Denomination effect

Last updated

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]

Contents

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. Exchange Money Conversion to Foreign Currency.jpg
The denomination effect influences spending decisions.

Raghubir and Srivastava conducted three distinct studies as part of their experiment. Their first experiment involved 89 undergraduate students from two United States universities. As a cover story, the students were thanked for their participation and randomly given either a small denomination (four quarters) or a large denomination ($1 bill) and told they could keep or spend the money on confectionery. 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 confectionery. About 63% of the participants with the four quarters purchased candy, yet only 26% of the participants with the $1 bill spent money, suggesting the students were more inclined to spend when given a smaller denomination. [3]

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 to buy something compared to customers receiving a single $5 bill. Customers who received five $1 coins had the lowest likelihood of spending, however the currency is in low-circulation and some are retained as souvenirs. [4]

A third study sought to understand whether the 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 (CNY) 100 banknote or five banknotes of equivalent value (in 2009, CNY 100 was equivalent to roughly $14.63 USD or €10.40 EUR [5] ). The cash represented a significant amount of money based on the monthly income of the participants, as 18.7% (28/150) earned less than CNY 300, 65% earned (97/150) between CNY 301 and 600 and 16.7% (25/150) earned over CNY 600. The average household size was about 3.3 people in both conditions. Some who purchased household items were less satisfied if they had received a large banknote, compared to the others who felt more satisfied spending smaller denominations. [6]

Early studies

Alternate payment methods Credit-cards.jpg
Alternate payment methods

One study, conducted by marketing professors Arul Mishra, Himanshu Mishra and Dhananjay Nayakankuppam in 2006, documented a phenomenon whereby consumers spent less of a large denomination, but not with smaller denominations. [7] In the study, they concluded that people give higher value to a large single denomination because it is more difficult to process the transaction, leading people to overvalue it and make them less likely to spend compared to an identical amount in smaller denominations. Unlike Mishra et al., who studied purchase intentions, Raghubir and Srivastava examined actual purchase decisions. [8]

Previous research by Raghubir and Srivastava in 2008 found a higher inclination to spend using alternative payment methods, such as a credit or gift cards. [9] Their experiment built on earlier research studies, including one by Harvard business professor John Gourville in 1998, [10] which showed that people are more likely to analyze a transaction positively when the same amount of money is presented as an equally distributed sum each day instead of a single lump sum each year. [3]

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. [11]

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 won't be able to stop spending the change. [12]

The researchers suggested that the denomination effect may involve imposing self-constraints or incentives to alter future behavior, noting a large denomination can serve as a precommitment mechanism to prevent the urge to spend compared to small denominations. [13]

Applications

Raghubir and Srivastava believe the influence of denomination on spending decisions has implications on consumer welfare and monetary policy. [14] Raghubir suggested offering smaller denominations to encourage spending and proposed increasing circulation of $1 coins and introduce $2 coins in the United States. [2]

The denomination effect has implications in buying and selling stocks. Stockmarket.jpg
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, suggesting small denomination banknotes tend to get assigned to a "mental petty cash account" to spend on trivial things. In contrast, larger denomination banknotes are perceived as "real money" and likely to spend on things of greater importance. [15] [16]

A 2009 National Public Radio report noted that as the recession worsened, a Sacramento businessman noticed that people were using more coins, rather than banknotes, in his office vending machine. The businessman believed the consumers were feeling economic hardship and that using coins instead of banknotes made them feel thriftier. [2]

John Manning, columnist at the International Banker, noted the effect surfaces in the finance field, 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, as the belief is that a less expensive share price can increase stock demand. [17]

See also

Related Research Articles

Euro Currency of most countries in the European Union

The euro is the official currency of 19 of the 27 member states of the European Union. This group of states is known as the eurozone or euro area and includes about 343 million citizens as of 2019. The euro, which is divided into 100 cents, is the second-largest and second-most traded currency in the foreign exchange market after the United States dollar.

Cash Physical money

In economics, cash is money in the physical form of currency, such as banknotes and coins.

Seigniorage, also spelled seignorage or seigneurage, is the difference between the value of money and the cost to produce and distribute it. The term can be applied in two ways:

Deutsche Mark Official currency of West Germany and later Germany from 1948 to 2002

The Deutsche Mark, abbreviated "DM" or "D-Mark", was the official currency of West Germany from 1948 until 1990 and later the unified Germany from 1990 until the adoption of the euro in 2002. In English, it is commonly called the "Deutschmark" ; this expression is unknown in Germany. The Germans usually called it D-Mark when referring to the currency, and Mark when talking about individual sums. One Deutsche Mark was divided into 100 pfennigs.

Federal Reserve Note Current paper currency of the United States

Federal Reserve Notes, also United States banknotes, are the currently issued banknotes of the United States dollar. The United States Bureau of Engraving and Printing produces the notes under the authority of the Federal Reserve Act of 1913 and issues them to the Federal Reserve Banks at the discretion of the Board of Governors of the Federal Reserve System. The Reserve Banks then circulate the notes to their member banks, at which point they become liabilities of the Reserve Banks and obligations of the United States.

Banknote Form of physical currency made of paper, cotton or polymer

A banknote is a type of negotiable promissory note, made by a bank or other licensed authority, payable to the bearer on demand. Banknotes were originally issued by commercial banks, which were legally required to redeem the notes for legal tender when presented to the chief cashier of the originating bank. These commercial banknotes only traded at face value in the market served by the issuing bank. Commercial banknotes have primarily been replaced by national banknotes issued by central banks or monetary authorities.

Philippine peso Currency of the Philippines

The Philippine peso, also referred to by its Filipino name piso, is the official currency of the Philippines. It is subdivided into 100 centavos or sentimos in Filipino.

Hungarian forint Currency of Hungary

The forint is the currency of Hungary. It was formerly divided into 100 fillér, but fillér coins are no longer in circulation. The introduction of the forint on 1 August 1946 was a crucial step in the post-World War II stabilisation of the Hungarian economy, and the currency remained relatively stable until the 1980s. Transition to a market economy in the early 1990s adversely affected the value of the forint; inflation peaked at 35% in 1991. Since 2001, inflation is in single digits, and the forint has been declared fully convertible. As a member of the European Union, the long-term aim of the Hungarian government may be to replace the forint with the euro, but that does not appear to be likely until some time during the 2020s.

Psychological pricing

Psychological pricing is a pricing and marketing strategy based on the theory that certain prices have a psychological impact. In this pricing method, retail prices are often expressed as just-below numbers: numbers that are just a little less than a round number, e.g. $19.99 or £2.98. There is evidence that consumers tend to perceive just-below prices as being lower than they actually are, tending to round to the next lowest monetary unit. Thus, prices such as $1.99 may to some degree be associated with spending $1 rather than $2. The theory that drives this is that pricing practices such as this cause greater demand than if consumers were perfectly rational. Psychological pricing is one cause of price points.

The North Korean won, also known as the Korean People's won or Democratic People's Republic of Korea won, is the official currency of North Korea. It is subdivided into 100 chon. The currency is issued by the Central Bank of the Democratic People's Republic of Korea, based in the North Korean capital, Pyongyang.

United States one-hundred-dollar bill Current denomination of United States currency

The United States one-hundred-dollar bill ($100) is a denomination of United States currency. The first United States Note with this value was issued in 1862 and the Federal Reserve Note version was launched in 1914, alongside other denominations. Statesman, inventor, diplomat, and American founding father Benjamin Franklin has been featured on the obverse of the bill since 1914. On the reverse of the banknote is an image of Independence Hall in Philadelphia, which has been used since 1928. The $100 bill is the largest denomination that has been printed and circulated since July 13, 1969, when the denominations of $500, $1,000, $5,000, and $10,000 were retired. As of December 2018, the average life of a $100 bill in circulation is 22.9 years before it is replaced due to wear.

Token money Form of money that has little intrinsic value compared to its face value

Token money, or token, is a form of money that has little intrinsic value compared to its face value. Token money is anything that is accepted as money, not due to its intrinsic value but instead because of custom or legal enactment. Token money costs less to produce than its face value. A banknote, e.g a five pound note, is token money because despite its value being 5 pounds it only costs a few pence to produce. A gold coin is not considered token money. The Token money system is becoming adopted in many businesses around the world as an effective way to exchange value between companies and customers. Token money as a system is predominantly used in mobile games, but is also becoming prevalent in the realm of e-commerce. Token money is similar to fiat money which also has little intrinsic value, however they differ in that token money is a limited legal tender. It is the consensus that people reach a medium to improve transaction efficiency. In a commodity economy, money is a measure of the value of goods and services (prices) within a sovereign country or the same economy, as well as a particular commodity to pay off debts. The token is also used as a medium of exchange, as a store of value, and as a unit of account. In the Internet age, money has become a decentralized blockchain technology.

Canadian Tire money, officially Canadian Tire 'money' or CTM, was a loyalty program operated by the Canadian retail chain Canadian Tire. It consisted of coupons, issued by the company, which resemble real banknotes. It could be used as scrip in Canadian Tire stores, but is not considered a private currency. The notes were printed on paper similar to what Canadian currency was printed on when they were still paper, and were jointly produced by two of the country's long-established security printers, British American Banknote Company (BABN) and Canadian Bank Note Company (CBN). Some privately owned businesses in Canada accepted CTM as payment, since the owners of many such businesses shop at Canadian Tire. In Canadian Tire stores, CTM was accepted for Canadian money at par, ie; 1 Canadian Tire Dollar = 1 Canadian Dollar.

Penny debate in the United States Potential abolition of the United States penny

A debate exists within the United States government and American society at large over whether the one-cent coin, the penny, should be eliminated as a unit of currency in the United States. The penny costs more to produce than the one cent it is worth, meaning the seigniorage is negative – the government loses money on every penny that is created. Several bills introduced in the U.S. Congress would have ceased production of pennies, but none have been approved. Such bills would leave the five-cent coin, or nickel, as the lowest-value coin minted in the United States.

Currency-counting machine Machine that counts money

A currency-counting machine is a machine that counts money—either stacks of banknotes or loose collections of coins. Counters may be purely mechanical or use electronic components. The machines typically provide a total count of all money, or count off specific batch sizes for wrapping and storage.

Bank Financial institution that accepts deposits

A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets.

5 euro note Euro banknote

The five euro note (€5) is the lowest value euro banknote and has been used since the introduction of the euro in 2002. The note is used in the 25 countries which have it as their sole currency ; with a total population of about 343 million currently. In May 2021, there were approximately 1,977,000,000 five euro banknotes in circulation around the eurozone. It is the fifth most widely circulated denomination, accounting for 7.3% of the total banknotes. Estimates suggest that the average life of a five euro banknote is less than a year before it is replaced due to wear.

Cashless society Economic state

A cashless society describes an economic state whereby financial transactions are not conducted with money in the form of physical banknotes or coins, but rather through the transfer of digital information between the transacting parties. Cashless societies have existed from the time when human society came into existence, based on barter and other methods of exchange, and cashless transactions have also become possible in modern times using credit cards, debit cards, mobile payments, and digital currencies such as bitcoin. However this article discusses and focuses on the term "cashless society" in the sense of a move towards, and implications of, a society where cash is replaced by its digital equivalent—in other words, legal tender (money) exists, is recorded, and is exchanged only in electronic digital form.

The history of Philippine money covers currency in use before the Hispanic era with gold Piloncitos and other commodities in circulation, as well as the adoption of the peso during the Hispanic era and afterwards.

The pain of paying is a concept from Behavioral Economics and Behavioral Science, coined in 1996 by Ofer Zellermayer, whilst writing his PhD dissertation at the University of Carnegie Mellon, under supervision of George Loewenstein. The term refers to the negative emotions experienced during the process of paying for a good or service. In other words, to make this simpler to understand, the more a purchase hurts, the less people are willing to make this purchase. During the payment process, the handing over of money is akin to losing money. As most people are loss averse, this is experienced as a negative feeling, and as such can also be used to avoid or reduce spending. The pain of paying has been tested in several contexts, and has been found to differ per payment method. The pain of paying is often heralded as a tool to curb individuals' spending.

References

Citations

  1. ↑ Kane, Libby (September 9, 2016). "15 cognitive biases that could keep you from building wealth". Business Insider. Retrieved 25 January 2017.
  2. 1 2 3 "Why We Spend Coins Faster Than Bills". NPR. May 12, 2009. Retrieved 24 January 2017.
  3. 1 2 3 Raghubir & Srivastava 2009, p. 701.
  4. ↑ Raghubir & Srivastava 2009, p. 705.
  5. ↑ "Historic exchange rate: CNY to USB as of 2009". X-Rates. Retrieved 29 January 2018.
  6. ↑ Raghubir & Srivastava 2009, p. 704-706.
  7. ↑ Mishra, Arul; Mishra, Himanshu; Nayakankuppam, Dhananjay. "Money: a Bias For the Whole" (PDF). Advances in Consumer Research. 34: 166. Retrieved 24 January 2017.
  8. ↑ Raghubir & Srivastava 2009, p. 701,702,704,706.
  9. ↑ Raghubir & Srivastava 2009, p. 701,712.
  10. ↑ Gourville 1998, p. 395-498.
  11. ↑ Raghubir & Srivastava 2009, p. 701-713.
  12. ↑ Gregory, Sean (March 27, 2009). "Want to Save Money? Carry Around $100 Bills". Time. Retrieved 24 January 2017.
  13. ↑ Raghubir & Srivastava 2009, p. 702-704.
  14. ↑ Raghubir & Srivastava 2009, p. 712.
  15. ↑ Gilovich, Tom; Belsky, Gary (January 26, 2012). "Why (Bill) Size Really Does Matter". Time. Retrieved 25 January 2017.
  16. ↑ Riju, Dave (September 19, 2016). "Going shopping? Don't fall for these 14 retailer tricks to make you spend more". Economic Times. Retrieved 25 January 2017.
  17. ↑ Manning, John (June 24, 2016). "Cognitive Bias Series: 6. The Denomination Effect". International Banker. Retrieved 25 January 2017.

Sources

This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.