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Mental Accounting

In: Business and Management

Submitted By centaurgirl1
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* What is mental accounting and how does it impact consumer decision making?
Mental accounting is an economic term penned by Richard Thaler that describes how people code, categorize , and evaluate economic outcomes. The result is that consumers place their money into mental buckets based on how they got it (i.e. work, lottery winnings, or other windfalls) and the intent for each bucket such as current income, current wealth, and future income. According to Thaler’s theory, these assets are assigned different functions for each group which can lead to harmful and irrational effects on their buying decisions and other spending behaviors. (Thaler, 2008)
Thaler purports that the consumer utilitzes mental accounting in each economic situation that that they are involved in and this what influences the decisions that the consumer makes. There are two key concepts in mental accounting. First, there is framing ; which is the way a person subjectively frames a transaction in their mind will determine the utility they receive or expect. This concept is similarly used in prospect theory In which people make decisions based on the potential value of losses and gains rather than the final outcome, and that people evaluate these losses and gains using certain heuristics. This model is tied to real life choices and not to optimal decisions. (Kahneman and Tversky, 1979)
Another concept that is important in mental accounting is modified uitility which purports two values to a transaction: acquisition value money that one is willing to part with to acquire a good and transaction value which is the value that one assigns to having a good deal. (Thaler, 2008). If the price that one is paying is equal to the mental reference price for the good, the transaction value is zero. If the price is lower than the reference price, the transaction utility is positive.

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