Effects of mental accounting on intertemporal choices

Abstract

Two experiments with undergraduates as subjects were carried out with the aim of replicating and extending previous results showing that the implication of the behavioral life-cycle hypothesis (H. M. Shefrin & R. H. Thaler, 1988) that people classify assets in different mental accounts (current income, current assets, and future income) may explain how consumption choices are influenced by temporary income changes. In both experiments subjects made fictitious choices between paying for a good in cash or according to a more expensive installment plan after they had received an income which was either less, the same, or larger than usual. In Experiment 1 subjects were supposed to have savings so that the total assets were equal, whereas in Experiment 2 the total assets varied. The results of both experiments supported the role of mental accounts in demonstrating that subjects were unwilling to pay in cash after an income decrease even though they had access to saved money. Thus, in effect they chose to pay more for the good than they had to. Indicating a need for further refinement of the concept of mental account, choices to pay in cash after an income decrease tended to be more frequent when the consumption and savings motives were compatible than when they were incompatible. Furthermore, increasing the total assets made subjects more willing to pay in cash after an income decrease.