To a rational decision-maker, the possession of $20 translates exactly to the ability to buy $20 worth of goods. The form of the $20 should not matter—whether it is one $20 bill, two $10s, four $5s, twenty $1s, or any configuration of change, the purchasing power is the same.
However, humans are rarely perfectly rational, and this case is no exception. In the event that a person is given $20, that person is more likely to spend it if it is given in smaller denominations (for example, $1 bills or change) than if it is given in larger denominations (especially in the case of one $20 bill). This is known as the denomination effect.
A study by Raghubir and Srivastava (2009) tested this unusual outcome in three scenarios using real money. The first scenario involved students receiving one dollar for participation in an experiment, the second scenario involved drivers at a gas station receiving five dollars for participation in a survey, and the third scenario involved women in China receiving 100 RMB for participating in a survey. Some participants in each group were given their money in one single bill and others were given the money in multiple smaller bills or in change. Each participant was given the option to spend the money right away or keep it. Despite the different contexts and participants, in all three scenarios participants who were given money in smaller denominations were more likely to spend compared to those who were given money in larger denominations, even though the amount of money within each test was the same.
Once the phenomenon had been observed by researchers, a second part of the study was conducted to explore possible explanations. Participants were given a hypothetical scenario involving a savings budget which had either been met or not been met and a $100 participation reward in either one $100 bill or five $20 bills. Then, participants were asked how likely they were to spend that reward. The study found that those who wanted to save more (those who were randomly assigned to the group that had not met their savings budget) generally preferred to receive large denominations (Raghubir & Srivastava, 2009), and it was indicated that participants saw this as a means of aiding their self control. Furthermore, “the results suggest that large denominations are perceived to be less fungible than smaller ones” (Raghubir & Srivastava, 2009).
The denomination effect, then, appears to be highly connected to the ideas of framing and loss aversion, two other cognitive biases which often impact people’s economic decisions. It also reveals one way in which people think about money somewhat separately than they think of value. Spending, for example, $5 by giving up a $20 and receiving change is felt differently by consumers than giving up a $5 bill, even though the total value is the same. A larger denomination of money feels more significant to part with, and that feeling is not completely erased by receiving change.
Raghubir, P., & Srivastava, J. (2009). The denomination effect. Journal of Consumer Research, 36(4), 701-713. DOI: 10.1086/599222