Law of Diminishing Marginal Utility
I got on the subject of the Law of Diminishing Marginal Utility with The Wife today, a theory that I was able to explain to her today in English. Despite it being an economic theory (read: usually hard) it is quite easy to understand. The first thing is first – utility means satisfaction. Investopedia defines the Law of Diminishing Utility as,
A law of economics stating that as a person increases consumption of a product – while keeping consumption of other products constant – there is a decline in the marginal utility that person derives from consuming each additional unit of that product.
This post begs the obvious question, “How the hell did this come up with your wife?” Well, today we had pizza in the city (People from Long Island and NJ refer to NYC as ‘the city’) and it was the thin-crust kind of pizza that you can eat tons of. Well, the Wife and I were STARVING as we jetted out of work to the city to visit my father in the hospital. So when we got to the restaurant we inhaled our food!
Inevitably, and for anyone who has an 8-year-old, whenever the Wife eats fast, and in large quantities (for her!), her stomach hurts. I really have to emphasize the quantity part because this main point of the post and in reality, this woman barely eats anything LOL – look at her site…that is actually her in the pic she is tiny.
Well, her utility (read satisfaction) with each subsequent slice was less than the previous slice. Read the sentence again, her utility with each subsequent slice was less than the previous slice. LIGHT BULB! That is it…that is the Law of Diminishing Marginal Utility.
Law of Diminishing Marginal Utility and Debt Repayment
You should be thinking, “well My Journey thanks for the Economics 101 lesson, but what does this have to do with debt repayment?” Well, the answer is simple yet complex,
The Law of Diminishing Marginal Utility doesn’t Apply to Debt Repayment
Woah, am I going against Economic Doctrine? I might be, which is why this may just be the tip of the iceberg for this topic. Let’s take a look at the graph I found on Wikipedia – It clearly shows that while the quantity of a good or service increases the less utility I get out of that last unit supplied (there is a separate theory that says eventually the total utility is not just marginal will go down too – ignore that)
Well, this leads me to the point that this theory doesn’t apply to Consumer Credit available. Every unit (dollar) I free from the grasp of Visa, American Express, Discover, BofA, HSBC, etc. makes me that much happier – it provides me that much more satisfaction! Take that Austrian School of Economics…
Give me some feedback, whether academic or not, I know this isn’t your typical post you find here or on other personal finance blogs but I need to see if I am going crazy!
I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.
“Diminishing Marginal Utility” Wow, it’s been a while since I’ve heard that term. Next cocktail party, I need to dust that one off…
Tragically, your comments are well taken; unfortunately I think that few people think in those terms. Usefulness of credit vs. the shiny new item presented in front of them.
Thanks for bringing me back to a discussion from an economics side… sometimes I loose site of the forest for the trees.
I’ll bring back old school econ terms if you bring back cliches statements like the forest and the trees! lol
Thanks for commenting
The first dollar you borrow makes you happier – BUT it has to be repaid. If you pay promptly and with no interest, then the net effect is NO change in your level of happiness – or a slight positive, since you were able to gratify yourself sooner than if you had paid cash.
When you have debt over a period of time, the first dollar you repay has a much greater effect on the total debt over time (compounded interest) than the last dollar you repay.
Well you asked us if you were crazy so I’m here to say, no you’re not crazy, completely clueless, but not crazy. But I suppose you’ll grasp the flaw in your rationalizations when you reach that point where the amount required to service your debt exceeds your ability to pay, as it has for millions of your fellow debt slaves.
Why don’t you, in your supreme being self, explain to me how I am clueless in my rationalizations? If you had actually read the post you would see that I am not actually rationalizing debt. Rather stating the economic theory of diminishing marginal utility doesn’t apply to debt REPAYMENT.
So instead of just acting holier than thou, maybe you can leave an actual thought provoking comment.
The Law of Diminishing Marginal Utility of Debt means that for every dollar of new debt created less than a dollar’s worth of productive value is returned.
Your debt load increases while you receive little to no benefit from that increase.
Compounding interest is a primary example of an increasing debt load of diminishing value.
Government borrowing to wage war in foreign places is another example of increasing tax payer debt load of diminishing value.
I appreciate the links you sent me, I will go through them all later tonight, but I think you misunderstood the post. I wasn’t talking about macroeconomic forces and policy.
Put in 30 words or less the post was about, “Every single dollar that I pay back to a credit card company FELT better, i.e. my marginal utility was increasing.”
I think you might like some of my political posts, bu this wasn’t one of them.
The reason the law of diminishing utility doesn’t apply to debt repayment is that debt repayment is not consumption, except for the interest you’re paying on that debt. Your consumption happened when you bought the item and incurred the debt. Making payments is not consumption. The Investopedia definition clearly states incremental satisfaction declines with each additional unit of consumption.
OTOH, as others have pointed out, if you have borrowed so much that you can’t pay the money back then, by definition, your payments to pay down the debt aren’t working – it’s likely your debt repayment is less than the interest due on that debt (this is all hypothetical), and your debt compounds increasingly until you go bankrupt. The interest IS the part you are currently consuming, not the principal.
Yes, we all get satisfaction when the car loan, student loan or mortgage is paid off. That’s utility, but, except for the interest portion, the debt repayment is not a cost nor is it consumption.
In fact, I would argue that as you successfully pay down your debt you are actually consuming less as your interest payments generally decline as your principal does. Assuming no new debt and steady rates your monthly interest consumption – cost of money – declines.
IOW, you’re misapplying the concepts of marginal utility as tied to marginal consumption.
Now, if you’re saying you yourself are happier because your debt is decreasing and so are your interest costs then I agree with you. And when the debt is finally paid off your disposable income increases. But your consumption (interest payments) is declining, not increasing, so the law of marginal utility does not apply.