Like cursive handwriting, paying with cash has been made practically obsolete by technological advances. More cell phone manufacturers are adding near-field communication chips to their handsets, allowing consumers to use their phone like a credit card at retail stores.
Shifting to a system of virtual money is convenient, but it could have significant consequences for consumers and their family budgets.
According to a Consumer Reports study last year, consumers who used credit cards for gift purchases during the 2009 holiday season spent an average of $896 on gifts, 10% more than the overall average of $811.
Psychological studies and research papers compare the effects of credit cards and cash payments, with the universal conclusion being that consumers spend less with cash because cash is the most vivid and transparent method of payment. The more transparent the payment, the higher the pain of paying and the greater the resistance to spending.
The pain of handing over hard-earned cash is actually a good warning signal that makes you think twice about your purchase. But many consumers avoid this by shopping with credit cards, especially if it is a cash-back credit card.
Here are several ways credit cards increase spending, according to psychologists and researchers. These can also apply to smartphone payments:
- Credit cards are much less transparent and make it much easier to follow through on a transaction. This reduces our psychological barriers and makes it easy to ignore the warnings of our inner voice.
- Paying with a credit card separates the purchase from the actual payment. Since actual payment occurs long after the purchase, it dulls the pain of payment. The pleasant feelings you get from the purchase and immediate gratification are almost disconnected from the reality of the payment.
- Credit cards combine a month of purchases into one payment. It is easy to look at the final number and overlook how much you really spent on specific purchases or categories such as clothes, groceries, dining or entertainment.
- An individual expense is viewed as much bigger on its own than when it is part of a bigger payment. Adding a $50 purchase to a $1,000 credit card bill makes the purchase feel smaller and can result in increased spending.
- No pain, no memory. If there was little pain or deliberation at the point of purchase, it is easy to forget what you have charged on your credit card and to underestimate past spending.
Retailers and credit card issuers understand this psychology and use it to increase spending. It is the reason retailers are willing to pay credit card companies approximately 2% of their revenues on credit card purchases (even though they have fought many years for the regulations for lower interchange fees). Many retailers offer and aggressively promote their own credit card because the interest payments further increase revenue.