Case Study. Acknowledging Cognitive Biases in Decision Making: Mental Accounting
The concept of mental accounting, developed by economist Richard H. Thaler, refers to the way we manage and organise our financial activities and it may well illustrate how cognitive biases impact the decision-making process. Though Thaler defined mental accounting as ‘the set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities’ (Richard H. Thaler, Mental Accounting Matters, Journal of Behavioral Decision Making, 12: 183-206, 1999), he went on describing how mental accounting also impacted corporate financial decisions, (Ibid.) Thaler pointed out that ‘the primary reason for studying mental accounting is to enhance our understanding of the psychology of choice.’ (Ibid.) It is argued that, if left unacknowledged, mental accounting may result in irrational decisions regarding investment or spending. For example, research has indicated that we are more willing to pay for goods when we pay by credit card, not in cash. We tend to differentiate between the ways we earn money and in case of any unexpected financial gain, such as gambling winnings or any windfall, we are more likely to spend the money or make a high-risk investment. Yet, once these cognitive biases are recognised and analysed, mental accounting may be used as a tool for reinforcement of positive behaviour.
- How would you decide if you could really afford that small treat of a cookie (2 euros) every working day at a coffee shop?
- You have bought 100 shares of stock at $10 a share. Would you sell that stock when the price of stock fell, that is, would you sell the loser?
Cognitive biases in decision making; mental accounting