The purpose of money is to provide a uniform method for valuing things. It doesn't matter whether I have a crisp new $1 bill in my pocket, an old dollar bill, four quarters, or even a check made out to me for a $1. They all have the same value. This currency system allows us great freedom to buy and sell things and services.
Despite the great flexibility that money permits us, people have trouble treating every dollar the same as every other dollar. Here are two examples.
First, sociologist Viviana Zelizer in her fantastic book The Social Meaning of Money has done an extensive analysis of the way that people use money. One thing that becomes clear quickly is that people really do create different types of money to help them organize their lives. As a simple example, people treat birthday money differently than other money. For example, if a relative gives you $25 for your birthday, you are likely to spend it on something nice for yourself rather than on bills, even though the gift money is part of your total pile of money once it has been given to you. That is, we keep the money psychologically separate.
One way to see this idea of different types of money is in gambling behavior. There is a phenomenon that arises in research on gambling called the "house money effect." Basically, people get more risky in their bets when gambling after they have won a bit. The idea is that the money that they have won isn't really theirs. They are gambling with the house's money. Somehow, that money is less valuable, and so people are more willing to risk it.
The second example ties the value of money to our motivational system as well. A new study by Adam Alter and Danny Oppenheimer in the October, 2008 issue of Psychonomic Bulletin & Review, looked at how the ease of thinking about money influences the value of money. This ease of thinking is usually called fluency. Alter and Oppenheimer suggested that being more fluent with a type of money would make that money seem more valuable.
To test this idea, they did a number of studies in which they contrasted the value of a familiar form of money with an unfamiliar form of money. For example, in one study, the familiar form of money was a one-dollar bill. The unfamiliar form of money was a Sacagawea dollar. They gave people a list of inexpensive items (like paper clips and Hershey's kisses) and asked how many of them they thought they could buy for a dollar. People suggested that they would be able to buy far more of the items with the familiar one-dollar bill than with the unfamiliar Sacagawea dollar. This result suggests that people found the familiar form of money more valuable than the unfamiliar form of money.
Findings like these suggest that the psychology of money is far more complex than the economics of money. For economists, every dollar is the same as every other dollar. For people, though, some dollars have different uses than others. Perhaps more importantly, some dollars have more value than others.
There are important implications for research like this. Politicians tend to assume that the free-hand of the market will work to ensure that businesses run efficiently. However, this belief makes many assumptions. Among these assumptions are that there are no systematic biases in people's economic behavior that will distort the way markets operate. These results suggest that there are systematic biases in the way people treat money all the way down to the level of the value of a single dollar.