Recently on a return journey from Vancouver to Europe, I found myself surprised by my irrationality. Not that I am not susceptible to moments of dense ignorance, but having studied mental accounting, I knew what was going on yet I indulged my irrational behavior.

At the Vancouver Airport, I realized I had a few hundred Canadian dollars left over in my wallet, not having spent the Euros I converted on arrival. I was adamant on spending this money and not converting it back to Euros- as it seemed “wasteful” to me. So I spent it all on duty free chocolates, makeup and things of the like. Now money is money, Euros or Dollars, yet my brain failed to comprehend that. The thing is, that all of us have accounts in our heads. Our resources are allocated to various heads mentally, and then we track our expenses against each budget head (Heath & Soll, 1996; Thaler, 1985).

A typical example discussed in this stream of literature goes like this: You are going to the movies and you had bought a movie ticket worth $ 10. When you reach the cinema you realize you lost the ticket. Now, are you likely to buy another movie ticket?

Most people say they won’t buy another ticket.

Now lets say you are going to the movies and on reaching you realize you have lost $ 10. Would that prevent you from buying a movie ticket when you reach the cinema? Most people say that would not stop them from buying a movie ticket.

Why does this happen?

In the first scenario, we deduct the price of the $10 movie ticket from our “entertainment budget”, in the latter scenario however we do not deduct the $10 from the specific budget category since it was “unallocated” money, leaving our entertainment budget intact for further expenditure. Simple as that.

Now mental accounting is a good thing for most part. But sometimes it can backfire. Most of the times people do not transfer funds across accounts. Having said that, this inability to transfer funds often leads to people foregoing things they desire. For instance, purchasing a movie ticket earlier in the week can make someone skip a dinner with friends since his/her “entertainment budget” has been depleted. This dinner might have resulted in oodles of satisfaction for this individual, but the fact he/she does not consider transferring funds from other accounts with unused funds (say travel or alcohol account), leads to underconsumption(Heath & Soll, 1996).

Heath, C., & Soll, J. B. (1996). Mental budgeting and consumer decisions. Journal of Consumer Research, 40–52.

Thaler, R. (1985). Mental accounting and consumer choice. Marketing science, 4(3), 199–214.