One form of mental accounting is where you give yourself separate budgets for things like food, entertainment, gas, etc. It’s suboptimal because these separate budgets make you less flexible in your consumption plans. For example in a month where there are many attractive entertainment offerings, you are unable to reallocate spending away from other goods in favor of entertainment.
But it could be understood as a second-best solution when you have memory limitations. Suppose that when you decide how much to spend on groceries, you often forget or even fail to think of how much you have been spending on gas this month. If so, then its not really possible to be as flexible as you would be in the first-best because there’s no way to reduce your grocery expenditures in tandem with the increased spending on gas.
That means that you should not increase your spending on gas. In other words you should stick to a fixed gas budget.
Now memory is associative, i.e. current experiences stimulate memories of related experiences. This can give some structure to the theory. It makes sense to have a budget for entertainment overall rather than separate budgets for movies and concerts because when you are thinking of one you are likely to recall your spending on the other. So the boundaries of budget categories should be determined by an optimal grouping of expenditures based on how closely associated they are in memory.
(Discussion with Asher Wolinsky and Simone Galperti)
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4 comments
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May 1, 2013 at 12:24 pm
Avner
This idea is closely related to this one:
Click to access gps_consumer_complexity_mental_accounting.pdf
May 1, 2013 at 12:36 pm
Luis Quintero
This is a very interesting addition to the mental accounting theory. I had not thought about mental accounting as a solution to limited memory. I have a working paper on using mental accounting to design policies that can reduce the appearance of bubbles in asset markets. Through an experimental approach, I show that interventions that pool together mental accounts for speculative assets and regular cash or savings can diminish or eliminate altogether the investment in assets that are very likely to be experiencing unsustainable increases. Your interpretation could be applied here: when the accounts are separate, there is limited memory problems that make investors not be aware that the losses int he asset market are as valuable as those in their cash account.
May 2, 2013 at 12:38 am
Kenan Kalayci (@Kalayci_Kenan)
the remaining challenge is to adress the dynamic problem when memory improves with (rational) optimisation efforts. mental accounting might be efficient in a static sense but can also lead to mental laziness. the problem is similar to “nudges” making consumers more reliant on paternalism over time.
May 3, 2013 at 10:36 am
Enrique
In addition to the memory problem, behaviors of mental accounting pose an interesting research question: is there any Coasian bargaining among the the holders of the various mental accounts? That is, perhaps one can distinguish not only between one’s present and future self but also among multiple present selves, each one having a claim to a separate Mental account