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Mental accounting is a cognitive bias that refers to the tendency for people to categorize and treat money differently based on arbitrary categories, like the source of the money or its intended use. It often involves simplifying the probabilities and impacts of financial decisions, impacting economic behavior and individual decision-making.
Mental accounting works by segregating funds into different 'mental accounts' that are earmarked for specific purposes or originate from different sources. For example, a person might have a mental account for necessary expenses, one for leisure activities, and another for savings. Money is not freely transferable between these mental accounts, which can lead to irrational financial behavior.
The consequences of mental accounting can include suboptimal financial decisions, such as overspending on discretionary purchases while not saving enough for retirement. This can lead to financial strain or the inability to achieve long-term financial goals.
To counteract mental accounting, individuals should strive to integrate all their financial resources into a comprehensive budget, and make financial decisions based on overall financial status rather than having separate accounts for each category. Additionally, awareness and education about this bias can help individuals make more rational decisions.
Critics of the concept of mental accounting argue that it oversimplifies human behavior and disregards the complex motivations behind financial decisions. Others suggest that while mental accounting can lead to seemingly irrational behavior, it can also serve as a practical tool to help people manage their finances by psychologically imposing self-discipline.
Mental Accounting Matters
Richard Thaler (1999)
Journal of Behavioral Decision Making
The Psychology of Sunk Cost
Hal R. Arkes and Catherine Blumer (1985)
Organizational Behavior and Human Decision Processes
Prospect Theory: An Analysis of Decision under Risk
Daniel Kahneman and Amos Tversky (1979)
Econometrica