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."

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.