The sunk-costs fallacy pops up any time people feel that they’ve invested time, effort, or money in something and don’t want to see that sacrifice go to waste. Of course, that is understandable, but it can fly in the face of logic. On occasion, it simply doesn’t matter how much you’ve invested; sticking with a failing plan will only cost you more. In these instances, it can be very hard to see through your own stubbornness, but cutting your losses might be the smart thing to do.
The Price Is Wrong
The gambler’s fallacy and the sunk-costs fallacy are two specific ways that we screw up our lives when it comes to money or other resources, but it turns out that we make even more fundamental errors when it comes to things of value: we routinely goof up the process of assigning value in the first place.
Consider the games that retailers can play with price tags—and how effective their ploys are. For example, many studies have shown that consumers gravitate toward items that are marked as discounted, regardless of the actual final price. A twenty-dollar shirt will move much faster if it is priced at forty dollars and then discounted to 50 percent off. We humans measure value in relative terms, not absolute ones.
We also have an anchoring bias. People give a great deal of value to the first piece of information they receive, regardless of its trustworthiness. This leads all further information to be valued not in strict terms but relative to the original. Using the example above, the first piece of information is the original (inflated) price of the shirt. This makes the sale price of twenty dollars seem much lower by comparison.
The same is true in a salary negotiation or a home purchase. The first person to name a figure always sets the bar, and all of the parties in the negotiation perceive—and value—every counteroffer that follows relative to that opening bid. Savvy salary negotiators always make their first request way above what they think they will get; they know that this allows managers to feel like they got a “deal” by getting the employee to accept 5 percent to 10 percent less, even if this is still more than they initially intended to pay.
This cognitive bias is so ingrained in the human social psyche that people rarely even question it. I experienced this firsthand when I was contacting solar-power companies to come look at my home and make proposals—I found myself comparing every offer with the first one. The first offer happened to be way inflated because the company did not have a history of building the kind of system that I wanted and basically didn’t want the job. After getting several lower bids, I was left feeling that installing solar panels was cheap! Only when I discussed the bids with my dear spouse was I reminded that these offers were all way above what I originally said I would spend.
Why did the people at that first company give me a sky-high bid instead of just passing on the job? Perhaps they felt that if they charged me way too much, it would make up for however much it cost them to take on a job that wasn’t really in their wheelhouse. More likely, however, they knew that by giving a very high bid, they would leave me with the impression that they were the Cadillac of solar companies. It worked too! Several weeks later, I caught myself telling a friend, “Now, if you can afford it, probably the highest-quality company out there is . . .” What was I talking about? I had no idea about the quality of the craftsmanship of that or any other company. All I knew was the bid, but that was enough. The contractors had successfully convinced me that they ran a superior company by inflating their price, and I was perfectly happy to serve as their unpaid spokesman.
Valuation biases are well known to marketing and sales professionals. The beverage industry is just one of the many sectors of the economy where these professionals can draw on scientific research to sell more products. For instance, studies have shown that people will avoid wine that is priced too low because they think it reflects poor taste or quality. Blind taste tests have demonstrated that people’s perceptions are actually altered when fake price tags are put on bottles. Faked higher prices make people like the wine better, while lower price tags (but not actually cheaper wine) make people turn up their noses. When the deceit is revealed, the participants in these studies, while often embarrassed, frequently confess that the higher-priced wine really did seem to taste better. It was not merely a matter of trying to impress the researcher; false valuation actually affects perceptions, including taste.
As wine salespeople know, valuation biases can work in the opposite direction as well. Next time you go to a nice wine store, take note of the prices. A single bottle of expensive wine is often thrown in with middle-priced bottles to make those bottles look cheap by comparison. That single bottle might not actually cost that much. It could be a very cheap bottle with a big inflated price tag. It’s just there for show anyway!
Similarly, a bottle of cheaply priced wine can be thrown in to make the others look more respectable. This, too, can be done with false pricing. When a wine merchant is down to her last bottle of something, she’ll often mark it way down and then use it to help move some other kind of wine that isn’t selling well. Let’s say there are ten-dollar bottles of Merlot that haven’t been moving. If she sets a bottle with a six-dollar price tag right next to them, suddenly they start to look better. Of course, once she’s ready to unload the six-dollar bottle, all she has to do is put a fifteen-dollar price tag above the other one and then put a big X through it. It’ll sell in minutes.
By now, you have probably realized that many of the cognitive biases and errors common in humans manifest most acutely in the handling of money, whether it’s gambling, markets, or financial planning. Of course, currency is a human invention with no direct correlate in the natural world, and for most of human history, economics involved the exchange of actual commodities—things that were useful in and of themselves, not arbitrary representations of value. Thus, it shouldn’t be surprising that we haven’t evolved the cognitive skills to manage currency. It’s purely a conceptual construct with no biological basis, and that’s why so many people choose to rent their homes and buy their cars instead of the other way around.
But while money itself is relatively new, the ways in which we misuse it reflect ancient glitches in our species’ mental circuitry. That claim is less surprising when you consider that, although human cognitive capacity evolved in a world where currency did not exist, resources certainly did exist, and thus so did the concept of value and its impact on decisions. Humans have always had a relationship with goods, services, and real estate, the tangible things that bring value to the possessor. Goods can be things like food, tools, or even trinkets. Services can be things like cooperation, alliances, grooming, midwifery (yes, it has existed for a long time!), and so on. Real estate means that certain locations are more coveted than others for building a camp, nest, hunting blind, and so on. Economic forces, in other words, predate currency by quite a long time.
Although it’s hard to compare our species’ current relationship with valuable resources to its past one, insofar as we can measure it, other animals make many of the same errors that we do. For example, many animals purchase sexual access with food or other gifts. There are penguins that trade sex for nest-building materials. (If you’re interested, I have a whole section on prostitution among animals in my book Not So Different.) In bird colonies, nest location often correlates with social rank, and there is the equivalent of a bustling real estate market complete with attempted evictions and robberies. Nature offers many examples of how animals try to dominate resources above and beyond what they need to thrive and reproduce. Greed and envy are not uniquely human traits. Our species may have invented currency, but we are not the first to engage in economic transactions, and thus neither are we the first to confront issues of economic psychology.
Just how similar our flawed economic thinking is to that of other animals is becoming clear, thanks to research involving our primate cousins. Dr. Laurie Santos, an animal behaviorist and evolutionary psychologist, has spent years establishing “monkeynomics,” an environment in which capuchin monkeys have b
een trained to use and understand currency. From the many papers she has published on this fascinating work, the most important lesson is that monkeys exhibit many of the same irrational behaviors as humans do when it comes to resources. They are loss-averse, meaning they will take foolish risks when faced with the prospect of losing “money” that they’ve already earned, risks they wouldn’t take in order to earn the same amount. They also, like us, measure value in purely relative terms and can be tricked into changing their choices by price manipulation, like we are at the wine store.
The fact that monkeys have a lot of the same cognitive flaws that we do points to a deeper evolutionary truth about our defective economic psychology. Behaviors that we now see as erroneous and irrational—falling for one’s own confirmation bias, for instance, or making decisions based on the sunk-costs fallacy—likely served our preagriculture ancestors well, as such things as roulette tables and beachside condominiums had not yet been invented. Likewise, when resources were used purely for subsistence rather than social status, comfort, or power, the system of measuring value in purely relative terms probably made good sense.
Furthermore, the stakes—and thus the evolutionary pressures—are high for animals in the wild, and our ancestors were no different. For most modern humans in the developed world now, losing some money generally means that they might have to scale back some aspects of their lifestyles. Losing resources in the Pleistocene epoch might have meant starvation. Thus, extreme aversion to loss also made good sense. When the alternative is an almost certain death, taking a risk doesn’t seem so foolish. Desperate times call for desperate measures.
So the flaws in our economic thinking did serve an evolutionary purpose. But as wine merchants, the casino industry, and many other economic opportunists know well, this feature is a significant bug.
Power of the Anecdote
Another form of human irrationality is found in our species’ extreme sensitivity to the influence of anecdotes. Often, one particular event in your life, or even something told to you by someone else, can overpower everything else you know about the phenomenon in question. This effect is a subset of a larger fallacy known as neglect of probability.
I was once a passenger in a friend’s car as he prepared to merge onto an interstate highway from the city streets. As he approached the point of merger, he slowed the car down and eventually came to a full stop so that he could look over his shoulder and observe the oncoming traffic on the highway behind us. I shouted in disbelief, “What are you doing?” He responded, “One time, I was merging into highway traffic and got into an accident, and now I just wait until there is a total break in traffic before I get on the highway.”
My friend had succumbed to the power of an anecdote. Both driver’s education courses and the rules of the road agree that it is safer and more efficient to keep moving as one merges into traffic from a ramp. There is ample road to accomplish this on interstate highways. It’s actually dangerous to stop because cars could be approaching at high speed from the ramp behind you and, depending on road and lighting conditions, may not be able to come to a full stop in time to avoid a collision. My friend had no doubt been in cars many times when drivers, including himself, safely merged into highway traffic. Yet one bad incident totally changed his thinking and his behavior, leading him to drive less safely in an attempt to drive more safely.
Of course, large data sets are simply collections of individual anecdotes—but their size is what makes them so powerful. By assembling and analyzing lots of different data points, researchers can find statistical patterns and hidden truths that individuals relying exclusively on their own limited reservoirs of experience cannot possibly see. Yet anecdotes convince us when statistics cannot, because data doesn’t move us; stories do. Stories carry more weight with us than generalized statistics do because we can relate to the protagonists of a story and feel empathy for them. We cannot feel empathy for data.
Playing the lottery is a different form of worshipping anecdotes over statistics. My parents have been playing the lottery for as long as I can recall. They don’t waste their money on scratch-offs and small payouts in the pick-three and pick-four games. No, they go for the big lotteries, which promise life-transforming amounts of money. Over the years, my parents have surely thrown away tens of thousands of dollars that could have been put to very good use, as my parents are penny pinchers who use their money wisely in every other way. Any time I remind them of this, my mother defends herself with the “purchasing hopes and dreams” logic that is as flimsy as it is common. After all, hopes and dreams are free.
My parents, like everyone else who plays the lottery, are moved by stories of nurses winning a million dollars. They see people on television receiving the check and think, That could be me! What they don’t see is the several million people who are each a few dollars poorer for having purchased the lottery ticket. The power of the anecdote reigns supreme.
People often combine the power of anecdotes and the confirmation bias to support their positions on any number of social issues. If you think government welfare is wasteful, you probably have a ready example to prove your point. If you think that corporations ignore environmental destruction, you likely can list catastrophes wrought by evil industries. You surely can recount exactly why so-and-so is the best quarterback in the NFL. Although none of these have as much evidentiary power as a large set of data and accompanying statistical analysis, they’re much more convincing in an argument. And that’s just bananas.
The reason that anecdotes are so much more powerful than data is once again that our minds are trapped in the world of finite math and small numbers. Our brains evolved on a planet where humans came into contact with no more than a couple hundred people in their lives. It was crucial for them to draw conclusions from what they saw and what they learned from others so they wouldn’t have to learn every lesson themselves. Questions about how government policies affect millions of people were just never on the docket while our species was taking shape. Today we can use pen and paper (or, um, computers) to crunch the numbers, but our brains will never really be able to wrap themselves around large numbers, even when we’re able to complete math problems mentally. You might be able to compute ten million times three hundred billion in your head, but you can’t really comprehend ten million of anything.
Because early human societies were never larger than a couple hundred individuals, there was no need to understand mathematical conceptualizations larger than that. Therefore, that skill simply didn’t evolve. Some have even argued that the human brain is naturally wired to understand only three numbers: one, two, and many, an argument bolstered by the discovery that the Pirahã tribe of South America has words for only those three numbers. While there is vigorous debate on what numbers, if any, humans have hardwired conceptions of, there is little debate that the human brain is poorly designed for mathematics.
We often pay a price for that—literally, in the case of lottery addicts. But when it comes to another one of our cognitive defects, the cost is even higher.
Youth Is Wasted on the Young
The clichés are well known. Old people drive slowly and carefully and always wear their seat belts. Young people are reckless and inattentive behind the wheel.
These statements seem so obvious that we often forget how paradoxical they are. Shouldn’t young people, with their whole lives ahead of them, be more careful when operating the deadliest machine most of them will ever come in contact with? And shouldn’t old people, with such precious little time left, want to get places quickly?
This conundrum is more than just a cliché, however; it’s backed by data. Young people are indeed the most dangerous drivers, the least likely to buckle their seat belts, and largely indifferent to safety features when selecting cars to purchase. Youthful reckless driving is not a function of inexperience either, because studies have shown that novice drivers who are more mature when they begin to drive are almost as successful at avoiding accidents a
s more experienced drivers. It’s age, not skill, that appears to lead to caution and care behind the wheel—something that car-rental companies have long recognized. They often refuse to rent to drivers under the age of twenty-five. If it were simply a matter of experience, the policy would instead be against drivers with fewer than eight or nine years of driving experience, but it’s not. It is youth itself that makes some drivers just not worth the risk.
Of course, this phenomenon goes well beyond driving. Young people are bigger risk-takers in pretty much every way. They try dangerous and illegal drugs at much higher rates. They’re much less likely to use protection when having sex. Young people are much more likely to enjoy extreme sports such as bungee jumping, skydiving, rock climbing, BASE jumping, and so on. Even when there are safety measures in place, these activities are pretty risky, and in any case, they give the people who participate in them the perception of danger, which is at least partly responsible for the thrill. Psychologists often treat habitual thrill-seekers as addicts—they’re addicted to the adrenaline rush that accompanies danger.
Young people seem to actually enjoy being in danger. One manifestation of this phenomenon is cigarette smoking. Young people will take up this habit even though they all know cigarettes are deadly. In fact, smoking is very unpleasant the first time you do it. I remember my first few cigarettes. I felt a harsh, stinging pain in my throat, and I immediately coughed. The nicotine made me feel lightheaded and eventually nauseated. Some people even vomit while “enjoying” their first cigarettes. Despite the unpleasantness, I didn’t stop. I actually worked to get myself addicted to smoking. Each cigarette was a little bit easier to take, and the nausea eventually gave way to a mild relaxation. By then, I was hooked, and it took me twenty years to kick the habit. Six years after finally quitting, I still curse myself for having started in the first place.
Human Errors Page 19
