Saturday, 29 May 2010

Deadweight Loss

I'm currently reading Joel Waldfogel's book "Scroogenomics". In it, he expands on some of the points made in his classic research paper "The Deadweight Loss of Christmas". The basic premise is that people (especially distant relatives) don't know what you want as well as you do, so any gifts they buy you are less desirable to you than anything you could have bought yourself with the money. He has plenty of facts and figures to back up this eminently plausible theory, and I think a serious point to make.

However, he does have at least one minor slip. In describing what deadweight loss is, he says the following:
If a dollar disappears from my pocket and appears in yours, it's a loss to me, but it's not a deadweight loss to society. If you take my dollar and destroy it lightling your Cohiba, then it's a deadweight loss.
This isn't quite right, for the simple reason that dollars only have purely symbolic value. Burning a dollar bill is a genuine loss of $1 to the burner, but can't possibly make society as a whole worse off... you can't eat money. So who benefits? As the wikipedia article on burning money explains, everyone. Burning a banknote has a (very) slightly deflationary effect, so makes all of the money in everyone else's pocket worth slightly more.

I first encountered this idea in Steve Lansburg's excellent Armchair economist, and it seems to be pretty standard fayre in economics literature, so how did Waldfogel miss it? Or did he think that burning money seemed more wasteful than any other genuine example of a deadweight loss, so sacrificed accuracy for impact?

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