Milton Friedman on Four Ways to Spend Money

In chapter 4 of his book Free to Choose, Milton Friedman uses a simple table to outline four ways to spend money based on whose money is spent, and upon whom it is spent. Combining these two factors give four possibilities shown in the following table:[1]

Four Ways to Spend Money

Category 1: You spend your money on yourself. For example, you buy food in the supermarket; you buy a hamburger for lunch. You have a strong incentive to economise and get full value for every dollar.

Category 2: You spend your money on someone else. For example, you buy gifts for someone’s birthday or wedding. As in category 1, you have a strong incentive to economise but less incentive to get full value, as judged by the person receiving the gift. If the objective were to allow the recipient to gain maximum value, you would give them cash. This converts category 2 spending into category 1 spending.

Category 3: You spend someone else’s money on yourself. You buy lunch on an expense account. You have a strong incentive to get full value but little incentive to economise.

Category 4: You spend someone else’s money on someone else. You buy someone else’s lunch on an expense account. You are on the committee of a community organisation spending your contributors’ money on your organisation’s programs; you are a politician or bureaucrat, spending taxpayers’ money on government programs. You have little incentive either to economise or get full value. In this last category of spending, we are likely to see higher costs and lower quality.

[1] Ideas paraphrased from Milton Friedman, Free to Choose, 1980, pp. 115-119

Leave a Reply

Your email address will not be published.

This site uses Akismet to reduce spam. Learn how your comment data is processed.