Sheng Dan Kuai Le! (圣诞快乐!)
Wishing you an enjoyable day, and a happy holiday season spent with good people, surplus amounts of food and drinks, and a large number of gifts!
One idea that is firmly associated with Christmas is gift giving. This is a central part of the Christian tradition, and also has an important place in broader Western culture, which retailers are obviously happy to encourage and embrace.
The festive season’s spirit of giving provides us with a nice opportunity to revisit basic notions of “value”, “price” and “cost”.
We can think of “value” as the benefit provided by a good or service to the end user.
Economists typically interpret this as the consumer’s “willingness of pay“. That is, the maximum amount that a consumer would be willing and able to pay for a good or service. This allows them to introduce the idea of “consumer surplus“, which is the difference between willingness to pay and the actual price level. And the notion of consumer surplus leads to the idea of “gains from trade“; the idea that both consumers and producers can be made better off if they are allowed to trade freely.
Christmas gives us a chance to re-examine this mainstream interpretation of “value”.
It is evident at this time of year that a gift’s value is often totally disconnected with how much the recipient would have been willing or able to pay for it.
Factors that might affect the value of a gift include:
- The strength of the relationship between the giver and receiver of the gift;
- Whether or not the gift is a surprise;
- How well the gift matches the recipient’s needs and interests;
- The message on the card;
- The decorations surrounding the gift (Xmas tree, stockings, reindeer, Nativity scene);
- The colourfulness of the packaging;
- How fun or difficult the packaging is to rip open; and
- The atmosphere, experience and ritual of opening gifts together with family and friends.
Christmas is a time of year when people go to great lengths to maximise the value of what they give to others, so much so that it shatters mainstream Economists’ interpretation of “value” as “willingness to pay”.
Next we can consider “price” (what a firm receives from a customer (who may or may not be the end user) in exchange for a good or service) and “cost” (what the firm needs to pay for inputs that are used to produce it).
When I studied Economics as an undergraduate at Sydney University (under such luminaries as Kunal Sengupta, Tiho Ancev, and Don Wright) it was explained to me that firms aim to maximise profits. They can do this by adjusting price and quantity in order to increase the distance between total revenue and total cost. At a minimum, I was told, they will never set a price which is lower than the average cost of producing one extra unit (that is, price will never be lower than variable cost).
At Christmas, people spend significant resources (time, money, effort, imagination) to purchase or create gifts which they then give away for free. People tend to hunt for the best “value” gift that they can find within a given budget. That is, they seek to maximise the gap between “value” and “cost”, not “price” and “cost”. Christmas shoppers will often hunt for a bargain, but if they stumble upon a remarkable gift which exceeds their budget they will often buy it anway.
“This is far too expensive! Meh, it’s Christmas! I’ll put it on my credit card!”
Your response might be that a firm is not a family, and so this Christmas analogy is invalid.
But is it?
What would the world be like if firms thought of consumers like family members?
And, more to the point, how did many of today’s most valuable technology firms become billion dollar companies? Think of Whatsapp, Twitter, WeChat, and Facebook. They did it by trying to provide value for as many end users as possible, and only afterwards did they find a business model to sustain and grow the firm.
Sheng Dan Kuai Le! (圣诞快乐!)
Image: Tom Spencer