In this section, we're going to talk about the psychology of money.
There's a little joke that a group of people is waiting at the bank to do all
kinds of transaction, get money and so on. All of a sudden, two robbers come in.
They point their guns. They try to rob the bank.
They do all kind of things. Unintentially, one of them, as they move,
puts his masks out, and all of a sudden his face is visible.
He puts his mask back on and he turn to the person next to him and says, did you
see my face? The person says, yes.
Boom, he shoots him dead. He turns to the next person and says, did
you see my face? The person says, yes.
Shoots him dead. He turns to a third person, a woman, and
he says, did you see my face? And the woman says, I did not, but my
husband did. What is the psychology of money?
When we think about money, money's all about the opportunity cost.
Every time we buy something, we buy a sandwich, it's about what we are not going
to be able to do in the future. If you buy one thing, the money would come
up from somewhere. But this opportunity cost is something
that is very hard for us to envision, very hard to, hard for us to think about, very
hard, for us to actually realize the trade-off that we're making.
So instead, what do we do as human beings? We look at all kinds of shortcuts.
All kinds of other things that we could do with money, to make us feel that we're
making the right decision. This is why we do things, like we care
about the method of payment that we're using.
We look at relativity. We look at relative prices.
We do all kinds of other things that are not perfectly rational, but at least makes
us feel that we're making the right decision.
And my hope is that, by the end of this section, you will not just better
understand the psychology of money, you might actually be able to make slightly
better decisions with your own money. Hi.
Today, I want to talk a little bit about the psychology of money.
Now, this might seem strange, because after all, we use money all the time.
We use it day in and day out, over time, lots of kind of payments, cash, credit
cards and so on. And because we use it so much, we might
think we're experts in using money. But I want us to question this.
I want us to go back a little bit, and I want us to ask, are we really, do we
really understand how money works? Do we really kind of figure out how it
works, what kinds of tricks it has, how we use it, how it influences what we're
willing to do? But before we say some bad things about
money, my mother always told me that it's always nice to say something good.
To start with, so let's talk about some good things.
So, money is an incredible invention. Just think to yourself how the world would
look like without money. We would probably have to do barters all
the time. We might grow broccoli and somebody else
might raise chickens and we would have to take our broccoli and go to the chicken
farmer and try to trade. How much broccoli for how much chicken?
Do you they want some broccoli today or not?
The world would be incredibly difficult if we had to do barters on a domain by domain
in domain by domain abil, way. Now, what does money do?
Money creates a central mechanism that everything could be traded of.
We can trade broccoli for money, and then money for chicken, and so on and so forth.
So now, we don't need to worry about all of those exchanges.
We can just do one exchange with money. So, from that perspective, it's amazing to
think about what an invention money has been, and how it helps the market operate
in a much more efficient and wonderful way.
I think it's a, at the level of the wheel. Like it's a, such an important invention
for society. Okay, so now that we've said something
good about money, let's start examining the bad side about mar, money and the, all
kind of the challenges that we have. So psychologically, what is money about
and how should we think about money? Well, money's all about opportunity cost.
Every time you spend $2.50 on a cup of coffee, what should you be thinking to
yourself? You should be thinking about what else
could you have done instead. Where is this money coming from?
Would it have been best spent on a cup of tea today and a cookie tomorrow?
So when the tea and cookie sum the same amount, should you save it for a long time
and go to the movies in 15 years or maybe buy a slightly different stereo in, 35
years from now? Every time you're buying something, it's
about what are you giving up, and what else could you do if you did not take this
action. And of course, thinking about money this
way is incredibly difficult. You can ask yourself, when was the last
time that you thought about opportunity cost, that you made those trade-offs?
In fact, we went to a Toyota dealership a few years ago.
We went to a dealership and we got people who were just about to buy a new car.
And we said, please tell us, what are you giving up?
If you go ahead and buy this car, what would you not be able to do?
And people gave us no answer. Why?
Because nobody thought about it. They kind of, stumped them.
You know, what, what do you mean something would, would give up?
But then, we insisted. We said, hey, something we'll have to give
up. What are you going to give up?
And the most people would, would give us, the most they told us is that they buy a
Toyota, they can't buy a Honda. Which means that they made a substitution
in the same time frame in the same category.
Now, what people should have said is that, this amount is equivalent to what I would
have to give up by two weeks of vacation for the next four years, and 700 lattes,
and 37 books. Something like that, which is across time
and across many categories. But the fact is, it's incredibly hard to
work this way. So, we don't.
Now, there's another thing to think about money, which is the way that we have money
functioning in our environment makes it more difficult.
So imagine, for example, that we I was in charge of your finances and every week I
would give you an envelope with cash, and this was the cash that you had to spend
during that week and you had nothing else. What will happen in the beginning of the
week? You would feel that you could pay for a
cab and buy a sandwich, and get beer, and get a new shirt.
But as the money, as the amount went down and down and down, you would realize your
trade-offs to a higher degree. You would say, if I buy this, I can't buy
that. And the trade-off would become that much
more clear. Now, that would work out if I gave you
money for a week. And it would only probably really kick in,
in the last few days. What if I gave you money for the whole
year? Now, it would be really difficult to think
about this. But, what if the world looks like the
current economy in which I gave you credit cards?
And I made, I gave you student loans and mortgages and car payments.
And now, in that environment, what would have been the horizon of your pain?
You see, if you get an envelope with a fixed amount of money, that's your
horizon. It's easy to see the cost and benefit.
It's easy to see the trade-off that you're making.
But if you don't have a clear horizon, it's saving for a retirement not really
clear how long I would live, I have all these student loans, and I have these
mortgage. The horizon is so unclear, the trade-offs
that we're making are less clear. So, the point is that we are supposed to
be thinking about money in a, a, a trade-off analysis.
We're supposed to think about the opportunity cost, or what sometimes called
the shadow value of price, the shadow value of money.
But, it's hard to do anyway. And the financial environment that we've
created makes it even harder to think this way.
So, what do we know in general when people face a problem that is too difficult to
compute, too difficult to figure out the right way?
We take some shortcuts. We figure out other ways to do it, not the
right ways but at least some, some ways. And this is what I want to talk about.
And this cartoon clearly indicates the idea of opportunity cost.
Not in the domain of money, but in another domain.
It says, we found, we really missed going to the theater and eating in nice
restaurants, so we gave our kids away. Because kids are the ultimate opportunity
cost. You get kids, there's lots and lots of
things you can't do. But even with kids, many people don't
think about it up front about what they're going to give up.
Here is one experiment that very elegantly illustrates this problem that we have with
thinking about opportunity cost. So, imagine that you gave it, you were
given a choice. And you said would you prerfer to buy a
Sony stereo system for $700 or a Pioneer system for $1000.
And basically, what you are being asked in this question is, how do you value of the
quality of the two stereos compared to the saving the financial savings of $300?
How much is the Pioneer better than the Sony, and how useful is the $300 for you?
That's one setup. And in that particular setup, lots and
lots of people choose the Pioneer system. In the second set up, it was given in a
slightly different way. It says, would you like to pay a $1,000
for this Sony stereo or a $1,000 for the Pioneer stereo?
But if you pay a $1,000 dollars for the Sony stereo, you also get $300 to spend on
CDs and DVDs. Now, think about it.
This second phrasing. You take the same $300 you had before when
you only spent $700 on this Sony station, on this Sony, stereo.
But now, this $300 goes only for CDs and DVDs.
From the rational perspective, the second case is less appealing.
Because the Sony includes $300 you can only spend on CDs and DVDs, when the first
case, you could have taken this $300 and spend it on anything else you want.
But what happens? Now the Sony Studio looks even more
appealing than the previous case. Why is it?
It's because when you think about the representation of $300, right?
Sony for $700 plus $300. This representation doesn't include a lot.
It's a general fuzzy topic. What exactly am I getting with $300?
But, in fact, what you could do is you could take this $300.
And you could make them concrete in one domain.
And while, generally, they'll be worthless than more now that you have one domain,
you can think about them in more concrete way, and you can actually get more excited
about it. I'll give you one more example of this.
Can you imagine that you like coffee? I assume most of you like coffee.
And let's say that they, the price for a cappuccino is $3.
Can you imagine that I could get you to do something for me, for a cappuccino, that
you would not be willing to do for $3? And if that's the case, and many people
report that this is the case, that means that the representation of the cappuccino
is somehow worth more in your mind than the preservation of $3.
Even though you could take the $3 and buy a cappuccino or you could buy all kinds of
other things, the representation, the hedonic value, the emotional appeal that
we have from a cappuccino is higher than the emotional appeal for $3.
So what this, going back to the Sony and the Pioneer example, what this suggests is
that we just have money in the equation. It's not as valuable because it's about
opportunity cost. It's general.
We don't know how to think about it. And because of that, we could take that
amount of money, make it specific, make it concrete, make it less valuable from
economic perspective. But nevertheless, have a higher perceived
value for it. And with that, change how people make
decisions.