Mental Accounting or Psychological Accounting

Mental accounting is simply a psychological process of accounting of impact upon any transaction or events incurred. It is also called 'Psychological Accounting', because whole processing is done within mind.

It refers to the way in which the consumers encodes the product, categorizes it and finally evaluates its financial outcomes from available alternatives. 

It is to be noted that, different people derive different kind of utilities (mental accounts) under same circumstances. Therefore the values may differ as per person and circumstances.

There are no logical patterns for categorization, however there is certain trend to categorize funds and quantify a certain value for it.

Let us see an example for this,

when you get any income from any source than what do you do?

you allocate your budget in different parts (accounts), like you fix some portion of your budget in consumption, rent, household expenses, health, education, investment, savings and so on. However, you can easily shift your allocation into other heads as per the necessity. This implies that, although there is a certain trend to categorize and quantify a certain value, but there is no set of any logical patterns for such categorization.

Now, let us see next example to understand the flow of mental accounting:

Situation i :

You have decided to drink a cappuccino costing Rs 300 in the reputed restaurant. you purchased it but found it to be tasteless. what would you do?

Well !, I don't know about you, but i would definitely throw my drink. If you have the same state of mind, then the actual loss for your cappuccino is Rs. 300. you may not consume the same product again.

Situation ii:

Assume that you have realized that, you lost Rs 300. ...What happens?

In this case, you are more likely to purchase cappuccino because the money that was lost, didn't belong to any account, so you had not exceeded your mental concert budget.

However, in the first case you had allocated the money for the drink. So, the purchase of another drink will exceed your mental concert budget.

Richard Thaler (an american economist) of Chicago has said that - the mental accounting is based upon the following core principles :

• consumer tend to segregate gains. 

• consumer tend to integrate losses. 

• consumer tend to integrate smaller losses with larger gains.

• consumer tend to segregate small gains from large losses. 

The principle of mental accounting is derived from 'Prospect theory'.

Prospect theory is the theory which says that, people choose between probabilistic alternatives that possesses risk, where the probabilities of outcomes are known. This means that, the people makes decisions based upon potential values of losses and gains rather than final output. In simple words, consumers frame their decision alternatives in terms of gains and losses as per the value function.

So, the propensity to consume depends upon the level of mental account. Similarly, mental accounting depends upon the utility one derives. It also depends upon how one stimulate and respond towards such stimulation. Higher the mental value, higher will be the urge to consume. Therefore, the whole process is subjective. So, the researchers have found out that, the consumers use mental accounting to handle their resources. 

Some important links:

• Stress Management

• Psychological Capital

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