18.2: Psychological Accounting

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People frame the outcomes of choices as well as the choices themselves. Tversky and Kahneman asked people what they would do in the following situation:

Case 1: You have decided to see a play where admission is $10 per ticket. As you enter the theater, you discover that you have lost a $10 bill. Would you still pay $10 for a ticket to the play?

88% of the respondents said they would still pay the $10 for the ticket. Tversky and Kahneman then asked other people about this situation:

Case 2: You have decided to see a play and paid the admission price of $10 per ticket. As you enter the theater you discover that you have lost the ticket. The seat was not marked and the ticket cannot be recovered. Would you pay $10 for another ticket?

Only 46% would pay another $10 for a ticket. But the two cases are completely equivalent in terms of the total amount a person would be out. Nevertheless, when the case is framed in these two different ways, people make quite different choices.

Tversky and Kahneman hypothesize that people do psychological accounting. In effect, we keep different psychological books for different things. In Case 2, the respondents seem to add the second $10 to the overall amount they would be spending on a ticket, and they aren’t willing to pay $20 to see the play. In this scenario, people see the entire $20 coming out of their “budget for play.” But in the first case, the $10 they lost comes out of a different psychological account—not out of the account set aside for seeing plays—so they see the ticket as costing just $10. When we get windfalls, “easy money,” we tend to think of it as less valuable than money we work hard for. An extreme example of this occurs when people are gambling. They tend to think of their winnings as “house money” which is not quite their own. So, they find it easy to bet with it (and, typically, to lose it).

Many people owe thousands of dollars on their credit cards. The use of credit cards also involves something like mental accounting. It is easy to overspend on a credit card because it doesn’t feel quite like spending. The money isn’t coming out of a psychological account where we have stashed money we are reluctant to part with. In fact, however, money from this account is especially real, because we pay interest on our credit card bills. This is one thing people sometimes mean when they speak of ‘compartmentalization’.

Although one of the best ways to save is to treat all money equally, we can sometimes use mental accounting to our advantage. For example, if you receive an unexpected gift, you can put the money in a bank account set aside to pay for next year’s tuition. This moves it from the “easy-come easygo” psychological account to another account from which you are more reluctant to draw.