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Posts Tagged ‘gifts’

The optimal Gift-giving Strategy

In popular economics on June 5, 2009 at 5:58 am

My roommate received a new copy of Twilight as a gift. I suggested to auction it on eBay. I checked Amazon and it was listed for a price of P700, which we will assume as the cost of the giver in buying the book from the bookstore. Then I surveyed the prices of the same book with slightly worse condition on eBay and estimated the average selling price to be around P500.

To compete with other similar items, P500 should be our price floor (the price before the first bid). Clear enough, this is economically inefficient. The situation is called deadweight loss. The giver bought the gift for P700, but it was only valued by the recipient for P500. The difference of P200 is called the deadweight loss. (Though the deadweight loss can decrease as more bids are offered, raising the initial price of P500, the price will never go beyond P650, which is the eBay buyer’s point of indifference, because of the added shipping cost of P50 that will increase the buyer’s total cost to P700, the bookstore price).

Joel Waldfogel, who wrote The Deadweight Loss of Christmas, is far from “condoning the healthy effect of [gift] spending on the macroeconomy” by focusing on the negative microeconomic impact of gift-giving. He estimates that Christmas gift-giving destroys 10% to 1/3 of the value of gifts. In our case, gift-giving erodes the value by almost 30% or P200, consistent with Waldfogel’s estimate.

Why is deadweight loss bad? Because it results from inefficient allocation. Gift-giving constrains consumer’s choices and does not maximize the utility of a good. Waldfogel points out that the size of a deadweight loss is determined by (1) the giver’s knowledge of the recipient’s preferences, and (2) the recipient’s knowledge of his own preferences.

The more a giver knows about the preferences of a recipient, gift-giving can create rather than destroy value. This is why parents and significant others give the almost “perfect” gifts. When you are in doubt about the recipient’s preferences, just give the gift in cash (which makes grandparents very efficient in gift-giving). The most inefficient gift-givers are the other relatives and friends.

The optimal gift-giving strategy must aim to reduce the deadweight loss. An economics blogger gives this funny but sound advice:

…if you give a gift valued at £40, but costing £50, the recipient can reduce the quantity that he buys for himself until the marginal value has risen back to £50. The solution is therefore to give gifts that the recipient purchases regularly. Things like cars and washing machines are bad – it’s hard to reduce your purchases if you only buy a new one every few years. Things like soap, toothpaste and bacofoil are good. [“But that’s so unromantic,” you protest. Tough. I’m trying to make you more efficient, not get you laid.]