[Preamble: this post has officially become my Christmas regular. Because everyone loves gifts. But not everyone knows how to give them.]

Christmas really is the most wonderful time of the year, because holidays and mince pies and baked ham. And Christmas morning is all about gifts.

Something that you should know about economists: gifts drive them mad.


Because, for most economists, gifting is wildly inefficient.

The Deadweight Loss of Christmas

I’ve linked the subheading above to the now-seminal* paper by Joel Waldfogel, the Yale econogrinch that ruined Christmas.
*yes – that really is an academic term.

Here is his theory [paraphrased]:

  1. Let’s say that I have $25 to spend.
  2. Because I am the master of me, I am best placed to know how I would maximise the use of that $25.
  3. And since I’m a person of taste, that means spending it on a cool dictionary app that I’ve had my eye on for some time (and just couldn’t bring myself to buy).
  4. In the gift-giving scenario, however, there is a disconnect: because I am sitting without $25, and the gift-giver is sitting with $25.
  5. Therefore, in order for a gift to be optimal, the gift-giver would have to use the $25 in the exact same way that I would have. Otherwise, I’d be better off with the cash.
  6. If, however, the gift-giver just knew that I liked stuff in general, and instead bought me the Pentatonix Christmas album, then something has been lost.
  7. To put it in numerical terms: the gift-giver is short of $25; while I am not up by $25.
  8. The next question is: how cheap would the Pentatonix Christmas album have to be before I would buy it myself?
  9. Maybe if it were on special for $3. Because now we’re talking about the choice between a beer and a Christmas album – and it’s always fun to have a-capella-style carolling playing in the background over December.
  10. So to summarise: the gift-giver has spent $25 to give me a gift that’s worth $3.
  11. $22 just vanished in a cloud of wrapping paper, and that 22 bucks is “deadweight loss” to society.
  12. It’s not very sentimental, but I’d have been $22 better off if the gift-giver had just slid some cash into an envelope (and/or organised an iTunes giftcard).

So that’s Mr Waldfogel’s theory, and he then went and investigated it by conducting a number of surveys. The essential finding: he demonstrated that the act of gift-giving destroys 10% to 30% of the value of the gift – and that’s consistent across the price range of gifts (ie. even the very expensive gifts lose it).

That is: at least 10% of everyone’s Christmas gift-spending just evaporates on Christmas morning.

Also, who are the best gift givers?

Mr Waldfogel also investigated the impact of the relationship between the gift-giver and the recipient on the value of the deadweight loss. And he established what we all already know to be true:

  1. The best gift-givers are friends.
  2. Followed closely by significant others and parents.
  3. While gifts from grandparents and aunts/uncles are the most likely to be exchanged.

He also demonstrated that people are mostly aware of this. Because it turns out that the higher the risk of deadweight loss, the more likely that the person is just going to gift cash and/or gift vouchers:

  1. Grandparents are the most likely to give you cash.
  2. Followed by the rest of the extended family.
  3. Parents, friends and significant others do it much more rarely.

In those surveys in that seminal* paper, the questions contained the following phrases:

“Apart from any sentimental value of the items”


“not counting the sentimental value of the gift”

Which makes the whole experiment a bit blurry, if you think about it. The conclusion implied in the paper is that it’s generally better to receive a cash gift than a non-cash gift, because that maximises the value for the recipient.

But the minute you re-consider the value of sentiment, all that we can really say is: it’s better to get a gift that you want from someone you like than it is to receive a gift that you don’t really want from someone you like. And it’s better to get cash from someone you don’t really know.

Which is a little obvious, don’t you think?

The Power of Sentiment

To assist with this trickiness, I’ve assembled a quick gift hierarchy. It goes something like this (in order):

  1. Top of the list: a gift that you didn’t realise that you really wanted until you received it (so you couldn’t ask for it even if you tried).
  2. A gift that you really want that you didn’t have to ask for.
  3. A gift that you like that you didn’t have to ask for.
  4. A gift that you wanted that you had to ask for.
  5. Practical gifts that you appreciate in retrospect (this includes cash).
  6. No gift.
  7. Bizarre gifts that demonstrate that the gift-giver felt obligated to give something, but couldn’t think what, and so recycled something that they didn’t want.

To summarise: I think that the niceness of a gift is actually secondary. The gift-giver’s ingenuity (and attention to the detail of the recipient as a person) is more important.

To phrase it economically: gifts demonstrate a social utility that is not captured by the purist assessment of value vs price. And that social utility is closely linked to social importance of the pre-existing relationship (ie. there’s no sentiment attached to gifts from distant acquaintances).

The Real Conclusion when it comes to gifts
  1. For important people, get them gifts.
  2. For other people, organise them gift vouchers or cash.

And for more on gifts, this WSJ article by Dan Ariely.

Rolling Alpha posts opinions on finance, economics, and sometimes things that are only loosely related. Follow me on Twitter @RollingAlpha, or like the Rolling Alpha page on Facebook at www.facebook.com/rollingalpha.