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Mental accounting – 3 main components to the theory

In mental accounting there are three main components to this theory. The three of them are as follows and may affect the individuals preferences as follows:

Value Function

This is a function that represents gains and looses with respect to some reference point. In rational behavior theory, it would predict that an individual gains some sort of utility in a gain situation and inversely a same amount of disutility for the same size loss. In mental accounting however, this does not hold true in that individuals typically show contrasting behavior. Value function states that in gains individuals typically view their gains in a concave function to which it displays diminishing marginal returns and in losses it is convex showing increasing marginal returns.

It also implies that people are risk adverse in gains and risk seeking in losses. Individuals can be seen to segregate gains but integrate losses. This may affect the individual in this question by the way she feels about the situation at hand. If she feels that she is ‘loosing out’ on entertainment, she may consequently take income out of her necessity, which is viewed as ‘gains’ and allocate it towards entertainment since there is more to be gained with a loss situation since there is increasing marginal returns, where as will loose less by taking away a little bit of gains because of decreasing marginal returns.

Transaction Utility

This component implies that through a transaction people get utility from the value of the good but also through the value of the transaction. This meaning that the individuals value how they have been treated in terms of being fair or not. In the question, the individual may feel like she has been “ripped off” when buying overpriced food and consequently enacts some sort of reciprocity towards the food, and shifts more income allocation towards that of entertainment.


Fungibility is the thought that money has no labels and that people do not associate money with anything specific. In mental accounting this does not hold true. People will often give names to the money they have in hand. An example is a savings account and a credit card. Although people have an outstanding balance on their credit card and enough money in their savings account to cover it, they will not spend it due to the fact the money is labeled as savings. Relating to the question, the individual may need some extra necessity, but since the extra money is associated with her entertainment, she may be reluctant to spend the money on the necessities.

[tags]mental accounting[/tags]

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