Opportunity Costs

Moving Your Money From One Pocket To Another

One of the things that makes money useful is the ease with which it can be transferred among accounts: from one person to another, or within one person or organization, from one account to another.

Sometimes, however, people associate certain sums of money with certain purposes, and try to keep the accounts separate. For example, if someone is saving money toward a specified purchase, that person may be reluctant to use any of the saved money even to deal with moderate emergencies. This applies whether the money is being hidden in a jar, or deposited in a special bank account, or perhaps just segregated mentally from the rest of the money in one's wallet or checking account.

This sort of segregation of money for specific purposes can lead to decisions that seem paradoxical.

Some people would buy the new ticket, but a large percentage choose not to, in such a case. Paying $70 seems to them too much for that concert. That is, they are reluctant to transfer an extra $35 from "general funds" into the mental "concert account."

Here most people would proceed to buy the ticket and hear the concert. Of course, someone who has hardly any more money might consider foregoing the concert and transferring the $35 from the mental "concert account" back to "general funds." But most people who can afford $35 concerts do not make this transfer.

The paradox arises because the two situations can be framed in identical fashion. Either one attends the concert, with $70 less in the sum of all one's money, or one foregoes the concert, having $35 less. The difference in behavior in the two situations stems from the reluctance to transfer money into or out of the mental "concert account."

Another example arises in judging whether to make an effort to get a discount. If you know that a certain calculator is available for $15, at a store that you can reach with a 20 minute walk, and you see it in front of you for $20, you will probably take the walk to save $5. On the other hand, if you know that a leather jacket is available for $175, at a store that you can reach with a 20 minute walk, and you see it in front of you for $180, you are likely to purchase it and avoid the walk.

Each decision should turn on the question of whether it is or is not worth it to you to make the extra effort to save $5. The difference arises because $5 is a substantial fraction of the money in the "calculator" account but it is a near-negligible fraction of the money in the "leather jacket" account. These accounts are purely mental, however, and you can frame each decision as a decision about whether to make a particular effort in order to save $5.