Friday, October 28, 2011

Spending money with credit cards and cash

In my last blog entry, I wrote about research suggesting that people may spend small bills more freely than large bills. A number of people asked me what happens with credit and debit cards.

Debit and credit cards are an important part of our economic lives. These days, it is almost a surprise to go to a store and see someone pay with cash or a check.
There are many advantages of debit and credit cards, of course. They are easy to carry. You are not limited by the specific amount of money in your pocket. There is protection for cards that are lost or stolen, while money that is lost is just gone.

Obviously, credit cards have their dangers. The most obvious of these dangers is that they typically carry high interest rates. Once a person goes into credit card debt, it can be hard to dig out from beneath the payments.

There is also a lot of evidence that consumers spend more money when paying with credit cards than when they are spending cash. For example, Drazen Prelec and Duncan Simester reported studies on this topic in a 2001 issue of Marketing Letters. In one study, they told that randomly selected participants in the study would be offered the opportunity to purchase tickets to an actual professional basketball game that had just sold out. These tickets were highly desirable. Participants were told either that they would have to pay in cash or that they would have to pay by credit card. They were asked how much they would be willing to pay for these tickets. Those who were told they would have to pay by credit card were willing to pay over twice as much on average as those who were told that they would have to pay by cash.
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What is going on here?

There are many possible explanations for the observation that people pay more when using credit cards than when using cash.

For example, Richard Feinberg explored the link between credit cards and spending in a 1986 article in the Journal of Consumer Research. He varied whether people could see credit card logos while they were making purchases or leaving restaurant tips. People left higher tips and indicated that they would be willing to spend more for products when they could see a credit card logo at the time than if they could not.

In addition, people may pay less attention to prices when they are paying by credit card than when they are paying by cash. For example, the article by Prelec and Simester cites an unpublished study by Dilip Soman suggesting that people are less likely to remember the amount they spent on a purchase when they pay with a credit card than when they pay with cash.

This last finding relates to many observations in a variety of settings that people are better able to control their behavior when they have physical objects that help to guide their behavior than if they have to think conceptually. For example, people taking food at a buffet may have the desire to control the amount of food that they eat, but they still tend to fill their plate. Thus, they eat more overall if they are given a large plate than if they are given a small plate.

Likewise, driving behavior is affected by the type of speedometer in the car. For a while, car manufacturers were putting digital speedometers in cars. It is hard for people to judge the change in speed with a digital speedometer relative to an analog speedometer, because they have to actually think about the change in numbers.

Credit cards have this character as well. To stay within a budget using a credit card, you have to remember the prices for each of the items and then keep track of how those prices relate to your overall budget. If you have cash, then you can also limit the amount of cash that you carry as a way of limiting the amount you spend without having to remember all of the purchases you have made.

As you can see, many factors come together to make it difficult to maintain a budget when spending with credit cards. Perhaps the title of the paper by Prelec and Simester says it best: "Always leave home without it."