The wacky economics of gift-giving

Christmas, birthdays, graduations, housewarming parties — all wonderful times to celebrate and reunite with family and friends. But for a certain class of unlucky revelers, beneath that celebration lies that haunting specter of the gift.

I’m terrible at finding good gifts for people. Maybe I was one of those born without the proper genes. Malls and department stores are scary places for people of my type at this time of year, where everyone but you seems to be running from store to store, picking out the perfect products without breaking a sweat. For people like me, these celebrations always come with a side of dread as I worry about what gifts to buy for friends and family.

I’ve often asked myself whether it would be appropriate to ditch the standard plan and simply wrap some cash in an envelope along with a nice handwritten letter. It makes perfect sense, I think: given that I lack any sort of skill in selecting goods that other people might enjoy, it would be better to simply let the giftee decide what he or she wants.¹ With cash the recipient can choose to buy any of the potential gifts I was considering, or anything else that he might prefer. Then everyone is better off: I don’t sink hours into fruitless gift searches and end up buying the wrong thing, and the person receiving the gift instead gets to buy exactly what he has always wanted.² So cash is okay, right? The answer, unfortunately for me, is almost universally no.³

Why don’t we give cash gifts?

I began to undertand why this is so just a few weeks ago as I listened to Russ Roberts and Michael Munger discuss the economics of gifts in an EconTalk episode. The two discuss the common scenario of a dinner party, where guests are often expected to arrive with a small gift in hand. Most guests would arrive with a bottle of wine, chocolates, or maybe some flowers. Wouldn’t the most “thoughtful” guest be the one that arrives with a $20, though — the guest that lets the host decide what would be best for himself? Obviously not, as anyone with a modicum of training in manners can confirm. But why is this the case?

Munger uses Aristotle’s theory of value, which decomposes the concept of “value” into a subjective and idiosyncratic value in use and a more universal value in exchange, to justify why we are so repulsed by the $20 gift:

There’s an ancient distinction, I think first and most importantly made by Aristotle, between value in use and value in exchange. Something that you make as an artisan, or something that you make for the specific purpose of using it, or having someone else use it, is just better. He claimed it was morally better. … What he’s comparing that to is value in exchange. And he agreed that things that we make to exchange have value, but it’s a morally much lower kind of value.

He implies that when we talk about whether a gift is “good” or “meaningful,” we really are evaluating its value in use. While a $20 bill has a significant value in exchange, it has little if any value in use. On the other hand, a bottle of wine brought to a dinner party holds a certain value in use — it can be put directly into use at the party — as well as some value in exchange.

What differentiates gifts of the same value?

All right, so cash doesn’t make the cut. But outside of the restricted context of the dinner party, picking the right gift for a person is just so difficult. It’s possible to establish a fixed value in use and still find two items which lead to radically different reactions from the recipient. I can’t help but use Munger’s example:

Suppose that for your [Russ Roberts] wife’s birthday you bought her a new vacuum cleaner. Let’s suppose it’s a really, really nice new vacuum cleaner. It’s still a cold night at the Roberts house.

Even the most state-of-the-art vacuum cleaner would still be an offensive gift in this scenario. It seems in this case that the gift actually has too much direct utility. We want gifts, rather, that are something of a surprise: something we didn’t know we wanted.

Hold on a second — we’re in a society where people try to “surprise” a recipient by subverting his idea of what would maximize his own utility? And the recipient wants (or expects) the surprise? Something is wrong here.

Munger poses an addition to this theory by holding that the best gift is more than just a signal: it is a costly signal. In spending more money than is likely necessary on a gift which we expect to surprise its recipient, we signal multiple things:

1. I am willing to spend my free time searching for a “good” gift.
2. I am willing to spend more money than the recipient might consider reasonable on the gift that I find.
3. I know the recipient well enough that I am confident this gift will be a good surprise.

This act of costly signaling reinforces our altruistic image in the recipient’s eyes, and also distinguishes the gift from what could otherwise be interpreted as a compensation or bribe — an idea that no one would want to support in giving a gift to another.

It’s not clear that the task of gift-buying will be any less painful now that the economic principles behind it have been demystified. But at least you can know exactly what you’re talking about as you trod through shopping malls and grumble to yourself: these costly signals just cost too much!

Further reading

• The incentive for gift-giving as posed here may have its roots in the rotten kid theorem.
• David Friedman suggests different signals that he claims make gift-giving special.
• Read more about costly signaling.⁴