Another shopping tip: Consider opportunity costs

As we approach the holidays many of us are doing a lot of shopping.  We buy gifts for family and friends, and we also pick up a few things for ourselves, taking advantage of holiday sales. 

It ought to seem obvious that every dollar we spend on one purchase is a dollar that we can’t spend on another purchase.  Economists would say that each purchase has an opportunity cost.  Once we have made that purchase, that money cannot be spent on something else in the future.  To what extent do these opportunity costs affect the purchases we make?

A paper by Shane Frederick, Nathan Novemsky, Jing Wang, Ravi Dhar, and Stephen Nowlis in the December 2009 issue of the Journal of Consumer Research suggests that people often ignore opportunity costs for a purchase. 

They start their paper with a compelling story.  One of the authors of their paper was trying to decide between two stereo systems, one of which cost $1000 and had somewhat better speakers than a second system that cost $700.  After agonizing over the choice, the salesman asked whether he would rather have the better system or the cheaper system and $300 worth of CDs.  Immediately, he selected the cheaper stereo.  That is, even after putting in a lot of effort to think about this choice, the shopper had not considered the prospect that money not spent on the stereo would be available for other purchases that might enhance the quality of the stereo.

In a series of studies in this paper, the authors set up a number of situations in which people had to make choices.  In some cases, they chose between purchasing an item (say a DVD) and not purchasing it.  In other cases, they chose between a more expensive option and a less expensive option.  In each case, people were far more likely to purchase the cheaper option (or not purchase at all) if they were reminded of the opportunity cost of making the purchase.  These results suggest that people generally ignore opportunity costs when making choices.

People tend to ignore these opportunity costs in a variety of settings beyond just shopping at the holidays.  For example, the University of Texas is working hard to help students graduate from college in 4 years.  An increasing number of students are staying in college for a fifth year.  Often, the students reason that tuition for that fifth year is not so expensive.  However, the students who make this choice are typically not factoring in the opportunity cost of the extra year in school.  There is salary that they are not making for that year, as well as other ways that they may have chosen to spend their time.  Some students may elect to stay in school for an extra year even after considering these opportunity costs, but many students have never considered them at all when making this decision.

So as you do your shopping in this holiday season—and as you make important decisions in the years to come—spend some time thinking about how opportunities in the future may be affected by the choices you are making now.

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.

What’s the harm in asking?

As the parent of high school kids, I see the number of surveys that go to kids trying to determine their risky behavior.  They are frequently asked about drug use and sex.  On the one hand, it seems like a good idea to have a sense of what high school students are doing as a group.  On the other hand, there can be a real downside to asking questions.  For example, a 2008 issue of the Journal of Consumer Research had a nice research dialogue on the influence of asking questions on a person’s future behavior.

The target article was written by Gavan Fitzsimons and Sarah Moore.  Gavan, along with his colleague Vicky Morwitz have done quite a bit of research over the past few years on the paradoxical effect that asking people questions about future behavior may actually influence the behavior itself.  To take a simple example, there is a classic study by Jim Sherman demonstrating that asking people whether they will volunteer for a good cause leads them to overestimate how likely they will be to volunteer relative to people who are not asked to predict whether they will volunteer.  However, this over-prediction becomes a self-fulfilling prophecy, because this group ends up volunteering more often than a control group that is not asked to predict their future volunteer behavior.

The question of interest in the target article by Fitzsimons and Moore is whether asking teens about risky behaviors like sex and drug use will actually increase the likelihood that these kids will engage in the risky behavior.  There is a growing body of data suggesting that this question-behavior effect does occur.  (There is a commentary on the Fitzsimons and Moore article by Jim Sherman who argues that a lot more research is required to really demonstrate how pervasive this effect is, but there is certainly enough data around to be concerned.)

To be clear, the issue here is that asking kids about whether they plan to use drugs in the near future might make them more likely to use drugs in the near future.  Asking kids whether they plan to have unprotected sex in the near future might make them more likely to have unprotected sex.  Furthermore, there are number of large-scale studies that are being conducted in which these kinds of questions are asked of teens, so this is not an idle concern.

Happily, there are some ways to guard against the question-behavior effect.  Most importantly, there is evidence that if people are told about the question-behavior effect in advance, they don’t seem to be affected by the questions they are asked.  One reason why knowing about the effect may reduce the question-behavior effect is that if you respond to a question about a risky behavior, it will bring to mind both the knowledge that the behavior is risky as well as knowledge about the attractive aspects of the behavior.  The positive feeling about the risky behavior may hang around even after the memory of the survey has faded, leaving you with a positive feeling about a potentially dangerous behavior and no clear source of where that positive feeling came from.  If the opportunity to engage in that risky behavior then arises, this residual positive feeling may lead you to engage in the behavior, because you mistakenly think this positive feeling indicates you want to engage in that behavior.  Knowing about the question-behavior effect in advance gives you an explanation for the positive feelings about the risky behavior, making it less likely that you will believe that these feelings indicate that you want to engage in the behavior.

As a parent, that means that if you find out that your kids are going to participate in a survey or if you find out that they are going to get any kind of sex or drug education in school, you should talk to them beforehand about the fact that being asked a question about a risky behavior can affect future behavior, but primarily when you don’t know that being asked a question can affect that behavior. 

In addition, as a parent, you should talk to your kids about the survey or education program after it is over.  We all hate to talk to our kids about sex and drugs.  It is easier to hope or assume that they are not having sex and taking drugs.  However, just asking about the survey or education program is much easier than having to talk to your kid about why they are taking drugs or having sex (protected or unprotected).  So intervene with your kids before and after a survey to eliminate the impact of questions on future behavior.

And by the way, kids are not the only ones who are susceptible to the question-behavior effect.  In one study, adults who were asked how likely they would be to buy a car in the next six months were significantly more likely to buy a car in that period than a control group that was not asked that question.  So, before you participate in any kind of questionnaire, remind yourself that being asked questions about your future behavior can affect that future behavior.

And finally, even though you now know about the question-behavior effect, if you are given the chance to volunteer your time, do it.