The Economics of Gift Giving

Here’s something interesting to consider: if we really care about our loved ones’ best interests, we ought to reconsider giving them gifts other than cold hard cash.  I already know what you’re thinking — giving cash, how tacky!  How can it possibly be better to give our loved ones cash instead of gifts?  This may sound strange to the non-economist, so allow me to explain.  Before reading on though, please heed the following warning: I don’t generally recommend taking romantic advice from economists.  You’ve been warned.

So here’s the issue: gift giving (non-cash gifts) is often a potential source of what economists call deadweight loss.  According to the theory of consumer choice the consumer (i.e., the receiver of the gift) knows more about what will maximize their utility than the gift giver does.  Accordingly, if we really care about allowing the receiver of the gift’s ability to maximize their utility, we should only give cash as a gift.

Consider a hypothetical ugly shirt that you received on your last birthday from your great aunt.  Let’s suppose that the shirt was purchased from Gap for $39.99, but let’s also suppose that you only value at, say, $10.  Now, think of all the other things you might like to do with that $39.99 that don’t involve owning an ugly shirt.  The difference between the price of the ugly shirt and the amount you value at it after receiving it is the deadweight loss.  Notice that the deadweight loss destroyed almost 75% of the gift’s original value.  Your estranged aunt who gave you the Gap shirt could have improved your financial welfare by $20.99 if she had simply given you cash instead of the shirt.

Interestingly enough, I recently stumbled across a paper by the economist Joel Waldfogel called “The Deadweight Loss of Christmas“.  In the paper, he conservatively estimates that the deadweight loss of all 1992 gift giving was roughly $4 billion (yes, that’s billion with a “b”).  In Waldfogel’s book, Scroogenomics, he claims that Americans spent $66 billion on gifts in 2007.  However, the gift recipients only valued the gifts they received at $54 billion, producing a near $12 billion deadweight loss.  Holy smokes!

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Here, then, is the interesting question: why don’t people give cash as gifts more often?  The reason, I think, is that giving cash signals that one has money and that’s about it.  And gift giving is really all about signaling, not helping others maximize their utility as efficiently as possible.

Giving cash may be the best way to ensure that the gift recipient can maximize their utility, but it doesn’t really signal anything of importance to our loved ones.  I’m not all that wise, but I am wise enough to know that giving my girlfriend a $100 bill for her birthday is not a prudent thing to do.  This is true no matter how romantically I wax poetic about the potential for deadweight loss.  Alas, there is more to romance than efficiency!

To put it simply, anyone can give her cash.  She expects me to signal that I’m closely in tune with her by showing her that I listen and know what gifts she would like.  It’s certainly a possibility that I could make a major financial gaffe when it comes to picking out a gift, but I suspect that my attempt at signaling is more important to her than is my concern that her utility be maximized.  Obviously, if I were to spend $100 on a gift that she valued at $100, it still wouldn’t make her any better off than if I just gave her cash.  This is because she could simply buy the gift with the equivalent amount of cash I gave her.

Is it possible that gift giving is sometimes purely selfish too?  Absolutely!  Giving gifts can be used as a means to control people.  The gift, then, is not a gift at all, but a way to make the recipient feel guilty and in emotional debt.  It sounds sinister and it is.  However, I think it occurs more often than most of us realize.  I think many parents (both strategically and inadvertently) do this to their kids sometimes.  My parents, however, have never done this to me and I’m very thankful for that!

In case I haven’t made it abundantly clear, I don’t think we should give non-cash gifts because we want to help our loved ones maximize their utility.  As I’ve mentioned, giving cash is certainly a more efficient way to do that.  Rather, I think we should give gifts because they can make for great signals.  And sometimes the signals have to be incredibly inefficient or wasteful, otherwise they don’t work.  Ultimately, the practice of gift giving is a terribly inefficient and costly way to help our loved ones; however, it’s an amazingly cheap way to signal how much we care.

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3 Comments on “The Economics of Gift Giving”

  1. Excellent post! Economics often assumes that people are ‘rational’, but in the sense it is assumed, people are not, not all, and not always. Hence, ‘efficiency’ alone doesn’t work in practical life.

  2. Kelvin Kf Tai says:

    This is why the gift card arised as a balance between cold cash and hard gift yo minimize the deadweight loss as low as possible


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