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    Topic 4: Mental Accounting

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    Himanshi Arya
    Mental accounting refers to how individuals code, categorize, and evaluate financial activities in their minds. People tend to segregate gains but integrate losses to reduce feelings of loss aversion. They also integrate or cancel smaller losses with larger gains. Thaler identified components of mental accounting including perception/evaluation of outcomes, assigning activities to accounts, and determining relevant time periods. Budgeting, fungibility, reference points, framing, and sunk costs influence mental accounting evaluations.

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    Topic 4: Mental Accounting

    Uploaded by

    Himanshi Arya
    34 views13 pages
    Mental accounting refers to how individuals code, categorize, and evaluate financial activities in their minds. People tend to segregate gains but integrate losses to reduce feelings of loss aversion. They also integrate or cancel smaller losses with larger gains. Thaler identified components of mental accounting including perception/evaluation of outcomes, assigning activities to accounts, and determining relevant time periods. Budgeting, fungibility, reference points, framing, and sunk costs influence mental accounting evaluations.

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    Mental accounting refers to how individuals code, categorize, and evaluate financial activities in their minds. People tend to segregate gains but integrate losses to reduce feelings of loss aversion. They also integrate or cancel smaller losses with larger gains. Thaler identified components of mental accounting including perception/evaluation of outcomes, assigning activities to accounts, and determining relevant time periods. Budgeting, fungibility, reference points, framing, and sunk costs influence mental accounting evaluations.

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    © All Rights Reserved
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    Download as pptx, pdf, or txt
    34 views13 pages

    Topic 4: Mental Accounting

    Uploaded by

    Himanshi Arya
    Mental accounting refers to how individuals code, categorize, and evaluate financial activities in their minds. People tend to segregate gains but integrate losses to reduce feelings of loss aversion. They also integrate or cancel smaller losses with larger gains. Thaler identified components of mental accounting including perception/evaluation of outcomes, assigning activities to accounts, and determining relevant time periods. Budgeting, fungibility, reference points, framing, and sunk costs influence mental accounting evaluations.

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    of 13

    Topic 4

    Mental Accounting
    Definition – Thaler (1985)
    Mental accounting is the set of cognitive operations used by individuals and
    households to code, categorize and evaluate financial activities.

    Hedonic-Editing Hypothesis
    (1) segregate gains (because the gain function is concave due to diminishing
    marginal sensitivity).
    (2) integrate losses (because the loss function is convex, due to diminishing
    marginal sensitivity).
    (3) integrate or cancel smaller losses with larger gains (to offset loss-aversion), and
    (4) segregate small gains from larger losses (the utility of a small gain can exceed
    the utility of slightly reducing a large loss, again due to diminishing marginal
    sensitivity).
    A Few Concepts
    • Cancellation

    • Silver lining

    • Acquisition utility

    • Transaction utility
    Transaction Utility Experiment
    • You are lying on the beach on a hot day. All you have to drink is ice water.
    For the last hour you have been thinking about how much you would enjoy
    a nice cold bottle of your favorite brand of beer. A companion gets up to go
    make a phone call and offers to bring back a beer from the only nearby
    place where beer is sold (a fancy resort hotel) [a small, rundown grocery
    store]. He says that the beer might be expensive so asks how much you are
    willing to pay for the beer. He says he will buy the beer if it costs as much or
    less than what you state. But if it costs more than the price you state, he will
    not buy it. You trust your friend, and there is no possibility of bargaining
    with the (bartender) [store owner]. What price will you tell him?

    • The median answers, adjusted for inflation, were $7.25 and $4.10.
    Components of Mental Accounting Process
    Thaler’s papers refer to three components of the mental accounting
    process:

    • The perception of outcomes, and the making and evaluation of decisions.

    • The assignment of activities to specific accounts – budgeting

    • The determination of the time periods to which different mental accounts


    relate.
    Evaluations

    • Why?

    • Expectations

    • Reference point

    • Framing – bunldling and price-partitioning


    Budgeting
    • Fungibility

    • two-pocket mental accounting / house money

    • Denomination effect

    • Time frame

    • Wealth budgeting
    Time Periods in Mental Accounting
    • Sunk cost & sunk cost fallacy

    • Sunk cost & opportunity cost - how long does the memory of a past purchase linger?
    Suppose you bought a case of good Bordeaux in the futures market for $20 a bottle. The
    wine now sells at auction for about $75. You have decided to drink a bottle. Which of the
    following best captures your feeling of the cost to you of drinking the bottle? (The
    percentage of people choosing each option is shown in brackets.)
    (a) $0. I already paid for it. [30%]
    (b) $20, what I paid for it. [18%]
    (c) $20 plus interest. [7%]
    (d) $75, what I could get if I sold the bottle. [20%]
    (e) –$55. I get to drink a bottle that is worth $75 that I only paid $20 for so I save money by
    drinking this bottle. [25%]
    Sunk Cost & Opportunity Cost
    Suppose you buy a case of Bordeaux futures at $400 a case. The wine will retail at
    about $500 a case when it is shipped. You do not intend to start drinking this wine for a
    decade. At the time that you acquire this wine which statement more accurately
    captures your feelings? Indicate your response by circling a number on each of the
    scales provided. 1: strongly agree; 5: strongly disagree
    (a) I feel like I just spent $400, much as I would feel if I spent $400 on a weekend
    getaway.
    1 ---- 2 ---- 3 ---- 4 ---- 5 Mean: 3.31
    (b) I feel like I made a $400 investment which I will gradually consume after a period of
    years.
    1 ---- 2 ---- 3 ---- 4 ---- 5 Mean: 1.94
    (c) I feel like I just saved $100, the difference between what the futures cost and what
    the wine will sell for when delivered.
    1 ---- 2 ---- 3 ---- 4 ---- 5 Mean: 2.88
    Where PT is Silent
    • Break even effect

    74%

    26%

    61%

    39%

    77%

    23%
    References
    • Wilkinson, N. and Kleas, M. An Introduction to Behavioral Economics,
    Palgrave McMillan, ch 6

    • Thaler, Richard. Misbehaving: The Making of Behavioral Economics,


    Allen Lane, ch 7 -10

    • Angner, Erik, A course in Behavioral Economics, Palgrave McMillan, ch


    7
    Policy Implications
    • Individual Agents

    • Marketers

    • Sales promotion
    • Extra product promotion
    • Price off promotion
    • Premium promotion

    • Disaggregated pricing

    • Trade-in pricing

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