Relative Money

Well I came across an interesting concept the other day.  Money, despite being absolute, is treated by people as if it were relative.  What the hell am I talking about?  Well an example will help.  The store across town has a new electronic thingamabob, that you want, for $50 off it’s regular price of $100.  So you drive over and get it.  It’s a good deal at 50% off.  Now would you drive across town to save $50 on a new car worth $20,000?  Most people would say no.  Who wants to do that to save 0.25%?  Despite the fact in either case you are still saving the same $50.

So if you stripped out the other numbers above ($100 and $20,000) you would then be less likely to treat money as relative, but in fact today most marketing people know we treat money as relative and suck us in all the time using this trick.  It’s why you see ‘regular’ prices on ‘sale’ items at stores and lots of different ads.  It’s also why keeping a few expensive items in stock helps sales of lower cost items in a store.

Yet what is interesting is if you expand this to your savings life.  If you were to do X to save a $1, would you do Y to save $1.  What if I told you X only costs $4 regular and while Y is a service fee on your bank account you could avoid by doing one less transaction each month.  Most of us would likely save on X first despite the fact that Y will likely save you more in the long run.  We compare things all the time including when we are not even aware we are doing it.

So are we doomed to make irrational decisions?  Yes to some degree.  This effect is hardwired into our brains, but if you know about it you at least stand a chance of being rational about decisions.

4 thoughts on “Relative Money”

  1. Excellent post! I think the same thing can be applied to the psychology of pricing. What’s $9.99 vs $10.00? A whopping one cent, but more people will buy at $9.99 because of a ‘perceived savings’.

  2. There’s also the “is it cheaper to outsource”? mentality. For example, I have a cleaning lady who comes in twice a month. She mops the floor, scrubs the bathrooms, and does an all around cleaning job so we just have to do maintenance tidying up while she’s not there. Why do we pay her for something we could do ourselves? Time. My husband and I work stressful jobs and I would rather spend my weekend relaxing than cleaning the house, hence the cleaning lady. (Needless to say in retirement we’ll probably cut out this expense). Psychologically, that $80 we pay her each time she comes in feels OK, but we wouldn’t spend $80 on something like say, a carwash.

  3. Another situation where this comes into play is buying a house. Let’s say you offer $135,000 on a $150,000 house. The seller counter-offers at $137,500. I’m sure most people would say “only $2500? Ok fine.”

    I don’t know about anyone else. But I think $2500 is a lot of money, and I would not hesistate to make my realtor do a little more work to get that price dropped even further, or get credits/closing costs covered.

    People also tend to think in terms of how much their monthly mortgage payment is affected, and not the bottom line figure. This just compounds the problem (pun intended).

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