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Mental Accounting

Definition 1

Finding that the value of money differs depending on its origin and intended use, contrary to the concept of Fungibility, which states the opposite.

Source: Behavioral Science Lab, 2017

Definition 2

Mental accounting is a concept associated with the work of Richard Thaler (see Thaler, 2015, for a summary). According to Thaler, people think of value in relative rather than absolute terms. They derive pleasure not just from an object’s value, but also the quality of the deal – its transaction utility (Thaler, 1985). In addition, humans often fail to fully consider opportunity costs (tradeoffs) and are susceptible to the sunk cost fallacy.
Why are people willing to spend more when they pay with a credit card than cash (Prelec & Simester, 2001)? According to the theory of mental accounting, people treat money differently, depending on factors such as the money’s origin and intended use, rather than thinking of it in terms of the “bottom line” as in formal accounting (Thaler, 1999). An important term underlying the theory is fungibility, the fact that all money is interchangeable and has no labels. In mental accounting, people treat assets as less fungible than they really are.
Consumers’ tendency to work with mental accounts is reflected in various domains of applied behavioral science, especially in the financial services industry. Examples include banks offering multiple accounts with savings goal labels, which make mental accounting more explicit, as well as third-party services that provide consumers with aggregate financial information across different financial institutions (Zhang & Sussman, 2018).

Source: Behavioral Economics

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