Economists Do It With Models

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Happy Holidays From Econgirl!

December 23rd, 2011 · 5 Comments
Behavioral Econ · Books · Uncategorizable

First, a holiday favorite from last year:

(Fun fact: the other kid in the video will be helping me out at the AEA meeting in Chicago in a couple of weeks, so come say hi!) Second, my mom made a new version of an xmas tree skirt:

See? Economists can be festive even though we recognize the potential inefficiency of gift giving. (I will admit that it probably doesn’t help our grinchey image that we write books entitled Scroogenomics.) The argument against gift giving, as explained by Joel Waldfogel, the author of Scroogenomics, goes something like this:

My objection is that the holiday spending doesn’t result in very much satisfaction. Normally if I spend $50 on myself, I’ll only buy something if it’s worth at least $50 to me. But if you buy something for me, and you spend $50, since you don’t know what I like, and you don’t know what I have, you may buy something I wouldn’t pay anything for. And so you could turn the real resources required to make things into something of no value to me. And that would destroy value.

Hm. I suppose that is why my mom informed me that she was sending a big box of economic inefficiency my way. (How did she know that I had asked Santa for deadweight loss for xmas?) So do economists have a right idea with this gift thing, and is the rest of the world just doing life wrong? Maybe not. It *is* theoretically possible to get a gift for someone that the person values more than it cost, so not every gift is inefficient. (This is particularly true when the gift giver finds an item that the receiver doesn’t know exists or doesn’t have access to, for example.) Furthermore, behavioral researchers such as Mike Norton has found that spending on others has more of an impact on happiness than spending on one’s self:

We conducted a number of studies—from national surveys to a field study in which we examined how the manner in which employees at a Boston-based company spent a profit-sharing bonus impacted their long-term happiness—in which we showed that money can buy happiness, when people spend that money prosocially on others (giving gifts to friends, donating to charities) rather than on themselves (buying flat-screen televisions).

Norton and his colleagues even find similar evidence in an experimental setting when they direct people to spend small amounts of money either on themselves or on others. So don’t return that snuggie that you got for your roommate just yet…but, if you are going to get gifts for people, at least abide by my Economist’s Guide to Holiday Gift Giving. Or you could take advice from Matt Yglesias, who focuses a bit more on the potential redistributive benefits of gifts. Either way, happy holidays!

Tags: Behavioral Econ · Books · Uncategorizable

5 responses so far ↓

  • 1 James // Dec 23, 2011 at 5:11 pm

    Happy Holidays to you too Jodi. Come to the LA area soon. Jet Blue flies into Long Beach………

  • 2 DAS // Dec 23, 2011 at 5:11 pm

    Scrooge will often find that he is incorrect because he fails to account for goodwill.

  • 3 David Welker // Dec 24, 2011 at 2:04 pm

    This whole thing about gift giving being inefficient is just another example of the foolishness of a subset of economists who have forgotten that they are making assumptions that are not strictly true.

    One of the most common assumptions in economics is that preferences are fully known and also fixed, and therefore the purchasing choices of individuals are utility maximizing, as individuals are capable of rationally ranking their choices.

    This is obviously false. In a world where there are an overwhelming number of products, most people couldn’t rank anything more than a subset of them, and then in only an imperfect and imprecise manner.

    Imagine the following scenario. A person is capable of earning wages of $25 per hour, which we will take as a rough measure of the opportunity cost of searching. This person wants to buy a novel (which will take 20 hours to read) that will cost $10. This person spends at least 2 hours at the book store trying to find the “right” book.

    In this example, the actual cost of the purchase ($10) is much less than the cost of searching ($50). This is not uncommon.

    I think it is pretty obvious that a friend who has already read a book that they have a good reason to think you will like is in a position to provide to you a benefit worth about $60 to you at a cost of only $10 to them, assuming that their selection is just as good as one you would have made.

    To top it all off, when a decision is finally made after you perform a search yourself, you the purchaser really don’t know which book you would actually like best, but instead are merely guessing. More likely than not, even after a search, you will fail to choose the utility maximizing novel. Indeed, the actual selection of the book that is actually purchased isn’t based on any real ability to rank the books, but instead on various heuristics and cognitive shortcuts (e.g. I usually like fantasy novels more than westerns. I like a previous book by this author, so I am more likely to enjoy this book. This book is prominently displayed by the bookstore, it must be popular and therefore personally enjoyable to me.)

    I think it is completely obvious that if you have this person, lets call them a “friend” (a concept that is strangely absent from most economic models, despite its obvious influence on many economic transactions) who has some history and insight into you, that they are in many cases going to actually be able to better select a book for you than you would be able to select for yourself. After all, this friend can combine their knowledge of your preferences and select from various books that they have actually read. Whereas if you are buying a book for yourself, you usually have to combine knowledge of your preferences to guess about the best book to buy from a group of unread books rather than read books.

    Also, your friend may be able to help you to overcome certain heuristics and biases which may lead you to overlook certain products that you would really like. Whereas perhaps you wouldn’t really consider a western (because you heavily employee the heuristics that you like fantasy more than westerns), your friend, combining their knowledge about you with the knowledge of there own experiences consuming a particular book from the western genre may gift to you a western novel that you will actually turn out to enjoy more than most fantasy novels. Maybe this will even turn out to be a goldmine, as your enjoyment of this particular western leads you to purchase a series of books by the same author that you would not have otherwise considered.

    Finally, since enjoyment of a book can be social, the fact that your friend has read and enjoyed the book will give you a basis for discussion and possibly lead you to better relate to that person and build a stronger relationship with them.

    I think this is all very obvious.

    I am not sure how serious the economists who talk about gift giving in this way are. I have heard enough seemingly sincere arguments on this topic to think that some of the arguments against gift giving possibly represent actual puzzlement. Probably, most economists who make this argument are kidding.

    In any case, I think that the point that standard assumptions of economics makes gift giving seem irrational should strongly cause us to question the rationality of the assumptions chosen by economists more than the rationality of people who give gifts.

  • 4 jonathan // Dec 27, 2011 at 5:16 pm

    Big Bang Theory, Bath item gift hypothesis

    sums it up well. btw some of my classes call me Sheldon….

  • 5 David Chester // Jan 10, 2012 at 7:08 am

    Many of the models used by macroeconomists for representing the social system are baically wrong and consequently the results are in error. Keynes was a good example of this. The rule for constructing a model should follw Prof. Einstiens advice. It should be as simple as possibe without being too simple. This requires all of the system to be included. The simplist way to do this comprehensively is shown in my diagram in Wikipedia, Macroeconomics. It stime for the Harvard professors to wake up and understand (with the students revolt) what REALLY comprises our tottering social system!

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