Understanding Hyperbolic Discounting and Spending Habits During the Holidays

Each holiday season, millions of people go over the budget they'd set for themselves, often regretting their actions after the fact. They make large purchases rapidly and then feel remorseful about what they did. The reason isn't that these consumers are undisciplined; seasonal marketing strategically exploits one of the most robust findings from behavioural economics: hyperbolic discounting.

In contrast to the rational agent of economic theory (exponential discounting), consumers display an overwhelming preference for short-term rewards, placing much greater value on immediate gratification than on something that may be available later. Conversely, potential future expenses are almost non-existent to them because they aren't tangible until the expense occurs. In this way, marketers specifically engineer holiday campaigns to take advantage of this cognitive bias.

The Economic Underpinnings

Prospect Theory provides one of the most significant insights into consumer decision making. Created by Kahneman and Tversky in 1979, Prospect Theory describes how consumers evaluate outcomes relative to a reference point rather than according to the objective value of the outcome. It also indicates that consumers demonstrate greater sensitivity to loss than to equal increases; that is, consumers fear losing what they have more than they like gaining new things—this is also known as loss aversion. When a promotional campaign ends, the consumer’s point of reference shifts so that they see the end of the promotion and the associated potential savings as a loss. Promotional holidays and last-minute half-off offers are incredibly effective marketing strategies because consumers perceive the end of a promotion as the loss of an opportunity to save money rather than simply the absence of a future gain.

Mental Accounting, a concept defined by Richard Thaler, refers to how individuals mentally separate their funds into separate mental budgets or spending categories. During the holidays, many people typically create a gift and party category for their spending. In this way, they often feel they can spend more freely than they might otherwise do because they have set up a specific category for their gift and holiday expenses. For example, when looking to buy an item costing £200 in March, a consumer may be uncertain about making that purchase. However, if that same consumer is now considering purchasing the same item in December, they may feel more comfortable making that purchase.

Additionally, the present bias is also a contributing factor. Simply put, because humans typically weigh present rewards more than future costs, many individuals who spend during the holiday season will likely regret that spending once they see the financial effect of the spending in January.

Real-World Example

Amazon Prime Day, which has become an annual event since its introduction, is an example of manufactured scarcity, which causes hurried decision making resulting in over $12.9 billion in online sales for Amazon over two days in 2023. Research suggests that consumers often experience regret after impulse purchases, particularly in high-urgency promotional environments such as Prime Day. Many factors cause this regret, among them are countdown clocks, low inventory messages, and lightning deals, all of which act as behavioural nudges that reinforce hyperbolic discounting by reducing the time available for careful evaluation. Platforms including Dreamina Seedance 2.0 are now being used by marketers to generate dynamic promotional video content at scale, further accelerating the speed at which urgency-driven campaigns can be deployed.

Coca-Cola's prolonged Christmas campaign is a good illustration of the application of the concept in practice. In the 1990s, Coca-Cola began building emotional connections with consumers through advertising campaigns as opposed to giving them useful information about the characteristics and use of the product. Christmas campaigns capitalise on salience bias by making holiday spending particularly prominent in consumers' minds. Emotional cues in the form of messages contained in the commercials of Coca-Cola (i.e. the red Coca-Cola truck, family gatherings) act as emotional triggers and make it easy to remember and purchase the products. The development of AI video generator tools have significantly reduced the cost of producing emotionally driven advertising content, allowing brands of all sizes to replicate the kind of high-production Christmas campaigns that once required substantial broadcast budgets."

Holiday Purchasing Impact on Society

Holiday spending by consumers has a significant impact on the economy. According to a 2023 LendingTree survey, American consumers incur, on average, $1,223 worth of debt as a result of holiday expenses. This is not necessarily due to consumers being unaware of the consequences, but because of continuous exploitation by merchants using the concept of present bias. Furthermore, the given amount of debt demonstrates the scale of consumer surplus gained by merchants due to the use of behavioural economics.

The field of behavioural economics holds both opportunities and dangers for the policymakers. The very same choice architecture, which makes people consume more as a result of present bias, can be utilised to increase the well-being of society. Possible examples of such practices would be automatic enrolment in savings, opt-out of charitable donations at point-of-sale transactions, and cool-off periods for large transactions. The approach to behaviour change known as "Libertarian Paternalism" suggested by Thaler and Sunstein could be used as a theoretical background for implementing counter-nudges while leaving freedom for consumers to make their purchasing decisions.

The patterns of holiday purchases show that the markets are populated not by the entirely rational "Homo Economicus" presented in the introductory economics. Markets include real people, who are predictably irrational, inconsistent in time and sensitive to countdown timers.