possibility of loss
 

• You will tend to overestimate the value of items you get for free. Resist this by viewing free stuff skeptically rather than welcoming it with open arms. If it was really that great, why would it be free?
• Free stuff often comes with well hidden and subtle strings attached. How will using a free service or obtaining a free item influence your future choices? What paid alternatives are you avoiding by choosing the free route, and why?
• How much effort will the free option cost you? Are there non-free options which would cost less in time or effort? How much is your time worth?
• When you use a free service or product, you are implicitly endorsing and encouraging the provider, effectively beating a path to their door. Is this something you are comfortable with?

Don’t.Just.Hold.The.Phone.Hold.Up.The.Phone.Company. Was this book written while the author was on LSD? First, let’s be nit-picky. What do you mean chose? Do you mean buy? I assume they were limited to buying either the truffle or the kiss, but were they limited to buying only one of them? Since this criteria isn’t stated, it would be reasonably assumed that it doesn’t matter. When guess what, standard economic theory doesn’t say what you are saying it does. At p=0 normal goods’ demand graphs are effectively asymptotic. That’s lim as p->0 = infinity for you math fans.

If they can only have one kiss or one truffle and there is absolutely nothing they can ever spend the money on again, then yes I do not understand the change because I don’t understand the valuation. If and only if that condition is true (they can only buy one kiss or one truffle) do I understand the author’s point. But since it’s not stated I can only rationally assume the author did not feel it was important to include, and therefore still irrational of him to say it’s not rational.

On this next one I’ll give half a point to Jeff for his advise but -1000 to the author of the book because it’s again, not an example of irrationality!

The AARP asked lawyers to participate in a program where they would offer their services to needy employees for a discounted price of $30/hour. No dice. When the program manager instead asked if they’d offer their services for free, the lawyers overwhelmingly said they would participate
 

• Companies may appeal to your innate sense of community or public good to convince you to do their work at zero pay. Consider carefully before choosing to participate; what do you get out of contributing your time and effort? Is this truly a worthy cause? Would this be worth doing if it was a paid gig?

Jeff gets half a point because it’s a warning about how you determine value. As a programmer I understand first hand the danger of incorrectly weighting my desire to see friends/family/friends of family pleased and my other opportunity costs. I ended up making a win-lose trade: they win I lose. Their satisfaction with me and my work was not worth my time and effort in hindsight. So Jeff’s advice is good advice, but the book quote is not an example of irrationality (defined by someone who seeks to maximize profits but makes terrible valuations).

The real world works in signals, and if you are trying to make claims of irrationality, you cannot just invent your own world, you must live in the real one. $30/hour signals to prospective clients of that lawyer that his services are not sought out (i.e. he’s not good), because if they were their price would be higher. But working for zero pay signals altruism: this lawyer isn’t just good (based on the price people are willing to pay when he does charge) but he also cares about people enough to work for free. Talk about upside for the lawyer! Sounds like it’s rational, again!

 This post is running a little long, so I’ll break it up into two parts and retro-link. However these posts are really good at selling the book, now I have to buy it just to see if the author is this irrational!