Mental Accounting and Self-Control

The 2017 Nobel Prize in Economics was awarded to Richard Thaler from the University of Chicago.  Like Daniel Kahneman (who won the Nobel in 2002), Thaler works at the intersection of psychology and economics.  His work has focused on people’s economic behaviors and on ways that people’s behavior differs from the predictions of economic models.

One of the things that Thaler has become known for is the concept of the “nudge,”

which is a small change to someone’s environment that can have a big influence on their behavior in economic situations. The most famous example of a nudge is forcing people to “opt out” of default options.  Suppose you are signing up for a driver’s license and you are asked whether you want to become an organ donor.  Typically, to become an organ donor, you have to “opt in” by checking a box on a form. However, you could change the default on the form and assume that everyone would be an organ donor unless they opt out of doing it. 

Research suggests that people typically stick with the default option on a form.  That means policy makers can decide which option they want most people to choose and make that one the default. 

My personal favorite concepts from Thaler’s work is the idea of mental accounting.  The idea behind mental accounting is that people don’t treat all of their money (or time or effort or other resources) as if they have one big pool of it. Instead, they have separate mental accounts, and when they spend money (or time or effort) they keep track of it based on the mental account it came from. These accounts are typically based on people’s goals. 

For example, suppose you decide to treat your friend to a movie. Each ticket costs $10, so your total will be $20. When you get to the front of the line, you look in your wallet and discover you lost a $20 bill. Do you still decide to go to the movie?

Most people given this scenario say that they will see the movie. It seems like a strange question to ask.

Suppose, though, that the scenario is slightly different. Now, you decide to treat your friend to a movie where each ticket costs $10. You stop by the theater that morning and grab two tickets (for $20). When you get to the theater, you realize you have lost the tickets. Do you still decide to go to the movie? 

Now, people often still decide to go to the movie, but they now feel bad about it. It feels as though the movie costs twice as much. 

What is the difference here? In both cases, the economics are the same. You have two tickets to see the movie and you have $40 less than you did when you started the day. But, psychologically they feel different.  

In the first case, the $20 bill you lost came out of your overall "wealth" because you hadn’t applied it toward any goal yet. In the second case, though, you apply the first $20 you spent toward your mental entertainment account. When you lose the ticket and buy another one, you add that $20 to your mental entertainment account as well.

Why would people do this?

The idea is that by keeping these separate mental accounts, it is easier to engage in self-control. When you start to spend too much against one of your mental accounts, it makes it easier to walk away from new purchases. For example, by feeling that you already spent $40 toward entertainment that evening, you might decide not to go out for snacks or drinks after the movie to avoid spending more money that you should on entertainment. This same set of psychological mechanisms might also help people at work balance the amount of time they spend on different projects or help students to avoid studying too much for one exam and not enough for another.

Many of Thaler’s studies focus on interesting decision processes like these. Like Kahneman and Tversky, he often finds strategies people use that fly in the face of predictions of economic models. However, his work has also been quite interested in understanding how people use these strategies to govern their own behavior.

References

Thaler, R. H. (1985). Mental accounting and consumer choice. Marketing Science, 4, 199-214.

Thaler, R. H., & Sunstein, C. R. (2008). Nudge. New Haven: Yale University Press.