Planet Money's Dec. 25 podcast was another episode that was too good not to blog. They perform a classroom experiment related to gift-giving: randomly distributing ten different treats to a classroom of seventh-graders. Each student received one snack, which ranged in desirability from raisins and Fig Newtons to Three Musketeers and Sour Patch Kids.

Upon initially receiving their gifts, the kids gave an estimate of how much they liked what they received on a scale from 1 to 10. The total utility of the class at this stage of the experiment was 50. It took about 11.8 seconds for one of the middle schoolers to suggest that they could all be better off by trading. After one minute of swapping, the class's utility went up to 82.

Economists are used to this sort of thing, but take a minute to appreciate how significant this is. The students' assessment of how well off they were went up 60 percent in only 60 seconds. That's without the addition of any other resources except time, and a free market. Without any more "stuff," they still achieved more happiness.

This reminded me of two economics lessons related to trade. The first reminder was of R.A. Radford's classic article, "The Economic Organization of a P.O.W. Camp." Radford discusses how soldiers would trade items from their Red Cross packets (gifts, of a sort) to achieve greater total utility. There was so much utility left on the table in the initial allocation that a middleman--a chaplain, if I recall correctly--was able to facilitate the trades and turn his own packet into two as a reward for his efforts. (See this podcast for a discussion of the paper.)

The second reminder was of a very similar classroom experiment. Marc Bellemare runs a trading game at the beginning of his microeconomics course. It has the same setup as above: a random initial allocation of goods (in this case, inexpensive toys and trinkets), pre-trade measure of aggregate utility, a short trading period (five minutes), and a post-trade utility increase. Last fall his students experienced similar gains to the middle schoolers discussed above:

When I ran the Trading Game last week, my class’ “aggregate welfare” went from 128 to about 180, if I recall correctly, and you could just see that it had become obvious to students that (in this context of well enforced property rights) trade not only left no one worse off, but it increased aggregate welfare.

One final, interesting aspect gets brought up in the Planet Money podcast but not resolved: several of the students seem rather displeased with what they get, even though it was a gift. They are certainly no worse off but it does seem odd to assign a value of 0 (i.e. no different than their pre-gift utility) after receiving something that they did not have to work for. The Planet Money hosts seem to think that the kids should be happier.

It seems to me that the kids are grasping another subtle economic concept--opportunity cost. Even though they had no candy initially and had done nothing to earn it, the experiment publicly gave everyone an opportunity for a gift and they could see what their fellow students received. The kids may have assigned some value to their expected gift (the average of those around them, say) before they received anything. If what they got was worth less to them than what they expected, they were disappointed because they had lost the opportunity for something better. (Keep in mind that at that stage of the experiment they did not know that trading would occur.) The takeaway from this last comment is that the experiment actually includes an additional treatment because participants can see what others receive, and that changes their expectations.

For a tongue-in-cheek discussion of how additional choices can reduce utility, see the video below:

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