Saving Christmas From the Economists

03/18/2010 05:12 am ET | Updated May 25, 2011

Every year around the start of December, I remember an article from The Economist magazine back in 2001. (An ungated version of the article is available here.)

The author's premise is simple: holiday gift giving produces a deadweight loss for society. He cites a study that estimates that holiday gift giving in the United States costs society $4B, not to mention the countless hassles of returns, exchanges, and the second and third-order effects of regifting bad gifts.

Upon reading the article, the evidence seems incontrovertible -- nobody knows one's own preferences better than himself, and relatives' attempts to divine them through gift giving often result in lost utility and suboptimal outcomes. The article concludes on a reconciliatory note about how the sentimental value attached to gifts increases their value beyond merely their utility in use, citing children's artwork's value to loving grandparents as an example.

Well, duh! I would like to thank economists worldwide for again confirming human intuition in the shroud of science. Normally, I'd let an article like this slide, but since they took aim at one of my favorite holidays, Christmas, I feel compelled to retort.

Indeed, studies like this get to the heart of the limitations of the modern practice of economics. The joy of Christmas showcases the many issues economists face in translating their microfoundational models of human behavior to the domain of the real world. Here are two examples:

1) Nobody really knows his preferences - Economists love talking about preferences and utility maximization. Given their own tastes, a budget, and absent prohibitive transactions costs, all agents will achieve an optimum point of consumption if left to their own devices. Economists assume that actors know their preferences and are the best at choosing the optimum consumption combination to make themselves happy.

But this isn't always true in practice. Those introspective economic agents that populate economists' models (aka human beings) are not Newtonian automatons but indecisive, fickle animals. You do not have, as economists assume, "complete preferences," but highly incomplete, disjointed, and even unknown preferences for things. People do not have perfect knowledge of their world. Nor do they always know what will always make themselves happy.

Sometimes, we need others to send us signals and change our preferences. I had the luxury of spending this past Christmas in Canada, where my girlfriend's parents gave me a novel and distinctly Canadian red and black plaid flannel button-down shirt. The likelihood of my purchasing this shirt on my own volition was probably less than 1%. But now that I have it, I have suddenly developed a penchant for shirts in this style. In other words, receiving this gift changed my preferences. This dynamism is often ignored by modern economics. And mere ownership of this shirt predisposes me to it, as posited by the notion of the endowment effect.

2) More choice isn't necessarily better- Economists also assume that rational economic agents prefer more choice to less. This microfoundation of economic actors is also being debunked by modern psychology. In Dr. Barry Schwartz's book, The Paradox of Choice: Why More is Less, he explains why the fetishism of choice maximization might create more stress, and therefore less utility, for decision-makers. When faced with a preponderance of choice, the sheer volume of possible scenarios often overwhelms decision-makers. When a decision is finally reached, people often second guess their actions, fixating on counterfactuals of foregone choices. All of this choice creates anxiety for individuals.

Luckily, Christmas helps remedy this problem. By outsourcing choice, we are more willing to accept the decisions made on our behalf, provided they are made in good faith, as most Christmas gift giving would qualify.

In short, there is no reason to believe that Christmas is any less worthwhile on an economic basis than a religious, familial, or societal one. On the contrary, perhaps giving gifts is a psychological favor you can offer in the holiday season, broadening your receiver's preferences and reducing some of their choice anxiety. Armed with this new information, is it too early to start thinking about Christmas 2010?