24. Mental Accounting
Wireless Philosophy, Cognitive Biases, 3:37. Original title: CRITICAL THINKING - Cognitive Biases: Mental Accounting [HD]
Summary
Laurie Santos (Yale University) uses a pair of lost-ticket scenarios to introduce mental accounting, the tendency to keep separate mental "accounts" for money earmarked for different purposes.
Two ways to lose ten dollars
Imagine you go to see a movie, hand the cashier twenty dollars, and get back a ten dollar bill and a ten dollar ticket. At the door you discover the ticket is lost. Would you pay another ten dollars for a new ticket, or go home? When Kahneman and Tversky put this question to college students, fifty-four percent said they would probably head home rather than buy a second ticket.
Now imagine the same trip, except the cashier gives you two ten dollar bills instead of a ticket, so that you can pay at the door. This time you lose one of the ten dollar bills before reaching the door. Would you still pay ten dollars to get in? Here eighty-eight percent of students said they would go ahead and see the movie anyway.
Why the two losses feel different
Both scenarios involve losing ten dollars, yet people respond very differently. Santos attributes this to mental accounting: we keep separate mental accounts for different activities, and money lost from one account does not automatically feel like it should come out of another. Losing the ticket empties the "movie" account, so buying a new one feels like paying twenty dollars for the film. Losing a ten dollar bill empties a general cash account, leaving the "movie" account untouched, so paying at the door still feels like the original ten dollars.
The same habit shows up elsewhere: we rarely take fifty dollars out of a 401k account to pay for a nice meal, but we happily spend an unexpected tax return or a coupon windfall on things we would never buy out of savings. Gamblers, likewise, gamble more freely with money they think of as the casino's rather than their own, so-called house money.
An economic principle we violate
Classical economics holds that money is fungible, that a ten dollar bill and a ten dollar ticket should be interchangeable. Mental accounting shows that our minds do not actually work that way.
Turning the bias to your advantage
Santos notes that mental accounting can be used deliberately. A friend of the behavioural economist Dick Thaler set up a mental account of money earmarked for a year-end charity donation, and drew on that account whenever something bad happened, a parking ticket, a lost ten dollars for a movie, which made the losses feel less painful because the money did not feel like it was really his.
Key takeaway
Because we naturally sort money into separate mental accounts rather than treating it as fungible, we can choose which accounts to set up and draw from, turning the same bias that normally distorts our decisions into a way of softening the sting of everyday losses.