Irrationality: Understanding the limitation of human decision making and its impacts

Let us think of a very simple example. Imagine in your minds, a friend of yours, approaching a bank, well dressed up, with a smile on her face. How would you imagine the scene? Maybe a well dressed up lady walking towards a nice and furnished bank building. But how many of you would have considered a lady on a boat slowly reaching the bank of a river? Think about another case. Take three groups of labourers -- one group is given their weekly salary in cash at the end of the week, one group is given the same salary in cash every day and finally the last group is given the same salary in cash every day, but now in an envelope. Who do you think saved more? The group where the envelope was given saved more.
The first example was adopted from the book 'Thinking Fast and Slow' by Daniel Kahneman, and the second example was adopted from 'The Upside of Irrationality' by Dan Ariely. Both examples highlight an interesting aspect of human beings. A core assumption in Economics and Decision Sciences is that the Decision Maker (we humans) is rational. Being a rational being would mean that we should have spotted the two possible meanings of the term 'bank' or that people's savings should not have depended on the methods with which they have been paid. But we should know better. In the first example, we thought of the bank building probable due to this article appearing in Financial Express. On the second example, people who were given each payments in separate envelopes had to go through the task of opening an envelope when the contents of the previous envelope had finished -- a simple task, but one which alerts the person mentally that he is running out of money. These two examples, along with many others, are findings from studies conducted by social scientists all around the world, and they all point to one direction -- human beings are not rational, under the most simple and normal set of circumstances. And this understanding of human irrationality opens up a completely new set of opportunities for the future of decision making in business and government policy making.
Financial scenarios can be one such area where human irrationality can play a large role. The financial market collapse in the United States, and the ripple effect of it on the rest of the world highlight the lacking in the financial risk analysis. This does not mean that the financial risk analysis and management tools were themselves to blame, as some of these tools are very thorough and well designed. But the problem was that designers of these tools had assumed that the user of the tools would be a rational human being. It was the famous book of Nicholas Nassim Taleb -- 'The Black Swan', which argued that one reason for the problems in the financial markets, was that negative returns for some stocks and equities were thought of as impossible. People invested most of their money in portfolios which were earning above average returns. If the investors were truly rational, should they not have noticed that any abnormal or above average return should have been countered by equally abnormal falls, leading to an overall average return, in order to maintain a market average? What really happened is nicely explained by the term coined by Kahneman -- WYSIATI -- 'what you see is all there is'. Most people saw the above average returns to be more common in the market and assigned a higher probability to the events that they thought to be more likely based on what they saw, and didn't consider the spectrum of all the possible outcomes.
More examples of irrational behaviour can be taken from our everyday lives. For instance, you may feel depressed due to a family problem or a relationship issue or simply because you had a bad day at work. However, instead of actually digging deep or seeking for an expert opinion- the next solution you come up that may give you instant relief is by going out and shopping something for yourself. Surprisingly -- it works, may essentially make you feel a little better while the fact remains the same- the relationship issue that you were worried about remains unresolved. This, in marketing terms, is called retail therapy.
Retail therapy means shopping with a purpose of improving the buyer's mood. The term retail therapy was first introduced in Chicago Tribune of Christmas Eve in 1986 where it mentioned- "We have become a nation measuring out our lives in shopping bags and nursing our psychic ills through retail therapy". Nowadays this expression is not uncommon anymore and many marketers wickedly and widely apply it when advertising for accessory items that people may not necessarily require yet will draw their attention and ultimately lead them to spend money on it without thinking rationally and of its possible consequences.
The point we are trying to make is that as human beings, we constantly worry about how our ever rising daily expenses and how we are underpaid while our employers make a good fortune by picking our brains. However, we do not think twice before purchasing something we already have or may not need with that same little amount of money that we make. Hence, if we could educate people/ourselves about such irrational decision making- it can not only help to look into the actual matter but also save money.
People also act irrationally while making employment and HRM decisions. It is often seen that people are stuck in jobs that are not meaningful, enriching or worth the hard-work; yet they are not able to make rational decisions of switching the job and moving forward in the career. This might happen due to the phenomenon called "Endowment effect" -- the tendency that causes people to overvalue something just because they own it. Even though these people know that they should be treated well, paid more or given growth and learning opportunities; they do not switch the job when they are not provided with all this just because they are too comfortable with the organisational culture, working environment or current position they hold; or maybe because they are inherently risk or loss averse. They are not willing to take risks because they feel losses hurt more than equivalent gains feel good. Rationality is influenced by emotional issues or ownership bias.
People often act irrationally while making decisions related to retirement plan and acting upon those decisions. They surely know that they should save for their life after retirement but they fail to do so probably because of their impulsive buying behaviour. The gap between the planning and implementation of the saving plan might be caused by the inability to follow through their own intentions. In such cases, default retirement plan can help people save money according to their plan. In our country, both in government and private organisations, a fixed amount is deducted from the employee's monthly salary before making the salary available in the bank account so that people do not have to make an extra effort to put aside some money for the provident fund. The default option of contributing money gives them a signal that they should save the money as other employees are saving as well.
So far we have looked into examples of irrationality in investing, market and even career and job related fields. These examples sum up to point to one simple outcome -- we, as human beings are not rational. But then, is irrationality bad? Not necessarily. If we do understand human beings are prone to irrationality, then we could actually design our contexts in order to make the best or the most appropriate use of this irrationality. For example, many food packages are required by law to mention the number of calories they have. Unfortunately, people find the calorie information more or less useless as most of them are busy contemplating other daily life issues while consuming the food. But recently many food packages come with a little bit more information, for example an apple juice box package says "one of 10 daily servings". This means you will be done consuming one tenth of your daily calorie just by consuming that juice box. The calorie information is also given, but this information has worked miracles in making people more health conscious. Examples such as these are coming up more and more, as more people are embracing the irrationality of the human behaviour. We believe that through a good understanding of this irrationality in every steps of the problems that we face as a society, economy and as a nation, we could bring about a better set of chances. As a final message of this article, we would like the reader to understand that sometimes, along with more information and a better analysis, it is the understanding of the decision makers irrationality that could actually lead to a better solution for a problem.
K. M. Saqiful Alam and Tasnim Rezoana Tanim are lecturers at Dept of Management of North South University (NSU) while Shahneela Naheed is a lecturer at Dept of Marketing of the same university. Their respective e-mail addresses are: [email protected], [email protected] and [email protected]