The introduction of the Euro as a common currency in 12 European countries on January 1, 2002, raises an interesting question: How will consumers perception of value be affected by the new currency?
Dilip Soman, Associate Professor of Marketing at the Hong Kong University of Science and Technology, and INSEADs Klaus Wertenbroch, Associate Professor of Marketing, and Amitava Chattopadhyay, the LOréal Chaired Professor of Marketing, Innovation & Creativity, explore the topic in their recent study of how the denomination of money, or its numerosity (the number units into which it is partitioned), affects ones perception of its value.
As it turns out, studies can be traced back to the 1940s, when research on chickens showed that one kernel split into four pieces serves as a better reinforcer than one single kernel. Similarly, a 1989 study revealed that rats prefer eating four, 75mg pellets of food to a single 300mg pellet. And economic literature as far back as 1920s has suggested that people tend to focus on nominal rather than real value when making economic decisions, a phenomenon called money illusion.
What does that mean in terms of cold, hard cash? The authors began with past studies that show when the nominal value of the foreign currency is a multiple of the home currency, consumers are likely to spend less, versus a foreign currency that is a fraction of the home currency. For example, look at a candy bar that costs the equivalent of one US dollar in the US, Canada and the UK. The US consumer will likely buy fewer candy bars in Canada, where they cost $1.50 Canadian dollars each, than in the UK, where they cost £0.67.
If you begin investigating these aspects of money illusion in relation to the introduction of the Euro, perceptions are rapidly changing. Last year, an Italian consumer paid more than two and a half million lira for a computer that he can now buy for 1300 euros. What might the effect be on individual consumer choice, consumption patterns, competition, and inflation?
The authors look to answer the question in six controlled experiments at the individual consumer level. Using respondents in the U.S., Hong Kong, Germany, and at the new INSEAD Social Science Research Center in Paris, the researchers look at how the numerosity framework affects the perceived value of money and prices under conditions of different nominal prices and budget constraints, for example, when prices and budgets are given in the same currency, when prices and budgets are given in different currencies, when budgets are not salient to consumers, or when prices of different brands are compared.
The results could indicate important long-term economic implications for consumer demand, in terms of an inflationary (or even deflationary) boost in price levels in the economy as a whole, well beyond that observed due to upward rounding of prices due to the Euro introduction in recent months.