Mental Accounting
Mental accounting refers to the different values a person places on the same amount of money, based on subjective criteria, often with detrimental results. Mental accounting is a concept in the field of behavioral economics. Developed by economist Richard H. Thaler, it contends that individuals classify funds differently and therefore are prone to irrational decision-making in their spending and investment behavior.
Mental Accounting
Definition
Mental accounting refers to the phenomenon where individuals assign different values to the same amount of money based on subjective criteria, often leading to suboptimal outcomes. This concept originates from behavioral economics and highlights how people make irrational decisions in consumption and investment due to different classifications of funds.
Origin
The concept of mental accounting was introduced by economist Richard Thaler. In his research during the 1980s, Thaler discovered that people tend to divide their money into different 'accounts' and decide how to use these funds based on the purpose of each account. This finding challenges the traditional economic assumption that people always make rational decisions.
Categories and Characteristics
Mental accounting can be divided into the following categories:
- Income Accounts: People decide how to use money based on its source (e.g., salary, bonus, gift).
- Expenditure Accounts: People manage funds by categorizing expenses (e.g., daily expenses, entertainment, savings).
- Investment Accounts: People determine investment strategies based on different types of investments (e.g., stocks, bonds, real estate).
These classifications often lead to irrational decisions. For example, people might be more inclined to spend a bonus on luxury items because they consider it 'extra money' rather than saving or investing it.
Specific Cases
Case 1: John receives a year-end bonus and decides to spend it on a vacation instead of paying off his credit card debt. Although paying off the debt would be more rational, he views the bonus as 'extra income' and prefers to use it for enjoyment.
Case 2: Jane allocates a portion of her monthly salary to a 'rainy day fund' and another portion to daily expenses. Although her total income remains the same, she treats the funds in these two accounts very differently.
Common Questions
Question 1: Why does mental accounting lead to irrational decisions?
Answer: Because people tend to categorize funds into different types and decide how to use them based on these categories, often ignoring the actual value and optimal use of the money.
Question 2: How can one avoid the negative effects of mental accounting?
Answer: By considering the actual value and use of all funds comprehensively, avoiding excessive categorization, and making more rational decisions.
