Is one euro the same as the next?
It is relatively common to budget separately for food, fuel and housing. But research suggests there are often surprising spin-offs from this type of categorising of spending. Academic and co-author of behavioural economics book Nudge, Richard Thaler, writes how people tend to treat money categorised as for food differently from money categorised as for fuel. Thaler calls it mental accounting. This behaviour, also detailed on the Behavioural Finance website, turns on its head the commonly held idea that money is “fungible” – or that one euro is the same as another euro.
It’s as if a $2 increase in gasoline prices “decreased their annual income by $10,000s”
New research on the Brown University website tells how mental accounting is feeds through into the way households spend. When the likes of rent, gas and food are budgeted for separately, shoppers treat the money separately. Associate professor of economics Justine Hastings wrote that if petrol prices rise, people typically changed petrol buying habits rather than cutting back in a different area of spending, such as food.
“A clear pattern emerged,” the research said. “People behaved as if they were much poorer, buying cheaper gasoline as if a $2 increase in gasoline prices had decreased their annual income by tens of thousands of dollars.”
How worthwhile is that discount?
Mental accounting can also play tricks when we buy big ticket items.
We might perceive a €20 discount as not being as worthwhile if it relates to an expensive product – but as a big discount if related to a cheaper product.
Shoppers might be more inclined to drive 30 minutes out of their way to get €30 off a €80 mirror than drive 30 minutes to get €30 off a €1,250 bedroom suite.