Irrationally Predictably Irrational – Part 1

March 25, 2009

I’m reading an interesting book called “Predictably Irrational” by Dan Ariely that fascinates me on several levels. He describes many noble attempts to understand human irrationality, but unfortunately, continuously injects his own flawed commentary. I often take issue with his conclusions.

For example, there’s a chapter in which he describes our innate sense of fair prices, but only as they relate to other prices on comparable items. If you introduce a product with no obvious substitutes you can inject almost any price into our subconscious by manufacturing an appropriate value attribution — an emotional response to the product in question. This process is called “anchoring” a price; all future purchases of similar products will be compared to that original anchor price regardless of market conditions.

Certainly the implications are huge, producers can increase profits through psychological techniques. But if you believe Dan Ariely’s prescription it would seem producers are rampantly “tricking” poor helpless mindless sheep into buying any Gucci purse peddled on TV, thus government is required to protect the herd from exploitation by capitalist wolves. I’m not sure what role he had in mind, does he expect the government to regulate propaganda by legislating a “beautiful girl per square inch” ratio on TV commercials? Or perhaps, the government should ban music in radio advertisements? Or perhaps, instead of market forces finding a balance between a price consumers are willing to spend (regardless of how that number is determined) and a price producers are willing to accept, he would prefer a government bureaucrat determine the appropriate level of profitability for each product and impose sweeping price controls? Or perhaps, instead of people allocating their disposable income as they choose, the government will compel everyone to submit sales receipts to a regulator and ensure nobody spends more than 1% of their annual income on a purse? What about the producers who anchor a price below the market value (accidentally, or deliberately trying to disrupt a competitor), should there be a special tax to recover lost profits? He indicates a preference for government regulation with no details, that’s not a tenable position.

Acknowledging that freedom has risks or that markets are sometimes imperfect does not by definition prove or even suggest that government interference will add positive value. In fact, in my estimation the world has just witnessed the consequences of a move from free market to over-regulation, which is a move from imperfection to mediocrity. Instead of isolated and short lived crises, we now have enormous and systematic crises. The government is not a living being with more knowledge and intelligence than ordinary people, it’s a bureaucracy run by ordinary people. If we are irrational, so too is the government. The difference — irrational decisions made by individuals result in consequences with limited scope, irrational decisions made by powerful government agencies or corporations protected by government regulatory firewalls result in consequences that proliferate throughout the entire economy.

Should excess spending be directed towards clever producers using psychological techniques to increase sales beyond what people can bare, less money will flow to other companies and industries, forcing them to change their strategy (lower prices, improve service, introduce new products) or go out of business. If the losing companies actually add value to the world as they disappear consumers will suddenly realize the $2000 Gucci purse isn’t more important than food. So much for the anchor, we regularly go through these generational long wave cycles. If on the other hand clever producers can introduce products with an unjustifiably high value attribution without destroying the world, why should I care? We don’t buy goods to save the rain forest, we buy goods to increase our utility (unless saving the rain forest gives us pleasure). What difference does it make if that sense of utility is with us before or after a commercial? We bought, we enjoyed, we move on.

The government can not legislate away irrationality or stupidity.

More coming soon…