The Impact of Income Framing on Spending and Saving

Abstract (via booth)

All income increases a person’s absolute wealth, but consumption decisions may be based more heavily on perceived changes in wealth. Change is computed by comparing  a current state with a former state, and we predicted that people would be more likely to  spend income framed as a gain from a current wealth state than income framed as a  return to a prior state. Four experiments confirmed this prediction on people’s memory for spending of a government tax rebate (Experiment 1), on unobtrusive self-report measures of spending an unexpected windfall (Experiments 2 and 3), and on actual spending on items for sale in a laboratory experiment (Experiment 4). These results can be explained, at least in part, by the reference points implied in the framing of income (follow-ups to Experiments 1 and 4). Discussion focuses on implications for the consumption of other commodities, assessments of risk, and government tax policies.

Excerpts (Via Booth)

In this paper we suggest that whether people save or spend any particular piece of income, such as a tax windfall, depends critically on how they perceive changes in their overall wealth state, rather than simply how they perceive their absolute wealth state. Traditional economic theory makes no distinction between the two, and assumes that the marginal propensity to consume (MPC) is largely a function of a person’s absolute wealth (Keynes, 1936)—the greater a person’s overall wealth, the more he or she will actually spend. Although the percentage of spent income is predicted to fluctuate systematically over one’s life to maintain a consistent level of consumption (Modigliani, 1986), and overall spending is predicted to change only for permanent rather than temporary changes in income (Friedman, 1957), income is assumed to be fungible (i.e., without labels or accounts) and hence consumed without regard for its source or contextual circumstance. If a person’s current MPC is 0.6, then 60 cents of each dollar earned will be spent and 40 cents will be saved.
Both psychologists and psychologically-minded economists, however, have questioned this assumption (Arkes et al., 1994; Fogel, 2004; Heath & Soll, 1996; Kahneman & Tversky, 1984; Shefrin & Thaler, 1990; Thaler, 1990; Warneryd, 1999). Few stimuli in the environment, after all, can be evaluated absolutely but instead must be evaluated in comparison to some standard or reference point. People are tall, attractive, or happy, for example, only in comparison to others who are shorter, uglier, or sadder. As Kahneman and Tversky put it, ‘‘our perceptual apparatus is attuned to the evaluation of changes or differences rather than to the evaluation of absolute magnitudes’’ (Kahneman & Tversky, 1979). This suggests that decisions about whether to spend income may depend more on changes in wealth rather than on absolute wealth (Fogel, 2004; Thaler & Johnson, 1990), and are therefore influenced by comparisons with existing standards or reference points. When considering one’s income, the default reference point is the status quo, or one’s current wealth, and changes in wealth therefore are perceived as a relative gain or loss from that reference point (Kahneman & Tversky, 1979).

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26. September 2009 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

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