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Use simple to decorate cutout cakes as an alternative to expensive character cakes. There are oodles of books and craft magazines available that illustrate how to take ordinary round, square and sheet cake pans and create any number of popular designs. Check your local library, craft or family magazines, or an online bookseller to find a book with cutout instructions. Another alternative to character cakes is simply putting plastic standups on a sheet cake. There are many popular character standups at craft stores. You could use the action figure(s) or doll(s) you were going to give as one of the party honoree's presents as a cake topper. Many come with plastic stands that would make it easy to stand the character on the cake without clean up becoming an issue. Making the birthday cake yourself goes a long way to help defray party expenses.
Party favors are another big expense. Look for these at close-out stores, paper supply stores, and at local retail stores after a holiday. For example, I got twenty bottles of bubbles for a birthday party after New Year's Day. Each bottle had "2000" on it, but the birthday party occurred in the year 2000, and all the children cared about were having their own bubbles to blow. I got the case of bottles for a third of the regular price. Anticipate the expense of party favors prior to planning your party. Discounted Valentine candy provides a wonderful, economical party favor for March, April or May birthdays. Same goes for discounted Easter, Halloween and Christmas candy. In addition, some holiday novelties can also be appropriate for use as party favors. Rings, hats, masks, and small toys always bring smiles to little faces. In addition, small bags available for the holidays can make good party favor bags if you're able to find some that don't have the holiday theme obviously emblazoned on the bags. I once ran across snowmen bags that I was able to use for party favor bags and small gift bags all winter long.
If you're still unable to afford party favors, give each child a lunch bag in which to gather loot, and let the children have a piñata. Some piñatas are expensive, but if you're creative, you can make your own using a blown up balloon, some glue and construction paper.
Games aren't expensive, but still you spend a lot of dear time wondering what you'll do with your child's guests once you get them at the party. Cake, ice cream and opening presents can only take up so much time. One alternative is to have a theme party. Say, you have a pirate party. With a shoebox decorated to become a treasure chest (with the party favors inside) and a treasure map, children can have a good time pretending to search for buried treasure (under a blanket or in the sandbox will be buried enough for little pirates). For older children, your theme might correlate with a holiday, and you could rent movies relating to your theme. For girls, you could have a makeover party, in which they could do each other's hair, makeup and nails. You could even make "glamour" photos of the girls after they have their makeovers, and this could serve as a wonderful memento for the party.
In short, use your imagination and let your children use theirs. Birthday parties don't have to cost a lot to be both memorable and fun.
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