Question

Explain why holiday gift-giving may generate a deadweight loss. Specifically, suppose that the recipients of gifts estimate that they would have been willing to pay only 75% of the estimated amount of money spent by the givers of the holiday gifts.

Answer 1

Deadweight loss refers to any fall in the total surplus from the market transactions. Total surplus consists of consumer surplus and producer surplus. Holiday gift-giving can result in a fall in consumer surplus, which reduces total surplus and results in a deadweight loss.

Consumer surplus is the difference between the maximum price a consumer is willing to pay and the price actually paid by the consumer. The receivers of gifts are most likely to be willing to pay a much less amount than the amount of money spent by the givers of the holiday gifts. Since the maximum willingness to pay of the receivers are lower than the maximum willingness to pay by the givers, the givers pay a higher price for the goods. So, if we calculate consumer surplus by taking the difference of the maximum willingness to pay by the receivers and the actual amount paid by the givers, there will be a fall in the consumer surplus. So, there is a deadweight loss.