relativity and immediate gratification

watch "relativity and immediate gratification" on vimeo

note: Ever since I started mondaydots my friend, Professor Doolittle, has encouraged me to read Back of the Napkin. I finally did this past week and I can easily say it is one my favorite books. I used the SQVID process from his book to refine some of the ideas in this post. If you are interested in the drawings, you can find them here

Transcript

Most people believe that the inherent need to satisfy immediate gratification stems from greed, a lack of self control, or the ability to sacrifice a smaller short term gain for a greater long term gain. While I agree, I also think that some of our short sighted decisions stem from the natural way we compare alternatives in the decision making process.  In fact I think the real cause of immediate gratification can be found in this picture from Dan Ariely's "Predictably Irrational". Which of the darker dots is larger? In this illusion it looks as though the dot on the left is larger. If we do a quick measure, we can easily see that the dots are in fact  the same size. Even with this newly minted knowledge if we loose the ruler, our eyes go back to seeing the dot on the left as being larger.  

The problem is relativity. As Ariely states, "our natural tendency is to compare things that are easily comparable-- and avoid comparing things are not easily compared." So how does this apply to immediate gratification? Just as our eyes can be tricked by visual illusions, our mind can be tricked by cognitive illusions. A great example of a cognitive illusion is my slightly modified example  from "Predictably Irrational". 

It is an illusion I have fallen for many times before. Suppose you are standing in line at the market getting ready to check out with your fancy $15 toothbrush when the person in front of you turns around and tells you that across town, the same toothbrush is on sale for $7. You get out of line, hop in your car, and drive 20 minutes across town to get your toothbrush on sale for $7. The next week you are at the suit store. You are standing in line ready to check out with your $500 suit when the person in front of you tells you that across town they have the same suit on sale for $492. You think to yourself $8 off a $500 suit that's not worth the 20 minute drive, so you stay in line and buy your suit. Aha! You have fallen for the cognitive illusion! How come you were willing to drive 20 minutes to save $8 off a toothbrush but not a suit? Before I explain, let me show you how this same type of cognitive illusion can cause you to fall into the immediate gratification trap. 

The example comes from the book "Driven: How Human Nature Shapes Our Choices" by Paul Lawrence and Nitin Norhria.  In the example participants were given a choice to receive $100 in 28 days or $120 in 31 days.  Most of the participants in the study chose waiting 3 extra days to get the $120. Next participants were given the decision of receiving $100 now or $120 in 3 days. In this decision the same participants chose the $100 now over waiting three extra days for the  $120 reward. So why did the participants decide to change their decision if the time between rewards in both choices is 3 days? The same reason you were willing to drive across town to save $8 on a toothbrush but not a suit! 

The problem occurs because like in the dot visual illusion we measure the alternatives of our decisions based off of relative information. The only sure way to know if the dots are the same size is to use an external measuring device like a ruler. The same holds true for the cognitive illusions, yet most people don't take the time to establish the correct cognitive ruler. In the toothbrush example our natural tendency is to compare the $8 in savings to the $15 toothbrush and think it is a great deal. In the suit example we compare the $8 in savings to $500 price tag and think not a great deal. Yet in both instances you save $8 dollars by driving 20 minutes. The correct cognitive ruler to assess both decisions is to ask yourself whether driving 20 minutes to save $8 is worth it, and if it is, then you should always drive 20 minutes to save $8 whether you are buying a toothbrush or a suit!

In the money and time example participants compare 3 days with 28 days and decide that waiting 3 extra days after having waited 28 does not seem like that much longer to get the larger $120 reward. But when compared with receiving the $100 reward right now, having to wait three days seems like an eternity and the participants chose the fast money. The correct way to establish a cognitive ruler and avoid the immediate gratification trap is to look at the time between rewards and the value of both rewards. In both decisions the time is between rewards is 3 days. The difference in value is also the same at $20 or a 20% return on your money. So the correct cognitive ruler is to ask yourself if waiting 3 days is worth making 20% on your money.  I don't know of any investments that guarantee a 20% return in 3 days and in this example it is always better to wait three days for the larger reward. 

The best way to avoid the relativity that causes immediate gratification traps is to establish an external measuring device such as a cognitive ruler. Because the ruler changes from decision to decision I ask myself three simple questions to make sure I am evaluating a decision properly:

1. What information am I using to evaluate the decision?

2. Am I making a relative comparison?

3. Can I establish an external cognitive ruler? 

If you can answer these questions and establish a cognitive ruler you will avoid the relativity that causes immediate gratification traps! Thanks for watching and I look forward to your feedback! 

Comments

[Jamie]

Does it not depend on the method by which the $100/$120 is paid? Someone who values their time is more likely to settle for $100 instantly rather than go out of their way in 3 days' time to pick up an extra $20... once the subject has to go away and come back to pick up money, it makes little difference how long they have to wait so they opt for more. So they're willing to give up $20 to avoid wasting time in the future - would that make sense?

[Jamie]

What happens if the amounts are increased? I'd bet that more people would be willing to wait three days if they were offered $1000 instantly or $1200 in the future.

[Dave Wheeler]

I think the "$100 instantly" choice reflects our basic human need to take the "sure thing" vs. waiting 3 days for a potential reward. A lot can happen in 3 days.

On the other hand, if you have to wait 28 days anyways, you may as well wait 31, since from the perspective of the decision point they are relatively the same. (refer to the "Time value of money")

In this example, the "cognitive ruler" analogy fails since it does not capture the full range of choices / options / human assumptions, e.g. that the offer could be withdrawn at any time.

Dave Wheeler

[EricTheHalf]

Not quite sure how the picture is illustrative of the story.

Nice picture, though, and good story.

[Mike Luderitz]

Sometimes "A bird in the hand is worth more than two in the bush" is relevant.

[Jack]

This plays out continuously in finance. A P/E of 20 is a good deal relative to a P/E of 25 (today vs. 2007 ~normalized earnings). But on an absolute level, 20 is "often" precursor to a weaker market.

[Ale]

@Dave and Mike

I think the experiment assumes that the offer wouldn't be withdrawn, else it wouldn't be a fair experiment.

If you waited 28 days and you wait till the 31th day, you are waiting 3 days more. Which is what people refuse to wait _later on_! The _same people next_ didn't wait 3 days. They didn't wait what they had already waited for the first reward.

Cheers,

[jeff monday]

Jamie,

The study was done by two Harvard professors, Paul Lawrence and Nitin Nohria, the book did not provide specifics as to how the participants were paid. I have emailed them and if they get back to me I will let you know the answer to your question.

The problem in the $100/$120 example is the irrational behavior exhibited by the participants. The participants were willing to wait 3 days for the extra $20 when the reward was way in the future but not when the reward was only 3 days away (versus 31 days away). It is this inconsistency that proves the relativity trap.

The technical term for this type of behavior is hyperbolic discounting. Check out this wikipedia article:

A great quote from the article: "Subjects using hyperbolic discounting reveal a strong tendency to make choices that are inconsistent over time. In other words, they make choices today that their future self would prefer not to make, despite using the same reasoning. This dynamic inconsistency [3] happens because hyperbolic discounts value future rewards much more than exponential discounting."

If you were to increase the rewards, my guess is that participants would make the same irrational decisions. It is not the size of the rewards that is impacting the outcome, rather it is the hyperbolic discounting that sets the relativity trap.

-jeff

[jeff monday]

Dave,

I understand your point "that a lot can happen in three days", however the goal of an experiment is to isolate a variable and take a snapshot of the behavior. You can assume the participants trusted the harvard professors to pay out, as they were willing to wait 3 extra days in the 28 day/ 31 day decision.

Regarding the time value of money. The difference between rewards in both decisions is 3 days. There aren't very many (if you have one please pass it on) investment opportunities that yield 20% return on your money in 3 days. If you have a way to make 30% in 3 days then your decision for both instances would be to take the money and invest in your 30% yield opportunity.

The relativity trap is proven by the fact that participants made inconsistent decisions. If they had established a cognitive ruler to assess the situation, they could have avoided the relativity trap and maximized their reward given their investment opportunities:

- Access to investment that yields >20% in 3 days -->> take $100 now and invest it.

- Access to investment that yields > wait 3 extra days and take the $120.

- jeff

[Ram]

I am not sure if we are comparing apples to apples when we are comparing the outcomes for two situations involving 3 days later. Would like to point to a paper in Econometrica,76(3), May 2008, 583-618, titled:
"Eliciting risk and time preferences" where they tackle the issue.