Why We Spend More Using Credit Versus Cash Why is it that people seem to spend more when they use credit cards than when they use cash? The answer could be rooted in psychology. Robert Frank, an economics professor at Cornell University, talks about how the brain works when it comes to paying for goods, and how people can avoid spending too much of their money.

Why We Spend More Using Credit Versus Cash

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And if you're trying to spend less, here's a radical suggestion: Cut up your credit card. Studies show that people who use plastic tend to spend more than people using cash. We've asked Cornell economics Professor Robert Frank to explain why that is.

Welcome to the program.

Professor ROBERT FRANK (Cornell University): Good morning, Ari.

SHAPIRO: Why do people with plastic spend more?

Prof. FRANK: Cash really when you fork it over across the counter, parting with it is just a more vivid sensation than the abstract act of signing a pledge to pay sometime later in the future.

SHAPIRO: The experience of parting with money is fundamentally different from pledging to pay that money?

Prof. FRANK: It does seem that this bias toward present things is rooted very deeply in the evolutionary past. In the psych lab, for example, Richard Herrnstein and George Ainslie - they're two Harvard psychologists, Herrnstein now dead - they've shown that even pigeons seem to have trouble weighing the present versus the future. So what they did was they gave the birds two buttons they could peck. A red one - if they pecked it they'd get a small morsel of food right away. If they waited a few moments and pecked the green button they'd get a much bigger morsel of food. Yet the birds almost invariably pecked for the immediate reward. They just couldn't wait those few extra seconds to get the bigger reward.

SHAPIRO: You know, I read that when McDonald's started allowing credit card purchases, the average purchase went from $4.50 up to $7.00. That's a huge increase.

Prof. FRANK: Oh, no kidding. Yeah, and I think sellers have been exploiting this basic impulse control problem for as long as there have been markets.

SHAPIRO: In this society that we live in, is it actually practical to cut up a credit card and go without? I mean, is this a world where one can subsist only on cash?

Prof. FRANK: You know, the good thing about credit cards is they make life more convenient. The fact that it's easier to buy things, though, puts a lot of people in a position where they spend too much. If that's a problem, yes, there's a solution. You can take that credit card, put the scissor to it, cut it in half and replace it with a debit card. Then you're in a position where if you can't afford it, you don't buy it.

SHAPIRO: What if I don't want to go so far as to cut up my credit card? Are there other things that I can do when I'm shopping that can keep me from overspending even if I am using credit?

Prof. FRANK: Well, you just have to set up rules for yourself and ask yourself three times, do I really need this? Can I afford to pay for it this month, not roll it over? If you ask yourself all those sorts of questions before you buy, you're less likely to buy if you can't afford it.

SHAPIRO: People often talk about wanting to spend less. But at a national economy level, if people did make a serious cut in their spending, would that hurt the country's economic growth?

Prof. FRANK: Well, it's true. Consumption is about two-thirds of total spending. So I think it's natural people worry. If they think what would happen if people saved more and spent less, wouldn't the economy go into a tailspin? And that's really just a basic misconception, I think.

If you save $1,000, that money goes into the capital market. Some investor somewhere borrows it and spends it to buy a machine or add onto his factory. And the process of building the machine and building the factory, that creates jobs the same way you create jobs if people bought an extra car, an extra house. So total spending will go up in the long run.

SHAPIRO: Cornell economics Professor Robert Frank, thank you very much.

Prof. FRANK: You're quite welcome, Ari.

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