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December 28, 2003 - So, Scrooge was right after all!

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Economists simply can't understand why people would do something as stupid as giving presents at Christmas.  This was an idea first formulated in 1993 by Joel Waldfogel, an economics professor now at the University of Pennsylvania, in his seminal paper, The Deadweight Loss of Christmas.


Ross Gittins explains this in So, Scrooge was right after all in the December 24th issue of the Sidney Morning Herald.

Conventional economics teaches that gift giving is irrational. The satisfaction or "utility" a person derives from consumption is determined by their personal preferences. But no one understands your preferences as well as you do.


So when I give up $50 worth of utility to buy a present for you, the chances are high that you'll value it at less than $50. If so, there's been a mutual loss of utility. The transaction has been inefficient and "welfare reducing", thus making it irrational. As an economist would put it, "unless a gift that costs the giver p dollars exactly matches the way in which the recipient would have spent the p dollars, the gift is suboptimal".


The difference between what givers pay for presents and the value the recipients put on those presents is the loss being referred to and, since it's equivalent to tearing up banknotes, economists call it a "deadweight" loss.


Ah!  This goes a long way to explaining any number of ugly neckties I have received.


Here are the details:


Waldfogel has recently refined his calculations on Christmas's deadweight cost, using a new survey to estimate that, per dollar spent, people value their own purchases 18 per cent more than they value items they receive as gifts.


But there has been research to identify some hidden consideration that makes the seeming irrational rational after all.


One possibility is that gifts may procure a source of insurance for the giver. Parents, for instance, may give gifts to their children in the hope the children will care for them in their old age. Adult children may give gifts to their elderly parents in the hope of being remembered at that last great gift giving with lawyers present. Then, money will do fine.


Another line of inquiry is that gifts, particularly inefficient ones, serve as costly signals of the giver's intention to invest in a future relationship. Or maybe gifts are exchanged to break down mistrust, permit co-operation and build relationships.


But such a model doesn't explain why people continue to give gifts in well-established relationships where there is little mistrust and dumb signaling isn't necessary.


Then there is the paper by the economists Bradley Ruffle and Todd Kaplan, Here's something you never asked for, didn't know existed and can't easily obtain: A search model of gift giving.  (Hard copy available from the School of Business and Economics, University of Exeter, Streatham Court, Rennes Drive, Exeter EX4 4PU)


These two claim gift giving makes sense in cases where the giver's knowledge of where to find something the recipient wants is greater than the recipient's own knowledge.  Or if the giver is in a position to get it cheaper.


So the rule is that the giver gives a gift only when her "search costs" for the gift are lower than those of the recipient.


Gittins comments that this emphasis on the hassle involved in finding suitable presents helps explain why, even though it's regarded as poor form to give money, parents are more likely to resort to money as their children get older.  The parents' search costs rise as they become less certain what their kids would like, whereas the kids' search costs fall as they become more independent.  This theory also helps explain why people who go on trips return with presents.  Their gifts tend to be things that are dearer or harder to find at home.  Even so, it's hard to believe the theory accounts for more than a fraction of gifts.


Gittens adds his own theory:


I prefer the theory that, because of the discipline many people impose on themselves to ensure they stay within their budgets and make ends meet, many of us have trouble allowing ourselves to indulge in the odd luxury purchase.


So we're pleased when friends and rellos brighten our lives by giving us little luxuries - from chocolates to perfume to jewelry - and when Christmas and birthdays give us a license to spoil the kids.


I should tell you Ruffle has opined that the utility from gifts consists of not only the monetary cost and value of the gift, but also the emotions associated with it.


He contended that "gift giving improves welfare if the giver's pride and the receiver's surprise from the gift plus the receiver's monetary valuation of the gift exceed the giver's monetary cost".


Predictably, however, the economics profession has shown little enthusiasm for this airy-fairy speculation and Ruffle himself seems to have abandoned it.


I see this emotional component a slightly different way.


I myself hold that the shame of not giving a gift when everyone else has drives the whole business.  One must give gifts.  If one doesn't, one is a pariah.  And the shame of giving a gift that is "not right" - or so obviously inexpensive that the recipient wonders how they have offended you and why you're insulting them, but is of course too kind to voice those thoughts - also drives up the "gift cost factor." 


Thus the whole business of giving gifts is an elaborate social mechanism by which we avoid the pain of being ostracized.  One gives what one really cannot afford to another who really doesn't need the item, and avoids a whole lot of pain.


But I liked the gifts I received.  The very rare brandy will go well with the cool nights, and the gourmet cookware I'd never buy for myself will enable me to do some great meals for my friends.   I just assume that what gifts I gave to others were shrugged off as marginally acceptable - the best I can hope for these days.


And I bought myself a new pipe - the kind I like.  My gift to myself.  I got that right.