What’s the deal with ‘Utility Theory?’

Traditionally defined in economics as satisfaction, utility is a representation of consumer preference. When making any investment or purchasing decision, consumers will always try to maximize their own utility. Rational consumers will always want more, but are faced with budgetary constraints. Decisions then must be made with consideration of opportunity costs; the explicit and implicit cost of choosing A over B.

Marginal utility is the excess utility derived from consuming one more unit of a good. A consumer’s utility is maximized when the last pound spent on good X yields the same marginal utility as the last pound spent on good Y. Therefore, we should consume in accordance with the “equi-marginal principle of consumption.” Need a little more  explaining? Okay. Picture this.

You and your friend are at Tesco for grocery shopping. You both have £30. You each take your trolley and do your shopping separately. 20 minutes later, you meet up at the counter. While queuing, you then proceed to gossip about your other mates, your demented Math lecturer and that agreeable guy/girl at the frozen chips aisle. You then glance at your friend’s trolley to see an exorbitantly expensive brand of detergent. You notice this because you opted for Tesco’s in-house brand of soapy delight. You are bemused by this choice; why on Earth would someone pay so much more for a bottle of bubbles you wonder.

This is your friend’s choice. The reasons why we buy a certain brand of a product are vague. It could simply be the price, the ridiculous design of the packaging that catches our eye, or because we wish to avoid bending over to grab it from the lowest shelf. In any case, we are dealing with our individual utility or satisfaction derived from paying a particular price for a product. You notice another conundrum. Your friend has opted for a cheaper brand of egg. Briefly shocked by how someone could eat inorganic eggs, you quickly recover and realize it is your choice to be health conscious when it comes to egg consumption.

Tallied up, your trolley of groceries cost the same as but consist of varying goods of varying prices.  Whatever the composition may be, we know that the two of you are maximizing your respective utility for a 30 pound shopping spree.

Rational consumers will always want more, but are faced with budgetary constraints.

Appraisal of a product tells us how much it is worth to us. You do not have to look at your friend’s trolley to know what to buy. We should restrict ourselves to a budget that gives us the most bang for our buck. After that, you can go back to talking about that guy/girl who you both found most satisfying indeed.