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I want to talk to you today a little bit

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about predictable irrationality.

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And my interest in irrational behavior

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started many years ago in the hospital.

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I was burned very badly.

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And if you spend a lot of time in hospital,

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you'll see a lot of types of irrationalities.

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And the one that particularly bothered me in the burn department

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was the process by which the nurses took the bandage off me.

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Now, you must have all taken a Band-Aid off at some point,

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and you must have wondered what's the right approach.

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Do you rip it off quickly -- short duration but high intensity --

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or do you take your Band-Aid off slowly --

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you take a long time, but each second is not as painful --

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which one of those is the right approach?

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The nurses in my department thought that the right approach

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was the ripping one, so they would grab hold and they would rip,

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and they would grab hold and they would rip.

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And because I had 70 percent of my body burned, it would take about an hour.

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And as you can imagine,

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I hated that moment of ripping with incredible intensity.

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And I would try to reason with them and say,

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"Why don't we try something else?

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Why don't we take it a little longer --

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maybe two hours instead of an hour -- and have less of this intensity?"

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And the nurses told me two things.

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They told me that they had the right model of the patient --

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that they knew what was the right thing to do to minimize my pain --

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and they also told me that the word patient doesn't mean

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to make suggestions or to interfere or ...

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This is not just in Hebrew, by the way.

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It's in every language I've had experience with so far.

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And, you know, there's not much -- there wasn't much I could do,

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and they kept on doing what they were doing.

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And about three years later, when I left the hospital,

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I started studying at the university.

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And one of the most interesting lessons I learned

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was that there is an experimental method

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that if you have a question you can create a replica of this question

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in some abstract way, and you can try to examine this question,

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maybe learn something about the world.

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So that's what I did.

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I was still interested

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in this question of how do you take bandages off burn patients.

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So originally I didn't have much money,

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so I went to a hardware store and I bought a carpenter's vice.

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And I would bring people to the lab and I would put their finger in it,

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and I would crunch it a little bit.

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(Laughter)

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And I would crunch it for long periods and short periods,

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and pain that went up and pain that went down,

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and with breaks and without breaks -- all kinds of versions of pain.

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And when I finished hurting people a little bit, I would ask them,

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so, how painful was this? Or, how painful was this?

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Or, if you had to choose between the last two,

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which one would you choose?

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(Laughter)

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I kept on doing this for a while.

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(Laughter)

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And then, like all good academic projects, I got more funding.

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I moved to sounds, electrical shocks --

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I even had a pain suit that I could get people to feel much more pain.

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But at the end of this process,

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what I learned was that the nurses were wrong.

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Here were wonderful people with good intentions

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and plenty of experience, and nevertheless

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they were getting things wrong predictably all the time.

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It turns out that because we don't encode duration

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in the way that we encode intensity,

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I would have had less pain if the duration would have been longer

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and the intensity was lower.

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It turns out it would have been better to start with my face,

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which was much more painful, and move toward my legs,

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giving me a trend of improvement over time --

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that would have been also less painful.

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And it also turns out that it would have been good

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to give me breaks in the middle to kind of recuperate from the pain.

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All of these would have been great things to do,

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and my nurses had no idea.

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And from that point on I started thinking,

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are the nurses the only people in the world who get things wrong

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in this particular decision, or is it a more general case?

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And it turns out it's a more general case --

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there's a lot of mistakes we do.

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And I want to give you one example of one of these irrationalities,

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and I want to talk to you about cheating.

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And the reason I picked cheating is because it's interesting,

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but also it tells us something, I think,

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about the stock market situation we're in.

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So, my interest in cheating started

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when Enron came on the scene, exploded all of a sudden,

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and I started thinking about what is happening here.

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Is it the case that there was kind of

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a few apples who are capable of doing these things,

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or are we talking a more endemic situation,

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that many people are actually capable of behaving this way?

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So, like we usually do, I decided to do a simple experiment.

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And here's how it went.

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If you were in the experiment, I would pass you a sheet of paper

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with 20 simple math problems that everybody could solve,

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but I wouldn't give you enough time.

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When the five minutes were over, I would say,

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"Pass me the sheets of paper, and I'll pay you a dollar per question."

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People did this. I would pay people four dollars for their task --

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on average people would solve four problems.

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Other people I would tempt to cheat.

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I would pass their sheet of paper.

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When the five minutes were over, I would say,

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"Please shred the piece of paper.

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Put the little pieces in your pocket or in your backpack,

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and tell me how many questions you got correctly."

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People now solved seven questions on average.

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Now, it wasn't as if there was a few bad apples --

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a few people cheated a lot.

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Instead, what we saw is a lot of people who cheat a little bit.

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Now, in economic theory,

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cheating is a very simple cost-benefit analysis.

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You say, what's the probability of being caught?

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How much do I stand to gain from cheating?

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And how much punishment would I get if I get caught?

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And you weigh these options out --

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you do the simple cost-benefit analysis,

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and you decide whether it's worthwhile to commit the crime or not.

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So, we try to test this.

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For some people, we varied how much money they could get away with --

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how much money they could steal.

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We paid them 10 cents per correct question, 50 cents,

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a dollar, five dollars, 10 dollars per correct question.

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You would expect that as the amount of money on the table increases,

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people would cheat more, but in fact it wasn't the case.

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We got a lot of people cheating by stealing by a little bit.

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What about the probability of being caught?

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Some people shredded half the sheet of paper,

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so there was some evidence left.

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Some people shredded the whole sheet of paper.

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Some people shredded everything, went out of the room,

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and paid themselves from the bowl of money that had over 100 dollars.

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You would expect that as the probability of being caught goes down,

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people would cheat more, but again, this was not the case.

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Again, a lot of people cheated by just by a little bit,

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and they were insensitive to these economic incentives.

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So we said, "If people are not sensitive

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to the economic rational theory explanations, to these forces,

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what could be going on?"

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And we thought maybe what is happening is that there are two forces.

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At one hand, we all want to look at ourselves in the mirror

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and feel good about ourselves, so we don't want to cheat.

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On the other hand, we can cheat a little bit,

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and still feel good about ourselves.

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So, maybe what is happening is that

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there's a level of cheating we can't go over,

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but we can still benefit from cheating at a low degree,

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as long as it doesn't change our impressions about ourselves.

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We call this like a personal fudge factor.

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Now, how would you test a personal fudge factor?

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Initially we said, what can we do to shrink the fudge factor?

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So, we got people to the lab, and we said,

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"We have two tasks for you today."

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First, we asked half the people

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to recall either 10 books they read in high school,

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or to recall The Ten Commandments,

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and then we tempted them with cheating.

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Turns out the people who tried to recall The Ten Commandments --

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and in our sample nobody could recall all of The Ten Commandments --

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but those people who tried to recall The Ten Commandments,

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given the opportunity to cheat, did not cheat at all.

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It wasn't that the more religious people --

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the people who remembered more of the Commandments -- cheated less,

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and the less religious people --

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the people who couldn't remember almost any Commandments --

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cheated more.

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The moment people thought about trying to recall The Ten Commandments,

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they stopped cheating.

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In fact, even when we gave self-declared atheists

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the task of swearing on the Bible and we give them a chance to cheat,

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they don't cheat at all.

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Now, Ten Commandments is something that is hard

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to bring into the education system, so we said,

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"Why don't we get people to sign the honor code?"

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So, we got people to sign,

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"I understand that this short survey falls under the MIT Honor Code."

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Then they shredded it. No cheating whatsoever.

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And this is particularly interesting,

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because MIT doesn't have an honor code.

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(Laughter)

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So, all this was about decreasing the fudge factor.

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What about increasing the fudge factor?

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The first experiment -- I walked around MIT

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and I distributed six-packs of Cokes in the refrigerators --

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these were common refrigerators for the undergrads.

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And I came back to measure what we technically call

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the half-lifetime of Coke -- how long does it last in the refrigerators?

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As you can expect it doesn't last very long; people take it.

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In contrast, I took a plate with six one-dollar bills,

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and I left those plates in the same refrigerators.

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No bill ever disappeared.

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Now, this is not a good social science experiment,

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so to do it better I did the same experiment

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as I described to you before.

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A third of the people we passed the sheet, they gave it back to us.

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A third of the people we passed it to, they shredded it,

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they came to us and said,

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"Mr. Experimenter, I solved X problems. Give me X dollars."

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A third of the people, when they finished shredding the piece of paper,

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they came to us and said,

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"Mr Experimenter, I solved X problems. Give me X tokens."

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We did not pay them with dollars; we paid them with something else.

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And then they took the something else, they walked 12 feet to the side,

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and exchanged it for dollars.

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Think about the following intuition.

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How bad would you feel about taking a pencil from work home,

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compared to how bad would you feel

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about taking 10 cents from a petty cash box?

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These things feel very differently.

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Would being a step removed from cash for a few seconds

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by being paid by token make a difference?

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Our subjects doubled their cheating.

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I'll tell you what I think

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about this and the stock market in a minute.

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But this did not solve the big problem I had with Enron yet,

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because in Enron, there's also a social element.

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People see each other behaving.

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In fact, every day when we open the news

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we see examples of people cheating.

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What does this cause us?

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So, we did another experiment.

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We got a big group of students to be in the experiment,

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and we prepaid them.

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So everybody got an envelope with all the money for the experiment,

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and we told them that at the end, we asked them

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to pay us back the money they didn't make. OK?

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The same thing happens.

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When we give people the opportunity to cheat, they cheat.

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They cheat just by a little bit, all the same.

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But in this experiment we also hired an acting student.

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This acting student stood up after 30 seconds, and said,

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"I solved everything. What do I do now?"

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And the experimenter said, "If you've finished everything, go home.

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That's it. The task is finished."

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So, now we had a student -- an acting student --

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that was a part of the group.

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Nobody knew it was an actor.

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And they clearly cheated in a very, very serious way.

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What would happen to the other people in the group?

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Will they cheat more, or will they cheat less?

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Here is what happens.

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It turns out it depends on what kind of sweatshirt they're wearing.

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Here is the thing.

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We ran this at Carnegie Mellon and Pittsburgh.

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And at Pittsburgh there are two big universities,

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Carnegie Mellon and University of Pittsburgh.

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All of the subjects sitting in the experiment

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were Carnegie Mellon students.

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When the actor who was getting up was a Carnegie Mellon student --

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he was actually a Carnegie Mellon student --

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but he was a part of their group, cheating went up.

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But when he actually had a University of Pittsburgh sweatshirt,

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cheating went down.

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(Laughter)

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Now, this is important, because remember,

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when the moment the student stood up,

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it made it clear to everybody that they could get away with cheating,

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because the experimenter said,

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"You've finished everything. Go home," and they went with the money.

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So it wasn't so much about the probability of being caught again.

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It was about the norms for cheating.

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If somebody from our in-group cheats and we see them cheating,

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we feel it's more appropriate, as a group, to behave this way.

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But if it's somebody from another group, these terrible people --

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I mean, not terrible in this --

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but somebody we don't want to associate ourselves with,

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from another university, another group,

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all of a sudden people's awareness of honesty goes up --

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a little bit like The Ten Commandments experiment --

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and people cheat even less.

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So, what have we learned from this about cheating?

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We've learned that a lot of people can cheat.

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They cheat just by a little bit.

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When we remind people about their morality, they cheat less.

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When we get bigger distance from cheating,

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from the object of money, for example, people cheat more.

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And when we see cheating around us,

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particularly if it's a part of our in-group, cheating goes up.

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Now, if we think about this in terms of the stock market,

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think about what happens.

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What happens in a situation when you create something

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where you pay people a lot of money

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to see reality in a slightly distorted way?

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Would they not be able to see it this way?

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Of course they would.

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What happens when you do other things,

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like you remove things from money?

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You call them stock, or stock options, derivatives,

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mortgage-backed securities.

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Could it be that with those more distant things,

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it's not a token for one second,

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it's something that is many steps removed from money

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for a much longer time -- could it be that people will cheat even more?

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And what happens to the social environment

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when people see other people behave around them?

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I think all of those forces worked in a very bad way

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in the stock market.

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More generally, I want to tell you something

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about behavioral economics.

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We have many intuitions in our life,

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and the point is that many of these intuitions are wrong.

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The question is, are we going to test those intuitions?

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We can think about how we're going to test this intuition

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in our private life, in our business life,

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and most particularly when it goes to policy,

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when we think about things like No Child Left Behind,

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when you create new stock markets, when you create other policies --

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taxation, health care and so on.

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And the difficulty of testing our intuition

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was the big lesson I learned

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when I went back to the nurses to talk to them.

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So I went back to talk to them

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and tell them what I found out about removing bandages.

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And I learned two interesting things.

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One was that my favorite nurse, Ettie,

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told me that I did not take her pain into consideration.

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She said, "Of course, you know, it was very painful for you.

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But think about me as a nurse,

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taking, removing the bandages of somebody I liked,

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and had to do it repeatedly over a long period of time.

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Creating so much torture was not something that was good for me, too."

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And she said maybe part of the reason was it was difficult for her.

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But it was actually more interesting than that, because she said,

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"I did not think that your intuition was right.

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I felt my intuition was correct."

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So, if you think about all of your intuitions,

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it's very hard to believe that your intuition is wrong.

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And she said, "Given the fact that I thought my intuition was right ..." --

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she thought her intuition was right --

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it was very difficult for her to accept doing a difficult experiment

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to try and check whether she was wrong.

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But in fact, this is the situation we're all in all the time.

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We have very strong intuitions about all kinds of things --

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our own ability, how the economy works,

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how we should pay school teachers.

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But unless we start testing those intuitions,

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we're not going to do better.

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And just think about how better my life would have been

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if these nurses would have been willing to check their intuition,

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and how everything would have been better

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if we just start doing more systematic experimentation of our intuitions.

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Thank you very much.