Peter Ubel is professor of medicine and psychology at the University of Michigan, where he directs the Center for Behavioral and Decision Sciences in Medicine. He’s the author of the forthcoming book, Free Market Madness (Harvard Business, 2008), which investigates the irrational tics that lead people to overbid on eBay, eat too much ice cream and take out mortgages they can’t afford. Mind Matters editor Jonah Lehrer chats with Ubel about his research.

LEHRER: Your new book, Free Market Madness, argues that conventional economics, which assumes that humans are rational agents acting in  their own self-interest, is deeply naive and scientifically  unrealistic. Instead, you describe a brain brimming with biases and flaws. Do you think these flaws are responsible for the latest economic turmoil? If so, how?

UBEL: Irrationality is responsible for the economic mess we find ourselves in right now.  Irrationality plus greed, of course, and a substantial dose of ignorance.

Let’s start with ignorance. I’m sad to say that many Americans have a difficult time with even simple math—around a third of American adults cannot calculate 10 percent of 1,000. People who struggle with concepts such as percents have an extremely difficult time with more complicated ideas, such as compounding of savings and, very relevant to our current crisis, adjustable rate mortgages.

To make matters worse, most of us are hard-wired for optimism. Ask us how we rate as drivers, and the vast majority of us are convinced we are above average, even those of us who have gotten into multiple car accidents. As a result of our unrealistic optimism, we are convinced that our incomes will rise fast enough to keep up with our outsized mortgage, or that our adjustable rate won’t rise, or that our house’s value will indefinitely outpace inflation.

We are social beings, too, and frequently judge our own decisions by seeing what other people are doing. If my neighbor added on a new kitchen through a home equity loan, I might assume that is a good idea for me, even if a more rational weighing of my finances would suggest otherwise.

Even savvy financiers can get caught up in irrational impulses. If a competitor’s firm makes huge profits on risky loans, it is easy for me to push aside my fears about such risks: if he took those risks and was rewarded, maybe I overestimated the risks!

LEHRER: What can eBay teach us about human irrationality?

UBEL: eBay auctions help reveal the rational and irrational forces driving consumer behavior. People are often quite rational, after all. Raise the price of a t-shirt and, generally, fewer people will buy it. Reduce the quality of a good, and you better reduce its price, too!

But behavioral economists have analyzed eBay data to help identify some ways that consumers act irrationally. Offer a really low price for opening bids, a price everyone knows won’t be the final selling price, and you nonetheless lure some consumers into making an initial bid. That increases the number of people bidding on the product, which makes it look more attractive, thereby generating even more bids. And then bidders, who knew the price would rise from their initial bids, get emotionally attached to the product, and keep raising their offers.

Now you know why it makes sense to tell people that bids for that Picasso hanging in your living room can start at $5!

LEHRER: You also argue that, by taking our own irrationality into account, we can improve our health and well-being. What's an example?

UBEL: Precommitment!

One reason we humans don’t always behave rationally is because we have limited will power. We know that exercise is good for us. We understand that junk food is bad. But we cannot follow through on our rational desires. We plan to run for 30 minutes, but after 10 we get off the treadmill, and convince ourselves we are a bit stiff today. We try to cut down on empty calories, and then grab a handful of M & M’s from a candy bowl, almost unaware of our action.

No single M & M caused anyone to have diabetes. No one experienced a heart attack because they were 20 minutes short of their exercise goal. And yet our lives, our waistlines even, are the result of thousands of such decisions and behaviors.

To improve ourselves, we have to act like each M & M matters. Like each decision has important consequences.

To do this, it helps to make rules and follow them. Commit yourselves to no candy, no desserts, and you’ll become more mindful of M & M bowls. Run outside, rather than inside on a treadmill, and you’ll be forced to finish your running loop. Tell a friend you’ll walk with them for 30 minutes this afternoon, and you’ll be forced to show up. 

Want to save more money? Have some money automatically deposited into a savings account that you cannot access easily through ATMs, debit cards or checkbooks.  Sometimes the best way to behave better when you are weak is to impose martial law upon yourself when you feel strong.

LEHRER: Has your awareness of these innate flaws changed your daily routine in any way?

1 Comments

1. 1. Swmorgan77 12:41 PM 12/26/08

   The point of the free-market theory is not that people always act perfectly in their best interest, nor that they are always immediately aware of what that best interest is...
   
   The point is that you let the free market teach them through natural consequences when something ISN'T in their best interest. Nice mischaractarization of free-market theory and straw-man argument though...

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