I get it!

So at lunch the other day with Karen (over glasses of wine, because let's face it: we can drink at lunch), she was describing how Sean doesn't understand how she makes money by buying on sale. Karen's rationale goes like this: If the handbag costs $900, and I get it on a great sale for $500, I have made $400 dollars. Sean counters: No, you spent $500, so you lost $500. The truth is, they are both wrong, but Karen is closer to right.

Karen's wrong only because she hasn't made money, but she has increased her utility.

Say Karen values the handbag at the full price (meaning she would buy it for $900). If she pays $900, her utility is the same. She has lost $900, but gained the handbag which she values at $900.

Now, say the handbag is on sale for $500, and Karen buys it. Out of Karen's $900 she has lost $500, and in exchange she got something she values at $900 and still has $400 of her money left. Her total utility (as measured by dollars) is $1300, a gain of $400.

Happy bargain hunting!