Denomination Effect

The denomination effect is a form of cognitive bias relating to currency, whereby people are less likely to spend larger bills than their equivalent value in smaller bills.[1] It was proposed by Priya Raghubir and Joydeep Srivastava in their 2009 paper "Denomination Effect".[2][3]

In an experiment conducted by Raghubir and Srivastava, university students were given a dollar, either in quarters or as a single dollar bill. The students were then given the option to either save the money they were given or spend it on candy. Consistent with the theory, the students given the quarters were more likely to spend the money they were given.[2]

Raghubir and Srivastava experiment

Priya Raghubir and Joydeep Srivastava conducted three distinct studies as part of their experiment. They described the first of their three studies as follows: "Eighty-nine undergraduate business students from two U.S. universities were assigned at random to either a small denomination (four quarters) or a larger denomination ($1 bill) condition....The cover story was that students were being thanked for their participation in an experimental session. They were told that they could keep the money or buy candy with it." The students "were more likely to spend when they were given four quarters than when they were given a $1 bill. While about 63% (27/43) of the participants chose to purchase candy in the small denomination condition, only 26% (12/46) chose to purchase candy in the large denomination condition."[2]

In the second of their studies, seventy-five gas-station customers "were individually asked to participate in a short survey with three questions on gas usage (used as the cover story), for which they were given $5 in one of three forms: five $1 bills, five $1 coins, or one $5 bill." They were then told that they could spend the money at the gas station's convenience store. The customers were more likely to buy something "when five $1 bills were given (24%) relative to when a single $5 bill was given (16%). The likelihood of spending when five $1 coins were given was the lowest of all three conditions (12%, or 3/25)," because they are low-circulation and were kept as souvenirs.[2]

In their third study, 150 Chinese women were given money, supposedly in exchange for completing a survey, and were offered a chance to spend it on certain reasonably priced household items. Those who received the money in a single large-denominated bill spent more, but were less satisfied with their purchases, than those who received the same sum in smaller denominations.[2]

Conclusions

The researchers' conclusions have been summed up as follows: "study 1 shows...that the likelihood of spending is lower when an equivalent sum of money is represented by a single large denomination (e.g., one $20 bill) relative to many smaller denominations (e.g., 20 $1 bills)....Study 2 then shows that consumers deliberately choose to receive money in a large denomination relative to small denominations when there is a need to exert self-control in spending. Study 3 further shows that the denomination effect is contingent on individual differences in people's desire to reduce the pain of paying associated with spending. The results suggest that the denomination effect occurs because large denominations are psychologically less fungible than smaller ones, allowing them to be used as a strategic device to control and regulate spending."[4]

In 2009, Sean Gregory with TIME magazine explained the denomination effect as follows: "First off, some consumers see large bills as more sacrosanct than a bunch of chump change....We tend to isolate the cash in our minds. Each $20 is a separate, less valuable entity than that single $100 bill. So it's easier to part with five of those twenties than with a single precious hundred in our pockets." Second, "consumers fear that once they break that large bill, they won't be able to stop spending the rest."[5]

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. "In our context," they wrote, "a large denomination may serve as a precommitment mechanism to exert self-control and willpower to overcome the urge to spend, relative to many small denominations."[2]

Early studies

The experiment by Raghubir and Srivastava built on earlier research studies, including one (Gourville, 1998) which showed that "people evaluate a transaction more positively when an identical amount of money is framed as 'pennies a day' ($1 a day) rather than aggregately ($365 a year)."

Previous research by Raghubir and Srivastava in 2008 showed that "people tend to spend more when using different payment modes, such as a credit card or a gift certificate, than when using cash."[2]

One earlier study (Mishra, Mishra, and Nayakankuppam, 2006) documented the so-called "bias for the whole," meaning that consumers spent less when given an amount in a large denomination and not in smaller denominations (five $20 bills).[6] In that study, the researchers concluded that "people perceive higher value when money is in the form of a large single denomination because of the greater fluency experienced in processing the large denomination relative to many small denominations. The greater processing fluency translates into positive affect toward the money, which leads people to overvalue the whole, thereby making them less likely to spend it compared to an equivalent amount in smaller parts." Unlike Mishra et al., who studied purchase intentions, Raghubir and Srivastava examined actual purchase decisions.[2]

Implications

"The systematic influence of denomination on spending decisions," wrote Raghubir and Srivastava, "has important implications from a consumer welfare perspective as well as a monetary policy perspective."[2] "If we want to get consumers going again...we should hand out lots of change," Raghubir suggested. "If I were President Obama, the very first thing I'd recommend is increase the circulation of $1 coins and consider introducing $2 coins." She also suggested that the IRS, instead of issuing lump-sum tax rebates, send the rebates in the form of travelers checks or twenty-dollar bills.[3]

"Mental accounting"

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 bills tend to get assigned to something like a mental petty cash account, and so we're willing to spend them on petty things. Larger bills, in contrast, are naturally thought of more as 'real money' and so we're reluctant to spend them on things that aren't of real importance."[7][8]

A 2009 NPR report noted that as the recession worsened, a Sacramento businessman observed that his employees were using more coins, rather than bills, in his office vending machine. When he looked into it, his supposition was confirmed - the machine's users felt it was thriftier to use coins. NPR observed that this was a classic example of the denomination effect in action.[3]

Stock splits

One financial expert has noted that the denomination effect surfaces in the field of finance, "where the unit value of a particular asset exposes investor propensity to spend less when it is denominated in large amounts." The expert cited the example of a stock split, whereby 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. Such measures are taken largely because of the denomination effect: "The psychology of a new, cheaper share price can create more demand for the stock."[9]

The "What-the-hell effect"

In 2009, Rajan Sambandam linked the denomination effect to what was previously known as the "What-the-hell effect", meaning that once the decision to spend has been made, people think 'what the hell' and end up spending a lot of money. He also linked it to the so-called "Shopping Momentum Effect."[10][11]

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. JSTOR 10.1086/599222. doi:10.1086/599222. 
  3. ^ a b c "Why We Spend Coins Faster Than Bills". NPR. May 12, 2009. Retrieved 2017. 
  4. ^ Raghubir, Priya; Joydeep, Srivastava (December 2009). "The Denomination Effect". Journal of Consumer Research. 36 (4): 701-713. doi:10.1086/599222. Retrieved 2017. 
  5. ^ Gregory, Sean (March 27, 2009). "Want to Save Money? Carry Around $100 Bills". TIME. Retrieved 2017. 
  6. ^ Mishra, Arul; Mishra, Himanshu; Nayakankuppam, Dhananjay. "Money: a Bias For the Whole" (PDF). Advances in Consumer Research. 34: 166. 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. 
  10. ^ Sambandam, Rajan. "Pennies and Pounds: The Denomination Effect and the What-the-Hell Effect". TR Chrome. TR Chrome. Retrieved 2017. 
  11. ^ Raghubir, Priya; Srivastava, Joydeep; Dhar, Ravi (2006). "The Shopping Momentum Effect" (PDF). European Advances in Consumer Research. 7. Retrieved 2017. 

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