Utility Theory and Happiness


Well I’ve finished my last actuarial exam (should be the last…but who knows with these things, they keep cropping up!) and feel liberated. I wrote this exam to finalize my suite of professional designations which were long term goals of mine over the last decade! Mission accomplished.

Having an extra couple hours a day really makes a difference. The focus has turned to finalizing some details for the Wedding in May and continuing through the busy season at work.

On to today’s topic though – there was a choice on writing this exam. A choice of exchanging hours after work to slave over the books exhausting the final ounces of the day’s brainpower, for my long term goal of building more credibility at work, increasing job security and increasing potential earnings.

There’s a concept in economics called “utility theory”. Utility theory is the idea that we can transcribe all the numerous answers that may exist for a question into ordinal values to determine the answer that is best suited for the question. Take a look at the graph above courtesy of EconomicsHelp.Org.

This graph shows a broader relationship of money and the utility of said money. When you increase the amount of money you earn from say, $10,000 to $20,000 per year, there’s a lot of marginal utility gained as you can use that extra cash to spend on needs. When you increase earnings from $100,000 to $110,000 (also an extra $10,000), there’s much less utility gained as your needs have been met long before. This extra $10,000 could go to savings or maybe you’ll spend it on something that doesn’t actually increase your happiness.

Put another way, it is a way to measure the value of a good or service to an individual. If you’re looking to buy coffee, you may not distinguish any value in having coffee made for you, so you wouldn’t pay someone $2.50 for a cup’o Joe when you can make it at home for $0.05.

Essentially, utility theory is about maximizing the relevance of goods & services without overpaying.

Take my exam for example – I could have chosen not to write it and gain all those hours I would’ve spent studying doing all sorts of other fun things. However, I felt the trade off to attain my final designation was worth it to me. The price I paid for the value of the good received, maximized the utility of the good.

Utility theory can, and is, used broadly in any economical situation. I find it’s extremely useful when trying to determine the solution to any event in life. It is a quintessential tool in my decision-making toolbox.

Is the marginal gain in my happiness, worth me spending more (or any) money / time to upgrade the good or service I’m receiving?

This is a great cornerstone self-imposing question if you want to start living your life the way you want to – hopefully it can help you align your decision-making with your ethos!

The great thing about utility is that it is individualistic. The happiness that something brings to one person, may be completely different for another. So it’s important to remember one size does not fit all. The application of utility theory is a principle-based approach, not rules-based.

The other wonderful thing about applying utility theory is that you can use it for any decision you decide to make. Enjoy!

3 thoughts on “Utility Theory and Happiness

  1. Pingback: Study Up On: Wealth Factors | The Frugal North

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