The Credit Card Premium

Using a credit card for everyday purchases has increased substantially in the past decade.  The ease of obtaining credit cards plus the benefits credit card issuers provide have stimulated use by many Canadians.  In 2013 there were over 80 million credit card accounts in Canada.

One of the negative side effects of using a credit card is something called the Credit Card Premium.  This is the propensity of consumers to be willing to spend more on an item when using a credit card then when they purchase the same item using cash.

An article by Joe Pinsker that appeared in the April 2015 edition of The Atlantic Journal noted that the Credit Card Premium usually negates any benefit gained by using a credit card such as the interest free period, travel miles and cash back offers.

What is the Credit Card Premium?  A study by Drazen Prelec and Duncan Simester titled “Always Leave Home Without It: A Further Investigation of Credit-Card Effect on Willingness to Pay” found that consumers were usually willing to pay more for an item when paying with a credit card than when paying with cash. In fact in some situations, they were willing to pay as much as twice the amount when using a credit card.  Other studies have found that people using credit cards will leave bigger tips in restaurants and will make larger purchases in department stores.  In addition, these individuals will frequently forget the amount they spent or underestimate the amount they spent.

In another study by business psychologists Priya Raghubir and Joydeep Srivastava, they found that one of many reasons the consumer is willing to pay the Credit Card Premium is that “. . . the actual parting of the money occurs after the purchase decision thereby dulling the pain that is felt in a cash purchase. “

In summary, use of credit cards to make purchases should be kept to a minimum.  Even if you have the funds in your bank account to pay the monthly statement balance, the cost of the Credit Card Premium outweighs any benefit.  If you need to use a credit card, carefully consider what you are paying and make sure the cost of the item does not include a Credit Card Premium.  The ideal solution is not to use your credit card and instead use cash or debit for all your purchases.