week 2.1 - mental accounting

Question 1

what is mental accounting

Answer 1

it describes how people simplify decisions they need to make in life by separating choices into different accounts in ones head

Question 2

what are three things that mental accounts can explain

Answer 2

1) how income sources affect spending
2) how individuals rationalise bad investments
3) how individuals group events to ‘balance’ accounts

Question 3

what is the consumer problem in mental accounting

Answer 3

given budget k = y1 + y2, Max x1,x2 U(x1, x2)

s.t. p1x1 + p2x2 ≤ y1 + y2

Question 4

what can we conclude from the consumer problem in mental accounting

Answer 4

p1x1 ≤ y1
p2x2 ≤ y2

This means in this two goods model an additional restriction, which if binding leads to a suboptimal allocation of resources
according to the rational model

Question 5

define mental accounting

Answer 5

a theory of grouping and categorising money and transactions so that the individual may systematically evaluate the potential tradeoffs. Spending is categorised into separate budgets for various types of items

Question 6

key elements of mental accounting

Answer 6

1. Decisions are made as if the budget for different mental accounts are not fungible (mutually interchangeable)
2. Losses and Gains relative to a reference point in each account are treated differently according to a value function
3. Individualsrecieve transaction utility as well as acquisition utility

Question 7

what is fungiability

Answer 7

In public finance, we call money fungible when it can be moved between different accounts

Question 8

what are the four effects of integrating vs segregating gains and losses

Answer 8

1) v(x) + v(y) > v(x + y)
individual is better off segregating
2) v(−x) + v(−y) < v(−x − y)
individual is better of integrating
3) loss and gain, net is positive
better off integrating but with strong loss aversion
4) loss and gain but net is negative; undetermined

Question 9

In each transaction within an account, people receive both:

Answer 9

• consumption utility in terms of gains and losses to the value function
• transaction utility for that particular deal

Question 10

what does -p and pr denote

Answer 10

• p: actual price
• pr: reference price that the consumer thinks is fair

Question 11

what does va(.) denote

Answer 11

acquisition utility, the sum of utility from consumption and the pain of paying for it

Question 12

how is the segregated acquisition utility written

Answer 12

va(x) + va(−p)

with x denoting the monetary equivalent of consumption

Question 13

how is the integrated acquisition utility written

Answer 13

va(x − p)

Question 14

how is transaction utility denoted

Answer 14

vt(.)

Question 15

how is transaction utility written as

Answer 15

vt(−p + pr)

Question 16

how can the value of consumption be written

Answer 16

va(x − p) + vt(−p + pr)

Question 17

why are consumers more indulgent when using a credit card

Answer 17

When paying by credit card you could also integrate many losses in one loss (you get one bill)

Question 18

what are the implications of having to pay a debt off in instalments

Answer 18

payment decoupling is harder as the payer is constantly reminded of the debt making it unpleasurable

Question 19

what id the discount factor denoted by

Answer 19

d, ranging from 0-1

Question 20

what did Prelec and Loewenstein hypothesize, when, and what did they find

Answer 20

• 1998
• people are
  more likely to pay with instalments for durables that give repeated pleasure (e.g. washing machine) than for one-off consumption such as holidays
• On average participants wanted to prepay the vacation but wanted to buy the washing machine on credit

Question 21

how can mental accounting and payment depreciation be written as

Answer 21

va(xn − pd^t/n) + vt(−pd^t + pr(n))

Question 22

what are the three main properties of mental accounts

Answer 22

• People behave as if transactions across accounts are not
  fungible
• Gains versus losses matter
• Transaction utility also matter

Question 23

Why did Aryan make Alicia his GF?

Answer 23

Cause she has a big bum