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As we said, thinking about money in the
right way is a difficult thing to do so we

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find tricks to think about it in a wrong
way.

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And one of those tricks is thinking about
money in relative rather than absolute

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terms.
So let me first give you some examples to

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how to, how to think about it.
A very classic and standard example is the

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following.
Imagine you're going to buy a pen, and you

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find a pen that you like and that pen is
$15.

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And as you're about to check it at the
cashier, the cashier tells you, you know

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what?
You have such a lovely face.

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You have such a lovely smile.
I don't want to abuse you, so I'll tell

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you what, our competitor sells the exact
same pen instead of for $15 for $7.

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It's three blocks down the street, it's up
to you if you want to buy the pen here or

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go to this other place and now you can
think to yourself.

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Would you walk three blocks down the
street, to save $8 on this pen?

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And most people when given this decision,
say yes, I will do that.

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Now imagine a slightly different case.
You're coming and you're buying a camera,

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it's an expensive camera, its cost:
$1,015.

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And as you're about to check out, the
salesperson says you know what, you have

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such a lovely face, you have such a lovely
smile.

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I'll tell you what.
Our competitor is selling the same exact

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camera, three blocks down the street for
$8 dollars less, instead of $1,015, for

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$1,007.00 dollars.
Would you now take the trip down to the

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other store to buy the camera?
And most people now say, absolutely not.

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Now the reality is that your checking
account doesn't care where the $8 came

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from, they came from a pen, or they came
from a camera, or they came from a small

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amount of purchase, or a big amount of
purchase.

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But we care, $8 from 15 looks like a
really big amount, more than half, $8 from

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1,015 looks like a tiny amount, doesn't
seem to be worth it.

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Or think about the following example.
Imagine you buying a car, you're going to

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buy a car, the car is $40,000 and the
sales person tells you that for $2,000

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more you could get leather seats.
Now I'm not really sure what the benefit

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of leather seats are, but let's say that
there are benefits for the leather seats,

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and the question is, is it worth $2,000
when you buy a $40,000 car.

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Or imagine the second case, you going to
buy a chair for your office and the sales,

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the sales person tells you that for $2,000
more, the chair costs $500, and for $2,000

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more you could get the leather seat.
Would you do it?

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Now for most people they would say the
first one is an easy decision the second

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one seem offensive.
Spend $2,000 more on a $500 chair, just to

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get leather.
Now presumably, you sit more in your

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office chair then in the car and whatever
the benefits are from leather would be

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higher in the office then in the car, but
that's not how we think about it.

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You spend $40,000, $2,000 seems very
small, you spend $500, $2,000 looks

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incredibly large.
And here's another example.

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If you're like me, a couple of times,
we've renovated, our house.

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And when you renovate your house, the
contractors come and give you an initial

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price and then there's all kinds of
options for upgrades and changes and so

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on.
And what I found myself doing, and I think

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it's universal, is making very, very quick
decisions on big sums of money.

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Why?
Because the renovation is incredibly

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expensive, so all of a sudden spending
only, you know, x extra thousands of

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dollars on, you know, better tile or
French something or another or Italian or

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counter tops or granite, all of a sudden
seems like a good, a good deal.

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But at the same day, that they spend this
huge amount of money in a quick decision,

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I can go to the supermarket and look very
carefully, do I want the more expensive

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tomatoes then the cheaper tomatoes.
Which one makes more sense?

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Now my whole life of making decisions
about tomatoes could not sum up to that

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snap decision I made a few hours ago with
the contractor.

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But because the amount of money we start
with, with the contractor is so large,

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it's incredibly easy to make snap quick
decisions.

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And by the way all of this also should
tell you that there are probably ways to

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think about how to fight this.
That what we don't want to do, is we don't

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want to make a decision based on something
relative that we're spending, we want to

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think about them as independent.
And the question is how can we do that?

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And now this, these decisions are not just
about how we feel about spending money,

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they're also about happiness.
So ask yourself for example, what would

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you prefer to be, to be a person that
makes $90,000 a year, which is a very

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good, salary in a company where everyone
makes between 90 and 100.

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So you're making 90, but you're the lowest
paid employee, versus to work in a company

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that pays less, between 60 and 85,000 and
you're the highest paid employee, you get

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85,000.
So in an absolute way, you would get paid

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less in the second company, but in a
relative way you would be at the top at

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you game, while in the first company you
would be at the bottom.

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Now the interesting thing is when you ask
people these choices next to each other,

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most people say I'll take the first one, I
prefer to get more money and be the lowest

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paid employee.
When you ask people where they would be

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happier with, most people recognize,
they'll be probably happy in the second.

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Okay, So'll be the highest paid employee
even if they get paid less for it.

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Now, this is an interesting question of
yes, we do understand the issue of

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relativity and we do understand the
influence of happiness, but are we willing

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to pay a premium for this increased
happiness?

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And the answer is not so much.
Now if you think about all these examples,

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of relativity, they all come about the
fact that we have diminishing returns.

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We have this function in which our
happiness starts very high, and then we

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have diminishing returns.
And another way to think about it is that

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we think in terms of percentages, so ratio
increases.

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So think about the following graph.
What we have on the x-axis is the amount

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of money, the physical amount of money,
how much is actually involved.

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And what we have on the y-axis is the
psychological intensity of that.

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Now because this curve has a diminishing
return shape function to it, what does it

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mean?
It means that if we take an amount of

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money, on the x-axis, in the left side of
the lower end of the scale.

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And we take an amount that is exactly the
same in terms of the amount of money on

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the, far right, they project very
different psychologically.

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So this is why, 7, 8 dollars out of 15,
which is represented by the left two

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columns, look like it has a huge
psychological effect between thirty and

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forty something on that scale.
Where $8 on the right side of the scale,

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even though it has the same $8 effect,
psychologically it has a much, much

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smaller effect.
And this is basically the way that

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relativity works, and how diminishing
returns work.

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And why the same physical amount in terms
of money has very different psychological

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implications.