The paradoxes of mental accounting

The Washington Post has a fascinating article on the psychology of mental accounting – a seemingly simple process but one which seems to have curious effects on how we decide to spend our money.

The article suggests we mentally divide our money for different purposes, and tend to be reluctant to change our thinking, even when it is against our interests.

There’s a nice example of turning up to the cinema and discovering you’ve lost your $20 ticket. How would you feel about shelling out for another one?

Compare this situation to one in which you turn up to the cinema to buy a ticket, but find you’ve lost a $20 bill. How would you feel about buying a cinema ticket in this situation?

Intuitively, it seems as if the first situation is worse, because you’re buying another ticket, when, in fact, the loss is exactly the same in both situations.

It also seems that we assign different sources of money to different purposes, despite the fact that money is completely interchangeable:

Arkes and his colleagues once cited an anecdote in a study: Employees of a publishing firm who were in the Bahamas for an annual meeting were each given a cash bonus for getting a big contract. Almost to a person, the bonus recipients took the money to a local casino and blew it. What is interesting is that most of these people did not lose more than the $50 — they slowed down or stopped when they felt they were playing with their “own” money rather than with the $50 of “free” money. The irony, of course, is that the $50 these people lost was their own money, too.

The article has got some more great examples of how we make spending decisions based on our own idosyncratic internal accounting schemes.

UPDATE: An interesting note from jswolf19, grabbed from the comments:

In my mind, the loss of the ticket and the loss of $20 are not the same. It’s possible that I might find either the ticket or the $20 later (that it’s misplaced instead of lost). However, the ticket will have become useless to me whereas the $20 will not have.

Link to Washington Post article ‘mental accounting’ (thanks Enchilada!)

7 Comments

  1. Martin Byröd
    Posted May 29, 2007 at 4:16 pm | Permalink

    Well, although we some times behave in quite funny and irrational ways, one shouldn’t under estimate the “unconsious” decisions we make. There are often subtle but some times quite good reasons for these actions.
    For instance, the people in the study mentioned probably enjoy gambling a bit and for them the thrill is probably worth the realtively small amount of money. However, if they do this in their everyday life with their normal salary money, how do they know when to stop? How can they be sure they won’t go gambling again next week and the week after that?
    A simple rule like “I only play with small amounts of money I get ‘for free’” is perhaps not so stupid after all…
    One could argue in a similar way with the ticket lost vs. cash lost example.

  2. Martin Byröd
    Posted May 29, 2007 at 4:17 pm | Permalink

    Great blog by the way. Only just stumbled in.

  3. cszar
    Posted May 29, 2007 at 5:12 pm | Permalink

    Interesting.
    Howie Mandel – the Host of “Deal or no Deal” talked about stuff like that in a great interview on Penn Jillettes Radio Show.
    He said that people rejected huge sums of money (upwards of 50.000$) because it wasn’t “their” money. They rather went home with nothing than with a small fortune.
    Casinos all over the world are in business exactly because of this mechanism – they hand out chips because people playing with real paper money are a lot less willing to bet high.

  4. prowler
    Posted May 29, 2007 at 5:49 pm | Permalink

    haha actually, i might be inclined to react in the opposite way. i mean, if i lost the ticket, i might buy another out of inertia, thinking “hey i already bought this, so i must’ve thought it was worth it, so it has to be worth it one more time”
    on the other hand, if i found out i’m $20 poorer before buying the ticket, i’d ask myself if that ticket is really worth buying :) yes i know, i’m a cheap bastard

  5. jswolf19
    Posted May 30, 2007 at 10:22 am | Permalink

    In my mind, the loss of the ticket and the loss of $20 are not the same. It’s possible that I might find either the ticket or the $20 later (that it’s misplaced instead of lost). However, the ticket will have become useless to me whereas the $20 will not have.

  6. Andrew
    Posted June 13, 2007 at 5:44 pm | Permalink

    Actualy the article says you lost the $20 on the “Metro”. You’re more likely to somehow derive value out of the expired ticket (which is probably in your other pocket btw) than you are you find a $20 on a bus.

  7. Posted October 28, 2010 at 6:56 pm | Permalink

    I know this post is more than three years old, but I stumbled on it while searching “mental accounting” in Google. I was reading a post in another blog about specialized savings accounts, and someone left a comment stating that using this strategy to save money is mental accounting. Do you think it is?

    http://unclutterer.com/2010/10/28/specialized-savings-accounts/


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