mental accounting

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Brown psychologist Steven Sloman asked his students to propose a social policy nudge grounded in behavioral science. “It turned out to be harder than expected for students to decide what counted as a nudge as distinct from a shove,” he writes the Nudge blog. “But they all succeeded in the end.” Students proposed nudges for presenting the uncertainty associated with diagnoses of mental disorders, for rationalizing the rate “at which investors sell winning and losing stocks,” and for making the expense of cigarettes and the wastefulness of leaving the tap on more salient. Sloman sends along an account of three nudges that are noteworthy for “their simplicity and their strong scientific roots.”

1. Paige Kirstein proposed a nudge to reduce use of bottled water in fast food restaurants. Her idea is that tap water should be displayed prominently on menus beside bottled water either with a price of “free” or with a nominal charge for the cup that it is served in. Paige argued that customers will increasingly choose the tap water with consequent benefits to the environment because of the direct contrast to bottled water.

2. Maia Kipman proposed an automated system to induce drivers not to text while driving (estimates are that 66% of drivers 18-24 years old practice this dangerous habit!). Maia’s system would put the phone in a special mode when the vehicle is in motion. In this mode, the telephone would work normally but incoming text messages would not be heard. Once out of the car, the phone will inform the driver if they have a message. The phone will automatically let the sender of the message know that the driver is busy and cannot attend to their message but will respond shortly. Finally, if the driver tries to send or read a text, the system would play a recording by a celebrity suggesting that doing so is not a good idea. For instance, Maia suggests that Bill Maher might be induced to record a message that says “New rule: No killing people ‘cuz you are too self-involved.” She thinks it’s important that the message change frequently and hopes that the general public would get involved in generating such messages.

3. Aaron Foo proposed a whole series of nudges to get consumers to stop abusing credit cards. One of his ideas was similar to that of another student, Chloe Swirsky. Their proposal is to take advantage of mental accounting and prior commitment to get consumers to commit to spending limits for various categories of expenditures at the beginning of each time period. The credit card company will place each expenditure in one of those categories and enforce the spending limit. For instance, if the consumer decides that they do not want to spend more than $50 on fast food that month, then the credit card will not work in a fast food location after $50 has been spent.

For a past Nudge in the classroom, click here. To professors and students working on nudges in their classrooms, please share your stories with us.

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In thinking about how to apply mental accounting to public policy, George Loewenstein writes:

The process of mentally bucketing money in multiple accounts is often combined with earmarking the accounts for specific goals…While it seems like an inconsequential process, earmarking can have a dramatic effect on retirement saving. Cheema and Soman (2009) found that earmarking savings in an envelope labeled with a picture of a couple’s children nearly doubled the savings rate of very low income parents.

The results by Cheema and Soman could explain why some US financial institutions offer clients the opportunity to label college savings accounts with a child’s name. Saving becomes easier because the money is earmarked for the education of a specific child.

From a recent report on how behavioral economics and finance can improve retirement policies. Hat tip: Dan Goldstein.

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Nudge blog reader Chris Peterson previously wondered why banks don’t let him practice mental accounting by visualizing his online checking account as separate accounts for rent, food, entertainment, etc. He calls this process, “Saving with Shoeboxes.” Banks might not be helping Peterson budget and save, but others pointed him to the software package Bucketwise. Peterson responds with a tale about leaving Bank of America, which makes holding multiple small checking accounts an expensive pain, and switching to ING.

ING Direct, it seems, allows you to open up to 25 savings accounts for free, with no fees or minimums. Plus, they have “Automatic Savings Plans”, so one could say (for example) “Transfer $100 from my paycheck to my ‘Holiday Savings’ fund every month.” Now, is this a perfect shoebox solution? Not at all. You still have to open several accounts, and you can’t easily allocate everyday expenditures within those accounts – you can only transfer money from “groceries” to “checking” to cover the expense.

Overall, though, Peterson says he’s be “very satisfied” so far. He tells the Nudge blog he’s trying to push banks to implement a full visual shoebox system and has contacted the MIT center for civic banking. If an online mental accounting feature is something you wish your bank offered, read Peterson’s letter to his bank and spread the word at yours.

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Assorted links

1) Richard Thaler and George Osborne in the Guardian. U.K. pilot recycling programs to replace fines with rewards are showing results.

2) A new study finds calorie labeling for a hypothetical McDonald’s meal reduces calorie consumption. One key difference from past studies: People aren’t ordering meals for themselves. Parents are ordering meals for their children. Hat tip: Patti Hunter.

3) Crayola’s law says that the number of Crayola colors doubles every 28 years. How much faster do children who color with the original box of crayons finish compared to those with the mega 120-color box? Hat tip: Christopher Daggett.

4) A web-based version of Dustin Hoffman’s mason jars. Hat tip: Elliot Crosby-McCullough.

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Only 18 percent of Americans say the stimulus “has done anything to help improve their personal situation,” according to a USA Today poll. When it comes to the $300 million in tax cuts given out in small amounts in each paycheck, the whole point was for people not to notice them. Conor Clarke in the Atlantic reacts appropriately:

The simple fact that people don’t notice the stimulus dollars is not affirmative evidence that the stimulus is working. (Since it’s possible to imagine people saving money they don’t notice.) But the mere fact that most people tell pollsters they don’t notice the stimulus is not evidence one way or another. Relax, USA Today.


Thaler says mental accounting. As with financial accounts, people need to close their mental books and balance their accounts. But people in different professions unconsciously balance their books at different times. Standard wage employees may balance books on a biweekly or monthly basis, which is typically when they get paid. Cab drivers, in contrast, balance their mental books every day. Since business is brisker in the rain, once drivers hit their mental income targets for the day, they go home, leaving fewer cabs when you really need them.

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With high gas prices, you might have noticed promotions for free prepaid gas cards when you buy some product. Like a Callaway golf club. A Comfort Inn hotel room stay, a lodge stay on Big Bear Lake, or one booked through Expedia. Or a new Chrysler car with of three years of gas guaranteed at $2.99. Assuming these prepaid cards aren’t coming at a massive wholesale discount, companies could just offer a simple cash reward, or even a free prepaid generic Mastercard  or Visa that would be good anywhere, not just at gas stations. So why play up gas?

It’s a classic mental accounting trick. Most Americans have a transportation budget, which has been blown over the past year by $4 a gallon gas. People have a hard time moving money from one mental account to the other, say from clothing or dining out to gas. The prepaid cards give them a way to restore the solvency of the transportation account without upsetting their other budgets. Straight cash would be more fungible physically, but less fungible mentally.

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Ramit Sethi has an interesting blog post, “The A La Carte Method: Use Psychology Against Yourself to Save Money.” The method, which Sethi, author of the forthcoming I Will Teach You to Be Rich, says was partially inspired by ideas in Nudge, instructs wannabe savers to cut out major subscriptions in their lives (Netflix, cable, gym, magazines, Amazon Prime, fruit of the month, etc.) and instead pay for them one visit or item at a time, preferably using cash. (It’s similar to the paygo idea in politics where politicians promise to spend money on programs only when they have guaranteed tax revenue to fund them.) A la carte succeeds by making costs salient, at the small cost of making life less automatic.

Continue reading the post here.

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If you want some insight into how humans create and handle budgets, you could read about the theory of mental accounting as described by Thaler in his paper “Mental Accounting Matters“:

Expenditures are grouped into budgets (e.g. food, housing, etc.)…Such accounts would be inconsequential if they were perfectly fungible (i.e. substitutable) as assumed in economics. But, they are not fungible, and so they ‘matter’…Dividing spending into budget categories serves two purposes. First, the budgeting process can facilitate making rational trade-offs between competing uses for funds. Second, the system can act as a self-control device. Just as organizations establish budgets to keep track of and limit divisional spending, the mental accounting system is the household’s way of keeping spending within the budget…

Whenever budgets are not fungible their existence can influence consumption in various ways. One example is the case in which one budget has been spent up to its limit while other accounts have unspent funds remaining. (This situation is common in organizations. It can create extreme distortions especially if funds cannot be carried over from one year to the next. In this case one department can be severely constrained while another is desperately looking for ways to spend down this year’s budget to make sure next year’s is not cut.)

Etc. Etc.

Or you could just watch Gene Hackman tell this story about loaning money to Dustin Hoffman.


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