Dustin Hoffman’s mental accounting

If you want some insight into how humans create and handle budgets, you could read about the theory of mental accounting as described by Thaler in his paper “Mental Accounting Matters“:

Expenditures are grouped into budgets (e.g. food, housing, etc.)…Such accounts would be inconsequential if they were perfectly fungible (i.e. substitutable) as assumed in economics. But, they are not fungible, and so they ‘matter’…Dividing spending into budget categories serves two purposes. First, the budgeting process can facilitate making rational trade-offs between competing uses for funds. Second, the system can act as a self-control device. Just as organizations establish budgets to keep track of and limit divisional spending, the mental accounting system is the household’s way of keeping spending within the budget…

Whenever budgets are not fungible their existence can influence consumption in various ways. One example is the case in which one budget has been spent up to its limit while other accounts have unspent funds remaining. (This situation is common in organizations. It can create extreme distortions especially if funds cannot be carried over from one year to the next. In this case one department can be severely constrained while another is desperately looking for ways to spend down this year’s budget to make sure next year’s is not cut.)

Etc. Etc.

Or you could just watch Gene Hackman tell this story about loaning money to Dustin Hoffman.

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2 Responses to “Dustin Hoffman’s mental accounting”

  1. Deeda Says:

    This is something new to me in field of accouting :-D

  2. Damien (bite size idea guy) Says:

    Funny thing is, mental acounting can work to our benefit as well as detriment. If we label some funds as “for savings”, we won’t waste them on unimportant stuff.

    But most of the time, mental accounting does us harm, especially when we consider income as “found money”. I write more on this issue, specifically dealing with tax returns, here: http://www.bitesizeidea.com/bsi/your-tax-return-and-the-problem-with-found-money

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