Dollars and Sense
February 14, 2016
This is an excerpted summary of “The Rich Can Learn From the Poor About How to Be Frugal” by Sendhil Mullainathan that was published in The New York Times on February 12, 2016.
The New York Times — Research suggests that people are more likely to make an extra 30-minute trip to buy $50 headphones that are on sale for $40 than to make the same trip for speakers that cost $385 instead of $400.
At first glance, this makes sense. By taking the trouble to go to the other store, you can save 20 percent on the headphones and only 3.75 percent on the speakers. The bigger percentage in savings is more appealing.
Though intuitive, this way of looking at the choices is mistaken. In each case it will take 30 minutes to save some money. But with the headphones, you save $10; with the speakers, you save $15.
We tend to focus on the percentage rather than the amount we save, and fall prey to a mental illusion. After all, when your shopping is done, it is dollars — not percentages — that will be in your bank account.
This error is pernicious because it leads to a great deal of misdirected frugality.
Prof. Ofer Azar
Prof. Ofer H. Azar, an economist at BGU’s Guilford Glazer Faculty of Business and Management asked consumers in the United States how much they needed to save to justify spending an extra 20 minutes. The same pattern emerged. When shopping for a $10 pen, they required only a $3.75 savings, on average. For a $30,000 car, though, they needed $277.83 for that 20 minutes.
Another of Prof. Azar’s papers summarizes the problem perfectly: “Do Consumers Make too Much Effort to Save on Cheap Items and too Little to Save on Expensive Items?” The answer is, resoundingly, “Yes.”
What all of this amounts to is a tendency to think in relative rather than absolute terms. For example, we are more likely to notice that a drumbeat is loud if we have been listening to a gentle violin. And we will notice that we are lifting extra pounds if they are added to a lightly packed suitcase. The same additional weight is barely noticeable in a heavy one.
Not everyone falls prey to this effect, according to other research.
Lower-income people behave more consistently as consumers than more affluent ones. Poorer people tend to value a dollar more consistently, irrespective of the context. It is not simply that those with less money pinch more pennies; it is that they are compelled to value those pennies in absolute rather than relative terms.
The insight here is simple: When it comes to money, stop looking at relative values and start looking at absolutes. Dollars, not percentages, matter. In this case, the well-off can learn something about money management from the poor.
Read the full article on The New York Times website >>
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