Choices and Utility
Decisions are being made every day, every hour, every second. We look around us and see people making decisions:
Should I go to college? Should I get married? Should I buy this car? The choices never end. We always have to make
choices because of scarcity, and scarcity will always be with us. In this chapter, we take a close look at howwe make
choices. Some decisions seem to be based on feelings or come from personal experiences. Other decisions take a more
calculated approach, a cut-and-dried evaluation of our choices. Some decisions are quick and impulsive, while others
are based on time-consuming research. Think about what factors you look at when making a choice. For example, what
made you want to take the AP exam in economics? What benefits and costs did you consider? Ultimately, how will
your benefits exceed your costs in this decision? Were you influenced by your peers? Or were you more influenced by
your parents?
Answers to all of these questions depend on your self-interest. The lessons you have experienced all play a role in your
decision-making process. Although the details of decisions vary from person to person, everyone makes a decision in
pretty much the same way. Individuals (rational-thinking individuals, that is) evaluate the costs and benefits of a choice.
How will it affect them directly? Will they feel good about the decision? After this comparison of costs and benefits,
people tend to react differently; some act on impulse whereas others take the time to figure out what suits them best.
Common sense says that as the price of a product rises, consumers will be discouraged from buying that product. On
the other hand, people will buy more of a product if the price is lowered. To understand which factors influences con-
sumers’ decisions, we must take a closer look at what is called utility. Utility describes the satisfaction one gets from
making a choice. If Erin has to choose between going to school or going to the beach, she must weigh the utility both
choices give her. While on the surface the beach would give her plenty of satisfaction, would going to school ultimately
give her more utility?
Consumers make choices that give them the greatest satisfaction, thereby maximizing their utility. Each individual’s
utility varies depending on the taste or preference of that person.
Diminishing Marginal Utility
Utility is also used to demonstrate the law of demand. To better understand this concept, let’s look at an example.
Suppose Doug has just come back from a long run. When Doug walks into the house, the first thing that pops to mind is
that he is thirsty. So Doug walks over to the refrigerator and pours some cold water for himself. He quickly gulps down
the first glass of water and thinks that another glass of water would be a great idea. So Doug drinks the second glass of
water, thinks for a minute, and then decides to pour a third glass of water. Doug then slowly drinks half of the third
glass of water and can’t finish it. What has happened here is what occurs all over the world—diminishing marginal util-
ity. Doug has suffered from a bad case of diminishing marginal utility. His first glass of water was by far the best glass.
He was tired and thirsty, and his mind was set on getting water into his body. The first glass is always the best because
of your need for it. The second glass of water dropped a little in utility. Doug didn’t need the second glass of water as
badly as the first; nevertheless, he drank it with some satisfaction. By the time Doug got to the third glass of water, his
utility had dropped so low that he couldn’t finish the whole glass. This was because he received most of his satisfaction
from drinking the first two glasses.
Diminishing marginal utility describes the lessening of utility or satisfaction as each additional unit is consumed.
Marginal utility is the change in total utility that occurs because one more unit of a good is consumed:
Marginal utility Change in quantity
Change in total utility
=According to the law of diminishing marginal utility, the more units consumed, the less satisfaction additional units
provide.