20

The Credit Card Premium. How Much More Are We Paying?

by The Happy Rock on July 6, 2007

Duncan Simester created one of the first experiments that attempted to directly test how consumer’s ‘willingness to pay’ is affected by credit cards. In this experiment 1st year MBA students were instructed to provide a sealed envelope with the amount that they would be willing to pay for sold out Celtics and Red Sox tickets. One set of instructions required cash payment and the other a credit card payment. In both cases the face value of the tickets were not given. The prize was to be sold to the person who wrote down the highest price, but sold at the second highest price. This system was designed to extract the participant’s true ‘willingness to pay’.

boston_red_sox_tickets.jpgThe results were no less then surprising. Consumers were willing to pay 133% more for the Celtics tickets, and 76% more for the Red Sox tickets when using credit cards.

One of the suggested reasons is that consumers use different anchoring points to assess value. In one case the amount of cash the person has on them or in their account is probably used, and in the other the credit limit or remaining credit is probably used. Although the reason isn’t fully known, that shouldn’t really matter to the frugal spender. What matters is that there is such a thing as a ‘credit card premium’ and we need to be aware of it.

Has anyone noticed whether this is true in their own lives?

Source – Note the experiment was administered at a time when the Celtics were a playoff contender.

Advertisement :

Do you want to take control of your finances? Consider using a Prepaid Debit Card to manage and maintain your budget.

{ 10 comments… read them below or add one }

beth July 6, 2007 at 4:30 pm

I’ve noticed this. As soon as I started paying off my credit card in earnest, I resolved that all expenses would go on my debit card. Suddenly $200 for 6 windows’ worth of curtains felt FAR too expensive, when I wouldn’t have blinked a month prior. I did wind up buying them, on my card even!, but when it was getting super close to paid off – the purchase pushed pay-off out by about 2 weeks.

ps your commenting seems messed up: there’s no box for the anti-spam word so I had to tab into it.

Reply

tehnyit July 7, 2007 at 11:17 am

Interesting article.

I have found that I would determine how much I would pay of it first, and then determine how I would pay for it. Of course, this is only true for small value items such as books or tickets. However, subconsciously, I would always try to based my spending budget on cash only.

Reply

Tim Diehl July 8, 2007 at 11:38 pm

I know that, currently taking masters classes, it’s a lot less painful to put the $1200 payment for each class on a credit card even though we will write a check for it out of our savings before the end of the month. But that initial payment is almost an after thought b/c no money actually changes hands.

Reply

TheHappyRock July 9, 2007 at 2:14 pm

@Beth – Thanks for the heads up on the commenting. I will take a look at it. Also, it looks like you are using the credit card premium to your advantage! Nice job. Cash does hurt.

@Tehnyit – Thinking through your purchases first is a great way to avoid frivolous spending. I found that this isn’t as easy with smaller impulse buys, what do you think?

@Tim – I totally agree Tim. Putting a large bill on a card is a lot less painful. Sometimes we even get rewards for doing it. The caution would be that it removes us from the pain which might make use creative about spending more wisely. For example, $50 a week in gas on credit is usually thought of as a necessary charge. If we pay cash, it might make us think twice about running to the store five times a week, or the how I can change my 50 minute commute.

Reply

tehnyit July 9, 2007 at 11:20 pm

Rock, I tend to agree with you on the smaller impulse buys.
One of the things that we are trying out, although with varying degree of success, is to carry some spare change (perhaps $10-$15) in our pockets, the credit card is hidden in our wallet, a place where it is not as easily available as the spare change. When the impulse hits us, we would reach for the change instead of the credit card.
I found that just by putting a small obstacle would stop the impulse, but it hasn’t worked all the time.

Reply

TheHappyRock July 10, 2007 at 12:02 pm

Tehnyit,

I love the experimentation. I looks like you have learned some about your spending patterns, and can continue to tweak the system until it gives you the desired result.

Nice work.

Reply

Kci15 April 16, 2008 at 4:46 pm

The low security of the credit card system presents countless opportunities for fraud. This opportunity has created a huge black market in stolen credit card numbers, which are generally used quickly before the cards are reported stolen.

Reply

The Happy Rock April 16, 2008 at 10:36 pm

This premium is talking about spending more on your card than with cash. I am not sure that fraud plays into the equation much, since almost all credit cards companies have pretty solid fraud resolution. Thanks for the input.

Reply

Danny June 3, 2008 at 6:56 pm

The credit card premium is something we all need to take into consideration. If you do not pay of your balances you are more than likely paying up to 30% more for your purchases. PAY CASH!

Reply

Stuart December 23, 2008 at 6:19 pm

It’s funny, when interest rates go up the banks are very quick to pass on the extra percentage. But when the rates start going down again (as is happening here in Australia), they’re very very slow to pass on the savings to the customers.

So I’d agree that we do pay far too much of a premium on Credit Cards (rate’s here at the moment average around 20%).

Reply

Leave a Comment

{ 10 trackbacks }

Previous post:

Next post: