By Andrew Lepore | United States
The law of utility maximization through cost-benefit analysis holds true to human action in the market as the theory of gravity holds true to physics.
Utility maximization simply means every individual wishes to maximize the benefit they receive for every dollar, and for every moment of their time. Every consumer wish is to maximize the value they receive with the lowest cost.
The consumer navigates through the unlimited number of goods and services to satisfy their needs desires. It takes place when you’re buying anything, as you are always attempting to determine if the cost of something is worth the benefit received. For example, you might like sushi more than hamburgers, but you can get twice is full for less of a cost by buying a hamburger compared to sushi, so your cost-benefit analysis determined the benefits for purchasing the hamburger outweighs the benefits for purchasing the sushi.
On the same token, The same analysis is taking place when hiring a service provider or choosing a place to shop. Say for example grocery store A has a slightly smaller selection and bad customer service but low prices. And Grocery store B has a much larger selection, better customer service, but higher prices. Depending on the time and circumstance, you will choose one over the other.
A rational individual will purchase a good or service if the benefit they receive from that service is equal to or outweighs the cost of it.
The utility maximization model is based on four assumptions:
- Consumers are assumed to be rational, trying to get the most value for their money.
- Consumers’ incomes are limited because their individual resources are limited. They face a budget constraint.
- Consumers have clear preferences for various goods and services, thus they know their MU for each successive units of the product.
- Every item has a price tag. Consumers must choose among alternative goods with their limited money incomes.
This praxeological action taken by the consumer is what drives competition. It is what drives an individual to pick one service provider over another even if they offer slightly better prices or slightly more quality services. This, of course, forces companies who provide bad services at high prices to either compete and get better or go bankrupt. It’s a bit like Darwinism except we’re not tearing each other apart in the jungle.
Utility maximization through cost-benefit analysis is one of the underlying functions of human action in the market. Not only that, but it allows for a symbiotic relationship between service providers and consumers. The service providers who supply the most benefit at the least cost will be the ones who the consumers will choose and therefore will be the ones who succeed.