Measuring Benefits

However we approach consumer demand, a consumer will buy one more unit of a good or service only if she or he gets a benefit from it. The benefit is subjective, but that subjective benefit is the motivation for buying. The rational consumer will want to balance that benefit against the cost, and buy accordingly.

The cost of any purchase is an opportunity cost. For example, to get a diamond, I have to give up a number of gallons of water. It is equally correct to say that I give up a certain number of slices of pizza, of hamburgers, of subway rides and of movie tickets. When I hand over the money, I give up the goods that money would buy -- whether I spent it on pizza, bottled water, movie tickets or whatever.

This is the key to measuring benefits in terms of money. We can measure the subjective benefit a person gets from buying (for example) four hamburgers a week. Here is the way we do it. The benefit from four hamburgers is the market value of the most valuable goods the person would give up to get the four hamburgers. Suppose, for example, that I would give up three movie tickets to get the four hamburgers, and the movie tickets would cost me $6 each. And suppose there are no other goods I would give up to get my four hamburgers that would cost more than $18. Then we can say that the four burgers bring me a total benefit of $18. The market value of the goods I would give up is the measure of the benefit I get from the burgers.

Economists call this the "doctrine of revealed preference." The idea is that, by choosing the burgers over the movie tickets, I have "revealed" that I prefer four burgers a week to three movies a week, ceteris paribus. Of course, I would prefer to have both! But, when I have to choose -- perhaps because of a limited income -- my choice "reveals" which of these I most prefer. Preference in this sense is, of course, relative!

From here on, we'll explore demand theory in terms of benefits and costs, measured in money terms by that method. As usual, we will begin with an example -- this time the demand for hamburgers.