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Mental Accounting

Here are some other examples from everyday life:

· A friend of Thaler's once went to buy a bedspread. Where a double, queen and king size usually cost $200, $250 and $300, all three sizes were now priced at $150. Thaler's friend happily snapped up the king-size bedspread -- although she planned to use it on a double bed. The woman had a mental idea of what a bedspread should cost. Buying the double bedspread, which is what she needed, saved her only $50, but buying the king saved her $150. Mental accounting explains why many people eagerly snap up deals on items they do not need: When something sells for below the mental price we have assigned it, the deal takes precedence over the actual utility of the item.

· A man buys an expensive membership in a tennis club. Right after he puts down the money, which is nonrefundable, he hurts his ankle. He grits his teeth and continues to play through the pain -- even though not playing would mean much less agony. Mental accounting is behind the problem. Playing is the only way to ensure that the tennis club membership remains in the man's mental category of money well spent. To not play would be to write off the membership cost as a loss, which is more painful to the man than the agony of hobbling through games on an injured ankle.

· Another friend of Thaler's used mental accounting to devise an insurance plan against life's vicissitudes. He made a mental contribution to the United Way Campaign at the start of the year and then, every time he was unfairly given a parking ticket or had to fork over money for some other annoyance, he mentally deducted the amount from the sum he had set aside for charity. Assigning the money to charity allowed the man to feel that the money he was paying for parking tickets and other annoyances did not really belong to him anyway. (While this strategy is unlikely to be embraced by charities, Thaler's friend was careful not to set his annual target so low that he was left with nothing to give to charity at year's end.)

Mental accounting also explains why, when people are given a choice to get a cash bonus or a gift such as a free vacation for doing well on the job, they invariably choose cash. That's because people think they want the flexibility of cash. The problem is that flexibility comes with a price. You have to remember your obligations, such as fixing that leaky roof.

This is why studies show that employees who are not given a choice and are given a gift instead of cash usually turn out much happier. A vacation or a gift is "guilt-free" -- yours to enjoy. If you get cash instead, you could spend it buying yourself the same vacation or gift, but mental accounting would remind you that you are wasting money on frivolities.

Ohio State University psychologist Hal Arkes once found that mental accounting influences how people deal with sudden gains, such as lottery winnings. The same phenomenon influences millions of Americans at tax time, when they gleefully look forward to refund checks from the government -- even though refunds are really their own money being returned to them, minus interest. In terms of mental accounting, lottery winnings and refunds are invariably counted in the category of "free money" -- which is why people spend such dough not on health care, utilities and eliminating credit card debt but on discretionary items such as vacations or new patios.

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.

What does mental accounting have to do with the other puzzle we discussed at the start -- the difficulty of finding cabs on rainy evenings? Mental accounting, like financial accounting, requires people to close the books and balance their accounts. But people in different professions unwittingly balance their books at different times -- wage employees may balance books on a biweekly or monthly basis, whereas cab drivers often balance their mental books on a daily basis. Business is brisker on rainy evenings, so once cabbies meet their mental income targets for the day, they go home, leaving fewer cabs on the street, Thaler said.

Viviana Zelizer, a sociologist at Princeton University, noted that a similar phenomenon even affects how prostitutes think about their income. She cited a study of the Oslo prostitution market, which showed that prostitutes tend to spend money acquired through welfare checks and health benefits on essentials such as rent and bills and are far more likely to spend their income acquired from selling sex on drugs and alcohol, even if it means they have no money left over to pay for essentials.

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