What is mental accounting? What, according to Thaler, are the core principles on which mental accounting is based? Explain with examples

Question

What will be an ideal response?

Answer 1

Mental accounting refers to the way consumers code, categorize, and evaluate financial outcomes of choices. Formally, it is "the tendency to categorize funds or items of value even though there is no logical basis for the categorization, e.g., individuals often segregate their savings into separate accounts to meet different goals even though funds from any of the accounts can be applied to any of the goals."
According to Chicago's Thaler, mental accounting is based on a set of core principles:
1. Consumers tend to segregate gains. When a seller has a product with more than one positive dimension, it's desirable to have the consumer evaluate each dimension separately. Listing multiple benefits of a large industrial product, for example, can make the sum of the parts seem greater than the whole.
2. Consumers tend to integrate losses. Marketers have a distinct advantage in selling something if its cost can be added to another large purchase. House buyers are more inclined to view additional expenditures favorably given the high price of buying a house.
3. Consumers tend to integrate smaller losses with larger gains. The "cancellation" principle might explain why withholding taxes from monthly paychecks is less aversive than large, lump-sum tax payments—the smaller withholdings are more likely to be absorbed by the larger pay amount.
4. Consumers tend to segregate small gains from large losses. The "silver lining" principle might explain the popularity of rebates on big-ticket purchases such as cars.