CRITICAL THINKING - Cognitive Biases: Mental Accounting [HD]

Wireless Philosophy

19 Sept 201503:36

Summary

TLDRIn this lecture, Laurie Santos explores the concept of 'mental accounting,' a cognitive bias where people treat money differently based on its intended purpose. She uses the movie ticket scenario to illustrate how people are less likely to buy a new ticket after losing one compared to losing equivalent money. Santos explains that this bias stems from the mental accounts we set up for various expenses, which can lead to irrational financial decisions. However, she also highlights that understanding and leveraging these mental accounts can help us cope better with losses and make more informed financial choices.

Takeaways

🎬 Mental accounting is a cognitive bias where people treat money differently based on its intended use or source.
💸 In the first scenario, most people are reluctant to spend an additional $10 on a movie ticket after losing the first one, illustrating the reluctance to double the perceived cost for the same experience.
🤔 The second scenario shows a contrast where people are more willing to spend the found $10 bill for the movie ticket, even after losing one, because they don't feel the loss as personally.
🏦 Mental accounting creates different 'mental accounts' in our heads for different purposes, affecting how we spend or save money.
💡 The concept challenges the economic principle of fungibility, where money should be interchangeable regardless of its source or intended use.
🧩 People are less likely to use money from long-term savings like a 401k for short-term pleasures, due to the mental separation of accounts.
🎁 Unexpected money, like tax returns or windfalls, can lead to increased spending on items that wouldn't normally be budgeted for.
🎰 Gamblers are more likely to continue gambling when playing with 'house money,' money that is perceived as not their own.
💼 Mental accounts can be beneficial or detrimental, depending on how they are used and managed.
🛍️ People can strategically use mental accounting to their advantage, such as setting up accounts for specific goals or to deal with unexpected expenses.
🔄 The speaker suggests that by being aware of mental accounting, individuals can make more informed decisions about their financial behavior.

Q & A

What is the main topic of the lecture by Laurie Santos?
-The main topic of the lecture is mental accounting and its relation to cognitive biases.
What is an example of a cognitive bias presented in the lecture?
-The lecture presents 'mental accounting' as an example of a cognitive bias.
Why might someone choose to go home instead of buying a new movie ticket after losing the first one?
-According to the lecture, people might choose to go home because they perceive the lost ticket as a sunk cost and are reluctant to spend additional money.
What is the percentage of people who would probably go home if they lost their movie ticket after paying with a twenty-dollar bill?
-Fifty-four percent of people in the study by Kahneman and Tversky said they would probably go home.
How does the scenario change when the twenty-dollar bill is exchanged for two ten-dollar bills?
-In this scenario, when one of the ten-dollar bills is lost, most people would still choose to buy a movie ticket with the remaining ten-dollar bill.
What percentage of people would probably go to the movie anyway if they lost one of the two ten-dollar bills?
-Eighty-eight percent of people in the study would probably still go to the movie.
What is the concept of 'mental accounting' as described in the lecture?
-Mental accounting refers to the psychological practice of categorizing expenses and income into different 'accounts' in our minds, which affects our spending decisions.
Why do people rarely take money from their 401k account to pay for a meal?
-People rarely do this because they have mentally categorized their 401k as a separate account for retirement savings, not for everyday expenses.
What economic principle does mental accounting violate?
-Mental accounting violates the principle of fungibility, which states that money should be interchangeable regardless of its source or intended purpose.
How can mental accounting be used to one's advantage, as suggested by Dick Thaler's friend?
-One can use mental accounting to their advantage by setting up a separate account for unexpected losses, which can make it easier to cope with negative financial events.
What is the implication of mental accounting for classical economists?
-The implication is that people do not perceive money as a uniform entity, which challenges classical economic assumptions about rational behavior and decision-making.
What advice does the lecture give regarding the use of mental accounting?
-The lecture advises that we have control over the mental accounts we set up and from which we deduct, and we should be mindful of this when making financial decisions.

Outlines

00:00

🎬 Mental Accounting Introduction

Laurie Santos introduces the concept of mental accounting as part of a series on cognitive biases. She uses the scenario of losing a movie ticket after purchasing it with a twenty-dollar bill to illustrate how people are less likely to buy a new ticket compared to losing a ten-dollar bill. This behavior demonstrates the mental accounting bias, where individuals treat different monetary amounts as separate entities, affecting their spending decisions.

💭 The Impact of Mental Accounting

The lecture delves into the psychological phenomenon of mental accounting, explaining how people create separate mental accounts for different expenses and are less likely to transfer funds between them. Santos contrasts two scenarios involving movie tickets and ten-dollar bills to highlight the inconsistency in people's reactions to monetary loss, emphasizing the irrationality of mental accounting compared to the economic principle of fungibility.

💰 Practical Examples of Mental Accounting

Santos provides practical examples of mental accounting, such as not using retirement savings for a meal or spending a tax return on items one wouldn't normally buy. She explains that people tend to allocate unexpected money to different accounts and spend it more freely, as seen with gamblers playing with 'house money.' The concept of mental accounts extends to various life aspects, including entertainment and savings for children's education.

🤔 The Challenge of Economic Principles

The lecture addresses the challenge mental accounting poses to classical economic principles, particularly the idea of money fungibility. Economists find it puzzling that people do not treat all money as equivalent, as illustrated by the different responses to losing a ticket versus a bill. Santos points out that while this bias may seem irrational, it can be leveraged to one's advantage.

🛠 Leveraging Mental Accounting

Santos concludes by discussing how mental accounting can be used to one's benefit. She shares a story of a behavioral economist who set up a separate account for charity donations and used it to offset the emotional impact of everyday losses, such as parking tickets or lost movie tickets. This strategy demonstrates the potential for harnessing mental accounting to improve one's financial and emotional well-being.

Mindmap

Keywords

💡Mental Accounting

Mental accounting is a psychological concept where individuals mentally categorize their money into different 'accounts' based on its intended purpose or source, rather than viewing it as a unified pool of funds. This concept is central to the video's theme, as it explains why people react differently to losing a movie ticket versus losing cash. The video uses the example of losing a ticket versus losing cash to illustrate how mental accounting affects financial decisions.

💡Cognitive Biases

Cognitive biases are systematic patterns of deviation from rationality in judgment, whereby inferences about ambiguous or complex stimuli are biased in certain directions. In the video, mental accounting is introduced as a type of cognitive bias that influences financial decisions, such as whether to buy a new movie ticket after losing one or not.

💡Kahneman and Tversky

Daniel Kahneman and Amos Tversky are renowned psychologists known for their work on the psychology of decision-making and behavioral economics. They are mentioned in the video as the researchers who presented the problem of losing a movie ticket to college students, highlighting the impact of mental accounting on decision-making.

💡Fungibility

Fungibility in economics refers to the property of a good or a commodity whose individual units are essentially interchangeable. The video discusses how the concept of mental accounting violates the principle of fungibility, as people do not treat money as interchangeable when it comes from different 'mental accounts'.

💡Economic Principle

An economic principle is a fundamental concept or law in the field of economics that helps explain how economies or economic agents behave. The video contrasts the economic principle of fungibility with the mental accounting behavior, showing that people's intuitive financial behaviors often diverge from classical economic theories.

💡Behavioral Economics

Behavioral economics is the study of the effects of psychological, cognitive, emotional, cultural, and social factors on the economic decisions of individuals and institutions. The video touches on this field by discussing how mental accounting, a cognitive bias, influences financial decisions and can be leveraged to one's advantage.

💡Loss Aversion

Loss aversion is a cognitive bias where individuals prefer avoiding losses to acquiring equivalent gains. The video implies loss aversion in the context of mental accounting, as people are more sensitive to the loss of a movie ticket than the loss of an equivalent amount of cash.

💡Windfall

A windfall refers to an unexpected or sudden gain, often of money. In the video, windfalls are mentioned as a source of funds that people are more likely to spend frivolously because they are considered as 'extra' money in a separate mental account.

💡Gamblers

The term 'gamblers' is used in the video to illustrate the concept of 'house money,' which refers to money that is not considered as one's own. Gamblers are said to gamble more when playing with house money, demonstrating the impact of mental accounting on risk-taking behavior.

💡Dick Thaler

Dick Thaler is a prominent behavioral economist mentioned in the video. He is known for applying the concept of mental accounting in his personal life by setting up a separate account for charitable donations, which helps him cope with everyday losses by mentally allocating them to that account.

💡Classical Economists

Classical economists are those who adhere to traditional economic theories that assume rational behavior and complete information. The video contrasts their views with the realities of mental accounting, showing that people's financial behaviors often do not align with the predictions of classical economic models.

Highlights

The concept of mental accounting and its relation to cognitive biases is introduced by Laurie Santos.

A scenario involving a lost movie ticket and the psychological decision-making process is presented.

Statistical data shows that 54% of people would likely go home without buying a new ticket after losing the first one.

A contrasting scenario is introduced where a different approach to handling money affects the decision to buy a ticket.

88% of people would still go to the movie if they lost one of two ten-dollar bills, illustrating mental accounting bias.

Mental accounting is defined as using different mental accounts for different activities and not transferring resources between them.

Examples of mental accounting in everyday life, such as not using retirement funds for meals or spending tax returns differently.

The idea that extra money, like tax returns or coupons, is treated differently in mental accounts.

Gamblers are shown to spend more when playing with 'house money' due to mental accounting.

Different mental accounts are set up for various purposes, such as entertainment or children's education.

Mental accounting contradicts the economic principle of money fungibility, where all money is considered equal.

Behavioral economist Dick Thaler's friend uses mental accounting to his advantage by setting up a charity account.

Using mental accounting to mitigate the emotional impact of losses, such as parking tickets or lost movie tickets.

The potential to leverage mental accounting biases to improve financial and emotional well-being.

Control over mental accounts and the importance of awareness when making financial decisions.

A reminder of the influence of mental accounting on decision-making, especially when losing items like movie tickets.