Summary: A concept first named by Richard Thaler (1980), mental accounting attempts to describe the process whereby people code, categorize and evaluate economic outcomes.

One detailed application of mental accounting, the behavioral life cycle hypothesis (Shefrin & Thaler, 1988), posits that people mentally frame assets as belonging to either current income, current wealth or future income and this has implications for their behavior as the accounts are largely non-fungible and marginal propensity to consume out of each account is different.

Read The Full Article Here

-

Mental Accounting Matters

Mental accounting is the set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities. Making use of research on this topic over the past decade, this paper summarizes the current state of our knowledge about how people engage in mental accounting activities. Three components of mental accounting receive the most attention. This first captures how outcomes are perceived and experienced, and how decisions are made and subsequently evaluated. The accounting system provides the inputs to be both ex ante and ex post cost-benefit analysis’. A second component of mental accounting involves the assignment of activities to specific accounts. Both the sources and uses of funds are labeled in real as well as in mental accounting systems. Expenditures are grouped into categories (housing, food, etc.) and spending is sometimes constrained by implicit or explicit budgets. The third component of mental accounting concerns the frequency with which accounts are evaluated and ‘choice bracketing’. Accounts can be balanced daily, weekly, yearly, and so on, and can be defined narrowly or broadly. Each of the components of mental accounting violates the economic principle of fungibility.

As a result, mental accounting influences choice, that is, it matters.

Read The Full Article Here

If you enjoyed that why not find a job or read our guide to working in the 21st century. You can also join our Kiva team or hire me for your project.