The Nonfungibility of Mental Accounting: A Revision

Article excerpt

Mental accounting is a concept developed out of a synthesis of ideas in cognitive psychology and microeconomics. It was first proposed by Thaler (1980), and further developed by Tversky and Kahneman (1981). Mental accounting is defined as the set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities (Thaler, 1999). Thaler further theorized three components of mental accounting. How outcomes were perceived and experienced, and how decisions were made and subsequently evaluated were captured in the first component. Thaler developed the concept of transaction utility. An excess of the price of a commodity over a consumer's expectation means a negative transaction utility, which makes it less likely that the consumer would complete the transaction, and vice versa. This is also emphasized in this component by the special operation rule of mental accounting. Thaler (1985) summarized the operation rule as hedonic editing based on an "S" shaped value-function curve. People tended to segregate gains, integrate losses, segregate small gains from large losses, and integrate small losses with large gains. In the second component of mental accounting is the assignment of different activities to specific accounts. The main divisions of mental accounts include: (1) sources of funding (e.g., Kivetz, 1999), in which mental accounts are divided into normal earning and windfall; (2) consumer items, for example, Tversky and Kahneman's ticket experiments in which the loss of a $10 bill or a ticket costing $10 could lead to significant differences in participants' willingness to spend $10 to buy a ticket for a show; (3) saving patterns, for example, people divide their wealth into fixed accounts and interim accounts on the basis of their saving goals, and generally do not transfer money from the fixed account in order to meet temporary consumption demands. Thaler (1999) emphasized that spending was sometimes constrained by implicit or explicit budgets. This cognitive process was defined as mental budgeting, which was also regarded as the tool for self-control that helped people to balance their mental accounting (Heath & Soll, 1996; Thaler & Shefrin, 1981). The third component of mental accounting concerned the frequency with which accounts were evaluated. Accounts could be evaluated on a regular basis.

Thaler (1999) concluded that in all three of the components of mental accounting the classical economic principle of fungibility was violated. Namely, that a dollar is a dollar no matter where it comes from. The nonfungibility effect is regarded as the fundamental characteristic of mental accounting (Thaler, 1990). The nonfungibility effect arises from the fact that when individuals distribute money into different mental accounts, the money placed in each mental account has different functions and uses, and cannot simply be replaced by money from other accounts (Thaler, 1985). The existence of the nonfungibility effect in daily consumption has been confirmed in research. For example, Milkman and Beshears (2009) found in their study that the use of a $10 off coupon would significantly increase people's spending on groceries. In addition, people tended to spend the coupon on grocery items that they did not typically buy.

Since Thaler proposed the mental accounting theory, scholars (e.g., Arkes, Hirshleifer, Jiang, & Lim, 2007; Lim, 2006) have verified the correctness of its characteristics and rules. However, in other research the limitations of traditional mental accounting theory have been suggested. For example, Cowley (2008) and Lehenkari (2009) experimentally proved that hedonic editing was not universal among different people. Personality traits had an impact on how people edit the results of multiple gains and losses. In other words, Thaler's theory of hedonic editing applies only to parts of the population. As another example, in traditional mental accounting theory it is stated that how a person attains money tends to influence the way it is used for consumption. …