I want to talk to you today a little bit about uh predictable irrationality and um my interest in irrational Behavior started many years ago in hospital um I was burned uh very B ly and if you spend a lot of time in hospital you'll see a lot of types of irrationalities and the one that uh particularly bothered me in the burn Department was the process by which the nurses took the bandage of me now you must have all taken a Band-Aid off at some point and you must have wondered what's the right approach do you rip it off quickly short duration but high intensity or do you take your bandid off slowly you take a long time but each second is not as painful which one of those is the right approach the nurses in my department thought that the right approach was The Ripping one so they would grab hold and they would rip and they would grab hold and they would rip and because I had 70% of my body burned it would take about an hour and as you can imagine uh I hated that moment of ripping with Incredible intensity and I would try to reason with them and say why don't we try something else why don't we take it a little longer maybe 2 hours instead of an hour and have less of this intensity and the nurses told me two things they told me that they had the right model of the patient that they knew what was the right thing to do to minimize my pain and they also told me that the word patient doesn't mean to make suggestions or interfere or this is not just in Hebrew by the way it's in every language I've had experience with so far and um you know there's not much there wasn't much I could do and they kept on doing what what they were doing and about 3 years later when I left the hospital I started studying at the University one of the most interesting lesson I learned lessons was that there is an experimental method that if you have a question you can create a replica of this question in some abstract way and you can try to examine this question maybe learn something about the world so that's what I did I was still interested this question of how do you take bandages of burn patient so originally I I didn't have uh much money so I went to a hardware store and I bought a carpenter's Vice and I would bring people to the lab and I would put their finger in it and I would crunch it a little bit and I would crunch it for long periods and short periods that pain it went up and pain it went down and with breaks and without breaks all kinds of versions of pain and when I finished hurting people a little bit I would ask them so how painful was this or how painful was this so if you had to choose between the last two which one would you choose Cho I kept on doing this for a while and then like all good academic projects I got more funding I moved to sounds electrical shocks I even had a pain suit that I could get people to feel much more pain but at the end of this process what I learned was that the nurses were wrong here were wonderful people with good intentions and plenty of experience and nevertheless they were getting things wrong predictably all the time it turns out that because we don't encode duration in the way that we encode intensity I would have had less pain if the duration would have been longer and the intensity was lower it turns out it would have been better to start with my face which was much more painful and move toward my legs giving me a trend of improvement over time that would have been also less painful and it also turns out it would have been good to give me breaks in the middle to kind of recuperate from the pain all of these would have been great things to do and my nurses had no idea and from that point on I started thinking are the nurses the only people in the world who get things wrong in this particular decision or is it a more General case and it turns out it's a more General case there's a lot of mistakes we do and um I want to give you one example of one of these irrationalities and um I want to talk to you about cheating and the reason I picked cheating is because it's interesting but also it tells us something I think about the stock market situation we're in so my interest in cheating started when Enron came on the sca and exploded all of a sudden and I started thinking about what is happening here is it the case that there is kind of a few apples who are um capable of doing these things or are we talking more endemic situation that many people are actually capable of Behaving this way so like we usually do I decided to do a simple experiment and here's how it went if you were in the experiment I would pass you a sheet of paper with 20 simple math problems that everybody could solve but I wouldn't give you enough time when the 5 minutes were over I would say pass me the sheets of paper and I'll pay you a dollar per question people did this I would pay people $4 for their task on average people would solve four problems other people I would tempt to cheat I would pass the sheet of paper when the 5 minutes are over I would say please Shred the piece of paper put the little pieces in your pocket or your backpack and tell me how many questions you got correctly people now solve seven questions on average now it wasn't as if there was a few bad apples a few people who cheated a lot instead what we saw is a lot of people who cheat a little bit now in the economic theory cheating is a very simple cost benefit analysis you say what's the probability of being caught how much do I stand to gain from cheating and how much punishment would I get if I get caught and you weigh these options out you do the simple cost benefit analysis and you decide whether it's worthwhile to commit the crime crime or not so we tried to test this for some people we varied how much money they could get away with how much money they could steal we paid them 10 cents per correct question 50 cents a doll $5 $10 per correct question you would expect that as the amount of money on the on the table increases people would cheat more but in fact it wasn't the case we got a lot of people cheating but still by a little bit what about the probability of being caught some people shreded half the sheet of paper so there was some evidence left some people shredded a whole sheet of paper some people shredded everything went out of the room and paids from a bowl of money that had over $100 you would expect it as the probability of being caught goes down people would cheat more but again this was not the case again a lot of people cheated by just by a little bit and they were unsensitive to these economic incentives so we said if people are not sensitive to the economic rational Theory explanations to the these forces what could be going on and we thought maybe is happening is that there are two forces at one hand we all want to look at ourselves in the mirror and feel good about ourselves so we don't want to cheat and the other hand we can cheat a little bit and still feel good about ourselves so maybe what is happening is that there's a level of cheating we can't go over but we can still benefit from cheating at at a low degree as long as it doesn't change our Impressions about ourselves we call this like a personal fudge Factor now how would you test a personal fudge factor in initially we said what can we do to shrink the fudge Factor so we got people to the lab and we said we have two tasks for you today first we asked half the people to recall either 10 books they read in high school or to recall the Ten Commandments and then we tempted them with cheating turns out the people who tried to recall the Ten Commandments and in our sample nobody could recall the Ten Commandments but those people who tried to recall the Ten Commandments given the opportunity to cheat did not cheat at all it wasn't that the more religious people the people who remembered more of the Commandment cheated less and the less religious people the people who could remember almost any commandment cheated more the moment people thought about trying to recall the Ten Commandments they stopped cheating in fact even when we give self- declared atheist the task of swearing on the Bible and we give them a chance to cheat they don't cheat at all now Ten Commandments is something that is hard to bring into the education system so we said why don't we get people to sign the honor code so we got people to sign I understand that this short survey falls under the MIT Honor Code then they shredded it no cheating whatsoever and this is particularly interesting because MIT doesn't have an honor code so all this was about decreasing the fudge Factor what about increasing the fudge Factor the first experiment I walked around MIT and I distributed six packs of Cokes in the refrigerators these were common refrigerators for the undergrads and I came back to measure what we technically call the half lifetime of coke how long does it last in the refrigerators and you can expect it doesn't last very long people take it in contrast I took a plate with six $1 bills and I left those plates in the same refrigerators no bill was ever disappeared now this is not a good social science experiment so to do it better I did the same experiment as I described you before a third of the people we passed the sheet they gave it back to us a third of the people we passed it they Shred it they came to us and said Mr experimenter I solved X problems give me x a third of the people when they finished writing the piece of paper they came to us and said Mr experiment I solved X problems give me X tokens we did not pay them with dollars we paid them with something else and then they took this something else they walked 12T to the side and exchange it for dollars think about the following intuition how bad would you feel about taking a pencil from work home compared to how bad would you feel about taking 10 cents from a petty cash box these things feel very differently with being a step removed from cash for a few seconds by being paid by token make a difference our subjects double their cheating I'll tell you what I think about this in the stock market in a minute but this did not solve the the big problem I had with Enron yet because in Enron there's also a social element people see each other behaving in fact every day when we open the news we see EX examples of people cheating what does this causes us so we did another experiment we got a big group of students to be in the experiment and we prepaid them so everybody got an envelope with all the money for the experiment and we told them that at the end we asked them to pay us back the money they didn't make okay the same thing happens when we give people the opportunity to cheat they cheat they cheat just by a little bit all the same but in this experiment we also hired an acting student this acting student stood up after 30 seconds and said I solved everything what do I do now and the experimentor said if you finished everything go home that's it the task is finished so now we had a student an acting student that was a part of the group nobody knew there was it was an actor and they clearly cheated in a very very serious way what would happen to the other people in the group will they cheat more or will they cheat less here is what happens it turns it depends on what kind of sweatshirt they're wearing here's the thing we ran this at carig melon in Pittsburgh and in con at Pittsburgh there are two big universities K melan and University of Pittsburgh all of the subjects sitting in the experiment were K melan students when the actor was getting up was a kigy melon student he was actually a con melon student but he was a part of their group cheating went up but when he actually had the University of Pittsburgh sweatshirt cheating went down now this is important because remember when the moment the student stood up it made it clear to everybody that they could get away with cheating because the experiment said you finished everything go home and they worked with the money so it wasn't so much about the probability of being caught again it was about the norms for cheating if somebody from our in group cheats and we see them cheating we feel it's more appropriate as a group to behave this way but if it's somebody from another group these terrible people I mean not terrible in the this but somebody we don't want to associate ourself with from another University another group all of a sudden people awareness of honesty goes up a little bit like the Ten Commandment experiment and people cheat even even less so what what have we learned from this about cheating we've learned that a lot of people can cheat they cheat just by a little bit when we remind people about their morality they cheat less when we get bigger distance from cheating from the object of of money for example people cheat more and when we see things of cheating around us particularly if it's a part of our in group cheating goes up now if we think about this in terms of the stock market think about what happens what happens in a situation when you create something where you pay people a lot of money to see reality in a slightly distorted way would they not be able to see it this way of course of course they would what happens when you do other things like you remove things from money you call them stock or stock option derivatives mortgage back Securities could it be that we those more distant things it's not a token for one second it's something that is many steps removed from money for much longer time could it be but people would cheat even more and what happened to the social environment when people see other people behave around them I think all of those forces worked in a very bad way uh in the stock market more generally I want to tell you something about behavioral economics we have many intuitions in our life and the point is that many of these intuitions are wrong the question is are we going to test those intuitions we can think about how we're going to test this intuition in our private life in our business life and most particularly when it goes to policy when we think about things like no child lefts behind when you create new stock markets when you create other policies taxation Healthcare and so on and the difficulty of testing our intuition was was the big lesson I I learned when I went back to the nurses to talk to them so I went back to talk to them and tell them what I found out about removing bandages and I learned two interesting things one was that my favorite nurse etti H told me that I did not take her pain into consideration she said of course you know it was very painful for you but think about me as a nurse taking removing the bandages of somebody I liked and had to do it repeatedly over a long period of time creating so much torture was not something that was good for me too and she said maybe part of the reason was that it was it was difficult for her but it was actually more interesting than that because she said I did not think that your intuition was right I thought my intuition was correct so if you think about all of your intuitions think about it's very hard to believe that your intuition is wrong and she said given the fact that I thought my intuition was right she thought her intuition was right it was very difficult for her to accept doing a difficult experiment to try and check whether she was wrong but in fact this is the situation we all we're all in all the time we have very strong intuitions about all kinds of things our own ability how the economy work how we should pay school teachers but unless we start testing those intuitions we're not going to do better and just think about how better my life would have been if these nurses would have been willing to check their intuition and how everything would have been better we would just start doing more system itic experimentation of our intuitions thank you very much