Richard Thaler: Invest now, drink later, spend never: On the mental accounting of delayed consumption

My favorite sentence: “Rational is not necessarily happy, and irrational gives you the rare opportunity to enjoy ‘‘free’’ drinks.”

Abstract (Via Shafir & Thaler)

Monetary transactions in which consumption is temporally separated from purchase naturally lend themselves to multiple frames and to alternative accounting schemes, which nonetheless maintain a modicum of discipline and authenticity. We investigate some of the relevant accounting rules, and find that advanced purchases (e.g., a case of wine) are typically treated as ‘‘investments’’ rather than spending. At the same time, consumption of a good purchased earlier and used as planned (a wine bottle opened for dinner) is often coded as ‘‘free’’, or even as savings. However, when it is not consumed as planned (a bottle is dropped and broken), then the relevant account, long dormant, is resuscitated and costs associated with the event are perceived as the cost of replacing the good, especially if replacement is actually likely. Related phenomena and assorted implications are discussed.

Introduction (Via Shafir & Thaler)

One of us bought a house recently that came with an industrial, uninsulated stove which violated residential building codes. A protracted search for buyers produced only one promising lead, the owners of a nearby cafe´ who were looking to do more cooking. What should they pay for a stove, a couple of years old, originally worth well above $1000 but worthless to us and with no other buyers on the horizon? Some friendly bargaining (over very good coffee and pastries) soon led to a resolution. They would give us something dear to us but cheap to them: gift coupons to our closest and favorite local cafe´! The ensuing months saw frequent visits to the cafe´, with pocketfuls of decorated coupons, each worth $5, and bearing no expiration date. The coffee, the cookies, and the breakfasts felt free. In fact, our many (and growing list of) friends were regularly being offered treats with the usual norms of reciprocity seemingly suspended. Those who did not know about the coupons thought we were wonderfully generous; those who knew, thought it was only fair – in fact, had we made them pay good money while in possession of those ‘‘free’’ coupons, they would have found us petty and cheap. What was it about those coupons that made them feel so different from the cash we all knew they were worth? Would we have felt equally magnanimous had we lost the coupons rather than used them as intended?Would we have been so generous to our friends had the cafe´ owners paid us cash for the stove? And when we offered a friend a coupon, would it matter whether that coupon had been purchased at full price or gotten through these other means?

As this anecdote reveals, monetary transactions can sometimes be vague and confusing and can lend themselves to multiple representations. Mental accounting research has shown that slight variation in the naming, allocation, or organization of accounts can influence decisions in ways that are hard to reconcile with fundamental normative assumptions, such as the extensionality of outcomes and the fungibility of money (see Thaler, 1999 for a review). One category of spending that often leads to mental accounting ambiguities is when the purchase and act of consumption are separated over time. In such situations the value of things can change between when they are acquired and when they are consumed due to a variety of factors, including depreciation, appreciation, market valuation, the cost of money, and personal taste.

Example (Via Shafir & Thaler)

Imagine, for example, that you and a friend each bought a $20 bottle of wine years ago and decide to drink it tonight with dinner.When you drink your bottle, our findings below will show, it might feel that it costs you nothing, since you bought the bottle long ago and are simply getting to savor it now. But when your friend accidentally drops the bottle and breaks it, it feels that it costs her what it would cost to replace the bottle now, considerably more.

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25. December 2009 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

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