the gift card fallacy - a simple analogy for understanding deadweight loss in social programs

introduction

picture this: you get a 100$ gift card for a store you don't really like. you'd prefer the cash, so you could spend it however you want. this is a simple example of what economists call "deadweight loss." in this blog post, we'll use the "gift card fallacy" to help understand deadweight loss in social programs. we'll also explore the difference between excludable and non-excludable goods and services, and address common counterarguments.

the gift card fallacy

the gift card fallacy is a term we can use to describe when someone gets a good or service that's less valuable to them than its actual cost. let's say you value that 100$ gift card at only 80$. there's a 20$ deadweight loss because the giver would've been better off just giving you the 100$ in cash.

now, think about social programs that give goods and services to people instead of cash. when people get help in the form of a specific good or service, like subsidized housing, they might not value it as much as its cost. this can lead to deadweight loss, since resources aren't being used as efficiently as they could be if the recipients got cash instead.

excludable vs. non-excludable goods and services

it's important to know the difference between excludable and non-excludable goods and services. excludable goods and services can be limited to people who can afford them. housing is an example of an excludable good because only those who can afford it can access it. the fact that they're excludable means private enterprises can serve these needs.

non-excludable goods and services are available to everyone, whether they can pay for them or not. national defense is a great example of a non-excludable good since the value of being protected is shared by everyone in the country. the value of national defense is a positive externality that "leaks" to others, making it difficult for private markets to provide it. that's why it makes sense for the government to provide non-excludable goods like national defense.

addressing counterarguments

a common counterargument is that giving people money doesn't help with housing because scarcity keeps prices high. however, there's nothing special about affordable housing that makes it easier to build or more plentiful. we get housing by making it legal to build and paying people to build it. giving people an earmarked subsidy that they can only spend as a gift card on housing doesn't produce more housing.

another point to consider is that affordable housing is often only available by lottery. it's more equitable and efficient to give two people, say bob and alice, each a 500$ housing subsidy than to give 1,000$ to whichever of them wins a lottery.

conclusion

the gift card fallacy offers a simple way to understand the concept of deadweight loss in social programs. by recognizing the difference between excludable and non-excludable goods and services, and addressing common counterarguments, we can better understand how different types of assistance might lead to varying levels of deadweight loss. this insight can help policymakers consider whether cash transfers might be a more efficient way to address