Cash versus installment purchasing: contrasting axiomatic and experimental approaches to a new concept

This paper has a dual thrust. First, it provides a parsimonious theoretical investigation into a commonly vexing issue, that of the vast discrepancy between what people are willing to pay in a lump sum and the total present value of installments to which they are willing to commit. An annuity may be regarded as a multi-attributed bundle of monetary amounts and time spacings. The classical Present Value, or discounted cash flow, formula using a market interest rate is only one among many multi-attribute valuation functions which may conceivably apply for a given decision-maker. By use of a concept of a “now-equivalent” for an annuity, and some simple assumptions, we show that there exists a personal interest rate that must be at least as high as the prevailing market interest rate. Several implications are noted. In particular, it is argued that cultural pricing habits such as routine use of monthly payments may lead to confusion about the meaning of demand for credit. A second contribution of this paper is to demonstrate the power of the axiomatic methodological approach, by showing how it can parsimoniously yield insight into an issue commonly viewed as purely behavioral and only amenable to empirical treatment.