Richard H. Thaler (1999) in the article ‘Mental Accounting Matters’ discussed the processes of mental accounting that individual as well as households undergoes. Mental accounting in this respect is defined as the cognitive operations the individuals and households use to organize, evaluate and keep track of their finances. The processes are done by inference to a particular point and an observance of specific behavioral patterns the house hold or individual has participated.
There are three main components of mental accounting system that are outlined in the article. To begin with is the perception of the possible outcomes as a result of the decisions made and their final evaluation. The decisions made and their outcomes are followed by an outline of specific activities assigned in a particular order to come to particular desired result. The activities so undertaken are followed by continuous evaluation that comes after a particular fixed time. The evaluation may include the perceived needs by the person in question in a sociological and psychological aspect. This can be a day, week, fortnight, monthly, etc.
The decision is arrived from an analysis of the prospects theory and the value of the function. The value function is the description of the human pleasures that guide their actions. This include loses and the gains made over a certain period, in the recent past. The law of diminishing returns is applied in this scenario. The last part is the inherent desire of humans to avert losses. Therefore, based on this, the human’s makes decisions that guide them on how to spend the resources in their exposure.
Considering the minimal account, topical account, or comprehensive account, a decision is arrived at on how handle certain phenomenon. For example, it would beneficial to save a small amount for a low priced item than a highly priced item. In such a case, it would of benefit to save $ 10 for a commodity whose price is $ 30 than saving $ 10 for a commodity whose price is $ 300. This is one main aspect that many people consider as they make decisions on what to purchase.
People think in certain ways that are influence by hedonic rules. Based on this, most people may take expenditure as losses i.e. all money used is termed as loss. This means that the person does not consider the overall good of the commodity purchased. Considering this, people tend to buy things in an attempt to save time and energy. However, they are influence to buy things that they may not need due to the attractiveness of the deal this makes them undertake impulse buying that have adverse effects on their budget.
Many people tend to feel that actual losses, i.e. losses that are directly made to be more painful than the losses that are indirectly incurred. This makes them purchase goods whose cost have been sunk in the purchasing plan and end up spending more than if they paid in cash. The use of credit cards has such an effect of false cushion towards losses. Hire purchase order where goods and services are paid in bits has the same effect to the person.
Richard H. Thaler. Mental Accounting matters. Journal of behavioral decision making; Sep. 1999;12, 3.