On Christmas and deadweight losses

In the aftermath of Christmas, it is time to reflect on how economists view Christmas. Talking about the subject, many people will come to think of some economist talking about how important consumer spending during the Christmas season is for economic growth. Let’s call this the macro-story.

While that macro-perspective may be informative, the economist Joel Waldfogel published an article in the premier peer reviewed economics journal, American Economic Review in 1993 entitled “The deadweight loss of Christmas.” In the article, Waldfogel set out the argument for why the giving of Christmas presents is not as benign as the macro-story would suggest.

The problem that Waldfogel highlights is the fact that those giving Christmas presents tend to make bad choices. His argument is founded on some fundamental microeconomic theory, suggesting that when people get to choose themselves how they spend their money, they will maximize their own utility (you can think of utility as happiness). When somebody else spends money for a person (as in buying a Christmas present), the best he can do is buy exactly the same thing as the person would buy himself. Buying anything else will by definition give the receiver less utility, for if it would give him more utility he would have bought it himself in the first place.

Thus, based on a very simple theoretical argument, Waldfogel establishes that buying somebody a Christmas present for say 20 euros will at best give the receiver as much utility as he would have got had he himself chosen how to spend the 20 euros. And this is the best scenario. More likely the receiver will receive something that he himself would not have bought for 20 euros, thus creating what’s known as a deadweight loss.

So what is the deadweight loss in this case? The deadweight loss is the difference in the receivers valuation of the gift and it’s price. Say the gift giver receives a book that cost the giver 20 euros, but the receiver would only be willing to pay 15 euros for it. Then the deadweight loss is at least 5 euros. It could be larger, because the gift giver might be able to buy a shirt for 20 euros, that he’d be willing to pay 40 euros for. If this was the object he’d value the most, then the deadweight loss amounts to 25 euros.

The argument of Waldfogel is sound, but it can of course be criticized. It might be that the fact that the book is given by the gift giver actually has added value for the receiver. Also, the basic microeconomic argument rests on a full information assumption, that is it is assumed that the receiver has full information of all the different things he could buy for the 20 euros, including how useful/delightful the product will turn out to be. If this is not the case, and the gift giver has more information, then he might be able to make a better choice.

So what are the policy implications? When buying presents, buy something where you have superior information to the receiver. Thus, if you know that the receiver enjoys reading the odd book now and then, but has a hard time finding interesting books, while you yourself has immense knowledge of literature, buy the person a book. And of course, do take into account that the receiver may have differing taste, or as an economist would put it, preferences.

Which brings us to the other part of the Waldfogel article. Waldfogel also takes a stab at analyzing the issue empirically. What he finds out is that people more distant buy worse Christmas presents than close relatives and friends. Which might imply that you should really only buy presents for people you care about.