According to new research from the Stern School of Business, when tourists pay with foreign currencies, they will overspend or underspend, depending on the exchange rate. In a recent study published in the Journal of Retailing, Priya Raghubir, research professor of marketing, Vicki Morwitz, Harvey Golub Professor of Business Leadership, and PhD student Shelle Santana examine how tourists convert foreign currencies to make spending decisions.
The study titled “Europoly Money: How Do Tourists Convert Foreign Currencies to Make Spending Decisions?” reveals that tourists suffer from the “money-illusion” effect. For example, when an American travels to Japan where the exchange is $1 = 78 yen, they tend to underspend. A price of 800 yen can be off-putting when, in reality, it’s just a little more than $10. The reverse happens when the foreign currency is a fraction of the home currency.
Consumers succumb to the “money-illusion” effect because they use the face value of the product price as a starting anchor to make their purchase decision and inadequately adjust for the exchange rate. When exchange rates make conversion difficult (e.g., $1 = 42.50 Indian rupees), people naturally tend to round (e.g., $1 = 40.00 rupees). Using this sample conversion rate, an American tourist in India is likely to overspend as a result of rounding down. Consistent with the money-illusion effct, tourist spending in continental Europe was higher than in non-Euro countries after the changeover to that currency, which researchers refer to as the “Europoly effect.”
This is especially important because, according to the World Tourism Organization, tourism expenditures are the world’s largest exported product. In 2010, nearly one billion people traveled to a foreign country, and their total expenditures and transportation costs totaled more than $900 billion.
“Tourism expenditures have important implications for the economies of visited nations, domestic prices, wage rates, and consumer welfare,” the authors write. “So this research is of interest not only to academics, but also to business owners and marketers catering to foreign clientele.” The authors advise travelers to be aware of their natural biases and exert extra care when evaluating prices in unfamiliar currencies. They point to calculators and apps on mobile devices as helpful tools to accurately compute currency conversions.