Time, too, Is Relative ... Decisions about Money across Time

When I was a bachelor student, during my Economics courses, I have learned that taking a loan from the bank is equivalent with accelerating consumption. For example, if Said wants to buy a car that costs 15.000 Euros then he has two major options. First, Said can save money for a certain period of time, let’s assume three hundred Euros each month. After fifty months when the amount needed to buy a car has accumulated in his savings account, Said can go and buy the car. Taking this path, Said has one advantage and one disadvantage. The advantage is that he will pay for the car only the 15.000 Euros that represent the actual cost. The disadvantage is that for five years and two months (fifty months) Said will not have the car.

The second option Said has is to go to a bank and ask for a loan of 15.000 Euros and buy the car as soon as the loan is approved. If he follows this path, Said will have the car as soon as possible, but will have to pay across five years both the 15.000 Euros which represent the cost of the car and the cost of the credit, let’s say about 3000 Euros.

As my former Economics teacher would say, the 3000 Euros Said pays for the loan represent, in fact, a cost for having the car earlier.

Taking the car out of the picture, Said faces the following question: How much would you need to get now in order to give up 18.000 Euros in five years’ time?

In the case of Said buying a car, the answer was 15.000 Euros. However, let’s assume that you are faced with a similar question, namely what is the minimum amount you would accept now in order to give up 10.000 Euros in one year time? 

What is your honest answer? Would 8000 be enough? 9000?

From a rational point of view there is a (so called) correct answer to this. You should ask for at least 9803 Euros. This is because if you take this amount and place it in a bank deposit for one year with an interest rate of 2%, after one year you will have 10.000 Euros in your account.

However I am sure that you would have been happy with 9000 and for sure you did not compute the amount using the average interest rate for bank deposits in Euros. Don’t worry, most people ask for less than 9803 Euros and it is quite OK to do so.

You have just learned about time discounting or more accurately inter-temporal discounting. People are willing to give up a part out of a future outcome in order to get it faster. The so called correct answer to the question above, namely 9803 Euros, was obtained through a formula specific for the Discounted Utility Model. In an ideal world the discount rate would be equal to the interest rate on the financial markets. Simply put, in an ideal world, you should have a discount rate equal to the interest rate on the financial market, namely 2%. In the same ideal world, you should have asked for 9803 Euros, and then go immediately to the bank and place them in a deposit for one year, subsequently benefiting of 10.000 Euros in one year from now.

Most of the time, the discount rate is larger than the interest rate on the financial markets. For example if you would have accepted 9000 Euros now in exchange for giving up 10.000 Euros in one year time, then your discount rate would have been 10%, which is significantly larger than the interest rate for one year deposits in Euros, namely 2%.

You might wonder if this is wrong; if it is wrong to have a discount rate of 10% which is larger than the so called correct one of 2%? The answer is that it is not wrong, because the Discounted Utility model was never meant to be the correct one, or in more scientific terms the normative one. When it was proposed by Paul Samuelson in 1937 it was simply a proposition of a theoretical model. The author never claimed that it was the right model for describing or prescribing how decision over time should be made. However, this model was embraced by the scientific community and before long it gained the status of the correct model.

Let’s move away from the debate whether the Discounted Utility model is correct or not and focus on a very interesting aspect of decision making over time. Imagine that I’m asking you the following question:

What is the minimum amount you would accept now in order to give up 10.000 Euros in Four years’ time?

Would you accept 6000 Euros? Probably not… How about 7500? I think that you would be happy with this amount. Right?

The interesting thing that happens when deciding about how much we would want for giving up later rewards is that apparently we don’t hold the discount rate constant. Let me explain a bit more clearly. Let’s assume that you would accept 9000 Euros now in order to give up 10.000 in one year from now. This means that your discount rate is 10%. If we hold this rate constant, you should accept 8100 Euros in order to give up 10.000 in two years’ time. This is 10% less than 9000 Euros. Applying the same rate, you should accept 7290 Euros in order to give up 10.000 in three years’ time. Again, this is 10% less than 8100, which in turn is 10% less than 9000 – the amount you accepted in exchange for giving up 10.000 in one year time. The question was what is the minimum amount you would you accept to give up on 10.000 Euros in Four years’ time. In order to find this out we should discount again with 10% the 7290 Euros sum, leading to the amount of 6561 Euros.

However, most people would not be happy with this amount and would ask for more than 6561 Euros in order to give up on 10.000 Euros in four years’ time. My guess is that the minimum accepted amount would be higher than 6561 Euros, or at least that is what theory tells us. Probably 7500 Euros is closer to the amount you would be happy with in exchange for 10.000 Euros in four years’ time.

The key learning of this thought exercise is that close rewards are discounted more than distant once. Putting things differently, the discount you would be willing to accept in order to get the reward now instead of in 12 months is higher than the discount you would be willing to accept in order to get the reward in 12 months instead of in 24 months. This phenomenon is called hyperbolic discounting.  

For a long time, the belief was that the mechanism behind hyperbolic discounting is the decreasing discounting rates. For example if the discount rate for the first year was 10%, then the discount rate for the second year would be lower, say 7%. Similarly, the discount rate for the third year would be even lower, say 5%. Quite recently, this assumption was challenged by a study conducted by Professor Zauberman and colleagues who proved that the mechanism behind hyperbolic discounting is not the decreasing discount rates, but rather the subjective perception of time. In this study the researchers proved that when taking into account the subjective perceptions of time, the discount rate remains constant.

To better understand, let’s focus a bit on what subjective perceptions of time mean. The essence is that a time period of, say, three years is perceived subjectively different from the sum of three one year intervals. Putting this in mathematical sequence, with sp being the subjective perception, it would look like this:

sp(3 years) < sp(1 year) + sp(1 year) + sp(1 year)

According to Professor Zauberman and colleagues, the subjective perception of time explains the difference between the minimum sums accepted to give up on sooner and later rewards. This finding is in line with conclusions on subjective perceptions of other types of values. For example, prospect theory tells us that people perceive probabilities different than their actual value, except for probabilities of zero and one. Similarly the contrast effect tells us that absolute values are judged depending on reference points. According to the study by Professor Zauberman and colleagues, time makes no exception to the rule of relativity. 

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This post is documented from:

Frederick, S., Loewenstein, G. & O'Donoghue T. (2002), "Time Discounting and Time Preference: A Critical Review," Journal of Economic Literature, 40 (2), 351-401.

Zauberman, G., Kim, B.K., Malkoc, S. A., & Bettman, J. R. (2009). "Discounting time and time discounting: Subjective time perception and intertemporal preferences," Journal of Marketing Research, 46, 543-556.

How to See Personality from a Behavioral Economics Perspective

In the 4D Model of Human Behavior Personality is one of the sources of human behavior. Although in popular belief it is seen as the only source of behavior, the reality is that Personality is, out the four sources from the model, the weakest one. Taking this into account, a legitimate question is why is it still included in the model?

To better understand why personality is present in the model, I suggest taking a look at it from a behavioral sciences perspective. If we accept the System 1, System 2 perspective or in other words the bird and computer brains, then we will see that several personality traits are significantly important. Moreover, personality traits are relevant for components of the other three dimensions of the model, Environmental influences, Social influences and Internal state.

In previous posts I have presented the personality traits that I believe to be most important. These are Intelligence, The Big Five Personality Traits, Need for Cognition, Need for Uniqueness, Regulatory Focus, and Life History Strategy adopted. In the following paragraphs I will present most of these traits from the perspective of behavioral sciences.

Let’s take a look at intelligence. A very brief and somehow superficial definition of intelligence is the capacity of processing information. At the same time, intelligence implies accurate processing of information. Moreover, all tests that measure IQ include time pressure. In simpler words, a person who takes an IQ test has very little time to answer each question.

If we take the dual system of reasoning perspective, we see that time pressure implies a dominant reliance on System 1 or the bird brain. This system of reasoning is fast whereas the computer brain (system 2) is slow. From this point of view, it could be inferred that intelligence is strongly related to the accuracy of System 1 (bird brain) reasoning.

Let’s take a look at need forcognition. A very frugal definition of this trait would be how much a person likes to think. A more elaborate definition would be the tendency to engage in effortful thinking. If we take the dual system of reasoning approach, need for cognition can be seen as a measure of usage system 2 or the computer brain.

Things are similar for the Openness to experience trait from the Big Five personality traits. This trait is correlated with need for cognition and it can be briefly defined as intellectual curiosity. Openness to experience is strongly related to the use of the computer brain (system 2).

Let’s take a look at need foruniqueness. This trait could be briefly defined as the degree to which a person expresses her own individuality and at the same time belong to a social group. This trait is strongly related to social competition which is a component of the social influences dimension. In my humble opinion, people with high scores on need for uniqueness are more likely to be more competitive and engage in fierce social competition.

Conscientiousness, which is one of the Big Five personality traits, can be briefly defined as ability to work hard and thoroughly. This trait is strongly related to self-control, which in turn is very important for the internal state dimension. I believe that conscientiousness score of a person would predict well the influence of visceral influences on the person’s behavior.

Life History Strategy adopted is a trait that comes from evolutionary psychology and indicates how much a person is inclined to invest in her own development and improvement and how much is she inclined to “advertise” herself on the social market. This trait is highly significant for social competition, a component of social influences. People who are more on the side of the Fast Life History Strategy are more likely to be more competitive on the social market and allocate more resources for achieving a higher social status. People who are more on the side of the Slow Life History strategy will devote more resources to investing in themselves and less on communicating their value on the social market.   

Regulatory focus is a trait that reflects which goals are more important for a person. People who are more on the prevention focus side tend to have very salient goals of avoiding losses. People who are more on the promotion focus side tend to have very salient goals of achieving gains. This trait is strongly related to the concepts of loss and risk aversions from prospect theory. People with a dominant prevention focus, compared with people with promotion focus, exhibit higher levels of both loss and risk aversions.

Personality is a valid predictor of behavior and I believe that seeing it from this perspective gives more opportunities to understanding its role.  

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Explaining to Yourself Your Own Actions - Need for Justification

Finding reasons for our actions is one very interesting and important psychological phenomenon. Self-justification is part of what is called cognitive dissonance which in a nut shell means that we change our beliefs to become congruent with our actions. For example if you would be forced to do something that you don’t agree with such as campaigning for the communist party (assuming that you dislike this party), later on you will start liking the communist party more than before. This is because you have done something that is against your own beliefs and now you have to make sense of your own actions. Because you need to have congruency between your actions and your beliefs and because your actions can’t be changed, you will alter your beliefs about the communist party.

This, however, is not what I am intrigued by. After all cognitive dissonance is a well-known effect and in the last decade it has been challenged and criticized. My interest is more on the side of how we find perfectly reasonable motives for our actions. An example is how we support with solid arguments our purchases. This is very different from cognitive dissonance because in the case of cognitive dissonance there are two major particularities. First a person is somehow forced to do something that is in disagreement with his own beliefs. Second, the person changes his attitudes or his beliefs after the behavior took place.

Imagine the following scenario. You go to a shop with the aim of buying some drapes. The same shop sells cooking-ware and you are magnetically attracted to a nice frying pan. In the spree of the moment you buy it. This was a totally unplanned purchase and not a very necessary one since you have five frying pans. On your way home you are thinking how you are going to explain your purchase to your significant other. While finding arguments for buying the sixth frying pan to provide your better half with, you think that one of the old pans was already too used, that the new one is ceramic coated and you heard on TV that the food cooked in such a frying pan is healthier and so on. Before arriving home, you have already good reasons to support your purchase in front of your better half.

Two very interesting things are that, first, when you made the purchase none of these arguments ever played a role. Cooking-ware manufacturers know that non-professional cooks buy cute stuff and subsequently design the products to be simply irresistibly cute. Your decision to buy the pan was made when you found it to be very nice and think that it would look good in your kitchen. The arguments about needing to replace the old one and the new one being ceramic coated that makes healthier food came only after you made the purchase, on the way back home.

The second interesting thing concerns you coming up with arguments to defend your purchase in front of your life partner who might be a bit critical with buying stuff that is not necessary. However, your better half is not the one who needs convincing the most. The person who needs the solid rational arguments is in fact you! You need to explain your actions to yourself and only after doing this you need to explain them to others. It is not unlikely that your life partner would be satisfied with a simple and more honest answer such as “I bought it because I liked it”. But you need to explain the action to yourself and very likely “because I liked it” is not satisfying enough. It might be an issue of ego, or simply a natural need of knowing that what you do is your choice.

The above mentioned example is quite trivial because it concerns impulsively buying a frying pan. At the same time, the need for justification is present in many areas of our lives. Quite often our actions are not result of our own reasoning and choice, but rather the outcome of a mixture of internal states, emotions and external factors such as the social and physical environments. However, we have the need to believe that there are good reasons for why we do what we do.

Justifying impulse purchases is only one illustration and as mentioned before not a very important one. Let’s think a bit about tax evasion and discrimination. Do we need to justify these behaviors? Of course we do, and I don’t mean in a court of law, but rather in our regular lives.

In my recent trip in my home country, I have encountered several juicy examples of the need for justification. For example, an entrepreneur who has a small business and somehow avoids paying in-full the taxes, explained me that he does so because public services are unsatisfying and the transport infrastructure is poorly developed. These sound like very solid arguments and the sad reality is that they are true. However, small scale tax evasion has nothing to do with bad roads and increased bureaucracy. It is simply something that is done by almost all small businesses to make an extra income. Most small firms do it because other small businesses do it; because it is possible to do it and because there are countless notorious examples of “stealing from the state and getting away with it.” However, going with the herd and following the example of corrupt politicians, business people and public servants are reasons that would make the small scale entrepreneur not very proud. At the same time justifying the small scale tax evasion with real problems such as bureaucracy and bad infrastructure is a lot more comfortable for the entrepreneur.

It goes similarly for discrimination. I have heard a lengthy and elaborate pleading against the Rroma (Gypsy) community and why this minority is the biggest problem of the country. Most of the arguments that supported this thesis were not very solid, but the person providing them was convinced of them. In the end of the so-called explanation, the old gentleman said that when he was a child he had a very negative experience with some members of the Rroma community. In 1934 he was kidnaped by a group of nomad gypsies and rescued by his parents a couple of months later.

The gentleman’s negative feelings towards his experience can’t be challenged, but finding so-called solid arguments to support the idea that an ethnic minority that represents less than 5% of the population is the main problem of the country is a bit far-fetched. However, this person needed to justify his negative feelings and supported them with reasons that in fact have nothing to do with the source of the feelings.

Quite often we justify to ourselves our actions and feelings (attitudes). The dilemma is whether we think before we do something or we think after we have done something and find reasons for our already done actions.

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How Clothes and Uniforms Influence our Judgment and Behavior

One of many typical games children play is dress up. They pick some clothes, many of which belong to the parents, and play different roles. Probably doctor and fireman are the most common choices. However, dress up is not reserved only for children; grownups do it too, but usually are unaware. Each time we go to a black tie party we dress up; each time we put on the work around the house clothes we dress up. The clothes we wear influence how we think and how we behave. The same person who in one instance is dressed up for a black tie party will behave significantly different when she is dressed in the work around the house clothes. In order to better understand how the clothes we wear influence our judgment and behavior, let’s talk about a particular type of clothing, namely uniforms.

Uniforms are something that we encounter several times each day and they are very diverse. However, when we think about uniforms the first thing that comes into mind is not the McDonalds or KLM uniforms, but rather it is the Police, Military or School uniforms. This is easily explicable because long before corporations started using uniforms they were used by state organizations such as the Military. The use of uniforms has several implications that will be briefly presented in the following paragraphs.

The first implication of uniforms is identification. Imagine a very bloody and heated battle between two tribes. In the heat of the battle it would be possible for members of the same tribe to harm or even kill each-other because they confused the other for an enemy. This is highly plausible. Nowadays this is called friendly fire that is a nice term for we killed our own.  In order to avoid the possibility of two warriors from the same tribe to slaughter each other, identification features were introduced. These evolved into military uniforms. The primordial role of uniforms is for the individual to be identified as a member of a certain group.

The second implication of uniforms is to enhance the feeling of belonging to a certain group. Whereas the primary role was to identify another individual as a member of a group, the second implication refers to the individual’s feeling of belonging to the group. When dressed up in, let’s say, a military uniform the individual has an increased sense of belonging to the group, in this case the army.

There is a limitation to increasing the sense of belonging through the use of uniforms, namely that in order to enhance the sense of membership, the group must have a well-defined identity. In the case of the army this is not an issue since the institution has a very well defined identity. However, if at a new organization uniforms are introduced, they will not help much in increasing the sense of belonging if the organization has a weak identity. In simpler words, in order to increase an individual’s feeling of membership, first there must be something to belong to.

The third implication of uniforms is that they create anonymity. Once in a uniform the individual is less himself and more of just another member of a group. In the case of the army things are quite straight forward. The new recruit Hans is not any more the young man who lived in a quiet peaceful town with his working class parents. He is now a soldier; he is now just another soldier in the army. In other cases anonymity is slightly smaller than in the case of the army, but still exists. For example most shoppers in an Albert Heijn supermarket notice mainly the uniforms of the employees and significantly less the individuals who are wearing them.

The sense of anonymity leads to increased aggression. For example warriors who wear masks are more brutal than similar warriors who do not use masks. A much closer example of increased aggression due to anonymity is in the on-line environment. Behind nicknames or avatars a lot of people are brave, rude and aggressive. However, the same people would behave like pussy-cats when they are stripped of their disguises. The increased aggression of individuals who perceive themselves as anonymous is attributed to a lack of accountability. This implies that organizations that use uniforms should make sure that their members are aware of their accountability for their acts.

The fourth and, in my view, the most important implication of uniforms is that they induce prototypical judgment. In an earlier post on priming you have learned that exposure to a certain piece of information makes a mental construct more salient in the mind, thus influencing subsequent judgment and behavior. You have also learned that asking people to think like a trader influences judgment. Simply put, when we ask somebody to think like a prototypical character we are asking them to put themselves in the shoes of the character.

In the case of uniforms things go even further. By dressing up an individual in a uniform that is prototypical for a category, the person is in the shoes of the prototype.  For example dressing a regular person in a military uniform will make that person act in a more militaristic way. Similarly if someone would dress up in a doctor’s uniform she would speak using more medical terms and overall would behave more like she thinks and knows a doctor behaves.

The process behind these changes is the following. We have stored in our minds prototypes and their specific behaviors. When dressed as a prototypical character, say police people, all the mental constructs related to the police are salient in the mind. Moreover, the person is now like the prototype of a police person. Subsequently the individual will exhibit behavior specific for the prototypical character.

This post began with a discussion about clothes and how they make us think and behave differently. Uniforms are the best illustration of this phenomenon, but by far most people are not using uniforms. However, most people have different types of clothes. We have office clothes, pajamas, work around the house clothes, party outfits and so on. Each of these types of clothes is associated with a specific context and when we wear them information related to the context becomes salient in our minds. This in turn influences how we think and how we behave. Usually we use clothes that are appropriate for each specific situation. For example we don’t go to business receptions dressed in pajamas and we don’t vacuum the house in our party outfits. However, there are a few instances when we might not bother to change into more appropriate clothes. I’ll illustrate this with an example soon, but before that, there is another effect of clothes that should be mentioned.

In an earlier post you have learned that the furniture we use influences our body posture which in turn influences judgment and behavior. Clothes have a similar effect, especially when it comes to the position of shoulders. The shape and the cut of a shirt, coat or T-shirt influences the position of one’s shoulders. Some cuts favor an up-right position, while other cuts favor a round-shouldered position. This might not seem much, but the two shoulder positions are specific for very different internal states. The up-right is associated with increased confidence, while the round-shouldered is specific for very low confidence.

I would like to conclude this chapter with an anecdotic example from my own experience. When my wife finished her Master program she had to give a presentation on her thesis. Since it was something very important, at least at the time, she practiced a lot. At one point she decided that it is time to have some rehearsals in front of an audience and the audience was me. She asked me to help her in any way I can. I said that I would like to see the full presentation once and after I will give her some tips. So we placed the beamer on the table, the laptop next to it, Cornelia, my wife, was standing  next to them and I was sitting on the couch. She began the presentation and not before long some stuttering occurred.

I knew how much she had prepared and I was a bit surprised by these mishaps. Moreover, I was surprised by the lack of confidence she had while giving the presentation. This was not justified by anything since the thesis was good and she had worked on it for many months. Then I realized that both Cornelia and I were still wearing our staying in the house clothes. As you can imagine the clothes were quite loose and comfortable, maybe too comfortable. I noticed especially how her comfortable blouse was making her shoulders to not be up-right.

Realizing all these, I asked Cornelia to go and change into the clothes she plans to use for the actual presentation. She did so and in addition put on her elegant shoes. She started again the rehearsal and this time it went very well and very smooth. There were only a few fine tunings to be done and after three rehearsals everything was close to perfect. The actual presentation went very well, too.

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The Secret Behind Complicated Application Procedures

Take for example all the complicated and time consuming application procedures for getting admitted into a good university. Apart from having high scores on standardized tests, an applicant must fill in endless forms, upload a lot of documents, write motivational essays etc. Presumably universities want many students because it is one of the ways in which they make money. So, why is it that universities make it hard for people to apply for their programs? Is it because they want to not have too many applicants?

The answer to the questions above is that the complicated application procedure is in itself a part of the selection for admission process. One obvious element that is verified by asking applicants to go through a complicated procedure is motivation. Many people who would apply just for fun or to simply see what happens are discouraged to apply. This leads to avoiding an overload of the admissions office with applications from people who would no follow through.   

However, the motivation part is only one side of the advantages of having complicated application procedures. In order to better understand the other sides, let’s think a moment about the admission criteria and the profile of a good candidate. Although universities want many students, they also want good students who will be able to go through the education programs without too many troubles. Universities don’t want to have students who constantly fail exams and who need four years to finish a one year program.  This means that the education institutions want to admit candidates who have a good academic performance potential.

Recruiting and selection are mostly focused on assessing the personality of each candidate and making a decision on how well each personality fits with the ideal candidate profile. When it comes to academic, as well as job, performance there are two personality traits that are very good predictors, namely intelligence and conscientiousness. Intelligence can be defined in a nutshell as capacity of processing information and we have to admit that for academic performance the overall rule of the more the better applies. Conscientiousness can be defined briefly as ability to work hard, to work thorough on a task. Again, when it comes to reading textbooks, doing homework and other typical academic work tasks, the higher the level of conscientiousness a candidate has, the better the candidate.

Intelligence and conscientiousness are not the only predictors of academic or job performance, but out of the wide array of personality traits, they are the best predictors. So, universities want to get students who are highly intelligent and score high on conscientiousness. Although everyone seems to have an idea of what intelligence is, the reality is that this particular personality trait is not very easy to measure. In order to measure someone’s IQ, the person has to take an IQ test. Universities don’t explicitly ask for IQ test scores, since that would create endless controversies; what they do, is ask candidates to provide their scores on standardized tests such as the GMAT, in the case of business schools, or SAT. All these standardized tests are disguises for IQ tests. This is not to say that the GMAT is an IQ test, but rather to say that a candidate’s score on the GMAT is highly correlated with that candidate’s IQ score. To conclude on how universities assess candidates’ IQs is not by giving them actual IQ tests which would lead to controversies, but by using a proxy of intelligence scores, namely scores on standardized tests such as GMAT, GRE and SAT which are not subject to controversy.

Having clarified the way in which universities assess the intelligence levels of their candidates, it is time to look a bit on how they assess the conscientiousness levels of people who apply for education programs. The first way to assess conscientiousness is through the same standardized tests. If you have taken such a test, you probably noticed that they are completely unappealing and, in my humble opinion, really boring. In preparing for and actually taking such a test there is no intrinsic task motivation. The test has to be taken for the sake of taking it and with the only goal of scoring high.

A byproduct of the introduction and wide use of standardized tests is the development of a real industry of learning test taking. A quick search on amazon.co.uk with the key-word GMAT returned over one thousand results. This is only one standardized test and the search was done only on one website. The reliance on standardized tests led to a need of learning how to take the test. From a certain point of view, this is not exactly great, but from another point of view the difficulty of test taking is one of the key elements of standardized tests. By making a test difficult to take and by making people work a lot and prepare for taking a standardized test, the test actually measures conscientiousness. The higher the level of conscientiousness one has, the more she will work on the mostly pointless tasks of test taking and subsequently the higher the score on the test will be. In a nutshell, standardized test measure both intelligence and conscientiousness.

When it comes to assessing a candidate’s level of conscientiousness, universities go beyond relying only on the scores on the standardized tests. They also make the application procedure lengthy, complicated and somehow boring. By asking candidates to fill in endless forms, to write essays and to upload many documents, universities, in fact, assess the level of conscientiousness of each candidate. People who have a low level of this trait simply fail to complete the application procedure.

Before concluding this example of the up-side of making things harder, I have to make a final point regarding the predictive value of intelligence and conscientiousness on academic performance. Their predictive value is real, but applies mostly for average levels of the two traits. In other words, at the extremes of each trait, the differences are insignificant. For example, if one candidate has an IQ of 160 and another has an IQ of 163, the three points difference will not predict too much. However, a difference of three points between an IQ of 99 and an IQ of 102 will predict better academic performance. Extremes on these traits are very rare; there are very few people in the world with extremely high IQs and with very high scores on conscientiousness. Universities know this and act accordingly. In selecting future students who will perform well, the primary goal is not to get the exceptionally good ones, but rather to make sure that the not so good ones are not admitted. The complicated and time consuming application procedure will not distinguish between the people with very high and exceptionally high levels of conscientiousness. Rather, it will distinguish between the people with low and average levels of conscientiousness. 

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How to Buy Pasta in a Foreign Country - Social Proof

In an earlier post on social influences on our own behavior I have addressed the topic of social conformity, mainly from the perspective of “peer pressure” or conforming to group norms and behaviors in order to no be or feel excluded.

The social influences on our own behavior have also a different side, namely that we tend to conform to social norms and to “do what others do” not only to avoid feeling excluded, but simply because we infer that “others know better”. 

Imagine the following example. You are in a foreign country and want to buy pasta from a supermarket. None of the brands on the shelves are known to you and you don’t know the language of the country, so you can’t read too much on the packages. As you are looking at the pasta bags and packages trying to figure out which one to buy, a lady comes by the shelf with pastas and picks one bag, puts it in her shopping basket and leaves. The lady looks more like a local and a lot less like a tourist.

How likely are you to pick up the same type of Pasta as the lady did? 

My belief is that you are very likely to buy exactly the same type of pasta as the lady did. This is not because you are afraid that if you would not pick the same type of pasta you would be or feel excluded from a social group. After all you are in a foreign country, you don’t speak the language and have no idea what kind of pasta is the best… how more excluded can you get?

You will pick up the same type of pasta as the lady picked because you infer that she knows something you don’t, namely which pasta is better.

Social proof is similar to “peer pressure”, but it is distinct. One similarity is that we are influenced more by the actions of people who are similar to us. For example a Manchester City fan will not be influenced by the behavior of a Manchester United fan (City and United are rivals). At the same time if you are a young male, very likely you will be influenced by the behavior of other young males.

One distinction between social proof and peer pressure is that social proof occurs only when there is some ambiguity, whereas peer pressure occurs even in situations in which there is no ambiguity. We infer that others know better, but this implies that we ourselves don’t know too much. In the pasta example, you inferred that the local lady knows which pasta is best only because you had no idea which one is better.

Peer pressure, on the other hand, acts even if you know exactly which pasta is better. Let’s assume that you go to the supermarket to buy pasta and this time you know that brand B is the best pasta in the world. However, you are not alone on your shopping trip and your “in laws” are with you. They are also shopping. Your mother in law picks up some pasta brand A (which you know is inferior to brand B). Then your sister in law picks up the same brand A pasta… now even if you know brand B is better, you might buy brand A in order to not be excluded by your extended family.

Both social proof and peer pressure lead to the same outcome – “doing what others do”, the mechanisms behind each of them are distinct.

A characteristic of social proof is that it becomes more powerful with the increase in the number of people who exhibit a certain behavior. In the buying pasta example, if you see that ten ladies and not only one buy a certain type of pasta, you will feel no doubt that you should buy what they bought.

  

A particularly interesting thing about social proof is that it starts from a rational (or at least reasonable) assumption, namely “if I don’t know too much / anything on a topic, then others might know more on that topic and doing what they are doing is a smart idea.” However, this very assumption can lead to perfect irrationality in the sense that “if I don’t know what to do and I simply copy the behavior of others, then someone else may have the same issue and subsequently copy my behavior, but I don’t know why I am doing what I am doing.”

Learn more on my book: It Makes (No) Sense: Between the Joy of Gaining and the Fear of Losing

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The Similarity between a Colonoscopy and a Holiday

We live in a world full of “stuff”, of material possessions powered by the almighty philosophy of consumerism. Of course there are places on Earth that do not have the abundance that characterizes the “western” world, but even so, we are overwhelmed with “stuff”.

If you don’t believe me, try moving to a new home and while packing things up you will get the main idea. If you still don’t believe me, think about the “personal storage spaces” business. If we would not be overwhelmed with “stuff” why would people rent storage spaces outside their homes?

However, in this post, I don’t want to talk too much about material possessions, but rather I wish to cover the topic of experiences. Even if we are surrounded by “stuff”, our lives are not made out of “things”. The essence of living is the act of living. To put things a bit simpler, your life is made out of your experiences, of what you are experiencing every second.

We have experiences each moment in our lives. We experience sleeping (by the way, it’s not a bad idea to invest large amounts of money in a good bed), we experience eating meals, we experience using public transport, we experience driving, we experience working, we experience going out for dinner, we experience going on holiday and so on.

One interesting thing about experiences is that we believe that they are more or less like physical products, like “stuff”. We believe that the experience of a holiday in Spain is very similar to a couch. However, this is not true. Things (stuff) are roughly the same regardless if you use them at this point or if you think of using them. For example, there is not a huge difference between you sitting on your couch and you thinking about or remembering your couch. On the other hand, there is a huge difference between you being on holiday in Spain and you remembering your holiday in Spain.

The main characteristic of experiences is that the memory about an experience such as a holiday in Spain is different from the actual experience of being on holiday in Spain NOW.

As Daniel Kahneman puts it, we have two “selves”:  (1) the “experiencing Self” – the one that actually lives the experience in the present and (2) the “remembering Self” – the one that remembers the experiences lived by the “experiencing self”.  

Each of these two selves has its own evaluation of an experience. Surprisingly or not, the two evaluations are different.

The evaluation of the “experiencing self” is quite straightforward. We know how we feel and what we feel in every moment. For example if you like what you are reading now, you feel good, you are happy and so on. We know that we feel pleasure when we experience something pleasurable. Similarly, we know that we feel pain when we feel pain.

The evaluation of the “remembering self” is very different from the one of the “experiencing self”. If the two selves (experiencing and remembering) would be the same, then the memory of an experience would be the average of each and every instance of evaluations made at every point in time.

Let me illustrate a bit more. Imagine that you go on a week-end trip to a nice place in the mountains. You spend there about 24 hours and you decide to evaluate your experience every 15 minutes. This means that you will have 96 instances of evaluations made by your “experiencing self”.

If the experiencing and remembering selves would be alike, then your overall evaluation of your “trip to the mountains” experience would be the average of the 96 evaluations made every 15 minutes during the actual experience.

However, the “remembering self” is distinct from the “experiencing self” and what the “remembering self” thinks about your “trip to the mountains” experience is very different from the average of the 96 evaluations your “experiencing self” made.

   

What the scholars of happiness have found about the differences between the memory of an experience (“remembering self”) and the actual experience (“experiencing self”) can be summarized in two main principles.

First is the “Peak-End Rule” which says that a memory about an experience is influenced by the maximum point and the ending point of the actual experience. What this means is that apart from the maximum pleasure (or pain) and the pleasure (or pain) felt at the end of the experience, you will not remember much, or more accurately your retrospective overall evaluation of the experience will ignore all the other instances actually experienced.

For example imagine that you go on holiday to Spain. One week after you get back home, your friends ask you “how was your trip?”. In order to give an answer, you will look back and make an evaluation of your holiday in Spain. This is your “remembering self” at work. Your answer to the question mentioned above will be determined by the peak of your experience, let’s say visiting Sagrada Família (a monumental cathedral in Barcelona), and by the last thing you have experienced in Spain, let’s say the superb meal that you had on the last night before leaving Spain. Of course you could have had a miserable experience and remember getting robed (peak of experience) and the unfriendly staff at the airport (end of the experience), but let’s be positive.

Your actual experience of visiting Spain was, however, more complex than just the peak and the end of it. Fortunately or not even if you remember instances of the holiday other than the peak and the end, when making a retrospective overall evaluation you will ignore all the other instances.

The second principle about the differences between the actual and the remembered experiences is “Duration Neglect”. Closely related to the “Peak-End Rule”, duration neglect means that our overall retrospective evaluations of our experiences discard the actual length of the experience. To put things a bit simpler, when you actually have an experience (“experiencing self”) how long it is matters, but when you remember experiences (“remembering self”) how long the experience was has virtually zero importance.

Going back to the holiday trip in Spain, when you are asked “how was it?” your answer will be the same as before regardless if you have been in Spain for 6 or 7 days, as long as visiting Sagrada Família and having that wonderful last dinner in Spain still happen. However, when you actually are in Spain it matters if you are there for 6 or 7 days.

In a very famous study by Redelmeier, Katz, and Kahneman, the researchers investigated the difference between experience and memory of a painful experience (colonoscopy). One group of patients had a brief procedure, whereas the other group had a slightly longer one. The short procedure ended with a high discomfort (pain) for the patient, while the longer procedure ended with a lower discomfort (but still painful).

The actual experience was better for the patients who received the brief procedure as compared to the experience of the ones who received the long procedure in the sense that the total amount of experienced pain was smaller. However, when asked to evaluate their experience in retrospect the ones that received the longer procedure (with more experienced pain) rated their experience less bad than the ones who received the short procedure (with less experienced pain).

This is a very powerful illustration of both the peak-end rule and the duration neglect. People who have had less pain in total (short procedure), but the ending of experience was very painful remembered their experience as worse than people who have had more pain in total (long procedure), but the ending of the experience was less painful. As you can see, retrospective evaluations of our experiences are based on the peak of the experience (both groups of patients had the same peak of pain) and on the end of the experience which was different for the two groups. Moreover, the duration of the experience was ignored in the sense that people who have had actually longer painful experiences which ended with a less bad experience remembered their experience as being better (less worse) than the people who had suffered less actual pain.

Now, let’s go to the practical, business related implications of this difference between the experience and the memory about the experience.

A somehow naïve opinion on the difference between experience and memory would be to ignore it. A skeptic might think “What do I care what people remember? After all they remember whatever they want to remember!”

OK! Point taken, but answer the following question: “Who makes the decision? The experiencing or the remembering self?”  

The answer to this question is most often “The remembering self”. For example if you consider going on a holiday next year and one of your options is to go to Spain, then your memory  (“remembering self”) on your previous holiday in Spain will be crucial in your decision. It goes similar for recommending to others to go on holiday to Spain.

Another example can be about getting dental treatment. When you go to the dentist you live the experience, but when you decide to which doctor to go the next time, what actually counts is the memory of your previous experience with a certain doctor.

What can be done about this is quite simple. In many cases a business can’t control the “peak” of the client’s experience. For example a hotel can’t control the peak of a tourist’s experience in a city. However, it can do something about the end of the experience. Most hotels offer breakfast, but as far as I know none offer a “lavish good bye dinner”. The last meal a tourist has in a destination is very likely to be her “end experience” in that place. This means that by providing a nice ending to one’s holiday, the overall memory of the holiday will be more positive.

In other cases there is some control over both the end and the peak of a client’s experience. For example cruise ship operators can significantly influence the peak of the client’s experience simply because people are “captive” on a cruise ship and most of what they do on that ship can be influenced by the operator. It goes similarly for medical practices or other types of personal services because the entire experience can be controlled by the provider.

Before concluding, I would like to address one very serious question, namely “Which of the experiencing and remembering selves is more important?”.

This is a really hard question to answer. From a business perspective, the “remembering self” is more important because it is the one that will make future decisions. At the same time, the “experiencing self” is also very important because people are living in the “Eternal Now”. Moreover, the “experiencing self” is the one that may complain or be thrilled by your services.

One particular salient example of the tradeoff between the “experiencing” and “remembering” selves is the case of Asian tourists (at least in Europe). As I see it, most Asian tourists are more concerned with taking pictures and video-recording every possible landscape, building, plant, stone etc. At the same time, in my view, they actually miss their experience of visiting countries in Europe. I believe they fail to actually live the experience they go through.

I assume my observations on Asian tourists in Europe are a bit biased because I usually don’t take pictures and simply enjoy the experience.

Regardless of my impressions on Asian tourists, in many instances we are faced with the tradeoff between actual and remembered experiences. I guess both have roughly the same importance.

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Note: This post is documented from:

Kahneman, D. (2011). Thinking, fast and slow (chapter 35). London: Allen Lane.

Redelmeier, D. A., Katz, J., & Kahneman, D. (2003). Memories of colonoscopy: A randomized trial. Pain, 104, 187–194.