Christmas is not the most wonderful time of the year for economists. The holiday spirit is puzzlingly difficult to model: It plays havoc with the notion of rational utility-maximization. There’s so much waste! Price-insensitive travelers pack airports beyond capacity on Dec. 24 only to leave planes empty on Christmas Day. Even worse are the gifts, which represent an abandonment of our efficient system of monetary exchange in favor of a semi-barbaric form of bartering.
Still, even the most rational and Scroogey of economists must concede that gift-giving is clearly here to stay. What’s needed is a bit of advice: What can economics tell us about efficient gifting so that your loved ones get the most bang for your buck?
We need to start with the basic problem of gift-giving and barter in general: preference heterogeneity. Different people, in other words, want different stuff and they value it differently.
In a system of monetary exchange, everything has more or less one price. In that sense, we can say that a Lexus or a pile of coconuts is “worth” a certain amount: its market price. But I, personally, would have little use for a Lexus. I live in an apartment building near a Metro station and above a supermarket; I walk to work; and driving up to New York to visit my family is much less practical than taking a bus or a train. So while of course I won’t complain if you buy me a Lexus, its value to me will be low relative to its market price. Similarly, I don’t like coconuts and I’m not on the verge of starvation. If you dump a pile of coconuts in my living room, all you’re doing is creating a hassle for me. The market price of coconuts is low, but the utility I would derive from a gift of coconuts is actually negative.
In the case of the Lexus, the sensible thing for me to do would be to sell the car. But this would be a bit of a hassle and would doubtless leave me with less money in my pocket than you spent.
This gap between what something is worth to me and what it actually costs is “deadweight loss.” The deadweight loss can be thought of in monetary terms, or you might think of it as the hassle involved in returning something for store credit. It’s the gap in usefulness between a $20 gift certificate to the Olive Garden and a $20 bill that could, among other things, be used to buy $20 worth of food at Olive Garden. Research suggests that there’s quite a lot of deadweight loss during the holiday season. Joel Waldfogel’s classic paper (later expanded into a short book) suggests that gift exchange carries with it an average deadweight loss of 10 percent to a third of the value of the gifts. The National Retail Federation is projecting total holiday spending of more than $460 billion, implying $46-$152 billion worth of holiday wastage, potentially equivalent to an entire year’s worth of output from Iowa.
Partially rescuing Christmas is the reality that a lot of gift-giving isn’t exchange at all. Rather, it’s a kind of Robin Hood transfer in which we take resources from (relatively) rich parents and grandparents and give them to kids with little or no income. This is welfare enhancing for the same reason that redistributive taxation is welfare enhancing: People with less money need the stuff more.
This leads to my first guideline for efficient giving: Gift-giving should be redistributive. Reciprocity is a lovely sentiment, but the holidays are an excellent time to rebalance the overall family or friend group portfolio in favor of its needier members.
The indisputable fact is that cash is the most economically efficient gift. But cash is, in many cases, socially unacceptable, which means you need to pursue an alternative approach. Here your best bet is to show a taste for risk. The problem with presents is that you’re never going to do a better job of satisfying the gift-recipient’s preferences than she could do herself. But preference sets aren’t fixed. If someone had handed me $10, I never would have spent it buying the Cults album, for the simple reason that I hadn’t heard of the band. When it was given to me, I immediately checked it out and loved it. When you step outside the circle of things you know for sure your gift-getter likes, you risk creating a massive deadweight loss. (You give her a ticket to Las Vegas, without knowing that she hates gambling.) But with the greater risk comes a greater potential reward. You may introduce the recipient to something marvelous she would otherwise have never encountered. Giving stuff rather than cash is a way of saying you know better than the recipient what she really wants. The riskier the present, the more likely it is to generate significant benefit. (So, not a sweater.)
OK, so you have committed to buying a risky present. Now review the extensive research out there about what actually makes people happy. In particular, people consistently overrate the extent to which money in general and material possessions in particular will make them happy, underweighting interpersonal relationships and new experiences in the process. So try to give your loved ones the opportunity to go do something new, ideally with other people. This will, of course, impair the traditional box opening ceremony, but in the long run your recipients will benefit.
Last but by no means least, it’s worth pondering the old saw that it’s the thought that counts. Gift-giving obviously isn’t meant to be efficient; it’s meant to express affection. But this, too, can be done in more or less efficient ways. A gift is going to be more appreciated when it comes as a surprise: Nothing is less surprising than a Christmas present on Christmas. Scaling back a bit on your predictable holiday purchases will free up the cash you need to give at other times of the year, when your beneficence will have more psychological impact. Gift-giving is an inherently sentimental exercise, but that doesn’t mean you need to be sentimental about it. In tough times, it’s more important than ever to employ logic and economics to make sure that your loved ones are getting your money’s worth.