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Vol. 27, No. 1, January–February 2008, pp. 15–25
issn 0732-2399 eissn 1526-548X 08 2701 0015
informs®
doi 10.1287/mksc.1070.0330
© 2008 INFORMS
Mental Accounting and Consumer Choice
Richard H. Thaler
Johnson Graduate School of Management, Cornell University, Ithaca, New York 14853, thaler@chicagogsb.edu
Anew model of consumer behavior is developed using a hybrid of cognitive psychology and microeconomics.
The development of the model starts with the mental coding of combinations of gains and losses using
the prospect theory value function. Then the evaluation of purchases is modeled using the new concept of
“transaction utility.” The household budgeting process is also incorporated to complete the characterization of
mental accounting. Several implications to marketing, particularly in the area of pricing, are developed.
This article was originally published in Marketing Science, Volume 4, Issue 3, pages 199–214, in 1985.
Key words: mental accounting; consumer choice; pricing
History : This paper was received June 1983 and was with the author for 2 revisions.
1. Introduction
Consider the following anecdotes:
1. Mr. and Mrs. L and Mr. and Mrs. H went on a
fishing trip in the northwest and caught some salmon.
They packed the fish and sent it home on an airline,
but the fish were lost in transit. They received $300
from the airline. The couples take the money, go out
to dinner and spend $225. They had never spent that
much at a restaurant before.
2. Mr. X is up $50 in a monthly poker game. He has
a queen high flush and calls a $10 bet. Mr. Y owns 100
shares of IBM which went up 1
2today and is even in
the poker game. He has a king high flush but he folds.
When X wins, Y thinks to himself, “If I had been up
$50 I would have called too.”
3. Mr. and Mrs. J have saved $15,000 toward their
dream vacation home. They hope to buy the home in
five years. The money earns 10% in a money market
account. They just bought a new car for $11,000 which
they financed with a three-year car loan at 15%.
4. Mr. S admires a $125 cashmere sweater at the
department store. He declines to buy it, feeling that
it is too extravagant. Later that month he receives the
same sweater from his wife for a birthday present. He
is very happy. Mr. and Mrs. S have only joint bank
accounts.
All organizations, from General Motors down to
single person households, have explicit and/or im-
plicit accounting systems. The accounting systems
often influence decisions in unexpected ways. This
paper characterizes some aspects of the implicit men-
tal accounting system used by individuals and house-
holds. The goal of the paper is to develop a richer
theory of consumer behavior than standard eco-
nomic theory. The new theory is capable of explain-
ing (and predicting) the kinds of behavior illustrated
by the four anecdotes above. Each of these anec-
dotes illustrate a type of behavior where a mental
accounting system induces an individual to violate
a simple economic principle. Example 1 violates the
principle of fungibility. Money is not supposed to
have labels attached to it. Yet the couples behaved
the way they did because the $300 was put into both
“windfall gain” and “food” accounts. The extrava-
gant dinner would not have occurred had each cou-
ple received a yearly salary increase of $150, even
though that would have been worth more in present
value terms. Example 2 illustrates that accounts may
be both topically and temporally specific. A player’s
behavior in a poker game is altered by his current
position in that evening’s game, but not by either his
lifetime winnings or losings nor by some event allo-
cated to a different account altogether such as a paper
gain in the stock market. In example 3 the violation
of fungibility (at obvious economic costs) is caused
by the household’s appreciation for their own self-
control problems. They are afraid that if the vacation
home account is drawn down it will not be repaid,
while the bank will see to it that the car loan is
paid off on schedule. Example 4 illustrates the curi-
ous fact that people tend to give as gifts items that
the recipients would not buy for themselves, and that
the recipients by and large approve of the strategy. As
is shown in §4.3, this also violates a microeconomic
principle.
The theory of consumer behavior to which the cur-
rent theory is offered as a substitute is the standard
economic theory of the consumer. That theory, of
course, is based on normative principles. In fact, the
paradigm of economic theory is to first characterize
the solution to some problem, and then to assume the
relevant agents (on average) act accordingly.
The decision problem which consumers are sup-
posed to solve can be characterized in a simple fash-
ion. Let z=z1z
iz
nbe the vector of goods
15
Thaler: Mental Accounting and Consumer Choice
16 Marketing Science 27(1), pp. 15–25, © 2008 INFORMS
available in the economy at prices given by the cor-
responding vector p=p1p
ip
n. Let the con-
sumer’s utility function be defined as Uz and his
income (or wealth) be given as I. Then the consumer
should try to solve the following problem:
max
zUz
s.t. pizi≤I
Or, using Lagrange multipliers
max
zUz−pizi−I(1)
The first order conditions to this problem are,
in essence, the economic theory of the consumer.
Lancaster (1971) has extended the model by having
utility depend on the characteristics of the goods.
Similarly, Becker (1965) has introduced the role of
time and other factors using the concept of house-
hold production. These extended theories are richer
than the original model, and, as a result, have more
to offer marketing. Nevertheless, the economic the-
ory of the consumer, even so extended, has not found
widespread application in marketing. Why not? One
reason is that all such models omit virtually all mar-
keting variables except price and product characteris-
tics. Many marketing variables fall into the category
that Tversky and Kahneman (1981) refer to as framing.
These authors have shown that often choices depend
on the way a problem is posed as much as on the
objective features of a problem. Yet within economic
theory, framing cannot alter behavior.
To help describe individual choice under uncer-
tainty in a way capable of capturing “mere” fram-
ing effects as well as other anomalies, Kahneman and
Tversky (1979) have developed “prospect theory” as
an alternative to expected utility theory. Prospect the-
ory’s sole aim is to describe or predict behavior, not
to characterize optimal behavior. Elsewhere (Thaler
1980), I have begun to develop a similar descrip-
tive alternative to the deterministic economic theory
of consumer choice. There I argue that consumers
often fail to behave in accordance with the norma-
tive prescriptions of economic theory. For example,
consumers often pay attention to sunk costs when
they shouldn’t, and underweight opportunity costs as
compared to out-of-pocket costs.1
This paper uses the concept of mental account-
ing to move further toward a behaviorally based
theory of consumer choice. Compared to the model
in Equation (1) the alternative theory has three key
features. First, the utility function Ux is replaced
1These propositions have recently been tested and confirmed in
extensive studies by Arkes and Blumer (1985), Gregory (1982), and
Knetch and Sinden (1984).
with the value function v·from prospect theory. The
characteristics of this value function are described and
then extended to apply to compound outcomes. Sec-
ond, price is introduced directly into the value func-
tion using the concept of a reference price. The new
concept of transaction utility is developed as a result.
Third, the normative principle of fungibility is relaxed.
Numerous marketing implications of the theory are
derived. The theory is also used to explain some
empirical puzzles.
2. Mental Arithmetic
2.1. The Value Function
The first step in describing the behavior of the rep-
resentative consumer is to replace the utility func-
tion from economic theory with the psychologically
richer value function used by Kahneman and Tversky.
The assumed shape of the value function incorpo-
rates three important behavioral principles that are
used repeatedly in what follows. First, the function
v·is defined over perceived gains and losses relative
to some natural reference point, rather than wealth
or consumption as in the standard theory. This fea-
ture reflects the fact that people appear to respond
more to perceived changes than to absolute levels.
(The individual in this model can be thought of as
a pleasure machine with gains yielding pleasure and
losses yielding pain.) By using a reference point the
theory also permits framing effects to affect choices.
The framing of a problem often involves the sugges-
tion of a particular reference point. Second, the value
function is assumed to be concave for gains and con-
vex for losses (vx < 0x > 0; v x > 0x<0). This
feature captures the basic psychophysics of quantity.
The difference between $10 and $20 seems greater
than the difference between $110 and $120, irrespec-
tive of the signs of the amounts in question. Third, the
loss function is steeper than the gain function vx <
−v−x,x>0. This notion that losses loom larger
than gains captures what I have elsewhere called
the endowment effect: people generally will demand
more to sell an item they own than they would be
willing to pay to acquire the same item (Thaler 1980).
2.2. Coding Gains and Losses
The prospect theory value function is defined over
single, unidimensional outcomes. For the present
analysis it is useful to extend the analysis to incor-
porate compound outcomes where each outcome is
measured along the same dimension (say dollars).2
2Kahneman and Tversky are currently working on the single out-
come, multi-attribute case. It is also possible to deal with the com-
pound multi-attribute case but things get very messy. Since this
paper is trying to extend economic theory which assumes that all
Thaler: Mental Accounting and Consumer Choice
Marketing Science 27(1), pp. 15–25, © 2008 INFORMS 17
The question is how does the joint outcome x y
get coded? Two possibilities are considered. The out-
comes could be valued jointly as vx +y in which
case they will be said to be integrated. Alternatively
they may be valued separately as vx +vy in
which case they are said to be segregated. The issue
to be investigated is whether segregation or integra-
tion produces greater utility. The issue is interesting
from three different perspectives. First, if a situation
is sufficiently ambiguous how will individuals choose
to code outcomes? To some extent people try to frame
outcomes in whatever way makes them happiest.3
Second, individuals may have preferences about how
their life is organized. Would most people rather have
a salary of $30,000 and a (certain) bonus of $5,000 or
a salary of $35,000? Third, and most relevant to mar-
keting, how would a seller want to describe (frame)
the characteristics of a transaction? Which attributes
should be combined and which should be separated?
The analysis which follows can be applied to any of
these perspectives.
For the joint outcome x y there are four possible
combinations to consider:
1. Multiple Gains. Let x>0 and y>0.4Since vis
concave vx +vy>vx+y, so segregation is pre-
ferred. Moral: don’t wrap all the Christmas presents
in one box.
2. Multiple Losses. Let the outcomes be −xand −y
where xand yare still positive. Then since v−x +
v−y<v−x +y integration is preferred. For
example, one desirable feature of credit cards is that
they pool many small losses into one larger loss and
in so doing reduce the total value lost.
3. Mixed Gain. Consider the outcome x −y
where x>yso there is a net gain. Here vx+v−y <
vx −y so integration is preferred. In fact, since the
loss function is steeper than the gain function, it is
possible that vx +v−y<0 while vx −y must be
positive since x>y by assumption. Thus, for mixed
gains integration amounts to cancellation. Notice that
all voluntarily executed trades fall into this category.
4. Mixed Loss. Consider the outcome x −y where
x<y, a net loss. In this case we cannot determine
outcomes can be collapsed into a single index (utils or money)
sticking to the one-dimensional case seems like a reasonable first
step.
3This is illustrated by the following true story. A group of friends
who play poker together regularly had an outing in which they
played poker in a large recreational vehicle while going to and from
a race track. There were significant asymmetries in the way people
(honestly) reported their winnings and losings from the two poker
games and racetrack bets. Whether the outcomes were reported
together or separately could largely be explained by the analysis
that follows.
4For simplicity I will deal only with two-outcome events, but the
principles generalize to cases with several outcomes.
Figure 1 Segregation or Integration of Gains and Losses
Value
Losses Gains
Losses Gains
Integration preferred
Value
Silver lining,
segregation preferred
Integration
segregation
v(x)
v(x)
(x–y)
(x–y)
v(x–y)
v(x–y)
v(x)+v(–y)
v(x)+v(–y)
v(–y)
v
(
–
y)
–y
–y
x
x
without further information whether vx +v−y ≷
vx −y. This is illustrated in Figure 1. Segregation is
preferred if vx>vx−y−v−y. This is more likely
the smaller is xrelative to y. Intuitively, with a large
loss and a small gain, e.g., $40−$6000segregation
is preferred since vis relatively flat near −6,000. This
will be referred to as the “silver lining” principle. On
the other hand, for $40−$50integration is proba-
bly preferred since the gain of the $40 is likely to be
valued less than the reduction of the loss from $50 to
$10, nearly a case of cancellation.
2.3. Evidence on Segregation and Integration
The previous analysis can be summarized by four
principles: (a) segregate gains, (b) integrate losses,
(c) cancel losses against larger gains, (d) segregate
Thaler: Mental Accounting and Consumer Choice
18 Marketing Science 27(1), pp. 15–25, © 2008 INFORMS
“silver linings.” To see whether these principles coin-
cided with the intuition of others, a small experiment
was conducted using 87 students in an undergradu-
ate statistics class at Cornell University. The idea was
to present subjects with pairs of outcomes either seg-
regated or integrated and to ask them which frame
was preferable. Four scenarios were used, one corre-
sponding to each of the above principles.
The instructions given to the students were:
Below you will find four pairs of scenarios. In each
case two events occur in Mr. A’s life and one event
occurs in Mr. B’s life. You are asked to judge whether
Mr. A or Mr. B is happier. Would most people rather
be A or B? If you think the two scenarios are emotion-
ally equivalent, check “no difference.” In all cases the
events are intended to be financially equivalent.
The four items used and the number of responses of
each type follow.
1. Mr. A was given tickets to lotteries involving the
World Series. He won $50 in one lottery and $25 in the
other.
Mr. B was given a ticket to a single, larger World
Series lottery. He won $75.
Who was happier? 56 A16B15no difference
2. Mr. A received a letter from the IRS saying that
he made a minor arithmetical mistake on his tax return
and owed $100. He received a similar letter the same
day from his state income tax authority saying he
owed $50. There were no other repercussions from
either mistake.
Mr. B received a letter from the IRS saying that he
made a minor arithmetical mistake on his tax return
and owed $150. There were no other repercussions
from his mistake.
Who was more upset? 66 A14B7no difference
3. Mr. A bought his first New York State lottery
ticket and won $100. Also, in a freak accident, he dam-
aged the rug in his apartment and had to pay the land-
lord $80.
Mr. B bought his first New York State lottery ticket
and won $20.
Who was happier? 22 A61B4no difference
4. Mr. A’s car was damaged in a parking lot. He
had to spend $200 to repair the damage. The same day
the car was damaged he won $25 in the office football
pool.
Mr. B’s car was damaged in a parking lot. He had
to spend $175 to repair the damage.
Who was more upset? 19 A63B5no difference
For each item, a large majority of the subjects chose
in a manner predicted by the theory.5
5Two caveats must be noted here. First, the analysis does not
extend directly to the multi-attnbute (or multiple account) case. It
is often cognitively impossible to integrate across accounts. Thus
winning $100 does not cancel a toothache. Second, even within the
same account, individuals may be unable to integrate two losses
that are framed separately. See Johnson and Thaler (1985).
2.4. Reference Outcomes
Suppose an individual is expecting some outcome x
and instead obtains x+x. Define this as a refer-
ence outcome x +x x. The question then arises
how to value such an outcome. Assume that the
expected outcome was fully anticipated and assim-
ilated. This implies that vxx =0. A person who
opens his monthly pay envelope and finds it to be the
usual amount is unaffected. However, when x = 0
there is a choice of ways to frame the outcome cor-
responding to the segregation/integration analysis of
simple compound outcomes. With reference outcomes
the choice involves whether to value the unexpected
component x alone (segregation) or in conjunction
with the expected component (integration). An exam-
ple, similar to those above, illustrates the difference:
• Mr. A expected a Christmas bonus of $300. He
received his check and the amount was indeed $300.
A week later he received a note saying that there had
been an error in this bonus check. The check was $50
too high. He must return the $50.
• Mr. B expected a Christmas bonus of $300. He
received his check and found it was for $250.
It is clear who is more upset in this story. Mr. A
had his loss segregated and it would inevitably be
coded as a loss of $50. Mr. B’s outcome can be inte-
grated by viewing the news as a reduction in a gain
−v300−v250. When the situation is structured
in a neutral or ambiguous manner then the same four
principles determine whether segregation or integra-
tion is preferred:
(1) An increase in a gain should be segregated.
(2) An increase in (the absolute value of) a loss
should be integrated.
(3) A decrease in a gain should be integrated (can-
cellation).
(4) A small reduction in (the absolute value of) a
loss should be segregated (silver lining).
The concept of a reference outcome is used below to
model a buyer’s reaction to a market price that differs
from the price he expected.
3. Transaction Utility Theory
In the context of the pleasure machine metaphor sug-
gested earlier, the previous section can be thought
of as a description of the hard wiring. The machine
responds to perceived gains and losses in the way
described. The next step in the analysis is to use this
structure to analyze transactions. A two-stage pro-
cess is proposed. First, individuals evaluate potential
transactions. Second, they approve or disapprove of
each potential transaction. The first stage is a judg-
ment process while the second is a decision process.
They are analyzed in turn.
Thaler: Mental Accounting and Consumer Choice
Marketing Science 27(1), pp. 15–25, © 2008 INFORMS 19
3.1. Evaluating Transactions
Consider the following excerpt from a movie review:
My sister just found out that for a $235 per month sub-
let she shares with another woman, she pays $185 per
month. The other woman justifies her $50 per month
rent two ways: one, she is doing my sister a favor let-
ting her live there given the housing situation in New
York City, and, two, everyone with a room to sublet
in NYC will cheat her at least as badly. Her reasons
are undeniably true, and that makes them quadruply
disgusting. (Cornell Daily Sun, Feb. 21, 1983)
Notice that the writer’s sister is presumably getting
a good value for her money (the room is worth $185
per month) but is still unhappy. To incorporate this
aspect of the psychology of buying into the model,
two kinds of utility are postulated: acquisition util-
ity and transaction utility. The former depends on the
value of the good received compared to the outlay,
the latter depends solely on the perceived merits of
the “deal.”
For the analysis that follows, three price concepts
are used. First, define pas the actual price charged for
some good z. Then for some individual, define ¯
pas
the value equivalent of z, that is, the amount of money
which would leave the individual indifferent between
receiving ¯
por zas a gift.6Finally, let p∗be called the
reference price for z. The reference price is an expected
or “just” price for z. (More on p∗momentarily.)
Now define acquisition utility as the value of the
compound outcome z −p =¯
p−p. This is desig-
nated as v ¯
p−p. Acquisition utility is the net utility
that accrues from the trade of pto obtain z(which is
valued at ¯
p). Since v ¯
p−p will generally be coded as
the integrated outcome v ¯
p−p, the cost of the good
is not treated as a loss. Given the steepness of the
loss function near the reference point, it is hedonically
inefficient to code costs as losses, especially for rou-
tine transactions.
The measure of transaction utility depends on the
price the individual pays compared to some reference
price, p∗. Formally, it is defined as the reference out-
come v−p−p∗, that is, the value of paying pwhen
the expected or reference price is p∗. Total utility from
a purchase is just the sum of acquisition utility and
transaction utility.7Thus the value of buying good zat
6In the standard theory, ¯
pequals the reservation price, the maxi-
mum the individual would pay. In this theory, ¯
pcan differ from the
reservation price because of positive or negative transaction utility.
Acquisition utility is comparable in principle to consumer surplus.
7A more general formulation would be to allow differing weights
on the two terms in (2). For example, Equation (2) could be writ-
ten as
wz p p∗=vp −p +v−p −p∗
where is the weight given to transaction utility. If =0 then the
standard theory applies. Pathological bargain hunters would have
>1. This generalization was suggested by Jonathan Baron.
price pwith reference price p∗is defined as wz p p∗
where:
wz p p ∗=v ¯
p−p +v−p −p∗ (2)
Little has been said as to the determinants of p∗.
The most important factor in determining p∗is fair-
ness. Fairness, in turn, depends in large part on cost
to the seller. This is illustrated by the following three
questionnaires administered to first-year MBA stu-
dents. (The phrases in brackets differed across the
three groups.)
Imagine that you are going to a sold-out Cornell
hockey playoff game, and you have an extra ticket to
sell or give away. The price marked on the ticket is $5
(but you were given your tickets for free by a friend)
[which is what you paid for each ticket] {but you paid
$10 each for your tickets when you bought them from
another student}. You get to the game early to make
sure you get rid of the ticket. An informal survey of
people selling tickets indicates that the going price is
$5. You find someone who wants the ticket and takes
out his wallet to pay you. He asks how much you
want for the ticket. Assume that there is no law against
charging a price higher than that marked on the ticket.
What price do you ask for if
1. he is a friend
2. he is a stranger
What would you have said if instead you found the
going market price was $10?
3. friend
4. stranger
The idea behind the questionnaire was that the
price people would charge a friend would be a good
proxy for their estimate of a fair price. For each ques-
tion, three prices were available as possible anchors
upon which people could base their answers: the
price marked on the ticket, the market price, and the
price paid by the seller, i.e., cost. As can be seen in
Table 1, the modal answers in the friend condition are
equal to the seller’s costs except in the unusual case
Table 1 Percent of Subjects Giving Common Answers to Hockey
Ticket Question
Friend Stranger
Cost Market value 0 5 10 Other 0 5 10 Other
N=31
05 68
26 3 3 6 77 10 6
010 65
26 6 3 61658 19
N=28
5 5 14 79 07079714
510 779
4 9 01457 29
N=26
10 5 0 69 23 8 0 42 46 12
10 10 0 15 69 15 0 0 73 27
Note. Modal answer is underlined.
Thaler: Mental Accounting and Consumer Choice
20 Marketing Science 27(1), pp. 15–25, © 2008 INFORMS
where seller’s cost was above market price. In con-
trast, the modal answers in the stranger condition are
equal to market price with the same lone exception.
The implication of this is that buyers’ perceptions of
a seller’s costs will strongly influence their judgments
about what price is fair, and this in turn influences
their value for p∗.
The next questionnaire, given to those participants
in an executive development program who said they
were regular beer drinkers, shows how transaction
utility can influence willingness to pay (and therefore
demand).
Consider the following scenario:
You are lying on the beach on a hot day. All you have
to drink is ice water. For the last hour you have been
thinking about how much you would enjoy a nice cold
bottle of your favorite brand of beer. A companion gets
up to go make a phone call and offers to bring back
a beer from the only nearby place where beer is sold
(a fancy resort hotel) [a small, run-down grocery store].
He says that the beer might be expensive and so asks
how much you are willing to pay for the beer. He says
that he will buy the beer if it costs as much or less
than the price you state. But if it costs more than the
price you state he will not buy it. You trust your friend,
and there is no possibility of bargaining with (the bar-
tender) [store owner]. What price do you tell him?
The results from this survey were dramatic. The
median price given in the fancy resort hotel version
was $2.65 while the median for the small run-down
grocery store version was $1.50. This difference occurs
despite the following three features of this example:
1. In both versions the ultimate consumption act is
the same—drinking one beer on the beach. The beer
is the same in each case.
2. There is no possibility of strategic behavior in
stating the reservation price.8
3. No “atmosphere” is consumed by the respon-
dent.
The explanation offered for these choices is based
on the concept of transaction utility. (Acquisition util-
ity is constant between the two cases.) While paying
$2.50 for a beer is an expected annoyance at the resort
hotel, it would be considered an outrageous “rip-off”
in a grocery store. Paying $2.50 a bottle is $15.00 a
six-pack, considerably above the reference price.
3.2. Purchase Decisions—Multiple Accounts
The introduction of w·as the purchase evaluation
device requires additional changes to the standard
theory described in the introduction. Since w·is
8The question is what economists would call “incentive compat-
able”. The respondent’s best strategy is to state his or her true
reservation price. Subjects given extensive explanations of this fea-
ture nevertheless still display a large disparity in answers to the
two versions of the problem.
defined over individual transactions it is convenient
to give each unit of a specific good its own label. Opti-
mization would then require the individual to select
the set of purchases that would maximize w·sub-
ject to the budget constraint pizi≤Iwhere Iis
income. A solution to this integer programming prob-
lem would be to make purchases if and only if
wzip
ip∗
i
pi
≥k(3)
where kis a constant that serves a role similar
to that of the Lagrange multiplier in the standard
formulation.
Notice that if kis selected optimally then (3) can
be applied sequentially without any explicit consid-
eration of opportunity costs. This sort of sequential
analysis seems to be a good description of behavior.9
First, the consumer responds to local temporal budget
constraints. That is, the budget constraint that most
influences behavior is the current income flow rather
than the present value of lifetime wealth. For many
families, the most relevant time horizon is the month
since many regular bills tend to be monthly. Thus, the
budgeting process, either implicit or explicit, tends
to occur on a month-to-month basis. Second, expen-
ditures tend to be grouped into categories. Potential
expenditures are then considered within their cate-
gory. (Families that take their monthly pay and put
it into various use-specific envelopes to be allocated
during the month are explicitly behaving in the man-
ner described here. Most families simply use a less
explicit procedure.) The tendency to group purchases
by category can violate the economic principle of
fungibility.
Given the existence of time and category specific
budget constraints, the consumer evaluates purchases
as situations arise. For example, suppose a couple
is called by friends who suggest going out to din-
ner on Saturday night at a particular restaurant. The
couple would have to decide whether such an expen-
diture would violate either the monthly or the enter-
tainment constraints. Formally, the decision process
can be modelled by saying the consumer will buy a
good zat price pif
wz p p ∗
p>k
it
where kit is the budget constraint for category iin
time period t.
9The model that follows is based, in part, on some extensive, open-
ended interviews of families conducted in 1982. The families were
asked detailed questions about how they regulate their day-to-day
expenditures, and what they have done in various specific situa-
tions such as those involving a large windfall gain or loss.
Thaler: Mental Accounting and Consumer Choice
Marketing Science 27(1), pp. 15–25, © 2008 INFORMS 21
Of course, global optimization would lead all the
kit’s to be equal which would render irrelevant the
budgeting process described here. However, there is
evidence that individuals do not act as if all the
k’s were equal. As discussed elsewhere (Thaler and
Shefrin 1981), individuals face self-control problems
in regulating eating, drinking, smoking, and con-
sumption generally. The whole mental accounting
apparatus being presented here can be thought of as
part of an individual’s solution to these problems. For
example, the rule of thumb to restrict monthly expen-
ditures to no more than monthly income is clearly
nonoptimal. Yet, when borrowing is permitted as a
method of smoothing out monthly k’s, some families
find themselves heavily in debt. Restrictions on bor-
rowing are then adopted as a second-best strategy.
The technology of self-control often implies outright
prohibitions because allowing a little bit eventually
leads to excesses. (Although smoking cigarettes is
undoubtedly subject to diminishing marginal utility,
almost no one smokes between 1 and 5 cigarettes a
day. That level, while probably preferred by many
smokers and former smokers to either zero or 20, is
just unattainable.)
Unusually high category specific k’s are most likely
to be observed for goods that are particularly seduc-
tive or addictive. Unusually low k’s are observed for
goods viewed to be particularly desirable in the long
run such as exercise or education. Application of these
ideas to gift giving behavior is discussed below.
4. Marketing Implications
The previous sections have outlined a theory and pre-
sented some survey evidence to support its various
components. The following sections discuss the impli-
cations of this theory to marketing. There are two
types of implications presented here. First, the the-
ory is used to explain some empirical puzzles such as
why some markets fail to clear. Second, some advice
for sellers is derived, based on the presumption that
buyers behave according to the theory. This advice is
illustrated with actual examples. The implications are
derived from each of the three main components of
the theory: compounding principles, transaction util-
ity, and budgetary rules.
4.1. Compounding Rule Implications
This section will illustrate how the results from the
analysis of mental arithmetic can influence market-
ing decisions either in the design or products or in
the choice of how products are described. The results
of §2.2 can be summarized by two principles: segre-
gate gains and integrate losses. Each principle also
has a corollary: segregate “silver linings” (small gains
combined with large losses) and integrate (or cancel)
losses when combined with larger gains.
Segregate Gains. The basic principle of segregating
gains is simple and needs little elaboration or illus-
tration. When a seller has a product with more than
one dimension it is desirable to have each dimen-
sion evaluated separately. The most vivid examples
of this are the late-night television advertisements for
kitchen utensils. The principle is used at two levels.
First, each of the items sold is said to have a multi-
tude of uses, each of which is demonstrated. Second,
several “bonus” items are included “if you call right
now.” These ads all seem to use the same basic for-
mat and are almost a caricature of the segregation
principle.
The silver lining principle can be used to under-
stand the widespread use of rebates as a form of
price promotion. It is generally believed that rebates
were first widely used because of the threat of gov-
ernment price controls. By having an explicitly tem-
porary rebate it was hoped that the old price would
be the one for which new regulations might apply.
Rebates for small items have the additional feature
that not all consumers send in the form to collect the
rebate. However, rebates continue to be widely used
in the automobile industry in spite of the following
considerations:
(1) Price controls seem very unlikely during the
Reagan administration, especially with inflation
receding.
(2) All purchasers claim the rebate since it is pro-
cessed by the dealer and is worth several hundred
dollars.
(3) Consumers must pay sales tax on the rebate.
This can raise the cost of the purchase by 8% of the
rebate in New York City. While this is not a large
amount of money relative to the price of the car, it
nonetheless provides an incentive to adopt the seem-
ingly equivalent procedure of announcing a tempo-
rary sale.
Why then are rebates used in the automobile indus-
try? The silver lining principle suggest one reason.
A rebate strongly suggests segregating the saving.
This can be further strengthened for those consumers
who elect to have the rebate mailed to them from
the corporate headquarters rather than applied to the
down payment.10
Integrate Losses. When possible, consumers would
prefer to integrate losses. The concavity of the loss
function implies that adding $50 less to an existing
$1,000 loss will have little impact if it is integrated.
This means that sellers have a distinct advantage
10 In the first year that rebates were widely used, one manufacturer
reported (to me in personal communication) that about one-third
of the customers receiving rebates chose the option of having the
check sent separately. My impression is that this has become less
common as rebates have become widespread.
Thaler: Mental Accounting and Consumer Choice
22 Marketing Science 27(1), pp. 15–25, © 2008 INFORMS
in selling something if its cost can be added on to
another larger purchase. Adding options to an auto-
mobile or house purchase are classic, well-known
examples. More generally, whenever a seller is deal-
ing with an expensive item the seller should consider
whether additional options can be created since the
buyers will have temporarily inelastic demands for
these options. The principle also applies to insurance
purchases. Insurance companies frequently sell riders
to home or car insurance policies that are attractive
(I believe) only because of this principle. One com-
pany has been advertising a “paint spill” rider for
its homeowner policy. (This is apparently designed
for do-it-yourselfers who have not yet discovered
drop cloths.) Another example is credit card insur-
ance which pays for the first $50 of charges against a
credit card if it is lost or stolen. (Claims over $50 are
absorbed by the credit card company.)
The principle of cancellation states that losses will
be integrated with larger gains where plausible. The
best example of this is withholding from paychecks.
In the present framework the least aversive type of
loss is the reduction of a large gain. This concept
seems to have been widely applied by governments.
Income taxes would be perceived as much more aver-
sive (in addition to being harder to collect) if the
whole tax bill were due in April. The implication for
sellers is that every effort should be made to set up
a payroll withdrawal payment option. Probably the
best way to market dental insurance, for example,
would be to sell it as an option to group health insur-
ance through employers. If the employee already pays
for some share of the health insurance then the extra
premium would be framed as an increase in an exist-
ing deduction; this is the ultimate arrangement for a
seller.
4.2. Transaction Utility Implications
Sellouts and Scalping. The tool in the economist’s
bag in which most economists place the greatest trust
is the supply and demand analysis of simple com-
modity markets. The theory stipulates that prices
adjust over time until supply equals demand. While
the confidence put in that analysis is generally well
founded, there are some markets which consistently
fail to clear. One widely discussed example is labor
markets where large numbers of unemployed work-
ers coexist with wages that are not falling. Unemploy-
ment occurs because a price (the wage) is too high.
Another set of markets features the opposite problem,
prices that are too low. I refer to the class of goods and
services for which demand exceeds supply: Cabbage
Patch dolls in December 1983 and 1984, tickets to any
Super Bowl, World Series, World Cup Final, Vladimir
Horowitz or Rolling Stones concert, or even dinner
reservations for 8:00 p.m. Saturday evening at the most
popular restaurant in any major city. Why are these
prices too low? Once the Cabbage Patch rage started,
the going black market price for a doll was over $100.
Why did Coleco continue to sell the dolls it had at list
price? Why did some discount stores sell their allot-
ted number at less than list price? Tickets for the 1984
Super Bowl were selling on the black market for $300
and up. Seats on the 50-yard line were worth consid-
erably more. Why did the National Football League
sell all of the tickets at the same $60 price?
There are no satisfactory answers to these questions
within the confines of standard microeconomic the-
ory. In the case of the Super Bowl, the league surely
does not need the extra publicity generated by the
ticket scarcity. (The argument that long lines create
publicity is sometimes given for why prices aren’t
higher during first week’s showing of the latest Star
Wars epic.) The ticket scarcity occurs every year so
(unlike the Cabbage Patch Doll case) there is no pos-
sible surprise factor. Rather, it is quite clear that the
league knowingly sets the prices “too low.” Why?
The concept of transaction utility provides a coher-
ent, parsimonious answer. The key to understand-
ing the puzzle is to note that the under-pricing only
occurs when two conditions are present. First, the
market clearing price is much higher than some well-
established normal (reference) price. Second, there is
an ongoing pecuniary relationship between the buyer
and the seller. Pure scarcity is not enough. Rare art
works, beachfront property, and 25-carat diamonds all
sell at (very high) market clearing prices.
Once the notion of transaction (dis)utility is intro-
duced, then the role of the normal or reference price
becomes transparent. The goods and services listed
earlier all have such norms: prices of other dolls
similar to Cabbage Patch dolls, regular season ticket
prices, prices of other concerts, dinner prices at other
times or on other days, etc. These well-established ref-
erence prices create significant transaction disutility if
a much higher price is charged.
The ongoing relationship between the buyer and
the seller is necessary (unless the seller is altruistic),
else the seller would not care if transaction disutil-
ity were generated. Again that ongoing relationship
is present in all the cases described. Coleco couldn’t
charge more for the dolls because it had plans for
future sales to doll customers and even nondoll buy-
ers who would simply be offended by an unusually
high price. Musical performers want to sell record
albums. Restaurants want to sell dinners at other
times and days. When a well-established reference
price exists, a seller has to weigh the short-run gain
associated with a higher price against the long-run
loss of good will and thus sales.
The pricing of sporting events provides a simple
test of this analysis. For major sporting events, the
Thaler: Mental Accounting and Consumer Choice
Marketing Science 27(1), pp. 15–25, © 2008 INFORMS 23
Table 2 Recent Prices for Major Sporting Events
1983 World Series $25–$30
1984 Super Bowl All seats $60
1984 Indianapolis 500 Top price $75
1981 Holmes–Cooney fight Top price $600
price of tickets should be closer to the market clearing
price, the larger is the share of total revenues the seller
captures from the event in question. At one extreme
are league championships such as the World Series
and the Super Bowl. Ticket sales for these events are
a tiny share of total league revenue. An intermediate
case is the Indianapolis 500. This is an annual event,
and is the sponsor’s major revenue source, but race-
goers frequently come year after year so some ongo-
ing relationship exists. At the other extreme is a major
championship fight. A boxing championship is a one-
time affair involving a promoter and two fighters.
Those three parties are unlikely to be a partnership
again. (Even a rematch is usually held in a differ-
ent city.) There is no significant long-run relationship
between the sellers and boxing fans.
While it is impossible to say what the actual market
clearing prices would be, the figures in Table 2 indi-
cate that the predictions are pretty well confirmed.
Good seats for the Super Bowl are probably the sin-
gle item in greatest demand and are obviously un-
derpriced since even the worst seats sell out at $60.
Of course, some Super Bowl tickets and Cabbage
Patch dolls do change hands at high prices through
scalpers. Since the black market price does rise to the
market clearing level, why do the sellers permit the
scalpers to appropriate these revenues? There are two
reasons. First, the transaction disutility generated by
a high black market price is not attributed to the orig-
inal seller. The NFL sets a “fair” price; it is the scalper
who is obtaining the immoral rents.11 Second, in many
cases the seller is really getting more than the face
value of the tickets. Tickets to the Super Bowl are
distributed to team owners in large numbers. Many
of these tickets are resold to tour operators (see the
next section) at prices which are not made public.
Similarly, tickets to the NCAA basketball tournament
finals are distributed in part to the qualifying teams.
These tickets are sold or given to loyal alumni. The
implicit price for such tickets is probably in the thou-
sands of dollars.
Methods of Raising Price. A seller who has a mon-
opoly over some popular product may find that the
price being charged is substantially less than the mar-
ket clearing price. How can price be raised without
11 Transferring the transaction disutility is often a good strategy.
One way this can be done is to turn over an item for sale to an agent
who will sell it at auction. The seller then bears less responsibility
for the price.
generating excessive negative transaction utility (and
thus loss of good will)? The theory provides three
kinds of strategies that can be tried. First, steps can be
taken to increase the perceived reference price. This
can be done in several ways. One way is to explic-
itly suggest a high reference price (see next section).
Another way is to increase the perceived costs of the
product, perhaps by providing excessive luxury. As
the hockey question showed, perceptions of fairness
are affected by costs. In the beer on the beach exam-
ple, the owner of the run-down grocery store could
install a fancy bar. Notice that the extra luxury need
not increase the value of the product to the buyer;
as long as p∗is increased then demand will increase
holding acquisition utility constant. An illustration of
this principle is that short best-selling books tend to
have fewer words per page (i.e., larger type and wider
margins) than longer books. This helps to raise p∗.
A second general strategy is to increase the mini-
mum purchase required and/or to tie the sale of the
product to something else. Because of the shape of the
value function in the domain of losses, a given price
movement seems smaller the larger is the quantity
with which it is being integrated. The Super Bowl pro-
vides two illustrations of this phenomenon. Tickets
are usually sold by tour operators who sell a pack-
age including air fare, hotel and game ticket. Thus
the premium price for the ticket is attached to a
considerably larger purchase. Also, hotels in the city
of the Super Bowl (and in college towns on grad-
uation weekend) usually impose a three-night mini-
mum. Since the peak demand is for only one or two
nights this allows the hotel to spread the premium
room rate over a larger purchase.
The third strategy is to try to obscure p∗and thus
make the transaction disutility less salient. One sim-
ple way to do this is to sell the product in an unusual
size or format, one for which no well-established p∗
exists. Both of the last two strategies are used by
candy counters in movie theaters. Candy is typically
sold only in large containers rarely seen in other
circumstances.
Suggested Retail Price.12 Many manufacturers of-
fer a “suggested retail price” (SRP) for their prod-
ucts. In the absence of fair trade laws, SRP’s must
be only suggestions, but there are distinct differences
across products in the relationship between market
prices and SRPs. In some cases the SRP is usually
equal to the market price. In other cases the SRP
exceeds the market price by as much as 100% or
more. What is the role of an SRP that is twice the
typical retail price? One possibility is that the SRP
12 This paragraph was motivated by a discussion with Dan Horsky
several years ago.
Thaler: Mental Accounting and Consumer Choice
24 Marketing Science 27(1), pp. 15–25, © 2008 INFORMS
is being offered by the seller as a “suggested refer-
ence price.” Then a lower selling price will provide
positive transaction utility. In addition, inexperienced
buyers may use the SRP as an index of quality. We
would expect to observe a large differential between
price and the SRP when both factors are present. The
SRP will be more successful as a reference price the
less often the good is purchased. The SRP is most
likely to serve as a proxy for quality when the con-
sumer has trouble determining quality in other ways
(such as by inspection). Thus, deep discounting rel-
ative to SRP should usually be observed for infre-
quently purchased goods whose quality is hard to
judge. Some examples include phonograph cartridges
which usually sell at discounts of at least 50%, home
furniture which is almost always “on sale,” and silver
flatware where “deep discounting—selling merchan-
dise to consumers at 40% to 85% below the manufac-
turer’s ‘suggested retail price’ has become widespread
in the industry.”13
4.3. Budgeting Implications: A Theory of
Gift Giving
The analysis of budgeting rules suggests that category
and time specific shadow prices can vary. This implies
that individuals fail to undertake some internal arbi-
trage operations that in principle could increase util-
ity. In contrast, the standard theory implies that all
goods that are consumed in positive quantities have
the same marginal utility per dollar, and in the
absence of capital market constraints, variations over
time are limited by real interest rates. Observed pat-
terns of gift giving lend support to the current theory.
Suppose an individual G wants to give some recipi-
ent R a gift. Assume that G would like to choose that
gift which would yield the highest level of utility to R
for a given expenditure. (Other nonaltruistic motives
are possible, but it seems reasonable to start with this
case.) Then the standard theory implies that G should
choose something that is already being consumed in
positive quantities by R.
How does this compare with common practice?
Casual observation and some informal survey evi-
dence suggest that many people try to do just the
opposite, namely buy something R would not buy for
himself. Flowers and boxed candy are items that are
primarily purchased as gifts. “Gift shops” are filled
with items that are purchased almost exclusively as
gifts. Did anyone buy a pet rock for himself?
Once the restriction that all shadow prices be equal
is relaxed, the apparent anomaly is easily understood.
Categories that are viewed as luxuries will tend to
have high k’s. An individual would like to have a
13 See Business Week, March 29, 1982. This example was suggested
by Leigh McAlister.
small portion of the forbidden fruit, but self-control
problems prevent that. The gift of a small portion
solves the problem neatly.
A simple test of the model can be conducted by the
reader via the following thought experiment. Suppose
you have collected $100 for a group gift to a depart-
ing employee. It is decided to give the employee some
wine since that is something the employee enjoys.
Suppose the employee typically spends $5 per bottle
on wine. How expensive should the gift wine be? The
standard theory says you should buy the same type
of wine currently being purchased. The current theory
says you should buy fewer bottles of more expensive
wine, the kind of wine the employee wouldn’t usually
treat himself to.
One implication of this analysis is that goods which
are priced at the high end of the market should
be marketed in part as potential gifts. This suggests
aiming the advertising at the giver rather than the
receiver. “Promise her anything but give her Arpege.”
The gift-giving anomaly refers to those goods in
categories with high k’s. Individuals may also have
categories with low k’s. Suppose I like to drink expen-
sive imported beer but feel it is too costly to buy
on a regular basis. I might then adopt the rule of
drinking the expensive beer only on specific occa-
sions, such as at restaurants or while on vacation.14
Advertisers may wish to suggest other occasions that
should qualify as legitimate excuses for indulgence.
One example is Michelob’s theme: “Weekends are
made for Michelob.” However, their follow-up cam-
paign may have taken a good idea too far: “Put a
little weekend in your week.” Lowenbrau’s ads stress
a different category, namely, what beer to serve to
company. “Here’s too good friends, tonight is some-
thing special ” While impressing your friends is
also involved here, again the theme is to designate
specific occasions when the beer kshould be relaxed
enough to purchase a high cost beer.
Another result of this analysis is that people may
sometimes prefer to receive a gift in kind over a gift in
cash, again violating a simple principle of microeco-
nomic theory. This can happen if the gift is on a “for-
bidden list.” One implication is that employers might
want to use gifts as part of their incentive packages.
Some organizations (e.g., Tupperware) rely on this
type of compensation very heavily. Dealers are paid
both in cash and with a multitude of gift-type items:
trips, furniture, appliances, kitchen utensils, etc. Since
most Tupperware dealers are women who are second-
income earners, the gifts may be a way for a dealer to:
14 One bit of evidence that people on vacation adopt temporarily
low k’s is that all resorts seem to have an abundance of gift and
candy shops. Some of their business, of course, is for gifts to bring
home, but while on vacation, people also seem to buy for them-
selves at these shops.
Thaler: Mental Accounting and Consumer Choice
Marketing Science 27(1), pp. 15–25, © 2008 INFORMS 25
(1) mentally segregate her earnings from total fam-
ily income;
(2) direct the extra income toward luxuries; and
(3) increase her control over the spending of the
extra income.15
Another similar example comes from the National
Football League. For years the league had trouble get-
ting players to come to the year-end All-Star game.
Many players would beg off, reporting injuries. A few
years ago the game was switched to Hawaii and a free
trip for the player’s wife or girlfriend was included.
Since then, no-shows have been rare.
Conclusion. This paper has developed new con-
cepts in three distinct areas: coding gains and losses,
evaluating purchases (transaction utility), and bud-
getary rules. In this section I will review the evi-
dence presented for each, describe some research
in progress, and suggest where additional evidence
might be found.
The evidence on the coding of gains and losses
comes from two kinds of sources. The “who is hap-
pier” questions presented here are a rather direct test,
though of a somewhat soft variety. More research
along these lines is under way using slightly differ-
ent questions such as “two events are going to hap-
pen to you, would you rather they occurred on the
same day or two weeks apart?” The two paradigms
do not always lead to the same results, particularly in
the domain of losses (Johnson and Thaler 1985). The
reasons for the differences are interesting and sub-
tle, and need further investigation. The other source
for data on these issues comes from the investigation
of choices under uncertainty. Kahneman and Tversky
originally formulated their value function based on
such choices. In Johnson and Thaler (1985) we inves-
tigate how choices under uncertainty are influenced
by very recent previous gains or losses. We find that
previous gains and losses do influence subsequent
choices in ways that complicate any interpretation of
the loss function. Some of our data comes from exper-
iments with real money and so are in some sense
“harder” than the who is happier data. Kahneman
and Tversky are also investigating the multi-attribute
extension of prospect theory, and their results suggest
caution in extending the single attribute results.
The evidence presented on transaction utility was
the beer on the beach and hockey ticket question-
naires, and the data on sports pricing. The role of
fairness is obviously quite important in determin-
ing reference prices. A large-scale telephone survey
undertaken by Daniel Kahneman, Jack Knetch and
myself is under way and we hope it will provide
additional evidence on two important issues in this
area. First, what are the determinants of people’s per-
15 Tax evasion may be another incentive if recipients (illegally) fail
to declare these gifts as income.
ceptions of fairness? Second, how are market prices
influenced by these perceptions? Evidence on the for-
mer comes directly from the survery research, while
evidence on the latter must come from aggregate eco-
nomic data. The latter evidence is much more difficult
to obtain.
Both the theory and the evidence on the budgetary
processes are less well developed than the other top-
ics presented here. The evidence comes from a small
sample of households that will not support statistical
tests. A more systematic study of household decision
making, perhaps utilizing UPC scanner data, should
be a high priority.
More generally, the theory presented here repre-
sents a hybrid of economics and psychology that has
heretofore seen little attention. I feel that marketing is
the most logical field for this combination to be devel-
oped. Aside from those topics just mentioned there
are other extensions that seem promising. On the the-
ory side, adding uncertainty and multiple attributes
are obviously worth pursuing. Regarding empirical
tests, I would personally like to see some field exper-
iments which attempt to implement the ideas sug-
gested here in an actual marketing environment.
Acknowledgments
An earlier version of a portion of this paper was presented
at the Association for Consumer Research conference in San
Francisco, October 1982, and is published in the proceedings
of that meeting. The author wishes to thank Hersh Shefrin,
Daniel Kahneman and Amos Tversky for many useful dis-
cussions. Financial support from the Alfred P. Sloan Foun-
dation is gratefully acknowledged.
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