Why Do We Give Gifts?

My previous two posts were on gifting as a substitute for sale. This one is on gifts given without the expectation of a gift in return.

Economists find the practice of giving gifts puzzling. We expect individuals to know more about their own preferences than other people do so it would seem that a gift in money, which I can use to buy whatever I most value, would almost always make more sense than a gift purchased for me. There may be exceptions, cases where the giver happens to have special knowledge that the recipient does not,  but it is hard to see how they can explain the amount of gift giving we actually observe.^¹

The idea that giving a gift shows you were willing to go to the trouble to find one seems even less persuasive. Why not simply send a check equal to the value of the gift you would have found plus the value of the time you would have spent finding it? 

One possible solution to the puzzle starts with Gary Becker's analysis of the economics of altruism, which models an altruist as someone who has another person’s utility as one of the arguments in his utility function. If I am an altruist with regard to you it is in my interest to be well informed about your preferences in order that I can recognize situations where I have an opportunity to confer a large benefit on you at a small cost to me. It is also in my interest for you to know that I am an altruist with regard to you, since that makes it in your interest to act altruistically towards me — the better off I am the more I will be able to help you.²

Being well informed about your preferences makes it easier for me to find a gift you will like. Giving a gift you will like signals altruism since it is a signal that is cheaper to send if I am an altruist with regard to you than if I am not. 

This is a logically possible explanation of gift giving but I do not find it a very convincing one. 

Becker altruism implies that there is an optimum division of the combined income of altruist and beneficiary between the two, the division that maximizes the altruist's utility. If the beneficiary already has more than his share, the result is a corner solution: no transfer. If he has less, the altruist transfers money to him until his desired division is reached, that being the point at which an additional dollar of transfer would cost the altruist as much in lost utility from his own reduced consumption as it would gain him in increased utility from the beneficiary's consumption.

That implies that, when transfers occur, they should almost always be large.³ How likely, after all, is it that my beneficiary's initial share of our combined income will be precisely five dollars less than my optimum? Yet most gifts are only a tiny fraction of income. I have a possible solution to both that puzzle and the puzzle of giving gifts instead of money, but first a digression.

Economists model utility as combining all sorts of values into one, but it does not feel that way. When I decide whether or not to have an ice cream cone my behavior can be modeled as an attempt to maximize the present value of my utility stream, trading off pleasure today against the negative consequences of present calories for future welfare. But it feels more like a conflict between two me's, a short term pleasure maximizer and a long term utility maximizer, with the latter using various stratagems in attempting to control the former.

Suppose what the altruist values is not the welfare of the beneficiary as economists define it, the present value of his utility stream, but his current happiness, making the gift giver the ally of the short term me. Give me money and the long term me might insist on putting it away for our old age. Give me a box of candy and there is nothing to do with it but eat it.

This explains the small size of gifts. I can use an almost unlimited amount of money to provide for my old age or insure against medical risks but there is a low limit to how much candy I can eat, how much pleasure you can provide for me today by giving me stuff today. If your utility function exhibits declining marginal utility for my pleasure that effect can be expected to show up much faster than if it exhibits declining marginal utility for my utility.

Suppose we accept the plausible idea that I can be modeled as two individuals in one body, a short run pleasure maximizer, the me that almost always wants an ice cream cone or another potato chip, and a long term utility maximizer, the me that promises not to have ice cream for desert until he has lost five pounds and tries to force the first me to keep the promise. If we use the same model for altruist and beneficiary we have another explanation for gift giving. Spending an extra few dollars on a gift does not mean that I cannot afford an ice cream cone today, only that I will have a few dollars less when I retire. The long run me cares about that, the short run me doesn't. Spending an extra hour shopping, on the other hand, is a cost that occurs now and so counts for both versions of me. By giving you a gift instead of cash I demonstrate that the short run me as well as the long run me cares about you. Since a lot of my behavior is controlled by the short run me, that is valuable information.

The final question is why humans might have this sort of modified Becker altruism. Becker has offered an evolutionary explanation for altruism — that, due to the Rotten Kid Theorem, the existence of an altruist in a group makes it in the selfish interest of all group members to take account in their decisions of the welfare of all other members. The environment we evolved in did not contain savings accounts, annuities, insurance policies. Given the constraints of that environment, short term benefits may have been all it was practical to produce or observe. Hence we may have ended up as altruists targeting the current value of happiness rather than the present value of lifetime utility.

When proposing an economic theory it is worth thinking about whether it has any testable implications. This one does. A critical assumption in the argument is that the gift giver does not face a short term budget constraint, that spending money on a gift does not mean going hungry to bed or having to spend an extra couple of hours shoveling snow, costs for the short term as well as the long term me. It follows that the giving of money instead of purchased goods ought to be more common among people who do face such a budget constraint, most obviously poor people living paycheck to paycheck. Since I am by nature lazy, hence a theorist, I will leave to someone else the project of finding and analyzing relevant data.

Discussing the issue with my daughter she offered a third possibility, that the custom of gift giving developed in the past in a context where it made much more sense. You live in a society where markets are thin — few buyers, few sellers, unpredictable supply. I see something for sale that I am pretty sure you would like, buy it and give it to you. If I gave you money and a suggestion of how to use it, by the time you went looking it might no longer be there.

Why do We Tip?

The obvious economic function of tipping is as a way of rewarding waiters for good service (with high tips) and penalizing bad service (with low tips). It depends on social norms or repeat custom to work but takes advantage of the fact that the customer has information about the quality of the service that the employer does not have.

The problem with that explanation is that it depends on customers substantially varying the amount of their tip—and many, perhaps most, don't. If you almost always tip 15% and occasionally raise it to 20% for good service or lower to 10% for poor, that is not much of an incentive to the waiter.

An alternative explanation is that tipping exists because people like to feel generous. Giving a tip when you know you do not have to makes you feel better than paying the same amount on the bill. Abiding by the implied contract to tip if you get reasonable service when you know you could have stiffed the waiter and saved the money proves to yourself and your table companions that you are an honest and honorable sort.

Not only do we get to be generous and demonstrate our honesty, we get to do it for free. If tipping were not customary restaurants would have to pay their waiters more. Instead of paying $11.50 for dinner in a world without tipping I pay $10 plus a $1.50 tip. I could stiff the waiter and save $1.50, so not doing so lets me feel both honest and generous, but on average my dinner costs me no more than it would if tipping were not customary.

This may explain why tipping is less common in Europe. Europeans, judging by casual observation, are more concerned than Americans with issues of class and status. What an American sees as an opportunity to demonstrate his honesty and generosity a European may see as a way of claiming superior status, playing the role of an aristocrat tossing crusts to starving peasants. That fits the tone of exchanges on the subject I have seen online between Europeans and Americans.

1. The knowledgeable gift giver could always accompany his check with a note recommending the book he would have bought for me, leaving it up to me to decide whether to accept the recommendation.

2. Gary Becker's Rotten Kid Theorem; for details see chapter 21 of my webbed Price Theory.

3. This point is due to Howard Margolis. So is a second and related criticism of the Becker model.

Consider someone donating to a charity with many recipients. If his income goes up by a thousand dollars he should donate almost all of the increase to charity, since doing so will have a trivial effect on the utility of the ten thousand recipients, each of whom is getting an extra ten cents, hence a trivial effect on the marginal utility to the donor of increases in the utility of the recipients, while spending the money on himself will have a significant effect on his marginal utility of income. equating the marginal utility to him of a dollar donated with the marginal utility to him of a dollar spent on himself requires almost all of the money to be donated.

That is not consistent with the actual behavior of people who give money to charity.