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?