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Mental accounting

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A concept first named by Richard Thaler (1980), mental accounting attempts to describe the process whereby people code, categorise and evaluate economic outcomes. Mental accounting theorists argue that people group their assets into a number of non-fungible mental accounts. One detailed application of mental accounting, the behavioural life cycle hypothesis (Shefrin & Thaler, 1992), posits that people mentally frame assets as belonging to either current income, current wealth or future income and this has implications for their behaviour as the accounts are largely non-fungible and marginal propensity to consume out of each account is different. (Shefrin & Thaler, 1992) and (Karlsson, 1998]) argue that non-fungibility is a useful psychological defense mechanism against strong inclinations to immediately buy attractive goods and services.

In mental accounting theory, framing means that 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, and many mental accounting theorists adopt that theory as the value function in their analyses.

Another very important concept used to understand mental accounting is that of modified utility function. There are 2 values attached to any transaction - acquisition value and transaction value. Acquisition value is the money that one is ready to part with for physically acquiring some good. Transaction value is the value one attaches to having a good deal. 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.

More generally, a mental accounting cost or mental transaction cost, a kind of transaction cost, is the cost of making a useful decision, especially of a consumer making a useful decision to buy, and may set a lower bound on useful price granularity in a market. In a software engineering context the latter phrase refers to the cost to the user of making a useful selection in the user interface, in contrast to a computational transaction cost such as CPU, memory, or network usage.

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