The three pillars of human decision making
Despite the seeming complexity, the good news is that there are three simple principles that explain much of decision-making. The first principle if that context is everything. If you change the context, people's preferences change. The second principle has to do with procrastination. All of us want to be good human beings — we want to lose weight; we want to exercise; we want to save more for our future; we want to spend more time with our children - but not today. We tend to procrastinate all of the good things that we want to do because life gets in the way. The third principle that explains human behavior is the principle of inertia: the idea that human beings are cognitively lazy and that unless they are pushed to make active choices, they will actually not do so.
For instance, it probably comes as no surprise to most people that the most popular size of coffee sold in coffee shops is the medium size of coffee. It turns out about 74 percent of all coffee sales are in the medium cup. What's interesting is that most people don't know how much coffee is in the medium cup of coffee. The size, the number of ounces of coffee in medium cup of coffee is different across coffee shops.
Several years back, I studied a coffee shop which offered there sizes; Small (8 oz.), Medium (10 oz.) and Large (12 oz.). The medium coffee was the most popular, and when we stopped people asked them, people who had purchased a medium size provided a response that was something along the lines of a Goldilocks story; the small coffee has too little, the large size has too much, and the middle one was just right. After a period of three or four weeks we increased the size of each cup by two ounces. Lo and behold, the new medium size became the most popular size. When we again stopped people and asked them about their choice, and we heard the same kind of Goldilocks response; that the small size had too little and the large one had too much coffee! People who were previously claiming that 12 ounces of coffee was too much were now consuming it!
This illustrates two important ideas. First, context truly matters – people rely on the crutches of context to construct their preferences and seemingly trivial elements (forms, brochures, envelopes, layouts of waiting areas) might have large effects. Yet, we pay little attention to the details of the context. Second, people have poor insight into their own decisions and preferences. Surveying people in a different context will likely not provide any useful insights!
Amar Cheema and I were looking to help unbanked rural workers in India to save a portion of their cash earnings towards their children’s education. Rather than simply suggesting a target savings rate, we put the equivalent cash in a while envelope and marked it “savings.” Savings rates went up. We next put photographs of their children on the envelope. Savings further went up because the goal was now psychologically salient. A simple psychological intervention did much more than a financial literacy intervention or perhaps even a banking intervention could have done to try and get people to save more money. There is perhaps an e-banking version of these interventions waiting to be done. Suppose your online bank allowed you to create categories under your savings account that correspond to a savings goal. Say you were saving for your kids and for a new home. Perhaps you could create folders with pictures of your kids and your dream home in it, and set savings targets on a monthly basis, and perhaps if you fail to meet those targets the pictures on the folders might start deteriorating and nudge you to contribute. If implemented, I suspect that a last-mile intervention like this might have a significant role to play in helping people save; as significant as appeals to save, literacy programs or increased interest rates.