An Interview with Dan Ariely: Professor of Behavioral Economics and author of Predictably Irrational

Interviewed by Noah Graff

Today’s Machining World Archives January 2009 Volume 05 Issue 03

Dan Ariely is professor of Behavioral Economics at Duke University. Behavioral economics examines market trends like traditional economics, but distinguishes itself by not assuming that humans always act rationally. The research relies on observing how people behave rather than using traditional economics methods such as cost-benefit analysis.

What is the behavioral economics perspective of the recent stock market crash?
You can think about the recent stock market crash as a good example of the differences between standard and behavioral economics. In standard economics you let people run loose, and because people can optimize and be rational and they do only what’s best for themselves, the whole system works very well. In behavioral economics we don’t think this is the case. We think that there’s a lot of reasons why people make mistakes, and as a consequence they can’t be let loose on everything. The free market is not the right approach.

Define “irrational.”
When we act in ways that we don’t understand or predict. This matters because it gives us an opportunity to get into trouble. If I think that I will have safe sex when the time comes but when I get aroused I don’t, it’s an opportunity to get into trouble. If I think that I will save for a long time but then I get tempted to buy certain things, that’s a problem. If we think that people can compute what is the right amount of mortgage for them to take out that’s a problem. If we think like Greenspan said when he testifi ed in front of congress that he thought that people would work in the best interest of their companies, which is clearly not the case, we get into trouble.

Do you believe that because humans are not always rational, there is a need for certain regulations?
It would be correct for some reasonable regulation. We’ve done a lot of research showing that even good people, fantastic people, with the best intentions in the world tend to see the world from the perspective of what is good for them financially. In sports when the call is on the edge we always have the tendency to view our team as more correct than someone who prefers the other team. If you have an incentive to view the world from a certain perspective it’s very hard for you not to do it. What happened was that people got a ton of money to see the world in a certain perspective.

Does the human impulse to obtain revenge have a big impact on economics?
Yes. Imagine you and I lived 4,000 years ago. There was no police and no law, and one day you stole my donkey. If I was just doing cost-benefit analysis I would say that if you took my donkey and ran far away, it would not be worthwhile for me to chase you. It would take a week for me to chase you and fi nd my donkey, but in less time I could make enough money to buy a new donkey. But if I was the vengeful type, I would chase you to the end of the world to get back the donkey. I will not only take back my donkey, but your kid’s donkey. Note there is less chance that you would want to take my donkey to start with. It’s not a part of the economic structure, but it helps to maintain order. Yet if you bring this revenge model to the modern world it can become less productive.

How so?
For example, the feeling of revenge people have against Wall Street. We had a social trust. We gave them our mortgages or our retirement plans, and in a very deep way they betrayed our social trust. And now, once this trust is lost, not only are we willing to lose money to get these SOBs to lose more, we have lost a deep trust in the stock market, and unless we fix that trust I don’t think things will actually get better. Economists will say it’s just liquidity — lets inject more liquidity into the market. As we can see, the liquidity is not really helping. Liquidity is not a bad thing to do, but it’s not enough. It doesn’t help when there’s no trust.

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