Economist Writing Every Day

This post was co-authored with a recent AMU Economics Graduate, Michael Maynard (Linkedin here). It is based on his senior thesis entitled “The Highest Virtue: Re-examining gift Giving and Deadweight Loss”

When my older sister was in middle school, she received a book of baby animal stories. She loved that book and read it every day. A couple of years later my mother accidentally donated it, and my sister was heartbroken. We went to the thrift store repeatedly that week hoping to encounter it before it sold, but we never found it. Years later, our father scoured the internet trying to find the lost book – to no avail.

Years after that, I stumbled onto the exact same copy of the book in the for-sale corner of a nearby library. For a single dollar and negligible effort, I purchased the book that had long frustrated my family’s searching. Shortly before the birth of her first child, I gave the book to my sister for Christmas. It was one of the best Christmas gifts she had ever received.

Economic theory typically assumes that individuals have perfect information. Therefore, they are best suited to purchase their own gifts. That’s what motivates the not-so-romantic economist prescription to give a gift card or cash for birthdays, Christmas, graduations, etc. The theory states that, if we do not intimately know the receiver’s preferences, then we have incomplete information and it’s better to give a money-gift rather than to give a gift from which the receiver would enjoy less additional utility.

Given some gift budget, a gift giver possessing complete information and a recipient possessing perfect information would always purchase the receiver’s utility maximizing gift, regardless of who does the job of purchasing the gift. That occurs at point C below.

The problem is that the giver does not possess complete information and they do not know the utility maximizing gift. Think of the times that you bought someone a box of chocolates when, unbeknownst to you, they were trying to lose weight. Your imperfect gift may have increased their utility to point B, but it did not produce as much additional utility for them as a money-gift could.

This is often where the analysis ends. We buy our sibling a gift card and call it a day, knowing that the recipient can maximize their utility better than we can do it for them.

But that is where the real issue is. Will the recipient always utility maximize? Perfect information is a nice assumption, in part, because it makes our models easier. But it is not realistic. Retailers like Amazon and Walmart sell millions of products. It is impossible for anyone to examine all of them and to make a fully informed purchase that would maximize utility with a $25 gift card. As such, one cannot assume that a money-gift will always allow the recipient to utility-maximize.

Drop some Knowledge on it.

We should not think of ourselves simply as an ATM that increases the recipient’s wellbeing merely by an amount of cash. Rather, we often possess information that is more complete than the recipient’s imperfect information – such as knowing that my sister’s book was for sale at the library. Consequently, the gift chosen by the giver can leverage an information advantage. The recipient can then enjoy more additional utility than if they were to spend the money-gift themselves with their imperfect information. In the figure below, the imperfectly knowledgeable recipient would choose bundle B. But the more completely knowledgeable giver would choose bundle C.

If your sibling is looking for a new TV and you happen to be better informed about what is available, then you may be in the better position to buy the TV than they are. Or maybe, your child would spend Christmas money on toys, when trumpet lessons would be a gift that would have a greater benefit to their life and bring them more lasting joy. The information advantage can lead to great benefits for the gift recipient. BUT, gift-givers should first evaluate their susceptibility to hubris before deciding whether they can do better than a gift card. Purchasing what you think is a great gift which really is not, is…. uncomfortable.

So where does this leave us? Should we always purchase gifts for people because they lack perfect information of the market? Certainly not. While it is the case that the giver can possess better information than the receiver, the literature suggests (Waldfogel 1993, Rhodin and Lahtinen 2020) that gifts often contribute less additional utility than money-gifts. Likely, the one dollar that I used to purchase the book for my sister was spent very well and produced more utility than my sister could have produced with the same dollar. My gift was the better gift because, with the goal of increasing the recipient’s utility, I had the more complete relevant information (at least for utility improvement). Most of my gifts are likely not as efficient as money-gifts would be. For givers without an information advantage, it is best to give a cash or a gift card if we wish simply to maximize the recipient’s utility.

The analysis implies a couple of gift-giving guidelines:

1) If you see a good gift, buy it immediately before you lose the information advantage. Goods and their prices are sometimes specific to a time and place. A great opportunity may be a one-shot deal.

2) Ask the receiver what they want (maybe with some subtlety). If they want a new bookshelf or a cookbook, then you may be able to find a better one or find it at a better price. This way, you can increase the chance that you will purchase a gift that generates more additional utility than would a cash transfer.

In the end, more realistic assumptions make gift-giving start to look pretty good.