Milton Friedman and the Economic Efficiency of Gift Cards

Gift Cards

As is the norm these days, most (if not all) of us have received a gift card as a Christmas present instead of some other material object. In this post I would like to review Milton Friedman’s four ways of spending money, and analyze how gift cards fit his model.

Friedman presents four ways that money is spent. You can spend your money on yourself, spend your money on someone else, spend someone else’s money on yourself or spend someone else’s money on someone else. The first is the most efficient way to spend money, the last is the least and the second and third categories are roughly equal. The second and third categories are where we find the efficiency of gift cards.

Friedman Money Categorization

First, let’s consider spending money through a gift card.  This is an instance of spending someone else’s money on yourself. Here you don’t exactly pinch pennies, but you still do try to get a great value. You think to yourself, “What could I get for $25 without going really over?” You may not buy something you need, but that you might like to have. I don’t know about you, but I try to pay less than $5 out of pocket (that is, whatever amount is left over after the gift card is applied).

The trick to maximizing efficiency when spending a gift card? Stop believing that the money was someone else’s and understand that the money is yours. It’s easier to conceive that idea if you have cold, hard cash in your hands. Though you’re still tempted to spend cash as if it were someone else’s, you do have the other option to save it.

     If you felt a little bad about merely buying a gift card for someone this year, don’t. It could have been worse.

Now let’s consider spending your money on someone else, or you purchasing a gift card for someone. I’ve found this category interesting for gift cards. You might think to yourself, “I’m sure Uncle Joe would love a gift card to Dick’s Sporting Goods” or “Aunt Mary would use a gift card to Starbucks.”  You know that being the frugal couple Uncle Joe and Aunt Mary are, they probably wouldn’t go spend money at those places were it not for a gift card. So, you help make it happen.  It is a gift; you’re being generous by spending a little bit more on them than you would yourself.  But this isn’t why I find this category interesting.

What makes gift cards economically efficient is that you allow the individual spending the money to decide how it should be spent.  After all, they are the ones that know how they would like to spend it (or they’ll soon figure it out).  This is efficient because you don’t have to guess what they will want.  Isn’t it the worst when you buy someone a gift and they don’t like it or never use it?  Those are cases where your money was poorly used, which fit in the upper right category because the individual doesn’t use the gift (which represents a monetary figure).  You might as well have bought your relative’s dog a bone, because at least she would have enjoyed the treat.

So, if you felt a little bad about merely buying a gift card for someone this year, don’t. It could have been worse.

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