Utility maximization isn’t just for automobile manufacturers anymore. With just three short weeks until Black Friday I thought now would be a good time to talk about the utility of gift giving; so break out your Centurion Cards, flick them to hear the metallic ding and check that they are properly tapered at the magnetic strip for easy swipeage. My cousin is in a MBA program and is about to take an economics course that covers utility theory, so I gave her my usual utility speech that resulted in great confusion. Hopefully, I can now better explain my position than I did to her. My friend the Admiral once had the audacity to call me a kind and benevolent human being and this article may support his asinine position.
All purchases should be gifts; we should buy nothing for ourselves as this will maximize utility and happiness (view this as the appropriate time to sing Kumbaya). Why is it important to maximize utility? As we all know the peasants work harder the happier they are. Seriously happiness is a good thing and I’d like to demonstrate how without spending more we can exponentially (figuratively not literally) increase utility/happiness. You might think that gift giving is a zero sum game, meaning that any utility gained by the gift recipient would be offset by the loss of the giver, but you’d be wrong. When someone makes a purchase they innately make a determination of its value and will only purchase it if they find it to be a fair value regardless of any externalities. A perfect example of this can be taken from my childhood. As a little boy I wanted a Fisher-Price 3-in-1 game table; I loved playing pool, ping-pong, and whatever the third game was but alas I never had such a toy because my mother found the build quality to be so poor that regardless of the happiness or utility I would have derived from the gift, and it would have been considerable, and regardless of her wealth, which was considerable, the product wasn’t worth the $200 purchase price leaving me with better favorite childhood toys: Hungry Hungry Hippos, Laser Tag, the educational Monopoly, and this little mechanical dog that did flips.
Now back to the economics; a transaction is completed if the purchaser values the good or service equal to or, most likely, greater than the purchase price and the seller will only sell if he values the good or service equal to or, again most likely, less than the purchase price generating utility on both sides of the transaction. Typically that is the extent of the utility generation and that’s where it ends but, not when the transaction involves a gift. When you give a gift utility generation continues as the recipient gets at least the utility of and probably more than the purchase price plus added utility from the thoughtfulness of the gift giver plus the gift giver gets utility from the appreciation/joy of the recipient.
This theory is predicated on the gift being useful and desirable to the recipient; if the gift isn’t useful then the purchase price utility is lost to the recipient, but that’s what eBay is for. If the gift is inconsiderate it may cause ill will resulting in negative purchase price, thoughtfulness, and appreciation utility.
Let’s look at some numerical examples:
|
Regular $10.00 Widget Purchase |
$10.00 Widget Gift Purchase |
||||||||
|
Economic Catalyst |
Value* |
Price |
Utility |
Economic Catalyst |
Value* |
Price |
Utility |
||
|
Seller |
$9.99 |
$10.00 |
$0.01 |
Seller |
$9.99 |
$10.00 |
$0.01 |
||
|
Buyer |
$10.01 |
$10.00 |
$0.01 |
Buyer |
$10.01 |
$10.00 |
$0.01 |
||
|
Recipient |
N/A |
N/A |
N/A |
Recipient |
$10.00 |
$0.00 |
$10.00 |
||
|
Recipient’s Gratitude |
N/A |
N/A |
N/A |
Recipient’s Gratitude |
$0.01 |
$0.00 |
$0.01 |
||
|
Buyer’s Enjoyment |
N/A |
N/A |
N/A |
Buyer’s Enjoyment |
$0.01 |
$0.00 |
$0.01 |
||
|
Re-Sale |
N/A |
N/A |
N/A |
Re-Sale |
N/A |
N/A |
N/A |
||
|
Total Utility |
$0.02 |
Total Utility |
$10.04 |
||||||
|
*Assumes Lowest Reasonable Utility |
*Assumes Lowest Reasonable Utility |
||||||||
|
$10.00 Useless Widget Gift |
$10.00 Inconsiderate Widget Gift |
||||||||
|
Economic Catalyst |
Value* |
Price |
Utility |
Economic Catalyst |
Value* |
Price |
Utility |
||
|
Seller |
$9.99 |
$10.00 |
$0.01 |
Seller |
$9.99 |
$10.00 |
$0.01 |
||
|
Buyer |
$10.01 |
$10.00 |
$0.01 |
Buyer |
$10.01 |
$10.00 |
$0.01 |
||
|
Recipient |
$0.00 |
$0.00 |
$0.00 |
Recipient |
($10.00) |
$0.00 |
($10.00) |
||
|
Recipient’s Gratitude |
$0.01 |
$0.00 |
$0.01 |
Recipient’s Gratitude |
($0.01) |
$0.00 |
($0.01) |
||
|
Buyer’s Enjoyment |
$0.01 |
$0.00 |
$0.01 |
Buyer’s Enjoyment |
($0.01) |
$0.00 |
($0.01) |
||
|
Re-Sale |
$8.00 |
$0 |
$8.00 |
Re-Sale |
$8.00 |
N/A |
$8.00 |
||
|
Total Utility |
$8.04 |
Total Utility |
($2.00) |
||||||
|
*Assumes Lowest Reasonable Utility |
*Assumes Lowest Reasonable Utility |
||||||||
As we can see from the examples above, utility is maximized when thoughtful gifts are exchanged.
Black Friday through New Year’s is when most stores generate 40% – 60% of their annual revenues; go grab that black card and embrace the spirit of the season to make everyone, including yourself, happier. Maybe I am kind and benevolent or maybe I am an economist who believes that, almost always, more is better than less and it would be criminally negligent to not maximize utility; particularly when it costs nothing except for opportunity cost that can be cancelled out in a zero sum game with robust gift giving and perfect information about recipients’ wants.
{ 4 comments… read them below or add one }
Utils- The scientific unit of measure of an item’s utility.
I propose this thought to you:
Many Economists would argue that Utils are naturally built into the price based on the theory of demand. Since most purchasers made during the holiday season are presumed for the purpose of gifting, I would argue that you are in fact decreasing the value of an item by not gifting rather than increasing its value by giving it away.
The solution: Do not buy anything, whether it be for a gift or not. Make your purchases in January when 1) the gift utility is no longer built into the price of the item and 2) the utils achieved by the seller increases in January when sales are low, thus increasing your bargaining chips.
Was it a car or a cat I saw ?
Mr. Palindrome:
That is a very interesting point. However I must disagree with your premise. Utility is not a factor of price, rather a consequence. A perfect example is the I’m righ iPhone app that sold for about $1,000 and did nothing except proclaim it’s title. For most paying such a price for nothig is absurd though for a select few being able to demonstrate that they own the discressionary income to buy such an app was well worth the purchase price (I’d argue buying five shares of Apple would have been a better purchase though). Moreover, price gouging doesn’t occur and in fact prices are typically lower due to various sales during the holiday season increasing utility. Finally and particularly in these tough economic times the seasonal workers supported by holiday shopping add another level of utility in the form of a direly needed paycheck. Fundamentally just because an item is sold with the presumption that it will be presented as a gift in no way affects the the end utility regardless if it is presented as a gift or not.
Nice post! Agree with previous commenter that you might be conflating price and utility, but I get the argument, and it’s probably right that you are overall creating more happiness in the world. It’s too bad people don’t optimize for aggregate happiness in every decision they make :-/.
Dear Andrew P.,
I don’t think I’m conflating price and utility as fusing those two terms would inevitably lead to a discussion about wealth’s effects on happiness; a subject I leave each to his own. I would argue that for the purposes of this article price and utility are fungible; there is no quantifiable measure of happiness so if I posted the same examples with happiness or usefulness points it might be more precise but ultimately silly. One point I tried to make in the article, and apparently failed at, is that there is an innate decision in the consumption process about a product’s value. As I pointed out in The Gold Standard: Pyrite or 24ct Au 79 money has no value beyond its ability to be traded for goods and services. Purchases are predicated on satisfying a need or desire and while we may not think about enjoying needed purchases we do; since price valuations are inherently predicated on opportunity cost we can in fact think of money as happiness points. An example is that while I don’t care for lima beans I eat them to get the health benefits of the associated nutrients so the price I pay is equal to or less than the happiness or utility received from my good health. I eat lima beans instead of asparagus because the price differential demonstrates value to the cheaper lima bean; when choosing between the two my basis might be dollars and cents but it is really what else I can do with that money as money’s only value is its ability to be exchanged all value is derived from opportunity cost of other transactions. I’m standing in the grocery store thinking with the money in my pocket I can: A, buy asparagus be well and go home, B, buy a carton of ice cream go home and need a stent down the road, or C, buy lima beans, get nourishment, and buy a carton of ice cream as a treat; my first priority is good health but I’ve earned some chocolate as well so I choose C. Editorial Note: I loathe lima beans; I don’t and never shall eat those disgusting legumes. I guess I’d like my readers to know that:
1) I understand that utility and price are two unique terms with different meanings
2) price is a good proxy for this discussion as there is no better quantifiable scale
3) monetary value is a fluid construct predicated on a series of utility and opportunity cost calculations
4) utility can refer to happiness, usefulness, and monetary value
I agree with and like your elequent summation of the article but don’t understand your emodocon; I even looked it up to no avail.
-Hunch
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