With the passing of Christmas we have all just gone through the rat race, whether physical or online, of finding the perfect present for the so-and-so who has everything and, crucially, finding it at the best price. So it seems like a good time to explore what sort of a waste these gift giving holidays can be. I am not speaking from a Scrooge-like ‘save your money and keep working over the holidays’ point of view, and I enjoy the holiday season as much as the next man, but it is interesting to see what amounts to a rather large Dead Weight Loss when it comes to Christmas presents.

For those of you who might need a brief refresher, Dead Weight Loss is a loss of economic efficiency. It occurs when the equilibrium point (level of price and/or quantity) is not where Supply meets Demand. In other words, people who could benefit from a good or service are not buying it, or those who are buying it are not benefiting from it. This will tend to occur with Monopolies, quotas, tariffs, price floors or ceilings, or other forms of economic intervention. What makes the Dead Weight Loss of Christmas interesting is that it is not due to any of the usual reasons. It will occur even with perfect competition and no external controls. Market forces are the only stimuli during this holiday season, and yet we do not achieve a perfect equilibrium. We all follow the tradition of choosing something for our loved ones to put under their tree, which they may or may not like, and then receiving gifts that we may or may not enjoy ourselves, and then calling the whole thing a success. I think it’s interesting how rational human beings can follow the same routine year after year and realize this Dead Weight loss year after year.

Just for the record, I’m not talking about anything any potential reader may have given to me on my Birthday. Ok ok, I’ll speak hypothetically about Christmases, and analyze what tends to happen. Basically, say John finds a gift for Jane and vice versa. John doesn’t want to give cash, because that’s assumed to be tacky, and wants to give something that Jane doesn’t expect. Jane is thinking the same. Assuming they know each other fairly well, John will buy a present that Jane has a 75% chance of enjoying. However, if Jane had just received the cash, it’s very likely she would’ve bought a different model/color/edition/version etc. etc. I will then (optimistically) say there’s a 33% chance that the present is EXACTLY what Jane desired. Counting in the chance that some other person (Fred or Ted etc.) gives the same or similar present, I will bring it down to 25%, which I still find rather optimistic.

So John is spending 100% of the price for an object that Jane will get 25% of value from, and Jane does the same to John. Let’s transform this into utility by means of a quick calculation. We’ll take the gain (25% of value) and subtract the cost (100% of value) and we’ll multiply this by two (since presents flow two ways between John and Jane). This results in ((25%v)-(100%v))x2= -150%v. So for every gift exchange, there is a 150% loss in value. Now remember that this increases exponentially (2 exchanges between 2 people, 6 between 3 people, 12 between 4 people, etc) and remember this happens every Christmas.

So both John and Jane lose out, and where does the extra value go? The answer, obviously, is to the manufacturers. Well, assuming John and Jane aren’t entirely nitwits, they’ll know there is an element of risk with each present, so they will try to maximize their chance of providing as high a utility as possible. The manufacturers will help them with this by making products: A) discounted, B) look expensive and thoughtful. Therefore, the best way for the manufacturer to sell products on Christmas is entirely through a phenomenon called signaling. John will care less about the inherent value of a present, as long as it signals value to Jane, and vice versa.

Jane, on her part, will know this is occurring and expect a present to show more value than usual. In other words, she will assume that John spent the least amount for the highest amount of possible utility. So therefore Jane will assume discounts, rebates, etc. etc. Which means John could buy a present for 100% of value, while Jane will assume it to have been something less (say 80%), and John chose that because it was discounted or available in bulk etc. Here we’re assuming Jane knows the inherent value which, if it’s something she wanted in the first place, is safe to say she’ll know.

Well, I might be missing something, but it seems to me that in conclusion you’re better off giving money, so that everyone knows the value and achieves the full satisfaction, while with presents they’ll know the value, assume it cost less, and only achieve 25% satisfaction from it. So from now on, everyone can just give me cash. Thanks.

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