The meaning of money
What money means in economic terms, and what it means to us, are two — or many more — different things
Imagine you have just spent £70 (€80, $95) on something, only to realize that what you have bought is going to be of no use, and that there is no way you can return it for a refund. It’s the kind of experience that would leave even a seasoned stoic a little upset. But why is this? Is that because of the magnitude of the amount, or is there more to it?
Money has the same value for everyone — a pound is a pound — and you can buy exactly the same thing with any pound. That characteristic essentially endows it with its economic significance: money can fulfil three key roles for us (and for the economy as a whole): it allows us to buy goods and services, to measure their price (a proxy for value), and to store value so we can purchase later what we don’t need right now. From these three perspectives, the meaning of £70 would seem to be invariable, and so the experience of the loss (or the gain) of it should be independent of anything else.
Money in the mind
But that is not quite how we work. We engage in something called mental accounting, a term coined by Richard Thaler in 1985. Daniel Kahneman and Amos Tversky provided a clear example in their 1981 paper The Framing of Decisions and the Psychology of Choice. They conducted an experiment with two similar first-person scenarios about going to see a play, with tickets priced at $10 (cheap, but remember, it is 1981!). In the first version, as you arrive at the theatre, you notice you have lost $10: will you still pay $10 for a ticket? 88% of their participants said they would do so. In the second version, you have bought the ticket in advance, but upon arriving you notice you lost it. In this case, only 46% of their respondents would buy a new ticket.
The actual loss is exactly the same in both cases, yet the reaction is very different. We act as if we have multiple budgets, alongside unallocated cash. In the second case, we already depleted the theatre budget, and so we may not be able to justify…