Coronavirus (COVID-19) updates from the Australian Government

Appendix 5: Gift cards and consumer welfare

Date



This appendix examines consumer welfare in the context of gift cards from an economic perspective. In doing so it is possible to examine how gift card holders are affected when engaging in the market for gift cards.

The economic literature examines the welfare implications of gift giving where the receiver would have otherwise chosen a different gift. By not having a choice, the receiver is made worse off than they would be if they were able to choose their own gift. This welfare loss is called a deadweight loss as it is not simply a transfer of welfare from one individual to another, but rather welfare that is altogether lost. The deadweight loss to the gift receiver can be measured as the dollar amount that the receiver would be willing to give up in order to select their own gift, for example by receiving cash instead of a non-cash gift.

The diagram124 demonstrates this principle by examining the receiver's budget constraint (which measures the receiver's total consumption possibilities) together with a line that represents consumption combinations where welfare, or utility, is the same across different consumption possibilities.125 The horizontal and vertical axes measure the dollar value of goods in the receiver's possession. The horizontal axis represents goods of the kind that are given to them as a gift. The vertical axis represents all other goods that could be consumed.

The receiver's budget constraint is shown at aa'. Here, the receiver maximises their welfare, denoted by U0, by consuming the bundle of goods at point I. A gift, shown by distance X, is given to the receiver and their bundle is now at II on the hypothetical budget constraint at bb'. However, the receiver's welfare, denoted by U1, is not maximised relative to alternative bundles of the same dollar value. If the receiver was given a dollar amount to the same dollar value of the gift, X, they would optimise their welfare, denoted by U2, by consuming at III. The deadweight loss associated with consuming at II (instead of III) can be measured by the dollar amount of goods, shown by distance Y, that the receiver would be willing to forgo in order to consume at a consumption bundle of their own choosing, denoted by IV on the hypothetical budget constraint at cc'.

In summary, where the gift card holder is able to select their own gift, they can choose from alternatives that better suit their needs. Where a giver selects a gift, there is a chance that the receiver will not choose the gift that the receiver most prefers. Accordingly, the receiver can be made better off by providing them with the option to select their own gift.


124 Adapted from Waldfogel, J 1993, The Deadweight Loss of Christmas, The American Economic Review, 83:5, pp.1328-1336.

125 The welfare lines (U0, U1, U2) are convex to the origin to demonstrate the receivers preference for variety where U1 is preferred to U0 and U2 is preferred to U1.