Monday, October 24, 2011

How are spending habits affected by the type of money in your pocket?

When I was a kid growing up in central New Jersey, I had relatives who lived near Atlantic City.  To visit them, I could get a bus not too far from my house that was nearly free.  You paid for the bus, but then got a voucher from one of the casinos for $10.  When you got to the casino, you could cash in the voucher, and they would give you a roll of quarters worth $10. 

Why did they give out quarters?

Quite a bit of research suggests that the form of money that people have affects the way that they spend money.  From an economic standpoint, every dollar is just as good as every other dollar, whether it is a coin, a bill, or a number stored in a bank that can be accessed by a debit card.  Psychologically, though, the form of the money you have affects what you will do with it. 

There are at least two things going on here.

First, there are transaction costs with money.  A transaction cost is any cost (in money or time or effort) that is required to spend money.  The casino gives you quarters, so that you can immediately unroll the quarters and dump them directly into a slot machine.  If they gave you a $10 bill, you would first have to change it into coins to use in the slot machine.  That extra effort would make it less likely that you would play the slots.  That is the same reason why bartenders give you your change in dollar bills.  They hope that you will stuff a few of them in the tip jar (which you should, they work hard).

Second, research suggests that the size of the bills that you are carrying affects how likely you are to spend and how much you spend.  A paper in the December, 2009 issue of the Journal of Consumer Research by Priya Raghubir and Joydeep Srivastava looks at this issue.  In a number of studies (many of them looking at real purchases), they found that when people had money in larger bills, they were less likely to spend money than when they had money in smaller bills or coins.  Of interest, though, once people decided to spend money, they tended to spend more money when making purchases with the larger bills than with the smaller ones. 

The authors of this study interpret the results as arguing that large bills are treated as less flexible than smaller ones, and that is why people are reluctant to spend them.  I’d like to give a different interpretation of this work, though, based on some research I did with Miguel Brendl and Tory Higgins.

The form of money that you have tends to remind you of particular kinds of purchases.  If you are carrying $1 bills with you, those bills are most typically used for small purchases like buying candy or a cup of coffee.  Larger bills are more associated with larger purchases. 

When you have a particular amount of money in small bills, the form of the money helps you to think about spending it in a series of small purchases.  You are willing to make these small purchases, though each of them will be for only a small amount.  So, you spend money easily, but you spend a small amount each time. 

When you have that same amount of money in large bills, you treat it as a lump sum.  That lump sum supports making a larger purchase.  Large purchases often require more deliberation than smaller ones, and so you are less likely to spend the large bills at any given moment.  When you do spend those bills, though, you will probably make a larger purchase.

What does this mean for your cash spending habits?

If you are the sort of person who tends to blow through a lot of money making lots of small purchases, then you should probably avoid carrying lots of small bills with you.  The combination of the transaction cost for making small purchases (you’ll have to get change for your large bills) along with the fact that large bills are not strongly associated with small purchases will help you to control your spending.

If you are the sort of person who tends to make large purchases on impulse (that is, you are penny wise and pound foolish), then you may want to avoid carrying around large bills.  These large bills will be associated with larger purchases, and you may find yourself feeling like you have the money to make these large purchases.  Instead, you should probably carry around a small amount of money in small bills to keep yourself from over-reaching.