The Hindu Business Line : Why cash gifts buy luxury goods

Consider this. Your relatives and friends gift you some money at a certain religious ceremony that you perform at home. What would you do with it? Use it for your regular monthly expenditure? Or splurge on some exotic goods? If you are a typical person, you would choose the latter. Why?

Behavioural psychologists attribute it to “mental accounting”. Suppose you desire to vacation on the beaches of Hawaii. You set aside the plan for now; upgrading your car and paying down your mortgage seems a better way to immediately spend your hard-earned money.

Money meant to be splurged

And then you get sizable cash gifts from your relatives and friends. You suddenly revive your plan to visit Hawaii. Why? You figure that this cash is windfall — something that was not budgeted as income till yesterday. The money is, hence, meant to be splurged.

This behaviour goes against the basic principle of classical economics. Rationally speaking, money should mean the same to us. That is, Rs 10 lakh winnings from a lottery should be the same as Rs 10 lakh of salaried income. In reality, it is not.

mental accounts

The amount that we spend out of our monthly income causes more pain than the same amount that comes from a lottery winning or some such windfall. This is because we separate money into mental accounts, treating a rupee in one account differently from a rupee in another account.

Consider another example. You have been longing to buy a large-screen TV for quite a while now. Just when you wanted to set aside some money for it, you face an unexpected medical emergency in the family. After a month, your company reimburses the amount. What do you do? Buy the large-screen TV, of course. Why?

When you paid the hospital, you mentally debited your medical expense account. And when your company settled the amount, the cash inflow was treated as windfall. You, therefore, decided to splurge on the TV. There is, indeed, some economics in cash gifts and reimbursements!

(The author is founder of Navera Consulting. He can be reached at enhancek@gmail.com)

More Stories on : Economics | Simple Economics

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page