My friend recently went on a business trip to London. While his company arranged for the air tickets and hotel accommodation, my friend had to initially pay for his incidental expenses (primarily food), and later get the amount reimbursed. He preferred an expense account and was not happy with the reimbursement policy. Many companies, however, follow such a policy. Why?

Suppose my friend's employer provides him an expense account. My friend, though not adventurous when it comes to food, would be nevertheless tempted to try exotic dishes. His company, after all, was directly paying for the expenses!

You may argue that an expense account is no different from a reimbursement. That is not entirely true. The employer is in a better position to control expenses using a reimbursement policy; it can reject claims that are extravagant. And if your claims have been questioned once, you may spend wisely the next time around!

Deadweight Loss

Such a spending behaviour goes against the basic principle of economics. We are supposed to buy a product only if we expect to derive complete satisfaction from it. The decision to typically indulge when we are on an expense account suggests that there is deadweight loss. This refers to the difference in the price that we pay for a good and the satisfaction that we derive from consuming it. Suppose you pay Rs 500 but receive only Rs 350 worth of satisfaction, the deadweight loss is Rs 150.

Gifts typically have deadweight loss - the satisfaction your friend derives from the gift you gave is typically less than the price you paid for it! But it is not often that we incur deadweight loss on ourselves. Such a situation occurs when we spend on goods that we have not consumed before. You will have positive experience if your choice turns out right; deadweight loss occurs when you fail to get the required satisfaction. By offering a reimbursement and not an expense account, your company is discouraging you from incurring large deadweight loss.

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