Friday, March 13, 2009

Predictable Irrationality and Bernie Madoff

Dan Ariely is the author of the delightful book Predictably Irrational, a professor of behavioural economics at the Sloan School of Management at MIT, and a great speaker. He challenges the traditional notion in economics that people behave in a rational manner.

In fact, he has demonstrated that people are actually irrational, but in a predictable way. He told us about one series of experiments designed to test propensity to cheat.

The basic experiment had a group of student volunteers take a test with a number of math questions on it. The questions were all well within their capability, but there were too many for someone to possibly do within the time limit. They calibrated the test by giving it to lots of students which determined that the average number of questions solved was four. They then did a number of variations on this control experiment.

A lot of people will cheat a little
The first experiment administered the test and offered the students money for each question they got right. The students were asked to report how many questions they got right and then to shred their answer sheet. Many participants cheated - but only by shading their results up a bit. Ariely suggests that people cheat just enough that they still feel good about themselves.

People cheat less when they've been reminded of morality
In one variation, participants were asked to write down the Ten Commandments before starting the test. They didn't cheat. The students had very low recall of the commandments, suggesting that they weren't necessarily highly religious. Indeed the same effect was observed when they were asked to sign the MIT Honour Code before starting the test. This worked, even though MIT actually has no Honour Code!

People cheat more about things rather than money
In another variation, Ariely offered people tokens instead of money for reported correct answers. These tokens were then exchanged for money. By using tokens instead of money directly, cheating doubled.

He also described a simple test in a shared fridge. You can leave a Coke or an equivalent amount of money in the fridge to see how long before they are stolen. The half life of the Coke is much shorter than that of the money. Similarly, people who would never think of taking a dime from petty cash will nonchalantly take home a pencil from work.

People cheat more if members of their group are seen to be cheating
Another interesting variation on the math test had an actor taking the test, and claiming that he got all the answers; the other participants would know this had to be a lie. When this actor was wearing a sweatshirt from the participant's own university, this increased cheating. Without that affinity, the actor's claim had no impact.

Ariely tells a riveting story of how he became interested in how people make irrational decisions. As a young man, after an injury while he was in the Israeli army, he spent many months in hospital with third degree burns all over his body. During this time he suffered horrible pain during the changing of the bandages on his burns. The technique was to take the bandages off quickly, resulting in high pain levels. He proposed to the kindly nurses that they should experiment with removing the bandages more slowly - less pain over a longer period - but was unsuccessful in convincing them to try it.

He later did experiments that showed that we suffer less when we experience lower levels of pain over longer periods than more pain over shorter periods. Even when he returned to tell the nurses of this, he was unable to convince them they should consider changing their ways. This inspired him to investigate other areas in which humans hold strong views about how humans react, without necessarily having the evidence to support their position.

Ariely has commented on the lessons we might learn from the real-life "experiment" on cheating conducted by Bernie Madoff. As he points out, we're more at risk from many people cheating a little bit than from the the big cheaters like Madoff. He worries that the Madoff experience will cause us to shift our focus to catching the few big cheaters, instead of the thousands of little one. Click here to see what he has to say.

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