Wednesday, 24 October 2012

What is Marginal Utility?

I thought I'd write something a little more light hearted today.

As the blog is about "Living Well", this post is about spending rather than freeing yourself from the shackles of bad financial decisions. Of course, freeing yourself up first is always a good idea, as it ultimately leads to the goal of Living Well.

OK, so for a while now, I've been trying to think of an effective way to express a certain concept verbally. What I'm thinking of is related to the satisfaction you feel after you've made a purchase, and how long this lasts.

It's similar to something economists apparently call "Marginal Utility" which I heard about here.

Example: Your wife likes shoes, (of course she does, they all do *wink*). She buys 2 pairs of shoes for going out in and tries them both on different occasions. One set (Pair A), she wears a few times and then goes off them, finding she's not as keen on them as she used to be. The other pair (B) have the opposite effect. She loves the way her feet look in them, and she loves the way they make her feel, and they quickly become one of her "special" pairs of shoes.

The case of Pair A is all too familiar. You buy something which makes you feel good to begin with, but the feeling wears off over time - it has negative marginal utility. Many times you might buy something new because it's the Next Big Thing, or just Nice 'n' Shiny. We all fall victim to it, and as this is a money management blog, and not an austerity blog, I'm not going to judge you on that.

Thing is, we all have hobbies or interests that make life interesting for us, so there are times when buying the Next Big Thing, or some other Nice 'n' Shiny Thing are purchases which we may get disproportionately more happiness from. For instance, I have a classic car which is my Nice 'n' Shiny thing. When I first bought it 12 years ago I had the "new car" buzz (well new to me anyway), and that has of course worn off now. However, in the meantime, I have grown very fond of it and just owning it, never mind driving it, still gives me an awful lot of pleasure. This is an example of something with a positive marginal utility. It's my Pair B if you like.

Of course, neither the car or the shoes are "value" purchases in the traditional sense. Or the sensible sense even. In fact, on paper they make very little financial sense at all, but in terms of the satisfaction and happiness they bring they do.

You see, at the time, I had exactly the right amount of cash to spare, with which I could have done something sensible, or I could have bought the car. Doing the sensible thing would have been very laudable, but we do need to bring some sense of balance to our lives. And this is something we should try to take into account when we find ourselves craving something.
  • Is there spare cash for this?
  • Is the purchase going to provide real value?
  • Is it going to make life better and bring more contentment?
  • Is this purchase going to provide positive marginal utility?
But this post isn't just about naked materialism, marginal utility also applies to usefulness as well. Money enables you to buy other stuff besides "things". 

Yes, it's time for another example: I love making music and a few years ago I spent several thousand pounds on a sound engineering course. Originally, I spent the money because I wanted the qualification to wave in people's faces when applying for sound related jobs. In the end, I got so much more out of it. Basically, the course covered all the stuff I thought I knew, but it also highlighted all the stuff I wasn't aware that I was totally ignorant of. As a result, I have grown and learnt more about sound purely from now being able to identify when there's a hole on my knowledge and then filling it.

I also bought a few moderately, expensive pieces of musical equipment. When my finances hit the skids, I considered selling it all to try and clear some of my debts, but instead, decided it might be better to put them to good use instead, so I set up own sound business.

I did some recording work for a few people I knew, and sub-contracted myself out to touring companies, (basically I was a roadie). So over time, the equipment ended up paying for itself and I still have it. I can still make my own recordings whenever I want, or drag some of the gear out of my basement for paying gigs.

My education, and my gear both have that good old positive marginal equity.

So in conclusion, it's often worth giving thought to marginal equity before you make a purchase, and be especially aware of it when you crave something. If it turns out that purchase has negative marginal equity, you've basically wasted your money.

Remember: buying stuff to make yourself happy is one thing, but buying stuff that WILL make you happy is another entirely different thing

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