Last year, I argued that Christmas was the most inefficient time of the year due to the large loss of welfare that goes with the tradition of gift giving. This year I will argue that Santa Claus, as the tradition is embraced in the English speaking world, fails to provide children with strong enough incentives to behave nicely, thus resulting in too much naughty behavior, reducing society’s welfare in the months leading up to Christmas. We’ll explore a market-based solution to this market failure,  already being practiced across the European continent, which harnesses the power of incentives to improve children’s behavior, and the overall efficiency of the Christmas holiday.

The lyrics to the popular Christmas song, Santa Claus is Coming to Town, are a warning to little children that they better not act naughty, OR ELSE! Read them and see what I mean:

You better watch out, You better not cry
Better not pout, I’m telling you why
Santa Claus is coming to town
He’s making a list, And checking it twice;
Gonna find out who’s naughty and nice
Santa Claus is coming to town
He sees you when you’re sleeping, He knows when you’re awake
He knows if you’ve been bad or good, So be good for goodness sake!
O! You better watch out! You better not cry
Better not pout, I’m telling you why
Santa Claus is coming to town

“So be good for goodness sake,” a child will say, ” OR WHAT? What are you going to do Santa, if I am naughty? Are you not going to bring me a present that I really want?”

You see, this is the problem with the Santa I grew up with. He is all carrot, and no stick. Humans respond to incentives, and the Santa I grew up with is great at incentivizing nice behavior, but he’s really bad at disincentivizing naughty behavior. Consider the following:

• Santa sees me when I’m sleeping and knows when I’m awake, so he knows when I’ve been bad or good. If I’m good, the implication is that I will be rewarded with wonderful gifts from Santa come Christmas time.
• If I’m bad, however, I will experience no loss whatsoever. While I will not benefit as much as the good children, nothing will be taken away from me. I will be made no worse off by being naughty, rather the degree to which I will be made better off is reduced.

This is a classic incentive problem. Santa provides rewards for good behavior, but fails to dole out punishment for bad behavior. A culture which embraces this benevolent Santa will invariably produce too many naughty children. Such a market failure can be illustrated clearly using benefit and cost analysis:

As economists, we’re always exploring ways to improve efficiency in the markets for different goods, services, and human behaviors. Clearly, in the market above, in which children determine how naughty they will be based on their perceived private benefits and costs of their own behavior, there is a market failure.

Due to Santa’s hollow threat (“…you better watch out!”), children lack a strong disincentive to not act naughtily, and therefore choose to engage in naughty behavior to the extent that overall welfare in society is reduced. The marginal private benefits of naughty behavior are far greater than the marginal social benefits of naughty behavior (let’s face it, acting naughty is FUN!).

So how could Santa better harness incentives and disincentives (both the carrot and the stick) to reduce naughty behavior and increase overall welfare in society, thereby increasing the overall efficiency? Santa must do more than just encourage good behavior; he must also strongly discourage naughty behavior.

Well, as it turns out, the Santa I grew up with is not the only version of Santa Claus in the world, and in fact the Santa known to millions of children all over Europe is one with a fearsome, wrathful side that is not timid about doling out punishment to naughty children. Allow me to introduce the European Santa, and his evil alter-ego, known here in Switzerland by the ominous name Schmutzli (which translates loosely to “dirty face”).

img source: http://www.ricksteves.com

The Swiss news site Swissinfo.ch introduces the character Schmutzli:

This is not the Santa Claus known to English-speaking countries but the Swiss version – who is normally accompanied by a strange-looking individual with a blacked out face.

The Swiss Father Christmas was based on Saint Nicholas, whose feast day was celebrated on Saturday – his Swiss German name, Samichlaus, alludes to that. But the origins of his sinister companion are less easy to make out.

Known as Schmutzli in the German part of the country… Samichlaus’s alter ego usually carries a broom of twigs for administering punishment to children whose behaviour throughout the year has not been up to scratch.

You see, here in Switzerland, and in much of Western Europe, Santa brings gifts for the children who have been nice, but his partner Schmutzli delivers harsh punishments to those children who have been naughty. Schmutzli, who goes by different names in other parts of Europe, is known to throw naughty children in his sack, carry them into the woods, and administer a fierce beating with his birch stick, and for the naughtiest children, to eat them or throw their beaten bodies into a river.

Schmutzli, quite literally, provides the stick to accompany Santa’s carrot. In Europe, children not only receive wonderful rewards from Santa for good behavior, but fierce punishments from Schmutzli for naughty behavior.

From an economic perspective, Schmutzli’s existence increases the efficiency of the Santa character dramatically, and therefore improves overall welfare in society by giving children both an incentive to act nice and a strong disincentive to act naughty, thereby internalizing the negative social costs of naughty behavior. The outcome can be as illustrated as below:

As the graph illustrates, Schmutzli’s presence by Santa’s side come Christmas time forces children, in their decisions regarding naughty behavior, to account for the likelihood that Santa truly “knows when you’ve been bad or good”. For if he does know when you’ve been bad, Santa will unleash Schmutzli, his child-hauling sack and his birch stick on those whose behavior has been more naughty than nice.

Schmutli’s existence in Switzerland’s Santa story internalizes the external costs of naughty behavior among children, and thereby reduces the marginal benefits enjoyed by naughty children, reducing the actual number of naughty children and the size of the deadweight loss they impose on society. Fewer children will act naughty, the externality is reduced, and overall welfare in society improves.

There you have it. The deadweight loss of Santa. If you ever doubted that Economists could find the inefficiency in Christmas, I’ve shown you once again that it is indeed the most inefficient time of the year. By providing a balance of rewards and punishments, Schmutzli’s presence corrects the incentive problem of an always benevolent Santa. Society as a whole should therefore suffer from less naughty behavior among its children.

Once again, a little Economic analysis can help make Christmas more efficient for all!

Related posts:

1. Grinchonomics – or “how the Economist stole Christmas”
2. McJobs in America – under threat!
3. “Opulent in elegance. Bountiful in spirit”

This is the kind of humor economists love, from the folks at xkcd comics:

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Every year around this time economics students and teachers alike begin looking forward to the long Christmas holiday right around the corner. Two or three weeks of yuletide cheer, mistletoe, snow men, caroling, food, family and… dead weight loss. That’s right, what’d you think this post would be about, the efficiency of Christmas? Come on… it’s the DISMAL science! Not the jolly science!

The tradition of giving Christmas presents has long fallen under the scope of economic researchers who seek to understand more about the rational, or as it turns out, irrational behavior of individuals in society. From an economic standpoint, many of the things that Christmas traditionalists believe are bad, are actually good, while the traditions many believe are good are in fact quite bad from an economist’s viewpoint. Basically, economists are grinches. So prepare to be grinchified…

Are you the kind of person who thinks doing all your Christmas shopping online is cold, impersonal, and against the holiday spirit? Well, Stephen Dubner, co-author of Freakonomics, argues that shopping online is far more efficient than spending days roaming the malls and shopping centers searching for the right gift for your loved ones. Says Dubner about “clicking and gifting” (i.e. shopping online):

See here’s the thing: I like the sound of clicking and gifting, that sounds efficient to me. That’s what we need to bring to the holidays, is more efficiency, less emotion. Let’s get rid of that.

Economists’ disdain for Christmas shopping is not limited to criticizing the inefficiency of spending hours shopping for gifts, in fact the tradition of giving gifts itself is considered economically irrational and inefficient. Sure, you say, it’s the thought that counts. Well, that’s just stupid. A gift giver can think all he wants about what a friend or a loved one may want for Christmas, and end up buying the thing they think the other person wants. But when it comes down to it, each of us only really knows what one person in this world wants, and that is ourselves, that’s right, the royal ME.

So basically, any gift you can buy for someone else will bring them less benefit than a purchase they themselves make; so WHY BOTHER? What it comes down to is self-interest in the end. When we buy a gift for another person, it is ultimately for our own benefit, which as we will see soon, most often exceeds the benefit of the receiver of the gift.

This is what’s known as the dead weight loss of Christmas. From an economic standpoint, Christmas is not “the most wonderful time of the year”, rather it’s “the most inefficient time of the year” (not so catchy as a song lyric, I’m afraid). Dead weight loss is like when,

…my wife’s great-grandma buys me a sweater at $85 and to me it’s worth like $1.50. Because I don’t like it… so that’s $83.50 deadweight loss… And the holidays are jam-packed with that kind of waste.

We’ve all been there, as both the gift giver and the unfortunate receiver of a gift we don’t like or even want. In fact, this phenomenon can be graphed using a basic diagram learned by all high school economic students: the marginal benefit, marginal cost diagram. Look at the graph below and see if you can figure out what it shows, then scroll down and read the explanation.

Basically, what the graph above shows is that the act of giving gifts brings benefits to the gift giver that are not enjoyed by the gift’s receiver. From the ultimate consumer’s standpoint (i.e. from the perspective of the gift receivers), many of the gifts received for Christmas will be valued far less than the amount of money, time and energy that went into choosing and buying them by the gift giver.

In other words, the marginal cost of shopping for and buying Christmas presents exceeds the marginal benefit of those who receive them, hence, the market for Christmas gifts fails since the behavior of private individuals results in a level of Christmas shopping that exceeds the socially optimal efficient level, at which the marginal benefit of the give receivers intersects the marginal cost of gift production. Resources are over-allocated towards Christmas present shopping because it is simply impossible for gift givers to know the precise preferences of those for whom they shop.

That $85 sweater, for instance, may have only been “worth” $1.50 to the poor fellow who received it. The dead weight loss, therefore, is the resources that went towards producing and purchasing a sweater for someone who doesn’t even like it, and all the other possible ways those resources and that money could have been allocated.

Have I ruined your Christmas yet? Well, fear not, there is an economically efficient way to approach the Christmas season and to maintain the beloved tradition of gift giving! That’s right, even the Grinch economists have a solution to this wasteful problem! And it is so simple… it is… CASH! Cash is the ultimate gift, perfect in every way. No time whatsoever is wasted in the process of deciding what to give someone. Simply put your debit card in the ATM machine and your entire season of shopping is done!

Cash is the perfect gift to receive too. There is no chance you will be unsatisfied with what you ultimately “get” for Christmas.  Cash can be spent on the goods from which the receiver himself enjoys the greatest marginal utility per dollar he spends. The dead weight loss above is completely eliminated when cash is given instead of other presents. The marginal benefit of the giver and the marginal benefit of the receiver are the same since the giver can rest assured that the receiver will spend it on something that provides him with the greatest possible benefit.

So there is a happy ending to this story after all! Maybe someday when economic education has truly succeeded we can once and for all do away with the wastefulness and inefficiency of Christmases past and form new traditions rooted in the efficiency of cash gifts. So, students of economics, if you want to make your loved ones happy this Christmas, you now know what to do. In the process, you’ll help make the world just a little bit more efficient!

For more on the dead weight loss of Christmas, listen to and discuss with your class the two podcasts below, from two of my favorite shows, American Public Media’s Marketplace (from which the quotes above are taken) and NPR’s Planet Money.

Discussion Questions:

1. A market failure in economics exists whenever resources are allocated inefficiently towards the production or the consumption of a certain good. What makes holiday gift giving a market failure?
2. Why is the marginal benefit of a gift giver often times greater than the marginal benefit of a give receiver? How does this discrepancy result in “negative social benefits” as indicated on the graph?
3. What is dead weight loss and how does holiday gift giving result in it?
4. Why are cash gifts more “efficient” than buying presents for others? How would an economist analyze the efficiency of gift cards or gift certificates compared to presents? To cash?
5. Should we scrap Christmas and replace it with Economistmas? For Economistmas, everyone would get exactly what they want, which is to say, everyone would get money to BUY exactly what everyone wants. Surely you agree this would be far superior to our antiquated traditions rooted in inefficiency and dead weight loss, right?

Author’s note: For the record, I have bought my wife and family the perfect gifts this year! They’re simply going to love what I got them! And no, it is not cash! ;o) Merry Christmas!!

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1. Grinchonomics, 2nd edition: “Santa’s hollow threat…” or “how the Economist can help save Christmas”

One particularly witty student submitted his Economics Learning Log for our Elasticities unit with the following thoughtful poems.

On Price Elasticity of Demand:

Price may increase fast

Inelastic good’s demand

Stays in place for good

On Cross-price Elasticity of Demand:

Vodka drinkers fear

Russians tax it, prices soar

I’ll drink beer instead

On Income Elasticity of Demand:

Wages cut in half

No more decadent lifestyle

I miss my Rolls Royce

On Price Elasticity of Supply:

Demand for sweets down

Asbestos found in lollipops

Guess I’ll make fewer

Well done, Nick! Keep the haikus coming!

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Indexed » Blog Archive » Resources were not allocated efficiently

Econ students and teachers alike should appreciate this Venn Diagram. What happens when a nation chooses a point on its production possibilities curve somewhere between “guns” and “butter”? Answer, “Accidental shooting”… GET IT?

The punchline: “Resources were not allocated efficiently”

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I love this discussion between John Stewart and former director of the National Economics Council Lawrence Lindsey. Stewart pitches his own version of a fiscal stimulus package to the economist, and is surprised when Lindsey agrees with the plan.

I find Lindsey’s suggestion that a stimulus package should include subsidized mortgage rates to home owners fascinating. According to Lindsey, a homeowner with a $200,000 mortgage paying 6% interest on his loan would save $4,000 per year on interest payments if the government accommodated a refinanced rate of 4%. Millions of Americans currently struggling to meet all of their monthly debt obligations while continuing to put food on the table and participate in the consumer economy would benefit from such a scheme. In its current form, Obama’s stimulus package with its $150 billion or so in tax cuts will only put approximately $500 per year for two years into taxpayers’ pockets.

As a homeowner paying a 6% mortgage myself, I can personally say I’d prefer $4,000 in savings on my annual interest payments for the next 23 years (the time remaining on my mortgage) than I would $1000 in cash over the next two years. The mortgage relief plan would result in nearly $100,000 less in interest payments, freeing that income up to be spent on goods and services and contributing to real job creation.

And check out last night’s “moment of Zen”. While Obama’s stimulus package is not quite $1 trillion, it is darn close. Senator Mitch McConnell puts the vast size of the spending bill into perspective for us:

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3. Fiscal Stimulus package passes in Congress – here comes $170 billion, America!

xkcd – A Webcomic – Alternate Currency

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Comedian Louis CK puts things into perspective for us in these hard economic times. As he says, “Everything is amazing right now, yet nobody’s happy.”

Louis CK “Everything’s amazing, nobody’s happy”

Much of what Louis jokes about here refers to technologies that members of my generation hardly remember and that my students had never seen. This video did make me think… with all the talk today of the Great Depression, a new period of prolonged economic hardship in America and the world, it is easy to forget just how amazing our innovative economy really is. The impact of technology on our lives is astounding, and the pace of change humans have witnessed in the last 50 years is unprecedented in human history.

Hat tip to Tim Schilling at MV=PQ Blog for the link!

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Formidable Opponent – Business Syphilis | Thursday October 2 | ColbertNation.com

Business syphilis infects the market after a corporate orgy…

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Headlines – It’s the Stupid Economy | The Daily Show With Jon Stewart | Comedy Central

Thanks to Greg Mankiw for the link…

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1. Doom and gloom in the headlines as US economy teters on edge of recession…
2. Another insightful economic discsussion on the Daily Show: how to make fiscal stimulus work
3. Colbert’s solution to rising fuel prices: “Total Gas Holiday”

Hat tip to Greg Mankiw.

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Facebook | It’s time you experienced my positive externalities…

With prom right around the corner, it’s time to think about getting that perfect date. In this arena, it is undeniable that economics students have the upper hand. Our intelligence and wit is unsurpassed among our peers in other subject areas. Not only that, but our subject lends itself to several cunning and effective pick-up lines. Here’s a few from the Facebook group, “It’s time you experienced my positive externalities…”. Thanks to SAS senior David Xu for the tip:

I’ll maximize your utility.

What do you say we expand our production possibility curves?

What do you say I eliminate some dead weight loss and add to your consumer surplus.

Do you work for the Fed, cause your raising my reserves.

You’re like the village commons…*sigh* what a tragedy!

You won’t find any elasticity with my demand, cause there are no substitutes.

It’s OK baby…I’m a price taker.

You’ve been spending too much time with the invisible hand…time for some external intervention.

You can price discriminate against me!

I’m a pure public good…you can free-ride on me any time you want.

We’re like monopolistic competition…all we care about is the short run.

Our society is underproducing…but I’m sure if we hooked up we’d achieve an efficient allocation of resources.

My fiscal policy is all about contributing to your private sector.

Your industry shows promise…time for my firm to break the barrier of entry.

Think you can come up with something better? Follow the link above and join the group, add your own Economics pick-up line!

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Economics focus | Feet, dollars and inches | Economist.com

Okay, so I’m not rich. Nor will I probably ever be rich. The best I can hope for as a teacher is for successful interviews at good paying schools. But might I have an evolutionary, biological advantage over some other teachers when it comes to getting those good jobs that pay well in the teaching field? I might… and not because of my good looks (hey, don’t roll your eyes!), but because I’m six feet six inches tall. Read on to see why:

The tallest quarter of the population earns 9-10% more than the shortest quarter, according to two recent studies. Nicola Persico and Andrew Postlewaite of the University of Pennsylvania and Dan Silverman of the University of Michigan think this is because height gives adolescents self-confidence and helps them learn valuable social skills. Anne Case and Christina Paxson of Princeton University, on the other hand, argue that people who grow to their full potential are smarter, on average. Both brains and build depend on the care and nourishment a child receives.

Either way, the future looks a little brighter for tall people than it does for the “vertically challenged” among us.

Beyond the observable relationship between height and income, there are some interesting macroeconomic observations relating to height. For example, studies have shown that not only are tall people richer, but wealth helps make short people taller: “Earning enough to buy plentiful calories and protein makes a big difference to stature.” One may deduce, therefore, that as a country becomes richer, its poeple will grow taller. This has been shown in India, where…

Indian men of 20 are about 1cm taller than 40-year olds, partly because the country was substantially richer when they were born.

More can be drawn from the relationship between height and income. For example, equality of income distribution can be seen in the average height of the citizenry.

…the stature of society may reflect equality as well as prosperity. Extra resources add more to poor people’s growth than they add to rich people’s. So if two societies, with the same income per head, were to line up next to each other, the more egalitarian society should be taller.

This may be one explanation among many for the shrinking America of the 19th century. Tax records show that wealth gaps widened in America as industrialisation took hold. From 1820 to 1900, the Gini coefficient (a standard measure of inequality) in Massachusetts rose by 24%, according to Mr Steckel. Even as average heights fell, the stature of senior students at Yale and Amherst rose from 171cm to 173cm.

Who knew that biology and economics were so interconnected? Anyway, sorry to bum you out, shorties!

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It’s Friday morning here in Shanghai. My AP students are in the middle of their Macro Unit 2 test on Aggregate Demand and Aggregate Supply. I’m reading SAS’s weekly Parent Talk newsletter that I handed out to my homeroom this morning, and on the back cover is an advertisement for the housing compound across the street from school, “Rancho Santa Fe”.

I just had to post this to my blog, as I think it captures well the trajectory that rich, suburban, Shanghaites are heading as Shanghai and the other Eastern provinces continue to develop and get rich.

“Success has many stages.

Acquiring a definitive territory counts as the ultimate one.

Embracing the best nature and humanity have to offer.

Rancho Santa Fe Phase 3 is a magnum opus of a villa residence.

Opulent in elegance. Bountiful in spirit.

The grandeur lies not only in heritage, but the entirety of all that is perfect.”

I hope you enjoyed this as much as I did. Happy Friday!

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Chinese leader offered women to U.S. in 1973 – CNN.com

China’s demographic challenges have proved difficult to overcome for much of the last century, and indeed, throughout its long history. Feeding, employing, and sheltering 1.3 billion people has recently been made less difficult thanks to China’s economy opening up since 1978, but as recently as the early 1970′s scarcity posed a serious threat to the country’s health and strength.

So how did Mao, in 1973 and elderly leader on the brink of senility, propose solving China’s population growth problem? He made visiting US Secretary of State an enticing offer:

Amid a discussion of trade in 1973, Chinese leader Mao Zedong made what Secretary of State Henry Kissinger called a novel proposition: sending tens of thousands, even 10 million, Chinese women to the United States.

“You know, China is a very poor country,” Mao said, according to a document released by the State Department’s historian office.

“We don’t have much. What we have in excess is women. So if you want them we can give a few of those to you, some tens of thousands.”

A few minutes later, Mao circled back to the offer. “Do you want our Chinese women?” he asked. “We can give you 10 million.”

After Kissinger noted Mao was “improving his offer,” the chairman said, “We have too many women. … They give birth to children and our children are too many.”

“It is such a novel proposition,” Kissinger replied in his discussion with Mao in Beijing. “We will have to study it.”

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