Questions in Behavioural Economics -  Credit Cards and Spending

Why do people often spend more when they swipe a credit card than when they use cash? Arjun Bali offers a view.

It’s 2015 and there are two queues of people waiting to buy tickets for an FA Cup final. The longer queue is for those who can pay by cash only, the other is for those who have gained the right to hold a credit card through steady saving and responsible consumption.

Classical economics dictates that the consumption patterns of consumers should not be affected by their method of payment, but behavioural economists know better. Recent figures show how oblivious consumers can be to the debt problems created by using a credit card. In the UK, £200 billion is owed on credit cards and total consumer debt is over 100% of GDP. The situation described above could occur should banks and other lenders deem consumers to be incapable of taking on debt responsibly.

Put simply, people don’t view a credit card in the same way as they view money. Notes and coins are simply a store of value, a method of exchange, but carry no intrinsic value. However, in the human mind, they are perceived as the product of labour that one strives to gain, as well as being a perceived measure of success. People are therefore much less likely to part with cash than they are to swipe a credit card.

As a human being walking down the street, you would stop to pick up a £10 note in the same manner in which you would stop at a red traffic light. You almost certainly would not leave it or pick it up to hand in to the bank that issued it as you would with a credit card.

People have also been shown to be poor at evaluating the short term pleasure in making a credit card purchase against the long term cost of having to pay for it. In the instant in which the purchase is made, it appears to be free when (as the consumer discovers at the end of the month) it costs just as much as if cash had been paid for it.

Politicians have recently also demonstrated an awareness of how individuals can make such poor finance decisions when faced with the exciting prospect of immediate gratification. The use of credit is a surprisingly major contributor to such decisions. This is due to “moral hazard”, a term used to describe the tendency of borrowers to take greater risks with borrowed money, because they do not consider it to be their own. Dan Ariely’s studies have shown that individuals display less honesty when dealing with credit or coupons than they do with cash. The economic crisis is strong evidence for his findings.

The Conservative Party want to impose a seven day cooling off period for credit cards, so that consumers cannot immediately rack up debts on them in the heat of the moment when they are issued. Such in-store credit cards provide strong incentives for consumption of goods in the heat of the moment, when one is instantly taken by an in store product. Inability to consider credit cards in the same way as cash causes people to consume more than benefits them.