Question

Explain how mental accounting can result in choices that are not optimal for the decision maker.

Answer 1

Mental Accounting can be considered is a behavioral science that deals with keeping track of all economic decisions related to money. It helps in investigating the financial transactions committed by individuals that can be seen as total departure from rational value maximizing behaviour. Take for example the case of credit card. Because credit card does not result in paying a form of cash directly people tend to spend more with the credit card then with money holding in hand in the form of cash. This is called transaction decoupling. Because the transaction is made electronically and there is a delay in the payment this delay is not remembered by our memory and we do not feel as if we have spent something. This makes the decision making irrational.