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Mental Accounting

Mental Accounting. Tasdik Syed and David Hammel. Definitions. Fungible Nature of Money. Mental Accounting. One unit or piece must be perceived as equivalent to any other and capable of mutual substitution.

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Mental Accounting

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  1. Mental Accounting Tasdik Syed and David Hammel

  2. Definitions Fungible Nature of Money Mental Accounting • One unit or piece must be perceived as equivalent to any other and capable of mutual substitution • The system (sometimes implicit) that households use to evaluate, regulate, and process their home budget

  3. Interview with Gene Hackman and Dustin Hoffman http://ca.youtube.com/watch?v=d4FsBeLZhmk

  4. Outcomes of Mental Accounting • Potentially Harmful Outcomes • Gambling with “House Money” and “Break-even” effects • Interest Rates & Consumer Behaviour • Potentially Beneficial Outcomes • Saving for an objective

  5. Gambling with House Money… Thaler, Richard H.,and Eric J. Johnson. " Gambling with house money and trying to break even: the effects of prior outcome on risky choice" Management Science 36 (1990):643-60

  6. House Money Effect • People are more willing to gamble with money they consider “house money” • Increased risk seeking in the presence of a prior gain.

  7. Break-even Effect • In the presence of prior losses, outcomes which offer a chance to break even are especially attractive.

  8. Examples 77% Participate Second Round 50:50 $4.50 Winner 23% Do Not Participate First Round $15 $4.50 Less likely to Participate Loser Second Round 50:50 $15 More likely to Participate

  9. Interest Rates & Consumer Behaviour Gross, David B., and Nicholas S. Souleles. "Do Liquidity Contraints and Interest Rates Matter for Consumer Behaviour? Evidence from Credit Card Data." Quarterly Journal of Economics 117 (2002): 149-85

  10. Interest Rates & Consumer Behaviour • This paper utilizes a unique data set of credit card accounts to analyze how people respond to credit supply. • Many credit card borrowers simultaneously hold low-yielding assets. • Behavior is puzzling & inconsistent with any conventional model.

  11. Mental Accounting Paradox • Mentally divide money for different purposes, and tend to be reluctant to change our thinking, even when it is against our interests. • Assign different sources of money to different purposes, despite the fact that money is completely interchangeable.

  12. Useful application of mental accounting: • Put money away for university tuition fees and student loans • Save a certain percentage of current income for future spending • However, be aware of the paradox

  13. Thank you

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