Non-Fungibility and Mental Accounting: A Model of Bounded Rationality with Sunspot

Aditya Goenka

No 234, Econometric Society 2004 Australasian Meetings from Econometric Society

Abstract: In this paper we consider a model where some consumers act in a boundedly rational way by treating money as non-fungible (Kahneman and Tversky (1979) and (1984), Thaler (1987) and (1990). The budget is broken up into different expenditure groups (cookie-jars). Given the amount of resources allocated to a given expenditure group, boundedly rational consumers then decide how to spend the resources on commodities in that expenditure group. We study the general equilibrium effects of these `mental accounting systems'. An important implication of such behaviour is that consumers can act as if they are credit constrained even when they are not. It is shown that such environments are prone to self-fulfilling fluctuations. In three polar cases: (i) Where nearly every consumer is rational; (ii) Where the consumers are either rational or nearly rational; or (iii) If every consumer is boundedly rational and has an expenditure weight for each commodity, there are no self-fulfilling fluctuations. We also characterize properties of the demand functions so the demand of boundedly rational consumers can be distinguished from that of consumers whose first best behaviour is to have fixed expenditure weights

Keywords: Behavioral economics; bounded rationality; sunspot equilibrium; mental accounting; fungibility; economic fluctuations. (search for similar items in EconPapers)
JEL-codes: D11 D51 E32 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-cbe
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