Why Free Things Can Cost A Lot (And Make Your Brain Freeze)

  • Share
  • Read Later
TIM SLOAN / AFP / Getty Images

News that Slurpee sales spike on days when 7-Eleven gives Slurpees away got us wondering why — well, it got our editors wondering why — and we think we have an answer. So, in this Mind Over Money post, we’ll explain how virtue can sometimes lead to vice. In this case, how getting something for free can lead us to spend money we might have otherwise saved.
Superficially, the free-Slurpees phenomenon is easily explained: Slurpee fans are drawn by an offer of free-but-tiny (7.11 oz.) cups of frozen goodness, and because they’re getting a free Slurpee they bring others (kids, pals, co-workers) to join in the brain-freeze fun. But no one wants to stand there chugging a half dozen mini-Slurpees until they get their fill, so the next obvious step is to buy regular-size Slurpees for everyone before heading off to the Cardinals game. (Hey, it’s our hypothetical.) Mystery solved! Except there’s more to the story than that. And to explain, we’ll have to take you to a subject far from the pleasant precincts of frozen drinks and convenience stores.

(MORE: Finally, Money Advice That Will Make You Skinnier)

We’ll begin by reminding you of mental accounting, a concept whose ubiquity in behavioral economics is exceeded only by its importance. First described by Richard Thaler, mental accounting deals with the many ways people organize their thinking about money — or any valuable resource — depending on the amount, its source, its presumed use and where it’s kept. One interesting facet of mental accounting is how a gift, bonus, newly discovered bank account or other “found money” — say, free stuff from a retailer — can affect our spending and saving patterns. Although small and large chunks of found money both feel great, large amounts are more likely to make you think of saving, while small amounts will more likely lead you to spend. So, if you receive a small gift — say, $100 — you’re more likely to buy a $100 shirt than you are if you get a $1,000 surprise, even though you can afford it more in the second situation. It seems the more money we get the more seriously we view it, and “serious money” (which makes us happy and thoughtful) tends to get saved more often than lesser amounts (which just make us happy). In technical terms, small gifts increase our marginal propensity to consume (MPC), while large gifts boost our marginal propensity to save (MPS). This is not obviously a bad thing — after all, it’s found money — except for one problem: Small amounts of gift money can boost your MPC by more than what you “found” in the first place.

(MORE: The Case for Financial Procrastination)

We know this thanks to an economist at the Bank of Israel named Michael Landsberger, who years ago studied a group of Israelis receiving regular payments from the West German government after World War II. Although these “reparations” were certainly earned — they were intended to make up for Nazi crimes — they were also, basically, found money. And so, by studying these people and their finances Landsberger could see how these windfalls affected each recipient’s spending and saving rates. The results were truly surprising. Folks who got the largest checks had a spending rate of about 0.23. That is, for every dollar they received, their MPC increased by 23%. The rest was saved. But the group that received the smallest checks had an MPC of 2. That is, for every dollar of reparations they received, they spent $2. Now, there are a lot of factors that may contribute to this, but at least part of the explanation can be found in the experience of a friend of Gary’s (a story we first told in our book). This friend worked overseas for a U.S. company, and while on vacation in New York he stopped by headquarters and received a surprise $400 bonus. Lucky, right? Maybe not. By the end of his trip, Gary’s pal realized he’d spent that $400 about five times over. When in a store or restaurant, he regularly used his bonus to justify all sorts of purchases.

Our bet is that the smart suits at 7-Eleven know something crucial about so-called free giveaways. Customers who get them feel a little richer for the experience — not rich enough to consider socking away their “savings,” but rich enough to think about spending it. Over and over and over again.

0 comments
Sort: Newest | Oldest