Economics: Four Ways to Spend Money

Economics has always intrigued me. I remember a professor spending days lecturing about money supply, interest rates, demand, inflation, and other metrics; only to have me question her artistic theories with my observation of market realities. I appreciate the decisions people make relative to their own personal wealth and spending habits. 1

behavioral economics,Economics, Milton FriedmanEconomics has never been about carrots and potatoes, this oversimplifies the question of how people make decisions. All economic partners including governments, business, and consumers should actively study the actual choices people make as a reality check to their constructed theories and beliefs.

I believe in behavioral economics. I define behavioral economics as a combination of social-psychology, traditional economic/scarcity choice frameworks, and why generally sane people make some of the most seemingly irrational choices. I say irrational because their choices aren’t predictable under rational analysis.

Complex value choices surround us every day. Otherwise, why would anyone buy a Ferrari? Or, a Corvette for that matter. As an excellent presenter, Rory Sutherland 2 expressed most eloquently, “if the cost of vehicle transportation was the metric to be used for men to attract women, men would all drive lorries (English for Truck)”. I find this exquisitely logical and a reminder that value is both subjective and situational.

All of this leads to a simple consideration that there are four, and only four, ways to spend money:

  1. Money Spent on Yourself (think a new car)
  2. Money Spent for Another (think a gift for a friend)
  3. Other Peoples’ Money Spent on Yourself (think a reimbursed business)
  4. Other Peoples’ Money Spent on Other People (think of government)

I learned these lessons from my colleagues at the VeraSage Institute 3 where we leverage this concept in our pricing and modern business model related seminars. We have determined that the vast majority of people too frequently downplay the intricacies associated with people’s buying habits and such ignorance only exacerbates their all too frequent downward economic spiral.

Economics, Milton Friedman

Let’s consider why these four categories matter:

Quadrant 1: Spending my money on Me

Here I seek my best value. That doesn’t mean best price as price and value are separate. If say I am on the road traveling and for some reason, I need a crescent wrench to fix something in a rental car from rattling, a Dollar Tree or discount tool store model works just fine as I seeking the immediate utility of the tool. Whereas, if I am seeking one for my home toolbox, Craftsman, of course, I will seek out my options and consider alternatives because this is a tool that should last me a lifetime (at least that is how it worked BC {before children, now I understand my father much better}). Both are wrenches. Both will tighten and loosen. Both are used by the same person (me). Yet the two purchases are different as the situation and reason for purchasing and my expectations are different.

Quadrant 2: Spending my money on You

Here I seek good value. I don’t seek to maximize my value as I have one excellent option; I can give you the money and allow you to make the final decision (see why gift cards are so popular plus they have the added value that they are frequently never utilized {if you have a business that can profit from gift cards, even at a discounted price, you should consider their benefits – just saying}). In this situation, I am less interested in investing additional efforts to maximize the value. So I want to have good enough value. Think a bottle of wine as a hostess gift compared to one for your own anniversary. Gifts are different. This is why I can complete my holiday shopping in hours instead of days and months like others, I am aware of my quadrants.

Quadrant 3: Spending other people’s money on Me

Here I am less price sensitive as I benefit from the expenditure but I am not really the payer. This is why it is more expensive to fly on Mondays, Thursdays, and Fridays compared to Tuesday, Wednesdays, and Saturdays. Business people are spending company money and want to be home with their families and are not price sensitive. Whereas vacationers frequently spend hours and hours shopping Priceline and other discount options in order to maximize their value. Airlines and Hotels all have loyalty programs in large part to help reinforce sales to their most profitable market segments, business travelers.

Quadrant 4: Spending other people’s money On Other People

Here I reference government. A large bureaucratic organization is the same thing. This helps explain why a governmental body will spend what appears to be inexcusable sums of money on projects (regardless if you personally like the project or not – how money is spent matters). The people making the decision are never spending their own money (ignore their suggestions that they care for “your” money as if it is their own. Horse manure. They need to treat it as if it is not their money but our money. They can waste their own money on all of the Ferrari’s they desire but with my money, a Ford is just fine. When you are not spending your own money and you don’t benefit from it (example – purchasing toilette paper for some location a thousand miles away – what do you care if it is single ply and feels like sandpaper or if that hammer that you could buy for $15 costs $35) you are hassle sensitive and not price sensitive. It isn’t your money and you aren’t impacted. This is the same spending space that purchasing agents frequently find themselves and they are risk-averse so they purchase branded goods over alternatives. Even if the alternatives are superior. This is the background of “nobody ever got fired for buying IBM”. Quadrants matter.

Quadrants matter and not just today but tomorrow too. Quadrants matter during the election season as our candidates will be promising voters new or revised programs or cuts to some to benefit others. Think about where lobbyists fit into this discussion? What is their quadrant? They promulgate quadrant 4 spending on behalf of their quadrant 3 customers. Lavish dinners and rounds of golf at Pebble Beach are nothing if we can enhance a program that benefits the lobbyist’s customers. See it is perfectly reasonable that traditionally rational people are predictably irrational depending upon their quadrant.

Now the next time someone expresses their spending habits or purchasing desires, simply think out loud and say “that is Quadrant X spending” and you will have both an internal chuckle and an insight as to why people choose to spend their money the way they do.

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Daniel Morris
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  1. Photo: Thomas Hawk via Flickr

  2. Rory Sutherland is the Vice-Chairman of Ogilvy & Mather and an avid fan of behavioral economics.

  3. For more information on the subjective theory of valuation where value is solely based upon the evaluator simply search the Austrian School of Economics where there is plenty of information presented that clearly establishes that all value is subjective. This is a counter to the Labor Theory of Value that was promulgated by Karl Marx who valued all items based upon the amount labor necessary to build, farm, or crafts the items being evaluated.

    VeraSage Institute is a Think Tank I cofounded back in 2000 with Ron Baker and Justin Barnett. VeraSage is dedicated to assisting professional knowledge firms to develop improved business models including eliminating the concept of hourly pricing and its associated time-based value metric. Please visit www.verasage.com for additional information.


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