Monday, May 24, 2004

Ideas: Paying For What You Don't Want to Pay For

Did You Really Mean to Pay for That?

A friend is having problems and you want to help. Your friend is unemployed and has very little money. Unfortunately, he is also an alcoholic. This month he has $500 to spend. He can do various things with the $500: pay his rent, buy food, buy clothes, buy liquor, and so on. Let’s suppose that his priorities are to pay his rent first, then buy food, next buy clothes, and then buy liquor. If he doesn’t have enough money for everything, then he eliminates items beginning at the bottom of his list. In other words, the first item he would eliminate if he does not have enough money is buying liquor.

Well, at least your friend has his priorities straight. He is not willing to buy liquor instead of food, and he is not willing to buy liquor instead of paying his rent. Perhaps you believe that a person who his priorities straight and who needs help should receive some help. What is paradoxical, though, is that help may not always have the intended effect.

To illustrate, suppose your friend has to pay $300 in rent, $150 for food, and $50 for clothes this month. At these dollar amounts, his entire $500 will be spent on rent, food, and clothes. He will have no money left to buy liquor.
However, you choose this month to help your friend and so you give him $200. You tell him to use the money to buy more food or to buy a few more clothes or simply to keep the money for an emergency. But instead of buying more food or more clothes or saving for an emergency, your friend may prefer to buy liquor. True, buying liquor is lower on his list of priorities than paying $300 in rent, buying $150 worth of food, and buying $50 worth of clothes, but it may be higher than buying more food or more clothes or saving for an emergency.

What might your friend do with $700 instead of $500? It is likely that he will pay his rent ($300), buy food ($150), buy clothes ($50), and spend the remaining $200 on liquor. In other words, your charitable act of giving your friend $200 has given him the chance to buy liquor that he would not have purchased otherwise. Your intentions were good; you wanted to help your friend. But unfortunately, your action had an effect that you did not intend: it made it possible for your friend to buy liquor. From your perspective, your intention to make your friend better off ended up making him worse off.

Why Not Give Goods Instead of Money?
If you can’t make your friend better off by giving him $200 (he may just spend it on liquor), then why not give your friend goods instead of money? That is, instead of giving your friend $200 and telling him to spend it on food or clothes, you could simply buy your friend $200 worth of food and clothes.

Does giving goods (food and clothes) instead of money solve the problem? Is this the way for the charitable to make sure that their gifts are used in ways they want them to be used? Not necessarily.

To illustrate, again suppose that your friend plans to spend his $500 on food, clothes, and rent. He will not have any money left to buy liquor. Then, before he has fully spent his $500, you give him $200 worth of food and clothes. To keep things simple, we will assume that you give him $150 worth of food and $50 worth of clothes. Now that you have given him the $200 worth of food and clothes that he would have bought, he doesn’t have to buy $200 worth of food and clothes. In other words, he spends $300 (of his $500) on rent, you buy him $200 worth of food and clothes, and he has $200 (of his $500) to spend on anything he wants. It is as if you had simply handed him $200 cash. If he spends his $200 on liquor, then your $200 gift of food and clothes again would have had an unintended effect. It would have made it possible for him to buy liquor.

We conclude that whether you give your friend $200 cash or $200 worth of food and clothes, you make it possible for him to buy liquor that he would not have purchased otherwise.

Let’s Change the Example and See If We Get Different Results
For those who now think that it is impossible to obtain your objectives through giving, think again. A slight change in the example will bring about different results. Instead of your friend having $500 for the month, suppose he has only $300. You will remember that when he had $500, he planned to spend $300 on rent, $150 on food, and $50 on clothes. With $300 instead of $500, your friend cannot pay his rent and buy food and clothes too. If you give your friend $200, he will be able to pay his rent and buy food and clothes. But, he will not have enough money to buy liquor. In this case, your $200, if you choose to give it, will be used in a way that you deem acceptable.

What is the lesson? Simply, that your $200 gift will be used for whatever is next on your friend’s list that he cannot purchase without you. When he had enough money to pay rent and buy food and clothes, your money was used for what was next on his list—buying liquor. But when he had enough money only to pay rent, your money was used to buy food and clothes because these items were next on his list. The general principle is that the gift giver makes it possible for the gift recipient to do whatever is next on his or her “to do” list. If the next thing on the “to do” list is to buy a computer, then the gift giver makes it possible for the recipient to buy a computer. If the next thing on the “to do” list is to buy illegal drugs, then the gift giver makes it possible for the recipient to buy illegal drugs.

Why Professors May Say No to Review Sessions
Three days before an economics test, a student raises his hand and asks the professor, “Will you have a review session before the test?” The professor says, “No.” At this point, the students in the class might think that the professor is being selfish with her time and doesn’t care how her students do on the test. This might be true. Or, it might be far from the truth.

The review session can be seen by the students as something they don’t expect but would like to have. In other words, it can be viewed as a gift of sorts. But the professor may not want to give the gift of a review session because she knows that gifts sometimes cannot be given the way the gift giver prefers.

To illustrate, suppose the average student will study four hours for the test if the professor does not give a review session but will study only two hours if the professor does give a review session. So from the student’s perspective, the review session means that he does not have to study as long to get a certain grade. In short, what the professor gives (as a gift) to the student when she holds a review session is time. Specifically, she gives the student two hours of time.

What will the student do with those two hours of time? He will do whatever is next on his “to do” list. If the next thing on his list is “read a classic book,” then that is the gift given to the student. If the next thing on his list is “drink beer and watch television,” then that is the gift given to the student.

When the professor refuses to hold a review session, it is not clear whether she is selfish with her time and doesn’t care how her students do on the test or whether she wants to prevent her students from watching as much television and drinking as much beer.

What the Economist Thinks
• If you give money to a person and ask him to use the money to buy X, then even if he buys X, you might have paid for something other than X. For example, suppose a person has the following “to do” list: (1) Buy X for $100, (2) buy Y for $100, and (3) buy Z for $100. The person has only $100 to spend. You give the person $100 and ask him to use it to buy X. He does. Now he has $100 to spend on Y. It is just as correct to say that your money was used to buy Y as to say it was used to buy X.
• Giving goods instead of cash is no guarantee that your gift won’t make it possible for the recipient to purchase something you would have preferred she not purchase. For example, suppose a person has $100 and the same “to do” list as above. You know the person has $100, but you do not know the priorities of her “to do” list. In other words, you do not know that X is preferred to Y and that Y is preferred to Z. You want to make sure that the person consumes X, and you prefer that she not consume Y. So, you purchase X for her. You have made sure she will consume X (she would have done so anyway because X was at the top of her list), but you have also made it possible for her to purchase and consume Y. Giving the person good X had the same effect as giving the person $100 and directing her to purchase Y.

Questions to Answer
1. Why do people give to religious organizations and not to street gangs? (Hint: Consider each entity’s “to do” list.)
People feel that the next thing on a religious organization’s “to do” list is something they don’t mind the organization buying, but this is not the case for what is next on a street gang’s “to do” list.

2. A multimillionaire gives $5 million to a university with specific orders to use the money to build a new dormitory. The university complies with her orders. Did she pay for the dormitory? Explain your answer.
She may not have paid for the dormitory. The university officials might have spent $5 million on a new dormitory even if they didn’t receive the $5 million from the multimillionaire. Now they can use the $5 million they were going to spend on a new dormitory to buy something else. The multimillionaire might have paid for the “something else.”

3. Smith gives away about $10 million a year. When he makes a charitable contribution, he specifies how the money is to be spent. The people and organizations to which he has given any money always have complied with his wishes. One day, Smith realizes that the millions of dollars he has given away in the past might have made some things possible that he would prefer not to have made possible. Because he can no longer be sure that his money will be used exactly as he wants, Smith decides to reduce his gift giving. He decides to give away only $1 million a year. In short, his newfound knowledge has had the effect of reducing his charitable giving. Do you see this as desirable or undesirable? Explain your answer.
Answers will vary.

4. All other things being equal, who would be more charitable: the person who doesn’t care what is on a gift recipient’s “to do” list or the person who does care? Explain your answer.
The person who doesn’t care what is on a gift recipient’s “to do” list would be considered more charitable. The person who does care doesn’t know what is next on the recipient’s “to do” list but understands that it could be something she doesn’t want her money spent on. This may be enough to prevent her from giving a gift.

5. It is better to give than to receive. Comment.
Answers will vary. Maybe it is better to give than to receive, but most people seem to like receiving an awful lot.

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