It’s December. You are frantically searching the aisles for those last-minute Christmas gifts. You don’t quite know what to get anyone, so you buy a few scented candles and some fluffy toys for the kids and call it a day. Will they fully appreciate your gifts? Statistically, probably not. According to a 1993 paper by economist Joel Waldfogel, a recipient generally values their gift 10-30% less than its retail price. That is to say, if the recipient saw your gift in a shop, they probably wouldn’t buy it. Why does this matter? Well interestingly, gift-giving is a form of deadweight loss because the market isn’t efficiently allocating its resources to maximise economic utility. This means that the gifted goods aren’t being consumed by those who want them at market price. This problem is generally associated with asymmetric information. We can’t fully understand what recipients want because we don’t know everything about them. Worse, we can’t ask them what they want because that would contradict social conventions. So, we settle for a gift that isn’t quite right. In a neoclassical model, we can easily solve this issue by giving cash gifts. Cash would allow the recipient to buy anything they want and maximise their utility with perfect rationality. Does this mean I’m going to give my six-year-old cousin a wad of notes for Christmas this year? No way.

One reason for that is the paternalistic function of gift giving. Parents often give gifts which help their children develop into better adults. For example, a couple might be more inclined to buy their son a book than a video game. Although a video game might maximise their son’s utility, a book would encourage him to read more and perform better at school. It might also contain some valuable lessons for him, to help shape his view of the world. The parents therefore choose the book because it is in their son’s long-term best interest. You might think of it in the same way as the trade-off between capital and consumer goods. The parents are encouraging their son to invest in his human capital at the expense of his present utility.

On the other side of the spectrum, parents sometimes choose gifts which actually give their child more satisfaction than an equivalent cash gift. In a behavioural model, consumers often fail to maximise their utility due to consumer biases. Children are more affected by consumer biases due to a lack of experience and maturity, making them less likely to make rational consumer decisions. If I gave a toddler £20, they might spend it all on sweets which they would undoubtedly gobble up immediately and consequently feel sick. The toddler’s parent, who might buy them a toy instead, can thus maximize the child’s utility better than the child can do so himself.

Another argument in favour of gifts-in-kind, proposed by Harvard economist Greg Mankiw, is based on the signalling theory of Michael Spence. Mankiw argues that the gift acts as a signal to overcome asymmetric information in a relationship. Say, for example, a man needs to give an anniversary gift to his girlfriend. To maximise her economic utility, he would give her cash; but if he did so, she would likely be offended. Why? Because cash would not signal his love for her as much as something more personal. The asymmetric information in this relationship is that the girlfriend doesn’t know how much the man loves him. The man can signal his love by spending time and money choosing the perfect gift, thereby overcoming the asymmetric information and bringing the couple closer. Additionally, this increases their ‘emotional utility’ – that is, their utility gained from the relationship instead of from the consumption of goods and services. The gift would also have more sentimental value than an equivalent cash gift. I previously mentioned the research of Joel Waldfogel; he specifically framed his surveys to disregard the sentimental value of gifts. But if this sentimentality adds to the utility of the recipient, it should not be disregarded.

Gifts-in-kind can also be more beneficial to the giver. In every voluntary economic transaction, both parties seek to maximise their utility. Gift-giving is no different. But how would gifts-in-kind benefit the giver at all? After all, they have to spend time and money choosing it. The explanations are more psychological than economic. One reason is that social norms often condemn cash gifts as low-effort and worthy of reprove. Therefore, in order to avoid embarrassment or condemnation, the giver has to choose a gift-in-kind. Another reason is that gift-giving has an altruistic aspect to it. When we go out and spend hours looking for the perfect gift, our reward is pleasing the people we care about. Cash gifts are low effort, meaning that the giver wouldn’t get the same feeling of satisfaction as they haven’t invested as much time into the gift-giving process.

There is, however, a balance to be struck. For distant relatives or less-well-known acquaintances, it may be very hard to choose a utility-maximising gift. In these cases, a gift-card is the way to go. It is essentially equivalent to giving cash, but it bypasses the stigma associated with cash gifts. Nevertheless, for friends and family, the sentimental value of a gift is more important. Whether or not they like what you choose, it’s the message behind it that counts. After all, there’s more to life than maximising economic utility.