Question

Consider a high school student who is given $3 every school day by her parents as “lunch money”. The student works a part time job after school, earning a small amount of “spending cash”. In addition to her lunch money, the student spends $5 from her own earnings each week on lunch. Suppose her parents reduced her lunch money by $2 per day but that she simultaneously receives a $10 per week raise at her job, requiring no extra effort on her part.

What would the rational choice model suggest should happen to her spending on lunch?

Alternatively, what does the mental accounting framework predict?

Answer 1

One can get out of debt and build wealth by sticking with smart spending. This is a universal fact. This is what the high school student must follow religiously. She can only save and invest what she is left with after the expenses. It's thus prerequisite for the high school student to limit her expenses for the lunch. A weekly quota or ceiling for spending on lunch is a way to approach the same.

One can always spend all the money one earns, however hefty the paycheck be. The practice of spending wisely inculcates the habit of managing one's expenses judiciously, cutting the extravagant and shelling out money only for what is needed. How you spend your money comes first, only then the questions about where and how much to invest are relevant. The more you do so, the closer you reach to your financial goals. Thus, spending below her means as a golden rule of financial management should be the mental accounting framework in action.