Mental accounting describes how people mentally sort money into separate categories — a "vacation fund," a "grocery budget," a "sunk cost already spent" — and treat those categories as if they were genuinely separate, even though money is, in strict economic terms, completely interchangeable. This produces decisions that don't track the actual math: whether a dollar was already spent, already lost, or newly available changes how it gets weighed, even when the total remaining money is identical either way.
The effect explains a lot of everyday behavior that looks irrational on paper but feels completely natural in the moment — continuing to "honor" a sunk cost, treating a windfall differently from earned income, or feeling a loss more sharply when it closes out a specific mental account than when the identical dollar amount is simply absorbed into general funds.
Two sports fans face the same choice: whether to drive 40 miles through a dangerous blizzard to see a basketball game. One paid for his ticket himself; the other received his ticket for free from a friend. When people are asked to predict which fan is more likely to risk the drive, most say the fan who paid is more likely to go — even though, rationally, the ticket's cost is already spent either way and shouldn't affect a decision about whether the drive is currently safe. The predicted difference reflects mental accounting: the fan who paid feels an open 'account' (the money spent) that skipping the game would leave unresolved, while the fan with the free ticket has no such account to close.