Christmas Gifts: Cash Is Not Necessarily Optimal
Economists are often suspicious of gifts in kind, arguing that the same money value in cash provides more “utility” to the recipient (puts her in a more preferred situation) because she can use the cash to buy what is on top of her preference scale (her “utility function” in economics). If you don’t buy the gift that she would have bought for herself, your gift is worth less to her than what you paid for. (See Joel Waldfogel, “The Deadweight Loss of Christmas,” American Economic Review 83 .)
There are many objections or qualifications to this idea. In certain circumstances, a gift in kind will provide more utility to the recipient. If you know your recipient enough to have a good intuition of her preference scale, you may be able to approximate what she would have herself purchased with the cash. A well-chosen gift in kind signals that you know what she likes or that you have made some effort to please her. The pleasure and surprise in opening many boxes also count. This at least partly explains the resilient popularity of gifts in kind.
In their microeconomics textbook Price Theory and Applications: Decisions, Markets, and Information (seventh edition, Cambridge University Press, 2005, p. 110), Jack Hirshleifer, Amihai Glazer, and David Hirshleifer express a similar idea:
Does that mean that donors should always give cash? Not necessarily! A noncash gift may signal that the donor cares enough to devote time and thought to what the recipient desires or needs. Even if the choice itself misses the mark, the recipient may value the expression of concern that lies behind it.
For somebody whom the giver does not know well, cash or a gift card can be the best option. Yet, another option has developed which, even for persons you know well, marries the advantages of cash and of gifts in kind: wish lists, especially online like that of Amazon. You are sure to give her something she wants and there are boxes to open.
Still another reason for some gifts in kind is that the recipient may ignore how much utility something will give her. Your gift may make her discover it. Although economists assume that preferences do not change, it is mainly for methodological reasons. We sometimes discover things that we previously did not think we would enjoy.
Not only the preferences of a gift recipient must be considered, but also her budget. Any choice of buying or not buying is the product of two factors: preferences and budget constraint. A gift has an income effect. The recipient will be able to consume more than before she got the gift. This income effect may be canceled if your recipient gives you the same value in gifts that you give her. Indeed, this is what happens on Christmas, although the wealthier of the two gift-exchangers will frequently end up transferring a net amount of money (that is, of goods) to the poorer one.
But even when the income effect of receiving gifts is canceled by the cost of giving gifts in return, playing this exchange game gives utility to the two participants. Otherwise, one of them would not participate. In human relations, exchange is omnipresent—and much preferable to violence. As Adam Smith suggested, man is an animal who trades.
I have ignored the special case of business gifts, which are part of a more standard exchange. A gift to one’s customer is a price paid in the hope of continuous patronage. But note that an exchange of gifts between two friends, lovers, or family members can also be considered as a price paid for the continuation of a mutually beneficial exchange relationship. The festive atmosphere of Christmas adds to the utility produced by the exchange.
All this illustrates that economics is not about money, except in the subfield of monetary theory. It is not about telling one how to behave efficiently, even if it can inform one against many fallacies (the sunk cost fallacy, for example); it is about understanding individual choices and their actual social consequences.