Do consumers prefer 1 percent interest over 0 percent interest or is zero simply confusing?

November 15, 2010

Why would someone choose a credit card with a one percent interest rate over another with a zero percent rate? A new study in the Journal of Consumer Research finds that consumers are often flummoxed when it comes to zero.

"A reasonable assumption is that a product will be more attractive when it offers more of a good thing, such as free pictures (with a digital camera purchase), or less of a bad thing, like interest rates on a credit card," writes author Mauricio Palmeira (Monash University, Australia). But Palmeira's research found that consumer comparison methods tend to get confused when one of the comparison terms has a zero value.

For example, a consumer interested in a new credit card may need to choose between one with a $45 annual fee and a one percent interest rate and another with a $15 fee and a 20 percent interest rate. "One could view this decision as a choice between an extra $30 annually for a 19 percent reduction in interest rate. Alternately, it can be viewed in relative terms. In this sense, a $30 difference between $15 and $45 appears much bigger than the same difference between $115 and $145," writes Palmeira. Consumers tend to be more sensitive to relative rather than absolute differences, which is why a one percent interest rate looks good, since its interest rate is 20 times less than 20 percent.

But what if consumers compare a 20 percent interest rate to a zero percent one? "I argue that whereas a 20 percent interest rate may look very large compared to one percent (it is 20 times larger!), it may not look as large compared to zero percent. Zero eliminates the reference point we use to assess the size of things," Palmeira explains.

"This leads to a counterintuitive situation, in which a credit card can increase its likelihood of being selected when it has a small but non-zero interest rate," writes Palmeira. The same is true of other attributes that consumers want to minimize, like interest rates and fat content.

The inverse is true when desire an attribute. For example, if a digital camera offers a promotion that adds 200 free pictures to a purchase, a competitor may be better off offering nothing rather than just a few free pictures. "This is because 200 will look larger compared to 10 or 20 than compared to zero," Palmeira writes.

Explore further: Credit Card Users With Highest Balances Pay Lowest Rates

More information: Mauricio M. Palmeira. "The Zero-Comparison Effect." Journal of Consumer Research: June 2011. For further information, see ejcr.org

Related Stories

Credit Card Users With Highest Balances Pay Lowest Rates

June 20, 2005

People who hold credit cards with the lowest interest rates are not the ones you might expect – they're the borrowers who carry the highest credit card debt, according to new research. The assumption has been that credit ...

ND Expert: Fed’s rate cut risky for future

January 23, 2008

With the biggest one-day reduction of interest rates in history announced Tuesday, the Federal Reserve’s attempts to resuscitate the U.S. economy could be a mistake, according to University of Notre Dame economist Nelson ...

Interest rate shock could kick-start stock exchange

August 4, 2009

Norges Bank surprised most experts by cutting the interest rate by as much as 1.75 percentage points during the final interest rate meeting in 2008. Surprise interest rate changes like this, so-called interest rate shocks, ...

Consumers and their rights: A new study from Australia

May 18, 2010

Consumers tend to be cynical about the motivations of credit card companies, yet they lack the time or motivation to engage in political action to protect their rights, according to a new study in the Journal of Consumer ...

Recommended for you

Just how good (or bad) is the fossil record of dinosaurs?

August 28, 2015

Everyone is excited by discoveries of new dinosaurs – or indeed any new fossil species. But a key question for palaeontologists is 'just how good is the fossil record?' Do we know fifty per cent of the species of dinosaurs ...

Fractals patterns in a drummer's music

August 28, 2015

Fractal patterns are profoundly human – at least in music. This is one of the findings of a team headed by researchers from the Max Planck Institute for Dynamics and Self-Organization in Göttingen and Harvard University ...

0 comments

Please sign in to add a comment. Registration is free, and takes less than a minute. Read more

Click here to reset your password.
Sign in to get notified via email when new comments are made.