Excerpt: "Satisfaction: The Science of Finding True Fulfillment"

The options that money gives you are really options for acquiring more information about the world. As I have said before, novelty is what the brain really wants, and money is the most efficient means to that end. Even if you don't spend it. Just having money represents the possibility of experiencing things you wouldn't otherwise have, which in turn allows you to consider your options. I was about to learn, however, that although money buys possibilities, it is not the only way to achieve this type of freedom.

I picked the dollar amounts in the previous example for a simple reason. Most of the things that a person can buy cost less than $500. Think of all the things (including nonmaterial uses of money -- what economists call services) that cost less than $500. Now think of all the things that cost more. The first list is bigger. If we carry this to the extreme, we'd find that the list of the things that cost more than $100 million is exceedingly small.

The utility of money is rooted in the number of its possible uses, but increasing the amount of money is a fool's game. Since most of the purchases you would want to make are relatively modest in price, increasing your supply of money is good only to a point. If you can afford a computer or a television, both of which can be had for about $500, then you have already achieved the peak of purchasing power.

Bernoulli knew that money had diminishing utility, but he never explained why. In the 1970's, Daniel Kahneman and Amos Tversky, both psychologists, showed that Bernoulli had missed a crucial aspect of how people think about money. You view money not in terms of absolute wealth, they argued, but as gains and losses from your status quo. Moreover, people view the pain of losing money as worse than the pleasure of an equivalent gain. Kahneman and Tversky called this idea prospect theory, and it was based largely on observations of the kinds of lotteries people are willing to play.

Why should losses loom larger than gains? The reason, I think, comes from the way in which the prices of all the goods and services in the world are distributed. Once you have enough money to buy, potentially, anything under $500, then increasing that amount also increases the number of possibilities -- but at a diminishing rate. Conversely, if you lose the same amount of money, then you close off a greater number of possibilities than you would have acquired had you gained the equivalent amount. Imagine how it feels to lose $500 -- say the cost of a minor auto accident or an unexpected tax bill. You'll probably think about all the things you can no longer buy with that money (like a new TV or computer). Such thoughts explain why people are more averse to risk the wealthier they become. The wealthy live with greater possibilities of loss than of gain.

Economists hate this idea. Standard economic theory depends on the ability of the consumer to establish preferences in terms of their expected utility and not, as I just explained, by simply counting what they might buy with their money. But I can't be the only person who has a hard time gauging how much utility I will get from a high-definition television compared to a plane ticket to Hawaii, (which cost about the same).

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