Press "Enter" to skip to content

What is Marginal Utility?

As I write this post, I’m sitting in a hotel in Shanghai after a long day of work. I just returned to my hotel room after a huge meal with my local business contacts. It involved more food than you can possibly picture, all of it of the local Shanghai style. It was a fantastic meal which I thoroughly enjoyed with items like local lake crabs, river shrimp, and even some local rice wine to top it all off. And yet I know by the time I leave China, I will be sick of Chinese food. Just as I was sick of Indian food after 3 weeks in India a few years back. Lest you think I’m picking on specific ethnic foods I also felt that way with the food in a small town in the UK a few years back. Simply too much of a good thing in rapid succession becomes too much. Which brings us to today’s topic, Marginal Utility.

Marginal Utility of Quantity

Marginal utility is the change in satisfaction or well being that comes from consuming one more unit of something. Typically it is viewed as a law of diminishing returns. The more of something you have, the less value you will place on an additional unit. I say consuming, but it goes deeper than that. True, if you go out to eat 6 days a week, the 7th day is likely of less value to you. If you eat the same thing on a business trip for 6 days straight, on the 7th day even if it is your favorite food you’ll likely long for something else. But the same is true for quality as it is for quantity.

Marginal Utility of Quality

For example, what is the difference between a brand new luxury Mercedes and a brand new mid-tier Mazda 3? In cost and potential image easily a lot, but in actual experience? Both cars go from point A to point B and I’d venture to guess if you really sit down and think about it, most of the extra bells and whistles on the Mercedes do not make an appreciable difference on your enjoyment of the car. They certainly don’t make as much a difference to you as having a car that is 20 years old and breaks down once a week versus a new car. Another even more obvious way to look at it is the difference between last year’s model and this year’s. The difference, unless there is a major model change, is likely something small like a color option or LED head lights. The true value to you if you is much less than the value of having that model car versus not.
This is the point people try to make to you when they suggest you buy a used car to improve your financial position, or at least not buy a new luxury car. The reality is that the majority of people will be just as happy with the basic car once you get away from the “Keeping up with the Jones effect”. Even for us car nuts this is true to some extent. I have a 9 year old Corvette. I could upgrade it to a new Corvette or even a Porsche, but would the extra 20 horse power and a slightly nicer interior offset the extra 50-60k in cost? Unlikely.

Marginal Utility of Savings

Even more interesting is how a change in unit might not even be a consumption unit. I’ve seen a number of articles recently hitting on some excellent equations for how to understand the retirement impacts of your savings. The last point in many of these posts and even some comments in this very blog is that the question becomes harder to answer as your savings rate climbs despite the math not changing. Saving 10K more a year is still likely worth 20K 9 years from now, or 80k in 27 years, no matter how much you are saving already. And yet going from 70% savings rate to 80% is much less fulfilling then 5% to 15%, just like the ethnic food that is wonderful for a few days but after a week you just long for a hamburger and fries. Do higher amounts of savings begin to become less valued compared to spending? So what does that mean?

That doesn’t necessarily mean you should stop at 50% savings, but it does mean that your viewpoint on what savings and spending is the correct level is relative. For example my wife no longer working  dropped our savings rate to the point where the utility of extra savings was then higher than the additional utility we received by saving an extra hour not cleaning the house. Our relative values had shifted as we then had a lower savings rate and more time available to clean. Thus our decision changed.

Changing Marginal Utility

In practice whenever you see a major life change in your financial position you should reevaluate where it makes sense to adjust your saving and spending. Now, that doesn’t mean I am promoting lifestyle inflation here as over the long haul the more you can save the better off you are. It just means that within reason, accounting for your value of each unit of saving and spending will make you happier in the long run. Ultimately, the key to being successful and even the point of life itself is to be happy. It is not to get to millions or even to get to retirement. Never forget that.

Do you have any examples of the impacts of marginal utility on your life?

11 Comments

  1. Mustard Seed Money
    Mustard Seed Money November 28, 2016

    I still remember the example from my econ 101 class with pizza and how the first slice is amazing but by the 6th slice I am full and definitely not enjoying it as much.

    BTW…awesome post especially in light of some serious travel. I don’t know that I would have the same discipline to pound out a post after a heavy work dinner. Awesome job!!!

    • fulltimefinance@fulltimefinance.com
      [email protected] November 28, 2016

      Thanks. Especially on long distance travel pre jet lag adjustment I find myself with a lot of time to think. It’s probably a better use of my time then watching the TV at 2 am in the morning. 😉

  2. Finance Solver
    Finance Solver November 28, 2016

    The thing about marginal utility that people sometimes overlook is that the utility could be gone. People get enamored by the idea of a new iPhone or the newest Tesla but once they have stuff around for 3 weeks, the euphoria is basically gone so the marginal utility was only a temporary marginal utility. The sooner people understand this, the better off they will be at making choices that really matter to them, but alas, it won’t be that simple!

    • fulltimefinance@fulltimefinance.com
      [email protected] November 29, 2016

      Its definitely easy to get caught up in the moment and miss the true value to you. The whole concept of marketing is to make you feel like you need something, but what happens after they are no longer selling to you.

  3. Andrew
    Andrew November 29, 2016

    Nice post, really brings me back to my Econ 101 class!

    I definitely experienced this when I upgraded my old 1998 car. It was such a big change in driving experience. Ride was much smoother, I had act for once, and it was much more fuel efficient.

    • fulltimefinance@fulltimefinance.com
      [email protected] November 29, 2016

      Its amazing how quickly technology moves on. As a car nut I remember owning a late 80s sports car about a decade ago. My mothers mini van is faster and handles better then that toy car did.

  4. Mr Crazy Kicks
    Mr Crazy Kicks November 29, 2016

    I certainly noticed this when I graduated and bought a brand new RSX Type S. The high of having my dream car lasted only a few weeks. After that it was just there to get me from point A to point B. The funny thing is when I sold it for an old civic, I was once again excited. It did not seem to matter that this civic was worth 20k less, it was new to me and I was excited to play with it. I did autocross with both cars, and had more fun working on and racing with the civic. Even if you’re a car nut, it doesn’t take 60k to have a good time.

    Great post!

  5. Amber from Red Two Green
    Amber from Red Two Green November 29, 2016

    Hmmmm what I wouldn’t give to be back in Shanghai– just to eat! Love what you said at the end. I think a lot of folks (especially in the FIRE community) tend to focus on saving and living frugally so much that they forget what life is really all about– its not about having a big fat stack of cash to just sit on during retirement, its about being happy. Got to have balance in all things! (though saving a big stack of cash, understandably, will make lots of people happy)

    • fulltimefinance@fulltimefinance.com
      [email protected] November 29, 2016

      The food was definitely very tasty. Still when I got home we hit a more traditional steak joint. 😉

  6. Untemplater
    Untemplater December 1, 2016

    That’s cool you’re in Shanghai. I haven’t been there yet but I’m sure the food is great. Is the photo something you ate there?

    • fulltimefinance@fulltimefinance.com
      [email protected] December 1, 2016

      Yes, the picture is a soup dumpling. It contained a crab soup with little crab chunks.

Leave a Reply

Your email address will not be published. Required fields are marked *