Underspending in Bad Times

How to people respond to getting less income than they expect?

Posted Feb 18, 2019

Geralt CC0 via Pixabay
Source: Geralt CC0 via Pixabay

You have probably had times when money burned a hole in your pocket. Perhaps you got a gift from a relative when you were young and immediately went out and spent it. You might have gotten a bonus or tax refund and used it to splurge on something you really wanted.

There is lots of evidence that windfall gains lead people to spend more. A windfall is an unexpected gain in money. One great example of this kind of spending is what is called the house money effect. People take more risks after a gain in money. This effect is named after what happens when people go to casinos and have an early win. They get riskier, because they think of themselves as playing with the “house’s” money rather than their own.

This also happens with people’s spending habits in general. When the economy is good, people often stock up on luxury purchases like new televisions, cars, and furniture. Of course, we all know that the economy is cyclic, so good times are often followed by bad times. Yet, people spend based on their current income, without taking into account what might happen if there is an economic downturn.

What happens when times are bad, though? Does people’s spending go in the opposite direction? That is, do people actually spend less money than they should in bad times? While there has been a lot of research on overspending in the face of windfalls, there is less work on what happens when times are bad.

There is an observation that people can sometimes take risks when there are losses as well. Just as people may take risks when playing with the house’s money, they might also take risks when trying to “break even” after a period of gambling losses. But, it is possible that what people do in the context of casino gambling is not what they would do in situations that resemble spending income.

An interesting paper by Allessandro Del Ponte and Peter DeScioli in the February, 2019 issue of Cognition explored spending behavior in an experimental setting to see what happens when there are both good and bad days.

In one set of studies, participants were told that they lived on a fictitious deserted island in which they could only eat oranges to survive. They started with a small stock of oranges and a certain number of “health points.” They were told that they would lose 50 health points each day. The first orange they ate each day would give them 10 points, then next gave them 9, then 8, and so on. When they reached zero points, they would die.

Each day, they went hunting for oranges. Some days, they received a lot of oranges and some days they received few. In the extreme payments condition, they got 10 oranges on good days and 0 on bad ones, where half the days were good and half were bad. In the moderate payments condition, they got 7 oranges on good days and 3 on bad ones. In each condition, the average payment was 5 oranges.

Simulations showed that the ideal strategy is to figure out the average payment and eat that many oranges each day. That strategy allows participants to “live” longest.

In fact, participants choose to eat more than the ideal number of oranges on good days and fewer than the ideal on bad days. This happens both when the payment differences were extreme and when they were smaller. The researchers obtained this effect in studies with a number of different cover stories including monetary payments as well as situations in which people were trying to budget for a country based on the economy.

This research suggests a general strategy in which people match their level of spending to their income in the moment rather than spreading it out over longer periods of time. A strategy like this might make sense in highly dynamic environments. However, we can often do a pretty good job of forecasting our economic circumstances. Yet, we still use this strategy.

Ultimately, we might be better off putting a little extra money away in the good times to help even things out when times are not going so well.

References

Del Ponte, A. & DeScioli, P. (2019). Spending too little in hard times. Cognition, 183, 139-151.