Hey, it’s all in the mind


Racy Cases 84
V Pattabhi Ram

Wafers met up with China that Saturday evening at their usual joint; the Chennai Coffee Club. She had a problem on hand. That wasn’t surprising because the troubled lass was eternally in a thinking mode.

The previous evening Wafers had escorted her two friends to the airport. One of them, Muskan, was to fly to Delhi and the other, Tushar, was to head towards Calcutta. The flights were to take off at 730 pm and the check in counters were to close half an hour earlier at 7 pm.

They took a cab at 545 pm giving them ample time to bite a snack at the airport. The traffic was horrible; there was just no road discipline. The vehicles were moving at snails pace. A huge procession organized by a political group was coming from the opposite direction. By 7 pm the trio of Wafers, Muskan and Tushar, were still quite some kilometers away from the airport. It was unlikely that they would catch the flight. And there was no way that they could turn back to the city; the procession coming from the opposite side had made that impossible.

Finally at 8 pm, a full half hour after the scheduled departure time of the flights, the three managed to reach the airport. They rushed in, hoping against hope that the flight would be delayed. The smart young one at the counter told Tushar, “Sorry mate, the Calcutta flight took off as per schedule.” As Tushar smiled off at his luck, the lady turned to Muskan and said, “Your flight is just taking off; look there it’s leaving the runway.” Muskan was shattered. And Wafers felt terribly sorry for her.

An hour later, at her home, as she was flipping through a magazine, the shock began to sink in. After all both Tushar and Muskan had missed their flight; they had lost the same amount of money; it made little sense to show greater sympathy for Muskan. Yet why did she, Wafers, intuitively do so?

That was the problem-on-hand when she met up with China. “Ha, that’s what we call mental accounting” explained her encyclopedic friend. She had heard about Financial Accounting, she had heard of Cost Accounting; now what was this mental accounting wondered Wafers. “It’s the same thing that happened to you when you were at the casino at Las Vegas” said China, reading Wafers mind with élan.

Wafers, who had been deputed to the US for three months by her company, had been coaxed by her friends to play a game of roulette at the casino. She had agreed that she would play with the $50 (Oh, Rs 2,000), which her aunt had gifted her when she had called on her the previous day. Wafers had told her friends that she would play just one round; that’s all and no further. Her friends had agreed.

She won the first round; her capital doubled to $100/-. She won the second round as well; her capital went up to $200. Before she knew it, she had played 8 rounds and her corpus was a cool $12,500; that’s Rs 500,000/-. Forgotten was her assertion that she would play one round only. Riding her luck for one last time so that she could take home a million Rs Wafers had placed her bet on Number 5. Presto the needle closed on Number 6 and she lost $ 2500.

Eager to make good that loss she played another round and lost. Then another, and then another losing each time and finally ended up with $50, her initial corpus. She had come out saying “Well I haven’t lost anything. My $ 50 is in tact”. How stupid. She had actually lost about Rs 500,000; that is the money with which she could have walked out but did not. China had chided her thinking of it as “no loss.”

For Wafers the bell rang. And the scene from her Quantitative Techniques class jumped into her mind. Explaining probability the professor had asked, “If I toss a coin once, what is the probability that it will be head?” A guy from the middle row had said “0.5”. The professor swishing his mane in his trademark fashion, then asked, “I toss the coin once and it falls head. I toss it a second time; what is the probability that it will again be head”. A backbencher had screamed, “0.5”. The professor wasn’t through. “Suppose I have tossed the coin twice and suppose both times it falls ‘head’. Now when I toss it a third time what is the probability that it would be ‘head’? Someone tiredly responded, “0.5”. Wafers had wondered what the professor was upto.

Gosh, he wasn’t done with as yet. “Suppose I tossed it nine times and each time it fell head. Now if I toss it a tenth time and you want to win, what will your call be, ‘Head or Tail’?” Someone said, “Head; because it has fallen head nine times”. Someone else said, “Tail; because the law of averages will catch up”. A third person remarked, “It’s still either head or tail because the probability is still 0.5”. The professor nodded in appreciation. “He is right. The result of a coin flip is independent of the results of the earlier flips. Your argument favoring head because it fell head nine times or favoring tail because law of averages will catch up is a case of mental accounting”. For Wafers the coin clicked now, a full two years later!

Even as the professor had swished his mane, the nth time the horn rimmed guy sitting next to Wafers cracked, “But professor I would check the coin; for all that I know if its 9/9 head, there is a distinct probability that the coin has head on either side.” The class had exploded in mirth and Wafers had remembered only her friend’s out of the box thinking than the professor’s important point of observation

China interrupted her thought process to explain how his professor at IIT had in explaining the difference between sunk cost and opportunity cost thrown light on mental accounting. “You know the value of a wine goes up with time” he had remarked. The entire class sat up on hearing “Wine.” He had continued. Suppose you bought a bottle of wine two years ago at Rs 1,500 a bottle. Suppose today it costs Rs 3,500/-. Which means that if you sell it you can collect Rs 3,500/-. Now suppose you decide to consume it along with your friends. What is the cost of consumption?”

A few had said Rs 1,500. “Look after all we bought at that price.” Another group said, “But what about the interest cost. So it’s Rs 1,500 plus interest for two years.” A backbencher had remarked, “But professor I consume a Rs 3,500 bottle for Rs 1,500. So I am saving Rs 2,000 by having the drink!” Bravo. The frontbenchers said, “No cost. It’s sunk cost.” The professor was sad. “Hey, it’s Rs 3,500 because that’s what you would have got if you sold today. That’s opportunity cost. To think that it is sunk cost is to surrender to mental accounting. The same goes with other prices. China hadn’t forgotten that example.

Wafers was suitably impressed. She decided to look for more real life examples of mental accounting. Examples of situations where we think in a particular way knowing full well that it’s wrong!

Advertisements

About Pattabhi Ram

A chartered accountant by profession, a writer by passion and a teacher by accidental choice.
This entry was posted in Racy Cases and tagged , , , , . Bookmark the permalink.

One Response to Hey, it’s all in the mind

  1. Ranjan says:

    mind + emotion = mental
    Tushar = Mind + Low emotion
    Muskan = Mind + High emotion
    Leading Wafers sympathy more for Muskan.
    Conclusion : Mental accounting is fully driven by the “emotion attached to mind”.
    The equation goes hand on hand.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s