the official site of Michael Shermer

top navigation:

Why People Believe Weird Things About Money

January 2008

Would you rather earn $50,000 a year while other people make $25,000, or would you rather earn $100,000 a year while other people get $250,000? Assume for the moment that prices of goods and services will stay the same.

Surprisingly — stunningly, in fact — research shows that the majority of people select the first option; they would rather make twice as much as others even if that meant earning half as much as they could otherwise have. How irrational is that?

This result is one among thousands of experiments in behavioral economics, neuroeconomics and evolutionary economics conclusively demonstrating that we are every bit as irrational when it comes to money as we are in most other aspects of our lives. In this case, relative social ranking trumps absolute financial status. Here’s a related thought experiment. Would you rather be A or B?

A is waiting in line at a movie theater. When he gets to the ticket window, he is told that as he is the 100,000th customer of the theater, he has just won $100.

B is waiting in line at a different theater. The man in front of him wins $1,000 for being the 1-millionth customer of the theater. Mr. B wins $150.

Amazingly, most people said that they would prefer to be A. In other words, they would rather forgo $50 in order to alleviate the feeling of regret that comes with not winning the thousand bucks. Essentially, they were willing to pay $50 for regret therapy.

Regret falls under a psychological effect known as loss aversion. Research shows that before we risk an investment, we need to feel assured that the potential gain is twice what the possible loss might be because a loss feels twice as bad as a gain feels good. That’s weird and irrational, but it’s the way it is.

Human as it sounds, loss aversion appears to be a trait we’ve inherited genetically because it is found in other primates, such as capuchin monkeys. In a 2006 experiment, these small primates were given 12 tokens that they were allowed to trade with the experimenters for either apple slices or grapes. In a preliminary trial, the monkeys were given the opportunity to trade tokens with one experimenter for a grape and with another experimenter for apple slices. One capuchin monkey in the experiment, for example, traded seven tokens for grapes and five tokens for apple slices. A baseline like this was established for each monkey so that the scientists knew each monkey’s preferences.

The experimenters then changed the conditions. In a second trial, the monkeys were given additional tokens to trade for food, only to discover that the price of one of the food items had doubled. According to the law of supply and demand, the monkeys should now purchase more of the relatively cheap food and less of the relatively expensive food, and that is precisely what they did. So far, so rational. But in another trial in which the experimental conditions were manipulated in such a way that the monkeys had a choice of a 50% chance of a bonus or a 50% chance of a loss, the monkeys were twice as averse to the loss as they were motivated by the gain.

Remarkable! Monkeys show the same sensitivity to changes in supply and demand and prices as people do, as well as displaying one of the most powerful effects in all of human behavior: loss aversion. It is extremely unlikely that this common trait would have evolved independently and in parallel between multiple primate species at different times and different places around the world. Instead, there is an early evolutionary origin for such preferences and biases, and these traits evolved in a common ancestor to monkeys, apes and humans and was then passed down through the generations.

If there are behavioral analogies between humans and other primates, the underlying brain mechanism driving the choice preferences most certainly dates back to a common ancestor more than 10 million years ago. Think about that: Millions of years ago, the psychology of relative social ranking, supply and demand and economic loss aversion evolved in the earliest primate traders.

This research goes a long way toward debunking one of the biggest myths in all of psychology and economics, known as “Homo economicus.” This is the theory that “economic man” is rational, self-maximizing and efficient in making choices. But why should this be so? Given what we now know about how irrational and emotional people are in all other aspects of life, why would we suddenly become rational and logical when shopping or investing?

Consider one more experimental example to prove the point: the ultimatum game. You are given $100 to split between yourself and your game partner. Whatever division of the money you propose, if your partner accepts it, you each get to keep your share. If, however, your partner rejects it, neither of you gets any money.

How much should you offer? Why not suggest a $90-$10 split? If your game partner is a rational, self-interested money-maximizer — the very embodiment of Homo economicus — he isn’t going to turn down a free 10 bucks, is he? He is. Research shows that proposals that offer much less than a $70-$30 split are usually rejected.

Why? Because they aren’t fair. Says who? Says the moral emotion of “reciprocal altruism,” which evolved over the Paleolithic eons to demand fairness on the part of our potential exchange partners. “I’ll scratch your back if you’ll scratch mine” only works if I know you will respond with something approaching parity. The moral sense of fairness is hard-wired into our brains and is an emotion shared by most people and primates tested for it, including people from non-Western cultures and those living close to how our Paleolithic ancestors lived.

When it comes to money, as in most other aspects of life, reason and rationality are trumped by emotions and feelings.

This opinion editorial was originally published in the Los Angeles Times.

read or write comments (67)
topics in this post: , , , ,

67 Comments to “Why People Believe Weird Things About Money”

  1. Anarcissie Says:

    exile is correct. The original proposition does not consider the power difference resulting from wealth difference.

  2. It’s free and open for a reason! Says:

    […] an old psychology result that says people care more about their spending power in relative terms, than their absolute […]

  3. Matt Says:

    The first one needs more clarification in my opinion. Does everyone make more or less than you or do many? Its a huge difference. I would chose to make 50 if everybody else makes 25, but I would choose 100 if many were making 250.

    Is that a rational way of looking at it?

  4. Hopkins Says:

    in your example of people prefering to earn $50,000 a year when the average salary is $25,000 (as opposed to earning $100.000 when the average is $250,00), I too would sooner earn $50,000 and the LOGICAL reason is that if I earned $100,000 when the average is $250,000 I would NOT be better off because the people earning $250,000 a year would push up prices.

  5. Nathaniel Says:

    Yes, I was about to write what Hopkins wrote before I read his comment. The question, as stated, is too equivocal for the results to be interpreted meaningfully. It goes without saying that if everyone earned a trillion dollars a day, the value of the dollar would not be what it is now. If Shermer failed to recognize this rather obvious issue, i.e. inflation. It makes one wonder what neuroeconomic biases are hindering his understanding. I doubt this is the case, but he ought to have recognized the dubiousness of that question, as stated.

    I presume that what they meant to ask was something like, “would you prefer to earn $100,000 if this meant that everyone in your close circle of acquaintances would earn $250,000…” such that while the relative prestige the money confers would be less while the actual material value of the money would remain the same. However, even phrasing the question in that manner is dubious; it brings in issues about personal relations that might confute the subject. I mean, there is something to the point that few of us would be happy being the least materially successful person in our families, and that is not really so absurd when you think about it, since, to a large degree, we may judge our relative individual merits on the basis of how much we achieved given the opportunities afforded us; if everyone in the family did more than you, made more than you, it would seem to suggest that other people, with similar opportunities, tended to achieve more, and that’s an understandably abhorrent prospect.

    The basic point is that since the relative value of money is bound up in all kind of personal and social relations, personal achievement, family status, social status, let alone the numerous moral issues attached to wealth, you can’t really say that there is a “rational” course with regards to how one ought to deal with it, what values one ought to hold with respect to it. This field of inquiry is interesting, and I appreciate that it is being examined, I suppose there is a place for speculation about what the data suggests about human psychology, but it is important to be very cautious here.

  6. Money, Monkeys, Mortgages, and Motivation « Perspicacity Says:

    […] Shermer, author of The Mind of the Market, has long recognised the role that loss aversion and other irrational biases play in market making decisions. He writes of the Yale research: This research goes a long way toward debunking one of the biggest […]

  7. The Ultimatum Game of Banking Bailouts « Perspicacity Says:

    […] arises from an innate sense of social relativism as noted by Michael Shermer in his article, “Why People Believe Weird Things About Money“ Would you rather earn $50,000 a year while other people make $25,000, or would you rather […]

  8. Neuroeconomics Overview: Understanding “The Mind of the Market” « Experience Mind Says:

    […] For a short teaser, read Shermer’s recent essay:  Why People Believe Weird Things About Money […]

  9. Memed Bengul Says:

    Some remarks:
    1)i don’t like personal insults, but..anyone who suggest to make the assumption “that prices of goods and services will stay the same” is an idiot, skeptic or not. he has almost no understanding of the most fundamental aspect of economics. that majority which preferred $50k may be just as ignorant of econ theory, but at least they were smart (intuitively, at least). there is no such thing as an absolute dollar income; figures are all relative and merely dependen on the amount of money and amount of goods available. Shermer should then accept a $1000 per annum job today, since if you go back far enough even the richest people made much less. preferring to earn twice as much as the majority does not mean you want to crush everybody, it simply means you would rather be rich than poor.
    2)experiments with monkeys -or men, for that matter – mean nothing in the social sciences. i’ve even come to doubt this in the medical professions -to a degree, that is). economics can only exist in the realm of pure theory, based on a priori reasoning, along with a few axioms. a monkey trading for raisins means squat.
    3)another person wisely pointed out the Austrian approach. most people assume that economics is about money or material gain, when in reality it is about satisfying your wants, according to YOUR value judgements, utility schedule, etc. who ever said anything about money? preferring a material/fiancial loss in order to show off to a girl/to feeling more ethical, heroic, altruistic/to seeing someone else lose even more, etc. can indeed be more rational. living a religious life can be more rational. overdosing on heroin can be more rational (say, than drinking green tea). it all boils down to personal utility.

  10. More on Irrationality « auto insurance quote Says:

    […] people are so emotional and irrational when it comes to money and business decisions. Here’s an essay from his site regarding the book. Looks pretty […]

  11. heche Says:

    Just a thought, according to our way of life we live in fixed reality,it’s nature is transient. Industry, commerce, the aquisition of money to buy survival,comfort,convenience,status. To indulge in the paradigms of culture, perhaps as a matter of privelage?
    The politics of fitting in weaving it’s way through all of it. And isn’t it nice the economics is and always will be theory. Feels good to indulge in speculation though. Are we more driven today by association or suggestion.

  12. Dragantraces Says:

    A quick note:
    I find it curious that when these kinds of problems are dissected, the idea that the greatest reproductive success is a primary consideration in economic/financial decision making and that that kind of success can be equated with the greatest number of sexual partners. This completely ignores that for more than half of the human population this is utter crap. This is the same blinkered approach to humanity that looks at the treatment of cardiac disease as if it were a no more a disease of concern to women than is prostate cancer.
    I think it would be of value to know whether there is a significant diference in the way men and women respond to these set ups.

  13. We Just Don't Know Says:

    The problem with examining every human action within the sexual sphere, is that it blatantly ignores the existence of monogamous human relationships that are often entered into for the security that can be offered personally, and when rearing offspring. In these instances, more is at work than the simple notion of persistent “seed spreading.” Of course, sexual privilege plays a prominent role in human societies, but the complexity of the human emotional world allows for, and frequently involves other motivations.

    Many people simply want to live a fairly peaceful life, raise a set number of offspring, enjoy themselves and die. I don’t see how these narrow descriptions of status motivations effectively address the motivations of the average person.

    To assume that status seeking amongst human primates is derived solely from an instinct toward securing sexual privilege, is to promote a naive characterization of human evolution.

  14. Eddie Says:

    It’s called prospect theory.. Tversky proved it in 1979..

  15. Fillo Says:

    Without being 64-comments thorough, it seems, no one backs the concept that $100k in a $250k world is better than $50k in a $25K world. Me either; relative rules. Has MS run out of topical, inviting wisdom? Has the need for feed-the-beast volume diluted his center stage lighting and surgical logical/mental dexterity? Like MS says …..he wants what Mulder (X-files) had on his office door…..”I want to believe.” Me too. p.s. to MS: Change your position or defend it. I wonder too, how much the grow-or-die phenomena has a grip on MS and his empire. I’m sure it was tidier in the begining; poor guy has had to repeat himself to death.

  16. Share Filtration Says:

    Ha! What a coincidence! Frankee’s comment was not present when I typed mine… how interesting that we would make the same point at about the same time!

  17. Paul Says:

    Why Behavioural Economists Think Weird Things About People. People mostly pick the $50k vs $25k option because money and material possessions are only valuable relative to those of others. Duh. It’s the other side of the question as to why people with more money than they could spend keep trying to earn it. Perhaps we’re not really homo economicus.