Consumers' Mental Accounting
6 Pages Posted: 7 Jan 2019 Last revised: 28 Dec 2021
Abstract
When a consumer purchases an item, the presumption is that the benefit obtained from it exceeds the price paid—we can think of this difference as the consumer profit. How do consumers calculate this profit, especially when they do not immediately consume the purchased item? This technical note presents a model of mental accounting that gives insights into the process that consumers follow to calculate value. It compares rational logic, accounting logic, and mental accounting logic, incorporating the phenomena of loss aversion, transaction utility, and consumer anomalies. This note is used at Darden in the second-year “Behavioral Decision Making” course. It would also be suitable in courses covering rational decision-making in business.
Excerpt
UVA-QA-0908
Rev. Apr. 26, 2023
Consumers' Mental Accounting
When an individual purchases an item, say an airline flight or a bottle of wine, the presumption is that the benefit obtained from consuming the item exceeds the price paid. We could measure such benefit in dollars, as given by the most the individual is willing to pay for the item. The difference between the consumption benefit (or willingness to pay) and the monetary cost (the actual price paid) is known as the consumer surplus, or net profit from the purchase. It is safe to assume that consumers try to maximize their surplus by seeking items with the most benefit (e.g., the shortest flight path at the most convenient time) for the least possible cost.
Often, products are not consumed at the time of purchase. Examples include a flight bought today and used a month later; a durable good, such as a car, bought at one point in time and whose benefit of usage is spread over time; or a gym subscription paid up front with the benefit spread over each workout. For the situations just described, how do consumers exactly calculate the profit? One possible answer is simply to sum the benefits and subtract the costs to obtain the total surplus. Here, consumers would count a loss every time they pay for an item and would count a gain every time they use or consume a product.
When it comes to recognizing gains and losses, consumers think more like accountants who smooth out profits. To illustrate, consider the purchase of a case of four bottles of wine at a 20% discount over the regular price of $100 per bottle. Let's assume that the benefit of consuming the wine is $120 per bottle. While this is an intangible benefit, we pretend that drinking a bottle of wine is equivalent to a tangible revenue of $120. The plan is to consume one bottle per month over the next four months.
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Keywords: mental accounting, consumer profit, consumer surplus, reference price, loss aversion, transaction utility, payment depreciation, feeling of free consumption, flat-rate bias, hoarding, psychology, consumer behavior
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