• The Invisible Hand

The Economics of Christmas

"It's the most... inefficient?... time of the year"

Economists can hardly defend accusations of economics being the ‘dismal science’ with their analysis of Christmas. Although we all like to have fun and joy at Christmas, economists believe it is an example of a terrible misallocation of resources.

Economists put faith in the free market to allocate resources because they assume consumers will choose the goods and services which maximise their utility. Yet when it comes to gift buying the giver lacks sufficient knowledge about how to maximise the recipient’s utility. The gift you receive on Christmas is unlikely to be the one you would have bought if you had the money. There is a deadweight loss of Christmas equal to the difference between the price the gift giver paid and what the gift giver would have paid. This theory was popularised by Joel Waldfogel of Yale University in 1993 and he even went as far as to say that gifts lose 10-33% of their value. He supposed that most gifts end up being returned, sold or re-gifted. Christmas buying represents a large part of consumer spending so the deadweight loss is large when magnified to this level; approximately $4bn in 2001 in the USA. For economists it seems logical that Christmas is economically inefficient. Fundamentally, Christmas is based on tradition which suggests it is irrational. Rather than being based on evidence or the profit motive Christmas is based more on inertia.

So should we all just cancel Christmas? Well when looking at the economy there are other considerations. Christmas is definitely a bonus to companies and the macro-economy because it leads to greater consumer spending. December is always a time of exceptional growth in the money supply. Keynes said the type of spending did not matter; all that mattered was whether it occurred in the first place. Yet, as so often with economic analysis, externalities are not considered.

John List and Jason Shogren used experiments to test the value people placed on gifts and found it to be 21-35% higher than the costs to the giver. Based on this evidence they supposed that value was not just based on price but in fact total value= material value + sentimental value. The sentimental value derives from the external benefits the gift giver and the recipient receive from the surprise factor but also from a deeper emotional attachment created between the two economic actors.

There is also a signalling effect from present giving. A good present is a signal of appreciation and long-term commitment. It also signals a good mutual understanding of the recipient if the present is relevant. That is why closer relatives often give better presents, because they know you better. Signalling also helps explain why cash, the economist’s preferred gift, is not often used. Cash sends a signal that the person does not know the wants of the recipient very well and that they do not have enough time to pick their own present out.

I hope now you understand the economics of Christmas more. Based on economics, my Christmas tip would be to buy a present which is useful to the recipient (to minimise deadweight loss) but also to think carefully about it and be aware of the signals it gives. With Christmas, like many other parts of economics, an overly simplistic analysis fails to reflect how people really make decisions and gain utility.


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