Sunday, May 24, 2015

Credit cards and cognitive biases

This is a summary of a series of links from two articles on how credit cards exploit our cognitive biases to make us spend more than what we otherwise would have. First, the Atlantic has a nice article,
Consumers fancy themselves immune to this financial anesthesia. But study after study has documented credit cards’ ability to get people to spend more than they otherwise would, even when cash, credit, and debit were randomly assigned to experimental subjects: Credit cards make people more likely to forget how much they spent on something. They make frugal people spend recklessly. They make people willing to spend a lot more on one-off purchases. And large credit limits promote the illusion that daily purchases are inconsequential
Times article last year on the same topic had this to say,
One of the most well-known studies, published in 2001 and titled “Always Leave Home Without It,” showed that in certain contexts, people were willing to pay up to twice as much for the same item when paying with a credit card instead of cash. This is known as the “credit card premium.” A study in 2008, titled “Monopoly Money,” featured a gift card denominated in dollars. Even though the gift card lost value instantly when people used it, people were still more likely to spend freely with it than they did with cash. And a 2011 study showed that people considering using credit cards tended to focus more heavily on product features when shopping, while cash buyers paid closer attention to costs.
As the credit card markets deepen in emerging economies, these findings should serve as an important note of caution for governments. The standard response involving financial literacy and regulatory interventions are unlikely to make a dent to the problem. A more effective strategy would be through nudges which counteract these cognitive biases. 

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