The Deadweight Loss of Christmas (1993)
The American Economic Review 83(5), 1328-1336, URL
Welcome to the Christmas edition! Similar to last week, I couldn’t resist the temptation to exploit the date of this week’s AGNOSTIC Paper. As a rare exception (and due to the date), this one is not about finance and investing. Instead, we will look at the economics of Christmas gifts…
Everything that follows is only my summary of the original paper. So unless indicated otherwise, all tables and charts belong to the authors of the paper and I am just quoting them. The authors deserve full credit for creating this material, so please always cite the original source.
Many non-cash gifts are economically inefficient
Even if it sounds a bit crazy at the beginning, the idea of this week’s paper is actually quite simple and most of us probably experienced it ourselves… Imagine the following situation: It is Christmas Eve and you celebrate with the extended family. Some distant relative, whom you don’t really know and who doesn’t know you either, wants to be kind and presents you a gift. While this is a noble gesture, the gift is unfortunately completely useless and you would have never spend a dime on it yourself.1My grandfather gifted me a USB reading light last year. A kind gesture, but I would never even remotely think about spending money on this….
For normal people, this is just a slightly embarrassing moment at the dinner table. But for economists, this is close to a nightmare. Why? Because it is an inefficient outcome. Suppose the gifting person spends $50 on something that is completely worthless for you. This is a really bad deal! The gifting person is $50 poorer, but in terms of utility, you are not better off with the gift than before.2Utility is a basic concept of economic theory. Think of it as a measure for happiness that depends on a person’s individual preferences. So in aggregate, the gift destroys utility worth $50. Economists call this a “deadweight” loss.
Where does this deadweight loss come from? The problem is imperfect information. The gifting person don’t know what exactly we like and how we would spend $50 for ourselves. So people can only estimate what might make you happy. Depending on their estimate of your preferences, the deadweight loss of the gift fluctuates accordingly.
This already brings us to the solution for the problem. To minimize the deadweight loss of gifts, you must simply learn what the recipient likes. For example, my girlfriend usually knows exactly what I want and how much I would be willing to pay for certain things.3When I told her about this paper and congratulated her for her deadweight-loss-free gifts, she still found it somewhat crazy… Her gifts therefore have typically no deadweight loss and are pretty efficient.4Except when she gifts me something that she want me to do.
If you cannot (or want not) learn about the preferences of the recipient, there is also another solution. Just give money. Although money doesn’t provide the same utility to every person, it allows everyone to act according to her own preferences. If I give you $50, you will typically not spend the money on something that you don’t like. So when I give up $50, you buy something that provides you utility worth $50 and there is no deadweight loss. Problem solved.5Not quite. Many people don’t like cash gifts because they are not thoughtful enough. As an economist, I cannot understand this. But as I already mentioned, normal people find this entire analysis somewhat crazy…
Before someone complains that I am too negative on gifts and only advocate cash gifts, the effect can of course also turn around. This is the rare situation when someone gifts you something you thought you didn’t need, but that actually makes you happy after you got it. However, I would argue that this is rather the exception than the rule. In most cases, you end up with useless and inefficient gifts after Christmas…
The deadweight loss of Christmas is in the billions
The author of this week’s paper uses microeconomic theory and a survey of 86 Yale students in the year 1993 to scientifically analyse the deadweight loss of Christmas gifts. The results are fully in line with the ideas above. By and large, Christmas gifts are economically inefficient and produce a deadweight loss of about 10-30% of the gift’s value. This is substantial! According to estimates, Americans are expected to spend $178B USD on gifts in 2022. Based on the estimates from the paper, these gifts thus produce a deadweight loss between $17.8B and $53.4B. And the number gets even worse when you also consider the time spent buying all these useless gifts… The author also finds that the deadweight loss increases with more distant gift-givers. This is in line with the idea that those people have less information about the recipients preferences.
I know it is too late for this year because the gift-shopping for Christmas 2022 is already over, but the takeaway should be clear. If you don’t know what the recipient likes, you must either learn more about her preferences or just give money. In that sense, I wish you a lot of efficient gifts.6I also hope that you interpret this article as what it is – a supposed to be a funny special edition that is not meant too seriously ;) Merry Christmas!
- AgPa #72: Machine-Reading of Private Equity Prospectuses
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- AgPa #70: Equal vs. Market Cap Weights
- AgPa #69: Rebalancing Luck
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|1||My grandfather gifted me a USB reading light last year. A kind gesture, but I would never even remotely think about spending money on this….|
|2||Utility is a basic concept of economic theory. Think of it as a measure for happiness that depends on a person’s individual preferences.|
|3||When I told her about this paper and congratulated her for her deadweight-loss-free gifts, she still found it somewhat crazy…|
|4||Except when she gifts me something that she want me to do.|
|5||Not quite. Many people don’t like cash gifts because they are not thoughtful enough. As an economist, I cannot understand this. But as I already mentioned, normal people find this entire analysis somewhat crazy…|
|6||I also hope that you interpret this article as what it is – a supposed to be a funny special edition that is not meant too seriously ;)|