another kind of eh, close or distance relative to the pain of paying, is called
mental accounting. And here's the idea of mental accounting.
You know, sometimes companies have multiple departments, and what they do is,
they once a year they assign money to the different departments.
And the money after it's assigned is non-fungible, they can't switch it between
them. And if one department runs out of money,
too bad. If a department has too much money, you
know, they make a big party where everybody gets a new laptop.
But the idea is that once money is assigned to categories, money is not
fungible, and the idea of mental accounting is that we as individual
consumers also work a little bit like the accountant, that we assign money to
different categories and we spend money according to these categories.
So here's a beautful example that Dick Taylor gives.
And the example is the following. Eh, you bought a ticket for the theater.
It cost you a $100. You get to the theater, you open your
wallet and to your horror you discover that you lost the ticket.
Luckily you have another $100 bill so you can buy another ticket.
Would you buy another ticket? When people are aksed this question most
of them say no, I'm not going to buy anohter ticket.
I lost the ticket, too bad. I'm not buying another ticket.
But what if you bought another ticket? How much would you feel, then, the theater
cost you? Most people say $200, the first ticket
plus the second ticket. That's case 1.
Case 2, you haven't bought a ticket yet. You're going to the theater.
You're going to buy a ticket. You open your wallet.
And to your horror, you discover that you lost a 100 dollar bill.
What happens now? Do you say to yourself, oh, I lost a
hundred dollar bill, let's not go to the opera.
Most people say, how is this related? I lost a hundred dollar bill, why in God's
name would I not go to the theater now? And then, and then they go ahead and they
spend their hundred dollars and get a ticket to the theater.
And then how much do you feel that the tickets cost you?
A hundred dollars. Now think about both of these cases.
In both of them, you lost a piece of paper worth a hundred dollars.
Once it was called a ticket, once it was called a hundred dollars, but how it was
called makes you feel very different, right?
Now think back about the accounting story, if you assigned money to the entertainment
department you gave them $100 and the entertainment department bought a ticket.
And then also take it you say too bad to the entertainment department.
I'm not replenishing you. But if you lost money from your general
wallet, you don't feel any need to for the entertainment department to pay for it.
Say, I lost $100, why should the entertainment department suffer for it.
Here's a $100, go and buy a ticket. So there are a couple of things
interesting here. One is that as we assign money to
different categories, this assignment controls how we feel about the money.
And the second thing is that money that we haven't assigned, money that is in our
general wallet category, feels very, very differently.
Another way to think about his is what happens when you get money back.
What happen if you get some money back that is only assigned to one category like
a gift certificate or off to something like a return policy.
And all of sudden because it's assigned to one category, it's easy for us To spend
it, we don't, it's assigned to that category.
And here's another example for this. Image that you got paid $5000 dollars to
do a workshop somewhere. And you did it in one of two ways.
The money was either deposited in your checking account six months ago and now
you show up in Japan and you have this Workshop to give.
In the second case, they give you the money cash in Japanese yen as you get to
the hotel in Japan. Now Japan is expensive.
Everything is expensive, travel, food, drinks, entertainment, and so on.
In which of those cases would you have an easier time to spend the money.
In the first case, which was in your checking account, it's already a part of
your checking account it's a part of your wealth and now you would feel bad about
spending it. In the second case where you have all this
amount of money and it's connected to your trip it's easier for you to spend it
because it's more of a. Connected in the same mental category as
your trip, easier to go ahead and spend it.
Now you can also see why a, this notion of mental accounting is kind of connected to,
eh, the pain of paying, and how to either distance or a close cousins.
Mental accounting, by the way, is also why we see all kind of strange things in the
marketplace. Why we see, for example, leave money in a
low-bearing, checking account with very low interest on one hand.
On the other hand have high-interest credit card loans or car payment loans.
And we ask people about it they feel like these are 2, 2 separate domains.
These are savings and this is spending, and you don't differentiate the 2.
And if you think about all of these notions of separating money into different
accounts and spending according to, these separations.
It means money in our mind is not perfectly fungible.
Money have budgets and depending on our budget allocation to the different
categories that will depend our spending. Now mostly when we think about mental
accounting we think about as a mistake in decision making.
After all one of the main benefits of money is that is fungible.
You can switch it from place to place but people don't treat it as fungible.
But I would like to argue that mentally counting is actually a good strategy given
our inability. So, what are we asking people to do in
reality? We're asking them to think about every
purchase, how it could translate to all other purchases.
If I buy coffee today, what would I not be able to do?
If I buy a car today, what I would not be able to do across all categories.
Turns out, they're just too difficult to do.
So what are people doing? We are restricting ourselves, and we're
saying, okay this is probably not going to be ideal, but I'm going to think only
about this bucket. I'm going to assign money to this bucket
of, you know, let's call it dinners or entertainment or shopping, clothing.
Vacations, and I'm just going to think about it in this, in this bucket.
Is it optimal? Of course not.
Is it leading to mistakes? Of course, yes.
But nevertheless it's constraining the problem.
It's creating boundaries for it that are much more clear and therefore allowing us
to work better. So if we were all perfectly rational,
perfectly rational. Then mental accounting would not make
sense. But given how difficult it is for us to
think about money mental accounting does help us to partition the problem and at
least get one step ahead. Now, if we're going to create solutions
for people if we're going to create new digitized bank accounts and we tell
people, think better about money. You can have two approaches.
You could say, let's create something that assumes perfect rationality, and let's
help people think about perfect fungibility and how to move money between
accounts and what's the right thing to do. That's one approach.
The second approach is to say People are already adopting this approach of mentally
counting, maybe it's naturally a good way for people think about money.
And even if it's not optimal, and maybe what we could do is we could captialize on
this ill built And approach for partitioning money, and let's help people
do that better. So if I think if you think about those two
approaches. It's kind of how we are trying to help
people think better. Are we trying to get people to think all
the way to level of perfect rationality. Or are we taking something that is kind of
half way into it. We're taking something that people are
doing, that is kind of the shortcut that we already have.
To think about laughing, just trying to optimize that.
From the two types of solutions, I generally more believe in the, in the
second one. I believe that our, we have a better
chance of succeeding by taking some natural tendency of processing information
and building on that, rather than assuming it doesn't exist and build something that
is perfect.