If a third party pays for an individual to consume a good, how is the decision making of consumers affected? How does this affect the actions of suppliers?

Answer 1

When spending their own money, consumers will search for the best deal and patronize those suppliers who provide them with the most value per dollar of expenditure. When someone else is paying all or most of the bill, however, consumers will tend to patronize those suppliers thought to provide the highest quality. Why worry about either price or quantity consumed when someone else is paying the bill? Thus, third-party payments reduce the price sensitivity of consumers and encourage them to choose both a higher quality and larger quantity than would be the case if they were paying with their own money.

Because consumers are less sensitive to price, suppliers have less incentive to provide their goods and services at economical prices. Rather than providing value per dollar, suppliers get ahead by providing higher quality (including services that are only marginally related to the primary good) under a third-party payment system. Predictably, both prices and expenditure levels will tend to increase rapidly when the cost of a good or service is paid for by a third party.