Ariely Talk on Psychology of Money

I had the opportunity to attend a really cool conference over the past weekend called The Behavioral Economics Summit for Startups that is focused on helping startup founders and product designers understand and drive user behavior. There were some great speakers like Dan Ariely, Chris Anderson and Hal Varian.

Here are some notes on the talk Dan Ariely (Duke Professor & best-selling Author of Predictabyl Irrational) on the psychology of money and payment systems. Hope you guys find this valuable!

The paradox of money

  • Money is a tremendous invention – on the same level as the wheel
  • Extremely useful but because it’s so versatile, makes it hard to think about

Shadow Value of Price

  • When you buy coffee – you should ask: what else could I do with this $2.50?
  • The rational approach is to consider alternative uses / tradeoffs
  • Doing this with money is hard – it’s easier to think about what to do each day

Envelope Thought Experiment

  • Imagine you got an envelope with $1000 cash each week
  • How would you spend it?
  • You’d spend a lot early on, but then realize later the trade-off value of the money
  • We studied Intuit customers – this is the pattern we see with people’s spending their paychecks
  • Credit cards and other things make it hard to see financial horizons

Nice Speakers Thought Experiment

  • Imagine buying either $700 Sony speaker set vs $1000 Pioneer speaker set
  • Most people go for the better, pricer Pioneer speakers
  • New comparison: $700 sony + $300 only in CDs/DVDs vs $1000 Pioneer speaker set
  • Now – most people choose the speaker + CD package over the Pioneer
  • Why? It is easier to imagine the value of $300 of CDs
  • vs the diluted value of $300 spread across all kinds of things (despite the fact that you could buy CDs or anything else with the $300 saved from buying the Pioneer)

Considering Trade-Offs When Buying Cars

  • Went to a Toyota dealership and asked people:
  • What are you giving up in order to buy this car?
  • First got blank stares
  • Then people said – “Well I’m giving up buying a Honda”
  • No one said – “I’m giving up 700 lattes, 4 weeks of vacation, etc”

People Vary In Ability/Willingness to Make Trade-Off Comparisons

  • Turns out poor people are better at weighing the differences compared to wealthy people
  • When dealing just with cash – the difference is more clear/obvious that if you buy one thing (food) you can’t buy something else (shelter)
  • Also seen in the difference in Presidents: George W Bush vs Dwight Eisenhower
  • Bush said his budget increased the defense budget because the price of freedom is not too high
  • Eisenhower talked about how the cost of a single destroyer could house more that 8000 people


What are the WRONG ways we think about money?



1) RELATIVITY
  • We compare the value of stuff against other things
  • Thought Experiment: What would make you happier?
  • A) Making 90k in a company 90-110k or B) Making 85k in a company 60-85k
  • Most people say the 2nd would make them happier, but would still choose to accept the 1st job
  • Financial organization just made one database of all salaries
  • Despite making it through embezzlement, company crises, etc
  • He suspects if people all found out their salaries, all hell would break loose

“If you don’t think money buys happiness, you don’t know where to go shopping” – Bo Derek

Irrationality on Additional Spending (Large vs Small Amounts)

  • Imagine you are renovating a house, contractor prices whole job at $70k
  • He tells you – “For $10k more, we can get triple-glazed windows”
  • How easy is it for you to say “I’m already spending so much, what’s another $10k?”
  • Now consider how heavily you weight the decision to buy regular vs “premium” tomatoes?
  • You could always buy premium tomatoes and never spend $10k

2) MENTAL ACCOUNTING

Opera Ticket Thought Experiment

  • Imagine you buy a $100 opera ticket in advance of the show and lose it right before the event
  • You are annoyed and might not buy another ticket.
  • What is the cost of going to the opera? $200 right?
  • Alternative: you don’t buy the ticket in advance – you are going to buy at the door
  • You realize right before that you lost a $100 bill – are you still getting the opera ticket?
  • Most people say yes. And cost of opera? $100 – the lost $100 bill is unrelated

Debt vs Savings Accounts

  • How many people here have low interest savings accounts and high interest loans
  • Technically – this is an irrational financial decision (editors note – I disagree with this, but fine)
  • Mental accounting – putting so much in one category vs another

Speaking in Japan Thought Experiment

  • Imagine you are getting paid $10,000 to give a talk in Japan. You get paid in 2 ways:
  • 1st case – the $10k is deposited in the checking account
  • 2nd case – a stack of yens in your hotel room
  • Where are you more likely to spend money in Japan?
  • In the 2nd case you consider the money “part of your experience in Japan” not ” your money sitting in your bank account back home”

Thought Experiment for Buying Reading Material

  • We put people in a room and charge them one cent a minute to read cartoons, half a cent a minute to read sports/news and nothing to read post modern lit
  • 2 payment models – prepaid vs pay at the end
  • prepaid basically = 30% less compared to post pay
  • electronic wallet is a powerful stimulus – you can charge more when they pre-pay

3) PAIN OF PAYING

Paying Cuts into the Pleasure of an Experience

  • Imagine a restaurant that charges by the bite
  • This would really cut into the experience, even if the price was less overall
  • Other example: Cruise to to Alaska – 2 ways to pay:
  • You can pay 6 months in advance or pay end of the trip
  • It would make a vacation so much worse if tomorrow you need to pay $3000

Increased Use of Debit Cards by US Consumers

  • Why are people going to debit cards vs credit cards?
  • Debit cards are worse in almost every way (protection, additional spending capacity)
  • People seem to want the pain of paying – to prevent them from buying too much stuff

Big, Infrequent vs Frequent Smaller Bonus

  • Would you rather get a bonus of $1000 a month or $12k a year
  • Most people would rather get big bonus at end of the year
  • Large bonus more likely to be spent on fun / pleasure increasing things
  • Small bonus more like to be spent on boring stuff like bills, taxes, savings, etc

The Components that Lead to Aversion to Paying

  • Hassle of making payment (getting coins out of your purse)
  • Pain of paying (lots of small payments more painful than one big payment)
  • Cost itself (500 vs 50,000 dollars)

Interesting Questions to Ask

  • How would you add the pain of paying to something bad?
  • Amazon Prime – how does it reduce pain of paying?

AOL Pricing Case Study

  • Way back in the day – AOL gave you 20 hours a week for a certain monthly fee, then extra fees for more
  • They decided to change the pricing to an unlimited bandwidth
  • Looking at data, saw that most people didn’t hit limit, lots of weren’t even close
  • They increased bandwidth about 10%
  • Demand 4x overnight
  • Turns out people don’t like the pain of hitting the limit
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3 comments
auto lease
auto lease

This is very nice post. I like to read this post and feeling very nice.

bskinny129
bskinny129

This is a great post. I'm a big fan of Predictably Irrational and wish I was at this talk.

The topic of trade-off comparisons is extremely interesting. It's something I try to do in my life, not just regarding money. Basically the opportunity cost of what I'm doing with my time and being honest with myself rather than simply living through each day and seeing where I end up at the end of my life.

As a side note, the Eisenhower speech about the destroyers (http://en.wikipedia.org/wiki/Chance_for_Peace_speech) was extremely interesting. As someone that came from the military, he was trying to relate the spending back to the average citizen (which is never done today). As he left office he said: “God help this country when someone sits in this chair who doesn’t know the military as well as I do.” Things are a lot more complex today ...

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  1. [...] but in practice we tend to weigh things differently. Here is a thought experiment taken from a recent talking engagement (paraphrased): Imagine being presented with the decision to either by a $700 Sony speaker set or a [...]

  2. [...] but in practice we tend to weigh things differently. Here is a thought experiment taken from a recent talking engagement (paraphrased): Imagine being presented with the decision to either by a $ 700 Sony speaker set or a [...]

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