Why saving is smart: understanding the law of diminishing marginal utility

Chicago-style pizza is one of my guilty pleasures. I know it’s not healthy food, but every once in a while, I cannot resist indulging. I am further tempted because a place near me offers an all-you-can-eat lunch buffet. Going there is one of my favorite dining experiences.

Though a recent meal did not end quite the way I want it to, and this is why. After scarfing down my last pizza slice, I was so stuffed that I had trouble making it to my car and driving home. I spent the remainder of the day lounging and watching TV, and lamenting about how it all went so wrong.

I obviously overate, and vowed that the next time I would eat at least ten percent less food. That way I can still enjoy the buffet without overeating. To achieve higher total satisfaction to my day, it would be best to cut back on my pizza consumption. And that’s because of a lesson from economics called the law of diminishing marginal utility (DMU).

The law of DMU states that as you consume more and more of a good, at some point you will get less satisfaction (diminishing utility) from incremental (marginal) consumption. In the buffet, for instance, I really enjoyed the first bite of pizza. And the second. But as I became full, I was getting less joy from each bite. By the last few bites, I was not even enjoying the pizza. And if I had eaten any more”¦.well, I won’t go into details.

The law of DMU implies that you should not do any thing in excess and let moderation be the rule. This conclusion is not too surprising and I’m sure people without economic backgrounds understand it. I first understood the lesson as a five year old, when I devoured way too much Halloween candy. So here’s my next question: even though I should have known better, why did I overeat?

Temptation is the prime culprit. The food was right in front of me and I found it hard to resist. And it appears most of us suffer from this problem of food temptation. In one experiment, researchers demonstrated that we mindlessly overeat if more food is in front of us, say if we are eating “family style” where serving bowls are on the table.

Now here’s the kicker: I think it is just as natural for us to overspend as it is for us to overeat. And for the same reasons: because it is tempting and because it is instinctively hard to resist. And because of the law of DMU, if we scale back on places we overspend, we will get more value where we do spend money and a higher total satisfaction.

How can you avoid excess? Use a plan in the same spirit as how I vowed to avoid overeating: by planning. It is easier to resist temptation if you can commit yourself to a plan.

Here’s a four step plan to get started on planning and cutting back on places you overspend.

Step 1: Track your expenses

Tracking your money is a precise way to find out where you are overspending. You can get started with my free expense tracker (takes less than 2 minutes a day to do) or seek out an automatic tracker as suggested by Kyle in one of his comments.

Step 2: List three places you overspend

Go ahead and write down three places you spend a lot of money (for me, it’s restaurants, vacations, and bars). Think about whether you are really getting value for how much you are spending.

Step 3: Cut back spending by 10-25%, or more

The 10-25% is a rough guide, but here is an example of why it works. Let’s say you figure out that you eat at restaurants seven times during a week. One meal is 14% of your dining expenses. Would eating out one less time a week be that hard to do, and would you miss it?

Because diminishing returns have likely set in, I’m guessing won’t miss it.

Step 4: Use your extra money for an underutilized activity, like saving

Use the extra money to do those things you know you need to do, like paying off credit card debt, or starting a savings account, or adding to your investments.

Scale back and get more bang for your buck.

Here are some more amusing examples of diminishing marginal utility that I’ve run across:



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  • http://modite.com/blog Rebecca Thorman

    Great advice, and I love how you’ve framed it. It will be good to remember that spending that little extra on whatever it is won’t be worth it next time…

  • http://trueblue0213.blogspot.com/ Christina

    It’s possible, if the pizza were buffet style as you said, you overate because you were -trying- to get more bang for your buck…I know a lot of times when people go to all-you-can-eat places they feel like if they don’t eat a lot they didn’t get as much as they could for their money.

    Simple way to save money: getting water instead of soda or alcohol when you -do- go out. It really doesn’t diminish your pleasure in eating, and even if it only saves you $1.50 or $2 every time you go out, it adds up.

  • http://www.mawsoft.com/blog RohoMech

    @Christina – Yea, I was thinking the same thing, why go to an all-you-CAN-eat buffet and stop before you’re exploding? However, the buffet does have the advantage of variety.

    @Presh – Great post! I like the suggestions you give at the end, 10% to start is something that should be easy to do in most cases, but over time it will add up. And once you get comfy at the new level, you can repeat the process (eat out one less time a week, do that for a few months and you’ll get used to it, then cut out another day etc)

  • Joe P

    I think the same principle applies in other areas as well. Once something new becomes routine – there is always a chance to change again. Even with something like exercise…if you incorporate running or playing basketball into your routine let’s say twice a week, after a while it doesn’t become that hard to add a day either.

  • http://www.mindyourdecisions.com Presh

    @Rebecca: Your comment reminds me of why McD’s supersizing was not worth it.

    @Christina: Good catch on my logic mistake. I agree that eating more food at a buffet lowers your average food cost. I guess more importantly, though, was it worth it? I probably would have more enjoyment per dollar spent if I ate less…

    @Rohit: I like the suggestion of an iterative algorithm…

    @Joe P: Wow, I’m impressed with your comment since I was going to use this post as a segue into why mixing things up is a good idea.

  • http://blog.penelopetrunk.com Penelope Trunk

    I think about this stuff a lot, and it seems to me that we are hard-wired to ignore the law of diminishing returns. For example, when we were living in caves as hunter gatherers, we needed to eat and eat when we found food — we needed to ignore the fact that the first berry tastes much better than the fiftieth berry. Because we needed to just eat whatever food was there, when it was there.

    So it seems that traiing our brains to not eat that way is almost impossible and the only thing we can do is play tricks on ourselves. The not overeating and the not overpending seems all about tricks; creating scenarios where we do not have decisions to make rather than where we mind the decisions we have.

    Penelope

  • http://www.mindyourdecisions.com Presh

    @Penelope: I tend to agree that we are hard-wired to make “greedy” one-time decisions. And it is interesting that at the same time we need to make long-term decisions, like investing for retirement.

    Given those suppositions, I tend to think successful people are the ones that can make the tricks into habitual behavior. Once you make saving, or eating healthier, into a habit, it is easier to mind your decisions.

  • Joon

    Food directly translates to money in most cases. Eat less and save more! Also, make one purchase that will satisfy you to the point that other purchases are unnecessary. Say you hypothetically buy Halo 3 with the knowledge and intent of spending hundreds of hours on it. Not only have you made a good investment, but it can quench your desire to buy anything else.

  • http://www.mindyourdecisions.com Presh

    @Joon: Yes, video games are a good “cost per time” investment for responsible people. Unfortunately, though there is a large opportunity cost to the time. Especially when irresponsible people become addicted to the point that it affects their college grades, marriages, etc.

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  • Marcel

    Hello Presh,

    Thank you for your posting on DMUs. I am in the process of preparing a speech for our Toastmasters club and came across your web site as part of my research.

    My speech will focus on a quote I came across some years ago: “A Great Thing to Know: One of the greatest things to know, and often the least known knowledge,…is when you have enough.”

    Your pizza story will assist me in demonstrating my views on the quote and I thank you for this.

    Our part of the world lives in a land of plenty, however the feeding frenzy cannot sustain itself. We need to simplify our pace of life and learn how to be satisfied with less or focus on quality vs quantity.

    A simple example I came across the other day. Every work day I pick up a muffin at a local deli and have tended to wolf it down to satisfy some hunger/taste craving and have grown accustomed to it and take it for granted. One day I decided to pretend it was the last muffin I was ever going to consume. Well oddly enough, the muffin tasted that much better and, eventhough I wanted a second one, I simply controlled the urge and accepted that one was enough. It’s odd the little tricks we can play on our minds.

    I think if we ignored the flyers in the mail, turned off the tv during commercials, stayed away from the malls and stopped comparing with others that we would have better control of our wants/needs (desires).

    Cheers

    Marcel

    ps – I find it entertaining when companies keep harping about all the money we “save” when an item is on sale. I even recall a commercial saying “What are you going to do with the money you saved”. Well you don’t “save” anything… you just end up “spending” less money. There is a difference…

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