The End of a Myth: The Rational Man Theory of Markplace Behavior

Objective reality is more illusion than substantive. Every magician knows that how we perceive something is often determined less by what we see and otherwise sense than by what goes on in our brains. Neurologist V.S.   Ramachandran’s engaging book Phantoms in the Brain brilliantly supports that claim. He cites numerous examples showing how the brain generates illusory renderings of reality.

One of the most common examples of illusory reality is the phantom limb problem that amputees experience. When a legless person feels an itch on an ankle he no longer has it’s because certain neurons in the brain devoted to the missing limb haven’t noticed its absence.

Ramachandran tells of one patient whose brain injury from an auto accident prevents him from recognizing his parents even though he has no trouble remembering and recognizing anyone else.

Another patient does who suffered a right brain stroke denies the paralysis of the left side of her body caused by the stroke.  When asked to raise her left arm resting inertly in her lap she said it wasn’t her arm. It belonged to mother who left it in the hospital years ago. Oddly, however, when several drops of cold water were deposited in her left ear, she became fully aware of her paralysis: “Doctor, I can’t raise my left arm because I had a stroke,” she protests when asked to raise it. She remains fully aware of her paralysis for two to 30 minutes after receiving the water drops. Then, she loses all awareness of her paralysis as well as the brief interlude of awareness after the cold water was deposited in her ear.

 So you might say that such cases bear no relationship to how you or any other normal person internalizes reality.  However, those cases are merely extreme  examples in support of the proposition that normal or otherwise our perceptions are fundamentally subjective, meaning our brains ultimately determine what we see.

Take the optical illusion shown here. You perceive the inner circle in the cluster of small circles as larger than the inner circle in the cluster of large circles. The reality is that the inner circles are equal in size. But because the brain relies on comparisons for much of its work, it reckons the size of the inner circle as a proportion of the size of the individual circles in the cluster that surrounds it. 

We can draw from this visual illusion an important principle:  The brain’s rendering of an object, condition, concept or idea is influenced by comparisons it makes as part of its efforts to understand what it processes. 

This principle has been demonstrated in countless research studies. Economist Dan Ariely tells of a number of such studies he has conducted. In one study Lindt chocolate truffles were sharply discounted from 35 cents to 15 cents and Hershey kisses were more modestly discounted to   one cent in reflection of significant qualitative differences between the two candies. About 73 percent of the study’s participants chose the heavily discounted higher quality Lindt. But when the Hershey kisses were offered for FREE! against the Lindt truffle now priced at 14 cents, 69 percent of participants chose the qualitatively less impressive Hershey kisses. They apparently figured that FREE! was a better deal than a 14 cent Lindt truffle despite the fact that the effective price difference was no different than when they had the option of a 15 cent Lindt truffle or a one cent Hershey kiss.

This experiment and many more are discussed in Ariely’s provocative new book, Predictably Irrational: The Hidden Forces that Shape Our Decisions. I enthusiastically recommend Ariely’s book to anyone involved in product pricing in any category. You will likely come away from this read with a better handle on how to price products.

Classical economics has rested on a premise that Ariely shatters to smithereens. For well over two hundred years economists have based their thinking on the premise that marketplace trends are determined by the rational behavior of people acting in their own interests. This in fact is the keystone of Adam Smith’s book The Wealth of Nations, the Old Testament of capitalism.

Ariely is not the first to challenge the rational man premise of classical economics.  A whole new subfield called behavioral economics has taken root because some brave-minded stalwarts in the dismal science decided the emperor was stark naked. The notion that marketplace trends reflect the outcome of human reasoning in an objectively fathomable world is every bit as illusory as the appearance that the earth is more or less flat.

Michael Mandel, writing in BusinessWeek, says about another book debunking the rational man theory of classical economics, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by Nobel laureate George Akerlof and Yale economist Robert Shiller who is well-known for the Case-Shiller Home-price Index:

“The two superstars have produced a truly innovative and bold work that attempts to show how psychological factors explain the origins of the current mess and offer clues for possible solutions. At a time when plummeting confidence is dragging down the market and the economy, the authors' focus on the psychological aspect of economics is incredibly important.”

The cat is out of the bag, so to speak. I would expect to start seeing more accurate economic projections in the future now that such prominent  economists as those who wrote the books I’ve cited in this post have revealed just how naked the rational man theory is.

Comments

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[David Wolfe]

it's a mule. Click on "About" for details.

[Online Printing]

A very interesting post, thanks for sharing this! Your optical illusion example is a great way to demonstrate how the brain processes through comparison.

[joared]

Excellent blog post. I continue to appreciate how you integrate brain function and marketing. Thanks for inclusion of some books I think will be interesting reading.

I've worked with a lot of patients right hemisphere cortex trauma -- stroke, injury, etc. The "neglect" of any part of the body as you describe has been one fascinating challenge to remediate with patients. All Rehab Team members need to be aware of this. I had not heard of the temporary effects of water dripped into the ear. That might be a way to help a patient become more aware they even have a problem, since some have great difficulty in recognizing the issue despite explanations and demonstrations.

[David Wolfe]

Joared, I erred in my reference to the stroke victim. The cold water treatment was to the left ear. You can read more about it by going to Amazon.com and bringing up "Phantoms in the Brain." Once up, click on "Look inside," which brings up a search box. Type "Eduardo" in the search box, hit return and page 134 will pop up. The description of the treatment begins near the top of the page and continues for several pages. Maybe you should buy the book while on line. It is utterly fascinating.

Thanks for your comments!

DBW

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Just wanted to say a big huge CONGRATS on the book! I look forward to reading it, and I love your blog and your column. Can't wait for the new blog

[Matt Moore]

Ariely's book is good and his empirical work will stand the test of time.

However there are 2 big problems with behavioural economics:
1. It needs to move further beyond lab-based experiments to more real-world fieldwork;
2. It needs to replace its language of "biases" with some of the frameworks from cognitive science around pattern-recognition. Gary Klein's work is brilliant here.

Eventually, there will be a unification of naturalistic decision making (NDM), behavioural economics (BE) and evolutionary psychology (EP). But that'll probably take 10 years.

I'd get in quick.

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Two thumbs up, well done!

[Priya]

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