Expected Value and Consumer Choices

Mental Accounting

Roughly two-thirds of the US economy is attributed to consumer spending or roughly 10 trillion dollars in 2010 (US Department of Commerce: Bureau of Economic Analysis, 2011). This enormous amount of capital itself as well as how it is utilized is of constant interest to marketers, economists, and political leaders. Beyond the influences of social heuristics, how do your own internal metrics and accounting principles influence your decisions and how can those practices create opportunities? In other words, what is your mental accounting?

In 1980, Richard Thaler coined the term mental accounting in an attempt to describe how people categorize and quantify economic outcomes (Thaler, 1980). Eight years later, Shefrin and Thaler proposed that mental accounting is divided into discrete repositories; these “buckets” are current income, current wealth, or future income. Moreover these buckets have some interesting qualities from a cognitive and subsequently, accounting perspective (Shefrin & Thaler, 1988).

These accounts are largely non-fungible and the marginal propensity to consume from each account is different. The implications for this are profound; how utility is evaluated varies based on the mental account used. Likewise, perception of value changes at different points in time; people are prey to subjective frames.

Adding complexity to this mix, it is true that in your mental accounting applies two values to any transaction—acquisition value and transaction value. The acquisition value is the money you will trade to physically acquire a good or service while the transaction value is the price you place on getting a good deal.

Finally, the value placed on gains and losses differs between individual mental accounting. Similar to prospect theory, people have a tendency to skew utility in order to minimize losses and maximize gains.

Mental accounting of consumer-oriented decisions, coupled with the complexity of consumer choice (imagine all the different options and financing plans on the car purchase), and the departures taken from perfect rationality all influence consumer behavior. They determine when an individual chooses to act or postpone a purchase, how he or she perceives gains and losses, and how timing bears on the individual’s choices. Marketers especially want to leverage these predilections to frame one’s perceptions and choices in nonrational ways. However, one’s personal balance between self-control and buyer’s remorse is at stake.

Shefrin, H. H., & Thaler, R. H. (1988). The behavioral life-cycle hypothesis. Economic Inquiry, 26, 609–643.

Thaler, R. H. (1980). Towards a positive theory of consumer choice. Journal of Economic Behavior and Organization, 1, 39–60.

US Department of Commerce: Bureau of Economic Analysis. (2011). National economic accounts: National GDP. Retrieved from http://www.bea.gov/national/#gdp