Thaler explores the concept of mental accounting, a term he adopted from Daniel Kahneman and Amos Tversky. Mental accounting is essentially how people think about money and categorize their expenses. Thaler emphasizes the significance of mental accounting in understanding consumer behavior, noting that it’s a fundamental aspect of his career’s work.

Thaler explains that traditional economic theory views consumer decisions through the lens of opportunity costs, considering the alternative uses of time and money. However, he argues this approach is too complex for the average consumer. People don’t usually engage in such extensive analysis for everyday decisions, as it’s impractical and overwhelming. Instead, they use mental accounting, which simplifies financial decision-making.

He introduces two types of utility in mental accounting: acquisition utility and transaction utility. Acquisition utility aligns with standard economic theory, where consumer surplus is the utility of the object gained minus the opportunity cost. Transaction utility, on the other hand, is based on the deal’s perceived quality. It’s the difference between the actual price paid and the reference price (the price one expects to pay). This concept explains why people feel differently about the same product based on where or how they buy it, like paying more for a beer at a resort than at a grocery store.