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Cognitive Biases: Mental Accounting

The psychologist Laurie Santos (Yale University) explains the phenomenon of mental accounting: why we don't always assume that money is fungible. She explores why we set up different accounts for different purchases and how we can use our mental accounting biases to be happier about our financial decisions.

Speaker: Dr. Laurie Santos, Associate Professor of Psychology, Yale University.

Video transcript

(intro music) My name is Laurie Santos. I teach psychology at Yale University, and today I want to talk to you about mental accounting. This lecture is part of a series on cognitive biases. Imagine that you decide to go see a new movie opening up in your town You head to the counter and hand the cashier a twenty dollar bill. She gives you back a ten dollar bill and a ten dollar ticket. But when you get to the theater door, you realize you don't know where your ticket is. It's not in your purse or your pocket. It's just lost. What would you do? Do you think you'd pay ten dollars for a new ticket, or would you just head home? If you're like most people, you might be tempted to head home. In fact, when the psychologists Kahneman and Tversky presented this problem to college students, fifty-four percent of people said they'd probably just head back home. But now imagine a different scenario. This time, you decide to see the movie, and you head to the counter and hand the cashier twenty dollars. This time, she gives you back two ten dollar bills, so that you can easily pay ten dollars at the door to get in. But when you get to the door, you realize that you can only find one of the ten dollar bills. The other one's not in your purse or your pocket. It's just lost. What would you do? Would you pay ten dollars for the movie or just head home? if you're like most people, you'd probably still go see the movie. In fact, when Kahneman and Tversky presented this problem to college students, eighty-eight percent of people said they'd probably go to the movie anyway. The different responses to these cases illustrate a bias known as "mental accounting." We use different accounts in our heads for different activities, and the resources from one account aren't automatically transferred for use in another. This is why we pretty rarely take fifty dollars from our 401k account to have a nice meal, or why we sometimes blow our tax return on stuff we'd never blow our savings on. In our head, we automatically set up different accounts for different stuff, and if we end up with extra money we didn't expect, say from a windfall in a tax return, or even from an unexpected coupon, we end up blowing that money in this new extra account. It's why gamblers gamble a lot more when they're playing with house money. We use different mental accounts all the time, from the money we plan to spend on something fun like movies and plays, to the accounts we keep for our kids' college tuition. Our minds just naturally keep things separate. The problem is that our intuition to keep things separate violates a classic economic principle: the idea that money should be fungible. Classical economist are often puzzled by the fact that we can't just think of money as, well, money. Why shouldn't a ten dollar ticket and a ten dollar bill be the same thing? To an economist, it should be. But for our minds, not so much. The good news is that we can use these funny mental accounts to our advantage. A friend of the behavioral economist Dick Thaler did just this. He set up a new account with money that he planned to donate to charity at the end of every year. Each time something bad happened, a parking ticket or lost ten dollars for a movie, he took the money out of that account instead. His mental accounting caused him to think that the money wasn't really his anyway, and it made him feel less bad whenever he experienced losses. Our biases toward mental accounting mean that our minds don't work in the way that classical economists like to think. But we can use these mental accounting biases to our advantage. We have control over which accounts we set up and which we deduct from Just be sure to remember that the next time you happen to lose your movie ticket. Subtitles by the Amara.org community