When Apparent Savings is Consumption

Simple Saving for a Bicycle, not so simple

You are the sole owner of a bicycle shop on the corner. A familiar neighborhood twelve year old boy has entered your shop and has obviously fallen in love with one of your $250 bicycles. After a few minutes, you approach him to check out the prospects for making a sale.

He indicates that he wants to buy the bicycle, but that he will need to save $25 per week from his $100 take home pay for 10 weeks to be able to purchase it.

You have the following options:

1. You can praise his choice and encourage his thrift. If you do this, your expectation of the probability of his returning in 10 weeks with $250 to buy the bicycle is 33%.

2. You can offer to put the bicycle on layaway for him until he can return with the $250 in 10 weeks. If you do this, your expectation of the probability of an eventual sale is 67%.

3. You can offer an installment payment plan. If he can get his father to co-sign a plan to pay $25 per week for 10 weeks, bringing in the signed plan along with the first $25 payment will result in him going home with the bicycle. This would seem to be an almost certain done deal.

If we compare the results of 3) and 1), the boy gets his bicycle 10 weeks earlier and the only difference in his $25 payments is in whose possession they are at what time. If he really intends to save $25 for each of 10 weeks to buy the bicycle in 1), the fact that the $25 increments appear to be accumulating in his cash balance is only a superficial difference from the boy's POV from 3), where they immediately flow to you week by week.

You have the advantages in 3) of an accelerated cash flow and a quicker turnover of inventory. This is win-win unless you were to lose a $250 cash sale in the meantime.

Proposed general implication:

The earmarking of income (or a part of an existing cash balance), either present, future, or both, for a specific consumption purpose, is of no essential difference in character from an immediate consumption expenditure. This is independent of when, or in what order, the consumption good is acquired and/or consumed and the income is expended, all of which can occur in stages.

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