Friday, February 15, 2013

Marginal Utility Explains Our Choices

I came across a fascinating concept a few weeks ago. It's called "Marginal Utility".

What is marginalism? It is the notion that economic value extends from the incremental choice one unit at a time. Why does this matter?

Let me give the nearest example at hand. I have a cup of coffee in front of me. I made it with my Keurig coffee maker. Each Keurig cup costs 50 cents. Is that too much or too little? On the one hand, it is crazy expensive. I could pay $4 for a full can of coffee and make probably 40 cups, paying only 10 cents per cup.
Why don’t I do this? Because my choice is made at the margin. I’m not evaluating a whole stock of a good. I’m making my value judgments on just the one cup of coffee that I want to drink right now. This is the relevant unit, not some abstraction concerning how much coffee is at the store or on the ships coming from Africa or the whole stock of coffee growing in plantations all over the world. What matters to me in making the choice of whether the coffee is “worth it” is the cup right in front of me.
 It's from a book by Philip Wicksteed called "Common Sense and the Political Economy". I downloaded a .pdf to get around to reading eventually.

This helps explain a lot of choices we make. It explains why we probably do value a certain choice, but don't make it.

I tried to explain this to my 7 year old, Caleb, last night. I went to work yesterday, left work, and then drove 180 miles back home to New Jersey. I was exhausted and starving and sick of traffic. I have a lot on my mind now. I walk in the door to find Joshua wanting to play Second Life and Caleb wanting me to play Call  of Duty 2. I hadn't seen my boys in 3 weeks, so obviously I valued doing both a lot. But the marginal utility of setting up my laptop to play Second Life while I was still in my work clothes wasn't as high as it would have been after dinner and changing clothes.

Marginal Utility helps explain why our choices aren't binary.They've not "yes or no", but made on the margins based on many factors. I have a really good friend in Virginia. We served in the Navy together, and shared an apartment for 3 years in San Diego. We've kept in touch ever since. We've helped each other work through many crises and problems in our lives. He's one person I can trust to call bullshit on me, and I've called it on him a few times. We've had a lot of good beers together. But at the moment, he has a 3 year old. If I text him on Saturday to ask if he wants to get lunch and a couple beers at the VFW, right now he's saying he has other plans. That doesn't mean he doesn't value having a burger and beer with me, but on the margin, other things have higher value, like his daughter.

The author of the post I linked, Jeffrey Tucker, explains in that post or another on the subject how you could open a coffee shop and have no business. You could go out in the community and find lots of people thinking that a coffee shop is a great ides, but  not come in. The trick is, to increase the marginal utility to those people.

I've been studying economics lately, and thanks to people like Jeffrey Tucker and Aaron Cleary, I'm seeing how economics isn't some convoluted set of complex formulas that only seem to work at a level beyond our intelligence. Economics is a subject that affects the most basic moments of our lives, and is very simple. Those trying to make it sound complex are trying to confuse you so you don't realize they don't know what they're talking about.

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