Mental Accounting Theory

Mental Accounting Theory refers to the way people categorize and evaluate money in their minds, treating different amounts or sources of money differently. For example, individuals might feel more comfortable spending a tax refund on a vacation, viewing it as "extra" money, while hesitating to spend their regular salary in the same way. This behavior can lead to irrational financial decisions and inconsistent budgeting habits, as people assign different values to money based on its source or intended use, rather than treating all money as equally valuable. This concept is important in behavioral finance as it highlights psychological biases in economic decision-making.