As an economist, there’s nothing I love more than watching the free market work its magic around holiday season. There are so many lessons to learn about economic principles this time of year, but Christmas perfectly illustrates three in particular:

  1. Free markets create wealth
  2. Gift giving is signaling
  3. The seen and the unseen

Free markets create wealth

When we think about Christmas, we should appreciate that the holiday is the direct result of the wealth created by free markets. Not long ago, only the wealthiest people in society — the elites — could even think about such things as giving gifts or spending leisure time with their significant others.

But with the spread of markets, the average citizen accumulated enough wealth in savings that he could afford to engage in leisure activities like going out to dinner, going to a movie, or taking a vacation with his significant other. Moreover, the average citizen could afford to purchase gifts, thereby signaling his affection for the people he cared about.

Gift giving is signaling

Gift giving during the  Christmas season illustrates the economic concept of signaling. Signaling involves one person providing information to another who lacks complete information. To provide an illustration of the importance of signaling, consider a case where two people have just started dating. The boy is considering what gift to get the girl. Now, on the one hand, the boy could give the girl cash. She could then use this cash to purchase something that she values. But this signal would be weak. He doesn’t reveal any detailed information about how much he likes her.

Alternatively, he could get her the gift of the teddy bear she’s been looking at in the store for the past several weeks. By getting her this gift, the boy reveals that he has paid attention to what the girl values, sending a signal that he truly cares.

The seen and the unseen

Many pundits claim that Christmas stimulates the economy because people are spending large sums of money around this time of year. Indeed, it’s true that people spend significant amounts of money on things like flowers, chocolates, going out to dinner, or going out to movies with their spouse or significant other. But what this neglects is that people would have spent that money otherwise. Alternatively, they could have saved that money, which could then be used by other people to engage in productive behaviors.

The holiday season is a time for love and cheer. So this Christmas, as you’re huddled in front of fire drinking eggnog and singing carols, be thankful for the wealth and opportunity that the free market has generated, and signal your love by giving a gift that matters.

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