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When Chicago Booth’s Daniel Bartels took his family out to a casual burger-and-fries joint after many months of eating strictly at home during the COVID-19 pandemic, he found himself unpleasantly surprised upon receiving the bill. Although Bartels, his wife, and his three kids had been to this restaurant several times before the pandemic, he says, their meal was far pricier than it had been on those earlier visits.

“I had in mind that for all of us to eat and drink would be in the ballpark of $50 or $60,” he says, “but in the end, with tip, it was $90.” Given that full-service restaurant meal prices were up about 8 percent annually per federal data released in December—with prices at limited-service eateries such as McDonald’s and Panera up close to 7 percent—his experience was in line with that of many consumers.

After paying the bill, Bartels says, his first thought was that he and his family would have to skip their usual Friday night routine of ordering in dinner. After a busy week, they enjoyed the luxury of a nice meal that came without any cooking or cleaning, or even leaving the house. But since he had overspent on one meal that week, he figured he’d have to cut back on another. “I remember thinking when we got that bill, ‘That seems like a lot to spend on burgers and fries,’” he says. “I thought, ‘I guess I’ll be making dinner at home on Friday night.’”

Bartels sees significance in the fact that he didn’t consider how else he might have made up for the extra money that went toward the meal. He and his wife could have spent less on gifts, clothes, or any number of other items, for instance. Instead, his mind concocted a savings plan specifically related to dining out. He connected the sticker shock he experienced from the burgers and fries to an action item that prompted him to make cuts to the family dining budget for the rest of the week.

The way our minds organize mental accounts is a professional interest for Bartels. He and Booth PhD student Lin Fei have been examining how mental representation and the categorization of expenses are crucial to people’s budgeting approaches. Why, when looking at his family’s spending, did his mind send him straight to thoughts of cutting down on restaurant food delivery? What did it reject along the way?

Bartels and Fei are learning some answers to these questions—establishing, for starters, that consumers’ decisions are guided by a widely shared set of spending categories, which the researchers have been mapping. While personal finance experts often discuss “buckets” of spending, Bartels and Fei find that mental accounting actually more closely resembles a tree, with different spending categories connected by various branches. In the minds of consumers, some products and services can be closely, or distantly, related.

These categories and relationships can lead people to make some peculiar spending and savings decisions. Someone who receives a free plane ticket might then spend more on a hotel rather than bank the savings or apply them to another area of the household budget. Such decisions can be inconsequential on their own, but over time they can add up to financial mismanagement.

“The topic of budgeting has become increasingly relevant with inflation, dropping stock performance, and high interest rates,” says Fei. As inflation soared over the past year, millions of consumers have been making shifts to try to save money. They’ve been searching for different phone plans, switching grocery stores and food brands, and staying home rather than going out—all attempts to stretch their budgets.

The spending map that Bartels and Fei are creating could prove useful for marketers trying to better understand what consumers think and want, in any economic condition. But it could also be of interest to any consumers determined to rein in their own spending—and those who are simply interested in understanding how their mind goes shopping.

Putting labels on money

The concept of mental accounting goes back several decades. In 1985, Chicago Booth’s Richard H. Thaler, a Nobel laureate who was then at Cornell, found that people often classify money on the basis of categories such as food, gifts, or entertainment, even though, as Thaler wrote, this “violates the principle of fungibility.”

Fungibility is an economic principle that says money is money, no matter how you acquire it or where you spend it. It holds that if you overspend by $100 on dinner, you can make up for it by saving $100 on gas. But people tend not to treat money as fungible and instead consider factors such as what type of items they’re buying and how they acquired the money—be it through work, a tax refund, a sudden windfall, or some other way.

Thaler, in his study, gave the example of two hypothetical couples who returned from a joint vacation with salmon they had caught. But the airline lost their fish in transit and gave the couples $300 as compensation. They then took that money and spent $225 of it on the fanciest dinner they had ever eaten at a restaurant.

If money is fungible, why not buy a cheaper orange juice brand to make up for the money spent on gas?

“Money is not supposed to have labels attached to it,” Thaler wrote. “Yet the couples behaved the way they did because the $300 was put into both ‘windfall gain’ and ‘food’ accounts.”

Subsequent research on mental accounting suggests similar categorization practices affect consumer behavior. Bartels, along with University of Colorado’s Nicholas Reinholtz and University of Illinois Chicago’s Jeffrey R. Parker, observes in a series of six experiments that participants receiving retailer-specific gift cards, such as those for Levi’s or Whole Foods, were more likely to purchase items most typical of that merchant—such as jeans at Levi’s or organic produce at Whole Foods—than participants given more open-ended gift cards that could be spent at any store. And overall, the researchers write, “Receiving a retailer-specific gift card should create a retailer-specific spending goal and mental account, whereas unrestricted gift cards . . . or cash should create a more general spending goal and mental account.”

Notes Bartels, “When you give people a gift card, it changes their preferences; it actually makes them want some things more than other things. Because now instead of asking, ‘Well, what do I need for $100?’ you’re asking, ‘What am I going to buy at the Levi’s store for $100?’”

Research by University of Washington’s Justine Hastings and Harvard’s Jesse M. Shapiro finds that during the Great Recession, consumers bought less-expensive, lower-octane gasoline when gas prices rose and went back to more-expensive, higher-octane gasoline when prices fell in late 2008—even though the overall economic climate was worsening.

The researchers also find that lower gasoline prices did not lead to quality upgrading in other categories such as orange juice and milk, suggesting that the freed-up money “sticks where it hits,” just as the mental accounting hypothesis would predict.

Such behaviors may be considered economically irrational. If money is fungible, why not buy a cheaper orange juice brand to make up for the money spent on gas? Additionally, this kind of mental accounting can lead to potentially damaging behaviors such as falling for the sunk-cost fallacy, which involves, say, continuing to invest in a failing asset you’ve had in your portfolio for years because you’ve committed to it, rather than abandoning that asset and investing the remaining money in one that has a better chance of helping you recoup your losses.

Bartels notes that even though money is money, and buying the cheaper orange juice to make up for expensive gas is a rational behavior, humans aren’t wired to think of it that way. Consumers tend to think in categories—for example, allocating a certain amount for an entertainment fund and another amount for a household fund—despite money being fungible. “One reason we invented actual accounting is because we’re mental accountants,” he says, noting that most household budgets essentially resemble a mash-up of tangible and intangible ledgers. “If you google ‘how to set a budget,’ you find something in between actual accounting and mental accounting, because budgeting advice still often encourages people to think in categories.”

Booth’s Abigail Sussman concurs. From a traditional economic perspective, she notes, fully rational consumers would take into account not only their current income and expenses, but also their expectations of future income and expenses, as well as alternative possible uses of their money, to determine how much they should spend on, say, gas for their car. They would also consider how this relates to their borrowing across time. They don’t, of course. “There’s so much information in the world that we could possibly be processing at a given time, but people are limited in their motivation and their abilities to process it all simultaneously,” she says. “As a result, we break the world into categories, and this helps us organize and plan for our daily expenses.”

How we form spending categories

Recent research from University of Wisconsin’s C. Yiwei Zhang, Sussman, University of New South Wales PhD student Nathan Wang-Ly, and University of Colorado PhD student Jennifer K. Lyu examined consumers’ budgeting behaviors, beliefs, and approaches to categorizing consumption. The results suggest that over 90 percent of consumers who create household budgets track their spending within so-called budgetary categories such as food, clothing, gas, entertainment, and bills.

Yet the researchers also find variation in the detail of these categories. For example, while some consumers might use the broad category of “bills,” others get more granular and subdivide bills into “utilities,” “rent,” and so on.

To understand where these more granular categories come from, think of a person buying breakfast cereal. One might assume that consumers would put cereal in the “food” category, and thus would spend less on their grocery bill if they felt they had overspent on cereal. However, Fei and Bartels argue that consumers don’t necessarily think in such broad swaths and instead form “hierarchical, nested categories,” which might mean putting cereal into a more specific “breakfast foods” category. In doing this, if they feel they have spent too much on cereal, they will look to tamp down on other breakfast foods—such as eggs, bacon, or bagels—rather than cut into dinner purchases.

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The two researchers conducted three multipart experiments and an analysis of field data to evaluate how consumers form these categories. For the experiments, they recruited hundreds of US participants from crowdsourcing websites Amazon Mechanical Turk and Prolific. The number of people who participated in each experiment and its separate parts varied, from 27 to over 300.

In the first experiment, which measured consensus in people’s mental representations as well as the consistency of those representations across time, participants performed a successive pile-sort task online in which they were provided a set of 64 cards labeled with expenditures ranging from rent, gas, credit-card debt, and food to coffee, burgers, ski trips, and headphones. They then sorted these items into categories that made sense to them. In this way, the researchers could calculate the relational “distance” between items. Combining all the responses, Fei and Bartels measured the aggregate distance between two items on a scale of 0 to 4, with 0 being an item’s distance to itself and 4 representing items that participants never grouped together. According to this system, bread and a burger had a distance of 1, indicating a close relationship, while bread and car maintenance had a distance of 4.

This taxonomic exercise was inspired by cognitive anthropological studies, Bartels explains. In such an exercise about the natural world, participants might write down forest plants or animals on index cards, then sort the cards into piles as they classify them. In the end, Bartels says, “you end up with this branching tree structure that describes how people think about a domain like biology.” He and Fei had participants do the same thing, but with household expenditures.

Two more groups were asked to perform the same successive pile-sort task—but this time to do it twice, once in January 2022 and again in April. The researchers find that overall, there was broad consensus in how participants classified and separated the items, and this classification was consistent over time. “People share the understanding that shampoo and sunscreen are more closely related than are shampoo and movie tickets,” they write.

Distance from a ‘focal’ item

When Bartels spent more than he expected on burgers and fries, his immediate reaction was to spend less on another dinner. Fei and Bartels’s further experiments explain that thought process, laying out some connections we draw in our minds between products.

In their second experiment, the researchers had participants perform the same pile-sort task, but also asked them to think about their spending on five “focal” items—chocolate, juice, ski trips, jeans, and a microwave. (All of these items were featured in the first experiment.) They paired each focal item with three comparison items: a close-distance item, an intermediate-distance item, and a far-distance item, where the distance was also determined from the first study.

Participants grouped focal items with close-distance items 83 percent of the time, intermediate-distance items 55 percent of the time, and far-distance items just 13 percent of the time. For example, they lumped chocolate with pizza more often than with toys. Jeans were paired with shoes but not meat.

In the third experiment, participants imagined purchasing four items: one focal item and three others of varying mental distance from it. The focal item came with a price discount (of 10–40 percent) that participants could apply to one of the three remaining items. They had to rank order their list, indicating their preferences for applying the coupon.

When choosing which item to buy at a discount, 43 percent of participants picked the closest one, while only 31 percent selected the most distant one. If the first item was sunglasses, they were more likely to apply the discount to a backpack (considered close) than to a restaurant gift card (far). If the first item was a restaurant gift card, most chose a discount on a streaming service (close) over pet food (far).

Inside the minds of consumers

In an experiment, participants sorted through spending items and grouped those they felt were similar. The results reveal a broad consensus in how consumers classify purchases.

The distance between two items may not always be intuitive, Fei notes. A restaurant gift card and pet food both involve food, and yet participants put the gift card taxonomically closer to the streaming service. That’s because consumers often consider dining out to be more of an entertainment category, “related more closely to spending on movies and bars than spending on milk and cereal,” she says. Moreover, items can be placed in more than one category. Participants grouped groceries in general closely with household items such as microwaves, as well as with expenses such as rent.

In another version of this experiment, participants were told they could pick just one comparison item on the list to get for free as part of a promotion. In this scenario, 46 percent applied freebies to purchases that were most closely related to the initial item, as opposed to 28 percent who did so for the least closely related item. Gourmet chocolate truffles were most often paired with wine and least often with toys, while potted plants were most often paired with pots and pans (all household items) and least often paired with sunglasses.

The same was true when the experiment involved a random lottery incentive that made the choices real, not imagined, for some participants. In this variation, participants were told they had either bought or could choose a focal item, and that they could then apply a discount to one of three similarly priced comparison items. This time, three participants selected at random were later given the money to buy the item and realize their choice. Once again, the proportion of people choosing the closest item for the promotion was much larger, at 55 percent, than for the far-distant item, at 28 percent. “This is consistent with the notion that when people spent on a focal item, they want to save on the closest item,” the researchers write.

Finally, the researchers established that the same patterns exist outside of the lab by using NielsenIQ Consumer Panel Data housed at Booth’s Kilts Center for Marketing to study more than 7 million US grocery store trips taken from 2009 to 2018. They find that if the price dropped on a given product, consumers were willing to spend more on other items—particularly on those closer in categorical distance to the item that experienced a price drop. Thus, if the price dropped on detergent, consumers were more likely to spend the money they’d saved on toilet paper or diapers than they were on coffee or pet food. If they got a deal on pizza, they’d spend more money on coffee and pet food.

Balancing the budget

When study participants imagined overspending on an item, they adjusted spending the most on items they felt were closely related.

A map for marketers and consumers

The opaque connections in consumers’ minds drive purchases. And, clearly, marketers would benefit from better understanding this mental accounting going on in consumers’ heads. Once those working for an online supermarket know how consumers mentally group specific items—such as detergent and diapers—they can organize their search directory to place these products closer together on the menu. Those with a physical store can similarly place products closer together to make it easier for shoppers to find and purchase products they consider related.

Companies could also be savvier when grouping products and brands for promotions. While overspending on an item in one category can lead people to seek a discount on a closely related item, bundling can help push consumers toward buying two things rather than just one. It’s pretty obvious that if a consumer buys toothpaste from an online drugstore, the store might want to let the consumer know that it’s also running a sale on toothbrushes. Those items are clearly complementary. But the taxonomic experiments make visible some less obvious mental links between items—such as between storage rentals and gym memberships, Fei says—which marketers could use to design product bundles and promotions. Fei surmises that, both being recurring monthly expenses, “gyms could give out advertisements for storage units in their locations, or vice versa, and it might be effective.”

Fei and Bartels say a company could conduct its own studies using the pile-sort method to assess the distance between a new item and current products to determine what the potential marketing message should be.

“With a successive pile-sort, brands might know what kinds of products are perceived as close together and can be launched as a natural extension,” says Fei. “It would be natural for a mortgage lender, for example, to consider offering student loans if it is thinking about expanding its business, or for a clothing company to start making suitcases.” And if launching a new suitcase, Fei notes, the company could use categorization to target its pitch. Addressing a lifestyle audience? If so, bundle the suitcase with hotels and other travel deals. Trying to reach people buying everyday necessities? Pair the suitcase with shirts and shoes. “The marketing message can be completely different,” she says.

This takes advantage of the idea that, while most consumers group products similarly, there are some instances of diversion. “Consumers who more readily group together bread and cheese might be systematically different from consumers who more readily group together bread and milk,” Fei and Bartels write.

But while peering into people’s mental accounts could be valuable to companies, the same methods could also be used to help cash-strapped consumers. If credit-card companies or personal finance apps want to get users to decrease their spending or lower default rates, they could encourage consumers to label and track their expenses using the categories that many of us already use unconsciously. Skipping broad categories such as “food” in favor of subcategories such as “fast food” and “grocery” could help consumers control their spending, say the researchers, who suggest designing labels according to how people typically categorize.

Financial advisers might use pile-sort exercises to better understand how their clients think—and then help them to become better budgeters, Bartels notes. “If I knew how you thought about your purchases, I might be able to help you consider that you might be overspending in one of your user-defined categories—or categories that we can infer based on your sorts,” he says.

The key is helping people recognize their buying habits and override them if necessary. Just knowing how we naturally group items could help us improve our budgeting skills and recognize the tendency to splurge or spend. Says Fei, “The method in the research is a valuable approach for consumers to think about their own finances and construct their budgets.” And when money is tight, inflation is rising, and recession fears are mounting, the accounting going on in people’s heads represents a big opportunity—whether for spending or saving—for whoever can master it.

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