week 2.1 - mental accounting Flashcards
what is mental accounting
it describes how people simplify decisions they need to make in life by separating choices into different accounts in ones head
what are three things that mental accounts can explain
1) how income sources affect spending
2) how individuals rationalise bad investments
3) how individuals group events to ‘balance’ accounts
what is the consumer problem in mental accounting
given budget k = y1 + y2, Max x1,x2 U(x1, x2)
s.t. p1x1 + p2x2 ≤ y1 + y2
what can we conclude from the consumer problem in mental accounting
p1x1 ≤ y1
p2x2 ≤ y2
This means in this two goods model an additional restriction, which if binding leads to a suboptimal allocation of resources
according to the rational model
define mental accounting
a theory of grouping and categorising money and transactions so that the individual may systematically evaluate the potential tradeoffs. Spending is categorised into separate budgets for various types of items
key elements of mental accounting
- Decisions are made as if the budget for different mental accounts are not fungible (mutually interchangeable)
- Losses and Gains relative to a reference point in each account are treated differently according to a value function
- Individualsrecieve transaction utility as well as acquisition utility
what is fungiability
In public finance, we call money fungible when it can be moved between different accounts
what are the four effects of integrating vs segregating gains and losses
1) v(x) + v(y) > v(x + y)
individual is better off segregating
2) v(−x) + v(−y) < v(−x − y)
individual is better of integrating
3) loss and gain, net is positive
better off integrating but with strong loss aversion
4) loss and gain but net is negative; undetermined
In each transaction within an account, people receive both:
- consumption utility in terms of gains and losses to the value function
- transaction utility for that particular deal
what does -p and pr denote
- p: actual price
- pr: reference price that the consumer thinks is fair
what does va(.) denote
acquisition utility, the sum of utility from consumption and the pain of paying for it
how is the segregated acquisition utility written
va(x) + va(−p)
with x denoting the monetary equivalent of consumption
how is the integrated acquisition utility written
va(x − p)
how is transaction utility denoted
vt(.)
how is transaction utility written as
vt(−p + pr)
how can the value of consumption be written
va(x − p) + vt(−p + pr)
why are consumers more indulgent when using a credit card
When paying by credit card you could also integrate many losses in one loss (you get one bill)
what are the implications of having to pay a debt off in instalments
payment decoupling is harder as the payer is constantly reminded of the debt making it unpleasurable
what id the discount factor denoted by
d, ranging from 0-1
what did Prelec and Loewenstein hypothesize, when, and what did they find
- 1998
- people are
more likely to pay with instalments for durables that give repeated pleasure (e.g. washing machine) than for one-off consumption such as holidays - On average participants wanted to prepay the vacation but wanted to buy the washing machine on credit
how can mental accounting and payment depreciation be written as
va(xn − pd^t/n) + vt(−pd^t + pr(n))
what are the three main properties of mental accounts
- People behave as if transactions across accounts are not
fungible - Gains versus losses matter
- Transaction utility also matter
Why did Aryan make Alicia his GF?
Cause she has a big bum
