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Consider the Ultimatum Game, first described by three German economists in 1982. The game is between two players who interact only once, so reciprocation—or “payback”—is not at stake. The first player is given a sum of money—for simplicity let’s call it $10—and asked to divide it between himself and the other player. He can divvy it up any way he chooses, but if the second player rejects the division, neither player gets anything. If the second player accepts the deal, the first player takes his self-determined cut and the second player gets the rest. Both players know the rules: The first player knows that if he takes more than his share, the second player will either lose out or reject the offer outright; the second player knows that if he declines the first player’s offer, neither player will get any money at all. If the second player were
Homo economicus,
he would accept any offer above zero dollars for the excellent reason that some money is better than no money. But Homo sapiens behave differently: Most players decline to take an offer below $3 and some refuse anything less than a fifty/fifty split. Why anyone would leave empty-handed rather than accept less than half the pot has very little to do with reason and very much to do with perceptions of fairness.

The inclination for people to play fair and demand fairness from others has baffled economists for decades. Many people when confronted with what they consider an unfair deal—even one that benefits them—prefer no deal at all. In this context, humans are not acting in their own best financial interest: They willingly sacrifice their own share to ensure that the other player does not get more.

Sarah Maxwell, an associate professor at Fordham University and codirector of the Fordham Pricing Center, is an expert on fair pricing. A fair price, she told me, is one that is “emotionally okay” with the person doing the buying. This is hardly a precise assessment, but it is an eminently sensible one. Scientists have contended for some time that emotions are critical to economic decision making, far more important than economists once thought. This is not mere speculation, it is provable fact. For example, patients with brain injuries that impair their emotions find it almost impossible to make economic decisions. University of Southern California neurologist Antonio Damasio refined this observation in a series of experiments that he described in his book
Descartes’ Error: Emotion, Reason, and the Human Brain
. He outlines in fascinating detail how patients with prefrontal cortical damage can no longer generate the emotions necessary to make the simplest choices, such as the date and time of their next doctor’s appointment. Damasio describes one particular patient as he pondered various possibilities, never settling on a course of action: “For the better part of a half hour, the patient enumerated reasons for and against each of the two dates: previous engagements, proximity to other engagements, possible meteorological conditions, virtually anything that one could reasonably think about concerning a simple date.” This patient and others in the study showed no sign of intellectual or psychological impairment and could think perfectly rationally. But their inability to raise their own emotional temperature made it impossible for them to make a decision.

Damasio argued that both logic and emotion are required for decision making, and that systems that control these functions, while separate, communicate with one another to jointly affect our behavior. That said, the emotional system—the older of the two in evolutionary terms—typically exerts the first and more powerful force on our thinking and behavior. If we sense we are getting the short end of the stick, we balk, even if not grabbing the short end makes us tumble back into the lake.

 

 

 

SCIENTISTS
AGREE that an aversion to inequity is innate and probably inescapable. This is true not only for humans but for other primates. At Emory University researchers trained female capuchin monkeys to trade a plastic token for a piece of cucumber. The monkeys appeared quite pleased with the deal until they spotted other monkeys in nearby cages getting the more favored grapes in exchange for their token. Seeing this, the monkeys grew furious and in a fit of rage began throwing their cucumber bits out of their cages. A cucumber may not be as good as a grape, but it is edible, so tossing out chunks of the stuff appears self defeating and irrational. This behavior is consistent with the way monkeys and humans deal with what we perceive to be unfairness. At least some monkeys prefer nothing to less than the next monkey. The Ultimatum Game suggests that the same is often true for humans.

Mathematician and evolutionary biologist Martin Nowak, now director of the Program for Evolutionary Dynamics at Harvard University, has studied the evolutionary underpinnings of fairness. Nowak designed a virtual version of the Ultimatum Game in which players who collected the most money were also the fastest to reproduce. (One of the central tenets of evolutionary theory is that the fitter one is, the more likely one is to pass on one’s genes to the next generation.) Under this scenario, players who accepted any fraction of the total offered by the first player—even if it were far less than half—ultimately won more money, had more offspring, and were thereby “fitter” by natural selection standards. But when Nowak included one additional variable in his simulation—player reputation—everything changed. Under this new scenario, players could obtain information about an opponent’s previous behavior and therefore know which players would accept amounts of less than half. This resulted in the first players offering less and less to the second players, who they now knew would take any offer above zero. When reputation was factored in, a player who accepted any amount had less money and fewer offspring. Under this more realistic “natural selection” scenario, then, the demand for and pursuit of fairness contributed to fitness. People who pursued and demanded fairness were more likely than others to pass down their genes to the next generation and therefore had an “evolutionary advantage.”

Of course, evolutionary theory does not seem to explain why we sometimes subvert our own best economic interests, a thorny problem that has dogged economic psychologists for decades. Notable among those grappling with this mystery is behavioral economist Daniel Ariely, author of the best-selling
Predictably Irrational
. As a professor at Duke University as well as director of the e-rationality group at MIT’s famous media laboratory, Ariely has a lofty vantage point from which to observe and analyze the perplexing vagaries of human economic behavior. Ariely is an intensely intelligent but lighthearted fellow, and among his favorite crowd warmers is a joke that, told in his charming Israeli accent, goes something like this: “Two economists are walking on the street. One of them is noticing a hundred-dollar bill. He says, ‘Hey, look, a hundred-dollar bill!’ The other guy says, ‘That can’t be. If it was a real hundred-dollar bill, somebody else would have picked it up already.’ ”

Ariely has said, “People have two masters: cognition and emotion.” And the two don’t talk to each other much.” Ironically, Ariely said, this communication gap is at least partially the result of evolution or perhaps the lack thereof. The survival strategies of our ancient ancestors did not include learning the art of assigning monetary values to things. Before the onset of agriculture ten thousand years ago, commerce was likely a simple matter of trading one scarce resource, such as meat after a kill, for another, such as roots and berries to complement the meal. When we needed berries and had extra meat, or needed meat and had extra berries, we made the swap, plain and simple. But people don’t barter much anymore. They deal with money, which we can neither eat nor wear. Monetary values are abstract, highly variable, and vulnerable to the power of suggestion and manipulation: People will pay more or less for the same thing depending on the context of the transaction. As example, Ariely described an experiment in which he offered to recite Walt Whit-man’s
Leaves of Grass
to a classroom full of students. Half the students were asked whether they would pay $2 for the pleasure of hearing him read the poem, while the other half were asked if they would be willing to listen if they were paid $2. Then both sets of students were asked whether they would attend the recitation if it were free.

Only 8 percent of the students who were offered money to listen to the recitation were willing to attend the performance without pay, compared with 35 percent of the students who were originally asked to pay to hear it. Clearly, the “framing” of the event—the context from which the proposal emerged—influenced its perceived value, a perception that trumped whatever inherent value it might have held for the students (unlikely to be much).

“Economics is a religion,” Ariely said. “It assumes rational behavior and that people will do what is best for them. But like religion, this is only a belief; there is no proof.” I did not ask Ariely about his own religious leanings, but there is little doubt that his faith has been brutally tested. Born in New York City, he moved to Israel with his family, where at age eighteen he enlisted in the army. His military service was cut short by an exploding magnesium flare that left him with third-degree burns over 70 percent of his body. He spent three years in a hospital bed and his first year of college wrapped head to toe in an elastic stocking designed to create pressure on his recovering tissue. There were holes for his eyes, ears, and mouth, and it was through this tormented vantage point that Ariely witnessed the world. Notable among his observations was that people made judgments based on emotions, not evidence. “I had a strong feeling that when others observed me, they not only saw my injury but were also making inferences that my appearance and my intelligence were highly correlated,” he said. “It was very important to me to show my peers that this correlation did not exist.”

Ariely was quite successful in that regard; in the United States he earned doctorates in both business and psychology. It is from this dual perspective that he came to study human behavior, a quest that has led from the banal to the bizarre. One of his more controversial experiments involved dressing up as a bartender to investigate the impact of peer pressure on customer selection and the enjoyment of beer. Another entailed asking thirty-five male college students a series of sexually charged questions as they masturbated. The purpose of the latter exercise, Ariely told me, was to show how sexual arousal can influence judgment, producing insight that could be used, for example, to encourage men to don condoms before becoming overly aroused. Studies of this sort make colleagues wonder whether Ariely is as much provocateur as scientist: That sexual arousal has the power to sway judgment is not exactly breaking news, but a professor who asks college students to masturbate most certainly is. No doubt Ariely’s sometimes impish tactics serve a pulsing ambition, but this irreverence does nothing to diminish the significance of his work, which is focused on getting us to think much harder than we do now about what drives our financial decisions.

Shopping, Ariely said, is not a rational exercise but a process fraught with emotions ranging from guilt to jubilation. Shopping forces us to extrapolate future needs from current evidence, a surprisingly difficult task. How do we really know what we will want or need tomorrow, let alone a month from now? “The main problem is that shopping is for later, but for humans the here and now is always more important,” he said. Thanks to what psychologists call “hyperbolic time discounting,” humans are able to deal rationally when a reward is significantly delayed. But as the reward gets closer, our passions lead us to fits of impulsiveness. This is not a terribly deep insight: Everyone knows that it’s easy to make resolutions for the future but far harder to put those resolutions into immediate practice. That’s why so many of us pledge to stop overeating or smoking or gambling . . . next week. Still, hyperbolic time discounting can have far more subtle and surprising effects, especially when it comes to discounting.

“If I ask you whether you would prefer half a box of chocolates now or a full box in a week, you’ll take the half box,” Ariely said. “But if I ask you whether you’d prefer a half box of chocolates in a year or a full box in a year and a week, you’ll take the full box.” The difference in time—one week—is the same, whether next week or a week and a year from now. But the prospect of consuming something now versus later shades the calculation and the decision. Retailers can take advantage of this by offering “exploding discounts,” price reductions rigged like an arbitrary time bomb. “Exploding discounts work by really heightening the emotions,” Ariely said. “Whether you need it or not, whether you want it or not, the time limit itself gives you a reason to act now. The emotional response is ‘Buy it now, or it will be gone.’ The benefit of the buy is the discount itself; it’s what makes you feel good, smart, savvy, right now. You are focusing on the present, not the future, and that’s where they want you to focus, because we are all much more emotional about the present and more rational about the future.”

Discounting plays many tricks on the human mind, and among the more intriguing is the influence of discounting on our relationship to the purchase itself. Although almost everyone seeks bargains, most of us make the tacit and often unconscious assumption that doing so involves a trade-off of quality for price: Regardless of what the tag or brand claims, we perceive things bought on sale or at a discount as less desirable or efficacious or durable than things for which we paid full price. The less we pay for something, the less we value it and the less likely we are to take care of it, with the result that cheaper things—even if well made—seem to wear out and break more quickly. For most of us the fact that we paid less than full price actually discounts in our minds the value of what we bought, and that impression, in turn, can have a profound impact on our expectations of the worth and power of the product.

In a series of elegant experiments, Ariely and colleague Baba Shiv, a professor at the Graduate School of Business at Stanford University, have demonstrated just how powerful these expectations can be. In one of these experiments, 125 college students were asked to drink SoBe Adrenaline Rush, an energy drink that claims to sharpen mental acuity. (Being college students, almost all the subjects were well acquainted with this product.) The cost of the drink was billed against their college accounts; half of the students were charged the full price of $1.89, the other half only 89 cents, thanks to what they were told was a bulk purchase price reduction. After drinking their pick-me-ups and watching a film on its benefits, the subjects were then asked to complete a series of word jumble puzzles. Students who drank what they were told was the full-price drink scored the same on the tests as did a control group that had no drink. But students who drank the discounted drinks performed poorly on the test; remarkably, drinking the discounted product actually impaired their performance. Hence, price not only had a significant impact on the perceived potency of the drink but even, it seemed, on the students’ physiological response to it.