First published in Business Life magazine, April 2008
Are you an idiot, or not? I expect you have a view on the matter. Most economists have a view on the matter, too: the mainstream view in economics is that people behave more or less rationally.
Yet an influential minority of economists think that, at least when it comes to some kinds of decision, you are an idiot after all. They’re called “behavioural economists”; one of them, Professor Dan Ariely of MIT, recently published a book called Predictably Irrational – the title may give you a hint at what he thinks of you.
The behavioural economists are inventive and their experiments tend to be a lot of fun. But there’s another reason to study behavioural economics: its insights are already being used by expert marketers to slurp money from your pocket.
Dan Ariely gives a simple example: a subscription to a magazine. If the choice is between “Print and web” for £100 or “Web only” for £50, a lot of people will pick “Web Only”. But add a new and unattractive option of “Print only” for £100, and suddenly many people will choose “Print and web”. Nobody wants the new option, of course, but its mere existence makes “Print and web” suddenly seem like a better deal, and the marketers know it.
Another trick has been spotted by Richard Thaler of the University of Chicago, one of the founding fathers of behavioural economics. Thaler points out that we are irrationally nervous about small risks such a losing a mobile phone that would cost £50 to replace, or facing a £70 repair bill for a washing machine that breaks down. These possible losses are annoying, but relative to the larger financial risks we run (will you get a raise at work? Will the value of your home rise or fall?) they are trivial. Most of us should take them on the chin.
But that is not what happens. Instead, we buy extended warranties for washing machines or insurance for mobile phones. And because we buy them from the same person selling the washing machine or the phone, we don’t enjoy the benefit of competition. Such insurance is usually hugely overpriced. Insurance buyer, beware.
There is some good news from behavioural economics, though. Sometimes, when marketers work out a way to jack up the price, they end up improving the quality of the product as a side-effect. Overpriced products can look better, taste better – even work better, just because they are overpriced. Dan Ariely showed that, for example, when he gave people fake painkillers (actually vitamin C tablets), the painkillers were effective anyway, just as long as people thought they were expensive. Perhaps a high price is a price worth paying, after all.