Life on the Margin: How to Make Optimal Decisions and Maximize Utility

Anyone who has taken an introductory Economics course has probably heard that optimal decisions are made at the margin. This is a foundational concept in Economics, but it can be confusing for those who are unfamiliar with Economics jargon. What is the margin? How do you know if a decision is optimal?

Here is an example to illustrate the concept: Consumer A has some free time and wants to figure out how to spend it. A new episode of a television show she likes has just become available to stream. It would take an hour of her time to watch the show. Consumer A is a rational consumer: the only thing she considers is whether spending an hour watching the episode will give her more satisfaction than anything else she could do with that hour. For example, she could read a book for an hour instead, or browse the internet, or redecorate her room, or do any number of other activities. Consumer A, however, chooses to watch the episode because it gives her positive utility.

Consumer A made her decision at the margin because she only considered the options in front of her, not anything else, no matter how relevant it might appear. Sometimes, however, consumers try to bring in other considerations. Unfortunately, this impedes optimal decision making.

Here is another example: Consumer B has some free time and wants to figure out how to spend it. A new episode of a television show, of which he has been a dedicated fan for years, has just become available to stream. Consumer B used to derive a lot of satisfaction from watching this show, but lately he feels like he has to force himself to keep watching and he always ends up being disappointed. He knows the episode will not be satisfying, but he has been watching for years and at this point he has spent over 100 hours of his life on this show. He thinks he has to see it all the way through to make all those hours worth it. Consumer B chooses to watch the episode; it is not satisfying and it gives him negative utility.

Where did Consumer B go wrong? He did not make his decision at the margin, and as a result he fell victim to the Sunk Cost Fallacy. What he failed to realize is that those 100+ hours he spent can never be regained, no matter what choices he makes going forward. Spending (or, rather, wasting) more time doing something that gives him negative utility will only ever decrease his utility more.

Hopefully, Consumer B can serve as a reminder to anyone who is currently struggling with the sunk cost fallacy. Time (or money or effort) already spent should not impact future decisions.

One Reply to “Life on the Margin: How to Make Optimal Decisions and Maximize Utility”

  1. This is a great illustration of a concept far too few people grasp (but could actually improve decisions). Of course, beyond sunk costs, there are other failures of optimal choice involving streaming related to intertemporal choice problems. Exhibit A… when I bing stream half a season of Walking Dead in a weekend. Clearly, I’m neither thinking about the opportunity cost of my time nor optimally allocating my current vs. future utility from enjoying the show. Yet, even economists can fall prey to bounded willpower.

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