The Psychology of Spending
People’s complex attitudes toward money often defy economic theory. So says Drazen Prelec, associate professor of marketing at the Sloan School of Management, who practices a fusion of psychology and economics in which he uses a little intuition and a lot of mathematics.
Prelec’s studies of consumer behavior focus on the irrationalities people exhibit toward money–why they buy lottery tickets and insurance at the same time, for instance. Although his work is designed primarily to help marketers understand how pricing and payment systems affect consumer buying decisions, his findings offer a fascinating glimpse into our own complex relationships with money.
“When people buy lottery tickets, they’re engaging in risky behavior with their money,” he explains. “When they buy insurance, they’re showing risk-averse behavior with their money. Doing both at the same time shows an inconsistent attitude toward risk–and yet many people do this.”
Living by the rules
Prelec says our spending habits are based on an accumulation of rules, like “I never take a taxi unless it’s an emergency” or “I never buy high-priced gourmet foods.” Those rules, he says, are designed to keep us out of financial trouble, and we suffer a sting of guilt whenever we break one.
“Let’s say I decide to splurge and buy cheese that costs $20 a pound,” he says. “The guilt I’ll feel about breaking one of my rules will probably ruin some of my enjoyment of eating the cheese. I call that sting the ‘moral tax on consumption.’ It interferes with the pleasure of consumption.”
It makes intuitive sense that our enjoyment of new purchases is offset slightly by the pain of having to pay for them. But Prelec says retailers could do more to lessen the sting of the moral tax–by adopting bundled pricing schemes, for example.
“When you buy Microsoft Office for your computer, you get the Internet browser as part of the bundle. But does that mean the browser is free?” he asks. “When items in a bundle are not priced separately, it creates a feeling that everything is free. And that provides a mental benefit.” The bundled pricing reduces the moral tax by simplifying the decision-making: you buy all or nothing.
The power of credit
Prelec has also found that credit cards can powerfully influence people’s spending habits. “We organized a silent auction for tickets to sold-out Celtics basketball games,” he says, describing a recent experiment conducted on unsuspecting Sloan students. “We told half the bidders they could only pay with cash and we told the other half they could only pay with a credit card.”
The results stunned even the researchers. “On average, we found that the credit card buyers bid more than twice as much as the cash buyers bid,” says Prelec. “That’s got to be crazy, right? It suggests that the psychological cost of spending a dollar on a credit card is only fifty cents.”
Credit cards are insidious, according to Prelec, because they disconnect the consumption transaction, which is pleasant, from the payment transaction, which is painful. “The moral tax gets blurred with credit cards,” he says. “When you’re consuming, you’re not thinking about the payments, and when you’re paying, you don’t know what you’re paying for.
“When the credit card bill arrives, people find paying it extremely unpleasant–worse than paying parking tickets,” he says, adding that debit cards, which deduct money directly from a checking account, are popular largely because of the unpleasant nature of credit card bills. “There’s no good reason to prefer debit cards over credit cards, unless we have learned to dread the credit card bill.”
Most debit cards still carry a credit card logo, however, and Prelec says the sight of the logo alone is a powerful inducement to spend. “If you put a credit card logo on the cover of a mail order catalog, you’ll increase sales significantly,” he says, describing a recent experiment conducted with a real mail-order firm. “Apparently consumers get excited just seeing the logo. It’s like waving a hamburger in front of a hungry person.”
In addition to its applications to marketing, Prelec says he hopes his work will influence how the public pays for access to things like parks, beaches, and highways. “The fact that you don’t have to pay every time you visit Boston Common provides a mental benefit,” he says. “You pay for it out of general taxes, but the cost is hidden, so you enjoy it more.
“It’s more efficient to have people pay for everything as they use it,” admits Prelec. “On the other hand, paying each time creates a psychological cost–the moral tax–that takes away from the enjoyment you get from these things. It’s a tradeoff.”
Prelec says measuring the effect of the moral tax more precisely is the key to balancing those tradeoffs, both in personal and in public expenditures. “It’s something we ought to measure and ought to consider,” he says. “The fact is that beyond the economic cost, payment does create an aggravation in and of itself.”