Ordinarily, there is nothing wrong with honest enquiry into how the world works, and we like to encourage economic thinking. However, every Christmas the same argument is presented that Christmas is “inefficient". The argument goes something like this: Al spends $20 on a fruitcake for Mom. Since Mom only values the fruitcake at $5, and would have instead placed a value of $40 on $20 worth of cosmetics, then Al is out 20 bucks and Mom is missing $35 in consumer surplus. Perhaps it is the thought that counts, but in a nation of 300 million people, the deadweight costs of Christmas gift giving added up to an estimated $4 billion in 2001. Sentimentality and thought are not taken into account, but the fact remains that gift givers are less likely to fully understand the subjective values of gift recipients.
Of course, folks can overcome this inefficiency by giving cash, but cash can sometimes seem impersonal; and we worry that recipients will not use the money to “treat themselves”. So instead of money, we go to stores and purchase gift cards which, offer more fungibility and say, “hey, I cared enough about you to brave the crowds and go and buy this rather than just cutting you a cheque.” Unfortunately, gift cards present deadweight costs of their own. A percentage of recipients may lose them or fail to use the full amount. Furthermore, the lag between purchase and use is essentially an interest free loan to the issuing retailer.
Although gift cards may lessen the subjective value problem of gift-giving, they do not completely alleviate it. A parent may give a gift card to child for a store the child would not be caught dead in. If Al gives Mom a gift card for Home Depot, and Mom gives Al a gift card for Tiffany’s, then the deadweight loss will be considerable. Fortunately, the rise of internet exchange (via e-bay) has created a secondary market in gift cards. Unfortunately, according to this article, these gift cards tend to fetch 80 percent of their value, which still appears to diminish the gift, despite increasing the consumer surplus for the recipient (they presumably still value the 80 cents in cash more than the gift card dollar). Some gift cards do better than others in both redemption percentage and in the secondary market. Supermarkets enjoy the highest redemption rate (98%), while gift cards for large “big box” retailers sell for about 90 percent of their value on the secondary market. Specialty stores suffered both the lowest redemption rates (85%), and only traded at around 80 cents on the dollar. Lastly, higher denomination gift cards were more likely to find their way onto to secondary market and tended to trade at steeper discounts.
So if you don’t feel like braving the stores and want to spare your friends and loved ones the bother of re-selling their gift cards and suffering dead-weight losses, then there is nothing wrong with gifting a little medium of exchange this holiday season. Please feel free to enclose this post as an explanation for your gift and to highlight the extra 20 percent in consumer surplus included in your gift. However, please note, this advice does not extend to either diamonds or ponies.
Intriguing. I wonder if it would be beneficial for retailers, especially those whose cards trade at a significant discount, to purchase the cards back themselves and guarantee the profit rather than play the odds of the card going un-redeemed?
Posted by: Aaron S. Rose | 26 December 2007 at 01:10 PM