Mental accounting

Question 1

Define mental accounting

Answer 1

-refers to a set of cognitive operations/behaviour used by individuals to order/compare and evaluate financial activity/prospects.

-Eg) objectively £1 is the same as any otther £1, however differenent people/groups value a £1 differently.

Question 2

Sunk cost effect

Answer 2

-Refers to costs which cannnot be recorved, yet influence decision making when in rational bahvuour they should be ignored

-Standard economic theory suggests sunk cost should have no influence on decisions.

-In terms of mental accounting a £x losy in money doesnt enter the account of the purchase.

Question 3

Payment depriciation

Answer 3

-Example puchasing a pair of shoes however each day you try them on they hurt your feet even further.

-The greater the price of the item the more times you will attempt to keeo (try them on). Evenetually stop using item (wearing) but dont bin/get rid of the item.

-At somepoint item/shows will be thrown away and the purchsasw will be fully depriciated, intead od rational decision of selling, physcolgical connetion to item prevents reational decision.

Question 4

Payment decoupling

Answer 4

-Refers to seperation of payment and act of paying. Depending on act of payment changes mental account of cost of consumption.

-By decoupling paymeny from consumption perceived cost of item reduced.

-Eg) win bought for 30, now sellfs for 75. Most people beleive cost of drinking is now 0 or 45 (difference in costs). Therefore occurs a decopling of payment and consumption, reducing perceived cost of activity

-Credit cards act as a decopuler, example of students leaving bookstore remember value fo purchases in cash rather than credit card.

Question 5

Example of wide bracketting with Taxi drivers (one day at a time)

Answer 5

-In nyc demand for taxis diffrent depending on day. Typically rent a vehicle for 12 hours and keep all revenues.

-The rational wide bracketting approach takes into account all days and potential payoffs therefore work longer on busy days and less on quiet days. Maximising revenue/hr. Generating higher utility

Question 6

Example of narrow bracketting with taxi drivets (one day at a time)

Answer 6

-With narrow bracketing the taxi driver takes a 1 day at a tme approach to aim to achieve a daily target of earnings instead of considering all prospects.

-Only consider daily prospect of earnings.

-Therefore on busy days tagets earned wuicket than less busy days, lower potential earnigns. Not rational

Question 7

Wide and narrow bracketing + what usually occurs

Answer 7

-Wide bracketting refets to analsying prospect by putting them together whilst narrow bracketting is conseidering each prospect and consequences individually.

-Wide bracketing typically leads to higher utility, all outcomes/consequences considered. But evidence whos people often fail to wide bracket even if feasible

-Wide and narrow bracketting yields different utiltiys for prospects (joint or sepreate)

Question 8

Conclustions of hedonic framing

Answer 8

-Hedonic framing combined with prospect theory allows predictions to be made about how losses and gains are framed.

-Losses are integrated
eg)
V(x) + V(Y) = -6 < V(X+y) = -4.5
Hedonic framing suggests by combining losses (PT) utility is greaters.

-Hedonic framing suggests gains are segregated. seperating gains instead of joining leads to higher utility.

-When losses great and wins small segregation should occur.

-When losses small and wins great integration should occur.

-Use value functions combined and seperated to show utilities generatd.