Denomination Effect
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Denomination Effect

The denomination effect is a form of cognitive bias relating to currency, suggesting people may be less likely to spend larger currency denominations than their equivalent value in smaller denominations.[1] It was proposed by Priya Raghubir, professor at the New York University Stern School of Business, and Joydeep Srivastava, professor at University of Maryland, in their 2009 paper "Denomination Effect".[2][3]

Raghubir and Srivastava conducted three studies in their research on the denomination effect; their findings suggested people may be more likely to spend money represented by smaller denominations and that consumers may prefer to receive money in a large denomination when there is a need to control spending. The denomination effect can occur when large denominations are perceived as less exchangeable than smaller denominations.

The effect's influence on spending decisions has implications throughout various sectors in society, including consumer welfare, monetary policy and the finance industry. For example, during the Great Recession, one businessman observed employees using more coins rather than banknotes in an office vending machine, perceiving the customers used coins to feel thriftier. Raghubir and Srivastava also suggested the effect may involve incentives to alter future behavior and that a large denomination can serve as a mechanism to prevent the urge to spend.

Raghubir and Srivastava experiment

The denomination effect influences spending decisions.

Raghubir and Srivastava conducted three distinct studies as part of their experiment. Their first experiment involved 89 undergraduate business students from two United States universities. As a cover story, the students were thanked for their participation in the study and given at random either a small denomination (four quarters) or a large denomination ($1 bill) and told they could keep or spend the money on candy. Small denominations were given to 43 students (48% of study group) and 46 students (52% of study group) were given large denominations. Approximately 44% (39/89) of the participants, in both conditions, chose to purchase candy. About 63% of the participants with the four quarters purchased candy, yet only 26% of the participants with the $1 bill purchased candy, suggesting the students were more inclined to spend when given a smaller denomination.[2]

In a second study, 75 gas-station customers were each asked to participate in a short survey on gas usage. Each participant was given $5 as either five $1 bills, five $1 coins or one $5 bill and told they could spend the money at the gas station store. Customers who were given five $1 bills were more likely (24%) to buy something from the store relative to customers who were given a single $5 bill (16%). Customers who received five $1 coins had the lowest likelihood of spending (12%) because the currency is in low-circulation and were kept as souvenirs.[2]

A third study tried to understand whether the denomination effect was particular to American culture. In China, 150 housewives were given an envelope of money in exchange for completing a survey, containing either a single Renminbi (RMB) 100 banknote or five banknotes of equivalent value (RMD 100 is equivalent to roughly $15.25 USD or EUR12.82 EUR). The cash represented a significant amount of money; based on the monthly income of the participants, 18.7% (28/150) earned less than RMB 300, 65% earned (97/150) between RMB 301 and 600 and 16.7% (25/150) earned over RMB 600. The average household size was about 3.3 people in both conditions. The women were offered a chance to spend the money on specific reasonably priced household items, yet were less satisfied when they received a large banknote and spent it, compared to the others who spent if receiving smaller denominations.[2]

Early studies

Alternate payment methods

One study, conducted by Arul Mishra, Himanshu Mishra, and Dhananjay Nayakankuppam in 2006, documented a phenomenon they coined "bias for the whole," meaning that consumers spent less when given an amount in a large denomination and not in smaller denominations.[4] In the study, they concluded that people give higher value to a large single denomination because it is more difficult to process the transaction relative to the process of small denomination transaction. The difficulty in a large denomination's transaction results in a positive affect towards the money, leading people to overvalue it and make them less likely to spend it compared to an identical amount in smaller denominations. Unlike Mishra et al., who studied purchase intentions, Raghubir and Srivastava examined actual purchase decisions.[2]

Previous research by Raghubir and Srivastava in 2008 found that people will spend more money when using alternative payment methods, such as a credit car or gift card, than with cash.[2] The experiment by Raghubir and Srivastava built on earlier research studies, including one (Gourville, 1998) which showed that people are more likely to analyze a transaction positively when the same amount of money is framed as $1 a day rather than $365 a year.[2]

Conclusions

Raghubir and Srivastava concluded in study 1 that people are more likely to spend when an equivalent amount of money is represented by a smaller denomination relative to a single large denomination. In study 2, they concluded that consumers prefer to receive money in a large denomination compared to small denominations when there is a need to control spending. Study 3 further proves that the denomination effect depends on an individual's desire to reduce the uneasy feeling associated with spending money. The denomination effect occurs because people perceive a large denomination as less replaceable than smaller denominations, which can be used to control and regulate spending.[5]

In 2009, Sean Gregory with Time magazine explained that consumers view large denominations as more valuable than smaller denominations and that they tend to isolate the cash in their minds. Each smaller denomination $20 bill, he noted, is a less valuable entity than the single large denomination $100 bill. It's easier to spend five $20 bills than it is to spend a single $100 bill. Gregory also added that consumers fear breaking a single large denomination because they wont be able to stop spending the change.[6]

The researchers suggested that the denomination effect may involve so-called "precommitment"; in other words, the imposition of self-constraints or incentives to alter future behavior. They wrote that a large denomination can serve as a precommitment mechanism to prevent the urge to spend compared to small denominations.[2]

Applications

Raghubir and Srivastava wrote that the influence of denomination on spending decisions has important implications on consumer welfare and monetary policy.[2] Raghubir suggested that if we want consumers to start spending, we should give out smaller denominations and that if she were president, she'd propose increasing circulation of $1 coins and introduce $2 coins. She also suggested that the Internal Revenue Service, instead of issuing lump-sum tax rebates, send the rebates in the form of travelers checks or twenty-dollar bills.[3]

The denomination effect has implications in buying and selling stocks.

In 2012, Gary Belsky and Tom Gilovich of Time magazine stated that Raghubir and Srivastava's results were consistent with what they called "mental accounting." They explained that small denomination banknotes tend to get assigned to a "mental petty cash account" and that we're likely to spend that money on "petty things." However, larger denomination banknotes are perceived as more "real money" and we're likely to spend it on things of greater importance.[7][8]

A 2009 National Public Radio report noted that as the recession worsened, a Sacramento businessman noticed that his employees were using more coins, rather than banknotes, in his office vending machine. The businessman believed the customers felt "pinched" and that using coins instead of dollar bills, made them feel thriftier.[3]

John Manning, columnist at the International Banker, has noted that the denomination effect surfaces in the field of finance when an asset's unit of value exposes an investor's tendency to spend less when given in larger amounts. Manning cited the example of a stock split, suggesting the number of shares is increased by a certain ratio and diminished in price by the same factor, so that the company's total equity value remains the same. Stock splits are done largely because of the denomination effect: the bias of a new, less expensive share price can increase demand for the stock.[9]

See also

References

  1. ^ Kane, Libby (September 9, 2016). "15 cognitive biases that could keep you from building wealth". Business Insider. Retrieved 2017. 
  2. ^ a b c d e f g h i Raghubir, Priya; Srivastava, Joydeep (December 2009). "The Denomination Effect". Journal of Consumer Research. 36 (4): 701-713. doi:10.1086/599222. JSTOR 10.1086/599222. 
  3. ^ a b c "Why We Spend Coins Faster Than Bills". NPR. May 12, 2009. Retrieved 2017. 
  4. ^ Mishra, Arul; Mishra, Himanshu; Nayakankuppam, Dhananjay. "Money: a Bias For the Whole" (PDF). Advances in Consumer Research. 34: 166. Retrieved 2017. 
  5. ^ Raghubir, Priya; Joydeep, Srivastava (December 2009). "The Denomination Effect". Journal of Consumer Research. 36 (4): 701-713. doi:10.1086/599222. Retrieved 2017. 
  6. ^ Gregory, Sean (March 27, 2009). "Want to Save Money? Carry Around $100 Bills". Time. Retrieved 2017. 
  7. ^ Gilovich, Tom; Belsky, Gary (January 26, 2012). "Why (Bill) Size Really Does Matter". Time. Retrieved 2017. 
  8. ^ Riju, Dave (September 19, 2016). "Going shopping? Don't fall for these 14 retailer tricks to make you spend more". Economic Times. Retrieved 2017. 
  9. ^ Manning, John (June 24, 2016). "Cognitive Bias Series: 6. The Denomination Effect". International Banker. Retrieved 2017. 

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