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The psychology of money
• Opportunity cost
• Relativity
• Pain of paying
• Mental Accounting
• Fairness
• Price of 0
• Self herding
 Opportunity cost
• How should we make decisions about money?

• “Decision makers confronted with a showcase of

beluga caviar consider how much hamburger they
could buy with the money [that] a pound of caviar
costs…People intuitively take opportunity
costs into account…” (Becker, Ronen &
Sorter, 1974)
We found we really missed going to the
theatre and eating in nice restaurants, so
we gave our kids away
$1,000
$700 $1000
Sony Pioneer

+
$300
worth
of
CD’s
 Shadow value of price
• The concept of the shadow value of price is
crucial for people to be able to make tradeoffs
between goods
• Can people do it?
• Naturally -- not, but maybe under some
conditions?
• What does that means for spending and for
savings??
Relative size matters !!!
Thinking in %
Relativity
The importance of relativity
 Relativity

• Because it is hard to estimate

absolute levels (pleasure) we use
relativity as a decision rule
• We use it in many decisions
across many domains
Pain of paying
3 components of the aversion to making a payment

Pain of paying: psychological

Total disutility of a payment

aversion to parting with the

payment, above and beyond the
economic disutility and the hassle
Hassle, effort, or annoyance of
actually executing the payment
Disutility of money spent: the
utility that could be realized by
spending the money is the best
available alternative if the payment
were not made
Payments over time
The utility of pain of paying
Consumption Spending Utility

50

30

10

-10

-30
t1 t2 t3 t4 t5 t6 t7
The AOL story
Can the pain of paying
diminish over time?
 Pain of paying: summary
• The pain of payment is an additional aspect of
disutility
• It is influenced by the timing of the payment,
and by the coupling of experience with payment

• Club med? Subscriptions? Micro payments?

• Can the pain of paying be useful?
Mental Accounting
We behave differently with respect to
money that is allocated to account vs.
money not allocated

Bought ticket
(cost $100)

Lost $100 on the way to

Lost ticket
theater

Buy new ticket? Buy ticket?

We allocate money (which is fungible)
to mental accounts (and therefore
make it not-fungible)

Theater tickets Restaurant meals

We allocate money (which is fungible)
to mental accounts (and therefore
make it not-fungible)

Sunk money
feels free

Theater tickets Restaurant meals

Are there benefits for MA?

• Mental accounts causes many mistakes in

decision making
• But, it might also help people fight the problems
of making monetary decisions (shadow value of
price, trading off goods and money etc.)....
• Having savings as a mental account can help
people save more
Mental accounting summary
Money is not fungible in peoples’ minds!

Money has budgets which in turn have effects on

spending

Where money comes from determines where it

can be spent
Fairness
Price of 0
Halloween
Experiment 2 Results
100
1&2 93
90
0&1
80
70
70

60
% choice

50

40
30
30

20

10 7
0 0
0

1 oz Snickers 2 oz Snickers Nothing

 Self herding
&
the importance of
first decisions
 How should people
What is the self herding
decide about buying a
version of these decisions?
cup of coffee?
 Auctions of real products
Mean value Low ss# High ss# Increase
Trackball 16.25 10.38 21.52 107%
Keyboard 32.47 21.81 42.03 93%
$9 wine 15.80 11.62 19.55 68%
$82 wine 22.89 17.42 27.76 59%
Design book 18.81 14.15 23.00 62%
Belgian Chocolates 13.31 10.04 16.24 62%

High dependency between the prices of the

2 wines and 2 computer accessories
Tom Sawyer
???
Arbitrary Coherence ...
Just because you’ve always done it that way
doesn’t mean it’s not incredibly stupid.
Internet 0.0
$600
$400

? ?
Not all bad news ..
Comparing Apples & Oranges
Social and Market
Norms
 Theater Restaurant
tickets meals

0¢ 25¢
Lessons
VS.
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