Fermat's Library | Mental Accounting and Consumer Choice annotated/explained version.

Richard Thaler is an American economist and Professor of Behavioral...

The principle of fungibility is the property of a good/commodity wh...

The theory of the consumer is the part of microeconomics connecting...

Kelvin John Lancaster (December 10, 1924 – July 23, 1999) was a mat...

Gary Stanley Becker (December 2, 1930 – May 3, 2014) was an America...

We previously talked about framing and prospect theory on Fermat's ...

This is a key point: the evidence comes from a small sample of hous...

Vol. 27, No. 1, January–February 2008, pp. 15–25

issn 0732-2399 eissn 1526-548X  08  2701  0015

inf

orms

doi 10.1287/mksc.1070.0330

Mental Accounting and Consumer Choice

Richard H. Thaler

Johnson Graduate School of Management, Cornell University, Ithaca, New York 14853, thaler@chicagogsb.edu

new 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

today 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 = z

z

 be the vector of goods

Thaler: Mental Accounting and Consumer Choice

available in the economy at prices given by the cor-

responding vector p = p

p

. Let the con-

sumer’s utility function be deﬁned as Uz and his

income (or wealth) be given as I. Then the consumer

should try to solve the following problem:

max

Uz

s.t.



≤ I

Or, using Lagrange multipliers

max

Uz− 





− 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.

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 Ux is replaced

These 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 (v



x < 0x >0; v



x > 0x<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 vx <

−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).

Kahneman 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

The question is how does the joint outcome x y 

get coded? Two possibilities are considered. The out-

comes could be valued jointly as vx + y in which

case they will be said to be integrated. Alternatively

they may be valued separately as vx + vy  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.

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.

Since v is

concave vx + vy>vx+ y, so segregation is pre-

ferred. Moral: don’t wrap all the Christmas presents

in one box.

2. Multiple Losses. Let the outcomes be −x and −y

where x and y are 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 vx+v−y <

vx − y so integration is preferred. In fact, since the

loss function is steeper than the gain function, it is

possible that vx + v−y < 0 while vx − 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.

This 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.

For 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

Integration preferred

Value

Silver lining,

segregation preferred

Integration

segregation

v (x)

(x –y )

v (x–y)

v (x)+v (–y)

v (–y)

(

–

–y

without further information whether vx + v−y ≷

vx − y. This is illustrated in Figure 1. Segregation is

preferred if vx>vx−y −v−y. This is more likely

the smaller is x relative to y. Intuitively, with a large

loss and a small gain, e.g., $40 −$6000 segregation

is preferred since v is relatively ﬂat near −6,000. This

will be referred to as the “silver lining” principle. On

the other hand, for $40 −$50 integration 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,

Thaler: Mental Accounting and Consumer Choice

“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.

Two 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 vxx = 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

−v300 − v250. 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

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 p as the actual price charged for

some good z. Then for some individual, deﬁne

p as

the value equivalent of z, that is, the amount of money

which would leave the individual indifferent between

receiving

p or z as a gift.

Finally, 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 p to 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 p when

the expected or reference price is p

∗

. Total utility from

a purchase is just the sum of acquisition utility and

transaction utility.

Thus the value of buying good z at

In the standard theory,

p equals the reservation price, the maxi-

mum the individual would pay. In this theory,

p can differ from the

reservation price because of positive or negative transaction utility.

Acquisition utility is comparable in principle to consumer surplus.

A more general formulation would be to allow differing weights

on the two terms in (2). For example, Equation (2) could be writ-

ten as

w z p p

∗

 = vp −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 p with reference price p

∗

is deﬁned as wz p p

∗



where:

wz 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

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.

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

The 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



≤ I where I is

income. A solution to this integer programming prob-

lem would be to make purchases if and only if

wz

p

∗



≥ k (3)

where k is a constant that serves a role similar

to that of the Lagrange multiplier in the standard

formulation.

Notice that if k is 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.

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 z at price p if

wz p p

∗



where k

is the budget constraint for category i in

time period t.

The 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

Of course, global optimization would lead all the

’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.

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

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

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

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.

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

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.

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

This paragraph was motivated by a discussion with Dan Horsky

several years ago.

Thaler: Mental Accounting and Consumer Choice

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.”

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

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.

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 k should 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:

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

(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.

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-

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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Discussion

Richard Thaler is an American economist and Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business. In 2017, he was awarded the Nobel Prize in Economic Sciences for his contributions to behavioral economics. Along with Daniel Kahneman and Amos Tversky, he has played a big part in defining the field of behavioral finance. The principle of fungibility is the property of a good/commodity where the individual units are essentially interchangeable. For example, one share of a company should be interchangeable with the same share of a company and one barrel of crude oil should be interchangeable with another barrel of crude oil. Fungibility is distinct from liquidity which means a good is exchangeable for money. More about fungibility here: https://en.wikipedia.org/wiki/Fungibility This is a key point: the evidence comes from a small sample of households that will not support statistical tests. That is true of this work as well as much of Tversky and Kahnemans. It doesn’t mean that the conclusions are incorrect, just that the sample sizes / study designs are flawed and the conclusions are not statistically valid. Retraction Watch and Andrew Gelman have written a lot about p value hacking, social psychology, and the statistical limitations of small sample sizes. Kahneman even admits the limitations of his past studies (based on their small, selection biased sample sizes). For more, read here: https://retractionwatch.com/2017/02/20/placed-much-faith-underpowered-studies-nobel-prize-winner-admits-mistakes/ And here: https://andrewgelman.com/2016/06/26/29449/ Gary Stanley Becker (December 2, 1930 – May 3, 2014) was an American economist and empiricist, and Nobel laureate in Economics. Becker was one of the first economists to branch into what were traditionally considered topics that belonged to sociology, including family organization, and household economics as mentioned here. He was known for arguing that many different types of human behavior can be seen as rational and utility maximizing. The research described here is from the 1960s when he and Jacob Mincer developed the New Home Economics, of which Becker's theory of allocation of time is the centerpiece. In the theory of allocation of time, Becker argued that household decisions are made in a marginal-cost and marginal-benefit framework and that marriage markets affect allocation into couples and individual well-being (i.e. the impact of higher real wages in increasing the value of time and therefore the cost of home production such as childrearing. As women increase investment in human capital and enter the workforce, the opportunity cost of childcare rises). https://en.wikipedia.org/wiki/Gary_Becker We previously talked about framing and prospect theory on Fermat's Library here: https://fermatslibrary.com/s/prospect-theory-an-analysis-of-decision-under-risk For a brief refresher: Tversky and Kahneman (1981) came up with the theory behind framing. Framing is a cognitive bias, where people react to a choice in different ways depending on how it is presented (as a gain or as a loss). People avoid risk when a positive frame is presented but seek risk when a negative frame is presented. Gain and loss are defined in the scenario as descriptions of outcomes (e.g., lives lost or saved, disease patients treated and not treated, lives saved and lost during accidents, etc.). Prospect theory shows that a loss is more significant than the equivalent gain, that a sure gain is favored over a probabilistic gain, and that a probabilistic loss is preferred to a definite loss. https://en.wikipedia.org/wiki/Framing_effect_(psychology) The theory of the consumer is the part of microeconomics connecting preferences to consumption expenditures and to consumer demand curves. Consumer theory analyzes how consumers maximize the desirability of their consumption as measured by their preferences subject to limitations on their expenditures (i.e. consumers maximize their utility subject to their budget constraint). The theory of the consumer is the standard microeconomic model of supply, demand, and indifference curves that an introductory economics class will teach. There are many assumptions of consumer demand theory. The assumptions include the behavioral assumption that all consumers seek to maximize utility; the assumption that preferences are complete and that the consumer fully understands their own preferences; the assumption that preferences are transitive: if A is preferred to B and B is preferred to C then A must be preferred to C; and that all goods are available in all quantities. To read more about other assumptions as well as the theory of the consumer, this is a nice intro: https://en.wikipedia.org/wiki/Consumer_choice Kelvin John Lancaster (December 10, 1924 – July 23, 1999) was a mathematical economist best known for the development of the Theory of the Second Best. This Lancaster (1971) research is noteworthy for it’s ability to distinguish between objective and subjective choice and demand theory. Every subjective consumer has unique preferences for the characteristics they desire in a product. According to Filip Palda in his book The Apprentice Economist: Seven Steps to Mastery: His insight was that the basic qualities that consumers seek could be manipulated by combining different products. His insight was that the basic qualities that consumers seek could be manipulated by combining different products. Hotelling had not considered this possibility. He had been content to accept that one good provided one underlying feature that could be measured in characteristics space. Lancaster saw the matter in greater breadth. Dinner was not just food on a table. It was an attempt to manipulate the basic constituents of flavor and nutrition into a satisfying gastronomic experience. Being a good cook meant knowing that taste had several dimensions including sweet, salty, sour, and savory. For a meal to be agreeable, it had to combine these elements of flavor and it also had to be easily digested, suggesting that nutritional dimensions such as greasiness, protein content, and temperature had to figure into the cook’s understanding. These basic culinary entities could each be thought of as lying on a left-right scale, or space. The ideal meal, then, sought to combine these features by varying each one as precisely as possible. For more, read on here: https://en.wikipedia.org/wiki/Kelvin_Lancaster

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