The Deadweight Loss of Christmas (revisited)

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Economics is about the efficient allocation of resources. But gift giving is anything but efficient. From a purely transactional point of view, wouldn’t Uncle Jim be better off if you just handed him $50 than spending that $50 on another ugly sweater for him?  Why guess what the other person wants?  Perhaps a $50 gift card from Walmart might work, but what if what Uncle Jim really wants is not sold at Walmart?  Instead, what if you just give him $50 and he gives you $50?  Wouldn’t that be the most efficient gift exchange of all? 

Joel Waldfogel presented and analyzed this problem in the December 1993 issue of The American Economic Review in an article entitled: “The Deadweight Loss of Christmas.” For close relationships such as a good friend or significant other, the loss of efficiency from gift giving may average about one-tenth of the value of the gift; whereas, for more distant relatives or friends, the loss of efficiency may average closer to a third of the value of the gift. 

It is clear that social relationships are different from economic relationships. The problem is that economics students are taught to view the world from a purely transactional point of view. This doesn’t mean that we don’t care about other people, but just that economists don’t generally consider “intent” as important. But it is important. Meaning may be imbued into a gift by virtue of the fact that the gift-giver meant well, even if the gift was not optimal to the recipient given the amount paid for the gift. Gift giving is associated with good intent, but behavior can also be distorted by bad intent. Having your car dented in a hail storm is much less upsetting that someone denting it with a hammer. 

How about all those great Thanksgiving dinners your mother-in-law made in years past? As you left, did you give her a tip, or pull $50 out of your wallet to pay her for the great meal? People who are trying to build or strengthen a relationship don’t want to be simply paid off for their efforts in some sort of quid pro quo manner. Social (noncognitive) skills are often more important than technical (cognitive) skills in navigating the real world. Unfortunately, most economic textbooks in the past have tended to ignore such considerations.

Economists create a fantasy world where everything is about money and market relationships. In the past economics professors have tended to ignore aspects of life that cannot be measured or understood in terms of money. But this ignores the most important relationships of all. The problem boils down to prediction. Neurologists frequently point out that the primary purpose of the human brain is prediction. In primitive times knowing what to expect in different circumstances was often a matter of life or death. Even today, accurate prediction is often the key to success or failure. If people are motivated by things other than money, then an economic prediction methodology based primarily on money may lead us seriously astray if people tend to deviate from gaining the highest monetary return because they are willing to sacrifice money for other less tangible and less measurable objectives. 

Remember over this holiday season, that it is not the gift that counts, but the thought behind it that matters. (And that there is sometimes more truth in old cliches, than in that Principles of Economics textbook.)

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Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone
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Please provide your insights and comments on the Deadweight Loss of Christmas (revisited) at:
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