The Frontal Cortex

Anchoring and Credit Cards

Another way that credit cards dupe the brain into spending way too much money on interest payments:

New research by the University of Warwick reveals that many credit card customers become fixated on the level of minimum payments given on credit card bills. The mere presence of a minimum payment is enough to reduce the actual amount many people choose to pay on their bills, leading to further interest payments.

The research, by University of Warwick Psychology researcher Dr Neil Stewart, is to be published in Psychological Science, in a paper entitled “The Cost of Anchoring on Credit Card Minimum Payments”. It focuses on the psychological phenomenon of “anchoring” in which arbitrary and irrelevant numbers bias people’s judgments.

The research reveals that anchoring affects the way people repay their credit card bills. For those people who make only partial repayments of the outstanding balance (about 35% of card holders), the suggested minimum payment on the credit card statement acts as an anchor and lowers the actual repayments people choose to make.

A few years ago, a group of MIT economists decided to conduct an auction with their business graduate students. (The experiment was later conducted on executives and managers at the MIT Executive Education Program with similar results.) The researchers were selling a motley group of items, from a fancy bottle of French wine to a cordless keyboard to a box of chocolate truffles. The auction, however, came with a twist: before the students could bid, they were asked to write down the last two digits of their social security number. Then, they were supposed to say whether or not they would be willing to pay that numerical amount for each of the products. For instance, if the last two digits of their social security number were 55, then they’d have to decide whether or not the bottle of wine or the cordless keyboard were worth $55. Finally, the students were instructed to write down the maximum amount they were willing to pay for the various items.

If people were perfectly rational agents, then writing down their social security numbers should have no effect on their auction bids. In other words, a student with a low valued social security number (like 10) should be willing to pay roughly the same price as someone with a high valued number (like 90). But that’s not what happened. Look, for instance, at the bidding for the cordless keyboard. Students with the highest social security numbers (80-99) made an average bid of $56. In contrast, the average bid made by students with the lowest numbers (1-20) was a paltry $16. A similar trend held for every single item. On average, students with higher numbers were willing to spend 300 percent more than those with low numbers. All of the business students realized, of course, that the last two digits of their social security number were completely irrelevant. Such a thing shouldn’t influence their bid. And yet, it clearly did.

This is known as the anchoring effect, since a meaningless anchor⎯in this case, a random number⎯can strongly impact our subsequent decisions. The same thing happens when people see the minimum payment on a credit card bill, which distorts the payment they end up making. While it’s easy to mock the irrational bids of the business students, the anchoring effect is actually a common consumer mistake. Consider the price tags in a car dealership. Nobody actually pays the prices listed in bold black ink on the windows. Rather, the inflated sticker is merely an anchor that allows the car salesman to make the real price of the car seem like a better deal. When we are offered the inevitable discount, the brain is convinced that the car is a bargain.

In essence, the anchoring effect is about the brain’s spectacular inability to dismiss irrelevant information. Car shoppers should ignore the manufacturer’s suggested retail price, just as MIT grad students should ignore their social security number. The problem is that the rational brain isn’t good at disregarding facts, even when it knows those facts are useless. And so, if we’re looking at a car, the sticker price serves as a point of comparison, even though it’s merely a gimmick. And when we’re making a bid on a cordless keyboard, we can’t help but tender an offer that takes our social security number into account, simply because that number has already been placed into the pertinent decision-making ledger. The random digits are stuck in the conscious brain, occupying valuable cognitive space. As a result, they become a starting point when we think about how much we’re willing to pay for a computer accessory or how big a check we’re willing to write to the credit card company.

Thanks for the tip, Kevin!

Comments

  1. #1 JoeM
    October 17, 2008

    “The problem is that the rational brain isn’t good at disregarding facts, even when it knows those facts are useless.”
    Isn’t your point that there is no such thing as the “rational brain”? That the brain is an agglomeration of neurological processes that function according to their own logic which has little to do with rationality as we know it? A brain that can’t disregard facts that it knows are useless is by definition not rational.

  2. #2 Art
    October 17, 2008

    Quite an interesting piece.

    A quantifiable manifestation of the same effect used so often by the right wing.

    They have long used extreme right outliers to make their radial positions seem more reasonable. In effect they always open a discussion with some loon adding extremist drivel to the mix.

    ie: If they want to eliminate welfare they might have someone submit an editorial to a newspaper claiming that it is a proven fact that all poor people were lazy criminals. That they should be heavily taxed so that they would have a greater incentive to get out of their indolent lifestyle. That at the very least they should be forced to eat these babies to take care of their own needs and reduce the burden on the society.

    By comparison the proposal to cut welfare funding in half seems reasonable.

    This technique takes advantage of the human tendency to split the difference and compromise. It is widely used to shift public debates to the right.

    The left is much more self moderating and is far less shameless in getting the most extreme versions of their thoughts out into the public eye. What the left needs is a think tank of unvarnished extreme leftists that can be nurtured and kept employed to make the moderate liberals more reasonable.

    They could start with elimination of all private property, the family and marriage. Follow that with a demand for the elimination of all coercive organizations, police and military. An outlawing of all meat consumption. The lowering of stress by eliminating all time keeping, watches and clocks.

    Put these out and in addition to giving the right conniptions, always fun to watch, they make things like universal health care and curbing of aggressive militarism much more reasonable.

    The left needs to cultivate our radical loons so they can run interference for the main body and shift the discussion to the left to counter the shift to the right of the last twenty years.

  3. #3 David
    October 18, 2008

    You just gave me the same feeling I had after reading “Kluge” on the subject of anchoring — very troubled. I’d so much rather believe that I am rational, or at least that rationality is within reach, but the evidence seems to consistently suggest otherwise. I wonder, is the desire to possess this thing we idealize as “rationality” itself a trick of the brain?

  4. #4 William Conger
    October 18, 2008

    First, Jonah’s book, Proust Was a Neuroscientist is destined to be a layman’s classic on the emerging recognition that neuroscience is a pathway to a new achievements in accessing the arts.

    Anchoring reminds me of past foolishness in advertising: The 50lb. freezer was a staple in refrigerator ads. Another was the phrase ($ any number) value, now only $, when in fact no one ever payed that fictitious value. Yep, anchoring works and all the market predators have used it since antiquity, and probably before that.

  5. #5 Paul Gilmartin
    October 20, 2008

    Very much enjoyed this article but I do have a question. Is there a tipping point where the anchoring number becomes meaningless?
    i.e. A car dealer could, in theory put a sticker on a car that says “$100,000″. Just like in the MIT experiment, this is a completely random number yet someone would never pay that much for a Ford Focus or Chevy Malibu!
    I understand the main point, that the mind has a difficult time disregarding useless facts so that in the case of the over-inflated car price, we can easily disregard the $100,000 sticker price, but doesn’t this mean that the original anchor number is in fact not random?

  6. #6 Credit Repair
    February 22, 2011

    It’s amazing how experiments and the scientific method can produce such effective and useable sales strategies. However questioning the basis of rationality of the brain can be quite a troublesome task. I think that if society as a whole would use more common sense when going into financial endeavors it would solve most of the whole credit debt problem. If you were brought up to work for your money you will automatically have more discipline when it comes to finances and not leave your choices up to non-rational acts triggered by devious employed sales tactics.