Hot wiring the brain to pay off more debt

Monday, November 02, 2009

This report for Radio 4’s Money Box programme is a superb example of behavioural economics in action and in particular the anchoring effect. Researchers have found that by putting a small minimum required payment at the bottom of credit card statements, people’s brains are wired to pay less back than if no such minimum was posted. The result is that debt takes many years more to repay and the accumulated interest to the lender is naturally much higher. Offering low minimum repayments each month seems seems intuitively to benefit the borrower - making the servicing of debt appear more manageable on a month-by-month basis. But the anchoring effect in fact lifts the profits of finance houses.

Anchoring describes the human tendency to rely to heavily or ANCHOR on a trait or piece of information in particular. Natural human nature is to rely to heavily on certain pieces of information and then adjust to that piece of information to account for other elements of the circumstance.

When a price anchor is established for a product, it serves as a reference price for all similar products and substitutes. For example, when bread-makers were first introduced to consumers in the USA at a retail price of $275, consumers were not prepared to buy them. However, when a similar product was priced at $400, consumers flocked to buy the $275 bread-maker because they perceived it to be available at a bargain price. This was because their price anchor had shifted from $275 per bread-maker to $400. Anchoring a price for a good or service at a higher level helps to attract consumers to products priced below the level of the anchor.

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Posted to A2 Macro • A2 Micro • Behavioural Economics • Teaching of Economics
Tags: price, profit, debt, compound interest, anchoring, credit cards
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Questions in Behavioural Economics - Credit Cards and Spending

Friday, June 19, 2009

by Geoff Riley

Why do people often spend more when they swipe a credit card than when they use cash? Arjun Bali offers a view.

It’s 2015 and there are two queues of people waiting to buy tickets for an FA Cup final. The longer queue is for those who can pay by cash only, the other is for those who have gained the right to hold a credit card through steady saving and responsible consumption.

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