Peter A. Ubel is professor of medicine and psychology at the University of Michigan at Ann Arbor, where he explores the quirks in human nature that influence our health, happiness and society. He is author of the book Free Market Madness (Harvard Business School Press, 2009), which investigates the irrational tics that lead people to overbid on eBay, eat too much ice cream and take out mortgages they cannot afford. In an interview with Jonah Lehrer, Ubel explains how innate optimism, greed and ignorance can depress financial and physical well-beingand how individuals can commit to change.

Scientific American Mind: 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?

Peter Ubel: Irrationality is responsible for the economic mess we find ourselves in
right nowirrationality plus greed, of course, and a substantial dose of ignorance. Let us start with ignorance. I am sad to say that many Americans have a difficult time with even simple matharound 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 hardwired for optimism. Ask us how we rate as drivers, and the vast majority of us are convinced we are above averageeven 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 will not rise, or that our houses 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 with 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 competitors 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!

Mind: What can eBay teach us about human irrationality?

Ubel: eBay auctions help to 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. [For more on eBay and irrationality, see Is Greed Good? by Christoph Uhlhaas; Scientific American Mind, August/September 2007.] Offer a really low price for opening bids, a price everyone knows will not 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!

Mind: You also argue that by taking our own irrationality into account, we can improve our health and well-being. Can you provide an example of a way to achieve such improvement?

Ubel: Precommitment! One reason we humans do not always behave rationally is that we have limited willpower. 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&Ms 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 he was 20 minutes short of his 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 as if each M&M matters, as if 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 will become more mindful of M&M bowls. Run outside, rather than inside on a treadmill, and you will be forced to finish your running loop. Tell a friend you will walk with her for 30 minutes this afternoon, and you will be forced to show up. Do you 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 on yourself when you feel strong.

Mind: Has your awareness of these innate flaws changed your daily routine?

Ubel: It has made me almost impossible to live with! Imagine spending time with someone who is obsessed with rationality, who constantly tries to find ways to better himself. My poor wife!

Mind: If you could give one piece of advice for avoiding a few of the mental mistakes outlined in your book, what would it be?

Ubel: None of us is perfect. We will all make a boatload of mistakes before our lives are done. So try to think about the areas in your life where you can least afford to make mistakes or where you must, simply must, remain steadfast in the face of temptation, and concentrate your energy and attention on these few areas. Is saving money your Achilles heel? Do not worry, then, that you might not always make great decisions on the tennis court. Is food your downfall? Try to minimize the food-related mistakes you make, and do not get bogged down trying to fix everything else in your life. Once you have mastered food (is that possible?), you can move on to the next challenge.

Note: This article was originally printed with the title, "Explaining Fiscal Foolishness".