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Marginal utility and cost-benefit analysis

Does it get easier than this? Cost-benefit analysis is easy: what is it going to cost me to do X activity. Although it's good for all or nothing style decisions, it doesn't do much beyond that. Marginal utility is a concept that can not only tell you whether or not I'll eat pizza but also how much I will eat.

Let first define the concept of utility. Utility is a term economists use to basically describe how much happiness something brings you. Ice cream has a high utility, brussel sprouts has a low utility.

The amount of utility that an item brings is related to how much you have already had. If you are very hungry and you eat your first hamburger, that first hamburger has a high utility. The second hamburger has a little less utility and the third even less. This concept is known as diminishing marginal utility. Each successive thing (hamburger) brings less and less utility. In fact there comes time when another hamburger bring you no utility and it actually makes you sick. That is known as negative utility.

Diminishing marginal utility has a place in consumer decisions.

I like hamburgers AND I like french fries. Let's say that I have $6.00 and that hamburgers and french fries each cost $1.50. I can spend the entire six dollars buying either four orders of french fries or four hamburgers.

I know that the first hamburger will bring a high marginal utility and each one after will bring a diminishing amount of marginal utility. I also know that the first hamburger will bring a high marginal utility and the first order of fries will bring me a high marginal utility as well. I like them both equally so I will make the choice to order two of each.

If I did not like french fries, I quite possibly would order four hamburgers or vice versa.

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This page contains a single entry from the blog posted on December 3, 2008 12:15 PM.

The previous post in this blog was Constraints and Opportunity Cost.

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