15.301/310, Managerial Psychology Prof. Dan Ariely Lecture 8: The Psychology of Money Welcome to the most exiting class so far Focus on one research project today We are talking about the psychology of money. Generally, how do we decide, when we go to ABP if we should pay 2.79 for coffee? Everyone here has bought coffee before? How do we decide if it is worth it or not? When were you last in a coffee shop? -a week ago Okay, so we go up to the counter, look at the coffee menu, what were you thinking? -sugar in coffee Want sugar in coffee, that’s free, what else? -flavored, caramel Okay, so we’re talking 5.25. How do you decide if you want it or not? -how much money in pocket Let’s say you just got paid, lots of money in pocket Does it make a difference? How do we make that decision? In theory, we are supposed to be able to evaluate how pleasurable something is for us. Cup of coffee, trip to Jamaica, whatever it is. Somewhere in our brain, imagine 0-100, how happy it makes us, map to money We can say, oh, this makes me happy .35. is that worth $2 or $3? Have this meter, in theory. Is it worth that? Then we decide to buy this thing or not. The thing to understand is that we can decide to change how much we want coffee every minute. Give us very diff level of pleasure in the morning, in the evening, when hungry, when thirsty, when tired, when not. That’s fine. But every moment, we are supposed to be able to map to how much we pay In theory, If internal value higher than price, we buy. If lower than the price, we don’t buy How much pleasure seems very hard Idea of internal understanding of amount of pleasure is called Fundamental Values Basic encoding of some quality that we understand deeply and can evaluate internally how much value it gives However, it’s very hard to measure fundamental values. How do we measure? -relative, Mercedes better than Ford Ok, you like one car more than another Change price of cigarettes, gas, see if consumption goes down. Change level of access and see how people change their minds. Can do all these relative things. But hard to evaluate absolute level, measure-50 Maybe one day, direct brain connection, give us amount of activity in cell and give us exact level of pleasure. Both cases what we do is we don’t have absolute levels, we have relative tests And relative tests fit with the idea of fundamental values, and therefore we say it’s possible we have fundamental values. For example, if we double the price of cigarettes, consumption goes down, fits with idea of fundamental values Increase price enough, drop smoking altogether Psychological perspective on preference Fundamental values is one way to thing about preferences Remember when we talked about listing Multiple reasons why love our SO? That indicated that people don’t know their preferences, right? That it’s easy to confuse them. An experiment Had roulette wheel, spun the roulette wheel, came up with a number. 74. Then they asked, are there more or less nations in the UN than 74? -less How many nations are there in the UN? And it showed that people who got high numbers, gave high numbers. People who got low numbers gave smaller Use the number to decide how many nations are in the UN Context effect 2 weeks ago we talked about Asymmetric dominance Compromise effect All those things show people have imperfect comprehension of their own values How do these things fit together? Economics predicts the fundamental values, psychology tells us we have very fuzzy preferences. (Sound) How much would I need to pay you to listen to this sound for 1 min? Write down a number. Now this sound is very simple. You all know what it’s like, right? I don’t need to play it again, it is clear to you, you know what it is. You don’t need any more new information. So let’s get some numbers. 10, .10, 1, 2 , 1, 2, 10 dollars 15.301/310, Managerial Psychology Lecture 8 Prof. Dan Ariely Page 2 of 15As you can see, there’s a big variance in how much people want to do this. It was what, 10 cents to 10 dollars. Say I sold can of coke,. I have a can of diet coke here, What is max you would pay for it? $1, 2, .01, 0, 0 Except for the difficult people here who don’t like diet coke, or don’t like coke, or don’t like the question. Otherwise the price you’d pay is what its worth. The variance on the annoying sound is going to be very high because it’s very hard to know how much you want to listen. For coke, variance small -$0.50 to $2 for people who like Coke We run into problems because everyone does not like Coke, but this is assuming everyone likes it. One of the questions we’d like to ask is how come there is so much variability in the valuation of the sound, and how come there is such a low variability in the valuation of diet coke? The suggestion here is we have no idea how much we like diet coke. But somebody told us once how much diet coke costs and we paid what people told us we should pay for it. When we buy things in the market, we don’t buy them based on what we like and what we don’t like or how much we like it, we buy them based what someone told us we should pay for it. That’s what its suggesting, when somebody sold you Coke, they could have charged you $10 for it, and then you could pay $1 a can for wine. Diet coke could be more expensive than wine. Why are the sounds so difficult compared to chocolate or Coke or other things? Present another intuition If I ask you right now, what would you prefer to have, Godiva chocolate or ice cream? A choice that you can seemingly easily make. Anyone have hard decision? No On the other hand if I say, given this piece of Godiva chocolate, give detailed description, what is the maximum amount of money you are willing to pay for it? Is it an easy decision or a hard decision? Much harder, right? We can decide if we want chocolate or ice cream much more easily than we can say what is the maximum amount we are willing to pay for a piece of chocolate. The argument is that it is hard to map hedonic pleasure to money But when have two things next to each other, two goods, we can decide which one we like more. 15.301/310, Managerial Psychology Lecture 8 Prof. Dan Ariely Page 3 of 15What I presented so far In economics, we have a theory of fundamental values. A theory that people would know how much they value things.