This is a great article by Nelson D. Schwartz published in the New York Times on March 25th. It's about how credit cards make it harder for people to really realize they are spending.
Nina Falcone has given up on cash.
Whenever and wherever possible, even at the vending machines in her building in Chicago, the 25-year-old marketer uses her Southwest Airlines Rapid Rewards card to collect points she says she uses for plane tickets to visit her family in California.
Ms. Falcone carefully follows the advice from consumer advocates and does not carry a balance from month to month or pay humongous interest charges.
But she admits there are probably some downsides to the ease of purchasing. Time magazines piled up around her apartment and gathered dust after she bought a subscription simply because it came with an offer for extra points. And she has increased the amount of time she spends shopping on the Internet because merchants offer incentives online for cardholders that are not available in stores.
“I haven’t paid for a trip on Southwest in years,” says Ms. Falcone, which may be technically true, but a host of economic and social science research suggests that consumers tend to spend more using plastic than they ever would with actual cash.
Incentives like frequent-flier miles or rewards points only amplify a temptation that banks and financial services companies have been profiting from for decades.
“When you vary the payment method, people are willing to pay more,” said Duncan Simester, a professor of marketing at M.I.T. who published a landmark paper on the subject in 2001. “You’re not forking over a dollar bill, so there is less sensation of loss.”
With M.B.A. students as the subjects, Mr. Simester and a colleague, Drazen Prelec, held an auction of tickets to basketball and baseball games featuring two local teams, the Boston Celtics and the Boston Red Sox.
Some participants were told they would have to pay by credit card, others were informed that only cash would be accepted.
When credit cards were an option, the M.B.A. students offered to pay roughly twice as much as they were willing to hand over in cash for the same tickets.
“The most surprising thing was the size of the effect,” said Mr. Simester, who titled the resulting paper ‘Always Leave Home Without It: A Further Investigation of the Credit-Card Effect on Willingness to Pay.’ ”
He added that while it was not unusual to see spending patterns shift by 5 or 10 percent in experiments, “you don’t see too many examples where people offer double what they would have otherwise.”
But the ease of buying with plastic, or what marketers call “friction-free spending,” is only half the story. Social scientists have also found that consumers have been conditioned by even the sight of credit card logos to want to spend more.
Unlike Mr. Simester, who created an experiment from scratch, Richard Feinberg of Purdue University persuaded restaurants near campus in West Lafayette, Ind., to let him study actual patrons’ spending habits.
Mr. Feinberg placed credit card logos and symbols on some tables and left others without them, as normal. The sight of images associated with credit cards prompted diners to spend more and leave bigger tips.
A similar exercise in a faculty member’s office produced larger donations to the United Way, Mr. Feinberg added, while credit card images bolstered sales at a Fannie May candy store.
“People spend more when these stimuli are present,” he said. “Just as Pavlov found that dogs would salivate when they heard tones that were associated with food, people have been conditioned to associate credit cards with spending.”
Although tools like Apple Pay and other mobile payment methods are too new to have generated much academic research, or allowed the kind of conditioning that half a century of credit card use has produced, Mr. Feinberg suggests a similar dynamic could be at work.
“The less friction there is, the easier it becomes to spend,” he said. “Just stand at Starbucks and watch how many people there use their smartphones to buy a latte.”
Speaking of lattes, credit cards also encourage people to pay more for everyday items than they might otherwise, according to Scott Bilker, founder of debtsmart.com and the author of “Talk Your Way Out of Credit Card Debt.”
“Paying $5 for a coffee might seem like a lot if you only have $10 in your wallet,” he said. “But if your credit card has a $10,000 limit on it, it doesn’t seem like much.”
The key, said Greg McBride, chief financial analyst at Bankrate.com, a personal finance website, is to try to exercise the same discipline with plastic that you would with cash, despite the urge to splurge.
If you can’t help yourself, or occasionally do have to carry a balance, avoid incentive cards at all costs. “They only work for consumers who pay their balances in full,” he said, as Ms. Falcone does scrupulously each month.
For the 60 percent of consumers who can’t pay off what they owe each month, a much smarter bet would be to seek out the card with the lowest possible interest rate.
Of course, even the best card rates are still high — the typical consumer today has $2,200 in credit card debt, with an average annual interest rate of nearly 16 percent, according to Bankrate.com.
Does that mean consumers should cut their cards up, stick to cash the way our great-grandparents had to and embrace the supposedly traditional value of thrift?
It’s not that simple today, nor was there really ever a golden age when Americans bought only what they could truly afford, said Lendol Calder, a professor of history at Augustana College in Rock Island, Ill.
“The river of red ink has run through American history from the beginning,” said Mr. Calder. “The Pilgrims took out loans from London investors and many of them died without ever having paid off their debts. As far back as you go, people were in over their heads.”
That said, Mr. Calder says he believes credit cards do offer advantages, despite the inevitable temptation to spend more.
“Credit cards are useful because people want to be thrifty with time,” Mr. Calder explained. “In the 20th century, time became scarce and credit cards and credit in general helps with that. It’s one thing to save and save and buy an engagement ring for someone you love, but not if you wait and she runs off with someone else.”
Nelson D. Schwartz is a reporter for The New York Times who covers the economy.