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A fundamental premise of the economic theory of Capitalism is that people will make decisions based on their "rational self-interest."

Author Dan Ariely demonstrates in Predictably Irrational that we often don't behave rationally or in our self-interest, but behave irrationally and sometimes in consideration of others in predictable ways.

The book includes the results of several experiments and observations.

For example, as a result of corporate improprieties, salaries for key executives of public companies are required to be disclosed. The idea was that shareholders would be outraged by high salaries and limit them. Instead, there has been an explosion in executive compensation! Executives are comparing their salaries to other executives and demanding that they should be paid as much or more than executives in other companies.

Ariely also demonstrated a principle called arbitrary coherence. Once a high price is suggested for an item, it creates an anchor for present and future prices. A group of students were asked to write down the last two digits of their social security numbers. Then they were asked to bid on several items. The students with higher value digits tended to bid higher on the items.

An implication of arbitrary coherence is the benefits of free trade and free markets are questionable. We can't rely on the market forces of supply and demand to set optimal market prices. The mutual benefits of trading rests on the assumption that the players in the market know the value of what they have and the value of what they will receive in the trade. If the estimated values in our trades are affected by initial anchors, the trades we make aren't necessarily going to be an accurate reflection of the real pleasure we get from those products.

Free - a price of zero - is an emotional hot button, a source of irrational excitement. In an experiment, two tables were set up. One with Lindt chocolate truffles and one with Hershey's Kisses. Lindt truffles usually cost about 30¢. A Hershey's Kiss usually costs about 6¢. When the price of a Lindt truffle was set at 15¢ and 1¢ for a Hershey's Kiss, about 73% of students chose the truffle and 27% the Kiss. When the price of a Lindt truffle was set at 14¢ and a Hershey's Kiss was free, 69% of students chose the free Kiss and 31% chose the truffle. The price difference was the same, but the free price made a big difference.

Predictably Irrational is a fascinating and valuable study in human nature, and belongs next to Robert Cialdini's Influence and Persuasion in a businessperson's library.

Buy it on Amazon: Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions.

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