House money effect and discount coupons

B. Venkatesh

My wife and I converted the reward points on our credit cards to discount coupons redeemable at a certain store. We laboriously exhausted our coupons over three months. We would have certainly avoided some of the purchases at that store had it not been for the coupons. Why was our behaviour altered when we used discount coupons?

The answer lies in what behavioural economists call the house money effect. Suppose you walked into this store and found a top or a shirt for Rs 2,000. On a typical day, you would have been appalled at the rate. But on this day, you are not, shopping as you are with discount coupons. You, therefore, buy the top or the shirt. Why?

No pain of paying

You do not suffer the pain of paying for the purchase. You reason that the credit card company is paying you to spend at this store. This behaviour is called house money effect.

It is named after the behaviour gamblers exhibit after they win at the table. They typically feel that they have house (casino) money after a win and, therefore, take larger bets on the next round. It is the same behaviour that prompts an equity trader to take large bets after she profits on a trade.

Our purchase decision at the store carried a deadweight loss. That is, the utility value we derived from the products that we bought was far less than the price we paid for it with our discount coupons.

Irrational decision?

Were we irrational in our purchasing decision? Had we used our credit card just to earn the reward points, then our purchase decision at the store would have been irrational. Why?

The discount coupons would then carry a price — the wasteful shopping that we did to earn the reward points. But we did not. Even if all credit card companies stop offering reward points, we would (I presume) still spend the same amount with the plastic. The coupons were, hence, free money. We were in the wrong store.

(The author is a self-styled investment psychologist. He can be reached at enhancek@gmail.com)

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