Money illusion and pricing

W. Fred van Raaij and Cecile L.A. van Rijen

Tilburg University and Fontys Hogescholen, Tilburg, The

Corresponding author: W. Fred van Raaij, Tilburg University, Department Social Sciences, P.O. Box 90153, 5000 LE Tilburg, The Netherlands. T. +31/13/4662434; F. +31/13/4662067; e-mail: [email protected]

Abstract With the introduction of the euro consumers have to develop a sense of value for euro prices. Consumers may be the victim of a illusion effect, in which they evaluate euro prices as cheaper than they actually are. For retailers, psychological or odd pricing may be less effective for euro prices than for prices. In this study, we find some support for the money illusion effect. We also find support for less psychological pricing for than for .

Key words: euro, money illusion, anchoring, psychological/odd pricing

Introduction The introduction of the common , the euro, in twelve member-nations of the European Monetary Union on January 1, 2002, demanded quite a number of adaptations of consumers. Salaries, savings, prices, loans, insurances, mortgages, pension plans, and other financial contracts are now in euros. Consumers have to learn new prices in euros rather than in the former national currency. They have to calculate and to think in a new value metric for their income and other amounts they receive, and for the prices and payments they have to make. Consumers have to develop a new reference system in euros for economic and psychological value and prices. According to the ‘invariance axiom’ (Tversky and Kahneman, 1988) people should not be influenced by the currency and give the ‘same’ answers irrespective the currency in which the information is provided.

In The Netherlands, the conversion rate of the euro is ƒ 2.20371 (Dutch guilders), in practice rounded to 2.2. If someone wants to convert a euro price into Dutch guilders, he/she has to multiply by 2 and to add 10 percent. If someone wants to convert a guilder price into euros, he/she has to divide by 2 and to subtract 10 percent. People may not be too accurate to do this calculation. They may forget to add or to subtract 10 percent. Or they may do a quick rounding rather than a 10 percent addition or subtraction. In Germany, this calculation is easier, because one euro is about two German marks.

In The Netherlands, the nominal amounts in euros are more than twice as low as the equivalent amounts in Dutch guilders. Thus, salaries and prices seem to be more than twice as low as they were in Dutch guilders. The low nominal prices give the impression that products are cheaper than before. This could lead to more spending and an increase of purchases. At the same time, the lower nominal income amounts could lead to a decrease of spending.

Research objectives Fisher (1928) introduced the concept of money illusion. This is the tendency to think of economic transactions in nominal terms, because the nominal value is a salient and natural unit of money. Dutch consumers are familiar with the guilder and know what is cheap and expensive in guilder prices. They may apply this reference frame to euro prices and tend to consider small amounts of euros as being cheap. They may consider a price of ƒ 51 a reasonable price for a dinner and € 24 as cheap, while actually € 24 is more expensive than ƒ 51. Scitovsky (1986) gives the example of workers that are satisfied with an income increase of 2 percent, while the is 3 or 4 percent. Shafir, Diamond and Tversky (1997) distinguish nominal and real assessment of prices and conclude that people often use a combination of real and nominal assessment in their evaluations. Van Everdingen and Van Raaij (1999) expected that the introduction of the euro may also lead to a money or price illusion effect, if Dutch consumers apply their guilder reference frame of nominal amounts to the new currency. One of the objectives of this study is to find empirical support for the price or money illusion, when consumers evaluate products priced in euros or in guilders. It is expected that consumers will evaluate prices in euros as being ‘cheaper’ than prices in guilders.

The second objective of this study is to investigate psychological prices in guilders and in euros. Psychological or odd prices are prices just below a rounded price such as € 2.95. The price of € 2.95 is perceived as a lot ‘cheaper’ than € 3.00, while the difference is only minor. The consequence of this is that the negative price elasticity is discontinuous just below a rounded price. This effect may occur for euros as well as for guilders.

The third objective is to study the highest accepted prices for products in guilders and in euros. A shirt with a price over € 60 may be considered too expensive. A price below € 25 may be considered cheap, even too cheap. The range of acceptable prices for a shirt varies then between € 25 and € 60 (Nyström, 1970). Students may consider a price of ƒ 100 for a textbook as being acceptable and a price over ƒ 100 as being too expensive. In the same way, students may consider a price of € 50 for a textbook as being acceptable and over € 50 as being too expensive. The upper anchor price is than changed from ƒ 100 to € 50; which is an increase of 10 percent. Consumers have to develop new ranges of acceptable euro prices and anchor euro prices for products and services.

Thus, there are several reasons why consumers may estimate euro prices as being lower than guilder prices. First, they may consider nominal amounts of money. Nominal amounts in euros are smaller than in guilders, and thus they conclude that products priced in euros are cheaper than products priced in guilders.

Second, consumers may perform an inaccurate calculation to convert euro prices into guilder prices. The conversion factor from euro to guilder is 2.2. They may multiply euro prices by 2 and forget to add 10 percent. Or they may multiply by 2 and do an inaccurate small addition that is lower than 10 percent. Thus, euro prices are underestimated.

Third, consumers may apply their guilder reference frame to euro prices. Reference prices may then serve as an anchor for price perceptions, evaluations and estimations (Shafir et al, 1997). The guilder prices are the anchor and consumers adjust insufficiently from this anchor to the euro prices. Northcraft and Neale (1987) found that lay persons’ (students) as well as experts’ (real estate agents) price estimations for real estate property are systematically affected by the listing price of these properties, although they received sufficient information to make their own price estimations. By the way, Dutch real estate agents still (2003) use guilders to estimate real estate value and comparisons over time.

A fourth reason to estimate euro prices as being lower may be the consequence of a negative evaluation of the euro. Van Everdingen and Van Raaij (1998) found that many Dutch consumers have a negative opinion about the euro and rather preferred the Dutch guilder. As a consequence, they may evaluate the euro as less valuable and thus euro prices as lower. However, Jonas, Greitemeyer, Frey, and Schulz- Hardt (2002) did not find support for this hypothesis with a German sample.

A fifth reason to estimate euro prices as being lower than guilder prices may be the time frame. Because the euro was introduced in 2002, the euro came ‘later’ than guilder. Due to inflation (4 to 5 percent annually in The Netherlands), an amount in euros (before January 1, 2002) is worth less than the same amount in guilders (after January 1, 2002). Euro prices are therefore perceived as being ‘cheaper’ than the equivalent guilder prices. However, Jonas et al (2002) did not find support for the time frame hypothesis.

Psychological aspects of prices Hanna and Dodge (1995) distinguish three psychological aspects of prices. The price may be an indicator of product characteristics such as quality, especially if quality cannot be judged directly such as with experience products. Price is also used for the categorization of products into cheap, acceptable and expensive. In the third place, price provides information on discounts.

Schindler (1991) found that rounded prices give the impression of high quality and status. ‘’ prices such as € 1,63 give the impression of precision and honesty. Psychological or odd prices, just below the rounded price, such as € 1.99, give the impression of discounting and ‘cheap’ (Schindler and Kibarian, 1996).

The idea behind psychological pricing is that the negative price elasticity for a price change from € 4.95 to € 5.00 is larger than for a price change from € 5.00 to € 5.05. The decrease of sales is larger when the price changes from € 4.95 to € 5.00 than when the price changes from € 5.00 to € 5.05 (Gabor and Granger, 1961, 1966). Psychological prices are perceived as being really lower than the rounded price, although the difference is negligible (Dodds and Monroe, 1985; Nagle, 1987). With a price increase from € 4.95 to € 5.00, the price comes in a higher euro unit, the category of € 5 prices. With a price increase from € 5.00 to € 5.05, the price remains in the same euro unit.

Psychological or odd pricing is in contradiction with assumptions of rationality, such as: - Price elasticity is a linear function of prices without price thresholds (bubbles). - Consumers have prefect information about prices. - Prices do not affect subjective needs. - Consumers possess information on product characteristics and quality, not depending on prices.

Psychological prices are less well remembered than rounded prices (Schindler and Wiman, 1989). Consumers may ‘edit’ psychological prices and remember these as rounded prices. This is a simplifying . Schindler (1991), Nyström (1970) and Monroe (1990) conclude that there is no clear evidence that the use of psychological prices leads to increased sales. Wedel and Leeflang (1998) conclude that the effect of psychological pricing is generally overestimated on the market. The effects are different for different price levels, products, situations and consumers.

Although psychological prices do not have the intended effects in all situations, retailers apply them often. Friedman (1967) discovered that 80 percent of all prices in supermarkets end with 9 or 5. The popularity of psychological prices may even have an adverse effect. If consumers are accustomed to psychological prices such as € 4.95, they may consider the rounded price of €.5.00 to be too expensive.

In this study, we will investigate whether there is an effect of psychological prices. And if so, whether this occurs both for guilder and for euro prices. We expect that psychological prices have less effect for euro prices than for guilder prices. For guilder prices, consumers have a traditional and clear sense of value, and categorize prices in guilder units. For euro prices, consumers do not have a reference frame and have to transform euro prices into guilder prices. A price of € 0.95 will be rounded to € 1.00 and then transformed into guilders: ƒ 2.20. If consumers still recalculate euros into guilders, and round prices to the nearest ‘round’ number, there will be no or less effect of psychological pricing.

Hypotheses The following two hypotheses will be tested:

Price illusion hypothesis: Consumers are willing to spend more for a product priced in euros than in guilders. The highest accepted price in euros is higher than in guilders.

Psychological pricing hypothesis: Consumers are more willing to buy a product for a psychological price than for the corresponding rounded guilder price. This hypothesis is not expected to be true for euro prices.

Research design and procedure Two products/brands were selected for this study: toothpaste (Prodent) and deodorant (Odorex). These are sex-neutral products/brands that many people use. These are also products of which consumers cannot recall the price easily, because these products are bought irregularly and often when on sale. For these products, psychological pricing may have an effect (Wedel and Leeflang, 1998).

Following the Gabor-Granger price test (Gabor and Granger, 1961, 1966), the participants were asked to respond to eight series of prices: for both products, two guilder series (psychological and rounded prices) and two euro series (psychological and rounded prices). In the Gabor-Granger price test, participants are shown a product and following a series of prices the highest accepted price will be determined. See Tables 1 and 2. In order to minimize memory effects the two products are alternated. To avoid that the experimenter gives directions, the procedure starts with the middle prices of the series, printed in bold in Tables 1 and 2. Depending on the answer, the experimenter asks the participant to respond to the next higher/lower price of the series.

Table 1. Price series for toothpaste.

1.Guilders, 2. Guilders, 3. Euros, 4. Euros, rounded psychological rounded psychological 1.40 1.39 0.64 0.63 1.60 1.59 0.73 0.72 1.80 1.79 0.82 0.81 2.00 1.99 0.91 0.90 2.20 2.19 1.00 0.99 2.40 2.39 1.09 1.08 2.60 2.59 1.18 1.18 2.80 2.79 1.27 1.27 3.00 2.99 1.36 1.36 3.20 3.19 1.45 1.45 3.40 3.39 1.54 1.54 3.60 3.59 1.63 1.63 3.80 3.79 1.72 1.72 4.00 3.99 1.82 1.81 4.20 4.19 1.91 1.90 4.40 4.39 2.00 1.99 4.60 4.59 2.09 2.08

Table 2. Price series for deodorant.

5. Guilders, 6. Guilders, 7. Euros, 8. Euros, rounded psychological rounded psychological 3.40 3.39 1.54 1.54 3.60 3.59 1.63 1.63 3.80 3.79 1.72 1.72 4.00 3.99 1.82 1.81 4.20 4.19 1.91 1.90 4.40 4.39 2.00 1.99 4.60 4.59 2.09 2.08 4.80 4.79 2.18 2.17 5.00 4.99 2.27 2.26 5.20 5.19 2.36 2.36 5.40 5.39 2.45 2.45 5.60 5.59 2.54 2.54 5.80 5.79 2.63 2.63 6.00 5.99 2.72 2.72 6.20 6.19 2.81 2.81 6.40 6.39 2.90 2.90 6.60 6.59 2.99 2.99

Participants were 117 customers of the ABN-Amro bank office in the centre of Tilburg during the period November 5-9, 2001, about two months before the introduction of the euro. The time frame can thus be excluded as an explanation for the money illusion effect. The experiment was done in the bank office. The participants were selected using quota based on age, sex, level of education, and travel habits (frequency of visiting foreign countries and thus being acquainted with other ). It is assumed that people that travel frequently to other countries, are more easily acquainted with other currencies and thus with euro prices.

Price illusion It is expected, according to the price illusion hypothesis that the highest accepted price for products priced in euros is higher than for products priced in guilders.

The average highest accepted price for toothpaste priced in guilders is ƒ 3.09 or € 1.40 and priced in euros is ƒ 3.16 or € 1.43. Note that the difference in euros looks smaller than the difference in guilders (a price illusion effect!). This difference (t=−1.93) is significant at 5%. The average highest accepted price for deodorant priced in guilders is ƒ 4.99 or € 2.26 and priced in euros is ƒ 5.04 or € 2.29. This difference is not significant (t=−1.29; p>.05), although the accepted prices are in the expected direction. The ‘price illusion’ hypothesis is thus supported for toothpaste, but not for deodorant.

Accepted prices For the accepted prices, cumulative frequencies are computed and given in four figures (Figures 1 through 4) with WTP (willingness to pay) curves. A WTP curve consists of cumulative frequencies of prices that consumers are willing to pay for a product (upper boundary). It is assumed that if consumers are willing to pay € 1.25 for a particular brand of toothpaste, they are also willing to pay lower prices for it. Consumers were shown the particular brand for which they had to evaluate the prices. There is thus no chance that consumers may judge the price as being too low (lower boundary).

Figure 1. WTP curve of accepted guilder prices for toothpaste.

100.00

75.00 ge buyers a

rcent 50.00 e ve p i t a 25.00 Cumul

0.00 1.39 1.59 1.99 2.19 2.39 2.59 2.79 2.99 3.19 3.39 3.59 3.79 3.99 4.19 4.40 4.60 1.40 1.60 2.00 2.20 2.40 2.60 2.80 3.00 3.20 3.40 3.60 3.80 4.00 4.39 4.59 Guilders toothpaste

Figure 2. WTP curve of accepted guilder prices for deodorant.

100.00

75.00 ge buyers a

rcent 50.00 e ve p i t a 25.00 Cumul

0.00 3.39 3.59 3.79 3.99 4.19 4.39 4.59 4.79 4.99 5.19 5.39 5.59 5.79 5.99 6.19 6.40 6.60 3.40 3.60 3.80 4.00 4.20 4.40 4.60 4.80 5.00 5.20 5.40 5.60 5.80 6.00 6.20 6.59 Guilders deodorant

Figure 3. WTP curve of accepted euro prices for toothpaste.

100.00

75.00 ge buyers a

rcent 50.00 e ve p i t a 25.00 Cumul

0.00

0.63 0.72 0.82 1.00 1.09 1.27 1.45 1.63 1.81 1.90 1.99 2.08 0.64 0.73 0.99 1.08 1.18 1.36 1.54 1.72 1.82 1.91 2.00 2.09 Euros toothpaste

Figure 4. WTP curve of accepted euro prices for deodorant.

100.00

75.00 ge buyers a

rcent 50.00 e ve p i t a

25.00 Cumul

1.54 1.72 1.82 1.91 2.00 2.09 2.18 2.27 2.45 2.63 2.81 2.99 1.63 1.81 1.90 1.99 2.08 2.17 2.26 2.36 2.54 2.72 2.90 Euros deodorant

The graphs of Figures 1 through 4 show clear negative price elasticities: The higher the prices, the lower are the percentages of buyers. It is striking in Figure 1 (guilder prices for toothpaste) that there ‘jumps’ from ƒ 2.99 to ƒ 3.00. The percentage of consumers that are willing to pay ƒ 2.99 is 71.1% and to pay ƒ 3.00 is 63.3%. This means that for a price increase of 1 7.8% - corrected for an average decrease of 0.3% for each cent 7.5% - of the participants indicates not to buy the product. A similar decrease can be found for ƒ 3.19 (55.3%) to ƒ 3.20 (43.8%), and for ƒ 3.39 (35.4%) to ƒ 3.40 (29.2%).

In Figure 2 (guilder prices for deodorant), similar effects are found for a price increase from ƒ 4.99 (62.3%) to ƒ 5.00 (50.9%), and for a price increase from ƒ 5.99 (15.6%) to ƒ 6.00 (6.1%).

The significance of the results on psychological pricing cannot be tested. The euro is a less articulated (fine) currency system than the guilder if the cents are included in both currencies. Consequently, the graphs of the euro prices have fewer values on the x-axis. There are thus fewer psychological prices and ‘jumps’ in the price ranges (Figures 3 and 4). Note that there is a steep decline of WTP, if the price of toothpaste increases from € 1.36 (76.3%) to € 1.54 (27.4%) (Figure 3). This is a corrected decrease of 36.3 percent. For many consumers, € 1.40 / € 1.50 seems to be their maximum price of toothpaste. In Figure 4, we observe a less steep decline. If the price increases from € 2.36 (47.6%) to € 2.54 (21.4%), the percentage buyers decreases with 14.3 percent.

Socio-demographics The sample consisted of men and women of different ages, education levels and travel habits. No differences were found between men and women, and between the different age groups. People with a high level of education (university) were less accurate in converting euros to guilders - maybe because they are less price conscious – and thus more prone to the price illusion than people with lower levels of education. With regard to travel habits, we expected that people travelling abroad frequently, will have more experience with foreign currencies. They will have fewer problems with the euro. Instead the data show that frequent travellers are more prone to the price illusion. Frequent travellers may have a higher level of education and be less price conscious. The socio-demographics of the sample did not provide a clear-cut picture of differences related to the euro.

Discussion We separate the discussion on the price illusion effect and on psychological pricing.

Price illusion For toothpaste, a price illusion effect has been found. Consumers are willing to pay higher prices for products priced in euros than for products priced in guilders. This effect can be explained in several ways. First, it may be due to the lower nominal amounts in euros as compared with guilders. This is the traditional ‘money illusion’ effect. The effect may also be explained by anchoring and by an inaccurate conversion from euro to guilder, for instance, by ‘forgetting’ to add 10 percent. Following Jonas et al (2002), explanations that this effect is due to a negative attitude toward the euro or the time frame, may be ruled out.

If consumers are misled by the price illusion effect, they are willing to pay higher prices for goods in euros than in guilders. This means that they spend their euro budget more easily than they spent their guilder budget (before 2002). As a consequence they have less money left over by the end of the month, and complain that ‘all’ prices have gone up. This is a case of an external attribution of their budget problem.

In euros, price differences look smaller, for instance the difference between prestigious and regular brands. Consumers are thus more easily persuaded to buy more expensive brands. This is another reason why consumers spend their budgets so easily. For retailers, a price discount becomes less attractive, because consumers do not perceive this discount as a substantial one. Other types of price promotions are becoming more attractive to retailers, e.g., three packages for the price of two.

Psychological pricing An effect of psychological or odd pricing is obtained for guilder prices, and less for euro prices. This is according to our expectations. Consumers may convert euro into guilder prices by rounding the euro prices to the next rounded number and then applying their 2.2 multiplication rule. An amount of € 0.99 will be rounded to € 1.00 and than multiplied by 2.2. Amounts of € 0.99 and € 1.00 will then have similar effects. This calculative approach to euro prices may preclude the effect of psychological prices. Only after a number of years, when consumers are accustomed to euro prices, this calculative approach will disappear. Psychological or odd pricing for euro pricing will then make sense for retailers.

The guilder price ranges for toothpaste (ƒ 1.39 to ƒ 4.59) and for deodorant (ƒ 3.39 to ƒ 6.59) contain more psychological prices than the euro price ranges for toothpaste (€ 0.63 to € 2.09) and for deodorant (€ 1.54 to € 2.99). The guilder price ranges contain 33 psychological prices ending with 9, while the euro price ranges contain only 15 psychological prices ending with 9 (Table 3). The same is true for prices ending with 5. For retailers, euro prices provide less than half the opportunities for psychological or odd pricing. Table 3. Psychological or odd prices for toothpaste and deodorant.

Guilder prices for Euro prices for Guilder prices Euro prices for toothpaste toothpaste for deodorant. deodorant. ƒ 1.39 € 0.69 ƒ 3.39 € 1.59 ƒ 1.49 € 0.79 ƒ 3.49 € 1.69 ƒ 1.59 € 0.89 ƒ 3.59 € 1.79 ƒ 1.69 € 0.99 ƒ 3.69 € 1.89 ƒ 1.79 € 1.09 ƒ 3.79 € 1.99 ƒ 1.89 € 1.19 ƒ 3.89 € 2.09 ƒ 1.99 € 1.29 ƒ 3.99 € 2.19 ƒ 2.09 € 1.39 ƒ 4.09 € 2.29 ƒ 2.19 € 1.49 ƒ 4.19 € 2.39 ƒ 2.29 € 1.59 ƒ 4.29 € 2.49 ƒ 2.39 € 1.69 ƒ 4.39 € 2.59 ƒ 2.49 € 1.79 ƒ 4.49 € 2.69 ƒ 2.59 € 1.89 ƒ 4.59 € 2.79 ƒ 2.69 € 1.99 ƒ 4.69 € 2.89 ƒ 2.79 € 2.09 ƒ 4.79 € 2.99 ƒ 2.89 ƒ 4.89 ƒ 2.99 ƒ 4.99 ƒ 3.09 ƒ 5.09 ƒ 3.19 ƒ 5.19 ƒ 3.29 ƒ 5.29 ƒ 3.39 ƒ 5.39 ƒ 3.49 ƒ 5.49 ƒ 3.59 ƒ 5.59 ƒ 3.69 ƒ 5.69 ƒ 3.79 ƒ 5.79 ƒ 3.89 ƒ 5.89 ƒ 3.99 ƒ 5.99 ƒ 4.09 ƒ 6.09 ƒ 4.19 ƒ 6.19 ƒ 4.29 ƒ 6.29 ƒ 4.39 ƒ 6.39 ƒ 4.49 ƒ 6.49 ƒ 4.59 ƒ 6.59

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