A concept first named by Richard Thaler

Richard Thaler

Richard H. Thaler is an American economist and the Ralph and Dorothy Keller Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business...

 (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

Marginal propensity to consume

In economics, the marginal propensity to consume is an empirical metric that quantifies induced consumption, the concept that the increase in personal consumer spending occurs with an increase in disposable income...

 out of each account is different.

Mental accounting, utility, value and transaction

In mental accounting theory, framing means that the way a person subjectively frames a transaction in their mind will determine the utility

Utility

In economics, utility is a measure of customer satisfaction, referring to the total satisfaction received by a consumer from consuming a good or service....

 they receive or expect. This concept is similarly used in prospect theory

Prospect theory

Prospect theory is a theory that describes decisions between alternatives that involve risk i.e. where the probabilities of outcomes are known. The model is descriptive: it tries to model real-life choices, rather than optimal decisions.-Model:...

, and many mental accounting theorists adopt that theory as the value function in their analysis.

Another very important concept used to understand mental accounting is that of modified utility function. There are 2 value

Value (economics)

An economic value is the worth of a good or service as determined by the market.The economic value of a good or service has puzzled economists since the beginning of the discipline. First, economists tried to estimate the value of a good to an individual alone, and extend that definition to goods...

s 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.

Mental accounting cost

More generally, a mental accounting cost or mental transaction cost, a kind of transaction cost

Transaction cost

In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange . For example, most people, when buying or selling a stock, must pay a commission to their broker; that commission is a transaction cost of doing the stock deal...

, 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.

Fallacies and biases

Mental accounting is subject to many logical fallacies and cognitive biases.

See also

• Decision making
  Decision making
  Decision making can be regarded as the mental processes resulting in the selection of a course of action among several alternative scenarios. Every decision making process produces a final choice. The output can be an action or an opinion of choice.- Overview :Human performance in decision terms...
  
  
• Behavioral economics
• Micropayment
  Micropayment
  A micropayment is a financial transaction involving a very small sum of money and usually one that occurs online. PayPal defines a micropayment as a transaction of less than 12 USD while Visa prefers transactions under 20 Australian dollars, and though micropayments were originally envisioned to...
  
  
• Preference
  Preference
  -Definitions in different disciplines:The term “preferences” is used in a variety of related, but not identical, ways in the scientific literature. This makes it necessary to make explicit the sense in which the term is used in different social sciences....
  
  
• Psychological pricing
  Psychological pricing
  Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact. The retail prices are often expressed as "odd prices": a little less than a round number, e.g. $19.99 or £2.98. The theory is this drives demand greater than would be...
  
  
• Transaction cost
  Transaction cost
  In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange . For example, most people, when buying or selling a stock, must pay a commission to their broker; that commission is a transaction cost of doing the stock deal...