It is often said (with good reason) that economics is the “dismal science.” In keeping with that maxim, and because this is the gift giving season in most parts of the world, I thought it would be interesting to revisit an economics paper published in 1993 by Joel Waldfogel, Unknownthen of Yale University and currently at the University of Minnesota. Dr. Walldfogel conducted a series of surveys of Yale students to answer a critical economics question that was no doubt keeping him awake at night: “What percentage of value is destroyed or created by gift giving?” In economics terms, he sought to determine what is known as the “deadweight loss,” which, technically speaking, is “a loss of economic efficiency that can occur when equilibrium for a good or service is not achievable.” (1) In other words, Dr. Waldfogel wanted the know DL of gift giving in order to calculate the value function of giving gifts in general, and thus reinforce the maxim which with I opened this post.

What exactly is DL in the this particular context? I can’t improve on his explanation, so here it is:

In the standard microeconomic framework of consumer choice, the best a gift-giver can do with $10 is to duplicate the choice that the recipient would have made. While it is possible to for a giver to choose a gift which the recipient ultimately values above its price — for example, if the recipient is not perfectly informed — it is more likely that the gift will leave the recipient worse off than if she had made her own consumption choice with an equal amount of cash. In short, gift-giving is a potential source of deadweight-loss.

In other words, any gift you give has three potential post-gift opening economic states:

1) Value Positive: You gave a gift that the recipient values more than the price you paid (or cash equivalent)

2) Value Neutral: You gave a gift that is valued exactly the same as the price you paid (or cash equivalent)

3) Value Negative: You gave a gift that is valued less than the price you paid (or cash equivalent)

To answer the DL question, he devised a pair of surveys which he gave to the students, which noted items such as estimates of the total amount paid (by the givers) for all the holiday gifts they received, the value recipients’ placed their gifts (based on their willingness to pay for the gifts), as well as demographic data about givers and recipients. The difference between the two surveys’ valuation methods, notes Dr. Waldfogel, was the following: “the first survey asks for the maximum the respondent would pay for her gifts, while the second survey asks for the minimum the responded would accept in lieu of the gifts.” In other words, the first survey focused on the most any student would pay for all of her gifts, while the second focused on the least each student would accept to give up any one gift.

The results of Dr. Waldfogel’s first survey were quite interesting:

  • The average Yalie surveyed received (in 1993, mind you) $438 dollars worth of gifts.
  • The value (or DLn point) the typical student placed on the gifts, however, was only $313.
  • Therefore, the average “yield” of the gift total of $438 was only 66.1%, and this figure stayed constant across gift prices as well as demographic status.

As Dr. Waldfogel summarized:

A regression of log value on log price across recipient’s total gift receipts confirms that the relationship between value and price is essentially proportional…Forming a deadweight-loss measure from average yield indicate that gift-giving destroys a third of gift value.

The second survey, as expected, pointed to a lower deadweight-loss of about 10%, which means that the correct DL of holiday gift giving is somewhere in between 10%-33%. After crunching all the data, Dr. Waldfogel reached the following conclusions:

  • 10% of non-cash gifts are exchanged
  • Aunt/uncle and grandparent gifts are the most likely to be exchanged (20.8 and 13.3 percent, respectively)
  • Only about 6-7% of sibling gifts are exchanged
  • None of the gifts from significant other were exchanged

On the whole, the greater the emotional distance between giver and recipient, the lower the yield, which suggested to Dr. Waldfogel that any grandparent or uncle/aunt should, to maximize utility, give only cash, which was not the case, since only about 42% of grandparents and 14.3% of uncles/aunts did so. This puzzled him, for, as he notes:

The average yields from for gifts from all sources except friends and significant others are significantly below unity, indicating that giving noncash gifts destroys not only value but also utility.

In response to this insight, he suggests that perhaps this class of giver choses non cash because “the giver may derive some utility from giving the particular gift” or because of the “stigma” that may be attached to giving cash gifts. Also interesting is that while none of the gifts from significant others were returned, there may be yet another social stigma attached to returning/exchanging the gift of a significant other, which may be skewing the data somewhat, suggesting that even romantic partners may not be that great at maximizing gift yields/minimizing DL.

Dr. Waldfogel’s conclusions, besides being interesting in themselves, have wider macroeconomic implications for any society where holiday gift giving is rampant. For, in closing his paper, Dr. Waldfogel concludes that, when all is said and done, somewhere between a tenth and a third of all gift giving is wasted regardless of the holiday or occasion. Given that in 2013, Americans alone spent over $600 billion on holiday gifts, a DL of possibly $200 billion in destroyed economic value is clearly a significant misallocation of resources that has gone on for decades.

In 1993, the author did not suggest a way out of the DL trap. Interestingly, however, in an 2013 interview with Paul Solman, Dr. Waldfogel finally suggested a simple solution:

Paul Solman: The cliché in gift-giving is it’s the thought that counts. It’s not the amount. It’s, did I think about you, have I gone that extra mile to try to understand what you want and show you that that’s what I’m doing?

Joel Waldfogel: I think the thought is very important. The thought doesn’t need to be communicated with a lot of money. … When I think about favorite gifts I’ve received from people who are kind of at arms-length knowledge about what I actually need, well maybe my favorite is a photograph of my nephew sitting on my lap. It maybe costs what, a dollar, two dollars to give me this in a modest frame? Favorite gift ever, no value destroyed.

So twenty years after his original research, he came to the answer: by spending a little and thinking a lot, we can maximize the economic utility function of gift giving and minimize any potential deadweight-loss at this special time of year. That sounds like great advice to me. In fact, if he keeps this up, we may have to rethink that whole “dismal” thing after all.

With that happy thought in mind, Happy Holidays to everyone good enough to all my readers around the world.

Cheers!

 

(1) http://en.wikipedia.org/wiki/Deadweight_loss

Read more:

https://www.amherst.edu/media/view/104699/original/christmas.pdf

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Posted by Carlos Alvarenga

Carlos Alvarenga is the Executive Director of World 50 ThinkLabs and an Adjunct Professor at the University of Maryland's Smith School of Business.

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